Here’s the entire text of the prepared remarks from Tiffany’s (ticker: TIF) Q3 2005 conference call. The company did not hold a Q&A session. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.
Mark Aaron, VP-IR
Jim Fernandez, EVP, Chief Financial Officer
Good day, everyone and welcome to the Tiffany & Company’s Third Quarter Earnings Conference Call. Today's call is being recorded. Participating on the call are 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, VP-IR
Thank you. Good morning, and thank you for joining us on this third quarter earnings conference call, on which Jim and I will review the results we reported today as well as Tiffany's near term outlook. Before continuing please note Tiffany's Safe Harbor provision as follows 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 2004 annual report and in Forms 10-K, 10-Q, and 8-K 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, let's proceed.
As an overview, sales growth of 8% in the third quarter reflected a continuation of strong U.S. comp store sales growth, and continued progress with our business in Japan. We were also pleased to achieve a higher operating margin in the quarter which game from a gross margin increase. Combined with a lower effective tax rate, net earnings rose 37% in the third quarter and we maintained our previously reported expectation for the range of earnings for the full year. Our balance sheet strengthened in the quarter, and we announced some important initiatives.
Let's first look at sales performance by channel of distribution. U.S. retail sales increased 9% in the quarter, due to 7% comp store sales growth, as well as solid contributions from several new stores. This comp performance was in line with our mid to high single digit expectation and compared with a 4% comp increase in last year's third quarter. In terms of the monthly trend, U.S. comp store sales rose 5% in August, on top of a 3% increase in August 2004, rose 8% in September on top of a 6% prior year increase, and rose 8% in October on top of a 5% prior year increase. From a geographical perspective, the 7% U.S. comp increase in the quarter was generated by 12% growth in the New York flagship store, which was on top of a 1% increase in the prior year, and a 6% increase in comparable brand store sales which was on top of a 5% prior year increase. The 7% comp increase was geographically broad based, ranging from an 8% comp increase in the entire New York region, to a 9% comp increase in California. Although lower tourist spending led to some softness in Hawaii.
A few stores posting exceptionally large percentage increases included Bellevue, Charlotte, Chicago, Dallas, and San Jose. Our store operations in Florida and Houston were disrupted by the devastating hurricanes, but Florida comp store sales still rose 12% in the quarter, due to particular strength in Orlando. We continue to be pleased with the performance of new U.S. stores opened during the past year, including the store we opened in San Antonio, Texas during the quarter. We finished the quarter with 57 U.S. stores, two weeks ago we opened a store in Pasadena, California, and we plan to open our new store in Naples, Florida, soon. And we have already announced plans to add four new U.S. stores in 2006.
Looking at U.S. retail sales dynamics several factors contributed to third quarter growth. Store traffic and the number of transactions in the quarter were virtually unchanged from the prior year, but there was an increase in jewelry unit volume and particularly strong growth in the higher-priced diamond jewelry sales which increased the average transaction size. That was evident in the price stratification analysis for the quarter, which showed substantially higher sales in the 3,000 to $20,000 range and also in sales over $50,000. From a customer mix perspective the increase in U.S. retail sales was divided pretty evenly between higher spending by local customers, and tourists, both foreign and domestic. Although the increase in our flagship New York store was entirely driven by higher tourist spending and that was primarily from foreign visitors.
Now, let's turn to the international retail channel, where we achieved a 7% quarterly sales increase due to growth in a number of markets. We should point out that there was a minimal overall translation effect in the quarter versus last year. And on a constant exchange rate basis, which excludes the effect of foreign currency changes, international retail sales also rose 7%. Our following comments will refer to sales on that basis.
Japan, of course, represents our largest international market and the third quarter results keep us encouraged with the progress we are making there; although we certainly have more to do. Looking at results in local currency, total retail sales in Japan rose 5% in the third quarter, which was largely due to increased sales and units of diamond and platinum jewelry collections and engagement jewelry. Comparable store sales rose fractionally but it rounded to zero, which was close to our expectation and compared with a 5% decline in last year's third quarter. We have said that one of our key strategies in Japan is to enhance our distribution base, which in certain markets means closing some locations and reopening in other department stores or in free standing sites, as well as renovating many locations. In 2005, five department store boutiques were closed, and during the third quarter, we opened prominent and spacious locations both in the Takashimaya department store in Yokohama, and in the Sogo department store in Osaka.
In addition, early in the quarter an extensive renovation of the Tiffany boutique in the Mitsukoshi Shinjuku store was completed and we then saw a double digit sales increase in that location. Therefore, despite the overall net reduction in locations this year, we are improving our distribution base, and will continue to pursue that strategy.
In the quarter, comp store sales consisted of a 4% comp increase in Tokyo, which included a 2% increase in our flagship store, while comps outside Tokyo declined 2%. In terms of the monthly trend in Japan, comps were down 2% in August, against a 10% decline last year, declined 1% in September versus a 4% decline last year and rose 4% in October. On top of a 2% prior year decline. We're not at all surprised that the trend line is a bit choppy from month to month; however, with at least slightly positive comps in Japan in the second and third quarters we believe our merchandising, marketing, real estate, and customer development strategies and Japan management's execution are important factors in making further gains. And any overall improvement in the economy and consumer spending in Japan is an added plus. One additional highlight in Japan was our eCommerce launch on the last day of the quarter. We believe it will be both a long-term sales generator and a powerful communications vehicle to compliment our established store base.
Outside of Japan, comp store sales in the rest of the Asia Pacific region rose 4% in the quarter which followed a 6% increase last year. The most meaningful comp gains were in Singapore and Australia, and our new store in Brisbane is enjoying an excellent start. In addition, we'll continue to pursue long-term growth opportunities for Tiffany in China by focusing on building customer awareness through advertising and with further expansion beyond our existing two stores.
In Europe, comp store sales declined 1% in the quarter, which compared with a 1% increase last year. Increased sales in most of our continental European stores were offset by sales decline in our flagship Bond Street Store in London. That reflects disruptions from the major construction in the Bond Street location which continues until the first half of next year, as well as reduced levels of tourism. Rounding out international we saw a healthy growth in Canada and Mexico. In addition, we launched eCommerce in Canada during the quarter, which brings Tiffany's product offerings to a wider audience, beyond our one retail store in Toronto and several Canadian trade accounts.
Turning back to the U.S., direct marketing sales rose 4% in the quarter which was somewhat below our expectation. Growth was generated by an increase in the average size of Internet and catalog orders. As expected we slightly decreased catalog circulation in the quarter, which has been the trend all year. We continually enhance our website, and encourage you to visit Tiffany.com to experience the new products feature on the home page, and you can also click on "Choose your country" to visit all four websites.
Finally, sales in our other channel of distribution rose 22% in the quarter, more than half of the increase came from ongoing wholesale sales of diamonds acquired through our diamond sourcing program, but not suitable for Tiffany's production. Those sales began on a small scale in last year's third quarter so we are starting to anniversary the year-over-year effect. Also contributing to other sales growth was a 10% increase in little Switzerland store sales and we continue to develop our Iridesse stores which focus on pearl jewelry. We have opened three stores this year, giving us five right now, with another opening soon and are formulating plans for further expansion in 2006. Lastly, we closed the Temple St. Clair store in South Coast plaza during the quarter and sold our equity interest. Based on a belief that there's greater potential for her to pursue growth through wholesale distribution. So that completes the review of sales by channel of distribution.
From an overall merchandising perspective, we saw strength during the quarter across a range of jewelry categories with especially strong results at higher price points. We continued to achieve healthy growth in the engagement jewelry category, especially in the U.S., but we also experienced a meaningful increase in Japan. As we alluded to earlier, there was also continued strength primarily in the U.S. in statement jewelry sales over $50,000 benefiting from our expanded diamond assortment, including colored diamonds. We continue to see strength in core fine jewelry collections such as Tiffany's hearts, jazz, wall, rose, and bubbles collections. We've expanded our extraordinary assortment of diamond and platinum jewelry and as part of that initiative are very pleased with customer response to the new "swing" jewelry collection, which happens to be featured in our ads today in both the "New York Times" and the "Wall Street Journal." Also our celebration rings campaign continues to attract both gift givers and self purchasers and we'll continue to expand that assortment.
At the other price extreme the silver jewelry category rose in the U.S. and in many international markets benefiting from new designs in the "atlas" and "1837" collections; however, silver jewelry sales in Japan were slightly lower than last year. In much smaller product categories, table top remains soft in the quarter with only a slight sales increase which was also the case for gift accessories. The watch category was flattish in the quarter but we're pleased with the reaction to the new Tiffany Grand collection. And looking out longer term, we were delighted to announce that the world renowned architect Frank Gehry will introduce his jewelry designs in certain of our stores in the U.S. and Japan in spring 2006 followed by a rollout to all stores in fall 2006. His designs are contemporary, bold, and innovative and will add another dimension to Tiffany's offerings. So there's clearly a lot happening within merchandising and product development at Tiffany which keeps our assortment fresh yet classic and certainly maintains customer excitement. I'm now pleased to turn the call over to Jim.
Jim Fernandez, EVP, Chief Financial Officer
Thanks, Mark. Key strategic initiatives, the strong appeal of Tiffany's products, and reasonably good external environment are enabling Tiffany to deliver solid earnings growth while simultaneously investing in longer term growth opportunities. Let's look at the rest of the income statement.
Gross margin in the third quarter of 54.1% met our expectation, and was higher than 53.2% a year ago. Favorable shifts in sales mix as well as the benefit from price increases taken earlier in the year, contributed to the margin expansion. In addition, we recorded a LIFO inventory charge of $4.2 million in the quarter, versus $8.7 million a year ago. Reflecting a decelerated rate of product cost increases. Continuing to modestly depress gross margin were wholesale sales of diamonds which rose in the quarter and which earned virtually no gross margin. SG&A expenses rose 9% in the quarter, which was at the high end of our high single digit expectation; however, we recorded two nonrecurring charges that totaled $4.3 million during the third quarter, one charge was for the sale of a small glassware manufacturing facility and the other charge was related to selling Tiffany's equity interest in Temple St. Clair. Therefore, the ratio of SG&A expenses to sales was 46.1% in the quarter, versus 46% in the prior year, which implies an underlying continuation of sales leverage on fixed costs. In fact, excluding the $4.3 million of charges related to the two business disposals, the expense ratio improved from last year by 0.7 of a point.
Operating earnings rose 19% in the quarter and the operating margin improved 0.8 of a point over last year. Again, excluding the nonrecurring charges in SG&A, operating earnings were 32% higher than last year, and the operating margin was 1.6 points above last year. Tiffany's effective tax rate of 33% in the third quarter was lower than the 38.2% rate a year ago as a result of favorable reserve adjustments relating to the expiration of certain statutory periods during the quarter. Putting it all together, net earnings of 23.8 million in the third quarter were 37% higher than a year ago, which we believe was a very solid quarter. Diluted earnings per share were $0.16 versus $0.12 last year. You may recall that at the end of last year, Tiffany adopted SFAS number 123R for share-based payment and we retroactively restated the first three quarters of 2004 which lowered the third quarters previously reported diluted EPS from $0.14 to $0.12 per share.
Tiffany's balance sheet is strong. We finished the quarter with $112 million of cash and cash equivalents, versus $130 million a year ago; however debt was substantially lower than the prior year and therefore the ratio of total debt to stockholders equity on October 31, was 24%, versus 44% a year ago. At October 31, accounts receivable was only 4% above the year ago, despite higher sales growth and receivables were turning at a very high 19 times per year. We are pleased to report that net inventories at October 31, were actually 2% lower than a year ago. At the same time, we have high in-store availability and are well-positioned for the holiday season. Finished goods inventory declined slightly and combined raw materials and work in process inventory were below last year.
This improved year-over-year inventory performance partly reflects a buildup in 2004 when we were deepening certain product assortments, especially in diamonds, and also increasing internal manufacturing and ramping up rough diamond sourcing. It also reflects our ongoing focus on improving our inventory processes as they relate to category management and demand forecasting. Based on our expectations for the holiday season, we are now comfortable projecting a low single digit percentage increase in net inventories for the full year, versus our previous midsingle digit expectation which supports our long-term objective to improve return on assets. In addition we are now forecasting full year capital expenditures of approximately $165 million versus our previous forecast of 175 million, which is still consistent with our 7 to 8% of sales expectation.
Also related to improving return on assets, during the quarter we completed the sale leaseback of our retail service and distribution center in New Jersey. Selling the facility for $75 million and entering into a long-term lease. We intend to operate in that facility for many years to come, but believe it is unnecessary to own it. In terms of stock repurchases during the quarter, we bought almost 791,000 shares, at an average cost of $38.42 per share, for a total of approximately $30 million. And there is still $295 million of capacity in the authorized program.
Tiffany's internal manufacturing operations provide us an important advantage to support current and future product needs; however, we must also be vigilant in rationalizing production in order to ensure an optimal production mix that supports our growth in a profitable way. As such during the third quarter we sold the glassware manufacturing operation that we believe was no longer necessary to support Tiffany's relatively small crystal business. And instead, we will source those products externally. On the other hand, our jewelry manufacturing facilities in the New York area, which we have expanded this year, and in Rhode Island, are helping us to meet growing customer demand for jewelry, with and without gemstones.
We have been pleased with results from new stores opened in 2005 and are equally excited about the new stores we have already announced for 2006. They include new U.S. stores in Nashville, Indianapolis, Atlantic City, and Tucson. On the international side we have recently announced plans to open a store in Monterey, which will be Tiffany's fifth store in Mexico and a store in Macau. We expect to open several other international locations as well.
In terms of earnings expectations, you can see in today's press release that we've maintained the range for sales and earnings growth for 2005. This includes 8 to 10% sales growth for the year, which continues to imply for the fourth quarter U.S. comp store sales growth in the mid to high single digit range and low single digit comps for Japan. We still expect a modest full year decline in gross margin, we expect SG&A expenses for the year to increase to a low to mid single digit range, which implies a single digit decline in SG&A in the fourth quarter due to some one-time expenses in last year's fourth quarter. In total we continue to look for earnings per diluted share in a range of $1.55 to $1.65 but we should have clearer visibility when we report holiday sales results on January 10.
Wrapping up, Tiffany has generated solid performance in many regions this year and we're pleased with our progress in Japan. We have expanded an already strong product assortment with exciting new designs and our advertising is successfully communicating our message. Our stores look great with several having been renovated this year, we've added eCommerce in Japan and Canada, and our distribution centers are functioning very effectively to ensure timely store replenishment and shipments to customers. In total, we believe we are well positioned around the world. That concludes this conference call, but please feel free to call Mark with any questions and thanks for listening.
Today's conference call will be available for replay starting today, November 30, at 9:30 a.m. central time, and will run through December 6, 2005, at 11:59 p.m. central time. The number to dial for the replay is 1-888-203-1112. That number again, 1-888-203-1112. And the pass code you will need to enter is 8044269. That pass code again 8044269. This does conclude today's conference call. You may disconnect at this time.
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