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Tiffany & Co. (TIF)

F3Q06 Earnings Call

November 29, 2006 8:30 am ET

Executives

Mark Aaron – Investor Relations

Jim Fernandez – CFO

Operator

Good day, everyone and welcome to this Tiffany & Co. 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. Jim Fernandez. At this time, I'd like to turn the call over to Mr. Mark Aaron. Please go ahead, sir.

Mark Aaron

Thank you. Good morning and thanks for joining us today. On this conference call, Jim and I will review Tiffany's third quarter performance and comment on the near-term outlook. Please first note the following Safe Harbor statement for Tiffany.

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.

The results we reported this morning included solid comparable store sales growth in the U.S. and in many international markets. Our gross margin declined modestly. The SG&A expense ratio improved. We recorded gains in the quarter associated with the sales of equity investments. Our effective tax rate rose modestly from last year. So all in all, we reported 23% net earnings growth.

Let's first look at Tiffany's sales performance in the four channels of distribution. Total U.S. retail sales rose 9% in the third quarter. On a total U.S. store basis, this was due to an increase in price and mix as well as some increase in unit volume. Comparable store sales growth of 6% in the quarter was pretty much in line with our recent expectations and was on top of a 7% comp increase in last year's third quarter. While we saw an increased number of transactions on a total U.S. store basis, as well as higher spending per transaction, comparable store sales growth was driven entirely by higher spending per transaction.

Sales rose nicely throughout the quarter with comps increasing 6% in August, 7% in September, and 4% in October. For comparison, you should note that U.S. comps in last year 's third quarter had increased 5% in August and 8% in both September and October. From a geographical perspective, sales in the New York flagship store rose 13% on top of a 12% increase a year ago. We were pleased to finally complete the multi-year renovation of our New York flagship store during the quarter, and the reaction of our customers has been quite favorable.

In addition, comps in the seven New York area branch stores rose 6%. Branch store comps around the U.S. rose 4% and there was no particular geographical concentration of strength. For example, a few stores with the largest percentage increases were in Seattle, Palm Desert, Houston, Coral Gables and Charlotte with varying degrees of change in other markets. However, the softest region was in the Pacific, where we continue to experience sales declines in Hawaii and Guam.

Our price stratification analysis for the U.S. indicated that the greatest growth occurred in sales and transactions over $20,000 and over $50,000 which as many of you know, occur at lower gross margins.

In terms of customer mix, the majority of the comp store sales growth came from higher sales to local market customers, which was also true for the New York flagship store.

Lastly, we are experiencing robust performance in the new U.S. stores we've opened in 2006 in Indianapolis, Nashville, Atlantic City and Tucson. We will wrap up our U.S. store expansion for the year when we open a beautiful store on the big island of Hawaii tomorrow.

Also in the U.S, sales in the direct marketing channel rose 11% in the third quarter which was slightly above our expectations and was on top of a 4% increase last year. Growth was generated by increased numbers of orders and increases in the amount spent per order. As planned, we reduced catalogue circulation in the quarter in line with our full year objective to reduce mailings by 10% to 15%. On the other hand, we began e-mail marketing earlier this year to the large customer database we have accumulated in recent years and these communications serve as timely reminders of upcoming holidays while providing appropriate gift suggestions.

Let's now look at international retail sales which rose 9% in the third quarter but included some very divergent results. The 9% growth was on top of a 7% increase last year and was pretty much in line with our expectations. There was minimal currency translation effect in the quarter, and on a constant exchange rate basis which excludes the effect of translating local currency results into U.S. dollars, international retail sales also increased 9% in the quarter while comparable international store sales rose 4%.

My following comments will refer to sales on a constant exchange rate basis. The international retail channel is composed of several distinct regions with approximately half of the channel sales in Japan while the other half includes the rest of Asia Pacific, Europe, Canada and Latin America.

Total retail sales in Japan in the third quarter declined 3% as a decline in unit volume was only partly offset by an increase in average price and mix. Comp store sales in Japan declined 5%, which was below our expectation for a smaller decline and compared with a flat comp in last year's third quarter. The yen averaged 117 to the U.S. dollar in the third quarter versus 112 a year ago; therefore, the 3% decline in total Japan retail sales in yen translated into an 8% decline in U.S. dollars. Results in Japan were consistently soft throughout the quarter with comp declines of 5% in August, 4% in September and 7% in October. In comparison, comps in last year's third quarter had declined 2% in August and 1% in September, but had increased 4% in October. In the quarter, the 5% comp store sales decline was divided pretty evenly between the Tokyo market, including a 4% decline in our Tokyo flagship store, and locations outside Tokyo.

Recent economic reports confirm that the Japanese economy is growing, although it appears that the environment for consumer spending is challenging. However, we believe that Tiffany has the potential to improve its performance there as we continue to focus on a more proactive customer engaging sales approach, as well as upgrading a number of our retail locations in Japan through renovations, expansions and/or relocations. This year we've opened four locations and closed one in Japan, including the highly visible opening earlier this month of our freestanding store in the Roppongi Hills section of Tokyo.

Sales growth was notably better in the other half of international sales, continuing the strong trends from the first half of the year. In the Asia Pacific region outside Japan, a 17% increase in comparable store sales in the third quarter was above our expectations and was on top of a 4% increase last year with notable strength in Hong Kong and Australia. We're also pleased with Tiffany's growing presence in China, with new stores opened this year in Beijing and Macau and a second store in Shanghai opening in December. Asia Pacific comps have gained 21% year-to-date.

Sales in Europe were also strong. Comparable store sales rose 21% in the quarter, which compared with a 1% decline last year and was above our expectations. London represents more than half of our European sales and we noted considerable strengthen all four stores there, as well as strength in our stores in Italy, France and Germany. This year, we opened our 14th retail location in Europe with a store in Vienna. We also completed the extensive renovation of our flagship store on Old Bond Street in July and since then sales have meaningfully increased in that important store. European comps have increased 20% in the year-to-date.

Rounding out international sales in the third quarter were solid increases in Canada and Latin America, and we are very much looking forward to opening a prominent Tiffany & Co. Store in Vancouver next week.

Finally, Tiffany's other channel of distribution, which has several components, posted a 23% sales increase in the third quarter. More than half of that growth came from a meaningful and expected increase in wholesale sales of diamonds that are below our quality standards. As you know, our objective for these wholesale sales is to simply recoup our cost.

Also in this channel, Little Switzerland sales rose 9% in the quarter, although that continued to be below our expectations. Lastly, a doubling of the Iridesse store base this year is contributing to their sales growth and we recently enhanced Iridesse.com when we launched e-commerce. So that covers our four channels of distribution.

From an overall merchandising perspective, the sales strength in the quarter was concentrated more toward higher-end jewelry. There was substantial growth in diamond statement jewelry as well as in fine jewelry such as our Swing and Legacy collections with diamonds and colored stones; and, we saw double-digit growth in engagement jewelry in the U.S. and many international markets except Japan.

It also looks like Celebration rings have become a perennial winner and we continue to expand that assortment with new designs. The designer jewelry category grew in the quarter fueled entirely by the incremental sales of Frank Gehry's jewelry collections which are exceeding our expectations. And of course, the 1837, Atlas and Return to Tiffany collections in gold and silver remain fashionable favorites.

Let's now look at the rest of the income statement. Gross margin of 53.6% in the third quarter was one-half point below the prior year and was slightly below our expectations. The decline was due to wholesale sales of diamonds and higher product costs, partly offset by sales leverage on fixed costs. We recorded a LIFO charge of $10.4 million in the quarter versus $4.2 million in last year's third quarter. We've increased retail prices in 2006 to address these cost pressures.

SG&A expenses rose 8% in the quarter which was exactly what we expected and represented a moderation in year-over-year growth from the faster rate in the first half. The majority of the third quarter increase reflected anticipated store-related and marketing-related spending. SG&A expenses as a percentage of net sales was 45.5% versus 46.1% in the third quarter a year ago. You should note that is SG&A expenses in the third quarter of 2005 had included $4.3 million of charges related to business disposition.

Other expense net in the third quarter was actually income of $1.2 million instead of the typical net expense. The change was largely related to pre-tax gains of $5.2 million associated with the sale of equity investments in an online retailer and a manufacturer, both of which had been written off in previous years. We also realized a pre-tax gain of approximately $1.6 million on the disposition of some marketable securities. The after-tax benefit of these two gains was approximately $0.03 per diluted share. Without these various gains, other expense net would have been an expense of $5.5 million, or higher than the $4.3 million last year, due to interest expense on higher average borrowings. We expect a similar year-over-year increase in the fourth quarter.

Tiffany's effective tax rate in the third quarter was 35.6% compared with 33% in last year's third quarter. In both periods, we had favorable reserve adjustments relating to the expiration of certain statutory periods during the respective quarters, but the favorable effect was greater last year. So adding it all up, Tiffany's reported net earnings rose 23 % in the third quarter to $29.1 million or $0.21 per diluted share.

I'll now turn the call over to Jim.

Jim Fernandez

Thanks, Mark. All in all, we were pleased and encouraged with Tiffany's third quarter results. We achieved solid growth in the U.S. while strong growth in most international markets more than offset continued softness in Japan. On a trailing four quarter basis, return on average assets was 9% and return on average stockholders equity was 14%, both of which are close to the minimum long-term objectives we set for at least a 10% ROA and at least a 15% ROE. Tiffany has the financial strength, the infrastructure and the commitment to grow our business and the potential to meet or exceed our profitability targets.

Let's look at Tiffany's balance sheet. At October 31, accounts receivable were up 16% over a year ago, partly due to sales growth and also reflecting some shift in credit card usage toward Tiffany's in-house card. In total, receivables are turning at a high 19 times per year. Net inventories at October 31 were 19% higher than a year ago and higher than initially planned, but part of the year-over-year increase can be attributed to an unusually low base in October of 2005.

Higher raw material and work-in-process inventories were related to internal manufacturing and diamond sourcing activities. Higher precious metal costs also represented part of the increase. Higher finished goods were largely related to new stores and certain existing stores, as well as broadened product assortments. We now expect inventory levels to increase by a low double-digit percentage for the full year which is somewhat higher than our previous expectation. However, we do expect sales results to benefit from high in-store availability levels.

To support our business and sales growth, Tiffany's two distribution centers are also in very good shape. They are efficiently handling store replenishment requirements and are ready to accommodate the expected surge in e-commerce and catalogue orders in the next few weeks.

Tiffany stepped up its pace of share repurchases in the third quarter, taking advantage of the recently increased authorization that was approved by our Board of Directors in August. We spent approximately $100 million to repurchase 3 million shares in the quarter, representing an average cost of $33.42 per share. Year-to-date, we've spent $264 million to repurchase 7.7 million shares representing approximately 5% of the shares outstanding at the start of the year. The current repurchase program expires in December of 2009 and we intend to act opportunistically in our share repurchase decisions.

We finished the quarter with $58 million of cash and cash equivalents, total short-term and long-term debt of $661 million and total stockholders equity of almost $1.7 billion. The ratio of total debt to stockholders equity was 39% at October 31st compared with 24% a year ago. The increase reflected borrowings for share repurchases and higher inventory levels.

In today's press release, we increased our full-year earnings outlook to $1.79 to $1.84 per diluted share. To achieve that expectation, we are looking for total sales to increase approximately 10% for the year which includes U.S. comparable store sales growth in a mid single-digit range and international comp store sales on a constant exchange rate basis, growing in the high single-digit range.

We are now looking for gross margin for the year to be slightly lower than the prior year, which implies a decline in the fourth quarter. We continue to expect a high single-digit increase in SG&A expenses for the year with a similar rate of increase in the fourth quarter. We now expect other expenses net to be in the area of $13 million to $14 million for the year, which is lower than we originally thought at the start of the year, reflecting the gains in the third quarter. Excluding the gains recorded, other expenses net would be close to the $20 million we had expected. We also expect an effective tax rate of approximately 37% for the year.

We believe Tiffany is well prepared for this holiday season. Mark mentioned merchandising highlights in the third quarter. On a related note, we held an exhibition in our New York flagship store in the last week of October called Simply Spectacular. It was tied into the recent publication of our annual blue book and showcased the extraordinary jewelry shown in that book. I can tell you that there was considerable customer attendance at the one week exhibition and the interest shown has continued, certainly indicating customers willingness to spend.

At more modest price points, charms are getting a renewed focus with a new twist at Tiffany. Based on customer requests, we've introduced a wide assortment of sterling silver charms for bracelets and necklaces, with a Tiffany exclusive lock mechanism that allows customers to make designs that reflect their own style. At higher price points, we have our new Tiffany Stars diamond collection with an assortment of styles. We certainly have exciting new designs at intermediate price points too, including Tiffany's new Novo diamond engagement ring, which is currently available in Japan and will be launched in the United States and other markets in early 2007.

Wrapping up my remarks, we are now almost halfway through the November-December holiday shopping season, at least from a calendar perspective. Tiffany's worldwide sales growth in November to date is currently running ahead of our expectation. Our expectation for the holiday season and fourth quarter includes U.S. Comp store sales increasing in the high single-digit range and international comps on a constant exchange rate basis growing in the mid single-digit range. We are currently exceeding those comp store sales expectations as well.

Of course, keep in mind that the vast majority of Tiffany's holiday business to be transacted is still ahead of us in December, so we will not and would advise you not to extrapolate results in November to the entire holiday season and fourth quarter, but at least we are enjoying a good start.

We plan to update you on Tiffany's holiday sales results on January 10th. Until then, our best wishes to you for an enjoyable holiday season.

That concludes this call. Of course, please feel free to call Mark with any questions or comments and thank you for listening.

Operator

Thank you. This concludes the conference.

Question-and-Answer Session

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Source: Tiffany & Co. F3Q06 (Qtr End 10/31/06) Earnings Call Transcript
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