Tableof Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form 10-Q**

 
| **(Mark  One)**                                        |
|--------------------------------------------------------|
| **x**                                                  | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES**

**EXCHANGE ACT OF 1934** |
|                                                   |   |
| **For the quarterly period ended August 2, 2008** |
|                                                   |
| **OR**                                                 |
|                                                   |   |
| **o**                                                  | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES**

**EXCHANGE ACT OF 1934** |

 

**Commission File Number  000-51315**

 

**CITITRENDS, INC.**

(Exactname of registrant as specified in its charter)

 

| **DELAWARE**                              | ** ** | **52-2150697**       |
|-------------------------------------------|------------|----------------------|
| (State  or other jurisdiction of          |       | (I.R.S.  Employer    |
| incorporation  or organization)           |       | Identification  No.) |
|                                      |       |                 |
| **104 Coleman Boulevard**                 |       |                 |
| **Savannah, Georgia**                     | ** ** | **31408**            |
| (Address  of principal executive offices) |       | (Zip  Code)          |

 

Registrant’stelephone number, including area code (**912)236-1561**

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes   x    No   o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definitions of“large accelerated filer,” “accelerated filer” and “smaller reporting company”in Rule 12b-2 of the Exchange Act.

 
| Large Accelerated Filer o                                              |   | Accelerated Filer x         |
|------------------------------------------------------------------------|--------|-----------------------------|
|                                                                   |   |                        |
| Non-Accelerated Filer o (Do not check if a smaller reporting  company) |   | Smaller Reporting Company o |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes   o    No   x

 

Indicate the number ofshares outstanding of each of the registrant’s classes of common stock, as ofthe latest practicable date.

 
| **Class**                     | ** ** | **Outstanding at August 15, 2008** |
|-------------------------------|------------|-----------------------------------------|
| Common  Stock, $.01 par value |       | 14,309,870  shares                      |

 

 

 

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**CITI TRENDS, INC.**

**FORM 10-Q**

**TABLE OF CONTENTS**

 
| ** **   | ** **                                                                                                          | **PAGE  NUMBER** |
|--------------|---------------------------------------------------------------------------------------------------------------------|------------------|
| PART I  | FINANCIAL INFORMATION                                                                                               |             |   |
|         |                                                                                                                |             |   |
| Item 1       | Financial Statements                                                                                                |             |   |
|         |                                                                                                                |             |   |
|         | Condensed  Balance Sheets (unaudited) August 2, 2008 and February 2, 2008                                 | 3                |   |
|         |                                                                                                                |             |   |
|         | Condensed  Statements of Income (unaudited) Twenty-six weeks ended August 2, 2008  and August 4, 2007     | 4                |   |
|         |                                                                                                                |             |   |
|         | Condensed  Statements of Income (unaudited) Thirteen weeks ended August 2, 2008 and  August 4, 2007       | 4                |   |
|         |                                                                                                                |             |   |
|         | Condensed  Statements of Cash Flows (unaudited) Twenty-six weeks ended August 2,  2008 and August 4, 2007 | 5                |   |
|         |                                                                                                                |             |   |
|         | Notes  to the Condensed Financial Statements (unaudited)                                                            | 6                |   |
|         |                                                                                                                |             |   |
| Item 2       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         | 9                |   |
|         |                                                                                                                |             |   |
| Item 3       | Quantitative  and Qualitative Disclosures About Market Risk                                                         | 13               |   |
|         |                                                                                                                |             |   |
| Item 4       | Controls and  Procedures                                                                                            | 13               |   |
|         |                                                                                                                |             |   |
| PART II | OTHER INFORMATION                                                                                                   |             |   |
|         |                                                                                                                |             |   |
| Item 1       | Legal Proceedings                                                                                                   | 14               |   |
|         |                                                                                                                |             |   |
| Item 1A      | Risk Factors                                                                                                        | 14               |   |
|         |                                                                                                                |             |   |
| Item 2       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                        | 14               |   |
|         |                                                                                                                |             |   |
| Item 3       | Defaults Upon  Senior Securities                                                                                    | 14               |   |
|         |                                                                                                                |             |   |
| Item 4       | Submission of  Matters to a Vote of Security Holders                                                                | 14               |   |
|         |                                                                                                                |             |   |
| Item 5       | Other Information                                                                                                   | 14               |   |
|         |                                                                                                                |             |   |
| Item 6       | Exhibits                                                                                                            | 15               |   |
|         |                                                                                                                |             |   |
|         | SIGNATURES                                                                                                          | 16               |   |

 

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**Item 1.Financial Statements.**

 

**Citi Trends, Inc.**

 

**Condensed Balance Sheets**

**August 2, 2008 and February 2, 2008**

**(Unaudited)**

 

**(in thousands, except share data)**

 
| ** **                                                                                                                                                                                                                                                                                             | ** ** | **August 2,  2008** | ** ** | **February 2,  2008** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| **Assets**                                                                                                                                                                                                                                                                                             |       |                     |       |                       |       |
| Current assets:                                                                                                                                                                                                                                                                                        |       |                     |       |                       |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                              |       | $                        | 7,191      |                       | $          | 6,203 |   |
| Investment securities                                                                                                                                                                                                                                                                                  |       | —                   |       | 56,165                     |       |
| Inventory                                                                                                                                                                                                                                                                                              |       | 85,330                   |       | 82,420                     |       |
| Prepaid and other current assets                                                                                                                                                                                                                                                                       |       | 8,058                    |       | 5,888                      |       |
| Deferred tax asset                                                                                                                                                                                                                                                                                     |       | 3,316                    |       | 2,838                      |       |
| Total current assets                                                                                                                                                                                                                                                                                   |       | 103,895                  |       | 153,514                    |       |
| Property and equipment, net                                                                                                                                                                                                                                                                            |       | 57,165                   |       | 52,207                     |       |
| Investment securities                                                                                                                                                                                                                                                                                  |       | 50,936                   |       | —                     |       |
| Goodwill                                                                                                                                                                                                                                                                                               |       | 1,371                    |       | 1,371                      |       |
| Deferred tax asset                                                                                                                                                                                                                                                                                     |       | 4,939                    |       | 2,756                      |       |
| Other assets                                                                                                                                                                                                                                                                                           |       | 369                      |       | 329                        |       |
| Total assets                                                                                                                                                                                                                                                                                           |       | $                        | 218,675    |                       | $          | 210,177 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                                                                                                         |       |                     |       |                       |       |
| Current liabilities:                                                                                                                                                                                                                                                                                   |       |                     |       |                       |       |
| Accounts payable                                                                                                                                                                                                                                                                                       |       | $                        | 43,521     |                       | $          | 43,566 |   |
| Accrued expenses                                                                                                                                                                                                                                                                                       |       | 10,690                   |       | 11,864                     |       |
| Accrued compensation                                                                                                                                                                                                                                                                                   |       | 6,771                    |       | 5,225                      |       |
| Current portion of capital lease  obligations                                                                                                                                                                                                                                                          |       | 1,636                    |       | 1,580                      |       |
| Income tax payable                                                                                                                                                                                                                                                                                     |       | 790                      |       | 1,155                      |       |
| Layaway deposits                                                                                                                                                                                                                                                                                       |       | 1,617                    |       | 635                        |       |
| Total current liabilities                                                                                                                                                                                                                                                                              |       | 65,025                   |       | 64,025                     |       |
| Capital lease obligations, less current  portion                                                                                                                                                                                                                                                       |       | 562                      |       | 1,403                      |       |
| Other long-term liabilities                                                                                                                                                                                                                                                                            |       | 6,921                    |       | 6,602                      |       |
| Total liabilities                                                                                                                                                                                                                                                                                      |       | 72,508                   |       | 72,030                     |       |
| Stockholders’ equity:                                                                                                                                                                                                                                                                             |       |                     |       |                       |       |
| Common stock, $0.01 par value. Authorized  32,000,000 shares; 14,475,581 shares issued as of August 2, 2008  and 14,265,471 shares issued as of February 2, 2008; 14,309,831 shares  outstanding as of August 2, 2008 and 14,099,721 outstanding as of  February 2, 2008 |       | 143                      |       | 142                        |       |
| Paid-in-capital                                                                                                                                                                                                                                                                                        |       | 69,976                   |       | 68,276                     |       |
| Retained earnings                                                                                                                                                                                                                                                                                      |       | 77,908                   |       | 69,894                     |       |
| Accumulated other comprehensive loss                                                                                                                                                                                                                                                                   |       | (1,695                   | )          | —                     |       |
| Treasury stock, at cost; 165,750 shares as  of August 2, 2008 and February 2, 2008                                                                                                                                                                                                           |       | (165                     | )          | (165                       | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                                                        |       | 146,167                  |       | 138,147                    |       |
| Commitments and contingencies (note 7)                                                                                                                                                                                                                                                                 |       |                     |       |                       |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                                                        |       | $                        | 218,675    |                       | $          | 210,177 |   |

 

See accompanying notes tothe condensed financial statements (unaudited).

 

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**Citi Trends, Inc.**

 

**Condensed Statements of Income**

**Twenty-six Weeks Ended August 2, 2008 and August 4,2007**

**(Unaudited)**

**(in thousands, except per share data)**

 
| ** **                                     | ** ** | **August 2,  2008** | ** ** | **August 4,  2007** | ** ** |
|------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| Net sales                                      |       | $                        | 236,651    |                     | $          | 203,402 |   |
| Cost of sales                                  |       | 144,964                  |       | 126,612                  |       |
| Gross profit                                   |       | 91,687                   |       | 76,790                   |       |
| Selling, general and administrative  expenses  |       | 73,118                   |       | 62,123                   |       |
| Depreciation and amortization                  |       | 7,781                    |       | 5,830                    |       |
| Income from operations                         |       | 10,788                   |       | 8,837                    |       |
| Interest income                                |       | 1,425                    |       | 1,181                    |       |
| Interest expense                               |       | (162                     | )          | (265                     | )          |
| Income before income tax expense               |       | 12,051                   |       | 9,753                    |       |
| Income tax expense                             |       | 4,037                    |       | 3,404                    |       |
| Net income                                     |       | $                        | 8,014      |                     | $          | 6,349 |   |
| Basic net income per common share              |       | $                        | 0.57       |                     | $          | 0.46 |   |
| Diluted net income per common share            |       | $                        | 0.56       |                     | $          | 0.45 |   |
| Weighted average number of shares  outstanding |       |                     |       |                     |       |
| Basic                                          |       | 14,071                   |       | 13,865                   |       |
| Diluted                                        |       | 14,248                   |       | 14,234                   |       |

 

See accompanying notes tothe condensed financial statements (unaudited).

 

**Citi Trends, Inc.**

 

**Condensed Statements of Income**

**Thirteen Weeks Ended August 2, 2008 and August 4,2007**

**(Unaudited)**

**(in thousands, except per share data)**

 
| ** **                                     | ** ** | **August 2,  2008** | ** ** | **August 4,  2007** | ** ** |
|------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| Net sales                                      |       | $                        | 115,655    |                     | $          | 96,826 |   |
| Cost of sales                                  |       | 70,731                   |       | 61,734                   |       |
| Gross profit                                   |       | 44,924                   |       | 35,092                   |       |
| Selling, general and administrative  expenses  |       | 36,877                   |       | 31,548                   |       |
| Depreciation and amortization                  |       | 4,078                    |       | 3,009                    |       |
| Income from operations                         |       | 3,969                    |       | 535                      |       |
| Interest income                                |       | 557                      |       | 536                      |       |
| Interest expense                               |       | (75                      | )          | (121                     | )          |
| Income before income tax expense               |       | 4,451                    |       | 950                      |       |
| Income tax expense                             |       | 1,605                    |       | 323                      |       |
| Net income                                     |       | $                        | 2,846      |                     | $          | 627 |   |
| Basic net income per common share              |       | $                        | 0.20       |                     | $          | 0.05 |   |
| Diluted net income per common share            |       | $                        | 0.20       |                     | $          | 0.04 |   |
| Weighted average number of shares  outstanding |       |                     |       |                     |       |
| Basic                                          |       | 14,095                   |       | 13,922                   |       |
| Diluted                                        |       | 14,279                   |       | 14,249                   |       |

 

See accompanying notes tothe condensed financial statements (unaudited).

 

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**Citi Trends, Inc.**

 

**Condensed Statements of Cash Flows**

**Twenty-six Weeks Ended August 2, 2008 and August 4,2007**

**(Unaudited)**

 

**(in thousands)**

 
| ** **                                                                                   | ** ** | **August 2,  2008** | ** ** | **August 4,  2007** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| Operating activities:                                                                        |       |                     |       |                     |       |
| Net income                                                                                   |       | $                        | 8,014      |                     | $          | 6,349 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |       |                     |       |                     |       |
| Depreciation and amortization                                                                |       | 7,781                    |       | 5,830                    |       |
| Loss on disposal of property and equipment                                                   |       | 8                        |       | 7                        |       |
| Deferred income taxes                                                                        |       | (1,568                   | )          | (1,814                   | )          |
| Noncash stock-based compensation expense                                                     |       | 973                      |       | 709                      |       |
| Excess tax benefits from stock-based  payment arrangements                                   |       | (465                     | )          | (3,059                   | )          |
| Changes in assets and liabilities:                                                           |       |                     |       |                     |       |
| Inventory                                                                                    |       | (2,910                   | )          | (20,549                  | )          |
| Prepaid and other current assets                                                             |       | (1,504                   | )          | (873                     | )          |
| Other assets                                                                                 |       | (40                      | )          | (14                      | )          |
| Accounts payable                                                                             |       | (45                      | )          | (1,475                   | )          |
| Accrued expenses and other long-term  liabilities                                            |       | (855                     | )          | 983                      |       |
| Accrued compensation                                                                         |       | 1,546                    |       | (926                     | )          |
| Income tax payable                                                                           |       | 100                      |       | 1,212                    |       |
| Layaway deposits                                                                             |       | 982                      |       | 843                      |       |
| Net cash provided by (used in) operating  activities                                         |       | 12,017                   |       | (12,777                  | )          |
| Investing activities:                                                                        |       |                     |       |                     |       |
| Purchases of investment securities                                                           |       | (4,000                   | )          | (4,629                   | )          |
| Sales of investment securities                                                               |       | 5,775                    |       | 24,149                   |       |
| Purchases of property and equipment                                                          |       | (12,747                  | )          | (11,238                  | )          |
| Net cash (used in) provided by investing  activities                                         |       | (10,972                  | )          | 8,282                    |       |
| Financing activities:                                                                        |       |                     |       |                     |       |
| Repayments on long-term debt and capital  lease obligations                                  |       | (785                     | )          | (994                     | )          |
| Excess tax benefits from stock-based  payment arrangements                                   |       | 465                      |       | 3,059                    |       |
| Proceeds from the exercise of stock options                                                  |       | 333                      |       | 348                      |       |
| Cash used to settle equity instruments  granted under stock-based payment arrangements       |       | (70                      | )          | —                   |       |
| Net cash used in financing activities                                                        |       | (57                      | )          | 2,413                    |       |
| Net decrease in cash and cash equivalents                                                    |       | 988                      |       | (2,082                   | )          |
| Cash and cash equivalents:                                                                   |       |                     |       |                     |       |
| Beginning of period                                                                          |       | 6,203                    |       | 7,707                    |       |
| End of period                                                                                |       | $                        | 7,191      |                     | $          | 5,625 |   |
|                                                                                         |       |                     |       |                     |       |
| Supplemental disclosures of cash flow  information:                                          |       |                     |       |                     |       |
| Cash paid for interest                                                                       |       | $                        | 151        |                     | $          | 292 |   |
| Cash paid for income taxes                                                                   |       | $                        | 5,505      |                     | $          | 3,257 |   |
| Supplemental disclosures of noncash  financing and investing activities:                     |       |                     |       |                     |       |
| Cumulative effect of adoption of FIN 48                                                      |       | $                        | —     |                     | $          | 301 |   |

 

See accompanying notes tothe condensed financial statements (unaudited).

 

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**Citi Trends, Inc.****Notes to the Condensed Financial Statements (unaudited)**

**August 2,2008**

 

1.Basis of Presentation

 

The condensed balance sheetas of August 2, 2008, the condensed statements of income for thetwenty-six and thirteen-week periods ended August 2, 2008 and August 4,2007, and the condensed statements of cash flows for the twenty-six weekperiods ended August 2, 2008 and August 4, 2007 have been prepared byCiti Trends, Inc. (the “Company”), without audit. The condensed balancesheet as of February 2, 2008 has been derived from the audited financialstatements as of that date, but does not include all required year enddisclosures.  In the opinion of management, such statements include alladjustments considered necessary to present fairly the Company’s financialposition as of August 2, 2008 and February 2, 2008, and its resultsof operations and cash flows for all periods presented. It is suggested thatthese condensed financial statements be read in conjunction with the financialstatements and the notes thereto included in the Company’s latest Annual Reporton Form 10-K for the year ended February 2, 2008.

 

The accompanying unauditedcondensed financial statements are also prepared in accordance with U.S.generally accepted accounting principles for interim financial information andwith the instructions to Form 10-Q and Article 10 of RegulationS-X.  Accordingly, they do not include all information and footnotesrequired by U.S. generally accepted accounting principles for completefinancial statements.  In the opinion of management, all adjustmentsconsidered necessary for a fair presentation have been included. Operating results for the interim periods ended August 2, 2008 are notnecessarily indicative of the results that may be expected for the fiscal yearending January 31, 2009.

 

The following containsreferences to years 2008 and 2007, which represent fiscal years ending or endedon January 31, 2009 (fiscal 2008) and February 2, 2008 (fiscal 2007),respectively. Fiscal 2008 and fiscal 2007 both have 52-week accounting periods.

 

2.Use of Estimates

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

 

3. Earnings per Share

 

Basic earnings per commonshare amounts are calculated using the weighted average number of common sharesoutstanding for the period. Diluted earnings per common share amounts arecalculated using the weighted average number of common shares outstanding plusthe additional dilution for all potentially dilutive securities such asnonvested restricted stock and stock options. During loss periods, dilutedearnings per share amounts are based on the weighted average number of commonshares outstanding.

 

The following table providesa reconciliation of the average number of common shares outstanding used tocalculate basic earnings per share to the number of common shares and commonstock equivalents outstanding used in calculating diluted earnings per sharefor the thirteen weeks and twenty-six weeks ended August 2, 2008 and August 4,2007:

 
| ** **                                                                | ** ** | **Twenty-six Weeks Ended** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                | ** ** | **August 2, 2008**         | ** ** | **August 4, 2007** | ** ** |
| Average number of common shares outstanding                               |       | 14,071,488                           |       | 13,864,632 |   |
| Incremental shares from assumed exercises  of stock options               |       | 176,295                              |       | 369,313 |   |
| Average number of common shares and common  stock equivalents outstanding |       | 14,247,783                           |       | 14,233,945 |   |

 
| ** **                                                                | ** ** | **Thirteen Weeks Ended** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                | ** ** | **August 2, 2008**       | ** ** | **August 4, 2007** | ** ** |
| Average number of common shares outstanding                               |       | 14,095,135                         |       | 13,922,130 |   |
| Incremental shares from assumed exercises  of stock options               |       | 183,850                            |       | 327,125 |   |
| Average number of common shares and common  stock equivalents outstanding |       | 14,278,985                         |       | 14,249,255 |   |

 

In accordance with theFinancial Accounting Standards Board (“FASB”) Statement of Financial AccountingStandards (“SFAS”) No. 128, *Earningsper Share*, the Company calculates the dilutive effect of stock-basedcompensation arrangements using the treasury stock method.  This methodassumes that the proceeds the Company receives from the exercise of stockoptions are used to repurchase common shares in the market.  In accordancewith SFAS No. 123R, *Share-Based Payment,*the Company includes as assumed proceeds the amount of compensation

 

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cost attributed to futureservices and not yet recognized, and the amount of tax benefits, if any, thatwould be credited to additional paid-in capital assuming exercise ofoutstanding options and vesting of nonvested restricted stock.  For thetwenty-six weeks ended August 2, 2008 and August 4, 2007, there wereapproximately 79,000 and 70,000 options outstanding, respectively, to purchaseshares of common stock excluded from the calculation of diluted earnings pershare because of antidilution.  For the twenty-six weeks ended August 2,2008 and August 4, 2007, there were no shares of nonvested restrictedstock included in the calculation of diluted earnings per share because ofantidilution.

 

4. Fair Value Measurement

 

Effective February 3,2008, the Company adopted the methods of fair value as described in SFAS No. 157,*Fair Value Measurements,* to valueits financial assets and liabilities. SFAS No. 157 defines fair value asthe price that would be received to sell an asset or paid to transfer aliability in an orderly transaction between market participants in theprincipal or most advantageous market at the measurement date. This statementalso establishes a fair value hierarchy that prioritizes observable andunobservable inputs used to measure fair value into three broad levels, whichare described below:

 

Level 1:  Unadjusted quoted prices in active marketsthat are accessible at the measurement date for assets or liabilities. The fairvalue hierarchy gives the highest priority to Level 1 inputs.

 

Level2:  Observable prices that are based oninputs not quoted on active markets, but corroborated by market data.

 

Level3:  Unobservable inputs are used whenlittle or no market data is available. Level 3 inputs are given the lowestpriority in the fair value hierarchy.

 

The following table providesa summary of changes in fair value of the Company’s financial assets for thetwenty-six weeks ended August 2, 2008 (in thousands):

 
| ** **                                                       | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|------------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| Balance as of February 2, 2008                              |       | $                | 56,165     |             | $          | — |   |
| Transfer from Level 2 to Level 3                                 |       | (56,665          | )          | 56,665           |       |
| Unrealized loss included in other  comprehensive loss            |       | —           |       | (2,788           | )          |
| Sales/redemptions of auction rate  securities                    |       | (3,500           | )          | (2,275           | )          |
| Purchases of auction rate securities                             |       | 4,000            |       | —           |       |
| Reclassification of interest receivable to other  current assets |       | —           |       | (666             | )          |
| Balance as of August 2, 2008                                |       | $                | —     |             | $          | 50,936 |   |

 

Investment securities on thecondensed balance sheets consist exclusively of municipal auction ratesecurities (“ARS”) issued by student loan funding organizations. These securitiesare high-grade (at least AA-rated with one or more rating agencies) andapproximately 83% are either guaranteed by the Department of Education underthe Federal Family Education Loan Program (37%) or backed by insurancecompanies, AMBAC Assurance Corporation (37%) or MBIA Insurance Corporation(9%). Historically, liquidity for investors in ARS was provided via an auctionprocess that reset the interest rate every 35 days, allowing investors toeither roll over their investments or sell them at par. Beginning in February 2008,there was insufficient demand for these types of investments during theauctions and, as a result, these securities are not currently liquid. TheCompany may not be able to access cash by selling these securities withoutincurring a loss of principal until either, liquidity returns to the auctionprocess, a secondary market emerges, they are redeemed by the issuer, or theymature in years ranging from 2010 to 2040. After the auctions began failing, certain issuers did redeem, at parvalue, $2,275,000 of the ARS held by the Company. However, it is not currentlypossible to determine whether other issuers of the ARS held by the Company willredeem their securities. Subsequent to the end of the second quarter, theCompany’s primary investment bank for ARS investments announced publicly thatthey have committed to provide liquidity solutions to institutional investors,such as Citi Trends, and will agree to purchase from their institutionalinvestors all or any ARS that remain outstanding in June 2010.  Approximately 93% of the Company’s ARS areheld at its primary investment bank that announced the commitment.

 

The Company classifies itsARS as available-for-sale and, therefore, they are carried at estimated fairvalue. As of August 2, 2008, there was insufficient observable marketinformation available to determine the fair value of the Company’s ARS.Accordingly, the Company estimated Level 3 fair values for these securitiesbased on assumptions that market participants would use in their estimates offair value. These assumptions included, among other things, discounted cashflow projections, the timing of expected future successful auctions orredemptions, collateralization of the underlying securities and thecreditworthiness of the issuer.  Through February 2,2008, the ARS were valued at par value due to the frequent resets thathistorically occurred through the auction process.

 

Based on the Level 3valuation, the Company has recorded an unrealized loss of $1,695,000 (net oftax) to accumulated other comprehensive loss in the condensed balance sheet asof August 2, 2008, reflecting declines in fair value of the Company’s ARS.Since the commitment by the Company’s investment bank to purchase the ARS in June 2010did not occur until after quarter end, it did not affect the valuation as of August 2,2008.

 

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Factors considered in determining whether theunrealized loss is temporary included the length of time and extent to whichfair value has been less than cost, recent redemptions of certain ARS at parvalue, the financial condition and near-term prospects of the issuers, and ourcurrent intent and ability to retain our investments for a period of timesufficient to allow for any anticipated recovery in fair value. If it is laterdetermined that the fair value of these securities is other-than-temporarilyimpaired, the Company will record a loss in the statement of income. Due to theCompany’s belief that the market for these investments may take in excess oftwelve months to fully recover, the Company has classified them as noncurrentassets on the accompanying condensed balance sheet as of August 2, 2008.

 

5. Comprehensive Income

 

The components of comprehensive income for all periodspresented are as follows (in thousands):

 
| ** **                                                                                                                                             | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-six Weeks Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                                             | ** ** | **August 2,  2008**           | ** ** | **August 4,  2007**             | ** ** | **August 2,  2008** | ** ** | **August 4,  2007** | ** ** |
| Net income, as reported                                                                                                                                |       | $                                  | 2,846      |                                 | $          | 627 |   | $ | 8,014 |   | $ | 6,349 |   |
| Other comprehensive loss:                                                                                                                              |       |                               |       |                                 |       |   |   |   |   |
| Unrealized loss on available-for-sale securities,  net of tax of $209 and $1,093 in the 13 weeks and 26 weeks ended  August 2, 2008, respectively |       | (324                               | )          | —                               |       | (1,695 | ) | — |   |
| Comprehensive income                                                                                                                                   |       | $                                  | 2,522      |                                 | $          | 627 |   | $ | 6,319 |   | $ | 6,349 |   |

 

6. Revolving Line of Credit

 

In March 2008, the Company obtained a $35 millionunsecured revolving credit facility with Bank of America, replacing a $3million facility that had been scheduled to expire on June 30, 2008.  The $35 million facility has a term of 364days, has an unused commitment fee equal to 0.15%, and has one restrictivefinancial covenant (adjusted leverage ratio). Loans under the facility bear interest at either (a) a rate equalto the higher of (i) the Federal Funds Rate plus 0.50% and (ii) Bankof America’s prime rate, plus an applicable margin; or (b) a rate equal toLIBOR plus an applicable margin. The applicable margin is dependent on theCompany’s adjusted leverage ratio and ranges from 1.00% to 1.50% forLIBOR-based loans, and from 0.00% to 0.50% for prime rate-based loans. The Companyhas had no borrowings under this facility.

 

7. Commitments and Contingencies

 

The Company from time to time is involved in variouslegal proceedings incidental to the conduct of its business, including claimsby customers, employees or former employees.  While litigation is subjectto uncertainties and the outcome of any litigated matter is not predictable,the Company is not aware of any legal proceedings pending or threatened againstit that it expects to have a material adverse effect on its financialcondition, results of operations or liquidity.

 

8. Recent Accounting Pronouncements

 

Effective February 3, 2008, the Company adoptedSFAS No. 157, *Fair Value Measurements.*  SFAS No. 157 defines fair value,establishes a framework for measuring fair value, and requires additionaldisclosures about fair value measurements. SFAS No. 157 applies to fairvalue measurements that are already required or permitted by other accountingstandards, except for measurements of share-based payments and measurements thatare similar to, but not intended to be, fair value and does not change existingguidance as to whether or not an instrument is carried at fair value. In February 2008,the FASB issued FASB Staff Position No. 157-2, *PartialDeferral of the Effective Date of Statement No. 157,*whichprovides a one year deferral of the effective date of SFAS No. 157 fornon-financial assets and non-financial liabilities, except those that arerecognized or disclosed in the financial statements at fair value at leastannually. Therefore, the Company has adopted the provisions of SFAS No. 157with respect to its financial assets and financial liabilities only. Theadoption of this statement did not have a material impact on the Company’sfinancial statements. See related disclosures in Note 4.

 

Effective February 3, 2008, the Company adoptedSFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities*.   SFAS No. 159 permits entities to chooseto measure specified financial assets and financial liabilities at fairvalue. Election of the fair value option is irrevocable and is applied ona contract-by-contract basis. The Company has elected not to apply the fairvalue option to the specified financial assets and financial liabilities, andaccordingly, the adoption of SFAS No. 159 had no financial statementimpact.

 

9. Reclassifications

 

Certain prior year amounts have been reclassified toconform to current year presentation. The decrease of cash and accounts payable through a reclassification ofoutstanding checks for all prior periods caused net cash used in operatingactivities shown in the statements of cash flows to increase by $1,540,000 fromthat previously reported for the twenty-six weeks ended August 4, 2007.

 

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**Item 2. Management’s Discussion andAnalysis of Financial Condition and Results of Operations.**

 

**Forward-Looking Statements**

 

Except for specific historical information, many ofthe matters discussed in this Form 10-Q may express or imply projectionsof revenues or expenditures, statements of plans and objectives for futureoperations, growth or initiatives, statements of future economic performance, orstatements regarding the outcome or impact of pending or threatened litigation.These, and similar statements, are forward-looking statements concerningmatters that involve risks, uncertainties and other factors that may cause theactual performance of the Company to differ materially from those expressed orimplied by these statements. All forward-looking information should beevaluated in the context of these risks, uncertainties and other factors. Thewords “believe,” “anticipate,” “project,” “plan,” “expect,” “estimate,”“objective,” “forecast,” “goal,” “intend,” “will likely result,” or “willcontinue” and similar words and expressions generally identify forward-lookingstatements. The Company believes the assumptions underlying these forward-lookingstatements are reasonable; however, any of the assumptions could be inaccurate,and therefore, actual results may differ materially from those projected in theforward-looking statements.

 

The factors that may result in actual resultsdiffering from such forward-looking information include, but are not limitedto: transportation and distribution delays or interruptions; changes in freightrates; the Company’s ability to negotiate effectively the cost and purchase ofmerchandise; inventory risks due to shifts in market demand; the Company’sability to gauge fashion trends and changing consumer preferences; changes inconsumer spending on apparel; changes in product mix; interruptions insuppliers’ businesses; interest rate fluctuations; a deterioration in generaleconomic conditions caused by acts of war or terrorism or other factors;temporary changes in demand due to weather patterns; seasonality of theCompany’s business; delays associated with building, opening and operating newstores; delays associated with building, opening, expanding or converting newor existing distribution centers; and other factors described in the sectiontitled “Item 1A. Risk Factors” and elsewhere in the Company’s Annual Report on Form 10-Kfor the fiscal year ended February 2, 2008 and in Part II, “Item 1A.Risk Factors” and elsewhere in the Company’s Quarterly Reports on Form 10-Qand in the other documents the Company files with the Securities and ExchangeCommission (“SEC”), including other reports on Form 8-K and 10-Q, and anyamendments thereto.

 

Readers are cautioned not to place undue reliance onthese 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 toupdate or revise publicly any forward-looking statements contained herein toreflect events or circumstances occurring after the date of this Form 10-Qor to reflect the occurrence of unanticipated events. Readers are advised,however, to read any further disclosures the Company may make on relatedsubjects in its public disclosures or documents filed with the SEC.

 

**Overview**

 

We are a rapidly growing, value-priced retailer ofurban fashion apparel and accessories for the entire family. Our merchandiseofferings are designed to appeal to the preferences of fashion consciousconsumers, particularly African-Americans. Originally our stores were locatedin the Southeast, and in recent years we expanded into the Mid-Atlantic andMidwest regions and Texas. We operated 335 stores in both urban and ruralmarkets in 21 states as of August 2, 2008.

 

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 entirefiscal year. Therefore, a store will not be considered a comparable store untilits 13th month of operation at the earliest or until its 24th month at thelatest. As an example, stores opened in fiscal 2007 and fiscal 2008 are notconsidered comparable stores in fiscal 2008. Relocated and expanded stores areincluded in the comparable store sales results. We also use other operatingstatistics, most notably average sales per store, to measure our performance.As we typically occupy existing space in established shopping centers ratherthan sites built specifically for our stores, store square footage (andtherefore sales per square foot) varies by store. We focus on overall storesales volume as the critical driver of profitability. The average sales perstore has increased over the years, as we have increased comparable store salesand opened new stores that are generally larger than our historical store base.Average sales per store increased from $0.8 million in fiscal 2000 to $1.5million in fiscal 2007. In addition to sales, we measure gross profit as apercentage of sales and store operating expenses, with a particular focus onlabor, as a percentage of sales. These results translate into store levelcontribution, which we use to evaluate overall performance of each individualstore. Finally, we monitor corporate expenses against budgeted amounts.

 

**Accounting Periods**

 

The following discussion contains references to fiscalyears 2008 and 2007, which represent fiscal years ending or ended on January 31,2009 (fiscal 2008) and February 2, 2008 (fiscal 2007), respectively.Fiscal 2008 and fiscal 2007 both have 52-week accounting periods. Thisdiscussion and analysis should be read with the condensed financial statementsand the notes thereto.

 

**Results of Operations**

 

The following discussion of the Company’s financialperformance is based on the condensed financial statements set forth herein.The nature of the Company’s business is seasonal. Historically, sales in thefirst and fourth quarters have been higher than sales achieved in the secondand

 

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third quarters of the fiscal year. Expenses and, to agreater extent, operating income vary by quarter. Results of a period shorterthan a full year may not be indicative of results expected for the entire year.Furthermore, the seasonal nature of the Company’s business may affectcomparisons between periods.

 

**Twenty-six Weeks Ended August 2,2008 and August 4, 2007**

 

*Net Sales. * Net sales increased $33.3 million, or16.3%, to $236.7 million in the twenty-six weeks ended August 2, 2008 from$203.4 million in the twenty-six weeks ended August 4, 2007.  Theincrease in net sales was due primarily to 35 new stores opened since lastyear’s second quarter, 23 new stores opened in the first half of 2007 for whichthere was not a full twenty-six weeks of sales in 2007’s first half, and a 3.2%increase in comparable store sales. Comparable stores include locations thathave been relocated or expanded. There were 6 stores relocated or expanded inthe first half of 2008 and 12 stores relocated or expanded in fiscal 2007, allof which impacted comparable store sales. Sales in comparable relocated andexpanded stores increased 16.3% in the first half of 2008, while sales in allother comparable stores increased 2.1%. The 3.2% increase in comparable storesales consisted of a 1.7% increase in the average customer purchase and a 1.5%increase in the number of customer transactions. Comparable store sales changesby major merchandise class were as follows in the first half of 2008:  Children’s +11%; Home +5%; Women’s +1%; Men’s+1%; Accessories -2%.

 

The new stores opened in 2007 and 2008, which are notyet included in comparable store sales, accounted for $27.1 million of thetotal increase in sales, while the 3.2% sales increase in the 277 comparablestores contributed $6.2 million.

 

*Gross Profit. * Gross profit increased $14.9 million, or19.4%, to $91.7 million in the first half of 2008 from $76.8 million lastyear.  The increase in gross profit is a result of the increase in sales,together with an improvement in the gross margin from 37.8% in last year’sfirst half to 38.7% this year.  Approximately half of this increase ingross margin was due to lower inventory shrinkage, with the other half beingdue to lower merchandise markdowns as a percentage of sales. We believe thatsteps taken to improve the hiring, training and retention of quality storemanagement, a reduction in the span of control given to our district managersin order to improve the focus on individual stores, and the addition ofsophisticated surveillance systems in high shrinkage stores have been the keysto reducing theft in our stores. Markdowns were lower due to better managementof inventory levels and improved sales results in 2008.

 

*Selling, General and AdministrativeExpenses. *Selling, general and administrativeexpenses increased $11.0 million, or 17.7%, to $73.1 million in the first halfof 2008 from $62.1 million in last year’s first half.  The increase inthese expenses was due primarily to additional store level, distribution andcorporate costs arising from the opening of 35 new stores since the end of lastyear’s second quarter.  As a percentage of sales, selling, general andadministrative expenses increased in the first half to 30.9% from 30.5% lastyear, due to higher bonus accruals resulting from improved performance in thefirst half of 2008 and increased store supervision costs associated with areduction in the span of control given to our district managers, partiallyoffset by improved management of store payroll and the benefit in this year’scomparison of approximately $550,000 of expenses related to a secondary stockoffering in last year’s first half.

 

*Depreciation and Amortization. *Depreciation and amortization expense increased $2.0million, or 33.5%, to $7.8 million in the first half of 2008 from $5.8 millionin the first half of 2007, as the result of capital expenditures incurred fornew and relocated/expanded stores and the expansion of the Darlingtondistribution center.

 

*Interest Income. * Interest income increased to $1.4million from $1.2 million in the first half of 2007 due primarily to highercontractual interest rates being earned on our investments in auction ratesecurities once the auctions of such securities began to fail in February 2008.See the discussion of auction rate securities below under “Cash Requirements”for more information.

 

*Interest Expense. * Interest expense decreased to $162,000in the first half of 2008 from $265,000 last year due to the normal decline inthe interest portion of payments on our capital lease obligations as theprincipal portion of such obligations is reduced.

 

*Income Tax Expense. * The provision for income taxes increased18.6% to $4.0 million in this year’s first half from $3.4 million in the firsthalf of 2007 due to higher earnings, partially offset by a decrease in theeffective income tax rate to 33.5% compared to 34.9% last year.  Theeffective rate reflects the benefit of tax-exempt interest income and variousincome tax credits.

 

*Net Income. * Net income increased 26.2% to $8.0million in the first half of 2008 from $6.3 million in last year’s first halfdue to the factors discussed above.

 

**Thirteen Weeks Ended August 2,2008 and August 4, 2007**

 

*Net Sales. * Net sales increased $18.9 million, or19.4%, to $115.7 million in the thirteen weeks ended August 2, 2008 from$96.8 million in the thirteen weeks ended August 4, 2007.  Theincrease in net sales was due primarily to 35 new stores opened since lastyear’s second quarter, together with a 6.5% increase in comparable store sales.Comparable stores include locations that have been relocated or expanded. Therewere 6 stores relocated or expanded in the first half of 2008 and 12 storesrelocated or expanded in fiscal 2007, all of which impacted comparable storesales. Sales in comparable relocated and expanded stores increased 18.9% in thesecond quarter of 2008, while sales in all other comparable stores increased5.5%. The 6.5% increase in comparable store sales consisted of a 3.6% increasein the number of customer

 

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transactions and a 2.9% increase in the averagecustomer purchase. Comparable store sales changes by major merchandise classwere as follows in the second quarter of 2008: Children’s +18%; Home +11%; Men’s +4%; Women’s +2%; Accessories 0%.

 

The new stores opened in 2007 and 2008, which are notyet included in comparable store sales, accounted for $13.0 million of thetotal increase in sales, while the 6.5% sales increase in the 277 comparablestores contributed $5.9 million.

 

*Gross Profit. * Gross profit increased $9.8 million, or28.0%, to $44.9 million in the second quarter of 2008 from $35.1 million lastyear.  The increase in gross profit is a result of the increase in sales,together with an improvement in the gross margin from 36.2% in last year’ssecond quarter to 38.8% this year.  This increase in gross margin was dueprimarily to markdowns being approximately 160 basis points lower as apercentage of sales in the second quarter of 2008 as a result of bettermanagement of inventory levels and improved sales results. In addition, grossmargin benefited from inventory shrinkage being approximately 80 basis pointslower in the second quarter of 2008 compared to the second quarter of 2007 dueto our efforts to improve the hiring, training and retention of quality storemanagement, a reduction in the span of control given to our district managersin order to improve the focus on individual stores, and the addition ofsophisticated surveillance systems in high shrinkage stores.

 

*Selling, General and AdministrativeExpenses. *Selling, general and administrativeexpenses increased $5.4 million, or 16.9%, to $36.9 million in the secondquarter of 2008 from $31.5 million in last year’s second quarter.  Theincrease in these expenses was due primarily to additional store level,distribution and corporate costs arising from the opening of 35 new storessince last year’s second quarter.  As a percentage of sales, selling,general and administrative expenses decreased in the second quarter to 31.9%from 32.6% last year, due primarily to the leveraging effect that occurs onexpenses as a percentage of sales when comparable store sales increase at arate, 6.5%, that is higher than the rate of inflation on expenses. In addition,the expense percentage decreased due to improved management of store payrolland because this year’s expense comparison benefited from $450,000 of expensesrelated to a secondary stock offering in last year’s second quarter.  The improvements in expenses as a percentageof sales were partially offset by higher bonus accruals resulting from improvedperformance in the second quarter of 2008 and increased store supervision costsassociated with a reduction in the span of control given to our districtmanagers.

 

*Depreciation and Amortization. *Depreciation and amortization expense increased $1.1million, or 35.5%, to $4.1 million in the second quarter of 2008 from $3.0million in the second quarter of 2007, as the result of capital expendituresincurred for new and relocated/expanded stores and the expansion of theDarlington distribution center.

 

*Interest Income. * Interest income increased slightly to$557,000 in the second quarter of 2008 from $536,000 last year. Most interestincome is earned on auction rate securities, which are discussed further belowin the “Cash Requirements” section.

 

*Interest Expense. * Interest expense decreased to $75,000 inthe second quarter of 2008 from $121,000 last year due to the normal decline inthe interest portion of payments on our capital lease obligations as theprincipal portion of such obligations is reduced.

 

*Income Tax Expense. * The provision for income taxes increased396.9% to $1.6 million in this year’s second quarter from $323,000 in the secondquarter of 2007 due to higher earnings, together with an increase in the secondquarter effective income tax rate to 36.1% compared to 34.0% last year. Theeffective rate reflects the benefit of tax-exempt interest income and variousincome tax credits.

 

*Net Income. * Net income increased 353.9% to $2.8million in the second quarter of 2008 from $627,000 in last year’s secondquarter due to the factors discussed above.

 

**Liquidity and Capital Resources**

 

Our cash requirements are primarily for working capital,expansion of our distribution infrastructure, construction of new stores,remodeling of our existing stores and the improvement of our informationsystems. Historically, we have met these cash requirements from cash flow fromoperations, short-term trade credit, borrowings under our revolving lines ofcredit, long-term debt and capital leases, and cash proceeds from our initialpublic offering.  We expect to be able to meet future cash requirementswith cash flow from operations, short-term trade credit, existing cash balancesand borrowings under our revolving credit facility.

 

*Current Financial Condition.*As of August 2, 2008, we had totalcash and cash equivalents of $7.2 million compared with total cash and cashequivalents of $6.2 million as of February 2, 2008. Inventoryrepresented 39.0% of our total assets as of August 2, 2008. Management’sability to manage our inventory can have a significant impact on our cash flowsfrom operations during a given interim period or fiscal year. In addition,inventory purchases can be seasonal in nature, such as the purchase ofwarm-weather or Christmas-related merchandise. Total inventories at the end of the second quarter of 2008 were down$8.6 million, or 9.1%, compared to the second quarter of fiscal 2007, whileinventory in comparable stores was 18% lower, due to our efforts toconservatively control inventory in what had been a slow sales environmentheading into the second quarter.

 

*Cash Flows From Operating Activities*. Net cash provided by operating activitieswas $12.0 million in the twenty-six weeks ended August 2, 2008compared to cash used in operating activities of $12.8 million in thetwenty-six weeks ended August 4, 2007. Overall efforts to improve ourinventory productivity resulted in $17.6 million of the increase in cash flowsfrom operating activities. The main sources of cash provided

 

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during the first half of this year were net incomeadjusted for depreciation and amortization, deferred income taxes and noncashstock-based compensation expense, totaling $15.2 million (compared to$11.1 million in last year’s first half), and an increase in accrued compensationof $1.5 million, due primarily to higher bonus accruals resulting fromimproved performance in the first half of 2008. Significant uses of cashconsisted of a $2.9 million increase in inventory since the beginning of 2008due to new stores, and a $1.5 million increase in prepaid and other currentassets.

 

*Cash Flows From InvestingActivities.* Cashused in investing activities was $11.0 million in the twenty-six weeksended August 2, 2008 compared to cash provided by investing activities of$8.3 million in the twenty-six weeks ended August 4, 2007. Purchasesof property and equipment included in cash flows from investing activitiestotaled $12.7 million and $11.2 million in the first half of fiscal 2008 and2007, respectively. The increase during the first half of fiscal 2008 was dueprimarily to construction work related to the expansion of the Darlingtondistribution center. Capital expenditures in the first half of both years alsoincluded routine amounts for new stores, relocated and expanded stores andother general corporate purposes. Net sales of municipal auction ratesecurities provided cash of $1.8 million and $19.5 million in the first half offiscal 2008 and 2007, respectively.

 

*Cash Flows From FinancingActivities.* Cashflows from financing activities were insignificant in the first half of 2008.In the first half of 2007, such cash flows totaled $2.4 million, primarilyrelated to excess tax benefits from stock option exercises.

 

**Cash Requirements**

 

Our principal sources of liquidity consist of: (i) cashand cash equivalents (which equaled $7.2 million as of August 2,2008); (ii) short-term trade credit; (iii) cash generated fromoperations on an ongoing basis as we sell our merchandise inventory; and (iv) a$35 million revolving credit facility. Short-term trade credit, which arisesfrom customary payment terms and trade practices with our vendors, represents asignificant source of financing for inventory purchases. Historically, ourprincipal liquidity requirements have been for working capital and capitalexpenditure needs.

 

As of August 2, 2008, the Company had $50.9million, net, of investments in municipal auction rate securities (“ARS”)issued by student loan funding organizations. These securities are high-grade(at least AA-rated with one or more rating agencies) and approximately 83% areeither guaranteed by the Department of Education under the Federal FamilyEducation Loan Program (37%) or backed by insurance companies, AMBAC AssuranceCorporation (37%) or MBIA Insurance Corporation (9%). Historically, liquidityfor investors in ARS was provided via an auction process that reset theinterest rate every 35 days, allowing investors to either roll over theirinvestments or sell them at par. Beginning in February 2008, there wasinsufficient demand for these types of investments during the auctions and, asa result, these securities are not currently liquid. The Company may not beable to access cash by selling these securities without incurring a loss ofprincipal until either, liquidity returns to the auction process, a secondarymarket emerges, they are redeemed by the issuer, or they mature in yearsranging from 2010 to 2040. After the auctions began failing, certain issuersdid redeem, at par value, $2,275,000 of the ARS held by us. However, it is notcurrently possible to determine whether other issuers of the ARS held by uswill redeem their securities. Subsequent to the end of the second quarter, theCompany’s primary investment bank for ARS investments announced publicly thatthey have committed to provide liquidity solutions to institutional investors,such as Citi Trends, and will agree to purchase from their institutionalinvestors all or any ARS that remain outstanding in June 2010.  Approximately 93% of the Company’s ARS areheld at its primary investment bank that announced the commitment.

 

We believe that our existing sources of liquidity willbe sufficient to fund our operations and anticipated capital expenditures forat least the next 24 months.

 

**Critical Accounting Policies**

 

The preparation of our financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and the disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates. There have been no material changes to theCritical Accounting Policies outlined in the Company’s Annual Report on Form 10-Kfor fiscal 2007 except as described below.

 

*Investments*

 

As of August 2, 2008, the Company had $50.9million, net, of investments in municipal auction rate securities (“ARS”)issued by student loan funding organizations. We account for our investments inaccordance with the provisions of SFAS No. 115, *Accountingfor Certain Investments in Debt and Equity Securities*. SFAS No. 115addresses the accounting and reporting for investments in fixed maturitysecurities and for equity securities with readily determinable fair values.Management determines the appropriate classification of debt securities at thetime of purchase and reevaluates such designation as of each balance sheetdate. Currently, all ARS held by the Company are classified asavailable-for-sale and are classified as long-term investments.Available-for-sale securities are carried at fair value, with unrealized gainsand losses, net of tax, reported as a separate component of stockholders’equity. Interest earned on securities classified as available-for-sale isincluded in interest income.

 

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Estimating the fair value of investments in ARSrequires numerous assumptions such as expected cash flows, the timing ofexpected future successful auctions or redemptions, collateralization of theunderlying securities and the creditworthiness of the issuer. These assumptionsare subject to uncertainties, are difficult to predict and require significantjudgment. The use of different assumptions and changes in future marketconditions could result in significantly different estimates of fair value.There is no assurance as to when the market for ARS will stabilize. The fairvalue of our ARS could change significantly based on market conditions andcontinued uncertainties in the credit markets. If these uncertainties continueor if these securities experience credit rating downgrades or changes in therates of default on the underlying assets, we may incur additional impairmenton our ARS portfolio. We continue to monitor the fair value of our ARS andrelevant market conditions and will record additional impairment if futurecircumstances warrant such charges.

 

**Item 3.Quantitative and Qualitative Disclosures About Market Risk.**

 

We are exposed to financial market risks related tochanges in interest rates connected with our revolving line of credit, whichbears interest at variable rates. We cannot predict market fluctuations ininterest rates. As a result, future results may differ materially fromestimated results due to adverse changes in interest rates or debtavailability. A hypothetical 100 basis point increase in prevailing marketinterest rates would not have materially impacted our financial position,results of operations or cash flows for the twenty-six weeks ended August 2,2008, because we did not borrow during this period of time.  We do notengage in financial transactions for trading or speculative purposes and havenot entered into any interest rate hedging contracts.

 

We source all of our product from apparel markets inthe United States in U.S. Dollars and, therefore, are not directly subject tofluctuations in foreign currency exchange rates. However, fluctuations inforeign currency exchange rates could affect our purchasing power with vendorsthat import merchandise to sell to us. We have not entered into forward contractsto hedge against fluctuations in foreign currency prices.

 

As of August 2, 2008, the Company had $50.9million, net, of investments in municipal auction rate securities (“ARS”)issued by student loan funding organizations. These securities are high-grade(at least AA-rated with one or more rating agencies) and approximately 83% areeither guaranteed by the Department of Education under the Federal FamilyEducation Loan Program (37%) or backed by insurance companies, AMBAC AssuranceCorporation (37%) or MBIA Insurance Corporation (9%). Historically, liquidityfor investors in ARS was provided via an auction process that reset theinterest rate every 35 days, allowing investors to either roll over theirinvestments or sell them at par. Beginning in February 2008, there wasinsufficient demand for these types of investments during the auctions and, asa result, these securities are not currently liquid. The Company may not beable to access cash by selling these securities without incurring a loss ofprincipal until either, liquidity returns to the auction process, a secondarymarket emerges, they are redeemed by the issuer, or they mature in yearsranging from 2010 to 2040. After the auctions began failing, certain issuersdid redeem, at par value, $2,275,000 of the ARS held by us. However, it is notcurrently possible to determine whether other issuers of the ARS held by uswill redeem their securities. Subsequent to the end of the second quarter, theCompany’s primary investment bank for ARS investments announced publicly thatthey have committed to provide liquidity solutions to institutional investors,such as Citi Trends, and will agree to purchase from their institutionalinvestors all or any ARS that remain outstanding in June 2010.  Approximately 93% of the Company’s ARS areheld at its primary investment bank that announced the commitment.

 

**Item 4. Controls and Procedures.**

 

We have carried out an evaluation, under thesupervision and with the participation of management, including the ChiefExecutive Officer and the Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures as of August 2,2008 pursuant to Rules 13a-15 and 15d-15 of the Exchange Act. Based onthat evaluation, the Chief Executive Officer and the Chief Financial Officereach concluded that our disclosure controls and procedures are effective toensure that information required to be disclosed by us in reports that we fileor submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms,and that such information has been accumulated and communicated to ourmanagement, including the officers who certify our financial reports, asappropriate, to allow timely decisions regarding the required disclosures.There were no changes in our internal control over financial reporting thatoccurred during the fiscal quarter ended August 2, 2008 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

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**PART II — OTHER INFORMATION**

 

**Item 1. Legal Proceedings.**

 

We are from time to time involved in various legalproceedings incidental to the conduct of our business, including claims bycustomers, employees or former employees. While litigation is subject touncertainties and the outcome of any litigated matter is not predictable, weare not aware of any legal proceedings pending or threatened against us that weexpect to have a material adverse effect on our financial condition, results ofoperations or liquidity.

 

**Item 1A. Risk Factors.**

 

There are no material changes to the Risk Factorsdescribed under the section “ITEM 1A. RISK FACTORS” in the Company’s AnnualReport on Form 10-K for the fiscal year ended February 2, 2008.

 

**Item 2. Unregistered Sales of EquitySecurities and Use of Proceeds.**

 

Not applicable.

 

**Item 3. Defaults Upon SeniorSecurities.**

 

Not applicable.

 

**Item 4. Submission of Matters to aVote of Security Holders.**

 

The annual meeting of our shareholders was held on May 28,2008.  The following proposals weresubmitted to a vote:

 

1)  The electionof three directors, one to hold office until our annual meeting of shareholdersin 2010 and until his successor is duly elected and qualified and two to holdoffice until our annual meeting of shareholders in 2011 and until theirrespective successors are duly elected and qualified.  This proposal received the following numberof votes:

 
| ** **                              | ** ** | **Affirmative** | ** ** | **Withheld** | ** ** |
|-----------------------------------------|------------|-----------------|------------|--------------|------------|
|                                    |       |            |       |         |       |
| Brian P. Carney (term expiring 2010)    |       | 10,788,448      |       | 38,350       |       |
|                                    |       |            |       |         |       |
| R. Edward Anderson (term expiring 2011) |       | 10,786,119      |       | 40,679       |       |
|                                    |       |            |       |         |       |
| Lawrence E. Hyatt (term expiring 2011)  |       | 10,788,466      |       | 38,332       |       |

 

The other members of our board of directors whoseterms of office continued after the meeting are John S. Lupo and Patricia M.Luzier.

 

2)  Theratification of the appointment of KPMG LLP as our independent auditors forfiscal year 2008.  This proposal wasapproved with 10,814,309 shares voting for approval, 12,132 shares votingagainst approval, and 356 shares abstaining.

 

**Item 5. Other Information.**

 

Not applicable.

 

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**Item  6. Exhibits.**

 
|   | 10.1   |   | Citi Trends, Inc. Amended and Restated 2005  Long-Term Incentive Plan*                                                                                                                      |
|--------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                             |
|   | 10.2   |   | Form of Restricted Stock Award Agreement for  Employees*                                                                                                                                    |
|   |   |   |                                                                                                                                                                                             |
|   | 31.1   |   | Certification of Chief Executive Officer Pursuant to  Rule 13a-14(a) of the Securities Exchange Act of 1934, Adopted  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* |
|   |   |   |                                                                                                                                                                                             |
|   | 31.2   |   | Certification of Chief Financial Officer Pursuant to  Rule 13a-14(a) of the Securities Exchange Act of 1934, Adopted  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* |
|   |   |   |                                                                                                                                                                                             |
|   | 32.1   |   | Certification Pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.* †                                                      |

 

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*           Filedherewith.

 

†     Pursuant to Securities and Exchange CommissionRelease No. 33-8238, this certification will be treated as “accompanying”this Quarterly Report on Form 10-Q and not “filed” as part of such reportfor purposes of Section 18 of the Securities Exchange Act of 1934, orotherwise subject to the liability of Section 18 of the SecuritiesExchange Act of 1934 and this certification will not be deemed to beincorporated by reference into any filing under the Securities Act of 1933 orthe Securities Exchange Act 1934, except to the extent that the registrantspecifically incorporates it by reference.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized, and the undersigned also has signed this report in hiscapacity as the Registrant’s Chief Financial Officer (Principal FinancialOfficer).

 
|                         | CITI TRENDS, INC. |
|------------------------------|-------------------|
|                         |              |   |
| Date: September 2, 2008 |              |   |
|                         |              |   |
|                         | By:               | /s/ Bruce D. Smith |
|                         | Name:             | Bruce D. Smith |
|                         | Title:            | Senior Vice President, Chief Financial Officer and  Secretary |

 

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