Tiffany & Co's (TIF) on Q1 2017 Results - Earnings Call Transcript

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Tiffany & Co (NYSE:TIF)

Q1 2017 Earnings Conference Call

May 24, 2017, 11:00 ET

Executives

Mark Aaron - VP, IR

Mark Erceg - CFO and EVP

Analysts

Operator

Welcome to this Tiffany & Co. First Quarter 2017 Conference Call. Today's call is being recorded. Participating on today's call is Mr. Mark Aaron, Vice President of Investor Relations and MR; and Mr. Mark Erceg, Executive Vice President and Chief Financial Officer.

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

Mark Aaron

Thank you. Good day, everyone. On today's conference call, Mark Erceg and I will comment on the first quarter financial results, our growth strategies and the full year outlook.

Of course, before proceeding, please note that statements made on this call that are not historical facts are forward-looking statements. Actual results might differ materially from the planned, assumed or expected results expressed in or implied by these forward-looking statements. Additional information concerning factors, risks and uncertainties 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 including the news release filed today under cover of Form 8-K. The company undertakes no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances except as required by applicable law or regulation.

Now let's proceed. As an overview, Tiffany's first quarter results showed a slight increase in worldwide net sales and higher growth in net earnings and our balance sheet remains strong. We believe that those results keep us on track to achieve our full year earnings guidance in light of an expectation for continued challenges from macroeconomic conditions, geopolitical uncertainty and a strong U.S. dollar.

In terms of the first quarter, starting with the top line, regional results included a total sales increase in Asia-Pacific, contrasting with modest declines in the Americas, Japan and Europe, although sales in Europe actually increased on a constant exchange rate basis.

In our largest region, the Americas, total and comparable store sales declined in the first quarter primarily due to lower jewelry unit volume. The U.S. experienced geographically mixed but generally soft performance across the country which we attributed to varying degrees of weakness in both local and foreign tourist demand. Elsewhere, our business in Canada was soft while we were pleased to experience solid growth in our stores in Latin America.

During the first quarter, we completed the major renovation of our store on Union Square in San Francisco and earlier this month, we relaunched our renovated and expanded store on Burrard Street in Vancouver. Both stores have extraordinary new presentations to serve customers in those important markets.

Our second largest region is Asia-Pacific, where an increase in total sales was due to higher wholesale sales and the effect of new store openings over the past year while comps declined slightly. The regional sales growth was entirely driven by increased jewelry unit volume, with the decline in the average price per unit sold. We attributed the continuation of strong sales growth in Mainland China to local customer spending.

Sales in Hong Kong continued to decline which we attribute to lower Chinese tourist spending, but the sales decline was only modest due to our increased focus on local clientele in that market. And we continued to experience varying degrees of softness elsewhere in the region. During the quarter, we closed 1 store in China that had temporarily overlapped with a new store opened last year and we relocated a store in Korea.

Turning to Japan. Total sales and comparable store sales declined slightly in the first quarter with minimal changes in jewelry unit volume and average price. Total sales also declined in part due to lower wholesale sales. We were pleased to see higher spending attributed to local customers who we believe represent about 90% of our sales in Japan. As part of our efforts to further strengthen local customer sales in the important bridal category, we've recently expanded the presence of our major Ginza store in Tokyo by opening a nearby boutique dedicated to that category. We've been pleased with customer's reaction to this heightened experience.

On the other hand, we continued to see a decline in sales attributed to Chinese tourists in Japan. However, as you may recall, we benefited in the first quarter of 2016 from higher sales attributed to Chinese tourists in Japan which then tapered off in the second quarter. During the first quarter, we closed 1 store in Japan.

Our business continues to gradually improve in Europe. Total and comp store sales in the quarter declined modestly as reported. As we saw in 2016, there were varying degrees of softness across Continental Europe, but we were pleased to see a resumption of sales growth in France in the first quarter. Total and comp store sales rose modestly on a constant exchange rate basis as we have been seeing healthy local currency sales growth in the U.K. that we attribute partly to increased demand by local customers and partly to multinational foreign tourist spending in London tied to the weak British pound. There were modest changes in the average price per jewelry unit sold and unit volume. Sales in the other segments had a big increase in the quarter but that was mostly due to an increase in our wholesale sales of diamonds with comp store sales roughly unchanged.

Given our focus on improving top line growth going forward, it's worth reiterating four important global strategies to do so, first, continuing to pursue clienteling and CRM strategies to more effectively engage with customers and enhance their Tiffany experience; second, adding newness to the product assortment at a faster pace; third, optimizing the global distribution base through store openings, renovations, relocations and, in limited cases, some closings; and fourth, enhancing brand awareness through effective marketing communication. We believe these are the key ingredients to achieve better sales growth in the future by increasing the frequency of customer store visit and improving the conversion rate.

Rounding out the sales review, global e-commerce sales were roughly unchanged in the first quarter, but as we've said before, our website served an important dual function of generating online sales while also delivering marketing communication that drives awareness and store traffic. From a product perspective in the first quarter, we were pleased with fashion jewelry sales which, once again, performed relatively better than our other categories. Fashion jewelry which represented 33% of worldwide sales in 2016, primarily consists of non-gemstone gold and silver jewelry.

In the first quarter, while gold jewelry sales led the category's growth, highlighted by the Tiffany T collection, we were pleased that fashion silver jewelry sales were modestly above last year led by the Return to Tiffany collection. Sales of the 1837 collection were also up nicely. And a few weeks ago, we launched the new hardware collection which spanned gold and silver in a range of styles and price points and customer feedback has been positive. Looking forward, additional designs in the T and hardware collections are planned for this fall.

Designer jewelry sales which represented 12% of worldwide sales in 2016, posted healthy growth in the quarter. The category consists of the designs of Elsa Peretti, highlighted by her Diamonds by the Yard and open heart designs; and the designs of Paloma Picasso which include her new Paloma's Melody collection.

The engagement jewelry and wedding bands category which represented 28% of worldwide sales in 2016, continued to underperform relative to our expectation and to the prior year. And performance in the high fine and solitaire jewelry category which represented approximately 20% of worldwide sales in 2016, was mixed. Our Victoria collection continued to perform well, though this performance was offset by softness in other collections in this category.

And regarding high jewelry, we were pleased with our annual Blue Book event that we held in New York in April. The event serves to highlight our extraordinary designs and craftsmanship and to strengthen our relationships with our top clients from around the world. We were pleased with the response to the event.

I should add that our sales growth in the watch category is encouraging, albeit off of a low single-digit percentage of sales base, as we continue to expand brand awareness in that category through advertising and by introducing new designs that are planned for later this year.

Rounding out the product overview, I'll just add that we're looking forward to this fall when we plan to launch our luxury accessories collection and a new signature fragrance for women.

And now Mark Erceg will comment on additional financial highlights as well as our outlook. Mark?

Mark Erceg

Thanks, Mark. Welcome, everyone. Looking at the rest of the income statement, gross margin improved by 80 basis points in the first quarter despite an increase in wholesale diamond sales. Several factors accounted for the increase. First, we continue to benefit from favorable product input costs, particularly lower diamond acquisition costs, where we have seen favorable trends over the past couple of years. Second, after not taking any meaningful price increases in 2016, expect to adjust for weakening foreign currencies, we took modest pricing actions in the quarter that varied by country but which averaged out to a low single-digit increase on a worldwide basis. Finally, we also benefited from favorable product sales mix as the percentage of total sales coming from fashion jewelry rose during the quarter.

With respect to SG&A, you may recall that during our last call, we commented that one of our priorities is to lower the rate of SG&A expense growth as a percent of sales. And while it goes without saying that we need better sales growth to achieve that objective on a sustainable basis, we were very pleased to see that first quarter SG&A expense which included some severance costs, rose less than 1%. Now with that said, we do expect higher rates of SG&A expense growth throughout the remaining quarters of the year as we invest in various growth initiatives.

With improvement in both gross margin and the SG&A expense ratio, Tiffany's operating margin expanded 110 basis points to 16.2% in the quarter from 15.1% last year.

Net interest and other expenses declined in the first quarter due to lower interest expense. Our effective tax rate was 31.7% in the quarter which was lower than expected largely due to the implementation of a new accounting standard related to the treatment of the excess tax benefits associated with divesting or exercise of stock-based compensation. Importantly, this new standard has the potential to create some level of additional earnings volatility in our future results as the amount of the excess tax benefit or shortfall will vary with changes in the stock price.

And finally, before leaving the income statement, it is probably worth mentioning that our tax rate last year was 29% which you may recall benefited from the conclusion of a tax examination in the first quarter of 2016.

Turning to the balance sheet and statement of cash flow. At April 30, we had $960 million of cash and short term investments which was up $170 million versus a year ago. Lower inventory contributed to that increase with net inventory at April 30 down 5% versus a year ago, although we still expect full year inventory to finish flat versus the prior year-end.

As we've stated in the past, we're focused on managing inventories more efficiently both through process improvements and by leveraging a new inventory management system which we anticipate will be fully implemented over the next several years.

Receivables were 5% higher than a year ago. Much of that was timing of collections related to the quarter ending on a Sunday. About 1/3 of our receivables are related to our in-house customer financing offerings, while the majority of our accounts receivable balances are related to other third parties such as credit card companies, department store operators and wholesale customers.

There's nothing particularly noteworthy regarding capital expenditures in the first quarter outside of saying we remain on track to spend about $250 million for the full year. We spent approximately $12 million repurchasing 123,000 shares during the quarter. And as of April 30, 2017, we had $299 million remaining available under our existing share repurchase authorization.

We're pleased with our strong balance sheet and high rate of cash conversion which collectively enables us to continue investing in our business while also providing us with an opportunity to return excess cash to our shareholders.

And now that we've pretty much built out our manufacturing and diamond supply chain which we believe provides us with important strategic and competitive advantages in the areas of supply availability, product innovation, product cost and corporate social responsibility, we're well positioned to maintain a strong balance sheet and generate strong cash flow going forward.

Finally, in terms of our outlook, first quarter results have not fundamentally changed our view for the full year. Specifically, our annual forecast calls for total sales to increase by a low single-digit percentage over the prior year and we're still assuming an increase in operating margin just at a slower rate of growth than in the first quarter. We expect that the increase in operating margin will be entirely due to an increase in gross margin with SG&A expense growing slightly above sales growth.

We also expect net interest and other expenses of approximately $40 million, an all-in effective income tax rate consistent with the prior year and the continued repurchasing of shares, although for the full year, we expect minimal benefits to diluted earnings per share growth from those repurchases.

Our 2017 outlook continues to call for net earnings per diluted share to increase by high single-digit percentage from last year's $3.55 on a GAAP basis and to increase by a mid-single-digit percentage over last year's adjusted EPS of $3.25 per share.

So to summarize today's call, while our first quarter bottom line results slightly exceeded our near term expectations, they certainly do not satisfy our longer term ambition. We believe this is an important distinction because tight cost control and disciplined cash management are prerequisites for a well-run business, but sustainable long term success can only be achieved when the top line is growing consistently.

With this in mind, we're not overly focused on macroeconomic factors we cannot directly influence. Instead, we remain focused on and excited about the top line growth initiatives we're pursuing, namely our efforts to bring more product newness and innovation to our customers while simultaneously enhancing the customer experience, sharpening our marketing efforts and optimizing our store network.

We also believe we have the potential to improve our financial performance by further leveraging our vertically integrated supply chain and by capitalizing on what we believe is a growing global awareness and affinity for the Tiffany brand by consumers all around the world. We continue to strongly believe that executing our strategies in a disciplined way will create sustainable shareholder value in the years ahead.

I'll now turn the call back to Mark.

Mark Aaron

Thanks, Mark. That concludes this conference call. Operator, please provide our audience with the replay information and I look forward to catching up with some of you soon.

Operator

A replay of this call will be available from 10:30 p.m. Eastern time today, March -- or May 24, 2017 until 10:30 a.m. Eastern time, May 31, 2017. To listen to the replay, please dial 719-457-0820 or 888-203-1112 and enter the passcode 272-6419. This concludes the call for today. Thank you for your participation and you may now disconnect.

Question-and-Answer Session

End of Q&A

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