Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Zale Corporation (NYSE:ZLC)

Q4 2008 Earnings Call

February 25, 2009 9:00 AM ET

Executives

David Sternblitz - Vice President and Treasurer

Neal L. Goldberg - President and Chief Executive Officer

Cynthia T. Gordon - Interim Chief Financial Officer, Senior Vice President and Controller

Analysts

Lorraine Maikis - Banc of America-Merrill Lynch

Jeffery Stein - Soleil Securities

William Armstrong - C.L. King & Associates

Janet Kloppenburg - JJK Research

Chia Kuo - Telsey Advisory Group

Brian Tunick - JPMorgan

Operator

Good morning. My name is Julianne, and I will be your conference operator today. At this time, I would like to welcome everyone to the Zale Corporation Second Quarter Fiscal 2009 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.

I would now like to turn the conference over to Mr. David Sternblitz, Vice President and Treasurer. Please go ahead.

David Sternblitz

Thank you, Julianne. Good morning and thank you for joining us for our second quarter 2009 conference call. I am David Sternblitz, Vice President and Treasurer of Zale.

With me on the call today are Neal Goldberg, Chief Executive Officer; Cindy Gordon, Senior Vice President, Controller and Interim Chief Financial Officer; Theo Killion, President; Gil Hollander, Executive Vice President and Chief Sourcing and Supply Chain Officer; William Acevedo, Executive Vice President and Chief Stores Officer; and Mary Kwan, Executive Vice President and Chief Merchandising Officer.

Before we begin, I'd like to review the Safe Harbor. Our commentary and responses to your questions on this conference call will contain forward-looking statements, including statements relating to our future 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.

Information concerning some of the 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 year ended July 31, 2008 and our quarterly report on Form 10-Q, for the quarter ended October 31, 2008.

In addition, we will present non-GAAP financial information on this call. For a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure, please refer to today's earnings release, which can be found on our corporate website, www.zalecorp.com, under Financial Information and then News Releases.

I would now like to turn the call over to Neal.

Neal L. Goldberg

Thank you, David. Today, I'd like to review our second quarter results and provide an update on our key initiatives.

As we stated in our January holiday release, the second quarter was the most difficult in memory due to the overall macro-economic situation. Customer traffic and transactions were down significantly for the period.

Comparable stores sales decreased 18.1% and gross margins declined 530 basis points from the same period last year. We have identified key internal factors that contributed to the disappointing performance. And most importantly, many these factors are correctable. We immediately made adjustments to improve performance going forward. A portion of this deterioration was the direct results of an aggressive promotional stance.

Originally, our strategy emphasized emotion and item specific promotions. As Christmas too closer, it was clear that the deteriorating retail environment was not going to improve and we adjusted our strategy to emphasize store-wide discounts and more urgent calls to action.

Because of these changes, we believe we lost approximately 500 basis points in margin and negatively impacted comp store sales.

Immediately following Christmas, we returned back to a strategy that emphasized emotion with a promotional posture that is item specific. The result has been more normalized 50% plus margins along with comparable store sales improvement to trend. These comp and margin improvements have held from January through the Valentine's Day selling period.

Looking ahead, the strategies we began over the last year are more important than ever: focusing on our value-oriented customer with a price appropriate assortment, operational efficiency in our supply chain end-stores, and most importantly in this climate the financial rigor of aggressively managing our cash and capital expenditures.

While not all of our initiatives have been reflected in our financial results, I sincerely believe we are doing the right things for the business that will benefit us over the long-term.

All three of our objectives are important in the current environment, when maintaining financial rigor and discipline and enhancing operational effectiveness or paramount.

We announced today that the next phase of our cost reduction plan that will rationalize the size and scale of the company. The first phase of the company's cost reduction plan, which began in February, 2008 identified $175 million in inventory and cost reductions. The next phase announced today, the company has identified a $140 million in addition of inventory and cost reductions. We continuing to aggressively look for efficiencies, as well as bring our expense structure inline with our current business.

As part of the cost reductions announced today, we recently eliminated a number of positions primarily here in Dallas. These reductions have been difficult for our entire organization. I'd like to thank both those associates who have left the organization and those who remain. We appreciate the dedication, their support, and hard work of all of our team members.

Financial rigor and discipline also extends to our inventory discussions. Our clearance strategy addressed our cluttered cases and inventories $100 million below last year. Despite the environment and soft holiday sales, we are in solid inventory position. This is our first step. The next step is to reduce inventory by an additional $75 million by making significant improvements in inventory efficiency and productivity.

To do this we are utilizing tools like micro segmentation to ensure each store has appropriate inventory mix based on key demographics and selling history. We believe this represents tremendous opportunity for efficiency, and we expect to further reduce inventory levels and increase returns.

We expect inventory to be approximately $715 million at year end, reduction of $65 million compared to last year on top of the $100 million reduction from July '07. I firmly believe that this business can be run with less overall inventory and fast returns and that will be our focus going forward.

Last week we announced the addition of our Canadian and Puerto Rican assets as collaterals to our asset-backed credit facility. This additional collateral under the credit facility enhances our flexibility. We will utilize our improved cash position to respond to trends in the business and further improvements in operational efficiency.

The same financial rigor will continue to be applied to capital decisions. We expect CapEx to be approximately $30 million, which is a 65% reduction over last year. Operational effectiveness continues to be an important focus, and some of our down payments in that area are starting to bear fruit.

We recently improved our supply chain and sourcing processes to let to stricter standards and a significant reduction in damage products, highlighting our focus on quality. We have taken actions to reduce a number of vendors by two-thirds since the beginning of 2008. We are continuing to seek further vendor efficiencies, creating stronger, more beneficial relationships with those who remain.

To enhance technology in our distribution center, we have created a more efficient replenishment process along real-time adjustments to sales trends, and improvements in in-stock rates which supports our inventory productivity initiative. These changes have led to improved customer satisfaction and increased efficiency throughout the business.

Additionally, our field organization is moving regional directors to live in their respective markets. This will foster more in-depth geographic expertise, efficient training, and communication and improvements in store execution.

Our field organization is critical. We have a tenured group of associates that understand the importance of building a bond with the customer. We are very proud of the team, and we will continue the work. Listening and supporting their needs to increase effectiveness.

As I stated in the opening, we are very disappointed with our results during the holiday period. However, we have used our learnings in holiday, as well as made other adjustments to the business in order to improve performance going forward. We continued to monitor our trends and make adjustments based on the environments.

Our key objectives will not change. We believe we are positioned to benefit from both the shakeout of competitors and our own decision to right size the business. We continued to aggressively look for opportunities to operate more effectively, while maintaining the financial disciplines to drive value for shareholders over the long-term.

I would now like to ask Cindy to review the second quarter performance, and provide further financial details.

Cynthia T. Gordon

Thanks Neal and good morning, everyone. My comments will relate primarily to the financial results of the second quarter, an update on the $75 million cost reduction plan announced last February, and the details of the next phase of our inventory and cost reduction strategies.

First; financial results for the second quarter. Comparable store sales decreased 18.1%. The one outlier to the trend is our Pagoda brand, which experienced low single-digit declines, and has seen positive results since holiday.

Total revenues were $679 million compared to $828 million for the prior year, a decrease of 17.9% for the second quarter. The average transaction, excluding the impact of the Canadian exchange rate was relatively flat compared to last year. However, transaction counts were consistent with the comparable store sales result.

The reported revenue reflects a $2.5 million increase in recognized warranty revenues. These increases should continue as products accounting normalizes over the next three to four years, and revenues recognized more closely reflect actual warranty sales.

Total sales of warranty products were 36 million in the second quarter of 2009 compared to 43 million in 2008, a 16% decrease, inline with the total revenue decline as the attachment rate remains flat at 47%.

The net change in unrecognized revenues was $23 million compared to $33 million last year. This includes a $4 million reduction in the balance of unrecognized revenues at January 2009 related to a lower exchange rate. The net change in unrecognized revenues represents both the incremental cash and a potential impact... positive impact on future earnings.

Gross margin for the quarter was 44% of sales versus 49.3% last year, a reduction of 530 basis points. As Neal discussed, we believe we gave up approximately 500 basis points in gross margin due to an aggressive promotional stance over the holiday.

Following holiday, we corrected course on the store-side discounting and have seen an improvement in merchandise margins to above 50%.

SG&A was approximately $284 million in the second quarter of 2009, down 18 million compared to the prior year. The decline in absolute SG&A dollars was primarily a result of the recognition of $21 million in cost savings from our $75 million expense reduction initiative announced last February, offset by $6 million primarily in increased merchant fees, severance and various legal expenses.

As a percentage of sales, SG&A was 41.9% for the second quarter versus 36.5% last year. The percentage decline relates to the de-leverage from the reduction in total revenues for the quarter.

During the quarter, we impaired $5 million of goodwill related to our domestic mall-based businesses, and approximately $8 million in store impairments across all name place.

Operating loss for the quarter was $15.2 million compared to earnings of $87.5 million last year. Operating loss excluding the impairment was $2 million.

During the quarter, the company made the decision to utilize Canadian and Puerto Rican inventory as collateral for the purposes of calculating the borrowing base under U.S. revolving credit facility.

As a result, the company revoked its APB 23 election to indefinitely reinvest foreign earnings outside the U.S. The revocation of APB 23 resulted in accumulated earnings of Canada being considered a dividend to the U.S. The $18.6 million charge is related to a value based reserve resulting from the revocation of APB 23.

Net loss per share this quarter was negatively impacted compared to the prior year due to the store impairments of $5 million or $0.16 per share, goodwill impairments of $5 million or $0.16 per share, charges related to a tax reserve of $18.6 million or $0.58 per share and a share count reduction compared to last year of approximately 13 million.

The net income for the quarter, excluding the goodwill and store charges and the tax reserve was 5.1 million. The net loss for the quarter from continuing operations including these charges was $23.6 million or $0.74 per share compared to earnings of $52.7 million or $1.16 per share last year.

The adjustment to net income to reflect total warranty sales was an additional $14 million or $0.44 per share. The weighted average shares outstanding were approximately 32 million, down 13 million to the 45 million weighted average shares in the prior year. The decrease reflects the impact of the 17.6 million shares repurchased during fiscal 2008.

We ended the quarter with 1,386 fine jewelry stores and 701 kiosks. We opened seven stores and closed 20. We opened no kiosks and closed 30.

Merchandise inventory was $847 million versus $949 million last year, a decrease in inventory of 11%, due largely to our clearance strategy over the last year and purchase reductions as we saw the sales decline. We believe there is further opportunity to reduce inventory levels and increase returns.

Now an update to our February 2008, $75 million expense reduction. In February 2008, we announced the first phase of our plan, to reduce expenses by $75 million with a majority being reductions in SG&A.

As I noted earlier, we realized $21 million of this savings in our second quarter. This is an addition to savings realized in the first quarter of $6 million.

For the six months ended January, SG&A was $503 million compared $521 million last year. The $80 million decline is comprised of $27 million in savings, offset by $9 million in inflationary cost increases, merchant discount fees on a proprietary card, severance and legal expenses.

In addition, we saved approximately $11 million in the last two quarters of fiscal 2008. The remaining $25 million in SG&A savings will be realized in Q3 and Q4 of this year, bringing the total SG&A reduction to $63 million. The balance of the $75 million savings initiative is a $12 million reduction in cost of goods sold, primarily related to distribution and centralized customer repair activity.

In the first six months, $6 million was realized. However, it was offset by our aggressive commercial stand during the holiday. The remaining $6 million will be realized in the third and fourth quarters.

Given the economic environment, we intend to be very cautious in all our spending decisions, and rigorous in identifying savings opportunity. We have already reacted to reverse the store-wide promotional stance during the holiday period, to more item driven approach as Neal discussed. We are getting gross margin dollars as well as utilizing inventory more productively.

We are enacting further reductions across inventory and expenses for a total of $140 million additional dollars to fiscal 2010. We believe we can effectively reduce inventory levels between January and July by $45 million, and an additional $30 million by July 2010, for a total inventory reduction of $75 million. This is in addition to the $100 million reduction in the prior year. We are utilizing inventory from closed doors, start balancing existing inventory, and more aggressively managing inventory at our lowest volume doors.

In addition, we have identified $65 million in SG&A savings, over and above the $75 million expense reduction announced last February. The additional savings will consist of 34 million of cost reductions from the closure of underperforming stores, where financial hurdles are not being met, representing approximately $7 million in negative contribution over the past 12 months; $21 million from staff reductions primarily, in Dallas for which actions were recently taken.

As a result, 245 associate positions including approximately 75 open positions were eliminated. And $10 million of cost savings from in-store efficiencies, focused on reallocating workload to customer facing priorities from non-value added tasks. These steps can have immediate impact and result in $65 million in savings beginning in Q3 2009, and through 2010.

In summary, the two programs combined to reduce expenses by $140 million primarily, in SG&A, and inventory by $175 million through 2010. We will focus on maintaining a solid balance sheet. With the addition of Canada and Puerto Rico collateral to our credit facility, we have provided potentially additional borrowing ability, as we continue to reduce overall inventory.

Debt levels are reasonable relative to our size, and our liquidity is sufficient to meet our foreseeable needs. We expect debt to be approximately $350 million at year-end July 2009, a decrease of approximately $40 million compared to the second quarter end.

Our continued focus on financial rigor will include a total review of our lease portfolio to identify further opportunities or efficiency in the business, and rationalize the size and scale of the company. This will include aggressively challenging ramp as leases renew, and proactively renegotiating existing leases, with a focus on returning the financial model to one of profitability.

We will also continue to prudently manage capital decisions. Capital expenditures are expected to be approximately $30 million in fiscal 2009, a reduction of 65% over last year. Capital investments will be primarily focused in the most profitable existing doors.

Financial rigor is critical in this environment. We will continue to focus on identifying opportunities to improve asset productivity and operational effectiveness, as we focus on aggressively managing expenses inline with the business trends.

I would now like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question is from the line of Lorraine Maikis Hutchison with Bank of America-Merrill Lynch.

Neal Goldberg

Hello Lorraine.

Lorraine Maikis - Banc of America-Merrill Lynch

Thank you. Good morning. Can you provide us with some idea of where you expect free cash flow to be in '09 and in 2010, if you have it?

Cynthia Gordon

Yes Lorraine. In '09, I think we had previously projected positive free cash flow. Given the promotional stance we took over holiday, we do not expect that. However, we do expect as we said earlier that we are looking at all the ways we spend our cash and expect to reduce debt by a minimum of 40 million between now and July.

Lorraine Maikis - Banc of America-Merrill Lynch

Okay. And then as we move into the back half, you come up against some pretty aggressive clearance activities from last year. Can you just talk about how you expect... no trends have improved, but how you expect to comp going forward up against that dramatic level of clearance? And then, what you think the margin impact will be this year from taking a less promotional stance?

Neal Goldberg

Well, I'll answer the last thing you said first. We said we think our margins were going to get more normalized in the 50s range and we're seeing that since the first of the year. Two, where we started facing that clearance initiative right after Valentine's Day.

We still have clearance much, much less. We think... we're going to benefit from a couple of things. One, by having the higher retails by not offering as much clearance we think that's going to be a benefit, we think our presentation is better. Clearly, it's going to be a hurdle to deliver the big comp numbers we have from the clearance initiative.

But we do have some clearance. We think we are presenting the clearance in a better fashion than we did in the past. And we think our assortments are more compelling at this time than we had last year.

And we also know from the previous year, other kind of promotional activity that were up against in '08 from '07, we don't have. So, certainly the macroeconomics are going to be challenging. But we think we have a good strategy and we think we're positioned well and the margin... the gross margin dollars should see a nice increase because of not being so promotional.

Lorraine Maikis - Banc of America-Merrill Lynch

Thank you.

Operator

Your next question is from the line of Jeff Stein with Soleil Securities.

Jeffery Stein - Soleil Securities

Good morning, guys. Question on how you get, kind of get back to regular price selling. And so I guess a follow-on to the last question. It seems that you were very, very aggressive in the first half of last year with the intent of... as you moved into holiday, having new goods that you would sell at regular price, obviously that didn't play out.

So it seems like you've trained that customer to buy on discount for the last year. And, I know it sounds like you're doing a little bit better in the January, February period, but timidly it's a period where you're not facing a lot of competition either. The competition is really come holiday again when everyone is out there with very aggressive promotions.

So how do you kind of see the year unfolding as move into the back half? I know it's still early yet, but the real battle is going to be fought six months from now, six, nine months from now, how do see your merchandising and promotional strategy as you look ahead?

Neal Goldberg

Okay. So let me... long question, I'll try to dissect it a little bit. For the new goods, I want to comment on that. We did have success in new goods. New goods through the holiday season actually were very successful and actually contributed 500 to 700 basis points improvement over in gross margins.

So we actually saw new goods sell at very good margins, number one. Number two, certainly the Valentine's period was one where it was promotional and crazy out there, and we were able to maintain the margins that we discussed in the low 50s, which is more normalized to where we've been before. So in that first test we were able to hold this strategy of making sure we're promotionally more by item as opposed to the entire store.

I really can't comment on the next nine months in the future, the macroeconomics, who knows. We believe though that by being very, very focused on making sure that the promotional activity is towards items, to making sure that we're doing the best we can from the operational efficiency and the financial rigor we've talked about in some of these expense and cost initiatives we talk to, we will position ourselves better.

The tenants to what we've talked about our key objectives are making sure we're focused on this value oriented customers with clarity of offerings with newness, which we'll continue to have newness to our assortment which again proved successful for the holiday season. We just didn't have enough of that, and certainly we promoted overall too much. We still think it's the right way to go. So can't predict the future.

Jeffery Stein - Soleil Securities

So Neal, just rewind that Christmas, if you had to do it over again, would you have promoted more on an item-by-item basis even in that environment, rather than promoting the entire store?

Neal Goldberg

Absolutely.

Jeffery Stein - Soleil Securities

Okay. And a question with regard to the valuation reserve on foreign tax credits. It seems to me that your... that this is kind of a device to stay up within your bank covenants, would that be correct, without making any changes to your lending agreement?

Cynthia Gordon

Not exactly, Jeff. I think it's more the fact that we have continued to reduce our inventory levels. Again, a 100 million last year, looking at productivity. And as we do that, we were eroding the collateral below our $500 million line. So this was to give us the flexibility.

There probably should have been in there from the beginning. But, for tax planning strategies, we did not. And where we are now, those tax planning strategies are not necessarily relevant.

Jeffery Stein - Soleil Securities

Got it. Okay. Thank you very much Cindy.

Operator

Your next question is from the line of Bill Armstrong with C.L. King & Associates.

William Armstrong - C.L. King & Associates

Good morning. You mentioned that January and February sales trends did improve from the holidays. Could you maybe give us some sort of parameter, what sort of comps we are looking at here?

Neal Goldberg

I'm going to stick to what we said. We saw improvement on those trends. We saw improvement into the low 50s on gross margin, which we were pleased to see.

William Armstrong - C.L. King & Associates

Okay. By improvement, we're still looking at negative same-store sales, are we so?

Neal Goldberg

Yes, we are.

William Armstrong - C.L. King & Associates

Okay. The 115 stores that you're planning to close through fiscal 2010, are these all money losing stores or not necessarily?

Cynthia Gordon

They are... we... they are closing at the end of their lease life. And they are either money losing stores, or they are stores that are so marginal, they do not provide adequate returns.

William Armstrong - C.L. King & Associates

Got it. And can you break out roughly, between... with those 115 between stores and kiosks?

Cynthia Gordon

The 115 is all stores, mainly in Zales' and Gordon's.

William Armstrong - C.L. King & Associates

Okay, great. Thank you.

Neal Goldberg

Thank you.

Operator

Your next question is from the line of Janet Kloppenburg with JJK Securities.

Neal Goldberg

Hi Janet.

Janet Kloppenburg - JJK Research

Hi everybody. Neal, let's talk about the trend now. The comp is better than it has been. The gross margin is better. Yet, you are up against heavier promotional activity versus last year. Is that right?

Neal Goldberg

That's all so far, so good.

Janet Kloppenburg - JJK Research

Okay. So, but does that mean that the transactions are down, but the average transaction value is increasing?

Neal Goldberg

Yes.

Janet Kloppenburg - JJK Research

Okay. And, can you talk a little bit about sort of the pattern of buying, are they buying those key item promotions, are they buying lower quality, lower ticket items? Maybe you could analyze the trend of the business right now.

Neal Goldberg

Okay.

Janet Kloppenburg - JJK Research

And also, with respect to inventories, why don't you answer that and then I'll come into the inventory question? Thank you.

Neal Goldberg

Good, thank you. First, lower quality, we are not selling lower quality. As we stated, we have really gone after aggressively improving our qualities. Our customer, our value-oriented customer deserves good quality.

Second, as what we saw in Valentine's Day strengthened our belief of being very focused on making sure we're we have a disortment of goods, but value is certainly key. We saw that in the Valentine's period. So, it's very focused on key items. It's focused on making sure we're distorting some of those key items. And we're offering them at a value price. And the good news is for Valentine's Day again, is by focusing on things we purchased to make sure that we promote them. We are able to enjoy our higher gross margin. And by not having the whole store on sale, we are able to again focus on getting a higher gross margin throughout the store.

So, we are seeing customers very focused on value which we think actually, long-term is our suite spot, and is a benefit to us. There is a price sensitivity out there. And we are making sure we are very competitive. But, we are not going to be discounting the entire store. We want to make sure we have very, very compelling key item promotional activity.

Janet Kloppenburg - JJK Research

But, what I want to focus on is, were you able to source that, these key items --

Neal Goldberg

Yeah.

Janet Kloppenburg - JJK Research

In a better way than last year so that your margin is more protected when you promote?

Neal Goldberg

Yes.

Janet Kloppenburg - JJK Research

And that's... is that a trend or a portion... will a higher portion of your assortments reflect that strategy going forward?

Neal Goldberg

Yes, yes. As we stated back in February in going forward. As we've looked at our source organization, merchandise organization by having a very focused merchandising team analyzing what's going on in the competition, analyzing what's going on in the marketplace and then having a sourcing team focused on ensuring that we get the best cost and best quality.

We're beginning to see some down payments on that. And certainly with diamond prices we're seeing some reduction in diamond prices and we are able to source and the more plant-full we are, the more we're able to place orders earlier, the more we're able to enjoy better cost leverage and then be able to offer some of that, especially the key items to the customers while we are still protecting our margins.

Janet Kloppenburg - JJK Research

Okay. And let's just talk about inventories a little bit. Comps are down 18, inventories down 11. Cindy, I think you said inventories are going to be down another chunk at the end of July, can't remember what that number is. Will inventories... do you... are you planning on inventories and relative sales and the trend of sales to be aligned by the end of the year?

Cynthia Gordon

Absolutely.

Janet Kloppenburg - JJK Research

So, if comps are down 15 and the second quarter inventory could be down around that level?

Cynthia Gordon

I would say around 10%.

Neal Goldberg

Directionally.

Cynthia Gordon

Directionally they will be similar, yes.

Neal Goldberg

And again, I want to be clear. We do believe and I have said this through the last year, we do believe that we can run this business on efficiency of inventory more than just inventory. And we're doing a lot of micro-managing of assortments to make sure that our lower level stores aren't just looked at lower level but they may have a summary or two that they do very will in and they should be supporting that.

If they have summaries or products that aren't doing as well, we are pulling inventory out in stock balancing into other stories. We are really being... we're really looking at the efficiency of our inventory with a goal of running this business in good times and difficult times with less inventory.

Janet Kloppenburg - JJK Research

Okay. And then on the store closings, I think you said 115 for the fiscal year ending July. Is that right?

Cynthia Gordon

For, through July 2010.

Janet Kloppenburg - JJK Research

Okay. Because my question was, how many more are there for '10. Is there any other way to get out of unprofitable stores? And Neal, in other words perhaps you can negotiate with landlords or maybe change your concepts from one to another or something like that, can anything like that go on?

Neal Goldberg

What we are dealing, we are in, probably in a very detail real estate portfolio review and we are aggressively challenging rents as lease renew and proactively renegotiating the existing leases. Clearly, in a macro-economic climate right now and retail climate puts us in a position that we are going to be very aggressive in looking at our portfolio.

David Sternblitz

Thank you, Janet.

Operator

Your next question is from the line of Jeff Stein with Soleil Securities.

Jeffery Stein - Soleil Securities

Hey guys. Couple of follow up questions. First of all, any one-time costs associated with the expense reduction program and how much of that would be cash and when, how with that hit the P&L?

Cynthia Gordon

There are some one-time costs that are not significant. A couple of million dollars and they will be in our third quarter.

Jeffery Stein - Soleil Securities

Got it. Okay. And, the adjustment to the reserve before foreign tax credits, is that on the... does that reserve get adjusted off of the tax line?

Cynthia Gordon

Yes.

Jeffery Stein - Soleil Securities

Okay. And final question, I presume that when you did your budgeting for these expense reductions, they were geared to a guesstimated level of sales. And I presume that is kind of a level that you guys think you need to be to, to get back to a positive cash flow. Could you possibly share that with us in terms of what kind of sales forecast these expense reductions are geared to?

Neal Goldberg

First, we're not going to talk about forecast or predicting the future. What we have said is and we'll continue to say, certainly in a difficult macro-economics, we are very, very conservative in any trending right now, number one.

Number two, we have been very focused on the right sizing the organization and that was the driving force to take out pyramids, to take out layers, both push the pyramid down from the top as well as move it from the sides. And we're very careful to make sure this restructuring, how we look at the business, the right sizing of the business gives us a position that we could be nimble, quick and agile and be able to react to different changes in the economy and get us back to a profitable level. But we are very conservative in what the near term future sales environment will be.

Jeffery Stein - Soleil Securities

Got it. Okay. Thanks a lot, Neal.

Operator

Your next question is from the line of Chia Kuo with Telsey Advisory Group.

Chia Kuo - Telsey Advisory Group

Hi, thanks. Just wondering of getting update on how that pacesetter stores are performing? To what extent are they outpacing the non-pacesetter stores on a comp and gross margin basis? And now that we've kind of gone through Christmas and Valentine's Day, are there any key learnings that you are ready rollout for rest of the fleet?

Neal Goldberg

Yeah, we are... the pacesetter stores, we're still excited about the learns we are getting. They are running about 500 basis points higher than the fleet. The most important learning, and as we look at the timeline of those as we roll those out, really the first part of the rollout was more the people part of it. And then we started getting into presentations, some physical changes, and then the merchandise came in more towards the end of first quarter, beginning of second quarter. The most important learnings that we are taking across the entire fleet is presentation.

It is clear to us that our customer wants clarity of offerings. They want cleaner presentation. And we are seeing that, and that's being rolled out to the entire fleet.

The other learning that we've seen in pacesetter stores is better goods. That they are... that a customer is surprising of people are getting married today. People are still celebrating anniversaries. People are still celebrating events. And they aren't looking only for a cheap poor quality good. They are looking for great quality goods at a good value price. And they are looking for newness. And we think we saw that in the pacesetter stores. And that's why we believe we've seen that 500 basis point 4, 500 basis points spread. And we hope to take many of those learnings across to the rest of the stores, and continue to enhance the pacesetter fleets.

Chia Kuo - Telsey Advisory Group

Okay, great. And then, can you just maybe talk about the contingent liability related to the operating leases of Bailey Banks & Biddle? Generally, end of the sorting, how immediately would you be on the hook for the leases, and can you maybe quantify the potential impact on the P&L?

Cynthia Gordon

Right. So, as of right now clearly, they have not defaulted. We do disclose an amount in our filings which represents the total contractual obligation. But, not what we believe we will be able to negotiate out, which is significantly less than that. Based on what we understand, and a way it would play out, it would be four to six months before we would... as we would go through those negotiations before we would actually have a cash outflow.

Neal Goldberg

But again, I think it's important to note that the amount that we've filed and disclose, is the non-negotiated amount which we believe will be substantially less as a liability.

Chia Kuo - Telsey Advisory Group

Great. Thank you.

Operator

Your next question is from the line of Brian Tunick with JPMorgan.

Brian Tunick - JPMorgan

Thanks, good morning.

Neal Goldberg

Hey Brian.

Brian Tunick - JPMorgan

How are you guys doing? I guess obviously, there is a lot of concerns from the equity market regarding your liquidity. So, maybe just talk about have you've been in negotiations with the banks about expanding the asset-backed facility, and maybe talk about what kind of valuation of your inventory that you think is appropriate? I think those are obviously the bigger questions on the stockholders minds.

Cynthia Gordon

Right. So, we have not been in negotiations to increase the ability. I think we feel based on our internal projections that we have sufficient liquidity for the foreseeable future. Our line does go up if you recall over the October, November, December timeframe to another potential $100 million.

As for the valuation, I think most retailers underwent valuations of their inventory during the holiday, after the holiday, as did we. And we... again, I think we've done that, and we feel comfortable where we are and where the position is for the foreseeable future.

Brian Tunick - JPMorgan

And then, just on the number of store closings, people are talking over a 1,000 independent jewelry retailers fortune offs. How much you think is realistic to think in this environment that you can actually pickup, share versus obviously, just going away with consumer?

Neal Goldberg

It's... again, I can't play Cormac (ph) and decide then I know how much we're going to pickup, especially in this macro-economic environment. What we do know is last holiday, we faced the Whitehall and Friedman liquidations which were very aggressive through the holiday season. We know they are not going to be around in the model.

We know that there are a lot of independents closing. We would like to think we will benefit some from that. If we do believe, which we do, the people are going to be beginning engaged, getting married and having anniversaries, birthdays and so forth. I am not going to try to take a stat of what share of that we will get, because of just the macros are so not normal right now. But, never wish anything bad for our competition. That said, and I've said before, we'd like our unfair share of that business as the people go shopping for.

Brian Tunick - JPMorgan

And just finally, you talked at the Analyst Day about changing the marketing message. Can you just maybe talk about, besides the macro, do you think you were correct in changing the message?

Neal Goldberg

We'd... as I said that we felt that our strategy going for this is one of the most emotional businesses there is. We've given some of the piece of jewelry is a serious purchase. And we believe that the emotional part of it is still right on. We did say, and I will continue to say on key promotional periods of time, we will be promotional but we will not be, the entire store will be item focused. We'll purchase those items. We will do everything we can to protect the gross margins even on those promotional items, which is only protecting the gross margin in the entire store, and make sure that our message cuts through with much more emotional feelings. And all of the responses we've gotten from our commercials when they were in our marketing, when they were more of this emotional driven were very positive.

Brian Tunick - JPMorgan

Alright. Terrific. Good luck.

Neal Goldberg

Thank you.

Operator

(Operator Instructions).

Neal Goldberg

In closing, I just wanted to thank all of our associates, our shareholders and vendors for their continued support. Everyone have a great day. Thank you.

Operator

Thank you for participating in today's Zale Corporation second quarter fiscal 2009 earnings conference call. This call will be available for replay beginning at 12 noon Eastern Standard Time, today through 11:59 PM Eastern Standard Time on Friday, February 27, 2009. The conference ID number for the replay is 871-82-486. Again, the conference ID number for the replay is 871-82-486. The number to dial for the replay is 706-645-9291. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Zale Corporation Q4 2008 Earnings Call Transcript
This Transcript
All Transcripts