Citi Trends, Inc. (CTRN) Q2 2020 Earnings Report, Transcript and Summary

Greetings, and welcome to the Second Quarter 2020 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded Thursday, August 20, 2020. I would now like to turn the conference over to Nitza McKee, Senior Associate. Please go ahead.

Thank you, Dina, and good morning, everyone. Thank you for joining us on Citi Trends second 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?

Thank you, Nitza, and good morning, everyone, and thanks for joining us today. It is a pleasure to be speaking with you on my second earnings call as the new CEO of Citi Trends, and I hope that you are all safe and well. The second quarter of 2020 at Citi Trends was unlike any other, posing challenges that required our entire team to commit to doing things differently and being ambassadors of change. To begin, COVID-19 continues to impact us and the retail landscape in unprecedented ways. As we have navigated through 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. As of July 18, 2020, we reopened all of our stores, except for our store on Lake Street in Minneapolis, which was damaged during the civil unrest that ensued over the Memorial Day weekend. The events that stimulated the nationwide movement moved all of us at Citi Trends to take a special interest in doing our part to address the indelible racism in our communities across the country and advance the cause of justice and racial equality. Operating stores predominantly in black communities, we have a longstanding commitment to provide a safe and welcoming place for our customers and associates where their differences and diversities are respected and celebrated. Now more than ever, we recognize that it is the time to speak up for our neighbors and stand together with others to support the fight against racism. In support of these efforts, effective June 2020, Citi Trends formed the CitiCARES Council made up of a diverse set of individuals that will create and oversee initiatives of change. This council will define how Citi Trends will take action and contribute to elevating humanity to a place of peace and inclusion so that families of color experience equality. In addition, we will rebuild in Minneapolis with the same commitment we’ve shown there for the past decade. Our Citi Trends store in Minneapolis stands at the crossroads of an international diverse community that will be stronger than ever. We opened with a pop-up this week and we’ll follow that with a beautiful store in time for this year’s holidays of Christmas and Kwanzaa. Before I jump into our business update, I want to once again pause and take a moment to thank our leadership team and associates for their unwavering dedication to the business and our communities throughout this crisis. The outpouring of support, as well as their collective grit and determination throughout our fleet reopening was nothing short of amazing. I reiterate what I said on our first quarter call. Our people are the heart and soul of Citi Trends. The flexibility and agility of our people over the past few months is a true testament to the unique and powerful winning culture we have built at Citi Trends. I’m honored to lead this great organization, and I’m immensely proud of all that we’ve achieved in the face of much adversity. Moving on to the topics to be discussed during today’s call. I will first update you on our healthy quarter-end financial position, highlighting the swift actions we took to bolster our strong pre-COVID-19 balance sheet. I will then discuss the safe and successful reopening of our store fleets, providing insight into the record results we achieved and highlight some insights into how we’re evolving our operating model. Through our use of data-driven insights, I will update you on the four notable patterns in customer behavior we identified during the initial reopening of our stores, and I will discuss a few new emerging patterns we plan to lean into and capitalize on over the coming months. I will provide an update on the business dynamics we are seeing in the early innings of our third quarter. Next, I will turn it over to Jason Moschner, our Vice President of Finance, who will briefly review our second quarter results. Finally, before opening the call to your questions, I will reaffirm the pillars of our long-term strategic plan, which when the country normalizes, will place us back on our plan to increase earnings per share at a compound annual rate of 20% to 25%. During the height of the pandemic, we took decisive actions to bolster our financial position, including but not limited to proactively drawing down $44 million under our revolving credit facility, temporarily suspending our quarterly cash dividend beginning in the second quarter, and appropriately reducing our inventory receipts. These prudent decisions allowed us to aggressively and opportunistically purchase sought after goods as we reopened our stores, which in turn, drove top line sales, resulting in strong second quarter cash generation ending the period with more than $147 million in cash and investments. We began reopening stores with reduced operating hours on April 24, and by July 18, all 574 of our stores across 33 states safely reopened with the proper social distancing and PPE, including required mask wearing for all our store team members and strongly suggested mask wearing for our customers. Customer response to our reopenings exceeded our expectations. We ended the second quarter with strong positive comparable store sales increase of 32.2% in reopened stores from their respective reopen dates and an impressive total sales increase of 18.2%. We attribute these results to the strength of our brand and on-trend assortments, our value proposition, and the federal government stimulus that was present throughout the quarter. Importantly, we achieved strong sales growth by selling high-quality inventory, primarily at full price, which resulted in a record second quarter gross margin of 41.2%, 390 basis points above last year’s second quarter. We also ended the second quarter in an extremely clean inventory position, down 28.4% to the prior year, allowing us to enter the third quarter in a very favorable open-to-buy position. Our business model has proved to be resilient during these uncertain times, and the experience we provide in the communities we operate in resonated in ways that effectively reset many of our operational metrics. This includes ending the quarter with significantly lower weeks of supply, fresher than ever merchandise receipts, and a workforce that returned with energy and excitement to serve our customers. What’s important to recognize is 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. Thanks to the overwhelming loyalty of our customer base. We are optimistic that our model will continue to build on our success to date with year-over-year improvements in key operational metrics, including but not limited to, inventory turns, gross margin and expense leverage over time. As I mentioned during our first quarter earnings call, using data-driven insights, our buying team identified four notable patterns in customer behavior, which we named Welcome Home; Mom, it’s too small; Mom and Dad, break time; and relax, just hang out. We successfully leaned into these behavioral patterns during the second quarter delivering broad-based strength across several categories, including home decor, kids’ shorts and tees, lingerie, intimate apparel, fragrances, leggings and slides. As we look forward to the second-half, we’re devoting attention to the extended from home trend that runs far deeper than WFH, or work from home. Continuing our insights-driven momentum, we are devoting an incremental attention to how our families EFH, entertain from home; LFH, lounge from home; SFH, school from home, PFH, play from home; and GFH, gym from home, among many others by providing moms, dads, daughters, sons and extended family members with appropriate solutions to live what will be a new lifestyle during the second-half throughout the country. These solutions, which will emerge in the third and fourth quarter, will be driven by fresh receipts coming from dozens of new vendor relationships that were established during the second quarter. I’m particularly impressed by our buying team’s ability to expand into new categories, such as Pet; VFH, vlog from home; cosmetics sets for young first-time beauty users; an enormous selection of masks; home fitness; and sought after brands that span the range of retro cool to must-have current trends. Lastly, our team is agile and adept at proactively chasing opportunities as they arise. And thus far, we’ve been able to react quickly to merchandise availability that syncs well with our customers’ needs and wants. Now for an update on how we’re planning the third quarter. With 2.5 weeks into the fiscal 2020 third quarter, we are navigating through macro changes in the consumer landscape, including unpredictable and nontraditional back-to-school timing and learning methods and the ongoing uncertainties stemming from the COVID-19 pandemic. As a result, our customer traffic, as measured via comparable store transactions in the first two weeks of August, has been soft. While it’s still very early in the quarter, we encourage – we are encouraged by the stability of our non-back-to-school-related businesses and the increase in average basket size relative to the same weeks of the prior year. We believe once we are beyond the traditional back-to-school selling season, that customer traffic trends will normalize. We are estimating the fiscal 2020 third quarter comparable store sales range of negative mid single digits to flat, along with continued margin expansion, building a momentum through the second quarter. This estimate is subject to potential consumer and marketplace volatility due to the COVID-19 pandemic and changes to the consumer landscape described above, and therefore, may change as the quarter progresses. I will now turn the call over to Jason Moschner, who will discuss our second quarter financials results. Jason?

Thank you, David. Total sales in the second quarter increased 18.2% to $216.2 million, including a comparable store sales increase of 32.2% for reopened stores. We achieved a record gross margin rate in the second quarter of 41.2%, an increase of 390 basis points, compared to 37.3% in the second quarter of 2019. The increase was primarily due to strong full price selling and fewer markdowns. SG&A expenses decreased by more than $5 million, or 8.5% compared to last year’s second quarter. As a percent of sales, SG&A expenses decreased to 26.7% from 34.5% due to both the total dollar decrease and the leveraging effect from higher sales. This decrease in SG&A expenses was primarily in payroll expense as a result of associate furloughs and reduced operating hours, combined with decreases in certain variable and semi-variable expenses. In addition, expenses were reduced due to government credits related to paying our associates, while our stores were closed. Although these reductions were mostly offset by incremental costs to provide PPE to ensure a safe and healthy working environment. Now to the bottom line. Our net income was $19.9 million for the quarter, compared to $377,000 last year. Earnings per diluted share was $1.90, compared to $0.03 last year. Now to our current liquidity position and inventory levels. As David noted, during the first quarter, we drew down $44 million on our revolving credit facility, and we entered the second quarter with cash and investments of approximately $108 million. As a result of our strong second quarter cash generation and tight controls over expenses and capital spending, we ended the quarter with cash and investments of approximately $147 million. As to inventory. As David noted, we ended the quarter in a very clean inventory position, down 28.4% compared to this time last year. The decrease was primarily driven by our customers’ incredible response to our offerings, as we reopened the chain starting in late April. In addition, prior to the COVID-19 pandemic, we were making progress on strategic efforts to optimize our inventory levels in order to improve turns and stay more liquid for off-price buying opportunities. As we continue to emerge from this pandemic, we remain confident in our current liquidity position. While it is hard to predict performance trends for the coming weeks and months, we remain very disciplined in our approach to running the business, while controlling expenses and spending capital wisely to support our growth. Due to the continued uncertainty surrounding the COVID-19 impact, we are not providing further guidance at this time. Now, I will turn the call back to David for closing comments. David?

Thanks, Jason. 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 and for our customers to shop in as we open 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’ll emerge from this crisis stronger and better equipped to grow our business. Now a few words on our long-term strategic plan. Let me first reiterate that we remain committed to achieving our stated goal of $1 billion in sales. As we navigate the current times and the country returns to a version of normal, our vision remains the same. Citi Trends aspires to be a leader in the value retailing space, one of the few multi-category, value-priced retailers focused primarily on the African-American market. We provide a differentiated assortment of basics, fashion, trends and sought after brands at compelling prices in a unique and compelling shopping environment. We see a path to return to executing on our plan to increase earnings per share at a compounded annual growth rate of 20% to 25%. The pillars of our plan remain anchored on the following: Number one, merchandise. Optimizing our apparel and non-apparel assortment with newness, trends, brands and extreme value, resulting in increased margins, faster turns and lower inventories. Number two, supply chain. Improving supply chain throughout – improving supply chain throughput with a focus on lowering processing cost and speeding up deliveries to stores. Number three, stores. Pursuing real estate and fleet improvement opportunities driven by a new store growth and remodels. And number four, data. Leveraging data and technology to create a culture of insights-driven decision making, centered on the customer and key operational functions to drive enterprise performance. Our second quarter performance has furthered my confidence. We operate a unique and scalable model, one that is embraced by our loyal customers. We give back to our customers through our steadfast commitment to our company’s values. The one I will highlight in today’s call is customer obsessed, which simply means, we commit to putting our customers at the center of all our decisions. We do this every day, every week and every month of the year. During the second quarter, the outpouring of customer support was humbling and something we are so thankful for. I have personally been in many stores since reopening, and nothing has made me smile more behind my mask at the positive attitude, high energy attributes, and let me tell you, shopping skills of our customers. They love fashion, trends, basics and everything in between within our apparel, accessory and home categories. It is because of this customer loyalty, Citi Trends celebrates the role of the store, a brick-and-mortar experience that is alive and well. To fuel our stores, we have the financial strength and a high energy team with a growth mindset that will propel the Citi Trends brands for many years to come. With that, we’re ready to take your questions.

Thank you. [Operator Instructions] Our first question comes from the line of Alex Silverman with Special Situations Fund. Please go ahead.

Hey, good morning. Congratulations. Wondering, can you spend a couple of minutes on what you think will drive third quarter gross margins? How much of that is related to less markdowns? How much of it is related to a different mix with higher margins? Can us just walk us through that?

Sure, Alex, thank you for the question. At a high-level, what I would take you through is for the second-half, we’re optimistic that we, a, have a really strong assortment that is predicated on supporting the trends that I highlighted on the call. And it’s really broad-based strength in initial markup across most of our categories, thanks to some terrific efforts by our buying team. So I would tell you there’s no one or two special aspects of the assortment. It’s really strong anticipated margin expansion across many of what’s in our current store. In terms of markdowns, we remain committed to being really disciplined in our markdowns and trying to keep those to a minimum as we buy smarter, improve turns, and celebrate selling out. And I think overall, if we get some of those things right, and we get that flywheel moving, we’ll see some margin expansion versus last year.

Okay, that’s helpful. And then in terms of back-to-school, in some of your markets, they’re through back-to-school at this point. Are you seeing a change in patterns in those markets?

Good question about back-to-school. Like many of us in the retail landscape, we’re experiencing headwinds. And I’ll say it this way, we look at our chain with a lot of discipline in terms of those stores and markets that fall in the early back-to-school timing of schools, then we look at mid back-to-school timing. So early August, mid-August, as you can imagine. And then we look at late stores, which is later August, even a little bit after Labor Day for some stores. And so as we look at those different tranches, the short answer is, yes, we’re starting to see some interesting comeback trends, following the lapping, if you will, of the early back-to-school timing. And my comment around the stability in our non-back to-school-related businesses speak to that as well. We’re seeing some recovery in our traffic in the – particularly in that early group since we’re kind of getting past it. And that that’s encouraging to see that in literally a couple of days, but it’s nice to see.

All right. And then last question, you guys are trying to sort of restructure a business in the middle of a storm. So it’s hard for us to look at SG&A and tell what’s the result of temporary changes along furloughs and such and what is the result of changes made by you guys on a structural basis? How should we think about SG&A on a go-forward basis on a permanent basis?

Thanks for that question. Well, I can’t share any specifics around second half. What I can say is that what we learned, Alex, during Q2 was enormous in terms of insights around the business, frankly, related to the actions we had to take relative to the pandemic, but also unrelated. When I got here, there hadn’t been enough study yet of all of our SG&A variables, if you will. And we commenced those irregardless of the COVID-19 pandemic. But, of course, the pandemic has accelerated the need to both understand the different dynamics better, use data to inform how can we do things differently? How can we, to your point, operate in a more efficient and productive manner? So I would tell you that we put all that into a blender and what’s coming out are some really important learnings that we do believe we can carry forward during a more normal state of operating hours and being fully staffed and all that good stuff. The second point I’d make is, we’re still very much operating within, like you said, the storm that – the clouds have not lifted yet. And we’re being very, very rigorous and disciplined around every decision we make regarding SG&A, everything from who we hire and how we operate things. And gosh, looking under every rock to determine how we can further provide leverage even when we’re, to your point, open fully and being in a period of more normalcy. So take that away as it’s a high, high focus of ours and teams are devoted to making a difference in that area.

Great. And then really my last question, which is, where are you in terms of building out your merchant and buying team?

We have – in terms of our merchant buying team up in New York and I’ll add planning an allocation, because they’re very important partners to the buyers. I would tell you that we have a terrific team. I would tell you that we’re built out in a way that allowed us to navigate through the early innings of the pandemic, which required significant muscle and attention towards canceling orders and hunkering down and then obviously turning the chain back on, required those teams to jump back into the foray and do what they do best. So led by Lisa Powell, our GMM, we have a terrific team all hunkered down in the New York, New Jersey, Connecticut area, doing their thing, visiting vendors and parks, approving product via Zoom, showrooming and so on. So honestly, we’re approaching it pretty much as best as we can as business as usual. And I think you can see in the results in Q2, their efforts paid off handsomely.

Got it. Thank you very much.

You’re welcome. Thanks, Alex. Have a great day. Stay safe.

Our next question comes from the line of Dana Telsey with Telsey Advisory Group. Please go ahead.

Good morning, David and team. Nice to see the improved results, certainly that you delivered. As you talk about the extended from-home offering that it’s going to go beyond just work from home, what categories do you see adjusting the merchandise mix to? What is the impact that you see on margins? And given what’s happening with back-to-school, how are you evaluating holiday to begin with in 2020? Thank you.

Hi, Dana. Thanks for jumping on today.

Hi.

Great question. To address your first question, the from-home trend is so deep. And I named probably six or seven and we – and just we probably have a dozen of them that we work on internally to make sure we’re satisfying the customers’ needs and wants in the from-home realm. But I’ll give you a high level thought. Certainly, our non-apparel business is something we’re really leaning into. And those areas include, as I mentioned briefly, entering a brand-new business called Pet, since I believe acquiring a dog or cat or lizard and other animals is probably like top three with pools and bicycles. And so, we felt we needed to ring that bell. And so, we launched a Pet business two weeks ago. The team took about four weeks to get it together, amazing, and it’s in our chain, just like that. So that’s one example. I guess, I didn’t name it FH for that, but that’s certainly, I don’t know, cuddle from home or pet from home. Other examples would be home decor leaning into that big time, top of bed, kitchen, uplifting wall art that speaks to our African-American clientele, all the above. And I would call it, lifestyle needs, and I briefly referred to it. But gym from home, which is fitness, we’ve got a partnership with a company that is producing Halle Berry line of fitness products. It’s blowing out. Halle is a terrific role model for our customers, and we love her as a partner. That’s terrific. And then we look at things like kids and frankly, millennials are streaming from home. In fact, right on my at-home desk here is one of our new streaming kits. So it’s really about what they’re doing from an activity standpoint. I would tell you it spans from older Gen Z to younger and older millennials all the way up to good old Gen X. And we’re trying to, frankly, develop cohorts along those lines. And then the merchants map products to those cohorts, it’s – frankly, and they get all the credit. It’s brilliant and they’re doing it everyday. On your question about holiday, too early for me to give you any details of any great substance. But I would tell you, as I mentioned in the call, this emerging from-home aspect and this idea of cozy comfort, spending more hours in your home than we probably would ever imagine, will drive a unique and compelling assortment for holiday. And we – we’re – I’m a big fan of the holiday period. It’s always been one of my favorite retail, and I think I can speak for our team. We’re all looking forward to Q4 and setting up great store environments, amazing displays of goods that resonate with our customer and I can’t wait to approach that time period. Thanks for your questions.

Thank you.

You’re welcome.

Our next question comes from the line of [Brian Long] [ph] with Stormborn Capital. Please go ahead.

Hi, thanks for the time, guys. Congratulations on a good quarter. I wanted to ask about the working capital dynamic. Specifically inventory and payables. So twofold on inventory. Do you have enough inventory to satisfy demand? Or do you think that’s partially contributing to the software back-to-school that you’ve seen? And then second, how much do you expect working capital to be a use of cash in 3Q, 4Q as you rebuild inventory? So how much inventory needs to come back into the system, given such strong 2Q? Thanks.

Thanks, Brian. Good questions, certainly touching on some of our operating model. At a high level from an inventory is it enough perspective, what I’d tell you is this. We entered the pandemic, meaning, we were in Q1 posting some good stats. We were up about a 3.1 comp, as previously disclosed. And we are working diligently on an overall strategic imperative of reducing inventories, both in stores as well as in our distribution centers. And what we recognized in Feb/March and upon my arrival in the CEO seat that we had a really – we had a really big opportunity to settle down from frankly, too high weeks of supply and too slow a turn. And while we had a terrific blueprint to work on that for the next 12 to 18 months, the pandemic brought about swifter change. And with an outsized performance in Q2, thanks to our customer loyalty metrics, we now can see the light, you can see the light of operating this business at low weeks supply and lower inventory. So is it enough? I think it remains to be seen. We’re turning it well. As you’ve heard me state, we’re selling full price. So we’re buying smarter, we’re selling through at the price that we always hoped to, therefore, reliant on lesser markdowns. We’re reducing our aged exposure, of course, as a result. And I think overall, we’re going to see some build up. But at the same token, our customers love this treasure hunt aspect of our experience. And so this idea of pivoting from too much to just right, and then shipping it to the right stores at the right time is something that we’re feeling and experiencing in a very positive manner right now. So, no, yes, we’ll monitor it. It’ll be surgical. We’ll strike a good balancing act as we enter the second-half to support our second-half plans. In terms of working capital and use of our liquidity or cash, it’s – as you know, it’s a game of generating cash through good sales and then funding receipts required to do those sales. And I – we don’t see any major headwinds right now, that has masters concourse attached to it based on, like I mentioned in the call, there are still many uncertainties and things could change. So we’ve got to state that. But at the end of the day, we’re going to be prudent in how we buy inventory for my earlier comments, buy smarter, buy a little less here and there, so that we can turn well and exit quarters clean and have enough open to buy and liquidity to buy from the next.

Great. And then a follow-up on your gross margin commentary. I was encouraged by the second quarter performance and the go-forward commentary. Can you shed any light though on whether you were implying gross margin simply just up year-over-year in third quarter? Or is that more of the building momentum comment related to the magnitude of improvement that you saw in the second quarter, such that gross margins could be up even more sequentially than they were in the second quarter?

Good question. Let me clarify. The comment is simply meant to state that we expect to be better than LY. No speculation on how much or how close it is at the 390 we did in Q2. But just simply learning from our Q2 rigor and disciplines, can we achieve an upward trend versus LY in Q3 and we think we can.

Understood. Thanks. And then I understand it’s a pretty dynamic environment right now. So no near-term expectation, but what is it that you need to see before you start returning this pretty big cash flow to shareholders again through buyback? How many quarters of stability? What is sort of the guidepost you’re looking for before you’d start thinking about cash return again?

Good question. I’ll probably have to keep that fairly brief as we’re not able to comment too much on that. But at a high level, we’re still operating within this period of uncertainty. So we’re still on pause mode. With respect to your questions on that topic, and we’ll monitor it. We are monitoring it and discussing internally what makes most sense. But I would tell you, it’s going to be a little bit of time. And so we return to kind of that version of normal in terms of share repurchase and dividend and whatnot. But know that it’s very much in our agendas. I think it’s the real balancing act is when we and the economy in the United States gets to a period of a bit more normalcy and stability on a macro level, we’ll be able to better comment on that and work internally to be able to come back to you and others with a plan.

Great. Thank you. And then last one for you. Is it – should we assume that you’re running within your sales plan right now quarter-to-date? Or is it the kind of thing since back-to-school is up to a slow start that you expect – that your guidance improves or sort of reflects the improvement through the quarter as we get passed back-to-school? Thanks.

Sure. Thanks, Brian. Yes, the high level on that one is, we’re seeing soft traffic, as I commented on, in the first couple of weeks, early innings in the third quarter. And what we expect to see is that, that traffic will moderate to more normal levels year-on-year and with that, will come a bit more of a moderation in the sales trends. So, like any quarter, that starts a little soft. We do expect to see some momentum improve, especially as we lap some of those back-to-school dates.

Perfect. Thank you so much.

Thanks, Brian. Have a great day. Stay safe.

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

Thank you, Dina. Thank you, everybody, for joining us today. Stay safe and healthy and we’ll see you next quarter. Bye-bye.

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