Zale Corporation Chairman Neal Goldberg has articulated a turn-around strategy that makes good sense. The problem is that the headwinds of the current recession are bashing and lashing the company with such force that it is difficult to see the progress that is being made.

 

On the surface, Zale’s numbers are extremely disappointing: sales are down, losses are up and cash flow is suffering. Despite these impediments, Goldberg continues to move ahead with his turn-around strategy.

 

The good news is that most retailers are resilient: they aren’t capital intense (like a manufacturing operation). They can close a few stores to generate cash and inventory for the remaining stores, and their product cycle is short enough that they can dump out-of-date merchandise easily and replace it with in-style goods. In short, they don’t die quickly or easily.

 

If there is a time bomb facing Zale, it is the liability for the leases of the divested Bailey Banks & Biddle units. But management has been open about its negotiations to gain a release from this liability. Further, this doesn’t appear to be a “killer” time bomb; rather, it is simply a nasty situation that is diverting management’s energy at the wrong time. Otherwise, there don’t appear to be any lenders, vendors, or shareholders that are threatening the vitality of the operation (there may be some saber-rattling, but that’s all it is, at this point). Thus, given enough time, it seems likely that Zale can get back on the path of growth and profitability.

 
The table below summarizes Zale’s performance for its third fiscal quarter ended April 2009.

 

 

 Highlights of the Quarter

 

• Zale’s total sales were down by 20.5 percent and same-store sales fell by 20.0 percent. While this appears to be extremely worrisome, it is important to remember that last year’s third fiscal quarter same-store sales increase of 5.8 percent (April 2008) was ahead by about 10 points due to an unusually high – 30 percent – mix of discontinued merchandise. If the impact of the obsolete merchandise sales is removed, last year’s same-store sales would have been down by an estimated 4-5 percent, and this year’s sales comparisons would not be nearly as onerous. While it is difficult to estimate this year’s total and same-store sales on the same basis, it is not unreasonable to assume that Zale’s sales for the April 2009 quarter were probably down by 10-11 percent or so on a “real” basis, rather than the reported decline of 20 percent.

• In the April quarter, Zale’s average ticket was up slightly. Unfortunately, virtually all of the sales decline came from the lack of traffic, resulting in fewer transactions in its stores.

• Management continues to cite the bridal jewelry category as its strongest. Roughly 40 percent of Zale’s sales are bridal-related.

• Zale has increased its mix of proprietary goods. Based on the success of proprietary brands and lines at other jewelers, this appears to be a solid strategy. Last year, Zale introduced its Diamond Celebrations diamond line, and it has helped differentiate the company’s merchandise offering and build sales.

• In an attempt to create other proprietary jewelry lines, the company has revised its research and development process for new merchandise. No specific details are available for competitive reasons. However, collections appear to hold much potential for Zale – especially collections that carry an emotional story.

• The attachment rate for its highly profitable warranty products was 49 percent this year, down modestly from 54 percent last year. The warranty attachment rate for discontinued goods is higher than for in-line goods. Since a higher percentage of goods in 2008 were discontinued merchandise, it is understandable that the warranty attachment rate was higher last year than this year.

• Zale has at least one more quarter of difficult same-store sales comparisons: its same-store sales for the quarter ending July 2008 were up by 6.1 percent, driven by liquidation sales of discontinued merchandise. By mid-August of 2008, the sales mix of discontinued goods began to decline, and same-store sales comparisons will be reported on a more-or-less comparable basis.

• Zale has also been able to raise its gross margin above 50 percent, one of its long term goals. A lower mix of discontinued goods and a higher mix of proprietary merchandise helped boost its margin.

• Zale has implemented a series of cost-cutting programs, including the following:

• Cut selling, general and administrative expenses by $22 million versus the prior year.
• Realigning its rent structure to match current weak sales trends. It has gone to landlords and asked for rent relief. Further, with weaker sales, its percentage rents are lower than last year.
• Closing under-performing stores. Currently, only 10-15 percent of its leases come up for renewal annually, so the company has engaged an outside firm to help renegotiate store leases, especially in under-performing stores.
• Realigning its product line and vendor organization. It has dramatically reduced its vendor base.
• Inventories will be reduced by another $75 million over the next year. The company has made dramatic progress with inventory reduction: in April 2007, inventories were $1.086 billion; today (two years later), they are $759 million.  

• During the quarter, the company opened one store and closed 31 units. It opened no kiosks and closed seven.