Zale's Dismal Results Likely to Continue Despite New CEO

Implications: Investors should be skeptical that Zale's new CEO will be successful as the board micro manages the business.

Analysis:  Zale, Signet, and Finlay announced their holiday results for the critical November-December sales period.  Dismal was about the best analysts had to say about the numbers.  Zale Corporation reported the worst results saying comparable stores were down (9.0%).  Surprisingly, Signets US numbers weren’t that much better with US store for store sales declining (8.1%).  Finlay’s same store sales dropped (5.9%) for the November- December period.  

With such disastrous results, it follows earnings expectations would also be reduced.  Zale now thinks it will earn between $1.08 and $1.13 for the quarter.  That’s about a 33% reduction in forecast earnings or about $23 million. Zale has its two weakest quarters remaining in its fiscal year 2008; meaning earning will almost certainly be substantially below FY 2007 levels.   

Likewise Signet has indicated its earnings could decrease by as much as $60-$70 million from 2006.  In contrast, Finlay now expects to lose between ($0.90) and ($1.00) per share compared to earlier projections of $2.15-$2.30 per share.  If true, it will the second consecutive year the company has lost money; losing ($0.71) per share in 2006.  

In general, these jewelers said reduced consumer spending because of higher jewelry prices and increased non-core inflation was the reason holiday sales collapsed.  That may be true for Signet which has out performed Zale and most of the industry for more than a decade.  Finlay’s problems are also well know as its sales have suffered from department store consolidation and reduced market share of jewelry in the department store mix.  However, Zale’s performance is more problematic.  Trailing Signet since about 1994, the company has continued to lose market share in spite of repeated turnaround attempts.  It now has its 3rd CEO in as many years which not only adds to the uncertainty about the likelihood of a future turnaround, but leaves investors, vendors, and employees wondering just what is going on in the minds of the people managing this company.  

As Neil Goldberg, the new CEO, takes over from Betsy Burton, investors will point to a number of problems in store planning, buying, merchandising, marketing, and operations that Zale needs to be corrected. For instance, years of declining performance has made a number of Zale and Gordon locations less profitable; suggesting the new CEO should close a significant number of stores.  They will also focus on gross margins and excessive markdowns as a root cause of the decline in profitability.  Higher inventories and obsolescent product will also have to be a target of the new CEO’s attention. Operationally, poor staff quality, high associate turnover, and overall poor execution will have to be addressed, while at the same time continuing to reduce Zale’s cost structure.  

That list isn’t very different from Burton’s list or Forte’s for that matter.  In deed, the fourth CEO, Beryl Raff had a similar list as she assumed the company’s leadership role; only to be sacked 6 months later when Christmas results failed to meet expectations.  In hindsight, it is doubtful Raff, the Forte/Gove coalition, or Burton were right for the CEO’s job, however, it was the Zale board that hired them and it’s the same board for the most part that just hired Goldberg.  If the board’s history in choosing and managing leaders is the measure, then investors have to be skeptical whether he will achieve any degree of success.

The board’s reactionary management style is illustrated by the termination of Burton and the hiring of Goldberg.  According to various accounts, after the board signed off on the sale of Bailey, Banks, and Biddle and the reorganization of division management structure in the summer, it decided to bring in Chief Operating Officer to support Burton in the downsized organization.  After three months, the new Chairman John Lowe, terminated the search and decided to replace Burton instead.  Goldberg was appointed about six weeks latter. Two years earlier, the same board had searched for a new CEO for nearly six months, only to name one of its own board members, Betsy Burton, CEO.  Then, both Burton and the board said the company was strategically on track and didn’t need a change agent.  Neil Goldberg’s early remarks suggest the board probably still believes that.  

An earlier comment by one of the directors also illustrates another side of the board’s management style when he justified the sale of Bailey, Banks, and Biddle because it took up one-third of the boards time and only produced 10% of the sales.  That reveals the tendency of the board to micro manage the business and is born out in part by the termination of its division executive management organization leaving Zale, Zale Outlet, Zale Online, Gordon, Gordon Online, Piercing Pagoda, Peoples and Mappin Jewellers in Canada to be run by a group of demoralized middle managers and the board of directors.  Clearly, the company stands little chance of recruiting a top quality CEO that know Zale and the jewelry industry, mush less a strong senior management team to run the day to day operations in this stifling, over managed environment.

Whether the board will change remains to be seen.  Breeden Capital now owns 15.9% of the approximate 44.6 million outstanding shares.  Shareholders that are either activists or sympathetic to them control about 50% to 60% of the companies equity.  With that kind of voting block, Richard Breeden could nominate his own slate of directors at the next annual meeting to be held in November 2008.  That would give him operational control of the company and the freedom to grow the business if he is indeed a long term player as he claims.  In the meantime, investors will have to wait to see if Goldberg fares any better than his last three predecessors.