Tableof Contents

 

 

 

**UNITEDSTATESSECURITIES AND 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 November 1, 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.**

(Exact name 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’s telephone number, including area code (**912) 236-1561**

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the 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 “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of 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  November 19, 2008** |
|------------------------------|------------|----------------------------------------------------------------|
| Common Stock, $.01 par value |       | 14,370,440 shares                                              |

 

 

 

----

Tableof Contents

 

**CITI TRENDS, INC.**

**FORM 10-Q**

**TABLE OF CONTENTS**

 
| ** **   | ** **                                                                                                               | **PAGE  NUMBER** |
|--------------|--------------------------------------------------------------------------------------------------------------------------|------------------|
| PART I  | FINANCIAL INFORMATION                                                                                                    |             |
|         |                                                                                                                     |             |
| Item 1       | Financial Statements                                                                                                     |             |
|         |                                                                                                                     |             |
|         | Condensed  Balance Sheets (unaudited) November 1, 2008 and February 2, 2008                                    | 3                |
|         |                                                                                                                     |             |
|         | Condensed  Statements of Operations (unaudited) Thirty-nine weeks ended November 1,  2008 and November 3, 2007 | 4                |
|         | Condensed  Statements of Operations (unaudited) Thirteen weeks ended November 1,  2008 and November  3, 2007   | 4                |
|         | Condensed  Statements of Cash Flows (unaudited) Thirty-nine weeks ended November 1,  2008 and November 3, 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               |

 

2

----

Tableof Contents

 

**Item 1. Financial Statements.**

 

**Citi Trends, Inc.**

 

**Condensed Balance SheetsNovember 1, 2008 and February 2, 2008(Unaudited)**

 

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

 
| ** **                                                                                                                                                                                                                                                                                       | ** ** | **November 1,  2008** | ** ** | **February 2,  2008** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| **Assets**                                                                                                                                                                                                                                                                                       |       |                       |       |                       |       |
| Current assets:                                                                                                                                                                                                                                                                                  |       |                       |       |                       |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                        |       | $                          | 12,415     |                       | $          | 6,203 |   |
| Investment securities                                                                                                                                                                                                                                                                            |       | —                     |       | 56,165                     |       |
| Inventory                                                                                                                                                                                                                                                                                        |       | 89,822                     |       | 82,420                     |       |
| Prepaid and other current assets                                                                                                                                                                                                                                                                 |       | 8,030                      |       | 5,888                      |       |
| Income tax receivable                                                                                                                                                                                                                                                                            |       | 1,149                      |       | —                     |       |
| Deferred tax asset                                                                                                                                                                                                                                                                               |       | 3,511                      |       | 2,838                      |       |
| Total current assets                                                                                                                                                                                                                                                                             |       | 114,927                    |       | 153,514                    |       |
| Property and equipment, net                                                                                                                                                                                                                                                                      |       | 58,659                     |       | 52,207                     |       |
| Investment securities                                                                                                                                                                                                                                                                            |       | 41,785                     |       | —                     |       |
| Goodwill                                                                                                                                                                                                                                                                                         |       | 1,371                      |       | 1,371                      |       |
| Deferred tax asset                                                                                                                                                                                                                                                                               |       | 5,411                      |       | 2,756                      |       |
| Other assets                                                                                                                                                                                                                                                                                     |       | 372                        |       | 329                        |       |
| Total assets                                                                                                                                                                                                                                                                                     |       | $                          | 222,525    |                       | $          | 210,177 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                                                                                                   |       |                       |       |                       |       |
| Current liabilities:                                                                                                                                                                                                                                                                             |       |                       |       |                       |       |
| Accounts payable                                                                                                                                                                                                                                                                                 |       | $                          | 46,366     |                       | $          | 43,566 |   |
| Accrued expenses                                                                                                                                                                                                                                                                                 |       | 11,656                     |       | 11,864                     |       |
| Accrued compensation                                                                                                                                                                                                                                                                             |       | 5,860                      |       | 5,225                      |       |
| Current portion of capital lease  obligations                                                                                                                                                                                                                                                    |       | 1,683                      |       | 1,580                      |       |
| Income tax payable                                                                                                                                                                                                                                                                               |       | —                     |       | 1,155                      |       |
| Layaway deposits                                                                                                                                                                                                                                                                                 |       | 2,598                      |       | 635                        |       |
| Total current liabilities                                                                                                                                                                                                                                                                        |       | 68,163                     |       | 64,025                     |       |
| Capital lease obligations, less current  portion                                                                                                                                                                                                                                                 |       | 123                        |       | 1,403                      |       |
| Other long-term liabilities                                                                                                                                                                                                                                                                      |       | 7,550                      |       | 6,602                      |       |
| Total liabilities                                                                                                                                                                                                                                                                                |       | 75,836                     |       | 72,030                     |       |
| Stockholders’ equity:                                                                                                                                                                                                                                                                       |       |                       |       |                       |       |
| Common stock, $0.01 par value. Authorized  32,000,000 shares; 14,536,039 shares issued as of November 1, 2008 and  14,265,471 shares issued as of February 2, 2008; 14,370,289 shares  outstanding as of November 1, 2008 and 14,099,721 outstanding as of  February 2, 2008 |       | 144                        |       | 142                        |       |
| Paid-in-capital                                                                                                                                                                                                                                                                                  |       | 71,033                     |       | 68,276                     |       |
| Retained earnings                                                                                                                                                                                                                                                                                |       | 77,221                     |       | 69,894                     |       |
| Accumulated other comprehensive loss                                                                                                                                                                                                                                                             |       | (1,544                     | )          | —                     |       |
| Treasury stock, at cost; 165,750 shares as  of November 1, 2008 and February 2, 2008                                                                                                                                                                                                   |       | (165                       | )          | (165                       | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                                                  |       | 146,689                    |       | 138,147                    |       |
| Commitments and contingencies (note 7)                                                                                                                                                                                                                                                           |       |                       |       |                       |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                                                  |       | $                          | 222,525    |                       | $          | 210,177 |   |

 

See accompanying notes tothe condensed financial statements (unaudited).

 

3

----

Tableof Contents

 

**Citi Trends, Inc.**

 

**Condensed Statements of Operations**

**Thirty-nine Weeks Ended November 1,2008 and November 3, 2007(Unaudited)**

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

 
| ** **                                     | ** ** | **November 1,  2008** | ** ** | **November 3,  2007** | ** ** |
|------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| Net sales                                      |       | $                          | 341,599    |                       | $          | 302,944 |   |
| Cost of sales                                  |       | 211,172                    |       | 191,638                    |       |
| Gross profit                                   |       | 130,427                    |       | 111,306                    |       |
| Selling, general and administrative  expenses  |       | 109,600                    |       | 94,578                     |       |
| Depreciation and amortization                  |       | 11,915                     |       | 9,095                      |       |
| Income from operations                         |       | 8,912                      |       | 7,633                      |       |
| Interest income                                |       | 2,215                      |       | 1,703                      |       |
| Interest expense                               |       | (256                       | )          | (372                       | )          |
| Income before income tax expense               |       | 10,871                     |       | 8,964                      |       |
| Income tax expense                             |       | 3,544                      |       | 3,128                      |       |
| Net income                                     |       | $                          | 7,327      |                       | $          | 5,836 |   |
| Basic net income per common share              |       | $                          | 0.52       |                       | $          | 0.42 |   |
| Diluted net income per common share            |       | $                          | 0.51       |                       | $          | 0.41 |   |
| Weighted average number of shares  outstanding |       |                       |       |                       |       |
| Basic                                          |       | 14,095                     |       | 13,917                     |       |
| Diluted                                        |       | 14,262                     |       | 14,235                     |       |

 

See accompanying notes tothe condensed financial statements (unaudited).

 

**Citi Trends, Inc.**

 

**Condensed Statements of Operations**

**Thirteen Weeks Ended November 1, 2008 and November 3,2007**

**(Unaudited)**

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

 
| ** **                                     | ** ** | **November 1,  2008** | ** ** | **November 3,  2007** | ** ** |
|------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| Net sales                                      |       | $                          | 104,948    |                       | $          | 99,542 |   |
| Cost of sales                                  |       | 66,208                     |       | 65,026                     |       |
| Gross profit                                   |       | 38,740                     |       | 34,516                     |       |
| Selling, general and administrative  expenses  |       | 36,482                     |       | 32,455                     |       |
| Depreciation and amortization                  |       | 4,134                      |       | 3,265                      |       |
| Loss from operations                           |       | (1,876                     | )          | (1,204                     | )          |
| Interest income                                |       | 790                        |       | 521                        |       |
| Interest expense                               |       | (94                        | )          | (107                       | )          |
| Loss before income tax benefit                 |       | (1,180                     | )          | (790                       | )          |
| Income tax benefit                             |       | (493                       | )          | (277                       | )          |
| Net loss                                       |       | $                          | (687       | )                          | $          | (513 | ) |
| Basic net loss per common share                |       | $                          | (0.05      | )                          | $          | (0.04 | ) |
| Diluted net loss per common share              |       | $                          | (0.05      | )                          | $          | (0.04 | ) |
| Weighted average number of shares  outstanding |       |                       |       |                       |       |
| Basic                                          |       | 14,141                     |       | 14,023                     |       |
| Diluted                                        |       | 14,141                     |       | 14,023                     |       |

 

See accompanying notes tothe condensed financial statements (unaudited).

 

4

----

Tableof Contents

 

**Citi Trends, Inc.**

 

**Condensed Statements of Cash Flows**

**Thirty-nine Weeks Ended November 1, 2008 and November 3,2007**

**(Unaudited)**

 

**(in thousands)**

 
| ** **                                                                                   | ** ** | **November 1,  2008** | ** ** | **November 3,  2007** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| Operating activities:                                                                        |       |                       |       |                       |       |
| Net income                                                                                   |       | $                          | 7,327      |                       | $          | 5,836 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |       |                       |       |                       |       |
| Depreciation and amortization                                                                |       | 11,915                     |       | 9,095                      |       |
| Loss on disposal of property and equipment                                                   |       | 110                        |       | 48                         |       |
| Deferred income taxes                                                                        |       | (2,333                     | )          | (2,499                     | )          |
| Noncash stock-based compensation expense                                                     |       | 1,500                      |       | 1,088                      |       |
| Excess tax benefits from stock-based  payment arrangements                                   |       | (863                       | )          | (3,172                     | )          |
| Changes in assets and liabilities:                                                           |       |                       |       |                       |       |
| Inventory                                                                                    |       | (7,402                     | )          | (20,526                    | )          |
| Prepaid and other current assets                                                             |       | (1,476                     | )          | (557                       | )          |
| Other assets                                                                                 |       | (43                        | )          | (39                        | )          |
| Accounts payable                                                                             |       | 2,800                      |       | (1,968                     | )          |
| Accrued expenses and other long-term  liabilities                                            |       | 740                        |       | 1,873                      |       |
| Accrued compensation                                                                         |       | 635                        |       | (1,997                     | )          |
| Income tax payable/receivable                                                                |       | (1,441                     | )          | 1,605                      |       |
| Layaway deposits                                                                             |       | 1,963                      |       | 1,776                      |       |
| Net cash provided by (used in) operating  activities                                         |       | 13,432                     |       | (9,437                     | )          |
| Investing activities:                                                                        |       |                       |       |                       |       |
| Purchases of investment securities                                                           |       | (4,000                     | )          | (11,198                    | )          |
| Sales/redemptions of investment securities                                                   |       | 15,175                     |       | 33,433                     |       |
| Purchases of property and equipment                                                          |       | (18,477                    | )          | (18,285                    | )          |
| Net cash (used in) provided by investing  activities                                         |       | (7,302                     | )          | 3,950                      |       |
| Financing activities:                                                                        |       |                       |       |                       |       |
| Repayments on long-term debt and capital  lease obligations                                  |       | (1,177                     | )          | (1,376                     | )          |
| Excess tax benefits from stock-based  payment arrangements                                   |       | 863                        |       | 3,172                      |       |
| Proceeds from the exercise of stock options                                                  |       | 469                        |       | 382                        |       |
| Cash used to settle equity instruments  granted under stock-based payment arrangements       |       | (73                        | )          | —                     |       |
| Net cash provided by financing activities                                                    |       | 82                         |       | 2,178                      |       |
| Net increase (decrease) in cash and cash  equivalents                                        |       | 6,212                      |       | (3,309                     | )          |
| Cash and cash equivalents:                                                                   |       |                       |       |                       |       |
| Beginning of period                                                                          |       | 6,203                      |       | 7,707                      |       |
| End of period                                                                                |       | $                          | 12,415     |                       | $          | 4,398 |   |
|                                                                                         |       |                       |       |                       |       |
| Supplemental disclosures of cash flow  information:                                          |       |                       |       |                       |       |
| Cash paid for interest                                                                       |       | $                          | 239        |                       | $          | 394 |   |
| Cash paid for income taxes                                                                   |       | $                          | 7,272      |                       | $          | 3,700 |   |
| Supplemental disclosures of noncash  financing and investing activities:                     |       |                       |       |                       |       |
| Cumulative effect of adoption of FIN 48                                                      |       | $                          | —     |                       | $          | 301 |   |

 

See accompanying notes tothe condensed financial statements (unaudited).

 

5

----

Table of Contents

 

**CitiTrends, Inc.******

**Notes to the Condensed Financial Statements (unaudited)**

**November 1,2008**

 

1. Basis of Presentation

 

The condensed balance sheetas of November 1, 2008, the condensed statements of operations for thethirty-nine and thirteen-week periods ended November 1, 2008 and November 3,2007, and the condensed statements of cash flows for the thirty-nine weekperiods ended November 1, 2008 and November 3, 2007 have beenprepared by Citi Trends, Inc. (the “Company”), without audit. Thecondensed balance sheet as of February 2, 2008 has been derived from theaudited financial statements as of that date, but does not include all requiredyear end disclosures.  In the opinion of management, such statementsinclude all adjustments considered necessary to present fairly the Company’sfinancial position as of November 1, 2008 and February 2, 2008, andits results of operations and cash flows for all periods presented.  It is suggested that these condensedfinancial statements be read in conjunction with the financial statements andthe notes thereto included in the Company’s latest Annual Report on Form 10-Kfor 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.  Operating results for the interim periods ended November 1,2008 are not necessarily indicative of the results that may be expected for thefiscal year ending 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 assumptions thataffect 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 thirty-nine weeks ended November 1, 2008 and November 3,2007:

 
| ** **                                                                | ** ** | **Thirty-nine Weeks Ended** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                | ** ** | **November 1, 2008**        | ** ** | **November 3, 2007** | ** ** |
| Average number of common shares outstanding                               |       | 14,094,872                            |       | 13,917,271 |   |
| Incremental shares from assumed exercises  of stock options               |       | 167,200                               |       | 317,745 |   |
| Average number of common shares and common  stock equivalents outstanding |       | 14,262,072                            |       | 14,235,016 |   |

 
| ** **                                                                | ** ** | **Thirteen Weeks Ended** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                | ** ** | **November 1, 2008**     | ** ** | **November 3, 2007** | ** ** |
| Average number of common  shares outstanding                              |       | 14,141,132                         |       | 14,022,549 |   |
| Incremental shares from  assumed exercises of stock options               |       | —                             |       | — |   |
| Average number of common  shares and common stock equivalents outstanding |       | 14,141,132                         |       | 14,022,549 |   |

 

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

 

6

----

Table of Contents

 

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 thethirteen weeks ended November 1, 2008 and November 3, 2007, therewere 149,010 and 214,609 incremental shares from assumed exercises of stockoptions, respectively, excluded from the calculation of diluted earnings pershare because to include them for loss periods would be antidilutive. For thethirty-nine weeks ended November 1, 2008 and November 3, 2007, therewere 77,035 and 76,500 options outstanding, respectively, to purchase shares ofcommon stock excluded from the calculation of diluted earnings per sharebecause of antidilution.  For the thirteen and thirty-nine weeks ended November 1,2008 and November 3, 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, which aredescribed 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 thethirty-nine weeks ended November 1, 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            |       | —           |       | (2,539           | )          |
| Sales/redemptions of auction rate  securities                    |       | (3,500           | )          | (11,675          | )          |
| Purchases of auction rate securities                             |       | 4,000            |       | —           |       |
| Reclassification of interest receivable to  other current assets |       | —           |       | (666             | )          |
| Balance as of November 1, 2008                              |       | $                | —     |             | $          | 41,785 |   |

 

Investment securities on thecondensed balance sheets consist exclusively of municipal auction ratesecurities (“ARS”) issued by student loan funding organizations. Thesesecurities are high-grade (at least AA-rated with one or more rating agencies)and approximately 79% are either guaranteed by the Department of Educationunder the Federal Family Education Loan Program (36%) or backed by insurancecompanies, AMBAC Assurance Corporation (32%) or MBIA Insurance Corporation(11%). 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 became illiquid. After the auctionsbegan failing, certain issuers did redeem, at par value, $7,675,000 of the ARSheld by the Company, and one of the Company’s investment banks purchased, atpar value, $4,000,000 of the Company’s ARS. In addition, in October 2008,the Company’s other investment bank offered the Company rights to require theinvestment bank to purchase the remaining ARS at par value at anytime during atwo-year period beginning June 30, 2010. Subsequent to November 1, 2008, the Company accepted the investmentbank’s offer to require it to purchase the remaining ARS during the futuretwo-year period. The Company may not be able to access cash by selling thesesecurities without incurring a loss of principal until either, liquidityreturns to the auction process, a secondary market emerges, the issuer redeemsthem, they are sold to the Company’s investment bank, or they mature in yearsranging from 2010 to 2040.

 

The Company classifies itsARS as available-for-sale and, therefore, they are carried at estimated fairvalue. As of November 1, 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 issuers and insurance companies.  Through February 2, 2008, the ARS were valuedat par value due to the frequent resets that historically occurred through theauction process.

 

Based on the Level 3valuation, the Company has recorded a temporary unrealized loss of $1,544,000(net of tax) to accumulated other comprehensive loss in the condensed balancesheet as of November 1, 2008, reflecting declines in fair value of theCompany’s ARS.

 

7

----

Table of Contents

 

Factors considered indetermining whether the unrealized loss is temporary included the length oftime and extent to which fair value has been less than cost, recent redemptionsof certain ARS at par value, the financial condition and near-term prospects ofthe issuers, and our current intent and ability to retain our investments for aperiod of time sufficient to allow for any anticipated recovery in fair value.If it is later determined that the fair value of these securities isother-than-temporarily impaired, the Company will record a loss in thestatement of operations. Due to the Company’s belief that the market for theseinvestments may take in excess of twelve months to fully recover, the Companyhas classified them as noncurrent assets on the accompanying condensed balancesheet as of November 1, 2008.

 

5. Comprehensive Income(Loss)

 

The components ofcomprehensive income (loss) for all periods presented are as follows (inthousands):

 
| ** **                                                                                                                                                      | ** ** | **Thirteen Weeks Ended**   | ** ** | **Thirty-nine Weeks Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                                                      | ** ** | **November 1,  2008** | ** ** | **November 3,  2007**            | ** ** | **November 1,  2008** | ** ** | **November 3,   2007** | ** ** |
| Net income (loss), as reported                                                                                                                                  |       | $                          | (687       | )                                     | $          | (513 | ) | $ | 7,327 |   | $ | 5,836 |   |
| Other comprehensive loss:                                                                                                                                       |       |                       |       |                                  |       |   |   |   |   |
| Unrealized loss on available-for-sale  securities, net of tax benefit of $89 and $1,182 in the 13 weeks and 39 weeks  ended November 1, 2008, respectively |       | (137                       | )          | —                                |       | (1,832 | ) | — |   |
| Reclassification of realized gains for  redeemed securities, net of tax provision of $187 in the 13 weeks and 39  weeks ended November 1, 2008             |       | 288                        |       | —                                |       | 288 |   | — |   |
| Comprehensive income (loss)                                                                                                                                     |       | $                          | (536       | )                                     | $          | (513 | ) | $ | 5,783 |   | $ | 5,836 |   |

 

6. Revolving Line ofCredit

 

In March 2008, theCompany obtained a $35 million unsecured revolving credit facility with Bank ofAmerica, replacing a $3 million facility that had been scheduled to expire on June 30,2008.  The $35 million facility has aterm of 364 days, has an unused commitment fee equal to 0.15%, and has onerestrictive financial covenant (adjusted leverage ratio).  Loans under the facility bear interest ateither (a) a rate equal to the higher of (i) the Federal Funds Rateplus 0.50% and (ii) Bank of America’s prime rate, plus an applicablemargin; or (b) a rate equal to LIBOR plus an applicable margin. Theapplicable margin is dependent on the Company’s adjusted leverage ratio andranges from 1.00% to 1.50% for LIBOR-based loans, and from 0.00% to 0.50% forprime rate-based loans. The Company has had no borrowings under this facility.

 

7. Commitments andContingencies

 

The Company from time totime is involved in various legal proceedings incidental to the conduct of itsbusiness, including claims by customers, employees or former employees. While litigation is subject to uncertainties and the outcome of any litigatedmatter is not predictable, the Company is not aware of any legal proceedingspending or threatened against it that it expects to have a material adverseeffect on its financial condition, results of operations or liquidity.

 

8. Recent AccountingPronouncements

 

Effective February 3,2008, the Company adopted SFAS No. 157, *FairValue Measurements.*  SFAS No. 157defines fair value, establishes a framework for measuring fair value, andrequires additional disclosures about fair value measurements. SFAS No. 157applies to fair value measurements that are already required or permitted byother accounting standards, except for measurements of share-based payments andmeasurements that are similar to, but not intended to be, fair value and doesnot change existing guidance as to whether or not an instrument is carried atfair value. In February 2008, the FASB issued FASB Staff Position No. 157-2,*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. In October 2008, the FASB issued Staff Position No. FAS157-3, *Determining the Fair Value of a Financial AssetWhen the Market for That Asset is Not Active* (“FSP FAS 157-3”), whichclarified the application of SFAS No. 157 in cases where a market is notactive. The Company has considered the guidance provided by FSP FAS 157-3 inits determination of fair values as of November 1, 2008, and the impactwas not material. For other disclosures related to SFAS No. 157, see Note4.

 

Effective February 3,2008, the Company adopted SFAS No. 159, *TheFair Value Option for Financial 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.

 

8

----

Table of Contents

 

9. Reclassifications

 

Certain prior year amountshave been reclassified to conform to current year presentation.  The decrease of cash and accounts payablethrough a reclassification of outstanding checks for all prior periods causednet cash used in operating activities shown in the statements of cash flows toincrease by $286,000 from that previously reported for the thirty-nine weeksended November 3, 2007.

 

**Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations.**

 

**Forward-LookingStatements**

 

Except for specifichistorical information, many of the matters discussed in this Form 10-Qmay express or imply projections of revenues or expenditures, statements ofplans and objectives for future operations, growth or initiatives, statementsof future economic performance, or statements regarding the outcome or impactof pending or threatened litigation. These, and similar statements, areforward-looking statements concerning matters that involve risks, uncertaintiesand other factors that may cause the actual performance of the Company todiffer materially from those expressed or implied by these statements. Allforward-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,” “will likelyresult,” or “will continue” and similar words and expressions generallyidentify forward-looking statements. The Company believes the assumptions underlyingthese forward-looking statements are reasonable; however, any of theassumptions could be inaccurate, and therefore, actual results may differmaterially from those projected in the forward-looking statements.

 

The factors that may resultin actual results differing from such forward-looking information include, butare not limited to: transportation and distribution delays or interruptions;changes in freight rates; the Company’s ability to negotiate effectively thecost and purchase of merchandise; inventory risks due to shifts in marketdemand; the Company’s ability to gauge fashion trends and changing consumerpreferences; changes in consumer spending on apparel; changes in product mix;interruptions in suppliers’ businesses; interest rate fluctuations; adeterioration in general economic conditions caused by acts of war or terrorismor other factors; temporary changes in demand due to weather patterns;seasonality of the Company’s business; delays associated with building, openingand operating new stores; delays associated with building, opening, expandingor converting new or existing distribution centers; the future liquidity ofauction rate securities; and other factors described in the section titled “Item1A. 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 toplace undue reliance on these forward-looking statements, which speak only asof the date of this Form 10-Q. Except as may be required by law, theCompany undertakes no obligation to update or revise publicly anyforward-looking statements contained herein to reflect events or circumstancesoccurring after the date of this Form 10-Q or to reflect the occurrence ofunanticipated events. Readers are advised, however, to read any furtherdisclosures the Company may make on related subjects in its public disclosuresor documents filed with the SEC.

 

**Overview**

 

We are a rapidly growing,value-priced retailer of urban fashion apparel and accessories for the entirefamily. Our merchandise offerings are designed to appeal to the preferences offashion conscious consumers, particularly African-Americans. Originally ourstores were located in the Southeast, and in recent years we expanded into theMid-Atlantic and Midwest regions and Texas. We operated 341 stores in bothurban and rural markets in 21 states as of November 1, 2008.

 

We measure performance usingkey operating statistics. One of the main performance measures we use iscomparable store sales growth. We define a comparable store as a store that hasbeen opened for an entire fiscal year. Therefore, a store will not beconsidered a comparable store until its 13th month of operation at the earliestor until its 24th month at the latest. As an example, stores opened in fiscal2007 and fiscal 2008 are not considered comparable stores in fiscal 2008.Relocated and expanded stores are included in the comparable store salesresults. We also use other operating statistics, most notably average sales perstore, to measure our performance. As we typically occupy existing space inestablished shopping centers rather than sites built specifically for ourstores, store square footage (and therefore sales per square foot) varies bystore. We focus on overall store sales volume as the critical driver ofprofitability. The average sales per store has increased over the years, as wehave increased comparable store sales and opened new stores that are generallylarger than our historical store base. Average sales per store increased from$0.8 million in fiscal 2000 to $1.5 million in fiscal 2007. In addition tosales, we measure gross profit as a percentage of sales and store operatingexpenses, with a particular focus on labor, as a percentage of sales. Theseresults translate into store level contribution, which we use to evaluateoverall performance of each individual store. Finally, we monitor corporateexpenses against budgeted amounts.

 

9

----

Table of Contents

 

**AccountingPeriods**

 

The following discussioncontains references to fiscal years 2008 and 2007, which represent fiscal yearsending or ended on January 31, 2009 (fiscal 2008) and February 2,2008 (fiscal 2007), respectively. Fiscal 2008 and fiscal 2007 both have 52-weekaccounting periods. This discussion and analysis should be read with thecondensed financial statements and the notes thereto.

 

**Results ofOperations**

 

The following discussion ofthe Company’s financial performance is based on the condensed financialstatements set forth herein. The nature of the Company’s business is seasonal.Historically, sales in the first and fourth quarters have been higher thansales achieved in the second and third quarters of the fiscal year. Expensesand, to a greater extent, operating income vary by quarter. Results of a periodshorter than a full year may not be indicative of results expected for theentire year. Furthermore, the seasonal nature of the Company’s business and thedifficult economic business conditions discussed in Item 1A of Part II mayaffect comparisons between periods.

 

**Thirty-nineWeeks Ended November 1, 2008 and November 3, 2007**

 

*NetSales. * Netsales increased $38.7 million, or 12.8%, to $341.6 million in the thirty-nineweeks ended November 1, 2008 from $302.9 million in the thirty-nine weeksended November 3, 2007.  The increase in net sales was due primarilyto 36 new stores opened since last year’s third quarter, 29 new stores openedin the first three quarters of 2007 for which there was not a full thirty-nineweeks of sales during that period, and a 0.8% increase in comparable storesales, partially offset by the closing of one store. Comparable stores include locationsthat have been relocated or expanded. There were 9 stores relocated or expandedin the first three quarters of 2008 and 12 stores relocated or expanded infiscal 2007, all of which impacted comparable store sales. Sales in comparablerelocated and expanded stores increased 7.9% in the first three quarters of2008, while sales in all other comparable stores increased 0.1%. The 0.8%overall increase in comparable store sales consisted of a 1.9% increase in theaverage customer purchase, partially offset by a 1.1% decrease in the number ofcustomer transactions. Comparable store sales changes by major merchandiseclass were as follows in the first three quarters of 2008:  Children’s +10%; Home +3%; Men’s -2%; Women’s-2%; Accessories -7%.

 

The new stores opened in2007 and 2008, net of the closed store, accounted for $36.3 million of thetotal increase in sales, while the 0.8% sales increase in the 277 comparablestores contributed $2.4 million.

 

*GrossProfit. * Grossprofit increased $19.1 million, or 17.2%, to $130.4 million in the first threequarters of 2008 from $111.3 million last year.  The increase in grossprofit is a result of the increase in sales, together with an improvement inthe gross margin from 36.7% in last year’s first three quarters to 38.2% thisyear.  This increase in gross margin resulted primarily from markdownsbeing approximately 90 basis points lower as a percentage of sales due toimproved management of inventory levels. In addition, gross margin benefitedfrom inventory shrinkage being approximately 40 basis points lower due to thesteps taken in the past year to better control inventory shrinkage, including,a reduction in the span of control given to our district managers in order toincrease the level of supervision, a greater focus on problem stores by thestore operations and loss prevention departments, the addition of sophisticatedsurveillance systems in high shrinkage stores, and lower inventory levels.

 

*Selling,General and Administrative Expenses. *Selling, general and administrative expensesincreased $15.0 million, or 15.9%, to $109.6 million in the first threequarters of 2008 from $94.6 million in last year’s first three quarters. The increase in these expenses was due primarily to additional store level,distribution and corporate costs arising from the opening of 36 new storessince the end of last year’s third quarter.  As a percentage of sales,selling, general and administrative expenses increased in the first threequarters to 32.1% from 31.2% last year, due primarily to the deleveragingeffect that occurs on expenses as a percentage of sales when comparable storesales increase at a rate, 0.8%, that is lower than the normal rate of inflationon expenses. In addition, store supervision costs as a percentage of salesincreased in connection with a reduction in the span of control given to ourdistrict managers. These increases in the expense percentage were partiallyoffset by the benefit in this year’s comparison of approximately $550,000 ofexpenses related to a secondary stock offering last year.

 

*Depreciation andAmortization. *Depreciation and amortization expenseincreased $2.8 million, or 31.0%, to $11.9 million in the first three quartersof 2008 from $9.1 million in the first three quarters of 2007, as the result ofcapital expenditures incurred for new and relocated/expanded stores and theexpansion of the Darlington distribution center.

 

*InterestIncome. *Interest income increased to $2.2 million from $1.7 million in the first threequarters of 2007 due primarily to higher contractual interest rates beingearned on our investments in auction rate securities once the auctions of suchsecurities began to fail in February 2008 and due to an increase in marketrates for a short period of time during the banking crisis in the thirdquarter. See the discussion of auction rate securities below under “CashRequirements” for more information.

 

*InterestExpense. *Interest expense decreased to $256,000 in the first three quarters of 2008 from$372,000 last year due to the normal decline in the interest portion ofpayments on our capital lease obligations as the principal portion of suchobligations is reduced.

 

10

----

Table of Contents

 

*Income TaxExpense. * Incometax expense increased 13.3% to $3.5 million in this year’s first three quartersfrom $3.1 million in the first three quarters of 2007 due to higher earnings,partially offset by a decrease in the effective income tax rate to 32.6%compared to 34.9% last year. The effective rate estimated through the thirdquarter of 2007 ultimately proved to be too high and was adjusted downward inthe fourth quarter to a full year rate of 31.0%. The year-to-date effectiverate of 32.6% is higher than last year’s full year rate of 31.0% due totax-exempt interest income and various income tax credits being less as apercentage of pretax income this year.

 

*NetIncome. * Netincome increased 25.5% to $7.3 million in the first three quarters of 2008 from$5.8 million in last year’s first three quarters due to the factors discussedabove.

 

**ThirteenWeeks Ended November 1, 2008 and November 3, 2007**

 

*NetSales. * Netsales increased $5.4 million, or 5.4%, to $104.9 million in the thirteen weeksended November 1, 2008 from $99.5 million in the thirteen weeks ended November 3,2007.  The increase in net sales was due primarily to 36 new stores openedsince last year’s third quarter, partially offset by a 4.2% decrease in comparablestore sales and the closing of one store. Comparable stores include locationsthat have been relocated or expanded. There were 9 stores relocated or expandedin the first three quarters of 2008 and 12 stores relocated or expanded infiscal 2007, all of which impacted comparable store sales. Sales in comparablerelocated and expanded stores decreased 3.8% in the third quarter of 2008,while sales in all other comparable stores decreased 4.3%. The 4.2% overalldecrease in comparable store sales consisted of a 6.3% decrease in the numberof customer transactions, partially offset by a 2.1% increase in the averagecustomer purchase. Comparable store sales changes by major merchandise classwere as follows in the third quarter of 2008: Children’s +10%; Home -3%; Men’s -7%; Women’s -9%; Accessories -16%.

 

The new stores opened in2007 and 2008, net of the closed store, accounted for a $9.2 million increasein total sales, while the 4.2% sales decrease in the 277 comparable storestotaled $3.8 million.

 

*GrossProfit. * Grossprofit increased $4.2 million, or 12.2%, to $38.7 million in the third quarterof 2008 from $34.5 million last year.  The increase in gross profit is aresult of the increase in sales, together with an improvement in the grossmargin from 34.7% in last year’s third quarter to 36.9% this year.  Thisincrease in gross margin resulted primarily from markdowns being approximately200 basis points lower as a percentage of sales in the third quarter of 2008due to improved management of inventory levels. In addition, gross marginbenefited from inventory shrinkage being approximately 50 basis points lower inthe third quarter of 2008 compared to the third quarter of 2007 due to thesteps taken in the past year to better control inventory shrinkage, including,a reduction in the span of control given to our district managers in order toincrease the level of supervision, a greater focus on problem stores by thestore operations and loss prevention departments, the addition of sophisticatedsurveillance systems in high shrinkage stores, and lower inventory levels.

 

*Selling,General and Administrative Expenses. *Selling, general and administrative expensesincreased $4.0 million, or 12.4%, to $36.5 million in the third quarter of 2008from $32.5 million in last year’s third quarter.  The increase in theseexpenses was due primarily to additional store level, distribution andcorporate costs arising from the opening of 36 new stores since last year’sthird quarter.  After a 17.7% increase in expenses during the first halfof the year, the Company tightly managed expenses in the third quarter in lightof the slowing sales environment. The result was that the rate of expensegrowth was lowered to 12.4% in the third quarter. In particular, store payroll,even with a minimum wage increase, was managed very closely, as were many otherexpenses. As a percentage of sales, selling, general and administrativeexpenses increased in the third quarter to 34.8% from 32.6% last year, dueprimarily to the deleveraging effect that occurs on expenses as a percentage ofsales when comparable store sales decrease while operating expenses areincreasing at a normal rate of inflation. In addition, store supervision costsas a percentage of sales increased in connection with a reduction in the spanof control given to our district managers.

 

*Depreciation andAmortization. *Depreciation and amortization expenseincreased $869,000, or 26.6%, to $4.1 million in the third quarter of 2008 from$3.3 million in the third quarter of 2007, as the result of capitalexpenditures incurred for new and relocated/expanded stores and the expansionof the Darlington distribution center.

 

*InterestIncome. *Interest income increased to $790,000 in the third quarter of 2008 from$521,000 last year due to an increase in market rates for a short period oftime during the banking crisis. Most interest income is earned on auction ratesecurities, which are discussed further below in the “Cash Requirements”section.

 

*InterestExpense. *Interest expense decreased to $94,000 in the third quarter of 2008 from$107,000 last year due to the normal decline in the interest portion ofpayments on our capital lease obligations as the principal portion of suchobligations is reduced.

 

*Income TaxBenefit. * Theincome tax benefit increased 78.0% to $493,000 in this year’s third quarterfrom $277,000 in the third quarter of 2007 due to a larger pretax loss,together with an increase in the effective income tax rate to 41.8% compared to35.1% last year due to the need in this year’s third quarter to adjust theyear-to-date rate to 32.6% from the 33.5% estimate used at the end of thesecond quarter, based on changes in expected levels of tax-exempt interestincome and various income tax credits.

 

*NetLoss. * Net lossincreased 33.9% to $687,000 in the third quarter of 2008 from $513,000 in lastyear’s third quarter due to the factors discussed above.

 

11

----

Table of Contents

 

**Liquidityand Capital Resources**

 

Our cash requirements areprimarily for working capital, expansion of our distribution infrastructure,construction of new stores, remodeling of our existing stores and theimprovement of our information systems. Historically, we have met these cashrequirements from cash flow from operations, short-term trade credit,borrowings under our revolving lines of credit, long-term debt, capital leases,and cash proceeds from our initial public offering.  We expect to be ableto meet future cash requirements with cash flow from operations, short-termtrade credit, existing cash balances and borrowings under our revolving creditfacility.

 

*Current Financial Condition.*As of  November 1,2008, we had total cash and cash equivalents of $12.4 million compared withtotal cash and cash equivalents of $6.2 million as of February 2,2008. Inventory represented 40.4% of our total assets as of November 1,2008. Management’s ability to manage our inventory can have a significantimpact on our cash flows from operations during a given interim period orfiscal year. In addition, inventory purchases can be seasonal in nature, suchas the purchase of warm-weather or Christmas-related merchandise.  Total inventories at the end of the thirdquarter of 2008 were down $4.1 million, or 4.3%, compared to the third quarterof fiscal 2007, while inventory in comparable stores was 14.7% lower, due toour efforts to conservatively control inventory in the current difficulteconomic environment.

 

*Cash FlowsFrom Operating Activities*. Net cash provided by operating activities was $13.4 million inthe thirty-nine weeks ended November 1, 2008 compared to cash used inoperating activities of $9.4 million in the thirty-nine weeks ended November 3,2007. Overall efforts to improve our inventory productivity resulted in $13.1million of the improvement in cash flows from operating activities between thetwo periods. The main sources of cash provided during the first three quartersof this year were net income adjusted for depreciation and amortization,deferred income taxes and noncash stock-based compensation expense, totaling$18.4 million (compared to $13.5 million in last year’s first threequarters), and an increase in accounts payable of $2.8 million (comparedto a decrease of $2.0 million last year) resulting from improved inventoryturnover which caused a greater percentage of inventory purchases to beincluded in accounts payable at quarter end. Significant uses of cash consistedof a $7.4 million increase (compared to $20.5 million in last year’s firstthree quarters) in inventory since the beginning of 2008 due to new stores andthe seasonal build of merchandise as we approach the Christmas season.

 

*Cash FlowsFrom Investing Activities.* Cash used in investing activities was $7.3 million in thethirty-nine weeks ended November 1, 2008 compared to cash provided byinvesting activities of $4.0 million in the thirty-nine weeks ended November 3,2007. Purchases of property and equipment included in cash flows from investingactivities totaled $18.5 million and $18.3 million in the first three quartersof fiscal 2008 and 2007, respectively. Such capital expenditures in both yearsincluded construction work related to the expansion of the Darlingtondistribution center and routine amounts for new stores, relocated and expandedstores and other general corporate purposes. Sales of municipal auction ratesecurities, net of purchases, provided cash of $11.2 million and $22.2 millionin the first three quarters of fiscal 2008 and 2007, respectively.

 

*Cash FlowsFrom Financing Activities.* Cash flows from financing activities were insignificant in the firstthree quarters of 2008. In the first three quarters of 2007, such cash flowstotaled $2.2 million, primarily related to excess tax benefits from stockoption exercises, net of repayments on long-term debt and capital leaseobligations.

 

**CashRequirements**

 

Our principal sources ofliquidity consist of: (i) cash and cash equivalents (which equaled$12.4 million as of November 1, 2008); (ii) short-term tradecredit; (iii) cash generated from operations on an ongoing basis as wesell our merchandise inventory; and (iv) a $35 million revolving creditfacility. Short-term trade credit, which arises from customary payment termsand trade practices with our vendors, represents a significant source offinancing for inventory purchases. Historically, our principal liquidityrequirements have been for working capital and capital expenditure needs.

 

As of November 1, 2008,the Company had $41.8 million, net, of investments in municipal auction ratesecurities (“ARS”) issued by student loan funding organizations. Thesesecurities are high-grade (at least AA-rated with one or more rating agencies)and approximately 79% are either guaranteed by the Department of Educationunder the Federal Family Education Loan Program (36%) or backed by insurancecompanies, AMBAC Assurance Corporation (32%) or MBIA Insurance Corporation(11%). 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 became illiquid. After the auctionsbegan failing, certain issuers did redeem, at par value, $7,675,000 of the ARSheld by the Company, and one of the Company’s investment banks purchased, atpar value, $4,000,000 of the Company’s ARS. In addition, in October 2008,the Company’s other investment bank offered the Company rights to require theinvestment bank to purchase the remaining ARS at par value at anytime during atwo-year period beginning June 30, 2010. Subsequent to November 1, 2008, the Company accepted the investmentbank’s offer to require it to purchase the remaining ARS during the futuretwo-year period. The Company may not be able to access cash by selling thesesecurities without incurring a loss of principal until either, liquidityreturns to the auction process, a secondary market emerges, the issuer redeemsthem, they are sold to the Company’s investment bank, or they mature in yearsranging from 2010 to 2040.

 

We believe that our existingsources of liquidity will be sufficient to fund our operations and anticipatedcapital expenditures for at least the next 24 months.

 

12

----

Table of Contents

 

**CriticalAccounting Policies**

 

The preparation of ourfinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities andthe disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from those estimates. Therehave been no material changes to the Critical Accounting Policies outlined inthe Company’s Annual Report on Form 10-K for fiscal 2007 except asdescribed below.

 

*Investments*

 

As of November 1, 2008,the Company had $41.8 million, net, of investments in municipal auction ratesecurities (“ARS”) issued by student loan funding organizations. We account forour investments in accordance with the provisions of SFAS No. 115, *Accounting for Certain Investments in Debt and Equity Securities*.SFAS No. 115 addresses the accounting and reporting for investments infixed maturity securities and for equity securities with readily determinablefair values. Management determines the appropriate classification of debtsecurities at the time of purchase and reevaluates such designation as of eachbalance sheet date. 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.

 

Estimating the fair value ofinvestments in ARS requires numerous assumptions such as expected cash flows,the timing of expected future successful auctions or redemptions,collateralization of the underlying securities and the creditworthiness of theissuers and insurance companies. These assumptions are subject to uncertainties,are difficult to predict and require significant judgment. The use of differentassumptions and changes in future market conditions could result insignificantly different estimates of fair value. There is no assurance as towhen the market for ARS will stabilize. The fair value of our ARS could changesignificantly based on market conditions and continued uncertainties in thecredit markets. If these uncertainties continue or if these securitiesexperience credit rating downgrades or changes in the rates of default on theunderlying assets, we may incur additional impairment on our ARS portfolio. Wecontinue to monitor the fair value of our ARS and relevant market conditionsand will record additional impairment if future circumstances warrant suchcharges.

 

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

 

We are exposed to financialmarket risks related to changes in interest rates connected with our revolvingline of credit, which bears interest at variable rates. We cannot predict marketfluctuations in interest rates. As a result, future results may differmaterially from estimated results due to adverse changes in interest rates ordebt availability. 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 thirty-nine weeks ended November 1,2008, 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 productfrom apparel markets in the United States in U.S. Dollars and, therefore, arenot directly subject to fluctuations in foreign currency exchange rates.However, fluctuations in foreign currency exchange rates could affect ourpurchasing power with vendors that import merchandise to sell to us. We havenot entered into forward contracts to hedge against fluctuations in foreigncurrency prices.

 

As of November 1, 2008,the Company had $41.8 million, net, of investments in municipal auction ratesecurities (“ARS”) issued by student loan funding organizations. Thesesecurities are high-grade (at least AA-rated with one or more rating agencies)and approximately 79% are either guaranteed by the Department of Educationunder the Federal Family Education Loan Program (36%) or backed by insurancecompanies, AMBAC Assurance Corporation (32%) or MBIA Insurance Corporation(11%). 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 became illiquid. After the auctionsbegan failing, certain issuers did redeem, at par value, $7,675,000 of the ARSheld by the Company, and one of the Company’s investment banks purchased, atpar value, $4,000,000 of the Company’s ARS. In addition, in October 2008,the Company’s other investment bank offered the Company rights to require theinvestment bank to purchase the remaining ARS at par value at anytime during atwo-year period beginning June 30, 2010. Subsequent to November 1, 2008, the Company accepted the investmentbank’s offer to require it to purchase the remaining ARS during the futuretwo-year period. The Company may not be able to access cash by selling thesesecurities without incurring a loss of principal until either, liquidityreturns to the auction process, a secondary market emerges, the issuer redeemsthem, they are sold to the Company’s investment bank, or they mature in yearsranging from 2010 to 2040.

 

**Item 4. Controls and Procedures.**

 

We have carried out anevaluation, under the supervision and with the participation of management,including the Chief Executive Officer and the Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures as of November 1, 2008 pursuant to Rules 13a-15 and 15d-15of the Exchange Act. Based on that evaluation, the Chief Executive Officer andthe Chief Financial

 

13

----

Table of Contents

 

Officer each concluded thatour disclosure controls and procedures are effective to ensure that informationrequired to be disclosed by us in reports that we file or submit under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms, and that such informationhas been accumulated and communicated to our management, including the officerswho certify our financial reports, as appropriate, to allow timely decisionsregarding the required disclosures. There were no changes in our internalcontrol over financial reporting that occurred during the fiscal quarter ended November 1,2008 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**PART II— OTHER INFORMATION**

 

**Item 1.Legal Proceedings.**

 

We are from time to timeinvolved in various legal proceedings incidental to the conduct of ourbusiness, including claims by customers, employees or former employees. Whilelitigation is subject to uncertainties and the outcome of any litigated matteris not predictable, we are not aware of any legal proceedings pending orthreatened against us that we expect to have a material adverse effect on ourfinancial condition, results of operations or liquidity.

 

**Item 1A.Risk Factors.**

 

There are no materialchanges to the Risk Factors described under the section “ITEM 1A. RISK FACTORS”in the Company’s Annual Report on Form 10-K for the fiscal year ended February 2,2008, except as discussed below.

 

**The adverse changes in globaleconomic conditions could adversely affect our customers’ spending habits.**

 

Our performance is subjectto factors that impact discretionary consumer spending, including generaleconomic conditions, employment, consumer debt, inflation in food prices,consumer confidence and other macroeconomic factors. The downturn in theeconomy may continue to adversely affect our business and could have an adverseimpact on our major suppliers and landlords.

 

**Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.**

 

Notapplicable.

 

**Item 3.Defaults Upon Senior Securities.**

 

Not applicable.

 

**Item 4.Submission of Matters to a Vote of Security Holders.**

 

Not applicable.

 

**Item 5.Other Information.**

 

Not applicable.

 

14

----

Table of Contents

 

**Item 6. Exhibits.**

 
|   | 10.1   | UBS Offer Letter dated October 8, 2008, together with Acceptance  Form of Citi Trends, Inc.*                                                                                      |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                             |
|   | 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.*†                                                        |

 

----

| *      |   | Filed herewith.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| † |   | Pursuant to Securities and  Exchange Commission Release No. 33-8238, this certification will be  treated as “accompanying” this Quarterly Report on Form 10-Q and not “filed”  as part of such report for purposes of Section 18 of the Securities  Exchange Act of 1934, or otherwise subject to the liability of  Section 18 of the Securities Exchange Act of 1934 and this certification  will not be deemed to be incorporated by reference into any filing under the  Securities Act of 1933 or the Securities Exchange Act 1934, except to the  extent that the registrant specifically incorporates it by reference. |

 

15

----

Table of Contents

 

**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized, and the undersigned also has signed this report inhis capacity as the Registrant’s Chief Financial Officer (Principal FinancialOfficer).

 
|                             |   | CITI TRENDS, INC. |
|-----------------------------|--------|-------------------|
|                        |   |              |
| Date: December 8, 2008 |   |              |   |   |
|                        |   |              |   |   |
|                        |   | By:               |   | /s/ Bruce D. Smith |
|                        |   | Name:             |   | Bruce D. Smith |
|                        |   | Title:            |   | Senior Vice President, Chief Financial Officer and Secretary |

 

16

----