“The results are better than a year ago, but not good enough overall.” That was the assessment by Zale president and interim CEO Theo Killion of Zale’s financial results for the fiscal quarter ended April 2010.

 

We’d agree with Killion. Management has done a number of things to reduce losses: 1) the company has reduced its store base to 7 percent over the past year by closing under-performing units; 2) it has cut other operating expenses; 3) it has reduced price-based promotions significantly in an effort to boost the gross margin.

 

What worries us most, though, is that same-store sales continue to decline. In the same quarter a year ago, same-store sales were down 20 percent; this year, they dropped further: down 2.2 percent. In other words, Zale continues to dig the sales hole deeper, rather than recovering in line with both competitors and the industry.

 

Here’s the core problem: there is no long term strategy in place. And that’s primarily because Killion is still the “interim” CEO. He’s blocking and tackling, but there is no coach on the bench plotting a broad-based long-term strategy.

 

We note that Killion has made one isolated strategic move: he is moving back toward differentiating each of the Zale brands. That makes sense to us: they had become homogenized and undifferentiated. 

 

The table below summarizes key financial data for Zale’s April 2010 quarter.

 

 

Highlights of the Quarter

 

·        Total revenues for Zale Corporation declined by 5 percent in the April 2010 quarter, with same-store sales down just over 2 percent.

 

o       With Zale’s low inventory levels, it is a surprise that sales were not weaker. While it is difficult to calculate comparative inventory levels per store for Zale (management does not break out Piercing Pagoda from traditional stores), we estimate that per-store inventories in the jewelry store division (excluding Piercing Pagoda units) were 10-15 percent below where they should have been to support stronger sales. Management acknowledged that incoming shipments were stopped in December, after a weak November. The bulk of incoming merchandise for the April quarter did not arrive until mid-April.

 

o       Same-store sales during the Valentine’s Day / President’s Day weekend were up 5.5 percent, which management attributed to sales efforts by its store associates. These results were achieved despite significantly less advertising: in the Zales branded stores, management eliminated radio ads, two direct mailings, a catalog, and had eleven fewer days of television advertising.

 

o       Further, in the third quarter, management eliminated 27 days of discounting the whole store, either at “10 percent off” or “10 percent-15 percent off.” We applaud this move, if for no other reason than it helps polish the professional image of jewelers, who are often compared to used car dealers when it comes to playing “pricing roulette.”

 

o       Zale was out of stock with far too much merchandise at opening price points. With the economic recovery still fresh on the minds of consumers, shoppers were looking for value-priced goods.

 

·        Zale’s gross margin was up in the quarter: 50.8 percent versus 50.1 percent last year. That was the primary benefit from reduced price-based promotions in the quarter. During the quarter, the company wrote down some slow-turning merchandise. If this one-time cost is excluded, the company’s gross margin would have been about 52 percent in the quarter, nearly two hundred basis points higher than the prior year.

 

·        Operating expenses fell to 53.9 percent of sales versus last year’s higher 55.3 percent. This was due in part to reducing its store base and keeping a lid on expenses.

 

·        The company received a tax refund for $12.8 million; this check was received on May 1, so this cash infusion is not reflected on the company’s balance sheet.

 

·        Over the past year, Zale has closed 149 locations – 132 stores and 17 kiosks – and ended the quarter with 1,901 units, down just over 7 percent from the prior year’s level.

 

·        On its conference call with Wall Street investors, Zale management spent a significant amount of time explaining its new financial arrangements. Rather than re-hash them here, we suggest that suppliers attend Zale’s vendor event in June: management will provide a full explanation of its financing arrangements.

 

Looking Beyond the Quarter

 

·        Killion and his management team have implemented a strategy to begin to restore brand identity to each of Zale’s retail brands. What triggered this? Zale’s merchandising team acknowledged that as each retail brand was collapsed into the Zale’s brand beginning in 2006, the sales comparisons quickly went from positive to negative. Over a three-year period, the company systematically merged brands: Gordon’s into Zales, then Zales Outlet into Zales, and finally Canada (Peoples & Mappins) into Gordon’s, Zales and Outlet. As management said, the brands became homogenized and shoppers recognized it.

 

·        Management said that sales during the Mother’s Day period were soft, but margins remained strong.

 

·        Longer term, management outlined two key programs to boost customer traffic and sales.

 

o       The company is focusing on improving its merchandise offerings at opening price points. Its inventory of goods at these low price points declined, and Zale’s customers who were seeking value-priced goods could not find merchandise at Zale. The company noted that sales of jewelry in its collections were not as strong as hoped; apparently, today’s shopper is a “price and item” customer.

As a result, we look for more core goods at lower price points. Further, management said demand for silver jewelry was very strong, so we think that more silver goods will show up in Zale’s showcases.

 

o       Zale plans to improve its bridal jewelry assortment. With an increase in the number of weddings likely over the next five or six years, Zale wants to be an important player in this category.

 

·        When asked about the prospects for price increases, especially since the cost of gold and diamonds have moved up, management said it plans to maintain a sales mix and merchandise margins that will yield a gross margin to “be well over 50 percent.” We think that’s a “yes” to potential price increases.

Management launched pagoda.com in May. It joins zales.com, zalesoutlet.com and gordonsjewelers.com. The company clearly wants to tap consumers who shop online.