Declaring that “the answers are in the store,” Neal Goldberg, Zale Corporation’s CEO has set the stage with his management team and vendors for rebuilding Zale into a highly profitable, financially stable company. This philosophy is both literal and figurative: Zale executives are expected to spend time in their stores, rather than retreating each day – as they have in the past – to the corporate support center in Texas. And, of course, as any good merchant knows: the answers really are in the store.

During a conference call with Wall Street analysts recently, Goldberg reiterated the mantra of his three-point recovery plan:

• Re-engage the core customer
• Enhance operational effectiveness
• Strengthen financial rigor 

Based on the company’s results, Goldberg and his team has hit and surpassed many of the benchmarks he set. Jewelry industry vendors may not be happy: the company’s vendor base has been reduced by two-thirds. Some overhead employees may not be happy, since expenses have been reduced by $65 million annually, much of which was accomplished by the elimination of personnel redundancies. But store employees are happier: they are getting better training, and their compensation system is understandable.

The only good news for competitors is that Zale is phasing out of its clearance mode. During the July quarter, about 20 percent of its sales came from clearance goods. On an on-going basis, 6-8 percent of its revenues will come from clearance merchandise; this is slightly above the historic level of 4-5 percent of revenues.

With reduced industry capacity – Friedman’s is gone, Whitehall is on its way out, and a large number of independents have shuttered their stores – Zale is well-positioned to pick up market share, especially when the inevitable economic recovery begins.

The following table summarizes Zale’s fourth quarter financial results.

The following are highlights from Zale’s fourth quarter and full year results for the period ended July 2008.

• The company’s recovery and rebuilding program continues to move ahead about on plan.

• The previously announced $100 million inventory reduction plan actually moved $127 million of clearance goods. The result is a 40 percent reduction in SKUs (number of goods in the line). There is less inventory cluttering the store cases, and the newness of the assortment – 2,000 new items are coming this fall – should attract customers. Essentially, the company is “doing more with less”, according to Goldberg. Further, the quality level of the new goods is higher. Finally, with fewer SKUs, the company can move with the market more quickly.

• Zale’s marketing campaigns appear to be working. The ads have an emotional pull (jewelry is an emotional sale, driven by fashion). The message is easier to understand and clearer. Zale’s direct marketing pieces have fewer items per page.

• The Pace Setter program consists of 135 stores generating more than 20 percent of the company’s total sales volume, and a greater percentage of profits. Aside from new carpets and other amenities in these Pace Setter units, sales associates have received more training. These stores have a 40 percent greater assortment of diamond jewelry than other stores. By mid-October, all of these stores will be re-set for the 2008 holiday selling season.

• In an effort to enhance operating effectiveness, the company has created a leaner, stronger organization. The brand “silos” are gone; the company operates as a unity. The field organization has been realigned, and the compensation system has been changed.

• Store openings will be determined by potential financial returns, rather than other decisions.

• During the October quarter, the company will be phasing out of its clearance mode. In the July quarter, roughly 20 percent of its sales came from clearance goods. That will decline to about 6-8 percent of sales for a fiscal year period; this is up from Zale’s historic level of 4-5 percent, a level which left it with too much obsolete inventory in the past.

• The company plans to refocus on its proprietary credit program. Several years ago, it sold off the credit unit to a third-party provider. As a result, credit sales as a percentage of total sales have fallen to the mid-30 percent range, down from the mid-to-high 40 percent range. Credit customers are not only loyal, they spend much more than cash customers. Yet, prior management let this market segment languish. Goldberg reported that credit applications are up, and the approval rate is holding about steady.

• The company currently has three areas for near-term growth:
  • Its Canadian division continues to post double digit sales gains. About 36 new stores are slated to be opened in Canada over the next two years, bring the total number of units in operation in that market to just over 200 stores.
  • E-commerce is growing rapidly. It was up 30 percent during the most recent fiscal year (ended July 2008) to $55 million; it grew 50 percent in the July quarter.
  • Piercing Pagoda has not had management focus since Paul Leonard was moved from the division several years ago. During the July quarter, Pagoda’s same-store sales rose by a high single-digit level, driven by diamonds and men’s steel jewelry.

• Longer term, Zale is pinning its hopes on the success of the Pace Setter stores, described above.

• In recent years, Zale’s holiday sales have been disappointing. The company’s prior management used the excuse, “The orders were placed too late, and vendors didn’t ship on time.” Goldberg said that as of September 1, all holiday orders have been placed. With fewer SKUs in the line-up, he expects to maintain a higher in-stock position for the holiday season.

• Zale has implemented some price increases, along with a few price decreases, according to management.

• The average ticket in the July quarter was $166, down from the prior year’s $172. This was due to a higher mix of lower-priced clearance goods.

• Lifetime warranty sales continue to grow.

• While the company’s fourth quarter gross margin was down – 47.3 percent versus 53.0 percent – it was about on plan, especially in light of the large sales mix of clearance goods.

• On an annual basis, the company posted nearly flat – (0.7 percent) – same-store sales comparisons. By division, these are the results for the fiscal year ended July 2008:
  • Zale & Gordon’s   -4.8 percent
  • Peoples   +16.9 percent
  • Piercing Pagoda   -1.1 percent
  • Zale Outlet   -2.7 percent
  • .com   +32.2 percent

• The company ended the year with 1,396 stores and 729 kiosks, for a total of 2,135 units, down just under 6 percent from the prior year’s levels.

• Year-end inventories declined to $780 million, down $240 million. About $153 million of the inventory reduction was related to the Bailey Banks & Biddle divesture; the remaining $87 million was related to a “real” reduction in inventory levels. A raw calculation of inventory per store at year-end indicates that same-store inventories were down about 19 percent; we think this may be affected by the store mix somewhat. None-the-less, the magnitude of the figure is impressive.