Tiffany (NYSE:TIF) warned investors back in January that they should expect profit challenges ahead as the company ramps up spending on its growth initiatives in 2018. However, Wall Street still reacted harshly to the jewelry specialist's detailed outlook that paired minor sales growth with another profitability decline. Shares dipped by 4% immediately following Tiffany's earnings release.

More on that 2018 forecast in a moment. First, here's how the retailer's holiday quarter results stacked up against the prior-year period: 

 Metric

Q4 2017

Q4 2016

Year-Over-Year Change

Revenue

$1.33 billion

$1.23 billion

8%

Net income

$62 million

$158 million

N/A

EPS

$0.50

$1.26

N/A

Data source: Tiffany's financial filings.

A solid quarter for sales growth

Revenue ticked up by 6%, after accounting for currency swings, which was consistent with management's upbeat post-holiday update. The results showed signs of stress on profitability, though, with expenses rising even as gross profit margin declined.

A diamond ring.

Image source: Getty Images.

Here are some of the key highlights from the quarter:

  • Comparable-store sales rose 3% over the holiday period to keep comps flat for the full year. Sales were relatively weak in the U.S. market and in Japan while China and Europe contributed modest growth.
  • Gross profit margin dipped to 63.7% of sales from 64.1% a year ago, which management blamed on a spike in sales of wholesale diamonds.
  • Selling expenses jumped 5% due to a mix of higher labor costs and increased marketing spending. As a result, adjusted operating margin declined.
  • Tiffany generated healthy cash flow, with free cash improving to $932 million for the full year compared to $706 million in 2016.
  • The sharp reductions in net income and earnings per share were a consequence of a short-term spike in tax expenses. Excluding these charges, net income rose 15% during the period.

Management's comments

CEO Alessandro Bogliolo said the management team was happy to end 2017 with some of their strongest revenue gains of the year. "We are pleased to be finishing the year with solid sales growth, both geographically and across product categories," he said in a press release.

Meanwhile, in a likely reference to the reduced profit margin in the period, Bogliolo listed several areas of the business that required scaled-up investment spending. These included its online sales channel, marketing, and store layouts. While these initiatives "will hinder pre-tax earnings growth in the near-term," Bogliolo explained, they are each important to Tiffany's long-term growth outlook.

Predicting higher spending in 2018

Tiffany's detailed 2018 forecast still sees sales rising in the low to mid-single-digit range to mark a slight acceleration over last year's result. Its earnings outlook implies an aggressive spending plan than will reduce operating margin, though. On the bright side, executives believe improved gross profits will offset some of that shift so that overall adjusted earnings hold steady.

The jewelry giant plans to cautiously expand its sales footprint by adding nine new stores, or an additional 2% of selling space, to its base. Still, capital expenditures will rise to $280 million from $239 million, they predict. Together with the flat earnings result, that extra spending should lead to a significant drop in free cash flow for the year.

Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.