Chico’s FAS, Inc. (NYSE:CHS) Q2 2020 Results Conference Call August 26, 2020 8:30 AM ET
David Oliver – Interim Chief Financial Officer and SVP Finance, Controller
Molly Langenstein – CEO and President
Conference Call Participants
Susan Anderson – B. Riley
Janine Stichter – Jefferies
Marni Shapiro – The Retail Tracker
Dana Telsey – Telsey Group
Janet Kloppenburg – JJK Research
Good morning and welcome to Chico’s FAS, Second Quarter 2020 Conference Call and Webcast. All participants will be in a listen-only mode. Please note, this call is being recorded.
I would now like to turn the conference over to David Oliver, Interim Chief Financial Officer and Senior Vice President, Controller. Mr. Oliver, please go ahead.
Good morning and welcome to the Chico’s FAS second quarter 2020 conference call and webcast. Molly Langenstein our CEO and President also joins me today. Our second quarter release can be found on our website at www.chicosfas.com under press releases on the Investor Relations page.
Today’s comments will include forward-looking statements regarding our current expectations, assumptions, plans, estimates, judgments, and projections about our business and our industry, which speaks only as of today’s date. You should not unduly rely on forward-looking statements, important factors that could cause actual results or events to differ materially from those projected or implied by our forward-looking statements or included in our earnings release issue this morning, and in our SEC filings, and in the comments made on this call. We disclaim any obligations to update or revise any information discussed on this call except as may be otherwise required by law.
With that, I’ll turn the call over to Molly.
Thank you, David, and good morning everyone. We have had a tough quarter as stores were effectively closed the same amount of time in Q2 as Q1. However, our results for Q2 are much stronger because of our ability to stay focused on our turnaround plan started in fiscal 2019. We are very optimistic about our future and are energized for growth despite the current headwinds.
In the fourth quarter of last year, we proved that we could drive our best sales performance in six years, an outstanding 9.2% comparable sales improvement from what we posted in Q1 of fiscal 2019. Based on customer acceptance of our new product, we have confidence in our strategy to return to the trajectory started in the first quarter.
We are taking advantage of this unprecedented period to be flexible and to stay laser focused. We have streamlined the organization, reduced expenses, reengineered our supply chains, and accelerated technology initiatives.
We are fortunate to have three distinctive brands with loyal customers and unique growth opportunities, a very robust digital business, a strong store portfolio, a solid financial position, and a nimble talented organization. Our business plan is based on delivering improved quarter-over-quarter performance.
In the second quarter, we substantially enhanced our financial performance from the first quarter. Digital and store sales combined improved by 9.2% in Q2 over Q1, despite stores effectively being closed the same number of weeks in second quarter, as in the first. Our gross margin rate rose more than 1800 basis points.
SG&A expenses decreased by $22.9 million or 18%. Our cash and cash equivalents increased by $7 million and our inventory levels were reduced by nearly 14%. We are taking actions to continue to capture market share and emerge an even stronger company. We are applying the same disciplines that drove last year’s fourth quarter performance.
And using this opportunity as a catalyst, we have better aligned our inventory and assortment to demand. We’ve streamlined organizational structure, reducing staffing by 30% and year-to-date SG&A expense by 33% compared to last year. We’ve reengineered our supply chain and we’ve continued to rationalize our store base and reduced occupancy costs and accelerated investments in innovation and technology. David and I will offer additional color on many of these actions.
Let’s start with digital. Digital sales have grown month-over-month and quarter-over-quarter. We had substantial learnings when our business became a 100% digital for 13 weeks. We took these learnings into the second quarter and the digital channel has not moderated since the stores have reopened, and we have new expertise with proven track records in driving the digital businesses.
For the second quarter, year-over-year digital customer count grew nearly 55% and conversion was up a 100 points, and year-over-year, total company second quarter digital sales grew substantially with our apparel brands growing by double-digits and Soma leading the way with digital sales up over 70%.
On the storefront, in early May, we initiated our multi-phase reopening plan for all of our boutiques. Our opening cadence was slower than planned and 96% of boutiques were reopened by quarter end, albeit with limited hours and customer capacity limitations. So, essentially, our boutiques were effectively closed for about the same amount of time in Q2, as in Q1, about half of each quarter.
In the aggregate, boutiques opened in the quarter generated sales at about 53% of last year’s levels. July was the one month where nearly all our boutiques were opened. This was slightly ahead of our expectations and above the initial level experienced in May. Our data shows sales trends inversely correlate to COVID case trends. Sales improve where COVID cases declines.
As customer sentiment improved, so to traffic and revenues. Customers are responding to our product as demonstrated by a 30% plus increase in conversion at the store level compared to the second quarter last year. Regarding our inventory, I’m pleased how swiftly our team continues to pivot our assortments and manage inventory.
After inventory write-downs in the first and second quarters, we ended the second quarter with inventories down nearly 14% and with current seasonally right product. Due to our diligence, we entered the second quarter with a streamlined organizational structure and significantly reduced expense base aligned to the needs of the business.
This fiscal year, we expect to generate approximately $245 million or about 24% in expense savings to plan before rent. We are committed to retaining at least half of this year savings into next year, driving leverage.
Communication is key during the challenging time and we continue to have biweekly calls with our leadership teams and monthly calls with the entire organization to keep our associates engaged, informed, and connected. We have made the decision for our corporate teams to continue to work remotely through the end of the calendar year.
Regarding our supply chain, COVID was a catalyst to quickly reengineer our supply chain. Shipments from agents and third-party suppliers will be cut almost in half this year, and we expect additional reductions next year.
In regards to our landlord suppliers and vendors, we are continuing to partner with our suppliers, vendors and especially our landlords to reduce operating costs. We have engaged a top tier real estate consultant, A&G Real Estate Partners, to assist in an arduous process, and our landlords are stepping up with rent relief.
We know that there will be some store shrink in the coming year as we are holding our stores to a higher profitability standard, either through increased sales per square foot or lower rent. We remain focused on our key initiatives started in our 2019 turnaround, and we are continuing to make tremendous progress on elevating our products and being customer focused.
Let me give you a few updates. First, on our product elevation and being a design driven organization, at Soma as we continue to focus on innovating and developing the most incredibly soft and amazing fabric and products that offer our customers, the beautiful solutions, effortless style and comfort that she expects and deserves.
The focus on innovation and franchise dominance produced another terrific quarter for Soma with strong sales in all proprietary intimate loungewear and sleepwear categories. Wireless and comfort products were strong for the quarter. We were especially honored that good housekeeping named Enbliss their choice for the best overall bralette. Soma posted a positive comp for the month of July with stores operating with reduced hours and limited customer capacity.
Our accelerating investments, recent results, and current momentum give us confidence that we will continue to catapult the Soma brand and take market share. At Chico’s and White House Black Market, our merchandising and design teams pivoted to quickly meet the need for casual, versatile apparel as many of our customers continue living and working from home, and her lifestyle needs have evolved.
Our new fabrications and washable knit jersey resonate with customers at White House Black Market, and Chico’s enhancement to these Zenergy Active franchise and newness in the casual assortment performed well for the quarter. Being customer focused and led, we are continually optimizing all touch points throughout the customer journey, by simplifying, digitizing and elevating our unique and personalized service, allowing her to shop whenever, wherever and however, she prefers.
Our innovative proprietary technology is an integral part of and compliments our great personalized service, and we have accelerated implementation of digital personalization tools to help us reach customers in new and creative ways. Style Connect our online styling service continues to be a differentiator for us, allowing our customers to connect digitally with her personal style experts to best link customers and products suited to her.
Year-over-year, Style Connect sales grew over 50% for the quarter. We are also so excited about our second quarter soft launch of the personal closet feature, an online personalized functionality that enables customers to shop digitally to augment their closet coordinating with their past purchases. Since launch, the conversion rate for this new feature has been remarkable, exceeding six times conversion rates versus the site average.
This unique program is a truly competitive advantage and based on early results, we accelerated the formal launch, which was planned for next year into this year third quarter. We are continually enhancing our customers’ shopping experience to digital site improvements. This month we added Shop For Look, which is also available on Style Connect. These tools are generating increased engagement and units for transaction.
The customer shopping behavior has changed, and we have quickly pivoted our business to ensure that she can always be connected with our style experts in new, personalized, simplified and innovative ways. These times have been a catalyst to think swiftly and differently, as we put the customer in the center of our shopping journey.
Before I turn the call over to David to discuss financial performance, let me take a minute to talk about inclusion and diversity. We are committed to an inclusive environment that celebrates our individuality, influences our culture, and innovates the way we work.
Earlier this year, we were so honored to be named one of the best employers for diversity in 2020 by Forbes Magazine, and to be included on the 2020 Corporate Equality Index, published by the human rights campaign for a corporate policies and practices related to the LGBTQ workplace equality, and we are always striving to do more. We are continually building upon our existing diversity infrastructure and initiatives.
We have an active inclusion and diversity council, which is developing specific goals, initiative and measurements for key pillars of the business. We want to build on our strengths and take serious and thoughtful actions to combat racism, prejudice, and discrimination from our company and from the communities we serve. This is important to all of us and we’ll keep you updated on our progress.
Thanks, Molly. We entered fiscal 2020 on solid financial footing and continued to maintain a healthy liquidity position. We ended the second quarter with a $125 million of cash and cash equivalents, up $7 million by end of the first quarter, and we have navigated the second quarter without making additional drawls in our credit facility.
We have taken steps to align our cost structure with revenues, preserved cash and increased liquidity, including aggressively reducing SG&A expenses, partnering with landlords, suppliers and vendors to lower operating costs and extending payment terms, reducing merchandise receipts and lowering planned capital expenditures.
We also temporarily suspended rent payments for our stores during the COVID-19 store closure period, and have made reduced or negotiated rent payments as stores have reopened. We’re about 55% through the initiative with A&G to restructure our lease portfolio and have already achieved rent abatements for fiscal 2020 that aggregates to a meaningful eight figures in savings, and we are in active discussions with our landlords to find a mutually accepted path forward for the remaining locations.
Focusing on real estate, during the quarter, we permanently closed 19 stores bringing our year-to-date closing to 28. We ended the second quarter with 1,313 boutiques across North America. For the remainder of the year, consistent with our plan, we anticipate permanent closing of additional 25 to 50 stores.
We are in the process of thoroughly reviewing our portfolio and re-evaluating each locations forecasted profitability and strategic value, which may lead to accelerating some closures or postponing or canceling certain closures, based on favorable rent concessions. We have additional flexibility because on average our remaining lease terms are relatively short. As Molly noted, we are holding our stores to higher profitability standards, either through increased sales per square foot or rents.
Turning to financial performance, we call that overall our stores were effectively closed the same number of weeks in the second quarter as the first. So the quarter started slowly but gaining momentum as stores reopened. Digital traffic and sales achieved meaningful year-over-year growth and this positive digital performance helped offset part of the loss from the closed doors. Second quarter net sales total $306.2 million up 9.2% from the first quarter reflecting the continued benefit of strong digital performance and store re-openings.
Compared to the second quarter of last year, sales declined 40%. This year-over-year sales decrease reflects, disruptions related to the pandemic, including the continuation of temporary store closures, limited hours when stores opened, and 74 net permanent store closures since last year second quarter. Productivity of the stores opened in the second quarter was approximately 53% of the prior year while operating with reduced hours, staffing and customer capacity.
For the second quarter, we reported a net loss of $46.8 million or $0.40 per diluted share, primarily reflecting the impact of lost sales during the COVID store closure period. Our loss in the second quarter also included an after tax inventory write-off $8 million or 0.07 per share. Gross margin in the second quarter was 14.6% of net sales, more than 1,800 basis points improvement in Q1. The year-over-year decline in gross margin rate primarily reflects sales deleverage of occupancy cost and the inventory write-off just mentioned.
The inventory write-off addressed excess work wear and special occasion apparel as well as current inventory in stores that became trapped due to slower-than-planned cadence of store re-openings. We entered the quarter with total inventory of $236 million, a 14% decrease prevented the first quarter. Ending the second quarter was somewhat elevated through the time of procedure and product held for liquidation.
We believe with our plant inventory receipts, we are entering the back half of the year with inventories that are current, appropriately balanced, and in line with future demand. SG&A expenses for the second quarter were down nearly $64 million compared to last year’s second quarter, primarily due to the aggressive reductions taken to align our cost structure with current and future expectations.
The $64 million represents a 37% decline in SG&A when compared to the second quarter last year and an 18% reduction from the first quarter this year. For the second quarter, the effective income tax rate was 25.7%, reflecting benefits provided by the CARES Act, net of a valuation allowance for certain state credit carry forwards that are expected to expire underutilized. Under provisions of the CARES Act, we realized a $16.4 million cash benefit in the second quarter related to the recovery of previously paid federal income taxes and employee retention credits.
Additionally, our balance sheet reflects an $83 million receivable related to the recovery of federal income taxes paid in prior years and other tax law changes. The Company also expects to realize an $11 million benefit in fiscal ’20 related to the referral of employer social security tax payments that will repaid in future years. Our cash flows in the first half of the year was impacted by the pandemic. In Q2, we can change to take aggressive actions to drive sales and monetize inventory, reduce expenses and manage cash flows.
Our financial position and liquidity are being bolstered by strong digital performance across all brands. Sales at reopened retail stores and our leaner expense structure to better align costs with sales. We believe the actions we have taken combined with our solid financial position, availability of our credit facility and our competitively positioned brands will enable us to successfully navigate the pandemic and emerge a strong company. Uncertainty surrounding the current environment continues to make our future performance extremely difficult to predict. So, we are unable to provide forward-looking guidance.
I’ll now turn the call back to the operator for Q&A.
Thank you. At this time, we will be happy to take your question. [Operator Instructions] And today’s first question comes from Susan Anderson with B. Riley. Please go ahead.
Hi. Good morning. Thanks for taking my question. I was wondering, if you could just talk about how much of the product you’ve been able to shift to more casual or comfort versus wear to work or fashion for the back half? And then also David, maybe if you could talk about what you’re expecting for free cash flow for the back half in the year? Thank you.
So, in regards to the product shifts for the back half, in March, we were finalizing our fall orders and we were in the middle of development for Q4. So, a 100% of Q4 is influenced with the new behavior of customers, and we were able to make significant pivots in the go forward-looking assortments in Q3 and make the necessary cancellations on occasion were and work, that was needed based upon what we knew at the time. So we feel confident. We’ve made significant product shifts in the back half that reflects the customers demand. In addition, we already had in Q4 laid out significant changes in casual and cozy and comfort across all three brands that have served us well in addition to these pivot changes. David?
Yes. With respect to cash flow in the back half of the year, we are not providing forward-looking comments or guidance in that regard, but the good news is. We expect our stores to be open and savings hotspots that might develop. And so, we are going to have the benefit of incremental sales improving our cash flow. We also put in place our $245 million in expense savings to plan, and we’re going to see that cascade across the back half of the year and delivering some benefits. So, we are definitely looking for improved cash flow versus the first half, but we have to run the numbers.
Our next question today comes from Janine Stichter with Jefferies. Please go ahead.
Hi. Good morning. I want to ask a little bit more about digital. I think you said digitally accelerate month-over-month. Can you provide some more color there on a cadence and then what you’re seeing into 3Q? And then also interested in just some of the learnings that you mentioned from when the stores were closed in the first quarter, some of the changes you made to digital to help accelerate that business? Thank you.
Good morning, Janine. I will start with digital. Yes, when we closed our stores in March and we had a 13-week period, where we were digital only, we learned a lot during that period, that we applied to the back half of the year, including accelerating a lot of our digital initiatives that we had in the glide path all the way through 2021.
As stores opened in the second quarter, we experienced across all three of our brands month-over-month improvement in our digital business, which we believe, has been benefited by the investments that we’ve made in our technology, investments that we’ve made in our talent and also the changes that we’ve done any organizational structure to put more emphasis on our digital channel and focus.
And can I ask you to repeat the second half of that question, Janine?
Yes, I think you’ve kind of answered it. I was just trying to understand some of the changes that you made to the digital business after you had the stores close in the first quarter. I guess just as a follow-up on the store performance. I’m interested to hear a little bit more about what you’re seeing in terms of reopening that I think the productivity at 53% is similar to where you were when you updated at the first quarter results. So just curious, if you’re seeing the stores continued to build or are they kind of plateauing at around 50%?
It really depends upon really the COVID cases. We are finding that the sentiment of the customer shopping behavior is really following COVID. So in the month of June, when some of that started to receive, we saw customer traffic improve. Then in the month of July, as you know, some of the biggest states that we have stores in, became five of the hotspots across the country and we saw a retraction in those states. So, really, we see this rolling behavior sort of follow escalating COVID cases and versus really a plateauing of sorts. The other thing that we also see is a 10-point improvement in open lifestyle centers and strip center mall versus enclosed malls and that’s been pretty consistent for the quarter.
And our next question today comes from Marni Shapiro with The Retail Tracker. Please go ahead.
Congratulations for making it through this in good shape. I have a couple of quick questions. Could you, Molly, just talk about your ability to have liquidated the older inventory and where the inventories are today as far as currency, and where your inventories are planned for the back half of the year?
So, yes, in terms of our inventories, you know, as we stated in Q1 that we liquidated all of the fall and holiday prior inventory. So, we had just spring current goods as we walked into the first quarter. What we didn’t know at the time is how long stores were going to be closed and the impact on people, the way they were living. And so in particular, two categories, the special occasion dress wear categories that are important for the summertime weddings and also the more career wear or goods that were challenging for us in the apparel brands in second quarter, which we have liquidated, and that was part of the write-down that we had for second quarter. So, we feel confident in our level of inventory that we have today and the go forward inventory we have aligned with our sales projection by brand and by channel.
Fantastic, and then, can you just give me a quick update on cost at the store level? You guys have very good COVID precautions, I guess, in place. And so is it an extra cost stores? Or is this being offset by lower payroll? Just curious how that works out?
It’s right now because of the limitations on capacity that is different by state. We are managing the costs in stores, one, with lower payroll, because we do not have our full part-time staff back yet. They’re still on furlough. And so, we’re managing predominantly the teams doing an outstanding job of really scrutinizing expenses, but putting the customer’s safety and our associate’s safety first to manage that experience, which as you know is challenging.
[Operator Instructions] Today’s next question comes from Dana Telsey with Telsey Advisory Group. Please go ahead.
Good morning everyone. As you think about the upcoming holiday season, Molly, how are you planning holidays differently than prior years? How you’re thinking about it both in terms of flow of merchandise and marketing? And lastly, on the digital channel, what are you seeing there in terms of supply chain, shipping costs, delivery expense and logistics? How is that changing? Thank you.
Thank you and good morning, Dana. In regards to the digital channel, for the back half of the year, we have surgically dissected last year’s customer and traffic data and overlay that with current traffic and customer behavior to make sure that we built this year’s strategy in the back half. This detailed strategy by day utilizes our new seamless shopping experiences, including curbside pickup, shop by appointment and Style Connect, and also our new digital features to be available for her whenever, wherever, and how she wants to shop. As you know, retail is about details. So, dissecting these details, have been key in building our back half strategy between both channels.
In regards to an effort to potentially have higher shipping costs and delays, in terms of timing for our customers and shifting our holiday efforts earlier this year, trying to capture more sales earlier, this will help us to reduce the amount of orders that we have and offer free shipping upgrades which is a larger driver of shipping expense. So, we are looking at the calendar and meticulously dissecting the calendar by day, to make sure that, we’ve offset each one of the channels so that we have the expenses built into the structure.
And just lastly, on the rent concessions and rent renegotiations that are occurring, how much are they lowered occupancy expense can you foresee having going forward?
Well, the occupancy expense going forward will also depend on the amount that we realized. As we indicated, our savings are roughly — we said at eight figures at this time, we’re about 55% through that initiative. We’re going to get in fiscal ’20 is the cash benefit. The earnings benefit will be over the remaining lease term from an accounting perspective. We’ll take that and have to amortize it. Since you are not going to see that immediately, but you are going to see the cash inflow, when you look the cash flow statement.
And our next question today comes from Janet Kloppenburg with JJK Research. Please go ahead.
Hi. I got a little bit late. I was wondering, if you could talk about your inventory content by brand? And if you think that, it’ll be aligned with current category trends as we move into the back half, and if we should report to a little higher year-over-year? Thank you.
Good morning, Janet, and thank you for joining us.
We are confident in our inventory positions and we feel that we are well positioned for the expected back half demand. We are fueling the high demand categories in casual, and we are also feeling Soma to capitalize on the trend within the intimate apparel and lounge wear space. So, the good thing is that, during this whole closure period, we did not miss a product milestone. So, we were able to pivot the back-half receipts to reflect the current customer sentiment.
Even if we look at White House where there’s more were focus?
Yes, Janet, I welcome you to go on to the site and look at.
I look at it site. I look at it often and I see what you’re doing, but I’m not the customer right now. So — and I’m in my swept hands every day. So give me an idea of what you’re seeing?
Yes, we pivoted a part of the changes that we made last Q4 were really not thinking about the White House brands. So singularly career and casual that we blended the two lifestyles and put a lot of new fabrications in place. I attribute this to the new talent that we’ve brought to the organization and that leadership team brought a lot of new washable knit, elastic way, really products that have ease that can take you all kinds of applications. And that’s what you’re seeing on the site in addition to really growing the denim categories and the T-shirt categories. So, you’re seeing that reflected today in our assortment, and that was due to all of the changes we started in Q4 that have just continued this year.
And how is the customer cautioned around entering the store right now? I know digital is leading your business, but what’s your outlook there as we go forward?
No, the customer sentiment has, since May has really not changed. She’s anxious to get in stores and to get back to speaking with her, her trusted associates, and we see that across the board. However, we do see in our data that the customer follows COVID. So as cases have escalated in spike and hotspots, the traffic does recede. And so, that is something that we pay close attention to. But the sentiment…
Are you seeing improvements then in the states with sites for moderating now?
Okay. Lastly, could you comment on the promotional environment and what kind of pressure you’re seeing their?
The promotional environment for the back half of the year, we are planning, flat to slightly down to last year. We believe that our inventory positions are in the right place and experiencing no additional shutdowns for the future. We believe we are in a great inventory position for the back half.
And ladies and gentlemen, this concludes the question-and-answer session. I’d like to turn the conference back over to Molly Langenstein for any final remarks.
Great, I’d like to thank our associates for their flexibility, understanding, and dedication to our customers, our communities and each other. Especially as we navigate through this challenging time, I am extremely privileged to lead this company of product and customer obsessed associates and these special brands that offer women thoughtful solutions that give them confidence and joy.
We are fortunate to have three distinctive brands with loyal customers and unique growth opportunities, a robust e-commerce business, a strong real estate portfolio, a solid balance sheet and financial position, and a talented experienced team that’s an agile organization. Our company is successfully navigating the challenges and becoming stronger and nimbler.
We have taken many actions to propel us forward. The continued enthusiasm of our customers for our brands, the financial foundation we have in place and our significant cost saving measures have positioned us to emerge a stronger company, and I am so excited about the future of Chico’s FAS.
Thank you for the interest in our company and for joining us today. We look forward to speaking with you again in November for our third quarter call.
This concluded today’s conference call. We thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.