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Executives

Mark L. Aaron – Vice President of Investor Relations

James N. Fernandez – Executive Vice President and Chief Financial Officer

Tiffany & Co. (TIF) F2Q09 Earnings Call August 28, 2009 8:30 AM ET

Operator

Good day everyone, and welcome to this Tiffany and Company second quarter conference call. Today’s call is being recorded. Participating on today’s call is Mr. Mark Aaron, Vice President of Investor Relations; and Mr. Jim Fernandez, Executive Vice President and Chief Financial Officer.

I would now like to turn the call over to Mr. Mark Aaron. Please go ahead, sir.

Mark L. Aaron

Thank you. Good morning and welcome to our second quarter conference call. Before we continue please note 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 2008 annual report on Form 10-K and on 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.

Okay, now let’s move forward. We’ve previously said that we planned our business cautiously for 2009. This morning we’re pleased to say that Tiffany’s second quarter sales of $612 million and earnings of $0.46 per share surpassed our expectations. It appears to us that the tide may be slowly turning in our favor. On today’s call, Jim and I will comment on these second quarter results and on the full year outlook.

In the quarter, worldwide sales in dollars declined 16% from last year and by 14% on a constant exchange rate basis. This was an improvement from the reported 22% and 18% respective declines in the first quarter, and it bolsters our thinking that we can experience further improvement in the second half due to easier year-over-year comparisons and therefore achieve our full year outlook.

Starting with the Americas, sales declined 23% in the quarter, which met our expectation. Total retail sales in the U.S. declined 26% due to roughly equal declines in the number of transactions and in the average transaction size. However, we were pleased to note a small improvement in the customer conversion rate for the first time in quite a while. Comparable U.S. store sales declined 27%, which improved from a 34% decline in the first quarter and compared with a 4% decline in last year’s second quarter.

Within that, aggregate U.S. branch store sales were down 26% without any geographically noteworthy areas of weakness or strength. Sales in the New York flagship store declined by 30% in the quarter for obvious local economic reasons, and comp store sales in the entire nine store New York region declined 29% in the quarter. You may be interested to know that the sales decline in our Wall Street store was identical to the New York flagship.

In last year’s second quarter, branch store comps were down 6%, while you may recall that the New York flagship was up 5% as it was benefiting from a strong inflow of European shoppers. The U.S. comp trend ranged from a 31% decline in May to a 25% decline in June and a 24% decline in July. Last year U.S. comps had declined 2%, 6% and 5% in those respective months.

As we’ve seen in recent quarters, our price stratification analysis continued to show the greatest percentage declines in sales occurring at the highest price ranges. That is over $50,000. And the smallest declines at more accessible price points. From a customer mix perspective, the sales decline was attributed to lower sales to local customers as well as foreign and domestic tourists. However, the New York flagship store felt a disproportionate effect from lower sales to European visitors this year.

The new stores that we’ve opened in the past year continue to perform well. Two weeks ago we opened a 5,800 square foot store in the Roseville Galleria near Sacramento and were welcomed by a lot of very enthusiastic shoppers. And we’re scheduled to open a store in the fourth quarter in the City Center Complex being built in Las Vegas. In addition, we continue to be pleased with customer reactions and operational efficiencies in our new format store in Glendale, California, and as we had previously suggested we recently added a representative engagement ring assortment that addresses the requests from many customers. We’re looking forward to opening a similar format store in Seattle’s University Village next week.

Also in the Americas, our e-commerce and catalog sales are showing encouraging signs. Combined sales declined 8% in the quarter due to a decline in the number of orders, while the average order size was unchanged from last year. This was better than our expectation, and was an improvement from the previous quarter when sales declined 17%. Catalog circulation declined in the quarter which we’d planned for the full year as well. We instead are relying more on the cost effective marketing benefit from email communications to drive customers to our website and stores.

Lastly in the Americas region, we achieved solid performance from our stores in Canada, Mexico and Brazil and we are pleased with initial results in our new second store in Toronto in the Yorkdale section. So while conditions are still challenging in the Americas, we’re pleased that sales trends in the first half have been moving in the direction we’ve planned, and believe the picture will brighten further in the second half when we compare it to the steep sales declines last year.

Our full year outlook continues to call for a mid-teens percentage sales decline in the Americas including a high-teens comp decline in the U.S., which implies much smaller declines in the second half of the year.

Looking across the oceans, we were pleased with improving sales in Asia-Pacific and Europe. In the Asia-Pacific region, total sales declined 1% in the second quarter, which followed a 9% decline in the first quarter. On a constant exchange rate basis, total sales declined 3% and comp store sales declined 4% with Japan down 11% while the rest of the region was up 5%. The results I’ll cover now are all on a constant exchange rate basis. Total sales in Japan declined 13% and comp store sales declined 11% which was somewhat below our expectation and was on top of a 7% comp decline last year. Comps declined throughout the quarter with no meaningful change in the monthly pattern, nor any meaningful difference in comps within or outside Tokyo.

The yen averaged 96 to the $1 in the quarter versus 106 last year which generated a favorable translation effect on sales. Tiffany’s business in Japan continues to be affected by softness in their economy and consumer spending, and we continue to plan for similar conditions and results for the full year.

Outside Japan, we experienced solid improvement in other Asia-Pacific markets and as a result total retail sales rose 14% with comp store sales up 5%. This followed a 5% comp decline in the first quarter, was on top of a 13% comp increase last year and it surpassed our expectation. Business remains strong in Australia and China, but as the quarter progressed we also saw solid improvements in most other countries including Hong Kong, Taiwan and Singapore. During the quarter we opened a store on Canton Road in Hong Kong and in July alone it posted the second highest volume of our eight stores in that market. Next month we will open our tenth store in Korea and our plans for later this year include opening our tenth store in China in the city of Schengen and our fifth store in Australia in the Melbourne suburb of Chadstone, all of which should expand our burgeoning success in those countries.

For the total Asia-Pacific region our sales outlook now calls for a low single digit sales decline in dollars, which is a little better than we previously expected. That would include a mid single digit comp decline on a constant exchange rate basis, with Japan performing below the rest of the region.

Things are also looking up for us in Europe, with a total sales increase of 13% in constant currencies but a 4% sales decline when translated back into dollars due to relative strength of the dollar versus European currencies. The 13% increase continues to reflect sales from the seven new stores we opened last year as well as good underlying demand. In fact, comp store sales rose 5% in the quarter, which exceeded our expectation and was on top of a strong 11% increase last year. Despite difficult economic conditions in the UK and continental Europe, we’re pleased to be achieving positive comps in London and on the continent, with the largest percentage increase in Italy in the quarter.

The new stores that we opened last year in the UK, Belgium, Germany, Ireland and Spain are generating excellent initial results. We look forward to entering the Netherlands when we open a store in Amsterdam later this year. And we’re planning to expand our presence in the UK with the opening of a boutique in Selfridges in Manchester. So we’re delighted with our performance in Europe and are now forecasting a low single digit comp increase in constant currencies for the full year, which is a bit better than our previous expectation for no comp store sales growth.

Lastly, sales in our other channel declined 66% in the second quarter. The decline reflected lower wholesale sales of low quality rough diamonds acquired through our sourcing program. Demand in the wholesale market was soft in the quarter which resulted in lower sales and related profitability.

Results for Tiffany’s Iridesse business are now shown in discontinued operations.

Though we now expect sales in the other channels to decline approximately 50% for the full year compared with our previous expectation of a 20% decline. That covers our segment sales review.

In terms of product categories, the overall trend with continued relative strength in more accessible price points that was offset by weakness in the highest price points. Within jewelry, the statement category continued to pose the steepest percentage decline, primarily due to a decline in pieces sold and not in the average price. On the other hand, fashion gold and silver jewelry was the best performing category, relatively speaking, with sales about equal to last year.

The engagement jewelry category declined roughly in line with total company sales, and name designer jewelry was a bit below the company average.

One big product launch this year, our big product launch this year actually is the new Keys collection of pendants in silver, gold and platinum with diamonds, ranging from $150 to $15,000. It is enjoying a stellar start. And the recent introduction of Tiffany’s new Bezet collection of diamond rings has further expanded our engagement jewelry assortment. And despite the current challenges in the luxury watch market, we are looking forward to the launch of new watch designs this quarter.

We think you’ll probably agree that Tiffany’s second quarter top line performance was respectable in light of the difficult environment, and that our recent trends may bode well for results later in the year. Lastly, we think that our geographical diversification is a significant advantage. Tiffany has a presence in more than 50 countries through company operated stores in 21 countries, and wholesale distribution to independent retailers in more than 30 additional countries, all of which offer growth potential for Tiffany to serve customers in their local markets as well as when they travel. It is a vast global opportunity for us.

I’m now pleased to turn the call over to Jim.

James N. Fernandez

Thanks Mark. Despite challenging external conditions, we were pleased that sales in Europe and the Asia-Pacific region came in better than we expected in the quarter. Margins and spending came in pretty close to what we planned for, so it was really the better top line performance that helped to put quarterly earnings above our expectations.

Looking at some details, gross margin in the quarter came in at 55.1%. This was 2.7 points lower than last year and was also a bit lower than our expectation. This was largely due to higher product costs, similar to what we experienced in the first quarter. While it’s true that diamond and precious metal costs declined this year, reversing large increases in the prior year, we don’t get the benefit in gross margin until we actually sell the product. And based on our rate of inventory turn, we should probably start to see that benefit in the first half of next year.

In addition, as part of our rough diamond sourcing program, wholesale sales and profitability were affected by soft demand in the diamond market for such goods and accordingly we’ve also adjusted our carrying value for those goods that will be sold in the near future.

SG&A expenses declined 14% in the quarter, partly due to lower staffing expenses and reduced variable expenses tied to lower sales levels. In addition, we’ve reduced our marketing spending this year as we previously disclosed, but believe our level of advertising and allocation by market is still appropriate to support our objective to increase Tiffany’s market share.

In the quarter, we recovered $4.4 million on a loan to Tahera Diamond Corp. that we had written off last year, and that amount is recorded as a gain in SG&A expenses and benefited EPS by $0.02 per share in the quarter. We expect SG&A expenses to decline by a high single digit percentage for the full year. Based on this first half performance, we continue to expect that Tiffany’s operating margin from continuing operations will decline in the full year from an adjusted 17.8% last year that excluded one time items, and that the decline will be about evenly divided between a lower gross margin and a higher expense ratio.

Interest and other expenses net rose as we expected to $12 million in the quarter from $3 million last year. The increase primarily resulted from higher interest expense tied to long term debt that we’ve issued in the past few quarters, and we continue to expect interest and other expenses net to total about $50 million for the full year.

Tiffany’s effective income tax rate was 26.7% in the quarter versus 36.9% last year. The rate was lower than we initially planned due to favorable reserve adjustments tied to the conclusion of some tax audits. The lower rate benefited EPS by $0.05 per share in the quarter. We now expect an effective income tax rate of approximately 34% for the full year.

Our net earnings from continuing operations for the second quarter came in at $57 million or $0.46 per diluted share versus $0.64 last year. Even excluding the total of $0.07 per share that resulted from the Tahera gain and the lower tax rate, earnings from continuing operations were still above what we expected due to the better sales results.

In total, Tiffany’s sales and earnings performance leads us to increase our outlook for net earnings from continuing operations for the full year from the previous range of $1.50 to $1.60 per diluted share to a new range of $1.65 to $1.75 per diluted share. This includes the forecasted net sales decline of about 10% for the year, combined with the other assumptions we’ve already mentioned on the call.

I should add that our full year sales forecast assumes no meaningful change in economic conditions from the current environment, so we have not changed our sales and earnings expectations for the second half of the year. And I should also add that we have no plans for store closings.

In terms of our balance sheet, we’re on track to achieve the objectives we established at the start of the year. Accounts receivable at July 31 were 23% lower than last year due to lower sales volume, and they are turning at 18 times per year. We’re pleased that net inventories at July 31 were just 2% higher than a year ago and have declined 4% since the start of the fiscal year, which is consistent with our objective to reduce inventory this year by a single digit percentage. Our balance sheet shows a high degree of liquidity to support our current business and planned expansion. We finished the second quarter with $334 million of cash and cash equivalents versus $152 million a year ago.

Total short term and long term debt was $752 million versus $639 million last year and during the second quarter we paid off $40 million of maturing long term debt. Capital expenditures were $30 million in the first half of the year compared with $68 million last year due to fewer store openings and other cost containment, and we remain on track to spend about $100 million on CapEx for the full year.

Adding this all up, we remain comfortable that we can achieve our full year forecast to generate approximately $400 million of free cash flow, which we define as cash flow from operating activities less capital expenditures. In addition, a few weeks ago we disclosed in an 8-K filing that Tiffany entered into a new multi-bank credit facility, replacing the one that was up for renewal next year. We decided that $400 million was an adequate level, down from the previous facility’s $450 million capacity. But due to strong levels of interest we did increase the number of participating banks from eight to nine.

Summing it all up, we believe that Tiffany is weathering this challenging environment and is positioned well going forward. We have a strong store presence around the world with numerous expansion opportunities. Our brand is respected and desired. Our product designs are renowned, and we have a well developed infrastructure and strong financial position to pursue growth. It should go without saying that we will maintain brand integrity while pursuing those opportunities.

That concludes this conference call. Please note on your calendars that we expect to report Tiffany’s third quarter results on November 25. Please feel free to contact Mark with any questions and thank you for listening.

Question-and-Answer Session

Operator

That does conclude today’s conference call. There will be a replay available until September 4th by dialing 888-203-1112 and entering the access code 9968845. Again that telephone number is 888-203-1112. The access code once more is 9968845. We thank you for your participation. You may now disconnect.

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Source: Tiffany & Co. F2Q09 (Qtr End 07/31/09) Earnings Call Transcript
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