IDEX Online Research: Zale’s Financial Woes Continue
December 08, 10(IDEX Online) - Zale’s struggles continue. Its financial results for the October 2010 quarter were disappointing, despite a couple of bright spots. Further, we don’t get a sense of energy, especially at the corporate level – it appears that a large number of the employees are burned out, after a succession of failed corporate leadership.
Zale is a company with strong brand recognition at the consumer level. But if things don’t change soon, it could join the likes of Friedman’s, Whitehall, Finlay, and others who simply didn’t make it.
Here’s how Zale stacks up, based on financial results from the October quarter:
· Zale’s total sales in the October quarter declined by 0.7 percent, with same-store sales down by 1.1 percent.
That’s well below both the total jewelry industry sales gain of 6 percent and the total sales gain for specialty jewelers of 3 percent. Further, it is well below direct competitor Sterling Jewelers’ total sales gain of 8.8 percent and same-store sales gain of 9.7 percent for the same period.
Further, Zale has nearly a decade long pattern of under-performance, as the graph below illustrates. The October quarter is simply a continuation of this trend.
Source: Zale & IDEX Online Research |
· While Zale’s operating loss of $42.0 million was smaller than last year’s operating loss of $56.6 million, unusual charges drove its pretax loss to $97.3 million versus last year’s $58.5 million. There was virtually no provision for taxes; this usually occurs when the auditors believe that the company will never generate enough profit in the foreseeable future to offset its operating losses, within IRS rules.
· Zale’s sales per store continue to fall more sharply than the industry average. For the fiscal year ended July 2010, the average sale per store in the combined Zale and Gordon’s brand was $1.034 million, down 17 percent since 2008.
In the same period, the average sales per U.S. specialty jewelry store have fallen by 11 percent, according to the Jewelers of America Cost of Doing Business Survey. Competitor Kay Jewelers’ average sales per store has risen just over 1 percent between 2008 and 2010.
The table below summarizes sales per store (U.S. dollars, except Peoples/Mappins in Canadian dollars) by operating division within Zale Corporation. Beginning in 2008, the company consolidated the average sales per store for Zale and Gordon’s.
Source: Zale |
· Zale’s average ticket for its Zale and Gordon’s branded stores was $396 in the most recent year; that’s up nearly 7 percent since the 2007-2008 period.
In contrast, the industry average ticket is down an estimated 10-11 percent in the same period to an estimated $315 or so. Further, Kay Jewelers’ average unit selling price was $307 for the most recent year, down about 6 percent over the two-year period. Zale’s average ticket isn’t directly comparable to Kay’s average unit selling price, but here’s the point: consumers shopped “down” for the jewelry needs in the recession. Kay met shoppers where they were by offering a selection of popular-priced jewelry. Zale apparently focused on raising the average ticket, which may have driven shoppers to competitors.
The table below summarizes the average ticket for each operating division of Zale Corporation.
Source: Zale |
· Zale’s shareholders’ equity – a key measure often called “net worth” – has fallen by a dramatic 77 percent over the past eight years – from $939.8 million in 2002 to $213.1 million in the most recent quarter – as the company has struggled through a succession of top management, reorganizations, and strategies, virtually all of which have generated increased losses for the company and eaten away at its net worth.
Because of this serious and worrisome decline in its capital structure, Zale is in real danger of becoming technically bankrupt, in our opinion. Its capital structure ratios are out of kilter, and at some point the lenders will become the equity holders, if the trend continues.
The graph below illustrates Zale’s shareholder equity – net worth – since 1994.
Source: Zale |
October Quarter Highlights
The following table summarizes Zale’s financial results for its first fiscal quarter ended October 2010.
Zale’s management made the following comments about its performance during the October quarter:
· Zale’s total sales were down by a modest 0.7 percent, with a 1.1 percent decline in same-store sales. The decrease in revenues was due to year-over-year store closures, offset partially by an increase in recognized revenues from its lifetime and 12-month warranty programs. The company did not break out these figures. Our sense is that Zale didn’t sell more jewelry; rather, it sold more insurance policies.
· Zale’s gross margin was 50.5 percent in the quarter, up from last year’s 48.6 percent. Most of the improvement in the gross margin was due to a higher level of warranty revenue, a euphemism for insurance. The company made it clear that it has not raised retail prices; rather, it has either hedged some of its commodity costs or it has not passed on higher costs related to precious metals and diamonds. Management noted that its markdowns were less this year versus the October 2009 quarter; this added about 75 basis points to the company’s margin in the current year. When non-product and other costs are eliminated, we believe that Zale’s raw merchandise margin likely declined in the quarter.
· Operating costs were 59.7 percent of sales in the October 2010 quarter versus 61.7 percent in the same quarter a year ago. Besides expense control, the company recorded lower professional fees. Last year, the company incurred extraordinary costs related to the restatement of its financial results.
· The company’s operating loss, before interest, declined to $42 million, compared to $57 million a year ago.
· Interest related to continuing operations was $9.5 million in the quarter versus $1.9 million in the October quarter last year. A one-time interest charge of $45.8 million was also incurred in the quarter; it related to the amendment of the company’s senior secured loan in September 2010. Of the one-time interest cost of $45.8 million, $30.6 million was a non-cash charge.
· We believe that interest costs are related to ongoing business operations; Zale does not report interest, when calculating operating earnings. Based on the inclusion of “normal” interest, the company’s operating loss was just under $52 million in the October 2010 quarter, versus $57 million last year. We believe it is correct to exclude one-time charges, such as the interest (and accelerated amortization of costs) related to amending its senior loan, when calculating operating earnings.
· Zale is not reserving a material amount for taxes. It has exhausted its net operating loss carry backs. Unfortunately, because of the uncertainty surrounding the prospects for generating future taxable income, the company did not reserve for income taxes which might be payable at some point in the future.
Despite dismal financial results year after year, the company received an unqualified audit from Ernst & Young for the fiscal year ended July 2010. Further, there was no mention of a “going concern” warning in any public documents. In the post-meltdown period following the financial improprieties of Wall Street and some audit firms, most auditors have become much more conservative. We, frankly, are surprised that Zale did not receive a “going concern” warning, though there may have been cautionary language in the management letter (which is not a public document).
· Management noted that Zale’s new private label credit card, which was put in place at the beginning of July 2010, has resulted in a 6 percent increase in the number of applications submitted per store, along with an increase of nearly 10 percent in the average credit sales ticket over the same period a year ago. Typically, the average credit sale for U.S. specialty jewelers is nearly three times as large as a cash ticket.
· Management noted that it now has lower opening price points; this should help rebuild loyalty among customers who shopped elsewhere in search of lower-priced goods.
· Zale management said that it will spend more on marketing in the 2010 holiday selling season than it did last year, but it did not provide specific figures. Management noted that it will increase its online banner ads; it will spend about 75 percent of its overall holiday advertising budget on television. The company has also increased its direct mail marketing program.
· Management said that it has not passed along “the lion’s share” of higher commodity costs this year. It noted that there have been changes in the product which should lead to lower costs. For example, in the Piercing Pagoda division, the company has implemented gold bonding in place of 10K gold.
Management also noted that it had ample diamonds which it had purchase in 2010 and prior years. Thus, its cost base for those diamonds – and the diamond jewelry – is low.