Tiffany & Co. is one of the most admired merchants in the jewelry industry, and it has earned that reputation rightfully. Not only has it shown the exceptional power of a store brand, but its financial results illustrate that retail specialty jewelers can operate profitably, even in a recessionary environment.

 

While its average ticket dropped modestly in 2009, its cash flow was dramatic, and its profit margins were four-times the industry average.

 

Tiffany recently filed its annual report (10-K) with the Securities & Exchange Commission; this document always contains nuggets that will help other jewelers see how a successful retail merchant runs its business.

 

IDEX Online Research culled the following highlights from two hundred or so pages of legal filings:

 

·         Tiffany’s average ticket rose for bridal jewelry, but fell for fashion jewelry – Fashion jewelry is a discretionary purchase, and Tiffany’s average ticket for “gemstone jewelry and gemstone band rings, other than engagement jewelry, constructed mostly of platinum (85 percent of this category’s sales), with some gold and silver (15 percent of this category’s sales), mostly with diamonds” fell to $2,300 in 2009 from $3,100 the prior year and $3,300 in 2007 on a global basis.

The average ticket by broad merchandise category for Tiffany globally is shown on the table below. The average ticket calculation for all jewelry categories (A+B+C+D) and the average ticket calculation for all jewelry except sterling silver (A+B+C) is based on Tiffany’s U.S. sales mix.

In addition, the company sells Tiffany & Co. brand merchandise in the following categories – none of which represent 10 percent or more of sales: timepieces and clocks; sterling silver merchandise including flatware, hollowware (tea and coffee services, bowls, cups and trays), trophies, key holders, picture frames and desk accessories; crystal, glassware, china, and other tableware; custom engraved stationery; writing instruments; eyewear; leather goods; and, fashion accessories. Fragrance products are sold under the trademarks Tiffany, Pure Tiffany and Tiffany for Men. Tiffany also sells other brands of timepieces and tableware in its U.S. stores.

 

In the U.S., the typical national chain jeweler – Kay and Zale, for example – generate an average ticket around $300 to $400. The typical AGS-type jeweler generates an average ticket of about $1,100. The typical specialty independent jeweler generates an average ticket for a diamond engagement ring of about $4,500 to $6,000.

 

·        Tiffany’s profit margins outpaced the industry averages dramatically– While other jewelers struggled to post a profit in the difficult environment of 2009, Tiffany’s earnings from continuing operations increased 12 percent year-over-year. The following table summarizes financial operating margins for Tiffany.

 

Segment	percent of Sales
Operating Margin
-Americas	19.4 percent
-Asia-Pacific	25.3 percent
-Europe	20.6 percent
-Other	(36.4 percent)
Earnings From Continuing Operations	16.3 percent
Pretax Margin	14.4 percent
After-tax Margin	9.8 percent

How does this compare with results for specialty jewelers in the U.S.? For the most recent year for which data is available – 2008 – the typical specialty jeweler in America reported a pretax margin of 3.6 percent. In short, Tiffany’s pretax margin was four times as high as the typical U.S. specialty jeweler.

 

·        Tiffany generated strong cash flow – On sales of about $2.7 billion, the company generated $600 million of free cash flow, defined as cash flow from operating activities less capital expenditures. In other words, it generated a 22 percent free cash flow return on sales, a dramatic level of cash. This cash flow was generated even after opening 14 new stores during the year, a 7 percent increase in new stores during the recessionary environment of 2009.

 

·        Performance drives compensation at Tiffany – At Tiffany, the board of directors takes this concept very seriously. Tiffany’s CEO Michael Kowalski’s salary represents only 16 percent of his potential annual compensation. If the company performs well, he is rewarded. While we believe that Tiffany posted solid financial results, especially in a recessionary period, the company’s board of directors has not rewarded Kowalski – or his top officers – with a cash bonus since at least since 2005, despite profits which are consistently above the industry average. Anyone who thinks bonuses are “automatic” needs to read Tiffany’s Proxy Statement.

Here are the components of the compensation plan for Tiffany’s CEO and its top officers. The proxy statement has several pages related to the actual computation of executive salaries for 2009 and prior years.

 

Compensation Component	Chief Operating Officer	Other Executive Officers
Salary	16 percent	21 percent
Annual Incentive	20 percent	19 percent
Long Term Incentive	47 percent	43 percent
Retirement & Other Benefits	17 percent	17 percent

 

·        Tiffany’s charitable contributions are a matter of public record – As we read corporate proxies, we continue to note that shareholders want full disclosure related to a company’s “charitable and political contributions.” Tiffany has a full page of disclosures about its contributions to director-affiliated charities. Those contributions are not nearly as large as we would expect, and in some cases, they represent merchandise. Tiffany is setting the pace for public disclosures of its charitable contributions, in our opinion.

 

·        Iridesse stores were not productive – Tiffany disclosed sales and losses in its discontinued Iridesse pearl stores. At its peak, the specialty chain operated 16 units; sales were less than $1 million per unit, and the pretax loss – during the best year of 2009 (FYE 1/10) – was about $500,000 per store.

 

 ·        Tiffany reduced its advertising during 2009 – Like many merchants, Tiffany reduced its advertising costs as a percentage of sales during the recessionary environment of 2009. Typically, it spends just over 6 percent of sales on advertising; in contrast, most jewelers spend about 4 percent of sales on advertising, according to the Jewelers of America Cost of Doing Business Survey. The table below summarizes Tiffany’s advertising costs versus all specialty jewelers advertising costs.

Advertising  percent of Sales	2009	2008	2007
Tiffany	5.9 percent	7.2 percent	6.4 percent
Specialty Jewelers	n/a	4.2 percent	3.8 percent

 

·        Tiffany’s sales mix is mostly jewelry – In 2009, Tiffany generated 90 percent of its revenues from jewelry, with the balance coming from timepieces, sterling silver goods (other than jewelry), china, crystal, stationery, fragrances and personal accessories. The company also generated a tiny portion of its revenues from wholesale sales of diamonds. The table below summarizes the company’s sales mix for the past three years.

Category	2009	2008	2007
Jewelry	90 percent	87 percent	86 percent
Other Consumer Goods	9 percent	11 percent	12 percent
Wholesale Diamonds & Other	1 percent	2 percent	2 percent

 

·        Tiffany’s product mix metrics illustrate its commitment to vertical integration – The following are key metrics related to Tiffany’s product mix.

o       Tiffany’s manufacturing facilities produce about 60 percent of Tiffany merchandise sold.

 

o       Products containing one or more diamonds of varying sizes, including diamonds used as accents, side-stones, and center-stones, accounted for 48 percent of sales in 2009, 46 percent of sales in 2008, and 47 percent of sales in 2007.

 

o       Products containing one or more diamonds of one carat or larger accounted for 11 percent of sales in 2009, 10 percent of sales in 2008, and 11 percent of sales in 2007.

 

o       In 2009, 70 percent of the polished diamonds acquired by Tiffany for use in jewelry were produced from rough diamonds purchased by the company. This was a dramatic increase from 2008 and 2007 when only 40 percent of the polished diamonds in its jewelry came from rough stock it had purchased.

 

o       Tiffany purchases finished jewelry from about 80 manufacturers, most of whom have long-standing relationships with Tiffany. However, Tiffany does not enter into long-term supply agreements with its finished goods vendors.

 

o       Tiffany generates sales of about $322,500 per employee (full and part-time), far above the jewelry industry average sales of $201,200 per employee (full and part-time). This is not due to a higher average ticket (shown above); rather, it is due to the superior productivity of Tiffany’s sales people.

·        Tiffany’s store sizes vary widely – While the company recently announced that it has settled on a “branch” store size of 3,000 to 4,000 square feet (up from a smaller test footprint of 2,500 square feet), its store sizes vary widely, as the table below illustrates.

 

Store Location	# Stores	Average Square Feet Per Store
U.S. New York Flagship	1	42,000
U.S. Branches	90	6,500
Tokyo Ginza	1	12,000
Other Asia-Pacific Stores	101	2,400
London Old Bond Street	1	22,400
Other Europe Stores	26	3,000

 

·        New York Flagship Store Is Very Important – While Tiffany has 220 stores selling jewelry, its Fifth Avenue store in New York City generated a whopping 9 percent of total corporate revenues. However, this is down very modestly from 10 percent of total revenues in prior years; we believe that the sharp decline on Wall Street affected demand for this location.

The table below summarizes segment sales by geographic area for Tiffany & Company.