Citi Trends Inc 10-Q

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: uncertainties relating to general economic conditions, including inflation, energy and fuel costs, unemployment levels, and any deterioration whether caused by acts of war, terrorism, political or social unrest (including any resulting store closures, damage or loss of inventory) or other factors; changes in market interest rates and market levels of wages; natural disasters such as hurricanes; uncertainty and economic impact of pandemics, epidemics or other public health emergencies such as the ongoing COVID-19 pandemic; transportation and distribution delays or interruptions; changes in freight rates; the Company’s ability to attract and retain workers; 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 confidence and consumer spending patterns; competition within the industry; competition in our markets; the duration and extent of any economic stimulus programs; changes in product mix; interruptions in suppliers’ businesses; the ongoing assessment and impact of the January 2023 cyber disruption we identified on January 14, 2023, including legal, reputational, financial and contractual risks resulting from the January 2023 disruption, and other risks related to cybersecurity, data privacy and intellectual property; 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, remodeling 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 January 28, 2023, 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. 11 Table of Contents 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. Executive Overview We are a leading specialty value retailer of apparel, accessories and home trends for way less spend primarily for African American and multicultural 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 October 28, 2023, we operated 606 stores in urban, suburban and rural markets in 33 states. Uncertainties and Challenges General Economic Conditions We expect that our operations in the short-term will continue to be influenced by general economic conditions, including the recent inflationary pressures, which are particularly impactful to the communities we serve. Given the macro-economic environment, we expect low-income families to remain under pressure through the remainder of fiscal 2023. In addition, we continue to monitor the impacts on our business of unemployment levels, wage inflation, interest rates, inflation rates, housing costs, energy costs, consumer confidence, consumer perception of economic conditions, costs to source our merchandise and supply chain disruptions. Seasonality and Weather Patterns The nature of our 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. In addition, sales of clothing are directly impacted by the timing of the seasons to which the clothing relates. While we have expanded our product offerings to become a one-stop-shop, traffic to our stores is still influenced by weather patterns to some extent. Cyber Disruption In January 2023, we experienced a disruption of our back office and distribution center IT systems, which was due to what is known as Hive ransomware (the “January 2023 cyber disruption”). In connection with this incident, we engaged third party consultants and forensic experts to assist with the restoration and remediation of the Company’s systems and, with the assistance of law enforcement, to investigate the incident. We do not retain sensitive customer data on our systems. The impact of the January 2023 cyber disruption is not expected to be material to our full year fiscal 2023 financial results. In the third quarter of fiscal 2023, we received insurance proceeds (reflected on our Statement of Cash Flows) related to the January 2023 cyber disruption. This resulted in a gain of $1.2 million that is recorded in Selling, general and administrative expenses on our Statement of Operations . In the first thirty-nine weeks of fiscal 2023, we recognized $1.7 million of costs related to the cyber disruption in Selling, general and administrative expenses on our Statement of Operations. We expect to incur ongoing costs to enhance data security and take further steps to prevent unauthorized access to, or manipulation of, our systems and data. Several putative class action lawsuits have been filed against the Company and several inquiries have been made to the Company with respect to the January 2023 cyber disruption. At October 28, 2023, we had an accrual of $0.8 million for estimated losses in connection with these matters recorded in Accrued expenses on our Balance Sheet. See Note 7 to the Financial Statements for more information. 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. The following discussion contains references to fiscal years 2023 and 2022, which represent fiscal years ending or ended on February 3, 2024 and January 28, 2023, respectively. Fiscal 2023 has a 53-week accounting period and fiscal 2022 had a 52-week accounting period. 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. 12 Table of Contents Results of Operations The following discussion of the Company’s financial performance is based on the unaudited condensed consolidated financial statements set forth herein. 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 the seasonality of our business and the current economic uncertainty. 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 13 th month of operation at the earliest or until its 24 th month at the latest. As an example, stores opened in fiscal 2022 and fiscal 2023 are not considered comparable stores in fiscal 2023. 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 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. Thirteen Weeks Ended October 28, 2023 and October 29, 2022 Net Sales. Net sales decreased $12.8 million, or 6.7%, to $179.5 million in the third quarter of 2023 from $192.3 million in the third quarter of 2022. The decrease in sales was due to a 6.2% decrease in comparable store sales and a decrease of $1.3 million from net store opening and closing activity. The decrease in comparable store sales was the result of continued inflationary pressures in the third quarter of 2023 that are particularly impactful to our core customers. Cost of Sales (exclusive of depreciation). Cost of sales (exclusive of depreciation) decreased $4.8 million, or 4.1%, to $110.9 million in the third quarter of 2023 from $115.7 million in the third quarter of 2022. Cost of sales as a percentage of sales increased to 61.8% from 60.2%. The increase was driven primarily by higher freight costs due to rebuilding inventory in certain categories, as well as an increase in shrinkage costs. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $0.6 million, or 0.8%, to $69.7 million in the third quarter of 2023 from $69.1 million in the third quarter of 2022. The increase was primarily due to: (1) higher incentive compensation this year due to the reversal last year of certain performance-based awards that were deemed improbable of vesting; and (2) higher occupancy expenses, including higher rent expense related to the sale-leasebacks of our distribution centers. These increases were partially offset by a $1.2 million gain on insurance this year and lower insurance costs resulting from lower claims for medical and workers’ compensation. As a percentage of sales, Selling, general and administrative expenses increased to 38.8% in the third quarter of 2023 from 35.9% in the third quarter of 2022, due to the deleveraging effect of lower sales. Depreciation. Depreciation expense decreased $0.4 million, or 6.4%, to $4.7 million in the third quarter of 2023 from $5.1 million in the third quarter of 2022. Gain on sale-leaseback. In the third quarter of 2022, we completed a sale-leaseback transaction for our distribution center in Roland, Oklahoma that resulted in a $29.2 million gain. Income Tax Benefit. Income tax benefit was $1.3 million in the third quarter of 2023 compared to income tax expense of $7.1 million in the third quarter of 2022. The difference is attributable to a pretax loss in the third quarter of this year compared to pretax income in the third quarter of last year that included the gain on sale-leaseback. For the third quarter of 2023, we used the discrete effective tax rate method to determine income tax expense based upon interim period results. Net Loss. Net loss was $3.9 million in the third quarter of 2023 compared to net income of $24.6 million in the third quarter of 2022 due to the factors discussed above. 13 Table of Contents Thirty-Nine Weeks Ended October 28, 2023 and October 29, 2022 Net Sales. Net sales decreased $52.8 million, or 9.0%, to $532.8 million in the first thirty-nine weeks of 2023 from $585.6 million in the same period of 2022. The decrease in sales was due to an 8.7% decrease in comparable store sales and a $3.2 million decrease from net store opening and closing activity. The decrease in comparable store sales was the result of continued inflationary pressures in the first thirty-nine weeks of 2023 that are particularly impactful to our core customers. Cost of Sales (exclusive of depreciation). Cost of sales (exclusive of depreciation) decreased $25.5 million, or 7.1%, to $331.8 million in the first thirty-nine weeks of 2023 from $357.3 million in the same period of 2022. Cost of sales as a percentage of sales increased to 62.3% in the first thirty-nine weeks of 2023 from 61.0% in the same period of 2022. The increase was driven primarily by higher freight costs due to rebuilding inventory in certain categories, as well as an increase in shrinkage costs. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $1.4 million, or 0.7%, to $210.0 million in the first thirty-nine weeks of 2023 from $208.6 million in the same period of 2022. The increase was primarily due to (1) higher rent expense this year related to the sale-leasebacks of our distribution centers; (2) higher incentive compensation this year due to zero bonus incentive accrued last year and the reversal last year of certain performance-based awards that were deemed improbable of vesting; and (3) an increase in other occupancy costs. These increases were partially offset by lower insurance costs resulting from lower claims for medical and workers’ compensation, lower professional fees and lower payroll expenses. As a percentage of sales, Selling, general and administrative expenses increased to 39.4% in the first thirty-nine weeks of 2023 from 35.6% in the first thirty-nine weeks of 2022, due to the deleveraging effect of lower sales. Depreciation. Depreciation expense decreased $1.7 million, or 10.5%, to $14.1 million in the first thirty-nine weeks of 2023 from $15.8 million in the same period last year. Gain on sale-leaseback. In the first quarter of 2022, we completed a sale-leaseback transaction for our distribution center in Darlington, South Carolina that resulted in a $34.9 million gain. In the third quarter of 2022, we completed a sale-leaseback transaction for our distribution center in Roland, Oklahoma that resulted in a $29.2 million gain. Income Tax Benefit (Expense). Income tax benefit was $5.3 million in the first thirty-nine weeks of 2023 compared to income tax expense of $15.6 million in the first thirty-nine weeks of 2022. The difference is attributable to a pretax loss this year compared to pretax income last year that included the gain on sale-leasebacks. For the first thirty-nine weeks of 2023, we used the discrete effective tax rate method to determine income tax expense based upon interim period results. Net (Loss) Income. Net loss was $15.5 million in the first thirty-nine weeks of 2023 compared to net income of $52.3 million in the same period of 2022 due to the factors discussed above. Liquidity and Capital Resources Capital Allocation Our capital allocation strategy is to maintain adequate liquidity to prioritize investments in opportunities to profitably grow our business and maintain current operations, then to return excess cash to shareholders through our repurchase programs. Our quarter-end cash and cash equivalents balance was $59.7 million compared to cash and cash equivalents of $77.8 million at the end of the third quarter last year. Until required for other purposes, we maintain cash and cash equivalents in deposit or money market accounts. Our principal sources of liquidity consist of: (i) cash and cash equivalents on hand; (ii) short-term trade credit arising from customary payment terms and trade practices with our vendors; (iii) cash generated from operations on an ongoing basis; and (iv) a revolving credit facility with a $75 million credit commitment. Inventory Our quarter-end inventory balance was $129.7 million, compared with $128.5 million at the end of the third quarter last year. The increase was primarily due to a strategic increase in our average in-store inventory, partially offset by a planned reduction in our packaway inventory. Capital Expenditures Capital expenditures in the first thirty-nine weeks of 2023 were $11.6 million, a decrease of $7.6 million over the first thirty-nine weeks of 2022, as we pared back our investments in new stores and remodels. We anticipate capital expenditures in fiscal 2023 in the range of $17 to $20 million, primarily for opening new stores and remodeling existing stores, combined with ongoing investments in our systems. 14 Table of Contents Share Repurchases We did not repurchase any shares of our common stock in the first thirty-nine weeks of 2023. During the first thirty-nine weeks of 2022, we returned $10.0 million to shareholders through share repurchases. See Part II of this Report and Note 8 to the Financial Statements for more information. Revolving Credit Facility We have a revolving credit facility that matures in April 2026 and provides a $75 million credit commitment and a $25 million uncommitted “accordion” feature. Additional details of the credit facility are in Note 4 to the Financial Statements . At the end of the third quarter of 2023, we had no borrowings under the credit facility and $0.6 million in letters of credit outstanding. Cash Flows Cash Flows From Operating Activities . Net cash used in operating activities was $32.9 million in the first thirty-nine weeks of 2023 compared to $23.1 million in the same period of 2022. Sources of cash this year included net loss adjusted for non-cash expenses totaling $36.0 million (compared to net income adjusted for non-cash items of $48.5 million in the first thirty-nine weeks of 2022). Significant uses of cash from operating activities in the first thirty-nine weeks of 2023 included (1) a $45.5 million decrease in accrued expenses and other long-term liabilities (compared to a $44.6 million decrease in the first thirty-nine weeks of 2022) due primarily to payments of operating lease liabilities; and (2) a $23.9 million increase in inventory (compared to a $5.9 million increase in the same period last year). Cash Flows From Investing Activities. Cash used in investing activities was $10.1 million in the first thirty-nine weeks of 2023 compared to cash provided of $63.3 million in the same period last year. Cash used in the first thirty-nine weeks of 2023 consisted of purchases of property and equipment of $11.6 million and insurance proceeds of $1.5 million. Cash provided by investing activities in the first thirty-nine weeks of 2022 consisted of $81.1 million net proceeds from the sale-leaseback transaction and insurance proceeds of $1.4 million, partially offset by $19.2 million for purchases of property and equipment. Cash Flows From Financing Activities. Cash used in financing activities was $0.9 million in the first thirty-nine weeks of 2023 compared to $12.2 million in the same period last year. Cash used in the first thirty-nine weeks of 2023 consisted of payments to settle withholding taxes on restricted stock that vested. Cash used in the first thirty-nine weeks of 2022 consisted of $10.0 million of repurchases of our common stock and payments of $2.2 million to settle withholding taxes on restricted stock that vested . Cash Requirements and Commitments Our principal cash requirements consist of (1) inventory purchases; (2) capital expenditures to invest in our infrastructure; and (3) operational needs, including salaries, occupancy costs, taxes and other operating costs. We may also use cash to fund any share repurchases, make any required debt payments and satisfy other contractual obligations. Historically, we have met these cash requirements using cash flow from operations and short-term trade credit. As of October 28, 2023, our contractual commitments for operating leases totaled $243.4 million (with $46.5 million due within 12 months). See Note 10 to the Financial Statements for more information regarding lease commitments. 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 material changes to the Critical Accounting Policies outlined in our Annual Report on Form 10-K for the fiscal year ended January 28, 2023. Item 3. Quantitative and Qualitative Disclosures About Market Risk. There have been no material changes in our market risk during the thirty-nine weeks ended October 28, 2023 compared to the disclosures in Part II, Item 7A of our Annual Report on Form 10-K for the fiscal year ended January 28, 2023 . 15 Table of Contents