Fool on Call: Chico's May Be Eyeing a Strong Fall Season

Chico's (NYSE: CHS  ) may finally have figured out the right mix of merchandise as the women's apparel retailer enters the fall shopping season. At least that's the word coming out of the company's second-quarter earnings conference call.

Recent fashion faux pas
Glancing at the retailer's second-quarter figures, a couple of numbers really jump out. The two I want to highlight are the 5.6% same-store sales decline at Chico's stores, and the subsequent drop in gross margins to 57.7% from the prior-year level of 60.4%. I lump both metrics together because of the impact that one has on the other.

Comps measure two important qualities for a retailer: traffic levels (the number of shoppers who make a purchase) and transaction values (how much money each customer spends). What we saw in the second quarter is that both Chico's and White House/Black Market experienced a significant drop in the price per transaction, which was partially offset by higher customer traffic.

It was pointed out in the call that one of the primary reasons for the decline in transaction values was the poor merchandise mix that the retailer had going into the summer months. A year ago, the problem Chico's faced was that it had too little casual wear on hand. It appears that management swung the pendulum too far the other way in recent months, as CEO Scott Edmonds explained that in the second quarter the merchandise mix was distorted too heavily in favor of the casual side. The effect of having too little dressy merchandise forced its customer "to shop elsewhere."

We know from a call in late November 2006 that Chico's had virtually no flexibility in addressing spring 2007 fashion missteps, as by that time the merchandise was already prepared. But my concern is why the company missed out on the fact that other retailers -- Ann Taylor's (NYSE: ANN  ) LOFT, Guess? (NYSE: GES  ) , Polo Ralph Lauren (NYSE: RL  ) , and G-III Apparel (Nasdaq: GIII  ) , representing Calvin Klein, to name just a few -- had stated that dress wear was one of the key categories this year. For whatever reason, the leadership at Chico's failed to properly position its summer merchandise to fully capitalize on this category.

As a result of the imbalance in merchandise, Chico's was forced to slash prices to move excess and unwanted inventory. These markdowns were a major reason for the aforementioned drop in gross margins -- lower merchandise prices resulted in decreased profitability.

A fashionable fall season?
The importance of covering conference calls to discern the direction of a company is once again reinforced when we note that Chico's November 2006 call also revealed that it would not be until fall 2007 that customers would see a fully revamped merchandise lineup. Its most recent second-quarter call provided evidence that the fall products are being well-received by customers.

Now that the summer merchandise has been cleared out, management is satisfied with current inventory levels. But more than the levels, the leadership team is most pleased with the make and mix of the newer inventory.

Edmonds indicated that the "assortment imbalance" that it had over the summer months has been corrected for the fall season, which should enable it to "satisfy" both the casual and dressy needs of its customers. According to Edmonds, August sales for the most part tracked Q2 figures. But since the mailing of its fall catalog over the past couple of weeks or so, Chico's is seeing "very strong performances in key categories," said Michele Cloutier, the company's new chief merchandising officer.

In the question-and-answer session, Cloutier provided additional color. The retailer is seeing a strong response to several important categories, including denim, sweaters, and outerwear, as well as fashion and novelty, she said. "September is going to be a big month for us."

It may be time to look at Chico's, finally
Because Chico's has suffered through a period of mediocrity, Cloutier's remarks are encouraging. And because of these positive developments, management has decided to "substantially increase" marketing spending in the second half of 2007.

If Cloutier's merchandising savvy is already leading to favorable results in the third quarter, then this speaks volumes about the opportunities in the coming months, when the apparel will more fully reflect her influences. Edmonds indicated that Q4 merchandise will include a greater impact from her work, and "all of 2008" will have her touch. Again, assuming Chico's is getting an accurate read on the most recent sales data, this is very good news indeed for current and prospective shareholders.

You can't overstate the importance of an apparel retailer having the right mix and make in merchandise. It is the "goods" that separate the winners from the losers in this biz. It looks like Chico's may finally be getting its closet in order.

Related fashionable Foolishness:

The Motley Fool CAPS community, now more than 60,000 strong, awards Chico's three stars out of a possible five. What's your take on the retailer? Join CAPS and share your opinion. It's fun and it's free!

Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Motley Fool has a fit and fashionable disclosure policy.


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