Zale has been under a microscope recently: the media, the jewelry industry and Wall Street are wondering if Neal Goldberg can turn this venerable jeweler around.

 

Many people in the industry have been skeptical of Goldberg’s innovative approach to running the company. After all, it represents change, and change is something the jewelry industry generally resists.

 

When you stand back far enough, we believe you will see two things: 1) Goldberg’s approach is not innovative; he’s simply implementing strategies and tactics that merchants in other retail categories embraced many years ago as they faced a rapidly changing consumer market; and 2) his financial and operating strategies will likely position the company for the long term, even if there is some short term dislocation.

 

Here are some of Goldberg’s key strategies:

 

• Cash is king – Every merchant wants to have cash, but Goldberg has aggressively pursued strategies and tactics to generate cash for Zale. He’s cut expenses, reduced inventories and slashed capital expenditures. On top of those cuts, he’s implemented programs to increase inventory productivity; that will improve cash flow.

• Increase inventory turn – This has been the bane of jewelers for millennia; jewelry inventory turn is so low that neither lenders nor Wall Street understand how the industry makes a profit. Most recently, Zale’s inventory turn increased to 1.2 times annually. This is still a dismal turn when compared to virtually any other retail category, but it puts them near the top of the jewelry industry’s inventory turn range. How is Goldberg doing it? He’s reduced the number of items in the stores, but is making sure that the company’s in-stock position is high. (And, he’s implemented some other programs that, for competitive reasons, we won’t highlight.)

• Streamline merchandise offering – Goldberg has gotten rid of slow-turning merchandise. The company has reduced its SKU (item) count by 40 percent. If it doesn’t sell, he returns it, melts it or blows it out at a discount.

• Reduce number of vendors – Zale has reduced its vendor base by two-thirds. While some vendors howled and cried, it was the right thing to do. Now, Zale is important to its remaining vendors, and those vendors are important to Zale. It is the perfect partnership.

• Improve customer experience – Zale has re-designed its display cases, adding color to capture the look and feel of the selling season. The company has reduced in-store signage to streamline and focus its message. It has cleared the cases of redundant product offerings so it can increase new products.

• Introduce new products – He has given customers a reason to keep coming back to Zale. If customers know that they will see something new when they visit Zale stores, they are more likely to return for repeat visits. Roughly 30 percent of the company’s merchandise offering is new.

• Revamp Zale’s store prototype – The company’s 135 Pace Setter stores are generating stronger sales and higher gross margins than the remaining stores. In addition, the average ticket in the Pace Setter stores is above the company average. That’s all the evidence we need to believe that the Pace Setter stores are likely to be the wave of the future.

• Improve training and compensation – For competitive reasons, the company does not disclose too much information about its training and compensation programs. But those two factors have been driving an unusually high attachment rate for the highly profitable product warranties – currently running about 55 percent of sales. There is other evidence that improved training and compensation programs are helping to boost Zale’s financials: just visit their stores. The biggest problem Zale faces is continuing high levels of employee turnover. That’s something that plagues every retailer, but in the jewelry business, it is particularly worrisome because jewelry usually requires a level of trust between sales people and customers that doesn’t exist in many other retail situations. For example, do you really care who sells you a load of 2x4s for your home remodeling project? But, you really do care who sells you an engagement ring.

• Introduce more proprietary brands – Zale’s new Celebration Diamonds carry an average ticket of $600, or double the company’s normal average ticket. That’s the purpose of proprietary brands: increase sales and margins.

On a recent conference call with Wall Street analysts, Goldberg declared, “We want our unfair share of the market.” Yes, you read that correctly: “our unfair share.” With the strategies listed above, Goldberg is on his way.

 

October Quarter Highlights
Zale’s financial results for the quarter ended October 2008 weren’t pretty, and they’ve been rehashed pretty well by most of the mainstream media. They are recapped below.

 

 

IDEX Online Research has spent time trying to understand what really happened. We bring you “Page 2, the Rest of the Story.”

 

The following are highlights from the three-month period ended October 2008. For Zale, this is their first fiscal quarter, since their fiscal year ended July 31, 2008.

 

• Total sales fell by 3.5 percent in the third fiscal quarter; same-store sales were down 3.7 percent. The company does not disclose sales by geographic division (U.S. versus Canada) or by brand on a quarterly basis.

• Sales by division were as follows:
• Fine jewelry stores - $314.0 million, a decline of 3.6 percent from the prior year.
• Kiosks - $47.0 million, a decline of 3.0 percent from the prior year.
• Other - $3.1 million, a decline of 1.6 percent from last year.

• Sales weakened as the quarter progressed. October same-store sales fell by 9 percent. Weak sales trends continued into November, with a sales decline in the mid-teen range.

• The average ticket rose by 2 percent in the quarter versus the same three-month period last year. The company’s proprietary Celebration Diamonds helped boost the average ticket.

• The number of customer transactions fell by 6.1 percent in Zale’s fine jewelry stores.

• The warranty attachment rate slipped slightly to 55 percent in the quarter versus 58 percent in the prior year. Warranties add both revenue and profits for jewelers.

• During the quarter, Zale management focused on the launch of its proprietary Celebration Diamond with an average ticket of over $600 or almost double the corporate average ticket.

• The company’s Pacesetter stores – 135 units that are retail laboratories – are posting sales gains about six percentage points better than the rest of Zale’s store base. Further, the gross margin in the Pacesetter stores is running about 200 basis points (two percentage points) higher than non-Pacesetter stores.

• Management said that its customers are “voting for newness” – they want something different from the run-of-the-mill product that far too many jewelers are showing. Because Zale has increased its level of new products, the company is seeing a higher average ticket and a greater gross margin among the new product categories.

• The company’s gross margin fell to 48.5 percent from 52.5 percent last year due primarily to inventory liquidation efforts and a highly competitive marketplace.

• The company’s operating cost ratio was 60.2 percent of sales, up from last year’s 58.2 percent of revenues. There were four notable factors that affected its operating cost ratio:

• De-leveraging resulting from disappointing sales.
• Litigation settlement costs.
• Higher occupancy costs.
• Expense reductions which helped to offset the first three factors.

• Inventories continue to decline – As a result of lower inventories, Zale achieved a rolling 12-month inventory turn of 1.22 times, up from the prior year’s 1.12 times. The company’s original goal was to slash inventories by $100 million (or roughly 10 percent). So far, it has liquidated $174 of excess inventory; this should help the company keep inventory levels lower.

• Inventory liquidation mostly behind Zale – Goldberg said that Zale’s inventory liquidation efforts are mostly over.

• Lower tax rate – Zale’s tax rate declined slightly because a greater percentage of its earnings are coming from its Canadian division where corporate tax rates are more moderate.

• Piercing Pagoda is not closing – Management noted that there has been “inaccurate speculation reported regarding the closing of Piercing Pagoda.” Goldberg said emphatically, “We are not shuttering the brand, and actually Pagoda has been one of our strongest performers.”

• Store expansion has been curtailed – Management revealed that there will be no net increase in kiosks in the fiscal year ending July 31, 2009, and there will be only about six or so new stores. Net-net, we don’t expect to see any material change in the number of units Zale operates: 1,399 stores and 731 kiosks.

• Zale appears to be obtaining rent concessions – Goldberg said that Zale’s rents are reflecting a new level of competitiveness in the real estate market. He expects that future deals will reflect notably lower rent rates.

• Zale noted two financial contingencies in its legal filings:

• In connection with the sale of Bailey Banks & Biddle to Finlay Enterprises in November 2007, Zale remains contingently liable for some of the store leases which generally have remaining lease periods from 2009 to 2017. The maximum potential liability for base rent payments is about $76 million, though Zale may also be obligated for common area charges and other payments. Finlay has been experiencing financial pressures of its own recently; if it were to file for court protection from creditors, some or all the BBB leases might become the responsibility of Zale.

• Recently, one of Zale’s vendors filed for bankruptcy protection. An affiliate of that vendor held about 5,000 ounces of gold, worth about $4 million, which belongs to Zale. Although Zale believes it is entitled to the return of the gold, it has not yet been returned, nor is it clear if or when the gold might be returned.