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August 31, 2006

Zale F4Q06 (Qtr End 7/31/06) Earnings Call Transcript (ZLC)

Filed under: Conference Call Transcript — Tags: — admin @ 12:00 am

Zale Corporation (ZLC)

Q4 2006 Earnings Conference Call

August 31, 2006, 9:00 am EST

Executives:

Betsy Burton, President Chief Executive Officer

George Mihalko, Chief Financial Officer

Cindy Gordon, Senior Vice President and Comptroller

David Sternblitz, Treasurer

Analysts:

Adrianne Shapira, Goldman Sachs

Janet Kloppenburg, JJK Research

Jeff Stein, KeyBanc Capital Market

Bill Armstrong, CL King & Associates

Mark Bettinger, Stanford Group

Dax Blassis, Gates Capital Management

Operator

Good morning. My name is Natwinda and I will be your conference operator today. At this time, I would like to welcome everyone to the Zale Corporation Fourth Quarter Fiscal Year 2006 Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press * then the number 1 on your telephone keypad. If you would like to withdraw your question, press the # key. Now, I would like to turn the call over to Ms. Betsy Burton, President and Chief Executive Officer. Thank you. Ms. Burton, you may begin your conference.

Betsy Burton, President and Chief Executive Officer

Thank you. Good morning and thank you for joining us for our fourth quarter conference call. I am Betsy Burton, Chief Executive Officer of Zale Corporation. With me on the call today are George Mihalko, acting Chief Financial Officer, Cindy Gordon, Senior Vice President and Controller, and David Sternblitz, our Treasurer. Before we begin, George will review the Safe Harbor.

George Mihalko, Chief Financial Officer

Good morning. Our commentary and responses to your questions on this conference call will contain certain forward-looking statements including statements relating to our expected sales and earnings, future goals, plans, and objectives. These forward-looking statements are not guarantees of future performance and a variety of factors could cause our actual results to differ materially from the anticipated or expected results expressed in these forward-looking statements. Information concerning some of the factors that could cause actual results to differ materially from those contained in the forward-looking statements is available in our annual report on Form 10-K for the year ended July 31, 2005, and our quarterly report on Form 10-Q for the quarter ended April 30, 2006, as filed with the SEC.

In addition, we will present non-GAAP financial information on this call. For a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure, please refer to our fourth quarter 2006 earnings release of this date, which can be found on our corporate website, www.zalecorp.com under Shareholder Information, and then clicking on the News Releases icon.

Betsy Burton, President and Chief Executive Officer

Thank you, George. Fourth quarter operating results were right on plan. Comp store sales of 3.5% were in line with expectations and fueled by better than expected topline growth in the Zales Brand, offset by pressure on gross margin due to increased clearance.

Some of the highlights this quarter were a strong Mother’s Day across all brands resulting in low double digit positive comps for the events. This was led by the Zales Brand which benefited from diamond fashion and solitaire inventory that began flowing into stores in late April. The diamond fashion business was again driven by Circle Pendants. But, we’re also excited about Journey, DeBeer’s product, featured in their advertising this holiday. Progressively small-to-large four stones or more, the Signature Squiggle is already a top seller in our outlet stores, and that was without any marketing exposure. Based on our initial test, we anticipate Journey has the potential to approach the volume of Circles.

Consistent with Mother’s Day expectations diamond fashion was also up 20% plus at Gordon’s. This was driven by Circles, the Nature Collection, and the exclusive Love collections. Bailey Banks & Biddle enjoyed strong growth in luxury watches, especially mid-priced sports watches and chronographs, which are experiencing double digit growth. The women’s sport watch business is also very strong, up 30% over last year. And Bailey’s designer fashion jewelry experienced its third year of 20% plus growth.

Outlets continue to perform as it grows its trunk shows and now sells…every day in 20 stores. Lab created stones, semiprecious and precious, also appear to be particularly popular with its core group of female cross-purchasers. Peoples Mappins continues a strong growth trend on all fronts with impressive comps and earnings increases as well as the opening of 20 new stores in fiscal ’07.

Pagoda’s negative comps were completely due to the drop off in Italian charms. Otherwise, its core businesses are strong, especially ear piercing, body jewelry, birth stone, and personalized jewelry. Alternative metals such as steel, titanium, and base metals continue to perform well.

And last but not least Zales.com continues to deliver near triple digit increases. This fall we’ll be relaunching a new and improved BaileyBanks&Biddle.com and testing a customized “Build the Ring” offering for Zales.com. We’re also planning the launch of Gordons.com in spring.

On the earnings front, we delivered EPS for the quarter of $0.02 excluding certain after-tax adjustments of $27.3 million. These charges were mostly non-cash and primarily consist of inventory write downs of $16.8 million, of which over half relates to the Zales Brand and reflects the recent decision to accelerate the clearance of previously discontinued assortments. The inventory charge also includes these continued items at Bailey Banks & Biddle as well as the residual amount related to the closed Bailey Banks & Biddle stores.

The write off of capital investments of approximately $3.3 million is for an information technology initiative that the company has determined does not meet the needs of the business. And third, an asset impairment charge of approximately $2.9 million relates to certain test stores in the Gordon’s and Zales brands as well as the test of jewelry repair stores, which has now been discontinued.

For the full year 2006, excluding the fourth quarter charges and other nonrecurring items recorded during the first nine months of the fiscal year, the company earned $1.84 per diluted share. On the cash flow front, we returned $100 million to shareholders in January in the form of the share buyback. We also made certain strategic decisions that had a cash cost but will benefit the company’s positioning and future profitability.

We closed 30 Bailey Banks & Biddle stores at a cash cost of approximately $20 million. Another item that impacted cash flow is an increase of $25 million in cash taxes this year over last, where last year the company benefited from a deferred tax cash savings. And there was an additional cash impact as a result of inventory builds. Capital expenditures were $83 million consistent with the prior year. So, essentially free cash flow after capital expenditures was flat.

Now, I’d like to focus on the Zales Brand. Let’s start with lessons learned at the Zales Brand from fiscal ’06. Breadth of assortment is necessary for a successful diamond solitaire ring business. The promotional diamond fashion business drives incremental volume and traffic. A diamond fashion assortment needs to be both broad and deep to drive gift giving. Orders need to be placed on time to ensure holiday delivery, and this continued inventory needs to be liquidated more aggressively. So, this leads to our merchandizing strategy for fiscal ’07.

There will be a renewed emphasis on diamond fashion and solitaire engagement rings. We will have dominant assortments in all bridal and jewelry classifications. The average store will see an increase in SKU count of 750 SKUs. Assortments will be consistent across all volume levels of stores. Last year some stores that were classified as high end didn’t have a sufficient amount of moderately priced merchandize. That will be fixed for this year. There will be an increased emphasis on promotional key items during holiday gift giving periods and key weekend events, and we will enforce a timely liquidation of unproductive inventory. And last, we will increase the penetration of merchandized purchased from our Diamond Direct Sourcing operation.

For the fiscal ’07 visual presentation plan for Zales, we will implement an enhanced element package enabling us to increase capacity. We will go back to merchandizing by classification. For example, all diamond bracelets will be in one showcase, all diamond fashion hearts and crosses in one location. We will utilize in-case signing to highlight merchandized storage, product attributes, and key price points; for example, our exclusive past, present, and future collections.

Now, on to Zales Brand marketing; fist, lessons learned from fiscal ’06. We need to target the gift giver more effectively and reach both the male gift giver and the female gift giver/influencer. We need to include event TV messaging to recapture a portion of lost event volumes. We need to enhance the TV media buy to increase visibility. And we need to maintain targeted direct mail efforts to increase customer retention.

Based on these learnings, we will make the following changes in fiscal ’07: we will launch new TV creatives which show breadth and depth of product along with a call to action, and we will return to the diamond store. Next, it’s all about people. We need to invest in people to make sure we deliver a great customer experience. We need to hire, train, and retain the best regional store managers and sales associates. We are starting to adjust compensation to make sure we are competitive. We’ve dramatically increased the number of associates who have been through product training and certified by the Diamond Council of America. We have introduced new bonus incentives as well as more achievable goals to reward our best people. And we have made changes to certain conditions that have made it a more employee friendly work environment, both in the field and at corporate.

Now, let’s talk about guidance for fiscal ’07. We are investing in the first quarter for a successful second quarter. We are aggressively opening 32 inline stores, a third of which are our very profitable Peoples and Mappins brands, and we are doing 41 remodels, refurbs, relocations between now and November 15th. Both new store openings and remodels are basically double what they were in the prior fiscal year.

We are investing $120 million in new inventory, so we get a new and expanded assortment into all Zales stores, and we’re cleaning out the discontinued merchandize aggressively in the first quarter. We are projecting that comps in the first quarter will be flat in the Zales Brand, as an increase in the number of transactions is offset by a decline in average ticket due to clearance mix. So, for the entire chain we’re looking at first quarter comps of flat to up 2%. And since it’s a light sales base, this quarter is historically one where there are not enough sales to leverage against increasing expenses. We are currently guiding to a loss of $0.42 to $0.46 EPS versus last year’s loss of $0.36. Note, that due to last year’s share repurchase we have 2 million less shares outstanding. This cost approximately $0.02 in EPS in the fourth quarter due to the fact that this quarter generates a loss.

For the critical holiday quarter, second quarter, we are projecting comps of 3% to 4% and EPS in the range of $2.17 to $2.22 compared to $1.96 last year when adjusted for Bailey Banks & Biddle closures, executive severance, and tax repatriation. For the full fiscal year ending July 31, 2007, we are providing guidance for comps in the range of 2% to 3% and EPS in the range of $1.98 to $2.08.

I’d now like to ask George to review the financials, and then we will open up the call to questions.

George Mihalko, Chief Financial Officer

Thank you, Betsy. Betsy already touched upon some of the financial highlights of the fourth quarter and fiscal 2006, but I will review in a little more detail the financials which are part of today’s earnings release. I will begin with the makeup of the fourth quarter charges and their impact on the income statement, move on to the balance sheet, and then conclude with a brief comment on fiscal year 2007 guidance.

Beginning with the fourth quarter charges, please note that we added to the financials a table detailing all of the special charges which affected our financials in the fourth quarter and throughout the year. When we first announced at the beginning of this month our intent to take a fourth quarter charge, we estimated a mostly non-cash charge of $38 million to $40 million. This was on a pretax basis. The actual equivalent charge came in at $38.3 million with the net range pretax, which converts to $23.9 million after tax or $0.50 per share. Betsy already itemized the major elements of this charge with 70% or $16.8 million relating to inventory valuation and the remaining $0.30 or $7.1 million impacting SG&A.

Separately, we also recorded an accrued percentage rent charge relating to prior periods amounting to $1.5 million after tax or $0.03 per share. We also recorded incremental taxes of $1.9 million or $0.04 per share primarily relating to Canadian earnings. Included in this Canadian item is an adjustment that was impacted by our decision not to elect ABP 23 partially offset by a benefit due to Canadian tax rate changes.

Now, let me move on to the income statement and highlight the impact of all of these special charges as we walk down from revenues to net income. For the fourth quarter, total revenues amounted to $490.7 million and comparable store sales increased by 3.5%. Fourth quarter gross margin as a percent of revenues was 47.5% on a GAAP basis but when we adjust this for the $26.9 million before tax inventory valuation reserve we took in the fourth quarter, gross margin is 53% versus 52.2% for the fourth quarter last year. The increase is primarily due to a change in our trade-in reserve estimate, which more than offset incremental clearance mark downs.

With respect to SG&A, the quarter-over-quarter increase is due to the special charge as well as higher rent, payroll, and promotional expense.

Moving on to the operating earnings line. On a GAAP basis, we are reporting an operating loss of $35 million, but when adding back the fourth quarter charges operating earnings are at $5.7 million or 1.2% of revenues versus 1.7% of revenues last year. Interest expense for the fourth quarter increased by $1.8 million to $3.5 million due to higher borrowings under our line of credit as well as the impact of higher interest rates. Including all charges, the fourth quarter ended with a GAAP net loss of $26.4 million or $0.55 per share. Excluding the charges, we had net earnings of $827,000 or $0.02 per diluted share.

Moving on to the balance sheet. Some of you may recall that during the third quarter conference call we advised you that we would use the strength of our balance sheet to position Zale for future improvement. We are doing exactly that. As a result, inventories are up approximately $50 million or 5.8% to $903 million this year versus $854 million last year. But let me give you some insight into the complexion of this year’s $903 million and last year’s $854 million.

This year’s $903 million includes $130 million or 14% of clearance and discontinued merchandize, while last year’s $854 million included only $73 million or 9% of clearance. This $57 million increase in clearance merchandize combined with the inventory charge we took in the fourth quarter illustrates that we are taking aggressive mark downs and clearing old merchandize. Other current assets increased by $39 million due to advances to gold vendors, prepaid advertising related to this coming holiday, and a balance sheet reclassification of a tax receivable.

On the liability side of the balance sheet, accounts payable and accrued liabilities increased by $46 million, which primarily relates to the increase in fresh inventory. Non-current liabilities decreased by $70 million, primarily due to the settlement of the retirement benefit obligations in the third quarter.

Long-term debt increased $73 million, primarily to fund the other balance sheet change that I just mentioned as well as a portion of last year’s capital expenditures, share repurchase, and timing of income and other tax payments, as well as over $18 million to settle Bailey Banks & Biddle lease obligations for the stores we closed in the second quarter. However, please note that we do expect long-term debt to moderate throughout this fiscal year relative to last fiscal year.

Let me finish by commenting on our fiscal year 2007 guidance. Fiscal 2007 will be a year of transition, as Betsy is refining and refocusing the company’s strategy and our operating manages are infusing fresh assortments while concurrently flushing out discontinued and excess inventory. Consequently, especially our sales and merchandized margins will be dynamic throughout the year. The guidance table in today’s press release is intended to provide our best current indication of how we expect the year to progress barring any unforeseen macroeconomic changes. If you have detailed questions about our guidance, David Sternblitz will be available after the call to assist you.

Betsy Burton, President and Chief Executive Officer

Thank you, George. Operator, we would now like to turn it back over to you and open the call up to questions.

Question-and-Answer Session

Operator

Yes ma’am. At this time, I would like to remind everyone, if you would like to ask a question, press * then the number 1 on your telephone keypad. We’ll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Adrianne Shapira with Goldman Sachs.

Adrianne Shapira, Goldman Sachs

Thank you. Betsy, we appreciate you sharing the lessons that you’ve learned. Can you give us a sense of where you are across these many initiatives in terms of marketing and merchandizing especially as you head into the holiday season, how many of these do you think will be complete and by when?

Betsy Burton, President and Chief Executive Officer

For the most part the merchandizing, the product has flowed into stores probably around mid September. We will be resetting all of our stores to new planograms to reflect the new product assortment. All of the merchandize has flowed in on time, and we’re very comfortable that our differentiated product assortment will be in place well in time for the holiday. In terms of key events, we have planned all of our key promotional events back in this year. By the way, we actually have already shopped to production and we’re ready with new creatives, and we have modified media buying schedule, which we believe will be significantly improved and will support our promotional key events. Our people are ready, I think our leadership has made substantial changes in terms in the field and I think everybody is excited and is building momentum going into the holidays. So, I feel very good about all of the pieces being in place.

Adrianne Shapira, Goldman Sachs

Okay, and then following up on that, as you mentioned the stores are going to be reset post Labor Day, mid September, but it sounds like you’ll still be in clearance mode. It would seem that the new merchandizing is not getting a clean slate, especially as you expect a dramatic improvement in comps from the first quarter to second quarter. Can you just comment on that given the fact there will be new as well as clearance in the stores, what will be the customer perception?

Betsy Burton, President and Chief Executive Officer

Sure, we are aggressively clearing out products in the first quarter. However, we will not aggressively clear merchandize in the second quarter. We do not want to trade regular price sales for clearance sales. So, the second quarter growth is clearly from the fresh new product assortment.

Adrianne Shapira, Goldman Sachs

Right, but do you think the image at all will be tarnished given the fact that currently all the new merchandizes coming in you’re still in clearance mode?

Betsy Burton, President and Chief Executive Officer

No, clearance will have a very reduced amount of footage in the showcases.

Adrianne Shapira, Goldman Sachs

Okay. And then comment about increased product cost, it sounds from the last call you had talked about increasing prices of gold to kind of catch up with the raw material increases, talk about customer acceptance of that.

Betsy Burton, President and Chief Executive Officer

We believe that we have not experienced the resistance. Again, we’ve been cautious in terms of raising our prices because we also need to make sure that we are competitive. But, at this point, we have not really experienced much if any resistance in terms of the increased prices.

Adrianne Shapira, Goldman Sachs

Okay, and then just lastly, usually around this time we would get an update on a buyback authorization, it sounds as if instead you’re directing cash flow to inventory investments, is that fair?

Betsy Burton, President and Chief Executive Officer

That is the correct statement, yes, we are not making any announcement about a buyback, and again we’re using our cash to rebuild the business.

Adrianne Shapira, Goldman Sachs

Great, thank you.

Operator

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

Janet Kloppenburg, JJK Research

A couple of questions; I’m wondering about your guidance for the fourth quarter when you talked about the inline stores and the 41 remodeled, has this changed, is this something higher than you would have originally anticipated, therefore the costs are higher there?

Betsy Burton, President and Chief Executive Officer

No, we are aggressively opening new stores. The costs are exactly as we had planned, but we are opening 32 stores versus 17 inline stores last year. So, we have just ramped up the number of stores that we will opening in the first quarter, because as you know if you can have them open for the second quarter you have the benefit of your biggest quarter.

Janet Kloppenburg, JJK Research

And what’s happening with the marketing spend both in the first quarter of this year and the second quarter versus their respective quarters last year?

Betsy Burton, President and Chief Executive Officer

Again, the first quarter is a relatively insignificant quarter.

Janet Kloppenburg, JJK Research

I thought there might be some spend, Betsy, in October as you prepare for the holiday season?

Betsy Burton, President and Chief Executive Officer

It’s slight, but our major spend is clearly beginning with Veteran’s Day.

Janet Kloppenburg, JJK Research

Okay, what about in the second quarter of the year?

Betsy Burton, President and Chief Executive Officer

Right, in other words, the actual dollar spend will be greater than last year. It will not be as heavy towards the last couple of weeks of Christmas. So, it will be spent more prudently in terms of backing our key promotional events starting again with Veteran’s Day.

Janet Kloppenburg, JJK Research

Okay, and if we look at the second quarter, and you talked about the assortments changing and you also talked about the marketing efforts really talking to products and important price points, will we be looking at average unit retails declining or given the prices of commodities will we be looking average unit retails to be increasing?

Betsy Burton, President and Chief Executive Officer

In the second quarter, again, we’ll be backing off our clearance and will be focusing on our regular priced goods. So, yes, you should see an increase in average tickets.

Janet Kloppenburg, JJK Research

But it sounds to me like you might be a little more promotionally driven, in other words you might be promoting some of your key item products at shop prices?

Betsy Burton, President and Chief Executive Officer

Keep in mind though that the breadth of the assortment, what we’ve done is we’ve added more choice for the customers. So, the goal here is to also increase the average ticket by selling at the higher end of the price range, not just selling what you’ve got on promotion, and we’ll have more promotional brilliant buys also on higher ticket items. So, you can also increase your average ticket by again trading up to that higher ticket item.

Janet Kloppenburg, JJK Research

Okay, and just lastly, you talked about investing in people and adjusting compensation to reflect market rates, I’m wondering if there’s going to be some pressure on payroll during the year.

Betsy Burton, President and Chief Executive Officer

You make your money in the second quarter, so you spend your money on people in the second quarter. So, I think again you’ve got much more leverage in terms of dropping to the bottom lines, so I think we will invest appropriately in people.

Janet Kloppenburg, JJK Research

But, what will happen to the payroll line?

Betsy Burton, President and Chief Executive Officer

We obviously have what we call an incentive component of our compensation, so that will directly parallel sales. But in terms of year-over-year as a percent of sales, it should be approximately the same.

Janet Kloppenburg, JJK Research

Great, thanks very much, and lots of luck.

Operator

Your next question is from the line of Jeff Stein with KeyBanc Capital Market.

Jeff Stein, KeyBanc Capital Market

Betsy, I’m wondering if you could give us a little bit of guidance in terms of how much of that clearance merchandize you’re budgeting to sell through during the first quarter. And then it sounds to me like whatever you don’t sell through you’re going to put away until holiday is over and resume the liquidation, I’m wondering if that’s the correct way to think about it?

Betsy Burton, President and Chief Executive Officer

Yes, I would say 25% of the clearance should be moved through in the first quarter, and then you’re right, we’ve got to put away and wait until after Christmas.

Jeff Stein, KeyBanc Capital Market

Okay, and will it all be gone by the end of the fiscal year?

Betsy Burton, President and Chief Executive Officer

No, we believe the majority will be gone, but we’re looking at probably 15 million of the existing clearance to remain in the fiscal year.

Jeff Stein, KeyBanc Capital Market

Okay, and with regard to your marketing message, I mean Zale historically has been more in price and item advertising and then you moved away from that last year, are you going back to that type of message to the customer?

Betsy Burton, President and Chief Executive Officer

Because of competitive reasons we really don’t talk about exactly what that strategy will be, but I think it will be a combination of showing the breadth of our assortment as well as the call to action.

Jeff Stein, KeyBanc Capital Market

Okay, and then finally, Signet in their conference all yesterday mentioned that they believe the time is right to launch an e-commerce initiative, and then you commented on the fact that Zale.com was up almost 100%, are you guys going to do anything to become more aggressive in your own e-commerce initiatives at the Zale division?

Betsy Burton, President and Chief Executive Officer

Obviously, we believe we’ve been very aggressive this year and we are very optimistic that we’ve got great growth opportunity, not just in the relaunch of Bailey’s and the launch of Gordon’s but to really build Zales.com. We believe that the “Build the Ring,” which is sort of a customization of a ring in terms of an engagement ring we believe is going to be huge and has the potential to be almost as great as all of the rest of our dotcom e-commerce assortments. So, we are very excited about the launch of that, we will be testing that in the fall. Yes, we are very excited about it. We also believe, if you look at the value of a multichannel customer, it’s a much more valuable customer. So, we will be also rolling initiatives in stores to aggressively try to sign people up on emails, so that again we truly merchandize as a multichannel retailer.

Jeff Stein, KeyBanc Capital Market

Great, thank you.

Operator

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

Bill Armstrong, CL King & Associates

Good morning, I had three questions. First, the last year Zale eliminated a Labor Day promotion as I recall, will you be resurrecting that this year?

Betsy Burton, President and Chief Executive Officer

We really don’t talk about that specifically, that’s competitive and confidential.

Bill Armstrong, CL King & Associates

That’s this weekend, so it’s going to come out…

Betsy Burton, President and Chief Executive Officer

You’ll have your answer soon.

Bill Armstrong, CL King & Associates

All right, how are customers going to know that?

Betsy Burton, President and Chief Executive Officer

We will be mailing, that’s as much as I would like to say.

Bill Armstrong, CL King & Associates

Okay, clearance inventories are about $130 million now, you had quite a bit of write down to that merchandize in the quarter, why not just write it all down to whatever you think you can get for it?

Betsy Burton, President and Chief Executive Officer

We basically are taking aggressive mark downs but at some point there are diminishing returns to marking it down further. So, again, if you don’t have the traffic to support the increased clearance sales, it makes sense, because it’s simply just giving away gross margin dollars.

Bill Armstrong, CL King & Associates

Okay, the write down that we saw in the fourth quarter, should we think that there might be any further write downs on that inventory, or is that inventory a risk for further write downs going forward?

Betsy Burton, President and Chief Executive Officer

No, we do not believe so. There is nothing wrong with this merchandize. It is simply a non-going-forward merchandize, and as I indicated before we will again be clearing the product in the third quarter and the fourth quarter, and we expect to end the year with only about 15 million remaining.

Bill Armstrong, CL King & Associates

Okay, and then finally on your direct sourcing initiatives, in the past management has indicated expectations of roughly 50 basis points per year of gross margin benefit from those initiatives, do you expect to get that sort of benefit for fiscal ’07 as well?

Betsy Burton, President and Chief Executive Officer

Yes, and just to give you a few statistics, in ’06 the sales from our direct diamond source goods increased from about 11.5% to 25% of diamond sales for our moderate brands, and we are on track. The margin on direct sourced diamonds increased 60 basis points year over year this year. So, we believe that the 50 basis points guidance is realistic for fiscal ’07.

Bill Armstrong, CL King & Associates

Okay, thanks very much.

Operator

Your next question comes from the line of Mark Bettinger with Stanford Group.

Mark Bettinger, Stanford Group

A few things, first of all the $1.98 to $2.08, can you give the gross margin SG&A assumptions in there in terms of percent of sales?

Betsy Burton, President and Chief Executive Officer

We try not to give too detailed information. So, in terms of the gross margin for the year-over-year improvement, it is about 90 basis points.

Mark Bettinger, Stanford Group

Okay. And this is off a base of the $1.84, in other words the clean numbers?

Betsy Burton, President and Chief Executive Officer

Correct.

Mark Bettinger, Stanford Group

So, you’re adding 90 basis points. And the SG&A with all your initiatives, what would you expect that to be?

Betsy Burton, President and Chief Executive Officer

Up about 40 basis points.

Mark Bettinger, Stanford Group

Okay, in terms of the comps, what’s your tipping point of when you start to leverage the occupancy cost?

Betsy Burton, President and Chief Executive Officer

It really depends on the quarter, in other words…

Mark Bettinger, Stanford Group

No, but to the year, you’re talking about 2% to 3% comps, so what do you leverage the occupancy as?

Betsy Burton, President and Chief Executive Officer

It’s around 3.

Mark Bettinger, Stanford Group

Okay, and the comps by brand, you’re saying Zales Brand should be about zero for the year?

Betsy Burton, President and Chief Executive Officer

No, not for the year but for the quarter, the first quarter, Zales has aggressive comps for the second quarter.

Mark Bettinger, Stanford Group

Give it to me again, the comp for the first quarter you’re saying it should be about flat?

Betsy Burton, President and Chief Executive Officer

For Zales Brand, correct.

Mark Bettinger, Stanford Group

And then what were you saying after that?

Betsy Burton, President and Chief Executive Officer

Let’s call it mid single digits for the Zales Brand in the second quarter.

Mark Bettinger, Stanford Group

Okay, Zales Brand, mid single. Do you have annual numbers for the various brands?

Betsy Burton, President and Chief Executive Officer

No; I mean we have them but we don’t share them.

Mark Bettinger, Stanford Group

Okay, just to give us guidance in terms of Canada and Gordon’s and so on that they were doing well in ’06 and what we might expect?

Betsy Burton, President and Chief Executive Officer

Yeah, we really have not done that in the past for competitive reasons.

Mark Bettinger, Stanford Group

And George, do you have a comp number? I know you used the 1.6, but you didn’t include the Bailey Banks & Biddle stores that you closed, do you have a straight up comp number?

George Mihalko, Chief Financial Officer

That is the straight up comp number. Comps wouldn’t allow you to include stores that have been discontinued.

Mark Bettinger, Stanford Group

Okay, fair enough. The charge that you’re taking, the $26.4 altogether, is that all in cost of goods sold?

George Mihalko, Chief Financial Officer

No, we indicated that to be about 70%, most of it is in margins and then a little bit more than 30% is in SG&A.

Mark Bettinger, Stanford Group

If I call you later is it possible to get a more definitive breakout?

George Mihalko, Chief Financial Officer

Yes.

Mark Bettinger, Stanford Group

Great, thank you very much.

Operator

Your next question is from the line of Dax Blassis with Gates Capital Management.

Dax Blassis, Gates Capital Management

I was curious what you expected your depreciation, amortization, and CapEx to be for fiscal ’07?

George Mihalko, Chief Financial Officer

Depreciation is $64 million.

Betsy Burton, President and Chief Executive Officer

And CapEx was $85 million.

Dax Blassis, Gates Capital Management

If I understand the charges correctly, you listed basically a table of certain charges including inventory mark downs, etc., and those were all after tax.

George Mihalko, Chief Financial Officer

Correct.

Dax Blassis, Gates Capital Management

The pretax numbers I assume are at the corporate tax rate that you’re using?

George Mihalko, Chief Financial Officer

Yes, they are.

Dax Blassis, Gates Capital Management

And the total amount of those I think pretax was about $40 million, is that correct?

George Mihalko, Chief Financial Officer

Yeah, just over $40 million.

Dax Blassis, Gates Capital Management

And could you give me the breakdown of the $40 million, how much of that was in SG&A and how much of that was in cost of goods?

George Mihalko, Chief Financial Officer

Same as I just mentioned.

Dax Blassis, Gates Capital Management

So, 70% of the charges?

George Mihalko, Chief Financial Officer

70/30.

Dax Blassis, Gates Capital Management

Okay, great, thank you very much.

Operator

There are no further questions at this time.

Betsy Burton, President and Chief Executive Officer

Okay, thank you all for your time this morning, and we will talk to you next quarter. Thank you.

Operator

Thank you for participating in today’s Zale Corporation conference call. This call will be available for replay beginning at 10 a.m. EST today through 11:59 p.m. EST on Thursday, September 7, 2006. The conference ID number for the replay is 4011345. Again, the conference ID number for the replay is 4011345. The number to dial for the replay is 706-645-9291. You may now disconnect.

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