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Zale (NYSE:ZLC)

Q3 2012 Earnings Call

May 23, 2012 9:00 am 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

Rick B. Patel - BofA Merrill Lynch, Research Division

David Wu - Telsey Advisory Group LLC

Jeffrey S. Stein - Northcoast Research

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

Operator

Good morning. My name is Christie, and I will be your conference operator today. I would like to welcome everyone to the Zale Corporation's Third Quarter Fiscal 2012 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Ms. Roxane Barry, Director of Investor Relations. Please go ahead.

Roxane Barry

Good morning, 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 on our website, www.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 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. 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 quarterly report on Form 10-Q for the fiscal quarter ended January 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 measures as part of our evaluation of the performance of the company. In addition, we believe these measures provide useful information to investors. Please refer to the appendix in the Investor Relations presentation for a reconciliation of these non-GAAP measures to the most comparable GAAP financial measures.

Now, I'll turn the call over to Theo.

Theophlius Killion

Roxane, thank you, and thank you to everyone joining us on the call today as we report our earnings for the third quarter. For those of you following along with the slides that we posted on our website, please direct your attention to Slide 3.

In our press release earlier today, we highlighted 4 important financial measures that underscore the progress we're making in executing our turnaround plan. They were a comparable store sales increase of 8%. This is our sixth consecutive quarter of comp store improvement and our sales results follow a 15% increase in the same period a year ago, resulting in a 2-year comp of plus 23%. Our plan is working. We have traction, and we're committed to not only returning the business to profitability in the near term, but returning long-term value to shareholders, who believe in our strategy and the work that we're doing to execute it.

Revenues increased $33 million for the quarter to $445 million. Gross margin improved $22 million to 51.3%. During the quarter, we implemented another price increase without adversely impacting sales. We believe that we're building equity in the Diamond Store with great product, and great guest engagement. This allows our jewelry consultants to focus on the features, benefits and quality of our assortment, not just price.

One of the significant accomplishments in our business is when a jewelry consultant sells $1 million worth of jewelry in a fiscal year. This year, for the first time, we had 4 jewelry consultants exceed $1 million by the third quarter, a tribute to their selling skills and to the improvements we're making in our merchandise offerings. And finally, operating earnings of $6 million, an improvement of $12 million compared to the prior year. This is the first time in over 5 years that we delivered positive operating earnings in the third quarter.

As a result of the 4 metrics we highlighted in the press release, net loss per share improved by $0.17. The performance highlights that I just described were driven by executing the business strategy that I referred to earlier, the first element of which is constant vigilance on the core assortment. By achieving our 80% plus goal, it allows us to continuously edit slow turning SKUs, while we methodically introduce new items, test them and expand them once that margin in turn characteristics at or above category norms. Our inventory is much more efficient as we've eliminated unproductive merchandise and reduced our clearance penetration to under 6%.

Having done so, it allows us to test and launch proprietary product, product like Vera Wang LOVE. Growing our penetration of proprietary product is a strategy that will continue to have increasing importance in the future. On our last call, I talked about the work that we're doing to tap into the emerging world of Omni-Channel retailing and marketing. The guest is not standing still and as the guest moves, so too must the way we communicate with them.

Our integrated Mother's Day campaign is an illustration of our blending traditional and new media to communicate with the guest on their terms, another important strategic imperative. And of course, none of this happens without strong execution by our customer-facing teams.

Please turn to Slide 4. Last quarter, I talked about the success that we're having with our Vera Wang LOVE collection. I'm pleased to report that not only has that success continued, but we're expanding the collection in the Zales and Peoples brands while beginning a test this fall in our Outlet division. In total, the collection will be in over 600 stores, and we've already begun testing new SKUs that we believe will keep the collection exciting for our guests. During the Mother's Day selling period, we were part of the We Love It campaign in the May issue of Brides Magazine, with the Vera Wang LOVE collection. Brides entered a Snap Tag app, which, when accessed with a smartphone, shows an exquisite 360-degree video of the Vera Wang ring. The reader has an opportunity to shop the collection from our zales.com site right from their phone. We're happy with the synergy that's been created with Brides Magazine, Vera Wang LOVE and the Diamond Store.

We've also continued the expansion of our bead category by adding approximately 80 additional Persona stores this spring in time for the Mother's Day selling period. We now have over 1,000 stores with this product, and it's continuing to perform well. We will continue to test proprietary products and collections with the expectation of creating a development pipeline that will continuously flow newness into our stores.

On Slide 5, you'll see a visual representation of the Omni-Channel model that we first presented last quarter. Omni-Channel retailing is a realization of the growing number of options for our guests as they interface with our brands whenever and wherever they choose. Over the Christmas selling period, the Ship-to-Store purchasing option was chosen by 16% of our customers placing online orders, and that's increased to approximately 25% this quarter. Of that number, roughly 75% of those guests are new to our brands, which gives us a great opportunity to show them our in-store product offerings in order to generate additional sales.

As the guest continues to refine the ways in which they interact with our brands, new and exciting opportunities are emerging. During the quarter, our Internet sales were up 24% over the prior year, and up 42% over the past 2 years. Mobile has also continued to grow as guests take advantage of the ease of access provided by their smartphones and tablets. In the social media space, we continue to increase the connections we're making with our guests using Facebook, Pinterest and Twitter to create brand engagement.

On Slide 6, we highlight our Celebrate Your Supermom Mother's Day marketing campaign. Last year during Mother's Day, we began to blend media with our What Mom Wants campaign. This year, Celebrate Mom, we took media integration to a whole new level. The idea was to create opportunities for our guests to engage with us on their terms. In April, we launched the campaign with a sweepstakes contest, virtual gifting and the sharing of Supermom stories on Facebook, which was implemented with live just chats on Twitter and collaboration boards on Pinterest. While the campaign was anchored on Facebook, we also used banner ads, direct mail catalogs and television to allow our guests to opt in, interact and choose their media of choice to engage with our brands. This blending of traditional and emerging media grew our Facebook fans by over 100,000 to almost 700,000 and most importantly, helped us to deliver a very good Mother's Day performance. Our approach, which was acknowledged by Google News, Adweek and the New York Times, recognizes that holidays are no longer defined by in-the-moment transactions but relationships that are built over time. But it's not just about emerging technologies. We also leveraged National Mom's Night Out, a live event at over 100 Simon Malls with an average of 1,500 moms attending each event. We sponsored momsnightout.com and used banner ads to drive traffic to our stores. The game has changed, and we believe it's critically important to adapt our business to embrace these changes.

Turning to Slide 7, I want to highlight some of the changes we've taken to continue to drive operational efficiencies in our business. First, we consolidated our distribution operations by moving our Piercing Pagoda Distribution Center, which was in a different building, to the store support center and integrating it with our Zale North America DC to increase efficiencies and reduce expense. We now have one workforce that's organized based on operating and process efficiencies to improve throughput and in-stocks.

During the quarter, we also held our second Vendor Summit with 50 of our top vendors. We're committed to building strong relationships with our key constituents and aligning interests for the long-term growth of our business. During the summit, we reinforced our expectations on quality, and delivery. We also restated our commitment that we and our partners operate to the highest ethical standards. We have been and we continue to be pleased by the strong sense of partnership and commitment shown by our vendors. Our focus on consistently improving operational efficiency helped us in achieving SG&A leverage with a 120 basis point improvement as a percent of sales.

Another important change that we made to our Pagoda business was to announce Jamie Singleton as Senior Vice President and General Manager. Jamie is an experienced retail executive with an extensive background in merchandising, sourcing and business development. Jamie has been with the business less than 2 months, but she's already had a deep immersion during her onboarding. She has worked extensively with our Pagoda merchants and planners, and she's worked in 2 different markets, selling to our Pagoda customers as a sales associate. This first-hand experience with merchandising with our Pagoda customers will serve her well as we focus on stabilizing and growing this important brand. We're pleased to welcome Jamie to the team.

On Slide 8, there's a recap of our Mother's Day results. Mother's Day, as you know, is our third biggest holiday, and I'm pleased to report that May month to date, we've delivered a 15% comp, or approximately 6%, when we adjusted for the Mother's Day timing shift from a year ago. Our selling teams did a terrific job of building great guest connections with our guests at point of sale and driving revenue.

I'll now turn the call over to Tom to talk about the financials in more detail.

Thomas A. Haubenstricker

Thank you, Theo, and good morning, everyone. I'm pleased to report our third quarter results and to discuss the progress we are making towards returning the company to profitability. Let me start my comments on Slide 9 with an overview of our third quarter financial performance, beginning with our top line.

Revenues for the third quarter were $445 million, an increase of $33 million, or 8.1%, compared to $412 million for the same period in the prior year. The increase in revenues is primarily due to the 8% same-store sales growth that Theo already mentioned. We also received an $8.5 million lift in revenue from the change in the warranty revenue recognition that we discussed in the first quarter's earnings call. The overall increase from these sources was partially offset by the revenue reduction associated with the net decrease of 54 stores compared to last year. Our 8% same-store comp this quarter reflects the sixth straight quarter of positive comps and comes on top of a 15.2% comp in the prior year's third quarter, giving us a 2-year comp of over 23%. The 8% comp for the quarter was achieved despite the unfavorable impact from the Mother's Day calendar shift. We estimate the unfavorable impact from this shift on our comps for the quarter was approximately 200 basis points.

Our 8% increase in comparable store sales was driven by an 8% increase in the number of units sold in our Fine Jewelry stores and a 1.5% increase in the average price per unit sold. In our Bridal business, which represents about 50% of our sales, we experienced a slight increase in number of units sold combined with an increase in average price per unit sold. We continue to be pleased with the impact that our Vera Wang product line has had on this merchandise category. For Fashion, we experienced an increase in unit volume offset by a lower average price per unit sold. The message for the Fashion business reflects both the recent price increases and the offsetting effect caused by the success of our lower price point bead business.

We believe this dynamic will continue in the near term as we maintain a selection of items at entry-level price points. Using constant exchange rates, which exclude the effect of change from foreign exchange rates, comparable store sales increased 8.3% for the quarter. The average Canadian currency rate weakened 2% relative to the U.S. dollar this quarter as compared to last year's third quarter. The impact of the foreign exchange rate on our third quarter's earnings was not significant, as the rate differential impacted both revenue and cost.

We achieved gross margin for the quarter of $228 million, or 51.3%, compared to $206 million, or 50.1%, for the prior-year period, an improvement of 120 basis points, or $22 million. Let me go through some of the factors that impacted the gross margin compared to last year. The revenue recognition change related to lifetime warranties improved our gross margin by 100 basis points. However, this was partially offset by a 50 basis point impact from higher LIFO charges. The overall progress we've made on our gross margin has been achieved through a combination of price increases, lower merchandise discounts and improved inventory quality, partially offset by the year-over-year impact of rising commodity costs.

SG&A expense for the quarter was $213 million, or 47.9% of revenues, compared to $202 million, or 49.1% of revenues, in the same period in the prior year. The $11 million increase in SG&A expense was primarily due to higher payroll and performance-based compensation earned by our field organization as the result of higher sales, and increasing credit fees, also a result of higher sales, and an increase in promotional and marketing expenses. These increases were partially offset by a decrease in SG&A in occupancy costs related to 54 store closures over the past year.

We are pleased with the 120 basis point improvement in the SG&A rate. As we discussed in previous calls, we plan to continue to make the necessary investments in our business, however, over time, our goal is to drive improvement in SG&A as a percent of revenue as we effectively leverage the growth of our business.

For the third quarter of 2012, we posted operating earnings of $6 million compared to an operating loss of $5 million in the prior year's quarter, representing an improvement of $12 million. On a percent of revenue basis, our operating earnings was 1.4%, compared to an operating loss of 1.3% in the prior year.

Interest expense for the third quarter of 2012 was $10 million compared to $9 million in the prior year. This increase was primarily a result of the higher average debt balance as compared to a year ago. In the third quarter of fiscal 2012, we recorded an income tax expense of $900,000 compared to a benefit of $4 million in the same period last year. The income tax benefit in the third quarter of fiscal 2011, which represented $0.14 earnings per share, was related to net operating loss carrybacks recognized pursuant to the Business Assistance Act of 2009. Loss from continuing operations for the third quarter of 2012 was $4 million, or $0.14 per share, an improvement of $0.17 per share compared to the prior-year loss of $10 million, or $0.31 per share.

Now please turn to Slide 10, where I'll outline the main drivers of our third quarter 2012 improvement in our net loss per share from continuing operations. Starting with last year's result, which was a $0.31 loss per share, the gross margin improvement was $0.40, driven by the top line growth that we've achieved. This improvement is net of the higher LIFO charges that I discussed earlier. The change in warranty revenue recognition improved net loss per share by $0.25. The increase in SG&A expense impacted this quarter by $0.32. Other items, mainly interest expense, negatively impacted the third quarter by $0.02, and the tax credit we received in the prior year's third quarter, which I mentioned earlier, had an impact of $0.14 in the comparison. This brings us to a quarter's loss per share of $0.14 and a $0.17 improvement over the prior-year comparable results.

Now, please turn to Slide 11, as I take you through comparable store sales details for the quarter. This quarter, as we stated earlier, total company comp was 8%, following a 15.2% rise in the last year's third quarter and up 8.3% on a constant currency basis.

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 10.9%. This increase follows a 15.9% rise in the same period last year. Our Canadian Fine Jewelry brands, consisting of Peoples and Mappins, had an increase in comparable store sales of 3.8%, or up 6% at constant exchange-rates. If you recall, our Canadian business produced a flat comp in the previous quarter, and we are pleased to see the resumption of growth in this area. Our 3.8% comp this quarter follows an increase of 21.6% in last year's third quarter, or 15% at constant exchange rates. And lastly, our Kiosk Jewelry had a comparable stores sales decrease of 1.1% in the third quarter, following an increase of 6.7% in the same period last year. I also want to mention that these comps include sales from the associated online businesses.

Please turn to Slide 12, as I take you through our balance sheet and liquidity. Inventory in April 30, 2012 stood at $779 million compared to $756 million at the end of third quarter last year. The increase of $23 million was primarily due to the impact of higher commodity costs on our inventory and the additional merchandise in stock at the end of the quarter due to a later Mother's Day this year compared to last year. As of April 30, 2012, the company had cash and cash equivalents of $37 million, which was essentially unchanged from last year's comparable quarter. At the end of the third quarter of fiscal 2012, the company had total outstanding debt of $446 million compared to $375 million as of April 30, 2011. In addition to the term loan of $140 million, long-term debt also included $302 million borrowed under the revolving credit facility and $3 million of capital leases. The increase in debt compared to last year was due in part to the financing of additional inventory. As of the end of the quarter, the company's total net borrowing availability, adjusted for the minimum liquidity requirements, was $109 million. It is also noteworthy to report that our fixed charge coverage ratio is now at 1.15, which is 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. A recent improvement in this ratio is important as we continue to evaluate opportunities to refinance our existing debt to reduce our current level of interest expense. For example, with our fixed charge coverage ratio now above 1, we are no longer prohibited from making principal prepayments on our term loan.

During the third quarter of 2012, capital expenditures totaled $4 million compared to $3 million in the prior-year quarter, and were devoted primarily to the refurbishment of stores and technology infrastructure investments. On a year-to-date basis, our capital expenditures totaled approximately $14 million, and we now believe that our capital expenditures for the current fiscal year will be approximately $23 million.

I'm now going to cover the overall store count for the quarter. I should mention we have included a page in the appendix that contains the current store count. We ended the third quarter with 1,134 Fine Jewelry stores and 658 Kiosks for a total of 1,792 retail locations, compared to the prior-year third quarter count of 1,173 Fine Jewelry stores and 673 kiosks for a total of 1,846 locations. During the quarter, we closed 17 Fine Jewelry stores and changed the nameplate on 1 Gordon's to Zales. We also closed 1 Kiosk. Our expectation continues to be that we will selectively close a small number of stores that are underperforming at lease expiration. We are not focused on opening new stores in the near term, but are instead focusing on improving the productivity of our current store base. This includes refurbishing select stores. This quarter we completed refurbishment of our Peoples store in Toronto Eaton Center, which we opened in April, and we completed renovation of 4 Zales stores in April.

Now please turn to Slide 13 while I walk you through some of our year-to-date financial highlights. Revenues for the first 9 months were $1.5 billion, an increase of $95 million, or 6.9%, compared to $1.4 billion for the same period in the prior year. The increase in revenues is primarily due to an increase of 6.5% in comparable store sales. We achieved gross margin for the first 9 months of 51.5% compared to 50.3% for the prior-year period, an improvement of 120 basis points, or $65 million. We achieved operating earnings year-to-date of $27 million, or 1.8%, compared to a loss of $4 million in the prior-year period, an improvement of 210 basis points, or $31 million. Our reported loss from continuing operations for the first 9 months of 2012 was $7 million, or $0.22 per share. In the prior-year period, loss from continuing operations was $79 million, or $2.47 per share.

Now, please turn to Slide 14, where I've outlined the main drivers of our year-to-date 2012 improvement and our net loss per share from continuing operations. Starting with last year's loss per share of $2.47, the first I have adjusted for the onetime interest expense item resulting from last year's amendment to our senior secured term loan, which negatively impacted last year's results by $1.43 per share. That brings us to an adjusted prior year loss per share of $1.04. Gross margin improvement contributed $1.07, primarily due to the top line growth. This improvement is net of the greater LIFO charges discussed earlier. Our other improvements totaled $0.21, which was driven by a lower tax expense in Canada, lower charges related to store closures and impairments, and lower depreciation charges partially offset by higher interest expense, all compared to the prior year. The change in the warranty revenue recognition improved net loss per share by $0.80. The increase in marketing and other SG&A expenses impacted the period by $1.12. The primary driver of this impact was the higher holiday marketing expense in the second quarter and other growth-related expenditures. And as I mentioned on the third quarter walk, tax credits received in the prior-year third quarter, which were not repeated in 2012, negatively impacted the year-over-year comparison by $0.14 per share. That brings us to the $0.22 loss per share we reported for the first 9 months, an improvement of $0.82 per share.

Now, please turn Slide #15. I want to quickly go over our year-to-date comparable store sales. The total company comparable store sales were up 6.5% and up 6.6% at constant exchange rates. Our U.S. Fine Jewelry brands had an increase of 9.1%, while our Canadian Fine Jewelry brands had a year-to-date increase in comparable store sales of 3.2%, or 3.8% at constant exchange rates. And finally, our Kiosk Jewelry year-to-date comparable store sales were down 2%. As Theo mentioned earlier, we are excited that Jamie Singleton has joined our team as Senior Vice President and General Manager of Pagoda and look forward to her contributions to growing this business.

Now, please turn to the next slide, #16. I want to make some final comments as we move into our fourth quarter. We are clearly focused on maintaining consistent positively quarterly sales growth and as Theo has already mentioned, May is off to a good start with comparable same-store sales month-to-date up approximately 15%. When adjusting for the favorable Mother's Day timing shift, comparable store sales for May month-to-date are up approximately 6%. As I mentioned earlier, this timing shift negatively affected the third quarter comp by approximately 200 basis points and we would expect the favorable impact in the fourth quarter to be of similar magnitude.

We've previously estimated that the revenue recognition change related to lifetime warranties would increase revenues by about $30 million for fiscal year 2012. With the year-to-date increase at $27 million, the full-year effect on revenue is now expected to be closer to $35 million.

On the gross margin side, we continue to expect gross margins at or above 50%, and we are focused on maximizing gross profit dollars. We will do that by closely monitoring commodity cost and taking pricing actions where necessary.

On SG&A, we expect the fourth quarter SG&A expense as a percent of revenue to be below last year's fourth quarter percent of revenue level of 54.1% as we continue to leverage the growth of the business. When we report our fourth quarter and fiscal 2012 results in August, we expect to include commentary on our financial expectations for fiscal 2013.

In closing, we are satisfied with the progress we've made in the third quarter, and look forward to further progress as we move into our fourth quarter. I would now like to turn the call over to the operator to begin the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Rick Patel of Bank of America Merrill Lynch.

Rick B. Patel - BofA Merrill Lynch, Research Division

Can you give us some more color on the price increases that you've passed along? Perhaps highlight the areas where you saw the most successes in and perhaps where customers push back a little bit, and should we anticipate more price increases as we think about the next few quarters?

Theophlius Killion

Let me give it a start. So, I think the best way to evaluate the effectiveness of the price increase program is looking at the financial performance that we've produced, both the comps on revenue, as well as the gross margin improvement. It's obviously a complex process in looking across the merchandise assortment and how and when we deliver price increases because it's not say every one of them has exact performance criteria. But overall, we're satisfied with how that program has gone. And I think the results are evident in looking at what we've been able to achieve in terms of gross margin dollar improvement over the last few quarters in, frankly, a pretty difficult environment with our pricing commodity cost. And as far as going forward, I mean, we're not going to get into discussions around our future price increases but we'll continue to do what we have to do. I mean, we've mentioned before, gross margin stabilization is important to the company, as well as driving positive comps, so we'll have to manage that program going forward and to react to what we see on the cost side.

Rick B. Patel - BofA Merrill Lynch, Research Division

Okay. And then can you talk to us about your latest thinking about your term loan. With the fixed charge ratio now above 1x, what do you see as the biggest obstacle to refinance that loan and perhaps highlight the pros and cons of actually doing so?

Thomas A. Haubenstricker

So, I'd love to talk about that. Clearly, we mentioned several calls ago, that the refinancing our debt structure and lowering our cost of borrowing is a key focus area for the management team. We thought at the time, the best way to move that forward was to really drive financial improvement and the operating performance, both in terms of improving the revenue comps and particularly improving the bottom line. We're very satisfied at what we look now, what we've been able to achieve from that standpoint. And there's no question that the financial performance improvement that we've driven, the fact that we now have positive operating earnings in the third quarter and the year-to-date, that the fixed coverage ratio is now better, really gives us more options and improves the quality of those options as we think about refinancing. There are a number of variables we have the look at. Clearly, we're focused on maintaining the necessary access to liquidity that we need to grow the business, but also then in driving better economics on the borrowing cost. And when we have more to definitively say about it, we will. There are a number of options we're looking right now. But clearly you should take away that we're in much better shape in terms of what we have in front of us, given what we've been able to achieve financially in the last several quarters.

Rick B. Patel - BofA Merrill Lynch, Research Division

Okay, that's great. And then just lastly, can you talk about perhaps just the competitive environment and what it feels like right now. Do you see this as very aggressive? Do you see it as balanced? And then as you think about your longer-term strategic vision, how much do you expect the proprietary brands' penetration to increase to? Should we expect meaningful upside from here or should we just expect incremental gains over the next couple of quarters?

Theophlius Killion

Rick, it's Theo. First of all, from the competitive standpoint, we think things are fairly stable. We haven't seen a whole lot of disruption over the last quarter and over the last 6 months, frankly. And we expect that, that will continue as we look forward into the next couple of quarters. In terms of -- I'm sorry, what was the second part of your question, Rick?

Rick B. Patel - BofA Merrill Lynch, Research Division

Yes, just define the penetration of proprietary products? Do you see that increasing meaningfully as you allow new brands and products?

Theophlius Killion

Yes. It continues to be a priority. We will continue to focus on it and expect that that penetration will increase as it relates to the fall season as we complete our testing through Mother's Day, get better reads and look to do a couple of other introductions this fall.

Thomas A. Haubenstricker

Yes, and Rick, if I can add in to that. As Theo talked about before, I mean, I think you have to look at the upside on proprietary products both in terms of we think there's more mileage to go on the ones we have out there in terms of increasing penetration in the stores but, and then also, new potential products. So we're still very excited about what we think is in front of us in terms of revenue in that category.

Operator

Your next question comes from the line of David Wu of Telsey Advisory Group.

David Wu - Telsey Advisory Group LLC

First, you mentioned that because you are above the fixed charge coverage ratio threshold of 1x, that you can now make prepayments. And I was wondering if this could be part of your cash usage going forward?

Thomas A. Haubenstricker

No, we mentioned it as simply an example of how our improving financial performance is really expanding the options that are available to us as we think about refinancing. We clearly are doing work in looking at the entire debt structure that we have, nothing is off-limits in terms of both the RCA and the term loan and looking to see how we can integrate those into the most effective structure for the company that, again, balances the preservation of access to liquidity but driving some significant benefits on reducing the borrowing costs. So it's really about looking at that whole program in different ways, in different options that we have to integrate those 2 together to come up with what makes sense for the company. As I said, we'll have more to say when we reach to a point that it's a definitive fast-forward, but we are very encouraged again by what the financial performance improvement has done for us. And we are all focused with our financial advisors now in looking at the right path forward. An example of one of the things that we could do now, which we couldn't do a couple of quarters ago.

David Wu - Telsey Advisory Group LLC

Great. And on credit sales, can you talk about sort of how trends are in the quarter? Any changes called out with respect to your approval rates and also with the alternative financing programs? Are you seeing your net credit sales in the U.S. increase sort of around -- sort of that mid-30s range now as a percentage of sales and do you think as you continue to sort of move higher especially as you enter into more of these type of arrangements?

Matthew W. Appel

Sure, David. This is Matt and I'll take that one. Our approval rates continue to be strong. Not significantly better, for example, than last quarter but last quarter was strong as well. When you factor in the impact of alternative financing, which we don't disclose separately, our approval rates are up 3% to 4% in the U.S. over the prior year. We're very encouraged by that. We're also very encouraged by the fact that spending by new accounts is up rather significantly. And so, the credit programs are healthy. And we intend to continue to focus to bring additional lenders to the alternative financing program. There were no changes during the third quarter. Perhaps we'll have some to talk about in the future. But that's been an area that supported our underlying base program in the U.S. very well, and has helped us gather additional momentum in the marketplace.

David Wu - Telsey Advisory Group LLC

Great. And just lastly, can you talk about the performance of the Warranty business and I know you've taken some initiatives and put them in place in terms of improving the employee training. I was wondering if that's also helped to drive better traction there?

Matthew W. Appel

Yes, David, that's a great question. Thanks for giving us the opportunity to highlight something that's performed -- an area that's performed quite well for us. The warranty business is very, very healthy. Both the price increases, the refinements we've made in the product line, the significant emphasis that our field personnel have put on selling warranties and demonstrating value to our guests have paid fairly substantial dividends to us. If you look at warranty on a cash basis, which is the way we measure, month over month, how effective we are, we were up over 30% year-over-year in the third quarter, that is third quarter of fiscal '12 versus '11, and that's a trend that's continued throughout the year. If you recall, when Tom talked about the accounting change a couple of quarters ago, a very significant portion of what's recognized is what you sell in the current year and so, there's no opportunity to rest on amortization of prior years. It's all about what we sell currently and with a 30% improvement, we're very pleased with the performance of our warranty programs and that's across Fine Jewelry and across the Kiosk business as well.

Operator

Your next question comes from the line of Jeff Stein of Northcoast research.

Jeffrey S. Stein - Northcoast Research

A question for you on just kind of what your customer's doing when they walk into the store. Are they coming in and are they buying to a specific budget or are they looking at the item and say, I'll take that item despite the fact that prices are going up, because it sounds like ticket is relatively flat. So it would seem more the former than the latter. Would that be correct?

Theophlius Killion

So I believe that when the guest crosses our lease line they're coming across because the marketing messages that they've seen in any number of sources, as I talked about earlier, I believe they're coming in because of the momentum that we're building with proprietary products like Vera and like our Persona Bead program. And I believe that they are looking at merchandise that's improved dramatically over the last 2 years, falling in love with the merchandise, and then listening to our jewelry consultants on a selling basis. As I said, we have 4 people who have sold $1 million worth of jewelry by the third quarter, which is a record for us, and I think that's a testimonial to not only the work that we've done on the merchandising side but also the quality of selling effort by our teams.

Thomas A. Haubenstricker

And Jeff, let me add to that. I think you have to look at that customer buying behavior is slightly different between Bridal and Fashion. In our Bridal business, there has been some price increases. We've also introduced the Vera Wang line which has increased the average price points and even with that, we're seeing an increase in number of volume, units in volumes. So we actually have both sides working for us, increasing prices and increasing volume. In Fashion, it's a little bit different and we've had price increases there as well, but we've also introduced the Beads, which has a much lower average price point. It aids them very well, in terms of resonating with the customers. We're seeing some interesting customer patterns in terms of multiple buying with the Beads that we're encouraged on. But it's that Bead business within fashion that basically brought down the overall average price.

Theophlius Killion

The other point that I'd make about the Vera Wang introduction is it hasn't cannibalized the rest of the bridal offering, so everything is actually performing quite well in addition to the progress that we're making with Vera.

Jeffrey S. Stein - Northcoast Research

Okay. So if we were to exclude Beads from the equation, what would AUR have been up in the quarter, approximately?

Thomas A. Haubenstricker

We've decided to report the numbers with Beads in place because it's becoming a big part of the number of transactions. So we don't want to exclude any one merchandise category. Clearly, the average price of a bead will be around $40 is going to bring down the average ticket as that business gets bigger. But it is an important part of the merchandise assortment. It's appealing to people looking for items at that entry-level price point, and it's generating good revenue, good margin for us.

Jeffrey S. Stein - Northcoast Research

Okay. On the Piercing Pagoda DC consolidation, any estimate time in terms of what the annual savings of that move will be?

Thomas A. Haubenstricker

Not at this point. I think the good news on it is that the costs associated with it are all behind us because it's been fully implemented. We know there'll be savings. The team is really getting into the full extent of those savings in terms of going all the way through the logistical process. We talked about that because we thought it was a good example for our -- the investors to understand our focus is clearly on growing the top line and improving the core merchandise assortment. But it's also in looking at how we can improve the efficiency of the business. And that's an important part of our roadmap to profitability. So I don't think the dollar savings of that one item are going to be that material in nature but it was just an example of an area where we can drive improvement and profitability and improve the efficiency of the business along the way.

Theophlius Killion

What it will do however, is it's going to dramatically increase our ability to have in-stocks. For instance, about 4 years ago, we invested in a new sortation technology here in this building and we weren't able to leverage that in Piercing Pagoda. Already, we've had as much as 220,000 items that would've normally taken about a week to get through our Pagoda DC that we can now get through in a day. So the ability to be able to get merchandise in time, in-store, in the right places has been increased dramatically.

Jeffrey S. Stein - Northcoast Research

Perfect. And a final question, this goes back to the possibility of refinancing, would you consider on an interim basis to use your credit line as kind of a bridge before you were to secure more longer-term financing on that piece?

Thomas A. Haubenstricker

So, as I mentioned, Jeff, at this point we're looking at a number of options. We haven't ruled anything out in terms of how we look at both facilities, the RCA and the term loan. There've been potential changes in place for both of those, and we look at it as an integrated debt structure. So we're looking at numerous options in a way that we can again, I mentioned before, preserve the access the liquidity that we need for the stability of the business. But to do so on a manner that significantly reduces the borrowing costs. So all those things are being looked that.

Operator

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

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

Going back to the Pagoda distribution center, what were the costs involved during the quarter in that integration and would those have been in the SG&A line or the cost of goods sold?

Thomas A. Haubenstricker

So, the cost associated with that move was not material. Some of the costs went to SG&A and cost to revenue but again it wasn't material. The team was able to execute that with minimal capital costs. So it's again -- it's more about an example of an area where it's not all about top line growth. It's also about improving the efficiency, both in terms of driving financial benefit and, as Theo mentioned, actually improving the operating efficiency of giving inventory in the stores. So we wanted to discuss that because it's something that we're proud of. We think it's going to have a benefit going forward. The costs are all behind us. The benefit's in front of us. And it's just a good example of hopefully more items that we'll look at to drive operating efficiency. But clearly, to answer your question, the costs were not material in terms of getting that done.

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

Got it. And so that means all -- that's all of Pagoda's distribution then? So now all of that is in the Zale Distribution Center?

Theophlius Killion

Yes. We have one DC for all of our businesses now except for our Canadian DC, which is in Toronto. So Zales, Zales U.S. and Pagoda has one workforce and they can be moved and pushed against work and aren't defined by the brand that they serve.

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

Got it. Okay. A clarification on Vera Wang. As I think, Theo, in your opening comments I heard you say 600 stores, is that -- are they in over 600 stores now or is that the big goal for later this year?

Theophlius Killion

That will be like fall this year. So later on this year, we'll be at 600 stores.

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

Got it. Okay. And then just a clarification on the warranty revenue recognition change. When we're looking at that $0.25, that's $0.25 improvement compared to what your earnings would have been under the old accounting treatment, is that correct?

Thomas A. Haubenstricker

Right, it's looking at what the impact in the quarter that the change in accounting drove to the EPS.

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

Right. So that is not the same as saying $0.25 of noncash income?

Thomas A. Haubenstricker

I mean, the nature of a warranty is it's all cash because the reflection for that, even with the change in accounting, we're still collecting the cash. I had it when we recognized the earnings. We're recognizing the earnings differently than how we've done in the past and that's what we've attempted to disclose but it's still cash coming in the door faster than earnings are being recognized.

Operator

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

Theophlius Killion

So on behalf of management, we want to thank everyone for joining us on the call today. And particularly, for your continued support. We look forward to speaking to you again as we report our fourth quarter and full-year results later on this year.

Operator

Ladies and gentlemen, that concludes Zale Corporation's third quarter fiscal 2012 earnings conference call. We appreciate your time, you may now disconnect.

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