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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

Jeffrey S. Stein - Northcoast Research

David Wu - Telsey Advisory Group LLC

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

Janet Kloppenburg

Steven J. Kernkraut - Berman Capital Management LP

Zale (ZLC) Q4 2012 Earnings Call August 29, 2012 8:30 AM ET

Operator

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

Roxane Barry

Good 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, zalecorp.com.

Before we begin, I'll read our Safe Harbor statement. Our commentary and responses to your questions on this conference call will contain forward-looking statements, including statements relating to our sales, margins, commodity costs and other expenses, operating and net earnings and other goals, plans and objectives. These forward-looking statements are not guarantees of future performance, and a variety of factors could cause our actual results to differ materially from the anticipated or expected results expressed in these forward-looking statements. Additional information concerning other factors that could cause actual results to differ materially from those contained in the forward-looking statements is available in our quarterly report on Form 10-Q for the fiscal quarter ended April 30, 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 interests, taxes, depreciation and amortization. A second non-GAAP measure is adjusted EBITDA, which excludes charges related to store closures. We use these measurements as part of our evaluation of the performance of the company. In addition, we believe these measures provide useful information to investors. Please refer to the appendix within the Investor Relations presentation for a reconciliation of these non-GAAP measures to the most comparable GAAP financial measures. I will now turn the call over to Theo.

Theophlius Killion

Thank you, Roxane, and good morning, everyone, joining us on the call today as we report our fourth quarter and fiscal year 2012 results. If you're following along with the slide presentation posted on our website, please turn to Slide 3. I'll begin by providing some texture to our financial results for the quarter and for the fiscal year, and then I'll outline our strategic focus for 2013. Starting with our fourth quarter, we delivered an 8.3% comparable store sales increase on top of a 9.8% increase in the same period last year. Importantly, this was our seventh quarter in a row of positive comps and our third consecutive quarter of achieving a positive comp on top of a prior year positive comp. In the quarter, we accelerated our progress towards returning the business to profitability. Our gross margin improved by 30 basis points, and our operating margin improved by 450 basis points. And as we continue to grow our top line, we gained further leverage on SG&A expenses.

Finally, as we announced last month, we significantly improved our capital structure by refinancing our debt. This increased our liquidity, modified our covenants and will substantially lower our annual interest expense. We believe that these results are a clear affirmation of our accomplishments over the past 2.5 years. Essentially the same constituents that evaluated our business in 2010, our bank group and Golden Gate Capital concluded that our business is now stronger, healthier and that we've made important progress towards returning the business to profitability.

Now turn to Slide 4. I'm now going to cover our fiscal year 2012 highlights. For the year, we achieved a 6.9% comparable sales increase on top of an 8.1% increase in the prior fiscal year. Our operating earnings for the year were $19 million, a $47 million improvement year-over-year and represented the first annual operating profit since fiscal year 2008. These financial accomplishments are a direct result of disciplined execution of our multiyear strategy. During 2012, we achieved significant progress in every area of that strategy. First, we continued our focus on the merchandise assortment, improving the core by thoughtfully layering in proprietary product. During fiscal 2012, our core product mix improved to over 85%, and we introduced Vera Wang LOVE and Persona, 2 proprietary collections that you can only get at the Diamond Store. Both collections have performed well and have been expanded. We focused on striking the right balance between the value our guest demands and taking price increases. We delivered on this promise by maintaining competitive offerings with opening price points, while managing the impact of commodity cost increases.

Another key area of focus in 2012 was our marketing presence, which was designed to support our merchandising strategies while also elevating our brands. There was no better validation of our marketing than to have 600,000-plus people opting in to view our television commercial montage for YouTube last holiday. And because speaking to guests is no longer a one-dimensional conversation, we expanded our Omni-Channel business model across mobile and social media, web stores and traditional stores to provide access to our products, where and when our guests want it. An important part of that strategy is our web store business. eCommerce sales increased 16% in 2012 and over 40% in the past 2 years. Revenue from eCommerce sales is now about 5% of total revenue, which doesn't adequately represent the true value of the eCommerce guest. We believe that most guests initiate their shopping experience online, researching and comparing what's available before making their purchase in one of our traditional stores.

A great example of the benefit of Omni-Channel is our Ship-to-Store option. In the second quarter, we introduced the Ship-to-Store capability in the United States, which has exceeded our expectations. In the second half of fiscal 2012, Ship-to-Store represented about 25% of web sales. This is important for several reasons. It provides us with an opportunity to add warranty to the sale. It also provides a convenient delivery option for our guests, and it enhances the guest relationship model. Importantly, about 75% of our Ship-to-Store guests haven't shopped in our traditional stores for over a year. Traffic that Ship-to-Store creates provides our jewelry consultants with the opportunity to showcase our collections and add on to the sale. We also expanded our social media presence over the last year, utilizing Facebook, Pinterest and Twitter to increase brand awareness. An example of our traction in social media is the number of Facebook followers we have. That number is now 0.75 million.

In fiscal 2012, we continue to make strategic investments in our team to build capability and improve our business. A key example is Piercing Pagoda, where we added Jamie Singleton in the third quarter to lead that business. We also made investments in our field selling, credit and repair, sourcing, IT and real estate teams. We've invested in a disciplined fashion, adding talent to provide additional focus on opportunities to drive revenue and fine-tune costs. Improving our processes is also an important pillar of our strategy. We've added focus to our brands by adding talent to our merchandising, planning and marketing teams that concentrate on the unique differences of our brands. We also introduced rigorous product testing processes to minimize risks and optimize productivity. We will not invest before successful test results.

Please turn to Slide 5. Our strategic focus for fiscal 2013 is consistent with our focus in 2012. In fiscal 2013, we will continue to improve our merchandise assortment, which includes fine-tuning our core products, while expanding proprietary collections in both bridal and fashion. In bridal, we have 2 key initiatives underway for fall. First, we're expanding the very successful Vera Wang LOVE collection to a total of 625 stores, including Zales Outlet and our Canadian brands. Second, this fall, we're relaunching our successful Celebration Diamond collection. The foundation of this business is our 102 facet Celebration Diamond in the U.S., and a similar 100 facet Celebration Diamond in Canada. We will be expanding this collection with a good, better, best product selection that will provide our guests with one more compelling reason to shop at the Diamond Store. The collection will complement Vera Wang LOVE and further strengthen our successful wedding business.

In diamond fashion, we'll be introducing an assortment of colored diamonds and gemstones in a rainbow of colors that have tested well, including blue, yellow, black and champagne diamonds. This product will be available in a variety of affordable price points. In watches, we're introducing new brands that are bringing better watches to select stores. To support this effort, we're providing comprehensive training on the features and benefits of these product lines to our store’s teams. Importantly, all of these initiatives are being implemented before the critical holiday season. In the upcoming fiscal year, our marketing will continue to celebrate the Diamond Store while also supporting our merchandising initiatives for the holiday selling period. We will continue to expand our Omni-Channel capability, so that we connect with our guests on their terms. For example, as a result of this success with Ship-to-Store in the United States, we'll be expanding this option to Canada in the fall. In the past, we've talked about our ongoing efforts in training and specifically, to our continuing commitment to the Diamond Council of America certification program. We’ve improved from 15% DCA certified associates in early 2010 to almost 65% today. Also, in partnership with our vendors, the training investment will continue and includes comprehensive training from the Celebration collection that we're relaunching this fall. We will invest about 20,000 training hours, educate our sales teams on the features and benefits of the Celebration collection. We are firmly committed to having talented, well-educated associates in our stores, who can elevate the guest experience and deliver the promise of being the Diamond Store.

In summary, we've made significant progress in our multiyear turnaround, but we know we have more to achieve. We expect to return the business to profitability in fiscal 2013, but we won't stop there. We will continue to strive to implement additional process efficiencies, improve the business and drive shareholder value. I'll now turn the call over to Tom to talk about our financial results in more detail, and to give you some color on our fiscal 2013 expectations.

Thomas A. Haubenstricker

Thank you, Theo, and good morning, everyone. I'm pleased to report our fourth quarter and fiscal year 2012 results today. Let me start my comments on Slide 6, with an overview of our fourth quarter financial performance, beginning with our top line. Revenues for the fourth quarter were $407 million, an increase of $30 million or 7.9% compared to $377 million for the same period in the prior year. The increase in revenues is primarily due to the 8.3% same-store sales growth that Theo already mentioned. We also received a $7.6 million lift in revenue from the change in 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 51 stores compared to last year. Our 8.3% same-store comp this quarter reflects the seventh straight quarter of positive comps and comes on top of a 9.8% comp in the prior year's fourth quarter, giving us a 2-year comp of approximately 19%. The 8.3% comp this quarter was driven by strong performance in our bridal business, where we experienced both an increase in number of units sold and an increase in average price per unit sold. We continue to be pleased with the impact our Vera Wang LOVE collection has had on this merchandise category.

Our fashion business also experienced overall growth for the quarter. As I discussed last quarter, we continue to experience an increase in unit volume in our fashion business, partially offset by a lower average price per unit sold. The metric for the fashion business reflect both recent price increases, and the offsetting effect caused by the success of our lower-price-point B business. We believe this dynamic will continue in the near term. Using constant exchange rates, comparable store sales increased 9.2% for the quarter. The average Canadian currency rate weakened almost 5% relative to the U.S. dollar this quarter as compared to last year's fourth quarter, causing a $3 million negative impact to revenue. The impact of foreign exchange rate on our fourth quarter earnings was not significant as the rate differential impacted both revenue and cost.

We achieved gross margin for the quarter of $210 million or 51.6% compared to $193 million or 51.3% for the prior-year period, an improvement of $16 million or 30 basis points. Our gross margin was favorably impacted by the revenue recognition change related to lifetime warranties of $7.6 million, and was unfavorably impacted by a LIFO charge of $6 million. Our gross margin in the prior year's fourth quarter was impacted by a similar-sized LIFO charge, and also contained a favorable adjustment to the inventory reserves due to an overall improvement in the inventory quality. As stated in prior calls, we have continued to adjust price points in the market to offset the impact of rising commodity costs in order to maintain stability in our gross margin rate.

SG&A expense for the quarter was $208 million or 51% of revenues compared to $204 million or 54.1% of revenues in the same period in the prior year. $4 million increase in SG&A expenses was primarily due to higher payroll and performance-based compensation, driven by our field organization, as a result of higher sales and an increasing credit cost. These increases were partially offset by a decrease in occupancy costs related to store closures over the past year and slightly lower corporate costs.

For the fourth quarter of 2012, we posted an operating loss of $8 million compared to an operating loss of $24 million in the prior year's quarter, representing an improvement of $16 million. On a percent of revenue basis, our operating margin was a negative 1.9% compared to a negative 6.4% in the prior year quarter. Interest expense for the fourth quarter of 2012 was $15 million compared to $9 million in the prior year. The increase is primarily due to a $5 million charge recorded in the fourth quarter for a transaction cost resulting from the debt refinancing completed on July 24.

In the fourth quarter of fiscal 2012, we recorded an income tax benefit of $2.6 million compared to a benefit of $0.6 million in the same period last year. This favorable performance on the tax line was due to increased efficiencies within our tax structure and to the favorable resolution of a few outstanding tax audits. Loss from continuing operations for the fourth quarter of 2012 was $20 million or $0.61 per share, an improvement of $0.41 per share compared to the prior year loss of $33 million or $1.02 per share.

Now please turn to Slide 7, where I've outlined the main drivers of the fourth quarter 2012 improvement in net loss per share from continuing operations. Starting with last year's result, which was $1.02 loss per share, the gross margin improvement was $0.25, driven by the top line growth we achieved. The change in warranty revenue recognition improved net loss per share by $0.20. Tax and other improvements totaled $0.21. This consists of the favorable tax performance, which I discussed earlier, along with lower charges related to store closures and impairments and lower depreciation. The increase in SG&A expense impacted this quarter by $0.10. There was a $0.15 per share impact to interest expense related to the cost associated with the July 2012 debt refinancing. This brings us to this quarter's loss per share of $0.61 and the $0.41 improvement over the prior year comparable results.

On Slide 8, I will take you through comparable store details for the quarter. This quarter, as we stated earlier, total company comp was up 8.3% or up 9.2% at constant exchange rates, following a 9.8% rise in last year's fourth quarter.

Let's look at this comp performance in greater detail. The comps on this page all include sales from the associated online businesses. Our U.S. Fine Jewelry brand, our largest business segment, which includes Zales, Zales Outlet and Gordon's, had an increase in comparable store sales of 11.2% in the fourth quarter of 2012. This increase follows a 9.7% rise in the same period last year, representing a 2-year comp of approximately 22%. Representing approximately 70% of our business, the performance of these brands will continue to be the cornerstone of our future growth strategy. Our Canadian Fine Jewelry brands, consisting of Peoples and Mappins, had an increase in comparable store sales of 7.1% at constant exchange rates on top of a 10% comp in the prior year period. On a U.S. dollar reported basis, comparable store sales were up 2% in the fourth quarter on top of an increase of 18% in the last year's fourth quarter, representing a 2-year comp of approximately 20%.

We are pleased to report a return to positive comparable store sales for our Kiosk Jewelry segment. As Theo mentioned, we recently made a key leadership addition in that business. In the fourth quarter, our Kiosk Jewelry business had a comparable store sales increase of 2.7%, following a 1.3% rise in the same period last year, representing a 2-year comp of 4%.

Please turn to Slide 9, as I take you through our balance sheet and liquidity. As of July 31, 2012, the company had cash and cash equivalent of $25 million compared to $35 million at the end of the last fiscal year. This change was largely due to year-end timing associated with the receipt of credit card payments. Inventory at July 31, 2012 stood at $742 million compared to $721 million at the end of the fourth quarter last year. The increase of $21 million was primarily due to the impact of higher commodity cost in our inventory this year compared to last year, as well as the result of higher inventory to drive future sales.

At the end of the fourth quarter of fiscal 2012, the company had total outstanding debt of $453 million compared to $395 million as of July 31, 2011. In addition to the amended term loan balance of $80 million, long-term debt also included $370 million borrowed under the revolving credit facility and $3 million of capital leases. The overall increase in debt for the year was due in part to the increase in inventory levels and $13 million of transaction cost associated with the recently completed debt refinancing.

As of the end of the quarter, the company's total net revolver availability was $149 million. Our fixed charge coverage ratio stood at 1.56, which is significantly above the key threshold of 1.0. The fixed charge coverage ratio measures our trailing 12-month EBITDA adjusted for LIFO charges, capital spending, taxes and certain other items compared to our trailing 12-month cash interest costs. Maintaining this ratio above 1.0 provides the company with additional flexibility relating to liquidity and future capital planning.

During the fourth quarter of 2012, net capital expenditures totaled $5 million compared to $8 million in the prior year quarter. On a full year basis, our net capital expenditures totaled $18 million compared to $19 million in the prior fiscal year. Expenditures in both the quarter and the fiscal year were devoted primarily to the refurbishment of stores and technology infrastructure investments.

I'm now going to cover the overall store count for the quarter. As we've mentioned, we have again included a page in the appendix that contains the current store count by brand. We ended the fourth quarter with 1,124 Fine Jewelry stores and 654 kiosks for a total of 1,778 retail locations compared to the prior year fourth quarter count of 1,163 Fine Jewelry stores and 666 kiosks for a total of 1,829 locations. During the quarter, we closed 10 Fine Jewelry stores, changed the nameplate on 6 Gordon's to Zales, and changed the nameplate on 1 Zales to a Zales Outlet. We also closed 4 kiosks.

Now please turn to Slide 10. In July, we announced significant improvements to our capital structure. We secured a new $665 million credit facility, made a prepayment of $60.5 million on our senior secured term loan, and renegotiated the remaining $80 million term loan. Together, these 3 transactions delivered several benefits to the company.

First, the economic benefits. Refinancing reduces the company's average borrowing cost from about 8% to 4% under current interest rates. We expect this improvement to produce a savings of approximately $17 million pre-tax per year beginning with fiscal year 2013. The savings are based on the interest rate reductions we achieved in both the revolving credit agreement and term loan and the changes in mix of debt, as a result of the term loan prepayment. The agreement also provides greater operating flexibility by eliminating certain covenants such as the Pagoda and Canada store contribution covenant and improves many other covenant and thresholds within the agreement. The changes made to the agreement also improved liquidity by approximately $50 million, bringing the company's total net revolver availability at the end of the quarter, as I mentioned earlier, to $149 million. The economic benefits of the refinancing represent a major step forward in our plan to return to profitability.

Now please turn to Slide 11, where I'll walk you through our fiscal year 2012 financial highlights. Revenues of $1.9 billion, an increase of $124 million or 7.1% compared to $1.7 billion for the same period in the prior year. The increase in revenues is primarily due to an increase of 6.9% in comparable store sales. We also received a $35 million lift in revenue from the change in warranty revenue recognition. The overall increase from these sources was partially offset by the revenue reduction associated with the net decrease of 51 stores compared to last year. We achieved gross margin for the fiscal year of 51.5% compared to 50.5% for the prior year period, an improvement of 100 basis points or $81 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 90 basis points, while the increase in LIFO charges as compared to last year adversely impacted our gross margin by 30 basis points. Excluding these 2 items, gross margin for the year improved by 40 basis points, resulting from increases in retail prices and lower merchandise discounts, partially offset by an increase in commodity cost. SG&A expense for the fiscal year was $902 million or 48.3% of revenues compared to $860 million or 49.3% of revenues in fiscal year 2011.

We achieved operating earnings for the fiscal year 2012 of $19 million or 1% of revenues compared to an operating loss of $28 million in fiscal year 2011, an improvement of 260 basis points or $47 million. Our loss from continuing operations for the fiscal year was $27 million or $0.84 per share. In the prior fiscal year, loss from continuing operations was $112 million or $3.49 per share.

On Slide 12, I've outlined the main drivers of our fiscal year 2012 improvement and net loss per share from continuing operations. Starting with last year's loss per share of $3.49, first, I have adjusted for the onetime interest expense item resulting from the 2011 first quarter amendment to the 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 $2.06. Gross margin improvement contributed $1.42 primarily due to top line growth. Tax and other improvements totaled $0.26, which was driven by a lower tax expense in Canada, lower charges related to store closures and impairments and lower depreciation charges. The change in warranty revenue recognition improved net loss per share by $1. The increase in marketing and other SG&A expenses impacted the fiscal year by $1.31. The primary driver of this impact was higher holiday marketing expenses in the second quarter and other growth-related expenditures. As I mentioned earlier, the impact from the debt refinancing charge in the fourth quarter was $0.15 per share. That brings us to the $0.84 loss per share we reported for fiscal year 2012, an improvement of $1.22 per share.

Please turn to Slide 13, while I go through our fiscal year 2012 comparable store sales detail. For the total company, comparable store sales were up 6.9% or up 7.1% at constant exchange rates. This increase follows a rise of 8.1% in fiscal 2011, giving us a 2-year comp of approximately 16%. Our U.S. Fine Jewelry brands had an increase of 9.5% on top of a 7.7% rise in the prior year, representing a 2-year comp of approximately 18%. Our Canadian Fine Jewelry brands had an increase of 4.5% at constant exchange rates on top of a 7.5% rise in the prior year. On a U.S. dollar reported basis, comparable store sales were up 2.9% on top of a 13.5% rise in the prior year, representing a 2-year comp of approximately 16%. Finally, in fiscal year 2012, our Kiosk Jewelry comparable store sales were down 1%, following a 3.6% rise in the prior year, representing a 2-year comp of approximately 3%. As we discussed earlier, our Kiosk business ended the year on a bright note, posting a 2.7% positive comp in the fourth quarter.

Overall, we believe we have made substantial progress in fiscal 2012. We've reported solid comps in each quarter and for the year as a whole. We have significantly improved our operating margin and recorded positive operating earnings for the year of $19 million, and we ended the year with a debt refinancing transaction, which will yield significant savings in the years ahead.

Before I close, I want to make a few comments as to our expectations for fiscal year 2013. Please go to the next Slide #14. As I stated before, we are satisfied with the direction of the business as we move into 2013. However, macroeconomic conditions continued to be uncertain and we are taking a cautionary view on the market as a whole in 2013. We do expect to continue to generate positive comps in fiscal 2013. The additional revenue from that growth will be partially offset by store closures, which we expect to be in line with the number of store closures in 2012. Our current focus is on improving the productivity of current store base, not on opening new stores. We expect the gross margin rate in fiscal 2013 to be consistent with the gross margin rate achieved in fiscal 2012. We are expecting a relatively stable commodity cost environment overall in the next 12 months, as compared to 2012. We will continue to manage our price points in the market, taking into account our margin expectation and changes to overall supply chain costs. In 2013, we expect to continue to effectively leverage SG&A based on top line growth, and as we discussed in previous calls, we plan to continue to make selective investments in the business. The net effect of all of this should result in continued improvement in operating earnings, taking us beyond the $19 million of operating earnings generated in fiscal 2012. As I discussed earlier, we expect significantly lower interest expense, as a result of the debt refinancing transactions. Therefore, we expect our interest expense in fiscal 2013 to be in the range of $23 million to $25 million, assuming interest rates remain at current levels.

On tax expense, we will benefit from the release of valuation allowances associated with the use of U.S. NOLs to offset income tax related to 2013 income. As a result, we expect our overall effective tax rate to be approximately 15% for fiscal 2013. Taking all of these items into account, we expect to achieve positive net earnings for fiscal 2013. We will continue to refine this view as we move through the important holiday period. 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 will come from the line of Rick Patel with Bank of America Merrill Lynch.

Rick B. Patel - BofA Merrill Lynch, Research Division

Can you give us an initial read on your holiday plans and what's going to be different from last year from a marketing perspective? And second, you had a big uptick in SG&A during the holiday quarter last year as you made some investments into Vera Wang and Persona. Do you expect to spend the same amount this year? Should we expect SG&A to decline during that quarter as you anniversary that period?

Thomas A. Haubenstricker

So Rick, let me address the SG&A first, and then Theo can talk about the -- some of the other plans on the holiday. The guidance we've given on SG&A, I think, we're not going to get into details on a quarter-by-quarter. I think what we're saying, you're going to see 2 things happen. We expect to continue to leverage SG&A as we grow the business much as what you saw in 2012, but we are going to make investments because we want to build this business for the long term, and we think there are areas where we need to make investments. But at this time, we're not going to get into the timing of where those are going to be or the nature. We'll continue to provide context on those as we move through the year.

Theophlius Killion

And from a product standpoint, we're really excited about the success that we've had with of the Vera Wang LOVE collection and that we continue to enjoy on the Persona charm bead collection, and we have product extensions that are actually in-store now, and that are going to be tested throughout the fall season. So we expect both of these brands to continue to grow as we test new products, new ideas and new innovations. We're also looking at extending our successful businesses with Citizen Boulevard and Movado, with some of the extensions that they have in testing new brands like Swiss Army and Rue 88, which is a brand that's part of the family of Raymond Weil. So we have lots of exciting product extensions. And from a marketing standpoint, we will be focused on, again, celebrating the Diamond Store, and that's what you'll see. As I mentioned earlier, we talked about the continued focus on Vera, and we also talked about our Celebration Diamond collection that we're adding in the fall season, and you'll see lots of marketing that will support both of those brands.

Rick B. Patel - BofA Merrill Lynch, Research Division

Okay, great. And can you just give us a little bit more detail on your outlook for the consumer and how you intend to manage the business? I'm wondering if you expect this tough environment to remain steady state or if you expect it to worsen over the next few quarters, and if things do get worse, can you talk about your ability to navigate risk, given what you've learned during the last recession?

Thomas A. Haubenstricker

So what we -- as I mentioned, we are taking a cautious view on the market as a whole. We've been able to make good progress, obviously, this last year, with the market conditions, but we feel things will remain difficult from a market standpoint. And from that point, when we think about our real estate strategy, our inventory strategy, our cost strategy, we're keeping that well in mind. I think we feel confident that we're going to be able to drive the business forward and deal with some of the uncertainty that exists in the market and manage the business in the right way on a monthly and quarterly basis. And we don't have a crystal ball to tell us exactly what's going to happen from a market standpoint, but we do think we have a pretty good framework in process that allows us to manage the variables. And we think if you look at the progress we made in 2012 in some difficult times, that's some proof point that we have a handle on this.

Theophlius Killion

And we think we have the flexibility in the business to chase it. If the business starts in an uptick and also to be able to make the kind of adjustments that we need to make if the business gets a little bit softer. So we're going to be very conservative in our outlook, but we have flexibility to adapt up or adapt down, depending on circumstances.

Thomas A. Haubenstricker

And just to add to that, I mean -- you look at our product category and there are some areas of our products that we know can have greater impact on economic downturns and others. So when we think about the inventory, we think about sales by some of our merchandise category, it's taking that into account in terms of where we've seen in the past, that sensitivity and where we've seen resiliency in some of that area.

Rick B. Patel - BofA Merrill Lynch, Research Division

And can you delve a little bit more into inventories? On a per square foot basis, it seems like inventory growth has lagged comp growth for a couple of quarters now. So as you expect positive comps to continue, can you help us understand how we should be thinking about inventories going forward?

Thomas A. Haubenstricker

Sure. It's a great question because I think if you look at the inventory on our balance sheet, which doesn't include memo, it looks like inventory's growing slower than sales. But keep in mind, one of the strategies we have for efficiency in the business around closing stores means that the reality is the average inventory sitting in a store is in line with the comp growth. So to us, that's part of the efficiency of the business around closed stores that we can continue to drive positive revenue growth, but with lower stores, and that gives us improvement on the SG&A, and it gives us improvement on the inventory turns, which is important to our cash flow. So we really think when you look at the average merchandise sitting in a store, which I expect is hard to see from looking at our consolidated balance sheet, that we're very comfortable with where we are in line with our growth expectations.

Operator

Your next question will come from the line of Jeff Stein with Northcoast Research.

Jeffrey S. Stein - Northcoast Research

Question for you on your inventory, Tom, you just mentioned your memo goods and I'm kind of curious, how much consignment inventory you have in your store on a per-store basis compared to the prior year? And I presume that, typically, that is lower margin goods. So how do you see that affecting kind of the mix of sales and margin for the year?

Thomas A. Haubenstricker

So Jeff, good question. We don't disclose the amount of memo that we have in each store, but what I will tell you is that right now, as a percent, it's higher than what it was at this time last year. So when you look at the average merchandise assortment residing in the store, a greater percent of that is going to be on memo. The process for managing that, you're absolutely right, the process for managing memo in terms of how we think about margins, how we think about our confidence level and inventory turn for a certain product, that's part of the whole merchandising framework that goes on here to look at where are we in that test, where are we moving out of that test into a point where we have confidence enough to take on the inventory as an assets, which does usually give us in certain cases, better margins. That's part of the testing process that Theo mentioned that is designed to avoid large risks in products that we don't have the track record.

Matthew W. Appel

It's worth mentioning, Jeff, that the degree of memo that Tom's reflecting on is a result of the tremendous support that we continue to receive from the vendor community. The vendors have really come through for us in the last 2 years, and we're very thankful for that support.

Jeffrey S. Stein - Northcoast Research

Got it. And I'm just kind of curious, what kind of comp assumption are you kind of thinking about to get to profitability? And maybe you could talk a little bit about based upon your cost structure, what kind of flow-through you see to the bottom line on each incremental dollar of sales, just approximately?

Thomas A. Haubenstricker

Sure. I think the way to think about the profitability roadmap for 2013, as we laid out on the slide, is really is to dissect 2012 and we talked about -- we reported $19 million of positive operating earnings in 2012, and that was up $47 million from prior year, albeit once the economy had a role in some of that improvement, but it was still $19 million of profit we reported, and we think we can expand on that in 2013. But in 2012, we had -- if you deduct from that $19 million then, almost $45 million of interest expense, and that's the interest cost of the old financing structure, plus the $5 million of onetime cost associated with that, and that's going to be, as we've said, significantly different in 2013. We provided the estimate out there of around $23 million to $25 million. If you start to think about then those being the big drivers of how we get to a breakeven, you can get a sense of what we really can rely on today in terms of interest savings versus then what we have to continue to drive on the operating profit side. And operating profit picture is going to be a function of the comps that we will drive, the gross margin, which we said, our goal is to remain stable, and then the SG&A efficiencies as a percent of revenue that we'll put in place, so...

Jeffrey S. Stein - Northcoast Research

Maybe can I ask the question a slightly different way, Tom, what is your leverage point approximately on SG&A? What kind of comp do you need to hold your SG&A flat?

Thomas A. Haubenstricker

I think that -- again, what we have in SG&A, so let me just define what we have in SG&A, our store expense, so the rent and our people costs in a store, promotion and credit costs and corporate costs. Leverage point in a store is effectively any type of comp. So if we get any type of positive revenue, we're going to start to see benefit on a percent of revenue on that element of SG&A. So we don't have a single point because there's so many different functions that we capture in SG&A. We will see that, but certainly, part of that SG&A structure, we'll get it from any type of comp we get whatsoever...

Jeffrey S. Stein - Northcoast Research

Okay. How about -- okay. Your LIFO accrual, can you tell us what the accrual was for the year? And I presume that with more stable raw material cost, you would also get some benefit from a lower LIFO charge. So why assume a flat gross margin? Wouldn't you get a lift from lower LIFO in the upcoming fiscal year?

Thomas A. Haubenstricker

So the LIFO charge in 2012 was $22 million, and so think about what happens from a LIFO standpoint is that's basically on a last-in first-out basis. We expect stable prices in our supply chain as we go forward, and so that cost basically creeps into your average cost. So while LIFO, you're right, from a technical standpoint, LIFO charges should be lower if we have a stable commodity cost environment in 2013. But from a margin -- all-in margin standpoint, the average cost of our product is still going up as we continue to replenish, and we still see the margin effect of that. So all in all, we think we should be able to drive stable gross margins. I think the fact that we have -- that we believe we're going to have more stable commodity costs would mean that price increases probably would be of a different tone than what we saw in 2012, but in our view is trying to drive positive comps with stable gross margin is the right way to move.

Jeffrey S. Stein - Northcoast Research

Okay, and 2 more questions real quickly. One, if your pricing is more stable, I would think that your assumption almost has to be that you're going to be driving your comps with stronger transaction growth this year, as opposed to prior year where it was more driven by ticket. Would that be correct?

Thomas A. Haubenstricker

Well, we actually saw in parts of our business very strong transaction growth. So as I mentioned before, our bridal business, not only do we have a higher ticket, but we drove extra volume, and so I think we actually did drive volume in parts of our business. In the Bead business, in our fashion area, we drove a significant increase. So yes, there were categories where we can look at and say, "Yes, that category transaction volume was down, and perhaps that was due to a price increase." But overall, I think we had a good progress in 2012 when we look at the traffic volume.

Jeffrey S. Stein - Northcoast Research

Okay. And finally, CapEx and D&A for the new fiscal year, can you give us just guesstimates on that?

Thomas A. Haubenstricker

Yes. I mean, CapEx, I think we would expect to be around $30 million to $35 million for the year. As we said before, those investments are going to be largely in the real estate refurbishment around our existing store footprint. We talked to you a little bit about the fact that we're changing the nameplate on certain stores, and we've seen some success in that area. There's modest amount of capital associated with that and with the IT area. So I think that I would expect it to be higher than what we reported in 2012. I would assume depreciation is going to be pretty flat with what we saw come out of 2012. I don't see any changes to depreciation.

Operator

Your next question will come from the line of David Wu with Telsey Advisory Group.

David Wu - Telsey Advisory Group LLC

First, your comp performance does imply that you've seen a deceleration, call it around low-single-digit growth in June and July, relative to the 15% comp in the first 3 weeks of May, which I know you obviously benefited from that Mother's Day shift. And given that your FY '13 outlook is based in part on current momentum, does that mean you are seeing improving trends so far in August?

Thomas A. Haubenstricker

So David, let me address your question. I think when we look at our comp for the fourth quarter, we don't believe there's been any decline when we look at the overall normalized growth of the business. I think we said that in the Mother's Day period, it was 15%, but then we said that if you took out the calendar shift impact, it would be 6%. And if you look at then the quarter's comp, as a whole, which was slightly over 8, the impact of the calendar shift on that larger base would be about 2 points. So the reality is we think the underlying growth less the calendar shift was right around 6%. If you look at what we reported, the comp in each quarter, we're above 5 in every quarter. We're at 6.9. I actually think the comp performance was fairly consistent throughout the course of the year. It doesn't mean we had exactly the same comp every week. You're always going to have some ups and downs, but overall, I don't see a lot of volatility, at least, what we saw in 2012.

Theophlius Killion

David, obviously, it's critical for us to maximize the peak selling periods in our business, which are holiday, Mother's Day and Valentine's Day, and we've continued to do that. But we feel very good about an 8.3% improvement on top of a 9.8% improvement a year ago, and we think that what we've been able to do with things like our bridal continuity program online is to actually be able to lift some of the valleys in the business, so that we have some consistency over time.

David Wu - Telsey Advisory Group LLC

Got it. And I mean, but the thing is, right, even if you excluded, right, the 6% comp, I mean, it's still in June and July. There was a bit of moderation, and so I was wondering if you did see -- and if you could comment on August and if there was any improvement there.

Thomas A. Haubenstricker

So again, I think we felt that if you take the calendar shift out of the May period, 6% was right where we trended for, for June and July. So we do feel that we had a pretty stable quarter as we go through it, and we're not going to get into any context in August. We'll be more than happy to talk about our first quarter performance in a couple of months when it's completed. I know we've done that in the past when we were coming off a major holiday when we think it's important, but at this point, August is -- doesn't contain any major holiday, and we think that it's best we just deal with it in the quarter's result in a couple of months.

David Wu - Telsey Advisory Group LLC

Okay. And obviously, the consumer environment still remains a bit challenged here, especially just given the weak August Consumer Confidence data yesterday. And I was wondering if you could shed more light on what you're seeing with consumer behavior in your store, and if you had to become more promotional at all to drive traffic and if consumers are paying more with credit?

Thomas A. Haubenstricker

So I think we obviously are very attuned to what's happening in the consumer marketplace. As I mentioned before, that can manifest itself into how we think of all our merchandise assortment, but we've certainly seen in certain bridal categories that that's a pretty resilient business, and the emotions behind that of those -- some of those transactions mean that business seems to prevail in the ups and downs of the economy. We've talked before earlier this year about expanding our credit program. That probably was well-timed with what we're seeing in the marketplace, and we continue to see that being helpful to our overall revenue comp. We talked about the Bead business that we put in on the fashion side. That probably was well-timed in terms of the opening price point in the fashion business. So yes, we're aware of what's going on in the market, and we are focused on ensuring that the business continued to drive forward within those conditions.

Theophlius Killion

We're pleased that we have an incredibly talented group of jewelry consultants that we're investing in, and taking lots of time to train them on all of the new product introductions that we have for the fall season. We think we'll be well-prepared to be able to sell our way through some of the fluctuations that may take place in the marketplace.

David Wu - Telsey Advisory Group LLC

Okay. And on commodity cost, diamond prices have obviously come down quite meaningfully, down around 24% since its peak in late July of last year. I mean given that you typically have onetime inventory turns, is it fair to say that the greatest gross margin pressure from higher diamond prices is over at least for now? And should you see easing pressure in the first half of '13?

Thomas A. Haubenstricker

Yes. So I think that, first of all, we certainly understand that price point changes that people can quote in the market and what's happening to rough diamond at very high-quality and what's happening to the supply chain that we're buying into can be very, very different. So it's probably dangerous to pull up one statistic, and assume that's what's happening in the supply chain that we interact with. But I think your point is certainly right that our view today is that the types of increases that we've had to talk about in 2012 that, that should be behind us. And what we should have, is while we're not prepared to say we're going to see reductions, we should have a more stable environment in terms of much lower cost increases, if any, at all, and that should play a factor into how we think about managing the gross margin going forward.

Theophlius Killion

David, we've been incredibly active this year in spending time in India. We've been there 5x already. We're going to be going back in the next month. So we're managing through on a very granular basis what's going on in the marketplace, so that we can get our forecast out. We can give the production to our vendors that Matt talked about before, and we can position ourself, so that we're advantaged as we go through the ups and the downs in the diamond pricing.

David Wu - Telsey Advisory Group LLC

Great. And just lastly, can you comment on how credit sales performed in the quarter? Are you still seeing see the approval rates there trend higher, especially just given the alternative financing programs?

Matthew W. Appel

Sure, David, this is Matt. We look at the credit programs in the aggregate. Certainly, the alternative financing program is a critical component of the way we address the marketplace. In the fourth quarter, in the U.S., our credit mix was very strong. We were up about 300 basis points. Our approval rates were up, equal or higher. Canada had a similar, but slightly lower trend, and so credit has improved. As Tom said, we've made some very timely moves to enhance our credit programs and credit is vital for this business, and we think we're well-positioned in 2013 to leverage these programs in a very positive way, so credit is healthy.

Operator

The next question will come from the line of Bill Armstrong with CL King & Associates.

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

So if we look at your gross margin for the full year, it was up about 100 basis points. Can you break out how much of that would have come from the deferred revenue recognition and how much positive or negative would have come from commodity price changes?

Thomas A. Haubenstricker

So Bill, I think in my comments, I did give some of those statistics. I think the warranty accounting change that we talked about drove -- I'm just looking back through my -- 90 basis points, and then we said the increase in LIFO charges adversely -- so offset some of that by about 30 basis points. So we think the net, if you take those 2 out, the net improvement was around 40 points, and what that represents is the combination of the price point increases, the lower merchandise discounts, the change in mix, offset by the increases in commodity costs. So all that comes together, those -- the increases in prices and lower discounts with the -- offset by the increase in commodity. All that comes together in that, and the net of all that drove about a 40 basis points improvement.

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

Okay, got it. And what should we model for deferred revenue impact on your fiscal '13 gross margins, which will be roughly flat year-over-year overall?

Thomas A. Haubenstricker

So I think as you've seen in the balance sheet, deferred revenue went down significantly in 2012 as a result of the change in the accounting. I think that trend will continue in 2013, but at a more moderate pace, so probably at -- the reduction is probably going to be 75% or so of the reduction that we saw in deferred revenue in 2012. So I think it will be the same type of flow, but it will be more moderate in terms of the net reduction due to deferred revenue.

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

Okay. And then final question, your same-store sales and kiosk turned positive in the fourth quarter, and I know you've got some new leadership there. What's changed on the floor that customers might see that may be causing an improvement in traffic flow?

Thomas A. Haubenstricker

I think, as always, with new leadership, I think the team there is looking at a whole host of different things that they're testing in the market in terms of how the merchandise is displayed, the merchandise itself, the promotional strategy. We're pleased to see that comp come out of the fourth quarter, and the team continues to look at what can be a driver of future success. It's a very important business to us. The margins in that business are very attractive. The cash returns are very attractive, and getting that business back to any type of growth would be very helpful.

Theophlius Killion

I think it's interesting. We had a conference call with our Regional Directors about 3 or 4 weeks ago, and we talked about some of the trend changes that have taken place in the business, and I asked them what they thought had changed in the business, and having a person who's in the business day-to-day, whose only job is to drive Piercing Pagoda is a big difference in having the kind of focus and accountability for those day-to-day sales has made a tremendous, tremendous change. And we think we're frankly very much at the beginning of the changes that we need to make in the Pagoda business, as we get deeper into inventory, product mix and opportunities going forward. We think this is a pretty exciting business.

Operator

Your next question will come from the line of Janet Kloppenburg with JJK Research.

Janet Kloppenburg

I just had a couple more questions on the gross margin line. Historically, the Piercing Pagoda and the Canadian businesses have had pretty attractive margins, and I'm wondering if that's incorporated into your guidance that the returns of business at those brands could influence gross margin in a positive way. And also I was thinking that as you have deeper penetration of your exclusive brands that, that may also have a positive effect on gross margins, and other retailers that I'm familiar -- jewelry retailers that I'm familiar with, I was expecting an improvement on gross margin this year, and so I'm just wondering if you could explore that for me a little bit. And also a question on marketing as a follow-up.

Thomas A. Haubenstricker

So Janet, on your gross margin point, you're absolutely correct that the Pagoda and the Canada brands do enjoy higher gross margins. Those areas have been growing at a slower rate than the overall company average. So both of those dynamics factor into our thought process as we think about 2013. Yes, those businesses have higher margin, but historically, even in the fourth quarter, the comps coming out of those areas have been slower than what we're seeing in some of the other areas. So we've got to keep both the mix issue in mind as well. And we feel, overall, we're trying to set expectations in terms of 2013, and obviously, if we see opportunities to drive gross margin improvement and it's within the context of driving earnings improvement, we'll look at that. But at this point in time, we feel stable gross margins is the right parameter to set.

Janet Kloppenburg

Well, I just wanted to make sure you weren't ruling out the possibility of some improvement in gross margin, Tom?

Thomas A. Haubenstricker

No, we would never rule out the possibility of gross margins if we think going after that gross margin improvement in the context of volume and everything else is in the overall interest of the company.

Theophlius Killion

And to your point, Janet, we absolutely expect greater margin opportunity in our proprietary brands.

Janet Kloppenburg

And Theo, would you consider adding additional proprietary brands? Or do you think the mix is appropriate right now?

Theophlius Killion

We will absolutely consider adding more proprietary brands, and we'll have more to talk about in our call in November. We have a couple of things that we're working on that we'll be talking about in more detail as holiday gets closer.

Janet Kloppenburg

Okay. And then on the SG&A side, I know you're expecting leverage in the minimal comp in the stores to achieve that. I was wondering if that guidance also incorporated a higher marketing expenditure, particularly in the holiday and holiday season, and what venues you may be increasing your marketing spend on: TV, social networking, eCommerce, what would you be doing?

Thomas A. Haubenstricker

So in -- as I mentioned before, Janet, in the context of 2013, what we've said around SG&A is that we are going to make investments in the business that we will expect SG&A to get leveraged as we grow the business. We certainly saw that in 2012. We expect to see it in 2013, but some of that is going to be offset by where we think investments are -- will best serve the financial interest of the company. We're not going to get into details in terms of when, where and how on those investment at this time. We just think for competitive reasons, it's not in our interest to do that, but we'll work through those as we go through the quarter with you.

Matthew W. Appel

Rather than focus on spend, Janet, we think the appropriate focus is on the effectiveness of the marketing programs and the impressions that we generate, and we're confident that we're focused on the right areas as we approach the upcoming holiday season.

Theophlius Killion

We had a very good upfront buy this year. We have roughly the same TRPs as we had a year ago. So we've always focused on efficient and effective, and that's what we'll be this holiday.

Operator

Your next question will come from the line of Steve Kernkraut with Berman Capital.

Steven J. Kernkraut - Berman Capital Management LP

I just have a couple of questions for you. First of all, you're starting the quarter with inventories up 2%, 3%, which is great, a real conservative management, but you've been running comps of 8%, 10%. What is the feeling that you're going to be able to chase goods? I mean, you're cautious about the economy, but if the businesses is there, are you going to have enough goods to do a 7%, 8%, 9% comp in the second quarter, in the holiday quarter?

Thomas A. Haubenstricker

So Steve, as I mentioned before, I think when you look at the inventory on the balance sheet and you see that that's up couple of percent, and we agree with you, first of all, that we want to maintain good control of inventory. But when you look at that, it doesn't represent the average inventory in the store. As I mentioned before, because we're closing stores, the average inventory in the store is actually, right, now, pretty much trending to our historical comps. On top of that, you have, well, I mentioned before the memo inventory, that's not on our balance sheet. That is, as a percent, is higher than what it's been in the past. We feel very good about 2 things. We feel very good about the fact that we have the right inventory in the store that can meet even an optimistic expectation on the holiday, and we feel good that we're going to be able to manage the inventory in the back half of the year much as we did in 2012, so that we can maintain some of the cash flow metrics. So that's how we're thinking about it from that standpoint, but we certainly don't believe sitting here today we've undershot inventory that will be in the store for the holiday period.

Steven J. Kernkraut - Berman Capital Management LP

Okay. And one other question, in terms of your game plan for 2013, where you say you'll be -- you'll have net income, could you just explain how the -- your incentive compensation works because -- in terms of your management team? Because I assume that if you make that plan, it will be a much larger incentive payout next year than it was this year.

Thomas A. Haubenstricker

So clearly, the incentive plan for the executive team is going to be lined up with net income. I mean that's been the goal over the last couple of years in terms of the turnaround is getting to a positive net income, and then producing above that, and that's how the incentive plans are lined up.

Theophlius Killion

Our board and our compensation committee are very focused on making sure that the management team is aligned with shareholder value and shareholder growth. So we're all looking at net income as a way of paying our shareholders and also paying ourselves.

Steven J. Kernkraut - Berman Capital Management LP

Okay. And just last question in terms of -- you're saying you're going to have a few more -- you're going to have store closures next year similar that what you had this past year. Are there going to be any store openings in outlet malls or is it status quo?

Matthew W. Appel

Steve, this is Matt. We're always looking at an opportunistic way of store openings, and we won't commit to a number right now. That is part of the discipline. Store productivity, as Tom indicated in his remarks, is a key driver of our financial results, and that will remain the focus as it has been for the last couple of years. We won't put capital to work unless we can get the right kind of return for it, and you can see that we did do that for the conversions that we talked about just a little while ago. But for the most part, this is about driving the existing stores to a higher level of productivity, which will be a great return on capital that's already invested.

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 I want to thank everyone for joining us on the call today, and I particularly want to thank our team here at the store support center and our field teams who have consistently stood in front of our guests and delivered on the promise of being the Diamond Store. As we begin fiscal 2013, we'll maintain our focus on disciplined execution in every aspect of the business. We're looking forward to returning the business to profitability, and then creating additional shareholder value. We look forward to talking to you again as we report our fiscal quarter results in November. Thank you.

Operator

Ladies and gentlemen, that concludes the Zale Corporation Fourth Quarter and Fiscal Year 2012 Earnings Conference Call. We appreciate your time. You may now disconnect.

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