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Zale (ZLC)

Q2 2011 Earnings Call

February 23, 2011 9:00 am ET

Executives

Theo Killion - Chief Executive Officer, President and Director

Matthew Appel - Chief Financial Officer and Executive Vice President

Roxane Barry - Director of Investor Relations

Analysts

Rick Patel - BofA Merrill Lynch

David Wu - Global Crown

William Armstrong - CL King & Associates, Inc

Jeffery Stein - Soleil Securities Group, Inc.

Janet Kloppenburg - JJK Research

Presentation

Operator

Good morning, my name is Ashley, and I will be your conference operator today. I would like to welcome everyone to Zale Corporation’s Fiscal Second 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 on the Zale Corporation’s Fiscal Second Quarter 2011 Conference Call. I'm Roxane Barry, Director of Investor Relations. On the call with me 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 would 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, 2010.

I'll now turn the call over to Matt.

Matthew Appel

Thank you, Roxane, and good morning to everyone. We are very pleased to report our second quarter results that marked another quarter of solid progress as we continue to execute the multiyear turnaround of the business. Revenues for the quarter ended January 31, 2011 were $626 million, an increase of $44 million or 7.6%, compared to $582 million for the same period in the prior year. The increase in revenues is primarily due to higher same-store sales, an increase in revenues recognized on our lifetime warranty programs and appreciation of the Canadian dollar. The increase was partially offset by a net decrease of 36 stores compared to last year.

Comparable store sales for the second quarter increased 7.9%, compared to a decrease of 11.2% in the prior year. The increase in comparable store sales was driven by an increase in both the number of customer transactions and average transaction price. The constant exchange rates, which excludes the effect of translating Canadian currency, denominated sales at the U.S. dollars, same-store sales increased 7% for the quarter.

During the second quarter, the Canadian dollar remained strong relative to the U.S. dollar, with an average exchange rate of approximately $0.99. In the second quarter of last year at this rate stood at approximately $0.95, therefore, year-over-year, the Canadian dollar was 5% stronger. Impact on the 2011 quarter's earnings was not significant, as the rate differential almost equally impacted all P&L line items.

Gross margin for the quarter ended January 31, 2011 was 50.3% compared to 49.8% for the prior-year period. The overall improvement of 50 basis points was due to the combination of the following factors: higher recognized revenues from lifetime warranty worth 65 basis points, a pickup of approximately 230 basis points due to improvement in overall inventory quality by moving from 60% to 78% core and higher rate of inventory turn compared to last year. This was partially offset by an approximate 200 basis point impact of higher cost of merchandise, which we account for on a LIFO basis, and a change in mix to lower margin merchandise.

I'd now like to address the subject of commodity prices. Since last fall, diamond producers have experienced a significant increase in the price of rough. We have accepted some modest price increases with more recent receipts. However, based on the well-publicized price pressure in the marketplace, it will be necessary to accept additional selective price increases this spring as we replenish our core inventory. As we manage through this process, we are evaluating our pricing strategy with a focus on maximizing gross margin dollars.

Gold pricing is far less significant to us. However, over the past year, gold prices have increased by approximately 24%. We have addressed this by shifting more merchandise into alternative metals for example, in Pagoda, and by taking selective price increases. Our objective remains to maintain gross margins above 50% while continuing to regain market share. SG&A expense for the quarter was 41.2% of revenues as compared to 43.3% of revenues in the fiscal 2010 period, or $258 million in the second quarter of fiscal '11 compared to $252 million in the comparable 2010 period.

The increase in SG&A expense of $6 million was due to the following factors: first, a higher level of staffing in our stores during the holiday season; secondly, higher performance-based compensation earned by our field and corporate personnel; and finally, lower promotional expenses as a result of the timing of certain Valentine's Day promotions and a more efficient advertising buy for holiday.

Keep in mind, as our sales increase, as demonstrated this quarter; we are beginning to realize SG&A leverage. Other charges of $2.9 million in the second quarter consist primarily of a non-cash $3.7 million charge to the impairment of certain underperforming stores. In the comparable 2010 period, other charges included a $23.3 million charge in the impairment of underperforming stores and a $3.7 million charge related to closed stores.

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