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Tiffany & Co. (TIF)

F1Q07 Earnings Call

May 31, 2007 8:30 am ET

Executives

Mark Aaron -IR

Jim Fernandez - CFO

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Operator

Good day, everyone and welcome to Tiffany & Co. first 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 would like to turn the call over to Mr. Mark Aaron. Please go ahead, sir.

Mark Aaron

Thank you. Good morning and welcome to all of you. On today's conference call, Jim and I will review Tiffany's first quarter performance and comment on the company's outlook.

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 these forward-looking statements. Additional information concerning risk factors that could cause actual results to differ materially is set forth in Tiffany's 2006 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.

Tiffany's performance in the first quarter exhibited strength in most areas of our business around the world and in a number of jewelry categories. In many ways, it represented a continuation of certain trends from 2006 and was essentially in line with the intra-quarter business update we provided when we reported full year 2006 results on March 26.

Let's first look at sales by channel of distribution. We posted a strong 15% increase in US retail sales in the quarter. This was largely driven by an increase in the amount spent per transaction, although there was a modest increase in the number of total store transactions. Comparable store sales rose 12%, which was slightly better than what we expected. In last year's first quarter, we posted a 1% comp decline, but that was on top of an 11% increase in 2005 and a 20% increase in 2004, so the multi-year run rate is quite strong.

By month, comp store sales increased 13% in February on top of a 1% decline in the prior year; rose 10% in March on top of a 1% increase; and rose 14% in April, on top of a 4% decline. The 12% comp increase was comprised of a 26% increase in our New York flagship store and a 9% increase in comparable brand store sales.

In terms of our customer mix, more than half of the overall US sales increase came from higher local customer spending. However in our New York flagship store, the larger part of its sales increase was due to higher foreign tourist spending, especially from European visitors who are likely taking advantage of their strong currencies. The New York flagship store also continues to benefit from the completion of its renovation last September.

Just outside Manhattan, the 7 branch stores in the New York market rose 8%. Around the US, the branch store comp sales increase was widely spread, but there was noteworthy strength in Florida as well as at our stores in Atlanta and Houston and at several of our California stores in Costa Mesa, Pasadena, Palm Desert, and Palo Alto. The only region with marked softness was in Hawaii and Guam, where a continuation of reduced spending by Japanese tourists led to sales declines there.

In terms of price stratification in the quarter, we saw double-digit growth in sales and in the number of transactions in almost every price strata from $500 to over $50,000, but the greatest percentage growth was at the high end.

Our new stores opened over the past year are performing well. In the first quarter, we opened a store in Austin, Texas which has had a very strong start and we've announced plans to open six additional US stores this year.

International retail sales were also strong in the first quarter with a 15% increase. On a constant exchange rate basis, which excludes the effect of translating foreign currency denominated sales into dollars, international retail sales rose 13% and comparable store sales rose 4%. As we saw in 2006, strong results in most international markets outside Japan, which represents slightly more than half of international sales, more than offset softness in Japan.

My following remarks will refer to sales on a constant exchange rate basis. In Japan, we think the environment for consumer spending is somewhat challenging. Tiffany's total retail sales in Japan declined 2% in the quarter with the decline in volume more than offsetting an increase in average spending per piece. On a related note, we continue to expand our relationships with key department store clients and develop our base of Tiffany registered clients in Japan. However, our lower ticket silver jewelry category continues to decline.

Comparable store sales in Japan declined 7% in the first quarter, which was below our expectation that called for virtually flat comps. Keep in mind that comps in Japan had increased 12% in last year's first quarter. The yen averaged 119 to the US dollar in the first quarter versus 117 a year ago, so there was minimal translation effect on results.

By month, comp store sales in Japan rose 7% in February, followed by declines of 15% in March and 10% in April. Part of the large fluctuation from February to March can be attributed to a price increase in mid-February with a surge in buying before the increase followed by an opposite effect afterwards. In 2006's first quarter, comps rose 15% in February and 11% in both March and April. The 7% decline in Japan comps included similar declines both in Tokyo and outside Tokyo.

We opened three new locations in the first quarter: in the Seibu department store in the Shibuya district of Tokyo; in Takashimaya store in the Shinjuku district of Tokyo; and in the Matsuzakaya department store in Hiroshima. We are very pleased with initial results in all three locations. During the quarter, we closed two locations in the Mitsukoshi stores in Okinawa and Hoshigaoka .

As mentioned before, we are continuing to experience considerable strength in most other international markets. In the Asia Pacific region outside Japan, comp store sales increased 24% in the first quarter, which was higher than the low double-digit increase that we expected and was on top of the 20% increase in last year's first quarter. There was broad-based strength with double-digit comps in most countries. In the first quarter, we opened our seventh store in Korea and our third store in Singapore in its Changi airport.

In Europe, comp store sales rose 11% in the quarter, which was close to our expectation and was on top of a 24% increase a year ago. We achieved solid growth in London and in most countries on the continent. Sales in London continue to benefit from the completion last summer of the renovation of our important flagship store on old Bond Street.

Lastly, we're seeing very strong growth in Canada, with our new Vancouver store having a terrific start and our stores in Mexico are also posting solid sales growth.

Turning back to the US, an 11% increase in direct marketing sales was in line with our expectation for the quarter and compared with a 4% increase a year ago. The 11% increase came from an increase in the number of orders shipped and in the average amount spent per order. Ecommerce sales continue to grow at a strong pace and represent the vast majority of this channel. As we previously disclosed, we are editing our catalog mailing list and reducing circulation by approximately 10% this year, as we continue to see more customers gravitate to our website.

Lastly, sales in our other channel increased 22% in the first quarter. Wholesale sales of diamonds represented $5.2 million of this $7.3 million increase and those sales earned virtually a zero gross margin. In specialty retail, Little Switzerland sales were up 5% in the quarter, and we continue to be encouraged with the development of our Iridesse stores.

Turning to the rest of the income statement, gross margin of 54.5% in the quarter was 1.3 points below the prior year. The decline was somewhat more than we expected. However, it should not be a surprise that higher product costs impacted margin as evidenced by a LIFO inventory charge of $6.9 million in the quarter versus only $1.4 million in last year's first quarter. In addition, gross margin was affected by the mix shift towards sales of higher-priced jewelry as well as increased wholesale sales of diamonds.

Selling, general, and administrative expenses increased 13% in the quarter, which was actually slightly below our expectations. The increase came from planned growth in store-related and marketing-related costs. SG&A as a percentage of net sales improved to 41.4% in the quarter from 42.1% a year ago. Other expenses net of $3.2 million was down from $4 million last year.

Our effective tax rate was 36.5% versus 38.6% last year due to some favorable reserve adjustments related to the expiration of certain statutory periods. Adding it all up, net earnings rose 15% to $49.7 million and diluted earnings per share of $0.36 was 20% higher than the $0.30 per diluted share earned a year ago.

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

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Jim Fernandez

Thanks, Mark. Tiffany's first quarter performance represented a good start to the year in many respects and we have reason to be encouraged with our prospects for the full year. Looking at the balance sheet, inventories represent a large portion of our assets and at April 30th, 2007, they were 14% higher than a year ago. The increase was partly due to higher product costs. In addition, finished goods were up to support new stores and expanded product offerings while higher raw materials resulted from expanded diamond sourcing operations.

Accounts receivable at April 30th increased only 4% above the prior year and receivables turnover remained at a very high 18 times per year.

In terms of stock repurchases, we spent approximately $25 million in the quarter to buy 521,000 shares at an average cost of $48.01 per share. We intend to opportunistically make additional repurchases and still have $670 million of remaining authorization for the duration of the program that runs through December of 2009.

Another use of our cash generation is dividend growth. Two weeks ago, Tiffany's Board of Directors increased the quarterly dividend rate by 20%, marking the fifth consecutive year of dividend increases. We finished the quarter with total debt to stockholders equity of 28% versus 27% a year ago. Tiffany's return on average assets was 9% in the quarter, and the return on average stockholders equity was 14%, which were close to ROA and ROE objectives that call for at least 10% and 15% respectively.

We have exciting plans for the rest of 2007. We are opening 7 US stores this year. In addition to the Austin store we opened in the first quarter, we plan to add stores later this year in Natick, Massachusetts; Providence, Rhode Island; Santa Barbara, California; Red Bank, New Jersey; a second store in Las Vegas in Caesar's Palace; and a store at 37 Wall Street to join in the business and residential revitalization of downtown Manhattan and provide added shopping convenience for our New York area clientele.

Internationally, we're pleased with the new locations we added in the first quarter, including three in Japan, one in Korea, and one in Singapore and we've announced additional stores to open later this year in London, Mexico City, and Hamburg. There will likely be others, as well. In total, we expect to increase our company-operated Tiffany & Co. store base by approximately 10% this year.

From a merchandising perspective, diamonds continue to be a standout category in the first quarter, with strong growth in the US and in a number of international markets. We also continued to benefit from a broadening of our Celebration Rings assortment and with the support of a targeted advertising campaign, it remains a very successful initiative targeted at the female self-purchase customer.

The legacy jewelry collections is a strong performer with new designs incorporating color gemstones. Frank Gehry's designs, including new ones being launched now, are definitely growing in popularity. And we are encouraged with initial sales of Tiffany's new Novo engagement ring.

At the other end of the price spectrum, sales of silver jewelry are improving in the U.S. and internationally; however, we are planning an even greater focus on silver jewelry product development and marketing for the Japanese market.

Our product development program is in high gear. In addition to the collections I just mentioned, we are substantially expanding Tiffany's assortment of silver and gold charms and early results are very strong. We will be introducing a new collection of mesh jewelry designs later this year.

We have a vast and highly developed infrastructure to support this growth. Our distribution centers are performing efficiently, and our internal jewelry manufacturing facilities have the capacity to produce increasing amounts of products. Our diamond division continues to expand its reach with additional sourcing arrangements to ensure the supply adequacy in this important category.

In today's press release, we also announced our plan to launch a significant expansion of wholesale distribution of Tiffany & Co. watches in major US and international markets during 2008. Tiffany has developed a powerful assortment of watches in recent years and our long-term objective has been to increase the percentage of sales coming from watches. We believe that now is the right time in this evolution to move forward. Wholesale distribution provides a meaningful opportunity to significantly grow watch sales by gaining the necessary scale to support marketing investments. We are still working on the details of the launch, but wanted you to be aware of this initiative.

We are now one month into the second quarter and we've provided a business update in today's press release. We reported that overall sales growth in May is meeting our expectation. Specifically, US comps are running ahead of our high single-digit expectation and most international markets are performing quite well. However, in Japan, we have seen no meaningful improvement from its rate of decline in April.

For 2007, our full year financial performance objectives call for net sales growth of approximately 12%, which includes an expectation of high single-digit comps in the United States, a mid to high single-digit comp increase in international sales, and the sales contribution from new stores.

Within that international expectation, we look for double-digit growth in most markets to offset softness in Japan. We expect a mid-teens increase in direct marketing sales and approximately a 20% increase in our other sales channel distribution.

Our full year expectation calls for Tiffany's operating margin to improve approximately one-half point through a combination of a higher gross margin and SG&A expense leverage. We expect other expenses net in the area of $20 million. We still expect an effective tax rate of approximately 38% for the year; however, you should note that we expect the tax rate to be in the range of 40% to 43% in the second and third quarters followed by a rate of approximately 37% in the fourth quarter, all due to the geographical mix of earnings during the year. All in all, our bottom line objective calls for earnings per diluted share in a range of $2.10 to $2.15 for the full year.

Tiffany has considerable growth potential and we are committed to pursuing many initiatives to achieve that potential. We appreciate your ongoing interest and we'll update you on our progress when we report second quarter results on August 30. Until then, please always feel free to call Mark with any questions or comments.

That concludes this conference call. Thank you for listening.

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