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Citi Trends (NASDAQ:CTRN)

F2Q08 Earnings Call

August 20, 2008 5:00 pm ET

Executives

Bruce Smith - Chief Financial Officer

Edward Anderson - Chairman and Chief Executive Officer

Beth Feher - Chief Merchandising Officer

Analysts

Evran Kopelman - JP Morgan

Jeff Klinefelter - Piper Jaffray

Patrick Mckeever - Mkm Partners

Dan Chase - Stevens Investment Management

Operator

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

Bruce Smith

Also on the call with me are Ed Anderson, Chairman and Chief Executive Officer and Beth Feher, our new Chief Merchandising Officer.

Our second quarter earnings release was sent out at 4:00 pm Eastern Time today. If you’ve not received a release it is available on our company website under the Investor Relations section at www.cititrends.com. 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, uncertainties and other factors that may cause the actual results to differ materially. We refer you to the company’s most recent report on Form10-K filed with the Securities and Exchange Commission for more detailed discussion of the factors that could cause actual results to differ materially from those described in any forward-looking statements.

Ed and I will provide you with some details related to the second quarter results and our guidance for the remainder of the year, after which Ed, Beth and I will address any questions you may have.

Now I will turn the call over to Ed.

Ed Anderson

Total sales in the second quarter increased 19.5% to $115.7 million and comparable store sales increased 6.5%. Net income was $2.8 million compared with $0.6 million in last year’s second quarter. Earnings per diluted share were $0.20 in the second quarter compared with $0.04 in 2007. Note that 2007 second quarter included $0.03 per share expenses related to a secondary stock offering.

Comparable store sales by month were as follows; up 5% in May, up 14.8% in June and down 1.9% in July for the quarter slightly more than half of 6.5% increased came from an increase in the number of customer transactions and the remainder from an increased in the number of items per transaction. By category, children’s sales were up 18% versus up 4% last to years second quarter. Home division was up 11% in this year’s second quarter versus up 2 last year. Men’s was up 4% after being down 1%, 2007 in the second quarter. Women’s was up 2% this year versus up 4% last year and accessories were flat compared to down 1% in 2007.

Sales of nationally recognized urban brands performed inline with our other merchandise and accounted for 42% of our sales the same as last year’s second quarter. Sales of the second quarter were clearly aided by the government tax rebate checks. Our sales closely tied to the rebate check process, increasing as they came out and slowing down immediately as the process ended.

Comparable store sales in the August month for, Tuesday August 19, for the first 17 days of the third quarter were down 1.7%. Beginning of August was negatively impacted by sales in the State of Florida, but the State of Florida did not anniversary last year ten day tax free holiday. We estimate that impact on the entire company was the 2% drag on comparable sales. The cause of the uncertain nature of the economy and our own sales trends, I believe our sales over the next couple of quarter will be flat, below single-digits.

We have continued our progress in inventory management. Total company inventories at the end of the second quarter were 9% less than the last year. Comparable store inventories were 18% less than last year. In the second quarter we have 13% less comparable store inventories than a year ago. So we delivered a 6.5% comparable store sales increased in the quarter with over 15% less average inventory. These lower inventory levels have had a very positive impact on our business, but the most obvious being reduced markdowns resulting in an improved gross margin.

Lower inventory levels have a positive impact on shrinkage results as well as store payroll. Despite the large decreases in inventory from last year I still believe we have enough inventories to deliver positive comp sales. Inventory shrinkage was 1.5% in the second quarter compared with 2.3% in last year’s second quarter. We are overall pleased with the shrinkage results this year; shrinkage was 1.7% in the first quarter. The main reason for the improved results has been our focus on reducing store manager turnover and reducing the span of control of district manager in order to increase the level of supervision.

As we have in the past we believe the store manager turnover is a leading indicator of past shrinkage. Our store manager turnover has increased recently, but we will continue to stay focused on this issue and intend to control into our shrinkage within reasonable limits. As I reported last quarter we completed the expansion of Darlington South Carolina distribution center in the first quarter.

The building and equipment are fully operational also we are in the final testing stages of new warehouse management system improved, productivity and inventory management. I expect to go line with the WMS in the third quarter. In the second quarter we opened four new stores and expanded two existing stores. Since quarter end we have opened one more new store and one more expanded store, with the opening tomorrow of another new store in Chicago we will have opened 18 new stores and expanded seven existing stores year-to-date.

New markets recently opened include Kansas City, Missouri and Philadelphia. The new and expanded stores have performed well to this point. We expect to open 38 to 40 new stores, expand 10 stores and close one store for the full-year. We do expect to add a net of a 15% additional selling square footage for the full-year. New store openings will be somewhat more backend loaded than previous years.

Now, Bruce Smith will review the operating results, the balance sheet and guidance for the remainder of 2008.

Bruce Smith

Total sales in the second quarter were up 19.5% and are up 16.4% year-to-date. The second quarter sales increase was a result of opening 35 stores since last years second quarter and the 6.5% increase in comparable store sales that Ed discussed.

Gross margins for the quarter increased to 38.8% from 36.2% last year due primarily to lower merchandise markdowns and inventory shrinkage. Our efforts to improve the management of inventory levels together with the strong sales performance in the second quarter resulted in a 160 basis point reduction and markdowns.

Additionally the steps taken in the past year to lower inventory shrinkage, this is reducing store manager turnover, decreasing the district manager span of control and installing sophisticated surveillance systems in our high shrinkage stores resulted in an 80 basis point decrease during the quarter.

SG&A expenses were 31.9% in the sales in the second quarter down from 32.6% last year. The year-over-year decrease in expense ratio was due to expense leverage from the 6.5% comp, better management of store payroll and the $450,000 in expenses last year associated with the secondary stock offering. These expense benefits were partially offset by higher bonus accrual this year due to the improved results in the second quarter and by increased store supervision cost as a result of reduce the span of store control given to our district managers in order to improve the focus on individual stores.

Depreciation expenses for the quarter increased $1.1 million and rose from 3.1% of sales in the second quarter last year to 3.5% this year. That was the result of capital expenditures incurred for new relocated and expended stores and the expansion on Darlington distribution center. The effect of income tax rate use in 2008 second quarter was 36% compared to 34% last year.

Higher rate in the second quarter this year is a result of us raising our effective tax rate forecast from the 32% used in the first quarter to a little more than 33% for the first six months of the year, thereby requiring an adjustment in the second quarter to get to that rate. The change in our effective tax rate expectation includes the decline in our interest rate environment over the past few months, which has the effect of reducing our interest income on auction rate securities. Since, this interest income is tax free, the expected decrease has an adverse impact on our tax rate.

Net income for the quarter was $2.8 million this year, compared to $627,000 in 2007 second quarter while earnings per share were $0.20 versus $0.04 last year. Year-to-date net income has increase from $6.3 million last year to $8 million this year, earnings per share have increase 24% from $0.45 to $0.56. Reviewing the balance sheet, total inventories were actually down 9% from the end of 2007 second quarter despite an increase in selling square footage of 16%.

Inventories and comparable stores were down 18% as Ed mentioned, as we continue to bring our inventory levels more inline with where we think they need to be. You may remember that at the end of last year’s second quarter, our comparable store inventories were up 12% over the previous year.

To give you an update, on the auction rate securities of more than $50 million on our balance sheet, we did have one issuer redeeming $2.3 million of securities at par value in the second quarter. More importantly, our primary investment bank for auction rate securities announced publicly that they have committed to purchase to all of there clients securities in June of 2010, at par value to the extent that any of them have not been redeemed by them.

Although we continue to earn interest income on ARS and have not needed liquidity in the securities to run the business. We do look forward to converting them back from a non-current investment for one that is current as was originally intended. We had discussed earlier this year that we 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 yet to borrow anything under the credit facility and may not have to even as we build inventory at Christmas season.

For the second quarter we have recorded an unrealized loss of $1.7 million net of taxes related to the auction rates securities. This charge has only affected the balance sheet not the statement of income due to the belief that this is a temporary loss. We believe that the undertaking by Investment Bank to purchase the ARS at par value in June of 2010 certainly increases the likelihood that this unrealized loss will proved to be temporary.

Our guidance for fiscal 2008 remains unchanged with earnings in the range of $1.10 to $1.15 per diluted share, which takes into account the strong second quarter results and the outlook for the second half that Ed discussed earlier. This guidance assumes an anticipated full year comp store sales increase of 1% to 2% and increase in selling square footage of 15% and an effective tax rate of approximately 33%.

One thing to keep in mind as it relates to income taxes is that last year our income tax rate in the second half of the year 27% was abnormally low and therefore will adversely effect the second half earnings comparison by about $0.05 per share.

Michael if you’d come back on, we are now ready to answer questions.

Question-and-Answer Session

Operator

(Operator Instruction) Your first question comes from Evran Kopelman - JP Morgan.

Evran Kopelman - JP Morgan

The first question, just to conform you said August to-date down 1.7%, but if you exclude the Florida impact that it would be about flattish?

Ed Anderson

That’s correct. We said that’s for yesterday, for the first 17 days of August our comp sales were down 1.7%, but we also said that during the same timeframe, we are going against last years Florida tax-free holiday, which they did anniversary and we have calculated that those stores have a negative impact that dived the company comp down about 2% so yes, without the Florida impact during that timeframe the sales would have been about flat during that timeframe. Yes.

Evran Kopelman - JP Morgan

Which is relatively inline with what you expect for the second half right, you said flat to up low single digit, so?

Ed Anderson

We pulled our estimate for the second half back some and you may have read that in the press release, but we have previously said 2% to 3% and if you look at the numbers we are not guiding for the full year, I guess its one to two that implies zero to one for the second half.

Evran Kopelman - JP Morgan

What are the drivers and pressures on comp growth in the second half, if you would talk about those?

Ed Anderson

We don’t see anything new going on in the second half, that really that hasn’t being going on I guess for probably most of this year, other than just a lot we are reading about the economy and the economy is seems to not be getting any better and we listening and watch what other retailers are saying about their business and frankly, our own business was negative in July, almost 2% and it’s been negative even there may be with an asterisk around the 1st of August, but our own business has been negative and so we think it’s prudent to manage business and manage our expectations towards something that’s suppose to flat.

Operator

Your next question comes from Jeff Klinefelter - Piper Jaffray.

Jeff Klinefelter - Piper Jaffray

A few questions for you, first of all Ed just continuing on that comp subject. Last year, could you sort of remind us what your comps where how they kind of flow during the three months of the quarter last year? Didn’t you post fairly strong comps at the beginning of August of last year?

Ed Anderson

Just continuing where we speaking with Evren. In addition to the fact that our sales our down negative 17 now at the beginning of August with a drag from the ninth anniversary Florida’s tax free holiday. August was a very strong month last year in fact weeks two and three of August we were up over 20%. The August month in last year’s third quarter was up 14.6. After August the comparisons comp considerably easier as we work away through the second half.

August last, was plus 14.6, September was negative 6, and October was negative 3. The third quarter in total for those three months was plus 2 and I’ll just push it though the rest of the year while on the subject. November was plus 5.3, December the big month was negative 4.6, January was flat, so the fourth quarter was negative 1, last year’s third quarter was plus 2, with strong August fourth quarter was negative 1 with the weak December.

Jeff Klinefelter - Piper Jaffray

So therein lies, you’re thinking about at least flat below single digit comp, obviously the easier comparison should…

Ed Anderson

Probably the easier comparison should make it easier, but that’s not in our future Jeff, and with July month, if we just go back to the second quarter for a second, the second quarter I guess May was up 45, Bruce and June was up 14, and then July was down 2, but May and June were positives against last year’s positives. July was actually a negative two this year against last years negative five. So, the July numbers bothers us a little bit and the fact that even though with an asterisk maybe at the beginning of August we are still running negative, so that’s why we are being a little more cautious about our forecast.

Jeff Klinefelter - Piper Jaffray

And then also a couple of other things, one on the warehouse management system you’ve indicated your testing and finishing your testing at it and maybe implanting it in Q3 you said, historically that has been a stumbling block for retailers, it is in some cases created some product flow issues, so any more color you could add there to provide a little bit more comfort on that being as a smooth process?

Ed Anderson

Well Jeff that was a well worded the way you characterize this risk, that companies take home when they installed warehouse management systems, because it is a risky thing for retailers and depending how it’s done, if its done poorly it can cripple a business. However at Citi Trends our approach is to be very conservative in this, we’re only bringing this system up and we’re about two DCs.

We have two distribution centers as you know and we bringing this system up and the larger of it are the two, but we are only bringing it up in one, we’ve installed the equipment that is going to be operating new and that’s been operating for some time and we actually bringing the system up in pieces and so we are actually already operating the part but already for example the inventory piece of the system is already up in running, the seating part of the system is coming up I think in this week or so, and the picking part really is the only piece that’s left to be done and that’s to be done sometime in September or October.

So we are bringing it up in pieces and we are watching it. We have back-up plan. We are only doing it one of our distribution centers. So I think we’re doing all the things that we can to and keep the risk down to a management level. We don’t have to do this by the way there is nothing volume related around it. So, if we see something we don’t like we just back and do it at a later day.

Jeff Klinefelter - Piper Jaffray

And then lastly on new stores and I guess the environment for one in terms of new store opportunities leasing rate etcetera what what’s happening in the marketplace are you seeing any changes for your particular type of real estate becoming more available in greater quantities or greater frequency pricing on those boxes and then also any more color you can give us on the new market performance. You said generally performing on plan you said before Baltimore was the one underperforming market. Could you give us some more color around the markets, which are performing above, which are below expectations?

Ed Anderson

Two sets of questions there, one is the general subject our real estate; its availability, its cost as it relates to Citi Trends, what we have seeing to this point is we’ve expected the commercial real estate market to react with lower prices and better availability and what we have seen to this point, as we have seen availability pick up in another words more sites available and so the selection for the sites and the markets we are looking at seems to be better. So we are getting a good look at more sites that we may have had maybe a year-ago or even two years ago.

One of the things that has not happened yet and as we now seeing landlords be realistic about pricing in this environment. So, there is a lot real estate debt coming onto market, but people are holding onto the prices. We think that’s going to change over the next few months and maybe as we go through this year end and we see some pricing come back to us but at this point the availability seems to be improving, but not quite yet pricing but we think it will.

On the second piece, on our new stores and how they are operating. I guess Chicago I guess is probably the biggest new market for us. This year I guess we have now two or three stores opened in the Chicago market. We just opened Kansas City and Philadelphia in the last two or three weeks. It’s a little early to make a real call of those stores, but generally speaking these stores have continued to be good Jeff. Those stores we have opened in Johnstown, Ohio and the Cleveland market and Chicago market additional stores Dayton Texas and I know the back few market since smaller towns have continue to perform well.

The Baltimore market has continued to be negative market for Citi Trends. I look at those stores today before the phone call to see how they are doing lately; these four stores out there continue to under perform our expectations. They are all four making money, but small amounts of money and not returns that we expect. All fours of them are running positive increases in 2008 from 5% to 10% but even at those rates, we are still are getting to levels that we would like to and we still have not yet solve that puzzle. Those are still the only market where we have not hit our expectations to this point.

Operator

Your next question comes from Patrick Mckeever - Mkm Partners.

Patrick Mckeever - Mkm Partners

The question on the back half of the implied earnings guidance for the back half of the year given the fact that the second quarter was so strong and so much above, I know you hadn’t given any specific EPS guidance for the quarter, but so far above the expectation, but the back half of the year guidance implies a pretty different, I guess different margin equation, but you’ve got such an easy comparison in the back half for the year you have got -- the operating margin was down 450 basis points in the back half of 2007.

So my question is what should we be thinking there. I think I understand the sales piece of it and how much the stimulus benefited the second quarter but your inventories are just so much better and such a better positioned than they were a year ago and shrink is improving and so forth so. Don’t you think you should be able to see some pretty significant operating margin recovery in the back half of the year even if comps are negative, or is it not the right way of thinking about it?

Ed Anderson

Let’s address, because I guess this is one of the big questions on the call is, what we are thinking about the second half of this year on the sales and the margin perspective. First let me do just a matter adjustment on last year’s second half. I think we actually mixed up in the press release. The last year’s second half had about $0.05 per share of tax sort of catch-up if you will.

So if you’re looking at the last years second half you should probity pull a nickel our of last year’s second half and then compared the implied guidance to this year and last year and you get a somewhat different number, but clearly with us coming in with a $0.20 second quarter against the street’s estimate of around $0.05 and yet assumed in our estimates we are in that same general neighborhood.

As you look at our expectations for the second half of 2008 have changed and the big change -- I guess in order by the two to three changes one is our point of view on comp store sales increases have lessened 2 to 3, to 0 to 1 that’s a pretty big change when you more flat times, I guess $250 million or so sales in the back half and the second piece which Bruce will get into as we have pulled back on our interest income estimates and it lay tax impacted that and there is a slight adjustment in the number of store lease in the second half, but the big impact is really the pullback of the comp sales and followed by the interest income, Bruce you want to add to that?

Bruce Smith

Yes I mentioned some extend in my earlier point, we have lower our expectation of interest income on the auction rate securities because of the decline in the interest rate environment over the past few months and I guess from the estimates that we provided earlier that probably has about a 3% to 3.5% impact in terms of lowering the interest income for the back half together with the income tax effective because it all go straight to the bottom line probably in the neighborhood of $500,000.

Patrick Mckeever - Mkm Partners

And then I got a question on availability of the brands. You said national brands I think were 42% sales in the quarter as same as last year. I mean is anything changing there in terms of availability of some of the hot brands you didn’t talk much about that, but often times you give some comments on what’s hot, what’s not and there is lot of distress out there, across the retail space, but I had seem some change at the off price level in general it seems like TJ and even Ralph are going after some of the urban brands a little more aggressively and I was just looking, though Macy’s back-to-school flyer and they’re pushing urban brands pretty hard right now. Is there change going on there with the competition for some of the national brands?

Ed Anderson

Patrick thanks for the questions and this question regarding just our branded sales and availability of knowledge branded goods, but the availability of off-price goods. I’m going to ask Beth to respond to that.

Beth Feher

Hi, Patrick, we definitely are continuing to seek out closeout as a big part of our business both in the branded and in the fashion area. We generally are finding sufficient quantities in all areas except for kids, which we do start to sense a slowdown there and we think that’s happening for two reasons. One is that the kids business overall has been strong leaving less goods to buy and I think the kids vendors are cutting closer to need from that piece of it.

Operator

Your next question comes from Dan Chase - Stevens Investment Management.

Dan Chase - Stevens Investment Management

Even understanding I guess the change in top line expectations from the comp perspective from 2 to 3 more flattish to and also the interest income part. I am still little confused on, fourth quarter last year had such a dramatic EBIT margin decline and I know some of that was bonus accrual, but when we look out this year running 18% our high double digit down comp inventories. It’s seems like even on negative comps you guys are having better gross margins. So I am just trying to reconcile the back half, is it just conservativeness because the environment or I am missing something.

Bruce Smith

I don’t think you are missing anything. We’re looking to give you he details of the pieces of the income statement I guess in a forecast basis, but I think it’s fair to tell you that we are expecting even with the sales being off to expect nicely improved gross margins in the second half. So, our inventory quality is very, very good, the good news is if sales do come just like what happened in the second quarter, very nice things could happen to us, but were we are not caring on it on a full cash perspective.

Dan Chase - Stevens Investment Management

So basically, this is a scenario where the environment, it is what it is and if you guys get a little bit better help then its going to be better but as the environment is been weak, you just provided ..

Bruce Smith

I complete the though to give you a little bit more information, perhaps. We are expecting even with flattish to maybe to a small negative to a small positive comp sales number to see some very nicely improved gross margins, because what happened last year, in the third and fourth quarter and our inventories are at a better shape than they were at that points, but also even though we have experienced leverage in the seconded quarter, we are running flattish comp sales increases, we’re going to see some de-leverage (Inaudible) does that make sense?

Operator

There are no further questions at this time.

Edward Anderson

We really appreciate your interest in our company, and thanks for joining the conference call.

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