Mark L. Aaron - Vice President, Investor Relations
James N. Fernandez - Chief Financial Officer, Executive Vice President
Tiffany & Co. (TIF) F3Q08 Earnings Call November 26, 2008 8:30 AM ET
Good day, everyone and welcome to this Tiffany & Company third quarter earnings conference call. Today’s call is being recorded. Participating on today’s call is the Vice President of Investor Relations, Mr. Mark Aaron and the Executive Vice President and Chief Financial Officer, Mr. James Fernandez.
At this time, I would like to turn the call over to Mr. Mark Aaron. Please go ahead, sir.
Thanks you. Good morning. It was a tough third quarter in terms of sales for well known reasons but our bottom line held up well. Jim and I will review Tiffany's performance and also comment on our outlook for the remainder of the year. We hope you have already had a chance to read today’s press release.
Before continuing, please note Tiffany's Safe Harbor statement that statements made on this call that are not historical facts are forward-looking statements. Actual results might differ materially from the expectations projected in those forward-looking statements. Additional information concerning risk factors that could cause actual results to differ materially is set forth in Tiffany's 2007 report on Form 10K and in other reports filed with the Securities and Exchange Commission.
The company undertakes no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances. Now let’s proceed.
After a solid first half of the year where sales and earnings growth surpassed expectations, as well as a good start to the third quarter, Tiffany's then faced a host of external challenges as the economy slowed, the credit markets froze and the equity markets tumbled. All of this dramatically affected consumer confidence and led to a further pull back in spending in the U.S. as well as initial softening in some of our non-U.S. markets.
As a result worldwide net sales in the third quarter were 1% below the prior year. Excluding the translation effect from stronger foreign currencies, sales declined 2% in the quarter. Net earnings from continuing operations were below last year but keep in mind we recorded a large gain last year related to the sale of our Tokyo flagship store building. Excluding that gain and a related contribution to the Tiffany & Co. Foundation, net earnings from continuing operations were higher than last year. You can refer to a non-GAAP analysis that is attached to today’s press release for further clarification.
So let’s look at sales results starting with the Americas region. Sales declined 7% in the third quarter. This was due to a 14% decline in comparable U.S. store sales which was below our expectation that called for only a modest decline and compared with a healthy 8% increase last year. The comp store sales trend ranged from a 6% decline in August, as expected, versus an 11% increase last year to much greater than expected declines of 15% in September versus a 2% prior increase and a comp decline of 20% in October versus a 12% increase last year.
U.S. comps have softened further in November. Geographically, sales in the New York flagship store declined 5% in the quarter and its low point was in October when sales in that store declined 17%. Total sales in the entire nine store New York region declined 6% in the quarter which includes the Wall Street store.
You may be interested to know that while our New York flagship store generated more than 20% of our U.S. store sales in the quarter the eight other New York area stores add up to slightly less than half of the flagship store’s volume.
Outside of the New York flagship store, our comparable U.S. branch store sales declined 16% in the quarter with the low point in October when total branch store comps declined 21%. The sales decline in the Americas resulted from substantial decreases in the number of transactions in every region of the U.S. except for the New York flagship store where it declined just slightly. While the average size per transaction rose slightly across the U.S. Our price stratification analysis showed weakness in sales and transactions across the board at most price levels with no meaningful differences.
Having said that we want to point out there is still plenty of sales activity occurring at high price points and our Blue Book event in New York in October confirmed ongoing interest among our customers. While the year-over-year comparison is down there are most assuredly still a significant number of high end purchases.
In terms of the customer base in the quarter the comp store sales declined entirely reflective lower sales to lower market customers. While sales to foreign tourists, especially from Europe, rose slightly with that increase occurring in the New York flagship store.
Notwithstanding the current environment, we have seen an enthusiastic response from customers to the new stores we have opened this year. In Topanga Canyon in the L.A. market, in West Hartford in Pittsburgh and in Columbus. We also recently completed the conversion of our location in the Mohegan Sun resort in Connecticut into a regular store. We were pleased with the initial reaction to our new smaller store concept we opened last month in Glendale, California.
Feedback suggests we were successful in creating an exciting new format for the self-purchase fashion customer. Also in the Americas region combined e-commerce and catalog sales in the U.S. declined 7% in the quarter with a decline in orders partly offset by an increase in the average order size. As intended we reduced catalog mailings in the quarter to focus on more email marketing and online search but circulation will again increase in the fourth quarter.
We were also periodically offering complimentary shipping on our website and will repeat it in the fourth quarter at a frequency consistent with last year. Our website and catalogs continue to represent important sales and marketing vehicles as they complement our retail stores and our overall multi-channel distribution model. I should add that business gift sales actually rose slightly in the quarter despite the environment.
Rounding out the Americas, our retail sales in Canada, Mexico and Brazil were up by double digit percentages in the quarter and e-commerce sales in Canada were strong too.
Now turning to the Asia Pacific region, sales rose 3% in the third quarter due to an increase in the average price per unit sold. Unit growth in the region was hampered by a decline in Japan. On a constant exchange rate basis, sales declined 1% and comps declined 3%. Japan represents just over half of that region and total sales in dollars rose 1% but declined 8% in Yen. Local currency comps in Japan declined 7% which was below our expectation and compared with a 1% decline in last year’s third quarter.
Comps in Japan began the quarter with a modest increase but then turned down in September and October. Last year comps varied in a pretty narrow range during the quarter. In addition, sales performance within and outside Tokyo was not meaningfully different in the quarter.
We have added four new boutiques in 2008 in the Daimaru Department store in Fukuoka, in the Hankyu store in Umeda, in the Matsuzakaya store in Tokyo and the Intetsu Store in Hamamatsu. Our flagship store on Nigenza in Tokyo, which was closed for the final stages of renovation in late September and October re-opened on November 1 to great media fanfare.
In the Asia Pacific region outside Japan total sales in constant currency rose 12% and comp store sales rose 4% which was on top of a huge 29% increase last year. We saw strength in most countries except Hong Kong where we believe a spending decline is at least somewhat tied to their heavy exposure to the financial services industry. On the other hand, markets such as Australia and Korea were strong in the quarter and we are very pleased with our business in China where we have eight stores on the mainland and two stores in Macao. The comp store sales trend for this region softened during the quarter due to the sales softening in Hong Kong.
During 2008 we have expanded our presence in China with three additional stores in Shenyang, Chengdu and Qingdao. We have broadened our successful business in Australia with a store in Perth. We have added two stores in Korea and closed an older one. We relocated a store in Malaysia. We were also pleased to launch our e-commerce website in Australia in September.
Now turning to Europe. Total sales rose 16% due to an increase in the number of units sold. Total sales on a constant exchange rate basis rose by an even stronger 24%. On that basis, comp store sales increased 8% which was on top of a 14% increase last year. Comps rose in all three months of the quarter. London represents a bit more than half of European sales and despite the various economic and market pressures it posted double digit sales growth that continued throughout the quarter.
In the U.K. we are also seeing strength in e-commerce and catalog sales. Retail store sales also rose in every country on the continent. This has been an unusually active year for Tiffany’s store expansion in Europe with seven new stores opened including two in London, one each in Brussels, Madrid, Dublin, Düsseldorf and Berlin. We are pleased with their initial results and especially with their potential to strengthen our European presence and increase Tiffany's market share.
So that rounds out our sales in the three geographical regions. Lastly sales in Tiffany's other channels declined 1% in the quarter on top of 137% increase last year which had been due to increased wholesale sales of diamonds in connection with our rough diamond sourcing. In addition, sales in our iridesced pearl jewelry stores declined and were below expectations.
From a merchandising perspective there obviously weren’t an abundance of positives to highlight in the quarter but I do still want to comment on our key categories. First, while overall statement jewelry sales declined in the quarter they rose slightly outside the U.S. Similarly, sales of our various fine jewelry collections declined modestly worldwide with a greater drop in the U.S. but increased nicely elsewhere especially in the Asia Pacific region. A single digit increase in worldwide engagement jewelry sales included a small decline in the U.S. in diamond solitaire sales but strong growth in wedding bands.
While outside the U.S. engagement sales were broadly up across the category. At more modest price points, fashion jewelry sales were up in the quarter due to the continued success of our silver and gold charm jewelry collection with particular strength in Europe. The designer jewelry category was down in the quarter with pronounced softness in the U.S.
Lastly, despite softness in watch sales we are excited about progress being made in our strategic alliance with the Swatch group which will result in the launch of new designs and greatly expanded distribution in 2009.
Now let’s turn to the rest of the earnings statement. Gross margin rose almost 2 points to 66.3% in the third quarter due to favorable changes in product sales mix, the benefit from the company’s precious metal hedging program and a reduction in anticipated management incentive compensation. We all know that it is currently a very promotional environment and it is important to note that Tiffany's opposition to engaging in such promotion helps to maintain brand integrity and also ensures gross margin stability.
Selling, general and administrative expenses decreased 7% in the quarter as a reduction in anticipated management incentive compensation more than offset incremental costs related to new stores. The translation effect from stronger foreign currencies was modest, increasing SG&A expenses by 1% in the quarter and 2% in the year-to-date.
Keep in mind that last year’s SG&A included a $10 million contribution to the Tiffany & Co. Foundation from the proceeds of the sale of our Tokyo flagship store building. Excluding that expense on an apples-to-apples basis the ratio of SG&A to sales improved by 8/10 of a point to 43.6% in the quarter. The operating margin was 12.7% in the third quarter. Last year excluding the $105 million pre-tax gain on the sale of the Tokyo store building and the $10 million Foundation contribution, the operating margin was 10.1%. So you can see that despite the sales softness we were able to hold our own from a margin perspective.
Other expenses net were $14 million in the quarter versus $2 million last year. One meaningful part of the increase resulted from the total write off of an interest rate swap we held with Lehman Brothers. Another portion of the increase came from foreign exchange transaction losses. To a lesser extent interest expense was higher and interest income was lower.
Tiffany's effective tax rate was 31.7% in the quarter versus 33.9% last year. In total, net earnings from continuing operations in the third quarter were $44 million or $0.35 per diluted share. Last year’s net earnings from continuing operations in the third quarter were $103 million or $0.74 per diluted share but adjusting for the gain on the Tokyo building and the foundation contribution it was $0.31 per share on a continuing operations basis or $0.29 per share of net income.
So we maintained a high level of profitability despite the current environment. Related to that our return on average stockholder’s equity was 17% and return on average assets was 10% which compared with our long-term objectives of at least 15% for ROE and at least 10% for ROA.
I am now pleased to turn the call over to Jim.
Thanks Mark. The third quarter certainly posed obvious challenges for Tiffany and the entire retail industry. Having said that we believe the Tiffany & Co. brand is stronger than ever and that such an attribute will help our company to out perform others and thrive over the long-term.
As you know, we operate in a competitively fragmented industry and it is likely that more than a few of those competitors are struggling as indicated by their high levels of price promotions. We have the financial strength to achieve our objective of increased market share. Tiffany's balance sheet at October 31 including cash and cash equivalents of $160 million, total short and long-term debt of $821 million and stockholder’s equity of $1.6 billion. Accounts receivable at October 31 were 3% lower than a year ago due to sales performance but receivable turnover remained at a very high 18 times per year.
Net inventories at October 31 were 12% above last year. The increase was directly related to the sudden softening of sales in September and October but also partly due to higher raw materials related to higher manufacturing and diamond sourcing as well as for new stores. The translation effect on inventories was not significant.
Tiffany's inventories are in good shape. It is important to keep in mind that unlike many other retailers our inventory is not seasonal in nature and does not go out of style. However, we will adjust purchase orders with outside vendors and will modify internal manufacturing levels to adjust to the near-term reductions in our sales expectations.
In terms of share repurchases, we were active early in the third quarter and spent $90 million to repurchase 2.3 million shares at what we thought was the very attractive average cost of $39.61 per share. However, as market turmoil and near-term uncertainties about business conditions increased we temporarily suspended our buying to conserve cash. Total debt to equity is typically near its seasonal high at October 31. The ratio is 50% at October 31 versus 23% a year ago, largely reflecting a smaller equity base tied to substantial share repurchases over the past year as well as higher short-term borrowings.
In fact, over the past four quarters Tiffany has spent $37 million to repurchase and retire 14.7 million shares of its common stock. Related to that we have disclosed in our second quarter report on form 10Q that we were evaluating opportunities to issue new debt, up to $300 million in order to repay $100 million of senior notes coming due within the next 12 months as well as to fund potential share repurchases. The credit market then froze and potential lenders postponed making commitments. Due to the credit market conditions we have secured some short-term financing arrangements to see us through our seasonal peak needs.
When appropriate, we will either refinance or replace these borrowings with long-term debt. In addition you should note that on our $450 million revolving credit facility we had $339 million outstanding at October 31 so there was still $111 million available.
Now let’s talk about our expectations for the remainder of the year. The environment is obviously filled with uncertainties about how customers will be spending in the coming weeks. Our stores are well stocked to serve our customers with a range of products and prices including many new exciting designs introduced this year to entice our customers. Our stores are appropriate staffed to deliver the outstanding shopping experience that everyone expects at Tiffany. Our distribution centers are operating very efficiently to ensure that products are shipped and delivered in a timely fashion.
We mentioned in today’s press release that U.S. sales in November to date have softened further from the decline we saw in October. So we are forecasting conservatively. In our judgment for the fourth quarter by expecting U.S. comp store sales to decline 25-35% which will be up against a 1% comp decline in last year’s fourth quarter. At the same time we are also taking a conservative position by forecasting relatively challenging conditions to one degree or another in Europe and Asia Pacific. Combined with the six stores we have opened this year in the U.S., seven stores in Europe and a net of nine stores in the Asia Pacific region we are looking for worldwide sales to decline 13-20% in the fourth quarter.
This would result in sales for the year coming in somewhere between a 2% decline to unchanged from 2007. Gross margin is holding up nicely and should be up for the year which of course reflects the non-promotional nature of our company. I’ll add that we have seen recent declines in precious metal and diamond costs which if they continue should ease pressure on our product input costs later in 2009 but it is too early to forecast that.
Tiffany's expense ratio will undoubtedly increase for the year as sales shortfalls result in de-leveraging of fixed costs. As such we are now forecasting the operating margin in a range of 17-18% for the full year. We estimate that other expenses net will be approximately $25-27 million for the year and we are planning the effective tax rate at approximately 36%.
As a result we are reducing our full-year earnings projection from $2.82 to $2.92 per diluted share to a new and somewhat wider range of $2.30 to $2.50 per share. There are obviously an infinite number of potential scenarios for sales performance by geographical market as well as the related margin implications but we think we are considering a reasonable range of fourth quarter sales outcomes.
Finally, our new range compares with net earnings of $2.20 in 2007 and an adjusted 2007 base level of $2.47 which excludes certain items last year. We are still in the very early stages of constructing our plans for 2009 but we will plan conservatively in our sales growth assumptions. I can also share with you we will adjust staffing levels and capital expenditures in order to most effectively allocate our resources in this environment.
Our new 2008 full year guidance does not include any fourth quarter one-time charge for staff reductions. We will continue to expand our store base, but have decided to slow the rate of growth and the number of locations from the longer term 8-10% annual rate to approximately 5-6% in 2009 by pursuing the most compelling location opportunities and focusing more on expansion outside the U.S.
This will probably mean opening about five stores in the Americas, across the U.S., Canada and Latin America and about eight stores across Asia Pacific and Europe in 2009.
In closing, the 2008 holiday season is upon us and many customers will undoubtedly be seeking Tiffany's extraordinary products. Tiffany is a trusted American institution. We offer timeless design and craftsmanship that lasts. The Tiffany & Co. brand is worthy for celebrating important personal milestones, incorporating the established values of romance, love and honor. Our management team is prepared to address the short-term business challenges of the current environment so that our company prospers over the longer term.
Please note that we expect to report sales results for the November/December period on Wednesday, January 14. Until then our best wishes to you for happiness during this holiday season. That concludes today’s call and please feel free to call Mark with any questions. Thanks for listening.
This concludes today’s conference. A replay of this conference will be available beginning at 9:30 CT on November 26, 2008 and ending December 3, 2008 at 9:30 CT. The replay may be heard at (719) 457-0820 or (888) 203-1112. The confirmation code is 4006080. Thank you for your participation in today’s conference. You may now disconnect.
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