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Tiffany & Co. (NYSE:TIF)

F2Q08 Earnings Call

August 28, 2008 8:30 am ET

Executives

Mark L. Aaron - Vice President, Investor Relations

James N. Fernandez - Chief Financial Officer, Executive Vice President

Operator

Good day, everyone and welcome to this Tiffany & Company second 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. James Fernandez. At this time, I would like to turn the call over to Mr. Mark Aaron. Please go ahead, sir.

Mark L. Aaron

Thanks and greetings to everyone. Tiffany had a good second quarter and on this call, Jim and I will review those results and also comment on our outlook. We hope that by now you’ve had a chance to read the press release we issued earlier this morning.

Before continuing, 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 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 let’s proceed.

Tiffany's results this year have been better than expected, despite dealing with challenging U.S. economic conditions and difficult year-over-year comparisons in some markets. In the second quarter, we continued to experience sales strength in many markets around the world, while not surprisingly our business in the U.S. was soft. The operating margin rose due to an improvement in gross margin, net earnings from continuing operations rose 21%, and because we reduced our share count due to substantial repurchases over the past year, EPS from continuing operations rose 31%.

Before looking at performance on the top line among our various geographical segments, we want to remind you that we began new geographical segment reporting with first quarter results. For your information, we’ve posted prior year sales results on our website at investor.tiffany.com, under the tabs financial information and reportable segments.

Now let’s review the details of our sales results. Starting with the Americas region, sales increased 3% in the second quarter, which was on top of a huge 19% increase last year. The 3% growth was due to an increase in the average price per unit sold, while the number of transactions was somewhat lower than last year.

Our price stratification analysis in the U.S. showed softness at the two extremes of the price spectrum. While we continued to see a decline in sales and transactions below $500, we also some softness in sales above $50,000, and there were mixed results in other price strata.

Comparable U.S. store sales declined 4% in the quarter, which was close to our slightly negative expectation but was on top of a huge 17% comp increase last year. On a monthly basis, U.S. comps declined 2% in May, 6% in June, and 5% in July. Keep in mind that in last year’s second quarter, U.S. comps had surged 20% in May, 10% in June, and 22% in July, so while the year-over-year comparisons were quite challenging, the two-year run-rates were generally strong.

That comparison will still be tough in the third quarter because U.S. comps rose 8% in last year’s third quarter, but the comparison will get substantially easier in the fourth quarter when we go up against a 1% decline last year. As we’ve said in the past, we do not draw conclusions from month-to-month fluctuations.

Looking at results geographically, comparable U.S. brand store sales declined 6% in the quarter, which compared with a 14% increase last year. The softness was generally spread around the country, although several stores with strong increases included Edina, Indianapolis, Kansas City, Denver, and some Texas stores. Not surprisingly, business was soft in Southern California but we were pleased to see our stores in Florida holding their own, with sales actually equal to last year. Sales were soft in Las Vegas, where tourism has softened, while on the other hand, our business in Hawaii increased as it benefited from growing sales to Japanese tourists.

Sales in our New York flagship store increased 5% in the quarter, on top of an enormous 31% increase last year due to higher spending by non-U.S. visitors, while sales to New Yorkers were below last year, which should not be too surprising to anyone. In fact, the 2% increase in total U.S. store sales was also more than entirely due to higher spending by customers from other countries.

It’s worth noting that while our U.S. sales growth continues to benefit from a strong influx of non-U.S. visitors, especially from Europe, we are simultaneously seeing strong sales growth within Europe, as I’ll address in a moment.

While the New York flagship store increased 5% in the quarter, total sales in the nine-store New York region increased 7%, as lower sales in most suburban stores were more than offset by the incremental sales from our new Wall Street store, which is not yet in the comp base. In fact, we continue to be very pleased with results in that store, which opened last October. That’s pretty remarkable performance considering the current state of the financial services industry but it points to the need that existed for a Tiffany store in downtown Manhattan to serve large numbers of new customers as well as provide greater convenience to some existing customers.

We are pleased with the performance of the other new stores we’ve opened during the past year, again considering the economic circumstances, and we have several new stores opening in the coming months.

Also within the Americas, combined e-commerce and catalog sales declined 4% in the quarter. That compared with a 12% increase in last year’s second quarter and was below our expectation that had called for a modest increase. The 4% decline reflected fewer orders shipped, which more than offset an increase in the average order size.

Catalog circulation declined modestly in the second quarter, which is in line with our full year expectation as we continue to focus on more effective targeted mailing.

It is understandable that consumers are generally spending more cautiously at the moment but we are encouraged with some recent consumer confidence reports that may be indicating stabilization in confidence, albeit at low levels.

Rounding out the Americas, we continued to achieve very strong sales growth in Canada through our stores in Toronto and Vancouver, along with a doubling of our Canadian e-commerce sales. We are also pleased with sales growth and development of our stores in Mexico and Brazil.

Now let’s turn away from the Americas and look at our performance in other regions. You should first note that our sales growth in dollars continues to benefit from the translation effects of foreign currencies that are stronger than the U.S. dollar. For example, Asia-Pacific region sales rose 7% on a constant exchange rate basis and rose 17% when translated into dollars, while European sales rose 29% in constant currencies and 35% in dollars. I’ll refer to sales on the constant exchange rate basis in my following remarks.

In the Asia-Pacific region, total sales rose 7% and comparable store sales rose 1%, reflecting growth in most markets that was partly offset by continued softness in Japan. Total sales in local currency in Japan declined 3% in the quarter, as a modest increase in jewelry units sold was more than offset by a decline in the average price per unit. Comp store sales declined 7%, which was below our expectations and compared with last year when comps had declined 6% in the quarter. Comps declined in each month of the quarter and there was no meaningful pattern, although comps in Tokyo were somewhat softer than outside Tokyo.

We’ve opened four new boutiques in Japan this year and we are pleased with customer reaction to our new Tiffany for Men boutique concept, and we are now participating in private selling events with the Gaisho sales professionals and their VIP clients at virtually all of our department store locations.

Lastly, our Tokyo flagship store is in the midst of a major interior and façade renovation that will undoubtedly generate plenty of customer and media interest when completed later this year. Until then, that store is open but its results are being significantly affected by the construction and the store will actually be closed from late September through October, but a newly opened department store boutique nearby is picking up some of the business.

In the rest of the Asia-Pacific region, total sales on a constant exchange rate basis rose 18% in the quarter, driven by a large increase in jewelry units sold. Comps rose 13% with double-digit growth in all three months. This was in line with our expectation and came on top of a huge 24% comp increase last year. Growth was led by increases in Korea, Australia, and Mainland China.

So far this year, we’ve opened three stores in China as well as a new store in Perth, Australia, and have relocated boutiques in Malaysia and Korea. Several more are planned for later this year.

Tiffany's in Europe also remained very strong in the second quarter, with a 29% total local currency sales increase that was ahead of our expectations with double-digit increases in most markets. Growth was driven by a large increase in jewelry units sold. Comparable store sales increased 11%, which was on top of a 23% increase last year, and growth was strong throughout the quarter.

We currently operate 19 stores in Europe, with six stores in London accounting for slightly more than half of European sales, so we are especially pleased that our business in London remained strong in the quarter and ahead of expectations despite adverse economic reports.

And we should add that the vast majority of our sales in London are made to local customers, as well as through our successful business on the Internet that reaches customers throughout the U.K.

We are actively expanding Tiffany's store base in Europe this year and have already added locations in London at Heathrow’s Terminal Five and in Brussels, with several additional European stores planned for other markets in the coming months. And we are pleased with our small but growing businesses in Russia and the Middle East through a network of independently operated Tiffany stores.

Rounding out the sales review is our other channel, which posted a 37% sales increase in the quarter, mostly due to increased wholesale sales of rough diamonds acquired through our diamond sourcing program. As most of you know, those wholesale sales typically carry a zero gross margin, so an increase in those sales reduced our total gross margin.

In this channel, we also have our Iridesse business, which posted a modest sales increase in the quarter and we are now recording license revenues from our eyewear agreement with Luxottica, which commenced distribution late last year. We expect other sales for the year to be approximately unchanged from the prior year.

That wraps up the sales review by geographical segment. From a merchandising perspective in the quarter, diamonds continued to be the main attraction, including strength in engagement rings, studs, pendants, and diamonds by the yard. In fact, we had double-digit percentage growth in the engagement jewelry category due to strength in diamond solitaires and band rings with the strongest growth in Asia-Pacific and Europe.

Statement jewelry sales, however, were down slightly due to the softness at the high-end in the U.S. that we already mentioned. At the other price extreme, sales around the world rose very nicely in our fashion jewelry category, which reflected the success of our silver and gold charms program, and designer jewelry rose modestly on a worldwide basis.

So while sales growth was mixed among the different categories and price points due to varying economic conditions, the core attraction of the Tiffany & Company brand ranges from the classics to newer designs. The new summer set and Tiffany Notes jewelry collections are doing well, as are the expanded legacy, swing, and Victoria collections. And we are excited about the potential for the newly launched metro collection, as well as recent additions to the 1837 and Atlas collection. And our celebration ring campaign definitely continues to resonate with customers.

To support our products, we are now launching a dramatic new advertising campaign that will be appearing in all of our touch points, including magazines, newspapers, online, catalogs, and outdoor ads. We think the ads will help to generate plenty of excitement and awareness among customers as we head toward the all-important holiday selling season.

So that now wraps up the sales review. Looking at the rest of the income statement, gross margin of 57.8% in the second quarter was higher than the 56.1% last year and also above our expectation, due to favorable moves in geographic and product sales mix, as well as sales leverage on the fixed costs that are in cost of sales.

Precious metal costs are higher than at this time a year ago, with both platinum and silver up approximately 15%. In addition, we’ve been seeing overall low double-digit percentage increases in polished diamond costs, with the largest cost increases among the bigger stones. However, we’ve selectively increased retail prices to address these rising costs.

Selling, general and administrative expenses increased 13% in the quarter, which was virtually in line with our expectations due to increased labor and occupancy costs related to new stores, along with higher marketing expenses. In addition, about a quarter of that 13% increase was simply due to the translation effect from stronger foreign currencies. The ratio of SG&A expenses to sales increased to 39.8% from 39.1% last year, due to insufficient sales leverage.

Other expenses net of $3.3 million was marginally higher than last year and the effective tax rate of 37% was in line with our forecast and compared with 39.4% last year.

So adding it all up, net earnings from continuing operations increased 21% to $80.8 million, or $0.63 per diluted share in the second quarter, which surpassed our expectation. Pretty good performance considering the currently tough environment, as well as the comparison to a strong quarter last year when net earnings from continuing operations had increased 29%.

Below that line, you should note that last year’s second quarter results included an after tax charge in discontinued operations of $24 million, or $0.17 per diluted share, related to our sale of the Little Switzerland business.

Lastly, we’ve made a number of references on this call to stronger foreign currencies. We thought you might be interested to know that the benefit to EPS from the translation of stronger foreign currencies into U.S. dollars was a modest $0.02 per share in the quarter and $0.04 per share in the first half.

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

James N. Fernandez

Thanks, Mark. Yes, we are pleased with our overall second quarter results and considering the various external challenges and uncertainties facing retailers and consumers, we feel Tiffany is more than holding its own and considering the degree of promotional activity in the U.S., we think that our sales performance especially demonstrates the strong attraction and appeal of the Tiffany & Company brand and our products.

In addition, we think most of you will agree with the benefits of Tiffany's geographical diversification as we establish and maintain relationships with customers who shop in a Tiffany store in their home country or shop when they are traveling. And the global footprint helps us to achieve overall success when temporarily soft results in some markets are counter-balanced by strength elsewhere, as we’ve demonstrated in the past few quarters.

At the end of the second quarter, we operated 196 Tiffany & Company stores in 19 countries, including 82 in the Americas, 95 in Asia-Pacific, and 19 in Europe. The current economic conditions do not deter us from pursuing substantial store expansion opportunities. In fact, this year we are growing our global store base at an above average pace. In the U.S., we’ve already stores that are performing well in the markets of Topanga and Los Angeles and in West Hartford, and are on track to open stores in Pittsburgh and Columbus in the coming months, as well as to soon convert a temporary location in the Mohican Sun Resort in Connecticut to a full line store.

We are also very excited about the potential of our new 2,000 square foot retail store concept which we will debut in Glendale, California in October, offering a wide selection of Tiffany's designs with the exception of engagement and high-end statement jewelry.

Outside the U.S., we have accelerated the rate of store openings, including 11 in Asia-Pacific, which includes a stepped-up pace of expansion in China, and seven stores in Europe, which includes opening our first stores in Belgium, Ireland, and Spain. In total, we are growing our worldwide store base approximately 13% this year and we will soon be launching e-commerce in Australia.

Tiffany's well-developed infrastructure and manufacturing, product sourcing and distribution is effectively supporting the growth of our existing business and our store expansion. We have the balance sheet strength to not only weather the adverse effects from short-term business cycles but to thrive by increasing our market share against local competitors, and we are taking advantage of adverse stock market conditions by actively repurchasing our shares.

Looking briefly at the July 31st balance sheet, net inventories at the end of the quarter were 10% higher than a year ago. Part of the increase was, of course, necessary for store expansion and expanded internal manufacturing necessitated an increase in raw material and work-in-process inventories. Lastly, approximately one-fifth of the increase was due to the effect of translating foreign inventories into U.S. dollars.

Accounts receivable at July 31st were 19% higher than a year ago, with much of the increase tied to sales growth, as well as some related to expanded international wholesale distribution and a portion due to the effect of translation.

Lastly, as our stock price softened during the quarter with the overall market, we stepped up our pace of share repurchases. In total, we spent $74 million to repurchase 1.7 million shares at an average cost of $42.75 per share. That still left us with $492 million of remaining authorization in the current program.

Adding it all up, total debt as a percentage of stockholders’ equity was 36% at quarter’s end, compared with 27% a year ago.

Profitability and asset efficiency continue to improve. Tiffany's 12% return on average assets in the quarter was above our 10% long-term objective, and our 20% return on average stockholders’ equity was well above our 15% long-term objective.

Now let’s conclude with our current outlook for the rest of the year. We expect total sales growth of approximately 9% for the year, which assumes sales growth in dollars of mid-single-digits in the Americas, low-double-digits in Asia-Pacific, and more than 25% growth in Europe. Built into those expectations for the Americas, we are now looking for full-year U.S. comparable store sales, as well as combined e-commerce and catalog sales, to be equal to last year.

While we do not claim to have knowledge about where the economy will be later this year, our U.S. assumption is based on a substantially easier year-over-year comparison in the fourth quarter. We have moderated the growth expectation from our last forecast but still believe that a modest increase in U.S. comp store sales in the fourth quarter is a reasonable assumption. We are also assuming comp increases on a constant exchange rate basis that include a low teens increase in Asia-Pacific stores outside Japan, a negative mid-single-digit comp in Japan, and a low-double-digit increase in Europe, and we base those growth assumptions on our potential to steadily increase Tiffany's market share.

Our full year expectations now call for the operating margin to increase slightly, which would include an increase in gross margin, partly offset by some increase in the SG&A expense ratio. We expect other expenses net to be in the area of approximately $17 million and we expect an effective tax rate of approximately 37% for the year.

Therefore, our first half performance and most recent trends lead us to project earnings per diluted share in a range of $2.82 to $2.92 for the year, which is slightly higher than our previous $2.80 to $2.90 forecast. That compares with $2.47 per share in fiscal 2007, as adjusted for various one-time items and our change in inventory accounting.

While our second quarter results substantially beat expectations, we are only slightly raising our full-year forecast as a result of our more moderate second half expectations for sales in the U.S. and Japan. Tiffany's longer term growth objectives continue to call for low-double-digit sales growth and mid-teens earnings growth, so we believe that achieving this current forecast in this environment is a clear indication of Tiffany's earnings power.

That concludes today’s call. Please feel free to call Mark with any questions and please note that we expect to report Tiffany's third quarter results on Wednesday, November 26th, and thanks for listening.

Operator

And that concludes today’s conference call. To listen to a replay of today’s call, you may dial 719-457-0820, or 888-203-1112, beginning today at 9:30 a.m. Central Time through September the 3rd at 11:59 p.m. Central Time and use the replay code 3468395. Again, that concludes today’s conference call. We thank you for your participation. You may disconnect at this time.

Question-and-Answer Session

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