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Edited Transcript of ZUMZ earnings conference call or presentation 5-Sep-19 9:00pm GMT

Q2 2019 Zumiez Inc Earnings Call

EVERETT Sep 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Zumiez Inc earnings conference call or presentation Thursday, September 5, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher Codington Work

Zumiez Inc. - CFO

* Richard M. Brooks

Zumiez Inc. - CEO & Director

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Conference Call Participants

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* Janine M. Stichter

Jefferies LLC, Research Division - Equity Associate

* Jeffrey Wallin Van Sinderen

B. Riley FBR, Inc., Research Division - Senior Analyst

* John Dygert Morris

D.A. Davidson & Co., Research Division - Research Analyst

* Jonathan Robert Komp

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Mitchel John Kummetz

Pivotal Research Group LLC - Senior Analyst of Footwear, Apparel Vendors and Retailers

* Sharon Zackfia

William Blair & Company L.L.C., Research Division - Partner & Group Head of Consumer

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen, and welcome to the Zumiez Inc. Second Quarter Fiscal 2019 Earnings Conference Call. (Operator Instructions)

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 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 will turn the call over to Rick Brooks, Chief Executive Officer. Please go ahead, sir.

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Richard M. Brooks, Zumiez Inc. - CEO & Director [2]

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Hello, and thank you, everyone, for joining us on the call. With me today is Chris Work, our Chief Financial Officer. I'll begin today's call with a few brief remarks regarding our second quarter and back-to-school performance to date. Then I'll share some thoughts about the future before handing the call over to Chris, who will take you through the numbers. After that, we'll open the call up to your questions.

We continue to be very pleased with performance of the business, as both top and bottom line results exceeded expectations. Comparable sales increased 3.6% in the second quarter versus our outlook of flat to 2%, marking our 12th consecutive quarter of positive comparable sales. On a 2-year and 3-year stacked basis, second quarter comps are up 9.9% and 14.6%, respectively.

Our relentless attention to serving our customers continues to fuel strong full price selling, which, combined with the powerful operating model we've built around the single cost structure and a steadfast focus on long-term strategy, has translated into significant improvement in profitability. Second quarter earnings per share more than doubled year-over-year to $0.36 from $0.17, which was $0.16 above the high end of our guidance range. As we moved into the third quarter, our momentum has accelerated with 7.1% comparable sales growth in August. This is on top of 9.5% in the year-ago period and represents our fourth consecutive back-to-school season with strong comparable sales in the business.

Our performance is a testament to our team's ability to consistently execute our consumer-centric growth strategy. It is the key elements of this strategy that we believe has separated us from the competition and will continue to distinguish Zumiez as a clear winner in the future of retail.

Before I hand the call to Chris for the numbers, let me dig into those key elements. It starts with having the right products and brands that our customers are looking for, made up of a distinct mix of the leading and emerging brands that are not broadly distributed. We've been able to consistently achieve this balance through the strong relations we've forged with our brand partners, and more recently, our global reach that allows us to serve both our customers and brand partners at heightened levels. This includes clearly articulating our culture-driven lifestyle brand position and showcasing our ability to connect with the target audience in an authentic, engaging environment that is uniquely curated by our people all the way down to the local level.

There are many brands important to our customers that may serve only a handful of our trade areas. Our customers want to express their individuality through many different avenues, which can drive unique assortments even in trade areas only miles away from each other.

Over the years, we've spent significant time and resources improving our localized merchandise assortments through investments in our people and technology that enhance the customer experience at each touch point. Our teams across the organization put a significant amount of effort into understanding our customers not only today, but how they will continue to evolve and what will be important to future generations. This thinking is embedded in our culture and is reflected in who we hire and how we operate. These teams are in tune with the local and national trends that are important to our customers and can speak authentically to them across all of our channels. This approach allows us to serve the customer in an authentic way, bringing all the touch points together through the customer's journey.

The next critical factor to our success is speed. We're already faster than most of our competitors due to our decision over 3 years ago to shut down our e-commerce fulfillment center and deliver all digital orders out of our stores. Not only does the concept of localized fulfillment mean that we now only have one cost structure to leverage, but we can now get product into customer's hands faster by reducing the order processing time, cutting down the shipping distance to the customer and also offering in-store pickup.

Looking ahead, we are going to get faster in every aspect of serving and meeting customers' needs than we are today. This will be driven over the next few years by getting to know our customers even more intimately through improved digital interactions and enhanced in-store experiences.

Finally, we've taken our operating model and expanded it internationally, in order to identify consumer trends that emerge locally and grow globally and to achieve the scale necessary to work together with our brand partners in serving our customers around the world.

Our expansion has established a strategic physical presence in 7 countries across 3 continents with a digital platform that allows us to reach even further. We're applying learnings and best practices from each of our markets to ensure that we are on top of the latest fashion trends and brand cycles, which can now launch from anywhere in the world and quickly spread globally due to the proliferation of smart devices and social media.

Furthermore, as our international businesses are primed for future growth, we're exporting our processes and tools from our more mature U.S. operations and seeing good results. Our international businesses accelerated in the second quarter, with comparable sales in both Europe and Australia growing in the double digits.

With the strong top line growth through the first half of the year, we've seen improved operating performance as well. We're excited about the progress being made by the Blue Tomato and Fast Times teams and continue to build upon the benefits of a globally integrated business. We are the only retailer in our lifestyle niche that can offer our brand partners global reach in major markets to meet consumer demand.

With regard to our financial model, we believe 2 key factors have contributed and will continue to contribute to our ability to drive improved results over the long term. First, as a lifestyle retailer, we have built our business to be exceptionally nimble, continuously evolving with customer trends and preferences. The capabilities we have built continue to provide us with a defensible strategy in maintaining and growing share with our segment of the lifestyle market that seeks to be unique and different. The first half of 2019 is a great example of this as we saw a category shift in our business globally, with footwear and hardgoods leading the comparable sales trends, while men's and women's apparel have shown softer results. This is a meaningful change from 1 year ago when we saw the apparel categories driving our positive comparable sales.

Overall, the goal continues to be selling at full price and full margin, while listening to the customer with regard to the categories and brands they want to see at Zumiez. This focus has resulted in growth of comparable sales in 34 of our 40 years and is something we believe will continue to be an advantage into the future.

Secondly, as we've transitioned into the digital age, we've done a tremendous amount of work creating an operating model that positions Zumiez to win with today's empowered consumer by combining our digital and physical sales channels to work seamlessly in service of the customer. With one inventory that is accessible from all consumer touch points, integrated sales teams, aligned goals and value sets and localized fulfillment, we are well positioned to scale the business in today's integrated world.

This strategy directly contributed to our 2018 results as we increased operating profit by 25.3% on 5.5% growth in revenue for the year. And we've continued that trend in 2019, delivering operating profit growth of 153.4% for the first half of 2019 on sales growth of 3.8%. We're very pleased with how 2019 has unfolded through the first half and back-to-school and feel we are well positioned to capitalize on the upcoming holiday season and deliver another year of record financial results.

Longer term, I believe that by staying true to our customer, our culture and brand, with an intense focus on our long-term strategies, we can continue capturing market share while generating increased value for our shareholders.

With that, I'll hand the call over to Chris for his review of the financials. Chris?

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Christopher Codington Work, Zumiez Inc. - CFO [3]

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Thanks, Rick, and good afternoon, everyone. I'm going to start with a review of our second quarter 2019 results. I'll then provide a brief update on August before discussing our third quarter guidance and our updated perspective on the full year.

Second quarter net sales increased $9.4 million or 4.3% to $228.4 million from $219 million in the second quarter of 2018. Contributing to this increase were positive comparable sales growth of 3.6% and the net addition of 7 stores since the end of last year's second quarter, partially offset by a decrease of $1.2 million due to changes in foreign currency rates.

During the 2019 second quarter, our comparable sales were driven by an increase in transaction volume as well as an increase in dollars per transaction. The increase in dollars per transaction resulted from higher average unit retail and higher units per transaction. During the quarter, the hardgoods category was our largest positive comping category, followed by footwear and accessories. Men's was our largest negative comping category, followed by women's.

From a regional perspective, North America net sales increased $5.9 million or 2.9% to $206.9 million. Other international net sales, which consist of Europe and Australia, increased $3.5 million or 20.2% to $21.5 million. Excluding the impact of foreign currency translation, North America net sales grew 3% and other international net sales grew 25.8% for the quarter.

Second quarter gross profit was $77.2 million, an increase of $4.7 million or 6.4% compared to the second quarter of 2018. Gross margin was 33.8% in the quarter, an increase of 70 basis points compared to 33.1% a year ago. The increase was primarily driven by 40 basis points of leverage in our store occupancy costs and 20 basis points decrease in distribution and shipping costs.

SG&A expense was $65.5 million in the second quarter compared to $65.8 million a year ago. SG&A as a percentage of net sales was 28.7% compared to 30% in the prior year. The decrease was primarily driven by 100 basis points of leverage in our store costs, including 30 basis points of depreciation and 20 basis point decrease related to the accrual of annual incentive compensation.

Operating income in the second quarter of 2019 increased 74.3% to $11.7 million or 5.1% of net sales, compared with the prior year's second quarter operating income of $6.7 million or 3.1% of net sales.

Net income for the second quarter was up 106.2% to $9 million or $0.36 per share, compared to net income of $4.4 million or $0.17 per share for the second quarter of 2018.

Our effective tax rate for the second quarter of 2019 was 30.7% compared with 39.1% in the year-ago period. The decrease was primarily due to a reduction in net losses in certain jurisdictions, which are excluded from our estimated annual effective tax rate due to the uncertainty of the realization of deferred tax assets and the proportion of earnings or loss before income taxes across each of our jurisdictions.

Turning to the balance sheet. Cash and current marketable securities increased 41.9% to $188.6 million as of August 3, 2019, up from $132.9 million as of August 4, 2018. This increase was primarily driven by $84.9 million in cash flow from operations, partially offset by $20.3 million of capital expenditures primarily related to new store growth and remodels.

We ended second quarter 2019 with $151.1 million in inventory, up 1% from last year. Excluding the year-over-year impact of foreign currency translation, inventory grew 1.8% from the prior year.

Now to our August sales results. Our comparable sales increased 7.1% during the 4-week period ended August 31, 2019, compared to a comparable sales increase of 9.5% for the 4-week period ended September 1, 2018. The comparable sales increase was driven by an increase in transactions and an increase in dollars per transaction. Dollars per transaction increased for the 4-week period due to an increase in units per transaction, partially offset by a decrease in average unit retail. During the 4-week period, the hardgoods category was our highest positive comping category, followed by footwear, accessories and men's. Women's was our only negative comping category in the month.

Looking at guidance for the third quarter of 2019. 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. Additionally, the following guidance does not contemplate the impact of changes in global tariffs. We are actively working with our vendors to minimize any potential impact on our customers.

With that in mind, we currently expect that comparable sales will increase between 3% and 5% for the third quarter of 2019, with total sales in the range of $258 million to $263 million. Consolidated operating margins are expected to be between 7% and 7.7%, and we anticipate earnings per share will be between $0.55 and $0.61 compared with last year's earnings of $0.55.

Now I want to give you a few updated thoughts around 2019, given our performance year-to-date. We are now building on 12 consecutive quarters of positive comparable sales. As we look to the back half of 2019 and beyond, we continue to believe that the investments we've made in our infrastructure, creating a seamless sales experience for our customers, our unique approach to merchandising as well as those investments we continue to make in the Zumiez team will drive long-term top and bottom line growth. With that in mind, we are updating our annual expectation of consolidated comparable sales growth to between 2% and 4% compared to our previous guidance for comparable sales growth in the low single-digit range for fiscal 2019.

In fiscal 2018, we achieved peak product margins, improving from the previous high point in 2017 despite a heavily branded cycle, resulting in a reduction of private label share of 370 basis points. In fiscal 2019 to date, we have also experienced mix shifts that have impacted margin. These mix shifts include our category sales trending towards hardgoods and footwear, which have lower product margins than the apparel categories, as well as higher top line growth in our international businesses. While international product margins continue to grow and have additional opportunity, they are currently lower than our U.S. operations based upon where those businesses are in their life cycle.

As a result of these mix shifts in the business, we are revising our annual product margin guidance. We now expect product margin to be down between 10 and 20 basis points from the prior year compared to our previous guidance of roughly flat.

We continue to manage costs across the business, with the more mature concepts in North America focused on leveraging at a low single-digit comparable sales growth. Internationally, we are focused on managing costs well within our current sales and unit growth rates and driving our concepts closer to breakeven, reducing the impact of the losses on the overall business. We are currently planning our business assuming an annual effective tax rate of approximately 27% as compared to our prior year rate of 27.5%.

Diluted earnings per share for the full year are now expected to be between $2.10 and $2.20, up from our previous guidance of $1.84 to $1.94, representing year-over-year growth between 17% and 23%. We are planning to open approximately 16 new stores in 2019, including 6 stores in North America, 7 stores in Europe and 3 stores in Australia.

We expect capital expenditures for the full 2019 fiscal year to be between $19 million and $21 million compared to $21 million in 2018. The majority of the capital spend will be dedicated to new store openings and planned remodels. We expect that depreciation and amortization, excluding noncash lease expense, will be approximately $25 million, down slightly from the prior year. And we are currently projecting our share count for the full year to be approximately 25.5 million shares. Any share repurchases during the back half of the year will reduce our share count from this estimate.

And with that, operator, we would like to open the call up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Sharon Zackfia with William Blair.

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Sharon Zackfia, William Blair & Company L.L.C., Research Division - Partner & Group Head of Consumer [2]

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Sorry for my voice today, but I've a couple of questions on the guidance for the third quarter. I guess I'm curious, given the strong start in August, how you're looking at September and October and why you would expect such a deceleration in the comp trend. And then on capital allocation, a little surprised there wasn't more share repurchase activity. So if you could kind of talk about your thoughts as it relates to the share repurchases.

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Christopher Codington Work, Zumiez Inc. - CFO [3]

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Sure, Sharon. Yes, I'm happy to take those. Obviously, as it relates to our Q3 guidance and our annual guidance, we're super happy to show the growth that we've projected here now with our annual guide planned to be over 20% and our Q3 guide of earnings growth well over 10%. So obviously, as it relates to the sales cadence, it's a pretty interesting position as we think about where we were last year, where we did 9%-plus comp in August that was followed by comps that were much, much lower in September and October. So as we thought about even our guidance last year, after coming out with a 9%, we ended up at -- we guided to 4% to 6% and came in at 4.8% comp for Q3.

So clearly, what we've seen for the consumer over the last couple of years or a couple of cycles of back-to-school is that there tends to be some slowdown after back-to-school. Now obviously, our goal is not to fade into that. We're still pushing very hard here, with right around 50% of the quarter in, to continue to drive comp, but we took a little more conservative approach in that guide for Q3 based on the trends we've seen over the last couple of years.

As it relates to the capital side of the business and what we're thinking from a cash perspective, not a lot of change from where we've been historically. Obviously, we're super happy with where the cash balance stands, around $188.5 million. That's a pretty good increase, up 42% since last year. That year-over-year increase is really driven by cash flow from operations, offset by CapEx. So the business is doing a good job at generating cash. And as you know, we have a $75 million buyback still outstanding, and we continue to review that capital plan with the Board. Our strategy is very consistent with what you've heard from us in the past. We're going to first and foremost invest in the business, and I think we're doing that through our CapEx. We're going to find ways to look outside the business that we could return value to shareholders. And lastly, we'll return cash to shareholders.

And I think if we look back historically, we've executed on all those things. We've invested in our store base, both domestically and globally. We've invested in our teams. We've invested in our integrated approach to retail, really bringing the stores and web through one customer experience. We've gone through acquisitions. We've done both the Blue Tomato and Fast Times acquisition. And we've bought back over 20% of the company since 2012. So as we look to the future, I think this is kind of what the winners in retail are going to be able to do. They'll be able to do all of those things. We continue to review where we're at with the Board, and we'll continue to try to execute on that strategy as we move into the future.

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Operator [4]

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And our next question comes from Janine Stichter with Jefferies.

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Janine M. Stichter, Jefferies LLC, Research Division - Equity Associate [5]

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Just wanted to get any updated thoughts you have on your long-term operating margin potential. I think in the past, you've talked to high single digits, and you're going to end up pretty close to that this year even with some of the headwinds you talked about between hardgoods, mix shift, international being lower margin and just private label still being above historical norms. Can you give us some thoughts just about how you think about where you potentially push towards? Is there a chance to get back to double-digit margins that you've seen in the past? And then as a corollary to that, can you talk about how you're thinking about private label this year? You had a big decline in penetration last year. Are you assuming that you mix back a little bit into private label this year in your merchandise margin guidance?

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Christopher Codington Work, Zumiez Inc. - CFO [6]

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Sure. I'll jump into the first question on operating profit and then maybe share a couple of thoughts on private label and let Rick add anything if he'd like. I think overall from an operating profit perspective, our goal is to drive this to the high single digits. As we look at this year, I think we're kind of getting to the low end of that, which we're excited about. Our strategy here, as we've laid out in the past, is really kind of twofold. As we look at Canada and the U.S. in North America, they're fairly built out from a store network perspective. We're looking at these long term, that -- we can grow sales in the low single digits, be very opportunistic in how we think about our investments and really try to push forward in these markets and grow earnings ahead of sales.

Internationally, as Rick even pointed out in the call today in his comments, we've got a lot of growth ahead of us. We're super-optimistic with how those businesses performed here in the first half of the year and especially Q2. I think we're getting some good momentum kind of with our global strategy here of really sort of incubating some process and ways to serve the customer here in our mature markets in North America and exporting them as our international concepts are ready. And we feel like that's working. And I think if we can do that right, we can continue to drive profit in the international markets, which will help the overall operating profit and we can push to kind of that higher single-digit operating profit level. At this point, to get back to double digits, I'm not going to say we're not going to try, but we're looking at the model here at kind of that high single-digit level here in the long term.

As it relates to private label, we're going to listen to the customer here. And our private label teams, I think, have done a good job managing that business despite the declines we've seen, but we were just in a heavy branded cycle. And as we know about the business over 40 plus years, the business cycles in and out of a lot of different things, whether it's across categories, within categories, from brands to private label and so on and so forth. So we're not going to comment on kind of where private label is going for the year. I think we need to see that all play out and see how some of our seasonal categories perform in the back half. But overall, we're going to manage private label to where the consumer wants it. I think what we're really happy with is what we've pointed out here over the last couple of years is we've had a good growth in product margin despite private label going from just over 20% of the business to about 13.5% of the business as of the end of 2018. So we feel good about where that business is positioned, and we'll see where the consumer takes over the long term.

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Operator [7]

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And our next question comes from Jeff Van Sinderen with B. Riley FBR.

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Jeffrey Wallin Van Sinderen, B. Riley FBR, Inc., Research Division - Senior Analyst [8]

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Let me say congratulations on great work for back-to-school. I have one question, then a follow up. Can you speak a little bit more about how you're thinking about the overall apparel segment of your business since it trended positive in men's for August. Seems like we're still on a strong branded cycle for your niche. And I guess, how would you expect the apparel category to evolve for holiday this year once we get through kind of the interim post back-to-school period?

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Richard M. Brooks, Zumiez Inc. - CEO & Director [9]

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I'll start, Jeff, and let Chris add in his thoughts too. I mean I -- I want to go back to the strength of our model. Our model is about diversity of categories -- departments and categories, and then of course diversity of brands, both trending brands as well as emerging and growth brands. So I'm going to say what I always say and I know you guys love this, which is I just want to run a gain and I don't care how we get the gain, I don't care whether it's a mix of apparel. Our teams are working super-hard on all fronts to get gains in all departments all the time, frankly. And what we have to do is, again, listen to our customer, go where they tell us to go. And right now they're telling us that skate hardgoods and footwear is where they really want to see newness and freshness in what we're doing. And yes, I'm encouraged by -- I'll let Chris comment a little bit on the difference in men's in August, that's great. I think our buyers have done a great job around, again, getting newness into the market in August.

But really, Jeff, I just want a gain. I think if we can run gains, we can then drive product margin dollars and gross margin dollars. And we're really good at controlling the cost side of the business, and we'll drive op. Even in today's world where we don't have to run a big gain, we can drive a lot of operating margin dollar flowthrough -- profit dollar flowthrough on these gains. And that's what I want: get the comps deliver results, drive the bottom line. I don't care how we get them. So we'll let our customer drive that. Chris, do you want to share a little bit more about the change between Q2 and August in terms of apparel?

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Christopher Codington Work, Zumiez Inc. - CFO [10]

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Yes, absolutely. I mean obviously, one of the things we're looking at here is, over the last 2 quarters, apparel has trended down, and it's been really the hardgoods and footwear that's driven the business. And obviously, to see men's turn positive in August was a -- it was a good sign for us as well. I think to add on to what Rick's saying, this is just kind of another example of how our model works. And we look at obviously sales many different ways, but one of the ways we tend to look at these things is kind of, hey, our top 10 trending brands, how did they compare in relation to the bottom 10 trending brands.

And I think what's really unique about August is -- again, it just sort of speaks to the model -- is the top trending brands performed significantly better than the bottom trending brands. So that's a really exciting thing. And then you couple that with 2 of the top 10, including the #1, weren't even in our ecosystem a year ago, and I think that again speaks to just our buyers' ability to generate trends, our entire team's nimbleness to move and get that product in-house and out of stores and our sales teams to sell it. So I think this is a really good thing. As you would imagine, a lot of these brands play in the t-shirts and fleece area, which is a big part of our business in back-to-school. And so we saw some good trends there. And we'll see how that plays out for holiday. Back-to-school has been a good indicator of us for holiday. We're obviously up against much stronger 2-year and 3-year stacks here as we move into the back half of the year. But we continue to believe we can grow through that. So I think it's kind of to be determined on holiday, but we're feeling good about where we're positioned here with our Q3 guidance.

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Jeffrey Wallin Van Sinderen, B. Riley FBR, Inc., Research Division - Senior Analyst [11]

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Okay. That's helpful. And then if we can switch to international for a minute, just wondering if you can elaborate a little bit more on the trends and drivers of international. Wondering if you're seeing footwear and hardgoods trends lead there similar to the U.S. and then any thoughts on the outlook for international for holiday.

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Richard M. Brooks, Zumiez Inc. - CEO & Director [12]

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Yes. I'll start again and let Chris add in, Jeff, but the headline to your question is yes, and that we are seeing hardgoods and footwear being strong in these and in fact strong all around the globe. And they basically almost turned on all at the same time in really late January -- early February and then have accelerated into the spring months in terms of skate hardgoods. So this is one of those areas for me that we've always seen, we've seen this -- as you know, we have the evidence that it's true that emerging brands can quickly become global buys, go from local to global, and of course, be localized in every market around the world for us. We've seen that with trending brands, where we've seen kind of fashion retro '90s brands go quickly. And when they go, they go everywhere in the developed world at the same time.

This is the first time we've really seen it with a category driver like skate. Remember, we had been running down for 4 years in our skate hardgoods business. And then literally it just turns on everywhere, and we're not exactly sure, we've asked our team, what was the catalyst. We're not exactly sure what the catalyst was. But this is why we stayed consistent and authentic with being positioned, never going away from skate, sticking with it as a core part of who we are and how our customers express their individuality. The consistency is super-important. Our brand partners understand that. And we're not going to chase it like other retailers might try to do. We're going to stay true and authentic. We'll ride those 4 years of tough results. And now we're probably in a multiyear cycle of positive results relative to skate hardgoods.

So yes, that was benefiting our international businesses, all geographies for that matter. So -- but more broadly, I'd just tell you, I think I'm really pleased with the progress we're making and our teams have made on the international front. And in particular, again, I want to credit our teams and the hard work they've had in building a strong alignment in culture and brand and strategy, in how we execute. Chris commented about how we've been exporting our tools and processes as we develop markets in Europe. We're able to export all of our omni tools and have our teams apply. And of course, that -- we're finding that customers love those tools everywhere that we can get them into the marketplace. So I would tell you that I think a lot of our improved response is the hard work of our teams, the dedication of building out and starting to really position ourselves as having scale in key markets in Europe. And of course, in Europe, we have to do that on a country-by-country basis. And in particular, I'm really pleased with Germany in Europe at this point because they have some of our strongest comps in what is a very tough economic environment, where we're seeing them near a recession. But yet, we're doing incredibly well there, and they have kind of been a big driver of our business. I should say, they've been an important driver of our business in Europe. So I'm really encouraged about that.

So I think it's a combination of trend cycles around brands and categories, and then even more so, it's the hard work our team have done, our ability to export tools and have our teams internationally put our practices, our best-in-class practices and processes in place to drive a result.

One thing I'll add about this before I let Chris add his thoughts, if he has any on this, is that long term, the international expansion is really, again -- it's about serving customers and our customers who want to express individuality. We see this consistently across all marketplaces. It's also about serving our brand partners with high-quality retail distribution across the global markets. And we're seeing that, again, brand cycles, trend cycles are very consistent on a global basis. And what I'm excited about long term is we continue to build out our presence in markets around the world -- and we have a lot of work yet to do in Europe and in Australia -- is that we are going to be the only platform, we're going to have the only retail platform in our lifestyle niche that can serve our brand partners because we know that trend cycles are as fast they've ever been. I would tell you that I think in the next 5 or 10 years, they're going to get faster.

So to take advantage of the opportunities that present themselves, we need to be there for our brand partners to help them execute globally against very fast trend cycles. That's the whole idea of international expansion. It's the whole idea of rolling out our best practices and processes, our best-in-class best practices and processes across the international businesses that we have and then driving those things that yield and optimize our business and get good strong results.

So long term, I think those are the things I'm most excited about, Jeff, in terms of how we think about the international business. I think we have a very unique position in the marketplace for doing this. And in fact, I think we're the only retailer positioned in our lifestyle niche to serve both customers and brand partners in this way.

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Jeffrey Wallin Van Sinderen, B. Riley FBR, Inc., Research Division - Senior Analyst [13]

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I wasn't sure if Chris was going to weigh in there.

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Christopher Codington Work, Zumiez Inc. - CFO [14]

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Yes. I mean I think the only other thing I would touch on, Jeff, is you asked about holiday, and to add some more color to what Rick said, I mean, Rick talked about Germany, I would tell you we're super-excited about our stores in Austria and Switzerland as well. We're excited about where the web trends have gone. I think it's all working together. And we're optimistic we're going to drive a much better result here for 2019 than where we were in 2018, and that's built into our guidance and our annual thoughts here.

Obviously, holiday is always dependent on weather, and we do still have a big snow business. And while that's diversified over the last couple of years as we've continued to grow into Northern Germany and the Netherlands and other places, it's still a big part of what we do over there. So that's a big part of Q4, more of their business is in Q4 than in any other part in the year. But obviously, the signs are super positive here in how the classes of stores are performing and the business overall and our ability to leverage here on the elevated comp.

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Operator [15]

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And our next question comes from Mitch Kummetz with Pivotal Research.

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Mitchel John Kummetz, Pivotal Research Group LLC - Senior Analyst of Footwear, Apparel Vendors and Retailers [16]

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I was hoping to drill down on Germany a little bit. I wasn't surprised, Rick, for you to say that Germany was a big part of the kind of the nice comp that you're seeing in Europe. And if -- correct if I'm wrong, but if I recall correctly, when you guys opened up Germany, that was a bit of a struggle. Some of those stores didn't go so well, and I think that put some pressure on the profitability of the Blue Tomato business. And help me understand what's changed. Did you figure something out? I mean is it systems? Is it leadership? Is it something else that has sort of sparked a turnaround in Germany? And I'm guessing the stores are still, in terms of like productivity, they probably still kind of lack the rest of the European business. I'm just trying to understand like how much opportunity is there as those stores are comping better to kind of get to sort of a maturity ramp, if that makes sense.

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Richard M. Brooks, Zumiez Inc. - CEO & Director [17]

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Yes. Yes, it does, Mitch. And again, I want to make sure I'm clear in my comments about Germany. Germany is the leader in terms of our comp, but we're getting good results across our store platform in Europe so -- and our web platform. I just want to be clear about that. Germany is just a stronger player within that platform, but we're doing well in Austria, as Chris said. We're doing well in Switzerland. We've been opening a couple of new markets, so I think we feel good about how we're performing in those new markets here out of the gate. So Germany is the leader. And I think it's a factor of a couple of things.

And we knew from the work we did before we entered the German market, we had done a lot of work. We worked with some outside parties to help us kind of understand the marketplace. And we knew from the beginning that the German market was a tough market to crack, that it would take 3 to 5 years from opening of our stores to really start to have the consumer trust and believe in us in that marketplace. So I think some of it, Mitch, is simply -- we've been there a while and we've started to build scale in the marketplace, which is important, I think, for customer recognition of what we're doing. And we're gaining customer trust through the fact that we're delivering a really good experience for our customers. And I think Germans take a little bit more time to accept new retail ideas, and what we're seeing is our dedication to that, the hard work of our teams. I can tell you, our engagement on our stores is at the highest level it's ever been in terms of serving with customers, and that's a large part because of the hard work they've done and the fact they've rolled out our store training programs here from the U.S. localized from the markets that we're doing business in across Europe. So the engagement of our sales teams in our European stores is, I think, at an all-time peak in terms of how they're interacting with customers.

So it's more a function, I would tell you, Mitch, is we did have more opportunity, as you're seeing in Germany. We're reaping the benefits of that from the work we've put in about executing best practices and processes, like rolling out our training programs and really seeing them after 3 years really start to take hold, getting that better engagement. But it's also the emerging brands that are flowing across the business, the trending brands, the emerging brands. So those are all things that have benefited us with this concept of gaining some scale and gaining acceptance in the marketplace, which just takes a bit of time, I think, in the German marketplace. And I would expect that this is our opportunity, as we are starting on a lower productivity base relative to Austria and how we performed in Switzerland. So we do have opportunity, I think, to run some significantly strong results over the next few years as we're able to ramp up productivity. And we continue to execute this in our effort to serve our consumers.

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Mitchel John Kummetz, Pivotal Research Group LLC - Senior Analyst of Footwear, Apparel Vendors and Retailers [18]

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Great. I appreciate that color. And then, Chris, I think you mentioned in your gross margin discussion that shipping -- or distribution and shipping improved by like 20 basis points. Hopefully I heard that correctly. If that was the case, could you -- was that just a function of just the scale that you're getting through your e-commerce business? I know that when you guys -- well, actually that's -- maybe that's not right. But I know this move towards sort of trade area optimization and shipping out of the stores, I think initially there were some issues with like split orders. I'm wondering if you've gotten better at that, or what's really driving the improvement from a distribution and shipping standpoint?

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Christopher Codington Work, Zumiez Inc. - CFO [19]

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Yes, absolutely. And Mitch, there's a variety of things that relate to this. Obviously, the comp levels are helping. We're getting a little bit of leverage out of some of the fixed cost structure within our distribution network. There are some things within the 4 walls of our DC that we're working on that have helped provide some leverage. As we go outside the DC, we had some initiatives around some of the shipping costs that we have around moving product around our store system that have actually taken to fruition and created some value here in the first 6 months, in the second quarter specifically. And then on the B2C shipping perspective, you're absolutely right, this was something as we moved out to all stores, we've seen challenges with split orders, we saw challenges upfront with how we allocated product around the country and the shipping times to customers. That's something we continue to work on, and how do we optimize product within a trade area, how do we optimize those shipping algorithms. So where we do see increases in splits at times, we're able to offset that through other types of shipping. And overall, it's come together to show some value really across all of those things. So -- I mean we're super happy to be leveraging distribution and shipping costs. It's an incredibly hard area to leverage from a rate perspective, whether you're working with obviously the carriers and/or the minimum wage impacts, specifically with our distribution center located in California. But -- like a lot of things at Zumiez, we try to be really creative in where we can work to optimize or take costs out of the business. And I think we've been pretty effective at it through the first 6 months.

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Richard M. Brooks, Zumiez Inc. - CEO & Director [20]

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And the only thing I'd add to Chris' comments, Mitch, is this: we continue to work hard on the concepts of what trade area means for us, how we define it, what the roles of stores are within a trade area and the roles of key people even within the trade areas for serving customers. We're now moving beyond the discussion of definitions and things like that, how do we execute against this at a higher level. We have new measures around how much of product is available every day to meet consumer demand, total consumer demand in a trade area. And our buyers are, as you would guess, with our competitive teams, responding really well to that, and we're getting better at it. And so all these factors get into play that will have multiple benefits of being, again, faster to the consumer, showing the consumers -- having more of what customers want in every trade area. And then of course, that -- more of it means we're faster in getting a shipment delivered to them, et cetera, et cetera, et cetera. And we gain share as we do that, from delivering to the customers' higher expectations.

So this is one of those areas for me, Mitch, that is about us making progress in the execution of the concept of trade area, how we see it playing out, how we understand the role of stores, understand the role of key managers within that and how our teams work to serve customers cross-functionally in the organization. We do split it -- we do splits, right? More of the product always available every single day to meet demand. This is that continuous effort to improve every single day, as Chris mentioned, and this is something we're working really hard on to improve a lot more, and I think we have great potential to do it.

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Operator [21]

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And our next question comes from Jonathan Komp with Baird.

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Jonathan Robert Komp, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [22]

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I want to ask about some of the emerging brand trends that you called out and especially [Juana] in particular, perhaps scaled quicker than we've ever seen over the last few months. And I just want to ask more specifically maybe what's changed or what's different that's allowing you to scale new trends so quickly. And then also -- in the past, you've talk about hot individual brands maybe reaching a mid- to high single-digit type sales penetration when they're really hot. And I just want to ask if that's the type of opportunity you see for some of the more recent brands that you've scaled.

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Richard M. Brooks, Zumiez Inc. - CEO & Director [23]

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I mean I would tell you, John, that I don't think we're seeing anything new here in our ability. It's our ability to react to customers. We constantly -- our buyers have a whole program for rolling out new brands for how many stores they should roll out to. There's no one answer, to be clear. It's based on each brand. We continue to roll out a lot of new brands, and I believe we are on track for our goals this year of rolling out new brands. So it is then up to the customer adoption. It is up to the job of our brand partners to execute on their end of their marketing and brand positioning in the market. And I would tell you that we still have a ton of room for improvement in our ability to respond to customer demand here in that we need to get way better yet at being able to respond to customer demand and that we actually have too many gaps yet in how quickly we are able to respond.

And our teams are looking how can we improve that, to both serve our customers better, but to serve our brand partners better too because the last thing any of us want to do is have to buy a ton of product and see it in stores all at once and then see it go to nothing. We'd rather have it flow consistently through our system always with maybe -- just on the edge of running out of product rather than having too much product. So I would tell you that we have a lot of work to do here yet in working with our brand partners, rethinking the ecosystem for our consumer niche and reworking who does what on behalf of those consumers. So I don't think anything is different or unique about what we're doing here. We're doing what we always tried to do, which is stay on the edge, stay -- listening to our consumer base, react quickly. And as Chris said, a lot of this product that really drove particularly August in men's was screenable product. So we could react very quickly to the marketplace. And I would tell you, we just need to get even better than we're at in terms of our ability to react to the marketplace.

So the key message is, I don't think there's anything different, Jonathan, in what we're doing. Our job is to be the absolute best partner for young brands that anyone -- of any retail partner they can do out there, to scale at their pace. We don't determine how fast we want brands to go. We work with brand partners, and they decide how fast they want to go in our world. And our job then is to help deliver for them and help them execute in areas that they don't have expertise. And then of course we'll work together to meet all this, our mutual customers' demand for the product. So I don't think anything new, per se. We're getting better at it, but again, as -- the good news is, from my perspective, we have a lot of room to get even better at executing for the speed that the consumer world moves today.

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Jonathan Robert Komp, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [24]

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And I guess as a follow-up, maybe your model hasn't changed per se, but would you say the current attitude of the consumer and the speed of the trends you're seeing as well as the openness to try new brands, do you think your model and the advantages it provides are more advantageous given the current consumer environment going forward relative to maybe what you've seen in the past?

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Richard M. Brooks, Zumiez Inc. - CEO & Director [25]

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I think our model is built to do exactly this. And our customers now know us as the place to come to find what's next. And if that's -- even if that's the trend cycles relative to trend brands like retro '90s, my expectation for our product team is we have those trend cycles at the very front of the cycle, not trailing others, but right there at the front of the cycle. And so our job is to be there to lead in those areas. I think we're pretty good at doing it. I think our big challenge, Jonathan, is going to be over the next 5 years and 10 years that we look forward, is that I really believe that trend cycles are going to speed up even more. And so if you have brands that take off where they have global demand, again, I think we all have to sit down and think about how we work together to meet that global demand when trend cycles are going to be even faster.

So those are the kinds of things that we're working on here and actually trying some new things about how we might execute against that. And as we test and try those things in the U.S., we'll be able to export them, as we -- as Chris and I both talked about here, to our international platforms, creating one really big fast retail platform to meet the demands of what we think are going to be faster and higher expectations for our customers -- our customers are going to have in the future. So always looking for continuous improvement in this area. But yes, I think this is right up our alley. And I think as brand cycles get even faster, we're going to be maybe the only retailer that can respond in our lifestyle niche to the demands of the consumer for global trending product.

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Jonathan Robert Komp, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [26]

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Okay. Great. Then -- and one last follow-up for Chris. It looks like the second half margin outlook, you're not really embedding much expansion even though the first half has expanded pretty significantly. So just wanted to maybe understand the factors behind those assumptions and also if you could include just comments on the product margin for the third and fourth quarter, what you're seeing there?

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Christopher Codington Work, Zumiez Inc. - CFO [27]

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Yes. Let me start with product margin as that kind of leads into the overall operating margin and growth. Just a couple of things here. From a product margin perspective, we called out in my comments on the script, some of the challenges the model's having right now in relation to product margin, and that specifically being that the highest trending items of hardgoods and footwear have a lower product margin than the apparel categories that were trending a year ago. So we have some mix issue there. And then also the international entities, top line is growing at a faster pace than domestic entity. So international entities also have a lower overall product margin based on where they are at in their life cycle.

So if we take those 2 items together, we are seeing some drag on product margin. We guided the year to down 10 to 20 basis points. That would be an acceleration -- to get there, we have an acceleration in the back half from where we've been in the first and second quarters. So the Q3 guidance, for example, has product margin down around 30 basis points at the top end. So really all mix related. In fact, we feel pretty good about the margin rate, both within our international entities as well as how it's trending. We've seen margin increases in some of our best performing categories, and we've seen margin increase in our international entities. It's just a matter of how the mix plays together that's creating some challenge there.

In relation to the overall operating margins and how the growth is, I mean, obviously, we've had pretty phenomenal growth here in the front half of the year. We've had great top line as well. We are not planning our top line to be as strong in the back half, again based on kind of that 2- and 3-year stacked comp. We also saw some things like SG&A was actually down slightly, as you probably noted, in Q2. It's not how we're planning Q3 and Q4 up. We had a couple of things in the quarter that were helpful as well as we've had some initiatives that are really -- have some cost savings associated with them. We'll have some smaller dollars, not significant to call out, but they're going to move from the front half to the back half. So I think with all of that, we're planning the back half a little bit more conservatively. And obviously, our goal is always to meet or beat that high end, and we're going to give our best shot to do that here as we roll through the back half.

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Operator [28]

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(Operator Instructions) Our next question comes from John Morris with D.A. Davidson.

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John Dygert Morris, D.A. Davidson & Co., Research Division - Research Analyst [29]

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Congratulations, everybody, on a great result there and start to back-to-school. I guess, Chris, picking up on that last one where you were talking about some of the shifts going on and the benefits that you saw, can you just -- they're probably not so significant, but any of the bigger pieces, just enumerate those for us just to pick up on what you were talking about there at the end of that last question.

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Christopher Codington Work, Zumiez Inc. - CFO [30]

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Yes. I think the bigger items are just the timing of incentive and how that's played out year-over-year. Through the second quarter of last year, we were really accelerating on our growth and therefore increasing our incentive accruals through the second quarter. This year, we're generally more on track around the target levels, maybe slightly above target levels. So we have some benefit there. There are some marketing dollars that have moved out and a few other from a store cost perspective that have moved out. So for example, we still have some stores to open this year, which will add to our SG&A growth in Q3 and Q4. So those types of things are what we're seeing move out that we didn't experience as heavy in Q2 and the front half of the year. And therefore, we're planning a little softer. Obviously, still happy to be growing earnings double digits here in Q3. And over 20% earnings growth here for the full year is where we forecast at the high end.

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John Dygert Morris, D.A. Davidson & Co., Research Division - Research Analyst [31]

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Got it. And on -- hate to be the one to ask about China tariff or trade tariff question on China and whatnot. But since we talked last or since last quarter, have you seen anything really different? What are the kinds of initiatives you're working on with respect to diversifying that's within your control? But I have a kind of a sub-question here, which is also -- I hadn't thought about it before, but are hardgoods any different in terms of sourcing geographically? So maybe just give us the update on that and then talk hardgoods.

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Christopher Codington Work, Zumiez Inc. - CFO [32]

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Sure. So from an overall tariff perspective, our update is at Q1, as we had indicated to you guys, we do have a few categories that were already subject to the higher level 25% tariff. Those primarily were around the accessory categories. To date, just kind of managing that since those went into effect. We have not felt any meaningful impact on tariffs, as we've been able to work with the brands to mitigate it and work with our overall sourcing strategy. Obviously, starting September 1 of this month, there are many new tranches of apparel and footwear that went into effect at that 15% tariff. Apparel and footwear are a large percentage of our business, as you're aware, but we've been working with our brands to really actively mitigate this. This is a little more unique scenario for us because we do have such a high brand position within our portfolio of sales. But we're currently seeing through the second quarter about 41% to 42% of our product come from China. This is down from 45% in the first quarter and down from about 60% for all of 2017, so about 18 months ago. So you can see that our brands and with our own private label, we've started to position ourselves differently.

I think the other piece that I caution with these numbers is we don't have the exposure from China that maybe others do because so much of our product is screenprint. So a lot of what's coming out of China is the blanks and things like that or the raw good where a lot of the value is still being added here in the States, which obviously diminishes the impact of the imported value and the tariffs. So like all retailers, we're working to decrease this and our exposure through responsive planning with our vendor partners and our manufacturers. And overall, our goal is really to maintain share with the customer, right, while also delivering the value that we've tried to lay out for this year. This means we continue to work with the vendors in light of where the FX rates have gone and different opportunities from a process perspective they have. This includes moving production, includes finding other potential offsets of cost savings within our supply chain process. In the last case scenario, raising prices, which we may have to look at for some of our smaller brands that have less scale and scope to be able to move production. But to this point, we haven't seen it and it's still kind of an issue we're monitoring and we'll see where that goes.

And the last question you had around hardgoods, I think it really depends on the type of hardgoods. Much of the skate hardgoods is actually not impacted here. Some of the snowboards and things like that do have more of the international component. But overall, we feel like the hardgoods is a safer spot to be in regards to what's trending on the skate side of the business.

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Operator [33]

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And I'm not showing any further questions at this time. I would now like to turn the call back over to Rick Brooks, Chief Executive Officer, for any closing remarks.

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Richard M. Brooks, Zumiez Inc. - CEO & Director [34]

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Thank you, Daniel. And again, I just want to thank everyone, as always, for their interest in Zumiez and what we're doing. And I think we view our path through the rest of the year as we've laid out the guidance relatively conservatively, but yet optimistic about our ability to deliver really another strong record year of earnings. So we're going to look forward to getting back with you in early December and talk to you about our third quarter results and then hopefully looking towards a great holiday season. Thank you, everybody. We appreciate your interest.

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Operator [35]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program, and you may all disconnect. Everyone, have a wonderful day.