Earnings Call Transcript - CTRN Q1 2020

Nitza McKee, Senior Associate

Thank you, Dina, and good morning, everyone. Thank you for joining us on Citi Trends First Quarter 2020 Earnings Call. On our call today is our Chief Executive Officer, David Makuen; and our Vice President of Finance, Jason Moschner. Our earnings release was sent out this morning at 6:45 a.m. Eastern Time. If you have not received a copy of the release, it's available on the company's website under the Investor Relations section at www.cititrends.com. You should be aware that prepared remarks made during this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance. Therefore, you should not place undue reliance on these statements. We refer you to the company's most recent report on Form 10-K and other subsequent filings with the Securities and Exchange Commission for a more detailed discussion of the factors that can cause actual results to differ materially from those described in the forward-looking statements. I will now turn the call over to our Chief Executive Officer, David Makuen. David?

David Makuen, CEO

Thank you, Nitza, and good morning, everyone. As the new CEO of Citi Trends, it is a pleasure to be speaking with you this morning, and I hope you are all safe and well. We are in unprecedented times, and COVID-19 has had a tremendous human impact and an impact on our economy and the retailing landscape. Throughout this crisis, our top priority has been and continues to be the health and safety of our associates, our customers, and the communities we serve. We, like many others, have made some difficult but prudent decisions throughout this pandemic to ensure that Citi Trends remains in a strong financial position and is poised to exit this crisis, well positioned for a safe recovery and long-term growth. I would like to take a moment to thank our leadership team and associates for their unwavering dedication to the business and our communities throughout this crisis. Our people are the heart and soul of Citi Trends, and alongside many other priorities in their own personal lives, they rose to the challenge of balancing life needs with the needs of the business. I am so incredibly proud of their efforts and all that we have collectively accomplished during this time. Moving on to the topics to be discussed during today's call. I will first discuss how we are safely and prudently navigating through COVID-19. I will review our reopening strategy, which is well underway, and I will provide an update on the early results we are seeing quarter to date. Next, I will turn it over to Jason Moschner, our Vice President of Finance who will briefly review our first quarter results. Finally, before opening the call to your questions, I will summarize how we are viewing our previously stated strategic initiatives. First, let me recap the highlights of actions we have taken to ensure the safety of our associates and customers, preserve capital, and bolster our financial liquidity. In response to the growing pandemic in New York City, we closed our corporate office on March 13 and instituted work-from-home policies. On March 20, due to stay-at-home and shelter-in-place orders and based on guidance from federal, state, and local authorities, we temporarily closed all 574 of our stores across 33 states. On March 27, we temporarily closed our 2 distribution centers and our corporate office in Savannah, Georgia. We made a difficult decision to furlough substantially all of our store and distribution center personnel and about 40% of our corporate staff. We temporarily reduced cash compensation for the Chief Executive Officer, senior executives, and Board members by 15% to 25%. We created a COVID-19 response team focused on business continuity that develops new protocols and action plans to limit and reduce operating expenses, address forward-looking safety requirements, and prepare the business for reopening. We partnered with vendors and extended payment terms. We partnered with landlords to negotiate store rent for the weeks of our closure. We announced that we do not intend to repurchase any shares for the time being under our previously announced share repurchase program. We proactively drew down $43.7 million under our revolving credit facility and extended the term of our credit facility to August of 2021. We temporarily suspended our quarterly cash dividend beginning in the second quarter, and we appropriately reduced our inventory receipts. It is important to highlight that the health of our balance sheet pre-COVID-19 helped us prepare for this uncertain and unpredictable period. We entered the 2020 fiscal year in a healthy financial position with no debt and cash and investments of roughly $63 million. Our prudent management of inventories, our largest payable, included the cancellation of spring goods resulting in a quarter-end inventory decrease of 7.1% compared to the end of the first quarter last year. I am confident that the actions we have taken combined with the stringent management of the business will keep Citi Trends in a strong financial position as we complete the reopening of our stores and shift our focus back to growth. As the first quarter of fiscal 2020 began to unfold, our comparable store sales increased 3.1% through March 7, and we were on track to have a stellar start to the year until the impacts of the COVID-19 pandemic began to affect our country in unprecedented ways. What unfolded next was a series of extraordinary actions taken by management, grounded in their passion, leadership, and attention to detail to guide the company through the COVID-19 pandemic. We quite literally hunkered down in our homes and leveraged technology to continue working together. Our leaders met multiple times a day and ultimately devised a plan to slowly reopen stores when we could safely do so. We began reopening stores on April 24; and by May 9, more than 300 of our stores were reopened. And as of May 28, more than 3,000 of our furloughed associates were back at work in 498 stores. Seeing our dedicated associates and loyal customers in stores for the first time in several weeks brought many smiles, and in some cases, tears of happiness. Moving to the topic of store reopenings. Let me first spend a moment discussing some specific in-store protocols we have in place to protect the health and safety of our associates and customers while also adhering to social distancing guidelines. Face masks, hand sanitizer, CDC-recommended cleaning procedures, reduced hours, social distancing signage, closure of fitting rooms, and suspension of our return policy became standards in our stores and where appropriate in our distribution centers. Once our corporate offices reopen, we will institute necessary safeguards to protect our employees. Now moving on to early results we are seeing in the stores we have reopened to date. As of today, we have reopened 498 stores across 26 of 33 states. Our performance quarter-to-date, while still very early, is quite strong as our customers and the communities we serve have enjoyed returning to a favorite pastime, shopping for the family. I am pleased to report that just shy of 4 weeks into our fiscal second quarter, reopened stores are registering comparable store sales growth that has substantially exceeded our expectations and plan benefiting from a combination of the strength of the company's brand, its value proposition, and the federal government stimulus to consumers that began in early April. The increase is driven by healthy transaction trends and an increase in the average number of items per transaction. Throughout our early stages of recovery, I'm impressed with our buying team, and how they have used data-driven insights to identify 4 notable patterns in customer behavior. These patterns help us to wisely navigate and develop plans for the balance of the quarter and remainder of the year. Let me take a few minutes to elaborate on these customer patterns. The first pattern, we'll call it, 'Welcome Home.' Customers turned to nesting, playing at home, dining in, and sprucing up their space. Our home business, including bedroom décor and kitchen, has thrived as customers looked to replenish, expand, and improve their personal spaces. Kids were also in need of some distraction from being limited in their activities, and we saw an increase in sales of toys, tech, and gaming. The second pattern, we'll call it, 'Mom, it's too small.' Simply put, our kids outgrew their seasonal closets. This prompted a disproportionate amount of spend in this area. Shorts, tees, matching sets, and dresses led the pack with a brand and fashion focus. The third pattern that emerged is, 'Mom and Dad, break time.' Breaking the cabin fever and getting outside became a major milestone as our customers started to head out of the house; updated fashion is a necessity. Men's branded and fashion apparel and women's new summer fashion performed exceedingly well. The fourth and last pattern, 'Relax, just hang out.' In other words, relaxed and easy comfort along with DIY activities ruled the day. Unconstructed bras, woven boxers, pajamas, loungewear, slides, and socks were key assortment drivers. With the closure of salons, cosmetic stores, gyms, schools, and playgrounds, we saw an increase in sales in a variety of products used in home-related activities. Beauty categories such as nail products, lashes, fragrances, and fitness also all outpaced expectations. Citi Trends' broad offering of basics, fashion, trends, and sought-after brands at extreme value price points, along with an engaging in-store experience, is strongly resonating with our customers. Importantly, we are driving the positive results at healthy margins as we entered the second quarter with appropriate inventory levels and in a strong open-to-buy position that has enabled our buying team to take advantage of unique opportunities in this changing environment. I will now turn the call over to Jason, who will discuss our first quarter financial results. Jason?

Jason Moschner, VP of Finance

Thank you, David. Total sales in the first quarter decreased 43.4% to $116 million, including a comparable store sales decrease of 44.5%. The decrease in sales was due to closing all 574 of our stores from March 20 until April 23, at which point we began to gradually reopen our stores. I want to reiterate David's comments that we had good momentum in the quarter prior to the onset of COVID-19, with comparable store sales positive 3.1% through the first week of March. However, as the pandemic set in, we began to see a decrease in the number of transactions, leading up to the closure of our stores. Gross margin in the quarter was 27.3%, a decrease compared to 37.5% in the first quarter of last year. The decrease was primarily due to markdowns that we took as a result of our stores being closed. SG&A expenses decreased by approximately $9 million or 14.8% compared to the first quarter last year. The decrease was primarily in payroll expenses as a result of furloughs, combined with decreases in certain variable and semi-variable expenses. As a percent of sales, SG&A expenses increased to 46.6% compared to 30.9% last year due to the material deleveraging effect from lower sales. Our net loss for the quarter was $20.9 million compared to net income of $7.8 million in the first quarter last year on a GAAP basis, or on an adjusted basis, a net loss of $20.2 million this year when adjusted for CEO transition expenses and asset impairment expenses compared to net income of $8.7 million in the first quarter of last year when adjusted for proxy contest expenses. Net loss per diluted share was a loss of $2 on a GAAP basis compared to earnings per diluted share of $0.65 in the first quarter of 2019. On an adjusted basis, net loss per diluted share was a loss of $1.94 compared to adjusted earnings per share of $0.72 in the first quarter of last year. I will now highlight a few items on our balance sheet. As David mentioned, we were fortunate to have a strong balance sheet coming into the COVID-19 pandemic, with approximately $63 million of cash and investments and no debt. On March 20, as a result of the pandemic and our company-wide store closures, we drew down $43.7 million on our revolving credit facility. We ended the first quarter in a healthy financial position with cash and investments of approximately $108 million. On May 12, we amended our credit agreement to extend the maturity date by 12 months out to August of 2021. We ended the first quarter with a very clean inventory position with our inventory down 7.1% compared to the end of the first quarter of 2019. As we emerge from the COVID-19 pandemic, we are confident in our current liquidity position, and we are continuing to evaluate our overall capital structure to ensure we have sufficient liquidity for our long-term growth plans. Combined with our clean inventory position and the positive comparable store sales we have experienced to date in our reopened stores, we are excited to capitalize on opportunities in the marketplace in the near term and return to executing on our strategy. Based on the company's quarter-to-date performance, the company is estimating a second quarter comparable store sales increase of mid- to high single digits and meaningful margin expansion. This estimate is subject to potential consumer and marketplace volatility during the early stages of post-COVID economic recovery, and therefore, may change as the quarter progresses. Due to the continued uncertainty surrounding the COVID-19 impact on consumer behavior and the company's business operations, we are not providing any further guidance at this time.

David Makuen, CEO

Thank you, Jason. At Citi Trends, we are a community-based retailer in primarily midsized markets. Nearly 75% of our customers live within a 15-minute drive to one of our stores. The outpouring of excitement and support during our reopening phase has been simply amazing. We've created a unique in-store experience. And in the words of our social media followers, 'Don't sleep on Citi Trends or you'll miss out.' None of this would have been possible without our store teams. I could not be more proud of our associates who exemplified our brand values through their agility and flexibility to ensure we provide a safe and healthy environment for our associates to work and our customers to shop as we reopen the company for business. And our commitment to putting safety first in all of our actions reflects the responsibility and accountability we have towards the communities in which we serve and conduct business. As we continue to navigate through this pandemic, we are evolving and adapting our operating model, and I feel confident we will emerge from this crisis stronger and better equipped to grow our business. Before we wrap up and take your questions, I'd like to share a few thoughts from my first few months as CEO. First off, I am so excited to lead this great brand towards our stated goal of $1 billion in sales. As the company navigates the current times and returns to a version of normal, our vision remains the same. Citi Trends aspires to be a leader in the extreme value-retailing space, one of few multi-category off-price retailers focused on the African-American market. I'm proud to say that our teams in our corporate offices and stores, our brand values, and our culture are stronger than ever. With a strong balance sheet, liquidity to manage through a chain closure, and a high-energy team with a growth mindset, Citi Trends is prepared to return to executing on many initiatives that will build a stronger foundation and set us up for scaling our unique model in the years to come. We intend to make meaningful progress on our long-term strategic plan, including number one, maximizing real estate opportunities, including opening three new stores during the first quarter of fiscal 2020 and 3 new stores in the second quarter, with the potential to open up to 14 total new stores this year; number two, making improvements in supply chain freight costs and four-wall efficiencies; number three, reducing inventories, increasing margins, and increasing churns, while delivering a highly appealing assortment of always-fresh merchandise for the entire family; and lastly, addressing select technology enhancements to improve efficiencies and productivity. The company anticipates that as the country normalizes and assuming no further complications from the COVID-19 pandemic that it will return to executing on its 3-year strategic plan to increase earnings per share at a compounded annual growth rate of 20% to 25%. Lastly, I want to thank Peter Sachse in his role as interim CEO for guiding the team in 2019 and through Q1 of 2020 and providing invaluable teaching and coaching that illuminated what great looks like. Peter has been an invaluable partner to me during my ramp-up, and I look forward to working with him in his Chairman role going forward. With that, we are ready to take your questions. I will turn it back over to Nitza.

Nitza McKee, Senior Associate

Okay. Operator, we're ready for questions.

Operator, Operator

Our first question comes from the line of Eric Beder with SCC Research.

Eric Beder, Analyst

Congratulations on weathering this COVID virus. You've opened a lot of stores. Obviously, it's somewhat of a crazy time. Did you take the opportunity to look at those stores? I'm sure you did. And were there any changes you decided to make in those stores as they rolled out in terms of focusing on product mix or different fixturing? How did you think about this, I guess, somewhat opportunity to somewhat reinvent the stores a little bit?

David Makuen, CEO

Thank you for your question, Eric. As you know, we had to close our stores quickly due to the pandemic. The closures happened within days as the situation escalated. After the peak of the pandemic, we allowed time for the stores to settle before reopening. When we did reopen, our primary focus was ensuring that personal protective equipment and safety measures were in place for both customers and associates. This included providing masks for our staff, hand sanitizer at entrances, appropriate social distancing signage, and floor markings to guide customers. We haven't made significant changes to the store fixtures because the number of customers allowed in stores has been dictated by local regulations. Generally, we've managed customer limits well and ensured compliance with CDC guidelines. Overall, when we reopened, the stores resembled their prior setup in terms of merchandise and fixtures. We're continually learning as we open more locations, but performance and adherence to new standards have been consistent across different clusters of stores. We’re proud of our teams and are committed to thorough cleaning protocols while opening and closing the stores. We are pleased with the results so far. Thank you again, Eric.

Eric Beder, Analyst

Looking at your current online presence, has this caused you to reconsider your approach to online sales? While I understand much of this is viewed as a treasure hunt within the stores and focused on product pricing, could there be a potential for online sales in the future?

David Makuen, CEO

It's an important question, Eric. Online sales have certainly seen a significant increase during the pandemic as people have been stuck at home. However, I believe it's too early to focus on online sales. The essence of our business is the treasure hunt experience, where customers discover new and exciting items as well as sought-after brands that our buying team has brought together. We also prioritize serving our local communities, not just through employment but by being an integral part of them. As I mentioned, many of our customers live within a short distance of our stores, and a lot even walk or bike to shop with us. We view this as the year of the store. After being cooped up at home, people want to get out and enjoy shopping again. The reality is that most people in the United States love visiting stores, and we are purely a store-based business, which will continue for the foreseeable future. As I acclimate to my role, I don't see any urgency to dive into e-commerce. Instead, I prefer to focus on enhancing our store presence, opening more locations, and leveraging the unique treasure hunt experience we provide for our targeted customers.

Operator, Operator

Our next question comes from the line of Elan Danon with Danon Capital.

Elan Danon, Analyst

Welcome aboard, David.

David Makuen, CEO

Thank you, Elan.

Elan Danon, Analyst

I want to start off by saying that I've been following this company for a while. David, do you see any changes in merchandise strategy compared to the previous approach over the last 5 or 6 years, which involved reducing inventory risk, focusing more on basics, and still limiting some of the national brands? I'm curious about your thoughts on merchandising and how you envision the store layout.

David Makuen, CEO

That's a great question. Merchandising and our assortment are essential to the brand, and we're fortunate to have Lisa Powell on board as GMM. She leads a fantastic team that focuses on the customer and anticipates their preferences. My approach has always been to work backward from the customer, and when done consistently, this strategy leads to success. Our buying team embodies this mindset. During my time here, I've come to appreciate that the assortment at Citi Trends combines basics, fashion, trends, and sought-after brands, and we will continue to refine that mix. Our customers want to pair basic tees and undergarments with fashion tops and stylish bottoms, all while enjoying great brands at incredible prices. The key difference going forward is our increased focus on the customer and market trends, which will empower our buyers to invest wisely in brands and non-brands that resonate with our audience. This presents a significant opportunity for us. Another opportunity lies in how we display these products in stores. Over time, we will enhance our visual merchandising to ensure we highlight the brands and convey their value. I am confident that if we excel in these two areas, our customers will respond positively, and we'll achieve great success.

Elan Danon, Analyst

And is the merchandise we see on the floor now, is that part of Lisa and her team's efforts?

David Makuen, CEO

Yes. The merchandise that's selling through right now is absolutely part of Lisa and her team's efforts. And they're based on our positive momentum. During our reopening, they're feverishly buying more and seeking out that right mix according to those sort of four buckets I mentioned, basics, fashion, trends, and brands, and they're all over it. It's great. Great to see a lot of energy coming from her team to fulfill what the customer is calling for.

Elan Danon, Analyst

Great. In terms of when you might begin buying back stock, considering how inexpensive it is now, do you have a timeline for that? Are you facing any restrictions on drawing down the revolver? What does that look like?

David Makuen, CEO

The simple answer would be no timeframe yet. We're in this period of recovery. We feel for the country, we feel for the people that have been affected by COVID-19. And I would tell you, Elan, we're just taking it slow right now. We've had to reopen a chain, which is no small feat, bring back thousands of people, and we're going to put that on the list in terms of when, how, and so forth. But right now, we're focused on managing our liquidity, managing the reopening process and success, and getting our feet on the ground for the rest of Q2, and then we'll turn our heads towards the second half. But we'll certainly keep your question in mind when we look at things a little further down the road. Jason, do you want to add anything on that?

Jason Moschner, VP of Finance

Sure. I'd add. I mean, absolutely. It's a wait and see approach right now as we emerge from the pandemic, but I would reiterate that we are absolutely committed to returning to our strategy to return capital to shareholders in the form of share repurchases and in the dividend. That's part of our long-term strategy that we have communicated, and it is our plan to get back to that, but just too early to tell at this point.

Elan Danon, Analyst

Got it. Have you had conversations with some of your landlords about rent reductions?

David Makuen, CEO

Yes. We are in active conversations. Landlords are so important to us. And our real estate current holdings, if you will, through our leases and our future real estate vision is just critically important to the growth of Citi Trends. And so we are in active negotiations with nearly all of them. And hats off to our small but nimble real estate team, and they're out there, figuring out what makes most sense landlord by landlord, and we'll get to a good place with all of them.

Elan Danon, Analyst

Got it. And then in terms of possibly monetizing the DCs. I mean, some of your large shareholders have had success with other companies they're involved with in monetizing some of those noncore assets. Any thoughts there?

David Makuen, CEO

I believe you said monetizing the DCs, if I heard you correctly. Not yet. Too early to kind of go down that road. We were fortunate to have the liquidity going into the pandemic, and we're able to draw down on our revolver, and we're in a strong cash position as we navigate through this early stage of recovery. So haven't addressed that yet.

Elan Danon, Analyst

Okay. Lastly, are you seeing some really good inventory and brand opportunities that the stores have not faced traffic issues with? If the brands are right, they tend to sell well. Given the current challenges in retail and clothing, do you have access to exciting products for the rest of the year?

David Makuen, CEO

Great question, Elan. At a high level, I would say that there are excellent opportunities in the marketplace for the Citi Trends buying team. We are focused on what's best for our customers, our business, and our pricing. There is some disruption occurring, and I can assure you that we are actively engaged in the marketplace, securing favorable deals for us.

Elan Danon, Analyst

Okay. My last question is about where you expect to see turnover. Clearly, it won't match that of a traditional price retailer. Where do you see turnover to reach operating margins in the mid-single-digit range? Additionally, what are your expectations for gross margins? Do you think they can exceed 40% annually?

David Makuen, CEO

There's significant financial potential for the brand that likely spans various aspects of our financials, with margins being a critical component. Overall, I believe there is room for margin improvement as we navigate the rest of the year and explore the product opportunities we have ahead. I appreciate your questions, Elan, and want to assure you that we take our financial results very seriously. I'm focused on data and will closely analyze how we can effectively leverage sales while managing our expenses to enhance profit. More details will follow, but thank you for your insights, Elan. It's great to connect with you.

Operator, Operator

We have no further questions at this time. I would now like to turn the call back over to David Makuen.

David Makuen, CEO

Dina, thank you so much. I think we're ready to wrap up for the day. Again, thanks to everyone who joined our first quarter 2020 earnings announcement. Please stay safe and healthy, and we'll see you next time for Q2. Take care now.

Operator, Operator

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.