Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The Company operates three channels of distribution: U.S. Retail includes retail sales in Company-operated stores in the U.S., wholesale sales to independent retailers in the U.S. and wholesale sales of fragrance products to independent retailers in the Americas; International Retail includes retail sales in Company-operated stores and boutiques, corporate sales and wholesale sales to independent retailers and distributors in the Asia-Pacific region, Europe, Canada, the Middle East and Latin America; and Direct Marketing includes corporate (business-to-business) sales and catalog sales in the U.S.

All references to full years relate to the fiscal year that ends on January 31 of the following calendar year.

The Company's net sales increased 24% in the three-month period (second quarter) ended July 31, 1999 and rose 22% in the six-month period (first half) ended July 31, 1999. Sales growth, combined with higher operating margins, resulted in a net earnings increase of 70% in the second quarter and 59% in the first half.

Net sales by channel of distribution were as follows:

                               Three months               Six months
                              Ended July 31,             Ended July 31,
                           ------------------        ------------------
(in thousands)                 1999      1998            1999      1998
--------------             --------  --------        --------  --------
U.S. Retail                $159,512  $129,733        $291,203  $237,757
International Retail        121,574    93,266         239,048   189,738
Direct Marketing             25,981    24,723          49,093    46,386
                           --------  --------        --------  --------
                           $307,067  $247,722        $579,344  $473,881
                           ========  ========        ========  ========

U.S. Retail sales increased 23% in the second quarter of 1999 and 22% in the first half. This resulted from 12% comparable store sales growth in both periods as well as from sales in new stores opened during the past year. Sales in the Company's flagship New York store rose 9% in the second quarter and 10% in the first half, while comparable branch store sales increased 14% in the second quarter and 13% in the first half. Comparable store sales growth resulted from an increased number of transactions. In addition, purchases by domestic customers continued to account for the largest portion of the sales growth, although there was a modest increase in sales to foreign tourists. The Company opened a second store in Dallas, Texas in May 1999, a second store in Los Angeles, California in June and plans to open a store in Boca Raton, Florida in October, consistent with the Company's strategy to open three to five new U.S. stores each year. Wholesale sales to independent retailers in the U.S., which represented less than 3% of total Company sales, declined in the

second quarter and first half. The Company will discontinue such business effective January 1, 2000, in order to focus on Company-operated store distribution in the U.S. and management does not expect that this decision or action will significantly impact the Company's financial position or earnings.

International Retail sales increased 30% in 1999's second quarter and 26% in the first half. In Japan, the Company's largest international market, comparable store sales in local currency increased 13% in both the second quarter and first half due to sales growth both in Tokyo and throughout Japan. The Company's reported sales and earnings reflect either a translation-related benefit from a strengthening Japanese yen or a detriment from a strengthening U.S. dollar. The yen strengthened in 1999's second quarter and first half and, as a result, total Japan retail sales, when translated into U.S. dollars, increased 31% and 28% in the second quarter and first half, respectively. The Company's hedging program utilizes yen put options in order to stabilize product costs over the short-term, despite exchange rate fluctuations. However, as a result of changes in the relationships between the yen and the dollar, the Company adjusts its retail prices when necessary to maintain its gross margin over the longer term.

In the Asia-Pacific region outside Japan, comparable store sales in local currencies rose 24% in the second quarter and 25% in the first half due to improvement in most markets. In Europe, comparable store sales in local currencies rose 21% in the second quarter and 20% in the first half, particularly due to strength in London.

The Company's international retail expansion plans for 1999 include: in Japan, opening two new department store boutiques and renovating/expanding five existing boutiques and its Tokyo Ginza flagship store; expanding its Hong Kong-Landmark store; opening a store in Mexico City; and opening a store in Paris.

Direct Marketing sales increased 5% in 1999's second quarter and 6% in the first half. Corporate sales increased 2% and 3% in the second quarter and first half, while catalog sales rose 9% and 11% in the second quarter and first half, due to a higher number of orders in both divisions. The Company anticipates increasing its catalog mailings by approximately 7% in 1999.

Gross Profit

Gross profit as a percentage of net sales was 57.0% in the second quarter and 55.8% in the first half, higher than 54.8% and 54.2% in the respective prior-year periods. Management attributes the increases to favorable shifts in sales mix and leveraging of fixed costs, as well as product manufacturing/sourcing efficiencies and selective price increases. The Company's ongoing gross margin and pricing strategy is to pass product-cost increases on to customers through higher retail selling prices in order to maintain gross margin at, or above, prior-year levels.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased 20% in the second quarter and 19% in the first half, primarily due to incremental occupancy, staffing and marketing expenses related to the Company's worldwide expansion program, as well as to sales-related variable expenses. As a percentage of net sales, the operating expense ratios of 43.3% in the second quarter and 43.5% in the first half represented improvements of 1.4 points and 1.1 points versus 1998. Management's ongoing objective is to reduce the expense ratio by leveraging the Company's fixed-expense base.

Other Expenses, net

Other expenses rose in the second quarter and first half primarily due to higher interest expense related to a $100,000,000 long-term financing that the Company completed in December 1998. Based on current plans, management expects interest expense in the remainder of the year to be higher than 1998.

Provision for Income Taxes

The provision for income taxes resulted in an effective tax rate of 42.0% in both the second quarter and first half of 1999, compared with 42.5% in the respective 1998 periods. The lower rate was due to a shift in the geographical business mix toward lower-tax jurisdictions as a result of the Company's ongoing expansion program.

Year 2000

The Company recognizes the need to ensure that its operations will not be adversely impacted by year 2000 computer hardware and software failures (information technology systems) and embedded chip or processor failures (non-information technology systems). Certain systems will, unless modified, be unable to process date-sensitive calculations using the year 2000. Such failures are a known risk to the future integrity of the Company's financial reporting and to virtually all aspects of the Company's operations, including the Company's ability to process sales transactions, fulfill customer orders and receive and manage inventories and other assets.

Accordingly, the Company has established a disciplined process to identify, prioritize and evaluate year 2000 problems and to replace or modify and test computer software and operating procedures. The objective of these efforts is to achieve year 2000 compliance with minimal impact on customer service or other disruption to, or loss of integrity in, business or financial operations. Sources of potential failure in internal systems have been identified and conversion efforts are underway. These conversion efforts are scheduled to be completed in the fall of 1999. By that time, the Company will have been required to remediate or replace (i) internally-developed computer code and (ii) code

purchased from third-party software vendors. At July 31, 1999, these efforts were 99% complete in category (i) and 97% complete in category (ii), on schedule with the Company's timetable for completion.

The foregoing conversion efforts address "information technology" systems (i.e., those operated and maintained by the Company's U.S. based Information Technology staff, such as financial, order entry, inventory control and forecasting systems). An analysis has also been completed of all "non-information technology" systems (i.e., those using embedded microprocessor technology such as security systems, safes, telephone systems and warehouse automation equipment) and upgrades or replacements are being deployed as required. Other applications software is maintained on personal computers by end-users in the U.S. and by wholly-owned Company subsidiaries outside the U.S. Typically, such software has been purchased from third-party vendors and specific applications have been developed by the end-user. The Information Technology staff together with end-users has completed the determination of the significance of these applications to the Company and their status regarding year 2000 compliance. As required, remediation and testing plans have been initiated. At July 31, 1999, these efforts were 89% complete, on schedule with the Company's timetable for completion.

The Company has also evaluated year 2000 issues that may be experienced by key merchandise and service vendors in order to assess the potential effect of vendor failure on the Company's operations. The responses from key vendors and suppliers indicate that 99% are year 2000 compliant at this time, will be year 2000 compliant before December 31, 1999, or are not dependent on computer technology to deliver products and services to the Company. To further clarify the extent to which vendors and suppliers have tested and confirmed their year 2000 readiness, a detailed questionnaire has been distributed and responses are being analyzed to further determine risk and potential remedial action.

Contingency plans for manual and delayed information processing will be completed by the end of 1999's third quarter. These plans are being developed because of the possibility of year 2000 failures or service interruptions within the domestic and international network communications infrastructure that the Company relies upon for daily operations. These plans and procedures address both proactive and reactive measures that may be deployed to provide merchandise to stores and customers and continue domestic and international operations. Due to the thorough project approach and rigorous testing that the Company has performed and continues to perform on its own information technology systems, the Company believes that any failures should be quickly rectifiable.

In addition to the cost of internal resources, the Company's total cost for achieving year 2000 compliance is estimated to

be $8,500,000 for third-party service providers and will be incurred through the year ending January 31, 2000. Year 2000 costs for such providers are charged to operations as incurred and amounted to $1,317,000 in the first half of 1999 and $8,277,000 on a cumulative basis.

The Company incurred net cash outflows from operating activities of $7,760,000 in the six months ended July 31, 1999 and $18,159,000 in the six months ended July 31, 1998. The decreased outflow resulted from increased net earnings partially offset by an increased use of working capital.

Working capital (current assets less current liabilities) and the corresponding current ratio (current assets divided by current liabilities) were $549,274,000 and 2.9:1 at July 31, 1999, compared with $522,927,000 and 2.8:1 at January 31, 1999 and $371,242,000 and 2.6:1 at July 31, 1998.

Accounts receivable at July 31, 1999 were 14% lower than at January 31, 1999 (which is a seasonal high-point) but were 29% higher than July 31, 1998 primarily due to sales growth.

Inventories (which represent the largest portion of assets) at July 31, 1999 were 11% higher than at January 31, 1999 and were 25% above the July 31, 1998 level. The increases were due to higher finished goods to support sales growth, new stores and new/expanded product offerings, as well as higher raw materials to support expanded internal manufacturing. In addition, the increase over prior year was also partly due to the translation effect of a stronger Japanese yen. The Company's ongoing objective is to improve inventory performance through:
refinement of worldwide replenishment systems; focus on the specialized disciplines of product development, assortment planning and inventory management; improved presentation and management of display inventories in each store; assortment editing by product category; and a time-phased program of improvements in warehouse management and supply-chain logistics. As a result, management expects a decelerating rate of year-over-year inventory growth during the remainder of 1999.

Capital expenditures in the six months ended July 31, 1999 were $32,800,000, compared with $30,658,000 in the prior-year period. Based on current plans, management expects that capital expenditures will be approximately $75-$80 million in 1999.

On July 16, 1999, the Company made a strategic investment in Aber Resources Ltd. ("Aber"), a publicly-traded company

headquartered in Canada, by purchasing 8 million shares of its common stock at a cost of $70,146,000, representing approximately 14.9% of Aber's outstanding shares. Aber holds a 40% interest in the Diavik Diamonds Project in Canada's Northwest Territories, an operation being developed to mine gem-quality diamond reserves. Production is expected to commence in 2003. The investment is being accounted for under the equity method.

In addition, the Company will form a joint venture and enter into a diamond-purchase agreement with Aber. It is expected that this commercial relationship will enable the Company to secure a considerable portion of its future diamond needs.

On July 23, 1999, the Company issued 1,450,000 shares of its Common Stock at a price of $49.375 per share, resulting in net proceeds of $71,593,750. The net proceeds from the sale were added to the Company's working capital and will be used to support ongoing business expansion.

As a result of the above factors, net-debt (short-term borrowings and long-term debt less cash and cash equivalents) and the corresponding ratio of net-debt as a percentage of total capital (net-debt plus stockholders' equity) were $142,096,000 and 18% at July 31, 1999, compared with $103,197,000 and 17% at January 31, 1999 and $126,601,000 and 22% at July 31, 1998.

The Company's sources of working capital are internally-generated cash flows and borrowings available under a five-year, $160,000,000 multicurrency, noncollateralized, five-bank revolving credit facility which expires on June 30, 2002. Management anticipates that internally-generated cash flows and funds available under the revolving credit facility will be sufficient to support the Company's planned worldwide business expansion and the seasonal working capital increases that are typically required during the third and fourth quarters of the year.

Market Risk

The Company is exposed to market risk from fluctuations in foreign currency exchange rates and interest rates, which could impact its consolidated financial position, results of operations and cash flows. The Company manages its exposure to market risk through its regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. The Company uses derivative financial instruments as risk management tools and not for trading or speculative purposes and does not maintain such instruments which may expose the Company to significant market risk.

The Company uses foreign currency-purchased put options and, to a lesser extent, foreign-exchange forward contracts to reduce its risk in foreign currency-denominated transactions in order to minimize the impact of a significant strengthening of the U.S. dollar against other foreign

currencies. Gains and losses on these instruments substantially offset any losses and gains on the assets, liabilities and transactions being hedged. The Company's primary net foreign currency market exposure is the Japanese yen. Management does not foresee nor expect any significant changes in foreign currency exposure in the near future.

The Company manages its portfolio of fixed-rate debt to reduce its exposure to interest rate changes. The fair value of the Company's fixed-rate long-term debt is sensitive to interest rate changes. Interest rate changes would result in gains/losses in the market value of this debt due to differences between market interest rates and rates at the inception of the debt obligation. Management does not foresee nor expect any significant changes in its exposure to interest rate fluctuations, or in how such exposure is managed in the near future.

Seasonality

As a jeweler and specialty retailer, the Company's business is seasonal in nature, with the fourth quarter typically representing a proportionally greater percentage of annual sales, earnings from operations and cash flow. Management expects such seasonality to continue.

Risk Factors

This document contains certain "forward-looking statements" concerning the Company's objectives and expectations with respect to store openings, catalog mailings, retail prices, gross profit, expenses, inventory performance, capital expenditures, cash flow and year-2000 compliance. In addition, management makes other forward-looking statements from time to time concerning objectives and expectations. As a jeweler and specialty retailer, the Company's success in achieving its objectives and expectations is partially dependent upon economic conditions, competitive developments and consumer attitudes. However, certain assumptions are specific to the Company and/or the markets in which it operates. The following assumptions, among others, are "risk factors" which could affect the likelihood that the Company will achieve the objectives and expectations communicated by management: (i) that sales in Japan will not decline substantially; (ii) that there will not be a substantial adverse change in the exchange relationship between the Japanese yen and the U.S. dollar; (iii) that the Company's commercial relationship with Mitsukoshi, Ltd. ("Mitsukoshi") and Mitsukoshi's ability to continue as a leading department store operator in Japan will continue; (iv) that Mitsukoshi and other department store operators in Japan, in the face of declining sales, will not close or consolidate stores in which TIFFANY & CO. boutiques are located; (v) that low or negative growth in the economy or in the financial markets will not occur and reduce discretionary spending on goods that are, or are perceived to be, "luxuries"; (vi) that existing product supply arrangements, including license agreements with third-party designers Elsa Peretti and Paloma Picasso, will continue; (vii) that the wholesale market for

high-quality cut diamonds will provide continuity of supply and pricing; (viii) that new stores and other sales locations can be leased or otherwise obtained on suitable terms in desired markets and that construction can be completed on a timely basis; (ix) that new systems, particularly for inventory management, can be successfully integrated into the Company's operations, and that warehousing and distribution productivity and capacity can be further improved to support the Company's worldwide distribution requirements; and (x) that no downturn in consumer spending will occur during the fourth quarter of any year.