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Zale (NYSE:ZLC)

Q2 2012 Earnings Call

February 22, 2012 9:00 am ET

Executives

Roxane Barry - Director of Investor Relations

Theo Killion - Chief Executive Officer and Director

Thomas A. Haubenstricker - Chief Financial Officer and Senior Vice President

Matthew W. Appel - Chief Administrative Officer

Analysts

Jeffrey S. Stein - Northcoast Research

Rick B. Patel - BofA Merrill Lynch, Research Division

David Wu - Telsey Advisory Group LLC

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

Janet Kloppenburg

Operator

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

Roxane Barry

Good morning, and thank you for joining us today. I'm Roxane Barry, Director of Investor Relations. Joining on the call today 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 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 those 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 October 31, 2011.

I'll now turn the call over to Theo.

Theo Killion

Thank you, Roxane, and good morning, everyone. The second quarter results that we're reviewing today represent tangible evidence of the progress we're making and executing our turnaround plan as we continue our focus on returning the business to profitability.

For those of you following along with the slides that we posted on our website, please direct your attention to Slide #3. For the quarter, comparable store sales increased 5.8%. As you may recall from our holiday sales release, we reported comp store sales up 10.1% in November and 4.2% in December. The results that we're reporting today incorporate a strong January performance. Importantly, our 2-year comp is up 14.3%, and we're reporting our fifth straight quarter of positive results. The journey that we've been on has been characterized by discipline and focus, sticking to our plan and executing against it. Even with the challenges in the North American economy and pressure from commodity cost increases, we continue to build business momentum.

Our sales results were primarily driven by initiatives that we've discussed in the past including improved core inventory and alternative credit program in the United States, a new marketing campaign, and integrated online and traditional store infrastructure, and strong execution by our customer-facing teams.

I will highlight more specifically how each one helped us deliver our second quarter results. The first initiative is our ongoing discipline of maintaining the core at 80% plus. During the holiday season, we were actually at 85% core with an average in-stock rate of 96%. The work that we've done in re-architecting the core allows us to continually edit and refine it while testing new product introductions and concepts.

You'll recall that for the holiday, we expanded our Persona bead collection to more than 900 stores. When you combine that with the Camilla program we have in our Mappins brand, we have beads in nearly all of our Fine Jewelry stores, and the category is performing nicely. We also introduced proprietary collections from Vera Wang and Jessica Simpson.

The Vera Wang LOVE collection has resonated with our guests, and we will continue to grow the collection as a foundational part of our wedding business. However, the Jessica Simpson test did not meet our performance hurdles, and we will not be continuing the program.

Turning to Slide 4. You'll see our best-performing holiday categories. In Wedding, it was bridal, solitaires, men's and women's wedding bands and solitaire jewelry. Since July 2010, the wedding categories have consistently performed, and they are a critical pillar to our aspiration of being the Diamond Store.

In fashion, colored diamonds have performed well. And as I mentioned previously, the charm bracelet category, led by our partnership with Neil Travis at Persona, has been a strong sales and margin contributor.

Another initiative that contributed to our results in Q2 and will continue to pay dividends in the future is the alternative credit program. By offering financing options to guests who don't qualify for our primary city program, we've effectively opened the aperture and provided greater access to our brands.

The third initiative that contributed to our revenue improvement is our marketing campaign, which is highlighted on Slide 5. As I have said before, we will never have the loudest voice, but when we speak, we want people to listen. Our integrated marketing approach in Q2 achieved our objectives of leveraging multimedia, being efficient and effective, building emotional affinity to the Diamond Store in Zales and Peoples and supporting the introduction of our proprietary brands.

The investment that we've made in new production will continue to be leveraged in the future, and importantly, the focus in investment that we've made in the Zales brands returned an 8.9% comp in our U.S. Fine Jewelry business for the second quarter. Rich Lennox and our partners at GSD&M have tapped into an emotionally rich vein, which will continue to be mined and we'll continue to develop it.

On Slide 6, you'll see a visual representation of an initiative that's continuing to grow in importance to our business, and that's Omni-Channel, the ability to interface with our guests whenever and whenever they'd like. Through initiatives like Ship-to-Store, online ordering in our stores, the optimization of our Web stores for mobile access, the connections we've made with over 530,000 Facebook fans and, of course, the commerce that we conduct in our stores and online, we're blurring the lines between traditional brick-and-mortar and eCommerce. The power of the new media is best exemplified by the over 600,000 people who elected to watch the 2.5-minute montage of our commercials on YouTube in November and December.

We're very much at the beginning of our immersion into the new Omni-Channel reality, but we're encouraged by our early efforts. Critical to delivering holiday results was the preparation and execution by our guest-facing teams, in-store and online. Our stores teams across all brands did a terrific job of delivering guest experiences that were focused on building relationships not merely completing transactions.

On Slide 7, you'll see that we've continued to build retail strength at the board level. This morning, we announced that Beth Pritchard has been appointed as a member of our Board of Directors. Beth is a retail industry veteran with extensive retail leadership experience. She currently serves as the North American Advisor for M. H. Alshaya Company, a global franchise business, representing over 65 premium brands throughout the Middle East, Eastern Europe, Russia and Africa. Beth also helped found Sunrise Beauty Studio, a developer of exclusive beauty brands and products. Prior to that, Beth served as Vice Chairman and Chief Executive Officer of Dean & Deluca and served as President and Chief Executive Officer of Limited Brands' Bath & Body Works. She currently serves on the boards of Vitamin Shoppe and Cabela's.

We also had 2 members joined our board in December. Shareholders elected Josh Olshansky, Managing Director of Golden Gate Capital; and Neale Attenborough, operating partner of the firm. At Golden Gate, Neale and Josh focus on retail, restaurant and consumer product sectors. Josh brings broad finance, retail and board experience; and Neale brings broad retail and operating experience to our board. Welcome Josh, Neale and Beth.

On behalf of our management team and the Board of Directors, I want to thank Stefan Kaluzny and Peter Morrow who stepped down from the board in December.

In addition to these board changes, we continued to strengthen our executive management team in the quarter. At the beginning of February, we announced the appointment of Ken Brumfield as Senior Vice President, Financial Products. Ken has over 25 years of financial services experience. He was instrumental in initiating our U.S. customer alternative financing program as well as the growth of our warranty and repair businesses. Ken will be responsible for all customer financing, warranty, insurance and repair product offerings, and he continues to report to Matt Appel. Ken joins a team of accomplished senior executives with extensive jewelry, retail and turnaround experience. The team is working diligently to refine the strategic framework for the long-term growth of the company.

Please turn to Slide 8.

Before I ask Tom to go to the financial results for the quarter in more detail, I wanted to touch on the results that we've seen month-to-date since it includes the very important holiday, Valentine's Day.

I'm pleased to report that for February month-to-date, we have a positive comp of approximately 8% representing a continuation of the positive momentum in the business. Tom will talk a little bit later about the expected effect of a later Mother's Day on our third and fourth quarter comps.

I will now turn the call over to Tom who will begin on Slide 9.

Thomas A. Haubenstricker

Thank you, Theo, and good morning, everyone. I'd like to start by covering our second quarter fiscal 2012 financial results. Revenues for the second quarter were $664 million, an increase of $37 million or 6% compared to $626 million for the same period in the prior year. The increase in revenues is primarily due to the 5.8% same-store sales growth that Theo already mentioned. We also received a $12.6 million lift in revenue from the change in warranty revenue recognition that we discussed in the first quarter's earnings call. The overall increases from these sources was partially offset by the revenue reduction associated with the net decrease of 61 stores compared to last year. Our 5.8% increase in comparable store sales was driven by a 10% increase in the number of units sold in our Fine Jewelry stores, partially offset by a 3% decrease in the average price per unit sold. These metrics reflect both the impact of the price increases taken in our traditional merchandise areas and the offsetting effect caused by the recent success of our lower price point bead business.

We believe this offsetting dynamic will continue as we adjust the merchandise assortment to maintain items at entry-level price points. Using constant exchange rates, which exclude the effect of the change from foreign exchange rates, comparable store sales increased 6.1% for the quarter. The Canadian dollar weakened 2% relative to the U.S. dollar as compared to last year's second quarter. Foreign exchange rate impact on our second quarter earnings was not significant as the rate differential impacted both revenue and costs. We achieved gross margin for the quarter of $336 million or 50.5% of revenue compared to $315 million or 50.3% of revenue for the prior year period, an improvement of 20 basis points or $20 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. However, this impact was offset by a $4 million higher LIFO charge and as previously disclosed last year, our prior year second quarter gross margin was favorably impacted by a reduction to inventory reserves. Excluding the impact from these 3 items, our gross margin improved 70 basis points compared to the prior year second quarter results. The improvement was achieved through a combination of price increases and lower merchandise discounts partially offset by the impact of rising commodity costs.

SG&A expense for quarter was $282 million or 42.5% of revenue compared to $258 million or 41.2% of revenue in the same period in the prior year. The $24 million increase in SG&A expense was primarily due to higher marketing expenses, mostly driven by the holiday advertising campaign, including the marketing for the launch of proprietary products. A significant percent of this cost increase was due to upfront marketing production and some activities, which are nonrecurring in nature and will provide a benefit to the company in future quarters.

For the second quarter, we posted other charges of approximately $1.2 million compared to $2.9 million in the prior year quarter. The amounts recorded in this line of the income statement consist primarily of charges related to store closures and impairment.

For the second quarter of 2012, we posted an operating profit of $43.2 million dollars compared to an operating profit of $43.6 million in the prior year quarter. On a percent of revenue basis, our operating margin was 6.5% compared to 7% in the prior year. Interest expense for the second quarter of 2012 was $10.4 million compared to $9.5 million in the prior year. This increase was a result of the higher average debt balance and higher interest rate as compared to a year ago. In the second quarter of fiscal 2012, we recorded an income tax expense of $3.8 million compared to an expense of $6.4 million in the same period last year. This reduction in tax expense was due to a reduction in the tax rate in Canada and a change in the profit mix of our business.

Earnings from continuing operations for the second quarter of 2012 were $29 million or $0.78 per diluted share, up $0.04 per share from the prior year comparable result of $28 million or $0.74 per diluted share.

Now please turn to Slide 10, where I've outlined the main drivers of our second quarter 2012 improvement in our net earnings per share from continuing operations.

Starting with last year's results, which again was $0.74 earnings per share, the gross profit improvement was $0.18 per share driven by the top line growth we achieved. This improvement is net of the higher LIFO charges and other items I've discussed earlier. Other improvements totaled $0.08, which was driven by the lower tax expense in Canada, lower charges related to store closures impairment and lower depreciation charges, partially offset by higher interest expense. The change in warranty revenue recognition improved earnings per share by $0.32. And the increase in marketing and other SG&A expenses impacted this quarter by $0.54. The main drivers of this impact, as I mentioned before, were higher holiday marketing expenses, which brings us to this quarter's diluted net earnings of $0.78 per share and a $0.04 improvement over the prior year's comparable results.

Now please turn to Slide 11 as I take you through comparable store sales detail for the quarter. As we stated earlier, total company comp was up 5.8% and up 6.1% at constant exchange rates. This increase follows a 7.9% rise in the same period last year.

Our U.S. Fine Jewelry brands, our largest business segment, which include Zales, Zales Outlet and Gordon's had an increase in comparable store sales of 8.9%. This increase follows a 7.6% rise in the same period last year. Our Canadian Fine Jewelry brands, consisting of Peoples and Mappins, had an increase in comparable store sales of 0.7% and up 2.3% at constant exchange rates. This follows an increase of 13.3% in last year's second quarter or an increase of 8% at constant exchange rates.

And lastly, our Kiosk Jewelry had a comparable store sales decrease of 3% in the second quarter following an increase of 2.7% in the same period last year. I should mention that these comps include sales from the associated online businesses.

In Canada, not unlike other retailers, we experienced a challenging holiday season as uncertainty within the economic environment appears to have dampened overall retail demand. The 0.7% comp, which was accomplished on top of the 13.3% comp a year ago, was disappointing. But given the overall economic environment, we are pleased to have continued momentum in the Peoples and Mappins brands.

Please turn to Slide 12, as I take you through our balance sheet and liquidity. Inventory on January 31, 2012, stood at $815 million compared to $777 million at the end of the second quarter last year. The increase of $38 million was primarily due to the impact of higher commodity costs on our inventory and additional merchandise purchased to fuel the higher level of expected sales activity, particularly in our bridal business.

As of January 31, 2012, the company had cash and cash equivalents of $27 million compared to $37 million in last year's comparable quarter. At the end of the second quarter of fiscal 2012, the company had outstanding debt of $425 million, compared to $385 million as of January 31, 2011. In addition to the term loan of $140 million, long-term debt also includes $285 million borrowed under the revolving credit facility. The increase in debt compared to last year was due in part to the financing of additional inventory.

As of the end of the quarter, the company's total net borrowing availability, adjusted for the minimum liquidity requirement was $108 million. During the second quarter of 2012, capital expenditures totaled $9 million compared to $3 million in the prior year quarter and 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. I should mention we have included a page in the appendix that contains the current store count. We ended the second quarter with 1,151 Fine Jewelry stores and 659 Kiosks for a total of 1,810 retail locations compared to the prior year second quarter count of 1,197 Fine Jewelry stores and 670 Kiosks for a total of 1,871 locations. During the quarter, we closed 5 Fine Jewelry stores and changed the nameplate on 2 stores from Gordon's to Zales. We also opened 1 Kiosk and closed 7 Kiosks. Our expectation continues to be that we will selectively close a small number of stores that are underperforming at lease expiration, and over time, we'll open new stores where the opportunity is compelling.

Now please turn to Slide 13, where I will walk you through some of our year-to-date financial highlights.

Revenues for the first 6 months were slightly above $1 billion, an increase of $61 million or 6.4% compared to $953 million for the same period in the prior year. The increase in revenues is primarily due to an increase of 5.8% in same-store sales. We achieved gross margin for the first 6 months of 51.6% compared to 50.4% the prior year period, an improvement of 100 basis points or $43 million.

Our reported loss from continuing operations for the first 6 months of 2012 was $3 million or $0.09 per share. In the prior year period, loss from continuing operations was $69 million or $2.16 per share.

Now please turn to Slide 14, where I've outlined the main drivers of our first half 2012 improvement and our net loss per share from continuing operations.

Starting with last year's loss per share of $2.16. First I have adjusted for the onetime interest expense item resulting from last year's amendment to our senior secured term loan, which negatively impacted last year's first quarter result by $1.43 per share. So that brings us to an adjusted prior year loss per share of $0.73.

Gross margin improvement contributed $0.67 primarily due top line growth. This improvement is net of a greater LIFO charge and other items I discussed earlier. Other improvements totaling $0.20, which was driven by a lower tax expense in Canada, lower charges related to store closures and impairment and lower depreciation charges, partially offset by higher interest expense.

The change in warranty revenue recognition improved net loss per share by $0.55, and the increase in marketing and other SG&A expenses impacted the period by $0.78. The primary driver of this impact was the higher holiday marketing expenses in the second quarter. That brings us to the $0.09 loss per share we reported for the first 6 months, an improvement of $0.64 per share over prior year comparable results.

Now please turn to the next slide, #15, I want to make some final comments as we move into our spring season and the second half of our fiscal year. We are clearly focused on maintaining consistent positively quarterly sales growth and, as Theo has already mentioned, February is off to a good start with comparable same-store sales month-to-date of approximately 8%.

I want to mention the potential impact of the later Mother's Day this year. Mother's Day is May 13, 5 days later than in 2011. This will likely push some Mother's Day sales out of the third quarter and into the fourth quarter. It could have up to a 2-point impact on our third and fourth quarter comps.

On the gross margin side, we continue to expect gross margin at or above 50%, and we are focused on maximizing the gross profit dollars. We will do that by closely monitoring commodity costs and taking pricing actions where necessary. On SG&A, we expect the second half SG&A rate as a percent of revenue to be at or more likely below last year's second half percent of revenue level of 51.5%.

Overall, we have continued to make progress in the second quarter of this year and look forward to accelerating the rate of progress as we move into our second half of fiscal 2012.

I would now like to turn the call over to the operator to begin the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Jeff Stein of North Coast Research.

Jeffrey S. Stein - Northcoast Research

A couple of questions for you. First of all, wondering, as we look at the top line, if you could possibly discuss the impact that your new credit offering for Monterey Financial -- what impact that may have had on the comp. And also, can you tell us what impact eCommerce had on the comp for the quarter?

Matthew W. Appel

Jeff, this is Matt. I'm going to take the credit portion of that if I can. Let me answer it this way. In terms of credit mix, our U.S. net credit mix was trending in the lower '30s, closer to 30%. And with the addition of the alternative financing program this year, we've successfully brought this credit mix back to the mid-'30s and where it was historically. So effectively, the alternative financing program has replaced some of the lost volume in our primary program.

Jeffrey S. Stein - Northcoast Research

Would that suggest Matt, that maybe it's 3 points or so, 3 or 4 points?

Matthew W. Appel

In terms of the credit mix?

Jeffrey S. Stein - Northcoast Research

No, in terms of the effect that Monterey had on our comps?

Matthew W. Appel

Yes, I'm not suggesting the impact on comp. I'm just suggesting that it had a 3% to 4% impact in terms of credit mix. I'll let you do the math, Jeff.

Theo Killion

And in terms of the direct business, the direct business contributed strong double-digit comps on top of strong double-digit comps. And I think importantly, Jeff, we're very pleased about the synergy that we're getting as we promote online, and we're able to do things like Ship-to-Store, when the guests comes online and pick up their package in-store and sell them another product when they're there. So increasingly, there's this synergy between the online business and our traditional brick-and-mortar businesses that we're starting to leverage. So we don't -- as Tom mentioned earlier, he reported some blended results. More and more, we're thinking about how we get efficiency from all of the channels and not as kind of segmented parts of the business.

Jeffrey S. Stein - Northcoast Research

Okay. And question regarding your -- both your inventory investment and your marketing spend. It would seem to me -- and I think you're doing it the right way guys, spending more money on marketing, investing in the business to build the brand but at the same time, your inventories are only up 5%, and I would presume that there's a lot of inflation in that number. So it would almost seem like the number of units that you have in your store are actually down to last year. So if you're kind of trying to build the brand and customers come in, and you don't have -- you actually have fewer units in the store, isn't that kind of contrary to what you're trying to accomplish?

Matthew W. Appel

So Jeff, one thing you have to keep in mind is, obviously, as we close stores, that allows us to take the inventory from those stores and redeploy it to the other stores and fuel some of the growth that we're looking for. You're absolutely right that the inflation is causing an increase in inventory. We're very focused on ensuring we've got the right level of inventory in the store, but also on maintaining very efficient levels. Another aspect of this, as you know, the company, in certain cases, will deploy memo inventory items that are on consignment that is not in our inventory balance as a strategic way to manage that. So we feel very comfortable with the level of inventory that's available to the guests in the store.

Jeffrey S. Stein - Northcoast Research

Tom, can you tell us what the level of memo inventory was just roughly relative to the prior year?

Thomas A. Haubenstricker

We don't disclose the absolute amount. I think it is trending up as we look at different product tests. But it's just part of the overall management of inventory that the company goes through.

Jeffrey S. Stein - Northcoast Research

Okay. And final question, then I'll pass it to someone else. Jessica Simpson, it sounds like that, that private label offering, that proprietary offering did not work. Do you have any inventory exposure there that would be unusually high that might cause some markdown risk later on?

Thomas A. Haubenstricker

No, we don't.

Operator

Your next question comes from the line of Rick Patel of Bank of America.

Rick B. Patel - BofA Merrill Lynch, Research Division

Just a follow-up question on the Jessica Simpson discontinuation. So should we expect any onetime charges stemming from that? And then, can you perhaps just touch upon what your plans are for that white space once you get out of that?

Thomas A. Haubenstricker

So let me address -- we do not expect any material onetime charge associated with Jessica. And then Theo, I'll let you handle the question as far as...

Theo Killion

Sure. So, Rick, one of the things that we feel really good about is that we're now at 85% core. What that allows us to do is to have an ongoing discipline of having tests running in our stores. So at any given time, there is product that is fighting this Darwinian fight to be able to exceed our category margin and turn characteristics. But we have several things that are in the stores right now. Our merchandising and sourcing teams actually are in Hong Kong and India as we speak, and we expect to have new tests that will be going in. But this will be an ongoing part of what we do. Having gotten to where we want to be in the core, we can continue to bring things in and continue to test them and to make the appropriate judgments about whether or not to expand or contract.

Rick B. Patel - BofA Merrill Lynch, Research Division

Okay. And then just a question on Valentine's Day. Did you see a continuation of the same trend you saw during the holiday in terms of the category performance? And then can you also touch upon the promotional environment, both in your stores and the industry in general?

Theo Killion

So the categories heros for Valentine's Day were really very much in line with the ones that I mentioned for holiday in the wedding categories and things like colored diamonds and in charm bracelets. So those categories continue to perform extremely well. We have our own promotional discipline that we stick to. What we've tried to do, even in the wake of -- particularly when you think about December, that was from a sign basis probably as bloody as any I've ever seen. We sticked to our promotional cadence, and that's the way that we can protect our margin, that's where we can run our business. So right now, it's all about what we need to do to run our business and not getting distracted by some of the things that are going on in the marketplace.

Rick B. Patel - BofA Merrill Lynch, Research Division

And then, you guys gave what your average price point was including charms and beads. Can you give us what that price point was excluding those businesses, and then can you also touch upon any future plans for price increases as we go through the next couple of months?

Thomas A. Haubenstricker

So, we think the best way to look at the transaction counts and price is the full merchandise assortment within our store. Obviously, if we remove the beads, it would have an impact on the volume. But what we're trying to do is ensure that customers who come into the store have merchandise available to them at the opening price points. We clearly have to protect our margin on the merchandise we have, and that has caused some price increases, but we want to make sure that we still have items for those guests looking for those points. So we think the best way to look at it is the overall store economics in terms of the comp growth and in terms of what's happening in terms of the numbers of units and transactions. And then as far as additional price increases, you clearly -- we're very focused on preserving the gross margin. I think we're satisfied with where we are in the first half of the year in terms of what we've achieved. And it's an ongoing process as we go into the second half and looking at -- by category, what's happening on the inventory, replacement costs and looking at ways we can structure promotions to ensure we preserve our margin. And it's not a switch yes or no on price increases. It's actually a category-by-category assessment that has to be done ongoing throughout the second half of the year.

Theo Killion

And this is one of the areas where we do keep a close eye on what's going on in the marketplace because we have to understand what other choices our guests have. So we look at the marketplace, we look at the fluctuation in commodity prices and then we make category-by-category decisions, as Tom mentioned.

Rick B. Patel - BofA Merrill Lynch, Research Division

Okay. And then, my last question is just around the changes in commodity prices. So it seems like diamond and precious metal prices are off their peak levels and you guys used LIFO accounting for inventory. So at what point does the change in commodity prices become a gross margin tailwind for you?

Thomas A. Haubenstricker

So I mean, I think we're not -- at this point, we're not seeing that reduction on the horizon. There's nothing in our financial planning that is suggesting that, that's going to happen. It will be great if it did. And clearly with LIFO, yes, it would bring some of that benefit into the income statement faster, but in terms of we're out buying in terms of merchandise, it's not something that we see in the near term.

Operator

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

David Wu - Telsey Advisory Group LLC

First, given that you expect the second half SG&A expense ratio to be flat or below last year, how should we think about marketing plans in the back half? Should we still expect the ad-to-sales ratio to continue to increase year-over-year?

Thomas A. Haubenstricker

So, when we -- let me just clarify, what we said is that the SG&A will be flat or below in terms of percent of revenue to last year. And that's really the metric that we're focused on in terms of looking at the SG&A as a percent of revenue. And so within the context of that, the marketing cost fits inside there, and we're still very focused on increasing the promotional aspect of the company, and we'll manage our overall SG&A cost structure in the context that we provided, but also with an emphasis on the real value that our marketing program can have.

David Wu - Telsey Advisory Group LLC

Great. So over the holiday, I mean, you obviously increased ad spending on an ad-to-sales ratio. I was wondering if you're planning to do the same still in the back half of the fiscal year given the guidance?

Thomas A. Haubenstricker

Yes. Clearly, it's not going to be to the same extent that we saw on the second quarter with the increases, but we will want to -- within our SG&A guidance that we've given, we will want to be able to bring the marketing costs to the highest extent we can.

Theo Killion

We see it is an important strategic lever. And obviously, with some of the results that we've seen from things like YouTube where people are volunteering, where we're not bludgeoning them with ads in their face, they're actually opting in. And 600,000 people strong saying that what we're doing is resonating with them. So it continues to be a very important part of the way that we build equity into the Diamond Store.

David Wu - Telsey Advisory Group LLC

Right. And secondly, can you give us an update on the performance of the warranty business, whether you've improved employee training, added more warranty to more products, if there's the potential for further price increases there as well in the spring?

Matthew W. Appel

I think, David, the answer to all of that is yes. The warranty programs have continued to be a very strong contributor on a cash basis. We've seen double-digit increases year-over-year in terms of cash sales, specifics of which we don't disclose. We look at price increases on a regular basis, and that we are -- we test certain price increases across the spectrum. But on an overall basis, warranty has performed exceptionally well. Our field organization has embraced it very strongly. The emphasis on adding a warranty attachment to every sale has been significant with our Ship-to-Store program, a feature that we added this year. We've been able to better drive warranty attachment for our Internet sales. So overall warranty is a very good positive.

David Wu - Telsey Advisory Group LLC

Great. And as a follow-up, could you quantify at all sort of the benefit to the gross margin from higher warranty sales this past quarter?

Thomas A. Haubenstricker

We've quantified in terms of the change in the accounting. I think the warranty does have a favorable impact on the margin based on it brings in a higher degree of profit margin. It's not significant for the second quarter outside of the accounting adjustment that we've already talked about.

Operator

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

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

Could you tell us what the incremental expenses or the cost of the Vera Wang and Jessica Simpson launches were during the quarter? Obviously, Jessica Simpson is not going to continue. Will there be continuing launch costs for Vera Wang going forward?

Thomas A. Haubenstricker

So we're not going to get into an inventory of cost of everything we did in the second quarter around the advertising. It was up significantly as we've said. And some of that was associated with the launch of the proprietary products. Yes, on Vera, we'll continue to have expenses throughout the quarters because that's a very important product for us, and we want to continue to promote it. It will be different in magnitude given we're not going to have to have some of the startup costs associated that we took in the second quarter.

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

I seem to recall that the Vera was launched in about 500 stores during -- for the holiday season, is that correct? And will there -- will you expand it to more stores this year?

Theo Killion

So yes, it was in 500 stores for the fall season, and we continue to see it as an important growth vehicle for our overall wedding categories. But at this point, we're not prepared to talk about what our expansion plans are.

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

Okay. Gross margins on those proprietary products, is that higher, lower, about the same as the company average?

Matthew W. Appel

So within the -- the way we look at it is within each merchandise category. We think those margins are at the high end within the respective categories.

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

Got it, okay. And then final question on the Piercing Pagoda kiosk, the comps turned negative after you had a pretty good run in the last couple of years. What happened there, and what can you do to turn that around?

Theo Killion

Yes. If you look at the year-over-year performance of Piercing Pagoda, it was flattish for the 2 years. It's a business that is an opening price point business. It's probably the business within our portfolio that had the greatest sensitivity to the price increases that we took. We started taking them as far back as last January, took a several over the course of the year including the ones we did in July and October. So we're in the process of testing new opening price point merchandise. And as I mentioned before, I spoke to the merchants yesterday with some of the things that they're going to be bringing back that they're very excited about to put into the Pagoda inventory and be able to reintroduce some of those opening price points. And we think that really was the issue.

Operator

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

Janet Kloppenburg

Just a couple of things on Piercing Pagoda for me. I assume that means that the opening price points will come down, and I'm just wondering if that is an implied gross margin implication there or -- I think that, that business is a pretty profitable business, so I'm just wondering if we can assume that as the business improves, that margin remains stable.

Theo Killion

No. We are incredibly focused on maintaining margins. This isn't about bringing margin down, it's about getting great product at lower prices that resonate with the Piercing Pagoda guests, but none of that will be done to sacrifice any margin whatsoever. We're going to stick with where we are.

Janet Kloppenburg

Okay. And as you look at Canada, another very profitable business for Zale. I'm wondering if you think what's going on there is primarily related to the economy and consumer being more conservative, or if there's some strategies of -- being initiated that could turn that business as well?

Theo Killion

So the good news about Canada is that for the month of February, that business is generally in line with our overall business. So we have seen a very, very nice uptick that's taken place. We are enormously bullish on the Canadian business. I think the economy is expected to expand by about 2%. It's the third largest oil producer in the world, third largest nickel producer. As we get better and better in understanding some of the geographic and demographic issues and how we allocate and place product, we continue to see growth in Canada.

Janet Kloppenburg

Okay. And then with respect to the fashion jewelry business, Theo, I see that Jessica Simpson is being discontinued. Your core product is selling very well. I mean, is there a focus now on just going back to the more traditional classic product line, or is there's something to be done on the fashion side?

Theo Killion

Yes. I think there's something to be done on all of them. We're not going to be -- we won't settle for where we are in bridal. The objective is to continue to make those categories better as well, but we certainly have opportunities in fashion that keep continue to grow that business and to continue to focus on it. There are a number of things right now that we're excited about that are tests, and we have a team that is a pretty new team. We just hired a Vice President DMM, a woman named Sharon Davis, to run the fashion category. She's with Gil Hollander, our chief merchant right now in Asia, and we have new eyes on the business, and we're pretty excited about what they've seen so far and what the opportunities are for the future.

Janet Kloppenburg

And what's going on in the watch business?

Theo Killion

Watches is fine. It absolutely is fine. We've gotten it to...

Janet Kloppenburg

Well, there's a big growth category right now in the industry, I wondered if you are having above average growth there.

Theo Killion

Our watch business is absolutely fine. We have no issues at all at this point with watches.

Janet Kloppenburg

Okay. And then just lastly, I got on a little late and I apologize if you said this, but did you talk about the metrics of the comp sales growth, the transaction value, the ticket size, traffic, did you give those out?

Thomas A. Haubenstricker

Yes we did. We'll follow up with you offline just to go -- yes, but we did. We did provide those.

Operator

Your final question comes from the line of Jeff Stein of North Coast Research.

Jeffrey S. Stein - Northcoast Research

Just a quick follow-up. I've been looking in the malls at some of your Piercing Pagoda locations. And I'm just kind of curious, it seems that your inventory has kind of flipped the last couple of years and I can understand that. It seems that you have a much higher percentage of gold -- silver in the inventory compared to gold. And I'm wondering how over the last couple of years that mix has shifted in the business?

Matthew W. Appel

Jeff, you're saying that you've noticed more silver than gold in past years? And that's an attempt to maintain the opening price point. With the rapid acceleration in gold prices, certainly you're familiar with that ascent. The way to appeal to the opening price point customer that's so important to Pagoda is to feature silver and a lot of the products and other innovations to maintain that the opening price point. And we're going to do more of that as Theo was saying before.

Theo Killion

Yes. We also have clad in the assortment, which is gold over other metals, which gives us a lower price point, and that is also done so that we have those opening price points that Matt alluded to.

Jeffrey S. Stein - Northcoast Research

Okay. And maybe can you tell us roughly what percent of your total inventory, including your stores and kiosks, today would be gold compared with where you were a couple of years ago, let's say, 3 years ago?

Thomas A. Haubenstricker

The percent of gold in the total inventory is very, very small. I don't have the exact numbers in front of me, Jeff, but it's very, very small. It's much more focused on diamonds.

Matthew W. Appel

Yes. And there's a lot more gold in the inventory in our in-line business than they would ever be in the kiosk business. And so, it hasn't changed appreciably, Jeff.

Operator

I will now turn the conference back over to Theo Killion for any closing remarks.

Theo Killion

So, I want to thank everyone for joining us on the call today. We're pleased with 5 quarters of positive consecutive comps. But we're well aware that we still have work to do as we continue our focus on returning to business to profitability. We look forward to talking to you in the next quarter.

Operator

Thank you, again, for participating in today's conference call. You may now disconnect.

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