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Zale (NYSE:ZLC)

Q1 2013 Earnings Call

November 20, 2012 5:00 pm ET

Executives

Roxane Barry - Director of Investor Relations

Theophlius Killion - Chief Executive Officer and Director

Thomas A. Haubenstricker - Chief Financial Officer and Senior Vice President

Matthew W. Appel - Chief Administrative Officer

Analysts

Jeffrey S. Stein - Northcoast Research

Rick B. Patel - BofA Merrill Lynch, Research Division

Oliver Chen - Citigroup Inc, Research Division

David Wu - Telsey Advisory Group LLC

William R. Armstrong - CL King & Associates, Inc., Research Division

Janet Kloppenburg

Operator

Good afternoon. My name is Amanda, and I will be your conference operator today. I would like to welcome everyone to the Zale Corporation's First Quarter Fiscal Year 2013 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Roxane Barry, Director of Investor Relations. Please go ahead.

Roxane Barry

Good afternoon, and thank you for joining us. Participating in today's call will be Theo Killion, Chief Executive Officer; Matt Appel, Chief Administrative Officer; and Tom Haubenstricker, Chief Financial Officer.

We have posted a slide presentation for today's call on the Investor Relations homepage of our website, zalecorp.com. Before we begin, I'll read our Safe Harbor statement. Our commentary and responses to your questions on this conference call will contain forward-looking statements, including statements relating to our sales, margins, commodity costs and other expenses, operating and net earnings and other goals, plans and objectives. These forward-looking statements are not guarantees of future performance, and a variety of factors could cause our actual results to differ materially from the anticipated or expected results expressed in these forward-looking statements. Additional information concerning other factors that could cause actual results to differ materially from those contained in the forward-looking statements is available in our annual report on Form 10-K for the fiscal year ended July 31, 2012. Also, please note that during this conference call, we may discuss certain non-GAAP financial measures as we review the company's performance. One of these non-GAAP measures is EBITDA, which is defined as earnings before interest, taxes, depreciation and amortization. A second non-GAAP measure is adjusted EBITDA, which excludes charges related to store closures. We use these measurements as part of our evaluation of our performance of the company. In addition, we believe these measures provide useful information to investors. Please refer to the appendix within the Investor Relations presentation for a reconciliation of these non-GAAP measures to our most comparable GAAP financial measures.

I'll now turn the call over to Theo.

Theophlius Killion

Thank you, Roxane, and good afternoon to everyone joining us on the call today as we report our fiscal quarter -- our fiscal first quarter for 2013. For those of you following along with the slides that we posted on our website, please direct your attention to Slide #3.

This quarter marks 8 straight quarters of positive comps. In the first quarter, comparable store sales were up 3.9%, which represents a 2-year comp of 10%. We improved our bottom line by $4 million as we continue our march toward profitability.

In the first quarter, we focus our efforts on setting the foundation for the important holiday selling season. First and foremost, we continue to improve our merchandise assortment. This includes fine-tuning our core products while expanding exclusive and proprietary collections in both Bridal and Fashion. I will talk in more detail about some of our proprietary product expansions and new exclusive collections as we turn to the next slide.

Our holiday television marketing campaign kicked off last week. In this campaign, we continue to build on the emotional affinity of the Diamond Store, supporting our proprietary and exclusive merchandise and embracing emerging Omni-Channel capabilities. I will expanded on our marketing plans a bit further in my comments.

To ensure that our stores will be ready for their busiest season, we made significant investments in product, technical and sales training. As I mentioned last quarter, to support the launch of our Celebration Diamond collection, we invested 20,000 hours of training during October so that every member of our selling team is well-versed on the features and benefits of the diamonds that make up that collection.

Our annual District Manager and Store Manager meetings also focused on product while emphasizing key guest services, such as warranty, repair and Ship-to-Store. Finally, we continue to increase the number of Diamond Council of America, or DCA, certified associates.

At the end of the first quarter, we had almost 70% of our full-time jewelry consultants trained, which is up from 15% in early 2010 and 65% at the end of last quarter. Our selling teams are better prepared than ever to deliver great guest experiences.

Because affordable financing options are so important to our guests, we continue to enhance our customer's credit options. Last week, we were pleased to announce the addition of Genesis Financial Solutions to our U.S. alternative financing program. Genesis will offer a revolving line of credit to select guests whose credit applications have been declined by our primary lender. This revolver provides guests with an affordable option and similar repayment terms to Citi when making Fine Jewelry purchases.

We will continue to manage our alternative financing program to maximize guest approvals while also minimizing our costs. By continuing to give our guests more credit options, we break down the barriers for them as they seek that perfect piece of jewelry to commemorate their special moments at one of our brands.

I mentioned Ship-to-Store earlier, and with the success of our Ship-to-Store capability in the United States, we expanded a program to our Peoples brand in Canada. To date, the Canadian rollout has exceeded our expectations. Importantly, about 75% of our Ship-to-Store guests haven't been in our traditional stores for over a year. When this guest chooses to ship an order to our stores, it provides us with an opportunity to not only show them our product offerings in order to add a selection to their purchase, but also offer a warranty with the sale.

Now please turn your attention to Slide 4, where I'll talk about some of our exclusive and proprietary collections. We're relaunching our successful Celebration Diamond. The entry point to the collection is the Celebration Grand, an expertly-cut ideal diamond that has 8 hearts and arrows. This diamond is cut with a table or surface that's 14% wider than a standard round in order to capture and reflect more light. At the core of the collection is the Celebration 102 in the United States and the Celebration 100 in Canada. This is a diamond that's been in our assortment for over 4 years and has consistently been a strong performer. The designation of 102 and 100 refer to the number of facets on each stone, nearly twice the facets of a typical diamond. And that takes us to the best of our good, better, best Celebration Collection, the Celebration Fire, a diamond that's been independently tested as the most brilliant diamond in the world. With 71 facets and a perfect symmetry that reveals 10 hearts and arrows, the Fire requires such precision that only 20 master craftsman worldwide can cut it.

We invite you to see it for yourself in 1 of the 223 stores that currently carry the Fire, or see it online. We think you'll agree: the Celebration Diamond is the most brilliant diamond in the world.

In diamond Fashion, we introduced Candy Colored Diamonds and Gemstones. The colored diamond trend has been growing, and we're capitalizing on this trend with an extensive assortment of diamonds and gemstones in a vast array of colors. This introduction is being supported by in-store visual as well as television and YouTube advertisements.

Building on our success from last year, we've expanded our successful Vera Wang LOVE collection to more than 630 stores, including Zales Outlet and our Canadian brands. This is an increase of more than 130 stores from our initial launch last holiday.

We've added 16 new Bridal styles, and we're testing men's wedding bands, earrings and pendants.

In our Persona bead collection, which is now in 950 stores, we're testing Persona Black Label, which has beads made with marcasite gemstones and sterling silver, and we're also testing Persona Girl, featuring fun, playful designs for young women.

We've talked in the past about how important our the peak selling periods are for testing new product. And, in addition to the tests that we're doing this holiday with Vera Wang LOVE and Persona, we have several other tests in our stores that will provide us with valuable insight for future growth opportunities. One example of this testing is the introduction of the proprietary Shaquille O'Neal Collection of steel jewelry that we announced earlier this month. The collection consists of approximately 36 SKUs, with crosses, pendants, bracelets and earrings.

You can purchase the product online and in approximately 200 total stores in the United States, Canada and Puerto Rico. This product introduction is an extension of the relationship that we have with Shaquille. His extensive -- his exclusive line of Dunkman watches have been selling successfully in Piercing Pagoda for almost a year and is available in 300 kiosks.

Please turn to Slide 5. Our holiday marketing campaign began on YouTube at the end of October with the release of a video of Vera Wang talking about her design sensibility and her partnership with Zales and her exclusive Vera Wang LOVE collection.

Since its launch on October 24, over 300 -- approximately 330,000 people have spent almost 2 minutes listening to the Vera Wang story. On November 5, we released 2 YouTube videos, the Finger Fashion Show, featuring our Candy Colored Diamonds and Gemstones collection, and Shaquille O'Neal's first day out of retirement as he begins working for Zales at the Willow Bend Mall in Plano, Texas.

Over 200,000 people have been entertained with our Candy Colored Diamond Fashion show spot, and approximately 130,000 have watched Shaq during his first day of work as a jewelry consultant.

Embracing emerging media like YouTube, Facebook, Pinterest, Instagram and Twitter allows us to gauge the relevance of our messages by not only allowing guests to engage with our brands on their terms, but it also allows us to tell stories and get feedback in ways that traditional media doesn't allow.

That said, we continue to utilize magazines, catalogs, inserts, online display, search and television to build emotional affinity for the Diamond Store. Our television advertising began last week, with spots supporting our branded messages, our key collections and the promotions that we'll be running this holiday season.

I'll now ask Tom to go through the financials in more detail.

Thomas A. Haubenstricker

Thank you, Theo, and good afternoon, everyone. I will start my comments on Slide 6, with an overview of our first quarter financial performance, beginning with our topline. Revenues for the first quarter were $357 million, an increase of $6.5 million or 1.8%, compared to $351 million for the same period in the prior year. The increase in revenues is primarily due to the 3.9% same-store sales growth that Theo already mentioned. That increase was partially offset by revenues associated with the net decrease of 52 stores compared to last year.

It is also important to note that our revenue for the quarter was adversely impacted by Superstorm Sandy. We estimate the lost revenue for the quarter was approximately $1 million, or 35 basis points of comp growth. Our 3.9% same-store comp this quarter represents the 8th straight quarter of positive comps, and comes on top of a 5.8% comp in the prior year's first quarter, giving us a 2-year comp of approximately 10%.

The 3.9% comp this quarter, consistent with the past few quarters, was highlighted by our Bridal business performance, where we experienced both an increase in number of units sold and an increase in average price per unit sold. We remain pleased with the impact our Vera Wang LOVE collection has had on this merchandise category and, as Theo already mentioned, we have expanded the number of stores where this line is sold.

In our Fashion business, we continue to experience an increase in unit volume, offset by a reduction in the average price per unit sold. The metrics for the Fashion business reflect both the prior year's price increases and the offsetting effect caused by the success of our lower price point beads and other entry price point merchandise. We believe this dynamic will continue in the near term.

Using constant exchange rates, comparable store sales increased 3.7% for the quarter. The average Canadian currency rate strengthened almost 2% relative to the U.S. dollar. The impact of the foreign exchange rate on our first quarter's earnings was not significant, as the rate differential impacted both revenue and cost.

We achieved gross margin for the quarter of $190 million or 53.2%, compared to $188 million or 53.5% for the prior year period. As you may recall, last year's gross margin of 53.5% was up 300 basis points over the previous year. The 30 point basis decline in this year's gross margin rate, compared to the prior year, was based on a slight shift in the mix of merchandise sold for the quarter.

As we stated in our fourth quarter call, we expect our overall gross margin rate in fiscal 2013 to be consistent with the fiscal year 2012 margin, and our performance in the first quarter is consistent with that expectation.

SG&A expenses for the quarter were $206 million or 57.7% of revenues, compared to $200 million or 56.9% of revenues in the same period in the prior year. The $6.5 million increase in SG&A expenses was primarily related to costs associated with growth initiatives and higher employee benefit costs. Our major growth initiative activities for the quarter were focused on merchandise training, expanding our merchandise assortment in our stores and driving our customer credit programs. These growth initiatives are focused both on sales growth in the current quarter and positioning us for growth in future quarters.

The higher cost of employee benefits was primarily driven by a significantly higher level of employee health claims paid in the quarter compared to the trend in prior years. Going forward, we would expect these costs to return to levels closer to our historical run rate.

For the quarter, we posted other gains of $1.8 million, compared to other charges of $500,000 in the prior-year quarter. The other gains recorded in this quarter were primarily due to a favorable $1.9 million settlement resulting from the De Beers class action lawsuit, while the $500,000 prior year charge was primarily related to store closures.

For the first quarter of 2013, we posted an operating loss of $23 million, compared to an operating loss of $22 million in the prior year's quarter. On a percent of revenue basis, our operating margin was negative 6.4%, which is flat with the prior-year quarter.

Interest expense for the first quarter of 2013 was $6 million, compared to $10 million in the prior year. The $4 million decrease is a result of the debt refinancing completed in July 2012. We expect this reduction in interest expense relative to the prior year to continue for the remainder of the fiscal year.

In the first quarter of fiscal 2013, we recorded an income tax benefit of approximately $600,000, compared to a benefit of $700,000 in the same period last year. The first quarter tax benefit in fiscal 2013 relates to tax credits generated in Canada.

Net loss for the first quarter of 2013 was $28 million or $0.88 per share, an improvement of $0.11 per share compared to the prior year net loss of $32 million or $0.99 per share.

Now please turn to Slide 7, where I've outlined the main drivers of the first quarter 2013 improvement in our net loss. Starting with last year's result, which was a $31.9 million loss, the gross margin improvement was $2.7 million, driven by the topline growth we achieved. The other gains and charges improvement was $2.3 million, primarily from the $1.9 million De Beers settlement, compared to the prior year's charge of $500,000, which was primarily related to store closures.

The increase in SG&A expense impacted the first quarter by $6.5 million, and as I discussed earlier, this was a result of growth initiatives and higher employee benefit cost. Interest expense improved $4.1 million as a result of the debt refinancing, and there was also a $1 million favorable impact due to lower depreciation.

This brings us to this quarter's net loss of $28.3 million and the $3.6 million improvement over the prior year.

On Slide 8, I will take you through comparable store sales detail. This quarter, as we stated earlier, total company comp was up 3.9%, or 3.7% at constant exchange rates, following a 5.8% rise in last year's first quarter.

Let's look at this comp performance in greater detail. The comps in this page all include sales from the associated online businesses. Our U.S. Fine Jewelry brands, our largest business segment, which includes Zales, Zales Outlet and Gordon's, had an increase in comparable store sales of 3.9% in the first quarter of 2013. This increase follows a 7% rise in the same period last year, representing a 2-year comp of approximately 11.4%.

Representing approximately 70% of our business, the performance of these brands will continue to be the cornerstone of our future growth strategy.

Our Canadian Fine Jewelry brands, consisting of Peoples and Mappins, had an increase in comparable store sales of 4% at constant exchange rates on top of a 4.7% comp in the prior year period. On the U.S. dollar reported basis, comparable store sales were up 5.5% in the first quarter, on top of an increase of 7.8% in last year's first quarter, representing a 2-year comp of approximately 13.1%.

We are pleased to report positive comparable store sales for our Piercing Pagoda segment for the second quarter in a row.

In the first quarter, our Kiosk Jewelry business had a comparable store sale increase of 2%, following a 1.6% decline in the same period last year.

Please turn to Slide 9 as I take you through our balance sheet and liquidity. As of October 31, 2012, the company had cash and cash equivalents of $15 million, compared to $30 million at October 31, 2011. This change was largely due to more efficient cash flow management. Inventory at October 31, 2012 stood at $908 million, compared to $857 million at the end of the first quarter last year. The increase of $52 million was primarily due to the impact of higher commodity costs on our inventory this year compared to last year, the timing of our merchandise build up for holiday and the overall higher level of inventory required for future sales growth.

At the end of the first quarter of fiscal 2013, the company had total outstanding debt of $524 million, compared to $494 million as of October 31, 2011. In addition to the amended term loan balance of $80 million, long-term debt included $441 million borrowed under the revolving credit facility and $3 million of capital leases.

The overall increase in debt year-over-year was due in part to the increase in inventory levels and $13 million of transaction costs associated with the debt refinancing completed in July.

As of the end of the quarter, the company's total net revolver availability was $213 million. Our fixed charge coverage ratio stood at 1.57, which is significantly above the key threshold of 1.0. The fixed charge coverage ratio measures our trailing 12-month EBITDA, adjusted for LIFO charges, capital spending, taxes and certain other items, compared to our trailing 12-month cash interest costs.

Maintaining this ratio above 1 provides the company with additional flexibility relating to liquidity and future capital planning.

During the first quarter of 2013, net capital expenditures totaled $7 million, compared to $4 million in the prior-year quarter. Expenditures in the quarter were devoted primarily to the refurbishment of stores.

I'm now going to cover the overall store count for the quarter. I should mention we have again included a page in the appendix that contains the current store count by brand. We ended the first quarter with 1,117 Fine Jewelry stores and 652 kiosks, for a total of 1,769 retail locations, compared to the prior year first quarter count of 1,156 Fine Jewelry stores and 665 kiosks for a total of 1,821 locations. During the quarter, we closed 7 Fine Jewelry stores and 2 kiosks.

Please turn to Slide 10, where I want to summarize the impact we had from Superstorm Sandy. As already stated, we estimate our loss revenue due to the storm for the first quarter was approximately $1 million, or 35 basis points of comp growth. As a reminder, we do not report our results on the retail calendar, which ended for most retailers on October 27. Our first quarter period did not end until October 31, so we had 3 days for the quarter impacted by the storm.

For a brief period, we had 375 retail locations closed due to Sandy, with many of these stores impacted for multiple days, extending into early November. Fortunately, none of our stores suffered any significant damage, and at this time, all of our stores have reopened for business.

For the first half of November, sales have been slower than expected, due in part to the impact of the storm. However, as the month has progressed, we have seen signs of recovery in the areas affected by the storm and in our business as a whole. As Theo already mentioned, our foundation, in terms of product, marketing and training for the holiday period, has been set, and our team is focused on executing a successful holiday quarter. We remain confident in our plans and preparation for the holiday selling season.

As we've previously stated, for the fiscal year as a whole, we expect to achieve positive net income. The building blocks for achieving these results are the same as we discussed in our last earnings call. You can find the chart from the previous call in the appendix of our presentation deck. Our focus will continue to be on driving positive comps and operating margin improvement through gross margin stability and leveraging our SG&A costs.

I would now like to turn the call over to the operator to begin our Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Jeff Stein of Northcoast Research.

Jeffrey S. Stein - Northcoast Research

Got a couple of questions for you. So as you think about the first quarter, if you set aside the effect of the storm, how did you feel about the quarter generally? Were you -- internally, did it meet your plan? Did you miss your plan? And maybe you could talk a little bit about the, maybe, the spread in performance of -- relative to the affected regions of the country, post-first quarter, relative to the rest of the country?

Thomas A. Haubenstricker

Well, Jeff, this is Tom. I'll take a stab at it. I mean, overall when you look at the quarter, clearly, the comps were somewhat affected by the storm. We've quantified for that. We're pleased that we've been able to put together 8 straight quarter of positive comps, and we're really building some momentum on the consistency of comps. And gross margin, we're satisfied with where we add up on the gross margin side. We had a very high gross margin in last year's first quarter. As we stated before, our goal is to have a consistent gross margin for the year at 51.5%, which is the year's gross margin last year, and we think where we add up in the first quarter is very consistent with that goal. On the SG&A side, as I mentioned, we had a -- our cost increase versus last year or two, the employee benefit issue. We don't expect that to continue to affect us in a material way in future quarters. So that was something that we'd rather not have in the quarter, but it is what it is, and we don't expect it to continue on. We certainly -- the first quarter is always unique, because it's always our lowest quarter in terms of revenue output, but it's a very important quarter in terms of getting ready for the holiday season, and we focused equally on executing the quarter, but also on getting ready for what we think is a very important season ahead of us.

Theophlius Killion

Yes, so with all of those things, we think it was solid. And Jeff, to answer your question about November, while we're not going to talk about the total month, we do believe that we've experienced about a $2 million negative impact due to Sandy in the earliest parts of November.

Jeffrey S. Stein - Northcoast Research

Okay, appreciate that, Theo. So the plan here is to, obviously, Tom, you've indicated, you plan to leverage your SG&A for the full year. So that did not happen in the first quarter. I don't know if you would care to comment on whether or not you were planning on that to be the case in the first quarter. i.e., did you have a sales shortfall relative to plan? And consequently, I would presume that in second quarter, which is your most important quarter, you would hope to see some SG&A leverage?

Thomas A. Haubenstricker

Yes, Jeff, I think the only comments I would have, just under SG&A, as I said before that certainly having the increase in the employee benefit cost was something that wouldn't have been part of our view of the long-term leverage, but as I said, we believe and are confident that's not going to have a material adverse effect going forward on the SG&A. So our intention is very much to leverage SG&A over the course of time. As I mentioned before, and every time we've talked about this topic, it's not going to be a straight line in terms of that -- how that leverage flows through our results. We are going to make investments from time to time, and in the first quarter, we felt it made sense to make some of those investments. So I think you can see the trend of SG&A leverage over the course of time being generated, but there's going to be a few spikes along the way as we choose to make investments.

Jeffrey S. Stein - Northcoast Research

Okay. And Tom, can you quantify the impact of the employee benefit charge over and above what you had anticipated?

Thomas A. Haubenstricker

Yes, I think that cost us $2 million in terms of adverse SG&A versus the prior year, with the majority of that coming from what I mentioned, with the additional health claim cost that we processed.

Jeffrey S. Stein - Northcoast Research

Got it. And final question, I'll it over to someone else. Can you talk about what were the primary drivers to comp in the first quarter if we look at traffic versus ticket?

Thomas A. Haubenstricker

Well, as I mentioned, we don't have -- we don't report traffic. We -- I think in terms of the drivers that I see, we continue to be very pleased with what we're seeing on our Bridal business, and the Vera Wang LOVE collection has had a very positive impact in that it's brought up the average retail price of the merchandise we're selling, and we're also seeing an increase in volume. So we're very pleased with what we're seeing there. On the Fashion side, we have some traction in some of our exclusive products there. They're at -- in a different price point, though, and so that's having a different dynamic on the overall mix, in terms of the average price and the volume.

Theophlius Killion

What I can say as a general statement, Jeff, we do our floor sets in October, the Wedding floor set was at the beginning of October, the Diamond Fashion floor set was around October 18. And as we've gotten the set in place, some of the new merchandise that we put out, the Celebration Collection, some of the new extended lines from Persona, we're very pleased with, and it looks like they're going to be nice additions to the overall inventory mix.

Operator

Your next question comes from Rick Patel of Bank of America.

Rick B. Patel - BofA Merrill Lynch, Research Division

Just -- can you update us on your SG&A plans for the second quarter? Specifically, you had a big uptick in marketing last year related to the Vera Wang and Jessica Simpson launches. And I'm just wondering, should we expect SG&A to decline on a year-over-year basis for the second quarter? And then, how are you thinking about SG&A for the back half of the year?

Thomas A. Haubenstricker

So, as we said, we haven't given specific guidance in terms of quarterly SG&A because we do want to reserve the right to make these investments where they -- we think they're important. As we said before, the investments don't always anniversary themselves. So, because we made one in last year's second quarter, doesn't mean you can see the same magnitude at this point. For the year, we'll continue to expect to see some degree of SG&A leverage. That will be offset by the investments we're making, but the net is, we would still expect to see some degree of SG&A leverage for the year as a whole.

Matthew W. Appel

Rick, this is an area that we very carefully and closely manage. We appreciate the leverage question, and especially in the second quarter, where the majority of the holiday sales will occur and we have higher marketing expenses, we're very closely managing SG&A, and we very closely manage it in every quarter, so we'll provide insight when we report the respective quarter, but not in advance of it, as Tom indicated.

Thomas A. Haubenstricker

Other than the state of it before, what our longer-term goal is, in terms of the SG&A rate. And I think, if you look at what we achieved in terms of 2012, we're able to demonstrate some leverage, even though it didn't occur every quarter.

Rick B. Patel - BofA Merrill Lynch, Research Division

Okay, and then can you talk about your outlook for pricing? Diamond prices have obviously come off their highs. Are there any plans to reduce prices in your stores? And just as a follow-up, if competitors become more aggressive on pricing or promotions, will you do the same, or is the plan to hold your ground and try to maximize margins? Just help us think about that.

Thomas A. Haubenstricker

Well, I don't think we're going to outline a detailed pricing strategy, particularly against competitors, on the call, but I can say that, unlike last year at this time, where we knew we had pent-up commodity cost increases building up behind us that we knew would require price increases going forward to stabilize margins, we don't have that issue at this point in time. And so I think that's a positive element that we know that to achieve stable margins, you're not going to have, unless something unique happens to the commodity prices over the next couple of months, you shouldn't have that demand pushing on you to need to go out there and increase prices.

Theophlius Killion

Yes, and I think that there hasn't been enough that's happened in the overall diamond market at this point to contemplate price reductions. And we're really looking at making our promotions part of an annual calendar, not reacting in the moment over a period of time. We've taken that about 250 promotions in the calendar, so we're now at cadence where we're thoughtful about it. We spend a lot of time about it. We talk about our holiday promotions beginning in January. So we've been talking about holiday and what we're doing since that time. And we don't think it's in our best interest to change things and to confuse our field and confuse our guests in a business that doesn't have a very high turn.

Rick B. Patel - BofA Merrill Lynch, Research Division

Okay, great. And my last question is really around just the fiscal cliff. Can you perhaps just talk about how you're approaching this issue that's coming up? Are you assuming that the economy stays similar to what it is today? Or are you anticipating your customers to have less money to spend on jewelry in the coming quarters?

Thomas A. Haubenstricker

Well, as I mentioned in our last call, and I think Theo mentioned it, we had our last earnings review -- we have taken an overall cautious approach when it relates to inventory and our thought process in terms of the some of the uncertainty in the economy. We've been able to generate positive comps in an uncertain economy now for about 8 straight quarters, so I certainly don't think that that's going -- is an obstacle that's impossible for us to overcome. And we don't know what's going to happen on -- in the economy, and whether the fiscal cliff is going to -- we'll roll over it or not, and the impact it would have on the consumers. We can just manage our business in a prudent way. But we still have every expectation that the fine jewelry industry is going to be fine going through the holiday period.

Theophlius Killion

We think that there are going to be expressions of love that the going to be shown with a piece of jewelry, and people are going to continue to get married. It tends to be a high proposal period between Black Friday and between New Year's. And we think that what we've done from an assortment standpoint, from a messaging standpoint, will help us to get the guests' attention and make us high on their consideration set.

Operator

Your next question comes from Oliver Chen of Citigroup.

Oliver Chen - Citigroup Inc, Research Division

Regarding the comp and sequentially, on a 2-year stock, it's very impressive at plus 9.7. The sequential decline, how should we think about the comp going forward in relation to the average unit retail opportunity versus the number of transactions? Does the relaunch of Celebration Diamond have impact to AUR?

Thomas A. Haubenstricker

Well, certainly I think, when you look at the respective exclusive brands that we talked about, each of them in their categories should help us in terms of price points: the Celebration in Bridal and some of the Candy Colored Diamonds in Fashion. So I think we should see both of them being supportive of driving what volume we will get with those products, assisting the average price points.

Oliver Chen - Citigroup Inc, Research Division

Okay, and the trends thus far in November sound pretty encouraging. Is there any way for you guys to dimensionalize how you -- why think that's happening in November versus October? Is it product driven? Or your launch cadence? Or simply the resolution of the election? How should we think about that?

Thomas A. Haubenstricker

I think there's so many different moving pieces you have when you look at that, between the storm, the election, the short period of time we have between Thanksgiving and -- so I don't think we're going to try to give you an assessment between October and November, other than say what we already have, which is, while we started the month slow for November, we certainly have seen improving trends, and we are absolutely focused on delivering a successful holiday period.

Theophlius Killion

Again, and since the time of our floor set, we obviously had the interruption with Sandy, but, as I mentioned earlier, we've started allowing guests to engage in our brand as early as October 24 with the Vera Wang video that we had on YouTube. We now, since October 24, in all of the impressions that we have on our YouTube station, have almost 850,000 people who've chosen to go on YouTube, who've chosen to share the content with their friends, engage in our brands, talk to us, so that, that conversation has been fairly consistent and, as recently as 36 hours ago or so, we put up a Celebration video that's almost -- it's over 3 minutes long, and we had 40,000 people who've already come and engaged on the Celebration video. So the idea of letting the guest interact with us when and where they want to interact with us has been very powerful, and we think that, that will continue to build as we get closer to the holiday season.

Oliver Chen - Citigroup Inc, Research Division

Okay, thanks. And the inventory number was also running above sales, as you stated. Where -- how should we think about that us the year evolved, will that eventually become in line with sales?

Thomas A. Haubenstricker

Yes, I think that we're still working through, Oliver, the increase in the commodity side. That eventually will flatten out as we get towards the later parts of the year. And as I mentioned before, we -- as Theo had stated, based on some of the training and the increased focus we had on the merchandise display in the stores, we actually got our inventory in a little bit earlier in the holiday buildup than last year. So we are very focused on inventory. Those of you who that listened to the call in the second half of last year know that we're able to drive inventory and make adjustments through our relationship with the vendors and through changing our reorder rates. So we're comfortable with where inventory stands, and we're comfortable with the process that we'll need to go through in the second half to manage it for the year as a whole.

Operator

Your next question comes from David Wu of Telsey Advisors.

David Wu - Telsey Advisory Group LLC

First, you had -- the pace of store closures slowed this quarter, and just given that you're still expecting just under a similar number of locations as last year, should we assume that the rate of closures should accelerate in the second quarter? And what sort of quarterly cadence, what should it look like over the next 3 quarters?

Thomas A. Haubenstricker

So I think when you think about store closures, as you saw in the first quarter, there was about 2-point differential in our comp between the reported comp and the absolute revenue growth, and I think for the year, that's a pretty good barometer of what we would expect. It probably would be a little bit less than 2% in the second quarter and a little bit higher than 2% in the second half of the year, as we do start to ramp up some of the closures. But overall, you're not going to be too far off of the mark around a 2% comp differential.

David Wu - Telsey Advisory Group LLC

Got it. And can you talk about how warranty sales trended in the quarter, especially with the improved employee training? And are still extending coverage to more products this holiday?

Thomas A. Haubenstricker

So we are -- we're very pleased with our warranty performance. On a cash basis, our warranty sales are actually up over 7%. From a GAAP standpoint, the warranty revenue now has straightened out versus last year, we had the year-on-year benefit, so on a GAAP basis, warranty revenue was up 2%, but I think the real way to measure the effectiveness of the business is on cash sales, and on that standpoint, it was up, as I said, 7.5%.

Theophlius Killion

And attachment rates are the highest they've been in about 5 quarters, David. And we've now extended warranty coverage in our Fine Jewelry business to approximately 98% of the merchandise. So there's very little growth left there. Our focus is on attachment. We've done a terrific job, both in Fine Jewelry, on attachment, as well as our Pagoda business.

David Wu - Telsey Advisory Group LLC

Got it, and can you talk about the credit participation rate, what that is currently versus last year? And how much would you say is attributed to the new alternative financing arrangements?

Theophlius Killion

Our credit mix year-over-year is about the same in the U.S., no material change. We have a slightly higher approval rate. There's a bit of a shift in mix, but it's really not that significant. Alternative financing is worth about 3 points of the credit mix, which is about -- it stands about 37% for the quarter in the U.S. You did see that we added a third lender, that lender wasn't added until the middle of October, and so the impact of bringing on Genesis, who offers a revolving program, won't be felt fully until we report the second quarter. In Canada, credit was just down slightly, but not materially. Approval rates are strong in Canada, and approval rates were up about 400 basis points overall in the U.S. So we're pleased with the portfolio providers that we have, and we think the performance is good.

David Wu - Telsey Advisory Group LLC

Great. And then you mentioned a slight mix impact to the gross margin. Is that driven more by outperformance of bridal, which has a lower gross margin versus some of your fashion merchandise?

Thomas A. Haubenstricker

Yes, I think it's -- again, we look at the -- our gross margin. We're satisfied with the combination of the comps we achieved and the gross margin. It was down a little bit. I think that's due to the Bridal side and then, the Fine Jewelry growth being a little bit higher than the Piercing Pagoda growth.

David Wu - Telsey Advisory Group LLC

Got it. And then, just lastly on CapEx, are you still expecting about $30 million to $35 million for the year?

Thomas A. Haubenstricker

Yes, we are.

Operator

Your next question comes from Bill Armstrong of CL King & Associates.

William R. Armstrong - CL King & Associates, Inc., Research Division

Most of mine have been answered. But the Genesis Financing Solutions, have you had -- is this your first third party provider for subprime customers?

Matthew W. Appel

No, this is -- we have 3 lenders in the group. Monterey, that we had talked about last year; Pioneer, who has been lending to military customers, and now to civilian customers. And so no, this is -- they are the third participant, Bill.

William R. Armstrong - CL King & Associates, Inc., Research Division

Okay, so what segment of the -- or subsegment of the subprime population would Genesis be serving that Monterey and Pioneer are not?

Matthew W. Appel

They all address the same segments, but they have different lending criteria. They also offer different plans. And so don't think of one as hitting a certain strata that another isn't. They're all very important to our program.

William R. Armstrong - CL King & Associates, Inc., Research Division

So does this open -- I guess the question is, and maybe this isn't the case, but to what extent have you had to turn away customers in the past that maybe you won't have to turn away now that you have Genesis on board?

Matthew W. Appel

What Genesis offers is a -- an attractive program that certain of our guests are -- were seeking from our primary lender, but weren't able to obtain. The Monterey product is typically an installment product. It doesn't have an open to buy, and it doesn't allow us to retain that customer. The Genesis product is a revolving product with an open to buy. So it's a customer that we can retain and sell to multiple times, like our primary program, and that's very important.

Operator

Your next question comes from Jeff Stein of Northcoast Research.

Jeffrey S. Stein - Northcoast Research

Two quick follow-ups, guys. One is LIFO. Wondering if there was any charge during the quarter compared to last year? And secondly, do you have any thoughts in terms of how many outlet malls you overlapped with Ultra?

Thomas A. Haubenstricker

So Jeff, the LIFO charge was immaterial in this year's quarter and it was immaterial in last year's first quarter. LIFO tends to be sub -- the heavier LIFO charges last year came in the second, third and fourth quarter. And then, as far as the Ultra, we think the overlap is about 50%. If we look at their stores, we think we've got a competing location in about half of them.

Operator

Your next question comes from Janet Kloppenburg of JJK Research.

Janet Kloppenburg

I had a -- just have a couple of follow-on questions. In terms of the gross margin and the mix change that affected it, is the Bridal category a bigger or smaller component of the business in the holiday season? And could it affect the gross margin, again, in the holiday season? That's my first question.

Thomas A. Haubenstricker

Well, I mean, I think both the Bridal and the Fashion business have better quarters during the holiday season. Obviously, the second quarter is a different quarter in terms of the promotional strategy and tactics than the first quarter, so the -- what happened in Quarter 1 really isn't a great barometer for the second quarter, because it's just such a different quarter, tactically, in terms of how we approach the market.

Janet Kloppenburg

So you wouldn't expect that a -- I mean, it's happening because of the success of the innovation you've brought to that category. So I'm not viewing it as a negative at all. I think it's a great strategy. And -- but I'm just saying, should -- for modeling purposes, should we think that strength in this new category, where you have great differentiation, could that have some adverse effect on the total gross margin we saw there? Conversely, could Piercing Pagoda ramp-up end and help the gross margins in the holiday season?

Thomas A. Haubenstricker

So we imagine that those are all good observations. We have, from our Fashion business as Theo talked about, some of the exclusive merchandise that we're positioning for the holiday also should drive success in that area. Overall, when we look at gross margins, we said we are comfortable with flat margins with 2012, and there's nothing we saw in the first quarter that would tell us that, that's not what our expectations were in terms of achievement.

Janet Kloppenburg

Okay, and I just wanted to ask for another point of clarification, please, which is, business at the beginning of the month being challenging, was that isolated to the states that were affected by the hurricane? Or was that an observation you would make for all of your markets?

Thomas A. Haubenstricker

I think it was a -- it was a general observation for the business as a whole, with one of the clear leading factors being driven by the affected areas. And importantly, what we said is the recent improvement in trend is not just in the affected areas, but the business as a whole as well.

Janet Kloppenburg

Okay so that's what gives you confidence as we go forward?

Theophlius Killion

Yes.

Thomas A. Haubenstricker

Yes.

Operator

Ladies and gentlemen, that is all the questions queued up for today. I. will turn the call back over to management for closing remarks.

Theophlius Killion

Yes, we'd like to close by offering our thoughts to all of the people who were adversely affected and continue to be adversely affected by the aftermath of Sandy. We know that people are still hurting in the Northeast and trying to get their footing again, and that has to be a primary concern for all of our friends and family, and certainly for our employees.

As Tom mentioned, none of our stores were damaged and, thankfully, none of our people were as well, although they certainly were, in some cases, inconvenienced and had some difficult times that they have to still work through. We'd like to wish everybody a happy and wonderful Thanksgiving and a great holiday season, and we will see you in a Zales store over the next month and a half. Thank you.

Operator

Ladies and gentlemen, that concludes the Zale Corporation's First Quarter Fiscal Year 2013 Earnings Conference Call. We appreciate your time. You may now disconnect.

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