OPERATOR: Good day everyone, and welcome to the Tiffany & Company’s fourth quarter tiffany money clips conference call. Today’s call is being recorded. Participating on today’s call are Mike Kowalski, Chairman and CEO, Jim Fernandez, Executive Vice President and CFO, and Mr. Mark Aaron, Vice President of Investor Relations.
At this time, I would like to turn the call over to Mr. Mark Aaron. Please go ahead.
MARK AARON, VP, IR, TIFFANY & CO.: Thank you. Good morning. Earlier today we reported Tiffany’s fourth quarter and full year results, and by now you have hopefully had a chance to read the press release. On this conference call, Jim and I will view those results, and then Mike will add his thoughts about Tiffany’s plans for 2008.
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 results 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 enjoyed a successful year in 2007. For the full year we achieved broad-based sales growth in most markets, and notwithstanding a U.S. slowdown in the latter part of the year, Tiffany performed well from a financial perspective. Our earnings per share exceeded the growth objective we set at the start of 2007. It also tiffany pendants the forecasts we had provided with our holiday sales results in January, when adjusted for the various one-time items noted in the press release. And we pursued a number of strategic initiatives during the year.
Let’s begin by looking at sales in our four channels of distribution. U.S. retail sales rose 4% in the fourth quarter, which was in-line with the results we had reported for the November/December holiday season. An increase in the average transaction size was partially offset by a decline in the number of transactions. U.S. price stratification for the quarter was similar to the holiday season, mostly reflecting greater sales strengths in the higher price ranges of various categories.
In essence, silver jewelry sales were soft below $500, but stronger above that price. Similarly, fine jewelry sales from $10,000 to $50,000 were relatively stronger, than in the $1,000 to $10,000 range, and while sales over $50,000, which represent almost 10% of U.S. retail annual sales, for the fourth quarter were modestly lower than the prior year. We were pleased see an increased number of transactions.
Comparable store sales declined 1% in the quarter. Similar to what we have heard from many other retailers, we believe that fourth quarter performance was affected by customers exhibiting some caution, tied to various macroeconomic factors. The monthly comp trend in the quarter was erratic, ranging from a 7% increase in November, which was on top of an 11% prior year increase, to a 5% decline in December, on top of an 8% increase, to a flat comp in January, on top of a 15% increase in the prior year.
Sales in our New York flagship store were strong all year, despite tough year-over-year comparisons, increasing 10% in the fourth quarter, on top of a 17% prior year increase, and 21% for the year, on top of a 9% increase. Sales in the nine store New York region, which includes the flagship store and our new Wall Street store, rose 9% in the quarter, and 16% for the year. Comparable branch store sales declined 4% in the quarter, with some softness in most markets, but sales increased 4% for the year.
Branch store comps had increased 8% in last year’s fourth quarter, and 4% for the year. Despite the fourth quarter softness, there were some strong performing stores, including Cincinnati, Edina, Houston, and Palo Alto. Sales in Hawaii, where we have four stores, rose fractionally, and sales declined in California with 12 stores, and Florida with eight stores, were roughly in-line with the overall branch store comp decline.
You may find it interesting that for the year our five largest U.S. branch stores ranked by sales volume were at South Coast Plaza in Costa Mesa, San Francisco, Chicago, Beverly Hills, and in the Bellagio in Las Vegas. Tiffany continued to benefit from higher sales to foreign tourists in 2007, especially Europeans visiting our New York store, as well as our branch stores in Orlando, Las Vegas, and San Francisco, along with customers from Japan visiting our stores in Hawaii.
In fact, fourth quarter comps in the flagship store entirely reflected higher foreign tourist spending. While for the full year, the New York flagship store increase reflected a combination of higher sales to foreign tourists and local customers. Overall, sales to foreign tourists represented 14% of U.S. retail sales in 2007, versus 11% in 2006.
For the full year, U.S. retail sales rose 11%, and comps rose 7%. As a percent of sales, the New York store increased to 20% of U.S. retail sales in 2007, versus 19% in 2006. New York flagship store sales approached $300 million in 2007, with sales productivity topping a record $7,000 per gross square foot.
It was another year of successful store openings. We added seven stores in Austin, Texas, the Forum Shops in Las Vegas, Natick, Massachusetts outside Boston, Santa Barbara, California, Providence, Rhode Island, Red Bank, New Jersey, and the Wall Street store. In Hawaii, we closed our Whaler’s Village store in Maui.
In total we added a net of 6 U.S. stores in 2007, which increased our U.S. store base by 9%, and square footage by 10%. We were also planning to open six U.S. stores this year. While we were disappointed with how U.S. retail sales finished the year, it was a good year nonetheless, and we enhanced our base of distribution.
Moving to the international side, our international retail sales increased 21% in the fourth quarter, due to very strong growth in the Asia-Pacific region outside Japan, and solid growth in our stores in Europe, Canada and Latin America. On a constant exchange rate basis, which excludes the effect of translating foreign currency denominated sales into U.S. dollars, international retail sales rose 14%, and comp store sales rose 6%. For the year, international sales rose by a strong 19%, with comps up 7% on a constant exchange rate basis. It is clear that our international business is steadily becoming more geographically diversified.
For the full year, international retail sales represented 41% of Tiffany’s worldwide net sales, with Japan tiffany earrings for 17%, versus 19% in the prior year, the Asia-Pacific region outside Japan increasing to 11%, Europe growing to 8%, and the rest of international sales at 5%. My following comments will be on a constant exchange rate basis, as noted on the non-GAAP measures schedule in today’s press release.
Total retail sales in Japan declined 2% in the fourth quarter, as the decline in jewelry units sold primarily in silver jewelry, was partly offset by an increased average price. And while silver jewelry sales were soft, we were pleased with an increase in sales of engagement jewelry, and in Elsa Peretti’s jewelry designs, and similar patterns were true for the full year. The Yen averaged 110 to the dollar in the fourth quarter, versus 118 in the prior year’s quarter. So although Japan retail sales declined 2% in Yen in the quarter, they rose 4% when translated into dollars. For the year, there was minimal translation effect with the Yen virtually unchanged at 117 to the dollar.
Generally speaking, it is a challenging retail environment in Japan. Comp store sales in Japan declined 6%, on top of a 4% comp decline in last year’s fourth quarter. The comp trend included declines of 4% in November, 6% in December, and 9% in January, versus respective declines of 4%, 5%, and 5% in last year’s fourth quarter.
Geographically, the 6% comp decline in the quarter was comprised of a 5% decline in Tokyo, and a 7% decline outside Tokyo, and a similar pattern existed for the full year as well. It is worth noting that for the full year, comp store sales in Japan declined 5%, but total retail sales were equal to the prior year, with the difference representing the importance of new stores and store relocations.
During the year, we opened four new department store boutiques in the Sabu department store in Tokyo’s Shibuya, in the Takashimaya department store in Tokyo’s Shinjuku, in the Sakuya department store in Hiroshima, and in the Matsuzakaya department store in Nagoya, while closing three underperforming locations, for a net increase of one location in Japan in 2007.
More recently the recent opening of a two-level Tiffany boutique in the Matsuzakaya department store in Tokyo, now gives us three street facing locations on Ginza. We have nearly completed our plan to convert key department store boutiques from standard format to full concession operations, with our own Tiffany trained employees, which enables us to enhance the shopping experience.
Outside Japan, sales in the rest of the world were to say the least quite robust. In the Asia-Pacific region outside Japan, comp store sales surged 28% in the fourth quarter, and 26% in the year, with double-digit percentage growth in every country. These gains were on top of strong 22% comp growth in both last year’s fourth quarter and the full year. Sales in Hong Kong itself represent almost 1/3 of that region. During the year, we added six stores in the region. In Seoul, in Singapore’s Changi Airport, in Macau, Kuala Lumpur, Hong Kong, and in Tianjin, China. We finished the year with 34 company operated Tiffany stores in that region.
We also experienced another year of strong growth in Europe in 2007. Comp store sales rose 8% in the fourth quarter on top of a 19% increase, and rose 13% for the year on top of a 20% increase. Europe was also a picture of broad-based geographical strength, both in London which represents a little more than half of European sales, and on the continent. We added three European stores in 2007. In Hamburg, London and Bologna, and finished the year with 17 company-operated Tiffany stores in Europe. And we continued to be pleased with our developing businesses in Canada, with very successful stores in Toronto and Vancouver, and in Mexico where we operate six locations.
Internationally, we added a net of 11 new stores and boutiques in 2007, representing an 11% increase in retail locations, and a 7% increase in square footage. Our plan is to accelerate that pace in 2008, with quite a few new stores and boutiques planned for Europe, Asia-Pacific, and Japan. Worldwide we added a net of 17 company-operated Tiffany and company stores and boutiques in 2007, representing a 10% increase in the number of locations. Square footage increased 9%, to approximately 860,000 gross square feet, including 533,000 in the U.S., and 327,000 internationally.
Returning to the U.S., it was not too surprising that our direct marketing channel also experienced the sales slowdown in the fourth quarter. Sales declined 1% in the quarter, compared with a 10% increase last year, but rose 5% for the year on top of an 11% increase in 2006. The number of orders was up in both periods but the average order size fluctuated.
For the full year, the average direct marketing order of $233 was virtually unchanged from $231 in the prior year. We relaunched our website in 2007 with enhanced functionality and graphics, and are pleased with customer reaction. We also increased the frequency of E-mail communication with the customers. Conversely, we reduced catalog mailings by about 10% in the year, although our current plan is to modestly increase circulation in 2008.
Tiffany’s Internet business has grown dramatically, with high profitability since being launched in 1999. E-commerce sales of more than $150 million in 2007, represented roughly 80% of the direct marketing channel. E-commerce nicely compliments our retail store presence, while also acting as an effective marketing communications tool.
Lastly, sales in the Other channel rose 9% in the fourth quarter, and 64% in the year. In both periods, the growth mostly came from increased wholesale sales of rough diamonds acquired through our diamond sourcing program, and subsequently determined to not meet our quality standards. Sales in our Iridesse stores increased in the year, due to new store openings, but did not meet our expectations. That covers sales by channel of distribution.
Briefly looking at some merchandising highlights, it was another very strong year for diamond jewelry at Tiffany, and an improving year for silver. The 10% worldwide sales growth in the quarter was spread across a number of jewelry categories. Engagement jewelry sales continued at strong pace in the U.S. and internationally for the quarter. And in fact, solitaire diamond ring sales rose more than 20% for the year. The average price of an engagement ring sold rose to $7,000 worldwide in 2007, from $6,500 in the prior year. Celebration ring sales are also maintaining strong popularity with existing and new designs, and the legacy jewelry collection is a solid performer, along with some of the established favorites, like the Swing, Jazz and Bubbles collections.
At more modest prices, sales of charmed jewelry in silver and gold also rose at a strong pace, and we are pleased with results from our new Somerset Collection. Of course, ongoing favorites in silver and gold also include the Atlas, 1837, and Return to Tiffany collection. The average price per piece of silver jewelry sold in 2007 rose to $196 worldwide, from $189 in the prior year. And named designer jewelry sales posted a decent increase in the quarter and year.
Lastly, despite some softening in in the U.S. in the fourth quarter, worldwide statement jewelry sales for the year were quite strong. Most notably in the U.S. as well as in certain international markets. Strong unit growth in statement jewelry was supplemented by an increase in the average price per piece sold, to $96,000 worldwide from $93,000 in the prior year.
I am now pleased to turn the call over to Jim.
JIM FERNANDEZ, CFO, EVP, TIFFANY & CO.: Thanks, Mark. It was a very active year at Tiffany. Not only in terms of store expansion, but also as it related to a number of strategic initiatives. I will highlight them as I complete the review of the income statement. Tiffany’s gross margin in 2007 was affected by various factors, tiffany key rings higher product costs, increased wholesale sales of diamonds that earn a zero margin, and shifts in sales mix.
The higher product costs were reflected in the LIFO charges we recorded in 2007. $9.9 million in the fourth quarter, and $28.7 million for the full year. However, the biggest item affecting gross margin in the fourth quarter, related to an obsolescence charge we recorded to write-off certain watches, as part of our new strategic alliance with The Swatch Group. Gross margin of 56.9% in the quarter was 0.7 of a point lower than the prior year. Excluding the $19 million charge, gross margin would have increased in the quarter, due to favorable product sales mix.
As we announced in today’s press release, we will discontinue utilizing the LIFO accounting method, and begin using the average cost method for all inventories beginning in the first quarter of 2008. This will result in our inventory reporting conforming to the manner in which we operationally manage inventories and evaluate retail pricing, and also will be consistent with many of our peer companies. We presume that analysts and investors will appreciate this change. The tax related cash outflow of approximately $60 million to be paid over four years is not significant, given the strength of our balance sheet.
In addition, we will provide adjusted figures for the 2007 quarters when we file our report on Form 10-K in the next week. SG&A expenses in the quarter and year were also affected by some one-time items. As reported, SG&A expenses increased 28%. However, that increase included two significant items. First, we have fully reserved against the $48 million loan that we made to the Tahera Diamond Corporation. Tahera recently sought protection from creditors, and the impairment charge reflects our expectation that the loan will not be repaid.
Second, we recorded an impairment charge of $16 million related to our Iridesse business, based on lower than expected store performance, and a related reduction in future cash flow projections. Excluding those two items, SG&A expenses would have increased 8%, and with the 10% sales growth would have resulted in an improved expense ratio. Similarly, for the full year, SG&A expenses increased 19%.
Excluding the Tahera and Iridesse charges, as well as a $10 million contribution we made in the third quarter to the Tiffany & Company Foundation, from the $105 million gain we realized on the sale leaseback of our Tokyo flagship store, SG&A expenses would have increased 12% in the year. Compared with the 15% sales growth we achieved, we would have shown an improved expense ratio.
Other expenses net in the quarter and the year, were lower than the prior year, largely due to reduced net interest expense, as we reduced net debt with operating cash flow, and with the proceeds from the sales of the Tokyo and London flagship stores, and the sale of Little Switzerland.
Tiffany’s effective tax rates in both the fourth quarter and the year increased from the prior year, but came in pretty close to what we had expected. Therefore, net earnings in the fourth quarter of $118 million, or $0.89 per diluted share, were lower than the prior year, but it was due to a number of non-recurring charges. Excluding those one-time items, noted in today’s press release, net earnings from continuing operations in the quarter would have increased 14% over the prior year. Similarly, for the full year, adjusting for those items, as well as the substantial gain we recorded from the sale of the Tokyo store, net earnings from continuing operations would have increased 20%, and EPS from continuing operations would have been $2.33 per diluted share. This performance exceeded the 15% EPS growth we targeted at the start of 2007.
We also finished the year with a strong balance sheet. Cash and short term investments were $247 million, versus $191 million a year ago. Our total short term and long-term debt was $453 million, and our stockholders’ equity was $1.6 billion. Therefore, total debt represented 28% of equity, versus 29% a year ago. Net inventories increased 8% in fiscal 2007, to support sales growth, new stores, and diamond sourcing.
You should note that approximately half of the increase came from translating international inventories into U.S. dollars and on the other hand, a $19 million obsolescence charge we recorded for watches, reduced inventories by almost 2%. All-in-all we were pleased to achieve an improvement in inventory turnover in 2007, and are in a strong inventory position. Net receivables rose 17% in 2007, with about 5% of the increase due to foreign translation. Receivable turnover remained at a very high 18 times a year. Capital expenditures were approximately $186 million in 2007, versus $175 million in 2006.
As many of you know, we have invested heavily in Tiffany’s infrastructure in recent years, for internal jewelry manufacturing and rough diamond sourcing, as well as for added distribution center capacity, and are now benefiting from that spending. CapEx was 6% of net sales in 2007, and we are planning future spending to continue at a rate of approximately 6 to 7% of sales. In our share repurchase program, we were increasingly active as 2007 progressed. After generating substantial proceeds in the third quarter from the sale leasebacks and the sale of Little Switzerland, we spent $418 million in the fourth quarter to repurchase 9.3 million shares of our stock, at an average cost of $44.99 per share.
For the full year, we spent $575 million, to repurchase 12.4 million shares, at an average cost of $46.44 per share. This led Tiffany’s Board of Directors two months ago to increase it’s authorization for future repurchase by an additional $500 million. At year-end, we had $621 million available for future repurchases through January of 2011, and we intend to be opportunistic in our purchases.
Tiffany’s productivity and profitability was improved in 2007. Return on average assets for the year increased to 11%, versus our objective that calls for at least a 10% ROA, and average return on average stockholders’ equity rose to 18%, which exceeded our objective that calls for at least a 15% ROE.
As Mark mentioned, we added a net of 17 company-operated Tiffany locations in 2007, increasing our worldwide store base by 10%, and square footage by 9%. For 2008, we are planning almost a 15% increase in the number of worldwide locations, and a high-single digit increase in square footage, as we accelerate the pace on the international side, to take advantage of opportunities in a number of new and existing markets.
In terms of the financial plans that we initially disclosed last month, we continue to expect a 10% increase in worldwide net sales in 2008. Coming from a low single digit increase in the U.S., comp store sales, which reflects the current difficult environment, and a mid-single digit increase in international comp store sales, which will range from minimal growth in Japan, to considerably stronger growth in Asia-Pacific outside Japan, and in Europe. We are also expecting a meaningful contribution from the new stores. We are also planning direct marketing sales to increase by a mid-single digit percentage for the full year, and sales in our other channel to increase by a low-single digit percentage in 2008.
It is difficult for us to improve our operating margin in this kind of environment, and we are looking for operating margin in 2008 to be approximately equal to last year. We will not attempt to forecast a direction of precious metal or diamond costs, but we are modestly benefiting from our zero cost collar hedging program, that covers a portion of our platinum and silver needs for internal manufacturing. Longer term, we have repeatedly said that higher costs will ultimately lead to increased retail prices, which is true for the entire industry. We expect other expense net tiffany necklaces approximately $20 million in 2008, and an effective tax rate of approximately 36 to 37%.
We are forecasting net earnings to grow by 5 to 9%, and an 11 to 15% increase in diluted earnings per share, to a range of $2.75 to $2.85 for 2008, which consists of an increase the to our previously issued guidance of $2.50 to $2.55 per share, because of better than expected 2007 results, as well as the benefit from changing our inventory valuation from LIFO to the average cost method. This compares with $2.47 in 2007, which is adjusted for the various one-time items, and the conversion from LIFO to the average cost method.
While we don’t provide quarterly earnings guidance, I should point out that we are planning for relatively and consistently strong international sales growth throughout the year in Asia-Pacific outside Japan, in Europe, and in Canada and Latin America, along with solid growth of wholesale sales in the Middle East and Russia. However, we are forecasting softness in the U.S. sales for the first half of the year, which in turn should lead everyone to expect pressure on earnings in the first and second quarters, before rebounding later in the year.