Earnings Call Transcript - CTRN Q3 2020

Nitza McKee, Senior Associate

Thank you and good morning, everyone. Thank you for joining us on Citi Trends third quarter 2020 earnings call. On our call today is our Chief Executive Officer, David Makuen; and 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 today 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, and thanks for joining us today on our third quarter 2020 earnings call. I hope that you are all safe and well. Despite the uncertain environment for Citi Trends, the third quarter was one with many high points. We registered stellar operating results, we fully repaid our outstanding borrowings under our revolving credit facility, we reinstated our $30 million share repurchase program, and we repurchased 545,000 shares under that program through November 20, and we appointed a seasoned Retail Executive, Pam Edwards as our Chief Financial Officer, effective in January. Now, onto the topics to be discussed during today’s call. I will first provide a review of our spectacular third quarter operating performance and accomplishments. I will then discuss our merchandising and marketing initiatives for the holiday season including our Fab Festive Finds Holiday Campaign. I will review notable expanded capabilities and critical business functions that provide us confidence in our model to deliver strong results in the months ahead. Next, I will turn it over to Jason Moschner, our VP of Finance, who'll review our third quarter results and financial position in more detail. Lastly, before opening the call to your questions, I will close out with a few high-level comments showcasing our confidence in our unique and scalable model. To begin, across the board from our distribution centers to Savannah to New York and in 585 stores, I could not be more thankful for everyone's tireless efforts in contributing to the ongoing transformation of Citi Trends. I will reiterate what I stated on our second quarter call. We have a unique and powerful winning culture at Citi Trends, and I continue to be impressed with our entire organization as we are not only successfully navigating this unprecedented period in our history, but through thoughtful innovation, with the use of data analytics and ingenuity, we are truly transforming our operating model, positioning Citi Trends for many years of profitable growth. Importantly, from an operations and store perspective, we continue to prioritize the safety and well-being of our associates, our customers, and the communities we serve. As we enter the critical holiday shopping season which typically garners meaningfully higher levels of traffic during peak days and weeks, we are doubling down on building associate awareness of our social distancing and safety protocols as well as our cleaning regimens. The dynamics of the third quarter were unique as we, like many others, experienced a slow start to the back-to-school season, which resulted in soft sales performance in the month of August. That was followed by a meaningful acceleration in our September business as families better understood how their children would return to school. We ended the quarter with October registering positive mid-single digit comparable store sales growth resulting in a strong third quarter comparable store sales increase of positive 6.3%, and a total sales gain just shy of 9%. We again achieved substantial growth in our gross margin, which was up 440 basis points compared to last year's third quarter, building on the momentum from the second quarter, which was up 390 basis points compared to last year, all of this driven by healthy full-price selling and well-managed inventories. In fact, we achieved a positive 6.3 comp on 33% less comparable store inventory, resulting in an impressive 55% increase in churns for the third quarter. These inventory and churn accomplishments dovetailed extremely well with our long-term plan; so we are very encouraged by the momentum we are experiencing. We entered the holiday season with clean and current inventories, stocked full of next season buys that we had purchased during the first half of this year coupled with opportunities based on learnings from last year to capture more market share in important wear-now apparel categories. Additionally, at the end of Q3, our stockpile of next season buys; items meant for selling in the first and second quarter of 2021 were up 37% versus the end of Q3 last year, as our buying team adeptly scoured the market for the right products at extreme values. During the quarter, we continued to support our store growth agenda by opening eight new Citi Trends stores, expanding our reach into Southeast Texas while also returning to meet the needs of our loyal customers in the diverse and important Minneapolis community. Recognizing the importance of offering a well-rounded and curated assortment of Home Trends, we rolled out our expanded home assortment to an additional 100 stores bringing the total to 200 locations with expanded home sections. Moving down the P&L, we've combined rigorous expense control with prudent investments in the business and delivered healthy expense leverage in the quarter. Coupled with our record third quarter gross margin, operating margin expanded 560 basis points to 4.7% of sales. These strong results demonstrate the strength of our brand, our on-trend apparel assortment, and outsized growth in Home, all of which continue to resonate with our loyal and expanding customer base. Our third quarter high points were not limited to operational excellence as we also announced the appointment of our new CFO, Pam Edwards, effective January 4. Pam brings extensive experience in finance, strategy, and operations across a variety of retail brands and sectors. Most recently, Pam spent 15 years at L Brands as Chief Financial Officer for various divisions of the company, including Mast Global, Victoria's Secret, and Express. Pam is a true leader with a proven track record of success. I'm confident she is the right leader for the business and we look forward to benefiting from her experience and expertise in just a few weeks. I want to take a moment to thank Jason Moschner, who's been my go-to trusted finance partner and will continue as the Vice President of Finance and Principal Accounting Officer of Citi Trends. Let me spend a little time on our third quarter merchandising performance as well as our positioning for the holiday season, including exciting new marketing strategies. Our third quarter performance was broad-based with positive comps in all five categories led by Home, men's, and women's. In line with how many of our customers are living and shopping these days, we captured significant market share in bedding, home décor, casual coordinating tops and bottoms for him, activewear and sleepwear for her, and statement tees that allowed our customers to express their passion. Lastly, our continued relationship-building with leading brands gave us the ability to provide an expanded assortment of current trends to the underserved communities that deserved access to these brands at affordable prices. We entered the holiday season with an elevated focus on gifting, anchored by our Fab Festive Finds marketing campaign. The assortment runs began at an extreme value giftables such as trendy toys, jewelry sets, plush robes, girls' cosmetics sets and a wide range of Bluetooth tech items; just to mention a few. These Fab gifts are proudly displayed on gift tables located at the front of our stores, creating a festive holiday spirit in our inviting store experience. Since joining in March of 2020, I've studied most facets of our business and I can tell you that we have been able to spark some really meaningful transformative actions and results across many functions of the business. While I referred to the evolution in our business as a reset during our Q2 call, I am more convinced that what we experienced is a transformation; we're experiencing a true transformation on the beginnings of a sustainable growth strategy. Central to our growth strategy is the innate understanding of our customers, coupled with the right tools of the trade to provide them with the right product at the right time, at the right price, and in the right store. While we are at early stages, I am delighted at what I'm seeing in the form of demonstrable progress due in no small part of the quality of our people, and the passion they are applying to our strategic initiatives. At the forefront of our progress is our ability to leverage data-driven insights across our business functions to inform what we ultimately do for the only thing that matters, our customers. For example, we are, for the first time rolling out data tools and a communication technology platform to our stores organization and transform from an operational-only focus to a sales-driven culture, one that is actively managing the dynamics of the fluid and fresh store assortment. For the buying team, we are implementing cloud-based solutions that enable advanced seasonal planning and robust inventory rationalization that greatly improve our craft at putting the right products in front of the right customers. In our supply chain, we ramped up new capabilities including drop shipments from vendor to the floor for time-sensitive trends into targeted store clusters which gets the hot trends into customers' hands much faster than in the past. I'm so excited about what's to come; I look forward to updating you on our progress on future calls. With that, I will now turn the call over to Jason Moschner, who will discuss our third quarter financial results.

Jason Moschner, VP of Finance

Thank you, David. Total sales in the third quarter increased 8.8% to $199.1 million, including a comp store sales increase of 6.3%. The increase in comp sales was driven by a substantial increase in the average ticket size, partially offset by a low double-digit decrease in customer transactions. We are especially excited about our 6.3% comp sales increase relative to the U.S. census data that reported a sales decrease of 14% for clothing and accessory stores in the third quarter. We achieved a record gross margin in Q3 of 41.8%, an increase of 440 basis points over Q3 last year. And this follows our Q2 margin rate of 41.2%, which was an increase of 390 basis points over Q2 of last year. The increase in our quarterly gross margin continues to be primarily the result of strong full-price selling and fewer markdowns. SG&A expenses increased by $3.7 million or 5.6% compared to the third quarter of last year. The increase in SG&A expense dollars was primarily due to higher bonus and equity compensation accruals combined with expected increases from operating more stores. As a percent of sales, SG&A decreased 100 basis points due to the leveraging effect from higher sales. Now, turning to the bottom line. Our net income for the quarter was $7 million compared to a net loss of $1.1 million in Q3 last year. Earnings per diluted share was $0.67 compared to a loss of $0.09 per share in the third quarter of last year. Now, turning to our year-to-date results. For the first nine months of 2020, total sales decreased 6.9% to $531.4 million and comparable store sales decreased 9% with the year-to-date decline driven by the effect of COVID-19 on our business. In the first quarter through March 7 when we began to see the impact of COVID-19 on our sales, we had a comparable store sales increase of 3.1%. Then, in the second quarter, upon reopening our stores we recorded a 32.2% increase in comp sales for our open-only stores. Then finally, in the third quarter, our comp sales increased 6.3%. Gross margin for the nine months period expanded 100 basis points to 38.4% in the first nine months of the year. The increase was due to strong full-price selling and fewer markdowns in the second and third quarters, partially offset by the reduction of more than 1000 basis points in the first quarter due to markdowns that we took when we temporarily closed our fleet of stores. SG&A expenses for the nine-month period decreased by $11 million or 5.8% compared to the prior year period. The decrease was primarily in payroll expense as a result of associate furloughs and reduced operating hours, combined with decreases in other expenses during the first half of the year that were primarily related to the temporary closures of our stores and distribution centers. In addition, we incurred $1.7 million of incremental costs related to COVID-19 for personal protective equipment and cleaning supplies. As a percent of sales, SG&A expenses for the year-to-date period increased to 34% compared to 33.6% in the same period of last year. For the nine months, our net income was $6 million compared to $7.1 million in the first nine months of 2019. And earnings per diluted share was $0.57 compared to $0.60. To summarize our year-to-date performance; our strong operational execution has paid off. Despite the headwinds we faced from the pandemic including significant store closures ranging from 35 to 100-plus days during the first half of the year, our year-to-date gross margin is 100 basis points higher than last year. And our year-to-date operating profit is more than $900,000 higher than last year. That is a powerful statement about the strength and appeal of the Citi Trends brand. We ended the quarter with $97 million in cash, compared to cash and investments of $72 million at this time last year. Through the first nine months of 2020, we have generated operating cash flow of $63 million compared to $21 million generated in the first nine months of 2019. In light of our stellar operating results, our strong financial position, and our overall confidence in the business; in September, we reinstated our $30 million share repurchase program. And to date, under this reinstated authorization, we repurchased 545,000 shares for $15 million. As to inventory, we ended the third quarter in a very clean inventory position with our inventory down 15.5% compared to the same time last year. As David noted, we ended Q3 with 33% less inventory in our comparable stores and 37% more inventory stored in our distribution centers as next season buys. This next season buy inventory represented 23% of our total inventory compared to 14% at the end of Q3 last year. As we continue to navigate through the COVID-19 pandemic, we remain confident in our current liquidity position and disciplined in our approach to running the business. We are planning the remainder of the year conservatively, given marketplace conditions as a result of the pandemic. As such, we are estimating our fiscal 2020 fourth quarter comp store sales to be approximately flat, which is consistent with November's trend. Due to the continued uncertainty surrounding the COVID-19 impact on customer behavior and our business, we are not providing further guidance at this time. Now, I will turn the call back to David for closing comments.

David Makuen, CEO

Thank you, Jason. Before I wrap up with a few closing comments, I wanted to talk about a few things. First off, I'm excited to update you on a new partnership with our CitiCARES platform in the Boys and Girls Clubs of America. I am pleased to announce the first event with clients of Citi Trends, a fundraising event to support Boys and Girls Clubs in select communities. School closures have created significant hardships for many households, particularly those in our communities and some of which have even affected our associates. From November 20 through December 20, select stores will accept donations that will directly benefit the clubs in these communities. CitiCARES Counsel worked directly with the staff at these centers to discuss their needs, programs and the shortfalls created as a result of the current pandemic. CitiCARES powered by Citi Trends is a proud partner of the Boys and Girls Club this holiday. Let me wrap up with a big shout out to our entire organization. I'm so very proud of our team's ability to adapt and continue to safely serve our customers in what remains a fluid operating environment. My confidence in our capabilities to profitably grow the Citi Trends brands, while creating positive change in the communities we serve has only strengthened as this year has progressed. Our third quarter performance further indicates that we operate a unique and scalable model, one that is embraced by our loyal customers. During the second and third quarters, the outpouring of customer support was humbling and something we are so thankful for. We continue to love our fashion, trends, basics and everything in between within our apparel, accessory and home categories. It's because of this customer loyalty that Citi Trends puts our store experience front and center, ensuring we create a warm inviting environment coupled with an easy-to-shop layout that features head-to-toe outfits in coordinating pickups across the entire spectrum of his, her and the kids' lifestyles. It's important to recognize that our stores sit in shopping centers that are vital to the Black, Hispanic and melting-pot towns and neighborhoods across America. We consider our unique in-store experience that showcases broad product choice for the entire family within an extreme value framework to be essential for our moderate to lower income underserved customers. We are optimistic that our model will continue to build on our success to date with continuous improvements in key operational metrics, including inventory turns, gross margin and expense leverage over time. With that, we are ready to take your questions.

Operator, Operator

Thank you very much. We will proceed with our first question on the line from John Lawrence from Baraboo Growth. Go ahead with your question.

Unidentified Analyst, Analyst

Thank you. Good morning, everyone. Congratulations on the numbers. David, could you take a step back and share your thoughts on the buying team? When discussing transformation, how do you go to market? Can you provide some background on how the vendor community is currently viewing Citi Trends and whether it has become a more valuable outlet for their products? Also, what changes have occurred in that process over the past six or eight months?

David Makuen, CEO

Thanks, John. Good question. Sure, I'll add a little color on that. Really beginning with the onset of the pandemic in March and April, and upon my arrival, the team really rallied around how could we expand our vendor base and attract the right vendors to our stores so to speak, and serve our customers with the goods that they're asking for and desiring. And kudos to our buying team, they went out and really attacked the marketplace on all fronts across things that we sourced ourselves to private label offerings, to nationally-known brands, and so forth. And as a result, they really developed and opened up new relationships that had previously not existed at Citi Trends. And I'll give a shout out to Lisa Powell, our Chief Merchandising Officer; she and her team really put a tremendous effort into this plan of how we expand our vendor base, how do we bring in more interesting and exciting style and fashion vendors to fuel the exciting fresh assortment that you will find at Citi Trends. And I know those new relationships are relationships that we're nurturing and fostering for a long-term approach to working with these vendors. So, we're looking forward to what lies ahead. We're seeing some of those fruits in our results year-to-date, and she and the team will continue to leverage and develop those relationships in the future.

Unidentified Analyst, Analyst

Great, thanks. Good luck.

Operator, Operator

Thank you very much. We'll get to our next question on the line from Alec Legg from B.Riley Securities. Go right ahead.

Alec Legg, Analyst

Hi, good morning. Hi David and Jason. First off, nice job on the quarter. My question relates just to the store fleet growth. So, this quarter you opened eight new stores and closed two; what are your thoughts on the long-term strategy in growing the store base? How many new stores do you think you can open per quarter or per year? And it looks like you have a lot of white space left.

David Makuen, CEO

Hi Alec, thanks for posing that question something near and dear to our hearts. First of all, Citi Trends is firmly a growth brand, there is no question about it; you hit upon it in the right way. There's a lot of space in the U.S. to support further Citi Trends fleet growth; and so while we aren't at liberty to share an exact number or plan today, what I can tell you is in the upcoming ICR Conference in mid-January, we intend to share more specifics. At a high level, we believe there is a lot of opportunity to serve the African-American communities and Hispanic communities that exist in the U.S. and we are serving a relatively small percentage of them today through our 585 store network. So, we believe there is a lot of upside in key geographies around the U.S., and I'll share more when you join us at ICR because I can tell you we have some good color to add on that front and kind of elaborate a little bit more on our long-range plan. But no, that store growth is a big part of our agenda, and we look forward to sharing more.

Alec Legg, Analyst

Perfect. I have a follow-up question. In the first quarter, you mentioned starting discussions with landlords about rent reduction and negotiations. Do you have any updates on that? Have you received any significant rent abatements or long-term restructuring of agreements?

David Makuen, CEO

Good question. To summarize our negotiations with landlords, I can say that they were understanding and open about what factors influenced their partnership with Citi Trends. As a result, we secured healthy abatements and deferrals. Additionally, we were able to renegotiate our current agreements or those nearing expiration, allowing us to sit down and discuss new terms. Overall, these outcomes aligned with our expectations, and I want to acknowledge our landlords for being accommodating; they recognized the seriousness of the situation, which led to a beneficial mix of abatements, deferrals, and renegotiations.

Alec Legg, Analyst

Perfect, thank you.

David Makuen, CEO

Thank you. Have a good day.

Alec Legg, Analyst

You too.

Operator, Operator

And we'll go to our next question on the line from Chuck Grom with Gordon Haskett. Go right ahead with your question.

Chuck Grom, Analyst

Hey guys, congrats on a great quarter. I just had a question, and maybe you talked about it and I hopped on a couple of minutes late. Just with regard to the change in trend during the quarter, it sounded like October and September were pretty strong, and then you're calling out November flat. So, just wondering if you could discuss the factors that contribute to that? And then also, if you're willing to share any comments on this past weekend Black Friday; how it fared for you guys?

David Makuen, CEO

Hi, Chuck. Thanks for being here. In November, several factors contributed to our performance. Unseasonably warm weather during the first 10 days of the month led to some moderation in those weather trends, which resulted in a positive uptick. We also noticed a delayed reaction to holiday shopping, which is advantageous for us since we are a popular last-minute destination; this played a role in making November relatively flat. Additionally, the Black Friday weekend saw a decline in foot traffic due to macro factors, including concerns from the CDC and a shift towards online shopping to avoid crowds. Overall, considering the safety warnings, we managed to navigate through these challenges reasonably well, but it still represented another period of slight slowdown. All these elements combined made for a flat performance in November.

Chuck Grom, Analyst

Okay, that's great. And then, just bigger picture; just wondering if you could comment on how you're thinking about the buying environment, the availability of product as we move into 2021?

David Makuen, CEO

Sure. As you might know, it's vital to our business. Well I'd tell you this, looking back at our accomplishments in Q3 when our buyers really scoured the globe, so to speak, to find the right stuff for selling in Q1 and Q2 of 2021, they did a stellar job at that. We don't see that progress abating; we think there is plenty of availability and momentum on the part of our team. So we are very optimistic about that, Chuck. And we won't take our foot off the pedal on that front.

Chuck Grom, Analyst

That's great to hear. Could you comment on the current mix of your Home business? Given the strength in that category and the housing complex today, are you considering expanding that category even more in the next couple of years? Thanks.

David Makuen, CEO

Sure, yes. No, good question. We've certainly mentioned our interest in growing our Home business; that really kicked off in mid-2019 and we've been seeing great momentum from it including the recent expansion into 100 more stores of a broader and deeper Home assortment. I'd tell you at the forefront, the Home business is relatively small still in our mix, and therefore there is a lot of upside for it to become a greater penetration of our mix in a total sense. And we see that 2021, 2022 and 2023 being some big years to further develop the Home business. Jason, you want to add something there?

Jason Moschner, VP of Finance

Yes. Hey Chuck, good morning. I could add, this is something that we break out in our Q2 and our revenue footnote that will break out the distribution and what the makeup is of our categories. But I can tell you just quickly, just looking at the last few quarters; it's growing from 4% of the business back in 2015 to most recently in Q3, it was 8% of the business. And it really just consistently posts high double-digit comps, 22% up in Q3; so like David said, not a significant portion of the business yet but consistently growing and consistently comping.

Chuck Grom, Analyst

Very helpful. Good luck. Thank you.

David Makuen, CEO

Thanks, Chuck.

Operator, Operator

Thank you very much. We'll get our next question on the line from Alex Silverman from AWM Investments. Go right ahead.

Alex Silverman, Analyst

Hey, good morning.

David Makuen, CEO

Good morning.

Alex Silverman, Analyst

Can you hear me?

David Makuen, CEO

Yes.

Alex Silverman, Analyst

Great. So, most of my questions have been asked and answered. Though couple of last questions. What happened to the size of the basket given your improved assortment?

David Makuen, CEO

Good question. The short answer is, it's increased pretty considerably since May. Now, it's important that there are some dynamics that we need to understand here. We do believe there is some loading up per trip that's happening based on the macro impact of the pandemic, and folks' desire to maybe make fewer trips; and when they do make a trip, they spend a bit more to make that trip even more worthwhile. So as Jason commented, we are seeing a softness in traffic to our centers but when they do visit, we're seeing some very healthy gains in our basket amount, which of course is driven by higher units per transaction, which is great to see, and in a slightly improved average unit retail. So those trends we love seeing, Alex, but it's important you recognize that some of that is driven by that macro impact of fewer trips and desires to spend more per trip. Does that make sense?

Alex Silverman, Analyst

It does, absolutely. Second question, this is the second quarter of greater than 41% gross margin; is this a good new level to be using on a go-forward basis or are there some unusual dynamics we should consider over the last couple of quarters?

David Makuen, CEO

Good question. I'll respond by sharing our internal perspective. The last six months have been unprecedented for us. The transformation of our metrics has accelerated within our business model. While we are excited about these numbers, we are not yet confident that they can be sustained indefinitely. I want to emphasize that our teams are intensely focused on achieving the results we saw in Q2 and Q3. Once things stabilize and we return to a more typical shopping environment in 2021, we may observe changes that affect our gross margin rate. However, we are prioritizing this aspect and are hopeful that we can maintain strong levels of gross margin.

Alex Silverman, Analyst

Very helpful. Last question from me. You guys bought a lot of inventory to put away for next season; is this an unusual dynamic that there were a lot of opportunities to buy inventory or is this a strategy that we should think about on a go-forward basis or both?

David Makuen, CEO

Good question. I'd probably say the latter point you make is the most important point. From a strategic lens, we need to always focus on finding the right next season buys and getting them in our hands and making sure we have them to deliver future great seasons. So I would say that's the big takeaway, Alex, and that's how we speak about it internally as part of our ongoing strategy. And more seriously than in the past is to determine and have the relationships with the right folks to deliver a constant stream of next season buys. Will it always be plus, plus, plus versus ROI, hard to tell and predict, but I can tell you it's a key pillar of our strategy.

Alex Silverman, Analyst

Great, thank you guys. Congratulations, great quarter.

David Makuen, CEO

Thanks, Alex. Have a great day.

Operator, Operator

Thank you very much. And Mr. Makuen, we have no further questions on the line. I'll turn it back to you for any closing remarks.

David Makuen, CEO

Very good, Tommy. Thanks to everybody who joined the call. Stay safe and healthy. Happy holidays. See you next quarter. Bye-bye.

Operator, Operator

Thank you very much. And that does conclude the conference call for today. We thank you for your participation. Please disconnect your lines. Have a good day, everyone.