Chic Business

Chic Business

COVER by Jean Gruss | Lee-Collier Editor

Deep inside the headquarters of Fort Myers-based women's retailer Chico's FAS, dozens of blouses, skirts and pants hang on a 20-foot wall. What may be an entire season's worth of new clothes for one retailer is just another month of apparel for Chico's.

About 50 designers pump out so many new clothes and accessories that every Chico's store can stock a new item every day. The result is an almost cult-like following: 92% of sales at its flagship stores last year were to customers who belonged to Chico's frequent-shopper program.

Loyal customers helped Chico's boost sales from $378 million in 2001 to $1.4 billion last year. Net income was up 37% last year to $194 million. Because its own employees design apparel, Chico's profit margins are more than double those of its peers who outsource the work.

But Chico's executives acknowledge that the company's huge size means it probably won't continue growing sales at a 30% to 40% annual rate. There are already 548 Chico's stores across the country, and the company estimates that there's room for a total of 700 to 850 stores.

Competitors are jumping into the boomer-women market that Chico's has dominated virtually unchallenged. Gap has launched Forth & Towne with a line of clothing also aimed at boomer women, for example. Retailers Talbot's and J.Jill have also shaped product lines after the chain.

With that in mind, Chico's executives are looking for other ways to grow sales. One promising area is a line of lingerie called Soma, targeted at the same generation of baby boomer women who buy Chico's apparel. Another is growing the White House|Black Market chain it acquired in 2003, with clothes in varying shades of black and white aimed at younger women. The company has also recently acquired Fitigues, a chain of 12 stores that sell sporty but upscale clothes mostly to women. Currently, there are 208 White House|Black Market stores and 16 Soma stores.

What's more, the company plans to boost its catalog and Internet sales, which last year only accounted for 2.6% of total net sales. It bought a 50,000-square-foot building adjacent to its distribution center in Winder, Ga., to handle the direct-to-consumer order fulfillment. It also recently hired an executive who built American Eagle Outfitters' successful online store.

But all that growth will probably pressure Chico's historically high profit margins as it builds more Soma's and White House|Black Market stores. Of the 135 to 155 stores it plans to open this year, 65 to 70 will be White House|Black Market stores and 25 to 30 will be Soma stores.

Meanwhile, despite the strong numbers, the company's recent stock price has fallen to below $35 recently from a high this year of nearly $49; Chico's trades on the NYSE under the ticker CHS. Its stock fell 14% in a single day in March after the company reported that sales at stores opened more than a year rose 5.7% in February. In 2005, stores opened at least one year rose 14.3%. Measuring sales at stores open at least one year is a retailing metric that is a good gauge of a company's growth.

"We're not here for short-term gains," says Charles Kleman, 55, Chico's chief financial officer. "If we put up the E, the P will come with it," he says, referring to the price-to-earnings ratio that many investors use to value stocks.

Don't bet against Chico's just yet though. An analysis published by The Wall Street Journal in February showed that Chico's stock had the best 10-year track record out of 1,000 companies it analyzed, with an average annual return of 68.2% for the decade ending last year. In a recent survey by Institutional Investor magazine, portfolio managers and analysts named Kleman the country's best CFO in the retailing/specialty stores category. (Kleman's base salary was $550,000 last year).

Fact is, Chico's has zero debt and generates enough cash to grow the business. It has so much cash that it will spend $100 million over the next year to buy back its own stock. "We cash flow so nicely," Kleman says.

Chico's boom

What Chico's executives are seeking is to repeat the success of their flagship brand. When Kleman joined the company in 1988, Chico's 12 stores generated $6 million in annual sales. Last year, its 3,333-square-foot Scottsdale, Ariz., store alone sold $7.8 million of apparel.

From its humble beginnings as a store on Sanibel Island selling folk art (hence its name, FAS, which stands for Folk Art Specialties), Chico's stores now sell clothing and accessories to women who have long been ignored by retailers that cater to a younger crowd.

Boomer women have lots of money to spend, and that's benefited Chico's. The company estimates there are 14.8 million women in the target age group of 35 to 55 who have annual incomes of more than $75,000.

The company's own designers in Fort Myers create enough apparel so that a customer can find something new every day in a Chico's store. The designs are sent to apparel makers in places such as China and India, who then ship the goods to Chico's distribution center near Atlanta. Using sophisticated inventory tracking software, the company ships apparel overnight to stores using FedEx. Hiring the designers in-house and farming out the production overseas has helped the company control costs and boosted the profit margins to more than double those of industry peers.

Chico's appeals to boomer women because they can shop for clothes and accessories in a single store. Because they're pressed for time, Chico's design center has 20 people in its "technical fit department" whose jobs are to make sure that sizes are uniform across all clothes. For example, a customer who is a Chico's size 1 can be sure that all clothes in that size will fit her, reducing time spent in the dressing room. Because of their elasticity, Chico's clothes only have four sizes-0 to 3. By contrast, American sizing in women's clothes typically has three times as many sizes.

Chico's rewards its customers' loyalty with a generous frequent-shopper program. Customers can enroll in the Passport Club at no cost, and they're entitled to a lifetime 5% discount on all merchandise once they've spent $500. In 2005, customers who were eligible for the 5% discount accounted for 78% of Chico's brand sales. Customers who were Passport Club members but who had not reached the $500 spending threshold accounted for another 14% of the brand's sales last year.

For four years starting in 1995, Chico's abandoned its Passport Club. In retrospect, Kleman says that was a poor decision. He relaunched it in 1999. "I was convinced we needed a frequent-shopper club," he says. Unlike other retailers, however, Chico's club is unique in that it's not tied to a credit card. "It's honest," Kleman says. "We won't earn credit-card fees."

Today, Chico's has 6.6 million Passport Club members. Those who are eligible for the 5% discount spent $111 per transaction and shopped at Chico's five or six times a year. The resulting database gives Chico's valuable information about its customers and provides a receptive audience for the 90 million catalogs and mailers it plans to print this year.

Because specialty clothing retailers are so focused on younger people, Chico's top competitors until recently have been department stores. That's because boomer women like to shop in one place and don't want the hassle of visiting a half-dozen stores to assemble an outfit. But department stores have cut back on customer service while Chico's has emphasized it. It trains and rewards employees who help customers buy Chico's apparel and gives them autonomy to reward good customers with discounts or to return goods without questions.

Kleman says he considers the Nordstrom Department Store to be Chico's biggest competitor. "I think it's because of the shoe department," he says. Because Chico's stores and back rooms are relatively small, they can't properly stock shoes that come in many sizes.

Building on Chico's success

Future growth will come from White House|Black Market and Soma stores, and Kleman says company officials will grow those businesses using the lessons learned from Chico's. For example, White House|Black Market has its own designers and contracts with other companies in the United States and overseas to make the clothes.

White House|Black Market stores already show a lot of promise. Stores open longer than one year in 2005 showed sales increase in the "mid-to-high" 30% range, versus "low-double digits range" at Chico's, according to the company's recent securities filings.

In October 2004, Chico's launched a frequent-shopper program for White House|Black Market called The Black Book. It's identical to Chico's Passport Club except that customers only need to spend $300 to get the 5% lifetime discount. The 334,000 customers eligible for the discount accounted for 55% of the brand's sales last year.

Meanwhile, Chico's plans to expand its intimate-apparel Soma division by opening 25 to 30 stand-alone stores and five to 10 "boutique" stores within or adjacent to Chico's stores. Chico's hired Charles Nesbit Jr., former president of the intimate apparel group of Sara Lee who launched the successful Wonderbra marketing campaign.

Soma targets customers it calls "Victoria's Secret graduates." Victoria's Secret targets young women, and Chico's executives believe the Soma brand will appeal to boomer women with better fitting intimate apparel. Because its customers are the same as Chico's, Soma customers can also use the Passport Club lifetime discount.

Meanwhile, the company isn't abandoning its Chico's brand. It plans to build another 45 to 55 of its flagship stores this year and is expanding in smaller markets such as Jonesboro, Ark., and Florence, S.C. Kleman says the company has no plans to expand overseas.

The company's strong cash flow can easily sustain the company's expansion. Strong store sales generated enough cash so that the company had $415 million in working capital by the end of last year. It recently announced a $100-million stock buyback program.

Although Chico's executives have demonstrated their skill at growing sales and its cash flow is strong, entering new businesses always carries risk. For example, Chico's is selling its White House|Black Market brand to a new audience that is younger than its flagship brand's devotees. Plus, there's more competition for younger women's spending.

"It certainly poses a risk that they may not be able to be as successful as in the past," says Kimberly Picciola, a stock analyst with Morningstar in Chicago.

"Their intimate apparel makes a lot of sense," says Picciola. "We've seen Victoria's Secret start to target a more youthful customer, and that makes way for someone like Chico's."

Still, Picciola says it's hard to persuade women to switch intimate-apparel brands, and Chico's will have to work hard to get them to try Soma's by doing things like plugging the Passport program.

Meanwhile, the company's physical growth comes with its own pains. The corporate headquarters it planned to build in Lee County was scrapped as the $250 million price tag exceeded what the company was willing to pay. Instead, the company bought 22 acres adjacent to its current headquarters where it will expand its existing facilities.

Plus, attracting talented young designers to Fort Myers from fashion hotspots such as New York City is challenging. "We have to throw stock options and restricted stock at them," Kleman says.

Chico's CFO knows real estate, too

Charles Kleman is well known as the financial wizard behind Chico's success. But a recent real estate deal reveals Kleman's sharp skills as a real estate investor.

Shortly after the terror attacks of Sept. 11, 2001, Kleman and Fort Myers friend and commercial real estate broker Drew Drake started looking for real estate opportunities around Southwest Florida International Airport.

Drake recommended Kleman buy two parcels totaling 38 acres at the corner of Alico Road and Ben Hill Griffin Parkway in Fort Myers.

Kleman says he was looking for ways to diversify his Chico's-heavy investment portfolio and rezone the land for a hotel.

Property records show he paid $3.26 million for the land in late 2001.

Everyone now knows how land has appreciated in the last few years. So when Pace Cooper, president and CEO of Memphis-based hotel company Cooper Cos., offered Kleman $11.25 million for the property last summer, Chico's CFO couldn't resist tripling his money.

AT A GLANCE

CHICO'S FAS

Headquarters: Fort Myers

CEO: Scott Edmonds

FY 2005 Revenues: $1.4 billion

Stock symbol: CHS

Recent stock price: $35

52-week stock-price range: $25.03 to $49.40

Price-earnings ratio (trailing 12 months): 33

Dividend: Nil

Market capitalization: $6.37 billion

Sources: Securities and Exchange Commission, Yahoo Finance.

CHICO'S FAS

INCOME STATEMENT

(in thousands) Years ended

Jan. 29, 2005 Jan. 28, 2006 %Change

Net sales by Chico's/Soma stores $889,429 $1,095,938 23%

Net sales by WH|BM stores 142,092 261,601 84%

Net sales by catalog and Internet 26,831 36,151 35%

Net sales to franchisees 8,530 10,885 28%

Net sales 1,066,882 1,404,575 32%

Cost of goods sold 411,908 547,532 33%

Gross profit 654,974 857,043 31%

General, administrative and

store operating expenses 398,117 514,529 29%

Depreciation and amortization 32,481 44,201 36%

Income from operations 224,376 298,313 33%

Interest income, net 2,327 8,236 254%

Income before income taxes 226,703 306,549 35%

Income tax provision 85,497 112,568 32%

Net income 141,206 193,981 37%

BALANCE SHEET

ASSETS

Current Assets:

Cash and cash equivalents 14,426 3,035 ?79%

Marketable securities 251,199 401,445 60%

Receivables 5,106 7,240 42%

Income taxes receivable 0 5,013

Inventories 73,223 95,421 30%

Prepaid expenses 9,429 13,497 43%

Deferred taxes 11,184 12,327 10%

Total current assets 364,567 537,978 48%

Property and equipment:

Land and land improvements 6,055 44,893 641%

Building and building improvements 29,286 35,573 21%

Equipment, furniture and fixtures 140,360 187,970 34%

Leasehold improvements 166,096 209,342 26%

Total property and equipment 341,797 477,778 40%

Less accumulated depreciation

and amortization ?93,834 ?131,846

Property and equipment, net 247,963 345,932 40%

Goodwill 61,796 61,796 0%

Other intangible assets 34,042 34,041 0%

Other assets, net 7,361 19,666 167%

Total assets 715,729 999,413 40%

Liabilities

Current liabilities:

Accounts payable 36,725 47,434 29%

Accrued liabilities 58,258 74,586 28%

Current portion of deferred liabilities 332 648 95%

Total current liabilities 95,315 122,668 29%

Noncurrent liabilities:

Deferred liabilities 47,149 65,189 38%

Deferred taxes 12,397 5,129 ?59%

Total noncurrent liabilities 59,546 70,318 18%

Total liabilities 154,861 192,986 25%

Source: Securities and Exchange Commission filings