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Executives

Rick Brooks – President and CEO

Chris Work – CFO

Analysts

Betty Chen – Wedbush Securities

Sharon Zackfia – William Blair & Co.

Edward Yruma - KeyBanc Capital Markets

Mitch Kummetz – R. W. Baird

Stephanie Wissink – Piper Jaffray

Christian Buss – Credit Suisse

Brian Czenszak - Janney Capital Markets

Dorothy Lakner – Caris & Co.

Pamela Quitiliano – Oppenheimer

Andrew Burns – D.A. Davidson

Richard Jaffe – Stifel Nicolaus

Dave Kang – Roth Capital Partners

Jeff VanSinderen – B. Riley & Co.

Paul Alexander – Bank of America Merrill Lynch

Simon Siegel – JPMorgan

Zumiez, Inc. (ZUMZ) Q2 2012 Earnings Call August 30, 2012 5:00 PM ET

Operator

Good afternoon, ladies and gentlemen, and welcome to the Zumiez Incorporated fiscal 2012 second quarter earnings call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of today’s conference.

Before we begin, I would like to remind everyone of the company's Safe Harbor language. Today's conference call includes comments concerning Zumiez Inc.'s business outlook and contains forward-looking statements. These particular forward-looking statements and all other statements that may be made on this call are not based on historical facts, are subject to risks and uncertainties, and actual results may differ materially. Additional information concerning a number of factors that could cause actual results to differ materially than the information that will be discussed is available in Zumiez's filings with the SEC.

And now, I would like to turn the call over to Mr. Rick Brooks, Zumiez Chief Financial Officer.

Rick Brooks

Thank you and welcome everyone. I'd like to start the call by introducing our new CFO, Chris Work. As you've likely seen from our press release last week, Chris has been with Zumiez for about five years, and as a result, has had the time to fully embrace the Zumiez's culture. Chris has been a key contributor to our financial operations and more recently played a major leadership role in the Blue Tomato acquisition.

I want to point out that this is our first internal promote to our executive team in many years. This promotion reflects our core values and our focus on developing our team and talent in the organization over the past few years. I look forward to all of you getting to meet him over the next few months.

Now, let's begin with our comments. I'll begin with thoughts about back-to-school followed by highlights about Blue Tomato, and then we'll discuss the Q2 results. After that, Chris will review our financial and operating highlights for the second quarter. After our prepared remarks, we'll open the call up to your questions.

Earlier today in our press release we announced the sales result for August with a 3.7% comparable store sales growth. As we've discussed over the past couple of years, the back-to-school season continued to shift later into the season. This year is no exception. The first three weeks produced essentially flat comps followed by high concentration of sales in the final week of the period, and while the back-to-school season is not over, when all is said and done, I expect results will once again show that we are a key destination for our customers' back-to-school fashion needs. I should also point out that the first two weeks of September represent for us nearly one-third of the entire back-to-school business. At the end of August, approximately 40% of schools in our store base had yet to start the academic year.

We're not only seeing the shift in sales moving later each year, but also that the back-to-school sales are becoming a smaller portion of our annual sales, a trend we've now seen since 2009. Part of the annual decrease is offset by the strength in our non-peak season results due to the increasing speed that the omni-channel consumer can find what they are looking for and complete their purchase in real-time throughout the year.

As you know, we closed our acquisition of Blue Tomato on July 4, 2012 for a total purchase price of EUR59.5 million. We're thrilled with this new addition and it's complementary to Zumiez geographic footprint and a logical and consistent extension to our operating philosophies. We're in early days of our combined business together, but Blue Tomato is continuing to show year-over-year growth and is well-positioned heading into the important winter and holiday season. I should point out that Blue Tomato has a higher concentration of sales in the fourth quarter than Zumiez operations, which is consistent with predominantly e-commerce business.

The addition of Blue Tomato added a compelling mix of e-commerce expertise and an expanded geographic footprint to our North American business. Although the business represents a small portion of our overall sales and earnings currently, the potential for this business both online and through growth in bricks-and-mortar have us excited about the future. We're now working together to build upon their existing business plans to form a joint view on growth, including the many ways we can leverage our independent strengths to improve not only Blue Tomato results, but all facets of the company. Having a foundation of shared values and culture positions us well for many years of future success together.

Now let me speak to the second quarter. We delivered solid organic results again in the second quarter with sales up 20% over the second quarter of last year with strong comparable store sales gains and productive new stores. At the same time, excluding the one-time expenses related to the relocation of our web fulfillment and home office and costs related to the acquisition of Blue Tomato, operating margins continued to improve, driving better-than-expected bottom line results. This quarter results are reflective once again of the strong execution by all of our teams.

We continued to stay focused on the key business drivers we’ve been talking to you about all year, higher store productivity, domestic new store growth, greater penetration in e-commerce, and international expansion. I'm pleased to report that this quarter produced positive momentum in each of these areas. Our highly differentiated product assortments and exceptional in-store experience continues to attract and engage our core consumer, evidenced by the continued strong comparable store sales growth.

Empowering our managers to impact and lead their teams on a daily basis is not only what makes our company culture unique, it's a critical top line growth driver. Currently we continue to invest in our team members, feeding their potential by promoting from within, and recognizing that our passionate team is essential to our growth as a company and as a leader in our space.

We opened 15 new domestic stores in the second quarter, working towards our long-term goal of 600 to 700 domestic locations. As I mentioned before, the ultimate store count in the US is a moving target and we regularly evaluate our current and potential store portfolio to ensure that we’re building the correct number of units to maximize productivity in an omni-channel world. Today our total US store count is at 463.

In Canada the second quarter marked our first full quarter with comparable store sales results in this market and this back-to-school season is a first comparable busy season, although only for a few stores. Overall, Canada is performing on plan for the quarter and year to date. We continue to show progress and we have confidence in our long-term strategy in Canada where we see the potential for 60 to 70 stores.

As we take these important steps towards building upon our position as a global action sports business, our commitment to our product, culture and operating philosophy has never been more important. We are dedicated to continuing to invest in our people, our infrastructure, and in those things that make the shopping experience in our stores both in person and online extraordinary. This relentless commitment to our fundamental principles is what got us here today and this will continue to drive this business going forward.

With that, I'll pass the call over to Chris to review our financial results from the quarter. Chris?

Chris Work

Thanks, Rick. Good afternoon, everyone. I'm excited to be here with you today and, as Rick mentioned, I look forward to meeting you in the coming months and years. I’ll begin by briefly reviewing the second quarter, then I’ll move on to guidance before wrapping up our prepared remarks.

Net sales for the quarter were $135.1 million, an increase of 20.4% compared to the prior year. Excluding the impact of Blue Tomato’s revenues, organic net sales were up $21.3 million or 19% over the comparable period last year. The increase in sales was driven by 9.5% comparable store sales increase and the addition of 50 net new stores since the end of the second quarter of last year.

Breaking down our North American results further, our men's, footwear, juniors', hard goods and accessories all comped positive in the quarter and boys' comped negative. Second quarter sales from our domestic e-commerce platform grew 40% and contributed 1.7% to the second quarter comp. We continued to see increases in dollars per transaction primarily as a result of higher average unit retail prices. This was the primary driver of comparable same-store sales gains in the quarter. Partially offsetting these gains were decreases in transactions and in units per transaction.

Second quarter gross profit increased $9.4 million in the quarter to $46.4 million or 34.4% of sales compared to $37.1 million or 33% of sales in the comparable period last year. The 140 basis point improvement was primarily driven by improved product margins and leveraging our occupancy and supply chain costs on a 20.4% sales increase. Offsetting these improvements were $0.5 million of costs associated with the relocation of our e-commerce fulfillment operation to Edwardsville, Kansas and $0.5 million charge related to a step-up in inventory to the estimated fair value in conjunction with our acquisition of Blue Tomato.

SG&A expenses for the quarter were $42.6 million or 31.6% of net sales compared to $33.5 million or 29.8% of net sales in the second quarter last year. The increase in expenses was primarily due to $2.4 million of costs associated with the acquisition of Blue Tomato consisting of $1.5 million of transaction costs incurred in the quarter, $0.7 million of estimated future incentive payments and $0.2 million of amortization of intangibles. Additionally, we incurred $0.8 million in costs associated with the move of our corporate offices to Lynnwood, Washington from Everett, Washington. Excluding these costs, our SG&A expenses leveraged on higher net sales.

Operating profit was $3.8 million or 2.8% of net sales compared to $3.6 million or 3.2% of net sales during the second quarter of last year. Also in the quarter, we recognized a $0.5 million foreign currency benefit in other income as a result of the timing of closing on the Blue Tomato acquisition.

We generated net income of $2.1 million or $0.07 per diluted share during the second quarter compared to $2.6 million or $0.08 per diluted share during the comparable period. As expected, cost associated with the acquisition of Blue Tomato and the relocation of our web fulfillment facility and home office weighed on our net income this quarter.

For clarification, let me layout the impact on the quarter that should be taken into consideration when looking at our results. One time costs associated with the acquisition of Blue Tomato, including the $0.5 million step-up in inventory value and the offsetting $0.5 million foreign currency gain were $1.5 million. The impact of these costs on our diluted earnings per share was approximately $0.04.

Blue Tomato operations, including the $0.7 million of estimated future incentive payments and $0.2 million of amortization of intangibles negatively impacted diluted earnings per share by approximately $0.02. In the quarter, we had $1.3 million or approximately $0.03 per diluted share of costs associated with the relocation of our web fulfillment center to Edwardsville, Kansas and our corporate offices to Lynnwood, Washington.

Looking now at our key balance sheet highlights, we ended the quarter with cash and current marketable securities of $96.8 million, down from a $131.9 million at the end of fiscal 2011. This decrease was primarily due to the acquisition of Blue Tomato, offset by cash generated by operations. As you know, the acquisition was funded with cash we had on hand. We had $2.2 million of debt at the end of the quarter, resulting from outstanding debt that we acquired as part of the Blue Tomato acquisition. We had no outstanding balances on our revolving credit facility.

Capital expenditures in the quarter were $13.4 million, primarily related to 21 new stores we opened since Q1 and the build-out of our new home office. Inventory was $100 million at July 28, 2012, which included $7.1 million of Blue Tomato inventory acquired during the quarter. In North America, on a per square foot basis, inventory was down slightly compared to the end of the prior year second quarter.

Now to our August results. Our comparable store sales increased 3.7% for the four-week period ended August 25, 2012. In the prior year, comparable store sales increased 4.3% for the four-week period ended August 27, 2011. Total net sales for the four-week period ended August 25, 2012 increased 15.2% to $74.7 million compared to $64.9 million for the prior year four-week period. On a weekly basis, comps were 0.6%, negative 1.2%, negative 1.6%, and 17.6% in weeks one through four respectively.

The increase in comparable store sales in the period was driven by an increase in dollars per transaction, partially offset by a decrease in comparable store transactions. Dollars per transaction were up for the four-week period due to an increase in average unit retail, partially offset by a decrease in units per transaction. During the four-week period, men's, juniors', footwear and hard goods posted positive comps, while accessories and boys' posted negative comps. Year-to-date 2012 comparable store sales were 9.4% on top of 8.6% for the same period last year.

Now, let me outline our guidance. As always, in putting forth this guidance, we want to remind everyone of the complexity of estimated sales, product margin and earnings growth given the variety of factors that impact performance, including challenging macroeconomic conditions.

For the third quarter we are planning same-store sales to increase in the range of 3% to 5% and total sales to be in the range of $181 million to $185 million. Operating margin for the quarter is expected to be between 12% and 13% and earnings per diluted share are projected to be between $0.42 and $0.45.

Included in this guidance is a full quarter of Blue Tomato results which are expected to be dilutive to consolidated earnings by $0.09 per share. This is primarily due to approximately $1.4 million or $0.03 per diluted share of expense projected to be recognized for the step-up in inventory to estimated fair value as part of the accounting associated with the acquisition, approximately $2 million or $0.05 cents per diluted share for the anticipated expense to be recognize in the quarter for estimated future incentive payments, and approximately $0.5 million or $0.01 per diluted share for the amortization of intangible assets associated with the transaction.

In reviewing these costs, it should be noted that the effective tax rate in the jurisdiction where these expenses are recognized is lower and therefore more impactful to earnings. Excluding these costs, we are expecting Blue Tomato to have a nominal impact to earnings in the quarter.

In regards to Blue Tomato, at the time of the acquisition, we estimated that the impact of Blue Tomato would be slightly accretive in the second half of the year inclusive of the estimated future incentive payments. At that time, we did not have full visibility to the accounting or tax impact of the acquisition. As a result, the inventory step-up impact and the effect on our effective tax rate associated with the non-deductibility of certain costs have us now projecting the impact to be approximately $0.09 per share dilutive in the third quarter of 2012 and slightly accretive in the fourth quarter of 2012. Operationally, the business continues to show positive year-over-year growth.

We will continue to refrain from providing specific guidance beyond the immediate quarter, but I do want to make a few additional points about the full year. We continue to plan a comparable store sales increase for the year including the back half of the year. Cotton prices are currently expected to be down in the second half of the year, although this will be partially offset by increases in labor costs and other raw material costs. Now, while we saw a nice margin appreciation in the second quarter, I want to reiterate that we are up against record product margins in 2011 and our product margins could be impacted by a variety of factors, most notably shifts in product mix. That said, we are planning our product margins flat for the remainder of the year.

We plan to continue making investments in people and infrastructure to support our growth in 2012. However, excluding the impact of Blue Tomato acquisition, we also expect SG&A expenses will grow at a lower rate than our sales growth.

As a reminder, there will be an extra week in fiscal 2012, resulting in a 14-week fourth quarter and a 53-week fiscal year. The extra week will benefit sales and earnings growth in fiscal 2012 and will be a detriment to sales and earning growth rates in fiscal 2013.

Excluding the impact from the Blue Tomato acquisition, we believe we can leverage our cost structure and achieve operating margin improvement with a mid-single digit comp increase. To the extent we are able to exceed a mid-single-digit comp, we expect incremental sales to flow through at a rate of 25% to 35%.

We are planning to open approximately 50 new stores in 2012, including up to 10 in Canada. We're not currently prepared to discuss a timeline for new store openings in Europe.

We expect capital expenditures for the year to be between $45 million and $47 million compared to $25.5 million in 2011, the major capital projects being the new store openings, plant remodels, and the build out of our new home office facility in Lynnwood, Washington.

We also expect depreciation and amortization, inclusive of Blue Tomato, to be approximately $24 million, an estimated increase of 20% over fiscal 2011. We estimate our third quarter and annual effective tax rate will be higher than the 35% US federal statutory rate than our fiscal 2011 effective tax rate, primarily resulting from the tax effects of the acquisition of Blue Tomato.

We will now open up the call for some questions.

Question-and-Answer Session

Operator

[Operator Instructions].

Your first question is from the line of Betty Chen with Wedbush Securities. Please go ahead

Betty Chen – Wedbush Securities

Thank you. Congratulations, everyone, on a great quarter. I was wondering, Rick, if you can give us a little bit more color, I think it was really helpful for you, for us especially, to hear about the timing of back-to-school, and certainly we’ve seen that shift later and later every year. Can you share with us by any chance, certainly it looks like August ended with a very strong sales number of up 17% the last week, what have you seen in early September trends, if anything you can share with us there?

Then also as we think about the business in the back half, if we should be looking for maybe flattish AUR gains after some very strong trends there. What are some potential drivers for comps? Is it traffic and if that’s the case you know how is the team thinking about driving traffic or transactions to kind of offset the AUR piece of the equation? Thank you.

Rick Brooks

All right. Thanks for those questions, Betty. Much appreciated. And I just want to say, again, I think we’ve kind of laid out of how we're viewing August results and how we’re thinking about the execution of back-to-school flowing through. As you said, it’s definitely happening late for us as evidenced by that last week, and we'll see how it plays out as we move through September, but we are not going to comment about any specifics around -- as is our policy around September results. So we'll wait till we get the whole month in and then we report to you later in the year.

As it relates to thinking about the back half a bit further out, and as you all know, our business had been AUR driven for a number of quarters now, and as we said over the last few calls, we expect to see that start to transition. And a lot of this has to do with mix shifts in our business relative to trends, relative to accessory trends, relative to the pricing changes a year ago. We do expect to see that over time transactions will take a lead versus AUR. Now I really don't think that, again, that -- I think a lot of this has really been driven by the mix within our business, not necessarily that per se there are fewer transactions in that sense, is that we’re just capturing the share of wallet differently with our consumers.

So I think that will be a natural way for it to play out. We’ve seen these cycles over the years in the past. And so I don't anticipate that we’ll see anything unusual, but a flow-through towards more transactions as those AUR gains change and our mix flow through the new categories are driving the business today, that will be a very natural transition of the business, and I don't think hopefully it's anything where we'll be having to focus on too much. I hope this will be a natural flow into a transaction-led trend.

Operator

Your next question is from the line of Sharon Zackfia with William Blair. Please go ahead

Sharon Zackfia – William Blair & Co.

Hi, good afternoon. I had a few questions. I think the gross margin gain year-over-year, if I excluded everything correctly, was kind of the strongest gain we've seen in close to two years. And I know you said merchandise margin was positive. It seems like it was pretty significantly positive. So I'm not sure if that is mix shift or if there is something else that you planned for really well in July quarter, what's driving that?

And then secondarily, I think accessories were negative in August. If you could talk a little bit about what's going on in the accessories business, if that's just a function of a late back-to-school, or help us understand a little bit about what's happening in that kind of important part of the business.

Rick Brooks

All right. Thank you, Sharon. And again, you're right about margin in Q2, so it was a very strong performance at the product margin level, and there is a lot of mix shift that's involved in there as it relates to that, as again categories move around and we move more towards apparel driven departments of business, Sharon. So a lot of it is relative to mix. And again as you know, our business is so diverse in terms of the breadth of categories that we represent, that I know this gets hard for everyone to understand and appreciate how complicated it is, but fundamentally there's two things happening here.

I think our buyers do great job in terms of driving our margin forward and negotiating with our partners on price. I would also add that our inventory levels are, in terms of the quality of inventories, are in very good shape. I think we all feel very strong about our position. So I think that reflects in markdown levels and the kinds of promotions that we do when we have that stronger position. And then lastly again, you're right, there are some mix shifts relative towards our apparel.

Operator

We lost the presenters once again, ladies and gentlemen. One moment while we get them back on the line. I apologize.

It looks like we have the presenters back in the room.

Rick Brooks

All right. Thank you, [Keith], and I think we have solved our problems here on the phone.

So, Sharon, I was talking about your question, and I don't -- I normally do hang up most of the time, Sharon, but I am going to finish my question for you here on this. So I'm not going to dodge you. I've tried everything else here, but I’m not going to do that or hang up on you.

So again it’s a combination of those three things, Sharon. We do a great job of working margin through our buyers, the mix itself of product again, again, the category mix of the business. And it was a very strong performance in margin for the second quarter.

As it relates to accessories going negative, some of it is definitely related to the late back-to-school because we think we have a lot left to go yet, and there are some drivers, as you know, in our accessories categories that will drive that volume going -- as we get deeper into the back-to-school window.

Now I will say though, and I think most of you know that we’ve been in a real accessories cycle over the last really two to three years, and again this is part of the shift in the volume and mix shifts we’re seeing in our business, the accessories is coming down and then apparels coming up in our business. So it’s a combination of both, I think, Sharon, as you say, potentially the late back-to-school related to key back-to-school accessory categories as well as mix towards apparel.

Sharon Zackfia – William Blair & Co.

Okay. Thank you.

Rick Brooks

Thanks.

Operator

Your next question is from the line of Edward Yruma with KeyBanc. Please go ahead.

Edward Yruma - KeyBanc Capital Markets

Hi. Thanks for taking my question. I guess I’m trying to understand, you talked about trying to drive transactions as you move away from AUR towards the back half of the year. Is that possible given the current accessory trend I guess? And is that too stiff of a headwind for you?

Rick Brooks

Well, no. In fact I think you’ve got to reverse your thinking there a bit. Part of the challenge in driving the transaction is related to previous accessory trends, and so as those trends play out, we’re going to see a natural where we had a lot of small dollar transactions. That is going to change, and we’re capturing the wallet share differently as we start to anniversary our gaps in the wallet share differently relative to higher -- fewer transactions but higher-value transactions relative to apparel; that’s one of the biggest shifts that is taking place in the business.

Edward Yruma - KeyBanc Capital Markets

Got you. And in terms of the incentives comp payments that you are expensing now as it relates to Blue Tomato, is this -- I'd assume you would normally expense it on a kind of an ongoing basis, but have you accelerated the accrual of that? And then I guess as we think about that going forward, will that be a continued headwind?

Rick Brooks

Again, I'll just make a quick comment and ask Chris to comment on how we are thinking about the incentive structure. But it was important in the Blue Tomato piece. We have a great partner in our team at Blue Tomato, very excited about the team, great cultural fits. And of course as part of the structure of the deal, we wanted to try to incent them not only for performance but to incent them to stick around with us for a while. So that is the whole point of the kind of incentive structures in place. So I’ll let Chris talk a little bit about how we’re thinking about the timing.

Chris Work

Yeah. As far as the timing of the incentive payments goes, the incentive period runs through April 30, 2015. So as we’re planning and modeling the business, there are certain metrics that the incentive payments are tied to and we will be estimating the probability of hitting those metrics throughout that time period and accruing accordingly. So as we move through the future quarters here up until that date, we do expect to see charges related to these types of incentives.

Operator

Your next question is from the line of Mitch Kummetz with R. W. Baird. Please go ahead.

Mitch Kummetz – R. W. Baird

Yeah, thank you. I guess I've got one multi-part question on Blue Tomato, so if you'll allow me to kind of just ask you one piece at a time. So, first, it looks like you now, for the second quarter, it was $0.07 hit to earnings. I think initially you were saying a $0.04 hit, $0.03 being acquisition related costs and $0.01 of operational drag. So, again, you guys gave a lot of Blue Tomato numbers, I don't think I have all them clear in my head. So, can you just, again, starting with the second quarter, just kind of walk through what was the impact from acquisition costs versus the impact just from an operational standpoint on the quarter?

Chris Work

Yeah, sure. I'll take that question. I think the important way to look at this is there's probably three pieces when you're thinking about the transaction. The first piece is the general operations of the business which as we disclosed to you in June is a growing business and a business that we're excited about merging with ours. The second piece that I look at when I think about this is the one-time transactions, which we laid out of it's about $1.5 million of transaction costs in the quarter, about $0.5 million of inventory step-up, offset by $0.5 million of our foreign currency gain that we experienced during the quarter.

So if you take all of those pieces together, you're right about $0.04. And then if you look at the ongoing charges, the incentive payout that we just discussed and the impact of the intangible amortization which was about $0.2 million during the quarter, that's going to round out about $0.03 and equal your $0.07 that you're reconciling to there.

Mitch Kummetz – R. W. Baird

Okay. On the back half, you mentioned, Rick mentioned that it's more weighted towards the fourth quarter than the core business. Could you give us some sense as to how either the sales last year broke out by quarter or how you expect the sales to break out by quarter for the back half of this year?

Rick Brooks

Mitch, we don't want to get that granular about this. I'm going to remind everyone, again, this is relatively small part of our overall business, but I will give you some general direction on it relative to the fourth quarter in that. As you look at our e-commerce business, our pure e-commerce business net of kind of some of the omni-channel things we're doing, it has a very similar mix in the November, December, January timeframe as our pure e-commerce business does.

Mitch Kummetz – R. W. Baird

Okay, that's helpful. Thanks, Rick. And then on the -- again, just to kind to reconcile everything, it looks like it's a $0.09 hit to earnings in the third quarter the way you've outlined the guidance, and then I think you guys made the comment that it's going to be slightly accretive in the fourth quarter. Is there any way you can kind of break out how you're thinking about the fourth quarter in terms of those buckets, whether it's inventory step-up or incentive comp or amortization of intangibles, in case we want to make any adjustments to those numbers as how we're modeling Q4?

Rick Brooks

Let's focus on Q3 where we've given more direction there, Mitch, and then I think it's -- I'll let Chris kind of walk you through the Q3 change there. And I think some of that will [fall] automatically as we think about that particular relative to the stepped-up basis of the inventory. So, Chris, why don't you go ahead?

Chris Work

Yeah, absolutely. As we mentioned, we had about $0.5 million in the second quarter related to the step-up in our inventory basis. That is something that we would expect to see continue into the third quarter, and we're currently projecting about $1.4 million of inventory step-up that will be expensed in the third quarter. And then we have, outside of that one-time charge that we'll only experience this year, we're also estimating about $2.5 million related to both the incentive payout as well as the amortization of the intangibles in the third quarter, and those charges, as we’re classifying them, are going to be the reoccurring charges that we’ll see in quarters -- each quarter to come.

Operator

And your next question is from the line of Stephanie Wissink with Piper Jaffray. Please go ahead.

Stephanie Wissink – Piper Jaffray

Thank you. Thanks for taking my question. Rick and Chris, could you just talk a little bit more about your current inventory position and how it relates, Rick, to what you’re talking about in the shifts in mix from two apparel -- excuse me, to apparel from accessories and footwear?

Rick Brooks

Again, when we talk about inventory position, Steph, we always want to start with the comment that we feel that we’ve managed inventories very well over the last number of years, and as you’ve heard us say for many quarters, we feel very good about the quality of our inventory. And I’m going to start there because that's where we’re going to end Q2 at, is that we feel very good about the quality of our inventory position going into Q3.

And now, to follow the second part of your question, Stephanie, is this idea that, of course, we’re reflecting with the trends we’re seeing in the business and the mix of inventory itself. So, obviously, in accessories while we’re playing the key categories in back-to-school, they are very important accessory categories to play out, there are other categories that had been the trend categories in the past where inventories are way, way down from where they were about a year ago at this point in time or two years ago at this point in time.

So we are merging and moving that inventory around I think very effectively, and our buyers are doing a terrific job in doing that. And that is one of the primary reasons that we can continue to give comfort around the quality of our inventory.

Stephanie Wissink – Piper Jaffray

Okay, Rick. And then just one follow-up here, given what you’re seeing in your apparel trends, what is it that’s giving you confidence regarding the key classifications, or what do you think from a fashion standpoint that’s getting you excited about what’s happening in apparel? Thanks.

Rick Brooks

For us, again, we have to break it down in a couple -- think about it a couple different ways, Stephanie. So, first, I'd talked about on the men's side of the business, I think we feel good about brand positioning, how we’re positioned with our brands, the assortment of brands we have in our mix, some unique brands we have in our mix. I'm hopeful that over the next year and two years we have a good group of brands that continue to growing our business on the men's side.

On the women's side in apparel, I would say that we are executing, as we've talked over the last few quarters, a new strategy relative to the team that’s been in place there now for a couple of years. It is both a branded strategy and both a strategy focused on key items and key categories. I'm not going to get into the details obviously of how we're executing that. Let’s just say that we've experienced some good success there in our women’s business and it’s complementing what we're doing on our men’s side of the business. And that is a really important aspect, as you all know, for us, is that we are an action sports lifestyle retailer. We’re going to do on women's side of our business, needs to be reflective of the lifestyle itself, just the same as it is on the men’s side of our business.

Operator

And your next question is from the line of Christian Buss with Credit Suisse. Please go ahead.

Christian Buss – Credit Suisse

I was wondering if you could talk about assortment planning and whether there are any major changes to the playbook when it comes to plans for fall and holiday.

Rick Brooks

Sure, Christian. And again I always warn my people, as we've been talking out for probably I think the last three years, that we have been in the process of acquiring, implement and, you know, installing and implementing and now training on as we execute our new assortment planning software tools, BI tools, assortment planning tools. And these are very -- this has really given our buyers all new levels of ability to dynamically assortment plan our business.

So we're talking about being able to, at a SKU level, be able to assortment plan on every brand category combination by week, by location. So, very powerful tools that allow us to build up from those base-level sort of plans up to what our overall open-to-buy planning is, and of course reconciling those things together.

So I think what you're seeing and I think over the last particular a year and 18 months has been the reflection of some of our success in assortment planning, that better micro-assorting of our stores. Because we're working at a very detailed level. So that being said, we have a long ways to go in terms of thinking about how we assort our stores and the tools -- there are still many facets of this tool that we have yet to fully exploit. In fact 2013, next year will be the first year that we really are going to pretty much have almost all of categories planned through the new assortment planning tools.

So, Chris, that's a broad overview of what we're trying to do with assortment planning. It’s a very key part of it. And I might add it's even more complicated now by the Army channel piece as a combination of looking at the sophistication of assortment plan that's needed when you break it down by channel. So that's a whole new intricate -- intricacy to assortment planning that I think that we're still getting our hands around how we think about that, how we incorporate that into the detailed planning of the business.

Now, naturally, it does affect how we think about -- how we planned going through and going forward for the back half of this year, but I am not going to actually share a lot of details with you about what the plan is. That's partly our competitive advantage for what we're doing in using our tools. So, but, yes it is, and it reflects again some of the broad shifts I think I talked about in Stephanie's question just a moment ago.

Christian Buss – Credit Suisse

Great. Thank you very much. And best of luck.

Rick Brooks

Thank you.

Operator

Your next question is from the line of Adrienne Tennant with Janney Capital Markets.

Brian Czenszak - Janney Capital Markets

This is Brian Czenszak calling on behalf of Adrienne. My question relates to price competition. Zumiez has consistently been one of least promotional retailers throughout the mall. And I was wondering if you could talk a little bit about how you see your plans holding up as the price competition especially heats up during the back-to-school season, particularly in categories like denim which we've seen a lot of aggressive price points around the sector. If you guys see any changes to your plans or if you're confident with that fourth week trend coming out of August that'll continue in the September, and you can kind of maintain that less promotional plans that you guys have continued to show.

And then also on the back end of that, I also wanted to just ask about the Zumiez Stash program. I know that's been an effort to build a more consistent and loyal customer base, which I'm assuming would also then help give you the ability to focus even less on the need to compete with promotional activity. And so I was just wondering for an update there, if you guys have seen any signs of benefits or success thus far with that. Thank you.

Rick Brooks

All right. Thanks, Brian. First, I appreciate you for paying attention that we have been less promotional than a lot of our competitors on the mall in many categories, and again as we talked about much earlier in the call, I think that's reflected in some of the success we've had in Q2 in growing our gross margin as part of our business. Now again we plan at a very detailed level and I think our buyers are very astute about trends and cycles and there are certain categories of business that we anticipated would be very promotional on the mall. They have been in the last few years and we anticipated they would be this year.

In most cases, when we look at that, we try to look at our business and say, how can we drive gains without having to play at a deep discount price promotional business? And so one of our goals is always to be different, to be unique in what we present to our customers. So we try to plan and run our games and forecast our business in a way that we don't have to be as be promotional -- as promotional. And then that gets to again tying back to the earlier question that was asked relative to inventory positions and the quality of inventory and how we’re planning those positions relative to assortment planning, open-to-buy. So I guess a long way of saying, Brian, that we anticipated these trends and the discount level. It planned in to what we had expected to do here in Q2 in August and it certainly is continuing to be part of our plans as we look forward for the rest of back-to-school and the rest of the year.

Now, as it relates to Zumiez Stash program, I love it when you ask me a question and answer it yourself, Brian. So you saved me a lot of work on that side. Yes, our intent is clearly that there are other ways to reward customers, and that there is a sense again about the uniqueness of our business, uniqueness of the product, the uniqueness of experience, and we wanted the Zumiez Stash program to reflect that same uniqueness. So we’re doing something in what we’re calling rewards and recognition program or more commonly referred to as a loyalty program. That is also very unique in the way we're approaching it, the way it’s living in the world that our customers listen, on the internet, the way we're allowing them to participate in a program through not only being in store and shopping but through their activities and the things they do with it and how they interact with us, and rewarding them for that loyalty in terms of their interaction, and rewarding them with things that are distinct and unique that they can’t get from the in-store environment.

We hope that over the long run, again, we -- I just want to emphasize again that we don't do these things for the short term. We do these things for the long run benefit of the business, long-term thinking, long-term strategy. We hope that in the long run that this is a program that will allow us to again gain share of wallet with our customer because they believe in what we’re doing and they value the uniqueness of the Zumiez experience; product, people and place. And whether that place be on their phone or that place be in our store or on some other mobile device or one of our events, wherever it may be, and that’s how the program ties it all together.

And it will be interesting how it’s going to work. I think we're pleased with the launch and I’m really thankful for all the hard work our team is putting to getting the launch for back-to-school. But realistically, we aren’t going to know -- we won’t really be able to use this data until we develop the baseline of the data over the next 12 months. And then we’ll really start to be able to analyze the data, look at how people are using it, and be able to use it as a lever within that business in a way that we can’t do that today.

Brian Czenszak - Janney Capital Markets

Great, definitely. Thank you. That's very helpful. And good luck for the rest of fall.

Rick Brooks

Thank you.

Operator

Your next question is from the line of Dorothy Lakner with Caris & Company. Please go ahead.

Dorothy Lakner – Caris & Co.

Hi, everyone. I wondered, Rick, if you could maybe speak a little bit about juniors' and young men’s. I mean, your juniors' business is significantly less as a percent of sales than a lot of the other retailers out there, and I wonder if there's, in addition to some of the other factors you’ve talked about as to back-to-school getting later and later, is there something in the patterns in which juniors' shopping versus young men’s shopping that also tends to push your business more later into the season? So that’s one question.

And then, Chris, just a little bit more color on the second half and the product margin. You were talking about flat product margins in the second half of the year, just if you could go over that for me one more time in terms of the cost inputs and the difficult comparison, why you think product margins should be expected to be flat in the back half of the year given how well you did in this quarter and even first quarter?

Rick Brooks

All right. Thank you, Dorothy. So I do think you bring up a good point in juniors' versus men's, so let me talk a little bit about, again, about fundamentally those two piece of our business. And I think last year our juniors' business was approximately 10% of our revenue mix. And when we talk about this particular -- when we talk in terms of this particular number, that is, it represents juniors' apparel. So, and then, you know, we have other juniors' categories in our footwear department across the business, so.

Now, in past years, our juniors' business has been as high as I think 15% to 16% of our revenue mix. So we really stepped back over the last few years, and as I think I said over previous calls, I think we didn't really understand what business we were in, in our juniors' business over the -- when we achieved the previous peak, we were more driven by hot brands, brand launches or brands driven off of mass media, MTD type programs.

So I think what we've tried to do over the last few years is develop a clear strategy about how our women's business is going to be different and how hopefully we can sustain that women's business on a more stable basis going forward. Now, as you know, women's, that's always tough right? Women's by nature is going to be more volatile than the men's business. But I am very encouraged by the progress that our women's team has made in re-thinking what our women's business is, and we've had good success around our women's business through the first six months of this year.

Now, you bring up a good point in that men shop a lot differently than women, and it will be true that I would expect that men's business will be more affected by the later back-to-school than our women's business is, and our data through August would probably support that assertion. And then -- so that's kind of my thoughts there, Dorothy. Did that cover it for you?

Dorothy Lakner – Caris & Co.

Yes, yes, that's helpful. Thank you.

Rick Brooks

Okay. And then I'll let Chris talk a little bit about the thinking on the second half in product margins.

Chris Work

Yeah, sure. Thanks Dorothy. As we did mention, Dorothy, we are planning margins pretty flat on the back half of the year. And you said some of my answer there in saying that the 2011 margins were our record levels. And so while we do anticipate some of the imports in the cotton prices and items like that on the back half of the year, we're hoping to get some benefit there. We also are seeing some increases in labor costs and other costs as well.

So, as we look at 2011, we were able to hold some prices up, on areas where we had purchasing power. And the product that was more competitive across the mall, we tried to hold prices and sacrificing margin. And really as we look at 2012, we're going to have some of the same challenges. And so going up against record margins, there's nothing out there right now for us that would indicate that we would bring those margins above the levels that we've seen in the prior year.

Rick Brooks

Yeah. We did have I think too, Dorothy, in the last year number, it was a tough snow year, and we talked about that previously. So there may be some potential that it could be better, but that's just not the way we plan our business at this point. And as Chris said, there's a lot of moving variables in our business again. That's a unique thing about our business, the diversity of brands, the diversity of categories that make it -- make us -- both give us some safe around kind of the diversification of those trends, but can also expose us in different ways to relative to things like snow. So we plan the business and we communicate the assumptions that underlie the guidance, and then of course, as you all know, we hope to outperform the guidance.

Dorothy Lakner – Caris & Co.

Right. Great. Thanks. That's helpful. And welcome, Chris.

Chris Work

Thanks.

Operator

Your next question is from the line of Pamela Quitiliano with Oppenheimer.

Pamela Quitiliano – Oppenheimer

Hey. Thanks so much for taking my question, guys, and congratulations on the promotion, Chris. So it's great to see that footwear is doing so well, and I'm sure you guys are aware that there's been a lot of concern out there regarding TOMS and how important it really is for you guys. So if you can help us just understand that and any other major brands that maybe skewing either footwear or apparel results. And then I just have a follow up on Blue Tomato from there.

Rick Brooks

Okay, Pam. So, you want me to tell you about our playbook on our how our key brands are performing. That's a good try. I always like it when you analysts try to get me to answer that question, and I'm just not going to answer it.

And again I want to go back to the point that our whole strategy is about being diversified in brands and about taking advantage of trends, whether it be category-driven trends, brand-driven trends that may play out. And I think as we talked about here earlier in the call, our goal is to always capture share wallet. And so, when trends change, whether it's a TOMS driven change or if another category trends down or -- there's always another one in our world that we believe is going to be trending up.

Now, can I always tell you what those are going to be? No. I mean, I don't think that's -- I'm not that smart. But we're so diverse in those brands, we're so diverse in the young brands coming up, we're so diverse in the categories reflecting everything in the lifestyle that I think we have a good chance to see where those next trends are going to emerge and to take advantage of those trends. So I have confidence based on the quality of our teams, the quality of our historical performance that we can take advantage of those trends, and that is the key reason that I don't want to talk about any particular brand’s performance in terms of the overall strategy we're trying to execute in the business.

Pamela Quitiliano – Oppenheimer

Can I ask just, and this is a historical question, when TOMS actually began to flow in? And just I noticed a statistic out there about not one brand accounting for more than a certain piece of the business. I know I’ve heard it from you guys before and I don’t know if that’s something that you could share with us again.

Chris Work

Yes, we'd glad to, and again you always have to look at it as a full-year basis because of the seasonality of the business. So at the end of 2011, our largest brand was approximately 6% of our total sales, and I can tell you that it was not TOMS, to be clear, in that mix. So, 6%.

Pamela Quitiliano – Oppenheimer

Great. That is very helpful. And then my next question for you, which hopefully -- I hope -- I don’t think it’s trying to get anything sneak out of and I apologize if it is, but just when I think about Europe being ahead, a bit ahead of us in terms of the trends, when do you think you can take the learnings you have from there and try to apply them to the domestic business, particularly for the snow season?

Rick Brooks

It’s really -- that’s a great question, Pam, and in action sports, it works a bit differently, and action sports is American driven lifestyle with brands that primarily are built and emerge from the West Coast of the United States, primarily Southern California. So in action sports, I think it actually works differently in the sense that brands tend to start here in the US, tend to grow, if they’re successful, grow in the US first, and then move to the international markets, particularly probably first Canada and then Europe.

So, our world it kind of I think works the opposite direction. Now that’s not to say that there aren't some brands that are European brands that are very good brands in the Blue Tomato business; there are. But in most cases it's going to flow the other way where the mix of brands that our business, and particularly again, as you know, we're very good at working with young brands, but those young brands are going to flow from the US business to Europe. That will be more the predominant trend here in our action sports lifestyle business.

Operator

Your next question is from the line of Andrew Burns with D.A. Davidson. Please go ahead.

Andrew Burns – D.A. Davidson

Thanks. And Chris, congratulations on your promotion. I had a question for you on Blue Tomato. With some time under your belt here, do you have a better handle on the upcoming hard goods season in Europe? You hear a lot about carryover hard good inventory in the channel due to last winter. Do you see this as a potential issue, and are you planning the business conservatively as a result? To ask another way, would this fourth quarter be indicative of a normal Blue Tomato season? Thank you.

Rick Brooks

Well, again, some context for your question, Andrew, is, early part of snow season in Europe last year was pretty terrible, and then in the latter part of the year got better in Europe. So I don't want to get down to too nitty-gritty on talking about a particular department of goods in the Blue Tomato business when that represents -- the Blue Tomato in total doesn't represent that significant a part of our business at this point, let alone the snow category. So I don't want to get too detailed.

But I will say that in broad terms, we are very fortunate to be partnering with the Blue Tomato team. This is -- Gerfried and his team are very, very culturally similar to us. They run -- he's run a great business with great profitability built upon that great cultural foundation and the authenticity of being an action sports retailer. They run a great business.

And I can tell you they have a number of strategies for managing their exposure in their snow hard goods business because, as we said, they are -- that is a significant portion of their business in the winter months. But Gerfried's been very smart and very clever in how he's managed inventory and how he tends to extend that experience. So we don't anticipate, and we're very comfortable with our position currently, and now as we look going into the season -- so now will be a function of what -- to see how the season is going to turn out, and I wish I knew what that was going to be. I clearly don't. But I know that Gerfried has a great team that's well-experienced in managing through all sorts of different kind of snow seasons in Europe.

Andrew Burns – D.A. Davidson

Thank you.

Operator

Your next question is from the line of Richard Jaffe with Stifel Nicolaus. Please go ahead.

Richard Jaffe – Stifel Nicolaus

Thanks very much, guys. And just a follow-on thought regarding the juniors' or young women's business and the possibility or opportunity of more private label to keep the product unique, differentiated and exclusive. So, if you could give me your thoughts on sort of those two factors?

Rick Brooks

Sure, Richard. Again, our juniors' business we said we've been -- we have worked hard the last couple of years, our juniors' team, in conjunction with all of our buying team and our private label team, in trying to establish a more sustainable unique strategy relative to what we're doing in women's. And I'm not going to get again into exactly what it is, but obviously we'll be clear that private label is a part of that strategy.

So the coordination that takes place with our teams there is very important. As you know that overall last year title was just under 18% of our revenue mix, and while we don't break it down to men's and women's, I think you can probably make some logical conclusions about that in our women's business by just going through the stores. And I think your question kind of drives the point that you have made some conclusions about the women's private label business.

So, our team has done a great job executing on it. Now, I'll say what I always say though when it relates to penetration of private label overall or whether it's men's or women's, is that it depends upon the cycles. If we can sell the branded product, then we want to sell the branded product, and our private label strategy in that sense hasn't changed in that we want it to supplement and complement our overall branded action sports lifestyle business. So, probably don't help you much, but that's kind of how we think about it internally.

Richard Jaffe – Stifel Nicolaus

It's helpful. And will go and start counting hangers. Thanks very much.

Rick Brooks

All right.

Operator

Your next question comes from the line of Dave Kang with Roth Capital Partners. Please go ahead.

Dave Kang – Roth Capital Partners

Thanks. Good afternoon, guys, and congrats on the promotion, Chris. I guess just first off, regarding to the 3% to 5% comp for the quarter which, taking a step back, seems a little bit lower than your traditional guidance in the mid-single digits. I just want to get a sense of how you're thinking about that. Is that somewhat of a new run rate that you guys are going to be guiding to as we think about it or is it more of a function of August, the month of August, which as we've talked, has been like a later back-to-school, I guess, just can you provide some context around that and how we should think about that going forward?

Rick Brooks

We said mid-single-digit I think in a lot of the previous quarters, Dave, so, hey, by 4% or 5% is still mid-single-digit I think as we had previously. So I'm not sure that's going to change in terms of how we think about the guidance, and again, I don't know how the rest of back-to-school has turned out. Again, I'm not omniscient in that sense, right? We need to see it play out. So I think that we reflect what we believe now and then we see what happens. And I think that's kind of how we set the guidance, how we think about it, and we need to see how it plays out over the next few weeks.

Dave Kang – Roth Capital Partners

Yeah, fair enough. And then, Rick, I noticed in the release there was no material number of new stores planned for Europe this fiscal year, but maybe if you look out going forward, have you had a chance to look at all the total market opportunity or do you have a better sense of that and given any thought to how we should think about kind of future growth there and build-out plans for next year, et cetera?

Rick Brooks

We're not ready to talk about that in detail at this point, Dave. We clearly have, and in fact as you would anticipate, we had done a lot of work in advance of getting involved with Blue Tomato and have worked particularly in the large markets in Europe at looking what the potential is in each of the large markets, particularly Germany and France. So we've actually been working quite now probably for the last 18 months on that project and looking at that. So I think we have a good idea of what particularly in Germany and France the capacity for that market is for locations.

But as we said in the script, this is something we want to, again, in our world, our Blue Tomato team is going to lead the charge there. They're the empowered ones in our world, and again they share our value set, they share our culture. So we’re working with them, again, as we said in the script, to build out, to take their growth plans and to add to it our joint thinking about where we think we can go and what the potential is.

Now it will be different, I can tell you that, as we think about what stores will look like in Europe. I mean there'll be some markets that will be much more driven towards street stores, because that’s the nature of the market. There simply aren’t many malls structure and there'll be other markets that will be more mall-driven, because that’s the nature of those markets. So I think -- and then, of course, we have to also look at the density of the population in Europe, which is different than it is here in the US. So, all these factors will contribute to our end-strategy as to how we think about growing units in Europe.

And again, we're far too early at this point to draw any conclusions. We have some ideas. We've done a lot of research. But we also have some experts in doing business in Europe in our Blue Tomato partners who happen to have a very large e-commerce business, which is a huge advantage for us in Europe, because we know where their customers are, and as I think we know from our previous releases about Blue Tomato, is they have done an exceptional job of internationalizing their website. And their website, they sell in 14 different languages.

So they have done a great job of helping build that roadmap for us I think as we think about the long-term growth for physical stores, brick-and-mortar stores. And again, we're going to work together with them and they're going to be a big driver of the thought process here about how we do that and where we go and why we go there, and then of course eventually how that leads into omni-channel strategies also.

So, a lot more come Dave, is basically the upshot. We don't have anything to tell you at this point. But that's kind of how we're thinking right now.

Dave Kang – Roth Capital Partners

No, that's all extremely helpful. I mean, is it fair to assume then that maybe we'd get that a few months down the road, you think it's more of a next year kind of thing where you start to have some numbers you can kind of give us around that or is it --

Rick Brooks

I think it will be more of a next year, and again this is going to be a multiyear evolution here as we think about building our business. And Blue Tomato have some very successful stores today, but we need to continue to learn and build off of their knowledge base and incorporate our expertise because we're pretty good at opening stores on our side. So this is where again, I think as you said in the call, there is opportunity for us to leverage each of the strengths in the process of working together.

So, a lot more to come. We will have more to say, obviously, as we get to next year, and of course we need to build the plan out and get -- involve our Board and their thinking about how their expertise and as we think about building this business too. But when we do talk about it, we're going to talk about it on a long-term basis and not just about next year, but what we think we can do over the long-term.

Operator

Your next question is from the line of Jeff VanSinderen with B. Riley. Please go ahead.

Jeff VanSinderen – B. Riley & Co.

Rick, to what you attribute the big jump in week four this year versus last year? And also, I would assume transaction count was up in week four. How do you think about that? And does your Q3 guidance assume the transaction count is up, or what timeframe are you thinking about there?

Rick Brooks

I'm not going to get down to that level of detail, Jeff. But clearly as we view what's going on in week four, is again as we've talked about earlier in the call, it's a number of factors moving these trends towards later back-to-school shopping. I mean, consumers are very smart. They know that deals get better the longer they wait.

There is also this trend I think that everyone has seen, is that not only does your shopping peak only now right before schools go back, but the peak extends after schools go back in each market. And we can measure that because we can look at -- we know for every location we have out there, when their schools are going back, we measure the plus-and-minuses from that date on every location we have in the marketplace. So we can see that post back-to-school the buying continues.

So we're definitely seeing those continuing shifts, Jeff, as they play out. And as I said too earlier, we've seen that just the overall importance of the four weeks of August, the first two weeks of September has been declining over all our business, and that gets to the nature of the world nowadays of the empowered consumers, smartphones, mobile devices. Kids want to know what's hot now and then they'll come buy it now.

So we definitely are believing that things are changing that the dollars aren't as constant as they once were and they're extending into the rest of the year. I think that's a long-term trend, Jeff, that we're going to continue to see over the next five and ten years of our business, that back-to-school continue to shift much like holiday has in to a certain extent over the last decade, shift to just at the peak and back-to-school right after the school goes back. And then we're going to see the spending spread out based upon, you know, kids want that new brand when it's new and when it’s viral, when it hits their smartphone and they see it, they want you to have it then and buy it then, and they’re not going to wait till August to do it.

So, those are the kinds of things I think that we expect to see on a long-term basis. Those kind of trends continue to slowly play out over the next five and ten years.

Now, I don’t want to get too detailed about week four, but obviously when you run up to 17.5 comp, yes, you run a transaction gain. The logic just tells you, you have to, based upon the fact of how we talked about the business against the 370 comp for the whole period.

So, yes, it was a transaction gain. There was an AUR gain in that window. So we'll see how it turns out. Again we’ll be able to tell you that a little bit more as we get through September, but at this point we just have let it play out.

Jeff VanSinderen – B. Riley & Co.

Okay. And then a clarification on promotional levels this year versus last year, did you say that your overall promotional level was down in Q2 versus last year? And then I guess maybe how would you characterize the promotional backdrop this year versus last year for back-to-school? Do you feel that promotional levels have eased in your niche versus last year? And then also any planned change in your overall promotional levels in Q3 this year versus last year?

Rick Brooks

Okay. As it relates to Q2, obviously, as we know, we've got a pretty decent improvement in gross margin percentage. So we think about promotional levels in multiple ways. Again, our goal is to be able to have exactly what every location needs for their customer base, right, so -- and the right mix of product and the right mix of categories. And that’s the Holy Grail of any retailer.

And we are certainly not perfect at it, to say the least, but we’re working towards making that better and better all the time, and we have a long ways to go on that front. But our goal is to be a full-price retailer, and because we represent brands that have value, brands that have equity, brands our consumers want to buy. And so we hope to be a full-price retailer, Jeff.

Now, that being said, there are certain categories of products that brands don't mean much in certain categories in our business. So in those areas then, what we try to do is we try to plan that business so that we can sell the product at the right value to the consumer but yet maintain a very healthy margin in the business. And those are categories that private label will naturally play a bigger part of our business.

So, when we think about that and when you look at promotions in our business as we plan them, many of what you see in our stores are planned promotions, things we plan to do, rounders as we plan to feed at those price points that have -- that show value to our consumer but yet reflect a good margin performance for us.

So, again, our business is kind of unique I think because we're again so brand diverse, so category diverse relative to most of our competitors. So, as we look into Q3, I mean I'm not sure that again we see a significant change in our promotional cadence. I think, as I think been talked about here earlier in the call, I think one of the other analysts called it out, that we seem to be less promotional. I think that would be true than a lot of our competitors. And I would characterize the competitive environment as continuing to be very competitive promotionally, particularly in denim. I think that's pretty obvious to everybody. I would have hoped it wouldn’t be as promotional, but that's clearly they play out that way, and unfortunately our buyers didn't plan it that way. So we expected it from a product perspective to be a promotional environment on key categories, some key categories, in particular denim.

Operator

Your next question is from the line of Paul Alexander with Bank of America Merrill Lynch. Please go ahead.

Paul Alexander – Bank of America Merrill Lynch

Hi. Thank you. Can you discuss your new store opening plans for 2013 yet? And is it too early to talk about that number of stores? Maybe if you could just talk about the real estate environment and your 8% to 10% annual domestic store growth number and how that that projection of goal might change over time as your chain gets closer to ultimate potential? Then, are you seeing any kind of change in the maturity curve you're seeing from young stores? Thanks.

Rick Brooks

Okay. There's a lot there, Paul. So let me take a shot at it. No, we're not prepared to talk about our plans for 2013 at this point. Actually probably won't come out with what we believe we're going to do there until our March discussion, after we share with you the yearend results. So I'm not going to talk about that at this point.

Obviously, we are preparing making deals at this point. We're a long way through thinking about the plan and working with landlords, which takes me to the secondly part of your question relative to the real estate environment. We have great partners in our landlords and we always appreciate their support in helping us with our business. But I can tell you that in the real estate world, that doesn't mean that doing deals is easy. Our landlords, they are good partners for us, but they have high expectation of their performance too. So we're always on the look way out as we think about deals and structuring deals, and you have to look at a lot of deals to get the deals you want done.

And so our landlords are as tough as ever, is what I would tell you, and kind of always, as you would expect, bifurcates into two kinds of centers, centers where the landlord has a leverage and centers where we have the leverage. And then of course we try to work both those together to get deals on both sides that are good for both of us, right, and where we could help each other out in terms of that overall meeting our both sides’ economic needs on the real estate deal.

So, I'd characterize the environment, Jeff, as similar to what it’s always been, which is landlords are tough, and they certainly need to achieve their objective as we have to achieve ours. And that's why deal-making takes so long for us to do.

Maturity curve of our new stores, I think we feel good about where we're at. I don't think there's been any major change in the curve itself. So we're basically satisfied. We feel good about where we're at. And again that's something by the way we look at on a regular basis, that our Board reviews on a regular basis, for how are those new store performing. We do it by class. We look back over the last four and five years how those classes are trending.

So we feel good about it. I don't think there's been any major change really. Really the major change was in 2007 and 2008 related to the recession. Those stores got worse. But since then we've actually been back to more of our historical levels of maturity curve for new stores.

Lastly, as it relates to the 8% to 10% growth rate, we're not prepared to talk about that at this point. I think that's a very complicated question. As we said in the script, we are constantly in the process of looking and thinking about our current existing portfolio of stores as well as what we view as what the mature portfolio, what the potential stores yet to be done looks like. And that's what we'll be involved over the next five years, Paul.

So I think that's something that we're always thinking about. We're thinking about more than 2013. We're thinking about that as it relates to the next five years, what that's going to look like. We have to think about what that looks like relative to the growth in Canada and what ultimately our plan will be for growth in Europe.

So, very complicated, in terms of our thought processes there, and so I won't tell you that we're expecting potentially any major change for 2013, but I will tell you that's something that's constantly being thought about, assessed and evaluated relative to all of our growth objectives.

Paul Alexander – Bank of America Merrill Lynch

That's helpful. Thank you very much.

Operator

Your final question today comes from the line of Simon Siegel with JPMorgan. Please go ahead.

Simon Siegel – JPMorgan

Thanks. So, Chris, how are you going to account for Blue Tomato in the comp calculations? I assume the 3% to 5% doesn’t include the Blue Tomato. So, maybe can you share the implied store related comps you guys are using to get to that third quarter sales range?

And then, sorry to belabor the point, I'm just trying to understand the implied overall gross margin guidance for the third quarter. So I think your gross margin compares eased in the back half. I thought you should be getting some gross margin lift from Blue Tomato, because I think we had said that that was accretive on the gross margin line at least. So, if you guys could talk about the consolidated assumption for the gross margin, that might be a little helpful?

Rick Brooks

Well, let me start, and then I'll let Chris add some comments to -- a little bit more probably more detailed than I'll give you. But clearly the 3% to 5% does not include the Blue Tomato. And typically, as we’ve managed acquisitions previously, particularly the Fast Forward one, we want to begin including Blue Tomato’s results in the comparative numbers until we anniversary the acquisition next July. So, going forward -- looking forward, when we talk about our guidance and future comp projections, they will not include any of the Blue Tomato data. That will be included in the overall total as if they were new locations. So that’s how we think about the comp side of the business.

The margin side of the business, again, I’ll let Chris give you a little bit more color around it, particularly again when we revisit it a little bit on Q3 Chris as we think by then the implication of that for Q4. But again there are some of these intangibles that hit this and particularly the inventory step up basis that will hit that are going to affect the overall gross margin and that’s why when we gave you the guidance, we broke it out between saying the guidance for our margin excluded the impact of Blue Tomato particularly because of the stepped up base of the inventory for the purchase accounting here in Q3. Chris you want to give a little bit more color?

Chris Work

Yes, we had two items impacting our margin in Q2. They were sort of one-time in nature. The move cost as well as the inventory step up that we mentioned. Now as you forecast into Q3, the move costs we believe are behind us, but you do have a fairly significant impact from the inventory step up. I think we said earlier in the call about $1.4 million.

So as you are looking into Q3, we're going to have some -- up against us a stiff increase there, related to this kind of one-time in nature challenge. Additionally, as we look in the back half of the year as we mentioned earlier, our 2011 margins were strong and I think that's given us reasonable thought process as we look to the back half of the year to plan accordingly and to plan margins mostly flat on the back half.

Simon Siegel – JPMorgan

Right. Thanks. And so just on the first part of the question, so, can you share with us what you're thinking in terms of the store related comps within that 3% to 5%, where you're seeing those?

Rick Brooks

No, we're not going to get down -- you mean in terms of product categories or regional or?

Simon Siegel – JPMorgan

Yes, so just -- since you guys included the -- you included that online segment within there -- so the online within the Blue Tomato won't go until next year as well. So I'm just trying to think about from pure store level comp what we can be thinking about in terms of the trends.

Rick Brooks

I have to tell you, we need to break you guys of this habit of asking about there's -- we want to know about relative to channel or pure stores versus e-commerce. It's an omni-channel world, and as we've said over the last number of quarters, we are attacking this idea, we're embracing this idea of an omni-channel environment. And we need to think about these as on an overall basis because they're very, very integrated. And you're going to see us integrate these channels much more closely over the next year and the years after that.

So I'm not going to get into talk about how that breaks now between what are stores and what's what, because it misses the point of that, that these are integrated channels going forward. They integrate today. They're going to be more tightly integrated going forward both for back half of this year and for the next few years, to the point where I'm not sure I'm going to be able to tell you in future what's driving volume and transaction in stores and what's driving volume and transactions online because they're going to be that tightly integrated. The consumer gets to choose and all that's important is that we're in every channel they want and the way they want us, with a great brand experience and the product they want.

So that's the reason we're not going to parse that because in our world already, that's a question that isn't as relevant as it was four years ago, and it's going to become less and less relevant and less and less of a distinction as we look forward.

Simon Siegel – JPMorgan

Got it. All right. Good luck in the fall.

Rick Brooks

Thank you very much.

Operator

And I'd now like to turn the call back over to management for some closing remarks.

Rick Brooks

All right. Thank you, everybody. We really appreciate your time today. We realize this was -- Q2 was a bit of a challenging quarter to understand all the moving parts. So we appreciate your time and attention to the details. Thank you very much for that. And we look forward to talking to you as we wrap up the Q3 results in late November. Thanks, everybody.

Operator

Ladies and gentlemen, that will conclude today's conference. Thank you very much for joining us. You may now disconnect, and have a great day.

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