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Tiffany & Co. (NYSE:TIF)

F1Q08 Earnings Call

May 30, 2008 8:30 am ET

Executives

Mark L. Aaron - Vice President, Investor Relations

Operator

Good day, ladies and gentlemen, and welcome to the Tiffany & Company first quarter earnings conference call. Today’s call is being recorded and we will now go to the Vice President of Investor Relations, Mr. Mark Aaron.

Mark L. Aaron

Thank you. Good morning to all of you. On today’s call, I’ll review Tiffany's quarterly results and then comment on our outlook for the remainder of the year. Jim Fernandez is traveling and can’t participate on this call, so I’ll take you through everything. But first please 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 2007 report on Form 10-K and on 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 let’s proceed. Two weeks ago we indicated at our annual meeting of stockholders that first quarter earnings would surpass our previous expectations. It’s a pleasure to now provide the complete details.

In summary, we achieved a 12% increase in worldwide sales, despite softness in our U.S. business. The operating margin rose in the quarter due to an improved gross margin, SG&A expenses were well contained, and net earnings per diluted share increased 28%, which was substantially better than our previous expectation that had called for EPS to be roughly unchanged from last year.

Before discussing these results, we noted in today’s press release that we are now segmenting sales by key geographical regions rather than by businesses within that market. As examples, direct marketing sales in the U.S. are now folded into the Americas region with retail store sales. This better reflects the synergies and trade-offs from multi-channel distribution that we frequently talk about. And Japan is now included in the Asia-Pacific region.

We will continue to explain relevant changes affecting sales in each market as we have customarily done. So let’s start with sales in the Americas region, which includes retail stores, Internet catalog, and business-to-business sales in the U.S., as well as sales in Canada, Mexico, and Brazil.

Total sales for this region increased 6% in the quarter, compared with a 16% increase last year. For your models, please note that total sales for this region for 2007 increased 19% in the second quarter, rose 12% in the third quarter, and rose 5% in the fourth quarter, adding up to a 12% increase for the full year of 2007.

In the Americas, the 6% increase in total sales was driven by incremental sales from new U.S. stores. The number of U.S. transactions equaled the prior year on a total store basis and declined on a comp basis. From a price stratification perspective, we experienced sales and transactional growth in most price strata, ranging from $500 to $50,000 and above, with no meaningful differences worth noting at various levels, except softness below $500.

U.S. comp store sales were equal to the prior year after increasing 12% in 2007’s first quarter. The flat comp was better than our plan had called for a slight decline in the quarter. The monthly comp trend ranged from flat in February to a 4% increase in March to a 3% decline in April.

Last year, U.S. comps rose 13%, 10%, and 14% in February, March, and April respectively. Frankly, we do not draw conclusions from month-to-month fluctuations.

In the quarter, sales in our New York flagship store rose 16%, which was on top of a huge 26% increase last year. Higher foreign tourist spending generated the increase because sales to New Yorkers were equal to last year. Sales in the entire nine-store New York region, which includes the flagship store and the new Wall Street store, rose 14% in the quarter. Strength in the flagship store was somewhat mitigated by softness in the suburban stores.

Despite the financial market challenges at the moment, our Wall Street store, which opened last October, is performing quite well.

On another New York note of interest, we opened the new Patek Philippe watch salon in our New York flagship store in April and initial sales have been excellent. It’s one of only five such salons in the world and we encourage you to visit it.

Aggregate U.S. brand store comp sales declined 4% in the quarter, versus a 9% increase last year, and the softness, which was not surprising, was not contained to any particular region. I should add that single-digit sales declines in Florida where we have eight stores and in California where we have 13 stores were not meaningfully different from the overall brand store comp decline. However, some stores around the country that performed well above average in the quarter included Chicago, Edina, Kansas City, Bell Harbor and Palm Beach, Portland, and San Francisco, and there was an improvement in sales trends in Hawaii and Guam.

As I mentioned, sales to foreign visitors, especially from Europe, continued to have a markedly positive effect on sales in the New York flagship store. Also, sales in Hawaii and Guam, where we operate six stores, benefited from growth in Japanese tourist spending. But overall the entire U.S. store sales increase came from higher foreign tourist spending.

We are pleased with performance from most of the new U.S. stores we’ve opened over the past year, in Austin, Las Vegas, Natick, Red Bank, Providence, Santa Barbara, and as I mentioned, Wall Street. We have exciting new store plans in the U.S. for 2008. The store we opened in the first quarter in the Westfield Topanga Center in the L.A. market is having a good start, and we also just recently had a successful opening in West Hartford.

Later this year, we plan to add stores in Pittsburgh and Columbus, and we plan to convert a holiday sales boutique we opened in late 2007 in the Mohican Sun Resort in Connecticut into a regular store due to its impressive results. We are also very excited about the new smaller store format we’ve developed, which will debut this October in the Los Angeles suburb of Glendale.

Combined Internet and catalog sales increased 1% in the quarter, with insignificant offsetting changes in the average order size and the number of orders. Catalog circulation declined slightly in the quarter. For the full year, we now expect circulation to be approximately equal to last year. However, we plan to introduce some catalog innovations in order to send a more product focused and targeted message to customers.

Rounding out the Americas, our Canadian stores in Toronto and Vancouver are posting strong increases, while comp store sales rose slightly in Latin America. We finished the first quarter with 81 company-operated Tiffany stores in the Americas versus 74 a year ago. For all of 2008, we are adding a total of six stores in the Americas.

Looking overseas, we experienced a continuation of very strong sales growth in Europe and in most of the Asia-Pacific region, which easily offset softness in Japan. Foreign currency also worked in our favor when translating local currency results back into U.S. dollars.

As examples, versus the dollar the Yen was 13% stronger than a year ago and the Euro was 15% stronger than a year ago, so our local currency results were translated into even larger sales growth in dollars.

My following comments will refer to sales on a constant exchange rate basis, which you can not in the attached, non-GAAP schedule that’s attached to today’s press release.

In our new sales segmentation, Asia-Pacific sales include Japan, other Asia-Pacific countries, and the Middle East. Total Asia-Pacific sales increased 10% in the quarter and comparable store sales rose 4%, versus increases of 9% in total and 2% in comps in last year’s first quarter.

Exceptionally strong growth in most countries was partly offset by softness in Japan. For your models, please note that sales for this region for 2007 in U.S. dollars increased 9% in the second quarter, rose 20% in the third quarter, and rose 17% in the fourth quarter, adding up to a 14% increase for the full year of 2007.

Total retail sales in Japan declined 3% in Yen in the quarter, as an increase in the number of jewelry units sold was offset by a decline in the average price per piece sold. Comp store sales in Japan declined 7%, with greater weakness early in the quarter. There was no meaningful difference in performance between Tokyo and the rest of Japan.

Economic challenges are affecting consumer spending in Japan; however, we continue to focus on building new customer relationships through client development activities and are also experiencing benefits from store relocations and boutique conversions to our own sales staff.

We were also active on the expansion front in Japan. In the first quarter, we opened boutiques in the Daimaru store in Fukuoka, in the Matsuzakaya store in Tokyo Ginza, and in the Entetsu in Hamamatsu, as well as opening a Tiffany For Men boutique in a Hankyu in Umeda and adding a Tiffany For Men section to our store in Tokyo’s Roppongi Hills.

We have also begun the extensive renovation of the Tokyo flagship store, which will result in a major redesign of the interior and a dramatic new façade, which should generate a lot of attention when it is completed in November. We finished the quarter with 57 company-operated stores and boutiques in Japan versus 53 a year ago.

Outside of Japan, Asia-Pacific comps rose 22% in the quarter, on top of 24% growth last year. Business was strong everywhere. Hong Kong is the largest market for us in that region and the seven stores there continue to generate exceptional sales growth. We are getting strong growth within China and have already opened two stores this year, with additional ones planned.

We are also excited to be expanding our very successful business in Australia when we open a store in Perth in a few months. We operated 36 stores in the Asia-Pacific region outside Japan at the end of the quarter versus 30 a year ago.

European sales were also strong in the quarter with a 12% comp store sales increase on top of an 11% increase last year. As you know, London represents a bit more than half of our European sales and every one of our stores there delivered strong sales growth in the quarter. We also had healthy sales growth in Italy and France.

We have some very exciting new stores planned for 2008 in Europe. In March, we opened a store in the new Terminal Five at Heathrow Airport, which is enjoying a good start, and we’ve announced plans for a store in West London and in Düsseldorf, as well as plans to enter Belgium, Ireland, and Spain this year when we open stores in Brussels, Dublin, and Madrid.

At the end of the quarter, we operated 18 stores in Europe versus 14 a year ago. For your models, please note that sales for the European region for 2007 in U.S. dollars increased 43% in the second quarter, 29% in the third quarter, and 29% in the fourth quarter, adding up to a 31% increase for the full year of 2007.

Adding it all up, we expect to open approximately 18 stores this year across Asia-Pacific and Europe.

Tiffany has clearly expanded its customer base and increased its sales growth potential over the years, while becoming a globally diversified retailer. In fact, our products are now sold in our own company-operated Tiffany & Co. stores in 18 countries, as well as in an additional more than 30 countries through wholesale sales to retail partners. Our presence will continue to expand.

Lastly, sales in the other channel declined 21% in the quarter. This was due to lower wholesale sales of diamonds related to our rough diamond sourcing program. The pattern of such sales can vary over the course of the year but we currently expect them to decline modestly for the full year.

Our diamond sourcing program continues to be a critical component in our expansion strategy. We need to purchase a significant number of diamonds each year and this program helps us achieve that objective by allowing us to gain access to the stones we need.

Please note that the other channel also includes sales in our Iridesse stores, as well as earnings received from our license agreement with Luxottica, and it excludes prior year sales for Little Switzerland, which was sold in mid-2007.

From a merchandising perspective, Tiffany's 12% sales growth in the quarter was spread among various jewelry categories. Engagement jewelry was again a strong performer in the U.S. and in non-U.S. markets, but silver jewelry sales were equally strong, led by the success of Tiffany's silver charm program.

Worldwide statement jewelry sales rose nicely in the quarter. Sales of celebration rings were strong and we are encouraged by the growth potential for other collections, such as legacy and swing collections in diamond jewelry.

The fashionable summer set and Tiffany Notes collections, both introduced in the past 12 months, are contributing to sales growth, and Elsa Peretti’s jewelry sales outpaced a modest increase in designer jewelry sales.

Lastly, we are pleased with customer response to Tiffany's first-ever eyewear collection, which is managed by Luxottica and was successfully launched earlier in the year in some of our own stores and in other retailers.

Tiffany has many new products in the pipeline to excite customers throughout the year. There will be new diamond jewelry collections, such as Tiffany Metro, as well as extensions of the successful Swing and Victoria collections. There will be new charms, including ones in platinum and diamonds in various design motifs, and there will be additions to the iconic 1837 and Atlas collections.

In addition, we are making excellent progress in partnership with The Swatch Group to develop a global Tiffany & Company watch business. This year is really a transition period as we collaborate with Swatch on product design and marketing and Swatch assumes control of manufacturing and distribution. We expect progress to be clearly evident in 2009.

Now let’s turn to the rest of the income statement. Gross margin in the first quarter rose to 57.1% versus a restated 56.1% a year ago. Effective with the first quarter, we changed our inventory accounting from the LIFO method to the average cost method. This now matches up our external inventory reporting to the internal method that we used to manage inventories and evaluate retail pricing, and is consistent with the reporting practices of many peer retailers.

The increased gross margin in the quarter was better than expected due to sales leverage on fixed costs and the decline in wholesale sales of diamonds.

Selling, general, and administrative expenses rose 13% in the first quarter, which was a bit above our expectation but this understandably reflected the translation effect of a weaker dollar.

The real increase was mostly due to higher labor and occupancy costs tied to new and existing stores, as well as increased advertising spending, all of which we had budgeted for. The ratio of SG&A to net sales was 41.6% versus 41.3% last year.

Other expenses net of $1.5 million were lower than last year’s $3 million, reflecting lower interest expense. Our effective tax rate of 36.7% in the quarter was virtually unchanged from 36.5% last year.

So adding it all up, net earnings of $64.4 million were 20% above the prior year’s net earnings from continuing operations. Earnings per diluted share increased 28% to $0.50 per share from $0.39 per diluted share last year, which was better than our expectation that called for EPS to be virtually unchanged from last year.

Tiffany's return on average stockholder’s equity was 18% in the quarter versus our long-term objective for at least a 15% ROE. The return on average assets was 11% in the quarter, which compared favorably with our long-term objective to achieve at least a 10% ROE.

Turning to our balance sheet, accounts receivable at April 30th were up 21% from a year ago due to sales growth, as well as the foreign tax receivable that we expect to collect later this year. Receivables turnover remained at a high 18 times per year.

Net inventories of $1.47 billion at April 30th were up 10% from a year ago. The increase partly reflected higher raw material and work in process inventories due to higher volume and costs that we require for internal jewelry manufacturing. Almost half of the increase came from translation of our inventories in non-U.S. locations into U.S. dollars, so we are pleased with our inventory performance, both in terms of aggregate levels and in-store availability.

In terms of share repurchases, we spent almost $55 million in the quarter to repurchase almost 1.4 million shares at an average cost of $39.66 per share. At April 30th, we had $566 million of authorization remaining under this program that runs through January 2011.

Adding up everything, Tiffany's balance sheet at April 30th was strong. Total debt of $611 million and stockholder’s equity of $1.7 billion resulted in a debt to equity ratio of 35% versus 27% last year.

Now let’s briefly look at our outlook for the rest of the year. We continue to look for about 10% worldwide sales growth in 2008. I’ve already highlighted our active pace of store expansion plans for the U.S., Europe, and throughout the Asia-Pacific region in 2008, which we expect in total will increase the number of company-operated Tiffany locations by approximately 13% and square footage by 9%.

In addition, we look for high single digit total sales growth in the Americas, which continues to include a low-single-digit U.S. comp increase for the year and a mid-single-digit percentage increase in Internet catalog sales.

Please note that our full-year expectation for the U.S. continues to call for slightly negative comps in the second quarter, which should continue to put some pressure on earnings in that period. In addition, we have moderated our U.S. growth expectations for the second half of the year and now expect only a slight comp increase in the third quarter, followed by a mid-single-digit comp in the fourth quarter, based on easier year-over-year comparisons, as well as our assumption of gradually improving economic conditions. Please feel free to agree or disagree with that assumption.

We are also looking for a low teens increase in annual sales growth in dollars in the total Asia-Pacific region and more than 20% growth in dollars for Europe, with local currency comps increasing by a mid-single-digit percentage in Asia-Pacific and slightly negative in Japan, and local currency comps increasing by a low double-digit percentage in Europe. And we expect sales in the other channel to decline modestly from last year.

We continue to expect the operating margin for the year to be approximately unchanged from last year when adjusted for the various one-time items recorded in 2007 and the change in the inventory accounting method. That would include an increase in gross margin but also an increase in the SG&A expense ratio.

Please note that despite some retreat in precious metal prices, they are still substantially higher than a year ago and our objective is to continue to increase retail prices as necessary to mitigate the effect on gross margin from higher costs.

We expect other expenses net in the area of $15 million to $17 million for the year and an effective tax rate of approximately 36% to 37%.

In total, we now expect net earnings per diluted share to increase 13% to 17% to a range of $2.80 to $2.90 per share, versus a previous range of $2.75 to $2.85. That compares with $2.47 per share last year as adjusted for various one-time items and our change in inventory accounting.

We are letting only a portion of the excess of our first quarter results over expected results flow through to the full year because, as I said before, we are now assuming that the recovery in our U.S. sales might occur a bit later in the year than we previously thought.

In today’s press release, we said that worldwide sales performance in May to date is meeting our expectation which, consistent with the first quarter pattern, reflects strength in markets throughout Asia-Pacific other than Japan and in Europe, more than offsetting softness in U.S. sales.

In conclusion, while we’ve always said that Tiffany's business is not recession proof, the increasingly global nature of our business is demonstrating the mitigating effect that it can have on economic weakness in any one particular region.

The Tiffany & Company brand stands for the highest levels of product quality, service, and enduring value, which are perhaps now more desired attributes than ever.

That concludes today’s conference call. We expect to report results for the second quarter on Thursday, August 28th. Please feel free to contact me with any questions. Thanks for listening.

Operator

Ladies and gentlemen, a recording of these remarks will be available for replay until June 6, 2008. To access these recordings, you may dial 888-203-1112, or 719-457-0820, and the replay pass code for today’s meeting is 4657301. This does conclude Tiffany & Company’s first quarter earnings conference call. We thank you all for joining us today. You may now disconnect.

Question-and-Answer Session

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