Chico's FAS' (CHS) CEO Shelley Broader on Q3 2016 Results - Earnings Call Transcript

| About: Chico's FAS, (CHS)

Chico's FAS, Inc. (NYSE:CHS)

Q3 2016 Earnings Conference Call

November 22, 2016 8:30 AM ET

Executives

Jennifer Powers – Vice President-Investor Relations

Shelley Broader – Chief Executive Officer

Todd Vogensen – Chief Financial Officer

Analysts

Kate Fitzsimons – RBC

Neely Tamminga – Piper Jaffray

Betty Chen – Mizuho Securities

Julie Kim – Nomura

David – SunTrust

Paul Lejuez – Citibank

Janet Kloppenburg – JJK Research

Adrienne Yih – Wolfe Research

Marni Shapiro – Retail Tracker

Susan Anderson – FBR Capital Markets

Operator

Good day, and welcome to the Chico's FAS Third Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Ms. Jennifer Powers, VP-Investor Relations. Please go ahead.

Jennifer Powers

Thanks, Arenson, and good morning, everyone. Welcome to Chico's FAS third quarter earnings conference call and webcast. Joining me today at our National Store Support Center in Fort Myers are Shelley Broader, our Chief Executive Officer; and Todd Vogensen, our Chief Financial Officer.

As a reminder, any forward-looking statements that we make today are subject to risks and uncertainties, the most important of which are described in our SEC filings and in today's earnings release. In these remarks, we are excluding Boston Proper from all financial data discussed for comparability purposes. Additionally, we'll refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP earnings per share is included in today’s press release for your reference.

And with that, I'll turn it over to Shelley.

Shelley Broader

Thank you, Jennifer and good morning everyone. Our third quarter earnings exceeded our expectations. Our performance reflects the significant progress we are making on our strategic plan and the successful execution of our initiatives to transform Chico's FAS for the future. We achieved a 54% increased in adjusted earnings per share to $0.20 versus $0.13 last year despite a 4.8% decline in consolidated sales excluding Boston Proper.

Additionally, our operating margin increased to 7% from 4.6% last year as we improved our merchandise margin rate, accelerated our cost reduction initiatives, and reduced consolidated inventory. Our ability to leverage expenses in a continually challenging environment reinforces our confidence that we are on the right path to return the Company to double-digit operating margin. We are in the second phase of our strategic plan.

Executing on the cost reduction and operating efficiency initiatives that we announced earlier this year and detailed during our recent analyst and investor event. We responded to a weaker sales environment by accelerating cost savings initiatives to improve our profitability, while we set the foundation for the third phase of our strategic plan, establishing and building on our robust growth platforms for each of our iconic brands, which we expect to start implementing in fiscal 2017. Strengthening the position of each of our brands is one of our key focus areas that we expect will lead to continued improved performance across our brands.

As we discussed at our analyst and investors event, we see opportunity to appeal to a broader group of women within our existing demographic by clarifying each of our brand's position. As part of these efforts, earlier this month we hired two key senior leaders for the Chico's brand. As you may have heard, Diane Ellis joined us as our new Chico's brand President at the beginning of November. She comes to us with an exceptionally merchandising, marketing and operational background.

With over 35 years of retail experience. Her most recent role was Chief Executive Officer of the Limited Stores. Prior to the Limited Stores, she was COO of Brooks Brothers. I was truly impressed by her methodical approach to strengthening a brand by clarifying its position, understanding existing and potential customers and developing execution priorities from that deep evaluation. Moreover, her talent for tapping into current and relevant fashion trends is nothing short of remarkable. We are looking forward to her leadership and expertise to propel our brand towards sustainable growth.

We anticipate sharing her insights and priorities with you next quarter. The other key appointment that we made is our new Senior Vice President of Marketing for Chico's, to lead the brand in its efforts to deepen its connection and relevancy with women and to leverage our wealth of consumer data. This is an additional step towards moving the marketing functions back into our brands where they know our customer best.

Shelagh Stoneham has over 25 years of broad based marketing experience spanning retail, telecom and prestige cosmetic companies. Shelagh joins us most recently from Canada Shoppers Drug Mart, which leads the industry in its data driven approach to marketing and loyalty. We look forward to leveraging her expertise to help us strengthen the Chico's brand position.

Now moving to our results by brand. For the Chico's brand, slowing traffic and planned reduction in promotions led to a comparable sales decline of 5.6%. However, the brand generated higher operating income than last year, driven by an increase in merchandising margin rate and SG&A leverage. Jackets, sweaters, and denim pants did not meet our expectations and weighed on comparable sales. Conversely, Chico's Juliette pant, which was introduced in September, was the brand’s best-performing pant ever. In terms of sales, units and merchandise margins. The ankle-length versatile pull-on pant can be dressed up or dressed down and comes in a variety of colors that our of customers love. It transitions well from season to season.

The relaunch and more modern Zenergy collection Chico's version of athleisure is showing growth compared to last year. Additionally, our knits started to bounce back in August as a result of adding tunic silhouettes and more sophisticated prints. The performance of these categories is increasing our confidence in our merchandising initiatives.

Now on to White House Black Market. Similar to the Chico's brand, White House Black Market has been focusing on reducing promotions and driving more profitable sales which impacted the top line this quarter. Comparable sales were down 5.5% but the brand saw merchandise margin, SG&A, and operating margin all leveraged in addition to higher operating income than last year.

White House Black Market was also impacted by our customers' increasing tendency to buy wear-now product, which was evidenced by weakness in sweaters and knit categories. Encouragingly, sweaters did start to show strength in early October as we transitioned into fall. This bodes well for our new sweater strategy of offering more seasonless and fashion relevant choices than prior years. Meanwhile, the brand continues to see strength in denim, woven tops and jackets.

For holiday, White House Black Market is offering customers a versatile collection of curated looks in rich reds, celestial blues, silver and of course black and white. The collection features a range of styles from glam and festive to transitional looks that she can wear from work to evening. Dresses will be a big push in the fourth quarter with an expanded online dress boutique. Dresses at work from day to night and our iconic one of a kind special occasion dresses.

Next, onto Soma. Comparable sales were up 0.4% which is the brand's 29th increase over the last 30 quarters. Similar to Chico's and White House Black Market, Soma drove higher operating margin rate and operating income through the expansion of merchandise margin rate and SG&A leverage. Building on Soma's regular flow of new bras, the brand launched three in the third quarter, the memorable, the sport, and the bralette. The memorable drove sales volume for bras with its smooth memory foam that contours to the body for a natural shape.

The sport bra showed great early success but we have more work to do to broaden that offering. Early indications for the bralette are positive as the product was only set in stores at the end of October. Overall, bras, panties, dressy sleepwear and casual sets performed well. However, the fashion side of the business continued to be lacking as Soma refines its brand positioning and navigates weaker apparel traffic patterns.

Soma's holiday collection features sexier and more elevated styles with more sparkle, sheer and lace details including trend-right lace bralettes, plunge style and a cheeky panty collection. Soma will also offer many gifting options such as plush robes, slippers and pajama sets.

I continue to be bullish on our opportunity in intimates and view this as an exciting growth vehicle for the Company. We are seeing many positive trends, so we're testing and learning from them to refine Soma's model to deliver stronger growth. While we're pleased with the consistency of Soma's positive comps, we clearly expect more of the brand and of the future. We look forward to sharing more detail on these strategies in the coming months as we formulate our plans.

Now, let me turn to the headway we've been making on our cost reduction and operating efficiency initiatives. We are now in the second segment of our supply chain efficiency initiatives the product life cycle. As a reminder, the first segment was the floor-set analysis where we determined that we could decrease the cadence of our full floor-set refreshes by up to 30% and reduced our choice counts by 20%. The second segment of the initiative centered on the product life cycle has resulted in several outcomes that will become key performance indicators for our design process. First, we determined the optimal fashion pyramid composition by brand that will ensure continual flow of newness while enhancing operational efficiency. The pyramid provides a planning guideline for the timing and choices for fashion and basics.

Second, we have standardized our calendars across all three brands resulting in the reduction of our cycle time by about 25%. Now that we have placed more customer facing decision making within the brands, design merchandising and marketing will collaborate on each line from day one for a more cohesive and efficient process. Last, we are improving collaboration with our vendors by leveraging our scale with their strengths and competencies.

By building a comprehensive vendor matrix, we are now able to take full advantage of their areas of expertise, where we may have only utilized a portion of them before. We also clarified and standardized merchant and design roles and responsibilities across our three brands to enable our merchants and vendors to speed our supply chain and improve our ability to chase product and to make it much easier to share talent across our organization. Completing this behind the scenes work will enable our brands to fully focus on providing beautiful product to our customers at just the right time.

We are pleased that we drove substantial growth in operating margin and earnings during the third quarter. But we know that we still have a lot of work left in front of us as we execute on our cost reduction and operating efficiency initiatives, which we expect will generate approximately $105 million annually. These initiatives are major and complex undertakings. Ensuring their successful implementation will remain a crucial priority going forward as we secure our foundation for future top line growth and begin to ramp our revenue driving actions in fiscal 2017.

As you can see, we are taking a strategic and phased approach to driving profitable growth and value creation for our shareholders. We are augmenting our strong and talented senior executive team with top tier leaders to advance our transformation for growth. We are executing on new merchandising strategies across each of our brands. We are progressing on our cost reduction and operating efficiency initiatives. Completion of these initiatives will not only reduce our operating costs but should also produce a strong, scalable foundation that positions us for the third most exciting phase of our transform, defining and igniting new resources of revenue for our iconic brands which we expect will begin to ramp up in 2017.

And now, I'll turn the call over to Todd.

Todd Vogensen

Thanks, Shelley and good morning everyone. This quarter we made significant progress toward our goal of delivering double-digit operating margin as we expanded our merchandise margin and accelerated SG&A savings. As a result of our efforts to right-size our cost structure, our adjusted earnings per share grew 54% to $0.20. Comparable sales were down 4.9% in concert with weaker consumer spending and our planned reduction in promotional activity. Our improved profitability more than offset the decline in sales as our third quarter adjusted net income increased 49% over last year to $26 million. When excluding Boston Proper compared to the third quarter last year, we increased merchandise margin rate by 50 basis points.

We accelerated our SG&A savings to $27 million versus last year, leveraging sales by 280 basis points. We increased free cash flow by $18 million and we reduced total inventory by 2.2%, with on-hand inventory declining by 4.2%. Consistent with past quarters, our digital commerce business continued to grow at a healthy pace. Sales, conversion and merchandise margin all increased as we expanded full price sales and reduced clearance activity in the direct channel as well as in our stores. While merchandise margin rate was up solidly, gross margin dollars decreased to $230 million from $244 million last year, primarily due to the decline in sales.

The important value creation story for the quarter is that we continued to execute on our cost reduction and operating efficiency initiatives. SG&A expenses declined by 13% or $27 million this quarter, primarily from a reduction in store labor and the elimination of unproductive marketing expenses. We accelerated the timing of our marketing expense optimization, resulting in savings of approximately $17 million in the third quarter compared to last year. The decrease chiefly reflects a designed reduction in unproductive TV advertising, as we optimized the allocation of funds to digital versus traditional mediums.

Our goal is to drive profitable sales, not sales at any cost, and we believe a more strategic ad spend that emphasizes digital can help us achieve this objective. Please note, since we historically have run the majority of TV in Q1 and Q3, we do not expect to see the same level of marketing savings in the fourth quarter. Operating margin increased 47% or 240 basis points to 7% of sales compared to 4.6% last year. As a result, adjusted earning per share grew to $0.20 from $0.13, a 54% increase versus last year.

Turning to the balance sheet. We ended the quarter in a strong cash position with $131 million in cash and short-term investments. Our free cash flow increased by $18 million to $12 million, up from a negative $6 million in the third quarter last year. Capital expenditures totaled $9 million in the third quarter, mostly comprised of investment in existing stores and technology. During the quarter we opened one new store and closed eight.

Our strong free cash flow enabled us to return $31 million to shareholders by repurchasing $20 million of common stock and paying $11 million in dividends. $184 million remains outstanding under our stock repurchase authorization. We also repaid $2.5 million in scheduled principal payments, ending the quarter with $85 million outstanding on our term loan. Capital allocation going forward will continue to emphasize value creating investment and shareholder returns.

Now I'll update you on our financial outlook for the rest of the year. We continue to see a challenging and competitive apparel retail environment. As a result of the environment, and our priority to drive profitable sales, we expect comparable sales to be down a low single-digit percentage in the fourth quarter. We do expect that execution of our cost reduction and operating efficiency initiatives will continue to drive savings to the bottom line, although not to the extent of Q3. Our ongoing focus on retail science and robust inventory management should allow us to leverage merchandise margin rate in the fourth quarter via effective pricing and strategic promotions.

However, our occupancy costs will likely deleverage with lower sales, resulting in slight gross margin deleverage. SG&A savings from our cost reduction and operating efficiency initiatives should roughly offset this gross margin pressure, resulting in an approximately flat operating margin rate compared to last year. Now that we have made significant strides through Q3 on our initiatives to adjust our cost structure, we expect to continue leveraging SG&A in the fourth quarter and for the full year 2016. However, the SG&A savings we realized in the fourth quarter will not be as large as we realized in the third quarter.

The reason is two-fold. First, store expense savings will be moderated as our associates will be focused on delivering our most amazing personal service. And second, we expect marketing expenses in Q4 to be generally higher than Q3 due to holiday marketing campaigns. That said, we have increased our estimate of overall marketing savings that we communicated at our investor and analyst event, based on testing and our marketing mix analysis. We are now expecting to save $20 million in marketing expenses this fiscal year for a total of $30 million on an annualized basis, which represents a $5 million increase over the savings targets that we discussed previously.

Thus, we expect our total cost reduction and operating efficiency savings from all of our previously announced initiatives to be between $95 million and $115 million on an annualized basis. As a result of our successful learnings around inventory management, we have planned inventory in the fourth quarter to be down compared to last year. We're still planning to close approximately 35 stores this fiscal year as we discussed last quarter.

As we've stated before, the closures will be primarily in the Chico's and White House Black Market brands. Our sales transfer rates from our closed store locations continue to be approximately 50% and continue to exceed our expectations and industry benchmarks. These high sales transfer rates from our loyal customers combined with the strength of our online business, reinforces our belief that rationalization of our fleet will lead to improved Company performance over time. And we will continue to move forward with store closures at a pace that best optimizes the changing retail landscape and our lease expirations.

Our capital expenditure estimate for the year has not changed from $60 million. CapEx reflects our plans to open approximately 17 stores more than half of which will be Soma stores. In addition, we will continue to invest in existing stores and technology to advance our priorities to evolve the customer experience.

In conclusion, we are confident in our future. Yet again, we executed on our plan and achieved the goals we set. We generated healthier sales and as demonstrated by the considerable growth in operating margin and earnings that we delivered in the third quarter. We also continue to strengthen our management team. As Shelley stated, we recently appointed new senior management to our Chico's brand with the addition of Diane Ellis, our new brand President; and Shelagh Stoneham, our new brand marketing, Senior Vice President.

We look forward to their talented leadership and their fresh perspective to write the next chapter for the Chico's brand. Additionally, as we mentioned at the analyst and investor event, we're building a new business development international and strategy group. We recently hired a leader for the team and look forward to updating you as they move forward on the third phase of our strategic plan, driving new sources of revenue for our three powerful and differentiated brands.

Now, I'd like to turn the call back over to Shelley.

Shelley Broader

Thanks Todd.

Todd Vogensen

Thanks Shelley.

Shelley Broader

Thank you, Todd. While we expect this challenging macro-environment to continue, we believe that our agility to adjust and refine our operating model will ensure we survive and thrive. I continue to be enthusiastic about the future of Chico's FAS. We are transforming our Company for long-term, profitable growth and value creation and I am pleased that the actions we have taken are resulting as planned. Our energized team, our brand positioning, our beautiful merchandise and our connection with our customer are at the core of all of our efforts.

Given the powerful and differentiated brands we have and our very loyal customer, we see tremendous opportunity to strengthen our brands positions through merchandising and marketing efforts. We also see considerable potential to successfully compete in new channels, as we continue to deliver on the promised actions of our four focus areas. We are becoming more nimble, adapting faster to our customers' needs, all the while improving our efficiency and cost structure.

Thank you. I'll now turn the call back to Jennifer for Q&A.

Jennifer Powers

Thank you, Shelley. At this time, we'll be happy to take your questions. In the interest of time and consideration to others, please limit yourself to one question. And I'll turn the call back over to Arenson.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Brian Tunick of RBC. Please go ahead.

Kate Fitzsimons

Yes, hi this is Kate Fitzsimons on the call for Brian. Thanks for taking our questions and congratulations on navigating well in a tough environment. I guess my first question would be on just any comments on monthly cadence that you saw in the third quarter or differences in regional performance, just any color there would be helpful. And then I guess Todd, when we’re thinking about the negative low single-digit fourth quarter guide, what are you embedding there in terms of comp levers and what should we think about sequentially improving from the down 4, 9 in 3Q? We've heard some mixed things on November traffic quarter to-date, so just any color there would be helpful? Thank you.

Todd Vogensen

So, I think as we look at monthly cadence and generally how we viewed the brands performing across the course of Q3, a lot of it had as much as anything the effect of what we were wrapping around on from last year. I would say generally we didn't see any massive shifts on a two year basis, either geographically or in total. So the real driver was the fact that as we go to being much more after a higher quality sale, we pulled back on promotions kind of across the board. And that as much as anything drove the comp through the quarter, resulted in higher average unit retail and resulted in the higher maintained margin which is really what we are looking for as we drive towards more profitable sales overall. And that should really drive forward as we go into Q4 that I think should be the story line for us.

We've entered the quarter lean on inventory. November has started off solidly for us, which is reflected in that data point of financial outlook that is geared towards a sequential improvement in comp sales. And at the same time, we intend to be very controlled on the amount of promotions and on our inventory as we go through the quarter.

Kate Fitzsimons

Great, best of luck.

Todd Vogensen

Thanks a lot, Kate.

Operator

Our next question comes from Neely Tamminga of Piper Jaffray. Please go ahead.

Neely Tamminga

Great. Good morning. Hey, following up on that, Todd, on the inventory side – maybe pre-shopping for ourselves here for White House Black Market we're noticing quite a bit of out of stocks. So I guess the question we have is you're lean on inventory, that’s great, but is there any way to kind of in-season effect some of your levels and possibly kind of reaccelerate on some of this like party dresses and things that are going to be very topical for her over the next couple of weeks? Thanks.

Todd Vogensen

Hi, you bet. Thanks Neely. So a couple of things that are unique going on at White House Black Market. We are building in a fair amount of ability to get out there and actually go after products that chased into products that are working well. So there is that element of the assortment. The other thing that just to be transparent, we have had some delivery slips versus when we had originally planned our stage sets. So the fact that you are seeing some out of stocks there for White House’s, probably not surprising. We're fortunate that it happened during the time of the quarter that is probably the least impactful from a total sales perspective and feel like we should be getting back into stock really now. So we'll be well positioned as we go into the rest of the quarter.

Neely Tamminga

Thank you. Good luck.

Todd Vogensen

Thank you.

Operator

Our next question comes from Betty Chen of Mizuho Securities. Please go ahead.

Betty Chen

Thank you. Good morning. Congratulations on nice execution there. I was wondering if you can talk a little bit about I think it's the fashion pyramid that you alluded to that would distinguish sort of the composition of fashion and basics. Can you share with us what proportion or how that pyramid may look like? And is that also something that we can anticipate being visible by the second half of 2017 along with some of the calendar changes that you alluded to at the Analyst Day? Thanks.

Shelley Broader

Sure. Hi, Betty, how are you. I can start with that. First of all, we treat ourselves as a fashion boutique and I think for many, many years we treated every single SKU as though it were a unique fashion item and because of the robust amount of data that we have it's easy for us to see when we've got a repeat customer after a basic item.

So in many ways we've just taken our assortment and said what is an item that we want to carry 365 days a year that our loyal customer comes in and loves, and how do we make that product the most efficient, how do we partner and position fabric, how do we make sure as we talked about that supplier matrix we talked about earlier that we are utilizing those basic products with the most advantageous supplier, both for cost and quality.

And that level is very different from Chico's to White House to Soma. And so this is a business of fashion. So it's at the top of the pyramid we've got our most exciting fashion forward product and that's what continues to make us relevant and exciting to consumers. Underneath that probably the majority of product that we sell is in that trend-right product, where we will be introducing a lot more chase than we have been now to make sure that we can read and react, and at the bottom in the base of our pyramid will be that profitable our renewable resource that you have in new basic products that we're selling today.

Betty Chen

And what about in terms of timing, Shelley?

Shelley Broader

We're starting to institute that today. We're starting to institute that now and we'll really be seeing that significantly in the second half of next year.

Betty Chen

Okay. And I don't know if I could have a follow-up for Todd. In term of the merchandise margin rate increases for the brands, any sort of help there in terms of maybe which brand saw the most or maybe rank the brands in terms of the merchandise margin rate increases and also remind us if you can where the brands are in terms of historical merchandise margin rate. So we can get a sense of their opportunities. Thanks.

Todd Vogensen

So I think coming into the year we are pretty transparent that I think both White House and Chico's had a fair amount of opportunity and that continues to be the case. Both brands are really looking to get back to more historical norms on merchandise margin and that is what you saw reflected in the bridge to that double-digit operating margin that we shared during our Analyst and Investor event.

And so going forward it really should be both of those brands driving that merchandise margin expansion as they look to be a little bit more targeted on their promotions, more specific on allocations and so forth.

Shelley Broader

The other piece too to address on that fashion pyramid, also in combination with the question of White House out of stocks earlier, is as we get into these special occasions, back into that special occasion dress business and into that exciting top of the pyramid more fashion forward, we do operate boutiques and we expect there to be a sense of urgency and scarcity around that exciting fashion forward product and that's really the essence of what we're trying to do we need. It's the get it while it's hot at the top of the pyramid. Where the bottom of that pyramid on basics is something that you want to find day in and day out throughout our boutiques.

Betty Chen

Okay great, thank you so much. Best of luck for the holidays.

Shelley Broader

Thank you.

Todd Vogensen

Thanks.

Operator

Our next question comes from Simeon Siegel of Nomura. Please go ahead.

Julie Kim

Good morning. This is Julie Kim on for Simeon. Thank you for taking our question. Do you have any updated thoughts on the path to returning to positive comps and what levers you have the most opportunity there, for example transactions or UPT. Thank you.

Todd Vogensen

Sure, thanks, Julie. So as we're looking at our overall sales growth, I think the bottom line is at this point we are looking for healthy, profitable sales. And the path of getting our sales to healthy profitable sales means that we have a lot of initiatives we're working on from an operating efficiency perspective. As Shelley alluded to in her script that are not check the box, easy, be done and move on type of things. They're projects that really transform the Company and that are going to take a little bit of time to get through as we go into next year.

At the same time, we are laying the groundwork for improved top line performance and you're seeing that through some of the hires we've made both in the Chico's brand as well as in our business development, international and strategy area and working really in 2017 to lay the groundwork for improved top line performance.

And so you'll continue to hear us say that same thing even as we go into 2017, because we think we could chase sales but make for a very nice headline but we're really looking to build a solid foundation for our long-term growth and that's something that will take us into 2017.

Shelley Broader

And another piece of that too, Julie, is we're very focused on our four strategic focus areas of which one of them is leveraging actionable retail science. And because more than 90% of our transactions go through our loyalty program, we have the ability to know what motivates our customer and who is sticky.

And we can see when you're in the business of renting sales and when you're in the business of high promotional activity, we now understand the stickiness of those customers and their lifetime value to us. And quite frankly, we're much better off as Todd alluded to building these profitable sales over the long haul on this sustainable base that we're building today. And you'll start to see us talk about with much more frequency our revenue driving opportunities in 2017.

Julie Kim

Great. Thank you.

Todd Vogensen

Thank you.

Operator

Our next question comes from Pamela Quintiliano of SunTrust. Please go ahead.

David

Hi, this is David for Pam Quintiliano. Thanks for taking our questions. Can you touch on the health of the consumer and the shopping habits heading into and post the election and the variance between divisions?

Todd Vogensen

Sure. I think probably the – sorry we're getting a little feedback.

Operator

It seems that there's a little bit of feedback coming from the questioner's line [Operator Instructions].

David

Hi, can you just touch on the health of consumer and the shopping habits heading into and post the election and the variance between divisions?

Todd Vogensen

Absolutely. Thanks David…

Shelley Broader

So David, you need to go on mute.

David

Okay.

Todd Vogensen

Okay. So we've talked about for a long time that our Chico's customer is one that is very savvy, very accustomed to the kind of – the CNN effect and can be influenced by it. So I think it's not a shock to anybody that this was fairly dramatic election season and I think we are all looking forward to the elections being done and moving on at this point. It's very difficult to parse out how much of behavior might be related to looking at elections and getting caught up in the news cycle, versus other things that are going on from a macro perspective.

But certainly as we look forward, we think our best path forward is to focus on our internal initiatives. As we do look at improving customer experience and strengthening brand position, those are the types of things that are the long-term initiatives that should stand the test of time and get us through any periods where there is ups and downs due to noise in the environment. And so that is where our focus is and we're very excited about the health of the customer for all of our brands at this point.

David

Great. And also as we think about holiday, are there any changes to timing of flows or cadence of marketing events, anything else that may be different year-over-year?

Todd Vogensen

I would say without giving away too much competitive information that generally we're, from a cadence perspective approaching holiday fairly similarly. Obviously, each brand has spent a lot of time doing analysis on previous periods and figuring out how we can get more gift able items within each of the brands. I think Shelley talked about that a little bit. For Soma in particular, Q4 ends up being a great gift giving period and probably one of the stronger quarters of the whole year and I think they are positioned very well to take advantage of that natural traffic flow as we go into Q4.

David

Okay, thanks. And finally, we've been very impressed with new product at Chico's. Can you just talk about more of the customer reaction and maybe standouts that you would like to highlight?

Shelley Broader

We've had some great success at Chico's. As we talked about in the script, Chico's for many years was known as a great place for pants and we – so for us to have launched our best selling pant ever this last quarter with the Juliette pant was incredibly exciting for us. So we continue to know if we can anchor the outfit with pants then the rest will come.

David

Okay. That's it from me. Thanks. Good luck for holiday.

Shelley Broader

Thank you.

Todd Vogensen

Thanks David.

Operator

Our next question comes from Paul Lejuez of Citibank. Please go ahead.

Paul Lejuez

Hey, thanks guys, on your comment about November starting off solidly, I'm just curious if you can give any more color by brand. And then separately on the Soma business, I'm just curious where you are right now relative to where you want to be. How far away are we from you guys getting on the call and kind of giving the all-clear on the Soma business? I guess when I say that, I mean across the entire business, not just on intimate side? Thanks.

Todd Vogensen

Sure. Thanks Paul.So first, in terms of November, I think we used to give our quarter to-date comps and we kind of moved away from that. So try to give a little bit of color on November and our broad-based trends across the business but don't want to get too specific at this point and get into monthly flows and so forth. So pardon me I just say, overall generally we're pleased with how November is started off across the Company and part of what gives us confidence as we look at our outlook for Q4 versus what we had trended in Q3.

In terms of Soma, I'll let Shelley comment. I'll start off by saying I think when I first started the Company back in 2009 and looking at 2010, there was a lot of concern about Soma's viability at that point and as we've transitioned over time we got to the point where Soma was EBITDA positive. I think it was back in 2012 where Soma was profit positive. And the brand has really continued to grow its profitability and its customer count and new customers really since that point so there has been an ongoing positive trend there. That being said, obviously we expect that – I would add in there 29 out of 30 quarters with a positive comp is pretty darn good in today's retail environment. So I think there's a lot of positives in there. That being said, obviously we would expect even more and that's where I'll let Shelley chime in on.

Shelley Broader

Certainly – thanks for the question. Certainly part of the attraction to the Chico's FAS opportunity just for me as an executive is there – there's just not that much white space in specialty retail where you really seeing the opportunity to grow. And that's absolutely how I feel about the intimate apparel segment and about Soma in particular. But much like everything else that we've talked about today, this can't be a launch and abandon or this can't be renting sales for the short-term.

That the growth potential for Soma is big as we've talked about before, the brand awareness is incredibly low, aided or unaided is very low. And you might ask been why aren't we talking more about the brands because we're not going to tell a story better than our store. We are going to get everything right at Soma. We're going to make sure that we are the Omni retailer that customers expect and expect especially in intimate apparel. Soma already has our highest penetration in decomp business. It has a tremendous repeat customer with low brand awareness. And so we are now finalizing that brand positioning, making sure that we have the right aesthetic, the right messaging, the right physical locations, the right omni plan for our consumer, and we look forward to sharing with you our significant growth plans and potential for that brand.

Todd Vogensen

Thanks Paul.

Paul Lejuez

Thank you very much.

Operator

Our next question comes from Janet Kloppenburg of JJK Research. Please go ahead.

Janet Kloppenburg

Good morning everyone. I had a couple of questions. Shelley, first of all, when you think about the core categories at Chico's, jackets, sweaters and denim being tough, I think that's been going on for a while.

That's what Chico's has been known for those categories. I'm wondering what the challenges are there and if you have better positioned those categories for the spring season? Could it just be styling or are there some pricing and quality issues there as well?

And for Todd, I was wondering – you say your total cost savings are $95 million to $115 million. I'm wondering what the level of incremental savings will be for fiscal 2017 since you've accelerated some of those costs here in the third quarter. And also Shelley, on – or Shelley and Todd on the marketing spend you're reducing it now. Do you think when you have better momentum in the brands on the top line that that marketing spend may start to move higher once again? Thank you.

Shelley Broader

Yes, I'll start with the Chico's trend and hit the marketing one quickly.

Janet Kloppenburg

Thank you, Shelley.

Shelley Broader

You're welcome. Certainly on Chico's I think we just had some misses. I wouldn't say we have pricing and quality issues as much as we just had some fashion misses. And you're right about our heritage. Some of those items where we missed are heritage items for us.

And certainly as you see artisan and bow hoe still continuing to be strong that is our heritage and I think you will see some corrected and style right product in the spring. And we've also got new leadership in place in some key positions there. Obviously even at the top of the house I think you'll start to see the turnaround there.

On the marketing side, as Todd has talked about quite a bit today and certainly at Investor Day, the marketing reductions that we have made we would consider in non-productive assets. Our customer-facing product and how we're speaking to our customer is something that we're happy to spend our hard earned dollars towards to bring them into the house and to teach them about our brand and entice them to shop with us.

Our marketing spend was higher than benchmark and higher than the industry. And so the reductions that we have made in marketing are putting us where we should be in marketing spend. And remember, you're dealing with a Company here that has decades of customer specific data in which to leverage to speak uniquely to one customer at a time about the product that they have purchased in the way that they choose to be communicated to.

So that should give us a pretty great competitive advantage on how we spend marketing dollars. So as we get the edges of our brand sharpened which is another one of our four key focus areas. Certainly we'll want to retool and go back out there more loudly with marketing but I do not anticipate that will be an increase in marketing spend because we are currently at the right level.

Janet Kloppenburg

Thanks.

Todd Vogensen

And in terms of total savings, so you're right, we do go from 90 to 110 is what we had talked about at the Investor and Analyst events in September to now we're at 95 to 115. So it went up $5 million. That $5 million is really marketing savings that we are able to increase and accelerate into 2016. So you’ll see that additional $5 million flow through – actually a lot of it flowed through in Q3 but that will flow through in 2016. And then I would say your savings in the year 2017 and beyond should be very similar to what you had modeled before.

Shelley Broader

Yes, we don’t need to invest that.

Janet Kloppenburg

Todd, what that level is for 2017 on the cost savings?

Todd Vogensen

Lots of different pieces to it, so there's an additional $10 million to come on marketing. We will get the rest of our org. – reorg. savings which there was $25 million in total which started in mid-Q3 of this year, so the rest of that will flow through $10 million to $20 million in non-merch procurements. And then our supply chain initiatives, we've pegged to $30 million to $40 million. That really will start in the second half of 2017 with I would say the bulk of those dollars probably coming as we get into 2018.

Janet Kloppenburg

Great. Thank you so much.

Todd Vogensen

Okay. Thank you.

Operator

Our next question comes from Adrienne Yih of Wolfe Research. Please go ahead.

Adrienne Yih

Good morning. Nice job on the SG&A control in a very tough environment. So my question, it's going to be a follow-on on Janet's. So it sounds like you have the capacity to kind of prolong these SG &A cuts or SG&A support even if we go into 2017 and it's still kind of a squishy mall traffic environment. So if you can just confirm that. And then at the Analyst Day the comps narrowed to get to the positive low double-digit was sort of modest, I think the comment was sort of modest top line growth. And if comps were to remain in a kind of negative low double-digit trend over that same horizon, how far does that push out the low double-digit target? Thank you very much.

Todd Vogensen

Sure. Thanks, Adrienne. So I do think that we have SG&A savings that flow into 2017 and margin savings on the sourcing side that flow into 2018. As we've planned these out, these are – as we mentioned before, these are not easy one-time check the box type savings that you just walk away from. These are things that are major programmatic, almost cultural shifts within the Company that are going to come over time. So those will flow into 2017. And in terms of the double-digit operating margin, just to be more precise on that, we thought long and hard about – before we threw out the double-digit operating margin along with a date, the date being 2019, and we pressure tested that from several different perspectives, one of which was what happens if comps are slightly negative going forward.

And amongst all of those different scenarios, we still felt confident coming forward with that double-digit operating margin by 2019 scenario, because we believe that as much as we believe in our top line opportunities, we also believe that we have a lot of ability to control our own destiny through getting higher quality sales through managing our cost structure and operating efficiencies and through all of those combination of things, we think we do have the control over our future destiny to get to that double-digit operating margin.

Shelley Broader

You really have to pressure test a business for this new environment…

Todd Vogensen

Yes.

Shelley Broader

And to get sort of wish that the sales are going to come back to the levels that we enjoyed many years ago, to me just isn't the way that you want to run a business going forward. We're going to drive for that top line revenue growth. We're going to pressure test and prepare the business for a different kind of retail environment, one where the power is in the hands of the consumer and they have multiple avenues in which to meet their needs and we need to make sure that we're in the forefront of meeting those needs whether they want to purchase that from us online, select and pick up in store, come to the mall for an event, find out alternative channels to utilize our great brand names and products. But we need to pressure test and build this business for the new reality and not wish for the good old days.

Adrienne Yih

No, it definitely seems like you've scrutinized the business for the best model go forward. My last question is on operating margin I think you intimated kind of flattish to last year. I know you're adding some marketing. Is it just because the sales volume is not that robust when you put in these extra expenses you may not get the leverage and the lift that maybe other people do when they have like 60% of their net earnings coming in the back half? Is that fair?

Todd Vogensen

That is exactly right. Q4 not that we think this is right long-term, but Q4 has historically been our lowest sales volume quarter of the year consistently and lowest earnings quarter. So that does limit our ability to drive some of that leverage.

Adrienne Yih

Okay.

Todd Vogensen

And so we are just kind of acknowledging that fact as we give the outlook for the rest of this year.

Adrienne Yih

Okay. Fair enough, best of luck. Congrats.

Todd Vogensen

All right. Thank you, Adrienne.

Operator

Our next question comes from Marni Shapiro of Retail Tracker. Please go ahead.

Marni Shapiro

Hey, everybody. Thanks for all the clarifications. Could we just talk a little bit about two things, White House, the dresses which I've been waiting to see in the stores and I've noticed they came in online obviously a little bit before? But it's pretty significant and pretty impressive assortment online and in stores it's still more limited. If you could talk a little bit more about the balance in stores between what's still a very wear to work kind of look and then the dress assortment and how we should see that over the next couple of months.

And then also just a clarification as you guide I think you said you had a higher AUR the assumption there as well that UPTs are lower. Of course, you're putting through fewer you units at sale prices.

Shelley Broader

I will start with the dress question and then I'll – Todd can chime in. We're excited about the opportunity with dresses at White House. As you know, that's a heritage item. We were talking about heritage items for Chico's before. That's a real heritage item for White House Black Market. We had seen that soften for us in the past years. So we're very excited about sort of the span of dresses that you'll see in-house, both in casual dresses, which is a go-to staple item for women today, dresses and tight in some places are taking the place of denim and leggings.

And so we're there with that casual exciting dress up, dress down dress. We're also very much into that transitional dress that you can wear to work during the day, put on a necklace and transition that into night as well as carrying those special occasion dresses in the boutiques but really carrying an incredible extended assortment online so you have seen those first online and you’ll continue to see a greater level of SKU choice count and proliferation online then you do in the boutiques.

Marni Shapiro

So the focus isn't to bring that sort of – that dress boutique into the store, it's a little bit more drive that online and keep the everyday business in-store?

Shelley Broader

It’s really a combination of both. It's an extended aisle online but you are seeing that in boutique today and you'll continue to see that. We're very happy with the early read on our holiday dresses now and I'm glad that you've noticed them and customers have too. And much to the point made earlier about scarcity, you don't want to go to the holiday party and see 13 people in your dress. And I think that's one thing that does and has set us you apart is there needs to be some scarcity when you're in the special occasion dress business and we have that extended assortment online but we are careful about the number that we have in the boutiques.

Marni Shapiro

Before we get Todd, can I just ask you one last follow-up on that, are your sales associates using technology to bring her online to show her that it's there So you’re capturing that customer because I do think she used to come into your stores for that and it was a traffic driver?

Todd Vogensen

Sure. Well, going back to the origins of White House Black Market, that was pretty well where the brand gotten, its start was the social occasion dresses. So yes, we have rolled out the customer book to all of our stores which is an app that our customers can use or our associates can use to better understand customer buying patterns, what might make sense for them and then also something that they can leverage to expose customers to the online assortment and something that we can leverage to really increase the amount of styles that are available to her.

Shelley Broader

And now that all of our boutiques are Wi-Fi enabled and with the data that we already have on each customer, I think that bodes to sort of some of the technology enhanced ways in which we want our customer to really feel surrounded by our brands, whether they're in the boutiques or shopping from home or somewhere else. You'll see us talk more about in the future.

Todd Vogensen

And in terms of units per transaction, you're exactly right. Our AUR has been increasing and we've been managing our inventory buys very tightly which means overall – and it's spotty but overall we are seeing units per transaction decline slightly. Again, that is all about getting that high quality of sale. And one thing, just to be really clear, as AUR has been increasing, that doesn't mean that we are increasing ticket prices, quite the opposite. What it does mean is that we are less promotional and we have less goods at clearance. And that's where in the past we've probably seen some unit proliferation is selling those goods at 30 and 40 and 50 off in the clearance section. So by not having as many goods back there inherently there are fewer units per transaction but at a much healthier AUR and profits.

Marni Shapiro

Thank you.

Todd Vogensen

Okay, thanks, Marni.

Operator

Our next question comes from Susan Anderson of FBR Capital Markets. Please go ahead.

Susan Anderson

Hi. Good morning, congrats on the nice quarter. I was wondering maybe if you could touch a little bit more on merch margins. Sounds like leaner inventory and better promotions drove the expansion. Was the AUC up or down in the quarter and what's your expectations for AUC going forward? And then also just to touch a little bit on the previous question on the double-digit op margin. I guess I was wondering same-store sales do remain pressured, can we get that occupancy does start to leverage as stores shut down or is that something that's going to continue to be a pressure? Thanks.

Todd Vogensen

So in terms of merchandise margin, I think there's a couple of things going on in there. One, as we do control inventories and the level of promotions that clearly helps drive the merchandise margins. The other thing that's probably less obvious on the surface is we have put a renewed emphasis around making sure that we have good tight controls and processes around coupons and discounting to make sure that we are giving her the offer that we intend to and that we're not ending up doubling up on coupons and types of things. Those two in combination are really what's driving the merchandise margin.

Average you unit cost for us, especially by category is something that has been relatively consistent and while we would always look for AUC opportunities and something that we're continuing to kind of dissect, I wouldn’t say that has historically been a huge driver of our margins and not something that we're baking into our plans at this point. In terms of double-digit operating margins, you're right. So as we do our algorithm going forward, rents especially in high volume A centers continue to increase. So that is a headwind that we continue to try to work against. We want to make sure that we are paying a fair rent but not an overly fair rent.

And at the same time we are going to have more store closures. So the net effect of those two should hopefully position us much better from an occupancy leverage perspective. As a matter of fact, our occupancy in total over the last couple of quarters has been relatively flattish and we would expect that to get better as we get further and further into our store rationalization program.

Susan Anderson

Got it. And then one last question, you talked a little about maybe the elections impacting your consumer. Maybe if you could just kind of give some color, your thoughts on just how you feel especially after the election, the messy environment is out there. It sounds like it's still very promotional. Does it seems like its worse than it has been historically and just kind of your thoughts on the level of inventory out there? Thanks.

Shelley Broader

We're glad we're not long pant suits.

Todd Vogensen

She's been dying to say that. I would say overall it's tough to imagine it being more promotional than last year. Last year was fairly extraordinary. I think we're in the early days after the election, so it's a little bit early to say. As we get through this weekend and heading into December it will become more clear. I’d certainly I think our intent is to focus on the things that we can control, which is if we are clean on inventory we know we have a customer that is willing to pay full price and that we don't have to be as promotional. It doesn't mean that we are not promotional because you do still have to compete.

Shelley Broader

But we do need to keep our powder dry because we did such heavy duty analysis on the promotions and the sales that we've done in the past to see which ones added value and which ones didn't. Where did we earn a customer's loyalty for the long haul and when did she come back and when did we just rent a sale that dropped our profitability. So certainly we're going to participate in the excitement that is the holiday season but we're going to do it analytically.

Susan Anderson

Got it. Good luck next quarter, you guys.

Todd Vogensen

Thank you, Susan.

Operator

Thank you very much. This concludes our question-and-answer session. I would like to turn the conference back over to Ms. Jennifer Powers.

Jennifer Powers

Thank you, Arenson. We apologize for any questions we didn't get to today. As always, I'm available for any follow-up questions if necessary. Now I'll turn the call back over to Shelley for some final comments.

Shelley Broader

Thanks, Jen. As you can see, we are working hard to transform our Company. And we are building a strong and talented team to lead our Company to improved profitability and growth in the future. We are executing on our cost reduction and operating efficiency initiative and our third quarter results demonstrate our ability to navigate this environment and provide us with confidence that the actions we're taking will help us achieve our goal of double-digit operating margin. As a final point, the execution of our initiatives and the development of our expanded top line growth opportunities will position Chico's FAS for sustainable earnings growth and shareholder value creation over the long-term. Thank you for your interest in Chico's FAS.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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