IDEX Online Research: Zale Transition Moving Slowly

New management at the helm of Zale Corporation cautioned Wall Street that the company’s ongoing transition to achieve stronger sales and profits will take time. In the all-important quarter ended January 2007, Zale posted a very modest 1.4 percent same-store sales gain and a 1.1 percent total sales increase. Further, the company generated an after-tax profit that was down 2 percent from the prior year, on an apples-to-apples basis. In addition, its after-tax profit margin was 8.8 percent of sales, flat with last year and below the company’s historical level in the 10-11 percent range.

Zale management also warned that same-store sales in the current quarter ending April 2007 would be down 2-3 percent. For the fiscal year ending July 2007, management expects same-store sales to be flat. Further, total profits for the year are expected to be well below the levels which the company generated earlier in the decade.

Based on sales levels for the first half of Zale’s fiscal year and its projections for the second half, it is highly likely that the company will lose market share in the U.S.

While turning around a company involves taking many steps one at a time, it seems that the number of steps required to turn Zale around continues to increase, each time management makes a presentation to investors. It is no secret that turning around a company as large as Zale could take 2-3 years, in our opinion. Even management acknowledges that the transition is taking longer than expected. Both Betsy Burton, CEO, and Rodney Carter, CFO, alluded to this; Burton said, “While not reaching our original expectations in the [January] quarter, I’m pleased with the progress we’ve made.” That puts a happy face on a stressful situation.

Burton said that Zale will focus on maximizing both its gross margin and its gross profit dollars rather than trying to boost sales. She noted, however, that there is a fine line between growing market share and growing gross profit dollars; the company is running various tests to see if it can find that fine line.

Highlights from management’s comments to investors follow: 

• “Merger” of Gordon’s and Zales – Acknowledging that both Zale and Gordon’s have basically the same customer base, management plans to centralize buying and merchandising for both brands. By the 2007 holiday period, there could be up to 70 percent overlap in product, up dramatically from the 5-10 percent overlap in the 2006 holiday period. Not only will much of the product be the same, but assortments will mirror each other in the two brands. Promotions will also be standardized. In the few Gordon’s stores which appeal to a particular ethnic group, assortments will be tailored to the particular market; otherwise, standardization with Zale will prevail.
  
  There are about 250 Gordon’s stores (out of 285 units) in the same mall with a Zales Jewelers store. Management noted that this was no different than in Canada where its Peoples and Mappins divisions have stores in the same malls. In addition, Kay Jewelers operates multiple stores in many malls, often with very similar assortments.
  
  Management said that if the merchandise “merger” is successful, Gordon’s could easily become a second national mass market brand for the company.  
• Online sales grow – Online holiday traffic at the zales.com website was up 23 percent, the conversion rate (browser-to-buyer) was up 50 percent, and sales advanced by 75 percent. Bailey Banks’ online sales tripled during the holiday period. Gordon’s will launch online commerce this spring. However, management gave not dollar figures, so Zale’s level of online commerce is not clear. For the full fiscal year ended July 2006, Zale’s total online commerce represented about 1 percent of corporate revenues. Total U.S. online jewelry sales were about 3.9 percent of total jewelry sales in 2006.
• Diamonds drove sales – During the all-important holiday selling season, Zale management said diamonds drove sales. Both diamond fashion and traditional diamond jewelry – solitaires, for example – posted strong sales gains. The company cut back on its assortments of other precious and semi-precious stones, so sales in these categories reflected its reduced inventory levels. Further, demand for precious metal jewelry – especially gold and silver – was weak due to higher prices for these commodities.
• Lifetime Protection Plan launch is successful – Describing it as a “great decision”, CEO Betsy Burton extolled the virtues of Zale’s new Lifetime Protection Plan for its jewelry. It creates a higher average ticket, an increased gross margin, and greater total revenues. Management wouldn’t say how long a “lifetime” is for accounting purposes (revenues from this program are amortized over the “lifetime” of the agreement), but they did say it was conservative. With Zale, the definition of “lifetime” is really the lifetime of the piece of paper which confirms that the customer purchased the protection plan, since it is valid only if the customer brings the Lifetime Protection Plan document back to the store when making a warranty claim.
• Valentine’s sales weak – Due to winter stores, Valentine’s sales at Zales were soft. Management noted that mall traffic was down even before the winter storms.

Direct sourcing increases – Zale has two direct sourcing programs: one for finished goods and one for commodities which are assembled by Zale into finished goods. Between both programs, about one-third of Zale’s product is being direct sourced, up from about one-fourth a year ago. Management was reticent to quantify the improvement in gross margin which was related to the direct sourcing program. It did note that inventories were up nearly 17 percent, year-over-year, in part due to increased merchandise levels related to direct sourcing.