Tiffany & Co. (TIF) Q3 2017 Earnings Conference Call Transcript

Tiffany & Co. (NYSE: TIF)Q3 2017 Earnings Conference CallNov. 29, 2017, 8:30 a.m. ET

Prepared Remarks:

Operator

Please stand by as we are about to begin.

Good day everyone. Welcome to the Tiffany & Co. Third Quarter 2017 Conference Call. Today's call is being recorded. Participating in today's call is Mr. Mark Aaron, Vice President of Investor Relations, Mr. Mark Erceg, Tiffany's Executive Vice President and Chief Financial Officer, and Mr. Alessandro Bogliolo, Chief Executive Officer. At this time, I would like to turn the call over to Mr. Mark Aaron. Please go ahead.

Mark L. Aaron -- Vice President Investor Relations

Thank you and good day, everyone. On today's call, we are pleased that Tiffany's new CEO, Alessandro Bogliolo, will begin by offering a few of his initial observations, which he will do in a moment. I'll then review Third Quarter sales results, and Mark Erceg will comment on the rest of the financial results and forecast.

Before continuing, 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, I am pleased to introduce Alessandro Bogliolo.

Alessandro Bogliolo -- Chief Executive Officer

Thank you.

I'm pleased to have this opportunity to briefly introduce myself to you, and I look forward to meeting many of you in the coming months. Let me begin by saying that I'm very excited to be here at Tiffany. I spent many years in the jewelry business at Bvlgari, and I've long respected Tiffany as a house of extraordinary design and as a formidable competitor. In my first seven weeks at Tiffany I've met with many members of our HQ, and regional teams, and I'm impressed with their skills and passion for our unique brand. I've traveled and visited, so far, about 40 stores in the Americas, Asia Pacific, and Japan. I'm very glad I also visited three of our manufacturing and logistic sites in the United States, in New York, in Rhode Island, and in New Jersey. We have powerful internal operations with hundreds of truly exceptional jewelry artists, stone setters, and engravers, it's thanks to them, to their skills, their hands that Tiffany can offer such a vast assortment from multi-million-dollar, one-of-a-kind creations, to everyday jewelry with consistent and supreme quality.

I accepted this position because I strongly believe that the Tiffany and co-brand is healthy with tremendous opportunities to grow. As we move forward, we will leverage our core strength and adapt as appropriate. Of course, we will always remain true to our heritage and brand integrity. We will be accelerating the pace of product innovation; we are focused on the most effective marketing communications. We will continue to enhance the in-store and online experience, and our growth is reinforced by our strong supply chain capabilities and a solid financial position. I believe our company has the capabilities to further delight our customers, inspire our employees, and reward our shareholders. At the same time, we acknowledge that some of our competitors have recently posted stronger sales growth than us which I can assure you will not be acceptable in the long-term.

I'm increasingly passionate about Tiffany, and I'm honored to be given this great opportunity. As I further study our business, I will be reviewing my thoughts with our board of directors and will then have more to say to you in the coming months. I appreciate your interest in this great company; I can assure you that we will continue to work very persistently to achieve the healthy long-term financial performance that you have come to expect from us. Thank you, and now I return the call back to Mark.

Mark L. Aaron -- Vice President Investor Relations

Thanks Alessandro for sharing those thoughts with us.

Now, let's look at the results. As an overview, we were pleased with some of the underlying factors reflected in these Third Quarter results. Important to us was that total sales growth was, again, driven largely by higher jewelry unit volume and not price. We were pleased to see a continuation of growth in fashion jewelry, and also encouraged to see a resumption of growth in the high fine, and solitaire jewelry categories.

Comparable store sales rose in the Americas and Asia Pacific but declined in Japan and Europe. Gross margin was up. SG&A expense growth was roughly in line with sales growth. Other expenses were unchanged, and the effective tax rate was a bit lower. The result was a 5% increase in net earnings which was a bit higher than what we had expected. We added a net of three stores and introduced some new jewelry designs, a new watch collection, and a new fragrance. Organizationally, Alessandro joined Tiffany, and our board of directors elected Roger Farah as it's chairman. It was indeed a very active quarter.

Let's look at performance in each region. In the Americas, sales rose slightly due to an increase in the number of jewelry units sold across all categories except engagement jewelry. In terms of the regions customer mix in the quarter, we attribute sales growth to higher spending by local customers, while sales to foreign tourists continue to trend lower. It will be interesting in coming quarters to see whether there is any impact from the recent weakening of the U.S. Dollar against certain currencies.

Comp-store sales rose 1% in the quarter. Results on a constant exchange rate basis were not materially different than as reported. Around the region, there were no significant variations in geographical performance worth highlighting. There has been quite a bit of recent store activity. During the quarter in the U.S., we opened a store in Fort Worth, Texas representing our third store in the Dallas-Fort Worth market. We relocated our store in Century City, California. In our New York flagship store, we recent reopened our newly renovated fourth floor offering a dramatic new presentation and experience. The floor showcases our new home and accessories collection, and we're pleased to say that you can now enjoy your breakfast or lunch and tea at Tiffany's in our newly opened Blue Box Café on the fourth floor. Based on the long queues every day, the café is fast becoming a New York tradition.

For the first time ever, we recently opened two pop-up shops in Manhattan, in Rockefeller Center and in Grand Central Station which are important hubs for both New Yorkers, and tourists. These shops offer a curated selection by our chief artistic officer Reed Krakoff of jewelry including the new hardware collection and gifts, including the new home and accessories collection. We are excited about the sales potential and brand exposure from those two shops. We also opened four pop-up shops in Holt-Renfrew department stores in Canada.

Now, let's turn to the Asia Pacific region which experienced growth in the quarter due to increased unit volume across jewelry categories. The region sales increase came from a continuation of very strong comparable store sales growth in mainland China, increased wholesale sales in Korea to support strong duty-free sales, and the effect of new stores. Comps were up 2% on a constant exchange rate basis. While we were pleased with sales growth in mainland China, we were also encouraged to see sales in Hong Kong almost flat with last year after three years of substantial declines. Comp declines in some other countries, which we attribute at least in part to lower Chinese tourist spending affected the regions overall results. During the quarter we opened one store in Wushi, China, and have several openings and relocations planned in the Fourth Quarter.

The picture was reasonably good in Japan. Sales declined on a GAAP basis due to a weakening of the Yen versus the Dollar. However, Third Quarter sales were equal to last year on a constant exchange rate basis. A decline in jewelry units sold was offset by an increase in average price, so as a reminder the number of units sold had a large increase last year. Comp-store sales decreased on a GAAP basis, but on a constant exchange rate basis were flat. We are planning for a tough comparison in the Fourth Quarter when we go up against the comp store sales increase last year that we believe was at least partly tied to extensive favorable publicity from a popular television show. There were no store openings or closings during the quarter.

Turning to Europe, we saw mixed results. Total sales were up on a GAAP basis due to increased price and volume. The Pound and Euro have strengthened in recent months which bolstered GAAP results. On a constant exchange rate basis, total sales were up slightly, and comps declined. In Continental Europe, total sales rose in most countries. Sales declined in the U.K., but keep in mind the very strong growth at this time last year when spending that we attributed to foreign tourists in London was surging in reaction to the weaker Pound. During the quarter, we added to our successful business in Russia when we opened a second store in the heart of Moscow on Petrovka Street, and we opened a store in Birmingham, England in Selfridges Department Store, representing our 11th store in the U.K.

Lastly, sales in our other segment declined in the quarter entirely due to lower wholesale sales of diamonds. This segment also includes four stores that we operate in the U.A.E., and we were pleased to see that their comps improved with a 7% increase in the Third Quarter. We closed our store in the Abu Dhabi mall during the quarter, but expect to replace it with a new store in the Abu Dhabi Galleria next year. In addition to these sales highlights, I should point out that e-commerce sales increased at a slightly faster pace than overall sales growth. We will certainly continue to invest in the online channel and digital marketing but believe that most customers, after getting their information online still are, and will continue to be attracted to the in-store experience.

Looking at product categories in total for the quarter, we continue to see solid growth in the fashion jewelry category; we're very pleased with results in the Tiffany Hardware Collection which we launched earlier in the year. We recently added new keys to the collection. We also recently expanded our very successful Tiffany Tea Collection. Near the end of the quarter, we launched an interesting build your own program on our website that allows customers to construct and personalize their own charm bracelets. It's worth point out the growth in our Tiffany Keys collection which spans both fashion and fine jewelry and includes new Fleur de Lis designs in earrings, pendants, and rings.

In the high fine and solitaire jewelry category, we were pleased to see a resumption of growth in the quarter led by iconic diamond jewelry designs which included extensions of some existing collections. In that regard, it's worth mentioning the popular Victoria, Yellow Diamond and Celeste collections. We had a solid increase in high jewelry sales in the quarter. Partly offsetting growth in those categories was engagement jewelry where sales continue to underperform in the quarter. While Tiffany offers a wide-ranging, and we believe dominant, diamond ring assortment, we've also observed that some customers wanted to customize their own rings. As a result, we recently introduced a program in our stores in the U.S. and Canada that allows customers to personalize their ring by separately choosing a diamond cut, setting, and metal.

We're pleased with progress in several non-jewelry categories as well. In watches, we saw good growth in the quarter, and there's been very favorable initial reaction to our new Tiffany Metro Watch collection for women. We also launched our new signature fragrance in the quarter, which is now available in Tiffany stores as well as in other select stores globally. As I mentioned, earlier, we recently introduced our new home and accessories collection both online and in our stores. The already popular collection spans more than 300 items both functional and whimsical in a wide range of price points and is now being distributed worldwide.

We've met with many of you in recent months, and I want to reiterate that Tiffany's top strategic priority is to drive solid comparable store sales growth. While we expect square footage to increase modestly each year in the future, it is comparable store and e-commerce sales growth through increased frequency of customer visits and the conversion rate that will ultimately contribute to driving higher margins and earnings growth.

With that, I'm now pleased to turn the call over to Mark Erceg.

Mark J. Erceg -- Executive Vice President and Chief Financial Officer

Thanks, Mark, and good morning everyone.

Third quarter results reflect continued progress toward our long-term financial goals which include mid-single-digit sales growth, and high single-digit diluted earnings-per-share growth. Worldwide sales growth of 3% in the quarter is obviously below that range, but importantly some sequential progress was made in comp store sales, which were down 1% in the Third Quarter after being down 3% in the First Quarter, and down 2% in the Second Quarter. A net earnings growth of 5% in the Third Quarter, brings fiscal year-to-date diluted earnings-per-share growth to plus 7% versus a year ago.

While we're encouraged with Third Quarter results, we also acknowledge that we have a lot more work to do. At the risk of stating the obvious, we will not be satisfied until we achieve meaningful and sustainable comparable store sales growth across all regions.

Moving to gross margin, gross margin increased by 30 basis points, due in part, to a decline in wholesale diamond sales. Sales mix was not a meaningful contributor to the increase as sales growth was generally balanced across a wide range of price points and product categories. Also, while we have continued to benefit from lower commodity input costs, we are seeing that benefit diminish as the year goes on, which is consistent with our prior expectations. We now expect gross margin to be roughly unchanged for the full year.

Selling, general and administrative expenses were roughly in line with sales growth in the Third Quarter with the increase tied to increased labor and incentive compensation costs, as well as higher store depreciation and occupancy costs partly offset by various ongoing cost savings initiatives. On a year-to-date basis, SG&A expenses have grown 2.4% versus reported sales growth of 2.3%. As has been previously stated, we remain committed to managing SG&A expense prudently and reducing costs where feasible in order to free up investment dollars to reinvest in the growth of our business.

Modest gross margin expansion coupled with SG&A expenses growing in line with sales allowed Third Quarter operating margin to expand by 10 basis points. Our full-year forecast calls for operating margin to increase over last year as reported but to be roughly in line with last year's margin when charges are excluded. Interest and other expenses were essentially unchanged in the quarter, and we expect it to be in the range of $35 to $37 million for the full year.

From a tax standpoint, the Third Quarter effective tax rate was 33.4% which was more than a full point below last years rate of 34.6%. Nonetheless 2017 full year effective tax rate is still expected to be approximately 33%. Net inventories at October 31 were only 1% above last year, which is below the rate of sales growth, which you may recall that July 31st of this year inventory was 4% below a year ago. Simply put, we've increased our internal manufacturing targets over the past couple of months for several key gold products that have been selling faster than expected which, in turn, has pushed up raw material and work in process inventory levels. Because of this change, we now expect net inventories for the year to increase at approximately the same rate as sales growth.

Capital expenditures year-to-date were $146 million, and our full-year forecast, which assumed approximately $250 million in spending, has been revised slightly downward with our best estimate now being somewhere in the $235 to $250 million range. The revision is solely due to timing and expenditures as we continue to anticipate annual CapEx spending of somewhere between 6% and 7% of sales. We invested $28 million in the Third Quarter to buy shares at an average cost of $92 per share which is slightly up from the $21 million we invested during the Second Quarter and more than double the $11 million we invested during the First Quarter. Tiffany's balance sheet remained strong having finished the Third Quarter with $1 billion in cash in short-term investments, and total debt representing only 1/3 stockholder's equity.

Putting it all together, we continue to expect total sales for the full year to increase by low single digits. Our forecast for diluted EPS continues to call for a high single-digit increase over last years $3.55 per share on a GAAP basis, and a mid-single digit over last year's $3.75 per share excluding charges. Relative to cash, we remain on pace with our expectations to deliver approximately $700 million of net operating cash flow and approximately $450 million of free cash flow for the full year.

In closing, while progress was made in the quarter, we remain focused on sharpening our strategies and improving our execution in order to generate sustainable comp store sales growth and consistent diluted earnings-per-share growth.

I'll now turn the call back over to Mark.

Mark L. Aaron -- Vice President Investor Relations

Thanks, Mark and Alessandro for your insights.

Everyone, please note that we expect to report our November-December holiday sales results on January 17th. As a reminder, we do not have a conference call with that release. Beyond that, we expect to report our full-year financial results in mid-March when we will have a conference call with time for Q&A with Alessandro and Mark. For today, please feel free to call me with any questions or comments. Thanks for listening.

...

Operator

And that does conclude today's conference. A replay of this call will be available as of 10:30 a.m. eastern time today and will be available until December 6, 2017. To access the replay, please dial 888-203-1112, or 719-457-0820; the passcode is 8911897. Thank you.

Duration: 22 minutes

Call participants:

Alessandra Bogliolo -- Chief Executive Officer

Mark J. Erceg -- Chief Financial Officer, and Executive Vice President

Mark L. Aaron -- Vice President Investor Relations

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