Cracker Barrel Old Country Store's (CBRL) Sandra Cochran on Q3 2014 Results - Earnings Call Transcript

May.28.14 | About: Cracker Barrel (CBRL)

Cracker Barrel Old Country Store, Inc. (NASDAQ:CBRL)

Q3 2014 Earnings Conference Call

May 28, 2014, 11:00 AM ET

Executives

Josh Greear - IR

Sandra B. Cochran - President and CEO

Lawrence E. Hyatt - SVP and CFO

Christopher A. Ciavarra - SVP, Marketing

Analysts

Alton Stump - Longbow Research

Joe Buckley - Bank of America Merrill Lynch Research

Michael Gallo - CL King & Associates, Inc.

Imran Ali - Wells Fargo Securities

Christopher O'Cull - KeyBanc Capital Markets Inc.

Stephen Anderson - Miller Tabak

Operator

Good day, and welcome to the Cracker Barrel Fiscal 2014 Third Quarter Earnings Conference Call. Today's conference is being recorded and will be available for replay today from 2:00 p.m. Eastern through June 12 at 11:59 p.m. Eastern by dialing (888) 203-1112 and entering passcode 6983800.

At this time, for opening remarks and introductions, I would like to turn the call over to Josh Greear. Please go ahead, sir.

Josh Greear

Thanks, Eli. Good morning, and welcome to Cracker Barrel's third quarter fiscal 2014 conference call and webcast. This morning, we issued a press release announcing our third quarter and outlook for the 2014 fiscal year. In this press release and on this call, we will refer to non-GAAP financial measures for the current quarter, adjusted to exclude proxy contest expenses and the related tax effects.

We will also refer to non-GAAP financial measures for the prior year, adjusted to exclude charges and tax effects related to severance and prior year proxy contests, as well as adjustments related to the retroactive reinstatement of the work opportunities tax credit.

The company believes that excluding these charges and tax effects from its financial results provides information that may be more indicative of the company's ongoing operating performance while improving comparability to prior periods. This information is not intended to be considered in isolation or as a substitute for financial information prepared in accordance with GAAP.

The last page of the press release includes a reconciliation from the non-GAAP information to the GAAP financials. The press release can be found on the Investors section of our website, crackerbarrel.com.

In the press release and during this call, statements may be made by management of their beliefs and expectations of the company's future operating results or expected future events. These are what are known as forward-looking statements, which involve risks and uncertainties, and in many cases, are beyond management's control and may cause actual results to differ materially from expectations.

We urge caution to our listeners and readers in considering forward-looking statements and information. Many of the factors that could affect results are summarized in the cautionary description of risks and uncertainties found at the end of this morning's press release and are described in detail in our reports that we filed with or furnished to the SEC. We urge you to read this information carefully.

We also remind you that we do not comment on earnings estimates made by other parties. In addition, any guidance or outlook we provide or statements we make regarding trends speak only as of the date they are given and we do not update or express continuing comfort with our guidance, outlook or trends, except in broadly disseminated disclosures, such as this morning's press release, filings with the SEC or as otherwise required by law.

On this call with me this morning are Cracker Barrel's President and CEO, Sandy Cochran; Senior Vice President and CFO, Larry Hyatt; and Senior Vice President of Marketing, Chris Ciavarra.

Sandy will begin with a review of the business and Larry will review the financials and outlook. We will then open the call up for questions for Sandy, Larry and Chris. We ask that you please limit your questions to matters related to the company's performance, outlook and plans.

With that, I'll now turn the call over to Cracker Barrel's President and CEO, Sandy Cochran. Sandy?

Sandra B. Cochran

Thank you, Josh. Good morning, everyone. This morning we announced our sales and earnings for the third quarter. During the quarter we improved our operating margins and outperformed the restaurant industry as measured by the Knapp-Track casual dining index for the 10th consecutive quarter, despite our comparable store traffic and retail sales being down on a year-over-year basis.

This was performance was achieved against the backdrop of a challenging consumer environment, increasing promotional behavior by our competitors and severe winter weather, all of which we believe negatively impacted our store traffic in sales. I'm pleased with the performance of our field teams and their ability to preserve margins during this challenging quarter.

Looking at our retail business during the quarter, we increased comparable store retail sales by 0.9%, while improving our retail gross margin by 140 basis points. As a result of the Board and management's confidence in the company's strategy and in keeping with our focus on delivering shareholder value, during the quarter we declared a $1 per share of quarterly dividend reflecting an increase of 33% over the previous quarter's dividend.

This morning, I will update you on the progress we've made around our 2014 business priorities and then Larry will provide more detail on the financial results for the quarter. To reiterate, our 2014 business priorities include the following. First, a focus on better-for-you menu additions and reinforcing everyday value on our menu. Second, continue messaging in support of the brand, menu and merchandize. Third, drive retail sales with improved quality and breadth of our merchandize assortment. Fourth, improve operations and margins by applying technology and process improvements. And fifth, to maximize long-term total shareholder returns.

Starting with the menu. During the third quarter we built upon the Wholesome Fixin's platform by offering five new better-for-you promotional items. These included a Citrus Spiced Rubbed Chicken Breast and oatmeal topped with apples and cinnamon, a Smoky Southern trout, a steak and egg breakfast for under 450 calories and a delicious Southern caesar chicken salad. In addition, we continue to reinforce the affordability of our menu by offering value offerings within our menu promotions.

Spring promotion which is in in-stores now includes a stapled insert in the menu highlighting our full line of country dinner plates priced at $769. We rounded out our third quarter menu promotions with a few of our traditional guests favorites. With our second priority focused on messaging, we have continued our advertising strategy focusing our national cable television spend mostly in our busiest quarters, the second and fourth quarter.

So while the third quarter was fairly quiet in terms of traditional advertising, we continued to focus on strengthening our relationships with our guests through the use of alternative channels such as digital, media and our music program. We use our website and social media outlets to support our menu promotions and to introduce new retail themes.

During the quarter, we successfully launched an exclusive music project with Michael W. Smith. The exclusive CD titled Hymns reached number one on Billboard's Christian albums music chart and has remained in the top 10 for the first seven weeks of the release.

In our retail business, our third priority, we continue to see strength in our apparel and accessories categories, largely driven by Women's Cardigans, fashion scarves and our new footwear category. Our merchandizing team was able to optimize on sustained guests interest in the category by expanding the overall assortment of offerings during the quarter. Additionally, our wall décor theme especially items containing sentiment was positively received by our guests during the third quarter and supported year-over-year growth within our home décor category.

We continue to make progress on our fourth initiative to improve margins. Our improvements in technology and process enhancements have resulted in our field management team's ability to maintain operating margins in a very tough operating environment. The investments that we've made in our labor management system and training platforms have allowed our operations team to continue to deliver a great guest experience, and our guest survey scores continue to remain high and showed year-over-year improvement in both overall satisfaction and overall value.

Our fifth business priority is a continued focus on maximizing shareholder return by increasing the quarterly dividend, expanding the footprint through new unit growth and extending the brand outside of the four walls. As I mentioned earlier, we announced a quarterly dividend of $1 per share. This increase represents an increase of 33% over the previous quarter's dividend and an increase of more than 350% over the last dividend prior to the announcement of the company's strategic priorities in September of 2011.

While immaterial to our P&L, we continue to be pleased with the progress of our licensed food products sold in grocery stores. Our bacon products continued to gain distribution and rank high in sales among other nationally recognized brands. During the third quarter, we introduced an applewood sliced bacon and five types of sliced-to-order deli meats.

In addition, we believe our guests positively responded to our second seasonal offering of our CB Old Country Store spiral ham during the Easter holiday. Earlier this month, we introduced two types of jerky exclusively in our Cracker Barrel retail stores and will continue to build on our licensing platform throughout the calendar year.

As we look to the fourth quarter, we have several plans to support our business priorities that we'd like to share. During the fourth quarter, we'll focus on expanding the footprint through the opening of four new stores. We're also reintroducing one of our most popular menu promotions, campfire chicken and campfire beef. These foil-wrapped camp style products will headline as limited time only offerings within our summer menu promotion.

Additionally, we'll continue to promote the Cracker Barrel brand through national cable TV and expand value messaging through our billboards. New billboard creative will communicate value positions at both lunch and dinner with $599 and $769 price points.

On May 21, we launched a nationwide charity auction to benefit the National Military Family Association, the NMFA. Proceeds from the Four-Star Salute, Cracker Barrel's military family online charity auction will support the NMFA's Operation Purple Family Retreat program. It's an opportunity to help our returning servicemen, women and their families while at the same time raising the awareness of the Cracker Barrel brand in a way that is consistent with our brand values.

We look forward to continuing our support of military families. The auction will be running through July 7 with five rounds of compelling priced packages including generously donated experiences such as Dollar General NASCAR racing experience, whitetail hunting with Austin Manelick in Allegheny, Tom Joyner Family Reunion and concert experiences with a range of artists from Dailey & Vincent to Romeo Santos. We encourage everyone to join us in support of this worthy cause.

I also want to mention that we were recently named in the list of America's 100 Most Trustworthy Companies published in Forbes Magazine. This list was developed by GMI Ratings which evaluated the accounting and governance behaviors of more than 8,000 publicly traded companies in North America. We are proud to be on the list and we believe further demonstrates that Cracker Barrel is a brand not only that our customers can trust but a solid long-term investment our shareholders can trust.

Finally, I'd like to share a few highlights from our May 1 analysts and institutional Investor Day. At the meeting we presented an update to our long-term strategy to enhance the core, expand the footprint and extend the brand. We shared our plans to increase relevance to draw traffic and sales in both the restaurant and retail business, implement geographic pricing tiers to optimize average check and reengineer store processes to drive margins.

We'll introduce our new Fusion prototype kitchen and selectively enter new markets and we'll build on the initial success of the licensing business, we'll leverage brand strength into a new fast casual prototype and grow retail into an omni-channel business. For more information on the meeting, please see the Investor Relations section of our website.

In closing, the Cracker Barrel Board and management team is focused and excited about the future and I remain confident that we have the right strategy and leadership in place to move the brand forward and drive long-term shareholder value.

With that, I'll hand the call over to Larry for more details on the quarter.

Lawrence E. Hyatt

Good morning, everyone, and thank you, Sandy. I would like to begin by discussing our financial performance for the third quarter of fiscal 2014 and then our outlook for the 2014 fiscal year.

For the third quarter of fiscal 2014, we reported net income of $28.7 million or $1.20 per diluted share. When adjusted for charges related to the April special meeting of shareholders, our adjusted net income was $1.23 per diluted share, a 20.6% increase over earnings per diluted share of $1.02 in the prior year quarter.

Our revenue in the quarter was $643.3 million, a 0.5% increase over the $640.4 in the prior year third quarter. Our restaurant revenues were $523.6 million and retail revenues $119.7 million. Our comparable store restaurant sales decreased 0.6% as average check increased 2.3% and traffic declined 2.9%. The increase in average check reflects menu price increases of approximately 1.8% and a favorable mix impact of 0.5%.

Our comparable store retail sales increased 0.9% for the quarter. Our total cost of goods sold in the quarter was 31.3% of revenue, a reduction of 20 basis points from the prior year quarter. Our restaurant cost of goods was 27.1% of restaurant sales which is flat to the prior year quarter. On a constant mix basis, our commodity costs declined 0.6% in the quarter compared to the prior year quarter, as increases in beef and seafood were offset by reductions in most other areas.

This reduction in commodity costs and the impact of higher menu prices were offset by the mix shift to higher cost menu items and increases in food waste. We believe that the increase in the food waste was caused by the unpredictable weather and traffic patterns in the quarter which made it difficult for our stores to accurately forecast production.

Our retail cost of goods was 49.9% of retail sales, an improvement of 140 basis points compared to 51.3% in the prior year quarter. This year-over-year improvement was the result of higher initial markups, reductions in freight expense and reduced shrinkage, partially offset by higher markdowns. Our retail inventories at the end of the quarter were $110.5 million, an increase of $12.4 million over the prior year quarter. This increase was primarily the result of higher in-stock positions in women's apparel, accessories and toys.

Our labor and related expenses were $243 million or 37.8% of sales which was flat as a percentage of sales to the prior year quarter, as lower store bonus expenses were offset by higher employee benefits expenses and store management labor. Our other store operating expenses in the quarter were $121.1 million or 18.8% of revenue compared with $116.4 million or 18.2% of revenue in the prior year quarter. This year-over-year increase of 60 basis points is due primarily to an increase in utilities, supplies, maintenance and depreciation expenses.

Our store operating income was $77.8 million or 12.1% of revenue compared with $80.2 million or 12.5% of revenue in the prior year quarter. On a GAAP basis, our general and administrative expenses in the quarter were $32.5 million or 5.1% of revenue. Adjusted to exclude special meeting expenses, our G&A expenses were $31.4 million or 4.9% of revenue compared with G&A expenses of $36 million or 5.6% of revenue in the prior year quarter. This 70 basis point reduction was primarily a result of lower incentive compensation.

On a GAAP basis, our operating income was $45.2 million or 7% of revenue. Adjusted for special meeting expenses, our adjusted operating income was $46.3 million or 7.2% of revenue, a 30 basis point improvement compared with operating income of $44.2 million or 6.9% of revenue in the prior year quarter.

Our interest expense in the quarter was $4.3 million compared to $10.2 million in the prior year quarter. This reduction in year-over-year interest expense was due primarily to lower interest rates following the expiration of our swaps at the end of last year's third quarter, reduced levels of borrowing and a lower credit spread on our bank facility.

Our effective income tax rate was 29.7% for the quarter compared to 27.6% in the prior year quarter. The tax rate for the current quarter and the anticipated tax rate for the full fiscal year reflect the expiration of the work opportunity tax credit on December 31 of 2013.

Our capital expenditures for the quarter were $23.9 million compared to $16.4 million in the prior year quarter, reflecting higher spending on new stores and store maintenance capital. Our balance sheet continues to be strong. We ended the quarter with $88.2 million of cash and equivalents and our total debt is approximately $400 million.

With respect to our outlook, everyone should be mindful of the risks and uncertainties associated with this outlook, as described in today's earnings release and in our reports filed with the SEC. So bearing that in mind, we now expect to report adjusted earnings per diluted share for the fiscal year between $5.50 and $5.60 which implies adjusted EPS for the fourth quarter of between $1.50 and $1.60. We currently expect our full year and quarterly adjusted EPS to be close to the midpoint of these ranges.

We now expect total revenue for fiscal 2014 of approximately $2.7 billion reflecting anticipated increases in comparable store restaurant sales of approximately 0.5%, approximately flat comparable store retail sales and the expected opening of seven new Cracker Barrel stores. We continue to expect increases in food commodity costs on a constant mix basis of approximately 2% for the fiscal year and we expect commodity costs increases of approximately 2.5% for the fourth quarter. We have locked in our pricing on more than 90% of our expected commodity requirements for the remaining quarter of fiscal 2014 which is similar to our locked percentage at this time last year.

We expect our adjusted operating margins for the year to be between 7.7% and 7.9% of revenues, depreciation expense of between $68 million and $70 million and net interest expense of between $17 million and $18 million. We expect an effective tax rate for the year of between 31% and 32% and capital expenditures for the year in the range of $90 million to $100 million.

The reduction in our full year earnings guidance reflects a more cautious outlook for the fourth quarter comparable store sales and higher expected commodity cost increases particularly in pork, beef, eggs and dairy. The unexpected increases in pork prices are due to the PED virus while the unexpected increases in beef prices are due to the loss of favorable fixed price contracts as a result of the bankruptcy of a major supplier.

Our guidance for adjusted earnings per diluted share does not include any expenses related to the November proxy contests or the special shareholders meeting in April nor any severance or other charges related to any organization changes. Proxy contests expenses related to the November annual shareholders meeting were $0.09 per diluted share while the expenses associated with the special meeting of shareholders on April 23 were $0.03 per diluted share.

With that, I will now turn the call over to the operator for your questions. Thank you very much.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We'll be going to first question today from Alton Stump with Longbow Research. Please go ahead.

Alton Stump - Longbow Research

Thank you and good morning.

Sandra B. Cochran

Good morning.

Alton Stump - Longbow Research

Thanks Sandy for all the color on the new product front in your opening remarks. Obviously you guys are going to be wrapping up I guess Wholesome Fixin's launch a bit later on this summer. Just want to get an idea of as you look at your new product endeavor over the next six to 12 months, how much of that do you think will be adding lines to the Wholesome Fixin's portfolio versus possibly some new categories?

Sandra B. Cochran

Well, I'm going to let Chris add the detail but in general we've got a number of initiatives focused on our menu that address generally what we continue to see which is a need to reinforce our value position and to offer value to our guests and then secondly to broaden our reach through a variety of programs. So let me let Chris sort of expand on that.

Christopher A. Ciavarra

Thanks, Sandy. Good morning. So on a value front we, as Sandy said, believe we need to continue to reinforce the marketplace, us being a destination for everyday values. So we have two main programs; our weekday lunch special program and our country dinner plates program. As Sandy indicated we are pushing a good portion of our billboards back to message on that. We have plans to kind of revitalize our weekday lunch special program within this fiscal year, add new products that will add reach on an everyday basis. So think of things like our LTO this past winter where we had a sandwich and soup offer and adding and reach. Our country dinner plates are in market right now. We'll continue to message against that. The second leg for us we continue to think about is better-for-you and as you noted, we did launch our Wholesome Fixin's category last fall. It's done a good job improving perceptions around offering fresh healthy options, if you will, fresh ingredients, restaurant I can trust, things like that. We've seen positive movements in those perceptual measures. We plan on continuing to add to that category. We've got a variety of new products coming that will add reach and margins. So, for example, in this spring promotion we had our Smoked Southern trout which we were very pleased with. You'll see that come back on the menu later in the year. It gave the operators a chance to get familiar with the product, so look for more of that. And then as Sandy said, certainly continuing to drive news in the marketplace with flavor and so looking to do that in two ways. One is through our limited time offers which give us guests some additional choice and drives a little more frequency. So this summer we're excited to bring back our campfire beef and chicken products as well as our multigrain pancakes. And then a little further out in the future we talked about in our Analyst Day sort of a midline dinner for lack of a different description for it at the moment, a category that would fit between our country dinner plates and our Fancy Fixin's that would pull from some existing products, some new products and feature bolder flavors. So that's what's on the horizon for us. Thank you for the question.

Alton Stump - Longbow Research

That's helpful. Thanks, Chris and Sandy. And then I guess just to follow-up, any idea on the weather front, how much of an impact there was in 3Q to comps?

Lawrence E. Hyatt

Hi, Alton. Weather clearly had an impact on us in the second quarter and the third quarter, and in particular of course in the months of February and March and we also had the impact of the three-week shift of the Easter holiday from what was in the March month last year to the April month this year. As far as the specific quantification of the impact, we've not disclosed that.

Alton Stump - Longbow Research

Okay. Thanks, guys. I appreciate it.

Operator

We'll go to our next question from Joe Buckley with Bank of America Merrill Lynch Research. Please go ahead.

Joe Buckley - Bank of America Merrill Lynch Research

Thank you. I want to ask a question on sales as well, just what you said to the fourth quarter guidance. You're few weeks into the fourth quarter obviously and based on the guidance it seems like you're not seeing any real change in sales or any pickup in sales. I guess I'm curious, is there any residual effect from school holidays being shortened or things like that what you've seen so far in the fourth quarter or what you may be anticipating for the fourth quarter at large?

Sandra B. Cochran

Joe, I'll make some general comments and we don't really give a whole lot of detail on forward-looking but we continue to be cautious about the consumer for a variety of reasons including we think many of our guests are still working through the impact of the weather and that could be absorbing the additional costs that they had in terms of heating bills and so on. And in some cases we do believe that school holidays were disrupted by the amount of winter weather. Now the bulk of that we thought was focused on the spring breaks which were many school districts were either abbreviated somewhat and to some degree we think people just didn't travel because they were so abbreviated or the consumer was absorbing these additional costs. We're also cautious about the level of promotional activity that's currently going on in the market. So I think both of those factors are impacting our outlook on the fourth quarter.

Joe Buckley - Bank of America Merrill Lynch Research

Just a question on the commodity outlook. Gave very detailed numbers and kind of the abrupt swing from I think you said modest deflation in the third quarter to 2.5% inflation in the fourth. Is it just the sudden changes in the pork market and you mentioned a supplier going bankrupt as well? Is it mostly around that? And I know this isn't the forum for guidance the next year, but at the Analyst Day you talked about food inflation for fiscal '15 possibly being a little bit of both what I think you laid out as a 2% to 3% kind of annualized outlook for that three-year timeframe?

Lawrence E. Hyatt

Joe, we had said actually I believe as far back as the first quarter that we expected our commodity costs to sort of hit their cyclical low in the third quarter and to gradually increase in the fourth quarter. It turned out that they increased more than we had anticipated and as I noted, a lot of that, in fact well over half of the unanticipated increase in commodity costs is a result of the pork price increases which as we understand it is directly related to the PED virus. Additionally, the bankruptcy of a major supplier which was actually continuing to operate under Chapter 11 for a couple of months and converted that to a complete liquidation within just the past few weeks which resulted in a shutdown of their operations and of course our fixed price contracts aren't very valuable. So it's been possible thanks to the great work of our strategic sourcing team for us to find additional sources of supply, but those of course have been at higher prices. Additionally, there have been some unexpected movement in the liquid dairy market and the egg market which appears to be due largely to increases in export demand.

Joe Buckley - Bank of America Merrill Lynch Research

Okay. And is it too early to talk about fiscal '15 and just how it may be shaping up on the commodity front?

Lawrence E. Hyatt

It is. We are continuing to contract as our strategic sourcing teams see the opportunities to lock in pricing for 2015, but our guidance for the 2015 fiscal year including our commodity guidance will be offered on our fourth quarter call in September.

Joe Buckley - Bank of America Merrill Lynch Research

Okay. Thank you.

Operator

We'll go to our next question from Michael Gallo with CL King. Please go ahead.

Michael Gallo - CL King & Associates, Inc.

Hi. Good morning.

Sandra B. Cochran

Good morning.

Michael Gallo - CL King & Associates, Inc.

A couple of questions. I was wondering the four stores that will open in Q4, will those have the prototype kitchen or will the first stores in the prototype be 2015?

Sandra B. Cochran

2015.

Michael Gallo - CL King & Associates, Inc.

Okay. And then a follow-up question for Larry. How much was the change in bonus accrual year-over-year?

Lawrence E. Hyatt

If you'll hold on for one second just so I can give you an appropriate answer to that question. Our change in incentive compensation between third quarter last year and third quarter this year was between 70 and 80 basis points.

Michael Gallo - CL King & Associates, Inc.

Okay. Thanks very much.

Operator

We'll go to our next question from Imran Ali with Wells Fargo. Please go ahead.

Imran Ali - Wells Fargo Securities

Good morning. Thanks for taking my questions. Just recapping, at your Analyst Day you talked about your plans to increase your advertising expenditures with some changes coming over the next three years. Can you just remind us about what some of these changes might be?

Sandra B. Cochran

Yes, good morning, Imran. We did talk about that and I'll ask Chris actually to expand on what he plans to do.

Christopher A. Ciavarra

Good morning, Imran. Yes, in the Analyst Day we did talk about the success we've seen over the past few years and our shift into national advertising and the various looks we've done and the fact that we believe it's had a positive impact on a financial basis and certainly in terms of being able to drive a different portion of our guest space. Our plan over the next three years calls for us to lay in, in each year sort of stair-step our way into this; and so it's not going to go all in, in year one. So it will come in each year. We'll be looking at it each year to understand its impact, make certain that's delivering what we want. And if it is continue to move forward.

Imran Ali - Wells Fargo Securities

Okay, great. And sort of a slightly different tack. In terms of expanding and you talked about this as well your Analyst Day, but in terms of expanding into new markets just the B2B market and catering and other opportunities, do you have a timeline established for those opportunities too or an updated timeline?

Sandra B. Cochran

Well, we do internally, Imran, in terms of our B2B. That's a business that we currently do and what we plan to do over the next three years is to introduce technology offerings, packaging and so on marketing all to do a better job of delivering the business that we currently have and to hopefully grow that business. So, I think what we announced in Analyst Day as one of the first steps is an online ordering platform which should be this fall and then we'll be sort of adding different elements as we go. There will be more on that in our September guidance for '15.

Imran Ali - Wells Fargo Securities

Okay. Thanks very much. I appreciate it.

Sandra B. Cochran

Thank you, Imran.

Operator

We'll go to our next question from Chris O'Cull with KeyBanc.

Christopher O'Cull - KeyBanc Capital Markets Inc.

Thanks. Good morning, guys.

Sandra B. Cochran

Good morning.

Christopher O'Cull - KeyBanc Capital Markets Inc.

Larry, the restaurant margin fallen in the past four quarters and it looks like you expect it may fall in the fourth. So my question is what comp increase do you think you need to keep the margin flat year-over-year?

Lawrence E. Hyatt

Chris, it's a difficult question to answer because of course there's a lot of factors that go into those store margins. As we've said, there are going to be quarterly fluctuations in our retail cost of goods sold. We have seen that. There can be some unanticipated changes in our restaurant cost of goods sold. Typically, if our pricing increases pulls through even with traffic flat, you should see store margins constant to slightly increasing.

Christopher O'Cull - KeyBanc Capital Markets Inc.

Okay, great. And then can you remind us where you are in terms of reducing the plate ware and maybe help us ballpark, what's the impact of that change?

Sandra B. Cochran

Chris, we will be sorting that initiative rolling out in the beginning of the next fiscal year. We haven't yet – we've quantified, we haven't yet laid out the specific numbers. That will be part of our guidance in September but that's actually a project that will – I think we anticipate some benefit in FY '15 and in FY '16.

Lawrence E. Hyatt

Chris, just to remind those on the call who may not have had an opportunity to go through our Analyst and Investor Day information, we anticipate that between now and 2017 that we will identify and will implement about $50 million of annual cost savings. 20 billion of that's expected to come out of labor costs, 20 million of that out of store management, about 5 million out of utilities and 5 million out of various other things. The plate ware initiative will be a meaningful part of that $20 million of labor cost savings and will also be a part of the utility cost savings although most of the utility cost savings is expected to come from the installation of energy management systems in our stores.

Christopher O'Cull - KeyBanc Capital Markets Inc.

Just as a follow-up, is it reasonable to assume that plate ware changes will be the most meaningful cost cutting improvement or opportunity in the next 12 months?

Lawrence E. Hyatt

We certainly expect it to be a meaningful opportunity in 2015 fiscal year. I don't know if I would necessarily say the most meaningful.

Christopher O'Cull - KeyBanc Capital Markets Inc.

Okay. Thanks.

Sandra B. Cochran

Thanks, Chris.

Operator

We'll go to our next question from Steve Anderson with Miller Tabak Research Firm. Please go ahead.

Stephen Anderson - Miller Tabak

Yes. Good morning and actually we spoke earlier but I want to touch now on the retail side of the business and wanted to see where you're markdowns were relative to the year ago basis? I have a follow-up on inventories.

Sandra B. Cochran

Good morning, Steve. I'll let Larry summarize what part of that he discloses.

Lawrence E. Hyatt

Hi, Stephen. As noted, our retail cost of goods margin improved 140 basis points in the third quarter versus the prior year's third quarter and that improvement was a result of having prior initial markups. We're continuing to see reductions in our paid expense as a result of our transportation management system. We are controlling shrinkage and we saw some meaningful benefit there. And as you know that was partially offset by higher markdowns. In terms of the specific, markdowns weren't that much more significant in the aggregate in the third quarter of this year than they were in the prior year and you really have to offset those against the fact that our initial markups were higher.

Stephen Anderson - Miller Tabak

I understand. And with regard to your increase in inventories, I noticed there in the categories where you've seen stronger sales, I mean is that reflective of any other inventory overhang?

Lawrence E. Hyatt

No. Our sales of women's apparel and accessories in particular have been very strong and that is a place a lot of the retail inventory increase has come. If there is one area that we perhaps are a little heavier in inventory than we might like, it would be in toys.

Stephen Anderson - Miller Tabak

All right, thank you.

Operator

It appears there are no further questions at this time. I would like to turn the conference back over to Susan Cochran for any additional remarks or closing.

Sandra B. Cochran

Thank you all for joining us today. I continue to be pleased with our ability to manage through a challenging period. We look forward to the summer travel period and continued progress on our business priorities during the last half of the year. We appreciate your interest and support and look forward to talking to you next quarter. Thank you.

Operator

That concludes today's conference. We appreciate your participation.

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