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Zale (ZLC)

F1Q11 Earnings Call

November 23, 2010 8:00 a.m. ET

Executives

Roxane Barry – Director, IR

Matt Appel – EVP and CFO

Theo Killion – CEO

Analysts

Rick Patel – Banc of America/Merrill Lynch

Jeff Stein – Soleil Securities Group

David Wu – Telsey Advisory Group

Presentation

Operator

Good morning. I would like to welcome everyone to Zale Corporation’s fiscal first quarter 2011 results 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 for the Zale Corporation’s first quarter fiscal 2011 conference call. I'm Roxane Barry, director of investor relations. On the call today are Theo Killion, chief executive officer; and Matt Appel, executive vice president and chief financial officer.

Before we begin, I'll read our Safe Harbor statement. Our commentary and responses to your questions on this conference call will contain forward-looking statements, including statements relating to our future goals, plans, and objectives. These forward-looking statements are not guarantees of future performance, and a variety of factors could cause our actual results to differ materially from the anticipated or expected results expressed in these forward-looking statements.

Additional information concerning other factors that could cause actual results to differ materially from those contained in the forward-looking statements is available in our annual report on Form 10-K for the fiscal quarter ended July 31, 2010.

I will now turn the call over to Matt.

Matt Appel

Thank you Roxane, and good morning to everyone. Revenues for the quarter ended October 31, 2010 were $327 million, compared to $329 million for the same period in the prior year, a decrease of 0.7%. Comparable store sales decreased 1.1% compared to a decrease of 6.8% in the prior year.

The decrease in revenues is primarily due to year-over-year store closures, partially offset by an increase in revenues recognized on our lifetime and 12-month warranty programs. Gross margin for the quarter ended October 31, 2010 was 50.5% compared to 48.6% for the prior year period. The 190 basis point improvement in gross margin was primarily due to the higher level of warranty revenue recognized in the quarter.

SG&A expense for the quarter ended October 31, 2010 declined approximately $8 million, or 3.9%, to $195 million compared to $203 million in the fiscal 2010 period. The decline in SG&A expense was due to our continuing discipline around expense levels, including lower occupancy costs due to store closures, renegotiated rents, and lower professional fees. In the 2010 period, professional fees included costs related to the restatement of our financial statements.

Operating loss in the first quarter improved $15 million to a loss of $42 million, compared to $57 million in the prior year period. Operating margin for the quarter was -12.8% compared to -17.2% in the fiscal 2010 period. This improvement reflects the initial progress made with respect to our turnaround program.

During the first quarter, the Canadian dollar remained strong relative to the U.S. dollar, with an average exchange rate of $0.97. In the first quarter of last year, this rate stood at $0.93, therefore year-over-year the Canadian dollar was approximately 4% stronger. Impact on the 2010 quarter's earnings was not significant, as the rate differential almost equally impacted all P&L line items.

Interest expense for the first quarter was $55 million compared to $2 million in the prior year. As previously disclosed in our fiscal 2010 10-K, this quarter's interest expense includes a charge totaling $45.8 million, which resulted from the amendment to our senior secured term loan executed on September 24, 2010.

In accordance with the applicable accounting standards, the amendment was considered a significant modification, which required us to account for the costs of the amendment and the previously incurred unamortized costs on the term loan as an extinguishment. $30.6 million of this charge was non-cash in the first quarter of 2011.

Excluding the $45.8 million charge, interest expense increased $7.6 million from the prior year. This increase was attributable to the borrowing costs related to the senior secured term loan, and higher costs related to borrowings under the extended tranche of the revolving credit agreement.

Now, moving to income taxes. Keep in mind that we remain subject to the three-year cumulative loss rules in the U.S. Therefore, net operating losses generated are fully reserved for due to the uncertainty surrounding future recognition. In the first quarter of fiscal 2011 we recorded an income tax benefit of approximately $100,000 compared to an expense of $1.2 million in the comparable period last year.

The 2011 benefit is primarily attributable to losses during the quarter in Canada. For the full year we anticipate some income tax expense related to our earnings in Canada. We have exhausted U.S. net operating loss carrybacks at this time.

The net loss from continuing operations for the quarter ended October 31, 2010 was $97.2 million, or $3.03 per share, compared to a net loss from continuing operations of $59.7 million, or $1.87 per share for the fiscal 2010 period. Excluding the interest charge related to the term loan amendment, loss per share from continuing operations for the quarter would have been approximately $1.60.

We ended the first quarter with 1,218 fine jewelry stores and 673 kiosks, for a total of 1,891 retail locations compared to 1,251 fine jewelry stores and 683 kiosks, for a total of 1,934 locations in the prior quarter. During the quarter we opened one fine jewelry store and two kiosks and closed one fine jewelry store and one kiosk. In addition, we rebranded three existing in-line locations.

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