Tiffany & Co. (NYSE:TIF)
Q2 2014 Earnings Conference Call
August 27, 2014 08:30 AM ET
Mark Aaron - VP of IR
Ralph Nicoletti - EVP and CFO
Good day, everyone and welcome to the Tiffany & Company Second Quarter Conference Call. Today's call is being recorded. Participating on today’s call is Ralph Nicoletti, Executive Vice President and Chief Financial Officer, and Mr. Mark Aaron, Vice President of Investor Relations.
And at this time, I would like to turn the call over to Mr. Mark Aaron. Please go ahead.
Thank you and hello everyone. We reported earlier today that Tiffany achieved better than expected financial results in the second quarter and I hope you’ve had a chance to read the news release. On today’s call, Ralph and I will review highlights of those results and comment on the full year outlook.
As always, 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. Company undertakes no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances.
Now let’s look at results. As an overview, Tiffany performed well in the second quarter with sales in most regions generally either met or exceeded our expectations. Three months ago, we had forecasted second quarter net earnings could be approximately equal to the prior year, reflecting a substantial softening in demand in Japan sale which for the second quarter occurred as expected. As well as continued softness in Europe, which, in fact, softened more than we expected in the quarter.
But as a result of solid growth in the America and Asia Pacific regions, worldwide net sales rose 7%. Embedded in the overall results was broad-based growth in most product categories and especially at mid-to-higher price points. Beyond the sales strength and important contributor to net earnings growth was an increase in gross margin which Ralph will address shortly.
SG&A expenses paced a bit favorably to our expectation while interest and other expenses net and the effective tax rate were essentially on track. Adding it all up, Tiffany second quarter net earnings rose 16%. Tiffany’s balance sheet remains strong and it made the Board of Directors increase the quarterly dividend rate by 12%.
Let’s now look at some details of regional sales performance in the quarter. In the Americas, total sales were up 9% primarily due to an overall increase in the average price per jewelry unit sold. We were pleased to experience healthy unit growth in the statement, fine and solitaire jewelry category as well as in our engagement jewelry and wedding band category. And we’re pleased that fashion jewelry unit sales are benefiting from strength in gold jewelry.
However, continued softness in silver jewelry unit sale in particular entry level sales under $500 was the reason why we had no growth in total jewelry units in the Americas. We’ve now seen three consecutive quarters of sales improvement in the Americas which we believe reflect both internal and external factors. Here’s the excitement of new products and compelling marketing, but we believe we are also benefiting in the Americas from new in-store selling initiatives focused on better engaging and consulting with our customers as well as enhancements in the visual merchandizing formats in our stores with those programs being extended throughout the store network.
In addition, we benefited from foreign tourist spending that is likely tied to growing brand awareness globally and perhaps some currency fluctuation too. And of course, conditions in the U.S. are favorable for many of our customers. On a constant and exchange rate basis comparable store sales rose 8% in the quarter which followed an 8% comp increase in the first quarter and compared with the flat comp in last year’s second quarter. Geographically, most markets in the U.S. posted healthy sales growth. A solid increase in New York flagship store sales was due to a combination of higher domestic customer demand as well as higher sales to foreign tourist especially from China and Europe. And sales have rebounded nicely in the tourist markets of Hawaii and Guam.
During the quarter we opened a 4800 square foot store in the Aventura Mall near Miami, marking our 94th store in the U.S. Our expansion plans for later in the year include opening stores in the Miami design district and on Boston’s elegant Newbury Street. Outside the U.S., we experienced high single-digit to low double-digit local currency total sales growth with our growing presence in Canada, Mexico and Brazil. The Asia Pacific region achieved a 14% total sales increase in the quarter due to growth in the average price per jewelry unit sold and in jewelry unit volume.
On a constant-exchange-rate basis increases of 13% in total sales and 7% in comp store sales reflected strength primarily in greater China and in Australia. You should note that the 7% comp increase followed a 10% increase in the first quarter and was on top of a 13% increase in last year’s second quarter. We didn’t open any stores in this region during the quarter but are on track to open two stores later in the year; one in Adelaide, Australia and one in China as well as relocating our store within the Hong Kong airport. Two additional stores in China and one in Thailand that were initially scheduled to open near the end of this year are now slated to open in the first half of 2015 due to timing delays.
Now let’s turn to Japan where sales have been volatile to say the least in the first half of this year. As I alluded to in the overview after experiencing a surge in spending in the first quarter as Japanese consumers purchased in advance of a consumption tax increase on April 1. We anticipated a significant demand to offset in the second quarter, which occurred as we expected. The good news is that following a substantial sales decline in April, we saw a decelerating rate of sales decline in each months of the second quarter. However, the return to monthly sales growth is taking longer than we expected. Department stores in Japan have reported that they have also been experiencing sequentially smaller rates of sales declines in jewelry sales in the past several months.
Reflecting the volatility in Japan, total sales declined 13% in the second quarter due to lower unit volume in all jewelry categories. On a constant exchange rate basis, total sales declined 10% and comp store sales declined 13%. However, keep in mind that the 13% comp decline followed a 30% increase in the first quarter and was on top of an 8% comp increase in last year’s second quarter. We do expect to return to single digit sales growth in Japan but have not yet done so in the first few weeks of August. We did not add any new locations in Japan during the quarter but we do plan to open a freestanding store in Shinjuku later this year.
Total sales in Europe increased 8% in the second quarter but the sales growth largely reflected the translation benefits from the stronger pound and euro versus the dollar. Looking at results on a constant exchange rate basis, total sales were up just 1% with higher jewelry unit volume offsetting lower average price and comp store sales declined 8%. This was a further slowdown from the 3% comp decline we had in the first quarter but was on top of the 7% comp increase in last year’s second quarter.
In terms of market performance across Europe, most countries posted weak sales results. Although the UK’s decline was greater than that of Continental Europe reflecting to some degree a decline in tourists spending in London. We think the weakness in the UK and to some degree on the Continent too might be resulting from the strength of the pound and euro which perhaps could also be enticing Europeans to shop in the U.S. and elsewhere. As most of you know a few months ago we expanded Tiffany’s presence in Paris to a fourth location when we opened the major store on the Champs Elysees, which is serving fine visitors and local shoppers as well.
In fact and not too surprisingly that store is quickly becoming one of our highest sales volume stores in Europe. All in all we believe Tiffany is still feeling the effects of both economic and currency related challenges in Europe although we are partially benefiting in the U.S. from European tourist spending. But longer term we are as excited as ever about Tiffany’s expansion plans and growth potential in Europe.
Wrapping up the regional sales review as our other segment where the bulk of the 28% sales increase in the second quarter was from retail sales largely from the opening of our store in Moscow in February as well as from 2% comp store sales growth in our five stores in the UAE. In addition, there was an increase in wholesale sales of diamond acquired through our rough sourcing program and subsequently sold because they don’t meet our requirements. Although, we had thought wholesale sales would have been higher in the quarter and therefore would have more negatively affected gross margin. Our websites around the world effectively complement our worldwide store base and e-commerce sales have been growing roughly in line with our overall worldwide sales. Of course beyond generating online sales, our website service powerful marketing vehicle to build brand and product awareness and drive store traffic.
To summarize various worldwide store expansion plans I mentioned in each region we are now expecting to open 10 stores in 2014 instead of the initial plan that called for 13 stores with the reduction due to the delays in opening two stores planned in China a store planned in Bangkok. Also we now plan to close three stores this year instead of our initial intention to close four because the store in Japan will be relocated within its host department store instead of being closed. In total, this represents a net 2% increase in company operated locations and a net 3% increase in gross square footage.
In addition to our strategy to gradually expand our company operated store base we are of course also renovating older stores with the objective to enhance visual merchandizing and the in store customer experience and to achieve the most effective space utilization.
So that wraps up the regional sales review. There are number of noteworthy highlights among our product categories with the key takeaway has been continued strength at mid-to-higher price points and healthy growth in both perennial classics and newer designs. Specifically, in the statement, fine and solitaire jewelry category, we enjoyed strong statement jewelry sales in the Americas and Asia Pacific regions resulting in part from customers who may have attended our successful Blue Book event in New York in April.
There was also healthy increase in fine jewelry sales in all regions, excluding Japan which of course had an exceptional first quarter increase. Fine jewelry highlights include the ongoing success of our Yellow Diamond collection, Elsa Peretti Diamonds by the Yard collection and our important Victoria collection. We’ve spoken for some time now about the increasing popularity of colored diamonds and other gemstones and our design initiatives in recent years have addressed that growing interest.
In our fashion jewelry category, which primarily includes jewelry without gemstones, we’re seeing particular strength in gold jewelry in a number of collections. Total silver jewelry sales were unchanged from the year ago as growth in higher-end silver pieces offset softness at entry level price point. The biggest story, as we noted since last fall, is the tremendous success of our Atlas jewelry collection introduce the best time and expanded with additional pieces in the spring.
And another popular collection demonstrating timelessness of design after many years in our assortment is our Return to Tiffany collection. Two very popular collections that span the fashion in fine jewelry categories at Tiffany Keys, which has been expanded with diamond accents and our Enchant collection which has been expanded into designs incorporating the RUBEDO metal.
Lastly, the engagement jewelry and wedding band category was strong especially in the Americas and Asia Pacific regions, led of course by our extraordinary Tiffany solitaire diamond ring and we’re delighted with the growing popularity of our relatively new harmony engagement collection.
Looking forward, we are excited about the launch of our new Tiffany T jewelry collection. Tiffany T is being offered in a range of materials with the majority of styles in yellow, white or rose gold with and without diamonds as well as some pieces in sterling silver making the collection available in a wide range of prices from a few hundred dollars up to about $20,000. This collection have more than 50 styles was introduced last week in our U.S. Canadian and Latin American stores and will be available globally in September.
You may have seen new advertising, now appearing in magazines and on tiffany.com. That’s just the start of the campaign and we intend to substantially step up ad spending in the third quarter to promote awareness of this dramatic new collection.
Lastly, outside of jewelry, we’re excited to be launching in the coming weeks a beautiful and elegant new collection of hand bags and small leather goods. The tightly focused assortment reflects a new modern aesthetic intended to attract and appeal the fashion-focused existing and new customers.
I’ll now turn the call over to Ralph to review the rest of the earnings statement, the balance sheet and our full year expectations. Ralph.
Thank you, Mark. Clearly, we had a strong quarter reflecting solid execution of our strategies in a volatile global environment. The key takeaways driving results were broad base sales growth in the Americas and Asia Pacific more than offsetting the expected decline in Japan and softness in Europe.
Sales strength across all key product categories and price strata and highlighted by improving fashion jewelry sales, a meaningful increase in gross margin and strong operating earnings growth while increasing our marketing investment. Factoring in the results from the second quarter, tempered with a bit of caution because of Europe and Japan and a generally uncertain global environment, we are raising our full year earnings forecast by $0.05 per share, representing a portion of the second quarters better than expected net earnings.
Now I’ll comment on the rest of the earnings statement. Gross margin rose 2.4 points to 59.9% in the second quarter, largely due to favorable product costs and price increases taken across all product categories and regions. And to a lesser extent some sales leverage on fixed costs. Additionally, we are pleased to see fashion jewelry sales grow in line with total company sales which contributed to the margin exceeding our expectations. Gross margin also benefited versus our forecast from a lower than expected level of wholesale sales of diamonds.
We saw a 9% increase in selling, general and administrative expenses in the second quarter primarily reflecting higher fixed and variable labor and store-related cost. In addition, marketing spending rose in the quarter and we expect the year-over-year growth to accelerate further in the second half of the year, but especially in the third quarter tied to the launch of the Tiffany T collection. In fact, while marketing spending in the first half of the year was about unchanged from the prior year, we are planning for to increase year-over-year by a double digit percentage in the second half.
While SG&A expenses rose a bit more than sales growth in the second quarter, we continue to expect that that rate of SG&A expense growth will be less than sales growth for the full year.
As a result of the increases in sales and gross margin operating earnings increased 18% in the quarter while the operating margin rose to 21% from 19% in last year’s second quarter. Interest and other expenses net of $16 million in the quarter were about a $1 million above last year and the effective income tax rate of 35.5% in the quarter was 1.3 points above last year but that was largely due to a one-time effect of a change in certain state tax legislation.
Adding it all up, net earnings in the second quarter increased 16% to $124 million or $0.96 per share. Tiffany’s strong balance sheet gives us a solid foundation to support our current business and planned growth. At the end of the second quarter we had $398 million of cash and cash equivalents versus $490 million a year ago and our debt leverage remains essentially unchanged. Inventories of $2.5 billion at July 31 were up 9% from a year ago, partly to support overall anticipated sales growth but with disproportionate increases in raw materials and work in process inventories partly to support the launch of the Tiffany T collection.
Our full year and longer term objective continues to call for maintaining inventory growth less than the rate of sales growth.
Capital expenditures of $91 million in the first half were up just slightly from last year’s first half. For the full year, we continue to forecast CapEx at $270 million versus the $220 million last year reflecting incremental investments in information technology including the global customer relationship management system and more advanced order and inventory management capabilities.
In terms of share repurchases during the quarter, we spent approximately $9 million to repurchase 102,000 shares at an average cost of approximately $91 a share. There was $284 million available for future repurchases under a $300 million three-year program that was authorized by Tiffany’s Board of Directors in March.
As Mark mentioned, Tiffany’s Board increased the quarterly dividend rate by 12% in the second quarter reflecting our longer term objective to grow dividends roughly in line with earnings growth and thus maintaining the current payout ratio.
Let’s now look at our outlook for the full year. We began 2014 projecting net earnings in the range of $4.05 to $4.15 per share or 9% to 11% higher than the adjusted $3.73 per share that was earned in 2013. When we reported strong first quarter results, we increased the forecasted range by $0.10 per share.
Now, based on performance in the second quarter but tempered by macro uncertainties and specifically the continued softness in Europe and the lingering sales declines in Japan, we are raising our forecasted range by $0.05 to $4.20 to $4.30 per share which will represent full year EPS growth of 13% to 15%.
That full year forecast continues to call for a high single digit percentage increase in worldwide net sales in dollars and we expect a healthy increase in the operating margin for the full year coming from a higher gross margin but factoring in gross margin in the second half being up less than in the first half. And we expect some improvement in the SG&A expense ratio for the year despite the considerably higher marketing spending.
Summing up, Tiffany’s performance in the first half of the year was quite good in most respects although a bit more volatile than we expected. With our growing store base, compelling product designs and new advertising, we believe we are nicely positioned for a successful second half of the year.
I’ll now turn the call back to Mark.
Thanks Ralph. We hope you’ve all benefited from the information and insights we’ve shared with you on today’s call. A replay of the call is available on our Web site or by dialing 888-203-1112 in the U.S. or 719-457-0820 outside the U.S. and entering passcode 7635206. As always, please feel free to call me with any questions and please note on your calendars that we plan to report third quarter financial results on Tuesday November 25th before the market opens. Thanks for listening.
And this concludes today’s conference call. You may disconnect your line. Thank you.
[No Q&A session for this event]
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