Table ofContents

 

 

 

**UNITED STATES**

**SECURITIES AND 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 AUGUST 1, 2009** |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                  |
| **OR** |
|   |                                                                                                                                                  |
| **o**  | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                               |

 

**Commission file number 000-51300**

 

**ZUMIEZ INC.**

(Exact name of registrant as specified in itscharter)

 

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

 

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

 (Address of principal executiveoffices)  (Zip Code)

 

Registrant’s telephone number, including areacode:**  (425) 551-1500**

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(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 mark whether the registrant hassubmitted electronically and posted on its corporate Web site, if any, everyInteractive Data File required to be submitted and posted pursuant toRule 405 of Regulation S-T during the preceding 12 months (or for suchshorter period that the registrant was required to submit and post such files).  Yes  o   No   o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer or asmaller reporting company.  Seedefinition of “accelerated filer and large accelerated filer in Rule 12b-2of the Exchange Act).  (Check one):

 

| Large  accelerated filer o |   | Accelerated  filer x         |
|----------------------------|--------|------------------------------|
| Non-accelerated  filer o   |   | Smaller  reporting company o |

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes   x  No

 

Number of shares of Common Stock outstanding asAugust 28, 2009 was 30,154,284 shares.

 

 

 

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**ZUMIEZ INC.**

**FORM 10-Q**

**TABLE OF CONTENTS**

 
| Part I.      | Financial  Information |                                                                                                                                         |
|-------------------|------------------------|----------------------------------------------------------------------------------------------------------------------------------------------|
|              |                   |                                                                                                                                         |   |
|              | Item  1.               | Condensed  Consolidated Financial Statements                                                                                                 |   |
|              |                   |                                                                                                                                         |   |
|              |                   | Condensed  Consolidated Balance Sheets at August 1, 2009 (unaudited) and  January 31, 2009                                         | 3 |
|              |                   |                                                                                                                                         |   |
|              |                   | Condensed  Consolidated Statements of Operations for the three and six months ended  August 1, 2009 and August 2, 2008 (unaudited) | 4 |
|              |                   |                                                                                                                                         |   |
|              |                   | Condensed  Consolidated Statement of Changes in Shareholders’ Equity for the six months  ended August 1, 2009 (unaudited)          | 5 |
|              |                   |                                                                                                                                         |   |
|              |                   | Condensed  Consolidated Statements of Cash Flows for the six months ended August 1,  2009 and August 2, 2008 (unaudited)           | 6 |
|              |                   |                                                                                                                                         |   |
|              |                   | Notes to  Condensed Consolidated Financial Statements                                                                                        | 7 |
|              |                   |                                                                                                                                         |   |
|              | Item 2.                | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                  | 18 |
|              |                   |                                                                                                                                         |   |
|              | Item 3.                | Quantitative  and Qualitative Disclosures About Market Risk                                                                                  | 35 |
|              |                   |                                                                                                                                         |   |
|              | Item 4.                | Controls and  Procedures                                                                                                                     | 35 |
|              |                   |                                                                                                                                         |   |
| Part II.     | Other Information      | 36                                                                                                                                           |
|              |                   |                                                                                                                                         |   |
|              | Item 1.                | Legal Proceedings                                                                                                                            | 36 |
|              |                   |                                                                                                                                         |   |
|              | Item 1A.               | Risk Factors                                                                                                                                 | 36 |
|              |                   |                                                                                                                                         |   |
|              | Item 2.                | Changes in  Securities; Use of Proceeds and Issuer Purchases of Equity Securities                                                            | 36 |
|              |                   |                                                                                                                                         |   |
|              | Item 3.                | Defaults  Upon Senior Securities                                                                                                             | 36 |
|              |                   |                                                                                                                                         |   |
|              | Item 4.                | Submission  of Matters to a Vote of Security Holders                                                                                         | 36 |
|              |                   |                                                                                                                                         |   |
|              | Item 5.                | Other Information                                                                                                                            | 37 |
|              |                   |                                                                                                                                         |   |
|              | Item 6.                | Exhibits                                                                                                                                     | 37 |
|              |                   |                                                                                                                                         |   |
| Signatures        |                   | 38                                                                                                                                           |
|              |                   |                                                                                                                                         |
| Exhibit 31.1 |                   |                                                                                                                                         |
|              |                   |                                                                                                                                         |
| Exhibit 31.2 |                   |                                                                                                                                         |
|              |                   |                                                                                                                                         |
| Exhibit 32.1 |                   |                                                                                                                                         |

 

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**ZUMIEZ INC.**

**CONDENSED CONSOLIDATEDBALANCE SHEETS**

**(in thousands, except share amounts)**

 
| ** **                                                                                                                                                                                           | ** ** | **August 1,  2009** | ** ** | **January 31,  2009** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                                                                           | ** ** | **(Unaudited)**          | ** ** | ** **                 | ** ** |
| **Assets**                                                                                                                                                                                           | ** ** | ** **               | ** ** | ** **                 | ** ** |
| **Current  assets**                                                                                                                                                                                  | ** ** | ** **               | ** ** | ** **                 | ** ** |
| Cash and cash equivalents                                                                                                                                                                            |       | $                        | 21,304     |                       | $          | 33,057 |   |
| Marketable securities                                                                                                                                                                                |       | 60,748                   |       | 45,525                     |       |
| Receivables                                                                                                                                                                                          |       | 7,486                    |       | 4,555                      |       |
| Income tax receivable                                                                                                                                                                                |       | 1,399                    |       | —                     |       |
| Inventory                                                                                                                                                                                            |       | 69,569                   |       | 51,974                     |       |
| Prepaid expenses and other                                                                                                                                                                           |       | 6,381                    |       | 5,614                      |       |
| Deferred tax assets                                                                                                                                                                                  |       | 4,048                    |       | 2,588                      |       |
| **Total  current assets**                                                                                                                                                                            |       | 170,935                  |       | 143,313                    |       |
| ** **                                                                                                                                                                                           | ** ** | ** **               | ** ** | ** **                 | ** ** |
| Leasehold improvements and  equipment, net                                                                                                                                                           |       | 74,367                   |       | 73,932                     |       |
| Goodwill and other  intangibles                                                                                                                                                                      |       | 13,211                   |       | 13,236                     |       |
| Marketable securities -  long-term                                                                                                                                                                   |       | 799                      |       | 1,767                      |       |
| Deferred tax assets                                                                                                                                                                                  |       | 2,291                    |       | 1,101                      |       |
| **Total  long-term assets**                                                                                                                                                                          |       | 90,668                   |       | 90,036                     |       |
|                                                                                                                                                                                                 |       |                     |       |                       |       |
| **Total  assets**                                                                                                                                                                                    |       | $                        | 261,603    |                       | $          | 233,349 |   |
|                                                                                                                                                                                                 |       |                     |       |                       |       |
| **Liabilities and Shareholders’ Equity**                                                                                                                                                        | ** ** | ** **               | ** ** | ** **                 | ** ** |
| **Current  liabilities**                                                                                                                                                                             |       |                     |       |                       |       |
| Trade accounts payable                                                                                                                                                                               |       | $                        | 43,352     |                       | $          | 15,909 |   |
| Accrued payroll and  payroll taxes                                                                                                                                                                   |       | 3,540                    |       | 4,739                      |       |
| Income taxes payable                                                                                                                                                                                 |       | —                   |       | 238                        |       |
| Current portion of  deferred rent and tenant allowances                                                                                                                                              |       | 3,227                    |       | 2,735                      |       |
| Other accrued liabilities                                                                                                                                                                            |       | 8,642                    |       | 7,600                      |       |
| **Total  current liabilities**                                                                                                                                                                       |       | 58,761                   |       | 31,221                     |       |
| ** **                                                                                                                                                                                           | ** ** | ** **               | ** ** | ** **                 | ** ** |
| Long-term deferred rent  and tenant allowances, less current portion                                                                                                                                 |       | 27,192                   |       | 24,177                     |       |
| **Total  liabilities**                                                                                                                                                                               |       | 85,953                   |       | 55,398                     |       |
| Commitments and  contingencies (Note 3)                                                                                                                                                              |       |                     |       |                       |       |
| ** **                                                                                                                                                                                           | ** ** | ** **               | ** ** | ** **                 | ** ** |
| **Shareholders’  equity**                                                                                                                                                                       | ** ** | ** **               | ** ** | ** **                 | ** ** |
| Preferred stock, no par  value, 20,000,000 shares authorized; none issued and outstanding                                                                                                            |       | —                   |       | —                     |       |
| Common stock, no par  value, 50,000,000 shares authorized; 30,155,034 shares issued and  outstanding at August 1, 2009, 29,533,067 shares issued and outstanding  at January 31, 2009 |       | 78,259                   |       | 75,789                     |       |
| Accumulated other  comprehensive income                                                                                                                                                              |       | 90                       |       | 117                        |       |
| Retained earnings                                                                                                                                                                                    |       | 97,301                   |       | 102,045                    |       |
| **Total  shareholders’ equity**                                                                                                                                                                 |       | 175,650                  |       | 177,951                    |       |
| ** **                                                                                                                                                                                           | ** ** | ** **               | ** ** | ** **                 | ** ** |
| **Total  liabilities and shareholders’ equity**                                                                                                                                                 |       | $                        | 261,603    |                       | $          | 233,349 |   |

 

See accompanying notes to condensed consolidated financial statements

 

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**ZUMIEZ INC.**

**CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(in thousands, exceptshare and per share amounts)**

**(Unaudited)**

 
| ** **                                                                 | ** ** | **Three  Months Ended** | ** ** | **Six  Months Ended** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------|------------|----------------------------|------------|
| ** **                                                                 | ** ** | **August 1,**           | ** ** | **August 2,**         | ** ** | **August 1,** | ** ** | **August 2,** | ** ** |
| ** **                                                                 | ** ** | **2009**                     | ** ** | **2008**                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net sales                                                                  |       | $                            | 85,170     |                       | $          | 92,258 |   | $ | 161,977 |   | $ | 170,960 |   |
| Cost of goods sold                                                         |       | 60,526                       |       | 62,155                     |       | 115,434 |   | 116,297 |   |
| **Gross  profit**                                                          |       | 24,644                       |       | 30,103                     |       | 46,543 |   | 54,663 |   |
|                                                                       |       |                         |       |                       |       |   |   |   |   |
| Selling, general and  administrative expenses                              |       | 29,870                       |       | 26,191                     |       | 55,208 |   | 49,125 |   |
| **Operating  (loss) profit**                                               |       | (5,226                       | )          | 3,912                      |       | (8,665 | ) | 5,538 |   |
|                                                                       |       |                         |       |                       |       |   |   |   |   |
| Interest income, net                                                       |       | 307                          |       | 495                        |       | 664 |   | 1,084 |   |
| (Loss) earnings before  income taxes                                       |       | (4,919                       | )          | 4,407                      |       | (8,001 | ) | 6,622 |   |
|                                                                       |       |                         |       |                       |       |   |   |   |   |
| (Benefit) provision for  income taxes                                      |       | (1,834                       | )          | 1,680                      |       | (3,257 | ) | 2,533 |   |
| Net (loss) income                                                          |       | $                            | (3,085     | )                          | $          | 2,727 |   | $ | (4,744 | ) | $ | 4,089 |   |
|                                                                       |       |                         |       |                       |       |   |   |   |   |
| Basic net (loss) income  per share                                         |       | $                            | (0.10      | )                          | $          | 0.09 |   | $ | (0.16 | ) | $ | 0.14 |   |
|                                                                       |       |                         |       |                       |       |   |   |   |   |
| Diluted net (loss) income  per share                                       |       | $                            | (0.10      | )                          | $          | 0.09 |   | $ | (0.16 | ) | $ | 0.14 |   |
|                                                                       |       |                         |       |                       |       |   |   |   |   |
| Weighted average shares  used in computation of (loss) earnings per share: |       |                         |       |                       |       |   |   |   |   |
| Basic                                                                      |       | 29,496,039                   |       | 29,072,536                 |       | 29,252,545 |   | 29,042,861 |   |
|                                                                       |       |                         |       |                       |       |   |   |   |   |
| Diluted                                                                    |       | 29,496,039                   |       | 29,378,589                 |       | 29,252,545 |   | 29,374,015 |   |

 

See accompanying notes to condensedconsolidated financial statements

 

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**ZUMIEZ INC.**

**CONDENSED CONSOLIDATEDSTATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY**

**(in thousands)**

**(Unaudited)**

 
| ** **                                         | ** ** | ** **            | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** **   | ** ** | ** ** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|-------------------|------------|------------------------|------------|--------------|------------|------------|------------|
| ** **                                         | ** ** | **Common Stock** | ** ** | **Comprehensive** | ** ** | **Retained**           | ** ** | ** **   | ** ** |
| ** **                                         | ** ** | **Shares**            | ** ** | **Amount**        | ** ** | **Income (Loss)** | ** ** | **Earnings** | ** ** | **Total**  | ** ** |
| **Balance  at January 31, 2009**              |       | 29,533                |       | $                 | 75,789     |                   | $          | 117          |       | $          | 102,045    |   | $ | 177,951 |   |
| Common stock issued  including tax benefit of $298 |       | 622                   |       | 686               |       | —                 |       | —       |       | 686        |       |
| Stock-based compensation  expense                  |       | —                |       | 1,784             |       |                   |       |         |       | 1,784      |       |
| Unrealized losses, net of  tax benefit of $17      |       | —                |       | —            |       | (27                    | )          | —       |       | (27        | )          |
| Net loss                                           |       |                  |       |              |       |                   |       | (4,744       | )          | (4,744     | )          |
| **Balance  at August 1, 2009**                |       | 30,155                |       | $                 | 78,259     |                   | $          | 90           |       | $          | 97,301     |   | $ | 175,650 |   |

 

See accompanying notes to condensedconsolidated financial statements

 

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**ZUMIEZ INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

**(Unaudited)**

 
| ** **                                                                                | ** ** | **Six Months  Ended**    | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                | ** ** | **August 1,  2009** | ** ** | **August 2,  2008** | ** ** |
| **Cash  flows from operating activities:**                                                |       |                     |       |   |   |
| Net (loss) income                                                                         |       | $                        | (4,744     | ) | $ | 4,089 |   |
| Adjustments to reconcile  net (loss) income to net cash provided by operating activities: |       |                     |       |   |   |
| Depreciation and  amortization                                                            |       | 10,755                   |       | 9,170 |   |
| Deferred tax expense                                                                      |       | (2,633                   | )          | (2,424 | ) |
| Stock-based compensation  expense                                                         |       | 1,784                    |       | 2,129 |   |
| Loss on disposal of assets                                                                |       | 116                      |       | 138 |   |
| Excess tax benefit from  stock options                                                    |       | (298                     | )          | (509 | ) |
| Impairment of long-lived  asets                                                           |       | 294                      |       | — |   |
| Changes in operating  assets and liabilities:                                             |       |                     |       |   |   |
| Receivables                                                                               |       | (2,931                   | )          | (3,501 | ) |
| Inventory                                                                                 |       | (17,595                  | )          | (23,359 | ) |
| Prepaid expenses and other                                                                |       | (767                     | )          | (1,215 | ) |
| Trade accounts payable                                                                    |       | 27,443                   |       | 24,922 |   |
| Accrued payroll and  payroll taxes                                                        |       | (1,199                   | )          | (1,602 | ) |
| Income taxes  payable/receivable                                                          |       | (1,339                   | )          | 3,192 |   |
| Other accrued liabilities                                                                 |       | 1,042                    |       | (387 | ) |
| Deferred rent and tenant  allowances                                                      |       | 3,507                    |       | 5,055 |   |
| Net cash provided by  operating activities                                                |       | 13,435                   |       | 15,698 |   |
|                                                                                      |       |                     |       |   |   |
| Cash flows from investing  activities:                                                    |       |                     |       |   |   |
| Additions to leasehold  improvements and equipment                                        |       | (10,957                  | )          | (19,006 | ) |
| Purchases of marketable  securities                                                       |       | (36,871                  | )          | (51,722 | ) |
| Sales and maturities of  marketable securities                                            |       | 21,954                   |       | 55,225 |   |
| Net cash used in investing  activities                                                    |       | (25,874                  | )          | (15,503 | ) |
|                                                                                      |       |                     |       |   |   |
| Cash flows from financing  activities:                                                    |       |                     |       |   |   |
| Change in book overdraft                                                                  |       | —                   |       | (5,183 | ) |
| Proceeds from exercise of  stock options                                                  |       | 388                      |       | 609 |   |
| Excess tax benefit from  stock options                                                    |       | 298                      |       | 509 |   |
| Net cash provided by (used  in) financing activities                                      |       | 686                      |       | (4,065 | ) |
|                                                                                      |       |                     |       |   |   |
| Net decrease in cash and  cash equivalents                                                |       | (11,753                  | )          | (3,870 | ) |
| Cash and cash equivalents,  beginning of period                                           |       | 33,057                   |       | 11,945 |   |
| Cash and cash equivalents,  end of period                                                 |       | $                        | 21,304     |   | $ | 8,075 |   |
|                                                                                      |       |                     |       |   |   |
| Supplemental disclosure on  cash flow information:                                        |       |                     |       |   |   |
| Cash paid during the  period for interest                                                 |       | $                        | —     |   | $ | 9 |   |
| Cash paid during the  period for income taxes                                             |       | 716                      |       | 1,768 |   |

 

See accompanying notes to condensed consolidated financial statements

 

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**ZUMIEZ INC.**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

**Basis of Presentation—**The accompanyingunaudited  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.

 

Inthe opinion of management, the unaudited condensed consolidated financialstatements contain all adjustments, consisting of normal recurring adjustments,necessary for a fair presentation of the condensed consolidated balance sheetas of August 1, 2009, the condensed consolidated statements of operationsfor the three and six months ended August 1, 2009 and August 2, 2008,the condensed consolidated statement of changes in shareholders’ equity for thesix months ended August 1, 2009 and the condensed consolidated statementsof cash flows for the six months ended August 1, 2009 and August 2,2008.

 

Thefinancial data at January 31, 2009 is derived from audited financialstatements which are included in the Company’s Annual Report on Form 10-Kfor the year ended January 31, 2009, and should be read in conjunctionwith the audited financial statements and notes thereto.  Interim results are not necessarilyindicative of results for the full year.

 

**Principles of Consolidation*****—***Theunaudited  condensed consolidatedfinancial statements include the accounts of Zumiez Inc. and its subsidiary,Zumiez Nevada, LLC, (collectively, “the Company”).  All significant inter-company transactionsand balances are eliminated in consolidation.

 

**Use of Estimates*****—***The preparationof financial statements in conformity with GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the financial statements as well as the reported amounts of revenues andexpenses during the reporting period. These estimates can also affect supplemental information disclosed bythe Company, including information about contingencies, risk, and financialcondition.  In preparing the financialstatements, the Company makes routine estimates and judgments in determiningthe net realizable value of accounts receivable, inventory, fixed assets,marketable securities, goodwill and other intangibles and accruedliabilities.  Some of the moresignificant estimates include the allowance for sales returns, the reserve forinventory valuation estimates, medical and dental insurance reserve, theexpected useful lives of fixed assets and assumed future cash flows supportinglong-lived assets.  Actual results coulddiffer from those estimates.  The resultsof operations for the three and six months ended August 1, 2009 are notnecessarily indicative of the results that might be expected for fiscal2009.  For further information, refer tothe Company’s financial statements and notes included in the Company’sForm 10-K filed on March 23, 2009.

 

**Nature of Business—**The Company is a leadingspecialty retailer of action sports related apparel, footwear, equipment andaccessories operating under the Zumiez brand name.  As of August 1, 2009, the Companyoperated 369 stores primarily located in shopping malls, giving the Company apresence in 34 states.  The Company’sstores cater to young men and women between the ages of 12 and 24 who seekbrands representing a lifestyle centered on activities that include skateboarding,surfing, snowboarding, bicycle motocross (or “BMX”) and motocross.  The Company supports the action sportslifestyle and promotes its brand through a multi-faceted marketing approachthat is designed to integrate its brand image with its customers’ activitiesand interests.  In addition, the Companyoperates a website that sells merchandise online and provides content and acommunity for its target customers.  TheCompany, based in Everett, Washington, was formed in August 1978 andoperates within one reportable segment.

 

**Fiscal Year—**The Company uses a fiscal calendar widely used bythe retail industry which results in a fiscal year consisting of a 52-week or53-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 2008” was the 52-weekperiod ended January 31, 2009.  Thefirst six months of fiscal 2009 was the 26-week period ended August 1,2009.  The first six months of fiscal2008 was the 26-week period ended August 2, 2008.  “Fiscal 2009” is the 52-week period endingJanuary 30, 2010.

 

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**2. Summary of Significant Accounting Policies**

 

Informationregarding the Company’s significant accounting policies is contained in Note 2,“Summary of Significant Accounting Policies,” to the consolidated financialstatements in the Company’s Form 10-K filed on March 23, 2009.  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—**The Company considers all liquid investments with original maturity ofthree months or less when purchased to be cash equivalents.

 

Thefollowing tables summarize the estimated fair value of our cash and marketablesecurities, the gross unrealized holding gains and losses, theother-than-temporarily impaired gross unrealized losses and the length of timeavailable-for-sale securities were in a continuous unrealized loss positions asof August 1, 2009 and January 31, 2009 (in thousands):

 
| ** **                             | ** ** | **August 1, 2009** | ** ** |
|----------------------------------------|------------|------------------------------|------------|
| ** **                             | ** ** | **Amortized  Cost**          | ** ** | **Gross  Unrealized  Holding Gains** | ** ** | **Gross  Unrealized  Holding Losses** | ** ** | **Estimated Fair  Value** | ** ** | **Unrealized  Loss Position  Less Than  Twelve Months** | ** ** | **Continuous  Unrealized  Loss Position  Greater Than  Twelve Months** | ** ** |
| Cash and cash equivalents:             |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| Cash                                   |       | $                            | 21,304     |   | $ | — |   | $ | — |   | $ | 21,304 |   | $ | — |   | $ | — |   |
| Total cash and cash  equivalents       |       | 21,304                       |       | — |   | — |   | 21,304 |   | — |   | — |   |
|                                   |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| Short-term investments                 |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| Treasury and agency  securities        |       | 2,998                        |       | 2 |   | — |   | 3,000 |   | — |   | — |   |
| State and local government  securities |       | 43,551                       |       | 258 |   | (10 | ) | 43,799 |   | (8 | ) | (2 | ) |
| Total short-term  investments          |       | 46,549                       |       | 260 |   | (10 | ) | 46,799 |   | (8 | ) | (2 | ) |
|                                   |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| Long-term investments                  |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| State and local government  securities |       | 14,852                       |       | 97 |   | (201 | ) | 14,748 |   | — |   | (201 | ) |
| Total long-term  investments           |       | 14,852                       |       | 97 |   | (201 | ) | 14,748 |   | — |   | (201 | ) |
| Total                                  |       | $                            | 82,705     |   | $ | 357 |   | $ | (211 | ) | $ | 82,851 |   | $ | (8 | ) | $ | (203 | ) |

 
| ** **                             | ** ** | **January 31, 2009** | ** ** |
|----------------------------------------|------------|--------------------------------|------------|
| ** **                             | ** ** | **Amortized  Cost**            | ** ** | **Gross  Unrealized  Holding Gains** | ** ** | **Gross  Unrealized  Holding Losses** | ** ** | **Estimated Fair  Value** | ** ** | **Unrealized  Loss Position  Less Than  Twelve Months** | ** ** | **Continuous  Unrealized  Loss Position  Greater Than  Twelve Months** | ** ** |
| Cash and cash equivalents:             |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| Cash                                   |       | $                              | 33,057     |   | $ | — |   | $ | — |   | $ | 33,057 |   | $ | — |   | $ | — |   |
| Total cash and cash  equivalents       |       | 33,057                         |       | — |   | — |   | 33,057 |   | — |   | — |   |
|                                   |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| Short-term investments                 |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| Treasury and agency  securities        |       | 8,329                          |       | 61 |   | — |   | 8,390 |   | — |   | — |   |
| State and local government  securities |       | 21,235                         |       | 149 |   | — |   | 21,384 |   | — |   | — |   |
| Total short-term  investments          |       | 29,564                         |       | 210 |   | — |   | 29,774 |   | — |   | — |   |
|                                   |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| Long-term investments                  |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| State and local government  securities |       | 17,540                         |       | 253 |   | (275 | ) | 17,518 |   | (275 | ) | — |   |
| Total long-term  investments           |       | 17,540                         |       | 253 |   | (275 | ) | 17,518 |   | (275 | ) | — |   |
| Total                                  |       | $                              | 80,161     |   | $ | 463 |   | $ | (275 | ) | $ | 80,349 |   | $ | (275 | ) | $ | — |   |

 

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The long-term grossunrealized holding losses on the state and local obligations consist of anunrealized loss on the Company’s auction rate security.  The Company has the ability and intent tohold its available-for-sale securities until recovery of fair value, which maybe at maturity, and thus does not currently consider any securities to beother-than-temporarily impaired.  All ofour available-for-sale securities mature in two years or less.

 

The Company did not record arealized loss for other-than-temporary impairments during the three and sixmonths ended August 1, 2009.

 

AtAugust 1, 2009, marketable securities, classified as available for sale,were $61.5 million and consisted primarily of state and local municipalinstruments, U.S. treasury reserves and U.S. agency debt instruments withoriginal maturities over 90 days.  As ofJanuary 31, 2009, we held two separate $1.0 million auction ratesecurities.  In May 2009, one of theauction rate securities sold at auction for par.  As of August 1, 2009, we had $0.8million invested, net of impairment charge of $0.2 million, in an auction ratesecurity which is classified as long-term, available-for-sale marketablesecurities on our condensed consolidated balance sheet.

 

Auctionrate securities are generally long-term debt instruments that provide liquiditythrough a Dutch auction process that resets the applicable interest rate atpre-determined calendar intervals.  Thismechanism generally allows existing investors to rollover their holdings andcontinue to own their respective securities or liquidate their holdings byselling their securities at par value. Prior to February 3, 2008, we invested in these securities for shortperiods of time as part of our cash management program.  However, the uncertainties in the creditmarkets, that began in early 2008,  haveprevented us and other investors from liquidating holdings of auction ratesecurities in recent auctions for these securities because the amount ofsecurities submitted for sale has exceeded the amount of purchase orders.  Should the auction continue to fail, weanticipate we have the ability to hold the security until the liquidity in themarket improves.  The investment is fullycollateralized by the United States government and insured against loss ofprincipal and interest by a bond insurer whose current credit rating is Ba3 byMoody’s Investors Services.  If thecredit ratings of the issuer, the bond insurers or the collateral deteriorate,we may adjust the carrying value of this investment.  Although we are uncertain as to when theliquidity issues relating to this investment will improve, we consider theissue to be only temporary.  It ispossible that further declines in fair value may occur, and those declines, ifany, would be recognized in our condensed consolidated balance sheet as “accumulatedother comprehensive income (loss).”  Wecontinue to monitor the market for auction rate securities and consider itsimpact, if any, on the fair market value of the investment.

 

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**Receivables—** At August 1, 2009 and January 31, 2009,receivables included the following (in thousands):

 
| ** **                    | ** ** | **August 1,  2009** | ** ** | **January 31,  2009** | ** ** |
|-------------------------------|------------|--------------------------|------------|----------------------------|------------|
| Credit cards receivable       |       | $                        | 3,326      |                       | $          | 1,884 |   |
| Tenant allowances  receivable |       | 2,169                    |       | 901                        |       |
| Vendor credits                |       | 682                      |       | 410                        |       |
| Interest receivable           |       | 673                      |       | 418                        |       |
| Employee receivables          |       | 355                      |       | 483                        |       |
| Other receivables             |       | 281                      |       | 459                        |       |
|                          |       | $                        | 7,486      |                       | $          | 4,555 |   |

 

TheCompany does not extend credit to its customers except through independentthird-party credit cards, which are generally collected within several businessdays.

 

**Merchandise Inventories—**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 sales prices and couldresult in a fluctuation in gross profit. Historically, any write-downs have not been significant to theCompany.  We have reserved for inventoryas of August 1, 2009 and January 31, 2009 in the amounts ofapproximately $2.7 million and $3.6 million. The inventory reserve includes inventory whose estimated market value isbelow cost, and an estimate for inventory shrinkage.  These reserve amounts are evaluatedquarterly.  The inventory related tothese reserves is not marked up in subsequent periods.

 

**Leasehold Improvements and Equipment—**Leasehold improvements and equipment are stated at cost lessaccumulated depreciation utilizing the straight-line method over the assets’estimated useful lives.  The useful livesof our major classes of assets are as follows:

 
| Leasehold improvements                                         |   | Lesser of 7 years or the term of the lease |
|----------------------------------------------------------------|--------|--------------------------------------------|
| Fixtures                                                       |   | 3 — 7 years                           |
| Computer equipment, software, store equipment & other |   | 3 — 5 years                           |

 

Thecost and related accumulated depreciation of assets sold or otherwise disposedof is removed from the accounts and the related gain or loss is reported in thecondensed consolidated statement of operations.

 

**Valuation of Long-Lived Assets—**The Company reviews the carrying value of long-lived assets for impairmentwhenever events or changes in circumstances indicate that the carrying value ofsuch assets may not be recoverable. Measurement of the impairment loss is based on the fair value of theasset or group of assets.  Generally,fair value will be determined using accepted valuation techniques, such as thepresent value of expected future cash flows.

 

Duringthe second quarter, management performed a review of the carrying value oflong-lived assets conducted in accordance with SFAS No. 144 “*Accounting for the Impairment or Disposal of long-Lived Assets*.”  The review revealed that three stores wereimpaired as of August 1, 2009. Accordingly, a non-cash impairment charge of approximately $0.3 millionwas included in selling, general and administrative expenses for the three andsix months ended August 1, 2009.

 

**Fair Value of Financial Instruments—**Statement of Financial Accounting Standards No. 107 *“Disclosures about Fair Value of Financial Instruments”* (“SFAS No. 107”),requires management to disclose the estimated fair value of certain assets andliabilities as financial instruments. Financial instruments are generally defined by SFAS No. 107 ascash, evidence of ownership interest in an entity, or a contractual obligationthat both conveys to one entity a right to receive cash or other financialinstruments from another entity and imposes on the other entity the obligationto deliver cash or other financial instruments to the first entity.  At August 1, 2009 and January 31,2009, 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, excluding auction ratesecurities described below, approximate the fair value because these financialinstruments have floating interest rates, which reflect current marketconditions.

 

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Statement of Financial AccountingStandards No. 157 “*Fair Value Measurements*”defines fair value, establishes framework for measuring fair value inaccordance with generally accepted accounting principles and expandsdisclosures about fair value measurements. In October 2008, the Financial Accounting Standards Board (“FASB”),issued Financial Accounting Standards Board Staff Position (“FSP”)No. SFAS 157-3 (“FSP 157-3”), “*Determining the Fair Valueof a Financial Asset When the Market for That Asset Is Not Active*.  FSP 157-3 clarifies the application of SFASNo. 157 *“Fair Value Measurements,”* in amarket that is not active and provides an example to illustrate keyconsiderations in determining the fair value of a financial asset when themarket for that financial asset is not active. Contractual maturities of investments underlying our available-for-salesecurities at August 1, 2009 included $0.8 million in an auction ratesecurity, net of $0.2 million temporary impairment.  Basedon current market conditions, auctions related to this security may beunsuccessful at the scheduled auction.  An unsuccessful auction couldresult in our holding the security beyond the next scheduled auction reset dateif a secondary market does not develop; therefore, limiting the short-termliquidity of the investment.

 

**Other Accrued Liabilities****—**At August 1, 2009 and January 31, 2009 other accruedliabilities consisted of the following:

 
| ** **                | ** ** | **Fiscal  Year Ended**   | ** ** |
|---------------------------|------------|--------------------------|------------|
| ** **                | ** ** | **August 1,  2009** | ** ** | **January 31,  2009** | ** ** |
| Accrued payables          |       | $                        | 2,381      |   | $ | 2,564 |   |
| Accrued sales tax         |       | 2,092                    |       | 1,425 |   |
| Gift cards unredeemed     |       | 2,078                    |       | 3,061 |   |
| Accrued legal             |       | 1,398                    |       | — |   |
| Other current liabilities |       | 693                      |       | 550 |   |
|                      |       | $                        | 8,642      |   | $ | 7,600 |   |

 

**Cost of Goods Sold—**Cost of goods sold consists of brandedmerchandise costs, and our private label merchandise including design,sourcing, importing and inbound freight costs. Our cost of sales also includes markdowns, shrinkage, certainpromotional costs, buying, occupancy and warehousing costs. This may not be comparable to the way in which the Company’s competitorsor other retailers compute their cost of goods sold.

 

Withrespect to the freight component of our ecommerce sales, we arrange and pay thefreight for our customers and bill them for this service, unless our customershave their product shipped to one of our stores in which case we do not billour customers.  Such amounts, if any, arebilled and included in revenue and the related freight cost is charged to costof goods sold.  For the three months ended August 1, 2009 andAugust 2, 2008, the Company incurred shipping costs related to ecommercesales of approximately $0.1 million.  For the sixmonths ended August 1, 2009 and August 2, 2008, the Company incurredshipping costs related to ecommerce sales of approximately $0.3 million.

 

**Stock Compensation—**The Company maintains a 2005Equity Incentive Plan under which non-qualified stock options, incentive stockoptions and restricted stock have been granted to employees and non-employeedirectors.  The Company accounts forstock-based compensation in accordance with FASB Statement No. 123(R), *Share-Based Payment* (“SFAS No. 123(R)”).  Under the provisions of SFAS No. 123(R),the estimated fair value of share-based awards granted under the 2005 EquityIncentive Plan is recognized as compensation expense over the vesting period.

 

Thefair value of stock option grants, excluding options granted under the exchangeoffer, discussed below, are estimated on the date of grant using theBlack-Scholes option pricing method with the following weighted-averageassumptions used for grants issued during the six month periods endedAugust 1, 2009 and August 2, 2008.

 
| ** **                         | ** ** | **For the  Six Months Ended** | ** ** |
|------------------------------------|------------|-------------------------------|------------|
| ** **                         | ** ** | **August 1,  2009**      | ** ** | **August 2,  2008** | ** ** |
| Dividend yield                     |       | —                        | %          | — | % |
| Volatility rate                    |       | 66.71                         | %          | 55.20 | % |
| Average expected life (in  years): |       |                          |       |   |   |
| Expected lives-Five years          |       | —                        |       | 6.50 |   |
| Expected lives-Four years          |       | 6.25                          |       | 6.25 |   |
| Average risk-free interest  rate:  |       | 1.65                          | %          | 2.78 | % |

 

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*Stock Option Exchange*

 

OnJuly 21, 2009, the Company completed an offer to exchange certain employeestock options issued under the 2005 Equity Incentive Plan (“Exchange Offer”).  Certain previously granted stock options wereexchanged for new, lower-priced stock options granted on a one and onehalf-for-one basis (1.5:1).  An aggregateof 460,700 previously granted stock options were exchanged for an aggregate of307,138 new stock options granted pursuant to the Exchange Offer with anexercise price of $8.64 per share.  Thenew stock option grants will vest annually over a four-year period beginning onthe first anniversary of the date granted. The Exchange Offer resulted in a nominal increase in stock-basedcompensation expense.

 

Thefollowing table summarizes the Company’s stock option activity for the sixmonths ended August 1, 2009 and August 2, 2008 (in thousands exceptweighted-average exercise price):

 
| ** **                                | ** ** | **Six Months  Ended**    | ** ** |
|-------------------------------------------|------------|--------------------------|------------|
| ** **                                | ** ** | **August 1,  2009** | ** ** | **August 2,  2008** | ** ** |
| ** **                                | ** ** | **Stock  Options**       | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Stock  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| Outstanding at beginning  of year         |       | 1,793                    |       | $ | 17.13 |   | 1,958 |   | $ | 16.29 |   |
| Granted year to date (1)                  |       | 520                      |       | $ | 7.92 |   | 155 |   | $ | 14.17 |   |
| Exercised year to date                    |       | (168                     | )          | $ | 1.33 |   | (79 | ) | $ | 3.45 |   |
| Forfeited and exchanged  year to date (2) |       | (543                     | )          | $ | 30.24 |   | (54 | ) | $ | 32.73 |   |
| Outstanding at the end of  the period     |       | 1,602                    |       | $ | 11.35 |   | 1,980 |   | $ | 18.26 |   |
| Exercisable at end of the  period         |       | 618                      |       | $ | 12.01 |   | 684 |   | $ | 10.33 |   |

 

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(1) Includes 307,138 stock options issuedpursuant to the Exchange Offer.

(2) Includes 460,700 stock options exchanged inthe Exchange Offer.

 

During the six months endedAugust 1, 2009 and August 2, 2008, the Company granted, excludingstock options granted under the Exchange Offer, approximately 213,000 and155,000 stock options with a Black-Scholes weighted average fair value of $4.24and $7.83.

 

The following tablesummarizes the Company’s restricted stock activity for the six months endedAugust 1, 2009 and August 2, 2008 (in thousands exceptweighted-average fair value):

 
| ** **                        | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|
| ** **                        | ** ** | **August 1, 2009**   | ** ** | **August 2, 2008** | ** ** |
| ** **                        | ** ** | **Restricted  Stock**          | ** ** | **Grant Date  Weighted  Average  Fair Value** | ** ** | **Intrinsic  Value** | ** ** | **Restricted  Stock** | ** ** | **Grant  Date  Weighted  Average  Fair Value** | ** ** | **Intrinsic  Value** | ** ** |
| Outstanding at beginning  of year |       | 285                            |       | $ | 15.49 |   | $ | 2,034 |   | 16 |   | $ | 37.19 |   | $ | 321 |   |
| Granted year to date              |       | 442                            |       | $ | 7.06 |   | — |   | 285 |   | $ | 14.33 |   | — |   |
| Vested year to date               |       | (68                            | )          | $ | 15.75 |   | — |   | (3 | ) | $ | 38.19 |   | — |   |
| Forfeited year to date            |       | (10                            | )          | $ | 10.63 |   | — |   | (3 | ) | $ | 14.00 |   | — |   |
| Outstanding at end if  period     |       | 649                            |       | $ | 9.80 |   | $ | 6,194 |   | 295 |   | $ | 16.37 |   | $ | 4,402 |   |

 

The intrinsic value ofrestricted stock awards is the market value of the outstanding restricted stockon the last business day of the quarter. The market value per share was $9.55 and $14.90 at August 1, 2009and August 2, 2008.

 

During the six months endedAugust 1, 2009 and August 2, 2008, the Company granted approximately442,000 and 285,000 shares of restricted stock with a weighted average fairmarket value on the date of grant of $7.06 and $14.33 per share. The Companyrecorded approximately $1.2 million and $1.8 million of total stock-basedcompensation expense for the three and six months ended August 1, 2009, ofwhich approximately $0.1 million and $0.2 million, was attributable to theBoard of Directors.  The Company recordedapproximately $1.2 million and $2.1 million of stock-based compensation for thethree and six months ended August 2, 2008, of which approximately $0.1million and $0.3 million, was attributable to the Board of Directors.  The stock-based compensation expense iscalculated on an accelerated method for stock options and a straight-line basisfor restricted stock over the vesting periods of the related equity grant.  This charge had no impact on the Company’sreported cash flows.

 

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At August 1, 2009 andJanuary 31, 2009, there was approximately $9.2 million and $8.6 million,of total unrecognized compensation cost related to unvested stock options andrestricted stock grants of which approximately $0.3 million and $0.2 million,was attributable to the Board of Directors. This cost is expected to be recognized over a period of approximatelythree to eight years.

 

**Goodwill****and OtherIntangible Assets** — In accordance with Statement of FinancialAccounting Standards No. 142, “*Accounting for Goodwilland Other Intangible Assets”* (“SFAS No. 142”), the Company doesnot amortize goodwill derived from purchase business combinations.  The Company evaluates the recoverability ofgoodwill 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 for thesix months ended August 1, 2009 and August 2, 2008.

 

**Recent accounting pronouncements—**

 

In December 2007, FASBissued SFAS No. 141 (revised 2007), *“Business Combinations”*(“SFAS 141No. (R),”) which replaces SFAS No. 141, *“Business Combinations”* (“SFAS No. 141”).  SFAS No. 141(R) retains theunderlying concepts of SFAS 141 in that all business combinations are stillrequired to be accounted for at fair value under the acquisition method ofaccounting but SFAS No. 141(R) changed the method of applying theacquisition 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) iseffective on a prospective basis for all business combinations for which theacquisition date is on or after the beginning of the first annual periodsubsequent to December 15, 2008, with the exception of the accounting forvaluation allowances on deferred taxes and acquired tax contingencies.  SFAS No. 141(R) amends SFASNo. 109, *“Accounting for Income Taxes,”*suchthat adjustments made to valuation allowances on deferred taxes and acquiredtax contingencies associated with acquisitions that closed prior to theeffective date of SFAS No. 141(R) would also apply the provisions ofSFAS No. 141(R).  The Company’sadoption of SFAS No. 141(R) does not have a material impact onits condensed consolidated financial statements.

 

InDecember 2007, the FASB issued SFAS No. 160, “*Non-controllingInterests in Consolidated Financial Statements.*”  (“SFAS No. 160”) amends AccountingResearch Bulletin No. 51, *“Consolidated FinancialStatements”* and requires (i) classification of non-controllinginterests, commonly referred to as minority interests, within stockholders’equity, (ii) net income to include the net income attributable to thenon-controlling interest and (iii) enhanced disclosure of activity relatedto non-controlling interests.  SFASNo. 160 is effective for fiscal years beginning after December 15,2008.  The Company’s adoption of SFASNo. 160 does not have a material impact on its condensed consolidatedfinancial statements.

 

InFebruary 2008, the FASB issued FSP No. FAS 157-2, (“FSP 157-2”),which delays the effective date of SFAS No.157, *“Fair ValueMeasurements,”*for nonfinancial assets and nonfinancial liabilities,except for items that are recognized or disclosed at fair value in thefinancial statements on a recurring basis (at least annually).  Nonfinancial assets and nonfinancialliabilities would include all assets and liabilities other than those meetingthe definition of a financial asset or financial liability as defined inparagraph 6 of SFAS No. 159, *“The Fair Value Option forFinancial Assets and Financial Liabilities.”*  This FASB Staff Position defers the effectivedate of SFAS No. 157 to fiscal years beginning after November 15,2008, and interim periods within those fiscal years for items within the scopeof FSP 157-2.  During the current fiscalyear, the Company adopted the provisions of FSP 157-2 and determined that itdoes not have a material impact on the condensed consolidated financialstatements.

 

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InApril 2008, the FASB issued FSP No. FAS 142-3, *Determination of the Useful Lives of IntangibleAssets*(“FSP 142-3”), which amends the factors that should be consideredin developing renewal or extension assumptions used to determine the usefullife of a recognized intangible asset under SFAS No. 142, *Goodwill and Other Intangible Assets*.  The intent of FSP 142-3 is to improve theconsistency between the useful life of a recognized intangible asset under SFASNo. 142 and the period of expected cash flows used to measure the fairvalue of the asset under SFAS No. 141(R) and other U.S. generallyaccepted accounting principles.  FSP142-3 is effective for financial statements issued for fiscal years beginningafter December 15, 2008, and interim periods within those fiscalyears.  The Company’s adoption of FSP142-3 does not have a material impact on its condensed consolidated financialstatements.

 

In March 2009, the FASBissued FSP No. FAS 157-4, *“Determining Fair ValueWhen the Volume and Level of Activity for the Asset or Liability HaveSignificantly Decreased and Identifying Transactions That Are Not Orderly”* (“FSP 157-4”), which provides additional guidance on determining whether a market for afinancial asset is not active and eliminates the proposed presumption that alltransactions are distressed (not orderly) unless proven otherwise  under the fair value measurements of SFAS No. 157,“*Fair Value Measurements*.”  FSP 157-4 is effective for interim periodsending after June 15, 2009.  TheCompany’s adoption of FSP 157-4 does not have a material impact on itscondensed consolidated financial statements.

 

In March 2009, the FASBissued FSP No. FAS 115-2, *“Recognition  and Presentation of Other-Than-TemporaryImpairments*” (“ FSP 115-2”) and FAS 124-2 *“Recognitionof Other-Than-Temporary Impairments,”* which provides additionalguidance for determining whether an impairment is other-than-temporary to debtsecurities in the financial statements. FSP 115-2 requires other-than-temporary impairments to be separated intothe amount representing the decrease in cash flows expected to be collectedfrom a security (referred to as credit losses) which is recognized in earningsand the amount related to other factors (referred to as noncredit losses) whichis recognized in other comprehensive income. FSP 115-2 and FAS 124-2 is effective for interim periods and annualperiods ending after June 15, 2009. The Company does not meet the conditions necessary to recognizeother-than-temporary losses, or credit losses, of its auction rate securitiesin earnings.  The Company’s adoption ofFSP 115-2 and FAS 124-2 does not have a material impact on its condensedconsolidated financial statements.

 

InApril 2009, the FASB issued FSP No. FAS 107-1, “*InterimDisclosures about Fair Value of Financial Instruments,”* (“FSP 107-1”),that require an entity to provide disclosures about fair value of financialinstruments in interim financial information and Accounting Principles BoardOpinion No. 28 (“APB 28-1”)*“Interim FinancialDisclosures,* that requires those disclosures in summarized financialinformation at interim reporting periods. FSP 107-1 and APB 28-1 are effective for interim periods ending after June 15,2009.  The Company’s adoption of FAS107-1 and APB 28-1 does not have a material impact on its condensedconsolidated financial statements.

 

In May 2009, the FASBissued SFAS No. FAS 165, *“Subsequent Events,”*(“FAS165”)*,* which provides guidance on management’sassessment of subsequent events and disclosure of the date of the subsequentevent.  FAS 165 is effective for interimand annual periods ending after June 15, 2009.  The Company’s adoption of FAS 165 does nothave a material impact on its condensed consolidated financial statements.

 

In June 2009,the FASB issued SFAS No. 168, “*The FASBAccounting Standards Codification and the Hierarchy of Generally AcceptedAccounting Principles — a replacement of FASB Statement No. 162”*(“FAS 168”).  The new statement modifiesthe U.S. generally accepted accounting principles (“GAAP”) hierarchy created bySFAS No. 162 “*The Hierarchy ofGenerally Accepted Accounting Principles”*by establishing only twolevels of GAAP: authoritative and nonauthoritative.  This is accomplished by authorizing the *FASB Accounting Standards Codification*(“Codification”)to become the single source of authoritative U.S. accounting and reportingstandards, except for rules and interpretive releases of the SEC underauthority of the federal securities laws, which are sources of authoritativeGAAP for SEC registrants.  FAS 168 iseffective for financial statements for interim and annual periods ending after September 15,2009.  All existing accounting standarddocuments are superseded and all other accounting literature not included inthe Codification is considered nonauthoritative.  The Company does not anticipate the adoptionof FAS 168 will have a material effect on the Company’s condensed consolidatedfinancial statements.

 

**3. Commitments and Contingencies**

 

L**eases**—The Company is committed under operating leases forits entire retail store locations.  Inaddition to minimum future lease payments, all store leases provide foradditional rental payments based on sales, as well as common area maintenancecharges.  A majority of our leasesprovide for ongoing co-tenancy requirements which would further lower rentalrates, or permit lease terminations, or both, in the event that co-tenantscease to operate for specific periods of time.

 

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Totalrent expense, base rent and contingent rent for the three and six month periodsended August 1, 2009 and August 2, 2008 (in thousands) is as follows:

 
| ** **                         | ** ** | **For the  Three Months Ended** | ** ** | **For the  Six Months Ended** | ** ** |
|------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                         | ** ** | **August 1,  2009**        | ** ** | **August 2,  2008**      | ** ** | **August 1,  2009** | ** ** | **August 2,  2008** | ** ** |
| Store base rent expense            |       | $                               | 8,700      |                          | $          | 7,308 |   | $ | 16,592 |   | $ | 14,095 |   |
| Other base rent expense            |       | 242                             |       | 243                           |       | 485 |   | 486 |   |
| Total base rent expense            |       | 8,942                           |       | 7,551                         |       | 17,077 |   | 14,581 |   |
| Contingent and other rent  expense |       | 5,434                           |       | 4,915                         |       | 10,658 |   | 9,368 |   |
| Total rent expense                 |       | $                               | 14,376     |                          | $          | 12,466 |   | $ | 27,735 |   | $ | 23,949 |   |

 

**Litigation—** On December 10, 2007, a putative class actioncomplaint was filed in the U.S. District Court for the Western District ofWashington against the Company and certain of its current and former directorsand officers.  The action was purported to be brought on behalf of aclass of purchasers of the Company’s stock during the period March 14,2007 to January 4, 2008 and alleged that the defendants violated thefederal securities laws during this period of time by, among other things,having made materially false or misleading statements and that the defendantsengaged in insider trading.  Thedefendants moved to dismiss all claims in October 2008.  On March 30, 2009, the U.S. DistrictCourt for the Western District of Washington issued its ruling without oralargument, dismissing the case with prejudice.

 

In addition, on December 20,2007, a shareholder derivative action was filed in the Superior Court of theState of Washington (Snohomish County), allegedly on behalf of and for thebenefit of the Company, against certain of the Company’s current directors andcurrent and former officers.  Following the March 30, 2009 ruling bythe U.S District Court on the putative class action complaint, the relatedshareholder derivative action was voluntarily dismissed.

 

OnMarch 5, 2008, a former employee commenced an action against the Companyin California state court (*Evan Johnson v. Zumiez, Inc.,et al.,*Case No. RG08374968, Alameda County Superior Court,filed March 5, 2008) alleging that the Company failed to pay all overtimewages owing to him and other employees in California, failed to provide mealbreaks as required by California law, failed to provide employees with properitemized wage statements (pay stubs) as required by California law, and failedto pay terminated employees waiting time penalties under California Labor Codesection 203.  On July 16, 2009, theCompany announced that it had reached an agreement to settle.  The settlement agreement, which is subject todocumentation and court approval, provides for a claims made settlement expectedto cost the Company approximately $1.3 million which includes settlement awardsto class members, an incentive payment to the plaintiff, attorney’s fees andcosts, and claims administration costs. This accrued charge was recorded in selling, general and administrativeexpenses in the condensed consolidated statement of operations for the threemonths ended August 1, 2009.

 

Aputative class action, *Chandra Berg v. ZumiezInc.*, was filed against the Company in the Los Angeles SuperiorCourt under case number BC408410 on February 25, 2009.  The action alleges causes of action forfailure to pay overtime wages to present and former store managers inCalifornia, failure to provide meal periods and rest breaks to store managers,failure to reimburse retail employees for clothing required by the Company’sdress code, failure to reimburse retail employees for business expenses,failure to provide store managers with accurate itemized wage statements,failure to pay terminated store managers all wages due at the time oftermination, unfair business practices and declaratory relief.  The Company has filed an answer to theComplaint and discovery is being conducted. No motion requesting certification of the case as a class action hasbeen filed.  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 responsiblefor medical and dental insurance claims up to a specified aggregateamount.  The Company maintains a reservefor estimated medical and dental insurance claims based on historical claimsexperience and other estimated assumptions.

 

**4. Fair Value Measurements—** On February 3, 2008,the Company adopted SFAS No. 157, *“Fair Value Measurements”*(“FAS 157”).  FAS 157 defines fair value,establishes a framework for measuring fair value and expands disclosure aboutfair value measurements 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;

 

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

 

TheCompany adopted FSP FAS No. 157-3, “*Determiningthe Fair Value of a Financial Asset When the Market for That Asset is NotActive”*(“FSP 157-3”), which was issued in October 2008 andbecame effective immediately for any unissued financial statements.  FSP 157-3 clarifies the application of FAS157 to financial assets for which an active market does not exist.  FSP 157-3 applies to financial assets withinthe scope of accounting pronouncements that require or permit fair valuemeasurement in accordance with FAS 157.

 

TheCompany adopted FSP No. FAS 157-4, *“Determining Fair ValueWhen the Volume and Level of Activity for the Asset or Liability HaveSignificantly Decreased and Identifying Transactions That Are Not Orderly”*(“FSP 157-4”), effective June 15, 2009.  The FSP provides guidelinesfor making fair value measurements consistent with the principles presented inFAS 157 and requires an assessment of whether certain factors exist to indicatethat the market for an instrument is not active at the measurement date.  If, after evaluating those factors, theevidence indicates the market is not active, a company must determine whetherrecent quoted transaction prices are associated with distressed transactions.

 

Thefollowing table summarizes assets measured at fair value on a recurring basisat August 1, 2009 and January 31, 2009, as required by SFAS 157:

 
| **Marketable  securities** | ** ** | **Level 1** | ** ** | **Level 2**         | ** ** | **Level 3** | ** ** |
|----------------------------|------------|-------------|------------|---------------------|------------|-------------|------------|
| ** **                 | ** ** | ** **  | ** ** | **(in  thousands)** | ** ** | ** **  | ** ** |
| At August 1, 2009     |       | $           | —     |                | $          | 60,748      |       | $ | 799 |   |
| At January 31, 2009   |       | $           | —     |                | $          | 45,525      |       | $ | 1,767 |   |

 

The$0.8 million in Level 3 marketable securities represents a $1.0 million auctionrate security net of temporary impairment charge of approximately $0.2million.  This security failed to sell atits scheduled auction in March 2009. The interest rate for this security reset to a rate of 1.16%.  The next scheduled auction for this securityis in March 2010.  The Company’svaluation method is based on numerous assumptions including assessments of theunderlying structure of the security, expected cash flows, credit ratings,liquidity and other relevant factors. Accordingly, this security is classified as Level 3 within SFAS 157’svaluation hierarchy since the Company’s initial adoption of SFAS 157 at February 3,2008.  These assumptions, assessments andthe interpretations of relevant market data are subject to uncertainties aredifficult to predict and require significant judgment.  The use of different assumptions, applyingdifferent judgment to inherently subjective matters and changes in futuremarket conditions could result in significantly different estimates of fairvalue.

 

Asa result of the temporary declines in fair value for the Company’s auction ratesecurity, which the Company attributes to current liquidity issues rather thancredit issues, it has recorded an unrealized loss of approximately $0.2 millionto accumulated other comprehensive loss in the condensed consolidated balancesheet as of August 1, 2009.  TheCompany believes the current illiquid conditions are temporary in nature andthat it has the ability to hold the auction rate security until liquidityreturns to the market.  If it is laterdetermined that the fair value of this security is other-than-temporarilyimpaired, the Company will record a loss in the consolidated statement ofoperations.  Due to the Company’s beliefthat the market for this investment may take in excess of twelve months tofully recover, the Company has classified it as a noncurrent asset on theaccompanying condensed consolidated balances sheet as of August 1, 2009and January 31, 2009.

 

TheLevel 2 marketable securities includes high credit money market accounts, UStreasuries, US government agency securities, certificates of deposit, andmunicipal bonds traded in the over-the-counter market.  Fair values are based on quoted market pricesfor similar assets or liabilities or determined using inputs that use as theirbasis readily observable market data that are actively quoted and can bevalidated through external sources, including third-party pricing services,brokers, and market transactions.

 

Thefollowing table presents the changes in the Level 3 fair-value category for thesix months ended August 1, 2009. The Company classifies financial instruments in Level 3 of thefair-value hierarchy when there is reliance on at least one significantunobservable input to the valuation model. In addition to these unobservable inputs, the valuation models for Level3 financial instruments may also rely on a number of inputs that are readilyobservable either directly or indirectly.

 

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| ** **            | ** ** | **January 31,  2009** | ** ** | **Transfers in  and/or (out) of  level 3** | ** ** | **Total unrealized income  included in Accumlated  Comprehensive Income  (Loss)** | ** ** | **August 1,  2009** | ** ** |
|-----------------------|------------|----------------------------|------------|----------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **            | ** ** | **(in thousands)**    | ** ** |
| Marketable securities |       | $                          | 1,767      |                                                           | $          | (1,000                                                                                                     | )          | $                        | 32         |   | $ | 799 |   |
|                       |            |                            |            |                                                                |            |                                                                                                            |            |                          |            |  |  |  |  |

 

Thefollowing table represents the fair value hierarchy for assets measured at fairvalue on a nonrecurring basis as of August 1, 2009:

 
| ** **                       | ** ** | **Fair Value Measurements at August 1, 2009** | ** ** |
|----------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                       | ** ** | **(in thousands)**                                                     | ** ** |
| ** **                       | ** ** | ** **                                                                  | ** ** | **Ouoted Prices in  Active Markets for  Indentical Assets** | ** ** | **Significant Other  Observable Inputs** | ** ** | **Significant  Unobservable  Inputs** | ** ** |
| ** **                       | ** ** | **Total**                                                                   | ** ** | **Level (1)** | ** ** | **Level (2)** | ** ** | **(Level 3)** | ** ** |
| Long-lived assets held and  used |       | $                                                                           | 74,367     |   | $ | — |   | $ | — |   | $ | 74,367 |   |
|                                  |            |                                                                             |            |  |  |  |  |  |  |  |  |  |  |

 

Inaccordance with the provisions of SFAS 144, “Accounting for the Impairment orDisposal of Long-Lived Assets,” long-lived store assets (primarily leaseholdimprovements and equipment) with a carrying amount of $74.7 million werewritten down to their fair value of $74.4 million, resulting in an impairmentcharge of approximately $0.3 million, which was included in the operatingresults for the period ended August 1, 2009.  Fair value is determined using a undiscountedcash flow model.  The estimation offuture cash flows from operating activities requires significant estimates offactors that include future sales and gross margin performance.  If the Company’s sales or gross marginperformance or other estimated operating results are not achieved at or abovethe forecasted level, the carrying value of certain store assets may proveunrecoverable and the Company may incur additional impairment charges in thefuture.

 

**5. Net Income (Loss) Per Share,Basic and Diluted—** Basic net income per share is computed pursuant toSFAS No. 128 *“Earnings per Share”* based on theweighted average number of common shares outstanding during the period.  Diluted net income per share is applicable onlyin periods of net income and is computed by dividing net income by the weightedaverage number of common shares outstanding for the period and potentiallydilutive common share equivalents outstanding for the period.  For purposes of calculating diluted earningsper share, incremental shares were excluded for the three and six months ended August 1,2009, as the Company is in a net loss position and any effect of common shareequivalents would be considered anti-dilutive.

 

Commonshare equivalents included in the computation of diluted net income per sharerepresent shares issuable upon assumed exercise of outstanding stock options,non-vested restricted stock and employee stock purchase plan share equivalents(“ESPP”).  Options to purchaseapproximately 447,000 and 862,000 shares of common stock in the three monthsended August 1, 2009 and August 2, 2008 and 446,000 and 862,000shares of common stock in the six months ended August 1, 2009 and August 2,2008, were not included in the computation of diluted earnings per sharebecause either the option exercise price or the grant date fair value of thenon-vested share is greater than the market price of the Company’s commonstock.  There were approximately 251,000and 208,000 shares of non-vested restricted shares included in the calculationof diluted earnings per share for the three and six months ended August 2,2008.

 

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Thefollowing table sets forth the computation of basic and diluted net (loss) pershare (in thousands, except share and per share amounts):

 
| ** **                                                              | ** ** | **For the Three Months Ended** | ** ** | **For the Six Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                              | ** ** | **August 1, 2009**                       | ** ** | **August 2, 2008**                     | ** ** | **August 1, 2009** | ** ** | **August 2, 2008** | ** ** |
| Net (loss) income                                                       |       | $                                                  | (3,085     | )                                                | $          | 2,727 |   | $ | (4,744 | ) | $ | 4,089 |   |
| Weighted average common  shares for basic net (loss) income per share   |       | 29,496,039                                         |       | 29,072,536                                       |       | 29,252,545 |   | 29,042,861 |   |
| Dilutive effect of stock  options, restricted stock and ESPP            |       | —                                             |       | 306,053                                          |       | — |   | 331,154 |   |
| Weighted average common  shares for diluted net (loss) income per share |       | 29,496,039                                         |       | 29,378,589                                       |       | 29,252,545 |   | 29,374,015 |   |
| Basic net (loss) income  per share                                      |       | $                                                  | (0.10      | )                                                | $          | 0.09 |   | $ | (0.16 | ) | $ | 0.14 |   |
| Diluted net (loss) income  per share                                    |       | $                                                  | (0.10      | )                                                | $          | 0.09 |   | $ | (0.16 | ) | $ | 0.14 |   |

 

**6.  Subsequent Events—** The Companyhas evaluated subsequent events through the filing date of this Form 10-Qand has determined that there were no subsequent events to recognize ordisclose in these financial statements.

 

**Item 2:  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

*The following discussion and analysis of our financial condition andresults of operations should be read in conjunction with our condensedconsolidated financial statements and related notes included elsewhere in thisquarterly report.  This discussioncontains forward-looking statements that involve risks and uncertainties.  Our actual results could differ materiallyfrom those anticipated in these forward-looking statements as a result ofvarious factors, including those discussed in the section entitled “RiskFactors” in our Form 10-K filed with the SEC on March 23, 2009 and inthis Form 10-Q.*

 

*Forward-looking statements are based on our expectations regarding netsales, selling, general and administrative expenses, profitability, financialposition, business strategy, new store openings, and plans and objectives ofmanagement.  The words “believe,” “may,” “will,”“estimate,” “continue,” “anticipate,” “intend,” “expect” and similarexpressions, as they relate to us and our business, industry, markets andconsumers, are intended to identify forward-looking statements.  We have based these forward-lookingstatements largely on our current expectations and projections about futureevents and financial trends that we believe may affect our financial condition,results of operations, business strategy and financial needs.  These forward-looking statements are subjectto a number of risks, uncertainties and assumptions, including, among others,those described in “Risk Factors” and elsewhere in this quarterly report and inthe Form 10-K referred to in the preceding paragraph.  New riskfactors emerge from time to time and it is not possible for our management topredict all risk factors, nor can we assess the impact of all factors on ourbusiness or the extent to which any factor, or combination of factors, maycause actual results to differ materially from those contained in anyforward-looking statements.  We assume noobligation to update any forward-looking statements as a result of newinformation, future events or developments. References in the following discussion to “we,” “us,” “our,” “theCompany” and similar references mean Zumiez Inc. and its consolidated subsidiary,unless otherwise expressly stated or the context otherwise requires.*

 

**Overview**

 

Weare a mall based specialty retailer of action sports related apparel, footwear,equipment and accessories operating under the Zumiez brand name.  As of August 1, 2009, we operated 369stores primarily located in shopping malls, giving us a presence in 34states.  Our stores cater to young menand women between the ages of 12 and 24 who seek brands representing alifestyle centered on activities that include skateboarding, surfing,snowboarding, BMX, and motocross.  Wesupport the action sports lifestyle and promote our brand through amulti-faceted marketing approach that is designed to integrate our brand imagewith our customers’ activities and interests. This approach, combined with our differentiated merchandising strategy,store design, comprehensive training programs and passionate employees, allowsus to provide an experience for our customers that we believe is consistentwith their attitudes, fashion tastes and identities and is otherwiseunavailable in most malls.

 

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**General**

 

Netsales constitute gross sales net of estimated returns.  Net sales include our in-store sales and ourecommerce sales, which includes ecommerce shipping revenue.  Information in this report with respect tocomparable store sales includes ecommerce sales.  Ecommerce sales were 1.6% and 1.2% of totalsales for the six month periods ended August 1, 2009 and August 2,2008.  Sales with respect to gift cardsare deferred and recognized when gift cards are redeemed.  The amount of the gift card liability isdetermined taking into account our estimate of the portion of gift cards thatwill not be redeemed or recovered (“gift card breakage”).  Gift card breakage is recognized as revenueafter 24 months, at which time the likelihood of redemption is consideredremote based on our historical redemption data.

 

Wereport “comparable store sales” based on net sales, and stores includingecommerce, are included in our comparable store sales beginning on the firstanniversary of their first day of operation. Changes in our comparable store sales between two periods are based onnet sales of stores which were in operation during both of the two periodsbeing compared and, if a store is included in the calculation of comparablestore sales for only a portion of one of the two periods being compared, thenthat store is included in the calculation for only the comparable portion ofthe corresponding period.  Whenadditional square footage is added to a store that is included in comparablestore sales, the store remains in comparable store sales.  There may be variations in the way in whichsome of our competitors and other apparel retailers calculate comparable orsame store sales.  As a result, dataregarding our comparable store sales may not be comparable to similar data madeavailable by our competitors or other retailers.

 

Costof goods sold consists of the cost of merchandise sold to customers, inboundshipping costs, ecommerce shipping costs, distribution costs, depreciation onleasehold improvements at our distribution center, buying and merchandisingcosts and store occupancy costs.  Thismay not be comparable to the way in which our competitors or other retailerscompute their cost of goods sold.

 

Selling,general and administrative expenses consist primarily of store personnel wagesand benefits, 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, public companyexpenses, legal expenses and other miscellaneous operating costs are alsoincluded in selling, general and administrative expenses.  This may not be comparable to the way inwhich our competitors or other retailers compute their selling, general andadministrative expenses.  We expect thatour selling, general and administrative expenses will, as described below,increase in future periods due in part to increased expenses associatedwith opening new stores.

 

Our success is largely dependent upon ourability to anticipate, identify and respond to the fashion tastes of ourcustomers and to provide merchandise that satisfies customer demands.  Any inability to provide appropriatemerchandise in sufficient  quantities ina timely manner could have a material adverse effect on our business, operatingresults and financial condition.

 

**Key Performance Indicators**

 

Ourmanagement evaluates the following items, which we consider key performanceindicators, in assessing our performance:

 

*Comparable store sales.*  Comparable store sales provide a measure ofsales growth for stores open at least one year over the comparable prior yearperiod.

 

Ourmanagement considers comparable store sales to be an important indicator of ourcurrent performance.  Comparable storesales results are important to achieve leveraging of our costs, including storepayroll, store supplies and rent. Comparable store sales also have a direct impact on our total net sales,cash and working capital.

 

*Gross profit*.  Grossprofit measures whether we are optimizing the price and inventory levels of ourmerchandise.  Gross profit is thedifference between net sales and cost of sales. Cost of sales consists of branded merchandise costs, and our privatelabel merchandise including design, sourcing, importing and inbound freightcosts.  Our cost of sales also includesmarkdowns, shrinkage, certain promotional costs and buying, store occupancy andwarehousing costs.  Any inability toobtain acceptable levels of initial markups or any significant increase in ouruse of markdowns could have an adverse effect on our gross profit and resultsof operations.

 

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*Operating income.* We view operating income as a key indicator ofour success.  The key drivers ofoperating income are comparable store sales, gross profit, our ability tocontrol selling, general and administrative expenses, and our level of capital expendituresaffecting depreciation expense.

 

*Store productivity.* Store productivity, including net sales peraverage square foot, average unit retail price, the number of transactions perstore, the number of units sold per store and the number of units pertransaction, is evaluated by our management in assessing our operationalperformance.  In addition, we review ourstores operating income as a measure of their profitability.

 

**Critical Accounting Policies and Estimates**

 

Ourdiscussion and analysis of our financial condition and results of operationsare based on our financial statements, which have been prepared in conformancewith accounting principles 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:

 

*Impairment of Marketable and Non-Marketable Securities*.  We periodically review our marketablesecurities for impairment.  If weconclude that any of these investments are impaired, we determine whether suchimpairment is “other-than-temporary” as defined under FSP 115-1.  Factors we consider to make such adetermination include the duration and severity of the impairment, as wellas the reason for the decline in value and the potential recoveryperiod.  If any impairment is considered “other-than-temporary,”we will write down the asset to its fair value and take a corresponding chargeto our consolidated statement of operations.

 

*Valuation of merchandise inventories*.  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 write-downs have not been significant and we do notadjust the historical carrying value of merchandise inventories upwards basedon actual sales experience.

 

Weestimate an inventory shrinkage reserve for anticipated losses for theperiod.  Shrinkage refers to a reductionin inventory due to shoplifting, employee theft and paperwork errors.  The estimate for the shrinkage reserve iscalculated based on historical percentages and can be affected by changes inmerchandise mix and changes in actual shrinkage trends.  We do not believe there is a reasonablelikelihood that there will be a material change in the future estimates orassumptions we use to calculate our inventory shrinkage reserve.  However, if actual physical inventory lossesdiffer significantly from our estimate, our operating results could beadversely affected

 

*Leasehold improvements and equipment*.  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.  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.  Theactual economic lives of these assets may be different than our estimateduseful lives, thereby resulting in a different carrying value.  These evaluations could result in a change inthe depreciable lives of those assets and therefore our depreciation expense infuture periods.

 

*Revenue recognition and sales returns 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.  Revenue is recorded net of estimated andactual sales returns and deductions for coupon redemptions and otherpromotions.  We offer a return policy of30 days and the estimated sales return reserve is based on projectedmerchandise returns determined through the use of historical sales returnsresults.  We do not believe there is areasonable likelihood that there will be a material change in the futureestimates or assumptions we use to calculate our sales return reserve.  However, if the actual rate of sales returnsincreases significantly, our operating results could be adversely affected.

 

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Revenueis not recorded on purchase of gift cards. A current liability is recorded upon purchase, and revenue is recognizedwhen the gift card is redeemed for merchandise. The amount of the gift card liability is determined taking into accountour estimate of the portion of gift cards that will not be redeemed orrecovered (“gift card breakage”).  Giftcard breakage is recognized as revenue after 24 months, at which time thelikelihood of redemption is considered remote based on our historicalredemption data.

 

*Lease Accounting.*  The Company occupies its retailstores and combined home office and distribution center under operating leasesgenerally with terms of five to ten years. Some of these leases have early cancellation clauses, which permit thelease to be terminated 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. Most of the store leases require payment of a specified minimum rent,plus a contingent rent based on a percentage of the store’s net sales in excessof a specified threshold.  Most of thelease agreements have defined escalating rent provisions, which arestraight-lined over the term of the related lease, including any lease renewalsdeemed to be probable.  The Companystraight-lines and recognizes its rent expense over the term of the lease, plusthe construction period prior to occupancy of the retail location, using amid-month convention.  For certainlocations, the Company receives cash tenant allowances and has reported theseamounts as a deferred liability which is amortized to rent expense over theterm of the lease.

 

*Accountingfor Income Taxes.*  As part of the process of preparing thecondensed consolidated financial statements, income taxes are estimated foreach of the jurisdictions in which we operate. This process involves estimating actual current tax exposure togetherwith assessing temporary differences resulting from differing treatment ofitems for tax and accounting purposes. These differences result in deferred tax assets and liabilities, whichare included within the balance sheet.  Thelikelihood that deferred tax assets will be recovered from future taxable incomeis assessed, recognizing that future taxable income may give rise to newdeferred tax assets.  To the extent thatfuture recovery is not likely, a valuation allowance would be established.  To the extent that a valuation allowance isestablished or increased, an expense will be included within the tax provisionin the income statement.

 

Significantmanagement judgment is required in determining the provision for income taxes,deferred tax assets and liabilities and any valuation allowance recorded againstnet deferred tax assets.  Based on ourhistory of operating earnings, no valuation allowance has been recorded as of August 1,2009.  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’s policy is to recognize penalties and interest related tounrecognized tax benefits in income tax expense.  Provisions for income taxes are based onnumerous factors that are subject to audit by the Internal Revenue Service andthe tax authorities in the various jurisdictions in which we do business.

 

*Stock-basedcompensation*.  The Companymaintains a 2005 Equity Incentive Plan under which non-qualified stock optionsand restricted stock have been granted to employees and non-employeedirectors.  The Company accounts forstock in accordance with Financial Accounting Standards Board (“FASB”)Statement No. 123(R), Share-Based Payment (“SFAS No. 123(R)”).  Under the provisions of SFAS No. 123(R),the estimated fair value of share-based awards granted under the 2005 EquityIncentive Plan is recognized as compensation expense over the vesting period.

 

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**Resultsof Operations**

 

Thefollowing table presents, for the periods indicated, selected items in thestatements of operations as a percent of net sales:

 
| ** **                                    | ** ** | **For the Three Months Ended** | ** ** | **For the Six Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                    | ** ** | **August 1, 2009**                       | ** ** | **August 2, 2008**                     | ** ** | **August 1, 2009** | ** ** | **August 2, 2008** | ** ** |
| Net sales                                     |       | 100.0                                              | %          | 100.0                                            | %          | 100.0 | % | 100.0 | % |
| Cost of goods sold                            |       | 71.1                                               |       | 67.4                                             |       | 71.3 |   | 68.0 |   |
| Gross profit                                  |       | 28.9                                               |       | 32.6                                             |       | 28.7 |   | 32.0 |   |
| Selling, general and  administrative expenses |       | 35.0                                               |       | 28.4                                             |       | 34.0 |   | 28.7 |   |
| Operating (loss) profit                       |       | (6.1                                               | )          | 4.2                                              |       | (5.3 | ) | 3.3 |   |
| Interest income, net                          |       | 0.4                                                |       | 0.6                                              |       | 0.4 |   | 0.6 |   |
| (Loss) earnings before  income taxes          |       | (5.7                                               | )          | 4.8                                              |       | (4.9 | ) | 3.9 |   |
| (Benefit) provision for income  taxes         |       | (2.1                                               | )          | 1.8                                              |       | (2.0 | ) | 1.5 |   |
| Net (loss) income                             |       | (3.6                                               | )%         | 3.0                                              | %          | (2.9 | )% | 2.4 | % |

 

**Three Months (13 weeks) Ended August 1, 2009 Compared With ThreeMonths (13 weeks) Ended August 2, 2008**

 

***Net Sales***

 

Net sales decreased to$85.2 million for the three months ended August 1, 2009 from$92.3 million for the three months ended August 2, 2008, a decreaseof $7.1 million, or 7.7%.

 

Comparable store net salesdecreased 18.8% for the three months ended August 1, 2009 compared to thethree months ended August 2, 2008. Geographically our stores in the western one-half of the U.S., whichaccount for approximately 55% of our comparable store sales, declined byapproximately 21%.  Our stores in therest of the country experienced a comparable store sales decline of approximately17%.  The decrease in comparable storesnet sales was primarily due to lower net sales in all merchandisedepartments.  For information as to howwe define comparable stores, see “General” above.

 

Thedecrease in total net sales was due to a decrease in net sales from comparablestores of approximately $17.4 million partially offset by an increase innon-comparable store sales of $10.3 million.  The decrease in comparablestore sales was due to fewer transactions and, to a lesser extent, a decreasein average unit retail.  The increase in non-comparable store net saleswas primarily due to the opening of 45 new stores subsequent to August 2,2008.

 

***Gross Profit***

 

Grossprofit for the three months ended August 1, 2009 was $24.6 millioncompared with $30.1 million for the three months ended August 2, 2008, adecrease of approximately $5.5 million, or 18.1%.  As a percentage of net sales, gross profitdecreased to 28.9% for the three months ended August 1, 2009 from 32.6 %for the three months ended August 2, 2008. The reduction in gross profit as a percent of net sales was drivenprimarily by increased store occupancy costs.

 

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

 

Selling,general and administrative (“SG&A”) expenses in the three months ended August 1,2009 were $29.9 million compared with $26.2 million in the three monthsended August 2, 2008, an increase of $3.7 million, or 14.0%.  This increase was primarily the result ofcosts associated with a litigation settlement, operating new stores and to alesser extent increases in infrastructure and administrative staff to supportour growth.  As a percentage of netsales, SG&A expenses increased to 35.0% in the three months ended August 1,2009 from 28.4% in the three months ended August 2, 2008.  The increase in SG&A expenses as apercentage of net sales was primarily attributable to litigation settlementcosts, an increase in store payroll and payroll related costs, additionaldepreciation on new stores, and administrative support for new store growth.

 

***Operating Profit or Loss***

 

Asa result of the above factors, operating loss was $5.2 million in the threemonths ended August 1, 2009 compared with operating profit $3.9 millionfor the three months ended August 2, 2008, a decrease of $9.1million.  As a percentage of net sales,operating  loss was 6.1% for the threemonths ended August 1, 2009 compared with operating profit of 4.2% in thethree months ended August 2, 2008.

 

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***Provision or Benefit  for IncomeTaxes***

 

Incometax benefit was $1.8 million for the three months ended August 1,2009 compared with income tax provision of $1.7 million for the three monthsended August 2, 2008.  The effectivetax rate was 37.3% and 38.1% for three months ended August 1, 2009 and August 2,2008.

 

***Net Income or Loss***

 

Netloss was $3.1 million for the three months ended August 1, 2009 comparedto net income of $2.7 million for the three months ended August 2, 2008, adecrease of $5.8 million.  As apercentage of net sales, net loss was 3.6% for the three months ended August 1,2009 compared to net income of 3.0% for the three months ended August 2,2008.

 

**Six Months (26 weeks) Ended August 1, 2009Compared With Six Months (26 weeks) Ended August 2, 2008**

 

***Net Sales***

 

Net sales decreased to $162.0 million for the six months ended August 1,2009 from $171.0 million for the six months ended August 2, 2008, adecrease of $9.0 million, or 5.3%.

 

Comparable store net sales decreased by 17.2% for the six months ended August 1,2009 compared to the six months ended August 2, 2008.  Geographically our stores in the westernone-half of the U.S., which account for approximately 55% of our comparablestore sales, declined by 21%.  Our storesin the rest of the country experienced a comparable store sales decline ofapproximately 14%.  The decrease incomparable stores net sales was primarily due to lower net sales in allmerchandise departments except footwear which experienced a nominalincrease.  For information as to how wedefine comparable stores, see “General” above.

 

Thedecrease in total net sales was due to a decrease in net sales from comparablestores of approximately $29.5 million partially offset by an increase innon-comparable store sales of $20.5 million. The decrease in comparable store sales was due to fewer transactionsand, to a lesser extent, a lower dollar amount per transaction.  The increase in non-comparable store netsales was primarily due to the opening of 45 new stores subsequent to August 2,2008.

 

***Gross Profit***

 

Grossprofit for the six months ended August 1, 2009 was $46.5 million comparedwith $54.7 million for the six months ended August 2, 2008, adecrease of $8.2 million, or 14.9%. As a percentage of net sales, gross profit decreased to 28.7% for thesix months ended August 1, 2009 from 32.0% for the six months ended August 2,2008.  The reduction in gross margin as apercent of net sales was driven primarily by increased store occupancy costs.

 

***Selling, General and AdministrativeExpenses***

 

Selling,general and administrative (“SG&A”) expenses for the six months ended August 1,2009 were $55.2 million compared with $49.1 million in the six monthsended August 2, 2008, an increase of $6.1 million, or 12.4%.  This increase was primarily the result ofcosts associated with a litigation settlement, operating new stores and to alesser extent increases in infrastructure and administrative staff to supportour growth, partially offset by a decrease in stock-based and incentivecompensation expenses.  As a percentageof net sales, SG&A expenses increased to 34.0% for the six months ended August 1,2009 from 28.7% in the six months ended August 2, 2008.  The increase in SG&A expenses as apercentage of net sales was primarily attributable to the increase in storepayroll and payroll related costs, additional new store depreciation,administrative support for new store growth and litigation settlement costs.

 

***Operating Profit or Loss***

 

Asa result of the above factors, operating loss was $8.7 million for the sixmonths ended August 1, 2009 compared to operating profit of $5.5 millionfor the six months ended August 2, 2008 a decrease of $14.2 million.  As a percentage of net sales, operating losswas 5.3% for the six months ended August 1, 2009 compared to operatingprofit of 3.3% for the six months ended August 2, 2008.

 

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***Provision or Benefit for Income Taxes***

 

Incometax benefit was $3.3 million for the six months ended August 1, 2009compared to income tax provision of $2.5 million for the six months ended August 2,2008.  The effective tax rate was 40.7 %and 38.3% for six months ended August 1, 2009 and August 2, 2008.

 

***Net Income or loss***

 

Netloss was $4.7 million for the six months ended August 1, 2009 compared tonet income of $4.1 million for the six months ended August 2, 2008, adecrease of $8.8 million.  As apercentage of net sales, net loss was 2.9% for the six months ended August 1,2009 compared to net income of 2.4% for the six months ended August 2,2008.

 

**Liquidityand Capital Resources**

 

Ourprimary uses of cash are for capital investments, inventory, store remodeling,store fixtures and ongoing infrastructure improvements, such as technologyenhancements and distribution capabilities. Our main source of liquidity is cash flows from operations.

 

Thesignificant components of our working capital are inventory and liquid assetssuch as cash, marketable securities and receivables, reduced by accountspayable and accrued expenses.  Ourworking capital position benefits from the fact that we generally collect cashfrom sales to customers the same day or within several days of the relatedsale, while we typically have longer payment terms with our vendors.

 

Asof August 1, 2009, we held a $1.0 million auction rate security valued at$0.8 million, net of approximately $0.2 million impairment charge.  The $1.0 million security failed to sell atits scheduled auction in March 2009. The interest rate for the security reset to a prescribed tax-free rateof 1.16%.  We previously had another $1.0million auction rate security, but in May 2009, this security was redeemedat par.  We currently do not intend tohold the security beyond the next auction date and will try to sell thissecurity when the auction date comes up in March 2010.  However, the uncertainties in the creditmarkets have prevented us and other investors from liquidating holdings ofauction rate securities in auctions for these securities because the amount ofsecurities submitted for sale has exceeded the amount of purchase orders.  If the March 2010 auction fails, we planto hold the security until the next auction date and the security coupon ratewill reset to a prescribed “failure” rate. An unsuccessful auction could result in our holding the security beyondthe next scheduled auction reset date if a secondary market does not develop;therefore, limiting the short-term liquidity of the investment.  The security has been classified as “longterm” assets on our condensed consolidated balance sheet as of August 1,2009.

 

Ourcapital requirements include construction and fixture costs related to theopening of new stores and remodeling expenditures for existing stores.  Future capital requirements will depend onmany factors, including the pace of new store openings, the availability ofsuitable locations for new stores, and the nature of arrangements negotiatedwith landlords.  In that regard, our netinvestment to open a new store has varied significantly in the past due to anumber of factors, including the geographic location and size of the new store,and is likely to vary significantly in the future.  During fiscal 2009, we expect to spendapproximately $19.0 to $21.0 million on capital expenditures, a majority ofwhich will relate to leasehold improvements and fixtures for the 36 total newstores we plan to open in fiscal 2009, and a smaller amount will relate toequipment, systems and improvements for our distribution center and supportinfrastructure.  However, there can be noassurance that the number of stores that we actually open in fiscal 2009 willnot be different from the number of stores we plan to open, or that actualfiscal 2009 capital expenditures will not differ from this expected amount.

 

Weexpect cash flows from operations and available borrowings under our revolvingcredit facility will be sufficient to meet our foreseeable cash requirementsfor operations and planned capital expenditures for at least the next twelvemonths.  Beyond this time frame, if thesesources are not sufficient to meet our capital requirements, then we will berequired to obtain 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 theterms will be satisfactory to us and not dilutive to our then-currentshareholders.

 

Netcash provided by operating activities for the six months ended August 1,2009 was approximately $13.4 million primarily related to increased tradeaccounts payable and deferred rent and tenant allowances, partially offset byan increase in inventory, receivables and a net loss.  Net cash provided in operating activities forthe six months ended August 2, 2008 was $15.7 million primarilyrelated to an increased trade accounts payable, taxes payable and deferredrent, partially offset by an increase in inventory and receivables.

 

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Netcash used in investing activities was $25.9 million for the six monthsended August 1, 2009, related primarily to $11.0 million of capitalexpenditures for new store openings and existing store renovations and by $14.9million in net purchases of marketable securities.  Net cash used in investing activities was$15.5 million for the six months ended August 2, 2008, related to$19.0 million of capital expenditures for opening 26 new stores and existingstore renovations predominately offset by the net sales of marketablesecurities.

 

Netcash provided by financing activities for the six months ended August 1,2009 was $0.7 million related to proceeds received from exercise of stockoptions and the related tax benefit.  Netcash used in financing activities for the six months ended August 2, 2008was $4.1 million related to the payment of book overdrafts somewhat offset byproceeds received from exercise of stock options and the related tax benefit.

 

OnJune 10, 2009, we renewed and amended our secured credit agreement withWells Fargo HSBC Trade Bank, N.A., and the prior facility agreement wasterminated.  The credit agreementprovides us with a secured revolving credit facility until September 1,2011 of up to $25.0 million.  Thesecured revolving credit facility provides for the issuance of standby letterof credit in an amount not to exceed $5.0 million outstanding at any time andwith a term not to exceed 365 days.  Thecommercial line of credit provides for the issuance of a commercial letter ofcredit in an amount not to exceed $10.0 million and with terms not to exceed120 days.  The amount of borrowingsavailable at any time under our secured revolving credit facility is reduced bythe amount of standby and commercial letters of credit outstanding at thattime.  There were no outstandingborrowings under the secured revolving credit facility at August 1, 2009or January 31, 2009.  The Companyhad open commercial letters of credit outstanding under our secured revolvingcredit facility of $2.6 million at August 1, 2009 and approximately $0.3million at January 31, 2009.  Thesecured revolving credit facility bears interest at the Daily One Month LIBORrate plus 1.00%.  The credit agreementcontains a number of restrictions and covenants that generally limit ourability 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, a maximum net loss of $10.0 million after taxes on a trailingfour-quarter basis provided, that, there shall be added to net income allcharges for impairment of goodwill and store assets on the balance sheet not toexceed $5.0 million in aggregate, and a minimum quick ratio of 1.25.  The quick ratio is defined as our cash andnear cash equivalents divided by the line of credit.  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 August 1, 2009.

 

**ContractualObligations and Commercial Commitments**

 

Therewas no material changes outside the ordinary course of business in ourcontractual obligations during the six months ended August 1, 2009.  Our operating lease obligations are notrecognized as liabilities in the financial statements.  The following table summarizes the totalamount of future payments (in thousands) due under certain of our contractualobligations at August 1, 2009:

 

| ** **                  | ** ** | ** ** | ** ** | **Less than** | ** ** | ** **     | ** ** | ** **    | ** ** | **More than** | ** ** |
|-----------------------------|------------|------------|------------|---------------|------------|----------------|------------|---------------|------------|---------------|------------|
| ** **                  | ** ** | **Total**  | ** ** | **1 Year**    | ** ** | **1- 3 Years** | ** ** | **3-5 Years** | ** ** | **5 Years**   | ** ** |
| Operating Lease Obligations |       | $          | 319,967    |          | $          | 19,746         |       | $             | 79,667     |          | $          | 75,979 |   | $ | 144,575 |   |
| Purchase Obligations        |       | 60,320     |       | 60,320        |       | —         |       | —        |       | —        |       |
| Letters of Credit           |       | 2,595      |       | 2,595         |       | —         |       | —        |       | —        |       |
|                        |       | $          | 382,882    |          | $          | 82,661         |       | $             | 79,667     |          | $          | 75,979 |   | $ | 144,575 |   |

 

Weoccupy our retail stores and combined home office and distribution center underoperating leases generally with terms of five to ten years.  Some of our leases have early cancellationclauses, which permit the lease to be terminated by us if certain sales levelsare not met in specific periods.  Someleases contain renewal options for periods ranging from one to five years undersubstantially the same terms and conditions as the original leases.  In addition to future minimum lease payments,substantially all of our store leases provide for additional rental payments(or “percentage rent”) if sales at the respective stores exceed specifiedlevels, as well as the payment of common area maintenance charges and realestate taxes, unless guaranteed in the lease agreement.  Amounts in the above table do not includepercentage rent, common area maintenance 

 

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chargesor real estate taxes unless costs are fixed and determinable.  Most of our lease agreements have definedescalating rent provisions, which we have straight-lined over the term of thelease, including any lease renewals deemed to be probable.  For certain locations, we receive cash tenantallowances and we have reported these amounts as a deferred liability that isamortized to rent expense over the term of the lease, including any leaserenewals deemed to be probable.  Rentexpense, including common area maintenance and other occupancy costs, was $27.7million and $23.9 million for the six months ended August 1, 2009 andAugust 2, 2008.

 

AtAugust 1, 2009, we had outstanding purchase orders to acquire merchandisefrom vendors of approximately $60.3 million. We have an option to cancel these commitments with no notice prior toshipment except for private label purchase orders.  At August 1, 2009, we had approximately$2.6 million of letters of credit outstanding.

 

**Off-BalanceSheet Obligations**

 

Ouronly off-balance sheet contractual obligations and commercial commitments as ofAugust 1, 2009 related to operating lease obligations, open purchaseorders, and letters of credit.  We haveexcluded these items from our balance sheet in accordance with GAAP.  We presently do not have any non-cancelable purchasecommitments, except purchase orders for private label merchandise.  At August 1, 2009, we had outstandingpurchase orders to acquire merchandise from vendors for approximately$60.3 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 shipmentexcept for our private label purchase orders. At August 1, 2009, we had $2.6 million of letters of creditoutstanding under our secured revolving credit facility.  At August 1, 2009, we were committed toproperty owners for operation lease obligations in the approximate  amount of $320.0 million.  Most of our leases contain cancellation orkick-out clauses in our favor that relieve us from any future obligation undera lease if specified sales levels are not achieved by a specific date.

 

**Impactof Inflation**

 

Wedo not believe that inflation has had a material impact on our net sales oroperating results in the recent past. There can be no assurance that our business will not be affected byinflation in the future.

 

**RiskFactors**

 

*Investing in our securities involves a high degree ofrisk.  The following risk factors, issuesand uncertainties 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.*

 

***Our growth strategy depends on our abilityto open and operate a significant number of new stores each year, which couldstrain our resources and cause the performance of our existing stores tosuffer.***

 

Ourgrowth largely depends on our ability to open and operate new storessuccessfully.  However, our ability toopen new stores is subject to a variety of risks and uncertainties includingthe current deterioration of the macroeconomic environment, and we may beunable to open new stores as planned, and any failure to successfully open andoperate new stores would have a material adverse effect on our results ofoperations and on the market price of our common stock.  We intend to continue to open 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 that financingon acceptable terms or at all.

 

Unlikeprevious years, the number of anticipated store openings in fiscal 2009 mayincrease or decrease due to market conditions. We have opened or acquired, on average, approximately twenty-fivepercent new stores over the last five years. 

 

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Aswe look to fiscal 2009 and beyond, we will likely slow this rate of growthuntil we see the macroeconomic environment improve.

 

***If we fail to effectively execute ourexpansion strategy, we may not be able to successfully open new storelocations in a timely manner, if at all, which could have an adverse affect onour net sales and results of operations.***

 

Ourability to open and operate new stores successfully depends on many factors,including, among others, our ability to:

 

·             identifysuitable store locations, the availability of which is outside of our control;

 

·             negotiateacceptable lease terms, including desired tenant improvement allowances;

 

·             sourcesufficient levels of inventory at acceptable costs to meet the needs of newstores;

 

·             hire, train andretain store personnel;

 

·             successfullyintegrate new stores into our existing operations; and

 

·             identify andsatisfy the merchandise preferences of new geographic areas.

 

Inaddition, many of our planned new stores are to be opened in regions of theUnited States in which we currently have few, or no, stores.  The expansion into these marketsmay present competitive, merchandising and distribution challenges thatare different from those currently encountered in our existing markets.  Any of these challenges could adverselyaffect our business and results of operations.

 

***Our business is dependent upon our beingable to anticipate, identify and respond to changing fashion trends, customerpreferences and other fashion-related factors; failure to do so could have amaterial adverse effect on us.***

 

Customertastes and fashion trends in the action sports lifestyle market are volatileand tend to change rapidly.  Our successdepends on our ability to effectively anticipate, identify and respond tochanging fashion tastes and consumer preferences, and to translate markettrends into appropriate, 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.

 

***Our ability to attract customers to ourstores depends heavily on the success of the shopping malls in which our storesare located; any decrease in customer traffic in those malls could cause oursales to be less than expected.***

 

Inorder to generate customer traffic we depend heavily on locating our stores inprominent locations within successful shopping malls.  Sales at these stores are derived, in part,from the volume of traffic in those malls. Our stores benefit from the ability of a mall’s other tenants togenerate consumer traffic in the vicinity of our stores and the continuingpopularity of malls as shopping destinations. Our sales volume and mall traffic generally may be adverselyaffected by, among other things, economic downturns in a particular area,competition from ecommerce retailers, non-mall retailers and other malls,increases in gasoline prices and the closing or decline in popularity of otherstores in the malls in which we are located. The continuing slowdown in the United States economy or an uncertaineconomic outlook could curtail new shopping mall development, decrease shoppingmall traffic, reduce the number of hours that shopping mall operators keeptheir shopping malls open or force them to cease operations entirely.  A reduction in mall traffic as a result ofthese or any other factors could have a material adverse effect on ourbusiness, results of operations and financial condition.

 

***Our sales and inventory levels fluctuate ona seasonal basis, leaving our operating results particularly susceptible tochanges in back-to-school and holiday shopping patterns.***

 

Oursales are typically disproportionately higher in the third and fourth fiscalquarters of each fiscal year due to increased sales during the back-to-schooland winter holiday shopping seasons. Sales during these periods cannot be used as an accurate indicator ofannual results.  Our sales in the firstand second fiscal quarters are typically lower than in our third and fourthfiscal quarters due, in part, to the traditional retail slowdown immediatelyfollowing the winter holiday season.  As a result ofthis seasonality, any factors negatively affecting us during the last half ofthe year, including unfavorable economic conditions, adverse weather or ourability to acquire seasonal merchandise inventory, could have a materialadverse effect on 

 

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our financial conditionand results of operations for the entire year.  In addition, in order to prepare for theback-to-school and winter holiday shopping seasons, we must order and keep instock significantly more merchandise than we carry during other times of theyear.  Any unanticipated decrease indemand for our products during these peak shopping seasons could require us tosell excess inventory at a substantial markdown, which could have a materialadverse effect on our business, results of operations and financial condition.

 

***Our quarterly results of operations arevolatile and may decline.***

 

Ourquarterly results of operations have fluctuated significantly in the past andcan be expected to continue 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 timing ofnew store openings and the relative proportion of our new stores to maturestores;

 

·             whether we areable to successfully integrate any new stores that we acquire and the presenceor absence of any unanticipated liabilities in connection therewith;

 

·             fashion trendsand changes in consumer preferences;

 

·             calendar shiftsof holiday or seasonal periods;

 

·             changes in ourmerchandise 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.

 

***Failure to successfully integrate any businessesor stores that we acquire could have an adverse impact on our results ofoperations and financial performance.***

 

Wemay from time to time acquire other retail stores, individually or in groups,or businesses.  We may experiencedifficulties in assimilating any stores or businesses we may acquire and anysuch acquisitions may also result in the diversion of our capital and ourmanagement’s attention from other business issues and opportunities.  We may not be able to successfully integrateany stores or businesses that we may acquire, including their facilities,personnel, financial systems, distribution, operations and general operatingprocedures.  If we fail to successfullyintegrate acquisitions or if such acquisitions fail to provide the benefits thatwe expect to receive, we could experience increased costs and other operatinginefficiencies, which could have an adverse effect on our results of operationsand financial performance.

 

***Our business is susceptible to weather conditions that are out of ourcontrol including the potential risks of unpredictable weather patterns,including any weather patterns associated with global warming, and theresultant unseasonable weather could have a negative impact on our results ofoperations.***

 

Ourbusiness is susceptible to unseasonable weather conditions.  For example, extended periods of unseasonablywarm temperatures (including any weather patterns associated with globalwarming) during the winter season or cool weather during the summer seasoncould render a portion of our inventory incompatible with those unseasonableconditions.  These prolonged unseasonableweather conditions, particularly in regions of the United States where we havea concentration of stores, could have a material adverse effect on our businessand results of operations.

 

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***We may be unable to compete favorably inthe highly competitive retail industry, and if we lose customers to ourcompetitors, our sales could decrease.***

 

Theteenage and young adult retail apparel, hardgoods and accessories industry ishighly competitive.  We compete withother retailers for vendors, teenage and young adult customers, suitable storelocations, qualified store associates and management personnel.  In the softgoods market which includesapparel, accessories and footwear, we currently compete with otherteenage-focused retailers.  In addition,in the softgoods market we compete with independent specialty shops, departmentstores, and direct marketers that sell similar lines of merchandise and targetcustomers through catalogs and ecommerce. In the hardgoods market which includes skateboards, snowboards,bindings, components and other equipment, we compete directly or indirectlywith the following categories of companies: other specialty retailers thatcompete with us across a significant portion of our merchandising categories,such as local snowboard and skate shops; large-format sporting goods stores andchains and ecommerce retailers.

 

Someof our competitors are larger than we are and have substantially greaterfinancial, marketing and other resources than we do.  Direct competition with these and otherretailers may increase significantly in the future, which could requireus, among other things, to lower our prices and could result in the loss of ourcustomers.  Current and increasedcompetition could have a material adverse effect on our business, results ofoperations and financial condition.

 

***If we fail to maintain good relationshipswith vendors or if a vendor is otherwise unable or unwilling to supply us withadequate quantities of their products at acceptable prices, our business andfinancial performance could suffer.***

 

Ourbusiness is dependent on continued good relations with our vendors.  In particular, we believe that we generallyare able to obtain attractive pricing and other terms from vendors because weare perceived as a desirable customer, and deterioration in our relationshipwith our vendors would likely have a material adverse effect on ourbusiness.  We do not have any contractualrelationships with our vendors, other than normal course of business purchase ordersand, accordingly, there can be no assurance that our vendors will provide uswith an adequate 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 vendors’sell 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 lower quality items, raise the prices they charge us or focuson selling their products directly.  Inaddition, a number of our vendors are smaller, less capitalized companies andare more likely to be impacted by unfavorable general economic and marketconditions than larger and better capitalized companies.  These smaller vendors may not have sufficientliquidity during economic downturns to properly fund their businesses and theirability to supply their products to us could be negatively impacted.  Any inability to acquire suitable merchandiseat acceptable prices, or the loss of one or more key vendors, would have amaterial adverse effect on our business, results of operations and financialcondition.

 

***If we lose key management or are unable to attract and retain thetalent required for our business, our financial performance could suffer.***

 

Ourperformance depends largely on the efforts and abilities of our seniormanagement, including our Co-Founder and Chairman, Thomas D. Campion, our ChiefExecutive Officer, Richard M. Brooks, our Chief Financial Officer, Trevor S.Lang, our 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.

 

***Our failure to meet our staffing needscould adversely affect our ability to implement our growth strategy and couldhave a material impact on our results of operations.***

 

Oursuccess depends in part upon our ability to attract, motivate and retain asufficient number of qualified employees, including regional managers, districtmanagers, store managers and store associates, who understand and appreciateour corporate culture based on a passion for the action sports lifestyle andare able to adequately 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 consistently providinga high level of customer service, as demonstrated by 

 

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theirenthusiasm for our culture and knowledge of our merchandise, our ability toopen new stores may be impaired and the performance of our existing andnew stores could be materially adversely affected.  We are also dependent upon temporarypersonnel to adequately staff our stores and distribution center, particularlyduring busy periods such as the back-to-school and winter holiday seasons.  There can be no assurance that we willreceive adequate assistance from our temporary personnel, or that there will besufficient sources of temporary personnel. Although none of our employees is currently covered by collectivebargaining agreements, we cannot guarantee that our employees will not elect tobe represented by labor unions in the future, which could increase our laborcosts and could subject us to the risk of work stoppages and strikes.  Any such failure to meet our staffing needs,any material increases in employee turnover rates, any increases in labor costsor any work stoppages or interruptions or strikes could have a materialadverse effect on our business or results of operations.

 

***Our operations, including our soledistribution center, are concentrated in the western United States, which makesus susceptible to adverse conditions in this region.***

 

Ourhome office and sole distribution center are located in a single facility inWashington, and a substantial number of our stores are located in the westernhalf of the United States.  We also havea substantial number of stores in the New York/New Jersey region andTexas.  As a result, our business may bemore susceptible 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 the vast majority of ourmerchandise to all of our stores and to fulfill our ecommerce sales.  As a result, a natural disaster or othercatastrophic event, such as an earthquake affecting western Washington, inparticular, or the West Coast, in general, could significantly disrupt ouroperations and have a material adverse effect on our business, results ofoperations and financial condition.

 

***We are required to make substantial rentalpayments under our operating leases and any failure to make these leasepayments when due would likely have a material adverse effect on our businessand growth plans.***

 

Wedo not own any of our retail stores or our combined home office anddistribution center, but instead we lease all of these facilities underoperating leases.  Payments under theseoperating leases account for a significant portion of our operating expensesand has historically been our third largest expense behind cost of sales andour employee related costs.  For example,total rental expense, including additional rental payments (or “percentagerent”) based on sales of some of the stores, common area maintenance chargesand real estate taxes, under operating leases was $27.7 million and $23.9million for the six months ended August 1, 2009 and August 2,2008.  As of August 1, 2009, we werea party to operating leases requiring future minimum lease payments aggregatingapproximately $175.4 million through fiscal year 2014 and approximately $144.6million thereafter.  In addition,substantially all of our store leases provide for additional rental paymentsbased on sales of the respective stores, as well as common area maintenance charges,and require that we pay real estate taxes, none of which is included in theamount of future minimum lease payments. These amounts generally escalate each year.  We expect that any new stores we open willalso be leased by us under operating leases, which will further increase ouroperating lease expenses.

 

Oursubstantial operating lease obligations could have significant negativeconsequences, including:

 

·                  increasing ourvulnerability to general adverse economic and industry conditions;

 

·                  limiting ourability to obtain additional financing;

 

·                  requiring thata substantial portion of our available cash be applied to pay our rentalobligations, thus reducing cash available for other purposes and;

 

·                  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.

 

Wedepend on cash flow from operations to pay our lease expenses and to fulfillour other cash needs.  If our businessdoes not generate sufficient cash flow from operating activities, andsufficient funds are not otherwise available to us from borrowings under bankloans or from other sources, we may not be able to service our operatinglease expenses, grow our business, respond to competitive challenges or to fundour other liquidity and capital needs, which would have a material adverseeffect on us.

 

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***The terms of our revolving credit facilityimpose operating and financial restrictions on us that may impair ourability to respond to changing business and economic conditions.  This impairment could have a significantadverse impact on our business.***

 

Wehave a $25 million revolving credit facility with Wells Fargo HSBC Trade Bank,N.A., that we entered into in June 2009 that replaced the revolving creditfacility maturing in August 2009. It contains a number of significant restrictions and covenants thatgenerally limit our ability to, among other things, (1) incur additionalindebtedness, (2) enter into certain transactions and (3) undergo achange in ownership.  In addition, all ofour personal property, including our inventory, equipment and fixtures, secureour obligations under the revolving credit agreement.  The credit agreement also contains financialcovenants that require us to meet certain specified financial tests and ratios,including, a maximum net loss of $10.0 million after taxes on a trailing four-quarterbasis provided, that, there shall be added to net income all charges forimpairment of goodwill and store assets on the balance sheet not to exceed $5.0million in aggregate, and a minimum quick ratio of 1.25.

 

Abreach of any of these restrictive covenants or our inability to comply withthe required financial tests and ratios could result in a default under thecredit agreement.  If a default occurs,the lender may elect to declare all borrowings outstanding, together withaccrued interest and other fees, to be immediately due and payable.  If we are unable to repay outstandingborrowings when due, whether at their maturity or if declared due and payableby the lender following a default, the lender has the right to proceed againstthe collateral granted to it to secure the indebtedness.  As a result, any breach of these covenants orfailure to comply with these tests and ratios could have a material adverseeffect on us.  There can be no assurancethat we will not breach the covenants or fail to comply with the tests andratios in our credit agreement or any other debt agreements we may enterinto in the future and, if a breach occurs, there can be no assurance that wewill be able to obtain necessary waivers or amendments from the lenders.

 

Therestrictions contained in our credit agreement could: (1) limit ourability to plan for or react to market conditions or meet capital needs orotherwise restrict our activities or business plans; and (2) adverselyaffect our ability to finance our operations, strategic acquisitions,investments or other capital needs or to engage in other business activitiesthat would be in our interest.

 

***Our business could suffer as a result ofsmall parcel delivery services such as United Parcel Service or Federal Expressbeing unable to distribute our merchandise.***

 

Werely upon small parcel delivery services for our product shipments, includingshipments to, from and between our stores. Accordingly, we are subject to risks, including employee strikes andinclement weather, which may affect their ability to meet our shippingneeds.  Among other things, anycircumstances that require us to use other delivery services for all or aportion of our shipments could result in increased costs and delayed deliveriesand could harm our business materially. In addition, although we have contracts with small parcel deliveryservices, we have the right to terminate these contracts upon 30 days writtennotice.  Although the contracts withthese small parcel delivery services provide certain discounts from theshipment rates in effect at the time of shipment, the contracts do not limittheir ability to raise the shipment rates at any time.  Accordingly, we are subject to the risk thatsmall parcel delivery services may increase the rates they charge, thatthey may terminate their contracts with us, that they may decreasethe rate discounts provided to us when an existing contract is renewed or thatwe may be unable to agree on the terms of a new contract with them, any ofwhich could materially adversely affect our operating results.

 

***Our business could suffer if a manufacturerfails to use acceptable labor practices.***

 

Wedo not control our vendors or the manufacturers that produce the products webuy from them, nor do we control the labor practices of our vendors and thesemanufacturers.  The violation of labor orother laws by any of our vendors or these manufacturers, or the divergence ofthe labor practices followed by any of our vendors or these manufacturers fromthose generally accepted as ethical in the United States, could interrupt, orotherwise disrupt, the shipment of finished products to us or damage ourreputation.  Any of these, in turn, couldhave a material adverse effect on our financial condition and results ofoperations.  In that regard, most of theproducts sold in our stores are manufactured overseas, primarily in Asia andCentral America, which may increase the risk that the labor practicesfollowed by the manufacturers of these products may differ from thoseconsidered acceptable in the United States.

 

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***Our failure to adequately anticipate acorrect mix of private label merchandise may have a material adverseeffect on our business.***

 

Salesfrom private label merchandise accounted for 15.0% of our net sales in fiscal2008.  We may take steps to increasethe percentage 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.

 

***Most of our merchandise is produced byforeign manufacturers, therefore the availability and costs of these productsmay be negatively affected by risks associated with international tradeand other international conditions.***

 

Mostof our merchandise is produced by manufacturers around the world.  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 generallyand 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.

 

***If our information systems hardware orsoftware fails to function effectively or does not scale to keep pace with ourplanned growth, our operations could be disrupted and our financial resultscould be harmed.***

 

Overthe past several years, we have made improvements to our infrastructure andexisting hardware and software systems, as well as implemented newsystems.  If these or any otherinformation systems and software do not work effectively, this could adverselyimpact the promptness and accuracy of our transaction processing, financialaccounting and reporting and our ability to manage our business and properlyforecast 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.

 

***Our inability or failure to protect ourintellectual property or our infringement of other’s intellectual propertycould have a negative impact on our operating results.***

 

Webelieve that our trademarks and domain names are valuable assets that arecritical to our success.  Theunauthorized use or other misappropriation of our trademarks or domain namescould diminish the value of the Zumiez brand, our store concept, our privatelabel brands or our goodwill and cause a decline in our net sales.  Although we have secured or are in theprocess of securing protection for our trademarks and domain names in a numberof countries outside of the United States, there are certain countries where wedo not currently have or where we do not currently intend to apply forprotection for certain trademarks or at all. Also, the efforts we have taken to protect our trademarks may not besufficient or effective.  Therefore, wemay not be able to prevent other persons from using our trademarks or domainnames outside of the United States, 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.

 

***The effects of war or acts of terrorismcould adversely affect our business.***

 

Substantiallyall of our stores are located in shopping malls.  Any threat of terrorist attacks or actualterrorist events, particularly in public areas, could lead to lower customertraffic in shopping malls.  In addition,local authorities or mall management could close shopping malls in response tosecurity concerns.  Mall closures, aswell as lower customer traffic due to security concerns, would likely result indecreased sales.  Additionally, theescalation of the armed conflicts in the Middle East, or the threat, escalationor commencement of war or other armed conflict elsewhere, could significantlydiminish consumer spending, and result in decreased sales for us.  Decreased sales would have a material adverseeffect on our business, financial condition and results of operations.

 

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***The outcome of litigation could have a material adverse effect on ourbusiness and******mayresult in substantial costs and could divert management’s attention.***

 

Weare involved, from time to time, in litigation incidental to our businessincluding complaints filed by investors. This litigation could result in substantial costs, and could divertmanagement’s attention and resources, which could harm our business.  Risks associated with legal liability areoften difficult to assess or quantify, and their existence and magnitude canremain unknown for significant periods of time. While we maintain director and officer insurance for litigationsurrounding investor lawsuits, the amount of insurance coverage may not besufficient to cover a claim and the continued availability of this insurancecannot be assured.  The Company alsomaintains other forms of insurance that have historically been adequate toaddress lawsuits, however, there can be no assurance that the actual outcome ofpending or future litigation will not have a material adverse effect on ourresults of operations or financial condition.

 

***Our operations expose us to the risk of litigation which could lead tosignificant potential liability and costs that could harm our business,financial condition or results of operations.***

 

Weemploy a substantial numberof full-time and part-time employees, a majority of whom are employed at ourstore locations.  As a result, we aresubject to a large number of federal and state laws and regulations relating toemployment.  This creates a risk ofpotential claims that we have violated laws related to discrimination andharassment, health and safety, wage and hour laws, criminal activity, personalinjury and other claims.  We are alsosubject to other types of claims in the ordinary course of our business.  Some or all of these claims may give rise tolitigation, which could be time-consuming for our management team, costly and harmfulto our business.

 

Inaddition, we are exposed to the risk of class action litigation.  The costs of defense and the risk of loss inconnection with class action suits are greater than in single-party litigationclaims.  Due to the costs of defendingagainst such litigation, the size of judgments that may be awarded against us,and the loss of significant management time devoted to such litigation, wecannot assure you that such litigation will not disrupt our business or impactour financial results.

 

***Our ecommerce operations subject us tonumerous risks that could have an adverse effect on our results of operations.***

 

Althoughecommerce sales constitute a small portion of our overall sales, our ecommerceoperations subject us to certain risks that could have an adverse effect on ouroperational results, including:

 

·                  diversion oftraffic and sales from our stores;

 

·                  liability foronline content; and

 

·                  risks relatedto the computer systems that operate our website and related support systems,including computer viruses and electronic break-ins and similar disruptions.

 

Inaddition, risks beyond our control, such as governmental regulation of theecommerce, entry of our vendors in the ecommerce business in competition withus, online security breaches and general economic conditions specific to theecommerce and online commerce could have an adverse effect on our results ofoperations.

 

***We have incurred and will continue to incursignificant expenses as a result of being a public company, which willnegatively impact our financial performance.***

 

Wecompleted our initial public offering in May 2005 and we have incurred andwill continue to incur significant legal, accounting, insurance and otherexpenses as a result of being a public company. The Sarbanes-Oxley Act of 2002, as well as related rules implementedby the SEC and The NASDAQ Global Select Market, has required changes incorporate governance practices of public companies.  Compliance with these laws, rules andregulations, including compliance with Section 404 of the Sarbanes-OxleyAct as discussed in the following risk factor, have caused and will continue tocause us to incur significant costs and expenses, including legal andaccounting costs, and have made and will continue to make some activities moretime-consuming and costly.  These laws, rules andregulations have made it more expensive for us to obtain director and officerliability insurance, and we have been required to accept reduced policy limitsand coverage.  As a result, itmay be more difficult for us to attract and retain qualified persons toserve on our board of directors or as officers. As a result of the foregoing, we have incurred and we expect to incursignificant legal, accounting, insurance and certain other expenses on anongoing basis, which will negatively impact our financial performance and couldhave a material adverse effect on our results of operations and financialcondition.

 

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***Failure to maintain adequate financial andmanagement processes and controls could lead to errors in our financialreporting and could harm our ability to manage our expenses.***

 

Reportingobligations as a public company and our anticipated growth are likely to placea considerable strain on our financial and management systems, processes andcontrols, as well as on our personnel. In addition, we are required to document and test our internal controlsover financial reporting pursuant to Section 404 of the Sarbanes-Oxley Actof 2002 so that our management can certify as to the effectiveness of ourinternal controls and our independent registered public accounting firm canrender an opinion on the effectiveness of our internal control over financialreporting on an annual basis.  Thisprocess requires us to document our internal controls over financial reportingand to potentially make significant changes thereto, if applicable.  As a result, we have incurred and expect tocontinue to incur substantial expenses to test our financial controls andsystems, and we have been and in the future may be required to improve ourfinancial and managerial controls, reporting systems and procedures, to incursubstantial expenses 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 containpersonal information of our retail customers could be breached, which couldsubject us to adverse publicity, litigation, and expenses.  In addition, if we are unable to comply withsecurity standards created by the credit card industry, our operations could beadversely affected.***

 

Databaseprivacy, network security, and identity theft are matters of growing publicconcern.  In an attempt to preventunauthorized access to our network and databases containing confidential,third-party information, we have installed privacy protection systems, devices,and activity monitoring on our network. Nevertheless, if unauthorized parties gain access to our networks ordatabases, they may be able to steal, publish, delete, or modify our privateand sensitive third-party information. In such circumstances, we could be held liable to our customers or otherparties or be subject to regulatory or other actions for breaching privacyrules.  This could result in costlyinvestigations and litigation, civil or criminal penalties, and adversepublicity that could adversely affect our financial condition, results ofoperations, and reputation.  Further, ifwe are unable to comply with the security standards, established by banks andthe credit card industry, we may be subject to fines, restrictions, andexpulsion from card acceptance programs, which could adversely affect ourretail operations.

 

***The current uncertainty surrounding theUnited States economy coupled with cyclical economic trends in action sportsretailing could have a material adverse effect on our results of operations.***

 

Theaction sports retail industry historically has been subject to substantialcyclicality.  As economic conditions inthe United States change, the trends in discretionary consumer spending becomeunpredictable and discretionary consumer spending could be reduced due touncertainties about the future.  Whendiscretionary consumer spending is reduced, purchases of action sports appareland related products may decline.  Thecurrent recession in the U.S. economy and increased government debt spendingmay result in economic uncertainties that could have a material adverse impacton our results of operations and financial position.

 

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

 

Ourcommon stock is traded publicly and various securities analysts follow ourfinancial results and issue reports on us. These reports include information about our historical financial resultsas well as the analysts’ estimates of our future performance.  The analysts’ estimates are based upon theirown opinions and are often different from our estimates or expectations.  If our operating results are below theestimates or expectations of public market analysts and investors, our stockprice could decline.  In December 2007,a securities class action litigation and associated derivative lawsuits wasbrought against us and such actions are frequently brought against othercompanies following a decline in the market price of their securities.  These lawsuits were dismissed on March 2009.  If our stock price is volatile, we may becomeinvolved 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.

 

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***The trading price of our investment in marketable securities mayfluctuate***

 

Wehave our excess cash invested in diversified high credit money market accounts,US treasuries, certificates of deposit, municipal bonds and auction ratesecurities.  The investments havehistorically been considered very safe investments with very minimal defaultrates.  However, the uncertainties in thecredit markets have prevented us and other investors 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.  As of August 1, 2009, wehad $0.8 million, net of $0.2 million temporary impairment, invested inauction rate securities that are classified as long-term marketable securitieson our consolidated balance sheet.  Forthe six months ended, August 1, 2009, we incurred a temporary impairmentcharge on these investments of approximately $0.2 million recorded in othercomprehensive income.  If marketliquidity issues continue, we may incur additional impairment charges on theseinvestments.

 

***A decline in the market price of our stock and ourperformance may trigger an impairment of the goodwill recorded on our balancesheet***

 

Goodwilland other intangible assets with indefinite lives must be tested for impairmentat least once a year or more frequently if management believes indicators ofimpairment exist.  We evaluate 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.  Any reduction inthe carrying value of our goodwill as a result of our impairment analysis couldresult in a non-cash goodwill impairment charge to our statement ofoperations.  A goodwill impairment chargecould have a significant impact on earnings and potentially result in a violationof our financial covenants, thereby limiting our ability to secure short-termfinancing.

 

***Changes to estimates related to our property and equipment, oroperating results that are lower than our current estimates at certain storelocations, may cause us to incur non-cash impairment charges.***

 

Wemake certain estimates and projections in connection with impairment analysesfor certain of our store locations and other property and equipment inaccordance with “Statement of Financial Accounting Standards (“SFAS”) No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets.”  For example, we review for impairment allstores for which current cash flows from operations are either negative ornominal.  Recoverability of store assetsis measured by a comparison of the carrying amount of an asset to estimatedundiscounted future cash flows expected to be generated by the asset.  If the carrying amount is higher, impairmentloss is measured by the amount, if any, by which the carrying amount of theassets exceeds their fair value based on the present value of estimatedexpected future cash flows.  Thesecalculations require us to make a number of estimates and projections of futureresults.  If these estimates orprojections change or prove incorrect, we may be and have been, required torecord impairment charges on certain store locations and other property andequipment.  If these impairment chargesare significant, our operating results would be adversely affected and our bankcovenants may be violated.

 

***Our business could suffer if our ability to acquire financing isreduced or eliminated.***

 

Inthe current economic environment, we cannot be assured that our borrowingrelationship with our lender will continue or that our lender will remain ableto support its commitments to us in the future. If our lender fails to do so, then we may not be able to securealternative financing on commercially reasonable terms, or at all.

 

It**em 3:   Quantitative and Qualitative Disclosures AboutMarket Risk**

 

Duringdifferent times of the year, due to the seasonality of our business, we mayborrow under our revolving credit facility. To the extent we borrow under our secured revolving credit facility,which bears interest at the Daily One Month Libor rate plus 1%, we are exposedto market risk related to changes in interest rates.  At August 1, 2009, we had no borrowingsoutstanding under our secured revolving credit facility.  At August 1, 2009, we had $2.6 millionof letters of credit outstanding under our secured revolving creditfacility.  We are not a party to anyderivative financial instruments.

 

**Item 4:   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 August 1, 2009, our disclosure controls andprocedures were effective.

 

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Disclosurecontrols and procedures, no matter how well designed and implemented, canprovide only reasonable assurance of achieving an entity’s disclosureobjectives.  The likelihood of achievingsuch objectives is affected by limitations inherent in disclosure controls andprocedures.  These include the fact thathuman judgment in decision-making can be faulty and that breakdowns in internalcontrol can occur because of human failures such as simple errors or mistakesor intentional circumvention of the established process.

 

*Changesin Internal Control Over Financial Reporting*.  There has been no change in our internalcontrol over financial reporting (as defined in Securities Exchange Act Rule 13a-15(f))during the quarter ended August 1, 2009 that has materially affected, oris reasonably likely to materially affect, our internal control over financialreporting.

 

**PART II - OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

We are involved from time totime in litigation incidental to our business. The Company is unable to predict the outcome of litigated cases.  A court determination in any of litigationactions against the Company could result in significant liability and couldhave a material adverse effect on the Company’s business, results of operationsor financial condition.

 

SeeNote 3 to the Notes to Condensed Consolidated Financial Statements found inItem 1 of this Form 10-Q (listed under “Litigation” under Commitments andContingencies).

 

**Item 1A.  Risk Factors**

 

Pleaserefer to the Risk Factors set forth in Item 2 of Part I of this Form 10-Qas well as the risk factors previously disclosed in Item 1A of Part I ofour Annual Report on Form 10-K for the year ended January 31,2009.  There have been no materialchanges in the risk factors set forth in our Annual Report on Form 10-Kfor the year ended January 31, 2009.

 

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

 

None

 

**Item 3.  Defaults Upon SeniorSecurities**

 

None

 

**Item 4.  Submission of Matters toa Vote of Security Holders**

 

At our Annual Meeting of Shareholders held on May 27, 2009, thefollowing proposals were adopted by the following number of votes:

 

Proposal Number One:  Theelection of three directors to hold office until the 2012 Annual Meeting ofShareholders.  Each of the followingnominees for director was elected to serve for a three-year term, by thefollowing margins of votes:

 
| **Nominees**   | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|----------------|------------|------------|------------|-------------|------------|-------------|------------|
| Richard Brooks |       | 26,299,273 |       | 209,322     |       | 10,509      |       |
| Matthew Hyde   |       | 25,941,938 |       | 566,657     |       | 10,509      |       |
| James Weber    |       | 26,299,722 |       | 208,873     |       | 10,509      |       |

 

Proposal Number Two: Approval of amendments to our existing 2005 EquityIncentive Plan to allow for a one-time stock option exchange program foremployees other than directors and executive officers.  The proposal passed by the following margin:

 

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| **Amendment to 2005 Equity  Incentive Plan** | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker Non-Votes** | ** ** |
|----------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|----------------------|------------|
| Stock Option Exchange Program                |       | 21,891,779 |       | 2,359,611   |       | 143,528     |       | 2,134,110            |       |

 

Proposal Number Three: Ratification of selection of Moss Adams LLP, independent registeredpublic accounting firm, reappointed by the Board of Directors to audit theconsolidated financial statements of the Company for the fiscal year ending January 30,2010 by the following margin:

 
| **Independent Registered Public  Accountants** | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|
| Moss Adams LLP                                 |       | 26,401,044 |       | 110,831     |       | 7,227       |       |

 

**Item 5.  Other Information**

 

None

 

**Item 6.  Exhibits**

 
| **Exhibit No.** | ** ** | **Description of Exhibits**                                                                                                                                                                                                                       |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.15                |       | Zumiez Inc. 2005 Equity Incentive  Plan, as amended and restated effective May 27, 2009 (incorporated by  reference from Exhibit 10.15 to the Form 8-K filed by the Company  on June 1, 2009)                                 |
|                 |       |                                                                                                                                                                                                                                              |
| 10.16                |       | Credit Agreement, including Revolving  Line of Credit Note, with Wells Fargo HSBC Trade Bank, N.A. dated  June 10, 2009 (incorporated by reference from Exhibit 10.16 to the  Form 8-K filed by the Company on June 11, 2009) |
|                 |       |                                                                                                                                                                                                                                              |
| 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                                                                  |

 

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**SIGNATURE**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, as amended, theregistrant has duly caused this report to be signed on its behalf by theundersigned hereunto duly authorized.

 
|                              | ZUMIEZ INC. |
|-----------------------------------|-------------|
|                              |        |
|                              | By:         | /s/ TREVOR S. LANG |
|                              |        | Trevor S. Lang |
|                              |        | Principal Financial  Officer and Secretary   (Principal Accounting Officer) |
|                              |        |   |
| Dated:  August 28, 2009 |        |   |

 

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