Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the section entitled “Selected Financial and Operating Data” and our audited consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements that involve risks and uncertainties. As a result of many factors, such as those set forth under the section entitled “Risk Factors” and elsewhere in this Report, our actual results may differ materially from those anticipated in these forward-looking statements.
Discussions of our results of operations for the year ended February 1, 2020 compared to the year ended February 2, 2019 that have been omitted under this item can be found in "Part II, Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Form 10-K for the year ended February 1, 2020, as amended, which was filed with the United States Securities and Exchange Commission on May 14, 2020.
Overview
We are a growing specialty value retailer of apparel, accessories and home trends primarily for African American and Latinx families. Our high-quality and trend-right merchandise offerings at everyday low prices are designed to appeal to the fashion and trend preferences of value-conscious customers. As of January 30, 2021, we operated 585 stores in urban, suburban and rural markets in 33 states.
COVID-19
In March 2020, the World Health Organization declared COVID-19 a global pandemic. As a result, we temporarily closed all of our retail store locations and distribution centers effective March 20, 2020. At the end of April 2020, we started to reopen stores in select states in accordance with government guidelines. As of July 18, 2020, we safely reopened all of our stores. The COVID-19 pandemic has resulted in a period of disruption, including the temporary closure of our stores and limited store operating hours, reduced customer traffic and consumer spending, and delays in the manufacturing and shipping of products. During this period, we continue to prioritize the health of our associates, customers and communities we serve.
The impacts of the pandemic have had, and may continue to have, an adverse impact on our financial condition, results of operations and liquidity. We took numerous actions beginning in the first quarter of fiscal 2020 in light of the uncertainties resulting from the pandemic, including: (i) the drawdown of $43.7 million in principal amount under the revolving credit facility on March 20, 2020, which we fully repaid on September 11, 2020; (ii) an amendment to the revolving credit facility to extend the term to August 2021; (iii) 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; (iv) temporary tiered salary reductions for management level corporate employees and a reduction to the cash portion of non-employee director fees; (v) extensions of payment terms with vendors and suppliers; (vi) the suspension of share repurchases; (vii) negotiations of rent concessions with landlords, some of which are ongoing; and (viii) a substantial reduction in operating expenses, store occupancy costs, capital expenditures and other costs. We expect continued uncertainty in our business and the global economy due to the duration and intensity of the COVID-19 pandemic, the duration and extent of economic stimulus, timing and effectiveness of vaccines, and volatility in employment trends and consumer confidence.
For a further discussion of trends, uncertainties and other factors that could affect our future operating results related to the effects of the COVID-19 pandemic, see “Item 1A – Risk Factors.”
Basis of Presentation
Net sales consist of store sales and layaway fees, net of returns by customers. Cost of sales consists of the cost of products we sell and associated freight costs. Depreciation is not considered a component of cost of sales and is included as a separate line item in the consolidated statements of operations. Selling, general and administrative expenses are comprised of store costs, including payroll and occupancy costs, corporate and distribution center costs and advertising costs. We operate on a 52- or 53-week fiscal year, which ends on the Saturday closest to January 31. Each of our fiscal quarters consists of four 13-week periods, with an extra week added to the fourth quarter every five to six years. The years ended January 30, 2021, February 1, 2020 and February 2, 2019 are referred to as fiscal 2020, 2019 and 2018, respectively.
Results of Operations
The following discussion of our financial performance is based on the consolidated financial statements set forth in the financial pages of this Report. The nature of our business is seasonal. Historically, sales in the first and fourth quarters of the fiscal year 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 due to changes in our business, consumer spending patterns, and the macroeconomic environment, including those resulting from the COVID-19 pandemic. Furthermore, the seasonal nature of our business may affect comparisons between periods.
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Net Sales and Additional Operating Data
The following table provides selected consolidated statement of operations data expressed both in dollars and as a percentage of net sales:
Fiscal Year
2020
2019
2018
(dollars in thousands)
Statement of Operations Data
Net sales
$
783,294
100.0
%
$
781,925
100.0
%
$
769,553
100.0
%
Cost of sales (exclusive of depreciation shown separately below)
(471,618)
(60.2)
%
(484,740)
(62.0)
%
(476,326)
(61.9)
%
Selling, general and administrative expenses
(260,198)
(33.2)
%
(259,629)
(33.2)
%
(247,938)
(32.2)
%
Depreciation
(19,259)
(2.4)
%
(18,535)
(2.3)
%
(18,886)
(2.5)
%
Asset impairment
(286)
(0.0)
%
(472)
(0.1)
%
(1,274)
(0.2)
%
Income from operations
31,933
4.1
%
18,549
2.4
%
25,129
3.3
%
Interest income
238
0.0
%
1,577
0.2
%
1,353
0.2
%
Interest expense
(776)
(0.1)
%
(158)
(0.0)
%
(154)
(0.0)
%
Income before income taxes
31,395
4.0
%
19,968
2.6
%
26,328
3.4
%
Income tax expense
(7,417)
(1.0)
%
(3,465)
(0.4)
%
(4,954)
(0.6)
%
Net income
$
23,978
3.1
%
$
16,503
2.1
%
$
21,374
2.8
%
The following table provides information about store activity and the change in comparable store sales for each fiscal year:
Fiscal Year
2020
2019
2018
Total stores open, beginning of year
571
562
549
New stores
18
16
19
Closed stores
(4)
(7)
(6)
Total stores open, end of year
585
571
562
Comparable store sales (decrease) increase (1)
(2.1)
%
(0.1)
%
1.6
% (2)
(1) Stores included in the comparable store sales calculation for any year are those stores that were opened prior to the beginning of the preceding fiscal year and were still open at the end of such year. Relocated stores and expanded stores are included in the comparable store sales results. Stores that are closed permanently or for an extended period are excluded from the comparable store sales results.
(2) The Company is reporting comparable store sales on a comparable weeks basis; for fiscal 2018, the 52 weeks ended February 2, 2019 were compared to the 52 weeks ended February 3, 2018.
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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 open 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 were not considered comparable stores in fiscal 2020. Relocated and expanded stores are included in the comparable store sales results. Stores that are closed permanently or for an extended period are excluded from 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 outdoor community 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.
Fiscal 2020 Compared to Fiscal 2019
Net Sales. Net sales increased $1.4 million, or 0.2%, to $783.3 million in fiscal 2020 from $781.9 million in fiscal 2019, despite our stores being closed for approximately 16% of the total available store days in fiscal 2020 due to the COVID-19 pandemic. Comparable store sales decreased 2.1% in fiscal 2020. The increase in net sales was due to strong performance in the second, third and fourth quarters of 2020 (beginning in the second quarter as the Company reopened its stores from temporary closures due to COVID-19). In the second quarter, comparable store sales increased 32.2% for reopened stores from their respective opening dates. In the third and fourth quarters, comparable store sales increased 6.3% and 16.7%, respectively. Also contributing to the total increase in sales was the opening of 18 new stores in 2020 and 16 new stores in 2019 for which there was not a full year of sales in 2019, partially offset by the closing of 4 stores in 2020 and 7 stores in 2019. Store opening and closing activity resulted in a net increase of $18.3 million in sales in 2020, while the 2.1% decrease in comparable store sales in the 551 comparable stores caused sales to decrease $16.0 million and layaway fee income decreased $0.9 million. Finally, despite the negative impact to sales from closures related to the pandemic, we experienced increased demand upon reopening partially due to government stimulus payments.
Cost of Sales (exclusive of depreciation). Cost of sales (exclusive of depreciation) decreased $13.1 million, or 2.7%, to $471.6 million in 2020 from $484.7 million in 2019. Cost of sales as a percentage of net sales decreased 180 basis points to 60.2% in 2020 from 62.0% in 2019 due to an increase of 140 basis points in the core merchandise margin (initial mark-up, net of markdowns), along with an improvement of 40 basis points in shrinkage.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $0.6 million, or 0.2% to $260.2 million in fiscal 2020 from $259.6 million in fiscal 2019. As a result of the temporary closure of all our stores, we took several steps to reduce selling, general and administrative expenses, including (i) temporarily furloughing substantially all store and distribution center personnel and a significant portion of the corporate staff; (ii) implementing temporary tiered salary reductions for management level corporate employees and a reduction to the cash portion of non-employee director fees; (iii) negotiating rent concessions with landlords; and (iv) executing substantial reductions in operating expenses and store occupancy costs. These reductions were offset by an increase in incentive compensation expense resulting from improved operating results in relation to budget and the opening of 18 new stores in 2020 and 16 new stores in 2019. As a percentage of net sales, selling, general and administrative expenses remained flat in 2020 relative to 2019 at 33.2%.
Depreciation. Depreciation expense increased $0.8 million to $19.3 million in 2020 from $18.5 million in 2019.
Asset Impairment. Impairment charges related to an underperforming store totaled $0.3 million in 2020, comprised of $0.1 million for leasehold improvements and fixtures and equipment, and $0.2 million for an operating lease right-of-use asset. In 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 Expense. Income tax expense increased $3.9 million to $7.4 million in 2020 from $3.5 million in 2019 due primarily to an $11.4 million increase in pretax income.
Net Income. Net income increased $7.5 million to $24.0 million in 2020 compared to $16.5 million in 2019, due to the factors discussed above.
Liquidity and Capital Resources
Our principal sources of liquidity consist of: (i) cash and cash equivalents (which equaled $123.2 million as of January 30, 2021); (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 million credit commitment (with no borrowings at the end of fiscal 2020). Trade credit represents a significant source of financing for inventory purchases and arises from customary payment terms and trade practices with our vendors.
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Cash Flows
As of January 30, 2021, we had total cash and cash equivalents of $123.2 million, compared with $19.9 million as of February 1, 2020. We had no short-term or long-term investment securities as of January 30, 2021, compared with $27.6 million and $15.7 million, respectively, as of February 1, 2020. These securities were comprised of bank certificates of deposit and obligations of the U.S. Treasury, states and municipalities.
Inventory represented 21.0% of our total assets as of January 30, 2021, compared with 30.1% as of February 1, 2020. Management’s ability to manage our inventory can have a significant impact on our cash flows from operations during a given interim period or fiscal year. In addition, inventory purchases can be seasonal in nature, such as the purchase of warm-weather or Christmas-related merchandise.
Cash Flows From Operating Activities. Net cash provided by operating activities was $110.9 million in 2020 compared with $42.6 million in 2019. Net income, 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, provided cash of $96.2 million in 2020 (compared with $84.0 million in 2019). Other significant sources of cash in 2020 included (1) a $33.6 million decrease in inventory (compared to a $1.2 million decrease in 2019) due to efforts to reduce inventory levels, improve inventory turns and maintain as much inventory liquidity as possible in order to take advantage of opportunistic deals and trend changes; (2) a $16.3 million increase in accrued compensation (compared to a $0.3 million increase in 2019) due to an increase in incentive compensation resulting from favorable operating results in relation to budget, combined with an increase in deferred payroll taxes under the Coronavirus Aid, Relief and Economic Security (“CARES”) Act; (3) a $5.8 million increase income tax payable (compared to a $1.6 million decrease in 2019) due to higher pretax income; and (4) a $5.1 million increase in accounts payable (compared to a $5.6 million increase in 2019) due to improved inventory turns and a high volume of merchandise receipts during the final two months of the year, with nearly all of such purchases still in accounts payable at the end of the year.
Significant uses of cash from operating activities in 2020 included (1) a $38.4 million decrease in accrued expenses and other long-term liabilities (compared to a $45.3 million decrease in 2019) due primarily to payments of operating lease liabilities; and (2) a $7.7 million increase in prepaid and other current assets (compared to a $1.6 million increase in 2019) due primarily to an employee retention credit receivable under the CARES Act, combined with increases in receivables for tenant improvement allowances and charge card receivables.
Cash Flows From Investing Activities. Cash provided by investing activities was $26.7 million in 2020 compared with cash used of $7.6 million in 2019. Sales and redemptions of investment securities, net of purchases, provided cash of $43.3 million in 2020 (compared with $16.0 million in 2019) due to converting our investments to cash as a result of the COVID-19 pandemic. Cash used for the purchase of property and equipment was $17.0 million in 2020 (compared with $24.2 million in 2019) due to reducing our capital expenditure plans as a result of the COVID-19 pandemic.
Cash Flows From Financing Activities. Cash used in financing activities was $34.3 million in 2020 compared with $32.9 million in 2019. Cash used for the repurchase of common stock totaled $32.9 million in 2020 and $28.4 million in 2019. Dividends paid to stockholders used cash of $0.8 million in 2020 and $3.8 million in 2019.
Until required for other purposes, we maintain cash and cash equivalents in deposit or money market accounts.
Cash Requirements and Commitments
Our cash requirements are primarily for working capital and for capital expenditures for our stores, distribution infrastructure and information systems. We also use cash to repurchase stock under our stock repurchase program. Historically, we have met these cash requirements using cash flow from operations and short-term trade credit.
As a result of the temporary closure of our stores due the COVID-19 pandemic, on March 20, 2020, we borrowed $43.7 million in principal amount under our revolving credit facility. On September 11, 2020, we repaid the full amount outstanding under the credit facility.
In addition, we reduced our operating expenses, capital expenditure plans and inventory receipts, as appropriate.
The Company announced a share repurchase program on March 13, 2020. On March 23, 2020, due to the economic uncertainty stemming from the COVID-19 pandemic, we suspended any repurchases and dividend payments. On September 14, 2020, we announced the reinstatement of the share repurchase program. During fiscal 2020, we repurchased shares of our common stock at an aggregate cost of $32.9 million, funded from cash on hand. We have continued repurchases in fiscal 2021, including a block repurchase of 250,000 shares on March 23, 2021 for an aggregate purchase price of $21.9 million.
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We believe that our existing sources of liquidity will be sufficient to fund our operations for at least the next 12 months as well as the foreseeable future. However, any significant reduction in customer willingness to visit shopping centers or levels of customer spending at our stores, or any future temporary closures of our stores or distribution centers, or any disruptions in the supply chains related to our merchandise could require us to take actions that could include material changes in our operations and seeking additional debt or equity capital. We will continue to monitor the situation and take action as necessary to reduce our expenses and preserve our financial flexibility.
The following table discloses aggregate information about our contractual obligations as of January 30, 2021 and the periods in which payments are due:
Payments Due by Period
Less than
1-3
3-5
More than
Total
1 Year
Years
Years
5 Years
(in thousands)
Contractual obligations:
Operating leases (1)
$
209,688
$
51,435
$
83,251
$
48,285
$
26,717
Purchase obligations
144,834
144,834
—
—
—
Total contractual cash obligations
$
354,522
$
196,269
$
83,251
$
48,285
$
26,717
(1) Represents fixed minimum rents in stores and does not include incremental rents which are computed as a percentage of net sales. For example, in fiscal 2020 incremental percentage rent was approximately $0.5 million, which represented 0.9% of total rent expense.
Indebtedness. On October 27, 2011, we entered into a five-year, $50 million credit facility with Bank of America. The facility was amended on August 18, 2015, extending the maturity date to August 18, 2020. On March 20, 2020, in response to the COVID-19 pandemic, we borrowed $43.7 million on our revolving credit facility to enhance our liquidity position. On September 11, 2020, we repaid the full amount outstanding under the credit facility. Such borrowings accrued interest ranging from 1.625% to 3.5%.
On May 12, 2020, the Company entered into a Second Amendment to Credit Agreement and Waiver (the “Second Amendment”) with Bank of America and the Company’s wholly-owned subsidiary, Citi Trends Marketing Solutions, Inc., as guarantor (the “Second Amendment”) to amend the credit facility (as amended, the “Revolving Credit Facility”) as described below.
The Revolving Credit Facility provides a $50 million credit commitment and a $25 million uncommitted “accordion” feature that under certain circumstances could allow us to increase the size of the facility to $75 million. The Revolving Credit Facility is secured by our inventory, accounts receivable and related assets, but not our real estate, fixtures and equipment, and it contains one financial covenant, a fixed charge coverage ratio, which is applicable and tested only in certain circumstances. The facility has an unused commitment fee of 0.25% and permits the payment of cash dividends subject to certain limitations, including a requirement that there were no borrowings outstanding in the 30 days prior to the dividend payment and no borrowings are expected in the 30 days subsequent to the payment.
The Second Amendment amends the Revolving Credit Facility to, among other things, extend the maturity date (which had been set to expire August 18, 2020) to August 18, 2021, increase the pricing for the loans and modify certain covenant and reporting terms. Following the effective date of the Second Amendment, borrowings under the Revolving Credit Facility will bear interest (a) for Eurodollar Loans, at a rate equal to LIBOR plus either 2.25% or 2.5%, or (b) for Base Rate Loans, at a rate equal to the highest of (i) the prime rate, (ii) the Federal Funds Rate plus 0.5%, or (iii) LIBOR for a period of one month plus 1.0%, plus, in each case either 1.25% or 1.5%, based in any such case on the average daily availability for borrowings under the facility.
Operating Leases. We lease our stores under operating leases, which generally have an initial term of five years with renewal options. The typical store lease requires a combination of both fixed monthly rents and contingent rents computed as a percentage of net sales after a certain sales threshold has been met. Rent expense was $60.1 million in 2020 compared with $58.1 million in 2019 (including contingent rent of $0.5 million and $0.3 million in 2020 and 2019, respectively).
Purchase Obligations. As of January 30, 2021, we had purchase obligations of $145.0 million, all of which were for less than one year. These purchase obligations consist of outstanding merchandise orders.
Critical Accounting Policies and Estimates
The preparation of our 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We believe the following critical accounting policies describe the more significant judgments and estimates used in the preparation of our consolidated financial statements.
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Inventory
Inventory is stated at the lower of cost (first-in, first-out basis) or net realizable value as determined by the retail inventory method for store inventory and the average cost method for distribution center inventory. Under the retail inventory method, the cost of inventory is determined by calculating a cost-to-retail ratio and applying it to the retail value of inventory. Inherent in the retail inventory calculation are certain management judgments and estimates, including, among others, merchandise markups, markdowns and shrinkage, which impact the ending inventory valuation at cost as well as resulting cost of sales. Merchandise markdowns are reflected in the inventory valuation when the price of an item is lowered in the stores. As a result, we believe the retail inventory method results in a more conservative inventory valuation than other accounting methods. We estimate and record an allowance for shrinkage for the period between the last physical count and the balance sheet date. The estimate of shrinkage can be affected by changes in actual shrinkage trends. Inventory shrinkage as a percentage of sales was 0.8% in 2020, compared to 1.2% in 2019 and 1.3% in 2018. The allowance for estimated inventory shrinkage was $5.2 million as of January 30, 2021 and $3.0 million as of February 1, 2020. Many retailers have arrangements with vendors that provide for rebates and allowances under certain conditions, which ultimately affect the value of the inventory. We do not generally enter into such arrangements with our vendors. There were no material changes in the estimates or assumptions related to the valuation of inventory during fiscal 2020.
Insurance Liabilities
We are largely self-insured for workers’ compensation costs, general liability claims and employee medical claims. Our self-insurance liabilities are based on the total estimated costs of claims filed and estimates of claims incurred but not reported, less amounts paid against such claims. We use current and historical claims data, together with information from actuarial studies, in developing our estimates. The insurance liabilities we record are primarily influenced by the frequency and severity of claims and the Company’s growth. If the underlying facts and circumstances related to the claims change, then we may be required to record more or less expense which could be material in relation to our results of operations. Our self-insurance liabilities totaled $2.9 million ($1.5 million current and $1.4 million noncurrent) as of January 30, 2021 and $2.6 million ($1.5 million current and $1.1 million noncurrent) as of February 1, 2020. There were no material changes in the estimates or assumptions related to insurance liabilities during fiscal 2020.
Operating Leases
We lease all of our retail store locations and certain office space and equipment. All leases are classified as operating leases. We record right-of-use assets and lease liabilities based on the present value of future minimum lease payments over the lease term. In determining the present value of lease payments, we use an incremental borrowing rate that approximates the rate of interest the Company would have to pay to borrow on a collateralized basis over a similar term. Our lessors do not provide an implicit rate, nor is one readily available, therefore we determine an incremental borrowing rate based on a buildup approach which utilizes rates and terms from the Company’s existing borrowing facility with adjustments to bridge for impacts to the rate due to differences in collateral, terms and payments. We record operating lease cost over the estimated term of the lease, which includes options to extend lease terms that are reasonably certain of being exercised, starting when possession of the property is taken from the landlord. Lease expense for fixed lease payments is recognized on a straight-line basis over the lease term. In addition, certain leases provide for contingent rents that are not measurable at inception. These contingent rents are primarily based on a percentage of net sales that are in excess of a predetermined level. These amounts are excluded from minimum rent and are included in the determination of total rent expense when it is probable that the expense has been incurred and the amount can be reasonably estimated. If an operating lease asset is impaired, the remaining operating lease asset will be amortized on a straight-line basis over the remaining lease term.
The above listing is not intended to be a comprehensive list of all our accounting policies. In many cases the accounting treatment of a particular transaction is specifically dictated by U.S. GAAP, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result.
Recent Accounting Pronouncements
See Note 2 to our consolidated financial statements included in this Report.
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