Tiffany & Co. (TIF)
F2Q06 Earnings Call
August 31, 2006 8:30 am ET
Mark Aaron - Vice President, Investor Relations
Jim Fernandez - Executive Vice President, Chief Financial Officer
Good day, everyone, and welcome to this Tiffany & Company second quarter earnings release 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. Jim Fernandez.
At this time, I would like to turn the call over to Mr. Mark Aaron. Please go ahead, sir.
Thank you. Good morning, and thanks for joining us on this conference call. We reported Tiffany’s second quarter results earlier today and hopefully you have had a chance to review the press release.
Before continuing, please note Tiffany’s Safe Harbor provision 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 2005 report on Form 10-K 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 we can proceed.
In the second quarter, Tiffany’s net sales increased 9% and we achieved solid sales growth in a number of markets. As we expected, a lower gross margin and higher expense ratio affected results. However, we said on our first quarter conference call that we expected virtually no pre-tax earnings growth in the second quarter and the results we issued today met that expectation.
Also in the past few months, we opened stores in exciting U.S. and international markets, we announced plans for some others, and we introduced a number of new products. The Board of Directors increased the dividend for the fourth consecutive year, and we again repurchased a considerable amount of stock.
Let’s first look at our sales performance by channel of distribution in the second quarter.
U.S. retail sales rose 8% in the quarter, primarily due to 5% comparable store sales growth, as well as results from several new stores. The 5% comp store sales growth was on top of a 6% increase in last year’s second quarter. In terms of the monthly trend during the quarter, comps rose 6% in May, increased 8% in June, and declined 1% in July. In last year’s second quarter, comps had increased 7% in May, 6% in June, and 4% in July.
We are not going to read too much into the volatility of the monthly numbers and will not speculate on what future sales conditions it may portend. In fact, U.S. comps have rebounded in the month of August to date, with a mid-single-digit increase.
After reporting disappointing results in the first quarter, sales in our flagship New York store rebounded in the second quarter with a 5% increase, which was on top of a 3% increase a year ago. We are looking forward to completing the renovation of the flagship store’s main floor, which has likely been somewhat disruptive to sales in the past six months, but which should be wrapped up next week.
Comps in our seven New York suburban stores also rose 5% in the quarter. Sales results in our U.S. branch stores improved in the quarter with a 4% comp increase, which was on top of a 6% increase a year ago.
Looking around the country, several regions with above average growth included our eight stores in Florida, our four stores in Texas and one in Denver, as well as the Northwest region, which includes our two stores in Washington, one in Portland and five stores in northern California.
However, the six stores in our Pacific region, that includes Hawaii and Guam, were again soft, primarily due to a decline in sales to Japanese tourists.
In terms of some sales dynamics, the 5% comp in the quarter was generated by an increase in the average spending per transaction, while store traffic and transactions were virtually equal to the prior year.
In terms of price stratification, there was sales growth in every price strata that we measure. However, there was smaller percentage growth in sales under $500, but meaningfully higher growth in sales and transactions over $10,000, $20,000, and $50,000, which of course are at a lower gross margin.
In terms of customer mix, the overall U.S. comp store sales growth in the quarter was due to higher sales to local market customers, which also accounted for the majority of the New York flagship store’s increase.
Our expectation calls for a mid-single-digit increase in comparable U.S. store sales for the full year. Last year, U.S. comps rose 7% in the third quarter, 5% in the fourth quarter, and 7% for the full year.
Consistent with our growth strategy, our U.S. plans include opening five new stores in 2006. We are getting strong results from our new store in Indianapolis that we opened in the second quarter. Also during the quarter, we expanded Tiffany’s presence in South Coast Plaza in Costa Mesa, California, when we added an 800 square foot diamond salon in our store there. South Coast Plaza is our highest volume U.S. branch store and the salon showcases Tiffany’s extraordinary diamond assortment and enables us to better serve the large and growing customer base.
Earlier this month, we had a terrific opening in Nashville when customers welcomed our new store there. We also enjoyed a strong opening in our new store on the pier in Atlantic City, a new luxury retail project, and we are on track to open stores on the big island of Hawaii and in Tucson later this year.
While U.S. comps rose 5% in the quarter, total U.S. retail sales rose 8%, indicating that new Tiffany & Co. stores continue to generate considerable sales and enthusiastic customer reaction.
Staying in the U.S. for a moment, our direct marketing sales also rebounded strongly in the second quarter, posting an 18% increase. This was on top of a 5% increase last year and was better than our expectation.
We said on the first quarter call that direct marketing sales at the end of April were soft because Mother’s Day occurred a week later than last year, which caused a shift in ordering and sales to early in the second quarter. These results are indicative of that shift.
The strong direct marketing sales growth was generated by increases in both the number of orders and in the average amount spent per order. We are very pleased with the pace of e-commerce growth, as well as the customer’s favorable reaction to the product news we began selectively e-mailing to customers earlier this year. As we have said previously, we are reducing catalogue circulation by 10% to 15% this year due to the synergies between our website and catalogue.
Let’s now turn to international retail sales, which increased 10% in dollars in the second quarter.
On a constant exchange rate basis, which excludes the translation effect from foreign currency changes, international sales rose 12%, indicating the foreign currencies were generally weaker than the U.S. dollar versus a year ago. For example, in the second quarter, the Yen averaged 114 to the dollar versus 109 a year ago. My following comments by region will reference sales on that constant exchange rate basis.
International comparable store sales increased 10% in the second quarter, which was on top of the 3% increase a year ago. Japan now represents approximately half of Tiffany’s international sales. Total retail sales in Japan increased 6% in the quarter, due to an increase in average jewelry price and mix. Comparable store sales from Japan rose 2% in the quarter, which was below our expectation and compared with a 1% increase a year ago.
In terms of the monthly results during the quarter, comps increased 4% in May, on top of a 5% decline in May last year, rose 6% in June on top of a 2% increase, and declined 4% in July, compared with a 5% increase in July 2005. As noted in today’s press release, comps in August to date have posted a high single-digit decline.
Geographically, the 2% comp increase in the second quarter was comprised of similar increases in Tokyo and outside Tokyo. The Ginza flagship store, rose 1%.
We opened two boutiques in Japan in the first quarter, in Mito and Yonago, and closed one in Tottori in the second quarter. We also recently announced plans to open a freestanding store in November in the important Roppongi Hills section of Tokyo, which is a key centre of luxury retail activity.
We are continuing to pursue attractive opportunities to expand and enhance Tiffany’s distribution base in Japan. Two current examples:
- We will soon complete a remerchandising of our Ginza flagship store and will highlight the change with a special bridal event, and the introduction of the Tiffany Novo Collection, a new brilliant cushion cut solitaire diamond ring. Building on our successful engagement jewelry business, Tiffany Novo will be exclusive to the Ginza flagship store in September and then rollout to the rest of Japan in October, followed by other international markets and the U.S. in early 2007;
- A complete renovation of Tiffany’s boutique in Mitsukoshi’s Ginza store will be completed in September, as part of Mitsukoshi’s overall renovation of that important store. We expect sales results to benefit from these initiatives.
Let’s now look at the other half of the international retail channel, which is generating strong growth in sales and profitability. Comparable store sales in the Asia-Pacific region outside Japan increased 27% in the second quarter, which was on top of the 6% increase in the second quarter last year, and was considerably above our expectation. We experienced exceptional growth in Hong Kong, Taiwan, Singapore, and Australia. We are also seeing strong growth in China in percentage terms, but it is still on a very small base.
We opened a second store in Beijing during the quarter, and later this year will further expand Tiffany’s presence in China with a second store in Shanghai and one in Macau. In addition, last week we opened a store in Busan, Korea to replace an older one that closed earlier this year.
In Europe, comparable store sales rose 17% in the second quarter, which was on top of a 5% increase last year and was also above our expectations. We achieved strong sales growth in every European market. Sales in London rose nicely in the quarter, although sales were lower in the flagship store on Old Bond Street due to the disruption from the major renovation. However, we completed that renovation in mid-July and since then have seen a pronounced sales pick-up at that location. With almost 50% more gross square footage, the newly renovated store provides a more spacious and luxurious environment for our customers, and we are delighted with the results. We will further expand Tiffany’s European presence in September when we open a store in Vienna.
Finally, turning to the other Americas, we achieved solid sales increases in our stores in Toronto, Mexico, and Brazil during the quarter. Our new store in Monterey has had a strong start and we are very excited about our plan to open a store in Vancouver this November.
Looking at international sales for the rest of the year, we are looking for a low single-digit increase in Japan comparable store sales for the full year, and for translation purposes are planning the Yen at 115 to the dollar. We are looking for healthy low double-digit comp store sales growth in the various other international markets outside Japan, but are not planning them at the robust rate seen in the first-half of the year.
Finishing the top-line review, sales in our other channel rose 4% in the second quarter. Sales at Little Switzerland stores increased 10%. In addition, we are continuing with our development of Iridesse stores, where we are adding seven stores this year.
There was actually a slight decline in wholesale diamond sales in the quarter, but we still expect the pace of such sales to accelerate in the remainder of the year based on increased rough diamond purchasing.
That covers sales by channel of distribution.
Looking at a few merchandising highlights in the second quarter, growth was seen across a range of product categories, with diamond jewelry maintaining a prominent role in the sales growth, from high-end diamond jewelry to diamond engagement rings, to new diamond and platinum pendants. We are also pleased with continued favorable response to some of Tiffany’s other relatively new fine jewelry collections, such as the Swing and Legacy collections.
Our celebration rings initiatives continue to be very successful and has become an important base of our business.
There was also growth in silver and gold jewelry, highlighted by the popular 1837 and Atlas collections.
Sales also rose in the designer jewelry category, including Elsa Peretti and Paloma Picasso.
We are pleased to report that the sales performance of Frank Gehry’s jewelry designs, even though only introduced into one-third of our stores at the end of the second quarter, is far exceeding our expectations, and we will complete the store rollout in the third quarter.
Lastly, the timepiece and tableware categories posted modest sales growth in the quarter.
I am now pleased to turn the call over to Jim.
Thanks, Mark. Now let’s look at the rest of the income statement. Gross margin of 55.1% in the second quarter was four-tenths of a point below a year ago, which was close to our expectation. The decline largely reflected higher product costs. We recorded a LIFO charge of $8.1 million in the quarter, compared with a charge of $3 million in last year’s second quarter.
We’d been affected by higher costs for precious metals, but as appropriate, are addressing cost pressures through retail price adjustments. Higher costs are affecting the entire industry, and while it is difficult to quantify any customer resistance to higher prices, we believe that Tiffany is maintaining its competitive position and value propositions.
We continue to expect that gross margin for the full year will be approximately equal to the prior year, based on our assumption for sales mix, product costs, and anticipated wholesale diamond sales.
SG&A expenses increased 12% in the second quarter, which was in line with our expectation. The year-over-year rate of growth accelerated in the second quarter, largely due to higher store-related costs. SG&A in the first-half has also included increased marketing related event spending tied to the launch of the Frank Gehry jewelry collection.
As expected, the expense ratio of 42.5% in the quarter was higher than the prior year because of insufficient sales leverage on these and other SG&A costs.
We continue to expect a high single-digit percentage increase in SG&A for the full year which, based on our assumption for sales growth, would still result in some improvement in the expense ratio for the full year.
Other expenses net of $5.3 million in the second quarter were in line with our expectation, and we expect it to be approximately $20 million for the full year.
Therefore, earnings before income taxes declined 4% in the second quarter and our expectation called for it to be approximately equal to the prior year.
The effective tax rate of 38.9% in the quarter was higher than the 28% rate in last year’s second quarter. You will recall that Tiffany had a tax benefit of $6.6 million, or $0.05 per diluted share, in the second quarter of 2005 related to the repatriation provisions of the American Jobs Creation Act of 2004. We continue to expect an effective tax rate of approximately 38% for the full year.
Adding it all up, Tiffany generated net earnings of $41.1 million, or $0.29 per diluted share in the second quarter versus $50.6 million or $0.35 per diluted share a year ago.
From a return perspective, at the end of the second quarter we were achieving a 9% return on average assets and a 14% return on average stockholder’s equity, which in both cases are close to our expectations. We remain committed to achieving appropriate and sustainable investment returns. Our long-term objectives continue to call for a 10% return on average assets and a 15% return on average stockholder’s equity.
Tiffany’s balance sheet remains strong. At July 31st, net receivables were up 14% from a year ago, largely due to sales growth, and are turning at 19 times per year. Net inventories at July 31st were up 16% from a year ago. An increase in finished goods was partly to support sales growth, as well as for new stores and new products. There were also increases in raw material and work in process inventories due to higher diamond purchasing and the effect of higher metal prices.
In total, our expectation continues to call for a mid- to high-single-digit percentage increase in inventories for the full year, and some improvement in inventory turnover.
Tiffany was again very active in its share repurchase program in the second quarter, spending almost $84 million to buy 2.5 million shares at an average cost of $33.20 per share. In the first half of 2006, we spent almost $164 million on share repurchases. That alone would have left us with $113 million authorized for repurchases under a $400 million program expiring in March of 2007. However, as announced today in a separate press release, Tiffany’s Board of Directors has extended the program to December of 2009 and added $700 million to the authorization. That means we can spend up to $813 million in the next two-and-a-half years to repurchase stock which, at roughly current stock prices, would represent 15% to 20% of shares outstanding and market cap.
We finished the quarter with cash and cash equivalents of $147 million versus $129 million a year ago. Tiffany’s debt leverage remained reasonable at the end of the quarter, with total debt to stockholder’s equity at 33% versus 24% a year ago.
We are optimistic about Tiffany’s prospects for 2006 and beyond. We certainly acknowledge that there are various economic uncertainties and geopolitical anxieties. However, we remain convinced that there are increasing numbers of discerning consumers seeking the extraordinary products that we offer.
In existing markets, we communicate to customers with effective marketing and public relations initiatives. We also have the opportunity to expand Tiffany’s market penetration by entering many new markets. This year, we are increasing Tiffany’s worldwide square footage by approximately 7%, which is slightly above our mid-single-digit growth strategy.
We will maintain our active product development program by introducing many new jewelry designs in a wide range of prices.
I am pleased to say that Tiffany’s infrastructure is performing very well in support of our growth initiatives. Our internal manufacturing facilities are operating effectively, and our distribution centers are performing efficiently, handling store inventory replenishment and shipping Internet and catalogue orders to customers in a very timely fashion.
We have substantial long-term opportunity to benefit from leveraging this highly developed infrastructure.
Tiffany operates in a large and competitively fragmented industry, and we believe that our multi-channel communications and distribution represent a powerful model for long-term growth.
In today’s press release, we noted that our expectation for this third quarter includes a mid-single-digit increase in earnings before income taxes and net earnings approximately equal to last year’s $0.16 per diluted share, which had benefited from a lower effective tax rate due to favorable reserve adjustments related to the expiration of certain statutory periods.
Our full-year expectation for 2006 calls for low double-digit growth in earnings before income taxes, and net earnings of $1.77 to $1.82 per diluted share. Beyond 2006, our objective calls for at least 12% growth in earnings per share.
We appreciate your interest in Tiffany. Please note on your calendars that we plan to report third quarter results on November 29th. That concludes this conference call, but as always, please feel free to call Mark with your questions or comments, and thanks for listening.
Thank you, gentlemen. If anyone in the audience would like to access the replay of today’s call, please call toll free 888-203-1112. Again, that is toll free 888-203-1112, or for international participants, that is 719-457-0820. Again, 719-457-0820, and please access the replay by using passcode 4510519. Again, that is 4510519. That replay begins at 9:30 Central time today, ending midnight on September 6th Central. Thank you for your participation. You may disconnect at this time.
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