Last week, the jewelry industry trade press, including IDEX Online, reported that Tiffany & Company’s earnings for the fourth quarter and full year ended January 2006 were down. This week, IDEX Online Research is telling you that Tiffany’s profits were actually up. What’s going on?

 

The short answer is this: Too many people in the media are not able to read and understand financial press releases. Further, Sarbanes-Oxley has strict requirements about how companies must report results. 

 

The simple fact is this: Tiffany’s earnings from its operations were up substantially in both the fourth quarter and full fiscal year ended January. Further, this is an excellent example of how Sarbanes-Oxley requirements resulted in misleading information. 

 

Aber Diamond Stock Sale Distorted Last Year’s Earnings

Here’s the first paragraph of Tiffany’s press release disclosing its sales and earnings for the fourth quarter and full year ended January, 2006:

 

New York, N.Y., March 28, 2006 - Tiffany & Co. (NYSE: TIF) today reported its financial results for the fourth quarter and full year ended January 31, 2006. Net sales rose 6% in the quarter and 9% in the full year, and earnings from operations increased 44% and 30% in those periods. However, as expected, net earnings declined in both periods due to a one-time gain in December 2004.

 

Unfortunately, in the race to be the first to post the company’s results on their respective websites, most of the media did not understand what Tiffany meant about “earnings from operations.” Further, it has been said that bad news makes for better reading. So the media picked up the news about sales gains (first part of second sentence) and the phrasing “net earnings declined” as noted in the third sentence, but neglected to report (or even try to understand) what the company meant about “earnings from operations” and “a one-time gain in December 2004.”

 

During December 2004, Tiffany sold its equity holdings in Aber Diamond for a handsome profit. In its press release and financial information, it correctly showed a line item “gain on sale of equity investment” as just under $194 million in results for both the fourth quarter and full year. 

 

Unfortunately, under Sarbanes-Oxley, the company could not re-state its earnings (often called a “pro-forma” presentation) to show profits from its core business. If Tiffany had been allowed to show pro-forma earnings, this year’s fourth quarter and full year results would have shown a dramatic gain: pretax earnings for the fourth quarter were up 45 percent and pretax earnings for the full year were up 32 percent. 

 

The tables below show Tiffany’s actual earnings from its core jewelry business, without the unusual gain from the sale of its Aber shares.

 

 

Two Other Positive Financial Measures

In addition to the dramatic gains in Tiffany’s pretax profits, the company reported solid gains for two other very important financial measures:

 

• Pretax Margin – For its fourth quarter ended January 2006, Tiffany’s pretax margin was a dramatic 23.3 percent, far above any of its publicly held competition, versus 17 percent for the prior year’s fourth quarter. In the 12 months ended January 2006, its pretax margin was 15.4 percent versus 12.6 percent in the prior year. 
• Net Profit – After-tax profits for Tiffany soared by 55 percent in the fourth quarter and were up 42 percent for the full year. However, there was a distortion in the most recent fiscal year. Tiffany’s fourth quarter and full year tax rates were down 4-5 points due to repatriation of credits from the Jobs Creation Act. Without these unusual credits, its net profits would have been up about in line with pretax profits. 

Is Sarbanes-Oxley Helping or Hindering?

Overall, IDEX Online Research believes that the Sarbanes-Oxley (SO) legislation is bringing increased transparency to publicly held companies. Pre-SO, too many companies took advantage of investor and journalistic ignorance: they abused both their shareholder owners and watchdogs in the media. Pro-forma financial results were used to cover up financial irregularities at companies like Enron, WorldCom, and others. Saks, the luxury retailer, was a frequent user of pro-forma financial information to mask unfavorable trends in the late 1990s and early 2000s. 

 

However, in the case of Tiffany and Company, IDEX Online Research believes that Sarbanes-Oxley requirements actually mislead investors. Many investors react too quickly to news (“ready, fire . . . aim”); by skimming the financial headlines, investors may have been tempted to sell off their TIF shares. Instead, a closer examination would have shown that the company posted dramatic profit gains, ex-unusual items. Most investors discount unusual items, but press releases are also governed by SO; as a result, Tiffany management was obligated to report earnings as shown on its press release.

 

Other Trends Positive for Tiffany

The following are highlights from the company’s fourth quarter and full year results:

 

• U.S. sales showed broad-based gains geographically, from coast to coast.
• Sales were driven by a higher average ticket. The number of sales and conversion rate (browsers-to-buyers) were about flat.
• Demand was strong across all price points. The strongest gains were in merchandise priced $50,000 and higher.
• Foreign tourists comprised about 12 percent of Tiffany’s U.S. sales, flat with the prior year.
• The company’s New York Fifth Avenue flagship store represented about 10 percent of corporate sales, about the same percentage as the prior year. This means that its Fifth Avenue store generated just over $200 million in annual sales. 
• Sales in Japan have turned solidly positive, after three years of declines. The company opened two stores and closed five units in this market in 2005. 
• Most Asia-Pacific markets, except Hong Kong, were very strong. The company has 25 locations in the Asia-Pacific region, including a new store in Brisbane (Australia). Tiffany management is looking for meaningful long term growth out of this region, which includes China.
• European sales were below plan. While all markets across continental Europe showed gains, sales from its London Bond Street store were well below plan. The London market, where Tiffany has four stores, represents a majority of sales in its European region. Tiffany has 13 units in Europe, including the U.K. 
• Stores in Canada, Mexico, and Brazil posted solid gains.
• Tiffany ended the year with 154 company units and 745,000 gross square feet of space, up 2 percent from the prior year. Store square footage in the U.S. rose 4 percent; total U.S. stores rose to 59 units from 55 in the prior year.
• Tiffany’s internet sales are now three times as large as its catalog sales. Sales were up in the direct marketing division – internet and catalog – due to more orders and a higher average ticket. The average ticket (internet and catalog combined) was $221 versus $210 in the prior year.
• Sales in Tiffany’s “other” division include Little Switzerland, Iridesse (6 units), and its wholesale diamond revenues. Most of the sales increase -- +32 percent for the year – came from wholesale diamond sales. Those stones, included in large diamond parcels which the company purchased, were not “Tiffany quality.”
• Tiffany’s best merchandise categories include the following:
• Higher price point goods
• Diamond rings, studs, pendants, bracelets, necklaces
• Colored diamonds
• Band rings, like Tiffany’s “Celebration”
• Core fine jewelry, including “Swing” and “Jazz”
• Collections such as “Legacy” which combines colored gemstones and diamonds
• Silver jewelry
• Average price points for selected jewelry were as follows:
• Statement jewelry – $81,000 versus $73,000 in the prior year
• Solitaire engagement ring (U.S. market) – $10,400 vs. $9,800 in the prior year
• Solitaire engagement ring (Japan) – $4,200, flat with the prior year
• Silver jewelry (U.S. market) – $187, flat with the prior year
• Silver jewelry (Japan) – $215 versus $235 in the prior year
• Tiffany’s gross margin rose for the fourth quarter and full year due to an improved sales mix, but higher raw materials costs (gold, platinum, etc.) and a greater mix of wholesale diamond sales hurt its margins.
• Tiffany’s operating cost ratio fell due to economies of scale and tight expense control.
• The company’s outlook for 2006 (FYE January 2007) is as follows:
• Corporate sales +10 percent
• Global same-store sales up mid-single digit (constant exchange)
• U.S. sales up high-single digit
• Japan sales up low single digit (in Yen)
• Same-store sales in other regions up low double digit levels in local currency
• Worldwide square footage up mid-single digit (including relocations and closings in Japan). An aggressive new store opening plan has been announced, including four units in the U.S. 
• Direct marketing (internet and catalog) sales up high single digit
• “Other” sales up 30 percent due to continuing turnover of sub-par diamonds
• The company’s Iridesse pearl store chain, with six units, is expected to add seven stores in 2006, more than doubling the size of this test concept. 
• Current sales trends are mixed. 
• U.S. same-store sales are down due to tough comparisons and the lack of foreign tourist activity. 
• Same-store sales in Japan and other markets are running above plan.