IDEX Online Research: Zale Operating Trends Still Generally Negative
(November 28, '07, 6:28 Ken Gassman)

Lower sales and larger losses characterized Zale’s fiscal quarter ended October 2007. One of the only positive signs was an improvement in the company’s raw gross margin (product gross margin before other costs such as buying expense are allocated), which rose by 80 basis points. At some point, the company’s improved gross margin should begin to flow through to bottom line profits.

 

If weak sales and greater losses weren’t enough bad news, Zale’s management reduced its holiday sales forecast and cut its profit estimate for both the fourth calendar quarter and full fiscal year ending July 2008. Management now estimates that holiday same-store sales will be flat to down slightly. Depending on several unusual cost factors which are either included or excluded, we estimate that the company’s new profit estimate is 10-20 percent lower than its prior guidance for the year.

 

Financial results for the October quarter have been adjusted to reflect the sale of Bailey Banks & Biddle in early November, 2007. Unfortunately, last year’s loss was larger after restatement; Bailey’s financial results last year helped reduce the company’s operating loss in the quarterly period ended October 2006.

 

The following table summarizes financial results on a year-to-year basis, with the impact of Bailey Banks & Biddle shown as “discontinued operations.” 

 

 


Highlights from the October Quarter

  • Total sales declined by 1.3 percent, based on continuing operations (BBB has been removed from both years); same-store sales were down by 0.4 percent in the October quarter.
    • Same-store sales were down low-to-mid single digit in Zale’s, Gordon’s, and Piercing Pagoda in the quarter.
    • Same-store sales rose in the Zale’s Outlet stores by about five percent.
    • Same-store sales were up double-digit levels in the Canadian stores (Peoples and Mappins).

  • Management cited a decline in U.S. mall traffic of 4-6 percent as one of the key reasons for its disappointing sales performance.

  • Zale’s credit quality appears to be stable. Approval rates have increased on a year-to-year basis. CitiGroup administers its credit program, and management says that no significant change has been made in credit scoring or approval.

  • The attachment rate for extended warranties remains at about 50 percent of sales. This will help boost revenues and profits longer term.

  • Zale’s reported gross margin fell to 52.5 percent of sales versus 52.9 percent last year. Virtually all divisions reported higher merchandise margins, but accounting related to warranty sales hurt the company’s reported gross margin.

  • Direct sourced loose diamonds rose to 10.4 percent of total diamond sales, up from 7.9 percent in the same quarter a year ago. Total direct sourced goods rose to 35.5 percent of merchandise versus 33.2 percent last year.

  • The company has not hedged gold for its jewelry, but it has locked in gold prices through the end of 2007.

  • The company’s inventory of discontinued merchandise has fallen dramatically to about $19 million from $68 million at the same time a year ago. We expect that discontinued merchandise levels may settle in near this level on an on-going basis.

  • Selling, general and administrative costs were 58.5 percent of sales, up sharply from last year’s 56.0 percent due to three key factors: 1) warranty accounting; 2) higher occupancy costs; and, 3) consultants’ fees. In addition, the lack of sales leverage hurt. Other costs, including interest, depreciation, and amortization brought the company’s total operating costs up to 63.8 percent of sales, somewhat above last year’s 62.3 percent, as shown on the table above.

  • New stores will probably just about offset store closings over the next 12 months. Currently, Zale has about 2,200 units in operation, after the sale of the Bailey Banks & Biddle units.

  • The company revised its holiday same-store sales forecast to “flat to down slightly.” Previously, management was predicting a same-store sales gain of 1-2 percent.

  • For the holiday selling period, Zale says its marketing spend will be comparable to last year. It will focus on Journey diamonds, fashion right hand rings, big gold hoop earrings and “Past, Present & Forever,” a variation of the DTC’s Past, Present and Future diamond promotion. There will be no special online promotions; all holiday promotions will be multi-channel marketing efforts.