Tiffany & Co. F4Q06 (Qtr End 1/31/07) Earnings Call Transcript

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Tiffany & Co. (NYSE:TIF)

F4Q06 Earnings Call

March 26, 2007 8:30 am ET


Mike Kowalski – Chairman and CEO

Jim Fernandez – CFO

Mark Aaron – Investor Relations


Good day, everyone and welcome to this Tiffany & Co. fourth 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; the Chairman and CEO, Mr. Mike Kowalski; 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.

Mark Aaron

Thank you. Good morning and thanks to all of you for joining us. On today's conference call, Jim and I will review Tiffany's fourth quarter and full year performance and then Mike will have some comments about our business for the coming year.

Please first 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 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.

With Tiffany's strong fourth quarter sales increase, we capped off a year of geographically broad-based growth in most markets. Let's begin by looking at fourth quarter sales in Tiffany's channels of distribution, which were closely correlated to the sales trends for the November/December holiday period that we had reported on January 10.

U.S. retail sales rose 13% in the fourth quarter. Comparable store sales rose 9% due to an increase in the average amount spent per transaction, which we also saw throughout the year. But we were also pleased to see an increase in the number of transactions on a comp-store basis.

Sales growth in the quarter ranged across many jewelry categories and price points, from silver jewelry under $500 to diamond jewelry over $50,000. However, the largest percentage sales growth was at the high end in both the quarter and the year.

The comp increase slightly exceeded our expectation and was on top of a 5% comp increase in last year's fourth quarter. The monthly trend ranged from an 11% increase in November to an 8% increase in December and a 15% increase in January.

Sales in our New York flagship store rose 17% in the quarter and comparable sales in our seven stores in the New York market outside of Manhattan rose 13%. Comparable brand store sales rose 8% in the quarter and the growth was pretty much spread from coast to coast. However, sales declined in Hawaii and Guam, which was entirely due to lower sales to Japanese travelers.

Overall U.S. retail sales growth in the fourth quarter largely resulted from increased sales to U.S. customers. It was not surprising that our New York flagship store benefited from increased sales to foreign visitors who took advantage of their strong foreign currencies. However, for the full year, foreign tourists accounted for 11% of U.S. retail sales versus 12% in the prior year.

Regarding the sales strength in the New York flagship store, it's also worth noting that we had hosted our Simply Spectacular event at the end of October featuring an extraordinary assortment of jewelry from our legendary Annual Blue Book and many subsequent sales occurred in the fourth quarter. The New York store is also likely benefiting from the conclusion last September of the multi-year store renovation.

For the year, U.S. comp store sales rose 5%, the New York flagship store increased 9%, brand store comps rose 4% in 2006, with the largest percentage increases in our Houston, Palm Beach, and Seattle stores. The New York flagship store represented 9% of company-wide sales in 2006 versus 10% in the prior year. In addition, the flagship store has achieved record sales productivity of more than $6,000 per gross square foot, a level not seen since the year before we added 25% to its square footage back in 2001.

In regard to our five largest U.S. brand stores by sales volume in 2006, the largest one was the South Coast Plaza store in Costa Mesa, California, followed by our highly successful stores in Chicago, Beverly Hills, San Francisco, and Las Vegas.

In 2006 we increased the number of U.S. store locations by 8% and our gross square footage by 4%, with the opening of new stores in Nashville, Indianapolis, Atlantic City, Tucson and on the big island of Hawaii. We're very pleased with their performance.

Let's now look at International Retail sales, which increased 15% in dollars in the fourth quarter. On a constant exchange rate basis, which excludes the effect of translating foreign currency denominated sales into U.S. dollars, international retail sales rose 12% and comparable store sales rose 6%.

Strong sales growth in most of our international markets more than offset continued softness in Japan. Tiffany sales in Japan have historically represented the largest portion of our international channel. However, you should note that in 2006 the growth of our international store base propelled sales in Europe, Asia Pacific, Canada, Latin America and elsewhere to a size that now slightly exceeds our sales volume in Japan. In fact, Japan represented 49% of international retail sales in 2006 versus 54% in 2005.

You can refer to the non-GAAP measure schedule attached to today's press release and note that my following comments are on a constant exchange rate basis.

In the fourth quarter, total retail sales in Japan were equal to the prior year, with an increase in average price offsetting a decline in unit volume. Comparable store sales in Japan declined 4% which was slightly below our expectation, but was on top of 7% comp increase in last year's fourth quarter. The yen averaged 118 to the U.S. dollar in the fourth quarter, versus 117 a year ago, which meant that the year-over-year comparison in yen and dollars was virtually the same. The monthly comp store sales trend included declines of 4% in November, 5% in December, and 5% in January.

For the quarter, comp sales store declined 4% in Tokyo and 5% outside Tokyo. Reiterating what we've said in recent months, the luxury retail market in Japan and for consumer household spending in general, is challenging. However, we are focused on improving the in-store shopping experience, on cultivating long-term customer relationships, and on upgrading the physical presence of certain boutique locations through renovations and/or relocations. We are convinced that such initiatives can generate improved sales performance.

In 2006 we opened four new locations while closing two older ones. For the full year, a 4% increase in total retail sales in Japan was largely due to higher jewelry unit volume, while for the second consecutive year, comparable store sales equaled the prior year.

Outside Japan, Asia Pacific comparable store sales surged 22% in the quarter, which was on top of a 13% increase last year, and it was led by very strong growth in Hong Kong, Taiwan and Australia. We're also pleased with our performance in China, where we added stores in Beijing, Shanghai and Macao in 2006. For the full year, Asia Pacific comps rose 22% on top of an 8% increase in 2005.

Europe was also very strong with a 19% increase in comp-store sales in the quarter, which compared with a 1% increase last year. European sales were strong in all markets and especially in London, which represents the majority of our European sales. In 2006 we completed the renovation and expansion of our London flagship store on Old Bond Street and it's been posting strong growth ever since. For the full year, European comps rose 20% with solid growth in all countries compared with a 1% increase in 2005.

Rounding out international sales, we achieved double-digit comp store sales growth in Canada and Mexico in 2006. We expanded Tiffany's presence with a store in Vancouver and one in Monterrey and both are posting excellent initial results.

During the year we increased a number of company-operated Tiffany & Co. international stores and boutiques by 8% and the related gross square footage by 10%. At the end of 2006, we operated 167 Tiffany & Co. stores and boutiques in 18 countries, which represented an 8% increase in the number of locations in the U.S. and internationally. We increased total square footage by 6% in 2006 to approximately 792,000 gross square feet, including 486,000 square feet in the U.S. and 306,000 square feet internationally.

Returning to the U.S., direct marketing sales rose 10% in the fourth quarter, which was on top of a 15% increase last year. Direct marketing sales rose 11% for the year on top of an 11% increase in the prior year. In both periods, these increases were very close to our expectations.

During 2006, sales growth came from increases in the number of Internet orders and in the average amount spent per Internet and catalog order. The average amount spent per direct marketing order rose to $231 in 2006 versus $221 in the prior year. Tiffany's e-commerce business has become highly successful since being launched seven years ago, while catalog sales have declined along with a reduction in catalog circulation. In fact, we mailed 22 million catalogs in 2006 versus 26 million catalogs seven years ago, while e-commerce sales in the U.S. have grown to be four times the size of catalog sales. Not surprisingly, this has had very favorable implications for profitability over that seven-year period.

Finally, sales in Tiffany's other channel rose 48% in the fourth quarter and 18% for the full year. The majority of growth in this channel in the quarter and the year came from increased wholesale sales of diamonds obtained through our rough diamond sourcing program, but not put into production due to their lower quality.

In our specialty retail businesses, Little Switzerland represents more than half of the other channel and their sales rose 11% in the quarter and the 6% in the year. In addition, Iridesse sales rose in the quarter and year, partly due to comp store sales growth, but also from a doubling of their store base from six to 13 stores. So that covers sales in our four channels of distribution.

From a merchandising perspective, Tiffany's sales growth in the quarter occurred in a wide range of jewelry categories. Diamond jewelry sales were especially strong, including engagement rings, necklace, studs and bracelets. This was also true throughout the year.

In terms of the average price per unit sold in 2006, for statement jewelry, the average price per piece sold in the U.S. rose to $91,000 from $81,000 in 2005. The average for a solitaire diamond engagement ring in the U.S. was unchanged at $10,400 while the average in Japan was $4,100 versus $4,200 in 2005.

Complementing the growth of our classics, we expanded our successful Swing and Legacy collections with additional designs incorporated colored stones and we launched Tiffany's Star collection. We also recently introduced Tiffany's Novo diamond engagement rings and initial customer response was very favorable.

From a different perspective, we launched the unique jewelry designs of Frank Gehry in 2006 and sales have exceeded our expectations. In the gold and silver jewelry categories, Tiffany's Atlas, 1837 and Return to Tiffany’s collections are perennial favorites, while a variety of new silver charms are delighting customers.

The average price per unit sold in silver jewelry in the U.S. rose slightly to $191 in 2006 versus $187 in 2005, while in Japan it rose to $221 versus $215 in the prior year. We are encouraged with our sales performance in most countries and in most jewelry categories.

I'll now turn the call over to Jim.

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Jim Fernandez

Thanks, Mark. I'll begin my comments by reviewing the rest of the income statement. Gross margins declined 1.6 points in the fourth quarter and three-tenths of a point in the year, which were lower than our expectations in the start of 2006. There were a myriad of factors causing the declines, but meaningful factors were higher precious metals cost and increase in wholesale sales of diamonds, which earn virtually no margin, and changes in sales mix. Sales leverage on fixed costs provided a partial offset to those factors.

The higher product costs were partly reflected in our reported LIFO inventory charges of $13 million in the fourth quarter and almost $33 million for the year, both of which were substantially higher than a year ago. We increased retail prices during 2006 to address these higher product costs and are positioned well for 2007.

SG&A expenses increased 12% in the fourth quarter, but the increase included the $6.9 million impairment charge for the write-off of goodwill related to our Little Switzerland business. The pre-tax $6.9 million charge also reduced net income by $6.9 million and fully diluted earnings per share by $0.05 per share.

For the full year, a 10% increase in SG&A was slightly above our initial, high single-digit expectations, reflecting store-related and marketing-related costs and the impairment charge. However, despite increasing our total advertising cost to 6.2% of net sales in 2006 versus 5.7% of sales in 2005, the full-year expense ratio of 40% was one-tenth of a point below the prior year.

Earnings from operations increased 11% in the fourth quarter and 9% in the year. The full year operating margin of 15.7% was slightly lower than the prior year. Other expenses net of $11 million in the full year were lower than our $20 million expectation at the start of the year. However, in the third quarter, we had recorded income and gains of approximately $7 million related to the disposition of marketable securities and the sale of equity investments in an online retailer and manufacturer, both of which had been written off in previous years.

Tiffany's effective tax rate in the fourth quarter was 36.6% and 37.2% for the full year. The tax rate in the year was slightly below our initial expectation of 38%. In addition, our effective tax rates in fiscal 2005 were only 29.9% in the quarter and 30.8% in the year, which reflected a tax benefit from repatriation of foreign earnings related to the provisions in the American Jobs Creation Act of 2004. Those benefits had amounted to $0.10 per diluted share in the fourth quarter and $0.16 per diluted share in the year.

Earnings before income taxes increased 11% in the fourth quarter and 10% in the year. Adding it all up, net earnings in the quarter and the year were virtually equal to the prior year. However, earnings growth met our expectations, factoring out the impairment charge in this year's fourth quarter. Earnings for the year rose to $1.80 per diluted share, which achieved the expectation of $1.77 to $1.82 per share we set out at the beginning of 2006. Excluding the impairment charge of $0.05 per diluted share, which we did not include in our last public forecast, EPS would have also been at the high end of the most recent guidance of $1.82 to $1.85 per diluted share.

Tiffany's return on average assets was 9% in 2006 and our return on average stockholder's equity was 14%, both of which were close to our long-term objectives to achieve at least a 10% ROA and at least 15% ROE.

Tiffany's balance sheet at January 31st included cash and cash equivalents and short-term investments of $192 million, short-term and long-term debt totaling $518 million and stockholder's equity of $1.8 billion. The ratio of total debt to stockholder's equity increased to 29% from 26% a year ago.

In fiscal 2006, accounts receivable rose 19%, which was partly due to sales growth and also reflected some shift in credit card usage towards Tiffany's in-house card which some customers have used to finance larger purchases. Receivable turnover was 18 times for 2006 compared with 19 times in the prior year.

Net inventories increased 15% in fiscal 2006, which was higher than our expectations. Inventory growth during the year was affected by new store openings along with our decision to deepen assortments in certain existing stores along with broadened product offerings, all of which we believe are benefiting sales results. Higher raw material and work in process inventories are largely due to expanded diamond sourcing operation as well as increased precious metal costs.

Tiffany's capital expenditures were approximately $182 million in 2006, which at 7% of net sales, was close to our initial expectations and was consistent with our objective to spend, on average, no more than 7% to 8% of net sales. Going forward, we now project that CapEx will average 6% to 7% of net sales.

One other factor affecting the balance sheet was our substantial share repurchase activity in 2006. In August, Tiffany's Board of Directors increased the authorization for repurchases and we took advantage of it. For the full year we spent $281 million to repurchase 8.1 million shares at an average cost of $34.50 per share, compared with spending $133 million in 2005.

We highlighted our financial expectations for 2007 in today's press release. Specifically, we said we are looking for net sales growth of 11% to 12% for the full year. This would include a high single-digit increase in comparable store sales on a constant exchange rate basis, consisting of similar growth both in the U.S. and internationally.

The international comp store sales expectation includes increases of low single-digits in Japan and low double-digits for Europe and Asia-Pacific outside Japan. From a translation perspective, we are planning the Japanese yen at 125 to the dollar versus 117 in 2006.

As we've previously announced, we expect to accelerate the rate of store openings by increasing the number of company-operated Tiffany & Co. stores and boutiques by approximately 10% in 2007. That reflects adding approximately 17 Tiffany & Co. stores net of closing a couple of underperforming boutiques in Japan, which should increase worldwide gross square footage by roughly 8%. We will also expand the number of independently-operated locations in certain international markets.

In other sales channels, we are looking for mid-teens increase in direct marketing sales with strong Internet sales and with catalog mailings approximately 10% lower than 2006. Lastly, we expect at least a 25% increase in other sales due to growth in wholesale diamond sales and our specialty retail sales.

We expect Tiffany's operating margin to increase approximately one-half point in 2007, mostly due to an improvement in gross margin that comes from sales mix, leverage on fixed costs, and assumes stabilization in product costs.

We expect only minimal improvement in the SG&A expense ratio in 2007 due to some initial expense pressure from an accelerated rate of store expansion. We expect other expenses net to be in the range of $21 million to $23 million in 2007, which would represent a modest increase from 2006 if you exclude the $7 million of gains from sales of investments and securities that we recorded in the third quarter of 2006. The increase would be due to higher interest expense.

We also expect Tiffany's effective tax rate to be approximately 38% in 2007, which is higher than the 37.2% rate in 2006.

In total, we currently expect Tiffany's earnings per diluted share to increase 15% in 2007, which is at the high end of the guidance we had published in January. We are planning for healthy EPS growth in most quarters, but less so in the third quarter when we will compare to the nonrecurring gains from the sale of investments and securities in 2006.

On the balance sheet, we are expecting a high single-digit percentage increase in inventories, which based on our sales expectation, would lead to improved turnover. We also expect capital expenditures of approximately $180 million or 6% of net sales and we certainly expect to continue our active share repurchase program.

Tiffany is well-positioned financially and operationally to pursue its strategies and to achieve solid sales and earnings growth. I'm now pleased to turn the call over to Mike.

Mike Kowalski

Thanks, Jim. I certainly agree that Tiffany's foundation for growth is solid and I share the enthusiasm about our entire management team about the many opportunities we are pursuing in 2007 and beyond.

However, before looking forward, it is worth repeating some of our successes in 2006. We achieved solid comp store sales growth in the U.S. and most international markets. In fact, Tiffany's international retail channel reached a milestone with sales of $1 billion. We were disappointed with results in Japan, but believe our ongoing investment in the Japanese market is appropriately calibrated against the market opportunity there.

Worldwide, we opened a substantial number of new stores which has generated excellent results while completing the multi-year renovations and expansions of our flagship stores in New York and in London.

Our merchants delivered an exciting array of new products, spanning a wide range of designs and price points, and the introduction of Frank Gehry’s new designs generated both enormous excitement and significant sales.

Our marketing and public relations initiatives delivered Tiffany's message of compelling designs to a growing number of customers, initiatives which included the start of e-mail marketing in the United States, the launch of an informational web site in China, and on a global scale, the continuation of the Celebration campaign that has so successfully engaged the self-purchase fine jewelry customer; as well as the launch of the Frank Gehry collection with its high-profile launch events around the world and its provocative advertising imagery.

In summary, our 2006 results demonstrated that the Tiffany brand is strong, relevant and clearly focused. While we are pleased with our performance and commend our employees around the world, we do have the potential to perform even better. We have exciting plans in place for 2007 and we have the financial strength and the management expertise to deliver against those plans.

As previously announced, we are accelerating our store expansion plans in the United States from a rate of three to five stores per year to a new rate of five to seven stores annually, reflecting the excellent results we have experienced in the numerous unserved markets that have significant sales potential. We just recently opened a store in Austin, Texas, and have announced exciting plans for a store on Wall Street this fall. A second store in Las Vegas in the Forum Shops at Caesar's Palace, stores in Massachusetts and New Jersey with additional U.S. stores in the works.

Internationally, we expect to open approximately ten new stores in 2007. We recently added an additional location in Korea, are adding three stores in Japan while closing several; new stores in Hamburg, Germany and at the Singapore airport, and we are planning additional locations in several other countries.

We continue to build an e-commerce business that has solid growth potential. Our distribution centers are efficiently handling store replenishment and the fulfillment of direct customer orders and our manufacturing and sourcing infrastructure performs well.

In our specialty retail operations, we've expressed our disappointment with the results of Little Switzerland, however, we remain pleased and optimistic about our progress in building the Iridesse brand and we'll continue to add additional stores this year while we refine our assortment in anticipation of greatly-accelerated growth in 2008.

Tiffany's product development program will deliver an array of new designs in 2007 to span a wide range of materials, price points and styles, and we have a significantly aggressive marketing plan to enhance product and brand awareness.

In this morning's press release, we also commented on the start of fiscal 2007, which began with strong sales growth in February, including a robust Valentine's Day. Being almost two months into the first quarter, we are pleased with better than expected sales trends in the United States and most international markets except Japan, but we've noted a greater than expected shift in sales mix towards higher end, lower margin diamond jewelry. Therefore, we are currently on track to achieve our overall earnings growth expectations.

The year 2007 marks the passage of 170 years since Charles Lewis Tiffany opened his store on lower Broadway in 1837, creating a brand that has since become among the widely known, trusted and admired in the jewelry world. We will continue to build upon that unique and invaluable heritage, pursuing a strategy to expand the reach of the Tiffany’s Co. brand that are consistent with our brand character, that make sense to our core customers, that are competitively viable and that have meaningful and sustainable growth potential.

That concludes this conference call. Please feel free to call Mark with any questions or comments. Thank you for listening and thank you for your continued interest in Tiffany & Co.

TRANSCRIPT SPONSOR Logo is committed to providing our customers the best value, quality, service and selection of certified diamonds and jewelry in the world. Our jewelers are dedicated to bringing you the finest jewelry available using only top-quality select stones. The Internet's largest and trusted destination for certified diamonds and fine jewelry.

Extraordinary Selection and Exceptional Value.

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30-day money back guarantee

To sponsor a Seeking Alpha transcript click here.

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