Jewellery retailer Zale draws restructuring bankers amid holiday gloom

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Restructuring professionals have set their sights on Zale Corp as the jewellery retailer’s prospects for the holiday season look grim, five financial advisors making unsolicited pitches to the company told Debtwire.

While Zale was rumored to be working with law firm Pachulski Stang Ziehl & Jones, a company official said that no legal or financial advisors have been retained in connection with a restructuring. Pachulski declined to comment.

“There is no doubt that Zale’s needs to do some sort of restructuring,” said an advisor. “Their numbers have been ugly and they seem unable to turn the corner with merchandising and promotions. They are miles behind competitors such as Kay [Jewelers].”

In 1Q10, Zale booked negative USD 41m of EBITDA – a 12% decline year-over-year – bringing the LTM figure to negative USD 167m, noted a shareholder. Sales during the quarter fell to USD 329m from USD 364m in the prior year period, according to SEC filings. November same store sales swooned by a whopping 18.6%

Zale’s common shares traded 2.22 today, down 0.31, against a 52-week range of USD 0.89-USD 8.51.

“Management keeps saying that everything will be OK,” said one of the company’s vendors. “But the truth is their liquidity is thinning. Their order book is less than last year’s [book] and the company has been slow paying. A lot of vendors are seeing this as the next Finlay.”

The company has been adjusting its merchandise receipts based on sales performance, said Zale’s treasurer David Sternblitz. “We are in the process of reviewing and canceling certain orders related to our November sales. There has been some delay in payment as we determine what merchandise will be needed for the season and what should be returned to suppliers,” Sternblitz said.

Many of Zale’s contractual agreements with suppliers allow for the return of a percentage of merchandise, he added. ”Since this process is currently ongoing, we do not have a dollar amount at this time. Importantly, we have the merchandise necessary to meet customer demand this holiday.”

At 31 October, Zale’s had USD 129m available under its USD 600m revolver, based on inventory and credit card receivables. But the credit agreement backing the Bank of America-led loan due 2011 specifies the company must maintain USD 50m of available borrowing capacity, or a 1x fixed charge ratio covenant kicks in. The retailer would not currently be in compliance with the metric if it were tested, SEC filings show.

Many of Zale’s operational problems mimic that of bankrupt Finlay Fine Jewelry, which recently entered the sector graveyard along with Whitehall Jewelers, said the vendor and a lender. Zale’s is similarly facing lower loan valuations on the back of declining appraisal values and credit card receivables, a combination that helped trip Finlay into bankruptcy, said the lender, which invested in both companies. “Zale’s is suffering from a double whammy: aged inventory and the retrenchment of the credit card user,” the lender said.

During the consumer boom period of 2005-2007, appraisal values for jewelry inventory increased, said Finlay’s liquidator Ken Frieze, principal of Gordon Brothers. More importantly, the loan-to-value ratios used by lenders to extend credit also increased, a double positive for retailers.

But now the industry is facing a compounded liquidity hit, Frieze explained. Appraisal values have fallen reflective of the downturn in the consumer economy. Perhaps a more important factor for retailers is loan-to-value ratios that have deteriorated since the hey-day due to the tightening of the credit markets, he added.

Adding to its financial woes, Zale is embroiled in a SEC investigation related to the restatement of FY08 and FY09 financials. The jewelry chain restated results due to adjustments related to advertising costs, intercompany accounts receivables, depository bank accounts, federal income taxes and personal property taxes.

Zale’s is also liable for USD 16.2m in lease obligations, stemming from the sale of Bailey Banks & Biddle. The company has made USD 6.2m in payments thus far, according to SEC documents.

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