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Executives

Mark L. Aaron - Vice President of Investor Relations

James N. Fernandez - Chief Operating Officer and Executive Vice President

Tiffany & Co. (TIF) Q3 2013 Earnings Call November 26, 2013 8:30 AM ET

Operator

Good day, everyone, and welcome to the Tiffany & Co. Third Quarter Conference Call. Today's call is being recorded. Participating on today's call is Jim Fernandez, Executive Vice President, Chief Operating Officer and Chief Financial Officer; and Mr. Mark Aaron, Vice President of Investor Relations.

At this time, I would like to turn the call over to Mr. Aaron. Please go ahead, sir.

Mark L. Aaron

Thank you. Greetings from our corporate offices here in New York, and welcome to our third quarter conference call. Jim and I will review results on this call and update you on our current full year outlook.

Please first 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. We are pleased to report a very solid quarter with a healthy rate of worldwide sales growth and a faster rate of earnings growth. Net sales rose 7% in dollars and 11% on a constant-exchange-rate basis, with the difference primarily reflecting the substantial weakening of the yen over the past year. And on a local currency basis, sales rose in all regions.

Operating earnings rose 31% as we benefited from a higher gross margin and SG&A expense leverage. Our effective tax rate was lower than last year. As a result, net earnings rose 50%.

In other news, we introduced important additions to our Atlas jewelry collection. We launched our redesigned website. We announced the hiring of Tiffany's new Design Director and we opened 6 new stores.

Let's look at sales performance by region. In the Americas, sales rose 4% in the third quarter, which was largely due to a higher average price per jewelry unit sold. A small increase in jewelry units sold included greater growth in fine jewelry, but we were pleased to see some growth in fashion jewelry, too.

Comparable store sales rose 1%. The New York flagship store posted a solid increase, primarily resulting from higher sales to foreign tourists from China and Europe but also with modest growth in domestic spending.

However, brand store sales were mixed by market. In the U.S., there was softness along much of the East Coast, strength along the West Coast and there were substantial sales declines in Hawaii and Guam due to lower Japanese tourist sales likely tied to the weaker yen.

Elsewhere in the region, results were mixed in Canada, Mexico and Brazil. We opened 4 stores in the Americas during the quarter: in the Garden State Plaza mall in New Jersey; in Cleveland, Ohio's Eton Center; in the West Edmonton Mall in Alberta, Canada; and in Curitiba, Brazil, finishing the quarter with 120 stores in the Americas.

We also relocated our Bloor Street store in Toronto to a nearby site that is providing our customers with an extraordinary shopping environment and experience. And we're delighted to be entering New Orleans when we open a store tomorrow at The Shops at Canal Place near the city's historic French Quarter.

The Asia-Pacific region posted a strong 27% sales increase in the quarter, with broad-based double-digit comp store sales increases in Greater China and in most other markets in the region. The increase was generated by roughly equal growth in the average price per jewelry unit sold and in the higher jewelry unit sold in most categories.

On a constant-exchange-rate basis, total Asia-Pacific sales rose 29%, with comp store sales growing 22% after a 4% comp decline last year.

We opened a store in Jinan, China during the quarter, marking Tiffany's 24th store in China. At quarter end, we operated 68 stores in the Asia-Pacific region. In the fourth quarter, 2 more stores are planned to open in China and we are adding 2 stores in Taiwan, 1 of which opened 2 weeks ago in the Shinkong Mitsukoshi Ximen store in Tainan.

We operate 54 stores in Japan, and our business there performed well in the quarter. In local currency, total sales increased 9% and comparable store sales rose 5%, which is on top of a 5% increase in last year's third quarter and was in line with our expectations. That 9% total sales increase was due to increases in the average price per jewelry unit sold, as well as unit growth in most jewelry categories. However, the yen has weakened more than 20% versus the U.S. dollar in the past year. So the 9% sales growth in the yen translated into a 13% sales decline in dollars.

Beyond our growing brand strength and product desirability, we believe our sales in Japan might also be benefiting, to some degree, from the decline in Japanese tourist spending in the U.S., which might be boosting local demand in Japan.

Our results in Europe were mixed in the quarter. Total sales rose 7% due to increases in both average price per jewelry unit sold and in the number of jewelry units sold. On a constant-exchange-rate basis, total sales rose 4% on a 2% comparable store sales increase that was below our expectation and was on top of an 8% comp increase in last year's third quarter.

Within the region, for the second consecutive quarter, sales growth was led by the U.K., which more than offset softness in Continental Europe. The sales growth reflected higher local customer and foreign tourist demand, although with no discernible pattern.

We opened a store in Stuttgart in the Breuninger department store in the third quarter, marking our seventh store in Germany, and giving us 36 company-operated stores in Europe at the end of the quarter.

We also completed a major renovation of our Frankfurt store during the quarter and recently relocated our Florence store to a more spacious nearby site on Via Tornabuoni. One more store is planned to open in Italy before year-end.

Lastly, Tiffany's other sales increased 14% in the third quarter, largely due to an increase in wholesale sales of diamonds that we acquire and then subsequently sell to meet our quality requirements.

Comparable store sales rose 1%, representing the first quarter of comparability for our 5 stores in the United Arab Emirates, 3 in Dubai and 2 in Abu Dhabi, that were converted from wholesale distribution to company-operated locations in the middle of last year. We're excited about the sales growth potential for Tiffany in the Middle East to enhance brand awareness and expansion of our store and customer base.

Complementing our store base is a strong global web presence, which now includes e-commerce in 13 countries and informational sites in a number of additional countries. And I should add that these websites are featured in 9 languages.

Worldwide Internet sales growth, which is included in each region in the third quarter was in line with retail sales growth in our stores. As I mentioned in the overview, we launched our newly redesigned website in October. The new site is, without doubt, more engaging with greater storytelling and video content. It's easier to navigate. And for the first time, we are showcasing our Blue Book Collection of million-dollar jewelry.

The new site also offers suggestions of related product ideas for customers and an interesting and fun Drop a Hint feature for the holidays. Early indications show that visitors are spending considerably more time on the new site and we encourage you to visit the site and take a look for yourself.

And as a reflection of our effective use of digital media, we were pleased to see that Tiffany, for the third consecutive year, was recently ranked #1 by L2, a think tank for digital innovation, in their Digital IQ Index, assessing the digital competence of 80 global watch and jewelry brands.

Now let's look at a few merchandising highlights for the third quarter. Overall, we continued to see the strongest sales growth in statement, fine and solitaire jewelry, meaning jewelry with gemstones at mid to higher price points. But we're also pleased to see some initial signs of improvement in the fashion jewelry category.

Strong statement jewelry sales in the quarter reflected the success of an exclusive event in New York that we held in October for some of our Tiffany registered customers as well as statement sales in some other markets.

Notable highlights in fine jewelry in the third quarter were strong sales in the Enchant collection, with an expansion of the collection coming next year; our extraordinary Yellow Diamond collection; new jewelry designs with pink diamond accents and our Victoria collection. And we are pleased with sales of our Cobblestone and Select collections, which have been expanded with a focus on diamonds and colored gemstones.

Straddling both the fine and fashion jewelry categories is our Keys collection, which is enjoying a strong sales resurgence. After being introduced 4 years ago, this popular collection is showing continued strength in gold and platinum styles accented with diamonds, and is now also benefiting from newer designs in platinum accented with colored diamonds.

In fashion jewelry, the big story right now is the success of our reinterpreted and recently launched Atlas collection in various metals and styles but with noteworthy popularity in gold pieces.

I should add that our marketing communications in support of the Atlas collection will be ongoing. The Ziegfeld collection in silver pearls and onyx continues to post strong results 5 months after the premiere of The Great Gatsby movie. And Tiffany's Metro collection continues to be a solid performer.

Engagement jewelry sales in the quarter were higher in most regions. While that very meaningful category is certainly led by our 6-pronged Tiffany setting, we've also successfully expanded the range of designs over the years. The latest innovation is our Harmony engagement ring collection, which we launched exclusively in Japan last year and rolled it out globally earlier this year and just recently expanded the assortment with the addition of Harmony band rings.

So we were pleased with either solid performance or initial signs of some improvement across most of our jewelry categories. There are a lot of new products in the development stages under the leadership of our new Design Director, Francesca Amfitheatrof, who we were delighted to welcome to Tiffany in September. She's already fully immersed in our design process with her team, especially focused on reinvigorating the fashion jewelry category.

Regarding our watch business, we are proceeding with plans to design, produce, market and distribute our own Tiffany & Co. brand watches. However, the previously disclosed claims and counterclaims between Swatch and Tiffany are still pending in a confidential arbitration in the Netherlands, and the panel will issue its decision at an undetermined future date.

I'm now very pleased to turn the call over to Jim.

James N. Fernandez

Okay, thanks, Mark, and good morning, everyone. Tiffany's third quarter results continued the improvement we've seen in the past few quarters and we're very pleased with our progress. Earnings benefited from healthy sales growth, gross margin improvement and sales leverage on well-managed cost.

Gross margin of 57% in the third quarter was 2.6 points above last year and above our expectation. This contrasted with a 3.5-point decline in last year's third quarter when we were experiencing significant pressure from higher product costs.

As we have previously noted, we began to feel diminishing product cost pressures near the end of 2012, which turned into a tailwind in the second quarter of 2013. I'm sure you are all aware of the lag we experience in realizing changes in gross margins due to our long lead times and relatively modest inventory turnover. And we are now benefiting from those reduced product costs, which should continue at least through year-end.

We are also benefiting from price increases we took earlier in the year to catch up with costs after avoiding any meaningful price increases in 2012.

Partly offsetting the product cost benefit in the quarter was a continuing shift in sales mix toward higher price point, lower gross margin products, including strong statement jewelry sales. However, we are now seeing some improvement in fashion jewelry sales growth, although it is not growing as fast as the total company.

Sales mix is an important component of gross margin and always more difficult to forecast, and we believe that it could have some mitigating effects on the extent of gross margin expansion in the fourth quarter as well.

But all in all, we are now forecasting that gross margin for the full year will be higher than last year's 57%.

Moving down the income statement, selling, general and administrative expenses increased 5% in the third quarter, largely due to higher labor and store-related costs. Excluding the effects of foreign currency translation, primarily from the weaker yen, SG&A expense rose 8%. So measuring it either on a GAAP or a constant-exchange-rate basis, we improved the ratio of SG&A expenses to sales by leveraging fixed costs and we continue to forecast an improved SG&A expense ratio for the full year.

As a result of the increase in gross margin and the improved SG&A expense ratio, earnings from operations rose 31% in the quarter on a 7% sales increase. And we are expecting operating margin improvement for the full year.

Interest and other expenses, net, were $14 million in the third quarter versus $15 million last year and we continue to forecast it at about $58 million for the full year.

Our effective tax rate of 32.3% in the third quarter was down from 38.4% in last year's third quarter. This year's rate benefited from the onetime favorable impact of tax regulations related to the tax basis of fixed assets as well as differences in the geographical mix of earnings. Last year's higher rate resulted from our truing-up of the prior year's tax position upon filing our tax returns. We estimate a full year effective tax rate in the range of 34% to 35%.

So with virtually everything moving in a favorable direction, we were able to generate a 31% increase in operating earnings and a 50% increase in net earnings in the third quarter, and diluted EPS rose 49%. This was better than the expectation included in our last published guidance, which leads us to increase our full year forecast.

Our guidance for the full year now calls for earnings per diluted share of $3.65 to $3.75, which does not include a $0.05 charge we recorded earlier in the year, and which compares with last year's $3.25 per share. We are basing that on full year assumptions, calling for mid-single-digit worldwide sales growth in dollars or high single-digit growth in local currency, with comp store sales growth in local currencies ranging from low-double digits in Asia-Pacific in Japan to mid-single digits in Europe and low-single digits in the Americas.

Backing into a fourth quarter sales forecast, this implies mid-single digit sales growth in dollars or high-single-digit sales growth in local currency with single-digit comp increases in all regions.

And our assumption of a full year improvement in the operating margin coming from a favorable gross margin and expense ratio implies a modest improvement in the operating margin in the fourth quarter.

We continue to pursue an active pace of organic expansion and we have a healthy balance sheet to support it. Our return on average assets was 10% on a trailing basis and return on average stockholders' equity was 18%. Our long-term financial objectives continue to call for achieving at least 10% ROA and 15% ROE.

I'm pleased to report that inventories are at very appropriate levels. Net inventories of $2.4 billion at October 31 was 6% higher than a year ago comprised of a 5% increase in finished goods and a 7% increase in combined raw material and work-in-process inventories. Excluding the effect of currency translation, primarily the stronger dollar versus the weaker yen, net inventories would've increased 9%.

For the full year, we are forecasting a 5% inventory increase in dollars. Whether it's measured in dollars or local currency, inventory growth this year has been slightly less than sales growth, which is consistent with our long-term objective.

Accounts receivable on October 31 were 3% above last year, reflecting worldwide sales growth and would've increased 10% when excluding the effect of foreign currency translation. Receivables are turning at more than 20x per year.

Capital expenditures were $149 million year-to-date versus $157 million in last year's year-to-date. And we are projecting about $225 million of CapEx for the year versus $220 million last year.

In terms of liquidity, we had $521 million of cash and cash equivalents at October 31 versus $345 million a year ago. Total short-term and long-term debt increased $30 million from a year ago, but as a percentage of stockholders' equity, declined to 36% from 40% a year ago.

So we have a solid balance sheet and continue to forecast achieving positive free cash flow of around $300 million in 2013 versus the $109 million in 2012.

Behind the scenes, our manufacturing facilities, diamond sourcing organization and distribution centers are functioning effectively to maintain high in-store product availability and to efficiently ship products to customers.

In summary, the third quarter was another good one for Tiffany and we believe we are well positioned for the holiday season. We have pursued an active pace of store expansion this year, which includes adding a net of 14 stores in 2013. We've introduced several exciting and well-received new jewelry collections and we've enhanced our marketing communications.

Despite the obvious economic and consumer uncertainties in some regions, our management team sees great opportunities ahead of us, and we're enthusiastic about our ability to fully realize Tiffany's longer-term growth potential.

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

Mark L. Aaron

Thanks, Jim. We hope all of you found today's conference call 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 passcode 3631782. Please feel free to call me if you have any questions. And also note on your calendars that we plan to report our November, December holiday sales results on Friday, January 10 through a news release but without a conference call. Thanks for listening.

Operator

And this does conclude today's conference call. You may disconnect. Thank you for attending.

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