Chico's FAS Inc (CHS) 2007 Q1 法說會逐字稿

Good morning. My name is Jennifer and I will be your conference Operator today. At this time, I would like to welcome everyone to the first quarter earnings results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. (OPERATOR INSTRUCTIONS)

When it gets to questions, if it's a little question where you can take it offline --

Thank you. I would now like to turn the call over to Michael Smith for the Safe Harbor statement.

Welcome to Chico's first quarter earnings conference call for the period ending Saturday, May 5th, 2007. Our first quarter release and related financial information as well as an audio replay of this webcast are available on our website. Before we begin as a matter of formality I will read our Safe Harbor statement. Certain statements contained here and including without limitation, statements addressing the beliefs and plans, objectives, estimates or expectations of the Company or future results or events constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 as amended. Such forward-looking statements involve known -- or unknown risks including, but not limited to, general economic and business conditions and conditions in the specialty retail industry. There can be no assurance that the actual future results, performance or achievements expressed or implied by such forward-looking statements will occur. Users of forward-looking statements are encouraged to review the Company's latest annual report on Form 10K its filings on Form 10Q, management's discussion and analysis in the Company's latest annual report to stockholders, the Company 's filings on Form 8K and other Federal Securities laws filings. For a description of such important factors that may affect the Company's business, the results of operations and financial condition. The Company does not undertake to publicly update or revise its forward-looking statements even if experience or future changes make it clear that projected results expressed or implied in such statements will not be realized. I will now turn the call over to our President and CEO, Scott Edmonds.

Thanks, Michael, and thanks to everyone for attending our first quarter fiscal 2007 conference call. With me on the call today are Charlie Kleman, our Chief Financial Officer and Michael Leedy, our Chief Marketing Officer. Net sales for the first quarter ended May 5, 2007, increased 16% to $453 million from $391 million for the fiscal 2006 first quarter ended April 29, 2006. Income from continuing operations for the fiscal 2007 first quarter was $49 million or $0.28 a diluted share compared to income from continuing operations of $53 million or $0.29 a diluted share in the prior year's first quarter. As previously reported, comparable store sales for the Company-owned stores decreased to 1.6% for the 13-week period ended May 5th -- excuse me, May 5, 2007, compared to the 13-week period last year ending May 6, 2006.

The Chico's brand same-store sales decreased by approximately 1% and the White House | Black Market brand same-store sales decreased by approximately 2%. Gross profit for the fiscal 2007 first quarter increased 16% to $280 million from $241 million in the prior year's first quarter. Gross profit as a percent of sales for the current quarter was 61.7% unchanged from the prior year's quarter. White House | Black Market's front line stores merchandise margins in the current quarter increased by approximately 180 basis points over such margins in the prior year's first quarter. Resulting in their highest ever first quarter level. The margin increase at White House | Black Market was attributable primarily to better merchandise with the attributes of improved initial markups and a slightly lower markdown rate.

At the same time, the Chico's front line stores merchandise margins for the current quarter came in slightly ahead of last year's record first quarter merchandise margins. Now this is primarily due to a more disciplined open to buy, Michelle's reaction to the soft start in February, and a merchandise shift quarter-over-quarter to higher IMU, lower price point categories. These record merchandise margins were offset by the mix effect resulting from the White House | Black Market and Soma sales continuing to become a larger portion of our overall net sales. Both White House | Black Market and Soma operate with lower gross margins and the gross margins experienced by the Chico's brand, and to a lesser extent, by our continued investment in its product development and merchandising function for each of our three brands.

Our first quarter income from continuing operations of $49 million or $0.28 per share is in line with our expectations considering the softness in sales during the quarter, particularly in April. We are pleased to see first quarter merchandise margins once again at record levels for Chico's and White House | Black Market as we continue to focus on providing our customers with a more compelling product offering. Chico's May sales trends continue to show softness, however we are pleased with our gross margins which are in line with last year's May merchandise margins. As previously stated, we continue to focus on providing the Chico's customer with a merchandise offering that is more compelling in fashion terms. Our May sales results would indicate that the corrective measures we've taken thus far have not yet been fully realized, although it was the newer merchandise in the stores that drove our business, we simply did not have enough of it in the stores. As we move closer to the fall selling period, we expect to see steady improvement in the Chico's same-store sales performance.

We're pleased to see an improvement in the White House | Black Market product offerings and the resulting sales as they move from a mid-single digit negative comp in April to a low-single digit positive comp in May. We believe this improvement is a result of getting the focus back on [Sydney], our customer edit point. With that being said, our expectations for this brand are higher than a low-single digit same-store sales performance. We continue to learn as we push this brand towards the $.5 billion mark. Based on the high sales productivity and unique marketing position, we maintain our confidence in the expansion of this brand as a significant contributor to our Company's growth and profitability.

The Soma intimates business continues to grow. We ended fiscal 2006 with 52 Soma Intimates locations. Since then we've opened an additional 9 locations bringing our total store count to 61. Early in the first quarter we successfully converted Soma Intimates to the SAP software. As in any major software conversion there's been a steep learning curve. I also think it's fair to say this software conversion had a short-term, negative impact on the Soma Intimates business in the first quarter that was somewhat more than we expected, however with each passing week, the Soma Intimates team is becoming more proficient with the system and gaining a better understanding of how the SAP software can be used to more effectively manage the business. From an overall corporate viewpoint it was a prudent decision to convert the smallest brand in our portfolio first. While we have not yet determined the specific timing to convert Chico's and White House | Black Market to SAP, Soma's conversion experience should certainly help make these -- hello? You with us, Operator?

Yes, sir.

Okay, thank you. Soma's conversion experience should certainly help make these less disruptive. We continue to believe that the Soma Intimates concept represents an excellent long-term market opportunity within the specialty store arena. As most of you know, Chico's began as a bricks and mortar retailer. In 2003, we acquired White House | Black Market, another bricks and mortar retailer. Historically, our direct-to-consumer or DTC business has never been a major contributor to our overall sales level. Only approximately 3% of our total sales. When Michael Leedy joined Chico's in April 2006, we made a committment to focus on the DTC business as a future growth opportunity. I'm pleased to report that our DTC business was up 35% in the first quarter and is up 50% for the month of May. This increase is a positive indication of a strong demand for our product be it catalog and internet and we will continue to focus on gaining market share from our competitors through this channel of distribution.

As Q2 unfolds, we continue to take expense control measures in the effort to offset to some degree the shortfall and gross margin dollar contribution against our internal plan. Our financial position is strong as we continue to be debt free with a combined cash and marketable securities balance at quarters end of approximately $275 million. Finally, while we were pleased to see our first quarter earnings get back to an acceptable level, we are not willing to accept anything less than once again being the leader in the women's specialty apparel sector. Our goal remains unchanged. To create and grow strong branded concepts that target clear and compelling niche markets and ultimately deliver predictable sustainable growth to our shareholders. Now over to Charlie for his comments.

Thanks, Scott, and good morning, everyone, and welcome to our first quarter conference call for fiscal 2007, our 15th year of being a public company. The first quarter of this year progressed pretty much as we had anticipated excluding the April set back that was felt by the entire industry. During the quarter and so far in May we are continuing our work on improving our product offerings, adjusting our marketing efforts and developing a more innovative and responsive approach to our customers' needs that we expect to show more solid improvements in the back half of this year. As you can see from the press release, the quarter saw small declines in same-store sales for both the Chico's and White House | Black Market's brands. The Chico's Small decline in same-store sales was in spite of a 7% plus decline in the average unit retail, thus we were encouraged to see strong transaction levels that effectively offset most of this decline in average unit retail. On the other hand, the White House | Black Market brand saw an increase in average unit retails of over 5%, which was offset by a decrease in average store transactions. The average store transactions decline at White House | Black Market is likely due to a less than compelling merchandise offering during the quarter when the Company was up against mid 30% same-store sales increases last year that included substantial average store transaction gains in last year's first quarter.

Turning to inventories, as we indicated last quarter, our inventories were somewhat below plan at year-end and we intended on pursuing a more conservative open to buy approach due to the lower than desired sales trends. This conservative approach to inventory management is reflected in our roughly 9% year-over-year decrease in inventory per selling square feet, yet it is also reflected in the increase in the overall dollars versus sales as we rebuilt the density of our inventory to stronger levels since the start of the year. Inventory levels at this point are essentially on our plan, even with our sales shortfall compared to plan. With our inventories more carefully managed during the quarter we were able to beat our internal plans for gross and merchandise margins as the Chico's front line stores slightly exceeded last year's record merchandise margins for the first quarter and White House | Black Market significantly exceeded its merchandise margin plans for its record first quarter merchandise margins as well.

Looking to the second quarter, the Chico's merchandise margins, although not at record levels last year were well within our second quarter record merchandise margins and we still strive to achieve levels for the Chico's front line stores that are in the range of last year's merchandise margins. White House | Black Market did set record merchandise margins in the second quarter and the goal within this brand is to meet and/or exceed these record levels as White House | Black Market continues to move closer and closer to the industry-leading Chico's merchandising margin levels. White House | Black Market has continued to improve its merchandise margins every year since the acquisition in 2003 and its gross profit per square foot and merchandise margins continue to rank amongst industry leaders although slightly behind Chico's at this point.

Other items affecting the year-over-year 61.7% overall financial gross margin includes our continuing investment in our product development and merchandising departments as a percent of sales, as we are intent on getting back to leading the missing sector -- to leading the missy sector in product innovation. This investment decreased the overall gross margin by about 30 basis points for the quarter and we anticipate this will continue at least at this level for the rest of the year. A bigger impact than gross margins that effectively offsets the record merchandise margins I described earlier is the mix effect we've discussed in many previous quarters as the White House | Black Market and Soma Intimates front line stores gained 3% points of the overall pie of sales in this first quarter versus last years first quarter. With all that data on our gross margins and looking at the second quarter, we are still expecting gross margins to be somewhat off last year's second quarter gross margins of 60.4% as we stated for the Fitigues brand, as we are not expecting such a strong increase in the White House | Black Market merchandise margins to offset the investment in product development and the mix changes. As the White House | Black Market and Soma brands continue striving to improve their margins, this miss -- mix effect will become less and less of an impact especially after we anniversary the store openings in last years third and fourth quarters and we anniversary the product development and merchandising increases of this year.

Moving to SG&A, I hope you like our new format which separately discloses our store related costs, our marketing costs and all of our shared services costs. As a point of reference, our store related cost includes all store costs, all field costs including district and regional sales management expenses, and it also includes all call center and web expenses as these costs are effectively their store costs. Our shared services line includes all other costs that are shared across the brand. For example, this includes the functions like our IT, HR, finance, real estate, and other shared services departments. As you can see the overall SG&A is dominated by our store cost, which amounted to 75% of all SG&A this year versus only 70% last year. This increase in store SG&A versus the total SG&A is largely due to the huge store opening program in the last two quarters of last year compared to the small increase in shared services cost. This is also one of the biggest factors in the deleverage of the SG&A cost as the mix effect is more profound here than in the gross margin line. This deleverage in store SG&A has been further amplified by our decision last year to increase our average new store size by about 50% over our existing chain as well as our continued investment in store service levels. We have talked extensively on these topics as to why we are doing this and the longer term benefits that result.

Remember, our "large stores" and I have that in quotes, are still only about 67% of the size of our competitors and the chain is producing about $1,000 per square foot in the smaller stores of last year. We expect store SG&A to move to a leverage point by the fourth quarter of this year as these newer larger stores begin to mature and realize the higher sales levels we expect over the longer term. Beyond the deleverage of these costs associated with our negative versus low-single digit same-store sales which we really haven't talked about, the cost category that deleverage the most which was as you might expect are occupancy costs as depreciation, rent, and other occupancy costs significantly deleverage. Beyond occupancy, our investment in payroll, bonuses and the related fringes show deleverage slightly ahead of our expectations and we experienced smaller deleverage amounts that are associated with our slightly increased quarter-over-quarter store closures and relocations with an increased level of store promotions and with our stepped up web associated cost and our direct-to-consumer store as we continue to increase sales and profits in this area.

For future expectations, we expect significant deleverage in store operating expenses for the next two quarters although not at the 550 basis point level we experienced in the first quarter, assuming we can get back to a low-single digit same-store sales performance. The decrease in the other two categories, marketing and shared services costs, as a percentage of sales was basically planned in the marketing arena as we moved marketing dollars into other more demanding time frames and then the shared services area we reduced our incentive compensation plans to more properly match our performance levels amongst other cost savings initiatives. Although we don't break out depreciation on the face of the statement anymore, you can find it in the cash flow statement. As you can see, total depreciation deleveraged from 3.9% of sales in last year's first quarter to 4.9% of sales in this year's first quarter. Again, the bulk of this is related to the new, larger stores and -- on a much smaller scale this deleverage is tied to our initial launch of the SAP software platform in all of its interfaces. For the year, we will not be tipping our hand as to when we will spend the additional marketing dollars, but we still intend to end the year between 3.7% and 4% of overall sales for our marketing spend.

Regarding store openings and excluding the two Fitigues closures, we opened a net number of 34 new stores during the quarter versus 26 last year. These openings move us closer towards our stated goal of 135 to 145 net new stores for fiscal 2007. These 34 net new stores were composed of 39 new stores net of 5 closures of under performing stores. We still expect the store opening pace to be in line with our quarterly break down and our 10K and our expansions are on track as well with 14 projects in the first quarter and a similar amount in the second quarter.

To wrap up, our first quarter was essentially where we expected it to be after considering the slowdown in April and we continue to focus on newness and innovation in the merchandising arena as well as traffic drivers in the marketing arena especially as we approach the fall selling season. We are diligently working on refocusing our merchandising team for Chico's on recapturing that innovation we have been known for and we are developing our new marketing team to support our move into the multibranded retail arena and better cover the diverse needs of the Chico's, White House | Black Market and Soma Intimates brand. We ended the quarter with inventory on plan and levels that can support our forward business and we look forward to moving into the summer and fall selling season. As I said last quarter, we realize we will have to show you that we can turn around the downward operating margin trend as we have indicated should happen in Q4 of this year and we realize that there will be challenges along the way, but we all must also realize that we are still producing very profitable stores with enviable store economics, with strong consolidated profit margins and solid cash flows and we intend on proving this in the future. The first quarter of fiscal 2007 saw a slowdown in the operating margin decline versus the fourth quarter of last year and we expect this trend to continue as we move through fiscal 2007. Thanks for being with us on the first quarter fiscal 2007 conference call. And now, we'll take some questions.

(OPERATOR INSTRUCTIONS) We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Kimberly Greenberger with Citi.

Thank you, good morning.

Good morning.

Scott, I was wondering if you could talk about the decision to defer some of your marketing expenditures into future quarters and how you are feeling about the progress in the merchandising initiatives for fall. And then secondarily, just a couple of finance questions. Charlie, on the first quarter incentive comp accrual, I'm assuming last year you accrued incentive comp in the first quarter and maybe even a second quarter and subsequently had to reverse it in the second half of the year. Could you just give us some insight on that? And if you could give us the occupancy cost of deleverage here in the first quarter that would be helpful. Thanks.

Okay. Kimberly, I'll handle the fall product discussion and Michael is sitting here and he can talk to our decision on the marketing spend by quarter. As everyone knows, Michelle really was given full authority over the brand on March 7th, which was the day we announced her promotion to Chief Merchandising Officer. With that being said, a lot of the basic story lines for the fall and a lot of the color palette, a lot of fall and quite a bit of holiday was already sort of framed in, if you will. At that point, she had the ability to review the entire fall and most of the holiday assortment, but it's certainly not her full viewpoint on where the merchandise ought to be, so we -- that's why we continue to say that we expect better business, improving comps in the Chico's core brand in the fall holiday season, yet her full authority over the entire business won't really be felt until 2008. With that being said, we totally expect to see improvements in assortment in fall and holiday. We saw some of her impact in -- a little bit in Q1. We'll see a little bit more of her impact in Q2 and just the deeper we get into the year the more you'll feel her impact.

Kimberly, hi, it's Michael Leedy. From a marketing spend standpoint, really, the shift from out of Q1 is really a shift into Q2, and it's more of a timing issue than anything, so we didn't consciously say we're going to spend less than a year ago in Q1. There definitely is some opportunity in the second half of the year, particularly in the fourth quarter to really apply some dollars there, and I think that through negotiating some long term contracts and really looking at the way we were spending our dollars, we're going to be able to have even more effectiveness in the fourth quarter.

And I'll take the last few questions. The first one was on incentive compensation. We pay out our bonuses or incentive compensation every six months here, so we did not have any accrual that reversed in the second half of the year. Last year we had a better first half of the year regardless of what Wall Street thinks, we had a good first half of the year. And we did not have such a great second half of the year. Regarding occupancy, we don't disclose the exact number. You can see the depreciation deleveraged by a whole 1% point. You would expect that the rent would de leverage in the same range as that but we don't disclose the exact number. Hope that answers everything.

Thanks, Charlie.

Next question comes from Jennifer Black with Jennifer Black & Associates.

Good morning.

Good morning.

Scott, I wondered if you could update us on your thoughts on the number of stores possible for each division, and are there any changes and strategy for small versus lifestyle versus street? And then I wondered, now that you're expanding your store size for both divisions, what are realistic sales per square foot ? Thank

We haven't changed our philosophy on store format, if you will, relevant to mall, lifestyle, streetfront for the Chico's brand and the White House brand. We are learning more about the Soma brand, especially now that we've dropped the by Chico's, and I think that we made some real estate mistakes in the last 12 to 24 months. I think the real estate team executed the strategy we asked them to execute, but I think strategically we placed some stores, as an example, I think we put a couple stores in Colorado for Soma that I really don't think should be there. We opened last week in Paramus Park in New Jersey and if we could open 500 of those we would all be loving life. Regarding the store count, Jennifer, it's in the IR presentation on the web and nothing has changed based on what we're seeing regarding the number of stores. Regarding the sales per square foot, Charlie, what are you speaking to that?

For the sales per square foot, we expect our stores to open up in the 600 to 650 foot range and I'd like to see this change -- the chain itself get back to about an $800 per square foot range. I think that's a much healthier than the $1,000 a foot so we still see very strong sales per square foot for the chain as a whole.

Okay. Thank you very much and good luck.

Thanks.

Your next question comes from Lauren Levitan with Cowen and Company.

Thanks. Good morning. Scott, you made a comment about expense control initiatives that you have under way. I'm wondering if you could elaborate on those and give us a sense of which of the expense buckets that Charlie called out you view as as available for expense control, and then related to that, given the increase in service levels that you've had in the stores over the last little while, can you give us your sense either anecdotally or empirically as to the impact that you're seeing that have, and how we should think about where those service levels will be going forward? Thanks very much.

There's no expense category that is not being looked at. And we'll start right there. But when you start looking at a Company that's growing at the rate we're growing and the number of new stores that we're opening, it's really first and foremost tied to headcount. The biggest controllable expense we have in the business is really headcount, but everything from store -- again, when you run a chain that has almost 1,000 stores, anything you can effect at the store level is where you really start to save money because it's times 1,000 obviously. So, we're really looking at everything from store supplies to the way we ship to stores to headcount. Everything down to our charitable budget to -- There's just nothing that's not going unchallenged right now and I think it's one of the positive things that comes out of a hiccup in your business, that you take a fresh viewpoint at everything that you've done in the past and throw it out on the table at the Executive Committee and make sure that we're looking at every single area of the business. Anything we spend money on, the way we travel, the hotels our staff stays in, everything is being looked at, Lauren.

And then vis-a-vis the service levels? I mean how should -- I mean it sounds like that's something that you want to be -- at least you talked about increasing that. Is that something that's also subject to review or do you feel like you've achieved the right levels to provide the levels of service you think are appropriate for the customer?

Well, I think plowing money back into the store payroll since fall has paid off. We were hearing a lot from the customer and a lot from store management vis-a-vis store leadership teams and poor store service. We don't hear that now. And in the retail business, you get your complaints every now and again that you're going to get and we deal with those appropriately, but overall, our staffing levels are back to where we think they need to be. With that being said, we're not sure that we're applying the payroll hours to the appropriate time slots at the store level, if you will. We are just a recent client of Shopper Track. We are working with Shopper Track now on store traffic count and a lot of focus on conversion, a lot of focus on floor coverage so overall payroll allocation I think to the stores is at a healthy level. Now we just need to focus on making sure that those payroll dollars are targeted at the appropriate time slots so that we can improve our conversion rate, if you will.

Great. Thank you very much, and good luck.

Thank you, Lauren.

Your next question comes from Brian Tunick with JPMorgan.

Thanks. Hi, guys.

Hi.

I guess, Scott, maybe just for you, you've had another quarter now to evaluate your missy customer and you're not the only one out there that's been suffering, so do you think the space is suffering from I don't know, a lack of newness, the competition, or maybe is she just getting a little more squeezed? Just love to hear your view now that we've had a couple of quarters that this missy customer has continued to slow.

Yes, Brian, it's a good question and a good comment. I really think that there are certain macro issues affecting the customers, such as gas prices, higher property taxes, higher insurance premiums and I think that ultimately affects store traffic. There's no question. We do our competitive recon if you will and we certainly are hearing what all of our -- all of the missy concepts are saying regarding store traffic and then the most recent Shopper Track info for May is that the U.S. retail index was down, it shows traffic down 4.9%. We see that as a headwind on the business, but we're -- we don't see that as an excuse. We have to -- we still believe that if we put the right product -- fashion right product in our stores and across all three of our concepts and we have the right service levels, that we'll get our share of conversion and then we'll once again be leading the sector. So while there are some headwinds on our business, there's still plenty of business out there to run a very successful specialty store chain. I mean, we still -- I still am so proud of our business. We achieve a 16% operating margin in Q1 which is twice that of most of our competitors and third, almost three times that of one of our biggest competitors. We still have an incredibly healthy business. We're still driving extremely strong cash flows in light of some of these macro issues.

And just finally for Charlie, from an operating margin goal perspective, is 16% to 18% still be the potential to get back to?

Yes. We are still planning to get back to a 16% to 18% over the longer run, and that will start, that reversal, we expect will start in the fourth quarter.

Okay. Good luck, guys.

Thanks, Brian.

Your next question comes from Lorraine Maikis with Merrill Lynch.

Thank you, good morning.

Good morning.

It sounds like you're changing your inventory buying strategy to buy fewer products, but to purchase them deeper. I was just wondering what kind of testing you'll be able to do before you start making those larger buys?

Well, we are shifting our inventory strategy a bit, but it really, it's something that we're being very careful with and certainly -- you certainly aren't going to come into a Chico's store and see a store that is totally different than the store that has driven us to the level of success we're at, Lorraine. With that being said, I do think that under our new leadership, specifically in the Chico's brand, we've recognized that we are over assorted in certain areas. As an example, instead of having 12 long-sleeved stripe shirts, we may only need to have 6 and we may want to get a little deeper behind those. So you're going to -- we certainly are buying a little deeper on certain items and trying to narrow our assortment a little bit, but with that being said, it's going to be a total evolution, not a revolution, and we are being very careful. We are testing that in certain stores across the country. We've gone into certain stores and refixtured them, taken a certain number of the items of the SKUs off the floor and we're currently reading those tests now. We've got a very strong visual test under way, so we are doing a lot of different things to test out the theories, if you will, of Michelle and Michael Leedy before we roll them out if you will across the chain.

Thank you.

Your next question comes from Margaret Mager with Goldman Sachs.

Hi. Good morning. Let's see. Scott, could you talk a bit more about the issues that you saw with the SAP rollout at Soma and how you'll make adjustments as you approach White House and Chico's? And then can you talk about the reaction of the Chico's team to slow sales in February? You commented that Michelle and her team did a great job making adjustments. Was that because it was so early in the season or is there something different about what they're doing now that you can react more quickly even in season and if you could speak specifically to May and how you may be reacting to the fact that May is slow right now. Thanks.

Alright, I'll -- let me talk a little bit about the SAP conversion first. You're talking about a chain of 50 plus stores. We began this whole process with SAP well over a year ago, originally we were thinking that we may launch in the fall of '06 and we decided not to risk holiday, so we decided to sort of convert in early February, which we did. Just the entire software change took the attention of say a Mike Conway, who's our Vice President of Planning and Allocation, you can imagine the amount of time he had to spent on SAP conversion versus truly analyzing the day in and day out requirements of the Soma business, so that took their focus off the core business itself. Just learning the new methodologies from in the merchandise planning allocation markdown replenishment arena is a steep learning curve, and that caused some pain, but at the same time, we also brought up the finance package in the finance arena, if you will, on SAP. We're cutting checks to Soma vendors out of SAP, and that went fantastic and that will play into the White House/Chico's conversion, if you will. We will already have that scar tissue behind us both from the Soma merchandise arena, if you will, as well as the interface to PKMS and the distribution center, the interface to finance a lot of that stuff will already be up and operational when we make the conversion to the other brands. I think it will play in handsomely. Regarding the comment about February merchandise, do you want to take it?

Yes, I'll take it. Margaret, hi, it's Michael Leedy. When it came to -- into February and how we reacted, I think what Scott was referring to is really more than ever before as a team marketing stores merchandising. We're looking at the business together and we have back up plans in place, so when things don't work the way we want to, whether it's based on the inventory, macroeconomic stuff that's happening, we're ready to move, and we test -- we're testing the promotional things we need to do to drive the business ahead of time. So we have these triggers in place, and when one of those triggers gets tripped we get together as a team, talk about it and then react, and that's really new to the Chico's business and we're doing that on a regular basis. That's how we operate today.

Across all three brands.

Across all three brands. Right.

Scott, you linked it to better open to buy. That's what I was wondering if there was some cancellations, or how you were --

Yes, exactly, Margaret. When you come into -- which was really the first real full shot of spring begins in early February, and as we said on the Q4 call, she didn't even turn her head to look at spring merchandise until after President's Day, which I believe was like February 16th. So those first two weeks when we were seeing that softness, we started to look at everything we could as far as receipt flow and inventory flow that was coming into Q -- Q1, and we did everything we could to manage the inventory levels in Q1 based on that softness. And you just hit the nail on the head. There's really about order cancellations, moving merchandise into Q2, even canceling some traveler's merchandise, some basics we were able to put a cancellation on.

And last question. You talked about some of the products sold well, but you didn't have enough of those. How do you address that going forward so that you're getting enough quantities of the correct items?

Mike -- Michael said -- he's looking at me like he wants to take that. Go ahead.

Well I think the opportunity we have is to -- from a process standpoint, we're reacting well to the business now, but we're not necessarily completely together in planning and looking at the merchandise ahead of time, and really putting some things in place to allow us to take advantage and maximize things we think are going to be big wins, i.e. buy a little deeper, and keep some of the seasoning because we are a boutique, but not necessarily buy it at the same level as everything else, and that's an opportunity that we're working on that I think is really going to pay dividends in the future.

The cover shot right now, the catalog that hit with the metallic hoodie, that was something that Michelle bought in Europe in February and it's in the stores and on the cover of the book today. And that was --

Absolutely.

Okay, well good luck in the rest of the year. Thanks, Scott and Mike.

Thank you.

Your next question comes from Barbara Wyckoff with Buckingham Research.

Hi, everyone. Good progress on the merchandise margins.

Thank you.

I have a question for Michael Leedy. Are you -- talking about the new sort of more lifestyle-oriented marketing, are you finding that this is attracting a wider range of customers, or exactly what -- and then I didn't hear you comment on the Passport Club and Black Book for the quarter. Could you talk about those, please?

Sure. I'll hit that one first, Barbara. From an active customer standpoint, we saw growth in all three brands, so at Chico's, 11% growth in Q1 over the year before. White House 34% growth, and at Soma 94% growth which makes sense given the size of the business and the number of stores we added. We also saw, and this is a statistic I'm very proud of, the number of visits per average customer that are on our database increase in Q1 over '06 -- Q1 '06, so pretty positive numbers from a growth standpoint. When it comes to the look and feel of the book, we're going to continue to evolve the book. We've hired for Chico's a new VP Creative Director, Ted [Dieter] who was with [Burglar] Goodman and did the Bergdorf book for 10 years and then most recently with Slatkin Candle Company, so continuing to build the team, add talent and depth and really add creativity to the book. I have -- I've seen from a reaction standpoint a positive reaction to the Chico's book. We survey customers every month after the book hits, and overall very positive feedback from customers.

Great. Thank you.

Our next question coming from Harry Ikenson with Soleil Securities.

Morning. Also my congratulations on the margins. I thought you did an outstanding job. But with that said, I wanted to get a little bit of feedback. The promotional levels when I looked at the stores, at both Chico's and White House | Black Market, particularly during Memorial Day, I thought the promotions were higher than I've seen possibly since December. So I was wondering if you could comment on that. And then also, with the inventory levels being back where you want on a per square foot basis, could you talk more about the content, since it seemed like the promotional levels were so high. And then also on Soma, could you please address the progress you feel you're making on product, where you still are, where you've made progress. And then also, on Soma, I visited a new store at Riverside Square, a side-by-side, is that typical the way that Soma store is versus the Chico's, or is that not typical? As soon as you walked in, some of the merchandise just hit you right on the wall and it just didn't seem as impactful as some of the other stores that are the same. Thank you.

As far as the promotional activity around Memorial Day, as far as the number of markdowns, we didn't have a much higher level of markdowns on the floor in either of the brands -- either of the core brands year-over-year. As far as the message to the customer, I felt like quite honestly, our take away was we didn't scream loud enough that we were on sale. We felt like that -- quite frankly, our inventory levels were in pretty good shape and we didn't really jump on -- sort of the bandwagon over Memorial Day weekend as strong as we should have, and that's our take away from Memorial Day weekend as far as promotional activity. Regarding the progress we're making on Soma, during the quarter, we launched 100% new panty collection in March. We launched five successful new core bra styles. We have -- and we have one bra style that the APS, the average per store, we are extraordinarily happy with, so we feel like we are making progress. Our active wear business was very strong in the quarter. Our mix still is about 50% foundations, 50% nonfoundation merchandise, we would like -- really like to see that get to a 60% foundation, 40% nonfoundation, so we feel like we're making progress. We -- as far as the side-by-side Soma store in Riverside Square in New Jersey, that is typical of our side-by-side stores in the chain, so I don't really know how to respond to your comment on that.

Okay. Alright. Thank you very much. I'll talk to Charlie more about it off line. Thank you.

Thanks for your question.

Your next question comes from Robin Murchison with SunTrust Robinson.

Great. Thank you. Just a question about your balance of fashion basics, as a percentage your move -- in that during the quarter. Presumably, it's higher vis-a-vis last year, and would also wonder if it is sort of a strategy that you'll take into the second quarter. Thanks.

The 50/50 is sort of where we are with the lead times on these foundation merchandise, Robin, we won't see much shift going into Q2 on that mix. With that being said, again, our goal would be to get it to 60/40, certainly if we could get there by Q4, which is an all-important selling season for this category we would be happy with that.

Scott, I'm sorry. I think I probably wasn't clear. I didn't mean -- I think you're referring to Soma, right?

I was, I'm sorry. Did I not understand the question?

I probably didn't state it right. No, I'm talking about -- I think in your prepared remarks, opening remarks you said something about supplying the stores, if you will, with bringing in some fashion basics, key item goods, if you will, maybe building that up a little bit, at least that was my interpretation and I was wondering -- T-shirts and stuff like that. I was wondering if you thought that would be a strategy, is that a strategy sort of going into Q2 for the time being and I'm assuming that it represents -- it's a higher percentage of the mix of the Chico's stores than it was last year.

The basics?

Yes.

If you look at sort of the pyramid -- the pyramid -- you have all your basics at the bottom of the pyramid and then you sort of get some of your seasonal items in the middle of the pyramid, and then at the very top, turning very fast, are these unique novelty items, and we -- that's sort of the model that we're moving -- that we're trying to manage to today is to have the right level of basics in the business, not too over assorted though, and then to sort of have that middle range, whether it happens to be -- depending on the time of year sort of call that seasonal basics if you will or seasonal items. And then the real spice to the brand being the very top of the pyramid in turning that very fast. That's where we're trying to position the brand, and what that looks like year-over-year, I don't think that there's been a huge change year-over-year. That is sort of the philosophy and the methodology that Michelle is sort of managing to, and we would -- I think that we would see that play out a little bit further into the year.

Thank you.

Your next question comes from Roxanne Meyer with CICB.

The first question is for Michael and Scott. Michael, you and Michelle have been investing in talent to improve processes and make your teams more robust and create more specialized positions. Can you talk to which positions that you've created -- do you think will be most incremental, how long it will take for some of your new teams to gel and how long before we can see an impact of some of these hires? And then, Scott, can you speak to that same thing in merchandising?

Yes. I mean, really, the way the team is structured is pretty proprietary, and what I can tell you is that we haven't had a hard time attracting world class talent. Chico's is a Company that, from a culture standpoint, people want to work for, and based on the track record of the team here and the people that have joined the team, we continue to bring people in and quickly, put them into roles and start to -- I think they are already paying dividends quite frankly. But I wouldn't go further to break out how it's going to, how it's set up and what the exact roles are.

Yes, we probably would rather the competition figure that out on their own. On the merchandise side, Roxanne, we do have an open position for Senior Vice President of Production, which is a new -- a higher level of talent than we've had on the Chico's side to date. We're searching for some fabric people and a few other proprietary hires, but again as far as getting into the structure of the department, sort of feel like that's proprietary.

Okay, fair enough, and then I know that you're spending a lot of time speaking with customers. What kinds of more recent general feedback are you getting?

Roxanne, it's Michael. Yes. We did a pretty extensive of research project in the fall and we're going to continue that this spring and what we're going to do is follow up with -- we've already done this with Chico's, more one on one in the store research, so we did some fit clinics for denim and for pants and bottoms for Chico's. We have some exit interviews planned, so we're going to continue to get more and more information from customers. Some of the things we heard in the fall that we've already reacted to, on the Chico's side, we definitely heard that the price value equation was off for customers and we reacted quickly to that. We're very sensitive to the fact that customers look at both Chico's and White House as boutiques, so keeping that as part of our DNA even as we grow and expand is something that we're very sensitive to. Research is something that's new to the Company. It's something that we're going to keep at a minimal size. It's not we're going to make every decision. It's just another input for us and something that we take with a grain of salt, but it already, I think, has had a positive impact.

Great. Good to hear. And then last, just housekeeping question. When do you expect to close the remaining Fitigues stores and if so in what quarter, or do you have plans to convert those stores?

The Fitigues stores are all gone now. I believe there might be one left that is going to close this week, I believe. The Fitigues stores will be gone by the end of this month.

Okay, great. Thanks, and good luck.

Okay.

Your next question comes from Marni Shapiro with The Retail Tracker.

Hi, guys, good job in the first quarter.

Thank you.

Can you talk a little bit about -- by the way and I love that metallic hoodie, Scott, that you mentioned. It looks fabulous.

Get it quick.

If you could talk about a couple of things, just the productivity, you mentioned the Paramus store, Soma, what are you seeing in that store, is it really just real estate? And if you could just explain a little bit about the real estate difference on that store versus the stores in Colorado. I believe you guys at the end of the year had talked about some learning out of Soma that the stores do better next to a Victoria's Secret possibly, and that surprised you. So I'm curious if you can compare and contrast the Paramus store versus the Colorado store on that basis. And then on the wise house side, could you just offer a little bit of color? I believe the casual part of the assortment you were struggling with a little bit. The stores looked much cleaner and dressier over the last 4 to 8 weeks, I guess. So could you just talk a little bit about the casual element, or has that been downplayed in favor of where the trends are and a little bit dressier look?

Just a quick comment on the White House, yes, as you -- I mean the knit dressing there has just really been fueling the business, and the casual assortment is definitely lighter and that's absolutely paying dividends for us. Regarding the Paramus store versus like the Colorado store, Marni. The Colorado stores we opened because of the success of the Chico's store in that market, and that's not necessarily where we're going today. Now, remember we just dropped the by Chico's tag line over the last few months and the word Intimates will be on all store fronts by the end of June. It's on a lot of the store fronts now, so now when a customer -- a new customer, and in Paramus Park it's Soma Intimates, so you open a store in Paramus Park, high traffic mall, Soma Intimates, no affiliation with Chico's and we saw a very strong customer reaction. Now it's only been open a very short period of time, wherein the Colorado stores there were sort of slower traffic centers with successful Chico's stores. We opened in there with Soma by Chico's and believe that we were tracking primarily a Chico's customer and that model didn't work for us. So just as we believe the White House business is much more of a high traffic center format, if you will, or concept, that's what we're learning about the Soma Intimates business. Yet again, it's been a very short time since we dropped the tagline, and we still don't even have Intimates up across the country, and I continue to believe that that is going to be a -- sort of a real positive for this business is to drop the Chico's tagline, as much as that hurts to say.

No, I would agree with that. Are you finding in -- and I know it's early and the stores only been open a short time, but are you finding that without the Chico's name there, you're getting a much broader base of customer versus say a White House customer that might not walk into a store that says Chico's because that's know the who she is, but she will walk into Soma if it doesn't have the affiliation?

Anecdotally, yes, but we don't have the data yet and Michael has taught me a lot in the last year and one is just read the data. It doesn't lie. One last comment on Soma is this is a business that takes a while to build and what we are finding is the longer the store's open, the better the stores performing. We're getting repeat customers. The business continues to build in the stores that are open the longest.

Great. And then one just follow up also on Soma. You're reaching a store level at 60 stores and through the rest of this year where as you think about direct mail, have you thought about a catalog or any kind of more aggressive stance on direct mail to coordinate with your website?

Yes. We've thought about it. We really aren't at a point where from an infrastructure standpoint we could manage a catalog, but it is something that we would like to test, so stay tuned.

Great. Thanks, guys. Good luck with the summer time.

Thanks.

Your next question comes from Dana Telsey with Telsey Advisory Group.

Good morning, everyone.

Good morning.

In the opening comments it was mentioned that the White House | Black Market merchandise isn't where it needs to be right now. Where do you see it going to and where would you like to get it to so it is where you want it to be? And also any thoughts in terms of the expanded store size at the core Chico's concept? Any categories that you're looking to go into, or how do you adapt to the larger size? Thank you.

Dana, we're definitely looking on expanded store size for Chico's, we're definitely looking at expanded categories, but again from a proprietary standpoint, we would rather the customer -- the competition see it in the store versus hear it on this call. Regarding the White House | Black Market merchandise not being where we want it today, it's a lot closer to getting back to the core [Sydney], our core edit point customer, but we still believe that when it gets to the mix of the merchandise, there's still room to improve vis-a-vis casual versus dressy versus some of the accessories, shoes. There's still a lot of work to be done, and while I think Patricia and her team did a great job reacting to a very weak Q1, I think that you're going to feel more of that impact with what they were able to change for their fall deliveries than Q2.

Thank you very much.

Your next question comes from Janet Kloppenberg with JJK.

Hi, everybody.

Hello.

Hi, Scott, I heard you say that -- I heard a couple of things about what helped the comps and the gross margin in the first quarter, and I think you talked a little bit about a shift in IMU, and I think you said some lower price point categories, and I'm wondering if there's a move toward lower price point categories. I also heard you talk about the importance of novelty, so I'm wondering novelty it in my mind is generally more expense ever, or a higher price point I would say. So I'm wondering if you could just talk a little bit about your pricing strategies. And I'm also wondering right now if you think in May that one of the reasons the comps might not be where you want them to be is because maybe some of this novelty has sold down or maybe some of these key items at lower price points have sold off. And maybe you could tell us like how you would remedy that. Thank you.

Regarding the price point comment, Janet, when we started getting a lot of feedback from our customers that our price points were too high, a lot of that was because of the mix in the store. We had two many long-sleeved printed T-shirts at $78 versus basic T-shirts at $22. A lot of that had to do with the mix.

So you -- have you gone back to more basics in the mix?

Well we're -- yes. I would answer that yes, that we're -- that we are a lot -- paying a lot more attention to the message the customer gets when she walks into the store regarding our price points relevant to our mix.

Okay.

And that has paid -- that has paid off. The customers -- we are literally not hearing anything about price point concerns today. Our customer is willing to pay a certain price for an embellished denim jacket, where I think we got into a little bit of trouble is we kept pushing that envelope. She's willing to pay a certain amount for a basic sweater. She's willing to pay a certain amount for a basic long-sleeved T-shirt, and we know -- we realized where that point is now.

Okay, so in other words the price point on more of the basics may be declining, but the price points on the novelty product will stay at premium levels?

I think that's a fair comment, but premium level is relevant because the value, the price value equation to this customer is huge.

Okay, but are you trying to bring down the price point on novelty it or are you going to just stay focused at the levels where that product now is?

That's really relevant. I think moves season to season, based on, I think that you're going to see probably a higher percentage of novelty it in the fall and holiday than you would in spring.

But if I can just decipher something --

But we're not -- there's no big huge move to lower price points though.

Right, but on the basic product, it sounds like your IMU s improved or was it just on the basic product you have a higher IMU?

No. The -- what I said on the opening call was that we moved the mix -- the mix moved to higher IMU -- the mix to higher IMU categories with lower price points. Not on -- that's not relevant to basics.

Okay. Should we look for that to continue, Scott, and in other words, give you a positive --

I think no --

-- influence on your margins?

I think -- Janet, I think it's relevant to the season and relevant to what fashion sells us to put into the store. I mean, it's relevant to the fabric the customers are looking for. It's relevant to the metallic items.

Okay.

So I don't think you can just say yes or no to that.

Okay, but did Charlie say maybe we shouldn't look for the gross margin to be as strong in the second quarter. That's what I was trying to get to.

Yes, I'm guiding down on gross margins for the second and third quarters, yes.

Okay.

For the overall Company now. For the overall Company, and we should probably take one more question and then we'll be through.

Okay. Thank you, Charlie.

Your next question comes from Crystal Kallik with D.A. Davidson.

Good morning, and let me add my congratulations on a solid quarter in a tough environment.

Okay. Thank you.

Just a couple of quick questions and I just -- on the inventory it sounds like are you pretty comfortable being down per square foot about where you are? Is that reasonable to assume what you'll hold through the rest of the year, or how should we think about the next few quarters as far as your inventory levels?

Well we're comfortable with where our inventory levels are right now, as far as our weeks of supply across all three brands on total weeks of supply and markdowns. Again, we're going to have a much more disciplined approach to managing our inventories in the future than we have in the past, and I think that you'll see our inventories maintained at a very healthy level.

Okay, so as far as for you to impact levels when we start to see the trends improve, how long would it take you to be able to chase inventory should the trend pick up, how long will it take you to get back to levels that can fuel your momentum?

It depends on where you are in the season to tell you the truth. If you go into fall and you start flowing your product in early August and you get some really good read, you might be able to backfill Q3, the end of Q3 and I'm talking about nonbasics. I'm talking about a the novelty sweaters, things like that. If you get some sort of read and early on in the season there's a chance that you can affect the back end of that quarter or the very front end of Q4. If you're flowing product in, and remember we bring merchandise in on almost a daily basis, if you bring that merchandise in at the end of Q3 and you get a good read on it, you don't necessarily want to bring it in because that gain is going to be over in a very short period of time. So it really depends -- as far as getting back into nonbasic merchandise in the quarter or in the season if you will, it really depends on when you flow it through initially, what your read is and how much time you have left in the season.

Okay, okay, but so it sounds like fair enough in the near future at least you'll be maintaining pretty conservative levels at least in the short term?

Well, we're -- yes. That's a definite.

Okay, okay, great. And then just this is probably more for Michael, but certainly the direct business trend is -- continues to grow at a pretty significant rate, up 35%, you said up 50% for the month. I guess any comments on how we should be thinking about a run rate for you going forward over the next several quarters for the direct business?

Well, essentially, the business was untouched so we turned the light on. That's about it. So as we add enhancements to the business, we expect to get a reaction each time. So I would -- I'm looking at the rest of the year to really continue with this kind of a pace. So I'm looking at a -- at least a 30% gain over last year for the year.

And I guess I would add what excites me about that is I feel like our competition has had sort of a free pass through this channel over the years, and it's a lot of what Michael and I talked about over a year ago when we talked about him joining the Company, was really attacking this area of the business and it's real exciting to me, because a year later it's starting to pay off and I'd just love to think where this is going to be a year from now.

Yes.

Yes, the website is definitely great. And then to just, finally, just examples of the reduced marketing cost for Q1. Was that more catalog circulation or TV, or where did you get the cost savings?

Really, it was we negotiated out of some long term contracts that we had when I joined the Company, but the real message there is we spent the same amount of money, it's really a timing issue for the 80 basis points decline.

Thanks so much, and good luck for Q2.

Thank you.

Thank you very much for joining us for our first quarter call, and we look forward to talking to you all again for our second quarter earnings call.

Thank you.

Thank you.

This concludes today's conference. You may now disconnect.