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Zales F1Q08 (Qtr End 10/31/07) Earnings Call Transcript

posted on: November 20, 2007 | about stocks: ZLC

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Zales Corporation (ZLC)

F1Q08 Earnings Call

November 20, 2007 9:00 am ET

Executives

Betsy Burton - CEO

Rodney Carter - CFO

Cindy Gordon - Controller

David Sternblitz - Treasurer

Analysts

Brian Tunick - J. P. Morgan

Adrianne Shapira - Goldman Sachs & Company

Lorraine Maikis - Merrill Lynch

Connie Wong - Cowen and Company

Jeff Stein - Keybanc Capital Markets

William Armstrong - CL King & Associates

David Mann - Johnson Rice and Company

Marc Bettinger - Stanford Group Company

Patrick J. Forkin, III, CPA – Tejas Securities Group, Inc.

Rod Whitehead – Deutsche Securities

Janet Kloppenburg – JJK Research

[Farouk Ferkey] - Imperial Capital

Presentation

Operator

I would like to welcome everyone to the Zales Corporation First Quarter Earnings Release Conference call. (Operator Instructions) I would know like to turn the call over to Mrs. Betsy Burton, Chief Executive Officer. Mrs. Betsy Burton, you may begin your conference.

Betsy Burton

Thank you. Good morning and thank you for joining us for our first quarter conference call. I am Betsy Burton, Chief Executive Officer of Zales Corporation. With me on the call today are Rodney Carter, Chief Administrative and Chief Financial Officer, Cindy Gordon, Controller and David Sternblitz, Treasurer. Before we begin, Rodney will review the Safe Harbor.

Rodney Carter

Thank you Betsy. Our comments, responses and responses to your questions on this conference call will contain certain forward looking statements including statements related 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 10K for the year ended July 31, 2007 as filed with the SEC.

In addition, we may present information on this call that would be considered non-GAAP financial information. For a reconciliation for each non GAAP financial measure to the most directly comparable GAAP financial measure, please refer to the company’s most recent sales and earnings release which can be found on our website www.ZalesCorp.com under financial information and in news releases.

Betsy Burton

Thank you, Rodney. Q1 results were in line with expectations. It should be noted that all numbers reflect results from continuing operations. We did complete the sale of Bailey, Banks & Biddle earlier this month and this results are reported in discontinued operations. The sale of Baileys is consistent with our strategy to focus on the core business and to increase returns on capitol. The recently announced share repurchase is also a way to return value to shareholders. I would like to thank the entire team of associates at Bailey, Banks & Biddle for their hard work, dedication and commitment to building a great brand. Now, for the quarter.

Comps for sales decreased slightly .4% and the net loss for the quarter from continuing operations was $0.54 per share, in line with guidance. Cash from warranty sales increased $9.5 million over the first quarter last year but, revenues recognized were $6.1 million less than last year as a result of the switch from a two year to a lifetime jewelry protection plan. This resulted in an increase in unrecognized revenues for the first quarter of $14.3 million, or $0.18 earnings per share. After adjusting for the incremental unrecognized cash sales, the net loss per share is $0.36 compared to a net loss of $0.43 last year, excluding the loss from derivatives.

Here are some of the highlights for the quarter. Zales, Gordons and Pagoda comp stores sales declined in the low to mid single digits upset by continued strengthened outlet up mid single digits, Peoples up double digits and .com with continued high double digit increases. We saw consistent gross margin rate improvement across all brands when you adjust for the warranty change. As we continue to focus on maximizing gross margin dollars.

Actual merchandise margins were up 80 basis points compared to last year. Merchandise gross margin percent at the Zales brand was up 50 basis points, due primarily to the lower clearance mix at a higher gross margin rate. Claires' was 11% of sales this year versus 20% last year. Gordons also experienced a 40 basis point improvement in gross margin rate which mostly offset negative comp sales. This is due largely to better coordination of marketing and promotional efforts with the Zales brand to mitigate cannibalization. Outlets’ strong performance continues with almost all summaries having positive comps, particularly wedding and sales of higher carat weight goods. Merchandise gross margin improved 70 basis points due to strength in pricing and markdown controls. At Pagoda, while negative comps track almost entirely to declines in mall traffic, margin dollars were actually above plan and 180 basis points higher than last year. This can be attributed to a combination of mix shift and retail price adjustments on gold chains and earnings.

Canada had a very strong performance on all fronts. Almost every summary had a positive sales trend, also benefiting from the strong Canadian dollar. And, albeit a higher Canadian dollar increased SG&A expenses in US dollars, sales more than compensated due to an even greater benefit. Canada also experienced a very strong 220 basis point improvement in gross margin percent due to an increase in direct sourcing and diamond fashion and the continued benefit from the repeal of the excise tax. We also made continued progress in Q1 in regards to our direct sourcing initiative. The percent of sales of goods from our loose diamond assembly operation increased from 7.9% to 10.4% and total direct source goods grew from 33.2% of sales last year to 35.5% this year with an improvement with direct source margin of nearly 100 basis points.

Let me know give you a quick update on our various strategic initiatives in progress to date. The first component of our strategy is the focus on our core mall business. We have identified three key initiatives to drive improvement. The first is a pilot to build a best in class customer experience which we believe can result in significant growth in same store sales. First and foremost in the focus on the customer. Areas of emphasis include product knowledge training and training in consulted selling. Next, are changes in work flow to free up the associates time to spend with the customer. Then, there are product assortment improvements, policy changes and tools to support and overall improved experience. The test is currently live and on track for the pilot stores to deliver increased sales of a trend for holiday.

The second initiative is focused on increasing gross margin through continued growth in direct sourcing, refinements in pricing and improvements in our supply chain strategy to drive cost savings. We also see an opportunity to improve store return by focusing on assortment optimization and gross margin return on investment in space and inventory. This includes a shift in assortment mix toward core diamond summaries, decreasing investment and non-core summaries and a reduction in the gap in SKU count between high volume and low volume stores in the diamond wedding categories.

The third major initiative is a continued emphasis on a return on capitol. This means putting a sharp lens on all real estate decisions and evaluating store-by-store performance based on return on capitol. This focus applies to new and existing stores. We will close stores that are not meeting their cost of capitol and where it is unlikely operational improvement would get it even close to the hurdle. We will also scale back investment in new stores for the Zales and Gordons brands until we have made progress in making operational improvements. Where we will invest is in those brands and formats that produced the highest returns on capitol: Canada, outlets and .com.

Now, our immediate focus is clearly holiday. Last year we returned to dominate assortment in diamond solitaries and diamond fashion. This year we will inject some newness into assortment but, an overall diamond focus will continue. Diamond fashion is always key at holiday and this year, again, Journey will be the must have item. We do have some next generation Journey styles including a new proprietary branded collection at Zales Past, Present, Forever. We also expect new right hand ring styling to show good growth and big, really big, gold hoop earnings with or without diamonds are the new hot trend for fall. In Canada, trends to be slightly behind the US markets so, Journey, introduced just this past spring presents a big opportunity for Canada this fall.

The marketing campaign for Zales will also be consistent with last year. We will build on TV creative from last year that returned us to Zales, the Diamond Store and featured the Vanessa Carlton song A Thousand Miles. The ads will remain in a blend of emotion and product. They began airing November 5^th so hopefully you’ve already seen them. We continue to be aggressive in primetime and highly visible TV spots. Our overall advertising spend should be relatively flat with last year.

We believe there is also an opportunity without pricing and brilliant buy strategy. We plan to continue our key item strategy, just not as broad or deep in terms of discounting. This is consistent with our strategy for the past several quarters of balancing top line growth with profitability. We expect these refinements and pricing to result in increased gross margin dollars during the holiday season. We recognize that even with our opportunities in improved execution, it is against a back drop of a more challenging retail environment. So, given current trends we are forecasting comps of Q2 of flat to slightly negative and as we continue to execute our strategy of maximizing gross margin dollars and maintaining good expense control we believe we can deliver bottom line results just slightly below current expectations. So, when you adjust for the sale of Bailey, Banks & Biddle, earnings from continue operations are expected to be in the range of $1.60 to $1.65 per share.

I’d now like to ask Rodney to review the financials and quarterly guidance and then we will open up the call to questions.

Rodney Carter

As Betsy indicated our first quarter results reflect Bailey, Banks & Biddle as discontinued operations. The results of the brands’ performance have been isolated and reported on separate line items that are not included in revenues or the traditional income statement for both October 31, 2007 and 2006 and balance sheet line items as of October 31, 2007.

The following are the key statistics for the first quarter of fiscal 2008. Comp store sales decreased .4% for the quarter. The strongest performance continue to be turned in by our Peoples and outlet brand, as well as .com. The remaining brands had low to mid single digit negative comp store sales. Total revenues were $377 million compared to $382 million last year; a decrease of 1.3% for the quarter. This reflects a $6.1 million decline in recognized warranty revenues.

Gross margin for the quarter was 52.5% of sales versus 52.9% last year. The decrease reflects an 80 basis point impact from the lower recognized revenues compared to last year due to the change in the lifetime warranty product. Actually merchandise margins were up 80 basis points compared to last year which was consistent with our plan and our reduced emphasis on clearance compared to the prior year.

Merchandise inventory as of October 31, 2007 was $1 Billion versus $1.2 Billion last year. Excluding the impact of Bailey, Banks & Biddle, inventory was relatively flat. Inventory levels include approximately $17 million due to the exchange rate impact on the Canadian brands’ inventory. Inventory turn over on a rolling 12 month basis was slightly lower at 1.1 times this year versus 1.3 times last year.

SG&A including the cost of insurance operations was 58.5% for the quarter versus 56% last year as a percentage of revenues. The increase from last year reflects 100 basis points from the lower recognized revenues due to the change in the lifetime warranty product, 100 basis points from increased occupancy expenses and 50 basis points in consulting fees associated with the initiatives Betsy mentioned.

The operating loss for the quarter was $37.5 million compared to $34.2 million last year which included the loss from derivatives of $8.6 million. The first quarter loss was negatively impacted by the change in amortized revenues associated with the change in the warranty product. The effective tax rate for the quarter was 36.9% versus 37.3% last year. The net loss for the quarter from continuing operations was $26.7 million or $0.54 per share versus a $24.7 million net loss or $0.51 per share last year.

During the holiday quarter last year we extended the service period for the warranty plan offered to our customers from two years to the lifetime of product ownership while simultaneously raising the retail price. Well actual sales continued to increase over the comparable prior year period, revenues recognized have been negatively impacted. As we indicated in our 2007 Year End Earnings Call, we believe that the net change in unrecognized revenues will consistently provide insight into the incremental cash and potential impact on future earnings. We will refer to this metric as cash warranty earnings per share. The increase in unrecognized revenues for the first quarter was $14.3 million or $0.18 per share. This compares to a decrease in unrecognized revenue of $1.3 million or $0.02 per share in the first quarter of last year. Including the impact of unrecognized revenues the cash warranty loss is $0.36 per share compared to $0.43 last year, excluding the loss from derivatives.

During the quarter we opened 12 stores and four kiosks. We closed two stores and five kiosks. In addition, we will open 10 additional stores prior to Thanksgiving. We remodeled and refurbished 16 stores and four kiosks in the quarter. Excluding Bailey, Banks & Biddle, we ended the quarter with 2,203 locations as follows: Zales 796, Gordons 282, Outlet 137, Peoples 196 and Pagoda 792. The capitol expenditure plan is approximately $100 million for the fiscal year for the total target of 37 new jewelry stores primarily in the outlet, Peoples and Zales brand and 10 new Piercing Pagoda kiosks.

We ended the quarter with borrowing of $298 million under the line of credit, or approximately $100 million lower than the prior year. We had $30 million in cash at quarter end compared to $50 million last year.

I would now like to turn the focus to our earnings guidance for the second quarter and the back half of the year in light of the impact of the sale of Bailey, Banks & Biddle. The Bailey, Banks & Biddle sale will allow the company to focus on the opportunities in our core modern brands but, at the same time return value to our shareholders in the form of a $200 million share repurchase program. We plan to enter into a $100 million accelerated repurchase program and a 10B51 program which should allow us to complete over half of the authorized amount in the second quarter. We expect to complete the balance of the $200 million authorization during the remainder of fiscal 2008. Given the timing, the full benefit in the reduction of shares outstanding will now be annualized in earnings per share until fiscal 2009.

We are reducing our second quarter comparable store sales expectations from up 1-2% to flat to slightly negative. This reduction reflects a cautious outlook on consumer spending. As adjusted for the sale of Bailey, Banks & Biddle and our share repurchase program, our GAAP guidance from continuing operations in the second quarter is $1.60 - $1.65. This compares to approximate earnings from continuing operations of $1.57 last year. This reflects a $0.27 reduction in earnings from Bailey, Banks & Biddle due to the sale, the anticipated benefit of the share repurchase plan of approximately $0.10 and a $0.10 reduction based on the company’s cautious outlook for the holiday season. Because of the positive impact of the share repurchase program that will be attained over the course of the fiscal year and the earnings of Bailey, Banks & Biddle will be immediately deducted, the sale will be dilutive for fiscal 2008.

The estimated increase in unrecognized revenues for the second quarter is $38 million or approximately $0.50 per share compared to an increase in unrecognized revenues last year of $30 million or $0.37 per share. Including the impact of the increased in unrecognized revenue cash warranty earnings per share are $2.10 to $2.15 this year compared to $1.80 last year excluding the impact of derivatives.

Our original GAAP guidance for the year was $1.11 to $1.16 adjusted for the anticipated $80-$90 million increase in unrecognized revenues our cash warranty earnings per share would have been $2.11 to $2.16. A revised fiscal year GAAP guidance from continuing operations which excludes Bailey, Banks & Biddle is $0.86 to $0.91 per diluted share. After adding back the same $80-90 million increase in unrecognized revenue, or a $1.00 of future earnings, cash warranty earnings per share is now expected to be $1.86 to $1.91. The revised guidance reflects a $14 million reduction in earnings from continuing operations related to Bailey, Banks & Biddle, our cautious outlook for the holiday quarter and the benefit of an estimated repurchase over the next three quarters of eight plus million shares. On an annualized cash warranty earnings per share basis, we expected transactions to be [inaudible].

Now, turning to forecasted free cash flow. Excluding the $175 million of net proceeds of the sale of Bailey, Banks & Biddle, we expect free operating cash flow in the range of $100-125 million. The decrease from our original projections of $125-150 million is primarily the removal of the free cash flow from Bailey, Banks & Biddle. So, again, we anticipate generating significant free cash flow in fiscal 2008, thus providing significant financial flexibility to the company.

David and I will be available to discuss any further questions after the call. We will now open up for questions.

Question-and-Answer Session

Operator

Your first question comes from the line of Brian Tunick - J.P. Morgan.

Brian Tunick - J. P. Morgan

Good morning Betsey and Rodney and David. I guess my question first for Rodney is, I think previously you talked about 30% earnings growth, half from the warranty recognition and half from the core business. Is that still something you endorse off these lowered numbers? And then secondly, on the same thinking there, are there any expenses related to any of these in store improvements from training to store payroll that you talked about today Betsey?

Betsy Burton

Okay, let me answer the first.

Rodney Carter

First of all, yes there is still, actually, some of the third revenue will now be recognized over a lesser share base. So, the types of increase, the annualized benefit of 09 and 2010, those were the years we talked about the 30% or so gain, roughly half coming from the warranty recognition still is valid.

Betsy Burton

Brian, in terms of the costs of some of the improvements, in the pilot stores there have been some costs and we’re in the process, obviously, of looking at where we get the biggest bang for the buck and return. So, post holiday will actually be refining it, looking at it and then, obviously, making a decision as to which elements pay off and which ones don’t. But, relatively minor cost to date.

Brian Tunick - J. P. Morgan

Okay. Thanks. Good luck.

Betsy Burton

Sure. Thank you.

Operator

Your next question comes from the line of Adrianne Shapira of Goldman Sachs.

Adrianne Shapira - Goldman Sachs & Company

Thank you. Just a few questions, as you clear tempering the top line based on consumer spending outlook into the holiday season, does that impact at all the warranty attachment rates? You had called out sort of a nice impressive step up to about 50%. Has that held steady? Any change at all to those attachment rates?

Rodney Carter

We’re not see any change to the attachment rate.

Betsy Burton

Yeah, it’s strong. It’s still as strong.

Adrianne Shapira - Goldman Sachs & Company

Okay. So, it’s maintained around that 50% level?

Betsy Burton

Correct.

Adrianne Shapira - Goldman Sachs & Company

Okay. Then, as far as you talked about the sharpening of the lens in terms of return on capitol. Any sense, can you give us in terms of store closures, or what sort of capitol you might be paring back as you scale back those investments? If you can sort of give us any type of range? You had alluded to it last quarter as well.

Betsy Burton

Yes. The range that we eluded to last quarter, and a lot of this is normal course. In other words, these are stores that we are just simply not renewing. So, it’s not a, “Buy now [inaudible] a big charge.” It is just simply not renewing. So, we had mentioned in the range of 30-40 stores. But again, we will look at this post holiday and the important thing to note too is that with some of the operational improvements that we’ve seen to date in our pilot stores we also need to go back and make sure that we would make the same decision based off if we were to overlay the operational improvements.

Adrianne Shapira - Goldman Sachs & Company

Great. That’s helpful. Thanks. Then, as far as, you know, obviously we were seeing commodities pricing increasing, obviously we’ve all seen what has happened to gold prices. Can you talk about what decisions are being made, how much of those increases are you passing through? How much is the consumer accepting? How much of the direct sourcing benefit should we expect to continue given how gold prices have escalated?

Betsy Burton

Okay. We have taken a lot of the price increases in the Pagoda brand in particular which is heavily dependant upon the commodity gold. In terms of the Zales brand and the Gordons brand, we did go out and we did a major competitive check and we found opportunities to raise our prices and in some instances we were not able to. So, it has been mixed but, you know, clearly we also need to be competitive. The bigger opportunity though also as we become less aggressive in terms of our brilliant buy pricing which is typically anywhere from 20-25% of our total mix.

Adrianne Shapira - Goldman Sachs & Company

Okay. That was just my last question. If you were to help us understand the year-over-year reduction in the brilliant but program, give us a sense what that represents this year, what it represented last year and perhaps reconcile that as you are expecting clearly a tougher holiday outlook. Talk about the decisions to kind of rein in those promotional prices. Thanks.

Betsy Burton

Sure. Our promotional prices, our brilliant buys this year will be approximately – are projected at 25% of our total mix. Last year it was 36% of our total mix and we project a 400 basis point improvement of gross margin in those brilliant buys. In terms of the back drop of the macro environment, clearly we believe this is a year in which we don’t chase sales. We believe we are competitively priced so we still have – last year we may have had 1,000 brilliant buys and this year we may have 700-800 key items. So, we have not cut back so significantly that we believe it will impact our sales. But, we also believe we have an opportunity to capture growth margin and to maximize gross margin dollars this year.

Adrianne Shapira - Goldman Sachs & Company

Thank you.

Betsy Burton

Thank you.

Operator

Your next question comes from line of Lorraine Maikis of Merrill Lynch. Lorraine your line is open.

Lorraine Maikis - Merrill Lynch

Hello?

Operator

Go ahead.

Betsy Burton

Hi Lorraine.

Lorraine Maikis - Merrill Lynch

Hi. Good morning. Can you give us a quick update on your inventory goals for the year? I know you had spoken about bringing that balance down by about $50 million and then also just update us on how much old clearance merchandise is still on balance sheet.

Betsy Burton

Okay, let me talk first about the old clearance merchandise. We’re down to about $19 million. This time last year we had $68 million down from the starting point at $85 million. So, we’ve worked through the clearance pretty successfully. And, clearance will always be about 10% of our total inventory. There is ongoing clearance as you bring in fresh goods. In terms of our overall inventory goals we are working through that. As I alluded to in one of the initiatives that our consultants are working on, we believe there may be a major SKU rationalization in some of the non-core categories. We need to come up with sort of a total plan for the inventory clean up. In addition to that, as I think I alluded to also, we are going to refocus on some of the core bridal and diamond categories. Not that we believe there will be a build in dollars, it will be simply a shifting of dollars. And so again, we’re not at this point ready to say that the $50 million is a real number. You also need to know that $10 million of that plan reduction would have been in the Bailey, Banks & Biddle brand so that will go away, that benefit.

Lorraine Maikis - Merrill Lynch

Your reversing course on the initiative you talked about earlier in the year about bringing the inventory balance down?

Betsy Burton

No, not really. What we had talked about was bringing down the excess which we have worked through in terms of the, as you know, with the Zales brand we brought in $120 million of inventory last year. You know clearly we had to work through about $50 million of excess inventory. But, it was good product going [inaudible] program and merchandise. We have worked through that however, we have also had to investment spend in some of the core categories identified in terms of this assortment optimization and we’ve investment spent in the Pagoda brand, as well as a little in the outlet brand. And then, $15 million or $17 million is due to growth I guess, is due to the Canadian exchange rate. So, that’s not real growth in inventory so, that would have been reduced had we been on a level playing field. Is that clear?

Lorraine Maikis - Merrill Lynch

Yes, that’s clearer. Can you just talk a little bit about SG&A as well? Do you have any initiative, I know you talked about some in store initiatives that sound like they’ll cost some money, is there anything you can cut at this point given the expected weakness in your top line going forward?

Betsy Burton

Let’s focus on holidays. For Q2 we are clearly going back and store by store building payroll which is by far your single largest line item. Looking at stores which have much more negative trends and cutting back there. We have looked at some potential saves in marketing but, at this point there are really no substantial cuts in terms of the corporate SG&A and the reason for that is we believe over time there will be efficiencies to be gained in terms of some of the centralization streamline of the merchandising organization operations. However, because of the magnitude of the potential upside to grow same store sales and the opportunity in terms of gross margins we felt that those have the opportunity to provide the most value, create the most value for shareholders that it focusing on cutting SG&A would potentially impair our ability to have those initiatives be successful.

Lorraine Maikis - Merrill Lynch

Thank you.

Betsy Burton

Okay, thank you.

Operator

Your next question comes from the line of Connie Wong of Cowen and Company.

Connie Wong - Cowen and Company

Good morning. Thank you for taking my question. Rodney, first question, given the accelerated $100 million in repurchase program and the 10B51 plan, is it safe to assume about a 43 million share range for the end of second quarter? Or, do you expect it to be even lower than that given, you know, you guys have an outstanding program of $200 million?

Rodney Carter

I think on an average basis it can be 46 or a little bit north of that because, the two programs combined are, we have chosen to limit them both within 10B18 limits. You know, there’s going to be somewhere between 100-120 million shares purchased and, again, the ASR as we mentioned in the press release can go as long as four and a half months depending upon trading volume. We’re targeting something in the 46-47 million share count as of Q2 for an average.

Connie Wong - Cowen and Company

As of Q2. Okay, great. Then, Betsy we’ve obviously seen some success in your online business. What are you anticipating for holiday? Do you expect your online sales penetration to increase? And, how are you positioning the online business for holiday? Anything different from what we should see in stores in relation to promotions?

Betsy Burton

We’re very optimistic, our online business is growing very nicely and we see that trend continuing. So, for the most part, the online will support all the promotions that we have going on in the brand. So, truly we’re trying to capture the multi channel customer and have the customer that shops online also come in store. But, we are not having, for instance, special Internet only promotions. They will all be multi channel promotions.

Connie Wong - Cowen and Company

Okay, great. And then lastly, are you seeing any regional difference in your sales given some costs, other retailers have mentioned given the macro environment in California and Florida?

Betsy Burton

We are experiencing the same macro trend, in particular, in Florida, that is correct.

Connie Wong - Cowen and Company

Okay, great. Thank you.

Betsy Burton

Thank you.

Operator

Your next question comes from the line of Jeff Stein of Keybanc Capital Market.

Jeff Stein - Keybanc Capital Markets

Good morning. I was wondering if you could talk about the number of stores that you have in this pilot test and how long they’ve been out there and what the performance has been to date?

Betsy Burton

The initiative is very, very early and for competitive reasons we aren’t going to identify where these are but, there are 24 stores in the initial pilot group and we’ve started, literally within the last week started another group of stores where we took what we think were the two most promising elements of the pilot and sort of cut out all the other stuff and are looking to run a sort of different variation of the original pilot. The results again, are too early to know but, right now are showing a very strong improvement versus their trends prior.

Jeff Stein - Keybanc Capital Markets

Okay. And Betsy, with regard to the incremental costs, and I’m not sure if the prior question relating to incremental cost was in conjunction with the pilot aspect but, what kind of an increase do you think you need to offset the higher training costs, or sustained increased costs of these pilot stores?

Betsy Burton

If the trend that we’re experiencing holds it is more than self funding. And again, we’re looking at paring back some of the elements that would reduce some of the costs as well.

Jeff Stein - Keybanc Capital Markets

Okay. And, if we look at the change in the guidance for the full year going to this $0.86 - $0.91 range, if we kind of delayer it and just look at the portion that you’re taking out of the guidance that relates to a more conservative holiday outlook, my math says it is about $6-7 million dollars after tax and I’m wondering if that’s a good guesstimate?

Betsy Burton

I think $0.09 to $0.10 EPS is what we had come up with just the reduction and, you know, a couple of percentage points in comps. So, the math gets real murky because again the share repurchase and obviously, the cash warranty add back.

Jeff Stein - Keybanc Capital Markets

Okay. Yeah, I come up with about $0.12 but, I guess that’s close enough. With regard to, can you give us some new interest expense and B&A numbers for the balance of the year? It looks like Bailey had about $5.3 million on an annualized basis so, we should deduct that and prorate it per quarter

Rodney Carter

I’m trying to look right now. Interest forecast is around $11 million, I’m sorry, yeah, about $11 million for the full year.

Jeff Stein - Keybanc Capital Markets

Okay. And B&A?

Rodney Carter

B&A is approximately $63 million.

David Mann - Johnson Rice and Company

$63-64 million.

Jeff Stein - Keybanc Capital Markets

Thanks.

Betsy Burton

Thank you.

Operator

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

William Armstrong - CL King & Associates

Good morning. Just to get clear on the share buy backs, over the next three months we should see 4.3 million plus 1.2 million bought back?

Rodney Carter

The 4.3 will come out immediately because of the equity treatment of the ASR. The other depends on the trading volume at the timing but, that would be kind of the goal, Bill.

William Armstrong - CL King & Associates

Okay. Then, the remainder just comes as you go through your open market purchase?

Rodney Carter

Correct. We’ll get back into broader periods of open market because, we’ll have open windows to trade. Obviously, we’re going into an extended blackout period and we thought the ASR would give us a meaningful impact of share count up front and then take advantage of the volume difference on a 10B51 to again, accelerate some of the benefits in a bigger quarter.

William Armstrong - CL King & Associates

Got it. So, the way that works is that J. P. Morgan delivers the shares to you tomorrow and then they will go into the open market and buy shares to make that whole?

Rodney Carter

Correct.

William Armstrong - CL King & Associates

Okay. So, then the guidance, the $0.86 - $0.91 does that include the impact of the lower share count? Or, is that before the share buy back?

Rodney Carter

It includes it.

William Armstrong - CL King & Associates

That includes it? So, what would be the.

Rodney Carter

But, it’s not annualized though, Bill. It just kind of gives you the timing and the step in. So, on average we’ll drop share count by a few million and then through the remainder of the year we’ll get about 8 million out for next year.

William Armstrong - CL King & Associates

I understand. And so then, the $0.86 - $0.91 what would be the, I guess denominator, or the average share count for the full year for that $0.86 - $0.91?

Rodney Carter

It’s about $0.455.

William Armstrong - CL King & Associates

Okay. Then, finally, just on the gross margins for the quarter, Rodney I think you were saying that you had an 80 basis point negative impact in deferred revenues, 80 basis points positive from merchandise margins, the overall gross margin was down about 50 basis points. I was wondering if you could just fill in the remainder above [inaudible] there?

Rodney Carter

The very minor amount as far as there is roughly about – if you need out Bailey’s last year would have been about 52.9 so there is about 40 net basis points down. Warranty was about 80 basis points and then basically just some timing of when we took in trade in merchandise, just timing going in and out of some of the zap merchandise and whatever else. So, basically it’s just 40 basis points of movement within the inventory categories.

William Armstrong - CL King & Associates

Okay. Then I guess, finally underline the lower guidance for the full year of about $0.25. How much of that decline would be just from Bailey, Banks & Biddle alone?

Rodney Carter

About $0.20.

William Armstrong - CL King & Associates

$0.20? Okay. And then, the remainder would be from, like you mentioned before, just a lower expected same store sales number?

Rodney Carter

That and the fact that we don’t annualize the shares and we go into two quarters were we have some losses.

Betsy Burton

In other words, you take all of the earnings away from Baileys but, you don’t get the full benefit in terms of share repurchase.

Rodney Carter

Right.

William Armstrong - CL King & Associates

Right, right. Okay. Any offsets, positive offsets to that? So, from maybe a better than expected gross margins? Or, not necessarily?

Betsy Burton

I think we feel that these are pretty realistic.

William Armstrong - CL King & Associates

Okay. Okay. Thank you.

Betsy Burton

Thank you.

Operator

Your next question comes from the line of David Mann of Johnson Rice.

David Mann - Johnson Rice and Company

Yes, thank you. Good morning. Rodney, can you talk a little bit about what you’re seeing on the credit side in terms of approval rates and penetration and just credit quality in general?

Rodney Carter

Right now approval rates are still continuing to climb. I think we had not emphasized credit to our detriment over time in the portfolio we have and again, the risk is born by Citigroup but, there’s not been any constraint. We’re not seeing anything other than a slight improvement in approval rates. The standards are, the underwriting standards are the same. So, it’s obviously something we want to watch given the macro background but, it’s not something that’s creating problems for us today.

David Mann - Johnson Rice and Company

And, regionally are you seeing that as well? Or, should we assume the macro trends are sort of [inaudible].

Rodney Carter

It’s really not that different.

David Mann - Johnson Rice and Company

Okay.

Then, can you just give us a sense on what the currency impact is on the P&L?

Rodney Carter

Currency impact is less than a half a cent.

Betsy Burton

It’s $300,000.

Rodney Carter

Less than a half a penny.

David Mann - Johnson Rice and Company

Okay. Then, in the second quarter should we see that jump at all?

Rodney Carter

Second quarter I think it will jump noticeable because the volume difference is significantly greater.

Betsy Burton

It is in the numbers though. It’s planned.

Rodney Carter

Yep.

David Mann - Johnson Rice and Company

Okay. Thank you very much.

Betsy Burton

Thank you.

Operator

Your next question comes from Marc Bettinger of Stanford Group.

Marc Bettinger - Stanford Group Company

Good morning everyone. Just real quickly, most of the questions have been answered, the merchandise margin of 80 basis points, how much of that, I guess was less clearance as opposed to holding wholesale?

Betsy Burton

I’d say probably half because the Zale brand is such a significant part, the Zale brand because of the magnitude but, the rest is true growth in terms of the direct sourcing efforts.

Marc Bettinger - Stanford Group Company

Okay. Thank you and good luck.

Operator

Your next question comes from Patrick Forkin of Tejas Securities.

Patrick J. Forkin, III, CPA – Tejas Securities Group, Inc.

Good morning. With respect to your private label credit program, are there any changes in the line up for, you know, as far as the promotions you’re running? And, I was wondering if you could comment on average transaction size for private label versus other means of payment?

Rodney Carter

Average transaction size for private label is materially higher than on average because you’ve got less gift giving, it tends to be more of a bridal SKU. But, there haven’t been any significant changes in those trends.

Patrick J. Forkin, III, CPA – Tejas Securities Group, Inc.

Okay.

Rodney Carter

It’s probably about three times average ticket on a private label card.

Patrick J. Forkin, III, CPA – Tejas Securities Group, Inc.

Okay

Betsy Burton

And, the holiday mailer that is in the mail, we are introducing, new to this year a six month same as cash no payment, no interest, no down which is new to this year.

Patrick J. Forkin, III, CPA – Tejas Securities Group, Inc.

Okay. And then, you mentioned in the past there hasn’t been really the level of emphasis on that in store credit that there should be. My recollection is that about 40% of your volume is on the private label card. Where do you want to be with that program?

Rodney Carter

It’s slightly above 30%, I think before that we’ve probably got eight to 10 percentage points higher mix. We have reemphasized the training and making people aware of the benefits and so, I think we’ll see – the steady decline has plateau or floored out and then we’ve regain some momentum in some of the brands at a modest level.

Betsy Burton

We actually see there’s an opportunity and we have recently put out some new materials, in terms of training materials because, we actually do have a stronger competitive offering than our major competitors. So, we think we have up side on that.

Patrick J. Forkin, III, CPA – Tejas Securities Group, Inc.

Are you talking about your major competitor, you know, in mall?

Betsy Burton

Correct.

Patrick J. Forkin, III, CPA – Tejas Securities Group, Inc.

Okay. Thank you.

Betsy Burton

Thank you.

Operator

Your next question comes from the line of Rod Whitehead of Deutsche Bank.

Rod Whitehead – Deutsche Securities

Hi there. Just three quick questions if I may. Firstly, you mentioned a 400 basis points improvement in brilliant buy. Are you saying that the 25% of sales that will be brilliant buy, those items would have a 400 bit improvement versus last year? Secondly, do you have any forward cover on your gold purchases as of now? Looking ahead to next year really. And, thirdly, your guidance on comps is no change in trend versus the last six months of comps of the group. Does that reflect of you that there will be no deterioration in the year’s consumer environment?

Betsy Burton

Okay. Let’s start with the first one, that’s easy. Yes, you are absolutely correct, the 400 basis point improvement over last year in terms of margins is real. So, in other words it will be brilliant buys will go from 36% down to 25% of the mix at a 400 basis point improvement in margin. In terms of we do not have hedged, we have not hedged but, we have bought and locked into our gold prices through holiday and have priced accordingly. Then, we also see an opportunity with some of the what I call skew rationalization and in some of the metal categories that potentially we have an opportunity to melt and even make a slight profit and then, obviously, repurpose the gold. In terms of comps, the nice thing about having sort of I call it diversified portfolio of brands is that even though US mall traffic is down and those brands have been hurt the most, we also have nice sales comp in outlets and Canada are driving helping offset some of the deterioration. So, the comps that we are projecting we feel pretty comfortable about.

Rodney Carter

We I only did adjust the guidance downwards to reflect this trend.

Betsy Burton

Yes. Did that answer your question?

Rod Whitehead – Deutsche Securities

Yes. Just to be completely clear on the brilliant buy, you’re not saying that it is the reduction from 36% to 25% that gives you 400 basis points?

Betsy Burton

No, it’s both. Yeah, no. It’s the reduction as a percent of the total and it’s an actual improvement in margin as well on that.

Rod Whitehead – Deutsche Securities

The two combined give you 400 basis points?

Rodney Carter

Correct.

Rod Whitehead – Deutsche Securities

Impact on the overall gross margin but then, there’s other things going the other way. You’re not guiding to 400 basis points on the [inaudible] gross margin, obviously?

Betsy Burton

Correct.

Rod Whitehead – Deutsche Securities

Okay, lovely. Thank you very much.

Betsy Burton

Thank you.

Operator

You’re next question comes from the line of Janet Kloppenburg, JJK Research.