Zale: ‘We May Not Have Sufficient Liquidity to Meet Our Operating Needs’

Zale, which provides about 40% of its U.S. costumers with financing to purchase jewelry, may lose its ability to provide credit, with “adverse consequences”

Zale is warning the market that based on its cash flow projections for the remainder of 2010, “We may not have sufficient liquidity to meet our operating needs.” It goes on to warn that Citibank may stop providing customer credit for purchases with the consequences being “material” and likely to impact Zale’s ability to continue to operate.

In a March 11 Securities and Exchange Commission filing, the embattled North American jewelry retailer stated five times that it may not have sufficient funds to meet its operating needs. As a result, it may lose some of its financing.

“As a result [of not having sufficient liquidity], we may not maintain our borrowing availability above $50 million, which would require us to satisfy a minimum fixed charge coverage ratio that we currently do not meet. This covenant violation would allow our lenders to exercise their rights with respect to the collateral securing our revolving credit facility, which includes our merchandise inventory and credit card receivables [emphasis added]. In addition, our revolving credit facility expires in August 2011,” Zale stated in its SEC filing.

Seeking Outside Help

In February, the company retained investment banking advisory firm Peter J. Solomon to assist it in finding alternatives to secure additional liquidity. “Conditions in the credit markets are volatile, and it is unclear if, or under what terms, we will be able to modify or extend our revolving credit facility or secure additional liquidity. The incurrence of indebtedness with less favorable terms would result in increased debt service costs,” it states in the 10-Q filing.

Citibank May Pull the Plug

Last December Citibank notified Zale that it does not intend to renew the Merchant Service Agreements, and will therefore expire in March 2011. Citibank provides customers with financing to purchase merchandise in about 40 percent of purchases in the U.S. and 25 percent of purchases in Canada.

The non-renewal is due to Zale’s failure to maintain a minimum volume of credit sales and a fixed charge coverage ratio. The agreements, however, may be terminated as early as June 2010, unless Zale pays Citibank $6 million by April 1. Zale said that it is currently evaluating its alternatives to determine whether it will make the payment.

Making sales even tougher, after Citibank decided to “tighten” credit customer approval criteria and close some high risk accounts. Zale said it is in preliminary discussions with several financial institutions, including Citibank, to replace the customer financing agreements.

The Bottom Line: Fewer Sales

“If we are unable to replace the agreements, our customers will have less credit available to them and our sales and earnings will be negatively impacted,” Zale warns.

“[I]f we were unable to realize all of the sales currently financed under the Citibank agreements, the adverse consequences would be material and would likely impact our ability to continue to operate. In addition, were we to no longer have a private label credit card agreement with Citibank or some other provider, we would no longer provide credit insurance, which generated revenues of $4.8 million for the six months ended January 31, 2010.”