Good day, and welcome to the Tiffany & Co. Third Quarter Conference Call. Participating on the call today are Mr. Mark Aaron, Vice President of Investor Relations; and Mr. Patrick McGuiness, Senior Vice President and Chief Financial Officer. Today's call is being recorded. At this time, I'd like to turn the call over to Mr. Aaron. Please go ahead, sir.
Mark L. Aaron
Thank you, and welcome to this conference call. We hope you've had an opportunity by now to review the news release that we issued earlier today. On this call, Pat and I will take you through a review of the third quarter results and also comment on the updated full year outlook.
Before continuing, 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 Form 10-K, 10-Q and 8-K 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 talk about the results. In summary, a 4% increase in worldwide net sales in the third quarter was virtually on our expectation with some offsets by region. The gross margin declined more than we expected. SG&A spending was very close to our expectation, but the effective tax rate was higher than expected. All of this resulted in net earnings of $63 million, which were 30% below the prior year and below the expectation that was embedded in our previous annual guidance. While these results partly reflect the weak consumer demand in a number of markets, among other factors, let's remember that we also faced very difficult year-over-year comparisons when net sales had increased 21% and net earnings had grown 52%, excluding nonrecurring items in last year's third quarter. But having said that, these results were below what we had forecast.
Let's start by reviewing third quarter sales by region, which ranged from modest growth on a constant-exchange-rate basis in the Americas, Japan and Asia Pacific to solid growth in Europe. In the Americas, sales rose 3%, with an increase in average price partly offset by lower jewelry unit volume. Not to minimize the unit decline, but it is worth noting that the entire volume drop was in silver jewelry at price points below $500, while every other jewelry category at higher price strata posted increased volume. On a constant-exchange-rate basis, sales also rose 3% and comparable store sales rose 1%, which was on top of a 15% comp in last year's third quarter. Despite the tough comparison, this was still below our expectation.
Geographically, Americas branch store comps declined 1% but had a difficult comparison to a 13% comp increase last year. Most markets performed in a narrow range, and there were no noteworthy market deviations from the norm. Sales in the New York flagship store rose 5% on top of a 24% increase last year, benefiting from some growth in sales to foreign tourists and U.S. customers. While we can no longer report foreign tourism data for the U.S. in its entirety due to legal restrictions on the collection of customer data in several of our important markets, sales to foreign visitors will continue to be of growing importance to certain of our U.S. stores.
In early October, we had hosted a successful selling event in New York for Tiffany's highest spending customers. Their marked enthusiasm was encouraging. In the last few days of the quarter, sales were obviously affected by Hurricane Sandy, which caused the temporary closing of 24 of our U.S. stores from D.C. up to Boston. Most stores reopened within a few days as power was restored in their markets. The New York flagship itself was closed for 2 days.
It's hard to know how much of a residual effect on sales might be felt in the fourth quarter, but regional management has factored some into their latest forecast. Most important, the hurricane was a tragic occurrence for millions of people and our thoughts are with those who have suffered from it.
Elsewhere in the Americas, comp store sales declined in Canada, but we achieved double-digit comp store sales growth on a constant-exchange-rate basis in both Mexico and Brazil. During the quarter, we added 7 stores in the Americas region, including our new SoHo store in Manhattan; a store in the San Francisco Centre, marking our second in that city; a store in Sherway Gardens, which is our third store in Toronto; and we converted 4 locations in Holt Renfrew department stores in Canada and Calgary, Montréal, Ottawa and Vancouver from wholesale distribution to company-operated stores. We now operate a total of 11 stores in Canada.
Rounding out the region, our combined Internet and catalog sales in the Americas rose modestly in the quarter. We recently mailed a newly designed catalog with a fresh and enticing look that customers should be seeing in their mailboxes around now. Please let me know if you'd like a copy.
Without a doubt, the most difficult year-over-year sales comparison we had in the quarter was in the Asia Pacific region, but sales did meet our expectations. Total sales rose 2% in the quarter, driven by higher jewelry unit volume in all categories and a small decline in average price. On a constant-exchange-rate basis, total sales also rose 2% and comp store sales declined 4% on top of a huge 36% comp increase last year. Tiffany is certainly not alone in experiencing some softness in Chinese consumer spending due to a plethora of economic and other factors.
Geographically, the softness in Greater China, especially in Hong Kong, mostly offset modest growth in other Asia Pacific markets. Notwithstanding what we have seen this year, we remain confident that China will experience significant economic growth in the years ahead and that the Chinese will continue to increase in importance as customers of Tiffany and other luxury goods purveyors. During the quarter, we added 2 new stores in China, in Harbin and Shenyang, and opened our second store in Singapore's Changi Airport.
We were pleased with our performance in Japan, with sales in the quarter fractionally higher than last year and meeting our expectations. Higher average price offset lower jewelry unit volume. In yen, total sales rose 3% and comps rose 5% on top of a 4% increase last year. Sales growth was a bit stronger in the Tokyo region than elsewhere. During the quarter, we opened a new department store location in Chiba that replaces a soon-to-be closed shop in a different department store.
We were also pleased with the results in Europe, where sales rose 6% in the quarter due to a combination of increased price and a slight increase in jewelry unit volume. This exceeded our expectations. In constant currencies, European sales rose 11% and comp stores sales rose 8% on top of a 6% comp increase from last year's third quarter.
Geographically, local currency comp store sales growth throughout Continental Europe, except Italy, more than offset some softness in the U.K. The sales increase benefited from higher foreign tourist sales. During the quarter, we added our 34th location in Europe when we opened a store in Prague. And just a few weeks ago, we were excited to announce that we will open a flagship store in Paris on the magnificent Champs-Elysées in 2014. While we have developed a successful but still relatively small business in Paris over the past decade, we believe this store will take Tiffany's presence to new heights by providing an extraordinary location and experience to international visitors and French customers.
Lastly, our other sales increased 73% in the third quarter. This mostly reflected the realignment in the second quarter when we converted 5 Tiffany stores in the United Arab Emirates from previously wholesale distribution to now company-operated stores in which we record retail sales and expenses. We are progressing very well in making merchandising, marketing and service enhancements as part of our longer-term plan to develop a significant presence in the Middle East.
That concludes the regional sales review. From a product and pricing perspective, we achieved growth in sales and units at most price points above $500. Therefore, from a product category perspective, sales of silver jewelry continued to be the weakest category. At higher price points, we posted modest sales growth in engagement rings and wedding bands. Designer jewelry sales were up. In the fine and fashion jewelry categories, we're seeing good growth in our expanding Yellow Diamonds collection, the Enchant jewelry collection is enjoying a good launch and the 1837 collection with the new RUBEDO metal is doing well. As we said 3 months ago, the difficult year-over-year comparisons in most categories make it challenging to assess more fundamental performance except to say that sales of higher price point jewelry continue to outperform entry-level silver jewelry.
Supporting product sales is a robust marketing campaign. Our advertising through print and digital media and catalogs always showcases the extraordinary beauty and range of our product offerings. But this year and next, the advertising also highlights Tiffany's 175th anniversary and our heritage. An eye-catching example of that advertising is in the November issue of Vogue magazine, where we ran an unprecedented 10-page opening spread about the legacy gemstones of Tiffany. If you haven't seen the ad, please contact me for a copy.
And I'm now pleased to turn the call over to Pat.
Patrick F. McGuiness
Thanks, Mark, for that sales review. I will now take everyone through the rest of the earnings statement. Gross margin of 54.4% in the third quarter was below the 57.9% gross margin in last year's third quarter. We are already forecasting a margin decline in the quarter, but this is more than we expected.
So what changed from our previous forecast? Part of it was higher-than-expected product cost tied to the sales mix by product category. In essence, our sales of fashion jewelry, specifically silver jewelry, were softer than we expected and this slower turn meant that lower silver cost did not flow through the earnings statement as quickly as we had expected. In addition, a product sales mix that is skewed towards higher-priced lower margin products puts pressure on gross margin and we are not yet seeing the benefit we expected from lower diamond cost flowing through the system. We saw some reduced leveraging of fixed expenses, but we expected that due to the modest sales growth. As a result, the lower gross margin cost us about $0.08 per share of earnings in the quarter. We expect that gross margin will improve as we flow through the lower product cost by the end of this year, but fourth quarter margin will still be lower than last year's fourth quarter.
Selling, general and administrative expenses increased 5% in the third quarter. This was close to what we expected due to the growth in store occupancy and marketing spending. Higher labor cost in the quarter were mostly offset by reduced variable incentive compensation. The ratio of SG&A expenses to net sales was 40.7% versus 40.1% in last year's third quarter.
Other expenses net of $14.8 million were up from $10.4 million last year and in line with what we expected. This reflected higher interest expense related to increased debt, which included the $250 million of long-term debt with a 4.4% coupon that we issued during the second quarter.
The effective tax rate of 38.4% in the third quarter was up from a rate of 33.9% in last year's third quarter. The higher-than-expected rate was primarily due to the true-up of the prior year's tax provision upon filing our tax return, as well as some changes in our geographic mix of earnings that affected our overall tax rate. The higher rate was equivalent to about $0.03 in earnings per share.
Adding it all up, the modest sales growth, the lower gross margin and the higher effective tax rate resulted in net earnings of $63 million, being 30% below last year's third quarter and below our internal forecast. Return on average stockholders' equity was 17% on a trailing basis and return on average assets was 10%.
While the near-term economic outlook remains uncertain, we do think we are well positioned for the holiday season and we are moving forward with exciting store, product and marketing plans that will benefit Tiffany over the longer term, and we have the financial means to pursue those initiatives. Looking at our balance sheet, we finished the third quarter with $346 million of cash, cash equivalents and short-term investments versus $297 million a year ago. Total short-term and long-term debt was $978 million versus $709 million a year ago. And that total debt represented 40% of stockholders' equity versus 31% a year ago. And as we noted in today's news release, we did not repurchase any of our shares in the third quarter.
Net inventories of $2.3 billion at October 31, were 11% higher than a year ago. Looking more closely at it, finished goods inventories were up 17% from last year while the total of raw materials and working process inventories were 2% above last year. These increases reflected a variety of factors, primarily new store openings, expanded product assortments and higher product acquisition costs. Looking at inventory growth sequentially, we have experienced decelerating rate of inventory growth over the past few quarters. Net inventories at January 31, 2012 were 28% over the prior year. At April 30, they were 27% above the prior year. At July 31, they were 21% above the prior year, and they are now 11% higher than a year ago. We project that net inventories at year end will be approximately 10% above the prior year.
Tiffany's 2 major distribution centers in New Jersey were closed for a few days after Hurricane Sandy, which temporarily affected store replenishment and customer order fulfillment, but they are now operating normally.
Now -- let's now turn to our financial outlook, which we updated in today's news release. We are now projecting full year sales to increase 5% to 6% versus our previous 6% to 7% forecast. Our annual forecast implies that total sales growth in the fourth quarter will be in a mid- to high-single-digit range with a low- to mid-single-digit comp store sales increase.
While we have moderated our expectations for the Americas and Asia Pacific in the fourth quarter, we are still looking for year-over-year sales growth in all regions. By early December, we have anniversaried all of last year's price increases. So our fourth quarter forecast assumes improvement in unit volume growth primarily coming from the easier year-over-year comparisons.
We've been pleased overall with initial results in the stores we've opened in 2012. We continue to project a net of 28 stores added in 2012, with just 4 more stores opening in the fourth quarter, including 1 in La Jolla, California, which opened 2 weeks ago; our fourth store in Brazil, in Rio de Janeiro; our sixth store in Australia and second in Sydney in Bondi Junction; and our 22nd store in China in the Galaxy Mall in Tianjin. And we'll soon close a store in Chiba, Japan that was replaced by a new one that opened in the third quarter.
As Mark alluded to earlier, we have been very encouraged with initial customer reaction to our newly introduced jewelry collections this year. This has included the launch of the new RUBEDO metal in our 1837 collection and which we have just now expanded into our Return to Tiffany collection; the new Enchant collection crafted in platinum with diamonds, rose gold and tanzanite; the introduction of pink diamonds, which expands our assortment of fancy-colored diamonds; Tiffany's Harmony collection of engagement rings and wedding bands, which was launched exclusively in Japan and will be distributed globally next year; and we have expanded our Yellow Diamond collection and our assortment of important engagement jewelry.
We are projecting that operating margin for the full year will be lower than last year. All of the decline will come from a lower gross margin with SG&A expense growth in line with sales growth.
Adding it all up, we now expect earnings in a range of $409 million to $435 million for the year, or $3.20 to $3.40 per diluted share versus a previous forecast of $3.55 to $3.70 per diluted share. About 1/3 of the delta comes from the third quarter shortfall and 2/3 comes from our reduced sales and gross margin assumptions for the fourth quarter. This implies fourth quarter EPS in a range of $1.35 to $1.55 versus $1.39 per diluted share last year.
We are now almost halfway through the holiday season calendar, but from a sales perspective, the most important part of the holiday season is clearly still ahead of us. Third quarter earnings were below what we had expected. However, the competitive advantages are in place for Tiffany to achieve better performance. We will not compromise on our proven approach to investing in and managing our business for long-term success.
Thanks for listening to today's conference call. Please note that we expect to report Tiffany's sales for the November-December holiday sales period on January 10. Here is Mark again.
Mark L. Aaron
Thanks, Pat. That wraps up today's call. If you missed any portion of it, a replay will be available through December 7. The number to call is (888) 203-1112 in the U.S. and (719) 457-0820 outside the U.S. The passcode is 5855458. The replay is also on our website at tiffany.com/investor. As always, please feel free to call me with any questions. We extend our season's greetings and best wishes for a happy new year to all of you. Thanks for listening.
That concludes today's conference. Thank you for your participation.
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