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Zales Facing SEC Probe; Stock Price Drops 9%.
Diamonds may be forever, but at beleaguered jeweler Zale (ZLC: 25.16, -2.64, -9.5%) new management is surely hoping that an investigation by the Securities and Exchange Commission will be short-lived.
Shares of the Dallas-based specialty retailer lost some of their sparkle Monday, falling 9.5% after Zale disclosed the probe. The SEC subpoenaed records relating to accounting for extended service agreements, leases and accrued payroll, as well as for executive compensation, severance, earnings outlooks and stock trading.
MarketWatch sums up Zales plummeting fortunes this year thus far culminating with today's announcement that it is facing an SEC investigation.
It's more bad news from a company that has seen three top executives resign this year amid sagging sales and a slumping stock price.
"It's very murky," says Bill Armstrong, an analyst for C.L. King & Associates, a boutique research firm in Albany, N.Y. "According to what they told me, they don't even know what the SEC is looking for, as far as what it's investigating. The SEC communicated to them in very general terms."
Zale Treasurer David Sternblitz says regulators have offered little information beyond the request for records. The company has already publicly elaborated on its accounting practices for extended service agreements and leases, he says, and KPMG, Zale's auditor, has consistently given Zale a clean bill of health. "We will be cooperating fully, and the company believes that it has complied with generally accepted accounting principles," Sternblitz says.
The company's 2,345 stores in the U.S., Canada and Puerto Rico, as well as its online division, had sales of $2.38 billion in 2005 and are on track for sales of $2.40 billion this year, according to analysts surveyed by Thomson First Call. Its Zales Jewelers division accounts for about half of all revenue, and an average sale is between $200 and $300, says Armstrong. Other brands include Zales Outlet, Gordon's Jewelers, Bailey Banks & Biddle, Peoples Jewellers, Mappins Jewellers and Piercing Pagoda.
For its fiscal second quarter ended Jan. 31, Zale's earnings fell 7% year-over-year to $1.78 a share. The company reported a profit of $1.96 a share, but that figure didn't conform to generally accepted accounting principles.
The Feb. 21 earnings announcement came on the heels of the January resignation of Mary Forte, president and chief executive, and the February resignation of Paul Leonard, president of the Zales Jewelers division. Sue Gove, chief operating officer, quit last month. Mary E. "Betsy" Burton was named interim CEO on Jan. 31.
Change at the top can muddy the waters beneath, says Alan Ratliff, a partner at Stone Turn Group, a forensic accounting firm in Houston. Generally, he says, situations like the one at Zale could attract some extra attention from regulators.
"I would say that every one of those [areas covered by the SEC subpoena] listed is the subject of one or more interpretive accounting standards, where someone could interpret it in a particular way and be just over the line," Ratliff says. "In the context of a company where the top management resigns or gets fired, it could be something like that."
The timing of extended service agreement revenues, in particular, is an area that's ripe for trouble, says Ratliff. "When do you report revenue? Over the life of the contract, or immediately, and then have an immediate result?" he says. "If someone reports that as revenue to make things look better, or creates a huge reserve they don't necessarily need, the issues of timing can come up anytime."
Sternblitz agrees the recent management turnover is likely a reason for the SEC's interest.
"My guess would be that requesting this type of information, such as earnings guidance and compensation, is probably standard practice in order for the SEC to determine if any person profited from the issues that are in questions," the treasurer says. "Some of our executives are scheduled to talk to the SEC next month, but they haven't given us a timetable in terms of their investigation."
Zale's main priority apart from the investigation is to find a new CEO, says Sternblitz. The company has a short list of candidates and should name a new chief within three months.
Shares are down nearly 20% since. Management upheaval, disappointing financials and now accounting questions have contributed to the decline.
That said, the jewelry business isn't such a bad place to be as the population of aging and affluent customers expands. "In general, baby boomers are in their peak earnings and jewelry-buying years," says Armstrong. "I think demographic trends are generally favorable to the jewelry industry."
Unfortunately for Zale, others are lining up to lure those deep-pocketed shoppers. The company faces intense competition from Kay Jewelers, its retail rival in malls across America, as well as from jewelry departments at larger retailers such as Wal-Mart Stores (WMT: 45.70, -0.32, -0.7%), J.C. Penney (JCP: 58.47, -1.54, -2.6%), Kohl's (KSS: 53.95, +0.55, +1.0%) and T.J. Maxx (TJX: 24.41, -0.06, -0.3%).
Zale's new management needs to move away from heavy promotional discounts and regain market share, wrote Brian Tunick, an analyst at J.P. Morgan, in a Feb. 17 research note that came out just after Valentine's Day, a key time for jewelry purchases. Zale's business prospects will become clearer, he wrote, by year's end once the critical holiday gift-giving season has come to a close.
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