Byline: David Moin / With contributions from Vicki M. Young

NEW YORK — With Robert DiNicola back again as its chairman and chief executive, Zale Corp., plagued by overstock and ballooning expenses, is moving fast into a “rebuilding” mode, seeking to stabilize the business in time to better capitalize on the next holiday season.
The Dallas-based specialty jewelry operation, which on Wednesday reported a sharp decline in earnings for its second quarter ended Jan. 31, will take some serious hits, including inventory writeoffs from markdowns to clear slow-moving merchandise. The writeoffs started with a $25 million bill in the most recent quarter.
Also, marketing and capital expenditures are getting reexamined, possibly affecting store openings. A plan to build a new distribution center in Irving, Tex., to replace the two in operation, is on hold, and comparable-store declines for the next two quarters are seen. While Zale hopes to get things under control before holiday selling, it warned that comp sales won’t be in the plus column until around this time in 2002.
“This is going to be a rebuilding year to get us refocused and back on track,” said DiNicola in an interview with WWD. “The outlook for the balance of the spring is fairly negative. It will result in high single-digit negative comps. For the rest of the calendar, for the entire fall season, we’re looking at relatively flat business.
“It has not been a good year,” he continued. “Since August, through holiday and up to now, our business has been affected more negatively than some others, perhaps because we got off our game plan. Now we need to get back on it.”
DiNicola returned as chairman and ceo on Feb. 21, succeeding Beryl Raff, who he recruited to the business and positioned as his successor. She lasted just 18 months as ceo, and six as chairwoman and ceo of the $1.8 billion chain.
Right after he came back, DiNicola and the team conducted an in-depth review of inventory. Its conclusions were disclosed Wednesday, along with the latest financial results. Zale now has a $150 million overstock to contend with over the next couple of quarters, including roughly $30 million that reportedly will be sent back to vendors, with about half of the $150 million considered of inferior quality, particularly in the diamond category. As the cost of diamonds rose, Zale last year worked to keep prices stable but in the process, sacrificed quality.
Zale, which counts on bridal-related sales for 35 percent to 40 percent of its business, also disclosed an overemphasis in marketing fashion jewelry at the expense of the core bridal business. “The bridal category is where the brand is made in the long term, but there was a shift into more the fashion and promotional categories,” DiNicola said during a conference call with analysts.
“We need to get our mix back into line. Department stores can’t be in bridal business effectively. That is a business we own and dominate as a specialty business. We need to get that back in line, and we think the $25 million markdown is sufficient.”
Also, capital expenditures were too high in proportion to business trends. For example, the Internet operation was built up with far too much staff for a business that does less than $10 million, according to reports. Currently, the Zale and Piercing Pagoda brands sell online. The company halted plans to put other brands online. “The launch of new sites last fall never happened in spite of major investments made there,” DiNicola said. “We will retrench and get the Zale site right.
“Let’s stop trying to do too many things ineffectively. Let’s do fewer things right and then we’ll get to the extra stuff,” DiNicola added.
Overall, efforts to sustain Zale’s track record of high same-store sales through the late Nineties, rather than playing it more conservatively as the economy slowed last year, backfired. The company went after big numbers and missed by a wide margin.
The down trend continues with February comp sales coming in at minus 6.5 percent, while March is tracking at minus 9 percent, according to the company.
DiNicola said a more disciplined approach to the business is required, with a view more to the long term and preserving the brand image, rather than seeking just short-term gains.
While sidetracked by inventory control and quality issues, primarily at two divisions, Zale and Gordon’s Jewelers, the company’s second-quarter results did beat Wall Street estimates. On Wednesday, shares of the company closed up 8.1 percent or $2.53 to reach $33.81 in trading on the New York Stock Exchange.
Still, there were warnings from Zale that second-half comps would remain challenging as the company implements initiatives to get back on course. Aside from the Zale and Gordon’s chains, the company operates Bailey Banks & Biddle Fine Jewelers, Peoples Jewellers, Mappins Jewellers, Zalecorp.com and Piercing Pagoda, which sells gold through kiosks.
For the quarter ended Jan. 31, the retailer posted $71.5 million in net income, or $2.07 a diluted share. The result, which includes a non-recurring charge, is a 14.5 percent drop from the $83.9 million, or $2.33, reported in the same year-ago period. Excluding a $25 million writedown for poorly performing inventory, net income in the most recent quarter was $87 million, or $2.52.
Sales were up 16.2 percent to $855.3 million from $736 million, but comps declined 2.3 percent.
Aram Rubinson, retail analyst at UBS Warburg, continues to rate the company a strong buy, but on Wednesday lowered earnings per share estimates for calendar 2001 to $3.10 from $3.70, reflecting a tough sales environment and changes in the promotional program.
“While EPS for the quarter grew a respectable 8 percent, that growth is deceiving,” he said. “After all, an aggressive sales plan and compromised product quality did some damage to the Zale franchises. Also, a more frequent promotional schedule will make for lumpy comparisons going forward,” he concluded.
Although Rubinson lowered estimates, he maintains faith in Zale’s long-term prospects. “It will take at least a couple of quarters for Zale to get back on its feet. After all, the organization is undergoing a dramatic amount of change. Nonetheless, we think the organization will again emerge as a vibrant and strong entity,” the analyst wrote in a research note.
For the six months, income dropped 15.4 percent to $75.6 million, or $2.17 a diluted share, from $89.5 million, or $2.48, in the comparable year-ago period. Excluding the inventory charge, income was $92.7 million, or $2.66. Sales inched up 15.4 percent to $1.2 million versus $1.1 million, while comps dipped 0.6 percent.
Company executives said in the conference call that Zale will cut its capital spending plan in half, with fiscal 2001 in the $80 million to $90 million range from the $100 million to $105 million range in fiscal 2000. The current projection on capital expenditures in fiscal 2002 is between $50 million and $60 million.
They also said that the company was not planning to reduce the number of store openings of any particular division, but will review its new store list in each division and open those that have the highest priority. In some cases, lease agreements bind the company to openings. No aggressive store closures are in the cards.
According to Sue Gove, executive vice president and chief financial officer, the average second quarter sales ticket for Zales was $247 versus $253 in the year-ago quarter and $251 compared to $278 at Gordon’s. The average check was up at the other divisions: $719 versus $703 at Bailey Banks & Biddle; $244 compared with $238 at Zales Outlets, and $180 against $175 at Peoples.
In response to an analyst’s query during the conference call, DiNicola was kind to previous management, stating, “It’s easy to be a Monday morning quarterback.” The ceo pointed out that things can “quickly get off track and out of pace during the holiday period.”
“We need to buy product based on a rate of sale,” he said. He also noted the dot-com business needs to be “reined in quickly” and there must be an orderly execution plan or amalgamation of Piercing Pagoda, which was purchased last year. The plans for the new distribution center to handle the entire company, he said, were brought on by that acquisition, but those plans are on hold.
“We need to write down inventory, lower growth expectations, improve quality of product and get our expense structure back in line,” DiNicola said. “Fiscal 2001 should have been conservatively planned. Calendar 2001 must be a rebuilding year.” The Zale and Gordon’s divisions performed worse than the corporate average, he noted. While the Zales and Gordons division have been slumping, the Peoples and outlet divisions are doing well, while Bailey Banks & Biddle is “slightly off track though there are no major concerns.” Zale Corp. operates a total of 2,350 stores.
Offering guidance to the analysts, DiNicola said he expects a mid- to high-single-digit drop in comps for second half of fiscal year, with flat comps by the next holiday quarter, and pluses a year from now.
“The next two quarters will be repositioning inventory, so we’re set in a good situation to execute the holiday season.”
He said it was difficult to measure how much of the decline was due to management miscalculations versus the consumer spending slowdown, but estimated that at least half were internal; half external.
“The inventory issue is mostly of a quality nature in the diamond category in the Zale and Gordons divisions,” he said during the call. “We need to adjust price points on programs, and will be marking down merchandise, taking that writedown and positioning the product to be properly priced and sold. The merchandise will be clearly marked as clearance so as to avoid diminishing the brand going forward. We need to instruct sales people on how to sell that product so that it doesn’t cause any longer-term damage.” The outlets have their own merchandise and are not accustomed to clearing merchandise from other divisions.
Regarding the expansion into Manhattan, where one store recently opened in SoHo and two more are planned, in the Flatiron district and uptown in the Sixties, DiNicola commented, “We still believe in Manhattan. At this juncture we just need to step back and make sure these three stores are working.”
During the interview, DiNicola said he signed a three-year contract with the same salary and bonus as before, and that he did not take any new options or a signing bonus.
Asked why he returned to the company after leaving on a strong note and being anxious to spend more time with his family and go sailing, he said “I felt obligated to help the company get back on track. The board asked me to come back, and I have a fairly significant financial stake in the company’s long-term financial success.”
DiNicola reportedly has about 750,000 stock shares and options.
“I am happy to be back to try and get the business in shape, though I wish circumstances were different. I’m disappointed things didn’t work out the way we had planned, but we’ve got our work cut out for us.”
DiNicola first became Zale ceo in April 1994. At the time, the retailer had much deeper problems. It emerged from a bankruptcy in 1993 after being saddled with heavy debt and DiNicola discovered it was being run like a loose network of mom-and-pop shops, with some stores even closing early for inventory during the peak Valentine’s Day period. However, he refocused the business by closing many doors, eliminating nameplates in different regions of the country and giving the remaining three divisions — Zales, Gordon’s and Bailey Banks & Biddle — clearer images, pricing, merchandising and growth strategies.
After the company got on firmer footing, he put it on an acquisition and expansion path, and launched Zale.com, which he now expects to grow into a $100 million business. He also launched the outlet division and orchestrated two key acquisitions, Peoples Jewellers in Canada and Piercing Pagoda.
Asked if he felt his second tour of duty amounted to another turnaround mission, DiNicola replied, “Not really. We are nowhere near the situation of 1994. However, we do have to get our organization refocused. We need to become disciplined, and we need to build the business with an eye towards the long term.”
During his hiatus, he said other job opportunities arose. “Quite frankly, I didn’t pursue them,” he said. “My wife and I were looking forward to spending quality time for a change.”
Asked if jewelry was worse off than other categories, DiNicola suggested it was. “It’s been up against the largest comparable sales of any category out there,” fueled by “millennium emotionalism.”
Zale, he said, was positioned with other programs such as Peoples and Piercing Pagoda operations “to pick up the slack,” as well as outsourcing the proprietary customer accounts receivable so the company would not have to rely purely on comp sale gains to drive the bottom line. Unfortunately, the strategy turned into a sprint for comp gains during the consumer slowdown.