Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Forward-Looking Statements
Except for specific historical information, many of the matters discussed in this Form 10-Q may express or imply projections of revenues or expenditures, statements of plans and objectives for future operations, growth or initiatives, statements of future economic performance, capital allocation expectations or statements regarding the outcome or impact of pending or threatened litigation. These, and similar statements, are forward-looking statements concerning matters that involve risks, uncertainties and other factors that may cause the actual performance of the Company to differ materially from those expressed or implied by these statements. All forward-looking information should be evaluated in the context of these risks, uncertainties and other factors. The words “believe,” “anticipate,” “project,” “plan,” “expect,” “estimate,” “objective,” “forecast,” “goal,” “intend,” “could,” “will likely result,” or “will continue” and similar words and expressions generally identify forward-looking statements, although not all forward-looking statements contain such language. The Company believes the assumptions underlying these forward-looking statements are reasonable; however, any of the assumptions could be inaccurate, and therefore, actual results may differ materially from those projected in the forward-looking statements.
The factors that may result in actual results differing from such forward-looking information include, but are not limited to: the ongoing COVID-19 pandemic and associated containment and remediation efforts; the potential negative impacts of COVID-19 on the global economy and foreign sourcing; the impacts of COVID-19 on the Company’s financial condition, business operation and liquidity, including the potential closure of any of the Company’s retail stores and distribution centers; transportation and distribution delays or interruptions; changes in freight rates; the Company’s ability to negotiate effectively the cost and purchase of merchandise; inventory risks due to shifts in market demand; the Company’s ability to gauge fashion trends and changing consumer preferences; changes in consumer spending on apparel; changes in product mix; interruptions in suppliers’ businesses; a deterioration in general economic conditions, whether caused by acts of war, terrorism, political or social unrest (including any resulting store closures, damage or loss of inventory), or other factors; the results of pending or threatened litigation; temporary changes in demand due to weather patterns; seasonality of the Company’s business; delays associated with building, opening and operating new stores; delays associated with building, opening or expanding new or existing distribution centers; and other factors described in the section titled “Item 1A. Risk Factors” and elsewhere in the Company’s Annual Report on Form 10-K for the fiscal year ended February 1, 2020, as amended, and in Part II, “Item 1A. Risk Factors” and elsewhere in the Company’s Quarterly Reports on Form 10-Q and any amendments thereto and in the other documents the Company files with the SEC, including reports on Form 8-K.
Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Form 10-Q. Except as may be required by law, the Company undertakes no obligation to update or revise publicly any forward-looking statements contained herein to reflect events or circumstances occurring after the date of this Form 10-Q or to reflect the occurrence of unanticipated events. Readers are advised, however, to read any further disclosures the Company may make on related subjects in its public disclosures or documents filed with the SEC, including reports on Form 8-K.
Overview
We are a value-priced retailer of fashion apparel, accessories and home goods for the entire family. Our merchandise offerings are designed to appeal to the fashion preferences of value-conscious consumers, particularly African-Americans. We operated 579 stores in both urban and rural markets in 33 states as of August 1, 2020.
COVID-19 Pandemic
In December 2019, a novel coronavirus (“COVID-19”) emerged and spread worldwide. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic. After closely monitoring and taking into consideration the guidance from federal, state and local governments, we temporarily closed all of our retail store locations and distribution centers effective March 20, 2020. Beginning April 24, 2020, we started to reopen stores in select states in accordance with state and local government guidelines. As of July 18, 2020, we safely reopened all of our stores. As we reopened our stores, we took numerous measures to protect the health of our associates, customers and communities we serve. Such measures include implementing occupancy limits, providing personal protective equipment for our associates and customers, encouraging social distancing, adjusting our processes for merchandise returns and implementing new cleaning procedures. We have incurred, and expect we will continue to incur, incremental costs for personal protective equipment, including masks, gloves and hand sanitizer for our associates and customers, as well as additional cleaning supplies.
The temporary closure of our stores has had, and may continue to have, an adverse impact on our financial condition, results of operations and liquidity as described in more detail below. In the first quarter of 2020, we took several steps to increase our cash position and preserve financial flexibility in light of uncertainties resulting from the COVID-19 pandemic, including (i) the drawdown
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of $43.7 million in principal amount under the revolving credit facility on March 20, 2020 and an amendment to the revolving credit facility to extend the term to August 2021; (ii) temporary furloughs of substantially all store and distribution center personnel and a significant portion of the corporate staff, with employee benefits for eligible employees continued through the temporary furloughs; (iii) temporary tiered salary reductions for management level corporate employees and a reduction to the cash portion of non-employee director fees; and (iv) extensions of payment terms with vendors and suppliers. Other measures taken by the Company to mitigate the impact of the pandemic that began in the first quarter of 2020 and are continuing include (i) negotiating rent concessions with landlords; (ii) executing substantial reductions in operating expenses, store occupancy costs, capital expenditures and other costs; and (iii) temporarily suspending share repurchases and dividend payments.
We continue to navigate through macro changes in the consumer landscape, including unpredictable and non-traditional back-to-school timing and learning methods and the ongoing uncertainties stemming from the COVID-19 pandemic. As a result, in the first several weeks following the end of the second quarter, our customer traffic as measured via comparable store transactions has been soft. However, 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 that once we are beyond the traditional back-to-school selling season that customer traffic trends will normalize. We will continue to monitor and evaluate the COVID-19 pandemic and work to respond appropriately to the impacts on our business, including those on our customers, vendors and the communities we serve.
Accounting Periods
The following discussion contains references to fiscal years 2020 and 2019, which represent fiscal years ending or ended on January 30, 2021 and February 1, 2020, respectively. Fiscal 2020 and fiscal 2019 both have 52-week accounting periods. This discussion and analysis should be read with the unaudited condensed consolidated financial statements and the notes thereto contained in Part 1, Item 1 of this report.
Results of Operations
The following discussion of the Company’s financial performance is based on the unaudited condensed consolidated financial statements set forth herein. The nature of the Company’s business is seasonal. Historically, sales in the first and fourth quarters have been higher than sales achieved in the second and third quarters of the fiscal year. Expenses and, to a greater extent, operating income, vary by quarter. Results of a period shorter than a full year may not be indicative of results expected for the entire year, as a result of changes in our business, consumer spending patterns, and the macroeconomic environment, including those resulting from the COVID-19 pandemic. Furthermore, as a result of the closure of our stores due to the COVID-19 pandemic for at least five weeks beginning on March 20, 2020, comparisons of expense ratios and year-over-year trends are not a meaningful way to evaluate our operating results for the twenty-six and thirteen weeks ended August 1, 2020.
Key Operating Statistics
We measure performance using key operating statistics. One of the main performance measures we use is comparable store sales growth. We define a comparable store as a store that has been opened for an entire fiscal year. Therefore, a store will not be considered a comparable store until its 13th month of operation at the earliest or until its 24th month at the latest. As an example, stores opened in fiscal 2019 and fiscal 2020 are not considered comparable stores in fiscal 2020. Relocated and expanded stores are included in the comparable store sales results. We also use other operating statistics, most notably average sales per store, to measure our performance. As we typically occupy existing space in established shopping centers rather than sites built specifically for our stores, store square footage (and therefore sales per square foot) varies by store. We focus on overall store sales volume as the critical driver of profitability. In addition to sales, we measure cost of sales as a percentage of sales and store operating expenses, with a particular focus on labor, as a percentage of sales. These results translate into store level contribution, which we use to evaluate overall performance of each individual store. Finally, we monitor corporate expenses against budgeted amounts.
Twenty-Six Weeks Ended August 1, 2020 and August 3, 2019
Net Sales. Net sales decreased $55.6 million, or 14.3%, to $332.3 million in the twenty-six weeks ended August 1, 2020 from $387.9 million in the twenty-six weeks ended August 3, 2019. The decrease in sales was due to closing all 574 of our stores as a result of the COVID-19 pandemic from March 20 until April 23, at which point we began to gradually reopen certain stores, with all stores safely reopened as of July 18, 2020. In the first quarter of 2020, net sales decreased $88.9 million, or 43.4%. Prior to the onset of the COVID-19 pandemic, comparable store sales increased 3.1% from the beginning of the first quarter through March 7, 2020. In the second quarter of 2020, net sales increased $33.4 million, or 18.2%, with an increase in comparable store sales of 32.2% for reopened stores from their respective opening dates.
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Cost of Sales (exclusive of depreciation). Cost of sales (exclusive of depreciation) decreased $31.4 million, or 12.9%, to $211.5 million in the twenty-six weeks ended August 1, 2020 from $242.9 million in the twenty-six weeks ended August 3, 2019. Cost of sales as a percentage of sales increased to 63.7% in the first twenty-six weeks of fiscal 2020 from 62.6% in the same period of fiscal 2019 due primarily to an increase of 250 basis points in merchandise markdowns, as more markdowns were taken in the first quarter of 2020 due to our store closures related to the COVID-19 pandemic. The increase in markdowns was partially offset by an improvement of 130 basis points in the initial mark-up, combined with slight improvements in freight costs and shrinkage.
Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $14.7 million, or 11.7%, to $111.7 million in the twenty-six weeks ended August 1, 2020 from $126.4 million in the twenty-six weeks ended August 3, 2019 due primarily to a $13.3 million decrease in payroll expenses as a result of associate furloughs and government credits under the CARES Act, as well as decreases in variable costs related to the temporary closures of our stores and distribution centers. These decreases were partially offset by $1.2 million of incremental supplies costs related to COVID-19 for personal protective equipment and cleaning supplies, as well as the impact on expenses of opening 20 new stores since the second quarter of last year. As a percentage of sales, selling, general and administrative expenses increased to 33.6% in the first twenty-six weeks of fiscal 2020 from 32.6% in the first twenty-six weeks of fiscal 2019.
Depreciation. Depreciation expense increased $0.7 million, or 7.1%, to $9.9 million in the first twenty-six weeks of fiscal 2020 from $9.2 million in the first twenty-six weeks of fiscal 2019.
Asset Impairment. Impairment charges related to an underperforming store totaled $0.3 million in the first twenty-six weeks of fiscal 2020, comprised of $0.2 million for an operating lease right-of-use asset and $0.1 million for leasehold improvements and fixtures and equipment. In the first twenty-six weeks of fiscal 2019, impairment charges related to underperforming stores totaled $0.5 million, comprised of $0.3 million for leasehold improvements and fixtures and equipment, and $0.2 million for an operating lease right-of-use asset.
Income Tax Benefit/Expense. Income tax benefit was $0.4 million in the first twenty-six weeks of fiscal 2020 compared to income tax expense of $1.4 million in the first twenty-six weeks of fiscal 2019, as a result of a pretax loss in the first twenty-six weeks of fiscal 2020. For the first twenty-six weeks of 2020, we utilized the discrete effective tax rate method to determine tax expense based upon interim period results, as the full-year tax rate is not reliably predictable.
Net Loss/Income. Net loss was $1.0 million in the first twenty-six weeks of fiscal 2020 compared to net income of $8.2 million in the first twenty-six weeks of fiscal 2019 due to the factors discussed above.
Thirteen Weeks Ended August 1, 2020 and August 3, 2019
Net Sales. Net sales increased $33.4 million, or 18.2%, to $216.2 million in the second quarter of 2020 from $182.8 million in the second quarter of 2019. The increase in sales was due primarily to strong comparable store sales performance upon reopening our stores that were temporarily closed due to COVID-19 and the opening of 20 new stores since the second quarter of last year. Comparable store sales for reopened stores from their respective opening dates increased 32.2% in the second quarter of 2020 relative to the same dates of last year.
Cost of sales (exclusive of depreciation). Cost of sales (exclusive of depreciation) increased $12.5 million, or 10.9%, to $127.1 million in the second quarter of 2020 from $114.6 million in the second quarter of 2019. Cost of sales as a percentage of sales decreased to 58.8% in the second quarter of 2020 from 62.7% in the second quarter of last year due to an improvement of 290 basis points in the core merchandise margin (initial mark-up, net of markdowns) and an improvement of 100 basis points in freight costs.
Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $5.4 million, or 8.5%, to $57.6 million in the second quarter of 2020 from $63.0 million in last year’s second quarter. The decrease was due primarily to a $5.3 million decrease in payroll expenses as a result of associate furloughs and government credits under the CARES Act as well as decreases in variable costs related to the temporary closures of our stores and distribution centers. These decreases were partially offset by $1.2 million of incremental supplies costs related to COVID-19 for personal protective equipment and cleaning supplies and the impact on expenses of opening 20 new stores since the second quarter of last year.
Depreciation. Depreciation expense increased $0.3 million, or 7.1%, to $4.9 million in the second quarter of 2020 from $4.6 million in the second quarter of 2019.
Asset Impairment. There were no impairment charges in the second quarter of 2020. In the second quarter of 2019, impairment charges related to underperforming stores totaled $0.5 million, comprised of $0.3 million for leasehold improvements and fixtures and equipment, and $0.2 million for an operating lease right-of-use asset.
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Income Tax Expense. Income tax expense was $6.2 million in the second quarter of 2020 compared to $0.1 million in the second quarter of 2019 due to an increase in pretax income. For the second quarter of 2020, we utilized the discrete effective tax rate method to determine tax expense based upon interim period results, as the full-year tax rate is not reliably predictable.
Net Income. Net income increased $19.5 million to $19.9 million in the second quarter of 2020 from $0.4 million in the second quarter of 2019 due to the factors discussed above.
Liquidity and Capital Resources
Our cash requirements are primarily for working capital and capital expenditures for stores, distribution infrastructure and information systems. We also use cash to repurchase stock under our stock repurchase program and to pay dividends. Historically, we have met these cash requirements using cash flow from operations and short-term trade credit. As further noted below, due to the COVID-19 pandemic and related economic disruptions, on March 20, 2020, we drew down $43.7 million on our revolving credit facility. During the second quarter of 2020, we repaid $2.1 million of the borrowings. We expect to be able to meet future cash requirements for at least the next 12 months with cash flow from operations, short-term trade credit, existing balances of cash and cash equivalents, and borrowings under our revolving credit facility. We intend to carefully monitor and manage our cash position in light of ongoing conditions and results of operations.
Cash Flows From Operating Activities . Net cash provided by operating activities was $55.4 million in the twenty-six weeks ended August 1, 2020 compared to $20.1 million in the twenty-six weeks ended August 3, 2019. Sources of cash in the first half of 2020 included a net loss adjusted for non-cash expenses such as depreciation, non-cash operating lease costs, asset impairment, loss on disposal of property and equipment, insurance proceeds from operating activities, deferred income taxes and stock-based compensation expense, totaling $33.4 million (compared to $43.1 million in the first half of 2019). In addition, during the first half of 2020, inventory decreased $43.7 million (compared to a $7.4 million decrease in the first half of 2019).
Significant uses of cash from operating activities in the first half of 2020 were (1) a $13.2 million decrease in accrued expenses and other long-term liabilities (compared to a $22.6 million decrease in the first half of 2019) due primarily to payments of operating lease liabilities; and (2) a $2.2 million decrease in accounts payable (compared to a $2.2 million decrease in the first half of 2019) related to the inventory decrease discussed above.
Cash Flows From Investing Activities. Cash provided by investing activities was $37.4 million in the first half of 2020 compared to cash used of $3.3 million in the first half of 2019. Sales and redemptions of investment securities, net of purchases, provided cash of $43.3 million and $4.5 million in the first half of 2020 and 2019, respectively. Cash used for purchases of property and equipment totaled $5.8 million and $8.4 million in the first half of 2020 and 2019, respectively.
Cash Flows From Financing Activities. Cash provided by financing activities was $34.0 million in the first half of 2020 compared to cash used of $7.2 million in the first half of 2019. In the first half of 2020, net borrowings under the revolving credit facility provided cash of $41.6 million, while cash used for the repurchase of common stock and dividends paid to shareholders totaled $7.1 million. In the first half of 2019, cash used for the repurchase of common stock and dividends paid to shareholders totaled $6.5 million.
Cash Requirements
Our principal sources of liquidity consist of: (i) cash and cash equivalents (which equaled $146.7 million as of August 1, 2020); (ii) short-term trade credit; (iii) cash generated from operations on an ongoing basis as we sell our merchandise inventory; and (iv) a revolving credit facility with a $50.0 million credit commitment (with borrowings of $41.6 million as of August 1, 2020). Trade credit represents a significant source of financing for inventory purchases and arises from customary payment terms and trade practices with our vendors. Historically, our principal liquidity requirements have been for working capital and capital expenditure needs.
As part of the actions we have taken to increase our cash position and preserve financial flexibility in light of uncertainties resulting from the COVID-19 pandemic, as described above in “COVID-19 Pandemic,” on March 20, 2020, we borrowed $43.7 million in principal amount under our revolving credit facility. During the second quarter of 2020, we repaid $2.1 million of the borrowings. In addition, on May 12, 2020, we entered into an amendment to our revolving credit facility to, among other things, extend the maturity date to August 18, 2021. In addition to the drawdown on our credit facility, we have reduced our operating expenses, capital expenditure plans and inventory receipts, as appropriate. The Company previously announced a share repurchase program on March 13, 2020, but no repurchases have been made under such program as of the date of this filing. The Company has temporarily suspended any repurchases as of March 23, 2020 and plans to continue to monitor the situation based on business conditions and regard for its financial liquidity needs. The Company has also suspended the payment of quarterly dividends.
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Based on these actions and our current expectations regarding the impact of COVID-19, we believe that our existing sources of liquidity will be sufficient to fund our operations for at least the next 12 months. We will continue to monitor the situation and, if necessary, take further action to reduce our expenses and preserve our financial flexibility during these uncertain times.
Recent Accounting Pronouncements
See discussion of Recent Accounting Pronouncements in Note 1 to the unaudited condensed consolidated financial statements included in Part I, Item 1 of this report.
Critical Accounting Policies
The preparation of our condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
There have been no other material changes to the Critical Accounting Policies outlined in the Company’s Annual Report on Form 10-K for the year ended February 1, 2020, as amended.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
There have been no material changes in our market risk during the twenty-six weeks ended August 1, 2020 compared to the disclosures in Part II, Item 7A of our Annual Report on Form 10-K for the year ended February 1, 2020, as amended.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.