**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C.**

 

**FORM 10-Q**

 
| **x**  | ** ** | **QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934 FOR THE QUARTERLY PERIOD ENDED MAY 3, 2008** |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |       |                                                                                                                                                    |
| **OR** |
|   |       |                                                                                                                                                    |
| **o**  | ** ** | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                |

 

**Commissionfile number 000-51300**

 

**ZUMIEZINC.**

(Exact name ofregistrant as specified in its charter)

 

| **Washington**                   | ** ** | **91-1040022**                        |
|----------------------------------|------------|---------------------------------------|
| (State or other jurisdiction  of |       | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)  |       |                                  |

 

**6300Merrill Creek Parkway, Suite B, Everett, WA 98203**

(Address ofprincipal executive offices)  (Zip Code)

 

Registrant’stelephone number, including area code:**  (425) 551-1500**

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes  x   No   o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company.  See definition of “accelerated filer andlarge accelerated filer in Rule 12b-2 of the Exchange Act).  (Check one):

 

Large accelerated filer  o          Acceleratedfiler  x          Non-acceleratedfiler  o          Smallerreporting company  o

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  o Yes   x  No

 

Number of shares ofCommon Stock outstanding as of May 30, 2008 was 29,306,632 shares.

 

 

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**ZUMIEZINC.**

**FORM 10-Q**

**TABLE OFCONTENTS**

 
| Part I.      | Financial Information |                                                                                                                              |
|-------------------|-----------------------|-----------------------------------------------------------------------------------------------------------------------------------|
|              |                  |                                                                                                                              |   |
|              | Item 1.               | Condensed Consolidated Financial Statements                                                                                       |   |
|              |                  |                                                                                                                              |   |
|              |                  | Condensed Consolidated Balance Sheets at May 3,  2008 (unaudited) and February 2, 2008                                  |   |
|              |                  |                                                                                                                              |   |
|              |                  | Condensed Consolidated Statements of Operations for the  three months ended May 3, 2008 and May 5, 2007 (unaudited)     |   |
|              |                  |                                                                                                                              |   |
|              |                  | Condensed Consolidated Statement of Changes in  Shareholders’ Equity for the three months ended May 3, 2008 (unaudited) |   |
|              |                  |                                                                                                                              |   |
|              |                  | Condensed Consolidated Statements of Cash Flows for  the three months ended May 3, 2008 and May 5, 2007 (unaudited)     |   |
|              |                  |                                                                                                                              |   |
|              |                  | Notes to Condensed Consolidated Financial Statements                                                                              |   |
|              |                  |                                                                                                                              |   |
|              | Item 2.               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                       |   |
|              |                  |                                                                                                                              |   |
|              | Item 3.               | Quantitative  and Qualitative Disclosures About Market Risk                                                                       |   |
|              |                  |                                                                                                                              |   |
|              | Item 4.               | Controls and  Procedures                                                                                                          |   |
|              |                  |                                                                                                                              |   |
| Part II.     | Other Information     |                                                                                                                              |
|              |                  |                                                                                                                              |   |
|              | Item 1.               | Legal Proceedings                                                                                                                 |   |
|              |                  |                                                                                                                              |   |
|              | Item  1A.             | Risk  Factors                                                                                                                     |   |
|              |                  |                                                                                                                              |   |
|              | Item 2.               | Changes in  Securities; Use of Proceeds and Issuer Purchases of Equity Securities                                                 |   |
|              |                  |                                                                                                                              |   |
|              | Item 3.               | Defaults  Upon Senior Securities                                                                                                  |   |
|              |                  |                                                                                                                              |   |
|              | Item 4.               | Submission  of Matters to a Vote of Security Holders                                                                              |   |
|              |                  |                                                                                                                              |   |
|              | Item 5.               | Other Information                                                                                                                 |   |
|              |                  |                                                                                                                              |   |
|              | Item  6.              | Exhibits                                                                                                                          |   |
|              |                  |                                                                                                                              |   |
| Signatures        |                  |                                                                                                                              |   |
|              |                  |                                                                                                                              |   |
| Exhibit 31.1 |                  |                                                                                                                              |   |
|              |                  |                                                                                                                              |   |
| Exhibit 31.2 |                  |                                                                                                                              |   |
|              |                  |                                                                                                                              |   |
| Exhibit 32.1 |                  |                                                                                                                              |   |

 

2

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**ZUMIEZ INC.****CONDENSED CONSOLIDATED BALANCE SHEETS****(in thousands, except share amounts)**

 
| ** **                                                                                                                                                                                        | ** ** | **May 3, 2008** | ** ** | **February 2, 2008** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|---------------------------|------------|
| ** **                                                                                                                                                                                        | ** ** | **(Unaudited)**      | ** ** | ** **                | ** ** |
| **Assets**                                                                                                                                                                                        | ** ** | ** **           | ** ** | ** **                | ** ** |
| **Current assets**                                                                                                                                                                                | ** ** | ** **           | ** ** | ** **                | ** ** |
| Cash and cash equivalents                                                                                                                                                                         |       | $                    | 7,622      |                      | $          | 11,945 |   |
| Marketable securities                                                                                                                                                                             |       | 58,565               |       | 64,587                    |       |
| Receivables                                                                                                                                                                                       |       | 6,315                |       | 4,775                     |       |
| Inventory                                                                                                                                                                                         |       | 58,654               |       | 48,721                    |       |
| Prepaid expenses and other                                                                                                                                                                        |       | 4,815                |       | 4,440                     |       |
| Deferred tax assets                                                                                                                                                                               |       | 2,758                |       | 1,089                     |       |
| **Total  current assets**                                                                                                                                                                         |       | 138,729              |       | 135,557                   |       |
| ** **                                                                                                                                                                                        | ** ** | ** **           | ** ** | ** **                | ** ** |
| Leasehold improvements and equipment, net                                                                                                                                                         |       | 71,056               |       | 65,937                    |       |
| Goodwill                                                                                                                                                                                          |       | 13,154               |       | 13,154                    |       |
| Marketable securities - long-term                                                                                                                                                                 |       | 2,000                |       | —                    |       |
| Deferred tax assets                                                                                                                                                                               |       | 1,631                |       | 1,447                     |       |
| **Total  long-term assets**                                                                                                                                                                       |       | 87,841               |       | 80,538                    |       |
|                                                                                                                                                                                              |       |                 |       |                      |       |
| **Total  assets**                                                                                                                                                                                 |       | $                    | 226,570    |                      | $          | 216,095 |   |
|                                                                                                                                                                                              |       |                 |       |                      |       |
| **Liabilities  and Shareholders’ Equity**                                                                                                                                                    | ** ** | ** **           | ** ** | ** **                | ** ** |
| **Current liabilities**                                                                                                                                                                           | ** ** | ** **           | ** ** | ** **                | ** ** |
| Trade accounts payable                                                                                                                                                                            |       | $                    | 33,769     |                      | $          | 19,672 |   |
| Book overdraft                                                                                                                                                                                    |       | —               |       | 7,384                     |       |
| Accrued payroll and payroll taxes                                                                                                                                                                 |       | 3,772                |       | 5,097                     |       |
| Income taxes payable                                                                                                                                                                              |       | 1,121                |       | 47                        |       |
| Current portion of deferred rent and tenant  allowances                                                                                                                                           |       | 2,424                |       | 2,136                     |       |
| Other accrued liabilities                                                                                                                                                                         |       | 7,906                |       | 9,060                     |       |
| **Total  current liabilities**                                                                                                                                                                    |       | 48,992               |       | 43,396                    |       |
| ** **                                                                                                                                                                                        | ** ** | ** **           | ** ** | ** **                | ** ** |
| Long-term deferred rent and tenant allowances, less  current portion                                                                                                                              |       | 20,475               |       | 18,097                    |       |
| **Total  liabilities**                                                                                                                                                                            |       | 69,467               |       | 61,493                    |       |
| Commitments and contingencies (Note 3)                                                                                                                                                            |       |                 |       |                      |       |
| ** **                                                                                                                                                                                        | ** ** | ** **           | ** ** | ** **                | ** ** |
| **Shareholders’ equity**                                                                                                                                                                     | ** ** | ** **           | ** ** | ** **                | ** ** |
| Preferred stock, no par value, 40,000,000 shares  authorized; none issued and outstanding                                                                                                         |       | —               |       | —                    |       |
| Common stock, no par value, 100,000,000 shares  authorized; 29,306,632 shares issued and outstanding at May 3, 2008,  29,002,852 shares issued and outstanding at February 2, 2008 |       | 70,739               |       | 69,297                    |       |
| Accumulated other comprehensive income                                                                                                                                                            |       | 161                  |       | 464                       |       |
| Retained earnings                                                                                                                                                                                 |       | 86,203               |       | 84,841                    |       |
| **Total  shareholders’ equity**                                                                                                                                                              |       | 157,103              |       | 154,602                   |       |
| ** **                                                                                                                                                                                        | ** ** | ** **           | ** ** | ** **                | ** ** |
| **Total  liabilities and shareholders’ equity**                                                                                                                                              |       | $                    | 226,570    |                      | $          | 216,095 |   |

 

See accompanyingnotes to condensed consolidated financial statements

 

3

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**ZUMIEZ INC.**** CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS****(in thousands, except share and per share amounts)****(Unaudited)**

 
| ** **                                                          | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                          | ** ** | **May 3, 2008**        | ** ** | **May 5, 2007** | ** ** |
| Net sales                                                           |       | $                           | 78,702     |   | $ | 68,791 |   |
| Cost of goods sold                                                  |       | 54,142                      |       | 47,070 |   |
| **Gross profit**                                                    |       | 24,560                      |       | 21,721 |   |
|                                                                |       |                        |       |   |   |
| Selling, general and administrative expenses                        |       | 22,934                      |       | 19,538 |   |
| **Operating profit**                                                |       | 1,626                       |       | 2,183 |   |
|                                                                |       |                        |       |   |   |
| Interest income, net                                                |       | 589                         |       | 426 |   |
| Other income (expense)                                              |       | —                      |       | (1 | ) |
| **Earnings before income taxes**                                    |       | 2,215                       |       | 2,608 |   |
|                                                                |       |                        |       |   |   |
| Provision for income taxes                                          |       | 853                         |       | 991 |   |
|                                                                |       |                        |       |   |   |
| **Net income**                                                      |       | $                           | 1,362      |   | $ | 1,617 |   |
|                                                                |       |                        |       |   |   |
| Basic net income per share                                          |       | $                           | 0.05       |   | $ | 0.06 |   |
|                                                                |       |                        |       |   |   |
| Diluted net income per share                                        |       | $                           | 0.05       |   | $ | 0.06 |   |
|                                                                |       |                        |       |   |   |
| Weighted average shares used in computation of  earnings per share: |       |                        |       |   |   |
| Basic                                                               |       | 29,012,733                  |       | 27,975,278 |   |
|                                                                |       |                        |       |   |   |
| Diluted                                                             |       | 29,352,350                  |       | 29,008,312 |   |

 

See accompanyingnotes to condensed consolidated financial statements

 

4

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**ZUMIEZ INC.****CONDENSED CONSOLIDATED STATEMENT OF CHANGES INSHAREHOLDERS’ EQUITY****(in thousands)****(Unaudited)**

 
| ** **                                         | ** ** | ** **            | ** ** | ** **        | ** ** | **Accumulated**   | ** ** | ** **   | ** ** | ** ** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|-------------------|------------|-------------------|------------|--------------|------------|------------|------------|
| ** **                                         | ** ** | **Common Stock** | ** ** | **Comprehensive** | ** ** | **Retained**      | ** ** | ** **   | ** ** |
| ** **                                         | ** ** | **Shares**            | ** ** | **Amount**        | ** ** | **Income (Loss)** | ** ** | **Earnings** | ** ** | **Total**  | ** ** |
| **Balance at February 2, 2008**               |       | 29,003                |       | $                 | 69,297     |              | $          | 464          |       | $          | 84,841     |   | $ | 154,602 |   |
| Common shares  issued including tax benefit of $50 |       | 304                   |       | 451               |       | —            |       | —       |       | 451        |       |
| Stock-based compensation expense                   |       | —                |       | 991               |       | —            |       | —       |       | 991        |       |
| Unrealized losses, net                             |       | —                |       | —            |       | (303              | )          | —       |       | (303       | )          |
| Net income                                         |       | —                |       | —            |       | —            |       | 1,362        |       | 1,362      |       |
| **Balance at May 3, 2008**                    |       | 29,307                |       | $                 | 70,739     |              | $          | 161          |       | $          | 86,203     |   | $ | 157,103 |   |

 

See accompanyingnotes to condensed consolidated financial statements

 

5

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** **

**ZUMIEZ INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(in thousands)**

**(Unaudited)**

 
| ** **                                                                                   | ** ** | **For the Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                   | ** ** | **May 3, 2008**           | ** ** | **May 5, 2007** | ** ** |
| **Cash flows from operating activities:**                                                    | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net income                                                                                   |       | $                              | 1,362      |   | $ | 1,617 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities: |       |                           |       |   |   |
| Depreciation and amortization                                                                |       | 4,397                          |       | 3,220 |   |
| Deferred tax expense                                                                         |       | (1,951                         | )          | (682 | ) |
| Stock-based compensation expense                                                             |       | 991                            |       | 807 |   |
| Loss on disposal of assets                                                                   |       | 23                             |       | 11 |   |
| Excess tax benefit from stock options                                                        |       | (50                            | )          | (7,247 | ) |
| Changes in  operating assets and liabilities:                                                |       |                           |       |   |   |
| Receivables                                                                                  |       | (1,540                         | )          | 102 |   |
| Inventory                                                                                    |       | (9,933                         | )          | (6,331 | ) |
| Prepaid expenses  and other                                                                  |       | (375                           | )          | (10 | ) |
| Trade accounts  payable                                                                      |       | 14,097                         |       | 2,469 |   |
| Accrued payroll  and payroll taxes                                                           |       | (1,325                         | )          | (1,034 | ) |
| Income taxes  payable                                                                        |       | 1,124                          |       | (5,210 | ) |
| Other accrued  liabilities                                                                   |       | (1,154                         | )          | (338 | ) |
| Deferred rent  and tenant allowances                                                         |       | 2,666                          |       | 2,222 |   |
| **Net cash provided by (used in) operating  activities**                                     |       | 8,332                          |       | (10,404 | ) |
|                                                                                         |       |                           |       |   |   |
| **Cash flows from investing activities:**                                                    | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Additions to leasehold improvements and equipment                                            |       | (9,372                         | )          | (8,771 | ) |
| Purchases of marketable securities                                                           |       | (34,100                        | )          | (24,876 | ) |
| Sales and maturities of marketable securities                                                |       | 37,750                         |       | 36,506 |   |
| **Net cash provided by (used in) investing  activities**                                     |       | (5,722                         | )          | 2,859 |   |
|                                                                                         |       |                           |       |   |   |
| **Cash flows from financing activities:**                                                    | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Change in book overdraft                                                                     |       | (7,384                         | )          | (3,327 | ) |
| Proceeds from exercise of stock options                                                      |       | 401                            |       | 1,291 |   |
| Excess tax benefit from stock options                                                        |       | 50                             |       | 7,247 |   |
| **Net cash provided by (used in) financing  activities**                                     |       | (6,933                         | )          | 5,211 |   |
|                                                                                         |       |                           |       |   |   |
| **Net decrease in cash and cash equivalents**                                                |       | (4,323                         | )          | (2,334 | ) |
| **Cash and cash equivalents, beginning of period**                                           |       | 11,945                         |       | 8,161 |   |
| **Cash and cash equivalents, end of period**                                                 |       | $                              | 7,622      |   | $ | 5,827 |   |
|                                                                                         |       |                           |       |   |   |
| **Supplemental disclosure on cash flow  information:**                                       | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Cash paid during  the period for interest                                                    |       | $                              | 9          |   | $ | 1 |   |
| Cash paid during  the period for income taxes                                                |       | 1,682                          |       | 7,020 |   |

 

See accompanying notes to condensed consolidatedfinancial statements

 

6

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**ZUMIEZINC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**1. Nature of Business and Basisof Presentation**

 

**Basis of Presentation—**The accompanying unaudited  condensed consolidated  financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”) for interim financial information and with the instructionsto Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by GAAP for complete financial statements.

 

In the opinion ofmanagement, the unaudited condensed consolidated financial statements containall adjustments, consisting of normal recurring adjustments, necessary for afair presentation of the condensed consolidated balance sheet as of May 3,2008, the condensed consolidated statements of operations for the three monthsended May 3, 2008 and May 5, 2007, the condensed consolidatedstatement of changes in shareholders’ equity for the three months ended May 3,2008 and the condensed consolidated statements of cash flows for the threemonths ended May 3, 2008 and May 5, 2007.

 

The financial data at February 2,2008 is derived from audited financial statements which are included in theCompany’s Annual Report on Form 10-K for the year ended February 2,2008, and should be read in conjunction with the audited financial statementsand notes thereto.  Interim results arenot necessarily indicative of results for the full year.

 

**Principles of Consolidation*****—***The unaudited  condensed consolidated financial statementsinclude the accounts of Zumiez Inc. and its subsidiary, Zumiez Nevada, LLC,(collectively, “the Company”).  Allsignificant inter-company transactions and balances are eliminated in consolidation.

 

**Use of Estimates*****—***The preparation of financial statementsin conformity with GAAP requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and the disclosureof contingent assets and liabilities at the date of the financial statements aswell as the reported amounts of revenues and expenses during the reportingperiod.  These estimates can also affectsupplemental information disclosed by the Company, including information aboutcontingencies, risk, and financial condition. In preparing the financial statements, the Company makes routineestimates and judgments in determining the net realizable value of accountsreceivable, inventory, fixed assets, prepaid assets, goodwill and certainliabilities.  Some of the moresignificant estimates include the allowance for sales returns, the reserve forinventory valuation estimates and the expected useful lives of fixedassets.  Actual results could differ fromthose estimates.  The results ofoperations for the three months ending May 3, 2008 are not necessarilyindicative of the results that might be expected for fiscal 2008.  For further information, refer to the Company’sfinancial statements and notes included in the Company’s Form 10-K filedon March 25, 2008.

 

**Nature of Business—**The Company is a leading specialtyretailer of action sports related apparel, footwear, equipment and accessoriesoperating under the Zumiez brand name. As of May 3, 2008, the Company operated 306 stores primarilylocated in shopping malls, giving the Company a presence in 28 states.  The Company’s stores cater to young men andwomen between the ages of 12 and 24 who seek brands representing a lifestylecentered on activities that include skateboarding, surfing, snowboarding, bicyclemotocross (or “BMX”) and motocross.  TheCompany supports the action sports lifestyle and promotes its brand through amulti-faceted marketing approach that is designed to integrate its brand imagewith its customers’ activities and interests. In addition, the Company operates a website that sells merchandiseonline and provides content and a community for its target customers.  The Company, based in Everett, WA, was formedin August 1978 and operates within one reportable segment.

 

**Fiscal Year—**The Company uses a fiscal calendar widelyused by the retail industry which results in a fiscal year consisting of a52-week or 53-week period ending on the Saturday closest to January 31.  Each fiscal year consists of four 13-weekquarters, with an extra week added to the fourth quarter every five or sixyears.  “Fiscal 2007” was the 52-weekperiod ended February 2, 2008.  Thefirst three months of fiscal 2008 was the 13-week period ended May 3,2008.  The first three months of fiscal2007 was the 13-week period ended May 5, 2007.  “Fiscal 2008” is the 52-week period ending January 31,2009.

 

7

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**Revision to Previously IssuedStatements of Cash Flows—**Prior to the second quarter of fiscal 2007 the Companyclassified tenant allowances received from landlords as a reduction ofleasehold improvements and equipment in the cash flows from investingactivities section of the statements of cash flows.  The appropriate classification is to includetenant allowances in deferred rent, which is included in net cash provided byor used in operating activities.  For thethree months ended May 5, 2007, we have corrected the classification oftenant allowances in the statement of cash flows.  The effect of this adjustment is to decreasecash provided by investing activities by $2.6 million and to decrease net cashflow used in operating activities by $2.6 million.  There was no impact on the net increase incash and cash equivalents on the statement of cash flows.

 

In addition, for thethree months ended May 5, 2007, we have corrected the classification ofchanges in income tax receivable from changes in receivables to changes inincome tax payable of $5.9 million to conform with the three months ended May 3,2008 and fiscal 2007 presentations. There was no impact on cash used in operations for the three monthsended May 5, 2007 or on the net decrease in cash and cash equivalents onthe statements of cash flows.  TheCompany has determined these adjustments are not material to the condensedconsolidated financial statements.

 

**2. Summary of SignificantAccounting Policies**

 

Information regarding theCompany’s significant accounting policies is contained in Note 2, “Summary ofSignificant Accounting Policies,” to the consolidated financial statements inthe Company’s Form 10-K filed on March 25, 2008.  Presented below in this note and thefollowing notes is supplemental information that should be read in conjunctionwith “Notes to Consolidated Financial Statements” in that annual report.

 

**Marketable Securities—**At May 3, 2008, marketablesecurities, classified as available for sale, were $60.6 million and consistedprimarily of municipal and U.S. agency debt instruments with originalmaturities over 90 days.  As of May 3,2008, we had $2 million invested in auction rate securities, which areclassified as long-term, available-for-sale marketable securities on ourcondensed consolidated balance sheet.  Wereduced our holdings of auction rate securities during 2007 through the auctionprocess.

 

Auction rate securitiesare generally long-term debt instruments that provide liquidity through a Dutchauction process that resets the applicable interest rate at pre-determinedcalendar intervals.  This mechanism generallyallows existing investors to rollover their holdings and continue to own theirrespective securities or liquidate their holdings by selling their securitiesat par value.  We generally invested inthese securities for short periods of time as part of our cash managementprogram.  However, the recentuncertainties in the credit markets have prevented us and other investors fromliquidating holdings of auction rate securities in recent auctions for thesesecurities because the amount of securities submitted for sale has exceeded theamount of purchase orders.  Should theauctions continue to fail, we anticipate we have the ability to hold thesesecurities until the liquidity in the market improves.  These investments are fully collateralized bythe United States government and are insured against loss of principal andinterest by a bond insurer whose credit ratings are under review.  If the credit ratings of the issuer, the bondinsurers or the collateral deteriorate, we may adjust the carrying value ofthese investments.  Although we areuncertain as to when the liquidity issues relating to these investments willimprove, we consider these issues to be only temporary.  Any temporary decline, if sustained, would berecognized in other comprehensive income. It is possible that declines in fair value may occur.  We continue to monitor the market for auctionrate securities and consider its impact (if any) on the fair market value ofthe investments.  If the current marketconditions deteriorate further, the Company may be required to recordunrealized losses in other comprehensive income or impairment charges in fiscal2008.

 

**Receivables—** At May 3, 2008 and February 2,2008 the Company receivables included the following:

 
| ** **                    | ** ** | **May 3, 2008** | ** ** | **February 2, 2008** | ** ** |
|-------------------------------|------------|---------------------------|------------|--------------------------------|------------|
| Tenant  allowances receivable |       | $                         | 2,489      |                           | $          | 1,334 |   |
| Credit cards  receivable      |       | 2,234                     |       | 2,108                          |       |
| Interest  receivable          |       | 704                       |       | 557                            |       |
| Vendor credits                |       | 368                       |       | 212                            |       |
| Employee  receivables         |       | 204                       |       | 257                            |       |
| Other  receivables            |       | 316                       |       | 307                            |       |
|                          |       | $                         | 6,315      |                           | $          | 4,775 |   |

 

The Company does notextend credit to its customers except through independent third-party creditcards.

 

8

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**MerchandiseInventories—**Merchandise inventories are valued at the lower of cost ormarket.  The cost of merchandiseinventories are based upon an average cost methodology.  Merchandise inventories may includeitems that have been written down to the Company’s best estimate of their netrealizable value.  The Company’sdecisions to write-down its merchandise inventories are based on its currentrate of sale, the age of the inventory and other factors.  Actual final sales prices to customersmay be higher or lower than the Company’s estimated net realizable value andcould result in a fluctuation in gross profit. Historically, any additional write-downs have not been significant tothe Company.  We have reserved forinventory as of May 3, 2008 and February 2, 2008 in the amounts ofapproximately $1.8 million and $3.0 million, respectively.  The inventory reserve includes inventorywhose estimated market value is below cost, and an estimate for inventoryshrinkage.  These reserves are evaluatedquarterly.  The inventory related tothese reserves is not marked up in subsequent periods.

 

**FairValue of Financial Instruments—**Statement of Financial Accounting Standards No. 107*“Disclosures about Fair Value of FinancialInstrument”* (“SFAS No. 107”), requires management todisclose the estimated fair value of certain assets and liabilities asfinancial instruments.  Financialinstruments are generally defined by SFAS No. 107 as cash, evidenceof ownership interest in an entity, or a contractual obligation that bothconveys to one entity a right to receive cash or other financial instrumentsfrom another entity and imposes on the other entity the obligation to delivercash or other financial instruments to the first entity.  At May 3, 2008 and February 2,2008, the carrying amounts of cash and cash equivalents, receivables, payablesand other accrued liabilities approximated fair value because of the shortmaturity of these financial instruments. The carrying value of marketable securities, approximate the fair valuebecause these financial instruments have floating interest rates, which reflectcurrent market conditions.  Contractualmaturities of investments underlying our available-for-sale securities at May 3,2008 included $2.0 million in auction rate securities.  Basedon current market conditions, auctions related to these securities may beunsuccessful at the scheduled auctions in fiscal 2009.  Unsuccessfulauctions could result in our holding securities beyond their next scheduledauction reset dates if a secondary market does not develop; therefore, limitingthe short-term liquidity of these investments.

 

**Cost of Goods Sold—**Cost of goods sold consists of the cost of merchandisesold to customers, inbound shipping costs, distribution costs, depreciation onleasehold improvements at the distribution center, buying and merchandisingcosts and store occupancy costs.  Thismay not be comparable to the way in which the Company’s competitors or otherretailers compute their cost of goods sold. In the three month period ended May 5, 2007, the Company previouslyreported shipping costs on internet sales in selling, general andadministrative expense.  During the quarterended May 5, 2007, the Company reclassified approximately $94,000 of thisexpense to costs of goods sold.

 

**Stock Compensation—**Effective January 29, 2006, theCompany adopted the fair value method of accounting for stock-basedcompensation arrangements in accordance with Financial Accounting StandardsBoard (“FASB”) Statement No. 123(R), *Share-Based Payment*(“SFAS No. 123(R)”), using the modified prospective method oftransition.  Under the provisions of SFASNo. 123(R), the estimated fair value of share-based awards granted underthe 2005 Stock Incentive Plan is recognized as compensation expense over thevesting period.  Using the modifiedprospective method, compensation expense is recognized beginning with theeffective date of adoption of SFAS No. 123(R) for all share-basedpayments (i) granted after the effective date of adoption and (ii) grantedprior to the effective date of adoption and after the Company’s initial publicoffering on May 5, 2005.  Prior to January 29,2006, the Company accounted for stock-based employee compensation plans usingthe intrinsic value method of accounting in accordance with AccountingPrinciples Board Opinion No. 25, Accounting for Stock Issued to Employees(“APB 25”), and its related interpretations. Under the provisions of APB 25, no compensation expense was recognizedwhen stock options were granted with exercise prices equal to or greater thanmarket value on the date of grant.

 

The fair value of stock option grants are estimated onthe date of grant using the Black-Scholes option pricing method with thefollowing weighted-average assumptions used for grants issued during the threemonth periods ended May 3, 2008 and May 5, 2007.

 
| ** **                         | ** ** | **For the Three Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------------------------|------------|
| ** **                         | ** ** | **May 3, 2008**                          | ** ** | **May 5, 2007** | ** ** |
| Dividend yield                     |       | —                                             | %          | — | % |
| Volatility rate                    |       | 55.20                                              | %          | 52.70 | % |
| Average expected  life (in years): |       |                                               |       |   |   |
| Expected  lives-Eight years        |       | —                                             |       | 6.38 |   |
| Expected  lives-Five years         |       | 6.50                                               |       | 6.00 |   |
| Expected  lives-Four years         |       | 6.25                                               |       | — |   |
| Average  risk-free interest rate:  |       | 2.78                                               | %          | 4.43 | % |

 

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The following table summarizes the Company’s stockoption activity for the three months ended May 3, 2008 (in thousandsexcept weighted-average exercise price):

 
| ** **                            | ** ** | **Stock Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
|---------------------------------------|------------|------------------------|------------|-----------------------------------------|------------|
| Outstanding at  February 2, 2008 |       | 1,958                  |       | $                                       | 16.29      |   |
| Granted year to  date                 |       | 155                    |       | $                                       | 14.17      |   |
| Exercised year  to date               |       | (16                    | )          | $                                       | 3.87       |   |
| Forfeited year  to date               |       | (9                     | )          | $                                       | 30.73      |   |
| Outstanding at  May 3, 2008      |       | 2,088                  |       | $                                       | 16.43      |   |
| Exercisable at  May 3, 2008      |       | 645                    |       | $                                       | 9.28       |   |

 

During the three month period ended May 3, 2008,the Company granted 155,000 stock options with a Black-Scholes weighted averagefair value of $7.83 and an exercise price of $14.17.  In connection with these grants, the Companyrecognized approximately $81,000 of stock-based compensation expense.

 

The following table summarizes the Company’srestricted stock activity for the three months ended May 3, 2008 (inthousands except weighted-average exercise price):

 
|                                  |   | **Restricted  Stock** |   | **Grant Date  Weighted  Average  Fair Value** |   |
|---------------------------------------|--------|-----------------------|--------|---------------------------------------------------------|--------|
| Outstanding at  February 2, 2008 |   | 16                    |   | $                                                       | 37.19  |   |
| Granted year to  date                 |   | 252                   |   | $                                                       | 14.06  |   |
| Exercised year  to date               |   | —                |   | $                                                       | — |   |
| Forfeited year  to date               |   | —                |   | $                                                       | — |   |
| Outstanding at  May 3, 2008      |   | 268                   |   | $                                                       | 15.44  |   |
| Exercisable at  May 3, 2008      |   | —                |   | $                                                       | — |   |

 

During the three month period ended May 3, 2008,the Company granted 252,150 shares of restricted stock to employees with aweighted average fair market value on the date of grant of $14.06 pershare.  In connection with these grants,the Company recognized approximately $108,000 in stock-based compensationexpense during the three month period ended May 3, 2008.  There were 20,000 shares of performance-basedrestricted stock included in the calculation of stock-based compensationexpense for the three months ended May 3, 2008.

 

During the first quarter of 2008, the Company issued40,000 shares of performance-based restricted stock that will vest between 0%and 100% based upon a predetermined earnings milestone.

 

The Company recorded approximately $1.0 million oftotal stock-based compensation expense for the three month period ended May 3,2008, of which approximately $0.2 million was attributable to the Board ofDirectors.  The Company recorded approximately$0.8 million of stock-based compensation for the three month period ended May 5,2007, of which approximately $0.1 million was attributable to the Board ofDirectors.  The stock-based compensationexpense is calculated 

 

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on an accelerated method for stock options and astraight-line basis for restricted stock over the vesting periods of therelated equity grant.  This charge had noimpact on the Company’s reported cash flows. For the three-month periods ended May 3, 2008 and May 5, 2007,the Company recorded approximately $41,000 in each three-month period instock-based compensation expense pursuant to APB 25.  At May 3, 2008 and February 2,2008, there was approximately $11.2 million and $9.2 million, respectively, oftotal unrecognized compensation cost related to unvested stock options andrestricted stock grants of which approximately $0.3 million and $0.5 million,respectively, was attributable to the Board of Directors.  This cost is expected to be recognized over aweighted-average period of approximately three to eight years.  The Company accounts for unvested stock-basedemployee compensation arrangements granted prior to its initial public offeringon the intrinsic value method in accordance with the provisions of APB No. 25,and related amendments and interpretations.

 

**Goodwill** — In accordance with Statement ofFinancial Accounting Standards No. 142, “*Accountingfor Goodwill and Other Intangible Assets”* (“SFAS No. 142”), theCompany does not amortize goodwill derived from purchase businesscombinations.  The Company evaluates therecoverability of goodwill annually based on a two-step impairment test.  The first step compares the fair value ofeach reporting unit with its carrying amount, including goodwill.  If the carrying amount exceeds fair value,then the second step of the impairment test is performed to measure the amountof any impairment loss.  Additionalimpairment assessments may be performed on an interim basis if the Companyencounters events or changes in circumstances that would indicate that, morelikely than not, the book value of goodwill has been impaired.  There was no impairment of goodwill in the2007 fiscal year or for the three months ended May 3, 2008.

 

**Recent accounting pronouncements—**

 

In February 2008,the Financial Accounting Standards Board (“FASB”) issued FSP No.  FAS157-2, which delays the effective date of SFAS No.157, “Fair ValueMeasurements,”**for nonfinancial assets andnonfinancial liabilities, except for items that are recognized or disclosed atfair value in the financial statements on a recurring basis (at leastannually).  Nonfinancial assets andnonfinancial liabilities would include all assets and liabilities other thanthose meeting the definition of a financial asset or financial liability asdefined in paragraph 6 of SFAS No. 159, “The Fair Value Option forFinancial Assets and Financial Liabilities.” This FASB Staff Position defers the effective date of Statement 157 tofiscal years beginning after November 15, 2008, and interim periods withinthose fiscal years for items within the scope of FSP No. FAS 157-2.  We are currently evaluating the effects, ifany, that FSP No. SFAS 157-2 may have on our condensed consolidatedfinancial statements.

 

In February 2007,the FASB issued SFAS No. 159, *“The Fair Value Option forFinancial Assets and Financial Liabilities”* including an amendmentof FASB Statement No. 115, which provides entities with an option toreport selected financial assets and liabilities at fair value.  SFAS No.159 also establishes presentation anddisclosure requirements designed to facilitate comparisons between entitiesthat choose different measurement attributes for similar types of assets andliabilities.  This statement is effectiveas of the beginning of the first fiscal year that begins after November 15,2007.  At the effective date, an entitymay elect the fair value option for eligible items that exist at thatdate.  The entity shall report the effectof the first re-measurement to fair value as a cumulative-effect adjustment tothe opening balance of retained earnings. The Company has not elected the fair value option for eligible itemsthat existed as of February 3, 2008.

 

 In December 2007, the FASB issued SFAS No. 141(revised 2007), “Business Combinations” (“SFAS No, 141(R)”), whichreplaces SFAS No. 141, *“BusinessCombinations”* (“SFAS No. 141”).  SFAS No. 141(R) retains theunderlying concepts of SFAS No. 141 in that all business combinationsare still required to be accounted for at fair value under the acquisitionmethod of accounting but SFAS No. 141(R) changed the method ofapplying the acquisition method in a number of significant aspects.  Acquisition costs will generally be expensedas incurred; non-controlling interests will be valued at fair value at theacquisition date; in-process research and development will be recorded at fairvalue as an indefinite-lived intangible asset at the acquisition date;restructuring costs associated with a business combination will generally beexpensed subsequent to the acquisition date; and changes in deferred tax assetvaluation allowances and income tax uncertainties after the acquisition dategenerally will affect income tax expense. SFAS No. 141(R) is effective on a prospective basis forall business combinations for which the acquisition date is on or after thebeginning of the first annual period subsequent to December 15, 2008, withthe exception of the accounting for valuation allowances on deferred taxes andacquired tax contingencies.  SFAS No. 141(R) amendsSFAS No. 109, “Accounting for Income Taxes,” such that adjustments made tovaluation allowances on deferred taxes and acquired tax contingenciesassociated with acquisitions that closed prior to the effective date ofSFAS No. 141(R) would also apply the provisions of SFAS No. 141(R).  Early adoption is not permitted.  We are currently evaluating the effects, ifany, that SFAS No. 141(R) may have on our condensed consolidatedfinancial 

 

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statements.  SFAS No. 141R is effective for theCompany’s fiscal year ending January 30, 2010.  We will evaluate theimpact, if any, that the adoption of SFAS No. 141R could have on ourcondensed consolidated financial statements.

 

In December 2007,the FASB issued SFAS No. 160, “*Non-controlling Interestsin Consolidated Financial Statements.*”  SFAS No. 160 amends Accounting ResearchBulletin No. 51, “Consolidated Financial Statements” and requires (i) classificationof non-controlling interests, commonly referred to as minority interests,within stockholders’ equity, (ii) net income to include the net incomeattributable to the non-controlling interest and (iii) enhanced disclosureof activity related to non-controlling interests.  SFAS No. 160 is effective for fiscalyears beginning after December 15, 2008. We will evaluate the impact, if any, that the adoption of SFAS No. 160could have on our condensed consolidated financial statements.

 

In April 2008, the FASB issued FASB StaffPosition 142-3, *Determination of the UsefulLives of Intangible Assets*(“FSP 142-3”), which amends the factorsthat should be considered in developing renewal or extension assumptions usedto determine the useful life of a recognized intangible asset under FASB No. 142,*Goodwill and Other Intangible Assets*.The intent of FSP 142-3 is to improve the consistency between the useful lifeof a recognized intangible asset under SFAS No. 142 and the period ofexpected cash flows used to measure the fair value of the asset under SFAS No. 141(R) andother U.S. generally accepted accounting principles. The Company does notexpect the adoption of FSP 142-3 to have a material effect on its consolidatedfinancial position or results of operations.

 

**3.****Commitments andContingencies**

 

L**eases**—TheCompany is committed under operating leases for all of its retail storelocations.  In addition to minimum futurelease payments, all store leases provide for additional rental payments basedon sales, as well as common area maintenance charges.  Total rent expense, base rent and contingentrent for the three month periods ended May 3, 2008 and May 5, 2007(in thousands) are as follows:

 
| ** **                         | ** ** | **For the Three Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------------------------|------------|
| ** **                         | ** ** | **May 3, 2008**                          | ** ** | **May 5, 2007** | ** ** |
| Base Rent  Expense                 |       | $                                                  | 7,030      |   | $ | 5,704 |   |
| Contingent and  Other Rent Expense |       | 4,453                                              |       | 3,620 |   |
| Total Rent  Expense                |       | $                                                  | 11,483     |   | $ | 9,324 |   |

 

**Litigation—** On December 10, 2007, a putativeclass action complaint was filed in the U.S. District Court for the WesternDistrict of Washington against the Company and certain of its current andformer directors and officers.  The complaint asserts claims underSections 10(b) and 20(a) of the Securities Exchange Act of 1934,as amended, and Rule 10b-5 promulgated thereunder. A substantially similar complaint was filed in the same court on December 14,2007.  These cases, which were subsequently consolidated, purported to bebrought on behalf of a class of purchasers of the Company’s stock during theperiod March 14, 2007 to November 7,2007.  Plaintiffs filed a consolidated amended complaint onMay 5, 2008, extending the class period to January 4, 2008, andalleging that the defendants violated the federal securities lawsduring this period of time by, among other things, makingmisrepresentations about the Company’s projected financial results in order toartificially inflate the Company’s stock price.  Plaintiffs are seekingcompensatory damages in an unspecified amount, interest, and an award ofattorneys’ fees and costs.

 

In addition, on December 20, 2007, a shareholderderivative action was filed in the Superior Court of the State of Washington(Snohomish County), allegedly on behalf of and for the benefit of the Company,against certain of the Company’s current directors and current and formerofficers.  The Company was named as a nominal defendant.  Thederivative complaint is based on the same allegations of fact as in thesecurities class action, and claims that the defendant directors and officersbreached fiduciary duties, abused their control, engaged in grossmismanagement, wasted corporate assets, unjustly enriched themselves, andengaged in insider trading.  The complaint seeks unspecified damages,restitution, disgorgement of profits, equitable and injunctive relief,attorneys’ fees, costs, and expenses.  Because the complaint is derivativein nature, it does not seek monetary damages from the Company.  However,the Company may be required throughout the pendency of the action to advancethe legal fees and costs incurred by the defendant directors andofficers.  Under the terms of its corporate bylaws and related indemnityagreements, the Company is obligated to indemnify all current and formerofficers and directors involved in civil, criminal, or investigative matters,in connection with their service. The Company is also obligated to advance feesand expenses, but only if the involved officer or director acted in “goodfaith.”  There is no limit on theindemnification payments the Company could be required to make under theseprovisions. The Company did not record a liability for these indemnificationobligations based on the fact that they are employment related costs.  At this time, the Company does not believethat any potential fees or expense arising from officer and directorindemnification will be material.

 

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On April 28, 2008, Zumiez moved to dismiss thederivative complaint for failure to make a demand.  Plaintiffs have until June 27,2008 to respond.  

 

The Company is unable to predict the outcome of thesecases.  A court determination in any of these actions against the Companycould result in significant liability and could have a material adverse effecton the Company’s business, results of operations or financial condition.

 

A former employee hascommenced an action against the Company in California state court (*Evan Johnson v. Zumiez, Inc., et al.,*Case No. RG08374968,Alameda County Superior Court, filed March 5, 2008) alleging that theCompany failed to pay all overtime wages owing to him and other employees,failed to provide meal breaks as required by California law, failed to provideemployees with proper itemized wage statements (pay stubs) as required byCalifornia law, and failed to pay terminated employees waiting time penaltiesunder California Labor Code section 203. Plaintiff recently filed a first amended complaint which adds anadditional claim that employees under age 18 worked more hours than permittedby the Labor Code; the first amended complaint also seeks to recover penaltiesunder the Private Attorney General Act for alleged violation of various LaborCode sections.  The suit was filed as aputative class action, but no motion requesting certification of the case as aclass action has been filed.  The Companyis investigating this matter and preparing to respond to the allegations of thefirst amended complaint.  No trial datehas been set.  At this early stage of thecase, it is not possible to estimate the amount or range of potential loss withany degree of certainty.

 

**Insurance Reserves—**The Company is responsible for medicalinsurance claims up to a specified aggregate amount.  The Company maintains a reserve for estimatedmedical insurance claims based on historical claims experience and otherestimated assumptions.

 

**4. Fair Value Measurements—**Effective February 3, 2008 (thefirst day of our 2008 fiscal year), the Company adopted SFAS No. 157, “FairValue Measurements” (“SFAS 157”), which defines fair value, establishes aframework for measuring fair value, and expands disclosure about fair valuemeasurements under SFAS 157 is as follows:

 

·                  Level 1**—**Quotedprices in active markets for identical assets or liabilities;

 

·                  Level 2**—**Quotedprices for similar assets or liabilities in active markets or inputs that areobservable;

 

·                  Level 3**—**Inputsthat are unobservable.

 

The following table summarizesassets measured at fair value on a recurring basis at May 3, 2008, asrequired by SFAS 157:

 
| ** **             | ** ** | **Level 1**        | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|------------------------|------------|-------------------------|------------|------------------|------------|------------------|------------|
| ** **             | ** ** | **(in thousands)** | ** ** |
| Marketable  securities |       | $                       | 58,565     |             | $          | —           |       | $ | 2,000 |   |
|                        |            |                         |            |                  |            |                  |            |  |  |  |

 

The$2.0 million in Level 3 marketable securities represents two $1.0 millionauction rate securities.  One of these$1.0 million securities failed to sell at its scheduled auction in March 2008.  The interest rate of this security reset to arate of 6.55%.  Subsequent to May 3,2008, the remaining $1.0 million security failed to sell at its scheduledauction.  The interest rate of thissecurity was reset to 3.20%.  The nextscheduled auction for these securities is in fiscal 2009.  Based on market conditions, the Companychanged its valuation methodology for auction rate securities to a valuationmethod that includes market and income approaches during the first quarter offiscal 2008.  Accordingly, thesesecurities changed from Level 1 to Level 3within SFAS 157’s valuation hierarchy since theCompany’s initial adoption of SFAS 157 at February 3, 2008.

 

The Company has reviewedboth securities for impairment and has concluded that no impairment exists asof May 3, 2008.  These securitieshave been reclassified from “current” assets to “long-term” assets as of May 3,2008.

 

The following tablepresents the changes in the Level 3 fair-value category for the three monthsended May 3, 2008.  The Companyclassifies financial instruments in Level 3 of the fair-value hierarchy whenthere is reliance on at least one significant unobservable input to thevaluation model.  In addition to theseunobservable inputs, the valuation models for Level 3 financial instruments mayalso rely on a number of inputs that are readily observable either directly orindirectly.

 
| ** **             | ** ** | **February 2,  2008** | ** ** | **Transfers in  and/or out of  Level 3** | ** ** | **May 3,  2008** | ** ** |
|------------------------|------------|----------------------------|------------|--------------------------------------------------------------|------------|-----------------------|------------|
| ** **             | ** ** | **(in thousands)**    | ** ** |
| Marketable  securities |       | $                          | —     |                                                         | $          | 2,000                 |       | $ | 2,000 |   |
|                        |            |                            |            |                                                              |            |                       |            |  |  |  |

 

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**5. Net Income Per Share, Basicand Diluted—**Basic net income per share is based on the weighted average number of commonshares outstanding during the period. Diluted net income per share is based on the weighted average number ofcommon shares and common share equivalents outstanding during the period.  Common share equivalents included in thecomputation represent shares issuable upon assumed exercise of outstandingstock options and non-vested restricted stock and employee stock purchase planshare equivalents.  Potentiallyanti-dilutive securities not included in the calculation of diluted earningsper share include options to purchase common stock where the option exerciseprice is greater than the average market price of the Company’s common stock duringthe period reported.  Total common stockoptions not included in the calculation of diluted earnings per share were895,975 for the three months ended May 3, 2008.  There were no potentially anti-dilutiveshares of common stock for the three-month period ended May 5, 2007.  There were 158,759 non-vested restrictedshares included in the calculation of diluted earnings per share as of May 3,2008.

 

The following table setsforth the computation of basic and diluted net income per share (in thousands,except share and per share amounts):

 
| ** **                                                       | ** ** | **For the Three Months Ended** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                       | ** ** | **May 3, 2008**                          | ** ** | **May 5, 2007** | ** ** |
| Net income                                                       |       | $                                                  | 1,362      |   | $ | 1,617 |   |
| Weighted average  common shares for basic net income per share   |       | 29,012,733                                         |       | 27,975,278 |   |
| Dilutive effect  of stock options and restricted stock           |       | 339,617                                            |       | 1,033,034 |   |
| Weighted average  common shares for diluted net income per share |       | 29,352,350                                         |       | 29,008,312 |   |
| Basic net income  per share                                      |       | $                                                  | 0.05       |   | $ | 0.06 |   |
| Diluted net  income per share                                    |       | $                                                  | 0.05       |   | $ | 0.06 |   |

 

**6. Goodwill—** In connection with the acquisition ofAction Concepts Fast Forward, Ltd., on June 24, 2006 the Company recordedgoodwill in accordance with SFAS 141 *“Business Combinations.” *As of May 3, 2008, theCompany had $250,000 of restricted cash held in escrow that was payable toAction Concepts Fast Forward, Ltd.  Thiswas accounted for as an addition to goodwill resulting in an increase in thetotal purchase price of the acquisition. The Company recorded $13.2 million of goodwill as the excess of thepurchase price of $15.5 million over the fair value of the net amounts assignedto assets acquired and liabilities assumed. In accordance with SFAS 142, *“Goodwill and OtherIntangible Assets,”* the Company will continue to assess, inaccordance with our “goodwill” policy as stated in Note 2, whether goodwill isimpaired.

 

**Item2:  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

 

*The following discussion andanalysis of our financial condition and results of operations should be read inconjunction with our condensed consolidated financial statements and relatednotes included elsewhere in this quarterly report.  This discussion contains forward-lookingstatements that involve risks and uncertainties.  Our actual results could differ materially fromthose anticipated in these forward-looking statements as a result of variousfactors, including those discussed in the section entitled “Risk Factors”in our Form 10-K filed with the SEC on March 25, 2008 and in this Form 10-Q.*

 

*Forward-looking statements arebased on our expectations regarding net sales, selling, general andadministrative expenses, profitability, financial position, business strategy,new store openings, and plans and objectives of management.  The words “believe,” “may,” “will,” “estimate,”“continue,” “anticipate,” “intend,” “expect” and similar expressions, as theyrelate to us and our business, industry, markets and consumers, are intended toidentify forward-looking statements.  Wehave based these forward-looking statements largely on our current expectationsand projections about future events and financial trends that we believe mayaffect our financial condition, results of operations, business strategy andfinancial needs.  These forward-lookingstatements are subject to a number of risks, uncertainties and assumptions,including, among others, those described in “Risk Factors” and elsewhere inthis quarterly report and in the Form 10-K referred to in the preceding*

 

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*paragraph.  New risk factorsemerge from time to time and it is not possible for our management to predictall risk factors, nor can we assess the impact of all factors on our businessor the extent to which any factor, or combination of factors, may cause actualresults to differ materially from those contained in any forward-lookingstatements.  We assume no obligation toupdate any forward-looking statements as a result of new information, futureevents or developments.  References inthe following discussion to “we”, “us”, “our”, “the Company” and similarreferences mean Zumiez Inc. and its consolidated subsidiary, unless otherwiseexpressly stated or the context otherwise requires.*

 

**Overview**

 

We are a mall basedspecialty retailer of action sports related apparel, footwear, equipment andaccessories operating under the Zumiez brand name.  Our stores cater to young men and womenbetween the ages of 12 and 24 who seek brands representing a lifestyle centeredon activities that include skateboarding, surfing, snowboarding, BMX, andmotocross.  We support the action sportslifestyle and promote our brand through a multi-faceted marketing approach thatis designed to integrate our brand image with our customers’ activities andinterests.

 

**General**

 

Net sales constitutegross sales net of estimated returns. Net sales include our in-store sales and our internet sales and,accordingly, information in this quarterly report with respect to comparablestore sales includes internet sales.  Ourinternet sales are and have historically been approximately 1% of totalsales.  Sales with respect to gift cardsare deferred and recognized when gift cards are redeemed.

 

We report “comparablestore sales” based on net sales, and stores are included in our comparablestore sales beginning on the first anniversary of their first day ofoperation.  Changes in our comparablestore sales between two periods are based on net sales of stores which were inoperation during both of the two periods being compared and, if a store isincluded in the calculation of comparable store sales for only a portion of oneof the two periods being compared, then that store is included in thecalculation for only the comparable portion of the other period.  When additional square footage is added to astore that is included in comparable store sales, the store remains incomparable store sales.  There may bevariations in the way in which some of our competitors and other apparelretailers calculate comparable or same store sales.  As a result, data regarding our comparablestore sales may not be comparable to similar data made available by ourcompetitors or other retailers.

 

Cost of goods soldconsists of the cost of merchandise sold to customers, inbound shipping costs,internet shipping costs, distribution costs, depreciation on leaseholdimprovements at our distribution center, buying and merchandising costs andstore occupancy costs.  This may not becomparable to the way in which our competitors or other retailers compute theircost of goods sold.

 

Selling, general andadministrative expenses consist primarily of store personnel wages andbenefits, administrative staff and infrastructure expenses, store supplies,depreciation on leasehold improvements at our home office and stores, facilityexpenses, training, advertising and marketing costs.  Credit card fees, insurance and othermiscellaneous operating costs are also included in selling, general andadministrative expenses.  This may not becomparable to the way in which our competitors or other retailers compute theirselling, general and administrative expenses.

 

**Critical Accounting Policies andEstimates**

 

Our discussion andanalysis of our financial condition and results of operations are based on ourfinancial statements, which have been prepared in conformance with accountingprinciples generally accepted in the United States of America (“GAAP”).  In preparing financial statements inaccordance with GAAP, we are required to make estimates and assumptions thathave an impact on the assets, liabilities, revenue and expense amountsreported.  These estimates can alsoaffect supplemental information disclosed by us, including information aboutcontingencies, risk, and financial condition. We believe, given current facts and circumstances, that our estimatesand assumptions are reasonable, adhere to GAAP, and are consistentlyapplied.  Inherent in the nature of anestimate or assumption is the fact that actual results may differ fromestimates and estimates may vary as new facts and circumstances arise.  In preparing the financial statements, wemake routine estimates and judgments in determining the net realizable value ofaccounts receivable, inventory, fixed assets, prepaid assets, goodwill andcertain liabilities.  We believe our mostcritical accounting estimates and assumptions are in the following areas:

 

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*Valuation of merchandiseinventories*.  We carry our merchandise inventories at thelower of cost or market.  Merchandiseinventories may include items that have been written down to our best estimateof their net realizable value.  Ourdecisions to write-down our merchandise inventories are based on our currentrate of sale, the age of the inventory and other factors.  Actual final sales prices to our customersmay be higher or lower than our estimated sales prices and could result in afluctuation in gross margin. Historically, any additional write-downs have not been significant andwe do not adjust the historical carrying value of merchandise inventoriesupwards based on actual sales experience.

 

*Leasehold improvements andequipment*.  We review the carrying value of our leaseholdimprovements and equipment for impairment whenever events or changes incircumstances indicate that the carrying value of such assets may not berecoverable.  Measurement of theimpairment loss is based on the fair value of the asset or group ofassets.  Generally, fair value will bedetermined using valuation techniques, such as the expected present value offuture cash flows.  The actual economiclives of these assets may be different than our estimated useful lives, therebyresulting in a different carrying value. These evaluations could result in a change in the depreciable lives ofthose assets and therefore our depreciation expense in future periods.

 

*Revenue recognition and salesreturns reserve*.  We recognize revenue upon purchase bycustomers at our retail store locations or upon shipment for orders placedthrough our website as both title and risk of loss have transferred.  We offer a return policy of generally 30 daysand we accrue for estimated sales returns based on our historical sales returnsresults.  The amounts of these salesreturns reserves vary during the year due to the seasonality of ourbusiness.  Actual sales returns could behigher or lower than our estimated sales returns due to customer buyingpatterns that could differ from historical trends.

 

*Impairment of Long-Lived Assets.* We review long-lived assets for impairment whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable.  Recoverability of assets tobe held and used is determined by a comparison of the carrying amount of anasset to future undiscounted net cash flows expected to be generated by theasset.  If such assets are consideredimpaired, the impairment recognized is measured by comparing projectedindividual store discounted cash flow to the asset carrying values.  Declines in projected store cash flow couldresult in the impairment of assets.

 

*Accountingfor Income Taxes.* As part of the process of preparing the condensed consolidated financialstatements, income taxes are estimated for each of the jurisdictions in whichwe operate.  This process involvesestimating actual current tax exposure together with assessing temporarydifferences resulting from differing treatment of items for tax and accountingpurposes.  These differences result indeferred tax assets and liabilities, which are included within the balancesheet.  The likelihood that deferred taxassets will be recovered from future taxable income is assessed, recognizingthat future taxable income may give rise to new deferred tax assets.  To the extent that future recovery is not likely,a valuation allowance would be established. To the extent that a valuation allowance is established or increased, anexpense will be included within the tax provision in the income statement.

 

Significant managementjudgment is required in determining the provision for income taxes, deferredtax assets and liabilities and any valuation allowance recorded against netdeferred tax assets.  Based on ourhistory of operating earnings, no valuation allowance has been recorded as of May 3,2008.  In the event that actual resultsdiffer from these estimates, or these estimates are adjusted in future periods,a valuation allowance may need to be established, which could impact ourfinancial position and results of operations. The Company adopted the provisions of FASB Interpretation No. 48, *“Accounting for Uncertainty in Income Taxes”* (“FIN 48”), on January 1,2007.  The Company’s policy is torecognize penalties and interest related to unrecognized tax benefits in incometax expense.  Provisions for income taxesare based on numerous factors that are subject to audit by the Internal RevenueService and the tax authorities in the various jurisdictions in which we dobusiness.

 

*Stock-basedcompensation*.  Effective January 29, 2006, we adoptedthe fair value method of accounting for stock-based compensation arrangementsin accordance with FASB Statement No. 123(R), Share-Based Payment (“SFAS No. 123(R)”),using the modified prospective method of transition.  Under the provisions of SFAS No. 123(R),the estimated fair value of share-based awards granted under the 2005 StockIncentive Plan is recognized as compensation expense over the vestingperiod.  Using the modified prospectivemethod, compensation expense is recognized beginning with the effective date ofadoption of SFAS No. 123(R) for all share-based issuances (i) grantedafter the effective date of adoption and (ii) granted prior to theeffective date of adoption and after our initial public offering on May 5,2005.  Prior to January 29, 2006, weaccounted for stock-based employee compensation plans using the intrinsic valuemethod of accounting in accordance with Accounting Principles Board Opinion No. 25,*“Accounting for Stock Issued to Employees”*(“APB 25”), and its related 

 

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interpretations.  Under the provisions of APB 25, nocompensation expense was recognized when stock options were granted withexercise prices equal to or greater than market value on the date of grant.

 

We account for unvestedstock-based employee compensation arrangements granted prior to our initialpublic offering on the intrinsic value method as allowed by SFAS 123(R).

 

**Resultsof Operations**

 

The following tablepresents, for the periods indicated, selected items in the statements ofoperations as a percent of net sales:

 
| ** **                                    | ** ** | **For the Three Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                    | ** ** | **May 3, 2008**                          | ** ** | **May 5, 2007** | ** ** |
| Net sales                                     |       | 100.0                                              | %          | 100.0 | % |
| Cost of goods  sold                           |       | 68.8                                               |       | 68.4 |   |
| Gross profit                                  |       | 31.2                                               |       | 31.6 |   |
| Selling, general  and administrative expenses |       | 29.1                                               |       | 28.4 |   |
| Operating profit                              |       | 2.1                                                |       | 3.2 |   |
| Interest income,  net                         |       | 0.7                                                |       | 0.6 |   |
| Earnings before  income taxes                 |       | 2.8                                                |       | 3.8 |   |
| Provision for  income taxes                   |       | 1.1                                                |       | 1.4 |   |
| Net Income                                    |       | 1.7                                                | %          | 2.4 | % |

 

**Three Months (13 weeks) Ended May 3,2008 Compared With Three Months (13 weeks) Ended May 5, 2007**

 

***NetSales***

 

Net sales increased to $78.7 million for thethree months ended May 3, 2008 from $68.8 million for the threemonths ended May 5, 2007, an increase of $9.9 million, or 14.4%.

 

Comparable store net sales decreased by 0.8% for thethree months ended May 3, 2008 compared to the three months ended May 5,2007.  The decrease in comparable storesnet sales was primarily due to lower net sales of men’s apparel, snow hardgoodsand juniors apparel partially offset by higher net sales of skatehardgoods.  For information as to how wedefine comparable stores, see “General” above.

 

The increase in total netsales was due to an increase in net sales from non-comparable stores ofapproximately $10.2 million.  Theincrease in non-comparable store net sales was primarily due to the opening of52 new stores subsequent to May 5, 2007.

 

***GrossProfit***

 

Gross profit for thethree months ended May 3, 2008 was $24.6 million compared with $21.7million for the three months ended May 5, 2007, an increase ofapproximately $2.9 million, or 13.1%. As a percentage of net sales, gross margin decreased to 31.2% for thethree months ended May 3, 2008 from 31.6% for the three months ended May 5,2007.  The reduction in gross margin as apercent of net sales was driven by occupancy cost growth outpacing revenuegrowth, partially offset by a higher average unit retail price and lower stockbased compensation expense included in cost of goods sold.

 

***Selling,General and Administrative Expenses***

 

Selling, general andadministrative, or “SG&A” expenses in the three months ended May 3,2008 were $22.9 million compared with $19.5 million in the threemonths ended May 5, 2007, an increase of $3.4 million, or 17.4%.  This increase was primarily the result ofcosts associated with operating new stores and to a lesser extent increases ininfrastructure and administrative staff to support our growth.  As a percentage of net sales, SG&Aexpenses increased to 29.1% in the three months ended May 3, 2008 from28.4% in the three months ended May 5, 2007.  The increase in SG&A expenses as apercentage of net sales was primarily attributable to the increase in storepayroll and payroll related costs, additional depreciation on new stores andadministrative support for new store growth.

 

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***OperatingProfit***

 

As a result of the abovefactors, operating profit was $1.6 million in the three months ended May 3,2008 compared with $2.2 million in the three months ended May 5, 2007, adecrease of $0.6 million or 25.5%.  As apercentage of net sales, operating profit was 2.1% in the three months ended May 3,2008 compared with 3.2% in the three months ended May 5, 2007.

 

***Provisionfor Income Taxes***

 

Provision for incometaxes was $0.9 million for the three months ended May 3, 2008compared with $1.0 million for the three months ended May 5, 2007.  Our income tax rate was relatively consistentfor both referenced periods.

 

***NetIncome***

 

Net income was $1.4million in the three months ended May 3, 2008 compared to $1.6 million inthe three months ended May 5, 2007, a decrease of $0.2 million, or15.8%.  As a percentage of net sales, netincome was 1.7% in the three months ended May 3, 2008 compared with 2.4%in the three months ended May 5, 2007.

 

**Liquidity and Capital Resources**

 

Our primary capitalrequirements are for inventory, store fixtures, store construction andremodeling, capital investments and ongoing infrastructure improvements such astechnology enhancements and distribution capabilities.  Historically, our main sources of liquidity havebeen cash flows from operations, borrowings under our revolving credit facilityand proceeds from the sale of our equity securities. 

 

The significantcomponents of our working capital are inventory and liquid assets such as cash,marketable securities and receivables, specifically tenant allowances andcredit card receivables, reduced by short-term debt, accounts payable andaccrued expenses.  Our working capitalposition benefits from the fact that we generally collect cash from sales tocustomers the same day or within several days of the related sale, while wetypically have extended payment terms with our vendors.

 

As of May 3, 2008,we held two Auction Rate Securities totaling $2.0 million or 3.3% of ourinvestment portfolio.  One of these $1.0million securities failed to sell at its scheduled auction in March 2008.  Subsequent to May 3, 2008, the remaining$1.0 million security failed to sell at its scheduled auction.  The interest rates for these securities resetto a prescribed “failure” rate of 6.55% and 3.20%, respectively.  We currently do not intend to hold thesesecurities beyond their next auction date and will try to sell these securitieswhen their auction dates come up in March 2009 and May 2009,respectively.  However, the recent uncertaintiesin the credit markets have prevented us and other investors from liquidatingholdings of auction rate securities in recent auctions for these securitiesbecause the amount of securities submitted for sale has exceeded the amount ofpurchase orders.  If the March 2009and May 2009 auctions fail, we plan to hold these securities until thenext auction date and the securities coupon rate will reset to a prescribed “failure”rate.  Unsuccessful auctions could resultin our holding securities beyond their next scheduled auction reset dates if asecondary market does not develop; therefore, limiting the short-term liquidityof these investments.  These securitieshave been reclassified from “current” to “long term” assets on our condensedconsolidated balance sheet as of May 3, 2008.

 

Our capital requirementsinclude construction and fixture costs related to the opening of new stores andremodeling expenditures for existing stores. Future capital requirements will depend on many factors, including thepace of new store openings, the availability of suitable locations for newstores, and the nature of arrangements negotiated with landlords.  In that regard, our net investment to open anew store has varied significantly in the past due to a number of factors,including the geographic location and size of the new store, and is likely tovary significantly in the future.  Duringfiscal 2008, we expect to spend approximately $33.0 to $35.0 million on capitalexpenditures, a majority of which will relate to leasehold improvements andfixtures for the 57 total new stores we plan to open in fiscal 2008, and asmaller amount will relate to equipment, systems and improvements for ourdistribution center and support infrastructure. However, there can be no assurance that the number of stores that weactually open in fiscal 2008 will not be different from the number of stores weplan to open, or that actual fiscal 2008 capital expenditures will not differfrom this expected amount.

 

We expect cash flows fromoperations and available borrowings under our revolving credit facility will besufficient to meet our foreseeable cash requirements for operations and plannedcapital expenditures for at least the next twelve months.  Beyond this time frame, if these sources arenot sufficient to meet our capital requirements, then we will be required toobtain additional equity or debt financing in the future.  There can be no assurance that equity or debtfinancing will be available to us when we need it or, if available, that the termswill be satisfactory to us and not dilutive to our then-current shareholders.

 

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Net cash provided byoperating activities for the three months ended May 3, 2008 wasapproximately $8.3 million primarily related to an increase in trade accountspayable and deferred rent, partially offset by an increase in inventory.  For the three months ended May 5, 2007net cash used by operations of $10.4 million was primarily related to anincrease in inventory and a decrease in income taxes payable, partially offsetby an increase in trade accounts payable.

 

Net cash used ininvesting activities was $5.7 million for the three months ended May 3,2008, related to $9.4 million of capital expenditures for new store openingsand existing store renovations partially offset by the $3.7 million in netsales of marketable securities.  Net cashprovided by investing activities was $2.9 million for the three months ended May 5,2007, related to $11.6 million in net sales of marketable securities partiallyoffset by $8.7 million of capital expenditures for new store openings andexisting store renovations.

 

Net cash used infinancing activities for the three months ended May 3, 2008 was $6.9million related to the payment of book overdrafts partially offset by proceedsreceived from exercise of stock options and the related tax benefit.  Net cash provided by financing activitieswere $5.2 million for the three months ended May 5, 2007, related toproceeds received from exercise of stock options and the related tax benefit,partially offset by the payment of book overdrafts.

 

We have a creditagreement with Wells Fargo HSBC Trade Bank, N.A.  The credit agreement provides us with asecured revolving credit facility until August 30, 2009 of up to$25.0 million.  The securedrevolving credit facility provides for the issuance of standby commercialletters of credit in an amount not to exceed $5.0 million outstanding at anytime and with a term not to exceed 365 days, although the amount of borrowingsavailable at any time under our secured revolving credit facility is reduced bythe amount of standby letters of credit outstanding at that time.  There were no outstanding borrowings underthe secured revolving credit facility at May 3, 2008 or February 2,2008.  The Company had open letters ofcredit outstanding under our secured revolving credit facility of $0.7 millionat May 3, 2008 and approximately $0.5 million at February 2,2008.  The secured revolving creditfacility bears interest at floating rates based on the lower of the prime rate(5.00% at May 3, 2008) minus 0.50% or the LIBOR rate (3.08% at May 3,2008), plus 1.00% for advances over $500,000 for a minimum of 30 days anda maximum of 180 days.  The creditagreement contains a number of restrictions and covenants that generally limitour ability to, among other things, (1) incur additional debt, (2) undergoa change in ownership and (3) enter into certain transactions.  The credit agreement also contains financialcovenants that require us to meet certain specified financial tests and ratios,including, minimum net income after taxes, maximum total liabilities divided bytangible net worth and minimum quick asset ratio.  All of our personal property, including,among other things, our inventory, equipment and fixtures, has been pledged tosecure our obligations under the credit agreement.  We must also provide financial informationand statements to our lender.  We were incompliance with all such covenants at May 3, 2008.

 

**Contractual Obligations andCommercial Commitments**

 

There was no materialchanges outside the ordinary course of business in our contractual obligationsduring the three months ended May 3, 2008. Our operating lease obligations are not recognized as liabilities in thefinancial statements.  The followingtable summarizes the total amount of future payments (in thousands) due undercertain of our contractual obligations at May 3, 2008:

 
| ** **                       | ** ** | ** ** | ** ** | **Less than** | ** ** | ** **               | ** ** | ** **         | ** ** | **More than** | ** ** |
|----------------------------------|------------|------------|------------|--------------------|------------|--------------------------|------------|--------------------|------------|--------------------|------------|
| **Contractual Obligations** | ** ** | **Total**  | ** ** | **1 Year**    | ** ** | **1- 3 Years** | ** ** | **3-5 Years** | ** ** | **5 Years**   | ** ** |
| Operating Lease  Obligations     |       | $          | 241.8      |               | $          | 22.6                     |       | $                  | 59.9       |               | $          | 55.6 |   | $ | 103.7 |   |
| Purchase  Obligations            |       | 104.7      |       | 104.7              |       | —                   |       | —             |       | —             |       |
| Letters of  Credit               |       | 0.7        |       | 0.7                |       | —                   |       | —             |       | —             |       |
|                             |       | $          | 347.2      |               | $          | 128.0                    |       | $                  | 59.9       |               | $          | 55.6 |   | $ | 103.7 |   |

 

We occupy our retailstores and combined home office and distribution center under operating leasesgenerally with terms of five to ten years. Some of our leases have early cancellation clauses, which permit thelease to be terminated by us if certain sales levels are not met in specificperiods.  Some leases contain renewaloptions for periods ranging from one to five years under substantially the sameterms and conditions as the original leases. In addition to future minimum lease payments, substantially all of ourstore leases provide for additional rental payments (or “percentage rent”) ifsales at the respective stores exceed specified levels, as well as the paymentof common area maintenance charges and real estate taxes, unless guaranteed inthe lease agreement.  Amounts in theabove table do not include percentage rent, common area maintenance charges orreal estate taxes.  Most of our leaseagreements have defined escalating rent provisions, which we havestraight-lined over the term of the lease, including any lease renewals deemedto be probable.  For certain locations,we receive cash

 

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tenant allowances and wehave reported these amounts as a deferred liability that is amortized to rentexpense over the term of the lease, including any lease renewals deemed to beprobable.  Rent expense, including commonarea maintenance and other occupancy costs, was $11.5 million and$9.3 million for the three months ended May 3, 2008 and May 5,2007, respectively.

 

At May 3, 2008, wehad outstanding purchase orders to acquire merchandise from vendors ofapproximately $104.7 million.  Wehave an option to cancel these commitments with no notice prior to shipment.  At May 3, 2008, we had approximately$0.7 million of letters of credit outstanding.

 

**Off-Balance Sheet Obligations**

 

Our only off-balancesheet contractual obligations and commercial commitments as of May 3, 2008related to operating lease obligations, open purchase orders, and letters ofcredit.  We have excluded these itemsfrom our balance sheet in accordance with GAAP. We presently do not have any non-cancelable purchase commitments.  At May 3, 2008, we had outstandingpurchase orders to acquire merchandise from vendors for approximately$104.7 million.  These purchases areexpected to be financed by cash flows from operations and borrowings under oursecured revolving credit facility.  Wehave an option to cancel these commitments with no notice prior to shipment.  At May 3, 2008, we had $0.7 million ofletters of credit outstanding under our secured revolving credit facility.  At May 3, 2008, we were committed toproperty owners for operation lease obligations in the amount of $241.8million.  Most of our leases containcancellation or kick-out clauses in our favor that relieve us from any futureobligation under a lease if specified sales levels are not achieved by aspecific date.

 

**Impact of Inflation**

 

We do not believe thatinflation has had a material impact on our net sales or operating results inthe recent past.  There can be noassurance that our business will not be affected by inflation in the future.

 

**Risk Factors**

 

*Investingin our securities involves a high degree of risk.  The following risk factors, issues anduncertainties should be considered in evaluating our future prospects.  In particular, keep these risk factors inmind when you read “forward-looking” statements elsewhere in this report.  Forward-looking statements relate to ourexpectations for future events and time periods.  Generally, the words “anticipate,” “believe,”“expect,” “intend” and similar expressions identify forward-lookingstatements.  Forward—looking statementsinvolve risks and uncertainties, and future events and circumstances coulddiffer significantly from those anticipated in the forward—lookingstatements.  Any of the following riskscould harm our business, operating results or financial condition and couldresult in a complete loss of your investment. Additional risks and uncertainties that are not yet identified or thatwe currently think are immaterial may also harm our business and financialcondition in the future.*

 

***Ourgrowth strategy depends on our ability to open and operate a significant numberof new stores each year, which could strain our resources and cause theperformance of our existing stores to suffer.***

 

Our growth largelydepends on our ability to open and operate new stores successfully.  However, our ability to open new stores issubject to a variety of risks and uncertainties, and we may be unable toopen new stores as planned, and any failure to successfully open and operatenew stores would have a material adverse effect on our results of operationsand on the market price of our common stock. We intend to continue to open a significant number of new stores infuture years while remodeling a portion of our existing store baseannually.  In addition, our proposedexpansion will place increased demands on our operational, managerial andadministrative resources.  Theseincreased demands could cause us to operate our business less effectively,which in turn could cause deterioration in the financial performance of ourindividual stores and our overall business. To the extent our new store openings are in markets where we alreadyhave stores, we may experience reduced net sales in existing stores inthose markets.  In addition, successfulexecution of our growth strategy may require that we obtain additionalfinancing, and we cannot assure you that we will be able to obtain thatfinancing on acceptable terms or at all.

 

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***If wefail to effectively execute our expansion strategy, we may not be able tosuccessfully open new store locations in a timely manner, if at all, whichcould have an adverse affect on our net sales and results of operations.***

 

Our ability to open andoperate new stores successfully depends on many factors, including, amongothers, our ability to:

 

·        identify suitable store locations, the availability ofwhich is outside of our control;

 

·         negotiate acceptable lease terms,including desired tenant improvement allowances;

 

·         source sufficient levels of inventory atacceptable costs to meet the needs of new stores;

 

·         hire, train and retain store personnel;

 

·         successfully integrate new stores intoour existing operations; and

 

·         identify and satisfy the merchandisepreferences of new geographic areas.

 

In addition, many of ourplanned new stores are to be opened in regions of the United States in which wecurrently have few, or no, stores.  Theexpansion into these markets may present competitive, merchandising anddistribution challenges that are different from those currently encountered inour existing markets.  Any of thesechallenges could adversely affect our business and results of operations.

 

***Ourbusiness is dependent upon our being able to anticipate, identify and respondto changing fashion trends, customer preferences and other fashion-relatedfactors; failure to do so could have a material adverse effect on us.***

 

Customer tastes andfashion trends in the action sports lifestyle market are volatile and tend tochange rapidly.  Our success depends onour ability to effectively anticipate, identify and respond to changing fashiontastes and consumer preferences, and to translate market trends intoappropriate, saleable product offerings in a timely manner.  If we are unable to successfully anticipate,identify or respond to changing styles or trends and misjudge the market forour products or any new product lines, our sales may be lower thanpredicted and we may be faced with a substantial amount of unsoldinventory or missed opportunities.  Inresponse to such a situation, we may be forced to rely on markdowns orpromotional sales to dispose of excess or slow-moving inventory, which couldhave a material adverse effect on our results of operations.

 

***Ourability to attract customers to our stores depends heavily on the success ofthe shopping malls in which our stores are located; any decrease in customertraffic in those malls could cause our sales to be less than expected.***

 

In order to generatecustomer traffic we depend heavily on locating our stores in prominentlocations within successful shopping malls. Sales at these stores are derived, in part, from the volume of trafficin those malls.  Our stores benefit fromthe ability of a mall’s other tenants to generate consumer traffic in thevicinity of our stores and the continuing popularity of malls as shoppingdestinations.  Our sales volume and malltraffic generally may be adversely affected by, among other things,economic downturns in a particular area, competition from internet retailers,non-mall retailers and other malls, increases in gasoline prices and theclosing or decline in popularity of other stores in the malls in which we arelocated.  A reduction in mall traffic asa result of these or any other factors could have a material adverse effect onour business, results of operations and financial condition.

 

***Oursales and inventory levels fluctuate on a seasonal basis, leaving our operatingresults particularly susceptible to changes in back-to-school and holidayshopping patterns.***

 

Our sales are typicallydisproportionately higher in the third and fourth fiscal quarters of eachfiscal year due to increased sales during the back-to-school and winter holidayshopping seasons.  Sales during theseperiods cannot be used as an accurate indicator of annual results.  Our sales in the first and second fiscalquarters are typically lower than in our third and fourth fiscal quarters due,in part, to the traditional retail slowdown immediately following the winterholiday season.  Any significant decreasein sales during the back-to-school and winter holiday seasons would have amaterial adverse effect on our financial condition and results ofoperations.  In addition, in order to preparefor the back-to-school and winter holiday shopping seasons, we must order andkeep in stock significantly more merchandise than we carry during other partsof the year.  Any unanticipated decreasein demand for our products during these peak shopping seasons could require usto sell excess inventory at a substantial markdown, which could have a materialadverse effect on our business, results of operations and financial condition.

 

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***Ourquarterly results of operations are volatile and may decline.***

 

Our quarterly results ofoperations have fluctuated significantly in the past and can be expected tocontinue to fluctuate significantly in the future.  As discussed above, our sales and operatingresults are typically lower in the first and second quarters of our fiscal yeardue, in part, to the traditional retail slowdown immediately following thewinter holiday season.  Our quarterlyresults of operations are affected by a variety of other factors, including:

 

·         the timingof new store openings and the relative proportion of our new stores to maturestores;

 

·         whether weare able to successfully integrate any new stores that we acquire and thepresence or absence of any unanticipated liabilities in connection therewith;

 

·         fashiontrends and changes in consumer preferences;

 

·         calendarshifts of holiday or seasonal periods;

 

·         changes inour merchandise mix;

 

·         timing ofpromotional events;

 

·         generaleconomic conditions and, in particular, the retail sales environment;

 

·         actions bycompetitors or mall anchor tenants;

 

·         weatherconditions;

 

·         the level ofpre-opening expenses associated with our new stores; and

 

·         inventoryshrinkage beyond our historical average rates.

 

***Failureto successfully integrate any businesses or stores that we acquire could havean adverse impact on our results of operations and financial performance.***

 

We may from time to timeacquire other retail stores, individually or in groups, or businesses.  In particular, in June 2006 we completedthe acquisition of the Fast Forward sporting goods store chain.  We may experience difficulties inassimilating any stores or businesses we may acquire, including the FastForward operations, and any such acquisitions may also result in the diversionof our capital and our management’s attention from other business issues andopportunities.  We may not be able tosuccessfully integrate any stores or businesses that we may acquire, includingtheir facilities, personnel, financial systems, distribution, operations andgeneral operating procedures.  If we failto successfully integrate acquisitions or if such acquisitions fail to providethe benefits that we expect to receive, we could experience increased costs andother operating inefficiencies, which could have an adverse effect on ourresults of operations and financial performance.

 

***Ourbusiness is susceptible to weather conditions that are out of our controlincluding the potential risks of unpredictable weather patterns, including anyweather patterns associated with global warming, and the resultant unseasonableweather could have a negative impact on our results of operations.***

 

Our business issusceptible to unseasonable weather conditions. For example, extended periods of unseasonably warm temperatures(including any weather patterns associated with global warming) during thewinter season or cool weather during the summer season could render a portionof our inventory incompatible with those unseasonable conditions.  These prolonged unseasonable weatherconditions, particularly in regions of the United States where we have aconcentration of stores, could have a material adverse effect on our businessand results of operations.

 

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***Wemay be unable to compete favorably in the highly competitive retail industry,and if we lose customers to our competitors, our sales could decrease.***

 

The teenage and youngadult retail apparel, hardgoods and accessories industry is highly competitive.  We compete with other retailers for vendors,teenage and young adult customers, suitable store locations, qualified storeassociates and management personnel.  Inthe softgoods market which includes apparel, accessories and footwear, wecurrently compete with a large number of other teenage-focused retailers.  In addition, in the softgoods market wecompete with independent specialty shops, department stores, and directmarketers that sell similar lines of merchandise and target customers throughcatalogs and e-commerce.  In thehardgoods market which includes skateboards, snowboards, bindings, componentsand other equipment, we compete directly or indirectly with the followingcategories of companies: other specialty retailers that compete with us acrossa significant portion of our merchandising categories, such as local snowboardand skate shops, large-format sporting goods stores and chains and internetretailers.

 

Some of our competitorsare larger than we are and have substantially greater financial, marketing andother resources than we do.  Directcompetition with these and other retailers may increase significantly inthe future, which could require us, among other things, to lower our prices andcould result in the loss of our customers. Current and increased competition could have a material adverse effecton our business, results of operations and financial condition.

 

***If wefail to maintain good relationships with vendors or if a vendor is otherwiseunable or unwilling to supply us with adequate quantities of their products atacceptable prices, our business and financial performance could suffer.***

 

Our business is dependenton continued good relations with our vendors. In particular, we believe that we generally are able to obtain attractivepricing and other terms from vendors because we are perceived as a desirablecustomer, and deterioration in our relationship with our vendors would likelyhave a material adverse effect on our business. We do not have any contractual relationships with our vendors and,accordingly, there can be no assurance that our vendors will provide us with anadequate supply or quality of products or acceptable pricing.  Our vendors could discontinue selling to usor raise the prices they charge at any time. There can be no assurance that we will be able to acquire desiredmerchandise in sufficient quantities on terms acceptable to us in thefuture.  Also, certain of our vendorssell their products directly to the retail market and therefore compete with usdirectly, and other vendors may decide to do so in the future.  There can be no assurance that such vendorswill not decide to discontinue supplying their products to us, supply us onlyless popular or lesser quality items, raise the prices they charge us or focuson selling their products directly.  Anyinability to acquire suitable merchandise at acceptable prices, or the loss ofone or more key vendors, would have a material adverse effect on our business,results of operations and financial condition.

 

***If welose key management or are unable to attract and retain the talent required forour business, our financial performance could suffer.***

 

Our performance dependslargely on the efforts and abilities of our senior management, including ourCo-Founder and Chairman, Thomas D. Campion, our President and Chief ExecutiveOfficer, Richard M. Brooks, our Chief Financial Officer, Trevor S. Lang, ourExecutive Vice President and General Merchandising Manager,Lynn K. Kilbourne and our Executive Vice President of Stores, Ford K.Wright.  None of our employees, except Mr. Brooks,has an employment agreement with us and we do not plan to obtain key personlife insurance covering any of our employees. If we lose the services of one or more of our key executives, wemay not be able to successfully manage our business or achieve our growthobjectives.  As our business grows, wewill need to attract and retain additional qualified management personnel in atimely manner and we may not be able to do so.

 

***Ourfailure to meet our staffing needs could adversely affect our ability toimplement our growth strategy and could have a material impact on our resultsof operations.***

 

Our success depends inpart upon our ability to attract, motivate and retain a sufficient numberof qualified employees, including regional managers, district managers, storemanagers and store associates, who understand and appreciate our corporateculture based on a passion for the action sports lifestyle and are able toadequately represent this culture to our customers.  Qualified individuals of the requisitecaliber, skills and number needed to fill these positions may be in shortsupply in some areas, and the employee turnover rate in the retail industry ishigh.  Competition for qualifiedemployees could require us to pay higher wages to attract a sufficient numberof suitable employees.  If we are unableto hire and retain store managers and store associates capable of consistentlyproviding a high level of customer service, as demonstrated by their enthusiasmfor our culture and knowledge of our merchandise, our ability to open newstores may be impaired and the performance of our existing and new storescould be materially adversely affected. We are also dependent upon temporary personnel to adequately staff ourstores and distribution center, particularly during busy periods such as theback-to-school and winter holiday seasons. There can be no assurance that we will receive adequate assistance fromour

 

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temporary personnel, orthat there will be sufficient sources of temporary personnel.  Although none of our employees is currentlycovered by collective bargaining agreements, we cannot guarantee that ouremployees will not elect to be represented by labor unions in the future, whichcould increase our labor costs and could subject us to the risk of work stoppages andstrikes.  Any such failure to meet ourstaffing needs, any material increases in employee turnover rates, anyincreases in labor costs or any work stoppages or interruptions or strikescould have a material adverse effect on our business or results of operations.

 

***Ouroperations, including our sole distribution center, are concentrated in certainregions in the United States, which makes us susceptible to adverse conditionsin these regions.***

 

Our home office and soledistribution center are located in a single facility in Washington, and asubstantial number of our stores are located in Washington and the western halfof the United States.  We also have asubstantial number of stores in the New York/New Jersey region and Texas.  As a result, our business may be moresusceptible to regional factors than the operations of more geographicallydiversified competitors.  These factorsinclude, among others, economic and weather conditions, demographic andpopulation changes and fashion tastes. In addition, we rely on a single distribution center in Everett,Washington to receive, store and distribute merchandise to all of our storesand to fulfill our internet sales.  As aresult, a natural disaster or other catastrophic event, such as an earthquakeaffecting western Washington, in particular, or the West Coast, in general,could significantly disrupt our operations and have a material adverse effecton our business, results of operations and financial condition.

 

***Weare required to make substantial rental payments under our operating leases andany failure to make these lease payments when due would likely have a materialadverse effect on our business and growth plans.***

 

We do not own any of ourretail stores or our combined home office and distribution center, but insteadwe lease all of these facilities under operating leases.  Payments under these operating leases accountfor a significant portion of our operating expenses.  For example, total rental expense, includingadditional rental payments (or “percentage rent”) based on sales of some of thestores, common area maintenance charges and real estate taxes, under operatingleases was $11.5 million and $9.3 million for the three months ended May 3,2008 and May 5, 2007, respectively, and $22.2 million,$31.9 million and $43.5 million for fiscal 2005, 2006, and 2007respectively.  As of May 3, 2008, wewere a party to operating leases requiring future minimum lease paymentsaggregating approximately $138.1 million through fiscal year 2012 andapproximately $103.7 million thereafter. In addition, substantially all of our store leases provide foradditional rental payments based on sales of the respective stores, as well ascommon area maintenance charges and other costs, and require that we pay realestate taxes, none of which is included in the amount of future minimum leasepayments.  We expect that any new storeswe open will also be leased by us under operating leases, which will furtherincrease our operating lease expenses.

 

Our substantial operatinglease obligations could have significant negative consequences, including

 

·         increasingour vulnerability to general adverse economic and industry conditions;

 

·         limiting ourability to obtain additional financing;

 

·         requiringthat a substantial portion of our available cash be applied to pay our rentalobligations, thus reducing cash available for other purposes;

 

·         limiting ourflexibility in planning for or reacting to changes in our business or in theindustry in which we compete; and placing us at a disadvantage with respect tosome of our competitors.

 

We depend on cash flowfrom operations to pay our lease expenses and to fulfill our other cash needs.  If our business does not generate sufficientcash flow from operating activities, and sufficient funds are not otherwiseavailable to us from borrowings under bank loans or from other sources, wemay not be able to service our operating lease expenses, grow ourbusiness, respond to competitive challenges or to fund our other liquidity andcapital needs, which would have a material adverse effect on us.

 

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***Theterms of our revolving credit facility impose operating and financialrestrictions on us that may impair our ability to respond to changingbusiness and economic conditions.  Thisimpairment could have a significant adverse impact on our business.***

 

We have a $25 millioncredit agreement with Wells Fargo HSBC Trade Bank, N.A., which we use forinventory financing and other general corporate purposes, that contains anumber of restrictions and covenants that generally limit our ability to, amongother things, (1) incur additional indebtedness, (2) undergo a changein ownership and (3) enter into certain transactions.  In addition, all of our personal property,including our inventory, equipment and fixtures, secure our obligations underthe credit agreement.  Our creditagreement also contains financial covenants that require us to meet certainspecified financial tests and ratios, including minimum net income after taxes,maximum total liabilities divided by tangible net worth and minimum quick assetratio.  Our ability to comply with theseratios may be affected by events beyond our control.

 

A breach of any of theserestrictive covenants or our inability to comply with the required financialtests or ratios could result in a default under the credit agreement.  If a default occurs, the lender may electto declare all borrowings outstanding, together with accrued interest and otherfees, to be immediately due and payable. If we are unable to repay outstanding borrowings when due, whether attheir maturity or if declared due and payable by the lender following adefault, the lender has the right to proceed against the collateral granted toit to secure the indebtedness.  As aresult, any breach of these covenants or failure to comply with these tests orratios could have a material adverse effect on us.  There can be no assurance that we will notbreach the covenants or fail to comply with the tests or ratios in our creditagreement or any other debt agreements we may enter into in the futureand, if a breach occurs, there can be no assurance that we will be able toobtain necessary waivers or amendments from the lenders.

 

The restrictionscontained in our credit agreement could: (1) limit our ability to plan foror react to market conditions or meet capital needs or otherwise restrict ouractivities or business plans; and (2) adversely affect our ability tofinance our operations, strategic acquisitions, investments or other capitalneeds or to engage in other business activities that would be in our interest.

 

***Our business could suffer as a result of small parceldelivery services such as United Parcel Service or Federal Express being unableto distribute our merchandise.***

 

We rely upon small parceldelivery services for our product shipments, including shipments to, from andbetween our stores.  Accordingly, we aresubject to risks, including employee strikes and inclement weather, which mayaffect their ability to meet our shipping needs.  Among other things, any circumstances thatrequire us to use other delivery services for all or a portion of our shipmentscould result in increased costs and delayed deliveries and could harm ourbusiness materially.  In addition,although we have contracts with small parcel delivery services, we have theright to terminate these contracts upon 30 days written notice.  Although the contracts with these smallparcel delivery services provide certain discounts from the shipment rates ineffect at the time of shipment, the contracts do not limit their ability toraise the shipment rates at any time. Accordingly, we are subject to the risk that small parcel deliveryservices may increase the rates they charge, that they may terminate theircontracts with us, that they may decrease the rate discounts provided to uswhen an existing contract is renewed or that we may be unable to agree on theterms of a new contract with them, any of which could materially adverselyaffect our operating results.

 

***Ourbusiness could suffer if a manufacturer fails to use acceptable laborpractices.***

 

We do not control ourvendors or the manufacturers that produce the products we buy from them, nor dowe control the labor practices of our vendors and these manufacturers.  The violation of labor or other laws by anyof our vendors or these manufacturers, or the divergence of the labor practicesfollowed by any of our vendors or these manufacturers from those generallyaccepted as ethical in the United States, could interrupt, or otherwisedisrupt, the shipment of finished products to us or damage our reputation.  Any of these, in turn, could have a materialadverse effect on our financial condition and results of operations.  In that regard, most of the products sold inour stores are manufactured overseas, primarily in Asia and Central America,which may increase the risk that the labor practices followed by themanufacturers of these products may differ from those consideredacceptable in the United States.

 

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***Ourfailure to adequately anticipate a correct mix of private label merchandisemay have a material adverse effect on our business.***

 

Sales from private labelmerchandise accounted for 15.4% of our net sales in fiscal year 2007.  We may take steps to increase thepercentage of net sales of private label merchandise in the future, althoughthere can be no assurance that we will be able to achieve increases in privatelabel merchandise sales as a percentage of net sales.  Because our private label merchandisegenerally carries higher gross margins than other merchandise, our failure toanticipate, identify and react in a timely manner to fashion trends with ourprivate label merchandise would likely have a material adverse effect onour comparable store sales, financial condition and results of operations.

 

***Mostof our merchandise is produced by foreign manufactures therefore, theavailability and costs of these products may be negatively affected byrisks associated with international trade and other international conditions.***

 

Manufacturers outside ofthe United States produce most of our merchandise.  Some of these facilities are located inregions that may be affected by natural disasters, political instabilityor other conditions that could cause a disruption in trade.  Trade restrictions such as increased tariffsor quotas, or both, could also affect the importation of merchandise generally,and increase the cost, and reduce the supply of merchandise available tous.  Any reduction in merchandiseavailable to us or any increase in its cost due to tariffs, quotas or localissues that disrupt trade could have a material adverse effect on our resultsof operations.  Although the pricescharged by vendors for the merchandise we purchase are all denominated inUnited States dollars, a continued decline in the relative value of the UnitedStates dollar to foreign currencies could lead to increased merchandise costs,which could negatively affect our competitive position and our results ofoperation.

 

***Ifour information systems hardware or software fails to function effectively ordoes not scale to keep pace with our planned growth, our operations could bedisrupted and our financial results could be harmed.***

 

Over the past severalyears, we have made improvements to our existing hardware and software systems,as well as implemented new systems.  Ifthese or any other information systems and software do not work effectively,this could adversely impact the promptness and accuracy of our transactionprocessing, financial accounting and reporting and our ability to manage ourbusiness and properly forecast operating results and cash requirements.  To manage the anticipated growth of ouroperations and personnel, we may need to continue to improve ouroperational and financial systems, transaction processing, procedures andcontrols, and in doing so could incur substantial additional expenses thatcould impact our financial results.

 

***Ourinability or failure to protect our intellectual property or our infringementof other’s intellectual property could have a negative impact on our operatingresults.***

 

We believe that ourtrademarks and domain names are valuable assets that are critical to oursuccess.  The unauthorized use or othermisappropriation of our trademarks or domain names could diminish the value ofthe Zumiez brand, our store concept, our private label brands or our goodwilland cause a decline in our net sales. Although we have secured or are in the process of securing protectionfor our trademarks and domain names in a number of countries outside of theUnited States, there are certain countries where we do not currently have orwhere we do not currently intend to apply for protection for certain trademarksor at all.  Also, the efforts we havetaken to protect our trademarks may not be sufficient or effective.  Therefore, we may not be able to preventother persons from using our trademarks or domain names outside of the UnitedStates, which also could adversely affect our business.  We are also subject to the risk that wemay infringe on the intellectual property rights of third parties.  Any infringement or other intellectualproperty claim made against us, whether or not it has merit, could betime-consuming, result in costly litigation, cause product delays or require usto pay royalties or license fees.  As aresult, any such claim could have a material adverse effect on our operatingresults.

 

***Theeffects of war or acts of terrorism could adversely affect our business.***

 

Substantially all of ourstores are located in shopping malls. Any threat of terrorist attacks or actual terrorist events, particularlyin public areas, could lead to lower customer traffic in shopping malls.  In addition, local authorities or mallmanagement could close shopping malls in response to security concerns.  Mall closures, as well as lower customertraffic due to security concerns, would likely result in decreased sales.  Additionally, the escalation of the armedconflicts in the Middle East, or the threat, escalation or commencement of waror other armed conflict elsewhere, could significantly diminish consumerspending, and result in decreased sales for us. Decreased sales would have a material adverse effect on our business,financial condition and results of operations.

 

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***Theoutcome of litigation could have a material adverse effect on our business and may result insubstantial costs and could divert management’s attention.***

 

We are involved, fromtime to time, in litigation incidental to our business including complaintsfiled by investors.  This litigationcould result in substantial costs, and could divert management’s attention andresources, which could harm our business. Risks associated with legal liability are often difficult to assess orquantify, and their existence and magnitude can remain unknown for significant periodsof time.  While we maintain director andofficer insurance, the amount of insurance coverage may not be sufficient tocover a claim and the continued availability of this insurance cannot beassured.  As a result, there can be noassurance that the actual outcome of pending or future litigation will not havea material adverse effect on our results of operations or financial condition.

 

***Our operations expose us to the risk of litigation whichcould lead to significant potential liability and costs that could harm ourbusiness, financial condition or results of operations.***

 

We employ asubstantial number of full-time and part-time employees, a majority of whom areemployed at our store locations.  As aresult, we are subject to a large number of federal and state laws andregulations relating to employment.  Thiscreates a risk of potential claims that we have violated laws related todiscrimination and harassment, health and safety, wage and hour laws, criminal activity,personal injury and other claims.  We arealso subject to other types of claims in the ordinary course of ourbusiness.  Some or all of these claimsmay give rise to litigation, which could be time-consuming for our managementteam, costly and harmful to our business.

 

In addition, we areexposed to the risk of class action litigation. The costs of defense and the risk of loss in connection with classaction suits are greater than in single-party litigation claims.  Due to the costs of defending against suchlitigation, the size of judgments that may be awarded against us, and the lossof significant management time devoted to such litigation, we cannot assure youthat such litigation will not disrupt our business or impact our financialresults.

 

***Ourinternet operations subject us to numerous risks that could have an adverseeffect on our results of operations.***

 

Although internet salesconstitute a small portion of our overall sales, our internet operationssubject us to certain risks that could have an adverse effect on ouroperational results, including:

 

·         diversion oftraffic and sales from our stores;

 

·         liabilityfor online content; and

 

·         risksrelated to the computer systems that operate our website and related supportsystems, including computer viruses and electronic break-ins and similardisruptions.

 

In addition, risks beyondour control such as governmental regulation of the internet, entry of ourvendors in the internet business in competition with us, online securitybreaches and general economic conditions specific to the internet and onlinecommerce could have an adverse effect on our results of operations.

 

***Wehave incurred and will continue to incur significant expenses as a result ofbeing a public company, which will negatively impact our financial performance.***

 

We completed our initialpublic offering in May 2005 and we have incurred and will continue toincur significant legal, accounting, insurance and other expenses as a resultof being a public company.  TheSarbanes-Oxley Act of 2002, as well as related rules implemented by theSEC and The Nasdaq Global Market, has required changes in corporate governancepractices of public companies. Compliance with these laws, rules and regulations, includingcompliance with Section 404 of the Sarbanes-Oxley Act as discussed in thefollowing risk factor, have caused and will continue to cause us to incursignificant costs and expenses, including legal and accounting costs, and havemade and will continue to make some activities more time-consuming and costly.  These laws, rules and regulations havemade it more expensive for us to obtain director and officer liabilityinsurance, and we have been required to accept reduced policy limits andcoverage.  As a result, it may bemore difficult for us to attract and retain qualified persons to serve on ourboard of directors or as officers.  As aresult of the foregoing, we have incurred and we expect to incur significantlegal, accounting, insurance and certain other expenses on an ongoing basis, whichwill negatively impact our financial performance and could have a materialadverse effect on our results of operations and financial condition.

 

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***Failureto maintain adequate financial and management processes and controls could leadto errors in our financial reporting and could harm our ability to manage ourexpenses.***

 

Reporting obligations asa public company and our anticipated growth are likely to place a considerablestrain on our financial and management systems, processes and controls, as wellas on our personnel.  In addition, we arerequired to document and test our internal controls over financial reportingpursuant to Section 404 of the Sarbanes-Oxley Act of 2002 so that ourmanagement can certify as to the effectiveness of our internal controls and ourindependent registered public accounting firm can render an opinion on theeffectiveness of our internal control over financial reporting on an annualbasis.  This process requires us to documentour internal controls over financial reporting and to potentially makesignificant changes thereto, if applicable. As a result, we have incurred and expect to continue to incursubstantial expenses to test our financial controls and systems, and we havebeen and in the future may be required to improve our financial andmanagerial controls, reporting systems and procedures, to incur substantialexpenses to make such improvements and to hire additional personnel.  If our management is ever unable to certifythe effectiveness of our internal controls or if our independent registeredpublic accounting firm cannot render an opinion on the effectiveness of ourinternal control over financial reporting, or if material weaknesses in ourinternal controls are ever identified, we could be subject to regulatoryscrutiny and a loss of public confidence, which could have a material adverseeffect on our business and our stock price. In addition, if we do not maintain adequate financial and managementpersonnel, processes and controls, we may not be able to accurately reportour financial performance on a timely basis, which could cause a decline in ourstock price and adversely affect our ability to raise capital.

 

***The security of our databases that contain personalinformation of our retail customers could be breached, which could subject usto adverse publicity, litigation, and expenses. In addition, if we are unable to comply with security standards createdby the credit card industry, our operations could be adversely affected.***

 

Database privacy, networksecurity, and identity theft are matters of growing public concern.  In an attempt to prevent unauthorized accessto our network and databases containing confidential, third-party information,we have installed privacy protection systems, devices, and activity monitoringon our network.  Nevertheless, ifunauthorized parties gain access to our networks or databases, they may be ableto steal, publish, delete, or modify our private and sensitive third-partyinformation.  In such circumstances, wecould be held liable to our customers or other parties or be subject toregulatory or other actions for breaching privacy rules.  This could result in costly investigationsand litigation, civil or criminal penalties, and adverse publicity that couldadversely affect our financial condition, results of operations, andreputation.  Further, if we are unable tocomply with the security standards, established by banks and the credit cardindustry, we may be subject to fines, restrictions, and expulsion from card acceptanceprograms, which could adversely affect our retail operations.

 

***The current uncertainty surrounding the United Stateseconomy coupled with cyclical economic trends in action sports retailing couldhave a material adverse effect on our results of operations.***

 

The action sports retailindustry historically has been subject to substantial cyclicality.  As economic conditions in the United Stateschange, the trends in discretionary consumer spending become unpredictable and discretionaryconsumer spending could be reduced due to uncertainties about the future.  When discretionary consumer spending isreduced, purchases of action sports apparel and related products maydecline.  A recession in the generaleconomy or continued uncertainties regarding future economic prospects couldhave a material adverse effect on our results of operations.

 

***We may fail to meet analyst expectations, which could causethe price of our stock to decline.***

 

Our common stock istraded publicly and various securities analysts follow our financial resultsand issue reports on us.  These reportsinclude information about our historical financial results as well as theanalysts’ estimates of our future performance. The analysts’ estimates are based upon their own opinions and are oftendifferent from our estimates or expectations. If our operating results are below the estimates or expectations ofpublic market analysts and investors, our stock price could decline.  Recently, a securities class actionlitigation was brought against us and such actions are frequently broughtagainst other companies following a decline in the market price of theirsecurities.  If our stock price isvolatile, we may become involved in this type of litigation in the future.  Any litigation could result in substantialcosts and a diversion of management’s attention and resources that are neededto successfully run our business.

 

***The trading price of our investment in marketable securitiesmay fluctuate***

 

We invest ourexcess cash in diversified high credit money market accounts, US treasuries,certificates of deposit, municipal bonds and auction rate securities.  The investments have historically beenconsidered very safe investments with very minimal default rates.  However, the recent uncertainties in the creditmarkets have prevented us and other investors

 

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from liquidating holdingsof auction rate securities in recent auctions for these securities because theamount of securities submitted for sale has exceeded the amount of purchaseorders.  We reduced our holdings ofauction rate securities during 2007 through the auction process.  As of May 3, 2008, we had$2 million invested in auction rate securities, which are classified aslong-term marketable securities on our condensed consolidated balancesheet.  If market liquidity issuescontinue, we may have impairment charges on these investments.

 

It**em3:   Quantitative and Qualitative Disclosures About Market Risk**

 

During different times ofthe year, due to the seasonality of our business, we have borrowed under ourrevolving credit facility.  To the extentwe borrow under our secured revolving credit facility, which bears interests atfloating rates based on either the prime rate or LIBOR, we are exposed to marketrisk related to changes in interest rates. At May 3, 2008, we had no borrowings outstanding under our securedrevolving credit facility.  At May 3,2008, we had $0.7 million of letters of credit outstanding under our securedrevolving credit facility.  We are not aparty to any derivative financial instruments.

 

**Item4:   Controls and Procedures**

 

*Evaluationof Disclosure Controls and Procedures*.  We carried out an evaluation, under thesupervision and with the participation of our management, including our ChiefExecutive Officer (“CEO”) and Chief Financial Officer (“CFO”), of theeffectiveness of the design and operation of our disclosure controls andprocedures (as defined in Securities Exchange Act Rule 13a-15(e)).  Based on this evaluation, our CEO and CFOconcluded that, as of May 3, 2008, our disclosure controls and procedureswere effective.

 

Disclosure controls andprocedures, no matter how well designed and implemented, can provide onlyreasonable assurance of achieving an entity’s disclosure objectives.  The likelihood of achieving such objectivesis affected by limitations inherent in disclosure controls and procedures.  These include the fact that human judgment indecision-making can be faulty and that breakdowns in internal control can occurbecause of human failures such as simple errors or mistakes or intentionalcircumvention of the established process.

 

*Changes in Internal Control Over FinancialReporting*.  There hasbeen no change in our internal control over financial reporting (as defined inSecurities Exchange Act Rule 13a-15(f)) during the quarter ended May 3,2008 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**PART II-  OTHER INFORMATION**

 

**Item1.  Legal Proceedings**

 

We are involved from timeto time in litigation incidental to our business.  The Company is unable to predict the outcomeof litigated cases.  A courtdetermination in any of litigation actions against the Company could result insignificant liability and could have a material adverse effect on the Company’sbusiness, results of operations or financial condition.

 

See Note 3 to the Notesto Condensed Consolidated Financial Statements found in Item 1 of this Form 10-Q(listed under “Litigation” under Commitments and Contingencies).

 

**Item1A.  Risk Factors**

 

Please refer to the RiskFactors set forth in Item 2 of Part I of this Form 10-Q as well asthe risk factors previously disclosed in Item 1A of Part I of our AnnualReport on Form 10-K for the year ended February 2, 2008.  There have been no material changes in therisk factors set forth in our Annual Report on From 10-K for the year ended February 2,2008.

 

**Item 2.**** Changes in Securities; Use of Proceeds and IssuerPurchases of Equity Securities**

 

None

 

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**Item 3.****  Defaults Upon Senior Securities**

 

None.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

 

None

 

**Item 5.**** Other Information**

 

None

 

**Item6.  Exhibits**

 

Exhibits

 
| **Exhibit No.** | ** ** | **Description of Exhibits**                                                                                                                                                                                                       |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1                 |       | Certification of the Principal Executive Officer  pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act  of 1934, as amended, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|                 |       |                                                                                                                                                                                                                              |
| 31.2                 |       | Certification of the Principal Financial Officer  pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act  of 1934, as amended, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|                 |       |                                                                                                                                                                                                                              |
| 32.1                 |       | Certifications of the Principal Executive Officer  and Principal Financial Officer pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350                                                   |

 

 

**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, as amended, the registranthas duly caused this report to be signed on its behalf by the undersignedhereunto duly authorized.

 
|                          | ZUMIEZ INC. |
|--------------------------|-------------|
|                     |        |   |
|                     | By:         | /s/ TREVOR S. LANG |
|                     |        | Trevor S. Lang |
|                     |        | Chief Financial Officer |
|                     |        |   |
| Dated: May 30, 2008 |        |   |

 

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