Earnings Call Transcript - CTRN Q3 2022

Operator, Operator

Greetings and welcome to the Citi Trends 3Q 2022 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. As a reminder, this conference is being recorded, Tuesday, November 29, 2022. I would now like to turn the conference over to Nitza McKee, Senior Associate. Please go ahead.

Nitza McKee, Senior Associate

Thanks, everyone. Thank you for joining us on Citi Trends third quarter 2022 earnings call. On our call today is our Chief Executive Officer, David Makuen; and Chief Financial Officer, Heather Plutino. Our earnings release was sent out this morning at 6:45 AM 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. Good morning, everyone, and thanks for joining us today on our third quarter fiscal 2022 earnings call. I will begin the call with a review of third quarter results, as well as some fourth quarter to date insights. Heather Plutino, our Chief Financial Officer will then elaborate on our financial results and a few other items related to the rest of our year outlook. Then we'll open the call up to your questions. To begin, we delivered $192 million in top line sales, which equates to a three year comp stack of 1.4%, both of which were in line with our expectations. Our Buy, Move and Sell teams worked tirelessly to deliver compelling value-driven trends coupled with an engaging in-store experience to post a 39.8% gross profit, our 10th consecutive quarter of expanding gross profit when compared to pre-pandemic 2019 levels. Additionally, we continue to manage inventories tightly with high freshness factor. Total inventory at the end of the quarter was only 1% higher than 2021, an improvement from 26% higher at the end of the second quarter. Lastly, I'm pleased to share that we delivered positive operating income of $2.4 million. I want to spend a few minutes on how we got here. It all starts with people and our team's ability to be both scrappy and strategic within a challenging macroeconomic backdrop. Our mantra is to remain laser-focused on controlling what we can control from front of the house to the back of house. At the end of the second quarter, we committed to lowering our expense structure while shoring up our foundational infrastructure and most importantly, offering an exciting curated assortment that will never break the bank for our customers. We are right on track on the expense savings front and Heather will provide more detail. What I will focus on is how we are driving the top line and margin. More specifically, we focused on four key areas to ensure we met expectations in the third quarter while preparing for a successful fourth quarter holiday season. They were: number one, we shipped record amounts of packaway inventory, full of incredible values to excite our customers; Number two, we continue to roll out new zip codes in our product cities, including Q merchandise, missy size ranges and tween girls offerings; Number three, we infused hot price points in key categories to capture market share from value shoppers; And number four, we successfully lapped last year's macro supply chain issues to deliver an on-time gift assortment for a strong start to the fourth quarter. It's important to recognize that the inflationary backdrop our core customers are facing is truly unprecedented, particularly in the areas of rent, food, utilities, and transportation. Our core customer, with an annual household income of about $40,000, and 50% of our customer base having an annual household income of $25,000 and below, has been hardest hit from these extreme macro pressures. Having said that, the Citi Trends customer is doing an admirable job adjusting his and her shopping patterns. What we saw in the third quarter is that our customer is shopping much closer to need, employing a buy now, wear now strategy for important events and end-use needs in their lives. Back to school was, I am pleased to report, a solid performance for Citi Trends this year. Throughout the third quarter, our traffic and conversion rates remain steady and strong, and our average dollar basket size continues to hold up very well against last year's results. Through it all, I can assure you, and consistent with my points in the past, that the Citi Trends customer relies on us in the heart of neighborhoods where we are the primary destination for their family apparel and accessories, home and essential needs. Before I turn the call over to Heather, I want to highlight a few remaining points. First, we are set up really nicely for the remainder of the fourth quarter. We generally excel during need-based events, and we are confident that our families will gift big and spend less at Citi Trends this year. As we exited strong Black Friday week, our stores are full of great values across gifts, stocking stuffers and wonderful self-purchase outfits. Next, we are reiterating our second-half guidance provided at the end of the second quarter. And lastly, it's no secret that the marketplace is ripe for procurement of high-quality, high-value goods. Our flexible and agile operating model combined with our strong balance sheet allows us to be quite active for spring and fall of 2023. With that, I'll turn it over to Heather to discuss our third quarter results in detail, as well as our outlook for the second half of the year. Heather?

Heather Plutino, CFO

Thanks, David, and good morning, everyone. As David mentioned, our third quarter results were in line with our expectations despite the challenging macro backdrop and the significant inflationary headwinds our customers are facing. We manage the business prudently, and our teams continue to execute against our transformation strategy, delivering strong gross margins and a reduction in SG&A dollars for the quarter. We ended the quarter with a strong balance sheet, including $77.8 million of cash, well-controlled inventory, and our $75 million revolving line of credit remained unused. We also completed the sale-leaseback transaction on our Roland, Oklahoma distribution center for $36 million in proceeds. The strength of our balance sheet positions us well to continue to navigate the current environment, while focusing on our strategic initiatives. Now let's turn to specifics of our Q3 financial results. As mentioned in our earnings release, we are comparing select operating results for the third quarter and 39 weeks of 2022 relative to the same periods in 2019 in order to provide a more normalized comparison of performance. Total sales for the third quarter were $192.3 million, a decrease of 15.6% versus Q3 2021, or an increase of 5.1% versus Q3 2019. Comparable sales decreased 18.3% compared to Q3 2021, lapping a 19.7% increase in Q3 2021 versus Q3 2019, representing a three-year stack of 1.4%. Comparable store transactions versus the prior year sequentially improved 760 basis points from Q2 to Q3, an improvement of 1,270 basis points from Q1. Gross margin was 39.8% versus 40.3% in Q3 2021 and 37.4% in Q3 2019. Our strong gross margin results are reflective of our disciplined inventory management and product assortments that continue to strongly resonate with our customers. While SG&A expense dollars declined 7.6% versus Q3 2021, we experienced SG&A expense deleverage of 310 basis points versus Q3 2021 to a rate of 35.9% of total sales. We announced last quarter that we are streamlining our organization and aligning SG&A expenses to our sales expectation as a result of a difficult macro backdrop. In the third quarter, we made terrific progress rightsizing our expense structure and driving operating efficiencies across our business. As a result, we remain on track to deliver approximately $10 million in expense savings for the second half of 2022, or about 7% of total SG&A expense. We will continue to manage expenses with a heightened focus on building further operating efficiencies across the organization. Operating income was $31.6 million in the quarter or $2.4 million as adjusted for the gain on the sale of our distribution center, compared to operating loss of $1.6 million in Q3 2019. Third quarter adjusted EBITDA was $7.5 million compared to $2.9 million in Q3 2019. GAAP net income was $24.6 million in Q3 2022, compared to net loss of $1.1 million in Q3 2019. Earnings per diluted share was $3.02 or $0.24 as adjusted versus diluted loss per share of $0.09 in Q3 2019. Turning to our 39 week results. For the first nine months of 2022, sales were $585.6 million, a decrease of 22% to prior year and a 2.6% increase to 2019. Comparable store sales declined by 24.5% versus 2021 on top of a 26.9% increase in 2021 sales versus 2019, a three-year stack of 2.4%. Gross margin was 39% versus 41.3% in 2021 and 37.4% in 2019. EBITDA in the 39 week period, adjusted for the gain on the sale of our two distribution centers was $19.6 million versus $82.2 million in 2021 and versus $22.6 million in 2019 as adjusted. Year-to-date earnings per diluted share was $6.34 or $0.35 as adjusted for the two sale-leaseback transactions compared to $5.71 in the first nine months of 2021 and compared to $0.60 in 2019, $0.67 as adjusted. Now turning to our balance sheet. As David mentioned, total inventory at quarter end increased only 1.3% to Q3 2021 versus an increase of 25.5% at the end of the second quarter. Compared to Q3 2019 total inventory decreased 5.1%, while sales increased 5.1%. Average in-store dollar inventory was down 19% compared to 2019 with units down 29%, reflecting our focus on turning goods fast and offering our customers fresh merchandise each and every time they shop. Our packaway goods decreased almost 40% from Q1 as planned as we released these exciting products to support fall and holiday sales. We continue to leverage this important merchandising strategy by packing away near to current season goods that represent a tremendous value for our customers, while supporting our high gross margin rate. We are comfortable with our level of inventory and are super proud of our team for their continued commitment to agile, disciplined inventory management. Turning to our fleet, during the quarter we opened two new stores, closed four locations, and remodeled three. Year-to-date, we've added 12 new stores, closed six stores, and remodeled 35 locations. As it relates to our buyback program, year-to-date we repurchased approximately 331,000 shares at an aggregate cost of $10 million, leaving approximately $50 million remaining on our program. Capital allocation remains a primary focus of our Board of Directors and in light of the dynamic macro environment, we are carefully evaluating our cash and investments to ensure we maintain adequate liquidity. Now turning to guidance. We are reiterating our second half 2022 guidance provided with our second quarter earnings. That guidance, including the impact of the sale-leaseback of the Roland distribution center, included low-single-digit increase in second half total sales compared with first half total sales. Gross margin in the high-30s to low 40s range for the second half, less SG&A deleverage versus prior year and the second half compared to the first half due to aggressive expense reductions, net of incremental lease expense from the sale-leaseback transactions. Second half operating income approximately in line with results from the second half of 2019. And year-end cash balance of approximately $85 million to $100 million. In summary, we are pleased with our third quarter results in light of the difficult inflationary environment. While we expect these challenges to continue, our teams are focused on managing inventory and expenses while continuing to execute against our transformation. Combined with our growth strategies, this gives us confidence in our ability to continue to delight our customers, especially during the upcoming holiday season. With that, I will turn the call back to David for closing comments. David?

David Makuen, CEO

Thanks, Heather. With three quarters of 2022 on the books and with plenty of data patterns to study, we have work to do to be better. Most of our insights center on reacting faster to trends and keeping pace with our fashionable customer base. They really do live our purpose of live bold, live proud, respect all on the daily. We've got to source faster, ship faster, and react faster. The great thing is nothing structural is in the way. Our foundation is strong, and our start-up mindset is in full gear. I'm committing to you that our amazing people are becoming excellent operators so that we can dial into our customers' needs better than we do today. Reimagined processes, revved up leadership, and important new technology and infrastructure solutions we will drive our momentum on top of a solid foundation. As we think about what's next, it's important to note that based on many external data sources, discretionary retail will likely be affected by inflationary pressures into a portion of 2023. Let me assure you this will not slow us down from making continuous improvements to our operating model. You've seen us play offense, you've seen us course correct when needed, and you've seen us evolve the Citi Trends brand to be as relevant as can be. I will highlight what we will spend our full days, and probably some nights on: number one, driving comp sales and margin, continuing to broaden the appeal of Citi Trends to new multicultural lower-income households in search of trend-right apparel, home and accessories at prices that don't break the bank; number two, upgrading our fleet, continuing to upgrade our customer experience via our CTX remodel program with 42 remodels to date combined with new stores to date within the CTX format, 78 stores or 13% of the fleet in the CTX format with many more to come; number three, maximizing our tech and DC investments leveraging our recent DC upgrades along with our upcoming new ERP system that will be a game-changer for our Buy team; number four, actively managing our balance sheet, stronger strength of Citi Trends, Heather is focused on applying fresh and innovative thinking to managing operating expenses, working capital, and cash usage; and finally, number five, expanding our Citi Cares program, our platform for both CSR and ESG. Some exciting things are afoot here when it comes to giving back and focusing on our CSR initiatives, which we will share in early 2023. And of course, we will conduct our third annual Black History Makers event during February. As we speak, we are knee-deep in the 2023 plan. I got to say, we're pretty excited about what's on the horizon. The off-price value space is ripe for evolution. As we improve our execution and take advantage of new long-overdue tools, we are optimistic about delivering better efficiencies and productivity throughout many areas of the business. As always, I want to thank the entire Citi Trends team, all the people that are the face of our brand, creators of our culture and drivers of our customer engagement. Their hard work and endless efforts in making a difference in the neighborhoods we serve never go unnoticed. Their passion to live our purpose is shining bright and will carry us into the future. We are now ready to take your questions. Malika, over to you.

Operator, Operator

Thank you. Our first phone question is from the line of Jeremy Hamblin with Craig-Hallum. Please go ahead, your line is open.

Jeremy Hamblin, Analyst

Thanks, and nice job in a tough environment. I wanted to see if I could get into the cadence of sales trends that you're seeing. Using 2019 as the best baseline, can you provide a sense for how things slowed in August, September, October? It sounds like you're encouraged by what you saw over the past week, but wanted to see if you might be able to provide a little bit more detail around the cadence of sales trends?

David Makuen, CEO

Sure. Hi, Jeremy. Thanks for joining us today. Good question. I'll take the first portion of that and Heather can enhance if needed. But at a high-level, a couple of things. We had our first really normal back-to-school since ‘19. That proved to be a really strong selling period for us that started kicking in at the end of July and peaked during the main weeks of August and a little bit in September. So we were very pleased with the performance of that time period, driven by outsized performance in our kids' business. As we moved into the rest of the quarter, we had some puts and takes based mainly on weather, but overall, our traffic conversion and sales flow was relatively consistent throughout the rest of September and October. The only thing that affected us was the warm weather trends in late October into early November, which clipped some of our basket sizes, as customers bought less higher price outerwear and heavier weight clothing. That seems to have a higher retail price. If it wasn't for that, we would have been better than we expected on that front. So overall, nothing to be concerned about. The warm weather was certainly a slowdown, but we bounced back right away when it got cold in November's second week, and we've been strong ever since.

Jeremy Hamblin, Analyst

Great. Helpful color. In terms of just the environment we're seeing, clearly, there has been a lot of shift in focus towards value messaging, which is a sweet spot for Citi Trends. Not everybody has managed inventory levels as well. I wanted to get a sense of the promotional environment and markdown environment you're seeing in Q4 compared to Q3 within your competitive set.

Heather Plutino, CFO

Hey, Jeremy, it's Heather. Thanks for the question. Really appreciate it. And thanks also for the compliment about inventory. We are proud of the team and the way they managed inventory throughout the quarter, and they will continue to manage inventory in Q4. There is no doubt that the fourth quarter is always a highly promotional season. So that will change, and that won't shock you. What I will remind you, though, is that we serve an underserved customer in their community. So our strategy of being in their neighborhood and being every day low-price means we're not high-low, we're not promotional, we don't need to be, because we are value all day long and our customer knows that and trusts us for it. So we're feeling good about the way we're positioned for the holiday season because of that plus the fact that we've got amazing product ready to fuel their holiday needs. And our price points are, to quote David Makuen, hot. The assortment is truly great. So we're feeling good about the way we're set up for the holiday season.

Jeremy Hamblin, Analyst

I just wanted to clarify. Is the environment more promotional in Q4 relative to a normal Q4 compared to the traditional promotional environment in Q3? I'm trying to understand if it has gotten a bit more promotional or is it unchanged?

David Makuen, CEO

Yeah. Jeremy. I'll take that one. Within our brand positioning and where we're located, we're not seeing that big of a difference in the promotional environment. It appears to be relatively consistent within the neighborhoods that we don't. If we broaden the lens a little bit to the outer rings, say, the mall ring and the A&B centers that are a bit away from our neighborhoods, we're seeing a heightened level of promotional activity. What I've learned over the years is that Q4 tends to be promotional, no matter what the year or backdrop. Black Friday sales have always started earlier for the last few years, Cyber Monday, etc. The last days leading up to Christmas will also be promotional. So it's going to be promotional, but again, for us, we tend to find ourselves more insulated from that activity, given our primary destination nature to our customers. So we are watching it, and it doesn't really change our behavior much. We need to stay focused on making sure that the right gifts and stocking stuffers are in stock at the hot price points that we planned months ago, and that's all unfolding nicely for us as we speak.

Jeremy Hamblin, Analyst

Last one from me, just in terms of store hours for Q4. Typically, there's a need for a little more staffing, and sometimes you have extended hours. You did less of that maybe in some years, but I wanted to get a sense of the rent expense from the DCs into your SG&A. Is it fair to assume that your Q4 SG&A, despite the expense management and savings, is a little higher than what you saw in Q3? Is that a fair assumption?

Heather Plutino, CFO

It’s a fair assumption, Jeremy. Q4 is typically a higher sales month than Q3. And you're right; there are extended hours to support that, plus significant product flow to drive sales. So yes, on an absolute dollar basis, but we leverage better in Q4 than in Q3 as well.

David Makuen, CEO

Thanks, Jeremy.

Operator, Operator

Thank you. Our next question is from the line of Chuck Grom with Gordon Haskett. Please go ahead, your line is open.

Chuck Grom, Analyst

Hey guys, good morning. Nice quarter. A question for you Heather, just to follow up on Jeremy's question on the implied fourth quarter guide. It looks like it backs into around roughly a 4% operating margin, which would be below what you guys posted in the fourth quarter of 2019. I'm curious about the pressure points. In the third quarter, you showed nice improvement relative to the third quarter of 2019, so could you dive into the expectations for the fourth quarter and the compression to occur?

Heather Plutino, CFO

Yeah. Just a further reminder that our guide is for the fall season. Versus 2019, there are a couple of pressure points to keep in mind. One is the freight environment. In 2019, we're told by our external sources that we might not see freight rates again anytime soon, even though we're starting to see some relief. That comparison for Q4 versus 2019 will always be tough. The other on the SG&A front is that we're carrying the lease expense from the two sale-leaseback transactions. That will make for a harder compare as well. Additionally, within SG&A, we have merit increases from 2019 to 2022 in stores and DCs. We're not immune to that. So those comparisons are what I would ask you to keep in mind.

Chuck Grom, Analyst

Thanks. Can you remind us the impact for the fourth quarter and maybe on an annual basis from the two sale-leasebacks you did this year?

Heather Plutino, CFO

Sure. In the third quarter it was $1.6 million. Use that as a proxy for the fourth quarter, totaling $2.8 million on a year-to-date basis through the third quarter. On an annualized basis, consider it about $7.6 million for the two transactions.

Chuck Grom, Analyst

Okay, great. Thank you very much. And then, David, when you look out over the next couple of years, can you share your thoughts on where you think you can grow productivity considering that 2021 was close to 150, and this year back to 128, which was consistent with 2019 and 2020 levels? What has you most excited, and where do you think you can grow that productivity level?

David Makuen, CEO

Thanks, Chuck. I appreciate the opening words and happy to answer. As we look over the next few years, we have a number of initiatives to fuel productivity gains and overall topline gains while continuing to expand our gross margins. The opportunity to grow productivity is very promising based on initiatives that mainly haven't been part of our mix. The first is product; adding key options to our guy and woman and kids that we haven't had prior. Anchored by enhancing our juniors business with missy sizing, we are beginning to see incredible traction appealing more to multicultural customers. We're also seeing excellent traction in the boys and girls businesses. Product is crucial. The second is systems; the new ERP system will provide a new tool set to our Buy team to plan and allocate smarter. Third would be the remodel program, as the product and systems will drive us to higher levels of sophistication. I would add one more, which is our ability to leverage data across business functions to improve our efficiency and productivity. That should give us a little bit of insight for now.

Chuck Grom, Analyst

That's a great answer. And just one more to follow up on. When you think about the number of stores you could add in 2023, and the number of remodels, are there any metrics you can share with us at this point, or are you waiting until January for specifics?

David Makuen, CEO

It's a little premature for us to share specifics; however, I can assure you that all of what I ranked and then some are in our plans to develop a point of view for ’23 that we will share early next year.

Operator, Operator

Thank you. Our next question is from the line of Dana Telsey with Telsey Advisory Group. Please go ahead, your line is open.

Dana Telsey, Analyst

Hi, good morning, everyone. The gross margin in the inventory levels definitely came in better than expected. Can you unpack the puts and takes of the gross margin and how you're thinking about inventory levels going forward? Additionally, when you think of your core customer base, David, anything that you're noticing different regionally or share gains that you may be making given the trade downs? Thank you.

David Makuen, CEO

Hi, Dana. Thanks for calling in. I'll take those. I'm pleased with the patterns we are seeing. One of the biggest patterns is that we're attracting more customers at the higher-end of our income range. Our average income is about $40,000, and we're seeing more customers above that, reaching up to the $50,000-55,000 range responding positively to our higher retail products. Overall, our lower-income customers are adjusting their shopping patterns better than we expected. They are doing their best to adapt to a rent landscape that's significantly changed. Our job is to ensure that we consistently offer exciting products at competitive prices, which the team is executing well. Heather will take inventory and margin data next.

Heather Plutino, CFO

Good morning, Dana. Thanks for the questions. Our margins came in at 39.8%, which is great news across the board. We have good IMU expansion, lower markdowns, and a focus on managing freight expenses. We'll leverage our packaway strategy, where we invested in great products earlier in the fiscal year that we are excited to move into stores now. We've been focused on keeping our inventory levels right and will continue monitoring those to avoid the pitfalls of 2019, which is an encouraging outlook considering average in-store dollar inventory was down 19% compared to 2019. We're all set for the upcoming holiday season.

Dana Telsey, Analyst

Thank you.

Heather Plutino, CFO

Thanks, Dana.

David Makuen, CEO

Thanks, Dana.

Operator, Operator

Thank you. Next question is from the line of John Lawrence with Benchmark. Please go ahead, your line is open.

John Lawrence, Analyst

Yes, thanks. Congrats, David and Heather. Can you talk about the 13% of the fleet that we've talked about CTX? Are you still seeing that lift of mid-single digits in productivity for those remodeled stores?

David Makuen, CEO

Hey, John. Thanks for calling in. Yeah, we’re still seeing strong lifts in our CTX remodeled stores. We've maintained single-digit to mid-high single-digit lifts, and we're continuously improving our operation capabilities as we move forward with these remodels across various geographies. So we're very pleased about that.

John Lawrence, Analyst

And in light of the current real estate landscape across the country, are you finding it easier to secure some of those units?

David Makuen, CEO

From a macro perspective, not too many changes are noted in the real estate landscape for remodel perspective. However, our real estate team is working actively to secure tenant allowance funding for remodels, which helps reduce costs. Most landlords see the benefits we offer and welcome the enhancements that come with these remodels. So overall, system is pretty supportive.

John Lawrence, Analyst

Yeah, thanks a lot for the color. Congrats and good luck.

David Makuen, CEO

Thank you, John. Take care.

Operator, Operator

Thank you. And at this moment, there are no further questions on the phone lines.

David Makuen, CEO

Great, Malika, thanks so much. Thanks everybody for joining. Happy upcoming holidays. We'll see you next time. Bye-bye.

Operator, Operator

Thank you. Ladies and gentlemen, that does conclude today's call. We thank you for your participation and ask that you please disconnect your lines. Have a good day.