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Tiffany & Company (NYSE:TIF)

F3Q09 Earnings Call

November 25, 2009 8:30 am ET

Executives

Mark L. Aaron - Vice President, Investor Relations

James N. Fernandez - Chief Financial Officer, Executive Vice President

Operator

Good day, everyone, and welcome to this Tiffany & Company third quarter 2009 earnings conference call. Today's call is being recorded. Participating on today's call are Mark Aaron, Vice President of Investor Relations; and Jim Fernandez, Tiffany's Executive Vice President and Chief Financial Officer. At this time, I would like to turn the call over to Mr. Mark Aaron. Please go ahead, sir.

Mark L. Aaron

Thank you. Good morning and thank you, everyone for taking the time to join us on this third quarter conference call. Jim and I will comment on Tiffany's latest performance and on the full year outlook but 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.

Now we can proceed.

Three months ago, we said on our second quarter call that it appeared to us the tide was slowly turning in our favour. This morning, we were pleased to report that Tiffany sales and earnings in the latest quarter again surpassed our expectations. In the third quarter, worldwide sales declined 3% to $598 million but were equal to last year if we exclude a decline in wholesale sales of diamonds tied to our diamond sourcing program. This followed a 16% decline in the second quarter and a 22% decline in the first quarter and bolsters our confidence that we can achieve our expectations for the rest of the year.

Let's look at sales by segment. First, sales in the Americas declined 9% in the quarter. This was a little better than we expected and included smaller declines in the latter part of the quarter. In the U.S., total retail sales were 9% below last year due to a decline in the average transaction size and a smaller decline in the number of transactions. While store traffic was still below last year's levels, a smaller decline in the number of transactions led to an improvement in the customer conversion rate for a second consecutive quarter.

Comparable store sales in the U.S. declined 10%, which compared with a 14% decline in last year's third quarter. It also compared with much larger declines of 34% and 27% in the first and second quarters. By month, comps declined 18% in August, 7% in September, and 5% in October. In last year's third quarter, U.S. comps had declined by 6%, 15%, and 20% in those respective months, indicating no meaningful change in the two-year run-rate over the three months.

From a customer mix perspective, the decline in total U.S. sales was primarily affected by lower sales to local customers and also to a lesser degree, by declines in tourist spending. The New York Flagship store also experienced declines in local customer and tourist spending.

Looking at it geographically, sales in our New York flagship store declined 8% and comp store sales in the nine-store New York region declined 9%. Aggregate U.S. brand store comp store sales declined 11%. There weren’t many markets meaningfully divergent from the overall rate of decline, although for what it's worth California was somewhat softer, Florida was somewhat stronger, and our stores in Hawaii and Guam posted solid increases.

What is most important to us is that the majority of our U.S. stores achieved their sales plans in the quarter.

From a price stratification perspective, we continued to experience the greatest percentage declines in sales occurring at the highest price ranges, with relatively better performance at more accessible price points. But compared with what we saw in the first half of the year, the percentage declines were smaller at all price strata in the third quarter.

Related to the high end business, we recently held our annual event in New York as well as in several other cities this year in the U.S. and Asia, tied to the publication of Tiffany's Blue Book, to which we invited some of our highest spending customers. We were encouraged with our guests' enthusiasm and with their purchases of some truly extraordinary pieces of jewellery.

During the quarter, we opened two stores in the U.S. -- one is a 5800 square foot store in the Roseville Galleria near Sacramento. The other is a 2200 square foot store in Seattle's University Village, which is our second store in the new concept that incorporates a different approach to visual merchandising, product assortment, and selling style.

It is difficult to evaluate the performance of a new store concept when it's launched in a challenging economy but we thought the headline in the Seattle Times on September 4th accurately described the store by calling it a new look for Tiffany's, upscale but approachable.

For those of you in the New York area, you can get a taste of this new approach by visiting our store in White Plains, where we recently introduced some of those elements, including a new selling environment where customers are encouraged to try on jewellery while being advised by a jewellery stylist.

Next week, we will complete our 2009 U.S. store expansion when we open our third store in Las Vegas, this one in the new Crystals at City Center complex.

We also have our U.S. e-commerce and catalog sales in the Americas. In the quarter, a 9% decline in combined sales was due to a decline in the average order size, and in the number of orders. But we were pleased to see some improvement late in the quarter, with orders growing in October.

We reduced catalog circulation by about 40% in the quarter, which is in line with the plan decline for the full year. However, we will continue to utilize e-mail communications as an effective way to attract customers to our website and the stores.

Rounding out the Americas region, we achieved solid comp store sales growth in Mexico and Brazil and we are pleased with the expansion of our business in Canada with the second store we opened in Toronto earlier this year.

For the full year, we now expect a low teens percentage decline in total sales in the Americas, which includes a mid-teens percentage decline in comparable U.S. store sales for the year.

Turning to other regions, we were very pleased with a further pick-up in our Asia-Pacific business. On a constant exchange rate basis, total sales increased 2% in the third quarter, which exceeded our expectations, and which followed a 5% decline in the first half. Asia-Pacific comparable store sales declined 3% due to continued weak sales in Japan that more than offset strength in the rest of the region.

The results I'll cover now are all on a constant exchange rate basis. In Japan, total sales declined 10% due to a 13% drop in comp stores sales that was slightly worse than we expected. Comps declined throughout the quarter with no improvement in many months, nor any meaningful difference in comps within or outside Tokyo. There was a favourable translation effect on our sales because of the strength of the YEN which averaged 92 to the dollar in the third quarter versus 105 last year.

On a related note, last week we reduced prices in Japan by an average of 5% to adjust for the strong YEN. We are not forecasting any improvement in Japan in the fourth quarter.

Our Asia-Pacific business outside Japan continued to improve in the quarter. Total sales increased 18% and comp store sales gained 9%. This followed a 5% comp decline in the first quarter and a 5% comp increase in the second quarter and it was above our expectations.

Performance ranged from continued strong growth in China, Australia, and Singapore to noteworthy improvements from the second to third quarters in Hong Kong, Korea, and Malaysia.

You may find it interesting that the new store we opened just earlier this year on Canton Road in Hong Kong is already posting the highest sales volume of our eight stores in that market.

During the quarter, we opened our 10th store in Korea in Seoul and in China we renovated and expanded our Plaza 66 store in Shanghai. Last week we were delighted to open our fifth store in Australia in the Melbourne suburb of Chadstone and we are getting ready to open our 10th store in China in the city of Shenzhen, both of which will strengthen our successful and growing presence in those countries.

In fact, we are on pace to roughly triple the number of Tiffany stores in Mainland China from the current nine stores to 25 to 30 in the next five or so years.

For the total Asia-Pacific region, our full-year sales outlook now calls for sales in dollars equal to the prior year, which is a little better than our previous expectation. That would include a mid-single-digit comp decline on a constant exchange rate basis for the year due to the softness in Japan.

We were also very happy with our performance in Europe where total sales rose 16% in constant currency. Comparable store sales rose 9% in the quarter, which widely exceeded our expectation and was on top of an 8% comp increase last year.

We continue to believe solid sales growth in Europe reflects our relatively young presence and growing attraction among customers who are discovering Tiffany. Our strength was again geographically broad-based. We are doing very well in London where the vast majority of our sales are made to local customers but our stores are also benefitting from increased spending by continental European and Asian visitors.

Sales on the continent rose in most countries with noteworthy growth in Italy. During the quarter, we expanded our presence in the U.K. when we opened a boutique in South Ridges in Manchester.

Yesterday, we entered The Netherlands by opening a beautiful 2100 square foot store in Amsterdam. Next month, we plan to open another shop at Heathrow Airport in its terminal 3, adding to the success we have had with our shop in terminal 5.

For the full year, we are now forecasting a low single digit increase in European sales and dollars, reflecting a high-single digit comp increase in constant currencies, which is better than our previous target.

Lastly, sales in our other channels declined 81% in the third quarter due to lower wholesale sales of low quality rough diamonds that reflect a reduction in our purchases of rough diamonds this year and therefore fewer low quality stones to resell. It also reflects a better quality mix in the assortments that we are purchasing. Therefore we expect sales in the other channel to decline by about 60% for the full year, compared with our previous expectation of a 50% decline.

So that's the review of sales by segment. From a worldwide product perspective, improved performance in many categories, especially later in the quarter, largely reflected the comparisons to last year when sales plummeted but we think may also reflect some improvement in underlying demand in some markets.

In any case, we were encouraged with a good increase in worldwide engagement jewellery sales in the quarter. We were pleased with growth in gold and silver fashion jewellery that was helped by the success of Tiffany's new Keys collection, which is enjoying a stellar start at all price points. We also saw improving performance in some of our other existing collections, including Return to Tiffany's, Metro, Tiffany Notes, and our collection of gold and silver charms.

On the other hand, high-end statement jewellery sales continued to decline, albeit at a lesser rate than earlier in the year, due entirely to a decline in pieces sold and not in the average price.

Sales of name designer jewellery were also down in the quarter and while watch sales declined in the quarter, they rose in October as some exciting new designs were launched in our U.S. stores. Take a look at our ads in today's New York Times and Wall Street Journal to see the handsome men's Atlas Dome watch from that popular collection.

So it was a quarter with some encouraging sales trends. I will now turn the call over to Jim to comment on the rest of the earnings statement and balance sheet.

James N. Fernandez

Thanks, Mark. We think the numbers we reported this morning showed the resilience of our business in a still challenging global environment. Let's look at the rest of the earnings statement.

Gross margin declined 1.5 points in the quarter to 54.8%. Precious metal costs have exhibited extreme price volatility over the past two years. As we expected, the headwinds we have encountered in the past few quarters from higher product costs tied to our slow rate of inventory turnover continued to affect margin in the third quarter, but to a lesser extent. Conversely, we expect some benefit from lower product cost in the first half of next year but for this current year, we expect gross margin to decline more than 1 point from the prior year.

On a related note, we've been seeing rough diamond prices increase in recent months, which we attribute to curtailed mining production earlier in the year that helped to reduce supply relative to short-term demand weakness, and it is certainly still our view that over the longer term high quality diamond prices will rise as increasing global demand exceeds supply.

SG&A expenses declined 2% in the third quarter, which was a smaller decline than we saw in the first half of the year and was pretty much as we expected. However, you may recall that we have reported a 7% decline in SG&A expenses in the third quarter last year. That decline had resulted from our reversing year-to-date accruals at that time for lower anticipated management incentive compensation as a result of the dramatic business slowdown.

We continue to track in line with substantial expected savings from the staffing reductions made at the start of the year. We have also reduced marketing spending this year but still believe our level of advertising and allocation by market is appropriate to support our objective to increase Tiffany's market share and with quarterly sales virtually equal to the prior year, there were only minimal variable cost savings.

Lastly, we reported SG&A expenses in the quarter, a $4 million charge or $0.03 per diluted share after tax, for terminating a management agreement after we bought out some of the minority interests in connection with our diamond sourcing and polishing operations in South Africa and Botswana.

We now expect SG&A expenses to decline by a mid-single-digit percentage for the full year from last year's SG&A that excluded various one-time items.

Based on these better-than-expected results, Tiffany's full-year operating margin from continuing operations should still decline from an adjusted 17.8% last year that excluded some one-time items but the decline should be less than we previously thought.

In a year that's been filled with macro challenges, this performance should point to our long-term potential for margin expansion.

Interest and other expenses net of $11 million in the quarter was lower than last year and a bit lower than we expected. However, last year included the write-off of an interest rate swap and some foreign exchange transaction losses. Excluding those items, higher interest expense in the third quarter versus last year reflected the long-term debt that we issued over the past year. We now expect interest and other expenses net to total about $48 million for the full year.

Tiffany's effective income tax rate of 22% percent in the quarter compared with 32.1% last year. The rate was lower than we initially planned and was not included in our earnings guidance from three months ago due to favourable reserve adjustments tied to the expiration of certain statutory periods.

This benefited EPS by $0.04 per diluted share in the quarter and we now expect an effective income tax rate of approximately 31% for the full year, which includes the various one-time tax benefits we have recorded.

Adding it all up, the third quarter net earnings from continuing operations of $43.3 million or $0.34 per diluted share, were slightly below $0.36 per diluted share last year but were meaningfully above our plan due to the higher than expected sales.

We've had a good start to the fourth quarter, with worldwide sales in November to date tracking favourably to our expectation, which calls for a mid-single-digit sales increase for the quarter but it should go without saying that results in December are most important.

Based on the better-than-expected sales in the third quarter and some fine-tuning of our fourth quarter sales expectations in certain markets, we are now forecasting an 8% decline in annual worldwide sales versus a previously expected 10% decline.

This leads us to again raise our annual earnings per share guidance from the most recent $1.65 to $1.75 to a new range of $1.88 to $1.98 per diluted share.

As with the previous guidance, please note that this new range includes the benefits and costs from reporting various one-time items.

Looking at our balance sheet, we have continued to invest in our business this year and have the financial strength to comfortably do so. Accounts receivable at October 31st were 8% below last year due to lower sales volumes and receivables are turning at 18 times per year. Net inventories at October 31st were in very good shape, down 6% from a year ago and down 4% from the start of the fiscal year. This is meeting our objective to reduce inventories this year by a single-digit percentage while maintaining high levels of in-store product availability that we believe are a real competitive advantage, especially in this environment.

Capital expenditures of $47 million year-to-date were down from $109 million last year due to fewer store openings and other cost containment, and we are now forecasting CapEx of about $85 million for the full year.

At the end of the quarter, we had $375 million of cash and cash equivalents, which was up from $160 million a year ago.

Total short-term and long-term debt was $753 million versus $821 million last year. For the full year, we now expect to generate in excess of $450 million of free cash flow, which we define as cash flow from operating activities less capital expenditures.

I'll close my remarks by reiterating Mike Kowalski's point in today's press release, that Tiffany has performed remarkably well this year despite the dramatic downturn in consumer spending by taking the steps necessary to ensure healthy levels of profitability and liquidity while also investing in our business and not compromising our brand principles.

That wraps up this conference call. We expect to report holiday sales results in a press release on January 12th before the market opens. The release will include any updates, if necessary, for sales and earnings guidance. However, please note that we have decided to discontinue the practice of conducting a holiday sales conference call, instead choosing to disclose all of the usual detailed information for the complete quarter when we report results in March. As always, please feel free to contact Mark with any questions. Best wishes for a happy holiday season and thanks for listening.

Operator

And this does conclude today's conference call. A replay of this call will be available starting today, November 25, 2009, at 10:30 Central Time, and ending December 2, 2009 at 10:30 Central. You may access the replay by dialling 1-888-203-1112, or 719-457-0820 and using the replay code of 4861048. Again, ladies and gentlemen, we appreciate your participation today. You may now disconnect your lines. Thank you and have a great day.

Question-and-Answer Session

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Source: Tiffany & Co. F3Q09 (Qtr End 10/31/09) Earnings Call Transcript
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