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Tiffany & Co. (NYSE:TIF)

Q2 2013 Earnings Call

August 27, 2013 8:30 am ET

Executives

Mark L. Aaron - Vice President of Investor Relations

Patrick F. McGuiness - Chief Financial officer and Senior Vice President

Operator

Good day, everyone, and welcome to the Tiffany & Co. Second Quarter Conference Call. Today's call is being recorded. Participating on today's call is Patrick McGuiness, Tiffany's Senior Vice President and Chief Financial Officer; and Mr. Mark Aaron, Vice President of Investor Relations. At this time, I would like to turn the conference over to Mr. Mark Aaron. Please go ahead.

Mark L. Aaron

Thank you for joining us today. Pat and I are going to review second quarter results on this call and also take the opportunity to update you on the full year outlook.

Before we continue, please note 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 proceed with a review of Tiffany's performance. Looking at the big picture, these second quarter results were better than our expectations. Three months ago, we had forecast second quarter net earnings would be about equal to last year on mid-single digit sales growth and some lingering margin pressure. So what changed? The 4% total sales growth in the second quarter was in line with our expectation, and I should add that the increase was a stronger 8% on a constant-exchange-rate basis, with solid growth in comparable store sales in all regions outside the Americas. On the upside, however, we were pleased to see a greater-than-expected improvement in gross margin, reflecting both diminishing product cost pressures and the price increases we've taken this year. And SG&A expenses were well controlled. So adding it up, the better margin performance helped produce 16% net earnings growth in the quarter, which now leads us to increase our annual earnings guidance. And during the quarter, we launched some exciting product designs, opened 3 new stores and finalized plans for some others, which I'll talk about shortly.

Let's now take a look at sales by region. Sales in the Americas increased 2% in the quarter to $444 million. Continuing the trend, sales growth was entirely due to an increase in average price per jewelry unit sold. A modest decline in jewelry units reflected softness in the moderate price point fashion jewelry category, which more than offset unit growth in higher-priced statement and fine jewelry.

Comp store sales in the Americas were equal to last year and in line with our expectation. Performance varied geographically, with growth in the New York flagship store sale, tied to both increased local and tourist demand, being offset by a slight decline in comparable brand store sales. And those brand store results were mixed by market, with no discernible pattern except for pronounced softness in Hawaii and Guam, reflecting a decline in Japanese tourist sales that we believe is attributed to the weaker yen.

Rounding out the Americas geographical review, sales were soft in Canada but we had reasonably good increases in Mexico and Brazil. Internet and catalog sales in the Americas mirrored store sales performance and we finished the quarter with 116 stores in the Americas, which included the opening of our 10th store in Mexico in Villahermosa.

Now let's look beyond the Americas to our other regions where results were quite good. In Asia-Pacific, sales rose 20% to $208 million, which was virtually on our expectation. That 20% increase reflected unit growth across most jewelry categories and an increase in the average price per jewelry unit sold. On a constant-exchange-rate basis, total Asia-Pacific sales also increased 20%, with comp store sales up by a solid 13%. The strongest comp growth was across Greater China. We finished the quarter operating 67 stores in that region, which included opening a new store in the Times Square shopping mall, marking our ninth store in Hong Kong.

As we've said repeatedly, we believe that expanding Tiffany's store presence and marketing, especially in China, increases brand awareness and stimulates local sales demand, but also is a catalyst for spending by Chinese customers when they travel to other regions. When we analyze our performance in Japan, we believe it's most relevant, especially now, to examine sales growth in local currency because of the substantial weakening of the yen versus the dollar over the past year. And just as other foreign brands have done, we've increased retail prices in Japan this year to address that weaker yen. When measured in local currency, we're pleased that total sales rose 7% in the quarter and comparable store sales rose 8% on top of the 10% comp increase in last year's second quarter. This exceeded our expectation. The total sales growth in yen was due to an increase in the average price per jewelry unit sold. While the overall unit decline in the quarter reflected declines in moderate-priced fashion jewelry categories, it was partly offset by unit growth in engagement and higher-end jewelry.

We believe we are partly benefiting from improved household spending that reflects consumer optimism around the Japanese government's efforts to stimulate their economy and it's possible that some of the decline in Japanese tourists spending in the U.S. could be showing up in more locally made purchases. Most importantly, we believe the overall sales growth continues to demonstrate the strength of our brand. So the good news is that sales in Japan are performing quite well, but the picture on paper looks different when considering that the yen year-over-year has weakened more than 20% versus the U.S. dollar. As a result, the 7% sales growth in yen translated into a 14% sales decline to $136 million. Our internal sales and earnings forecast for the second half of the year incorporates a yen rate roughly in line with recent levels.

We now operate 54 stores in Japan. During the quarter, a Tiffany store in Tokyo located within the Matsuzakaya Ginza department store was closed due to the entire department store's closing for a multiyear renovation, but we are well-situated to serve their existing customers in our major Ginza store nearby and in Mitsukoshi Ginza store.

In Europe, total sales rose 11% in the quarter due to higher average price and an increase in units sold in most jewelry categories. On a constant-exchange-rate basis, sales increased 10% in total and 7% on a comparable store basis, which met our expectation.

Looking across the region, like-for-like sales growth actually accelerated in the United Kingdom and exceeded more modest comp growth in most of Continental Europe in the second quarter, after seeing the opposite pattern in the first quarter. Sales to local European customers were up in the quarter. Sales to tourists have also become a meaningful factor, estimated to represent more than 1/4 of our European sales. But there were no discernible local-versus-tourist sales patterns from country-to-country from which to draw any conclusions.

During the quarter, we opened a store in Verona, Italy, marking our sixth store in that important country, and we finished the quarter operating 35 stores in Europe.

Rounding out the geographical review, Tiffany's other sales increased 33% in the second quarter. July marked the first anniversary of the conversion of 5 existing Tiffany stores in the United Arab Emirates, 3 in Dubai and 2 in Abu Dhabi, from wholesale distribution to company-operated locations, and we began to record the retail sales of those stores during July 2012. We believe there is solid, long-term growth potential for Tiffany to enhance brand awareness and expand its customer base in the Middle East. We finished the quarter with 277 company-operated stores. Our plan continues to call for opening 16 stores this year, with 4 already opened in the first half of the year. We've also closed 1 store each in Japan and Taiwan, resulting in a net addition of 14 locations for the year. And of course, we're also renovating a number of existing stores.

In the Americas, the 6 planned stores include 3 in the U.S.: in New Jersey's Garden State Plaza, which opened earlier this month; in Cleveland's Eton Center, which will open tomorrow; and a store in New Orleans, in The Shops at Canal Place. As well as our 10th store in Mexico in Villahermosa, which has opened; a store in the West Edmonton Mall in Alberta, Canada; and our fifth store in Brazil, in Curitiba. And we're excited that later this week, we will relocate our Bloor Street store in Toronto to a site 1 block away that gives us more selling space with actually less gross square footage, and will provide an extraordinary shopping environment and experience for our customers.

The 7 new stores planned in the Asia-Pacific region this year range from 4 in China, one of which has opened in Xi'an, to the store we opened in Hong Kong's Times Square shopping mall in the second quarter and 2 other locations elsewhere. Lastly, in Europe, the 3 new stores this year include the store we opened in the Excelsior in Verona, Italy in the second quarter; as well as the store in Stuttgart, Germany in the Breuninger department store; and 1 other planned store, which will get us to 37 European stores by year-end. And we're very excited to recently announce our plans to open Tiffany's first company-operated store in Russia next year. The 4,500 square foot or 420 square meter location will be situated in the renowned GUM department store in Moscow.

Before reviewing merchandising highlights, let me take a moment to define some categories for those of you less familiar with us. When we have been referring to fine jewelry, we are primarily talking about platinum and gold jewelry with the diamonds and/or other gemstones. Statement refers to jewelry pieces typically retailing for more than $50,000. And fashion jewelry is predominantly about non-gemstone jewelry and silver, gold and the RUBEDO metal, although small gemstones might be used as accents in some pieces. Now having provided those definitions, merchandising highlights in the quarter continued to reflect sales growth in fine and statement jewelry that outperformed the modest growth in fashion jewelry sales. Our success in higher-price-point jewelry does revolve around diamonds, including strong response to our growing assortment of colored diamonds. This range is from the statement jewelry category that had continued sell-through from April's Blue Book event and sales from our very successful Gatsby collection to solitaire diamond engagement rings, including the distinctive new Harmony collection, to the extraordinary Yellow Diamond jewelry collection, the Enchant diamond jewelry collection, our select collections with diamonds and colored stones, Tiffany Keys in diamonds and in gold and Tiffany's Metro collection. But as we've been saying recently, we're also focused on improving the fashion jewelry category, but in a luxury-brand-appropriate way. New designs, such as the Ziegfeld collection in silver, freshwater pearls and onyx that was introduced in the second quarter to strong customer response, and the reinterpretation of our iconic Atlas collection that makes its official debut on September 10, along with others in the product development pipeline, are intended to generate improving fashion jewelry sales trends over the next year.

That wraps up my comments, so I'll now turn the call over to Pat.

Patrick F. McGuiness

Thanks, Mark. We were pleased with Tiffany's second quarter results in a number of ways and certainly pleased with our earnings growth. We were very satisfied with sales results in all regions, except the Americas, where sales remained quite soft. In addition, we saw a favorable gross margin movement, and we were pleased with our management of expenses. And as such, this second quarter performance leads us to raise our full year outlook.

Now let's look at the rest of the earnings statement. Gross margin was 57.5% in the second quarter compared with 56.3% last year and better than our previous guidance. We are now benefiting from a moderation in product cost, tied to product flow-through and also benefiting from a needed price increase that we took during the first quarter this year after not taking any meaningful price increases in 2012. However, these gross margin benefits are still being partly offset by a continuing shift in sales mix toward higher-price-point, lower-gross-margin products. And we took an additional price increase in Japan in the second quarter to account for some further weakening of the yen versus the dollar. We are now forecasting gross margin for the full year to be at least equal to last year. Although we are focused on improving fashion jewelry sales with new product introductions, we continue to forecast 2013 fashion jewelry sales growth to lag growth in higher-priced categories.

Selling, general and administrative expenses rose by only 3% in the second quarter, largely due to store-related costs and marketing spending. The effect of foreign currency translation primarily from a weaker yen, reduced SG&A expense growth by about 3 percentage points. For the year, we continue to forecast SG&A expense growth slightly less than sales growth. Earnings from operations increased 14% in the quarter, and we are forecasting it to increase more than sales growth for the full year.

There remains ample opportunity to improve the operating margin over the longer term by achieving stronger sales growth and leveraging it against a relatively fixed expense base. Other expenses, net of $15 million in the quarter, were up slightly from last year and we continue to forecast other expenses at about $58 million for the full year. The effective tax rate was 34.2% in the second quarter, and we continue to estimate a 35% rate for the full year. Adding it all together, net earnings increased 16% in the second quarter and diluted EPS rose 15%, which was considerably better than our previous forecasted earnings equal to last year. Three months ago, we had reduced our sales growth expectation for the full year due to a disappointing performance in the Americas, as well as to factor in a weaker yen. At this point, we are maintaining a cautious sales outlook for the Americas until we see solid evidence of an upturn. Our assumptions call for full year worldwide sales to grow by a mid-single digit percentage in dollars and by a high-single digit in local currency. With local currency comp growth ranging from high-single digits in Asia-Pacific and Japan to low-single digits in the Americas.

Given these second quarter results, we are increasing our earnings forecast to a range of $3.50 to $3.60 per diluted share from the previous forecast of $3.43 to $3.53 per diluted share and last year's $3.25 per diluted share. This earnings forecast excludes $0.05 per diluted share of expenses tied to cost-reduction efforts that we recorded in the first quarter.

We are also well-positioned with our balance sheet. At July 31, we had $490 million of cash and cash equivalents versus $366 million a year ago. Short-term and long-term debt totaled $964 million at July 31, up from $940 million a year ago. Total debt was 35% of stockholders' equity versus 39% a year ago. Net inventories of $2.3 billion, which represents about half of total assets, have increased just 4% from a year ago, with finished goods inventory up 8% and combined raw material and work-in-process inventories down 1%. Net inventories would have increased 7% when excluding the translation effect of a stronger dollar, primarily against the weaker yen. We continue to project about a 5% increase in net inventories for the year or slightly less than projected sales growth.

Accounts receivables were 6% lower than last year, largely due to the translation effects from the substantially weaker Japanese yen. Receivables are turning at more than 20x per year. Capital expenditures were $87 million in the first half of the year versus $97 million in last year's first half, and we are continuing to project $230 million of CapEx for the year versus $220 million last year. All of this keeps us on track to achieve positive free cash flow of about $300 million in 2013 versus $109 million in 2012.

Tying it together, our return on average assets was 10% on a trailing basis and return on average stockholders' equity was 17%. Our long-term financial objectives continue to call for achieving at least a 10% ROA and a 15% ROE. So I am pleased to say that it was a good quarter for Tiffany. Looking forward, we remain focused on a range of growth opportunities, including new product introductions and further broadening brand awareness through marketing communications. On a related marketing note, Tiffany is one of the most recognized and awarded leaders in the luxury digital space. Our passion and creativity in this area is seen within tiffany.com, as well as in our innovative social media programs, online advertising and mobile applications. Everywhere in the world, Tiffany is maximizing connectivity with our customers through all digital platforms. And to become even better, we will relaunch our website later this year with enhanced content that will be even richer and more robust in an integrated presentation. We will, of course, also be focused on expanding our global distribution and on growing comparable store sales, and we have a strong management team in place to achieve that. In fact, during the second quarter, we bolstered our global organization when we brought in experienced leaders to head 2 of our regions. For Northern America, Anthony Ledru comes to us with many years of global retail jewelry experience; and in Europe, Florence Rollet comes to us with a strong luxury background, where she had retail management responsibility across Europe. Anthony and Florence, along with our other regional leaders, report to Frédéric Cumenal, our Executive Vice President who joined Tiffany 2 years ago.

That concludes my comments. I'll now turn the call back to Mark.

Mark L. Aaron

Thanks, Pat. That wraps up today's conference call, which we hope all of you found to be informative. You may also listen to a replay on our website or by dialing (888) 203-1112 in the U.S. or (719) 457-0820 outside the U.S. and entering pass code 5233127. Please feel free to call me if you have any questions. And also, note on your calendars that we expect to report third quarter results on Tuesday, November 26, before the market opens. Thanks for listening.

Operator

And that does conclude today's conference. Thank you for your participation.

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