Tiffany & Co. (TIF)
Q4 FY2005 Earnings Conference Call
March 28th 2006, 8:30 AM EST
Mark Aaron - VP of Investor Relations
Jim Fernandez - EVP and CFO
Mike Kowalski - Chairman and CEO
Good day everyone and welcome to this Tiffany & Co. fourth quarter earnings release conference call. Today's call is being recorded. Participating on today's call is the Vice President of Investor Relations, Mr. Mark Aaron; 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.
Thank you. Good morning. Earlier today we reported Tiffany's fourth quarter and full year results. On this call, Mike, Jim and I will comment on the results and the outlook.
Before continuing, please note Tiffany's Safe Harbor provision as follows: 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 2004 annual report and in reports on Form 10-K, 10-Q, and 8-K 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 we can proceed.
Let's start with a review of sales by channel of distribution. U.S. retail sales rose 8% in the fourth quarter. A 5% increase in comparable store sales was composed of a 7% increase in branch store sales and a 2% decline in the New York flagship store. The comp store sales increase was slightly below our expectation and was on top of a 7% comp increase in the prior year.
The monthly comp trend was volatile. Comps rose 4% in November on top of a 10% increase a year ago. Comps rose 7% in December on top of a 7% increase, and comps rose 1% in January on top of a 3% increase.
The flagship store's performance was affected by lower foreign tourist spending in the fourth quarter, which more than offset higher sales to local resident customers. Comp store sales in the seven branch stores in the New York region increased 2% in the quarter.
Looking at the rest of the U.S. outside the Northeast, the comp increase for branch stores was generally broadbased geographically. The stores posting the largest percentage increases included Houston, Orlando, Palm Beach Gardens, Portland, and Scottsdale. We were also extremely pleased with the results in the four new U.S. stores we opened in 2005 in Carmel and Pasadena, California; in San Antonio, Texas; and in Naples, Florida.
For the full year, U.S. retail sales rose 9% and comp store sales increased 7%, due to 7% growth in comp branch store sales and 5% sales growth in the New York flagship store. In addition, the New York flagship store's percentage of net sales in 2005 rounded to approximately 10%, which was equal to 2004. The five U.S. branch stores with the highest sales volume in 2005 were South Coast Plaza in Costa Mesa, followed by Beverly Hills, Chicago, San Francisco, and Washington, D.C.
In both the fourth quarter and the year, U.S. retail sales growth was generated by increases in the average amount spent per transaction. The numbers of transactions were approximately equal to the prior year and the traffic conversion rates were also equal to the prior year. From a price stratification perspective, there was growth in most price ranges, although the greatest percentage increases continued to be in sales and transactions above $50,000.
Lastly, U.S. retail sales growth in the fourth quarter was entirely generated by increased sales to local resident customers, while the full year increase was generated by a combination of local customer and foreign tourists sales growth. For the year, sales to foreign tourists represented 12% of U.S. retail sales in 2005, which was equal to the prior year.
Let's now turn to international retail sales, which rose 1% in the fourth quarter in dollars. However looking at international results on a constant exchange rate basis, which is more indicative of local market demand, international sales rose 10% and comparable store sales increased 7%, primarily due to growth in Japan and other Asia Pacific markets. You can note the regional details on the non-GAAP schedule attached to today's press release.
The following comments on international retail sales will refer to sales on a constant exchange rate basis. Total retail sales in Japan rose 8% in the fourth quarter due to increased jewelry unit volume. Comparable store sales increased 7%, which was better than we initially expected, and compared with a 7% comp decline a year ago. From a foreign currency perspective, the yen averaged 117 to the dollar in the fourth quarter, versus 104 last year demonstrating the extent of the strengthened U.S. dollar.
The 7% comp store sales growth was comprised of a 9% increase in Tokyo, including a 6% increase in our Ginza flagship store, and a 6% increase outside Tokyo. The monthly comp trend included a 6% increase in November on top of an 11% decline in the prior year, followed by a 7% increase in December on top of 5% decline and a 9% increase in January on top of a 7% decline.
After three years of comp declines in Japan, Tiffany made substantial progress in 2005 by pursuing sales training initiatives to enhance customer relationships. For the full year, total retail sales in Japan rose 4% due to increased jewelry units. Comp store sales equaled the prior year.
We opened two stores in 2005 while five underperforming locations were closed. We intend to make further enhancements to the distribution base in the coming year, which is consistent with our strategy. And these new stores and boutiques can generate meaningfully higher sales volume. Lastly we are pleased with initial results in our e-commerce business that we launched in Japan last fall.
In the Asia Pacific region outside Japan, comparable store sales rose 13% in the fourth quarter, which was on top of a 4% increase in the prior year. There was solid comp store sales growth in most markets except Hong Kong. We opened a store in Brisbane in 2005, which is having a very successful start, and we finished the year with 25 locations in this region.
For the year, Asia Pacific comps rose 8% on top of an 11% increase in 2004. We continue to believe that the Asia Pacific region offers meaningful long-term growth potential including further development of our business in China.
In Europe a 1% increase in comp store sales in the fourth quarter was below our expectation and was on top of a 2% increase in the prior year. We achieved growth in all continental European markets, but it was mostly offset by a decline in London which represents the majority of our European sales. We attribute some of London's disappointing performance to the disruption from the renovation of our Bond Street flagship store, while our three other stores in London performed better.
For the year, European comp store sales rose 1% on top of a 3% increase in 2004. During 2005, we opened a third store in Paris and finished the year with 13 European stores.
Rounding out international sales, we were pleased with sales growth in Canada, Mexico, and Brazil in the fourth quarter and a developing Tiffany's presence in each country.
At the end of 2005, we operated 154 Tiffany & Co. locations in 17 countries. Approximately 745,000 gross square feet represented a 2% increase for the year. Within that, Tiffany's U.S. store square footage rose 4% to 467,000; International square footage declined 1% to 278,000 but that included closing five boutiques in Japan during the year. Please note that these numbers do not include Little Switzerland or Iridesse square footage.
Turning back to the U.S., the direct marketing channel includes e-commerce and catalog sales, which in total rose 15% in the fourth quarter. That was above our expectations and was on top of a 10% increase in the prior year. The sales growth resulted from an increased number of orders and a higher average order size. Catalog circulation was slightly lower than the prior year. For the year, Direct Marketing sales rose 11% on top of a 7% increase in 2004.
Tiffany launched Internet sales in the U.S. six years ago and you may be interested to know that it has grown to represent approximately three times the volume of catalog sales. The combined average dollar size for Internet and catalog orders was $221 in 2005 versus $210 in 2004.
Finally, other sales increased 11% in the fourth quarter and 32% in the year. Most of the increases were due to wholesale sales of generally lower quality diamonds obtained through our overall direct diamond sourcing program. However, Little Switzerland stores account for the majority of sales in this channel and their sales declined 4% in the quarter but rose 7% in the year. Also included in this channel are sales of the six Iridesse stores, which are progressing nicely with their focus on the pearl jewelry category.
From a merchandising perspective, fourth quarter sales growth was spread among a number of jewelry categories and that was the case throughout much of the year. However, there continued to be greater strength in higher price point jewelry. There was solid demand for diamond jewelry all year, ranging from rings to studs, pendants, bracelets and necklaces.
Tiffany's expanded colored diamond assortment is also attracting customers. Band rings including celebration rings are performing exceptionally well. We are pleased with solid trends in core fine jewelry such as the new Swing Collection as well as the Jazz collection. The Legacy Jewelry Collection, which now includes colored stones complementing diamonds, is quite popular.
Other relatively new collections like Atlas and 1837 are contributing nicely to worldwide growth in silver jewelry sales, including an increase in Japan in the fourth quarter. So we are pleased with pretty broad-based jewelry demand.
Finally we want to share with you the average price per jewelry unit sold data for a few key categories that we provide annually. In 2005, the average price per piece of statement jewelry sold in the U.S. was $81,000 versus $73,000 in 2004. For a solitaire diamond engagement ring the average in the U.S. was $10,400 in 2005 versus $9,800 in 2004; while the average of $4,200 in Japan was equal to the prior year. For silver jewelry, the U.S. average of $187 in 2005 was approximately equal to the prior year, while in Japan the average went from $235 in 2004 to $215 in 2005. That covers the sales review. I am now pleased to turn the call over to Jim.
Thanks, Mark. Looking at the rest of the income statement, gross margin in the fourth quarter was 1.8 points higher than a year ago. We generally benefited from the changes in product and geographical sales mix, although there was still some pressure from higher raw material costs and some effect from increased wholesale sales of diamonds.
Gross margin of 56% for the year was 0.2 points higher than fiscal 2004. In addition, we recorded a LIFO inventory charge of $11.6 million for the full year versus $33.5 million in fiscal 2004.
SG&A expenses declined 6% in the fourth quarter, but that reflected several one-time costs in last year's fourth quarter including the contribution to the Tiffany & Co. Foundation as well as some impairment and exit costs. Excluding those costs, SG&A expenses would have increased 8% in the quarter. SG&A as reported rose 3% for the year, which was slightly better than our initial expectation.
Tiffany's operating margin was 23.6% in the fourth quarter versus 17.3% a year ago. For the full year, the operating margin was 16% versus 13.4% in 2004. Other expenses net came in at $14.7 million in 2005, which was lower than $16 million in 2004. However, the amount in 2005 benefited by approximately $2 million due to foreign currency transaction gains.
Tiffany's effective tax rate was 29.9% in the fourth quarter versus 34.5% in the prior year. For the year, the effective tax rate was 30.8% versus 35.6% in 2004. In both periods, the lower rates reflected the benefit from repatriation of foreign earnings related to provisions of the American Jobs Creation Act of 2004, which benefited net earnings per diluted share by $0.10 in the fourth quarter and $0.16 in the full year. We also had an AJCA benefit of $0.06 per diluted share in the fourth quarter of 2004.
Adding it all up, net earnings declined in the quarter and year, but that was due to the large gain we recorded in fiscal 2004 from the sale of Tiffany's equity stake in Aber Diamond Corporation. In addition, Tiffany's full year 2005 earnings of $1.75 per diluted share were higher than our previously published expectations in January of $1.60 to $1.62 per share. However, you should note that this was largely due to the lower effective tax rate in the fourth quarter that was primarily driven by the AJCA benefit.
Tiffany's balance sheet remained in very good shape at year end. Accounts receivable at January 31st increased 7% from a year ago due to sales growth. Net inventories increased only fractionally in 2005 after growing 21% in 2004. This was better performance than we had initially expected, reflecting excellent inventory management as well as increases in the prior year in certain finished good diamond inventories and the significant ramping up of direct rough diamond sourcing.
Also contributing to Tiffany's cash flow during 2005 was our sale leaseback of a distribution center in New Jersey for $75 million. We entered into a long-term lease because we essentially felt there was no strategic need to own it.
During the quarter we repurchased 469,000 shares of common stock at an average cost of $39.39 per share. For the year, we repurchased 3,835,000 shares at an average cost of $34.63 per share.
Summing up the balance sheet, we finished the year with $394 million of cash and cash equivalents; $472 million of short-term and long-term debt; and $1.8 billion of stockholders equity. The ratio of total debt to stockholders equity was 26% to January 31, which was equal to a year ago.
In today's press release, we highlighted and generally reiterated Tiffany's financial outlook for 2006. Specifically we are expecting approximate 10% total sales growth for the year. We are looking for a mid single-digit increase in worldwide comparable store sales on a constant exchange rate basis, which would include a high single-digit increase in U.S. comp store sales, which we are currently not achieving; and a low single digit increase in Japan comp store sales in yen, which we are currently exceeding. From a translation perspective, we are conservatively planning the yen at 120 to the dollar in 2006 versus the average of 111 in 2005.
We are looking for low double-digit comp store sales growth in other regions. We also expect to grow worldwide growth square footage of Tiffany stores by a mid single-digit percentage, which includes potential relocations or closings in Japan. We look for high single-digit percentage growth in direct marketing sales.
Lastly, we expect to increase Tiffany's direct diamond sourcing in 2006, which also subsequently increases our wholesale sales of residual non-Tiffany quality diamonds. This will probably lead to more than 30% sales growth in the other channel of distribution in 2006 with some gross margin implications as well.
Our expectation for gross margin in 2006 now calls for it to be unchanged from 2005. This assumes growth across a broad sales mix, as well as making appropriate retail price increases to offset higher product costs. It also assumes some gross margin benefit from further scale and efficiencies in internal jewelry manufacturing. However those various benefits may be offset by the expected increase in wholesale sales of diamonds.
We expect a high single-digit percentage increase in SG&A expenses in 2006. Growth will likely be slightly above that in the first half due to higher marketing costs as well as the annualized effect from a number of new stores opened in the second half of 2005. Such expense pressure should ease somewhat in the second half. Therefore for the full year, if we achieve our 10% sales growth objective, this would result in an improvement in the expense ratio for the year. Therefore we expect Tiffany's operating margin to increase by approximately 0.5 points in 2006.
We are looking for other expenses to be in the area of $17 million to $20 million in 2006 due to higher net interest expense. Regarding Tiffany's effective tax rate in 2006, now that we have completed the repatriation of foreign earnings under the American Jobs Creation Act of 2004, we should be returning to a more normal tax rate of approximately 38%. Adding it all up puts our earnings objective in a range of $1.77 to $1.82 per diluted share for the 2006 which is reiterating the objective we communicated when we reported holiday sales on January 10.
In terms of the balance sheet, we are planning a mid to high single-digit percentage increase in inventories and capital expenditures in 2006 should be no higher than our long-term objective of 7% to 8% of sales. Therefore, Tiffany should be able to achieve a healthy level of cash flow to support the growth of its business.
Finally, we indicated in today's press release that the year has started with mixed sales results. Comparable store sales in Japan and many other international markets are quite strong and above our expectations. However a comp decline in the U.S., and especially in the New York flagship store, is softer than we expected, which we attribute to a difficult comparison to last year's first quarter and to lower sales to foreign tourists.
With these trends we think earnings in the first quarter could be equal to or slightly above the earnings of $0.27 per diluted share a year ago. At this early point in the year, we believe Tiffany has the ability to achieve its full year growth objectives. I'm pleased to say that Tiffany is in very good shape both financially and operationally for 2006 and beyond.
I would now like to turn the call over to Mike.
Thanks, Jim. We are pleased with Tiffany's results in 2005 and with the initiatives we pursued to support long-term growth. Our worldwide comparable store sales growth was solid. We achieved success with the new stores we opened and with the products we introduced. We expanded our e-commerce platform in Canada and Japan. We advanced our product sourcing capabilities especially for diamonds. Clearly an important accomplishment in 2005 was the improved results we posted in Japan.
We will continue to pursue Tiffany's long-term growth strategies in 2006 and we have a number of exciting plans in the works. This will include new U.S. stores in Nashville, Indianapolis, Tucson, and Atlantic City. In addition, we have entered the final phase of renovating our New York flagship store with the main floor now getting an exciting facelift, which should be completed this fall, along with the newly renovated fifth floor for special exhibitions and customer events.
New international stores are planned in Monterey, Mexico; Vancouver, Canada; and Vienna, Austria. In Japan, we recently opened boutiques in department stores in Yonago and in Mito. We plan to open a store in Macau and to expand Tiffany's presence in mainland China with an additional store in both Beijing and Shanghai and enhance brand awareness with an information website that we recently launched.
Our specialty retail plans include expanding our network of Iridesse stores, by roughly doubling their store base with the opening of seven additional stores. Our objective is to improve the operating performance of the Little Switzerland stores.
It should be an interesting year on the product side as well. As always, Tiffany & Co. will introduce a range of new jewelry designs to complement its existing offerings. Of special note is the launch of six innovative jewelry collections designed by the renowned architect, Frank Gehry, which is now being launched in select stores in the United States and Japan to be followed by a worldwide rollout this fall.
Jim and I have just returned from the gala launch event that we held Sunday night on Rodeo Drive in Beverly Hills. The Gehry Collection adds a new design dimension to Tiffany and is intended to broaden our customer base, seeking bold contemporary designs and the advertising is certainly intended to create customer awareness. We encourage you to visit Tiffany.com to learn more about this exciting new collaboration.
On the marketing side, we will continue to reinforce brand awareness through print media, outdoor advertising, catalogs, and websites. In fact we recently began direct mail marketing to customers and expect that such communication will be an important way to showcase new products to customers and suggest gift ideas around the holidays.
We have made significant strides to strengthen Tiffany's infrastructure in recent years and are well positioned to benefit from it for a considerable amount of time. Tiffany has substantial internal jewelry manufacturing capacity to support our product needs. We continue to broaden our direct diamond sourcing relationships to ensure appropriate levels of availability. Our two distribution centers in New Jersey are efficiently supporting worldwide store replenishment and direct to customer shipments.
Perhaps of greatest importance is the strength of the Tiffany & Company brand. It is a brand that is admired, desired and trusted, traits that we believe are competitive necessities in the world of discerning customers who seek the finest products. We've taken a number of steps over the years to maintain the integrity of the Tiffany brand and remain committed to delivering extraordinary products and experiences to our customers and achieving sustainable long-term growth for our shareholders.
That concludes this conference call. Please feel free to call Mark with any questions. We appreciate your interest and we thank you for listening.
Thank you. A replay of today's conference will be available beginning today, March 28, 2006 at 9:30 AM CT. The pass code to access the replay: 4690157. The dial-in number is 888-203-1112. For international participants, 719-457-0820. Again, this does conclude today's conference. Thank you for your participation. You may now disconnect.
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