Mark Aaron - VP, IR
Mike Kowalski - Chairman and CEO
Jim Fernandez - CFO and EVP
Tiffany & Co. (TIF) Q4 2008 Earnings Call March 23, 2009 8:30 AM ET
Good day everyone and welcome to this Tiffany & Company Fourth Quarter Earnings Conference Call. Today's call is being recorded. Participating on today's call is Vice President of Investor Relations, Mr. Mark Aaron and the Chairman and CEO, Mr. Mike Kowalski, and the Executive Vice President and Chief Financial Officer, Mr. Jim Fernandez.
At this time I would like to turn the call over to Mr. Mark Aaron. Please go ahead sir.
Thank you. Good morning to everyone. Tiffany's fourth quarter and full-year results were issued earlier today and we hope that you had a chance to read the press release.
On this call, Mike, Jim and I will comment on the results and on the business outlook for 2009. First, please note Tiffany's Safe Harbor statement, 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 2007 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 let’s proceed.
As we said on our holiday sales call two months ago, the conclusion to 2008 was the most challenging in the 21 years since Tiffany became a public company. Consumers were bombarded with various external pressures that you are all well aware of. All of which not surprisingly took a toll on their spending and on Tiffany’s sales results. However, we were pleased that margins came in slightly better than we had projected, so that earnings excluding one-time items for the quarter and year were above the forecast we published two months ago.
Let's look at the details. Tiffany's world-wide net sales declined 20% in the fourth quarter. Excluding the effects from foreign currency translation, world-wide net sales declined 19% due to a 23% decline in comparable store sales that included extreme softness in the US and sluggish trends to one degree or another in other region.
In the Americas, sales declined 29% in the quarter, which reflected difficult economic conditions in the US, but also likely reflected the impact from heavy price promoting by competitors. Total retail sales in the US declined 31% and comp store sales declined 33%. We now know that the US recession officially began in late 2007, which coincided with a 1% decline in our US comps in the fourth quarter of that year.
On a monthly basis in this fourth quarter, US comps declined 39% in November, 33% in December and 23% in January. For the quarter, the softness was wide spread and consistent, with comps down 33% in branch stores, 35% in the nine store New York region and 34% in our New York flagship store.
For the full-year, comp US branch store sales declined 17%. In the New York flagship store, which represents 10% of worldwide sales, we saw a 9% sales decline. But despite that, it generated very high sales productivity of about $6,500 per gross square foot for the full year.
The ranking of our five largest US brand stores in terms of sales volume in 2008 was South Coast Plaza in Costa Mesa, again the largest, followed by our stores in Chicago, San Francisco, Beverly Hills and our Washington, D.C, store in Vienna, Virginia.
Most of the US sales decline in the quarter came from a decrease in a number of transactions, but the remainder coming from customers spending less per transaction. Just as an aside, the 16% US comp decline for the full year resulted almost entirely from fewer transactions.
In terms of how sales and transactions were stratified in the US, there were declines in every price strata in the quarter. But the declines were somewhat smaller in the sales below $500 and larger in the sales above $50,000.
From a customer mix perspective, local customers always generate a vast majority of our US business. And sales to those customers, obviously, declined in the quarter. But we also saw similar percentage declines in the sales to tourists visiting New York and around the country.
Overall for the full year, sales in the US made to foreign tourists represented 16% of US store sales in 2008, versus 14% in 2007 and 11% in 2006. The economic climate also affects new store performance, but despite that, we are encouraged with the results of the new stores that we opened in 2008, which included West Hartford, Columbus, Pittsburgh, Topanga Canyon in LA and in the Mohegan Sun resort in Connecticut. And customers seem to appreciate our new smaller format store in Glendale, California, although the economy is having an effect on its results there too.
Despite the tough environment though, we are pleased that the Glendale store is generating high levels of profitability relative to other new US stores. We finished the year with 76 stores in the US.
Also in the US, tiffany.com and our catalogs generate substantial sales volume and also support our marketing communications. Internet and catalog sales declined 20% on a combined basis in the quarter due to a lower number of orders shipped, while the average order size held steady.
For the full year, US Internet and catalog sales accounted for 10% of the Americas sales and a decline in orders caused their sales to drop 10%, while the average order size in the year rose slightly. We modestly reduced catalog mailings in 2008 and expect to reduce it further in 2009, as we continue to ship marketing resources in response to consumer behavior.
Rounding out the Americas, we continued to experience healthy local currency sales growth in Canada in the quarter, including the strong ecommerce sales there, while sales were soft in Mexico and rose in Brazil. As a result of this performance, the Americas region accounted for 55% of total sales in 2008 versus 60% in 2007.
Let's now turn to the Asia-Pacific region where total sales declined 3% in the quarter. However, on a constant exchange rate basis, sales declined 9% and comp store sales dropped 13%.
Japan is our largest market in that region and total sales rose 4% in the quarter. However, excluding the effects of the stronger yen versus a dollar, sales declined 13% in total and comps declined 16%.
This compared with a 6% comp decline last year, and sales declined in all three months. There were similar comp declines within Tokyo and outside Tokyo. For the full year, total sales in Japan in yen declined 7% and comps declined 10%.
Japan actually increased as a percentage of total company sales to 19% in 2008 from 17% in 2007, that increase was entirely driven by the translation effect on sales from the stronger yen. In fact the yen averaged 102 to the dollar in 2008 versus a 117 in the prior year.
We opened four department store boutiques in 2008 in Japan. In the Dimaru store in Fukuoka, and the Hankyu store in Umeda, in the Matsuzakaya store in Tokyo's Ginza, and in the Entetsu store in Hamamatsu. And we now operate 57 locations throughout Japan.
In Asia-Pacific markets outside Japan, total sales represented 13% of worldwide sales in 2008 versus 12% in 2007. Local currency comps declined 9% in the quarter. We might want to know that they were comparing against a 28% increase in the fourth quarter of 2007. Sales in the quarter ranged from strength in Australia, China, and Korea to softness in Hong Kong, Singapore, and Taiwan.
For the year, Asia-Pacific sales outside Japan rose 12% in constant currencies and comp store sales rose 5%. We added a net of five new stores in those markets in 2008, including three in China in Shenyang, Chengdu and Qingdao as well as new locations in Korea, Australia and a relocation in Malaysia.
Now let's turn to Europe. Total sales in dollars declined 2% in the fourth quarter due to the strengths of the dollar, but sales rose 20% in local currencies due to incremental sales from new stores. Local currency comp store sales were equal to the prior year as our sales softened in the UK and their comps turned modestly negative. Conversely, our comps rose in most countries on the continent. Total European sales in constant currencies rose 25% in 2008 and comps rose 6%.
We aggressively expanded Tiffany's European presence in 2008 by opening seven stores including two in London in Heathrow's Terminal 5 in West London, two in Germany in Berlin and Düsseldorf. And we entered three new countries with stores in Brussels, Dublin and Madrid. We now have 24 locations in Europe, and recently announced our plan to open a store in Amsterdam in 2009. Europe’s share on the worldwide sales mix increased in 2008 growing to 10% of sales from 8% in 2007.
In total, we expanded our worldwide store base with the opening of 22 Tiffany & Company operated stores and boutiques in 2008 and finished the year with 206 locations in 21 countries. This was a 12% increase in the number of location. Square footage rose 9% to approximately 935,000 gross square feet, including 600,000 in the Americas, 242,000 in the Asia-Pacific and 93,000 in Europe.
Rounding out our top line results, sales in our other channel declined 71% in the quarter. This was due to lower wholesale sales of diamonds that partly reflected the timing of greater sales that were made earlier in the year as well as some recent reductions in purchases of rough diamond due to current business condition.
And our IRIDESSE stores continued to perform below expectations. We are planning to close IRIDESSE as we reach agreements with our landlords and when we have sold off its inventory over the course of 2009. We decided to exit that business due to its operating losses and inadequate near-term growth prospects especially in this economic environment.
We recorded a pre-tax charge of $7 million in the fourth quarter for this and other costs. But by eliminating its operating losses, this will benefit Tiffany's bottom line by a few cents a share annually after it is completely closed.
I will wrap up my remarks with some merchandising highlights. The generally across the board softness and product sales that we described on the holiday sales conference call was not surprisingly true for the entire quarter, soft by category and by geography.
As we have noted, high-end statement jewelry sales were lower around the world and down more than the overall company average, due to declines in both units and average price. Sales of fine jewelry collections were also down due to lower units and average price with more of that softness in the Americas. Despite the overall softness, however, customers appreciate new designs including the sophisticated and sleek Tiffany Metro collection. It is certainly safe to say that great designs, whether new or classic, will always resonate with customers, such as our Legacy Jewelry collection. And as our advertising campaign states, Tiffany Celebration Rings are suitable for the moments that matter.
Engagement jewelry sales in the quarter declined less than the company average as we saw stronger sales of diamond engagement rings and wedding bands outside the Americas. In addition, sales in our silver and gold jewelry categories were also down in the quarter but less than the company average as we benefited from strong sales of Charm jewelry and other iconic designs such as our Atlas 1837 and Somerset Collection.
And although, it is just being launched now in the first quarter, we are very excited about the significant potential of the new Tiffany Keys collection of pendants in a wide range that spans platinum and diamond, gold and silver. Keys are already in some of stores and a fewer of the skews are on our website. And you can expect to see substantial advertising and publicity for it in the coming month.
Lastly, sales of watches were soft, but we are looking forward to a boost in watch sales as the Swatch Group begins to launch new designs and expanded distribution this year.
I will now turn the call over to Jim.
Thanks Mark. The fourth quarter and full-year performance we experienced were disappointing, but not surprising in light of the economic conditions in the US and certain other markets.
The sales shortfall obviously affected our operating margin. Gross margin at 58.6% in the fourth quarter was up from 57.9% in the prior year. We recorded the charge in the fourth quarter for the write-down of inventory in our IRIDESSE business. Last year's fourth quarter included a watch obsolescence charge related to the start of our strategic alliance with the Swatch group.
On an apples-to-apples basis, excluding those charges, gross margin in the fourth quarter would have declined four-tenths of a point, reflecting sales de-leverage on the fixed cost that are in cost to sales which are distribution centers, internal manufacturing and our merchandizing and diamond sourcing divisions. The sales de-leverage was partly offset by benefits from lower wholesale sales of diamonds and favorable product sales mix.
While we believe our sales were negatively affected by the ramp in discounting of some other jewelers and high end competitors. We did and will continue with our full price philosophy in order to maintain appropriate margins and very importantly to maintain the integrity of the Tiffany and Company brand.
Selling, general and administrative expenses declined 19% in the fourth quarter, and the decline was partly due to lower management incentive compensation and sales related variable cost savings. However, there were several one-time items distorting the year-over-year comparison. In this year's fourth quarter, SG&A expenses included the impairment charge for a loan to Target Resources, a diamond mining company, and a charge to close the diamond polishing facility in the Illinois, Canada and an IRIDESSE related charge.
Last year's fourth quarter included an asset impairment charge for IRIDESSE and an impairment charge for a loan to Tahera Diamond Company. Excluding those current and prior year items, SG&A expenses would have declined 9% in the quarter.
In order to maximize productivity, we recently closed our facility in Yellowknife, Canada and shifted their operations to other locations. We had opened the Yellowknife factory in 2003 to obtain rough diamonds from the new mines in the Northwest Territories and to establish closer ties with Canadian suppliers. However the high cost base of that operation and the lack of additional rough diamond supply opportunities in Canada prevented that operation from remaining viable.
Despite these charges related to our diamond sourcing operations, we still strongly believe that it is important to maintain close relationships with mining companies that can support our long-term needs for sufficient high-quality diamond supply.
Separately, we recorded a restructuring charge in the fourth quarter related to our offering and early retirement program and other staff reductions. As we previously announced, we offered an early retirement program to approximately 800 US employees and approximately 600 people elected to participate.
We also selectively reduced staff levels to address the current and expected environment. Those actions as well as the anticipated closing of our IRIDESSE stores will result in a reduction of about 10% of our worldwide staffing.
In the fourth quarter, we recorded a pre-tax one-time restructuring charge of $98 million of which more than half was non-cash. However, we anticipate realizing cost savings of approximately $60 million in 2009, which are incorporated into our expectations for gross margin and the SG&A expense ratio.
Other expenses net, rose in the fourth quarter, primarily due to higher interest expense and lower interest income. Other expenses net increased in the year for similar reasons as well as from the $4 million write-off in the third quarter of an interest rate swap with Lehman Brothers and several million dollars of transactions losses associated with foreign payables.
Our effective tax rate of 40.3% in the quarter was a bit higher than we expected and as compared with 35.8% last year. As a result of all this, Tiffany's net earnings in the fourth quarter were $31.1 million, or $0.25 per diluted share compared with $0.96 per diluted share last year.
However, excluding the various one-time items in 2008 and 2007, net earnings were $0.85 per diluted share, which compared with $1.34 per share last year. While we are not trying to sugarcoat these results, we do believe that this is respectable performance in this environment.
For the full year, net earnings of a $1.74 per diluted share were 26% lower than the $2.34 per diluted share that Tiffany earned last year. However, again excluding various one-time items, net earnings of $2.33 per diluted share in 2008 were 6% below the adjusted $2.47 per diluted share earned in 2007. Earnings in the quarter and full year came in higher than the guidance of $2.25, $2.30 per diluted share that we published in January when we reported our holiday results.
Let's look at the balance sheet. Accounts receivables of $164 million at year end were 15% lower than at the previous year end due to the sales decline. Receivable turnover remained at a healthy 17 times in 2008.
Net inventories at January 31st were 17% higher than a year ago. Our initial plans for 2008 called for improving inventory turnover, but we did not anticipate the dramatic sales slowdown in the later part of the year. Well it was impossible for us to completely adjust to such a sudden downturn in sales, we did quickly begin to address the sales slowdown in the third quarter by reducing purchase orders with outside suppliers and adjusting internal manufacturing levels.
We are planning for a single digit percentage decline in inventories in 2009, which will enable us to maximize relative productivity while maintaining high in-store availability. Of course, it's important to keep in mind that Tiffany's inventory is not subject to wide swings or risks from seasonality or rapidly changing fashion trends. So, we can manage it with prudence and not with panic. Our capital expenditures for 2008 came in at $154 million or 5.4% of net sales, which included expenses spending for new store openings and renovations.
We have already announced that we are moderating the rate of store expansion in 2009 which along with other reductions in capital spending should result in CapEx of approximately $100 million for the year. That's considerably less than our normal plan for annual CapEx to represent 6% to 7% of sales, but will still include some store openings and sufficient maintenance capital spending.
We also shifted gears during 2008 with our share repurchase program. After spending $218 million in the first eight months of the year to repurchase $5.4 million shares, we suspended the program as our business slowed in the third quarter in order to conserve cash. Despite our current stock price, we will continue to forego additional repurchases until further notice.
In terms of our debt position when the credit markets froze up in September, we had to postpone a planned long-term financing that we were seeking partly to refinance some maturing long-term debt. Within a few months, however, we were able to secure two important pieces of long-term financing in private transactions, one in December was for a $100 million at the rate of 9.05% with a seven-year maturity. And the other was in February for $250 million at a rate of 10%, maturing in 8 and 10 years.
Some of you have asked about our rationale on the debt issues and to reiterate what we have said, we are not attempting to guess nor speculate on when credit markets will improve in terms of availability and cost. But rather, we decided to ensure that our balance sheet maintains more than sufficient strength and flexibility to weather a prolonged downturn if that were to occur.
Adding this all up, we have finished the year with cash and cash equivalents of $160 million, short-term and long-term debt totaled $709 million and stockholders equity was almost 1.6 billion. Debt-to-equity at year-end was 45%, compared with 26% a year ago.
As a result of our cautious outlook for sales and our related planned declines in CapEx and inventories, we expect our business in 2009 to generate a significant amount of free cash flow, which we define as cash flow from operating activities minus CapEx of more than $400 million, combined with our recently completed long-term debt issuances, we are pleased to have a balanced sheet that provides more than ample liquidity to pursue our growth strategies.
I want to briefly address the current pricing environment for diamonds and precious metals. Prices especially for rough diamonds as opposed to polished stones have increased substantially in 2007 and for part of 2008 as global demand soared. As demand then started delaying, after September prices were up had meaningfully corrected. So while we are paying less now to purchase diamonds, we don't expect to see any meaningful benefit to gross margin until next year based on our manufacturing lead times and finished goods inventory turnover.
For platinum and silver, our zero cost color hedging program benefited us when costs were rising. So while precious metal costs have retreated in recent months, we won’t begin to realize any meaningful benefit on our input cost until next year.
Now let's look at our financial outlook. We have already said that we would take a cautious approach toward planning our business in 2009. And believe our expectations incorporate that thinking, which does not assume any meaningful economic improvement over the course of the year.
So the top-line we are looking for worldwide sales to decline 11% to about $2.6 billion. Within that, we expect sales in the Americas to decline by a mid-teens percentage. We expect the decline to be greater in the first half and less so in the back half. But do not expect US comp store sales to grow in any quarter of the year.
Within the Americas, we are also planning combined internet and catalogue sales to decline by a high single-digit percentage. We expect Asia Pacific sales to decline by a mid single-digit percentage in dollars with local currency comps declining in the 10% area in Japan and in the rest of the region.
In Europe, we are looking for local currency comps to be about flat for the year, but expect total sales in Europe to decline by a high single-digit percentage in dollars due to the translation effect of the weaker pound and euro against the dollar. And we expect other sales which will be almost entirely wholesale sales of rough diamonds to decline by around 20%.
We are looking for Tiffany's operating margin to decline a few points from the adjusted 17.3% in 2008 due to a lower gross margin and higher expense ratio resulting from sales de-leverage on fixed costs, partly offset by savings from our recent staffing reductions and other cost saving initiatives.
Within that, we are planning for about a 10% decline in SG&A from the GAAP reported number in 2008. While we have reduced expenses and we will spend judiciously, we will not compromise on the Tiffany shopping experience on our product development program or on maintaining brand awareness.
We also expect other expenses net of about $50 million in 2009 as a result of higher interest expense and we are planning for an effective tax rate of approximately 37%. So, based on our assumptions for sales and related margins, our sensitivity analysis puts net earnings from continuing operations in a range of $1.50 to a $1.60 per diluted share for the year.
Some of you may be thinking why give guidance in an environment where there is so much uncertainty. And our answer is that like every year, we develop an operating plan to chart our direction and guide our decision-making, and we want investors to understand the specific plans and macro-assumptions. These assumptions are subject to numerous risk factors and could change during the year. So as always, please feel free to agree or disagree with us.
We are now almost two months through the first quarter. And as we mentioned in today's press release, we have not seen any signs of improvement in sales trends. Quarter-to-date, worldwide sales are declining more than 20%, which is inline with our expectations. Regardless of short-term economic conditions, we intend to manage all parts of our business prudently and proactively and maintain a strong competitive position that will ultimately drive Tiffany's future growth.
I will now turn the call over to Mike.
Thanks, Jim. Good morning. The world experienced an economic sea change in 2008 that affected Tiffany & Company and the entire luxury retailing industry. We face an unprecedented environment with profound challenges, but also with promising opportunities for Tiffany.
The challenges are obvious, relating to weak economies and low consumer confidence tied directly to job insecurity, stock market losses, housing price declines and short-term competitive discounting. As such, our sales have declined and earnings have suffered.
I don't need to reiterate the measures we have taken to reduce our costs, but it should be clear to you that we are taking proactive prudent steps to mitigate the financial effects of the economic downturn.
On the other hand, we are also looking at opportunities to expand our business through selective store growth and market share gains. In terms of store growth, we are planning to open 13 stores in 2009, which is down from the 22 stores we opened in 2008 but will enable us to establish a presence in a number of important new markets.
In the Americas, we will add five stores, including three in United States, a second store in Toronto and another store in Mexico. Outside the US, we are planning one new store in Europe and seven stores in the Asia-Pacific, which will include several in China. In total, this will represent a 6% increase in the number of company-operated Tiffany & Company locations.
We are also looking to take market share. Right now the overall retail jewelry industry is under enormous stress. The industry is competitively fragmented, the number of doors has been declining for several years and many expect that the trend will accelerate in 2009. Several well-known names have already entered bankruptcy.
The jewelry industry is relatively capital intensive and capital scarcity will intensify these pressures. Tiffany's response to this market turmoil is to remain committed to offering extraordinary products and a superior shopping experience, while communicating customers to compelling long-term value that the Tiffany Company brand represents. This is how we envision increasing our share over the market.
Our product development program produced exciting new merchandise in 2008 and the pace will continue in 2009 with a wide range of new jewelry designs.
In addition to designing our products, we are proud of the meaningful amount of products that we manufacture in our workshops located here in New York and Rohde Island. This production is supplemented by some of the finest outside suppliers in the United States and Europe. This complementary manufacturing base insures our ability to secure sufficient product supply of the highest quality and is an important competitive advantage.
Another important initiative taking shape in 2009 will be the launch of new Tiffany & Company brand watches later this week at the Bazzell World Watch and Jewelry Show in Switzerland.
Through our strategic alliance with the Swatch Group, Tiffany watches will be manufactured and distributed worldwide by Swatch owned company formed as a result the strategic alliance with Tiffany. This is a long-term venture with the potential to establish Tiffany & Company as a leading brand for luxury watches.
Clearly, there will be plenty of new product excitement 2009, and although we are reducing marketing spending in that year more or so in the US and less so in other regions, we will still provide strong advertising support to maintain product and brand awareness in both existing and in new markets.
To conclude our call today, please be assure that we have unwavering commitment to the integrity of the Tiffany & Company brand and we will not seek short-term compromises.
What's made Tiffany & Company an extraordinary enduring brand also long-term is that our customers trust us to create those special objects that trends in time even difficult times like those we confront today.
Objects that are cherished pass from one generation to the next, objects that aspire, inspire that matter end at last. Those are things that are of a special importance today and there is no doubt in our minds that managing our brand to sustain and to enhance that special character remains even more critically important today and is the key to sustainable long-term growth.
Finally, please note on your calendars that we expect to report first quarter results on Friday, May 29th. That concludes our comments on the past year and our outlook and as always please feel free to call Mark with any questions. Thank you for listening.
A replay of today’s conference will be available starting 3/23 at 9:30 am Central Standard Time ending 3:30 at 9:30 am Central Standard Time. The phone number for international caller will be 719-457-0820 and the toll free number is 888-203-1112. The confirmation code would be 1851243. Once again the replay information is 888-203-1112 or 719-457-0820.
Thank you very much for your participation and you may now disconnect.
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