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Driven by robust sales performance and improved margins, U.S. based specialty retailer Chico's FAS Inc. reported the highest third-quarter earnings per share in 2012 since 2005. The company’s earnings of 25 cents per share for the quarter surged approximately 39% from the year-ago quarter's adjusted earnings of 18 cents, surpassing the Zacks Consensus Estimate of 22 cents.

Sales Report

Net sales climbed 18.2% to $636.7 million from the comparable quarter last year and were slightly above the Zacks Consensus Estimate of $634.0 million. Top line in the quarter mainly benefited from a comparable store sales (comps) increase of 9.9%, square footage growth of 8.2% and increase of $16.7 million in sales from Boston Proper.

Comps gains in the quarter resulted from a rise in both average dollar sale and transaction count. Innovative marketing plans and favorable customer response to its merchandise offerings also contributed to the comps growth.

In the reported quarter, Chico's/Soma Intimates brands' comparable store sales increased 11.6% and White House Black Market (WHBM) comparable store sales improved 6.4%.

Operational Update

Gross profit jumped 20.8% to $364.3 million while gross margin expanded 120 basis points (bps) from the year-ago quarter to 57.2%, largely due to higher full-price selling and effective promotional activities, which were partially offset by increased incentives.

Selling, general and administrative (SG&A) expenses in the reported quarter were $297.2 million, up 16.8% from the third quarter 2011 level. However, as a percentage of sales, SG&A expenses contracted 60 bps from the prior-year quarter to 46.7%, primarily due to sales leverage impact on store expenses partially offset by increased marketing and incentive expenses.

Adjusted operating income (excluding the impact of acquisition and integration costs related to Boston Proper) was $67.1 million compared with $47.0 million recorded in the third quarter of 2011, while operating margin came in at 10.54%, an increase of 182 bps primarily due to increased gross margin and lower operating expenses.

Financial Update

Cash and marketable securities as of October 27, 2012, were $371.5 million, compared with $239.8 million as of October 29, 2011. For the nine months ended October 27, 2012, the company used cash to fund share buybacks worth $41.0 million and dividend payments of $26.3 million.

The company spent $11.7 million during the third quarter to buy back 0.6 million shares under its ongoing $200.0 million share repurchase program authorized in November last year. At present, Chico’s has $137.7 million remaining under its current authorization.

Concurrent to its earnings release, Chico’s has also announced a cash dividend of 5.25 cents per share, an increase of 5% over the comparable-quarter last year. The dividend will be paid on December 17, 2012 to the shareholders of record date as of December 3, 2012.

At the end of the quarter, total inventories were $234.2 million compared with $247.5 million at the end of the third-quarter of 2011. The year-over-year decline in inventories was in the line with the company’s planned reductions.

Store Update

Chico’s is in the midst of its store expansion strategy. During the third quarter, it opened 5 Chico's frontline boutiques, 6 Chico's outlets, 17 WH|BM frontline boutiques, 6 WH|BM outlets, 7 Soma frontline boutiques, and 1 Soma outlet, while it closed 1 store each of WH|BM frontline boutiques and Soma frontline boutiques.

The company's Chico's brand currently operates 611 boutiques and 95 outlet stores, WH|BM runs 399 boutiques and 43 outlet stores, and Soma Intimates operates 191 boutiques and 16 outlet stores – cumulatively a total of 1,355 stores. The company has operations in 48 states, the District of Columbia, the U.S. Virgin Islands and Puerto Rico.

Guidance

Chico’s maintains its guidance for net sales for fiscal 2012 in the range of $2.55–$2.6 billion. Moreover, the company continues to expect comparable store sales for the year to increase in the mid-single-digit percentage range.

Further, Chico’s anticipates that gross margin for fiscal 2012 will improve in the range of 25– 50 bps from the 2011 level, while SG&A expense, as a percentage of sales, is expected to decline 50 basis points from 2011. The effective tax rate for the year is projected to be about 38%. Inventories at the end of fiscal 2012 are estimated to be in line with sales growth, while capital expenditures for the year is anticipated to be approximately $155 million.

Our Recommendation

Currently, Chico’s has a Zacks #2 Rank which implies a short-term Buy rating. We believe Chico’s management, which is focused on operational discipline and improved product direction, is leading a turnaround story while its competitors continue to struggle. One of the company’s main competitors, Nordstrom Inc. recently reported its third-quarter 2012 earnings per share, which jumped 20.3% year over year to 71 cents but fell a penny short of the Zacks Consensus Estimate.

Further, even though the economic environment remains uncertain, we believe that Chico’s merchandising and marketing initiatives are beginning to drive meaningful improvements in sales and profits. Moreover, Chico's products are best positioned in the missy space since its merchandise is of superior quality, more stylish and very different from that of its competitors. In addition, we believe that the company’s continuous focus on expanding its store network along with a leaner cost structure will drive considerable earnings leverage in the coming quarters.

However, Chico’s products are more sensitive to macroeconomic headwinds. We are concerned about the negative macroeconomic events, which may undermine the company’s performance. Therefore, we are maintaining our long-term ‘Neutral’ recommendation on the stock.

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