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May 31, 2006

Tiffany & Co. Q1 2006 Earnings Conference Call Transcript (TIF)

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Tiffany & Co. (TIF)

Q1 2006 Earnings Conference Call

May 31, 2006, 8:30 a.m. EST


Mark Aaron, VP of Investor Relations

Jim Fernandez, EVP and CFO


Good day everyone and welcome to this Tiffany & Co. First Quarter Earnings Release 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, VP, Investor Relations

Thank you and good morning everyone. We reported Tiffany’s first quarter results earlier today and on this call, Jim and I will comment on the performance and on our current outlook.

Before continuing, please note Tiffany’s Safe Harbor provision as follows: 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 2005 report on Form 10-K and on another 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 with the review of sales by channel of distribution. U.S. retail sales increased 2% in the first quarter while comparable store sales declined 1%. This was below our initial expectation for a high single digit comp increase but was in line with the intra-quarter update we gave when we reported our year end results on March 28th. We believe the slightly negative comp partly resolved it from a difficult year-over-year comparison to an 11% increase in 2005’s first quarter, and the 2% increase in total U.S. retail sales compared against a 14% increase in last year’s first quarter. The monthly comp trend included a 1% decline in February versus a 6% increase in 2005, a 1% increase in March on top of an 11% increase and a 4% decline in April, on top of a 16% increase in April 2005.

Geographically, comparable brand store sales around the U.S. were equal to the prior year and comps in the seven New York suburban stores were also equal to the prior year. However, sales in the New York flagship store declined 7%. The softness in the quarter was generally spread around the U.S. and the handful of stores that did post solid growth were not concentrated in any one region.

In addition, sales to foreign tourists declined from last year. Lower sales to European travelers accounted for the majority of the sales decline in the New York flagship store and lower sales to Japanese travelers resulted in a sales decline in Hawaii.

In terms of other sales dynamics, the 1% decline in comparable store sales reflected very slight declines in store traffic and in the number of transactions, while the conversion rate was virtually unchanged. Our analysis of sales by price stratification indicated the greatest year-over-year strength in sales from $3000 to $10,000, with mixed results in other strata.

Looking at it by product category, sales were up in engagement jewelry and silver jewelry. Sales of jewelry at the highest price points declined, which should not be too surprising considering the robust activity we saw in the first quarter of 2005.

We were pleased with the performance of the four new U.S. stores we opened in the past year, with most exceeding our expectations. We are also optimistic about the five new U.S. stores planned for 2006; in Indianapolis, Tucson, Atlantic City, Nashville, and the big island of Hawaii. And we are on track toward wrapping up our multiyear New York flagship store renovation this fall when we complete the work being done on the main floor.

Let’s now turn to international retail sales which posted very strong growth in the quarter. Sales increased 13% in dollars and rose 21% on a constant exchange rate basis that excludes the translation effect from currency changes. The yen averaged to 117 to the dollar in the first quarter versus 106 in the first quarter of 2005 and ceratin other foreign currencies were also weaker than a year ago. The 21% constant exchange rate sales growth for the international retail channel was driven by a 16% comparable store sales increase, as well as by new store results.

My following remarks by region will refer to the constant exchange rate basis. Tiffany is making progress in Japan through a multidimensional focus on sales training initiatives and on upgrading the physical presence of our retail location, complemented by product introductions and marketing support. Total retail sales increased 15% in the quarter due to an increase in jewelry unit sold as well as an increase in the average price mix. Sales growth occurred across a broad range of product categories including engagement jewelry, fashion, silver, and gold jewelry, higher and fine jewelry, name designer jewelry, and watches. Comparable store sales in Japan rose 12% which exceeded our initial low single digit expectation but was in line with the intra-quarter we reported on March 28th, the strong growth compared with the 10% comp decline in last year’s first quarter. In terms of the monthly trend, comps rose 15% in February, 11% in March, and 11% in April. In the first quarter of 2005, comps in Japan had declined 16% in February, 7% in March, and 6% in April. Geographically, the 12% comp increase was composed of a 13% increase in Tokyo including a 12% increase in our flagship Ginza store and an 11% comp increase outside Tokyo.

We are pleased with the performance of new stores we’ve opened in Japan over the past year including the two stores we opened in Mito and Yonago during the first quarter. We are also pleased to be offering e-commerce in Japan which serves as a sales vehicle and as a powerful marketing communications tool. We will continue to pursue our sales and operational strategies in Japan and are encouraged with our progress to date.

Sales are also strong in other international regions. In the Asia Pacific region outside Japan, comps rose 20% which was on top of a 5% increase last year. This was better than we expected and was driven by double digit increases in all countries in that region.

Tiffany launched an informational website in China during the first quarter, which helps to raise brand awareness and provides strong marketing support to our store expansion there. We are expanding Tiffany’s presence this year by adding second stores in both Shanghai and Beijing and opening one in Macau.

Comp store sales in Europe increased 24% in the first quarter versus a 3% decline last year and this was also well above our expectation. The growth was led by a solid pickup in London including an increase in our Bond Street flagship store, as well as increases in most markets in Continental Europe.

The multiyear renovation of our Bond Street store is on track to be completed this summer, when our customers in London will enjoy a dramatically new retail environment. Our expansion plans in Europe this year include entering Austria when we open a store in Vienna later this year.

Rounding out international sales of Tiffany’s company operated stores in Canada, Mexico, and Brazil, where we experience growth in all three countries. We opened a store in Monterey, Mexico in the first quarter which has had a solid start. In Canada, customers are taking advantage of the convenience of the e-commerce website and we are excited about our plan to open a store in Vancouver later this year.

Returning to the U.S., direct marketing sales rose 4% in the first quarter which was below our expectation but was on top of a 13% increase last year. The sales growth was generated by modest increases in the number of orders shipped and in the average order size. It’s worth noting that the timing of Mother’s Day this year which occurred almost a week later than last year, significantly delayed receipt of some direct marketing orders at the end of April because customers typically place their orders only one to two weeks before the holidays, but that was just a timing issue.

Lastly, catalogue circulation declined in line with our expectation to reduce catalogue mailings by 10 to 15% this year.

Finally, other sales declined 4% in the quarter. Little Switzerland represents approximately three quarters of this channel and their sales declined 3% in quarter due in part to lower cruise ship arrivals in some Caribbean markets. A portion of a sales decline in this channel also reflected selling our stake in Temple St. Clair last October.

Wholesale diamond sales in the quarter rose only slightly over last year, which meant there was minimal year-over-year adverse effect on gross margin, but we do expect the pace of rough diamond buying and the subsequent wholesale sales of lower quality stones to accelerate later this year.

Lastly, Iridesse which exclusively focusses on pearl jewelry continues to grow. There are now seven stores and we are adding six more this year,. But it’s contribution to overall sales in not yet significant. That completes the review of our four channels of distribution. I’ll now turn the call over to Jim.

Jim Fernandez, EVP and CFO

Thanks, Mark. It was certainly an interesting quarter with divergent results geographically and by product category, but the strong international results combined with an increase gross margin enabled Tiffany to post better than expected earnings growth.

Looking at the rest of the income statement, gross margin of 55.8% was 1.9 points higher than last year. The increase was more than we expected primarily due to a change in product sales mix towards higher margin categories as well as some benefit from geographical sales mix, especially between the U.S. and Japan.

Higher precious metals cost are negatively affecting gross margin and we have addressed some of it with retail price adjustments. If cost remained high or go even higher, it will likely continue to pressure more in going forward to some extent. We expect the gross margin for the full year will be approximately equal to the prior year based on our assumptions about sales growth and mixed product cost and anticipated levels of rough diamond wholesale sales.

SG&A expenses rose 9% in the quarter, which was somewhat better than we expected. The largest portion of the SG&A expense growth was tied to higher marketing spending especially related to the launch of Frank Gehry’s Jewelry Collections. We expect that SG&A expenses will have a somewhat larger increase in the second quarter before the year-over-year rate of increase moderates in the second half. The expense ratio in the quarter rose to 42.1% as the minimal U.S. sales growth precluded us from getting leverage on our base of mixed expenses. We still expect a high single digit percentage increase in SG&A expense for the full year, which based on our sales growth assumptions would result in the full year expense ratio improving from last year.

Operating earnings rose 12% in the quarter and the operating margin of 13.7% compared with 13% last year. Other expenses met of $4 million were close to our expectation and our tracking in line with our full year expectation of $17 to $20 million.

The effective tax rate was 38.6% was slightly above our expectation and was 3.1 points higher than last year. You should recall that Tiffany recorded a tax benefit of $1.5 million in last year’s first quarter related to the repatriation provisions of the American Jobs Creation Act of 2004. Keep in mind that we have recorded an additional benefit last year of $6.6 million of $0.05 per diluted share in the second quarter of 2005 and an additional benefit of $14.5 million or $0.10 per diluted share in the fourth quarter of 2005. We expect a 38% effective tax rate for the full year of 2006.

Adding it all up, net earnings rose 8% to $43.1 million or $0.30 per diluted share.

Tiffany’s balance sheet is in very good shape. Accounts receivable of April 30th were 29% above the prior year. However, the increase was partly due to the quarter ending on a Sunday which shifted normal end of month receipt to the beginning of May and also reflected sharply higher international sales. Receivable turnover is still at a very high 18 times per year.

Inventories at April 30th were up 6% over the prior year which was in line with sales growth but a little higher than we expected due to the U.S. retail sales shortfall. An increase in finished goods supports our store network while higher raw materials and work in process inventories support our internal jewelry manufacturing operations.

Also, during the quarter, we actively and opportunistically repurchased shares spending $80 million to buy 2.2 million shares at an average cost of $36.59 per share. We now have $196 million remaining under the current authorization which expires next March.

We finished the quarter with cash and cash equivalents and short-term investments of $227 million. Short-term and long-term debt totalling $482 million and stockholder’s equity of $1.8 billion. The ratio of debt to equity was 27% at April 30th versus 26% a year ago.

At April 30th, Tiffany’s return on average assets was almost 10% over the past year which is close to our long-term objective calling for at least 10% return. And Tiffany’s return on average equity was almost 15% and our objective goals were at least 15% ROE.

Looking forward in today’s press release, we provided our expectation for full year earnings. The key driver of course will be sales growth. In Tiffany’s two largest markets, the U.S. and Japan, we are not going to extrapolate first quarter sales trends based on a year-over-year comparisons we faced. However, we are fine tuning our full year expectations as follows. We expect U.S. comps to turn positive in the second quarter followed by mid single digit comps in the second half which would result in a mid single digit increase for the year versus our previous high single digit expectation.

On the other hand, we expect a comp growth in Japan will track in the mid single digit range for the remainder of the year in the full year versus our previous low single digit expectation and that the yen will average 115 to the dollar versus our previous expectation of 120 to the dollar.

We also continue to expect low double digit comp growth in most other international markets for the rest of the year, which means we are certainly not planning them at the robust levels of the first quarter and we look for healthy growth in direct marketing e-commerce sales.

Supporting this expectation for top line growth, Tiffany’s expansion plans for 2006 include opening five stores in the U.S. and eight internationally, which equates to a mid single digit percentage increase in square footage. Our product development activities are generating new designs to create excitement among our customers. We are adding extraordinary new diamond jewelry with some complimented by colored stones as well as new jewelry from the world recognized designers Elsa Peretti and Paloma Picasso. Perhaps the most visible product news in 2006 is the addition of jewelry collections from the world renowned architect Frank Gehry who adds another design dimension to our product offerings.

Also, supporting our expansion and enhancing customer awareness is extensive marketing communications through advertising, which now includes e-mail marketing to U.S. customers as well as public relations activities and our informative websites in the U.S., the U.K., Canada, Japan, and China.

I already alluded to our full year expectations for gross margin and SG&A expenses. Therefore, based on all of our assumptions we are holding to our full year expectation of at least 12% growth in earnings before income taxes.

In today’s press release, we reiterated our expectation the year-over-year pretax earnings growth will be concentrated in the second half of the year. That implies virtually no pretax earnings growth in the second quarter and therefore decline in earnings per share in the second quarter because of the lower tax rate last year related to the American Jobs Creation Act that boosted earnings by $0.05 per diluted share. However, we believe that Tiffany has the ability to achieve its goal of at least 12% growth in earnings before income taxes in 2006 and net earnings of $1.77 to a $1.82 per diluted share.

Wrapping up today’s call, we are pursuing many exciting plans with both short-term and longer term growth potential, and assuming a reasonably good retail environment, we believe Tiffany has the ability and the competitive strength to achieve solid performance in 2006. We appreciate your interest and we’ll update you on Tiffany’s progress when we report second quarter results on August 31st. And that concludes this conference call.

Please feel free to call Mark with any questions or comments, and thank you for listening.


This concludes today’s conference. A replay of today’s conference will be available beginning today, May 31, 2006 at 9:30 a.m. Central Time and running through June 6, 2006 at 11:59 p.m. Central Time by dialing 888-203-1112 and entering the pass code 194-9956. Once again, we thank you for your participation and you may disconnect at this time.

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