Citi Trends - Earnings Call - Q1 2021

Transcript

Operator (participant)

Greetings and welcome to the First Quarter Earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a Q&A session. At that time, if you have a question, please press the one followed by the four on your telephone. If at any time during the conference you need to reach an operator, please press star zero. As a reminder, this conference is being recorded Thursday, May 28th, 2020. I would now like to turn the conference over to Nitza McKee, Senior Associate. Please go ahead.

Nitza McKee (Senior Associate of Internal Relation)

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 is 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 13th and instituted work-from-home policies. On March 20th, 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 two distribution centers and our corporate office in Savannah, Georgia. We made the 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%-25%.

We created a COVID-19 response team focused on business continuity that developed 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 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 7th, 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 24th, and by May 9th, more than 300 of our stores were reopened. 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 four 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 four 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 decor 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 within an engaging in-store experience is strongly resonating with our customers.

Importantly, we are driving the positive results at healthy margins as we enter 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 20th until April 23rd, 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 12th, 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. Now, I will turn the call back to David for closing comments. David?

David Makuen (CEO)

Thank you, Jason. At Citi Trends, we are a community-based retailer in primarily midsize markets. Nearly 75% of our customers live within a 15 minute drive to one of our stores, and 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 stores' 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.

Their 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 a 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 three 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 turns while delivering a highly appealing assortment of always fresh merchandise for the entire family. 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, it will return to executing on its three-year strategic plan to increase earnings per share at a compounded annual growth rate of 20-25%. Lastly, I want to thank Peter Saxby 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?

Nitza McKee (Senior Associate of Internal Relation)

Okay, Operator, we're ready for questions.

Operator (participant)

Thank you. If you'd like to register a question, please press the one followed by the four on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the one followed by the three. Once again, to register for a question over the phone lines, please press the one followed by the four. Just going to be a moment for the first question. Our first question comes from the line of Eric Beder with SCC Research. Please go ahead.

Eric Beder (CEO and Senior Research Analyst)

Good morning. Congratulations on weathering this COVID virus. Hello?

Jason Moschner (VP of Finance)

Good morning, Eric. Nice to hear from you.

Eric Beder (CEO and Senior Research Analyst)

Hi. 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. Were there any changes you decided to make in the 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)

Hi, Eric. It's David. Thanks. Good question. Really how it panned out is we, as you know, and most of retailers throughout the U.S. had to close their chain rather quickly. I would tell you that closing the chain happened in a matter of days after we saw the pandemic rising to a level that required closure. As you may know, we also had to kind of stay away from those stores and let them sit for a little bit after the height of the pandemic passed. As we returned to our stores and opened them back up, really what we spent all of our time on was making sure the PPE, the personal protective equipment, was in place.

All of the safety measures for customers were in place, including masks for our associates to make customers feel safer, hand sanitizer as you walk in, the proper social distancing signage in place in the stores, the proper taped markings on the floors, the proper distance between you and the register, and so forth and so on. That's where we spent the bulk of our time. We haven't heretofore really changed any fixturing because with a limit of people coming into stores, which is largely dictated by state and local guidelines, we haven't had any trouble in general managing those customer limits and making sure people are adhering to the guidelines issued by the CDC. Overall, we opened everything back up pretty much like the stores looked prior to the closure from a merch and fixturing standpoint. We have continued to monitor things.

As you can imagine, every group of stores we open, we learn something new. I would tell you the overall learnings are we've been very consistent across the different clusters of stores we've opened from a performance standpoint and from an adherence to all the new standards standpoint. We're proud of the teams. We're following daily protocols to clean the stores thoroughly every time we open and close. We're really pleased with what we're seeing out there. Thanks for your question.

Eric Beder (CEO and Senior Research Analyst)

Great. When you look, thanks. When you look at, I know you guys do not do right now online. Has this led you to maybe rethink how you want to handle online? I know a lot of this stream is the treasure hunt of the store and the prices of the product. Is there a place you think maybe going forward in the future down the road for online sales?

David Makuen (CEO)

Eric, that's a good question. Obviously, online, the channel has enjoyed quite a big uptick during this pandemic based on people being confined to their homes. I would tell you overall, it's just too early to even think about online. The beauty of our business is, you nailed it, it's all about a treasure hunt. It's all about discovering newness and wow items and these amazing sought-after brands that our buying team has secured as part of our assortment. We're also in communities where we serve the locals. We not only employ the locals, but we serve the locals in the communities. As I mentioned in the script, we have a tremendous density of customers within a short drive and, in fact, many walk or bike to our stores. We think it's kind of the year of the store, quite frankly.

You've been pent up in your home, you've got cabin fever, and you want to get back out and enjoy shopping again. The truth is, the majority of our public in the U.S. loves going into stores. We are, as you know, 100% a store business. We're going to be that way for some time. I don't really, as the new guy who's obviously still ramping up into the business, I don't feel a need to rush into e-commerce at all. I'd rather celebrate our fleet, build more stores, and take advantage of the really unique treasure hunt we offer to the unique target customer we cater to.

Eric Beder (CEO and Senior Research Analyst)

Great. Again, congratulations and good luck going forward.

David Makuen (CEO)

Thanks, Eric. Stay safe.

Operator (participant)

Our next question comes from the line of Eli Danone with Danone Capital. Please go ahead.

Hey, guys. Welcome aboard, David.

David Makuen (CEO)

Thank you, Eli.

I want to start off with kind of following this company for a while. David, in your sense, any changes to the store in terms of merchandising that you want to implement versus kind of what the prior strategy was over the last five, six years, which was kind of de-risking some of the inventory, carrying more basics, also minimizing some of the national brands? Just curious to your thoughts on merchandising and how you want the store footprint to look.

Sure. That's a great question. I would tell you merchandising in our assortment is really the lifeblood of the brand. We're fortunate to have Liza Powell on board. She joined us last fall as GMM. She's got a great team. All they do is think about the customer and what that customer is likely to vote on. I can tell you, Eli, I come from the school of always looking back from the customer. If you do that right and in a consistent manner, you'll figure it out. That's exactly what our buying team is doing. What I've been able to do in my short time is really begin to understand the magic of the assortment at Citi Trends is this great blend of basics, fashion, trend, and sought-after brands.

We are going to continue to work on that mix as a team. Those are the very things that our customers need and want. They are pairing in their closet the basic tee, the basic undergarment with a fashion top. They might pair a fashion top with a fashion bottom. They are buying really cool brands at amazing prices. I would tell you it is a mix of all those things. Perhaps versus the past, the difference, maybe key difference is we are going to pay more and more attention to the customer and more and more attention to the trends in the marketplace and then free up our buyers to utilize their dollars wisely to go out and find the right brands and non-brands that resonate with our customer. That is the real biggest opportunity.

I would tell you the second opportunity is how we array those goods in the stores. Over time, we'll work on our visual merchandising of all of that great product and make sure we get credit for the brands, make sure we get credit for the value. I'm confident that if we do those two things really well, the customer will vote and we'll be off and running.

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

Yeah. The merchandise that's selling through right now is absolutely part of Liza and her team's efforts. 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, basic, fashion, trend, and brands. 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.

Great. In terms of when you can return to buying back stock, given how cheap the stock is and has been, do you foresee, do you have a timetable on that, or are you restricted from throwing down a revolver, or how does that work?

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. I would tell you, Eli, 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. We're going to put that on the list in terms of when, how, and so forth. 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. We will turn our heads towards the second half. We'll certainly keep your question in mind and relook at things a little further down the road. Jason, 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. 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. It is our plan to get back to that, but just too early to tell at this point.

Got it. In terms of have you had conversations with some of your landlords in terms of rent reductions?

David Makuen (CEO)

Yes. We are in active conversations. Landlords are so important to us in 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. We are in active negotiations with nearly all of them. Hats off to our small but nimble real estate team. They are out there figuring out what makes most sense, landlord by landlord. We will get to a good place with all of them.

Got it. In terms of possibly monetizing the DCs, I mean, some of your large shareholders have had success with other companies they've been involved with in monetizing some of those non-core assets. Any thoughts there?

I believe you said monetizing the DCs, if I heard you correctly.

Yeah.

Yeah. Not yet. Too early to kind of go down that road. We were fortunate to have the liquidity going into the pandemic and were able to draw down on a revolver. We're in a strong cash position as we navigate through this early stage of recovery. Haven't addressed that yet.

Okay. Lastly, in terms of you should see, I mean, I'm sure some really, really good inventory, good brands that the customer would, the stores have never had a traffic problem. If you had the right brands, it always seemed to sell through. Are you seeing an abundance of, given some of the dislocation in retail and in clothing, that you're able to get your hands on and excited about for the rest of the year?

Great question, Eli. Yeah. I think at a high level, I'd tell you that there are great opportunities in the marketplace being presented to the Citi Trends buying team. We're chasing what's right for the customer and our business and our price point. You nailed it. There's some dislocation going on. I can tell you and assure you we're active in the marketplace securing the deals that are good for us.

Okay. Last question is related to where do you think, where do you have to get turns to? I mean, clearly, you won't get turns as much as a traditional price retailer. Where do you have to get turns to to get operating margins in the mid to mid-digit range? Where do you think gross margins can go? Can they go above 40% on an annualized basis?

Let me say it this way. There is a lot of financial upside for the brand. It probably cuts across a lot of different line items within our P&L, margin, of course, being a huge factor. I think there overall is some room for margin expansion as we take this journey for the certainly rest of the year with some of the product opportunities that you mentioned in front of us. Give me a little bit of time to spend a little more time on all of your topics, that last question posed. We are going to just know, Eli, we are going to take our financial results really seriously. I am a data-driven guy.

We're going to wrap our arms around how can we lever right and use sales certainly as the opportunity, but also lever a lot of the expenses that we can in order to produce a higher profit throughput. More to come on that. Thanks for your questions, Eli. Good to hear from you.

All right. Thanks, guys.

Have a great day. Stay safe.

Operator (participant)

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

David Makuen (CEO)

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

Operator (participant)

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