Citi Trends Inc. Q3 2008 Earnings Call Transcript

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Citi Trends Inc. (CTRN

Q3 2008 Earnings Call

November 24, 2008 5:00 pm ET


Bruce Smith – Chief Financial Officer

Edward Anderson – Chairman, Chief Executive Officer

Elizabeth Feher – Chief Merchandising Officer


Evren Kopleman – J.P. Morgan

Robert Simmons – Oppenheimer

Jeffrey Klinefelter – Piper Jaffrey

Patrick McKeever – Mkm Partners


Welcome to the Citi Trends conference. (Operator Instructions) At this time for opening remarks and introductions, I would like to turn the call over to Chief Financial Officer Mr. Bruce Smith.

Bruce Smith

Thank you for joining us today. Also on the call are Ed Anderson, Chairman and Chief Executive Officer and Beth Feher, our Chief Merchandising Officer. Our third quarter earnings release was sent out at 4:00 pm eastern time today. If you've not received the release it is available on our company website under the investor relations sections at You should be aware that the prepared remarks made during the call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and management may make additional forward-looking statements in response to your questions.

These statements do not guarantee future performance therefore undue reliance should not be placed upon them. Such statements involve known and unknown risks and uncertainties and other factors that may cause the actual results to differ materially. We refer you to the company's most recent report on Form 10-K filed with the Securities and Exchange Commission for a more detailed discussion of the factor that could cause actual results to differ materially from those described in any forward-looking statements.

I will provide you with some details related to the third quarter results and Ed will discuss our guidance for the fourth quarter after which Ed, Beth and I will address any questions that you might have.

Total sales in the third quarter increased 5.4% to $104.9 million and comparable store sales decreased 4.2% after increasing 2% in last years third quarter. Comparable store sales by month were as follows: down 4.1% in August, down 5.4% in September and down 3.2% in October.

For the quarter a 2% increase in average unit retail was offset by 6% decrease in customer transactions.

By merchandise category, sales in the third quarter for the comparable stores were as follows: children's sales were up 10% versus up 1% in last years third quarter. The home division was down 3% in this years third quarter versus up 4% last year. Men's was down 7% after being up 3% in 2007's third quarter. Women's was down 9% this year versus up 2% last year, and accessories were down 16% compared to 5% increase in 2007.

Sales of nationally recognized urban brands increased 3.6% in the third quarter, just under the total company increase of 5.4%. These brands accounted for 49% of our sales in the quarter versus 50% in last years third quarter.

A number of our stores were impacted by hurricanes Gustaf, Hanna and Ike during the quarter however in the end the hurricanes had a negligible impact on our sales and earnings. We did lose over 300 store sales days due to closing from the hurricanes but after the stores re-opened, the sales rebounded to higher than pre-hurricane rates and by quarter end had offset the earlier sales losses in the quarter. We did have some damage from the storms and these expenses were included in the third quarter results, but were not significant.

Gross margin for the quarter increased to 36.9% from 34.7% last year due to lower merchandise mark downs and inventory shrinkage. Mark downs were a low about 200 basis points in this years third quarter even while facing negative comp store sales due to our efforts to improve the management of inventory levels.

Shrinkage dropped from 2% in last years third quarter to 1.5% this year as a result of the steps taken in the past year to better control inventory shrinkage including the reduction and the span of control of district managers in order to increase the level of supervision, better focus on problem stores by store operations and loss prevention, 24/7 camera surveillance systems in over 30 stores and lower inventory levels.

SG&A expenses were 34.8% of sales in the third quarter up from 32.6% last year. The year over year increase in expense ratio was due to the deleveraging effect that occurs when comparable store sales decrease while operating expenses are increasing at a normal rate of inflation.

After 18% increases in SG&A expenses in both the first and second quarters versus the comparable quarters in 2007, the percentage increase was held at 12% in the third quarter. In particular we were pleased with store operations ability to manage our biggest expense, store payroll, as we came out of a strong second quarter and started to see the sales decrease.

Although we were not able to reduce store payroll at the same rate as the comp sales decline particularly with another minimum wage increase this year, we were able to minimize the effect much better than we did for example, in the first half of last year when comp store sales began to slow.

In addition, efforts were made throughout the company to minimize or eliminate expenses in every line item on the P&L.

Depreciation expense for the quarter increased $900,000 and rose from 3.3% of sales in the third quarter last year to 3.9% this year as the result of capital expenditures incurred for new, relocated and expanded stores and the expansion of the billing and distribution center.

The net loss for the quarter was $687,000 this year compared to a loss of $513,000 in 2007's third quarter while the loss per share was $0.05 versus $0.04 last year. The year to date income has increased from $5.8 million last year to $7.3 million this year while earnings per share have increased 24% from $0.41 to $0.51.

In reviewing the balance sheet, total inventories were down 4% from the end of 2007's third quarter despite an increase in store selling square footage of 15%. Inventories in comparable stores were down 15% as we continue to conservatively manage our inventory levels in light of a difficult economic environment.

You may remember that at the end of last years third quarter our comparable store inventories were up 8% over the previous year. The lower inventory levels this year have had a very positive impact on our business with the most obvious being reduced mark downs resulting in improved gross margin. Lower inventory levels also have positive impacts on shrinkage results as well as store payroll levels.

Now turning to an update on the auction rate securities that are on our balance sheet, in Q3 we had one issuer redeem $5.4 million of securities at par value and one of our investment banks redeemed another $4 million at par value, and we've now signed the offer from UBS to have them purchase all of the remaining $42 million of our auction rate securities in June 2010 at par value to the extent that they have not been redeemed by then. In the meantime, we will continue to earn tax free interest income on the ARS.

We have not needed liquidity in these securities to run the business. We had discussed earlier this year that we had increased our credit facility to $35 million to be safe in light of the lack of ARS liquidity. However, as it turned out, we have not had to borrow anything out of the credit facility and won't have to this year. We've been able to fund our operations and store growth through cash flow.

As reported last quarter, we intended to implement our new warehouse management system in the third quarter. We did go live with the system in September however, we were not able to achieve the merchandise through put levels we expected so we backed out most of the new system and went back to our old system. We did leave it in place; the new hardware and material handling equipment as well as the inventory management and shipping software. We will re-implement the system in April 2009 after the spring shipping peak.

There were no significant merchandise flow disruptions or expenses incurred. We do like the new system and are sold on its benefits but now will not achieve all the benefits until 2009.

In the third quarter we opened seven new stores, expanded three existing stores and closed one. Since quarter end, we've opened 14 more new stores. We've now opened 37 new stores and expanded nine existing stores this year. The new and expanded stores have performed well to this point.

We expect to open two more stores in the fourth quarter, bringing the year total to 39 new stores, nine expanded stores and one closed store for the full year. Therefore, we will exceed our stated goal of 15% additional square footage for the full year.

Now, I'll turn the call over to Ed.

Edward Anderson

We clearly are now in a period of unprecedented economic difficulty and uncertainty. However, I believe that Citi Trends is well situated to withstand these economic head winds and to continue to prosper in this environment. Why do I believe this?

First, we are strong financially. We have no debt and $54 million of cash and investment on the books at the end of the third quarter. It has been comforting to be able to stay focused on our business despite all the noise going on in the financial markets. We've done a good job of managing our biggest asset, inventories. We are lean and this is a very good place to be with sales as uncertain as they are.

We have made a number of improvements in operations. First, we've gotten a handle on inventory shrinkage and have delivered much improved results. Second, we have made large improvements on payroll management. We have focused on expense control all year. In the third quarter, we delivered a smaller than expected loss in a tough sales quarter because we managed expenses very well.

So what are our plans to deal with this tough environment? We will continue to run lean inventories, to continue to focus on strengthening our operations and to tie even further our expenses.

What about growth? We are committed to continue our growth at the 15% square footage pace. We believe in this environment that real estate prices will come and we are positioned to take advantage. We'll push very hard to get cheaper rents and we will not chase any expensive deals.

How about a stock buy back plan? I though I would go ahead and answer this question because it will certainly come up in the question and answer portion of the call. We realize that today's prices a stock buy back plan might appear to be attractive. Because of the amount of uncertainty in the economic environment, we believe now is the time to preserve capital. Having said that, we obviously will continue to watch and gather information on this issue.

Now I will address guidance for the fourth quarter and the year. The big assumption of course is sales for the fourth quarter. Our comparable store sales trend is a decrease of about 4% from last year. That's what we achieved for the last 90 days or so. On a two year comparison our trend is a comp decrease of about 2%.

We do have sales for the first three weeks of November. However, Thanksgiving moving to week three to week four this year, is really clouding the numbers. Our best guess for November is a range in comp sales of -4% to 2%. Last year's November was a 5%, December a -5% and January flat.

So, we have decided to forecast a comp of -3% to -6% for the fourth quarter. This will yield earnings in a range of $0.44 to $0.54 for the quarter and $0.95 to $1.05 for the year. We will finish the year with an increase in store square footage in excess of 15% and expect and effective tax rate of approximately 33%.

We are now ready to answer your questions.

Question-and-Answer Session


(Operator Instructions) Your first call comes from Evren Kopleman – J.P. Morgan.

Evren Kopleman – J.P. Morgan

I was looking at your SG&A expense management and it looks like you did a really good job and you touched on that a little bit. Can you talk about opportunities for next year, more opportunity with payroll management or corporate overhead? Basically what kind of SG&A growth rate can we expect for '09?

Bruce Smith

When we look at '09 and we're obviously in the middle of the budgeting process right now, there are some things that we are counting on next year; certain initiatives that we actually put into place mid year this year will have a benefit for the first half of next year.

Store payroll I think as we mentioned, has been very well managed. We have also carefully grown the overhead base just selectively adding positions where they were really critical and making sure we don't go overboard in terms of building infrastructure. We obviously have to do some of that as we continue to grow but we're doing it selectively and really placing emphasis on certain area.

We did mention the distribution center and that we expect our distribution center to gain some efficiency next year as we re-implement the system in the spring. And when you look at our expense base, the big areas are obviously store payroll, the distribution payroll and store rents. Ed mentioned that our store rents is an area that we are really driving a hard bargain on. We're not going to chase rents or store locations that are not within our parameters and we're going to continue to be very selective on which stores we do pick.

We do think there are some opportunities out there for us to pick up some good real estate over the next year or two.

Evren Kopleman – J.P. Morgan

And how about the depreciation expense for next year?

Bruce Smith

Depreciation expense will be about $17 million to $18 million next year.

Evren Kopleman – J.P. Morgan

Can you touch on new store productivity based on the current environment? You're seeing new store volumes. I'm not sure if you touched on that earlier in prepared remarks but is it in line with what you've been seeing for the past 12 to 18 months or is it weaker?

Bruce Smith

The request was on new productivity for the '08 leased stores is about what we've seen in previous years. The '08 stores are performing good as a group and are within a percent or two of last years results, so we're continuing to see good productivity from our new stores.


Your next question comes from Robert Simmons – Oppenheimer

Robert Simmons – Oppenheimer

How much more gross margin opportunity do you see as we head into '09?

Edward Anderson

As we head into '09 historically what we've said is that a reasonable rate for us is right around 38%. You go back six or seven years, you'll see that we consistently were right around that number until 2007 when we had roughly a 200 basis point decline in gross margin because of all the mark downs we had to take to clear inventory.

I think we've shown this year that we can get back to that level of 38%. Maybe not all this year, but certainly expect that in 2009 we'll be at least back to 38%. I don't know that you should count on anything significantly higher than that because really our strategy has been to an every day low price retailer and to keep a reasonable gross margin but try to increase profits by leveraging expenses by getting top store sales increases.

So we're going to continue that pattern of being sharp on pricing and trying to drive sales and leverage expenses.

Robert Simmons – Oppenheimer

Are you seeing any new trends or new brands or is there an easier availability of brands in the market place right now?

Edward Anderson

I'm going to ask Beth Feher to talk about merchandising trends and availability of brands or op price buys.

Elizabeth Feher

The trends that we're seeing happening as we go forward, denim certainly continues to be a strong force in ladies, men's and kids. We are seeing the overall look starting to clean up both in the brands and in the non branded area, and we're liking a lot of the shorter lengths as we go forward, anything above the knee, from shorts to Bermudas replacing a lot of the Capri business.

From a brand point of view, we are seeing some new brands emerging that we are testing and we are seeing a little bit of flexibility happening between our top brands and some of our secondary brands taking some of their sales.

Robert Simmons – Oppenheimer

Can you provide just a little bit more color around some of the individual market performances?

Edward Anderson

Our business has been fairly consistent across the country pretty much the entire year. As we get into the cooler time of year, as we came to this fall, we did see the northern area of the company perform a little bit better. And actually, since the hurricanes, we talked about the hurricane impact and how we had a negative impact and a positive impact, and the hurricane affected stores I guess late September and October, the Texas and Louisiana stores have continued to outpace the rest of the chain. Probably our weakest area in our company for the last three or four weeks has been Florida.


Your next question comes from Jeffrey Klinefelter – Piper Jaffrey.

Jeffrey Klinefelter – Piper Jaffrey

On the real estate growth strategy and maintaining 15%, given that the new stores along with your total chain has been coming down in productivity as comps had decelerated the last couple of years, do you feel like from a new store return perspective you're going to be getting commensurate offsets in real estate costs? Is that the way you'd be thinking about those 2009 and 2010 opportunities to make sure that you're return is at or even ahead of prior trends?

Edward Anderson

Regarding productivity, the decrease in productivity that you're probably referring to has been productivity as we went through the second half of 2007 which I think is the comp stores but it also affected the new stores in existence at that time. We're not seeing a consequential down turn in new store productivity overall, so we're still getting that 95% to 100% return on the first year in our new stores and we expect that to continue.

About 2009 and 2010, we do intend, for now at least, and by the way the caveat here is how the fourth quarter turns and does the economy get materially worse and end up having a material affect on our business, assuming things don't get any worse and we start to see some light in next years spring, clearly we intend to stay with the 15% growth idea.

Having said that though we are going to be prudent. We are going to drive a harder bargain and an even harder bargain in 2009 than we did in 2008 because we think commercial real estate is in a condition that suggests that rents should be cheaper and we're finally starting to see it. In the past, we thought buildings, we thought about rents, and I told you before that we have seen prior to this quarter better availability.

Now we're finally seeing rents come down and I think that's what's going to help us achieve the returns that we've done historically. But we're going to drive hard bargains. Be very careful, very prudent in going about growth for next year, but I think again, a company that has a good model like we do, even in this environment can take advantage of cheaper real estate to continue. And that's what we intend to do.

Jeffrey Klinefelter – Piper Jaffrey

In terms of geography and maybe in general what you're seeing behavior wise out of the developers for more the strip center real estate. Are you seeing bankruptcies or very abrupt closures that are being presented to you as opportunities, because I know you have very short lead times to open your stores, so I imagine people are presenting it when they have a financial crisis situations with their tenants? And then geographically, are there areas of the country that you'll look to potentially accelerate and others that you might de-emphasize?

Edward Anderson

On an extraordinarily stressful situations for landlords or people that own large numbers of shopping centers, we have not yet seen that happen consequentially where people come to us with that kind of an idea. We clearly though are seeing much greater flexibility among landlords in the market or the fact that our company has grown.

It is one of the few retailers that's still growing in sizable numbers but we are seeing landlords come to us and present many more deals to us than they have historically. That's one of the reasons we think now is a good time for us to continue to grow with the model that we have.

As far as our growth into 2009 and later, we're going to continue to grow our stores with the vast majority of our stores being in the territories that we operate in today with less in outlying areas. As you know, we've gone to the extremities up to Detroit and Chicago and out west to Kansas City, and we're actually contemplating a move to California in the second half of 2009.

Again, that move will be determined upon the kinds of rents we can get in the California market. Again, the general economic environment will determine that move. So that's not a definite but that's something we actually are planning.

The majority of our growth is going to be in the southern part of our company where we operate currently, again fill in stores into the Detroit's and the Chicago's and the Kansas City's again in Portland, Texas, and very importantly in South Florida. At least 80% of what we do will be in core markets where we've had very good success in the past.

Jeffrey Klinefelter – Piper Jaffrey

On your systems from a merchandising system and inventory management perspective, do you feel like you have the adequate systems and software suites in place now to help you manage the complexities, growing complexities of going into these climates around the country?

Edward Anderson

I think the short answer is, generally speaking, yes. We think we have the platform that can support our growth for sure and with some modifications to our existing systems and requirements, I think we'll have the information systems that we need to take us to the next level. Obviously working with colder climates and being a lot better at handling these colder climates, we think it's still a very big opportunity for our company.

Having said that, that's been here now for about six or seven months, and we just hired a Vice President of Planning and Allocation about three or four months ago, and he'll come forth with a list of wish list of things. But these are primarily things that aren't that expensive, primarily in the modification area as opposed to a wholesale change out of our systems. So I think we're generally well situated.

We will modify. We will add as we go forward to support our business, but nothing consequential at this point.


Your next question comes from Patrick McKeever – Mkm Partners.

Patrick McKeever – Mkm Partners

A question on the pay check cycle. You mentioned the pay check cycle in the third quarter sales releases as becoming more pronounced. I'm just wondering if you might elaborate on that and talk about how things have changed with the pay check cycle over the past few months or couple, three quarters?

Edward Anderson

Are you talking about the first of the month phenomenon?

Patrick McKeever – Mkm Partners


Edward Anderson

I think if I understand your question, you weren't talking about the government rebate checks back in June and July, you're talking about the first of the month phenomenon where a lot of government checks are issued to people on various forms of government assistance and how that affects our business.

Patrick McKeever – Mkm Partners


Edward Anderson

It's always been a key to our business and our business has always moved up significantly in those weeks that have a first of the month income. It seems to us that in the last three or four months that has become even more pronounced. I don't have a measurement for you but it looks like, and I think again this is indicative of the fairly tough economic climate we're currently in, is that the first of the month business is still a phenomenon but as people spend that money and get into the second, third and fourth weeks of the month, those weeks have tended to be much more difficult. So we are seeing an exacerbation if you will of that first of the month phenomenon.

Patrick McKeever – Mkm Partners

Over the years is it something that has been more consistent over time and just recently has become more of an issue?

Edward Anderson

I think we talked about it because other people have talked about it and people have asked us about what's going on in our business different, And I just want to say that this is not a new phenomenon. This is the way our business has been pretty much forever.

Patrick McKeever – Mkm Partners

I feel like I'm seeing more and more urban apparel at some of your competitors including Marshall's and Ross stores to some extent and certainly that remains a big focus at A.J. Wright, so I was just wondering if you could talk about that and say whether you feel like they're putting more so Marshall's than Ross, whether you feel they're putting a bigger emphasis on urban apparel. And I was also wondering if you're seeing more competition on the buying side for some of the better urban brands.

Edward Anderson

I think I'll try to address both of those. One of them is you're seeing what appears to be more brands and some of our prices like Marshall's and T.J.'s I guess, Ross. And then a new competition for actually buying the brands.

We see the same thing that you're seeing. We see urban brands in a lot of our pricers and we see a lot of our off price compared to Marshall's and T.J.'s in particular as well as Ross, when they have stores that are in more urban markets, they clearly are able to put more of their brands in those markets. So we see that.

And that's what we would expect them to do. But I don't think that's a material change from where they had been before. I'm talking now about these major off prices being Ross and T.J. for the Marshall's idea and A.J. Wright included.

As far as competition for buying the brands, we talk at Citi Trends how over time we've become more important to the urban brands and we have moved up the pecking order to where we're number one or two rock price and close out buys for virtually all of the urban brands. That's still true.

And in fact now, virtually all the urban brands actually make goods for Citi Trends. But they also do the same thing for off prices too. We don't own that idea, but nothing's changed as far as Citi Trends' importance to these folks because urban brands is all that we do.

There is additional competition in the marketplace. The [Cato] chain has a chain called Its Fashion Metro which is growing fairly rapidly so there's another buy out effort in brands. But the flip of that is with people going out of business as well. I don't think our position has changed materially from where it would have been a year ago.


Mr. Anderson, at this time, I'll turn the call back to you for closing comments.

Edward Anderson

We appreciate you all joining the call today. Thank you.

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