IDEX Online Research: Zale Rebuilding Underway, But the Numbers Are Slow to Come

·        Reported revenues were up 1.1 percent to $432.5 million. If revenues from the 30-plus closed Bailey Banks stores are removed from last year’s results, corporate revenues from continuing operations would have advanced by about 3 percent.

·        Zale lost significant market share in the October quarter. With specialty jewelers’ sales up an estimated 9.9 percent, Zale’s sales rose by a meager 1.1 percent.

·        Clearance sales at the Zales Jewelers mass market brand hurt total corporate revenue growth for Zale’s. Earlier this year, management announced that it was disposing of $80 million of obsolete merchandise in an effort to generate cash to bring in fresh, new merchandise. As a result of these clearance sales, the number of transactions rose, but the average ticket was down about 4 percent. This year, the average ticket was $407; last year, the average ticket was $424. Roughly 20 percent of the Zales Jewelers brand revenues were clearance sales versus only about 5 percent last year. The good news is that the company moved through about 25 percent of its $80 million of clearance goods in the October quarter. All of the clearance merchandise should be gone by late 2007.

·        Zale’s Jewelers brand stores reported strong sales of diamond fashion, “Journey” diamond goods, diamond circles, alternative metals, three-stone jewelry, and Past, Present, and Future jewelry. All Zales Jewelers’ stores have been reset, with a larger diamond assortment. About $120 million of new merchandise has been brought into the Zales Jewelers stores to help update its merchandise assortment, including about $47 million of bridal goods and $45 million of diamond fashion merchandise.

·        Peoples / Mappins (Canada) reported that diamond circles and fashion diamond goods were up double digit levels in the October quarter.

·        Gordon’s Jewelers sales were below plan. Among hot products in this brand were composite styling, the new “Love” collection, and champagne diamond merchandise.

·        In the guild Bailey Banks & Biddle brand stores, solitaire demand softened. However, designer jewelry sales were up strongly. Luxury watch demand was up double digit. A new palladium solitaire line has just arrived, offering lower opening price points than platinum, but with a similar look. Diamond fashion goods which have been added to BBB’s mix appear to have potential for strong sales.

·        Zales Outlet stores posted strong same-store sales gains, with diamond fashion and bridal up 20 percent. “Journey” jewelry was strong. Diamond solitaires were in demand, especially with large diamonds. This brand’s average ticket of $422 set a quarterly record for Zales Outlet.

·        Piercing Pagoda’s sales were above plan, with CZ very popular. CZ now represents nearly 30 percent of Piercing Pagoda’s sales. Gold earrings and body jewelry are hot among Piercing Pagoda’s younger, less affluent customers. However, demand for Italian charms has dropped markedly over the past year, putting pressure on sales comparisons.

·        Zale’s internet sales effort – primarily the Zales Jewelers brand – rang up sales of $4.8 million in the quarter. The average ticket was $240, far below the Zales Jewelers’ average ticket of $407 for its stores.

·        Zale Corporation posted a reported gross margin of 52.0 percent versus 51.2 percent, though last year’s gross margin was dragged down by clearance sales in the Bailey Banks division. However, this year, the Zales division’s clearance sales hurt. On the positive side of the ledger, direct sourcing helped by about 30 basis points, the sale of Extended Service Agreements helped by 20 basis points, and fewer discounted tickets helped by 40 basis points. Management has clearly made a conscious effort to reduce store-level discounting in an effort to build retail price integrity.

·        Zale’s direct purchasing efforts – it has two programs, including direct importing of finished goods and assembly of loose diamonds – represented 34 percent of total purchases in the quarter, up from 26 percent last year. These purchases generated 27 percent of corporate sales this year.

·        Zale’s total inventory rose to $1.19 billion, up 17.8 percent due to two factors: 1) the addition of $120 million of merchandise in the Zales Jewelers brand stores; and 2) inventories which were $50 million below plan last year, when the company was plagued by out-of-stocks due to late ordering and delayed receipt of goods. If these two unusual items are eliminated, inventories would have been up a very modest 1.1 percent in the quarter, year-over-year.

·        Zale’s reported operating expense ratio was unfavorable at 61.7 percent this year versus 60.1 percent last year. However, last year had an unusual impairment charge related to the Bailey Banks division. On an apples-to-apples basis, the company’s operating cost ratio would have been 61.7 percent versus 58.1 percent, a much more unfavorable comparison. In addition, this year higher payroll costs hurt (Zale is adjusting its pay scale to be more competitive); its weak same-store sales de-leveraged operating costs; and, occupancy costs rose.

·        Zale has begun to use forward hedge contracts in an effort to smooth cash flow and fix its gold and silver purchase costs. Unfortunately, this hurt financials in the October quarter by more than $5 million after taxes (roughly 20 percent of the quarter’s loss is attributable to hedging losses). Based on GAAP accounting, the company should get this loss back at some point, but most analysts are taking a wait-and-see attitude.

·        Management declined to go into specifics about its holiday marketing plans, saying only that it will use more television, and will buy “better quality time slots with high visibility.”