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Tiffany & Co. (NYSE:TIF)

Q3 2007 Earnings Call

November 30, 2007 8:30 am ET

Executives

Mark Aaron – Vice President, Investor Relations

James Fernandez – Executive Vice President and Chief Financial Officer

Operator

Good day everyone, and welcome this Tiffany & Co. third quarter earnings conference call. [Operator Instructions] 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. 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 and good morning. Earlier today we reported strong sales and earnings growth for Tiffany’s third quarter. On this conference call, Jim and I will review those results and also comment on plans and expectations for the balance of the year.

First please note Tiffany’s safe harbor provision 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 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 third quarter was another good one. Net sales rose 18% on solid growth in most countries. We also are pleased to experience wide ranging product categories sales growth in a wide range of price points. Gross margin was only slightly lower than last year and core SG&A expenses were well controlled.

Net earnings rose significantly to $.71 per diluted share compared with $.21 in the prior year. There were some meaningful items worth noting in the quarter, including the sale of our Tokyo flagship store property which generated a sizeable gain, and a related contribution to the Tiffany & Co. Foundation. After adjusting for those items we were quite pleased with Tiffany’s strong overall performance.

Let’s review the details of the quarter starting with sales performance in our channels of distribution. US retail sales increased 12% in the third quarter largely driven by increased spending per transaction as well as an increase in the number of transactions. An 8% increase in comp store sales was in line with our high single digit expectation. From a price stratification viewpoint there was price [strated] growth in a wide range from under $500 to over $50,000 but the greatest percentage of growth in sales and transactions was in the $4,000 to $50,000 range. The 8% increase in US comps was on top of a 6% increase in last years third quarter. The monthly trend fluctuated, starting the quarter with an 11% increase in August on top of a 6% increase in August 2006, followed by a 2% increase in September on top of a 7% increase and finishing the quarter with a 12% increase in October on top of a 4% prior year increase.

Geographically we posted good growth in most US regions. Sales in the New York flagship store surged 25% in the quarter on top of a 13% increase last year, and we’re up 28% year to date with the increases coming from increased transactions and higher spending per transaction. The flagship stores increase far exceeded a 5% comp store sales increase at our seven other stores in the New York region.

In October we held an event in the flagship store that showcased the extraordinary pieces in our new Blue Book. It was an enormous success with sales substantially exceeding the level of last year’s Simply Spectacular event.

For all comparable US brand stores, a 4% sales increase was on top of a 4% increase last year. It was no specific regional pattern, although we do note that a slight increase in comps in California contrasted with the better than average increase in Florida.

Some branch stores with the largest percentage increases ranged from Bal Harbour and Orlando to Edina and Kansas City to Dallas and San Antonio to Bellevue and Palo Alto. The Pacific region, which includes Hawaii and Guam, continued to post year over year decline.

Looking at the customer mix analysis, the US sales increase in the quarter was pretty evenly generated by higher sales to local customers and foreign tourists, of which European visitors represented the largest increase. For the New York flagship store, more than half of its 25% sales increase came from higher sales to those foreign tourists.

We’ve added seven US stores this year in a diverse set of markets and will close a small store in Maui’s Whalers Village by year end. Openings have included Austin, Texas, a second store in Las Vegas, Natick, Massachusetts, Providence, Rhode Island, Red Bank, New Jersey and Santa Barbara, California and last month we were delighted to welcome some of you to our magnificent new store at 37 Wall Street, which has had a very good start.

International results in most markets also continued at a strong pace in the third quarter with sales up 22% in dollars on a constant exchange rate basis, international sales rose 18% and comps are up 10%. My following remarks about international sales performance are on a constant exchange rate basis.

In Japan, total retail sales rose 6% in the third quarter which was somewhat below what we expected and resulted from a higher average price per jewelry unit sold. It was comprised of a 2% increase in Tokyo, which included a 3% increase in our Tokyo flagship store and an 8% increase in other regions.

Comparable store sales declined 1% in the quarter, however, due to the extent of store openings, closings and relocations over the past year, which created a seven point spread between total sales and comp performance. Looking at total sales performance in Japan may be more relevant at the moment. In fact, over the past 12 months in Japan we’ve opened six new locations and closed three boutiques and are achieving increased market penetration.

Just for the sake of consistent reporting, the 1% comp decline in the quarter ranged from a 3% increase in August versus a 5% decline last year to a 1% increase in September versus a 4% decline last year and a 5% decline in October on top of a 7% decline. The environment remains challenging in Japan but we believe our initiatives are generating the best possible results at this time and the total retail sales growth of 6% in the quarter and 1% in the year to date indicate progress. Finally, the Yen averaged 116 to the dollar I the third quarter versus 117 last year so the translation effect on results was insignificant.

In other international markets, sales certainly continued at a robust pace in the third quarter. The Asia/Pacific region comp store sales rose 29% which was substantially better than the mid teens increase we expected and was on top of a 17% increase in the prior year. We achieved double digit sales growth in every country in that region. We’re pleased with the performance of new stores we’ve opened this year in Korea, Singapore, Hong Kong, Malaysia and Macao and plan to open stores in China in the coming months in the large cities of Tianjin and Chenyang.

In Europe comp store sales rose 14% which was in line with our expectation and was on top of a 21% increase last year. Sales were very strong in London, which represents more than half of our European sales but we’re also pleased with large increases in most markets on the continent. These are obviously very strong results and I’m especially impressed in light of the large number of Europeans who are traveling and shopping in New York.

This year we’ve opened a fifth location in London in Selfridges Department Store and a store in Hamburg, Germany, with a store in Bologna, Italy scheduled to open in December.

Rounding out international, we are doing very well in Canada, with strong growth in Toronto and excellent results at our new store in Vancouver and sales are also growing in Mexico.

Turning back to the US, direct marketing sales increased 4% in the quarter which was on top of an 11% increase last year but was below our mid teens expectation. The 4% sales increase was due to an increased amount spent per order.

Catalog sales decline in circulation and was 15% lower in the quarter, which was roughly in line with our projected decline in mailings for the year. The much larger part of direct marketing sales is ecommerce; we’ve re-launched our web site in October with enhanced content, improved graphics and easier navigation. You may find it interesting to visit tiffany.com and watch the Tiffany holiday video as well as the making of the holiday campaign.

Lastly, an increase of 137% in sales in our other channels was largely due to higher wholesales of diamonds acquired through our rough sourcing program but that are subsequently determined to not meet our quality standards.

Sales also increased at Iridesse due to the addition of new stores and we are currently focused on editing the product assortment and seeking ways to increase brand awareness and store traffic. That covers sales in our four channels of distribution.

We are also excited with what we saw from a product perspective. Statement jewelry at the very high end continued to post a sizeable increase in the third quarter. Engagement jewelry was a strong performer with solitaire diamond ring sales up almost 20% in the US alone. We even saw single digit increase in Japan, while band ring sales also posted big growth.

In fashion jewelry, our Charmed by Tiffany product and marketing initiative in silver and gold charms is paying off with strong growth in the US and many international markets as well as a modest increase in Japan. The named designer category was also up in the quarter and we saw reasonably good growth in watches and in the table ware category. Generally speaking, it was broad based strength in the jewelry category that propelled our sales growth. Our Celebration Rings campaign is maintaining popularity and broadening its appeal, our continually expanding Legacy Jewelry Collection in diamonds and colored stones is very strong. We are pleased with the response to relatively new collections like the Tiffany Somerset Collection of gold and silver mesh designs along with Tiffany’s Swing, stars and hearts platinum diamond jewelry collection.

Turning to the rest of the earnings statement gross margin was 53.7% in the third quarter versus 54% a year ago and was somewhat below our expectations. The modest decline reflected higher wholesale sales of diamonds that were partly offset by reduced LIFO inventory charges. We recorded a LIFO charge of $6.3 million in the quarter versus a charge of $10.4 million last year.

Selling, general and administrative expenses increased in the quarter with a large part of the increase due to labor and occupancy costs tied to new and existing stores as well as higher marketing expenses. However, SG&A expenses also included the $10 million contribution we made to the Tiffany & Co. Foundation with proceeds from the sale of the Tokyo flagship store property. Excluding that contribution SG&A expenses rose 16% and the expense ratio improved from the prior year.

You should also note on the income statement that the line item other operating income represents $105 million pre tax gain we recorded from the sale of the property housing Tiffany’s Tokyo flagship store.

Other expense net was $2.3 million in the quarter that compared with income of $1.3 million last year which was largely related to pre tax gains associated with the sale of equity investments and marketable securities. In total, the $6.8 million gain last year added approximately $.03 per share to last year’s bottom line. Without those gains, other expense net would have been $5.5 million last year.

Our effective tax rate from continuing operations of 34% in the third quarter was fractionally higher than last year’s rate. Adding it all up, net earnings in the third quarter excluding the $.48 gain from the sale of the Tokyo store and the $.04 expense for the contribution to the Tiffany & Co. Foundation was $.27 per diluted share. Last year’s net earnings excluding the $.03 gain from the sales of investments and securities was $.18 per diluted share so when excluding those various items year over year earnings per diluted share rose 50% and exceeded our expectation.

We’re pleased with these overall results and presume most shareholders are as well. Now I’ll turn the call over to Jim.

Jim Fernandez

Thanks Mark. On many fronts it’s been another very active year at Tiffany and especially so in the third quarter. This year we’ve maintained an active pace of store expansion, we’ve opened seven new stores in the US and by year end we will have added a net of 12 new international locations. In total, increasing the worldwide number of company operated Tiffany stores by 11% and the square footage by 8%. We’ve also been active in product development and as Mark mentioned we saw broad based growth in most jewelry categories in the quarter, ranging from diamonds to silver. Tiffany’s classic designs and newer introductions represent a very powerful offering for customers.

During the quarter we completed the sale on lease back of our flagship stores in Tokyo and London which was consistent with our long term objectives to monetize those assets while being assured that we can maintain our successful presence at those locations for many years to come.

As you know, we’ve completed a major renovation of our London store in 2006, by combining two adjacent buildings, which has contributed to excellent sales results there. We also recently announced that our Tokyo Ginza flagship store will undergo a major renovation in 2008 to dramatically enhance its presence at that important location. We also completed the sale of Little Switzerland during the third quarter.

Last month we announced the launch of a new generation of smaller US stores under the working name Tiffany Collections, those stores will be approximately 2,000 square foot each, will carry a wide range of Tiffany jewelry designs, except engagement and very high end statement jewelry and will enable us to further penetrate a number of existing markets as well as to enter smaller but attractive markets. The addition of this new format should ultimately increase the number of Tiffany stores in the US from our previous objective calling for at least 100 stores to a new objective for as many as 170 stores.

We are pleased to report that Luxottica is getting ready to introduce the Tiffany Eyewear Collection with a pre launch to select retailers in December and wider distribution of the complete collection starting in January.

We expect to soon be able to share more details with you about our plans for major expansion of watch distribution beginning in 2008.

Tiffany’s balance sheet strengthened further in the quarter as the result of the Tokyo, London and Little Switzerland sales. Cash in short term investments of $391 million of October 31st were seven times higher than a year ago. Total short term and long term debt of $463 million was 30% lower than a year ago and total debt to stockholders equity was 24% at October 31st versus 39% a year ago.

We will continue to take advantage of our strong financial position. During the third quarter we spent $97 million to repurchase almost 1.9 million shares of common stock at an average cost of $51.28 per share. At the end of the quarter we still had $539 million available under the current authorization and will be opportunistic in our purchases. In fact, we’ve done exactly that, November to date, by spending $208 million to repurchase 4.4 million shares at an average cost of $46.89. That leaves us with $331 million available for future repurchases in the current program.

During the quarter we also announced a 25% increase in our quarterly dividend rate, which followed a 20% increase that our border proved earlier in the year. Net inventories at October 31st were 8% above the prior year due to new store openings, expanded product assortments, higher precious metal costs and expanded diamond manufacturing and sourcing operations. Our inventory position is in good shape as we move into this most significant part of the holiday season.

In accounts receivable on October 31st we’re 14% higher than a year ago, largely reflecting strong sales growth but continuing to turn it 18 times per year.

Tiffany’s return on average assets improved to 11% which achieves our long term objective for at least a 10% return. Similarly, the return on average stockholders equity improved to 18% which meets our objective for at least a 15% ROE.

In terms of our financial objectives for the full year we are now projecting sales growth of approximately 15% which includes comparable store sales increasing 9-10% in the US and in the high single digits internationally on a constant exchange rate basis. For the fourth quarter, that implies a mid single digit comp increase in the US, strong comp growth in the European and Asia/Pacific regions and a modest increase in total Japan sales.

We are looking for direct marketing sales to improve in the fourth quarter as we increased the frequency of email messages to customers and generated 10% increase for the year. We think other sales will be up 50% for the year.

We are now half way through the all important November/December holiday selling season, although the vast majority of sales activity is still ahead of us in the next several weeks.

We indicated in today’s press release that sales trends in November were on track with our overall expectations for the quarter. The macro uncertainties about consumer spending are well known but our stores are well positioned.

Looking at the rest of the income statement, we expect gross margin to be down a few tenths of a point for the year, which implies a modest increase in the fourth quarter, however, we expect SG&A expense growth of approximately 13% for the year which would result in good expense leverage and an improved operating margin.

For the full year we also now expect other expenses net in the area of $10 million and an effective tax rate of approximately 37%. All this should result in net earnings in a range of $2.49 to $2.54 per diluted share for the full year. If you exclude the charge for Little Switzerland and its losses from operations the gain from the sale of Tokyo flagship store and the associated contribution to the Tiffany Foundation, net earnings would equate to $2.25 to $2.30 for diluted share which is higher than our previous expectation of $2.22 to $2.27 per diluted share that we issued three months ago.

As I said before, the next few weeks are the key to achieving a successful holiday season and Tiffany is well positioned in every controllable way to achieve one. We plan to report our holiday sales results on Friday, January 11. That wraps up my remarks and please feel free to call Mark regarding any questions about our third quarter results and thank you for listening.

Operator

[Operator Instructions] This concludes today’s conference, thank you for your participation.

Question-and-Answer Session

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