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Tiffany & Co. (NYSE:TIF)

Q4 2013 Earnings Conference Call

March 21, 2014 08:30 pm ET

Executives

Mark Aaron - Investor Relations

Jim Fernandez - Chief Operating Officer, Executive Vice President

Analysts

Operator

Good day, everyone, and welcome to the Tiffany & Company Fourth 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. Mark Aaron. Please go ahead, sir.

Mark Aaron

Thank you. Good day, everyone. Jim and I welcome you to our conference call to review highlights of Tiffany's performance in the fourth quarter and full year 2013, as well as to provide key financial expectations for 2014.

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. As an overview, worldwide net sales rose 5% in the fourth quarter or 9% on a constant exchange rate basis, which was a bit better than the respective 4% and 8% increases we had reported for the holiday period. Gross margin rose 1.4 points in the quarter. As previously disclosed, net earnings were impacted by the adverse arbitration rule that you are all familiar with resulting in a net loss of $104 million in the quarter. However, excluding net charge, net earnings rose 6% in the quarter.

Finally, we are pleased that the 6% increase in full year net sales met the expectations that we set a year ago, while net earnings growth excluding charges of 15% in the year surpassed our initial expectation. Let's now look at sales performance, where we posted growth in all regions on a constant exchange rate basis.

First, in terms of geographical mix by region, the Americans represented 48% of worldwide net sales in 2013, which was unchanged from 2012. Asia-Pacific was 23% of sales, up from 21% in 2012. Japan was 14% of sales versus 17% in 2012, but the decline was currency-related and Europe was 12% of sales, up from 11% in 2012.

Starting with the Americans, the 6% sales increase in the fourth quarter was consistent with holiday results and was driven by an increase in the average price per jewelry units sold. A decline in jewelry unit volume was limited to the fashion jewelry category, which occurred mostly at price points under $500.

For the full-year, our sales in the Americas rose 5% due to price and volume dynamics that were similar to the quarter. We concluded the year on a stronger than expected note in the Americans. We attribute the improvement to at least some extent to selling initiatives taken by our regional management that focused first on our 25 largest stores to better engage the customers to our sales professionals and through enhanced visual merchandising. That focus will eventually be extended to all stores.

On a constant exchange rate basis, comparable-store sales rose 7% in the fourth quarter due to geographically broad based sales growth across most markets, and comps were up 3% for the year with sales growth in the New York flagship store outpacing modest growth in branch stores.

We are not ready to call the 7% comp increase in the quarter the beginning of a trend, but are encouraged nonetheless. You may be interested to know that our three largest branch stores by sales volume in the region in 2013, were in South Coast Plaza in Costa Mesa, California, followed by our Union Square store in San Francisco and our store on Michigan Avenue in Chicago.

To reiterate what we have said previously, we can no longer quantify total foreign tourists sales in the Americas region, because of legal restrictions on data collection in some U.S. states. However in the New York flagship store, which in 2013 represented 8% of worldwide sales, were 16% of the Americas region, sales to foreign tourists increased and accounted for approximately 45% of that store's sales in 2013.

The increased spending came from Chinese visitors as well as higher spending by European visitors while a decline in Japanese tourist spending in New York and other markets too very likely reflected the yen's weakness. We believe that foreign tourist spending will continue to be a meaningful portion of sales in the Americans, as we generate greater brand awareness in Asia, Europe and elsewhere that also fosters greater spending when customers travel.

Elsewhere in the Americans, we achieved modest comparable store sales growth in constant currencies in Canada, Mexico and Brazil, in both, the fourth quarter and year.

We opened six stores in the Americas in 2013, in the Garden State Plaza Mall, New Jersey, in Cleveland, Ohio, Eton Center, in New Orleans, in the West Edmonton Mall in Alberta Canada, in Curitiba, Brazil and in Villahermosa, Mexico. Store relocations, renovations and enhanced visual merchandising complement our worldwide expansion strategy and is one example in 2013 we relocated on Bloor Street store in Toronto to offer the utmost shopping environment to our customers. We finished the year with 121 company-operated stores in the Americas, including 94 the U.S. 12 in Canada, 10 in Mexico and 5 in Brazil.

Turning to the Asia-Pacific region, sales increased 8% in the fourth quarter due to increased jewelry unit volume and rose 17% for the full-year due to increases in jewelry unit volume and price per jewelry unit sold. While the 8% sales increase in the quarter was lower than we had initially expected, it was nonetheless better than the 5% increase we had reported for the holiday period, indicating substantial improvements in January that reflected strong growth throughout the region and perhaps reflecting the celebration of the earlier Chinese New Year.

Total Asia-Pacific sales on a constant exchange rate basis increased 11% in the quarter and 18% in the year, reflecting comp store sales growth of 4% in the quarter, with growth in most countries and 11% in the year with growth in all countries, and of course the opening of a number of new stores. In fact, we opened seven stores in the region in 2013, including four stores in China, one in Hong Kong and two in Taiwan, while closing one older store in Taiwan. We finished the year with 72 stores in the Asia-Pacific region. 45 of those stores are located in Greater China and represented more than half of the region sales in 2013. Our highest volume store in the region is on Canton Road in Hong Kong.

Continuing to expand brand awareness of Tiffany in China through our store base and marketing activities is critical to generating local sales growth, but also to influencing Chinese tourists when they travel to our other markets. When sales are measured in yen, our business in Japan performed well throughout the fourth quarter and year. In local currency, total sales increased 8% in the fourth quarter and 11% in the full year due to a higher average price per jewelry units sold in both periods with some declines jewelry units sold.

Comp store sales in yen rose 8% and 10% in those periods. This was better than we had expected at the start of 2013, however the yen weekend about 20% against the U.S. dollar in 2013, which had a significant negative translation effect on our sales, resulting in reported total sales declining 12% in the fourth quarter and 9% in the full-year with roughly similar comp store sales declines.

While the weaker yen likely had a negative effect on our sales in New York, Hawaii and Guam and some other U.S. markets, it's very possible some of that demand shifted toward local consumption in Japan. For translation purposes, we are planning the yen at €105 to the $1 for 2014.

During 2013, the closing of the Matsuzakaya department store in Tokyo for multi-year renovation required the closing of the Tiffany store that they posted there, but we are guessing that much of that business probably shifted to our nearby Ginza store. We finished the year with 54 locations in Japan and our Ginza store produces the highest volume in Japan and accounts for more than 10% of total sales in Japan.

Tiffany stores in Europe faced some obvious macroeconomic challenges in 2013, but our expanded brand awareness and the opportunities provided by our under penetration in that region helped us to achieve generally healthy performance. Total sales increased 10% in the fourth quarter consistent with the holiday period and rose 9% in the year. The sales growth in both periods was fueled by increases in jewelry unit volume and in the average price per jewelry units sold.

On a constant exchange rate basis, total sales rose 7% in both the quarter and year, while comp store sales increased 2% in the fourth quarter and 4% in the year. Geographical trends in Europe were mixed over the course of the year. Sales in the U.K. represented a little more than 40% of European sales in 2013, and our highest volume store in Europe is on Old Bond Street.

Over the course of the year, relative sales performance between the U.K. and continental Europe fluctuated, but there was no meaningful difference in performance for the full year. Foreign tourist spending has become a meaningful part of our business in Europe, which we estimate represented more than a quarter of total sales. Our stores in France had the highest percentage of those sales to foreign tourists with Chinese shoppers accounting for significant part of it.

We opened three stores in Europe in 2013, one in Stuttgart, Germany and two in Italy, in Rome and Verona, and finished the year with 37 locations in Europe. We also renovated our Frankfurt store and relocated our Florence store. Lastly, Tiffany's other sales rose 47% in the fourth quarter and 53% in the year. We are very pleased with comparable store sales growth of 23% in the quarter and 14% in the year, representing the five stores in the United Arab Emirates, three in Dubai and two in Abu Dhabi, that were converted from wholesale distribution to company-operated locations in July 2012.

The remainder of the increase in other sales in both periods was primarily due to wholesale sales of diamond that we acquired through our rough sourcing program and subsequently sell, because they don't meet our requirements. For the full-year across all regions, we opened 16 company-operated stores and closed two existing ones, representing a 5% increase in the number of locations and a 3% increase in gross square footage.

In terms of sales productivity, Tiffany's company-operated stores generated $3,100 sales per gross square foot in 2013, versus $3,000 in 2012. Productivity range from Asia-Pacific at $4,800 per foot up from $4,500 in 2012 to $3,800 per foot in Japan versus $4,200 in 2012, to Europe with $3,300 a foot consistent with 2012 and the Americas at $2,400 versus $2,300 a foot in 2012.

It's worth noting that the decline in Japan's productivity in dollars was entirely due to the negative translation effect from the weaker yen, while retail store productivity in Japan measured in yen rose 12%. Our store base is complemented by our multilingual web presence that spans across 13 countries with e-commerce site, as well as informational sites in six additional countries. Worldwide e-commerce sales which are included in each region represented 6% of worldwide sales in 2013 or 8% of the total sales in the countries in which we operate e-commerce sites. Those percentages were unchanged from the prior year.

We launched our redesigned site last October and visitors appear to be more engaged with its enhanced content as they are spending more time on the new site. Now, looking at some merchandising highlights, sales growth in the fourth quarter occurred across most product categories. The strongest sales growth continued to be in the statement fine and solitaire jewelry category, which incorporates jewelry with gemstones at the mid-to-higher price points and we were encouraged with improvement in the fashion jewelry category with the sales strength coming from gold jewelry, implying continued softness in silver especially at price points under $500.

Statement jewelry continued to post strong growth in 2013 as more customers, especially in Asia-Pacific and the Americans discovered Tiffany's extraordinary offerings. As we mentioned previously, we invested considerably in recent years to expand our statement jewelry assortment and we are delighted with the performance of this ultra high-end category.

Our success in fine jewelry reflects an extraordinary assortment of diamond jewelry, with increasing demand for colored diamonds and other gemstone. In particular, Tiffany's yellow diamond collection continued to sparkle with great success in 2013. Additional popular collections worth noting, included the Enchant collection, new jewelry designs with pink diamond accents introduced in 2013 and our beautiful Victoria Collection. Also, our Cobblestone and Soleste collections were well received with their expanded designs focused on diamonds and colored gemstones.

Engagement jewelry category performed well in most regions in 2013. While that category is anchored by our six-pronged Tiffany setting and complemented by additional settings we have introduced over the years. The latest innovation has been the successful Harmony engagement ring collection. We launched Harmony in Japan in 2012, expanded distribution globally in 2013 and then most recently broadened this assortment with Harmony band rings.

I said the word encouraged with improvement in the fashion jewelry category, the best example is ATLAS. We could not be more pleased with the success of that newly reinterpreted collection in various metals and styles which debuted last fall and will be expanded this spring. We targeted much of our advertising on ATLAS during the holiday season and that focused approach and powerful message drove strong results. It's also worth mentioning Tiffany's stepping back into the Jazz age earlier in the year with the launch of our Ziegfeld and Gatsby collections tied to the premier of The Great Gatsby movie.

Paloma Picasso's new Olive Leaf collection enjoyed a very successful first year and let's not forget the importance of some our Tiffany's iconic collection such as Metro, which continues to be a solid performer.

Our Keys collection introduced five years ago, enjoyed a strong sales resurgence in 2013. This popular collection in gold and platinum, which straddles fine and fashion jewelry benefited from newer designs in platinum, accented with colored diamonds. We finish the year feeling quite good about trends in most jewelry categories and are equally excited about new designs that will debut in 2014.

Our design team is focused on an array of new designs, including the expanded ATLAS collection this spring and with a special focus on invigorating fashion jewelry. Please stay tuned for an exciting new collection that will debut this fall as well as of course other design introductions across all categories.

I will now turn the call over to Jim to review the rest of the earnings statement, the balance sheet and our expectations for 2014.

Jim Fernandez

Thanks, Mark. Notwithstanding some obvious economic and consumer uncertainties as well as an unfavorable arbitration ruling, 2013 was indeed an excellent year for Tiffany's sales and earnings, excluding the arbitration related charge reaching record levels. Tiffany's achievements span the areas of product development, store expansion, marketing, the supply chain and strengthening the management team with new regional heads of Northern America and Europe, and bringing in a new design director.

Looking at the rest of the earning statement, gross margin increased 1.4 points to 60.5% in the fourth quarter and rose 1.1 points to 58.1% in the year. In both periods, we benefited from price increases we took earlier in the year to catch up with costs after avoiding any meaningful price increases in 2012. In addition, we benefited from diminishing pressure and our actual reductions in product costs.

Partly offsetting those benefits in the full year was a shift in sales mix toward higher-priced, lower gross margin in fine and statement jewelry, however I will add that those higher price points sales provide substantial incremental gross profit that can be leveraged against fixed costs and ultimately improve our operating margin. In addition, recent improvement in fashion jewelry sales helped in the fourth quarter and should eventually provide some further upside to gross margin.

Selling, general and administrative expenses rose 7% in the fourth quarter reflecting higher fixed and variable labor costs such as sales commission, and incentive compensation and higher store-related costs. SG&A expenses rose 6% in the year for similar reason.

Excluding the effects of foreign currency translation, primarily from the weaker yen, SG&A expense growth would have been 3% greater in both, the quarter and the year. Please also note that full year SG&A expense includes $9.4 million pre-tax charge or $0.04 per diluted share recorded in first quarter related to staffing reduction and sub-leasing of certain office space.

As previously disclosed, we recorded the charge in the fourth quarter related to the adverse ruling in The Swatch arbitration. The total pre-tax charge was $473 million and the after-tax amount was $293 million or $2.27 per diluted share. We should note that $488 million of the pre-tax charge was recorded in earnings from operations while a $7 million foreign currency translation gain was recorded in interest and other expenses net.

In terms of earnings from operations, we think it is more relevant to look at the numbers on a non-GAAP basis that exclude the arbitration and other specific charges. Doing so, operating earnings increased 8% in the fourth quarter on the 5% sales growth and rose 14% in the year on the 6% sales growth giving us an adjusted operating margin of 19.7% for the year versus 18.4% last year.

Interest and other expenses net were $8 million and $49 million in the respective fourth quarter and year, excluding the $7 million transaction gain I just mentioned, interest and other expenses net would have been $16 million in the quarter and $57 million in the year, roughly in line with what we had previously projected.

Tiffany had an income tax benefit in the fourth quarter, due to arbitration award charge, while the full year effective income tax rate was 28.8%. Excluding the impact of the arbitration award and other specific charges, the effective tax rate was 36.1% in the fourth quarter versus 35% last year. The full year rate was 34.8% versus 35.3% in 2012.

The net $473 million pre-tax arbitration award charge led to a net loss of $104 million in the fourth quarter. Full year net earnings also included some specific charges that have been recorded in the first quarter, however excluding those charges Tiffany earned $190 million in the quarter and $481 million in the year representing EPS growth of 5% and 15%, respectively and putting us near the high end of our most recently disclosed expectations.

Our technically subpar 4% return on average assets and 7% return on average stockholders' equity in 2013 were due to the changes we recorded, and under more normal circumstances, would have been more in line with recent years and with our financial objectives.

I'm pleased to state that even after the payment of the arbitration award we finished the year with a balance sheet that provides with solid base to pursue our ongoing business plans and future expansions.

Inventories of $2.3 billion at year end were up 4% from the year ago. In comparison, net inventories had increased 8% in 2012, so we met our objective for a deceleration in the rate of inventory growth. The 4% increase in 2013, included a 3% increase in finished goods that support new stores and expanded offerings and a 5% increase in combined raw material and work in process inventories. Excluding foreign currency translation, net inventories would have increased 6% in the year.

We are pleased that, whether in dollars or local currency, inventory growth was less than sales growth in 2013, which is consistent with our long-term objectives. We are well positioned with high levels of inventory availability in our stores and our supply chain in diamond sourcing and internal manufacturing is operating efficiently to meet our growing product needs. Accounts receivables of $189 million at year end were up 9% in the year, reflecting worldwide sales growth. The increase would have been 14%, excluding foreign currency translation. Receivables turned at a rate of 22 times a year.

Capital expenditures came in at $221 million for the year versus $220 million last year and a bit less than our forecast due to timing differences and they represented 5% of sales. More than half of the spending went towards store openings, renovations and relocations. Investments in information technology is another major area and spending will increase this year and next as we upgrade and introduce new systems for global customer relationship management and for more advanced order and inventory management, all of which should yield longer-term sales and working capital benefits.

Adding it all up, Tiffany had free cash flow which we define as cash flow from operating activities, less capital expenditures, compared with last year's $109 million in ['12]. However in the fourth quarter, we made a payment to Swatch of $473 million for the adverse arbitration ruling. We expect to generate at least $400 million of free cash flow in 2014.

As a result of strong earnings growth and favorable working capital management, offset by the one-time arbitration payment, we finished the year with $367 million of cash and cash equivalents and short-term investments versus $506 million a year ago.

Total short-term and long-term debt of $1 billion at year end was about $40 million above the $959 million a year ago. Total debt as a percentage of stockholders' equity was 37% at year end, unchanged from the year ago. In addition, we announced in a separate news release this morning that we have been authorized to resume share repurchases in 2014.

Tiffany's board approved a new program and authorized the repurchase of up to $300 million of stock over the next three years. Based on our long-term outlook for earnings and cash flow, we think that this is an appropriate way to return a portion of the excess capital to stockholders while also mitigating dilution on earnings per share in stock based compensation.

Let's now turn to our outlook for 2014, which will be a year of exciting expansion and investing. My references to comparisons to 2013 will exclude the effect of the arbitration award in 2013's fourth quarter, as well as other specific charges recorded in 2013's first quarter.

We have a lot going on with the addition of new jewelry collections, the opening of some major new stores, incremental spending on IT systems and compelling marketing. In total, we are projecting net earnings to increase 9% to 11% to a range of $4.05 to $4.15 per diluted share. This compares with non-GAAP $3.73 per diluted share that Tiffany earned in 2013.

Looking at the components of the earnings guidance, we are projecting net sales to increase by a high single-digit percentage in both, dollars and on a constant exchange rate basis, with total sales and comparable store sales growth in all regions. We finished last year with 289 company-operated stores in 24 countries and reflecting our ongoing strategy of opportunistic store expansion, we expect to open 13 new stores in 2014 and close four.

New store plans include opening four stores in the Americas, including three new stores in the U.S, in Aventura, Florida, in Miami Design District and on Boston's Newbury Street, closing our store in East Hampton and opening our 11th store in Mexico in Cancun, opening five stores in Asia Pacific, including three in China, one in Australia, in Adelaide and our first in Thailand and closing one store in Taiwan. Opening two stores in Japan and closing one existing store, opening a major store in Europe on the famous Champs-Elysee in Paris and in the emerging markets opening Tiffany's first company-operated store in Russia in Moscow and closing a small store in Dubai.

We will, of course, also be renovating a number of older stores to enhanced visual merchandising and the in-store customer experience. We are projecting an increase in our operating margin tied to a higher gross margin and SG&A expense leverage. The forecasted gross margin improvement is based on sales leverage on fixed costs as well as taking on average a single-digit percentage price increase in this first quarter and some residual benefit from lower input costs.

We are also expecting some improvement in the SG&A expense ratio this year coming from sales leverage on fixed cost. We are projecting interest and other expenses net at $65 million to $70 million in 2014, with the increase over 2013, essentially reflected in the interest cost on higher average debt levels. We are estimating an effective income tax rate of approximately 35% in 2014, which is virtually unchanged from the adjusted 34.8% rate in 2013.

In summary, Tiffany enjoyed a solid year of sales and earnings growth and we believe company is well positioned for continued success throughout 2014. We hope that you share our excitement about Tiffany's many growth opportunities.

On a final note, I presume you saw the announcement two days ago that Tiffany has hired Mr. Ralph Nicoletti as an Executive Vice President and to serve as the company's next Chief Financial Officer. Ralph brings solid experience to Tiffany and a valuable global perspective and I'm sure that Mark will be introducing Ralph to many of you.

I believe we put together a strong global management team to lead the company to even greater success in the future. I'm especially proud of the world-class finance, IT, operations and supply chain organization that we built, and has decided that after an exciting 30-year career at Tiffany, this is a good time for me to retire at the end of July.

I truly enjoyed my relationships with many of you on Wall Street and have appreciated your interest in Tiffany. You can be sure that I will be following Tiffany's progress and its stock price and I wish all of you the best.

Now, I will turn the call back to Mark.

Mark Aaron

Thank, Jim. We hope all of you on today's call found our comments to be informative. A replay is available 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 5105327.

As always, please feel free to call me with any questions and please note on your calendar that we plan to report first quarter financial results on Wednesday, May 21st, before the market opens. Thanks for listening.

Operator

That does conclude today's conference call. You may disconnect your line at this time. Thank you.

Question-and-Answer Session

Operator

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