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**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K**

 
| **x**      | ** ** | **Annual  Report Pursuant to Section 13 or 15(d) of**     |       |       |
|------------|------------|---------------------------------------------------------------------|------------|------------|
| ** ** | ** ** | **the  Securities Exchange Act of 1934**                            |       |       |
|       |       |                                                                |       |       |
| ** ** | ** ** | **For the fiscal year ended January 31, 2009**                 |       |       |
|       |       |                                                                |       |       |
| ** ** | ** ** | **Or**                                                              |       |       |
|       |       |                                                                |       |       |
| **o**      | ** ** | **Transition  Report Pursuant to Section 13 or 15(d) of** | ** ** | ** ** |
| ** ** | ** ** | **the  Securities Exchange Act of 1934**                            | ** ** | ** ** |

 

**For the transition periodfrom                to                **

 

**Commission File Number: 000-51315**

 

**CITITRENDS, INC.**

(Exact name of registrantas specified in its charter)

 

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

 

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

 

Securitiesregistered pursuant to Section 12(b) of the Act:

 
| **Title of each class** | ** ** | **Name of each exchange  on which registered** |
|----------------------------------------|------------|-------------------------------------------------------------------------|
| Common  Stock, $.01 Par Value          |       | NASDAQ  Stock Market                                                    |

 

Securitiesregistered pursuant to Section 12(g) of the Act:

**None**

 

Indicate by check mark if theregistrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act.    Yes  o   No  x

 

Indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act.    Yes  o   No  x

 

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

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§ 229.405 of this chapter) is not contained herein, and will not becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. x

 

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-2 of the Exchange Act.

 
| Large accelerated filer  o |   | Accelerated filer  x |   | Non-accelerated filer  o  (Do not check if a smaller reporting company) |   | Smaller reporting company  o |
|--------------------------------------|--------|--------------------------------|--------|-----------------------------------------------------------------------------------|--------|----------------------------------------|

 

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

 

State the aggregate marketvalue of the voting and non-voting common equity held by non-affiliatescomputed by reference to the price at which the common equity was last sold, orthe average bid and asked price of such common equity, as of the last businessday of the registrant’s most recently completed second fiscal quarter:$327,760,015 at August 1, 2008.

 

Indicate the number of sharesoutstanding of each of the registrant’s classes of common stock, as of thelatest practicable date: Common Stock, par value $.01 per share, 14,685,737shares outstanding as of March 30, 2009.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Part III incorporatesinformation from the registrant’s definitive proxy statement, to be filed withthe Securities and Exchange Commission within 120 days after the close of theregistrant’s fiscal year covered by this Annual Report on Form 10-K, withrespect to the Annual Meeting of Stockholders to be held on May 27, 2009.

 

 

 

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**FORM 10-KREPORT INDEX**

 

Tableof Contents

 

**10-K Part and Item No.**

 
| PART I   |                                                                                                                    |   |
|---------------|-------------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.  | Business                                                                                                                | 3      |
| Item 1A. | Risk  Factors                                                                                                           | 9      |
| Item 1B.      | Unresolved  Staff Comments                                                                                              | 14     |
| Item 2.  | Properties                                                                                                              | 15     |
| Item 3.  | Legal  Proceedings                                                                                                      | 16     |
| Item 4.  | Submission of  Matters to a Vote of Security Holders                                                                    | 16     |
|          |                                                                                                                    |   |
| PART II  |                                                                                                                    |   |
| Item 5.  | Market for the  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities | 16     |
| Item 6.  | Selected Financial  Data                                                                                                | 18     |
| Item 7.  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                             | 20     |
| Item 7A. | Quantitative  and Qualitative Disclosure About Market Risk                                                              | 31     |
| Item 8.  | Financial  Statements and Supplementary Data                                                                            | 31     |
| Item 9.  | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                                   | 31     |
| Item 9A. | Controls and  Procedures                                                                                                | 31     |
| Item 9B. | Other Information                                                                                                       | 32     |
|          |                                                                                                                    |   |
| PART III |                                                                                                                    |   |
| Item 10. | Directors,  Executive Officers and Corporate Governance                                                                 | 33     |
| Item 11. | Executive  Compensation                                                                                                 | 33     |
| Item 12. | Security Ownership  of Certain Beneficial Owners and Management and Related Stockholder Matters                         | 33     |
| Item 13. | Certain  Relationships and Related Transactions, and Director Independence                                              | 33     |
| Item 14. | Principal  Accounting Fees and Services                                                                                 | 34     |
|          |                                                                                                                    |   |
| PART IV  |                                                                                                                    |   |
| Item 15. | Exhibits,  Financial Statement Schedules                                                                                | 35     |

 

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**PART I**

 

*Some statements in, or incorporatedby reference into, this Annual Report on Form 10-K (this “Report”) ofCiti Trends, Inc. (“we”, “us”, or the “Company”) may constitute “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended (the “Exchange Act”). All statements other than historical facts containedin this Report, including statements regarding our future financial position,business policy and plans and objectives and expectations of management forfuture operations, are forward-looking statements. The words “believe,” “may,” “could,”“estimate,” “continue,” “anticipate,” “intend,” “expect,” “plan,” “project” andsimilar expressions, as they relate to us, are intended to identifyforward-looking statements. We have based these forward-looking statementslargely on our current expectations and projections about future events,including, among other things: implementation of our growth strategy; ourability to anticipate and respond to fashion trends; competition in ourmarkets; consumer spending patterns; actions of our competitors or anchor tenantsin the strip shopping centers where our stores are located; and anticipatedfluctuations in our operating results.*

 

*These forward-looking statements aresubject to a number of risks, uncertainties and assumptions, including thosedescribed in Item 1A. Risk Factors and elsewhere in this Report and the otherdocuments we file with the Securities and Exchange Commission (“SEC”),including our reports on Form 8-K and Form 10-Q, and any amendmentsthereto. Because forward-looking statements are inherently subject to risks anduncertainties, some of which cannot be predicted or quantified, you should notrely upon forward-looking statements as predictions of future events. Theevents and circumstances reflected in the forward-looking statements may not beachieved or occur and actual results could differ materially from thoseprojected in the forward-looking statements. These forward-looking statementsspeak only as of the date of such statements. Except as required by applicablelaw, including the securities laws of the United States and the rules andregulations of the SEC, we do not plan to publicly update or revise anyforward-looking statements contained in this Report, whether as a result of anynew information, future events or otherwise.*

 

*Information is provided herein withrespect to our operations related to our fiscal years ended on January 31,2009 (“fiscal 2008”), February 2, 2008 (“fiscal 2007”) and February 3,2007 (“fiscal 2006”)*.

 

**ITEM1.          BUSINESS**

 

**Overview and History**

 

We are a rapidly growing, value-priced retailer ofurban fashion apparel and accessories for the entire family. We offer quality,branded products from nationally recognized brands, as well as private labelproducts and a limited assortment of home décor items. Our merchandise offeringsare designed to appeal to the preferences of fashion conscious consumers,particularly African-Americans. We believe that we provide merchandise atcompelling values. Our goal is to provide nationally recognized brandedmerchandise at 30% to 70% discounts to department and specialty stores’ regularprices. Our stores average approximately 10,200 square feet of selling spaceand are typically located in neighborhood shopping centers that are convenientto low- to moderate-income customers. Originally our stores were located in theSoutheast, and in recent years were expanded into the Mid-Atlantic and Midwestregions as well as the state of Texas. In fiscal 2008, we opened 39 new storesand closed one store.  As of January 31, 2009, we operated 357 storesin both urban and rural markets in 22 states.

 

Our predecessor, Allied Department Stores, was foundedin 1946 and grew into a chain of family apparel stores operating in theSoutheast. In 1999, the Company, then consisting of 85 stores throughout the Southeast,was acquired by Hampshire Equity Partners II, L.P., a private equity firm.Following the acquisition by Hampshire Equity Partners II, L.P., managementimplemented several strategies to refocus us on the growing urban market andimprove our operating and financial performance. After the successfulimplementation of these strategies and the successful growth of our chain from85 stores to 212 stores, we completed an initial public offering of our commonstock on May 18, 2005.

 

Our executive offices are located at 104 ColemanBoulevard, Savannah, Georgia 31408 and our telephone number is (912) 236-1561.Our Internet address is *http://www.cititrends.com*.The reference to our web site address in this Report does not constitute theincorporation by reference of the information contained at the web site in thisReport. We make available, free of charge through publication on our web site,copies of our Annual Report on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, and amendments to those reports, as soon asreasonably practicable after we have filed such materials with, or furnishedsuch materials to, the SEC. In addition, you may read and copy anymaterials we file with the SEC at the SEC’s Public Reference Room at 100 FStreet, N.E., Washington, D.C. 20549 or on the SEC’s web site at *http://www.sec.gov*, and youmay obtain information on the operation of the Public Reference Room bycalling the SEC at 1-800-SEC-0330.

 

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**Company Strengths and Strategies**

 

Our goal is to be the leading value-priced retailer ofurban fashion apparel and accessories. We believe the following businessstrengths differentiate us from our competitors and are important to oursuccess:

 

*Focus on Urban Fashion Mix.* We focus our merchandise on urbanfashions, which we believe appeal to our core customers. We do not attempt todictate trends, but rather devote considerable effort to identifying emergingtrends and ensuring that our apparel assortment is considered timely andfashionable in the urban market. Our merchandising staff tests new merchandisebefore reordering and actively manages the mix of brands and products in thestores to keep our offering fresh and minimize markdowns.

 

*Superior Value Proposition.* As a value-priced retailer, we seek tooffer top quality, fashionable merchandise at compelling prices. We seek toprovide nationally recognized brands at 30% to 70% discounts to department andspecialty stores’ regular prices. We also offer products under our proprietarybrands such as “Diva Blue,” “Red Ape,” and “Lil Miss Hollywood.” Theseprivate brands enable us to expand our product selection, offer fashion merchandiseat lower prices and enhance our product offerings.

 

*Merchandise Mix that Appeals to theEntire Family.* Wemerchandise our stores to create a destination environment capable of meetingthe fashion needs of the entire value-conscious family. Each store offers awide variety of products for men and women, as well as children. Our storesfeature sportswear, dresses, outerwear, footwear, intimate apparel andaccessories, as well as a limited assortment of home décor items. We believethat the breadth of our merchandise distinguishes our stores from manycompetitors that offer urban apparel primarily for women, and reduces ourexposure to fashion trends and demand cycles in any single category.

 

*Strong and Flexible SourcingRelationships.* Wemaintain strong sourcing relationships with a large group of suppliers. We havepurchased merchandise from more than 1,200 vendors in the past 12 months.Purchasing is controlled by a 25-plus member buying team located at ourSavannah, Georgia headquarters and our buying office in New York, New York. Wepurchase merchandise through planned programs with vendors at reduced pricesand opportunistically through close-outs, with the majority of our merchandisepurchased for the current season and a limited quantity held for sale in futureseasons. To foster vendor relationships, we pay vendors promptly and do not askfor typical retail concessions such as promotional and markdown allowances.

 

*Attractive Fashion Presentation andStore Environment.*We seek to provide a fashion-focused shopping environment that is similar to aspecialty apparel retailer, rather than a typical off-price store. Productsfrom nationally recognized brands are prominently displayed by brand, ratherthan by size, on dedicated, four-way fixtures featuring multiple sizes andstyles. The remaining merchandise is arranged on hanging racks. The stores arecarpeted and well-lit, with most featuring a sound system that plays urbanadult and urban contemporary music throughout the store. Nearly all of our storeshave either been opened or remodeled in the past eight years.

 

*Highly Profitable Store Model.* We operate a proven and efficient storemodel that delivers strong cash flow and store level return on investment. Welocate stores in high traffic strip shopping centers that are convenient tolow- and moderate-income neighborhoods. We generally utilize previouslyoccupied store sites which enables us to obtain attractive rents for our storesites. Similarly, advertising expenses are low as we do not rely on promotion-drivensales but rather seek to build our reputation for value through everyday lowprices. At the same time, from an investment perspective, we seek to designstores that are inviting and easy to shop, while limiting startup and fixturingcosts. As a result, our stores have generated rapid payback of investments,typically within 12 to 14 months.

 

**Product Merchandising and Pricing**

 

*Products.* Our merchandising policy is to offerhigh quality, branded products at attractive prices for the entire value-consciousfamily. We seek to maintain a diverse assortment of first quality, in-seasonmerchandise that appeals to the distinctive tastes and preferences of our corecustomers. Approximately 47% of our net sales are represented by nationallyrecognized brands. We also offer a wide variety of products from lessrecognized brands and a lesser amount representing private label products underour proprietary brands such as “Diva Blue,” “Red Ape,” and “Lil Miss Hollywood.”Our private brand products enable us to expand product selection, offermerchandise at lower prices and enhance our product offerings.

 

Our merchandise includes apparel, accessories and homedécor. Within apparel, we offer fashion sportswear for men, women and children,including offerings for newborns, infants, toddlers, boys and girls. We alsooffer accessories, which includes handbags, jewelry, footwear, belts, intimateapparel and sleepwear, as well as a limited assortment of home décor.

 

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The following table sets forth the merchandiseassortment by classification as a percentage of net sales for fiscal2008, 2007 and 2006.

 
| ** **      | ** ** | **Percentage of** | ** ** |
|-----------------|------------|------------------------|------------|
| ** **      | ** ** | **Net Sales**     | ** ** |
| ** **      | ** ** | **2008**               | ** ** | **2007** | ** ** | **2006** | ** ** |
| Women’s    |       | 35                     | %          | 35 | % | 36 | % |
| Children’s |       | 29                     | %          | 27 | % | 26 | % |
| Men’s      |       | 22                     | %          | 22 | % | 22 | % |
| Accessories     |       | 12                     | %          | 14 | % | 14 | % |
| Home décor |       | 2                      | %          | 2 | % | 2 | % |

 

*Pricing.* We purchase our merchandise atattractive prices and mark prices up less than department or specialty stores.We seek to provide nationally recognized brands at prices 30% to 70% belowregular retail prices available in department stores and specialty stores, andto provide a product offering that validates both our value and fashion positioningto our consumers. We also consider the price-to-value relationships of ournon-branded products to be strong. Our basic pricing strategy is everyday lowprices. The discount from the suggested retail price is usually reflected onthe price tag. We review each department in our stores at least monthly forpossible markdowns based on sales rates and fashion seasons to promote fasterturnover of inventory and to accelerate the flow of current merchandise.

 

**Sourcing and Allocation**

 

The merchandising department oversees the sourcing,planning and allocation of merchandise to our stores, which allows us toutilize volume purchase discounts and maintain control over our inventory. Wesource our merchandise from over 1,200 vendors, consisting of domestic manufacturersand importers. Our Chief Merchandising Officer supervises a planning andallocation team consisting of nearly 30 associates, as well as a buying team,which is comprised of four merchandise managers and approximately 25 buyers andassistant buyers.

 

Our buyers have on average more than 20 years ofexperience in the retail business and have developed long-standingrelationships with many of our vendors, including those controlling thedistribution of branded apparel. Our buyers, who are based in Savannah and NewYork, travel regularly to the major United States apparel markets, visitingmajor manufacturers and attending national and regional apparel trade shows,including urban-focused trade shows.

 

Our buyers purchase merchandise in styles, sizes andquantities to meet inventory levels developed by the planning staff. The buyingstaff utilizes several purchasing techniques that enable us to offer toconsumers branded and other merchandise at everyday low prices. The majority ofthe nationally recognized branded products we sell are purchased in-season andrepresent vendors’ excess inventories resulting from over-production orretailer order cancellations. We generally purchase later in the merchandisingbuying cycle than department and specialty stores. This allows us to takeadvantage of imbalances between retailers’ demands for specific merchandise andmanufacturers’ supply of that merchandise. We also purchase merchandise fromsome vendors in advance of the selling season at reduced prices and purchasemerchandise on an opportunistic basis, which we then store for sale three tonine months later. Where possible, we seek to purchase items based on style orcolor in limited quantities on a test basis with the right to reorder asneeded. Finally, we purchase private brand merchandise that we source to ourspecifications.

 

We allocate merchandise across our store baseaccording to store-level demand. The merchandising staff utilizes a centralizedmanagement system to monitor merchandise purchasing, planning and allocation inorder to maximize inventory turnover, identify and respond to changing productdemands and determine the timing of mark-downs to our merchandise. The buyersalso regularly review the age and condition of the merchandise and manage both thereordering and clearance processes. In addition, the merchandising teamcommunicates with regional, district and store managers to ascertain regionaland store-level conditions and to better ensure that our product mix meets ourconsumers’ demands in terms of quality, fashion, price and availability.

 

We accept payment from our customers for merchandiseat time of sale. Payments are made to us by cash, check, VisaTM or MastercardTM.We do not extend credit terms to our customers.

 

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**Seasonality**

 

The nature of our business is seasonal. Historically,sales in the first and fourth quarters have been higher than sales achieved inthe second and third quarters of the fiscal year. Expenses, and to a greaterextent operating income, vary by quarter. Results of a period shorter than afull year may not be indicative of results expected for the entire year.Furthermore, the seasonal nature of our business may affect comparisonsbetween periods.

 

**Store Operations**

 

*Store Format.* The average selling space of ourexisting 357 stores is approximately 10,200 square feet, which allows us thespace and flexibility to departmentalize our stores and provide directedtraffic patterns. We arrange our stores in a racetrack format with women’ssportswear, our most attractive and fashion current merchandise, in the centerof each store and complementary categories adjacent to those items. Men’s andboy’s apparel is displayed on one side of the store, while dresses, footwearand accessories are displayed on the other side. Merchandise for infants,toddlers and girls is displayed along the back of the store. Impulse items,such as jewelry and sunglasses, are featured near the checkout area. Productsfrom nationally recognized brands are prominently displayed on four-way racksat the front of each department. The remaining merchandise is displayed onhanging racks and occasionally on table displays. Large hanging signs identifyeach category location. The unobstructed floor plan allows the customer to seevirtually all of the different product areas from the store entrance andprovides us the flexibility to easily expand and contract departments inresponse to consumer demand, seasonality and merchandise availability.Virtually all of our inventory is displayed on the selling floor. Prices areclearly marked and often have the comparative retail-selling price noted on theprice tag.

 

*Store Management.* Store operations are managed by ourSenior Vice President of Store Operations, five regional managers and 42district managers, each of whom typically manages five to twelve stores. Thetypical store is staffed with a store manager, two or three assistant managersand seven to eight part-time sales associates, all of whom rotate work days ona shift basis. Store managers and assistant store managers participate in abonus program based on achieving predetermined levels of sales and inventoryshrinkage. District managers participate in bonus programs based on achievingtargeted levels of sales, profits, inventory shrinkage and payroll costs.Regional managers participate in a bonus program based on a rollup of thedistrict managers’ bonuses. Sales associates are compensated on an hourly basiswith incentives. Moreover, we recognize individual performance through internalpromotions and provide extensive opportunities for advancement, particularlygiven our rapid growth.

 

We place significant emphasis on loss prevention inorder to control inventory shrinkage. Initiatives include electronic tags onmost of our products, training and education of store personnel on lossprevention issues, digital video camera systems, alarm systems and motiondetectors in the stores. In certain stores, we use an outside service tovisually monitor the stores throughout the day using sophisticated camerasystems. We also capture extensive point-of-sale data and maintain systems thatmonitor returns, voids and employee sales, and produce trend and exceptionreports to assist in identifying shrinkage issues. We have a centralized lossprevention team that focuses exclusively on implementation of these initiativesand specifically on stores that have experienced above average levels ofshrinkage. We also maintain an independent, third party administered, toll-freeline for reporting shrinkage concerns and any other employee concerns.

 

*Employee Training.* Our employees are critical to achievingour goals, and we strive to hire employees with high energy levels andmotivation. We have well-established store operating policies and proceduresand an extensive 90-day in-store training program for new store managers andassistant managers. Sales associates also participate in a 30-day customerservice and store procedures training program, which is designed to enable themto assist customers in a friendly, helpful manner.

 

*Layaway Program.* We offer a layaway program that allowscustomers to purchase merchandise by initially paying a 20% deposit and a $2.00service charge. The customer then makes additional payments every two weeks andhas 60 days within which to complete the purchase. If the purchase is notcompleted, the customer receives a merchandise credit for amounts paid less are-stocking fee and service charge.

 

*Site Selection.* Cost-effective store locations are animportant part of our profitability model. Accordingly, we look for secondand third use store locations that offer attractive rents, but also meet ourdemographic and economic criteria.   We have a dedicated real estatemanagement team responsible for new store site selection. In selecting alocation, we target both urban and rural markets. Demographic criteria used insite selection include concentrations of our core consumers. In addition, werequire convenient site accessibility, as well as strong co-tenants, such asfood stores, dollar stores, rent-to-own stores and other apparel stores.

 

Shortly after we sign a new store lease, our storeconstruction department prepares the store by installing fixtures, signs,dressing rooms, checkout counters, cash register systems and other items. Oncewe take possession of a store site, we can open the store within approximatelythree to four weeks.

 

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**Advertising and Marketing**

 

Our advertising goal is to build the “Citi Trends”brand and promote consumers’ association of the “Citi Trends” brand with value,quality, fashion and everyday low prices. We generally focus our advertisingefforts during the Easter, back-to-school and Christmas seasons. Thisadvertising consists of radio commercials played on local hip-hop radiostations and cable television commercials that highlight our brands, value and everydaylow prices. We also do in-store advertising that includes window signsdesignated for special purposes, such as seasonal events and clearance periods,and taped audio advertisements co-mingled with in-store music programs. Signschange in color, quantity and theme every six to nine weeks. For store grandopenings and significant remodels, we typically seek to create communityawareness and consumer excitement through radio advertising preceding andduring the grand opening and by creating an on-site event with local radiopersonalities broadcasting from the new location. We also distributepromotional items such as gift certificates and shopping sprees in connectionwith our grand openings and significant remodels.

 

Our marketing efforts center on promoting our everydaylow prices and on demonstrating the strong price-to-value relationship of ourproducts to our consumers. We do not utilize promotional advertising.Merchandise is priced so that our competition rarely has lower prices. In thelimited situations where the competition offers the same merchandise at a lowerprice, we will match the price.

 

**Distribution**

 

All merchandise sold in our stores is shipped directlyfrom our distribution centers in Savannah, Georgia and Darlington, SouthCarolina. We generally ship merchandise from our distribution centers to ourstores daily, utilizing United Parcel Service, Inc. and FedEx Corporation.In addition to the distribution center in Savannah, we have a small merchandisestorage facility that is attached to our corporate offices.  The Savannah facilities have a combinedsquare footage of approximately 240,000, including 55,000 square feet ofoffice space. To support our continued growth, we completed an expansion of theDarlington distribution center in 2008 which increased the size of the facilityfrom 286,000 square feet to 550,000 square feet. We expect this expansion tosupport our growth plans through 2010.

 

**Information Technology and Systems**

 

We have information systems in place to support eachof our business functions. We purchased our enterprise software from IslandPacific, a primary software provider to the retail industry. The computerplatform is an IBM AS400. The Island Pacific software supports thefollowing business functions: purchasing, purchase order management, price andmarkdown management, distribution, merchandise allocation, general ledger,accounts payable and sales audit.

 

Our stores use point-of-sale software fromDataVantage, a division of MICROS Systems, Inc., to run the store’s cashregisters. The system uses bar code scanners at checkout to capture item sales.It also supports end-of-day processing and automatically transmits sales andtransaction data to Savannah soon after the close of business. Additionally,the software supports store time clock and payroll functions. To facilitate themarking down and re-ticketing of merchandise, employees in the stores usehand-held scanners that read the correct item price and prepare new pricetickets for merchandise. DataVantage software also enables us to sort andreview transaction data and generate exception and other database reporting toassist in loss prevention.

 

We believe that our information systems, with upgradesand updates over time, are adequate to support our operations for theforeseeable future.

 

**Growth Strategy**

 

Our growth strategy is to open stores in new andexisting markets, as well as to increase sales in existing stores. Addingstores in the markets we currently serve often enables us to benefit fromenhanced name recognition and achieves advertising and operating synergies. Infiscal 2006, we opened 42 new stores and entered the Indianapolis, Indiana;Dayton, greater-Cleveland, Akron, Ohio; and St Louis, Missouri markets. Infiscal 2007, we opened 42 new stores and entered the Tulsa, Oklahoma; Detroit,Michigan; Chicago, Illinois; and Milwaukee, Wisconsin markets. In fiscal 2008,we opened 39 new stores and entered the Philadelphia, Pennsylvania and KansasCity, Kansas markets. We expect to open approximately 45 new stores in fiscal2009. Approximately 85% of the new stores we intend to open in fiscal 2009 willbe located in states in which we are currently located.

 

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**Competition**

 

The markets we serve are highly competitive. Theprincipal methods of competition in the retail business are fashion,assortment, pricing and presentation. We believe we have a competitiveadvantage in our offering of fashionable brands at everyday low prices. Wecompete against a diverse group of retailers, including national off-priceretailers, mass merchants, smaller specialty retailers and dollar stores. Theoff-price retail companies with which we compete include TJX Companies, Inc.(“TJX Companies”), Burlington Coat Factory Warehouse Corp. (“Burlington CoatFactory”) and Ross Stores, Inc. (“Ross Stores”). In particular, TJXCompanies’ A.J. Wright stores target moderate income consumers and Ross Storeshas a similar concept targeting lower income consumers, called dd’s DISCOUNTS.We believe our strategy of appealing to African-American consumers and offeringurban apparel products allows us to compete successfully with these retailers.We also believe we offer a more inviting store format than the off-priceretailers, including our use of carpeted floors and more prominently displayedbrands. We also compete with a group of smaller specialty retailers that onlysell women’s products, such as Rainbow, Dots, Fashion Cents, It’s Fashions! andSimply Fashions. Our mass merchant competitors include Wal-Mart and Kmart.These chains do not focus on fashion apparel and, within their appareloffering, lack the urban focus that we believe differentiates our offering andappeals to our core customers. Similarly, while some of the dollar store chainsoffer apparel, they typically offer a more limited selection focused on basicapparel needs. As a result, we believe there is significant demand for a valueretailer that addresses the market of low- to moderate-income consumersgenerally and, particularly, African-American and other minority consumers whoseek value-priced, urban fashion apparel and accessories. See Item 1A. RiskFactors in this Report for additional information.

 

**Intellectual Property**

 

We regard our trademarks and service marks as havingsignificant value and as being important to our marketing efforts. We haveregistered the “Citi Trends” trademark with the U.S. Patent and TrademarkOffice on the Principal Register as both a trademark for retail departmentstore services and as a trademark for clothing. We have also registered thefollowing trademarks with the U.S. Patent and Trademark Office on the PrincipalRegister: “Citi Club,” “Citi Express,” “Citi Knights,” “Citi Nite,” “CitiSteps,” “Citi Trends Fashion for Less,” “Citi Women,” “CT Sport,” “Diva Blue,” “LilCiti Man,” “Lil Miss Hollywood,” “Univer Soul,” “Urban Sophistication,” “RedApe,”  and “Vintage Harlem.” Our policyis to pursue registration of our marks and to oppose vigorously infringement ofour marks.

 

**Employees**

 

As of January 31, 2009, we had approximately1,900 full-time and approximately 2,100 part-time employees. Of theseemployees, approximately 3,400 are employed in our stores and the remainder areemployed in our distribution centers and corporate office. We are not a partyto any collective bargaining agreements, and none of our employees isrepresented by a labor union. We believe our relations with our employees aregood.

 

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**ITEM1A.       RISK FACTORS**

 

*You should carefully consider thefollowing risk factors, together with the other information contained orincorporated by reference into this Report. The risks and uncertaintiesdescribed below are not the only ones we face.  Additional risks anduncertainties not presently known to us or that we deem to be currentlyimmaterial also may impair our business operations. The occurrence of any ofthe following risks could have a material adverse effect on our business,financial condition and results of operations.*

 

**Our success depends on our ability toanticipate, identify and respond rapidly to changes in consumers’ fashiontastes, and our failure to adequately evaluate fashion trends could have anadverse effect on our business, financial condition and results of operations.**

 

The apparel industry in general and our core customermarket in particular are subject to rapidly evolving fashion trends andshifting consumer demands. Accordingly, our success is heavily dependent on ourability to anticipate, identify and capitalize on emerging fashion trends,including products, styles and materials that will appeal to our targetconsumers. Our failure to anticipate, identify or react appropriately andtimely to changes in styles, trends, brand preferences or desired imagepreferences is likely to lead to lower demand for our merchandise, which couldcause, among other things, sales declines, excess inventories and highermarkdowns.

 

**If we are unsuccessful****incompeting with our retail apparel competitors, our market share could declineor our growth could be impaired and, as a result, our financial results couldsuffer.**

 

The retail apparel market is highly competitive withfew barriers to entry. We compete against a diverse group of retailers,including national off-price apparel chains such as TJX Companies, BurlingtonCoat Factory, and Ross Stores; mass merchants such as Wal-Mart and Kmart;smaller discount retail chains that only sell women’s products, such asRainbow, Dots, Fashion Cents, It’s Fashions!, and Simply Fashions; and generalmerchandise discount stores and dollar stores, which offer a variety of products,including apparel, for the value-conscious consumer. We also compete againstlocal off-price and specialty retail stores, regional retail chains,traditional department stores, web-based retail stores and other directretailers.

 

The level of competition we face from these retailersvaries depending on the product segment, as many of our competitors do notoffer apparel for the entire family. Our greatest competition is generally inwomen’s apparel. Many of our competitors are larger than us and havesubstantially greater resources than us and, as a result, may be able to adaptbetter to changing market conditions, exploit new opportunities, exert greaterpricing pressures on suppliers and open new stores more quickly and effectivelythan us. Many of these retailers have better name recognition among consumersthan us and purchase significantly more merchandise from vendors. Theseretailers may be able to purchase branded merchandise that we cannot purchasebecause of their name recognition and relationships with suppliers, or they maybe able to purchase branded merchandise with better pricing concessions thanus. Our local and regional competitors have extensive knowledge of the consumerbase and may be able to garner more loyalty from customers than us. If theconsumer base we serve is satisfied with the selection, quality and price ofour competitors’ products, consumers may decide not to shop in our stores.Additionally, if our existing competitors or other retailers decide to focusmore on our core customers, particularly African-American consumers, we mayhave greater difficulty in competing effectively, our business and results ofoperations could be adversely affected, and the market price of our commonstock could suffer.

 

The retail industry periodically has experiencedconsolidation and other ownership changes. In the future, other United Statesor foreign retailers may consolidate, undergo restructurings orreorganizations, or realign their affiliations. Any of these developments couldresult in our competitors increasing their buying power or market visibility.These developments may cause us to lose market share and could have an adverseeffect on our sales and results of operations.

 

**We could experience a reduction insales and cash flows if we are unable to fulfill our current and futuremerchandising needs.**

 

We depend on oursuppliers for the continued availability and satisfactory quality of ourmerchandise. Most of our suppliers could discontinue selling to us at any time.Additionally, if the manufacturers or other owners of brands or trademarksterminate the license agreements under which some of our suppliers sell ourproducts, we may be unable to obtain replacement merchandise of comparablefashion appeal or quality, in the same quantities or at the same prices. Inaddition, a number of our suppliers are smaller, less capitalized companies andare more likely to be impacted by unfavorable general economic and marketconditions than larger and better capitalized companies. These smallersuppliers may not have sufficient liquidity during economic downturns toproperly fund their businesses, and their ability to supply their products tous could be negatively impacted. If we lose the services of one or more of oursignificant suppliers or one or more of them fail to meet our merchandisingneeds, we may be unable to obtain replacement merchandise in a timely manner.If our existing suppliers cannot meet our increased needs and we cannot locatealternative supply sources, we may be unable to obtain sufficient quantities ofthe most popular items of the nationally recognized brands at attractiveprices, which could negatively impact our sales and results of operations.

 

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**As an apparel retailer, we rely onnumerous third parties in the supply chain to produce and deliver the productsthat we sell, and our business may be negatively impacted by their failure tocomply with applicable law.**

 

We rely on numerous third parties to supply theproducts that we sell. Violations of law by our importers, manufacturers ordistributors could result in delays in shipments and receipt of goods or damageour reputation, thus causing our revenues to decline. In addition, merchandisewe sell in our stores is subject to regulatory standards set by variousgovernmental authorities with respect to quality and safety. Regulations andstandards in this area may change from time to time, and substantial additionalregulations and standards have been proposed. Issues with the quality andsafety of merchandise we sell in our stores, regardless of our fault, orcustomer concerns about such issues, could result in damage to our reputation,lost sales, uninsured product liability claims or losses, merchandise recallsand increased costs, which could have an adverse effect on our results ofoperations. Further, we are susceptible to the receipt of counterfeit brands orunlicensed goods. We could incur liability with manufacturers or other ownersof the brands or trademarked products if we inadvertently receive and sellcounterfeit brands or unlicensed goods and, therefore, it is important that weestablish relationships with reputable vendors to prevent the possibility thatwe inadvertently receive counterfeit brands or unlicensed goods. Although wehave a quality assurance team to check merchandise in an effort to assure thatwe purchase only authentic brands and licensed goods and are careful inselecting our vendors, we may receive products that we are prohibited fromselling or incur liability for selling counterfeit brands or unlicensed goods,which could adversely impact our results of operations.

 

**If our growth strategy is****unsuccessful,our financial condition and results of operations could suffer and the marketprice of our common stock could decline.**

 

Our ability to continue to increase our net sales andearnings depends, in large part, on opening new stores and operating the new andexisting stores profitably. We opened 39, 42 and 42 new stores in fiscal 2008,2007 and 2006, respectively. We expect to open approximately 45 new stores infiscal 2009. If we are unable to open all of these stores or operate themprofitably, we may not achieve our forecasted sales and earnings growthtargets. The success of our growth strategy is dependent upon, among otherthings, the identification of suitable markets and sites for store locations,the negotiation of acceptable lease terms, the hiring, training and retentionof competent sales personnel, the effective management of inventory to meet theneeds of new and existing stores on a timely basis, the expansion of ourinfrastructure to accommodate growth, and generating sufficient operating cash flowsor securing adequate capital on commercially reasonable terms to fund ourexpansion plans. Additionally, growth of our store base will place increaseddemands on our operating, managerial and administrative resources and may leadto management and operating inefficiencies, including merchandising, personnel,distribution and integration problems. These demands and inefficiencies maycause deterioration in the financial performance of our individual stores and,therefore, our entire business.

 

**A significant disruption to ourdistribution process or southeastern retail locations could have an adverseeffect on our business, financial condition and results of operations.**

 

Our ability to distribute our merchandise to our storelocations in a timely manner is essential to the efficient and profitableoperation of our business. We have distribution centers located in Savannah,Georgia and Darlington, South Carolina. Any natural disaster or otherdisruption to the operation of either of these facilities due to fire,accidents, weather conditions or any other cause could damage a significantportion of our inventory and impair our ability to stock our stores adequately.

 

In addition, the southeastern United States, where ourdistribution centers and many of our stores are located, is vulnerable tosignificant damage or destruction from hurricanes and tropical storms. Althoughwe maintain insurance on our stores and other facilities, the economic effectsof a natural disaster that affects our distribution centers and/or asignificant number of our stores could increase our operating expenses, impairour cash flows and reduce our revenues.

 

**Our sales, inventory levels andearnings fluctuate on a seasonal basis, which makes our business moresusceptible to adverse events that occur during the first and fourth quarters.**

 

Our sales and earnings are significantly higher duringthe first and fourth quarters each year due to the importance of the springselling season, which includes Easter, and the fall selling season, whichincludes Christmas. Factors negatively affecting us during the first and fourthquarters, including adverse weather and unfavorable economic conditions, willhave a greater adverse effect on our financial condition than if our businesswas less seasonal.

 

In order to prepare for the spring and fall sellingseasons, we must order and keep in stock significantly more merchandise thanduring other parts of the year. This seasonality makes our business moresusceptible to the risk that our inventory will not satisfy actual consumerdemand. In addition, any unanticipated demand imbalances during these peakshopping seasons could require us to sell excess inventory at a substantialmarkdown or fail to satisfy our consumers. In either event, our sales and grossmargins may be lower than historical levels, which could have an adverse effecton our business, financial condition and results of operations.

 

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**We experience fluctuations andvariability in our comparable store sales and quarterly results of operationsand, as a result, the market price of our common stock may fluctuatesubstantially.**

 

Our comparable store sales and quarterly results havefluctuated significantly in the past based on a number of economic, seasonaland competitive factors, and we expect them to continue to fluctuate in thefuture. Since the beginning of fiscal 2005, our quarter-to-quarter comparablestore sales have ranged from a decrease of 4.2% to an increase of 25.0%. Themost significant fluctuations were due to the unusually high sales followingHurricanes Katrina, Rita and Wilma. In addition, we may be unable to maintainhistorical levels of comparable store sales as we execute our growth strategyand expand our business. This variability could cause our comparable storesales and quarterly results to fall below the expectations of securitiesanalysts or investors, which could result in a decline in the market price ofour common stock.

 

**Our sales could decline as a resultof general economic and other factors outside of our control, such as changesin consumer spending patterns and declines in employment levels.**

 

Downturns, or the expectation of a downturn, ingeneral economic conditions, including the effects of unemployment levels,interest rates, levels of consumer debt, inflation in food and energy prices,taxation, consumer confidence and other macroeconomic factors, could adverselyaffect consumer spending patterns, our sales and our results of operations. Thedeterioration in global economic conditions that began in 2008 may continue toadversely affect our business and could have an adverse impact on our majorsuppliers and landlords. Consumer confidence may also be affected by domesticand international political unrest, acts of war or terrorism, natural disastersor other significant events outside of our control, any of which could lead toa decrease in spending by consumers. Because apparel generally is adiscretionary purchase, declines in consumer spending patterns may have a morenegative effect on apparel retailers than some other retailers. Therefore, wemay not be able to maintain our historical rate of growth in revenues and earnings,or remain as profitable, if there is a continued decline in consumer spendingpatterns. In addition, since the majority of our stores are located in thesoutheastern United States, our operations are more susceptible to regionalfactors than the operations of our more geographically diversified competitors.Therefore, any adverse economic conditions that have a disproportionate effecton the southeastern United States could have a greater negative effect on oursales and results of operations than on retailers with a more geographicallydiversified store base.

 

**If we fail to protect our trademarks,there could be a negative effect on our brand image and limitations on ourability to penetrate new markets.**

 

We believe that our “Citi Trends” trademark isintegral to our store design and our success in building consumer loyalty toour brand. We have registered this trademark with the U.S. Patent and TrademarkOffice. We have also registered, or applied for registration of, additionaltrademarks with the U.S. Patent and Trademark Office that we believe areimportant to our business. We cannot assure you that these registrations willprevent imitation of our name, merchandising concept, store design or privatelabel merchandise or the infringement of our other intellectual property rightsby others. Imitation of our name, concept, store design or merchandise in amanner that projects lesser quality or carries a negative connotation of ourbrand image could have an adverse effect on our business, financial conditionand results of operations.

 

In addition, we cannot assure you that others will nottry to block the manufacture or sale of our private label merchandise byclaiming that our merchandise violates their trademarks or other proprietaryrights since other entities may have rights to trademarks that contain the word“Citi” or may have rights in similar or competing marks for apparel and/oraccessories. Although we cannot currently estimate the likelihood of success ofany such lawsuit or ultimate resolution of such a conflict, such a controversycould have an adverse effect on our business, financial condition and resultsof operations.

 

**If we fail to implement and maintaineffective internal controls in our business, there could be an adverse effecton our business, financial condition, results of operations and stock price.**

 

Section 404 of the Sarbanes Oxley Act of 2002requires annual management assessments of the effectiveness of our internalcontrols over financial reporting and an audit of such controls by ourindependent registered public accounting firm. If we fail to maintain theadequacy of our internal controls, we may be unable to conclude on an ongoingbasis that we have effective internal controls over financial reporting.Moreover, effective internal controls, particularly those related to revenuerecognition and accounting for inventory/cost of sales, are necessary for us toproduce reliable financial reports and are important in our effort to preventfinancial fraud. If we cannot produce reliable financial reports or preventfraud, our business, financial condition and results of operations could beharmed, investors could lose confidence in our reported financial information,the market price of our stock could decline significantly and we may be unableto obtain additional financing to operate and expand our business.

 

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**Adverse trade restrictions may disruptour supply of merchandise. We also face various risks because much of ourmerchandise is imported from abroad.**

 

We purchase the products we sell directly from over1,200 vendors, and a substantial portion of this merchandise is manufacturedoutside of the United States and imported by our vendors from countries such asChina and other areas of the Far East. The countries in which our merchandisecurrently is manufactured or may be manufactured in the future could becomesubject to new trade restrictions imposed by the United States or other foreigngovernments. Trade restrictions, including increased customs restrictions andtariffs or quotas, against apparel items, as well as United States or foreignlabor strikes, work stoppages or boycotts, could increase the cost orreduce the supply of apparel available to us and have an adverse effect on ourbusiness. In addition, our merchandise supply could be impacted if our vendors’imports become subject to existing or future duties and quotas, or if our vendorsface increased competition from other companies for production facilities,import quota capacity and shipping capacity.

 

We also face a variety of other risks generallyassociated with relying on vendors that do business in foreign markets andimport merchandise from abroad, such as:

 

·                  political instability, natural disasters, or thethreat of terrorism, in particular in countries where our vendors sourcemerchandise;

 

·                  increases in merchandise costs due to raw materialprice inflation or changes in purchasing power caused by fluctuations incurrency exchange rates;

 

·                  enhanced security measures at United States andforeign ports, which could delay delivery of imports;

 

·                  imposition of new or supplemental duties, taxes, andother charges on imports;

 

·                  delayed receipt or non-delivery of goods due to thefailure of foreign-source suppliers to comply with import regulations;

 

·                  delayed receipt or non-delivery of goods due toorganized labor strikes or congestion at United States ports; and

 

·                  local business practice and political issues, includingissues relating to compliance with domestic or international labor standards.

 

The United States may impose new initiatives thatadversely affect the trading status of countries where apparel is manufactured.These initiatives may include retaliatory duties or other trade sanctions that,if enacted, would increase the cost of products imported from countries whereour vendors acquire merchandise.

 

**We may continue to experience market conditionsthat could adversely affect the valuation and liquidity of our investmentportfolio.**

 

As of January 31, 2009, we had $43.8 million (atpar value) of investments in municipal auction rate securities (“ARS”) issuedby student loan funding organizations. These securities are high-grade (atleast AA-rated with one or more rating agencies) and approximately 79% areeither guaranteed by the Department of Education under the Federal FamilyEducation Loan Program (37%) or backed by insurance companies, AMBAC AssuranceCorporation (31%) or MBIA Insurance Corporation (11%). Historically, liquidityfor investors in ARS was provided via an auction process that reset theinterest rate every 35 days, allowing investors to either roll over theirinvestments or sell them at par value. Beginning in February 2008, therewas insufficient demand for these types of investments during the auctions and,as a result, these securities became illiquid. Although the auctions for thesecurities have failed, certain issuers did redeem, at par value, $8.2 millionof ARS held by us, and one of our investment banks purchased, at par value,$4.0 million of ARS held by us.  Inaddition, we have not experienced any defaults and continue to earn and receiveinterest on all of the investments that we still own.  However, interest rates had declined by theend of fiscal 2008 to levels that were much lower than earlier in theyear.  As a result, interest income maybe significantly lower in 2009 than in 2008.

 

In November 2008, we accepted an offer (the “Right”)from UBS AG (“UBS”) allowing us to sell at par value our remaining ARS to UBSat anytime during a two-year period from June 30, 2010 through July 2,2012.  In accepting the Right, we grantedUBS the authority to sell or auction the ARS at par value at any time up untilthe expiration date of the Right and released UBS from any claims relating tothe marketing and sale of ARS.  We willcontinue to earn interest on the ARS until they are liquidated.  The obligations of UBS under the Right arenot secured by its assets and do not require UBS to obtain any financing topurchase the ARS.  UBS has disclaimed anyassurance that it will have sufficient financial resources to satisfy itsobligations under the Right.  If UBS doesnot have sufficient funding to buy back the ARS and no alternative buyers arelocated either through the auction process, issuer redemptions or other means,then we may not be able to access cash by selling these securities withoutincurring a loss of principal.

 

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**Failureto attract, train, assimilate and retain skilled personnel could have anadverse effect on our growth strategy and our financial condition.**

 

Like most retailers, we experience significantemployee turnover rates, particularly among store sales associates andmanagers, and our continued growth will require us to hire and train even morenew personnel. We therefore must continually attract, hire and train newpersonnel to meet our staffing needs. We constantly compete for qualifiedpersonnel with companies in our industry and in other industries. A significantincrease in the turnover rate among our store sales associates and managerswould increase our recruiting and training costs and could decrease ouroperating efficiency and productivity.

 

If we are unable to retain our employees or attract,train, assimilate or retain other skilled personnel in the future, we may notbe able to service our customers as effectively, thus reducing our ability tocontinue our growth and to operate our existing stores as profitably as we havein the past.

 

**Increases in the minimum wage couldhave an adverse effect on our business, financial condition and results ofoperations.**

 

The Fair Minimum Wage Act of 2007 became law on May 25,2007. As a result, the federal minimum wage increased to $5.85 per hour in July 2007,then to $6.55 per hour in July 2008, and will increase again to $7.25 perhour in July 2009.  Additionally, from time to time, legislativeproposals are made to increase the minimum wage in certain individual states.Wage rates for many of our employees are slightly above the minimum wage. Asfederal and/or state minimum wage rates increase, we may need to increase notonly our employees’ wage rates that are under the new minimum, but also thewages paid to our other hourly employees. Any increase in the cost of our laborcould have an adverse effect on our operating costs, financial condition andresults of operations.

 

**Any failure of our managementinformation systems or the inability of third parties to continue to upgradeand maintain our systems could have an adverse effect on our business,financial condition and results of operations.**

 

We depend on the accuracy, reliability and properfunctioning of our management information systems, including the systems usedto track our sales and facilitate inventory management. We also rely on ourmanagement information systems for merchandise planning, replenishment and markdowns,as well as other key business functions. These functions enhance our ability tooptimize sales while limiting markdowns and reducing inventory risk throughproperly marking down slow-selling styles, reordering existing styles andeffectively distributing new inventory to our stores. We do not currently haveredundant systems for all functions performed by our management informationsystems. Any interruption in these systems could impair our ability to manageour inventory effectively, which could have an adverse effect on our business.To support our growth, we will need to expand our management informationsystems, and our failure to link and maintain these systems adequately couldhave an adverse effect on our business.

 

We depend on third-party suppliers to maintain andperiodically upgrade our management information systems, including the softwareprograms supporting our inventory management functions. If any of thesesuppliers is unable to continue to maintain and upgrade these software programsand/or if we are unable to convert to alternate systems in an efficient andtimely manner, it could result in an adverse effect on our business.

 

**Our ability to attract consumers toour stores depends on the success of the strip shopping centers and downtownbusiness districts where our stores are located.**

 

We locate our stores in strip shopping centers, streetfront locations and downtown business districts where we believe our consumersand potential consumers shop. The success of an individual store can depend onfavorable placement within a given strip shopping center or business district.We cannot control the development of alternative shopping destinations near ourexisting stores or the availability or cost of real estate within existing ornew shopping destinations. If our store locations fail to attract sufficientconsumer traffic or we are unable to locate replacement locations on termsacceptable to us, our business could suffer. If one or more of the anchortenants located in the strip shopping centers or business districts where ourstores are located close or leave, or if there is significant deterioration ofthe surrounding areas in which our stores are located, our business may beadversely affected.

 

**Our stock price is subject tovolatility.**

 

Our stock price is volatile. From our initial publicoffering in May 2005 through January 31, 2009, the trading price ofour common stock has ranged from $7.01 to $57.85 per share. As a result of thisvolatility, investors may not be able to sell their common stock at or abovetheir respective purchase prices. The market price for our common stock may beinfluenced by many factors, including:

 

·                  actual or anticipated fluctuations in our operatingresults;

 

·                  changes in securities analysts’ recommendations orestimates of our financial performance;

 

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·                  changes in market valuations or operating performanceof our competitors or companies similar to ours;

 

·                  announcements by us, our competitors or otherretailers;

 

·                  additions and departures of key personnel;

 

·                  changes in accounting principles;

 

·                  the passage of legislation or other developmentsaffecting us or our industry;

 

·                  the trading volume of our common stock in the publicmarket;

 

·                  changes in economic or financial market conditions;

 

·                  natural disasters, terrorist acts, acts of war orperiods of civil unrest; and

 

·                  the realization of some or all of the risks describedin this section entitled “Risk Factors.”

 

In addition, the stock markets have experiencedsignificant price and trading volume fluctuations from time to time, and themarket prices of the equity securities of retailers have been extremely volatileand have recently experienced sharp price and trading volume changes. Thesebroad market fluctuations may adversely affect the market price of our commonstock.

 

**Securities analysts may not continueto cover our common stock or they may issue negative reports, and this may havean adverse impact on the price of our common stock.**

 

The trading market for our common stock relies, inpart, on the research reports that financial analysts publish about our companyor our industry.  Public statements by these securities analysts mayaffect our stock price.  If any of the analysts who cover us downgradesthe rating of our common stock, our common stock price would likelydecline.  If any of these analysts ceases coverage of our common stock, wecould lose visibility in the market, which in turn could cause our common stockprice to decline.  Further, if no analysts continue to cover our commonstock, the lack of research coverage may depress the market price of our commonstock.

 

**We do not currently intend to paydividends on our common stock.**

 

We have never declared or paid any cash dividends onour common stock and do not currently intend to do so for the foreseeablefuture.  In addition, under the terms ofour revolving credit facility, the payment of cash dividends is prohibited.

 

**Provisions in our certificate ofincorporation and by-laws and Delaware law may delay or prevent our acquisitionby a third party.**

 

Our second amended and restated certificate ofincorporation and our amended and restated by-laws contain several provisionsthat may make it more difficult for a third party to acquire control of uswithout the approval of our board of directors. These provisions include, amongother things, a classified board of directors, advance notice for raising businessor making nominations at stockholder meetings and “blank check” preferredstock. Blank check preferred stock enables our board of directors, withoutstockholder approval, to designate and issue additional series of preferredstock with such dividend, liquidation, conversion, voting or other rights,including convertible securities with no limitations on conversion, as ourboard of directors may determine, including rights to dividends and proceeds ina liquidation that are senior to the common stock.

 

We are also subject to several provisions of theDelaware General Corporation Law that could delay, prevent or deter a merger,acquisition, tender offer, proxy contest or other transaction that mightotherwise result in our stockholders receiving a premium over the market pricefor their common stock or may otherwise be in the best interests of ourstockholders.

 

**ITEM1B.****                 ****UNRESOLVED STAFFCOMMENTS**

 

None.

 

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**ITEM2.****                          ****PROPERTIES**

 

**Store Locations**

 

As of January 31, 2009, we operated 357 storeslocated in 22 states. Our stores average approximately 10,200 square feet ofselling space and are typically located in neighborhood strip shopping centersand downtown business districts that are convenient to low- to moderate-incomecustomers. Originally, our stores were located in the Southeast, but in recentyears we expanded into the Mid-Atlantic and Midwest regions and the state ofTexas.

 

We have no franchising relationships, and all of thestores are company operated.  All existing 357 stores, totalingapproximately 4.45 million total square feet and 3.65 million sellingsquare feet, are leased under operating leases. Additionally, as of March 6,2009, we have signed leases for 11 new stores to be opened during fiscal 2009aggregating approximately 122,000 total selling square feet. The typical storelease is for five years with an option to extend the lease term for an additionalfive-year period. Nearly all store leases provide us the right to cancelfollowing an initial three-year period in the event the store does not meetpre-determined sales levels. The table below sets forth the number of stores ineach of the 22 states in which we operated as of January 31, 2009:

 

**Alabama—25**

**Arkansas—7**

**Florida—30**

**Georgia—52**

**Illinois—4**

**Indiana—7**

**Kansas—1**

**Kentucky—3**

**Louisiana—29**

**Maryland—5**

**Michigan—11**

**Mississippi—22**

**Missouri—4**

**North Carolina—34**

**Ohio—13**

**Oklahoma—2**

**Pennsylvania—2**

**South Carolina—39**

**Tennessee—13**

**Texas—37**

**Virginia—16**

**Wisconsin—1**

 

**Support Center Facilities**

 

We own an approximately 170,000 square-foot facilityin Savannah, Georgia, which serves as one of our two distribution centers. Weown another facility in Savannah totaling approximately 70,000 square feet,which serves as our headquarters and, to a lesser extent, as a merchandisestorage facility. We own an approximately 550,000 square-foot facility inDarlington, South Carolina, which serves as a distribution center. We expectthat our existing distribution centers will support our growth plans through2010. In addition, we currently lease an 1,800 square-foot office in New YorkCity which is used for buyer operations and meetings with vendors.

 

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**ITEM 3.****                         ****LEGAL PROCEEDINGS**

 

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

 

**ITEM4.****                         ****SUBMISSION OF MATTERS TOA VOTE OF SECURITY HOLDERS**

 

There were no matters submitted to a vote of securityholders through the solicitation of proxies or otherwise during the fourthquarter of fiscal 2008.

 

**PART II**

 

**ITEM 5.****                      ****MARKET FOR THEREGISTRANT’S COMMON EQUITY,RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**

 

Our common stock is traded on The NASDAQ Stock Marketunder the symbol “CTRN”. The following table shows the high and low per shareprices of our common stock for the periods indicated.

 
| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2007**       |       |     |       |    |       |
| First Quarter  |       | 48.00    |       | 38.20   |       |
| Second Quarter |       | 42.88    |       | 32.44   |       |
| Third Quarter  |       | 38.35    |       | 16.22   |       |
| Fourth Quarter |       | 17.97    |       | 10.76   |       |
|           |       |     |       |    |       |
| **2008**       |       |     |       |    |       |
| First Quarter  |       | 22.73    |       | 12.42   |       |
| Second Quarter |       | 28.12    |       | 17.72   |       |
| Third Quarter  |       | 25.88    |       | 11.33   |       |
| Fourth Quarter |       | 17.46    |       | 7.01    |       |

 

On March 30, 2009,the last reported sale price of our common stock on The NASDAQ Stock Market was$22.03 per share. On March 30, 2009, there were 121 holders of record andapproximately 2,000 beneficial holders of our common stock.

 

We have never declared or paid any cash dividends onour common stock and do not intend to pay any cash dividends on our commonstock in the foreseeable future. In addition, under the terms of our revolvingcredit facility, the payment of cash dividends is prohibited.

 

**Recent Sales of UnregisteredSecurities.**

 

None.

 

**Purchases of Equity Securities by theIssuer and Affiliated Purchasers.**

 

None.

 

**Equity Compensation Plan Information.**

 

See Item 12.

 

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**Stock Performance Graph**

 

Set forth below is a line graph comparing the lastforty-four months percentage change in the cumulative total stockholder returnon shares of our common stock against (i) the cumulative total return ofcompanies listed on The NASDAQ Stock Market and (ii) the cumulative totalreturn of the NASDAQ Retail Trade. The period compared commences May 18,2005, the date on which our common stock began trading on The NASDAQ StockMarket, and ends January 31, 2009. This graph assumes that $100 wasinvested on May 18, 2005 in our common stock and in each of the marketindex and the industry index, and that all cash distributions were reinvested.Our common stock price performance shown on the graph is not indicative offuture price performance.

 

**COMPARISON OF 44 MONTH CUMULATIVE TOTAL RETURN***

Among Citi Trends, Inc., The NASDAQ Composite Index

And The NASDAQ Retail Trade Index

 

 

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*$100invested on 5/18/05 in stock or 4/30/05 in index, including reinvestment ofdividends. Fiscal year ending January 31.

 
| **Total Return Analysis** | ** ** | **5/18/05** | ** ** | **1/06**   | ** ** | **1/07**   | ** ** | **1/08**   | ** ** | **1/09**  | ** ** |
|-------------------------------------|------------|-------------|------------|------------|------------|------------|------------|------------|------------|-----------|------------|
|                                |       |        |       |       |       |       |       |       |       |      |       |
| **Citi Trends, Inc.**          | ** ** | **100.00**  | ** ** | **292.99** | ** ** | **251.02** | ** ** | **87.07**  | ** ** | **60.70** | ** ** |
| **NASDAQ Composite**                | ** ** | **100.00**  | ** ** | **121.23** | ** ** | **132.21** | ** ** | **127.35** | ** ** | **77.32** | ** ** |
| **NASDAQ Retail Trade**             | ** ** | **100.00**  | ** ** | **134.88** | ** ** | **131.94** | ** ** | **143.14** | ** ** | **82.15** | ** ** |

 

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**ITEM 6.****                          ****SELECTED FINANCIAL DATA**

 

**SelectedFinancial and Operating Data**

 

The following table provides selected financial andoperating data for each of the fiscal years in the five-year period ended January 31,2009, including: (a) statement of income data for each such period, (b) additionaloperating data for each such period and (c) balance sheet data as of theend of each such period. The statement of income data for the fiscal yearsended January 31, 2009, February 2, 2008 and February 3, 2007and the balance sheet data as of January 31, 2009 and February 2,2008 are derived from our audited financial statements included in Item 8 thathave been audited by KPMG LLP, an independent registered public accountingfirm. The statement of income data for the fiscal years ended January 28,2006 and January 29, 2005 and the balance sheet data as of February 3,2007, January 28, 2006 and January 29, 2005 are derived from ouraudited financial statements that are not included in this Report. The selectedfinancial and operating data set forth below should be read in conjunctionwith, and are qualified in their entirety by reference to, thesection entitled “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” included in Item 7 and our financialstatements and related notes set forth in the financial pages of thisReport. Historical results are not necessarily indicative of results to beexpected for any future period.

 
| ** **                                                        | ** ** | **Fiscal Year Ended (1)**                                                          | ** ** |
|-------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                                        | ** ** | **January 31,**                                                               | ** ** | **February 2,** | ** ** | **February 3,** | ** ** | **January 28,** | ** ** | **January 29,** | ** ** |
| ** **                                                        | ** ** | **2009**                                                                           | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                        | ** ** | **(dollars in thousands, except per share amounts)** | ** ** |
| Statement of Income Data:                                         |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Net sales                                                         |       | $                                                                                  | 488,202    |   | $ | 437,515 |   | $ | 381,918 |   | $ | 289,804 |   | $ | 203,442 |   |
| Cost of sales                                                     |       | 301,867                                                                            |       | 278,783 |   | 235,744 |   | 178,953 |   | 127,308 |   |
|                                                              |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Gross profit                                                      |       | 186,335                                                                            |       | 158,732 |   | 146,174 |   | 110,851 |   | 76,134 |   |
| Selling, general and administrative expenses                      |       | 147,009                                                                            |       | 127,470 |   | 107,535 |   | 83,559 |   | 58,722 |   |
| Depreciation and amortization                                     |       | 16,261                                                                             |       | 12,583 |   | 8,326 |   | 6,087 |   | 4,872 |   |
|                                                              |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Income from operations                                            |       | 23,065                                                                             |       | 18,679 |   | 30,313 |   | 21,205 |   | 12,540 |   |
| Interest income (expense), net (2)                                |       | 2,188                                                                              |       | 1,914 |   | 1,655 |   | 546 |   | (732 | ) |
|                                                              |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Income before income tax expense                                  |       | 25,253                                                                             |       | 20,593 |   | 31,968 |   | 21,751 |   | 11,808 |   |
| Income tax expense                                                |       | 7,870                                                                              |       | 6,379 |   | 10,617 |   | 7,551 |   | 4,551 |   |
|                                                              |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Net income                                                        |       | $                                                                                  | 17,383     |   | $ | 14,214 |   | $ | 21,351 |   | $ | 14,200 |   | $ | 7,257 |   |
| Net income per common share:                                      |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                                             |       | $                                                                                  | 1.23       |   | $ | 1.02 |   | $ | 1.57 |   | $ | 1.21 |   | $ | 0.78 |   |
| Diluted                                                           |       | $                                                                                  | 1.22       |   | $ | 1.00 |   | $ | 1.51 |   | $ | 1.08 |   | $ | 0.67 |   |
| Weighted average shares used to compute net income per share (3): |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                                             |       | 14,131,077                                                                         |       | 13,946,342 |   | 13,574,718 |   | 11,746,866 |   | 9,302,800 |   |
| Diluted                                                           |       | 14,268,788                                                                         |       | 14,223,229 |   | 14,138,063 |   | 13,148,602 |   | 10,879,388 |   |
| Additional Operating Data:                                        |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Number of stores:                                                 |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Opened during period                                              |       | 39                                                                                 |       | 42 |   | 42 |   | 36 |   | 40 |   |
| Closed during period                                              |       | 1                                                                                  |       | 0 |   | 0 |   | 1 |   | 1 |   |
| Open at end of period                                             |       | 357                                                                                |       | 319 |   | 277 |   | 235 |   | 200 |   |
| Selling square footage at end of period                           |       | 3,654,378                                                                          |       | 3,168,866 |   | 2,628,539 |   | 2,123,684 |   | 1,715,943 |   |
| Comparable store sales increase (4)                               |       | 0.0                                                                                | %          | 1.0 | %(5) | 8.2 | %(5) | 16.7 | %(6) | 3.0 | % |
| Average sales per store (7)                                       |       | $                                                                                  | 1,444      |   | $ | 1,468 |   | $ | 1,492 |   | $ | 1,332 |   | $ | 1,127 |   |
| Balance Sheet Data:                                               |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                         |       | $                                                                                  | 33,516     |   | $ | 6,203 |   | $ | 7,707 |   | $ | 3,995 |   | $ | 6,812 |   |
| Short-term investments                                            |       | —                                                                             |       | 56,165 |   | 65,956 |   | 54,458 |   | — |   |
| Long-term investments                                             |       | 43,825                                                                             |       | — |   | — |   | — |   | — |   |
| Total assets                                                      |       | 240,789                                                                            |       | 210,177 |   | 192,107 |   | 142,205 |   | 65,800 |   |
| Total liabilities                                                 |       | 82,582                                                                             |       | 72,030 |   | 73,898 |   | 58,456 |   | 42,036 |   |
| Total stockholders’ equity                                   |       | 158,207                                                                            |       | 138,147 |   | 118,209 |   | 83,749 |   | 23,764 |   |

 

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(1)            Our fiscal year ends on the Saturday closest to January 31of each year. The years ended January 31, 2009, February 2, 2008, February 3,2007, January 28, 2006 and January 29, 2005 are referred to as fiscal2008, 2007, 2006, 2005 and 2004, respectively. Fiscal 2006 is comprised of 53weeks. Fiscal years 2008, 2007, 2005 and 2004 are each comprised of 52 weeks.

 

(2)            Series A Preferred Stock, which was redeemedusing a portion of the net proceeds from the IPO, was reclassified as debt asof the second quarter of fiscal 2003, in accordance with the FinancialAccounting Standards Board’s (“FASB”) Statement of Financial AccountingStandards (“SFAS”) No. 150, *Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity*.The amount of dividends treated as interest expense was $0 in fiscal 2008, 2007and 2006, $100,000 in fiscal 2005 and $324,000 in fiscal 2004.

 

(3)            Reflects 26 for 1 stock split completed in May 2005.

 

(4)            Stores included in the comparable store salescalculation for any period are those stores that were opened prior to thebeginning of the preceding fiscal year and were still open at the end of suchperiod. Relocated stores and expanded stores are included in the comparablestore sales results.

 

(5)            The Company is reporting comparable store sales on acomparable store and comparable weeks basis; for fiscal 2007, the 52 weeksended February 2, 2008 are compared to the 52 weeks ended February 3,2007; for fiscal 2006, the 53 weeks ended February 3, 2007 are compared tothe 53 weeks ended February 4, 2006.

 

(6)            This data includes the positive impact ofpost-hurricane sales as a result of Hurricanes Katrina, Rita and Wilma duringthe months of September 2005 through January 2006.

 

(7)            Average sales per store is defined as net sales dividedby the average of stores open at the end of the prior period and stores open atthe end of the current period.

 

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**ITEM 7.****                       ****MANAGEMENT’S DISCUSSIONAND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*The following discussion andanalysis of our financial condition and results of operations should be read inconjunction with the section entitled “Selected Financial and OperatingData” and our audited financial statements and the respective related notesincluded elsewhere in this Annual Report on Form 10-K. This discussionmay contain forward-looking statements that involve risks anduncertainties. As a result of many factors, such as those set forth under thesection entitled “Risk Factors” and elsewhere in this Report, our actualresults may differ materially from those anticipated in theseforward-looking statements.*

 

**Overview**

 

We are a rapidly growing, value-priced retailer ofurban fashion apparel and accessories for the entire family. Our merchandiseofferings are designed to appeal to the preferences of fashion consciousconsumers, particularly African-Americans. Originally our stores were located inthe Southeast, and in recent years we expanded into the Mid-Atlantic andMidwest regions and the state of Texas. We operate 357 stores in both urban andrural markets in 22 states.

 

We are pursuing an aggressive store growth strategyand believe that the addition of new stores will be the primary source offuture growth. In fiscal 2008 we opened 39 new stores, entering thePhiladelphia, Pennsylvania and Kansas City, Kansas markets for the first time.We expect to open approximately 45 new stores in fiscal 2009. Approximately 85%of the new stores we intend to open in fiscal 2009 will be located in statesthat we currently serve.

 

We measure performance using key operating statistics.One of the main performance measures we use is comparable store sales growth.We define a comparable store as a store that has been opened for an entirefiscal year. Therefore, a store will not be considered a comparable store untilits 13th month of operation at the earliest or until its 24th month at thelatest. As an example, stores opened in fiscal 2007 and fiscal 2008 were notconsidered comparable stores in fiscal 2008. Relocated and expanded stores areincluded in the comparable store sales results. We also use other operatingstatistics, most notably average sales per store, to measure our performance.As we typically occupy existing space in established shopping centers ratherthan sites built specifically for our stores, store square footage (andtherefore sales per square foot) varies by store. We focus on overall storesales volume as the critical driver of profitability. The average sales perstore has increased over the years, as we have increased comparable store salesand opened new stores that are generally larger than our historical store base.Average sales per store have increased from $0.8 million in fiscal 2000 to$1.4 million in fiscal 2008. In addition to sales, we measure gross profit as apercentage of sales and store operating expenses, with a particular focus onlabor, as a percentage of sales. These results translate into store levelcontribution, which we use to evaluate overall performance of each individualstore. Finally, we monitor corporate expenses against budgeted amounts.

 

**Basis of the Presentation**

 

Net sales consist of store sales and layaway fees, netof returns by customers. Cost of sales consists of the cost of products we selland associated freight costs. Selling, general and administrative expenses arecomprised of store costs, including payroll and store occupancy costs,corporate and distribution center costs and advertising costs. We operate on a52- or 53-week fiscal year, which ends on the Saturday closest to January 31.Each of our fiscal quarters consists of four 13-week periods, with an extraweek added to the fourth quarter every five to six years. The years ended January 31,2009, February 2, 2008, February 3, 2007, January 28, 2006 and January 29,2005 are referred to as fiscal 2008, 2007, 2006, 2005 and 2004, respectively.Fiscal year 2006 is comprised of 53 weeks. Fiscal years 2008, 2007, 2005and 2004 are each comprised of 52 weeks.

 

**Results of Operations**

 

The following discussion of our financial performanceis based on the financial statements set forth in the financial pages ofthis Report. The nature of our business is seasonal. Historically, sales in thefirst and fourth quarters have been higher than sales achieved in the secondand third quarters of the fiscal year. Expenses and, to a greater extent,operating income, vary by quarter. Results of a period shorter than a full yearmay not be indicative of results expected for the entire year.Furthermore, the seasonal nature of our business may affect comparisonsbetween periods.

 

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***Net Sales andAdditional Operating Data***

 

The following table sets forth, for the periodsindicated, selected statement of income data expressed both in dollars and as apercentage of net sales:

 
| ** **                                   | ** ** | **Fiscal Year Ended**                | ** ** |
|----------------------------------------------|------------|--------------------------------------|------------|
| ** **                                   | ** ** | **January 31,**                 | ** ** | **February 2,** | ** ** | **February 3,** | ** ** |
| ** **                                   | ** ** | **2009**                             | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                   | ** ** | **(dollars in thousands)** | ** ** |
| **Statement of Income Data**                 |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net sales                                    |       | $                                    | 488,202    |   | 100.0 | % | $ | 437,515 |   | 100.0 | % | $ | 381,918 |   | 100.0 | % |
| Cost of sales                                |       | 301,867                              |       | 61.8 | % | 278,783 |   | 63.7 | % | 235,744 |   | 61.7 | % |
|                                         |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Gross profit                                 |       | 186,335                              |       | 38.2 | % | 158,732 |   | 36.3 | % | 146,174 |   | 38.3 | % |
| Selling, general and administrative expenses |       | 147,009                              |       | 30.1 | % | 127,470 |   | 29.1 | % | 107,535 |   | 28.2 | % |
| Depreciation and amortization                |       | 16,261                               |       | 3.4 | % | 12,583 |   | 2.9 | % | 8,326 |   | 2.2 | % |
|                                         |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income from operations                       |       | 23,065                               |       | 4.7 | % | 18,679 |   | 4.3 | % | 30,313 |   | 7.9 | % |
| Interest income                              |       | 2,495                                |       | 0.5 | % | 2,383 |   | 0.5 | % | 2,014 |   | 0.5 | % |
| Interest expense                             |       | (307                                 | )          | (0.0 | )% | (469 | ) | (0.1 | )% | (359 | ) | (0.0 | )% |
|                                         |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income before income tax expense             |       | 25,253                               |       | 5.2 | % | 20,593 |   | 4.9 | % | 31,968 |   | 8.4 | % |
| Income tax expense                           |       | 7,870                                |       | 1.6 | % | 6,379 |   | 1.5 | % | 10,617 |   | 2.8 | % |
|                                         |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                   |       | $                                    | 17,383     |   | 3.6 | % | $ | 14,214 |   | 3.4 | % | $ | 21,351 |   | 5.6 | % |

 

The following table provides information, for theperiods indicated, about the number of total stores open at the beginning ofthe period, stores opened and closed during each period, total stores open atthe end of each period and comparable store sales for the periods:

 
| ** **                             | ** ** | **Fiscal Year Ended** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **January 31,**            | ** ** | **February 2,** | ** ** | **February 3,** | ** ** |
| ** **                             | ** ** | **2009**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                   |       |                            |       |   |   |   |   |
| Total stores open, beginning of period |       | 319                             |       | 277 |   | 235 |   |
| New stores                             |       | 39                              |       | 42 |   | 42 |   |
| Closed stores                          |       | 1                               |       | 0 |   | 0 |   |
|                                   |       |                            |       |   |   |   |   |
| Total stores open, end of period       |       | 357                             |       | 319 |   | 277 |   |
|                                   |       |                            |       |   |   |   |   |
| Comparable store sales increase (1)    |       | 0.0                             | %          | 1.0 | %(2) | 8.2 | %(2) |

 

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(1)            Stores included in the comparable store salescalculation for any period are those stores that were opened prior to thebeginning of the preceding fiscal year and were still open at the end of suchperiod. Relocated stores and expanded stores are included in the comparablestore sales results.

 

(2)            The Company is reporting comparable store sales on acomparable store and comparable weeks basis; for fiscal 2007, the 52 weeksended February 2, 2008 are compared to the 52 weeks ended February 3,2007; for fiscal 2006, the 53 weeks ended February 3, 2007 are compared tothe 53 weeks ended February 4, 2006.

 

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***Fiscal 2008Compared to Fiscal 2007***

 

*Net Sales.* Net sales increased $50.7 million,or 11.6%, to $488.2 million in fiscal 2008 from $437.5 million infiscal 2007. The increase in net sales was due to 39 new store openings infiscal 2008 and 42 new store openings in fiscal 2007 for which there was not afull year of sales in 2007, partially offset by the closing of one store in2008. Comparable store sales were up less than 0.1% in fiscal 2008. The39 stores opened in fiscal 2008 accounted for $30.2 million of theincrease in sales, the 42 stores opened in fiscal 2007 accounted for$20.7 million of the increase, and the 276 comparable stores contributed$0.3 million in additional sales, while the closed store had the effect ofreducing sales by $0.5 million. Comparable stores include locations thathave been relocated or expanded. There were 9 stores relocated or expanded infiscal 2008 and 12 stores relocated or expanded in fiscal 2007. Sales in thesecomparable relocated and expanded stores increased 6.2% in fiscal 2008, whilesales in all other comparable stores decreased 0.6%.

 

The negligible increase in comparable store salesincluded a 1.1% increase in the average customer purchase, offset by a similardecrease in the number of customer transactions. Comparable store sales changesby major merchandise class were as follows: Children’s +8%; Home +5%; Men’s-2%; Women’s -3%; Accessories -8%.

 

*Gross Profit.* Gross profit increased$27.6 million, or 17.4%, to $186.3 million in fiscal 2008 from$158.7 million in fiscal 2007. The increase in gross profit is a result ofthe increase in sales, together with an improvement in the gross margin from36.3% in fiscal 2007 to 38.2% in fiscal 2008. This increase in gross marginresulted primarily from merchandise markdowns being approximately 140 basispoints lower as a percentage of sales due to improved management of inventorylevels. In addition, gross margin benefited from inventory shrinkage beingapproximately 40 basis points lower due to the steps taken in the past year tobetter control inventory shrinkage, including, a reduction in the span ofcontrol given to our district managers in order to increase the level of supervision,a greater focus on problem stores by the store operations and loss preventiondepartments, the addition of sophisticated surveillance systems in highshrinkage stores, and lower inventory levels.

 

*Selling, General and AdministrativeExpenses.* Selling,general and administrative expenses increased $19.5 million, or 15.3%, to$147.0 million in fiscal 2008 from $127.5 million in fiscal 2007. Theincrease in these expenses was due primarily to additional store level,distribution and corporate costs arising from the opening of 39 new stores infiscal 2008. Selling, general and administrative expenses as a percentage ofnet sales increased to 30.1% in fiscal 2008 from 29.1% in fiscal 2007, dueprimarily to the deleveraging effect that occurs on expenses as a percentage ofsales when comparable store sales increase at a rate that is lower than therate of inflation on expenses. In particular, payroll-related costsincreased 80 basis points due to this deleveraging effect, together with higherincentive compensation expense resulting from better results in relation togoals, and an increase in store supervision costs in connection with areduction in the span of control given to our district managers. Theseincreases in the expense percentage were partially offset by the benefit inthis year’s comparison of approximately $600,000 of expenses last year relatedto a 2007 secondary stock offering and stock registration of which the Companyreceived no proceeds.

 

*Depreciation and Amortization.*Depreciation and amortization expenseincreased $3.7 million, or 29.2%, to $16.3 million in fiscal 2008 from $12.6million in fiscal 2007, as the result of capital expenditures incurred for newand relocated/expanded stores and the expansion of the Darlington distributioncenter.

 

*Interest Income.* Interest income increased to $2.5million in fiscal 2008 from $2.4 million in fiscal 2007 due primarily to higherinterest rates earned on our investments in auction rate securities once theauctions of such securities began to fail in February 2008 and due to anincrease in market rates for a short period of time during the banking crisisin the third quarter. By the end of fiscal 2008, market interest rates haddeclined from levels earlier in the year, which will likely cause interestincome in fiscal 2009 to be significantly lower than in fiscal 2008.

 

*Interest Expense*. Interest expense decreased to $307,000in fiscal 2008 from $469,000 in fiscal 2007 due to the normal decline in theinterest portion of payments on our capital lease obligations as the principalportion of such obligations is reduced.

 

*Income Tax Expense.* Income tax expense increased $1.5million, or 23.4%, to $7.9 million in fiscal 2008 from $6.4 million infiscal 2007 due primarily to higher pretax earnings in 2008. The effectiveincome tax rates for fiscal 2008 and fiscal 2007 were virtually unchanged at31.2% and 31.0%, respectively. If interest income earned on tax-freeinvestments declines as expected in 2009, it will cause the effective incometax rate to increase due to the reduction in tax-free income.

 

*Net Income.* Net income increased 22.3% to$17.4 million in fiscal 2008 from $14.2 million in fiscal 2007 due tothe factors discussed above.

 

***Fiscal 2007Compared to Fiscal 2006***

 

*Net Sales.* Net sales increased $55.6 million,or 14.6%, to $437.5 million in fiscal 2007 from $381.9 million infiscal 2006. The increase in net sales was due to 42 new store openings infiscal 2007, 42 new store openings in fiscal 2006 for which there was not a

 

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full year of sales in 2006, and a comparable store sales increase of1.0% (note that 1.0% is based on a 52-week fiscal 2007 compared to thecomparable 52 weeks in the prior year), partially offset by the 53-week fiscal2006 having an extra week. The 42 stores opened in fiscal 2007 accountedfor $40.3 million of the total increase in sales, the 42 stores opened infiscal 2006 accounted for $21.4 million of the increase, and the 235comparable stores contributed $3.5 million of the increase in sales on acomparable 52-week versus 52-week basis, but had a $6.1 million decrease on afiscal year basis due to the extra week in fiscal 2006. Sales in the extra weekin fiscal 2006 were $9.6 million. The increase in comparable store saleson a comparable weeks basis included a slight increase in the number of itemsper sale transaction, partially offset by slight declines in the number oftransactions and the average item price.  Comparable store sales changesby major merchandise class were as follows: Children’s +4%; Home +1%; Women’s 0%; Men’s -1%; Accessories -2%.  Comparable stores include locations that havebeen relocated or expanded.  There were12 stores relocated or expanded in fiscal 2007 and 7 stores relocated orexpanded in fiscal 2006.  Sales in thesecomparable relocated and expanded stores increased 18.1% in fiscal 2007, whilesales in all other comparable stores decreased 0.6%.

 

*GrossProfit.* Gross profitincreased $12.5 million, or 8.6%, to $158.7 million in fiscal 2007from $146.2 million in fiscal 2006. The increase in gross profit is aresult of the increase in sales, partially offset by a reduction in the grossmargin. As a percentage of net sales, gross profit decreased to 36.3% in fiscal2007 from 38.3% in fiscal 2006 due to a 210 basis points increase inmerchandise markdowns as a percentage of sales. The increase in markdowns occurred in the third and fourth quarters dueto negative comparable store sales during the months of September and October inthe third quarter and during the critical month of December in the fourthquarter.  With comparable store salesbeing negative during those months, higher clearance markdowns werenecessary.  Inventory shrinkage was 20basis points higher year-over-year; however, the increase in shrinkage wasoffset by a slightly higher initial merchandise mark-up and slightly lowerfreight costs.

 

*Selling,General and Administrative Expenses.* Selling, general and administrative expenses increased$20.0 million, or 18.5%, to $127.5 million in fiscal 2007 from$107.5 million in fiscal 2006. The increase in these expenses was dueprimarily to additional store level, distribution and corporate costs arisingfrom the opening of 42 new stores in fiscal 2007 and approximately $600,000 ofexpenses related to a 2007 secondary stock offering and stock registration ofwhich the Company received no proceeds.   Selling, general andadministrative expenses as a percentage of net sales increased to 29.1% infiscal 2007 from 28.2% in fiscal 2006, due primarily to the deleveraging effectthat occurs on expenses as a percentage of sales when comparable store salesincrease at a rate that is lower than the rate of inflation on expenses. In particular, occupancy expenses as a percent of sales were up 60 basis pointsand payroll was 40 basis points higher.

 

*Depreciationand Amortization.* Depreciationand amortization expense increased $4.3 million, or 51.1%, to $12.6 million infiscal 2007 from $8.3 million in fiscal 2006, as the result of capitalexpenditures incurred for new and relocated/expanded stores and for newscanning technology used in the stores.

 

*InterestIncome.* Interestincome increased to $2.4 million in fiscal 2007 from $2.0 million in fiscal2006 due to higher interest rates and a slightly higher average investmentbalance throughout the year.

 

*InterestExpense*. Interestexpense increased to $469,000 in fiscal 2007 from $359,000 in fiscal 2006 dueto the addition of a $4.8 million capital equipment lease in fiscal 2006.

 

*Income TaxExpense.* Income taxexpense decreased $4.2 million, or 39.9%, to $6.4 million in fiscal 2007 from$10.6 million in fiscal 2006. The effective income tax rates for fiscal2007 and fiscal 2006 were 31.0% and 33.2%, respectively. The tax rate decreasedin fiscal 2007 primarily as a result of continued increases in income taxcredits and tax-exempt interest income, while pretax income was decreasing.

 

*NetIncome.* Net incomedecreased 33.4% to $14.2 million in fiscal 2007 from $21.4 million infiscal 2006 due to the factors discussed above.

 

**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 and 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, if necessary, borrowings under ourrevolving credit facility (described below). In fiscal 2008, there was no needto borrow under the credit facility, including during the seasonal build ofinventory in advance of the Christmas season. Due to our strong cash and cashequivalents position at January 31, 2009 ($33.5 million), we believe thatwe will likely not have to borrow under the credit facility during fiscal 2009.

 

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**Discussionof Cash Flows**

 

***Fiscal 2008 Compared to Fiscal 2007***

 

As of January 31, 2009,we had total cash and cash equivalents of $33.5 million compared withtotal cash and cash equivalents of $6.2 million as of February 2,2008. The most significant factors in the increase in our net liquidityposition during fiscal 2008 were positive cash flow from operations and netsales/redemptions of investment securities, partially offset by capitalexpenditures.

 

Inventory represented 35.8%of our total assets as of January 31, 2009. Management’s ability to manageour inventory can have a significant impact on our cash flows from operationsduring a given interim period or fiscal year. In addition, inventory purchasescan be seasonal in nature, such as the purchase of warm-weather orChristmas-related merchandise.

 

*Cash FlowsProvided by Operating Activities*. Net cash provided by operating activities was $39.6 million infiscal 2008 compared to $16.6 million in fiscal 2007. The main source of cashprovided during fiscal 2008 was net income, adjusted for noncash expenses suchas depreciation and amortization, deferred income taxes, loss on disposal ofproperty and equipment, and stock-based compensation expense, totaling$35.4 million.  In addition, cashprovided by operating activities benefited from accounts payable increasing$8.7 million, despite inventory increasing only $3.8 million, due to improvedinventory turnover which caused a greater percentage of inventory purchases tobe included in accounts payable at the end of fiscal 2008. The only significantuse of cash, other than inventory, was a $4.1 million increase in prepaid andother current assets due to (1) an increase in receivables from landlordsfor tenant improvement reimbursements, as the result of an effort by us to takeon more of the construction work for new store leasehold improvements, in orderto better control the projects, in return for reimbursements from thelandlords, and (2) normal increases in credit card receivables, prepaidrent and prepaid insurance due to the Company’s growth.

 

*Cash FlowsUsed in Investing Activities.* Cash used in investing activities was $11.4 million in fiscal2008 compared to $20.3 million in fiscal 2007. Cash used for the purchaseof property and equipment was $7.1 million lower during fiscal 2008 than infiscal 2007 due primarily to the larger portion of the capital expendituresrelated to the expansion of the Darlington, South Carolina distribution centeroccurring in fiscal 2007.  In addition,fiscal 2007 capital expenditures included the purchase of our corporateheadquarters/inventory storage facility in Savannah, Georgia that hadpreviously been leased. Sales/redemptions of municipal auction rate securities,net of purchases, provided cash of $11.7 million and $9.8 million in 2008 and2007, respectively.

 

*Cash Flows(Used in)/Provided by Financing Activities.* Cash used in financing activities was $0.9million in fiscal 2008 and cash provided by financing activities was$2.2 million in fiscal 2007. Cash used in financing activities consistedof payments on capital lease obligations totaling $1.6 million and $1.8 millionin 2008 and 2007, respectively.  Inaddition, cash totaling $1.0 million was used in fiscal 2008 to settle a stockoption exercise.  Cash provided by financingactivities consisted primarily of the tax benefit from stock option exercisesof $1.2 million in 2008 and $3.5 million in 2007.

 

Until required for otherpurposes, we maintain cash and cash equivalents in deposit or money marketaccounts.

 

***Fiscal 2007 Compared to Fiscal 2006***

 

As of February 2, 2008,we had total cash and cash equivalents of $6.2 million compared with totalcash and cash equivalents of $7.7 million as of February 3, 2007. Themost significant factors in the change in our net liquidity position duringfiscal 2007 were positive cash flow from operations and net sales of investmentsecurities, offset by capital expenditures.

 

Inventory represented 39.2%of our total assets as of February 2, 2008. Management’s ability to manageour inventory can have a significant impact on our cash flows from operationsduring a given interim period or fiscal year. In addition, inventory purchasescan be seasonal in nature, such as the purchase of warm-weather orChristmas-related merchandise.

 

*Cash FlowsProvided by Operating Activities*. Net cash provided by operating activities was $16.6 million infiscal 2007 compared to $19.1 million in fiscal 2006. The main sources of cashprovided during fiscal 2007 were net income, adjusted for noncash expenses suchas depreciation and amortization, deferred income taxes, loss on disposal ofproperty and equipment, and noncash stock-based compensation expense, totaling$27.0 million, and an increase in accrued expenses and other long-termliabilities of $3.8 million. Uses of cash consisted of a $9.1 millionincrease in inventory, a $3.3 million decrease in accounts payable and a $1.1million increase in prepaid assets.  Thechange in income taxes payable was substantially offset by excess tax benefitsfrom stock option exercises. Accounts payable did not increase as wouldtypically be the case when inventory increases, because inventory turns sloweddown, particularly over the last five months of fiscal 2007 when comparablestore sales were negative. The decline in inventory turns forced us to takesignificantly more merchandise markdowns, as discussed in the “Fiscal 2007Compared to Fiscal 2006 - Gross Profit” section above, and caused us to slowdown purchases in the last half of the year. This reduction in purchasescontributed to the decrease in accounts payable at year end. Additionally, wetook advantage of more opportunistic purchases of next-season-buy 

 

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merchandise in 2007.  Such purchases are paid for well in advanceof shipping the merchandise to our stores, causing a reduction in inventoryturns and in accounts payable as a percentage of inventory.

 

*Cash FlowsUsed in Investing Activities.* Cash used in investing activities was $20.3 million in fiscal2007 compared to $26.9 million in fiscal 2006. Cash used for the purchaseof property and equipment increased during fiscal 2007 compared to fiscal 2006due primarily to capital expenditures in the amount of $30.1 million infiscal 2007 for the build out of 42 new stores and twelve storerelocations/expansions, purchase of our corporate headquarters/inventorystorage facility in Savannah, Georgia that had previously been leased,construction work related to the expansion of the Darlington, South Carolinadistribution center, and other general corporate purposes, compared to$20.5 million ($15.7 million, excluding equipment financed by capitalleases) in fiscal 2006 for the build out of 42 new stores and sevenrelocations/expansions, purchase of markdown scanners, build out of ourdistribution center in Darlington, and other general corporate purposes. Netsales of municipal auction rate securities provided cash of $9.8 million in2007, while net purchases of such securities used cash of $11.5 million in2006.

 

*Cash FlowsProvided by Financing Activities.* Cash provided by financing activities was $2.2 million in fiscal2007 and $11.5 million in fiscal 2006. Financing activities consistedprimarily of the tax benefit from stock option exercises of $3.5 million in2007 and $12.2 million in 2006, partially offset by repayments on long-termdebt and capital lease obligations totaling $1.8 million and $0.8 million in2007 and 2006, respectively.

 

**LiquiditySources, Requirements and Contractual Cash Requirements and Commitments**

 

Our principal sources ofliquidity consist of: (i) cash and cash equivalents (which equaled$33.5 million as of January 31, 2009); (ii) short-term tradecredit; (iii) cash generated from operations on an ongoing basis as wesell our merchandise inventory; and (iv) a $20 million revolving creditfacility. Trade credit represents a significant source of financing forinventory purchases and arises from customary payment terms and trade practiceswith our vendors.  Historically, our principal liquidity requirements havebeen for working capital and capital expenditure needs.

 

As of January 31, 2009,we had $43.8 million (at par value) 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 (37%) or backed by insurancecompanies, AMBAC Assurance Corporation (31%) 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 value. Beginning in February 2008,there was insufficient demand for these types of investments during theauctions and, as a result, these securities became illiquid. Although theauctions for the securities have failed, certain issuers did redeem, at parvalue, $8.2 million of ARS held by us, and one of our investment bankspurchased, at par value, $4.0 million of ARS held by us.  In addition, we have not experienced anydefaults and continue to earn and receive interest on all of the investmentsthat we still own.

 

In November 2008, weaccepted an offer (the “Right”) from UBS AG (“UBS”) allowing us to sell at parvalue our remaining ARS to UBS at anytime during a two-year period from June 30,2010 through July 2, 2012.  Inaccepting the Right, we granted UBS the authority to sell or auction the ARS atpar value at any time up until the expiration date of the Right and releasedUBS from any claims relating to the marketing and sale of ARS.  We will continue to earn interest on the ARSuntil they are liquidated.  Theobligations of UBS under the Right are not secured by its assets and do notrequire UBS to obtain any financing to purchase the ARS.  UBS has disclaimed any assurance that it willhave sufficient financial resources to satisfy its obligations under theRight.  If UBS does not have sufficientfunding to buy back the ARS and no alternative buyers are located eitherthrough the auction process, issuer redemptions or other means, then we may notbe able to access cash by selling these securities without incurring a loss ofprincipal.

 

We believe that our existingsources of liquidity will be sufficient to fund our operations and anticipatedcapital expenditures for at least the next 12 months.

 

We anticipate that capitalexpenditures will be approximately $18 million to $20 million infiscal 2009. These expenditures will relate principally to the capital costsassociated with approximately 45 stores that we plan to open in fiscal 2009. Weplan to finance these capital expenditures with cash flow from operations andexisting cash balances and, if necessary, borrowings under our $20 millionrevolving credit facility.

 

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The following tablediscloses aggregate information about our contractual obligations as of January 31,2009 and the periods in which payments are due:

 
| ** **                         | ** ** | **Payments Due by Period** | ** ** |
|------------------------------------|------------|-------------------------------------------|------------|
| ** **                         | ** ** | ** **                                | ** ** | **Less than** | ** ** | **1-3** | ** ** | **3-5** | ** ** | **More than** | ** ** |
| ** **                         | ** ** | **Total**                                 | ** ** | **1 Year** | ** ** | **Years** | ** ** | **Years** | ** ** | **5 Years** | ** ** |
| ** **                         | ** ** | **(in thousands)**                   | ** ** |
| Contractual obligations:           |       |                                      |       |   |   |   |   |   |   |   |   |
| Capital leases                     |       | $                                         | 1,475      |   | $ | 1,475 |   | $ | — |   | $ | — |   | $ | — |   |
| Operating leases (1)               |       | 79,103                                    |       | 22,801 |   | 36,115 |   | 16,367 |   | 3,820 |   |
| Purchase obligations               |       | 72,122                                    |       | 72,122 |   | — |   | — |   | — |   |
| Total contractual cash obligations |       | $                                         | 152,700    |   | $ | 96,398 |   | $ | 36,115 |   | $ | 16,367 |   | $ | 3,820 |   |

 

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(1)   Represents fixed minimum rents in stores and does not includeincremental rents which are computed as a percentage of net sales. For example,in fiscal 2008 incremental percentage rent was approximately $1.6 million,which represented 7.0% of total rent expense.

 

*Indebtedness.* In March 2008, we obtained a $35million unsecured revolving credit facility with Bank of America, replacing a$3 million facility that had been scheduled to expire on June 30,2008.  This new facility has a term of364 days, has an unused commitment fee equal to 0.15%, and has one restrictivefinancial covenant (consolidated leverage ratio).  Our earnings before interest, taxes,depreciation and rent expense have been well in excess of the level required bythe consolidated leverage ratio.  Loansunder the facility bear interest at either (a) a rate equal to the higherof (i) the Federal Funds Rate plus 0.50% and (ii) Bank of America’sprime rate, plus an applicable margin; or (b) a rate equal to LIBOR plusan applicable margin. The applicable margin is dependent on our consolidatedleverage ratio and ranges from 1.00% to 1.50% for LIBOR-based loans, and from0.00% to 0.50% for prime rate-based loans. We have had no borrowings under thisfacility.

 

OnMarch 25, 2009, we amended the credit facility with Bank of America toextend the expiration date to March 24, 2010 and to lower the commitmentto $20 million, reflecting our year end cash position and the fact that we havehad no borrowings under the facility.  Inaddition, changes were made to the pricing of the facility, including anincrease in the unused commitment fee to 0.25% and an amendment of the interestrates. Loans under thefacility now bear interest at either (a) a rate equal to the highest of (i) theFederal Funds Rate plus 0.50%, (ii) LIBOR plus 1.0% and (iii) Bank ofAmerica’s prime rate, plus an applicable margin; or (b) a rate equal toLIBOR plus an applicable margin. The applicable margin is dependent on ourconsolidated leverage ratio and ranges from 0.75% to 1.25% for loans bearinginterest at the rate described under (a) above and from 1.75% to 2.25% forloans bearing interest at the rate described under (b) above.

 

We previously had a $25million revolving line of credit with Wachovia Capital Finance secured bysubstantially all of our assets and pursuant to which we paid customary fees.This secured line of credit expired on April 2, 2007 and was not renewed.

 

*CapitalLeases.* We havecapital lease obligations that financed the purchase of technology equipment.As of January 31, 2009, our capital lease obligations, including interest,were $1.5 million. These obligations have a maturity date of December 2009and an interest rate of 11.3%. All of these obligations are secured by thetechnology equipment.  The lease agreements contain cross defaultprovisions which result in a default if the Company is out of compliance withany other borrowing agreements.

 

*OperatingLeases.* We lease ourstores under operating leases, which generally have an initial term of fiveyears with renewal options. The typical store lease requires a combination ofboth fixed monthly rents and contingent rents computed as a percentage of netsales after a certain sales threshold has been met. For fiscal 2008, rentexpense was $23.1 million compared to $19.3 million in fiscal 2007(including approximately $1.6 million and $1.9 million of percentage rent,respectively, in fiscal 2008 and 2007).

 

*PurchaseObligations.* As of January 31,2009, we had purchase obligations of $72.1 million, all of which were for lessthan one year. These purchase obligations primarily consist of outstanding merchandiseorders.

 

**Off-BalanceSheet Arrangements**

 

Other than the storeoperating leases described above, we do not have any off-balance sheetarrangements.

 

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**OutstandingStock Options**

 

As of January 31, 2009,we had outstanding vested options to purchase 154,170 shares of common stock ata weighted average exercise price of $15.94 per share and outstanding unvestedoptions to purchase 54,680 shares of common stock at a weighted average priceof $29.09 per share. The per share value of each share of common stockunderlying the vested and unvested options, based on the difference between theexercise price per option and the estimated fair market value of the shares atthe dates of the grant of the options (also referred to as intrinsic value),ranges from $0 to $1.25 per share. Based on the closing price of our commonstock of $9.53 per share on January 30, 2009, the intrinsic value of theoptions outstanding on January 31, 2009 was $392,000, all of which relatedto vested options.

 

**CriticalAccounting Policies and Estimates**

 

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. Webelieve the following critical accounting policies describe the moresignificant judgments and estimates used in the preparation of the financialstatements:

 

***Revenue Recognition***

 

While the recognition ofrevenue is predominantly derived from routine retail transactions and does notinvolve significant judgment, revenue recognition represents an importantaccounting policy of ours. We recognize retail sales net of sales taxes at thetime the customer takes possession of and pays for merchandise, less anallowance for returns. We allow for returns up to ten days after the dateof sale and we reduce revenues for each fiscal year for returns in theten days after the year ends. As of January 31, 2009, the reserve forreturns was $258,000. Revenue from layaway sales is recognized when thecustomer has paid for and received the merchandise. If the merchandise is notfully paid for within sixty days, the customer is given a store credit formerchandise payments made, less a re-stocking fee and a layaway servicecharge.  Layaway service charges, whichare non-refundable, are recognized in revenue when collected. All sales arefrom cash, check or major credit card company transactions. We do not offercompany-sponsored customer credit accounts or gift cards. There were nomaterial changes in the estimates or assumptions related to revenue recognitionduring fiscal 2008.

 

***Inventory***

 

Inventory is stated at thelower of cost (first-in, first-out basis) or market as determined by the retailinventory method, less a provision for estimated inventory shrinkage. Under theretail inventory method, the cost value of inventory and gross margins are determinedby calculating a cost-to-retail ratio and applying it to the retail value ofinventory. Inherent in the retail inventory calculation are certain significantmanagement judgments and estimates, including, among others, merchandisemarkups, markdowns and shrinkage, which impact the ending inventory valuationat cost as well as resulting gross margins. We estimate shrinkage for theperiod between the last physical count and the balance sheet date. The estimatefor the shrinkage reserve can be affected by changes in actual shrinkagetrends. Inventory shrinkage as a percentage of sales has ranged from 1.5% to1.9% during fiscal years 2006 through 2008. We believe the first-in, first-outretail inventory method results in an inventory valuation that is fairlystated. Many retailers have arrangements with vendors that provide for rebatesand allowances under certain conditions, which ultimately affect the value ofthe inventory. We do not generally enter into such arrangements with ourvendors. There were no material changes in the estimates or assumptions relatedto the valuation of inventory during fiscal 2008.

 

***Property and Equipment, net***

 

We have a significantinvestment in property and equipment. Property and equipment are stated at costless accumulated depreciation and amortization. Equipment under capital leasesis stated at the present value of the required minimum lease payments.Depreciation and amortization are computed using the straight-line method overthe lesser of the estimated useful lives (primarily three to five years forcomputer equipment and furniture, fixtures and equipment, five years forleasehold improvements, seven years for major purchased software systems, andfifteen to twenty years for buildings and building improvements) of the relatedassets or the relevant lease term, as defined in SFAS No. 13, *Accounting for Leases*. Any reduction in these estimateduseful lives would result in a higher annual depreciation expense for therelated assets. There were no material changes in the estimates or assumptionsrelated to the valuation and classification of property and equipment duringfiscal 2008.

 

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***Impairment of Long-Lived Assets***

 

We continually evaluatewhether events and changes in circumstances warrant revised estimates of theuseful lives or recognition of an impairment loss for long-lived assets. Futureadverse changes in market and legal conditions, or poor operating results ofunderlying assets could result in losses or an inability to recover thecarrying value of long-lived assets, thereby possibly requiring an impairmentcharge. If facts and circumstances indicate that a long-lived asset, includingproperty and equipment, may be impaired, the carrying value is reviewed. Ifthis review indicates that the carrying value of the asset will not berecovered as determined based on projected undiscounted cash flows related tothe asset over its remaining life, the carrying value of the asset is reducedto its estimated fair value. Impairment losses in the future are dependent on anumber of factors such as site selection and general economic trends, and thuscould be significantly different from historical results. To the extent ourestimates for net sales, gross profit and store expenses are not realized,future assessments of recoverability could result in impairment charges. Therewere no impairment charges during fiscal years 2006 through 2008. There were nomaterial changes in the estimates or assumptions related to impairment oflong-lived assets during fiscal 2008.

 

***Fair Value Measurements***

 

Effective February 3,2008, we adopted the methods of fair value as described in SFAS No. 157, *Fair Value Measurements,* to value ourfinancial assets and liabilities. SFAS No. 157 defines fair value as theprice that would be received to sell an asset or paid to transfer a liabilityin an orderly transaction between market participants in the principal or mostadvantageous market at the measurement date. This statement also establishes afair value hierarchy that prioritizes observable and unobservable inputs usedto measure fair value into three broad levels, which are described below:

 

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

 

Level 2:  Observable prices thatare based on inputs not quoted on active markets, but corroborated by marketdata.

 

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

 

As of January 31, 2009,we had $43.8 million (at par value) of investments in municipal auction ratesecurities (“ARS”) issued by student loan funding organizations. The ARS areclassified as trading securities in noncurrent assets and are reflected atestimated fair value. These securities are high-grade (at least AA-rated withone or more rating agencies) and approximately 79% are either guaranteed by theDepartment of Education under the Federal Family Education Loan Program (37%)or backed by insurance companies, AMBAC Assurance Corporation (31%) or MBIAInsurance Corporation (11%). Historically, liquidity for investors in ARS wasprovided via an auction process that reset the interest rate every 35 days,allowing investors to either roll over their investments or sell them at parvalue. Beginning in February 2008, there was insufficient demand for thesetypes of investments during the auctions and, as a result, these securitiesbecame illiquid. Although the auctions for the securities have failed, certainissuers did redeem, at par value, $8.2 million of ARS held by us, and one ofour investment banks purchased, at par value, $4.0 million of ARS held byus.  In addition, we have not experiencedany defaults and continue to earn and receive interest on all of theinvestments that we still own.

 

There was insufficientobservable market information available as of January 31, 2009 todetermine the fair value of ARS held by us. Accordingly, we estimated Level 3fair values for these securities based on assumptions that market participantswould use in their estimates of fair value. These assumptions included, amongother things, discounted cash flow projections, the timing of expected futuresuccessful auctions or redemptions, collateralization of the underlyingsecurities and the creditworthiness of the issuers and insurancecompanies.  Based on this Level 3valuation, we valued the ARS investments at $38.9 million as of January 31,2009, representing a $4.9 million decline from par value. Prior to fiscal 2008,the ARS were valued at par value due to the frequent resets that historicallyoccurred through the auction process.

 

In November 2008, weaccepted an offer (the “Right”) from UBS AG (“UBS”) allowing us to sell at parvalue our remaining ARS to UBS at anytime during a two-year period from June 30,2010 through July 2, 2012.  Inaccepting the Right, we granted UBS the authority to sell or auction the ARS atpar value at any time up until the expiration date of the Right and releasedUBS from any claims relating to the marketing and sale of ARS.  We will continue to earn interest on the ARSuntil they are liquidated.  Theobligations of UBS under the Right are not secured by its assets and do notrequire UBS to obtain any financing to purchase the ARS.  UBS has disclaimed any assurance that it willhave sufficient financial resources to satisfy its obligations under theRight.  If UBS does not have sufficientfunding to buy back the ARS and no alternative buyers are located eitherthrough the auction process, issuer redemptions or other means, then we may notbe able to access cash by selling these securities without incurring a loss ofprincipal.

 

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The Right represents a put option and is recognizedas an instrument separate from the ARS. We elected to account for this Right at fair value under SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities.*  We valued the Right using a discounted cashflow approach that includes estimates of interest rates and the credit riskassociated with UBS.  This valuation isbased on unobservable inputs, therefore, represents a Level 3 fair value.  We recorded a $4.9 million gain associatedwith the Right, together with the $4.9 million ARS impairment charge discussedabove.  We expect that subsequent changesin the value of the Right will largely offset the subsequent fair valuemovements of the ARS, subject to the continued expected performance by UBS ofits obligations under the Right.

 

***Stock-Based Compensation***

 

SFAS No. 123 (revised2004), *Share-Based Payment* (“SFASNo. 123R”), requires the measurement and recognition of compensationexpense for all stock-based awards made to employees based on the estimatedfair value of the award.  The determination of the fair value of our stockoptions on the date of grant using an option-price model is affected by ourstock price as well as assumptions regarding a number of complex and subjectivevariables.  These variables include, but are not limited to, the expectedstock price volatility over the term of the awards and actual and projectedemployee stock option exercise behaviors. The fair values of options issuedpursuant to the stock based compensation plans are estimated at each grant dateusing the Black-Scholes Merton option pricing model, while grants of nonvestedrestricted stock are valued based on the closing stock price on the grantdate. If factors change and we employ different assumptions in theapplication of SFAS No. 123R in future periods, the compensation expenserecorded under SFAS No. 123R may differ significantly from the amountrecorded in the current period. There were no material changes in the estimatesor assumptions used to determine stock-based compensation during fiscal 2008.

 

***Operating Leases***

 

We lease all of our storeproperties and account for the leases as operating leases in accordance withSFAS No. 13, *Accounting forLeases.* Many lease agreements contain tenant improvement allowances,rent holidays, rent escalation clauses and/or contingent rent provisions. Forpurposes of recognizing incentives and minimum rent expenses on a straight-linebasis over the terms of the leases, we use the date of initial possession tobegin amortization, which is generally when we enter the space and begin tomake improvements in preparation of intended use.

 

For scheduled rentescalation clauses during the lease terms or for rental payments commencing “rentholidays” at a date other than the date of initial occupancy, we record minimumrent expenses on a straight-line basis over the terms of the leases. For tenantimprovement allowances we record a deferred rent liability on the balance sheetand amortize the deferred rent over the terms of the leases.

 

Certain leases provide forcontingent rents that are not measurable at inception. These contingent rentsare primarily based on a percentage of net sales that are in excess of apredetermined level. These amounts are excluded from minimum rent and areincluded in the determination of total rent expense when it is probable thatthe expense has been incurred and the amount is reasonably estimable. Therewere no material changes in the estimates or assumptions related to operatingleases during fiscal 2008.

 

***Accounting for Income Taxes***

 

We account for income taxesin accordance with SFAS No. 109, *Accountingfor Income Taxes*. The computation of income taxes is subject toestimation due to the judgment required and the uncertainty related to therecoverability of deferred tax assets or the outcome of tax audits. We adjustour income tax provision in the period it is determined that actual resultswill differ from our estimates. Tax law and rate changes are reflected in theincome tax provision in the year in which such changes are enacted. There wereno material changes in the estimates or assumptions related to income taxesduring fiscal 2008.

 

The above listing is notintended to be a comprehensive list of all our accounting policies. In manycases the accounting treatment of a particular transaction is specificallydictated by U.S. generally accepted accounting principles, with no need formanagement’s judgment in their application. There are also areas in whichmanagement’s judgment in selecting any available alternative would not producea materially different result.

 

**RecentAccounting Pronouncements**

 

In May 2008, the FASBissued SFAS No. 162, *The Hierarchy of GenerallyAccepted Accounting Principles.* SFAS No. 162 identifies the sources of accounting principles andthe framework for selecting the principles to be used in the preparation offinancial statements of nongovernmental entities that are presented inconformity with generally accepted accounting principles in the UnitedStates.  SFAS No. 162 was effective November 15,2008 and did not have a significant impact on our financial statements.

 

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Effective February 3,2008, we adopted SFAS No. 157 which defines fair value, establishes aframework for measuring fair value, and requires additional disclosures aboutfair value measurements. SFAS No. 157 applies to fair value measurementsthat are already required or permitted by other accounting standards, exceptfor measurements of share-based payments and measurements that are similar to,but not intended to be, fair value and does not change existing guidance as towhether or not an instrument is carried at fair value. In February 2008,the FASB issued FASB Staff Position No. 157-2, *EffectiveDate of Statement No. 157,*which provided a one year deferralof the effective date of SFAS No. 157 for non-financial assets andnon-financial liabilities, except those that are recognized or disclosed in thefinancial statements at fair value at least annually. Therefore, we adopted theprovisions of SFAS No. 157 with respect to our financial assets andfinancial liabilities only in fiscal 2008. The adoption of this statement didnot have a material impact on our financial statements.  Effective February 1, 2009, we adoptedSFAS No. 157 for non-financial assets and non-financial liabilities, andit did not have a material impact on our financial statements.  In October 2008, the FASB issued StaffPosition No. FAS 157-3, *Determining the Fair Valueof a Financial Asset When the Market for That Asset is Not Active* (“FSPFAS 157-3”), which clarified the application of SFAS No. 157 in caseswhere a market is not active. We have considered the guidance provided by FSPFAS 157-3 in our determination of fair values as of January 31, 2009, andthe impact was not material.

 

Effective February 3,2008, we adopted SFAS No. 159, whichpermits entities to choose to measure specified financial assets and financialliabilities at fair value. Election of the fair value option isirrevocable and is applied on a contract-by-contract basis. The adoption ofSFAS No. 159 did not have a material impact on our financial statementssince we did not elect to apply the fair value option for any of our eligiblefinancial instruments or other items on the effective date of adoption.

 

In December 2007, theSEC issued Staff Accounting Bulletin 110, *Share-Based Payment*(“SAB 110”).  SAB 110 allows forcontinued use of the simplified method for estimating the expected term of “plainvanilla” share option grants under specified conditions.  The expected term used to value a shareoption grant under the simplified method is the mid-point between the vestingdate and the contractual term of the share option.  SAB 110 eliminates the December 31, 2007sunset provision previously specified in SAB 107.  SAB 110 is effective for share option grantsmade on or after January 1, 2008. We have utilized the simplified method for estimating the expected termof our stock option grants under SAB 107 and SAB 110 and will continue toutilize this simplified method until we have sufficient historical exercisedata to provide a reasonable basis to estimate the expected term.

 

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**ITEM 7A.****      ****QUANTITATIVE AND QUALITATIVEDISCLOSURE ABOUT MARKET RISK**

 

We are exposed to financialmarket risks related to changes in interest rates connected with our revolvingcredit facility, which bears interest at variable rates. We cannot predictmarket fluctuations 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 fiscal 2008, because we did not borrowduring the year.  We do not engage in financial transactions for tradingor speculative purposes and have not entered into any interest rate hedgingcontracts.

 

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 currency exchange rates could affect our purchasingpower with vendors that import merchandise to sell to us. We have not enteredinto forward contracts to hedge against fluctuations in foreign currencyprices.

 

As of January 31, 2009,we had $43.8 million (at par value) 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 (37%) or backed by insurancecompanies, AMBAC Assurance Corporation (31%) 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 value. Beginning in February 2008,there was insufficient demand for these types of investments during theauctions and, as a result, these securities became illiquid. Although theauctions for the securities have failed, certain issuers did redeem, at parvalue, $8.2 million of ARS held by us, and one of our investment bankspurchased, at par value, $4.0 million of ARS held by us.  In addition, we have not experienced anydefaults and continue to earn and receive interest on all of the investmentsthat we still own.  However, interest rateshad declined by the end of fiscal 2008 to levels that were much lower thanearlier in the year.  As a result,interest income may be significantly lower in 2009 than in 2008.

 

In November 2008, weaccepted an offer (the “Right”) from UBS AG (“UBS”) allowing us to sell at parvalue our remaining ARS to UBS at anytime during a two-year period from June 30,2010 through July 2, 2012.  Inaccepting the Right, we granted UBS the authority to sell or auction the ARS atpar value at any time up until the expiration date of the Right and releasedUBS from any claims relating to the marketing and sale of ARS.  We will continue to earn interest on the ARSuntil they are liquidated.  Theobligations of UBS under the Right are not secured by its assets and do not requireUBS to obtain any financing to purchase the ARS.  UBS has disclaimed any assurance that it willhave sufficient financial resources to satisfy its obligations under theRight.  If UBS does not have sufficientfunding to buy back the ARS and no alternative buyers are located eitherthrough the auction process, issuer redemptions or other means, then we may notbe able to access cash by selling these securities without incurring a loss ofprincipal.

 

**ITEM 8.****         ****FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

The financial statementsrequired by this item and the report of the independent accountant thereonrequired by Item 14(a)(2) appear beginning on page F-2 of thisReport.  See accompanying Index to the financial statements on page F-1.The supplementary financial data required by Item 302 of Regulation S-K appearsin note 11 to the financial statements.

 

**ITEM 9.****         ****CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING AND FINANCIAL DISCLOSURE**

 

Not applicable.

 

**ITEM 9A.****      ****CONTROLS AND PROCEDURES**

 

Evaluation of DisclosureControls and Procedures

 

We carried out an evaluationunder the supervision and with the participation of management, including theChief Executive Officer and the Chief Financial Officer, of the effectivenessof the design and operation of our disclosure controls and procedures as of theend of the period covered by this Report pursuant to Rules 13a-15 and15d-15 of the Exchange Act. Based on that evaluation, the Chief ExecutiveOfficer and the Chief Financial Officer each concluded that our disclosurecontrols and procedures are effective to ensure that information required to bedisclosed by us in reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms, and that such information has beenaccumulated and communicated to our management, including the officers whocertify our financial reports, as appropriate, to allow timely decisionsregarding the required disclosures.

 

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Changes in Internal ControlOver Financial Reporting

 

There were no changes in ourinternal control over financial reporting that occurred during the fiscalquarter ended January 31, 2009 that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

Management’s Report onInternal Control Over Financial Reporting

 

For the Report of Managementon Internal Control over Financial Reporting and the report of our independentregistered public accounting firm on Internal Control over Financial Reporting,see Item 8, Financial Statements and Supplementary Data.

 

**ITEM 9B.****      ****OTHER INFORMATION**

 

None.

 

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**PART III**

 
| **ITEM 10.** | **DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE** |
|--------------|-------------------------------------------------------------|

 

The information required bythis Item with respect to our executive officers and directors, compliance byour directors, executive officers and certain beneficial owners of our commonstock with Section 16(a) of the Exchange Act, the committees of ourBoard of Directors, our Audit Committee Financial Expert and our Code of Ethicsis incorporated herein by reference to information under the captions entitled “Boardof Directors and Committees of the Board of Directors,” “Executive Officers,”and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement (to be filed hereafter) in connection withour 2009 Annual Meeting of Stockholders and possibly elsewhere in the proxystatement (or will be filed by amendment to this Report).

 
| **ITEM 11.** | **EXECUTIVE  COMPENSATION** |
|--------------|-----------------------------|

 

The information required bythis Item is incorporated herein by reference to information under the captionsentitled “Executive Compensation,” “Board of Directors and Committees of theBoard of Directors” and “Compensation Committee Report” in our definitive proxystatement (to be filed hereafter) in connection with our 2009 Annual Meeting ofStockholders and possibly elsewhere in the proxy statement (or will be filed byamendment to this Report).

 
| **ITEM 12.** | **SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS** |
|--------------|------------------------------------------------------------------------------------------------------|

 

The information required bythis Item with respect to ownership of our common stock is incorporated hereinby reference to the information under the caption entitled “Security Ownershipof Certain Beneficial Owners and Management” in our definitive proxy statement(to be filed hereafter) in connection with our 2009 Annual Meeting ofStockholders and possibly elsewhere in the proxy statement (or will be filed byamendment to this Report).

 

**EquityCompensation Plan Information**.  The following table represents those securities authorized forissuance as of January 31, 2009 under our existing equity compensationplans.

 
| ** **                                                  | ** ** | ** **                            | ** ** | ** **                                 | ** ** | **Number of securities**     | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                  | ** ** | ** **                            | ** ** | ** **                                 | ** ** | **remaining available for**  | ** ** |
| ** **                                                  | ** ** | **Number of securities**    | ** ** | **Weighted average**                  | ** ** | **future issuance under**    | ** ** |
| ** **                                                  | ** ** | **to be issued upon**  | ** ** | **exercise price of**            | ** ** | **equity compensation**           | ** ** |
| ** **                                                  | ** ** | **exercise of outstanding** | ** ** | **outstanding options,**              | ** ** | **plans (excluding**              | ** ** |
| ** **                                                  | ** ** | **options, warrants and**   | ** ** | **warrants and rights (2)** | ** ** | **securities reflected in**  | ** ** |
| **Plan category**                                      | ** ** | **rights (1) (a)**          | ** ** | **(b)**                                    | ** ** | **column (a)) (3) (c)** | ** ** |
| Equity compensation plans approved by security  holders     |       | 446,160                               |       | $                                          | 19.38      |                                   | 855,248    |   |
| Equity compensation plans not approved by security  holders |       | —                                |       | —                                     |       | —                                 |       |
| Total                                                       |       | 446,160                               |       | $                                          | 19.38      |                                   | 855,248    |   |

 

----

(1)   Includes 59,100 outstanding options issuedunder the 1999 Allied Fashion Stock Option Plan.  This plan was replacedin May 2005 by the 2005 Citi Trends Inc. Long-Term Incentive Plan (the “IncentivePlan”), which provides for the issuance of up to 1,300,000 shares of commonstock upon the exercise of stock options or as awards of nonvested restrictedstock and other performance awards. Also, includes 149,750 outstanding optionsand 237,310 nonvested restricted stock grants issued under the Incentive Plan.

 

(2)   The weighted average exercise price is foroptions only and does not include nonvested restricted stock.

 

(3)   Consists of shares available for awards ofoptions, nonvested restricted stock and other performance awards under theIncentive Plan.

 
| **ITEM 13.** | **CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE** |
|--------------|--------------------------------------------------------------------------------|

 

The information required bythis Item is incorporated herein by reference to the information under thecaptions entitled “Certain Relationships and Related Party Transactions” and “Boardof Directors and Committees of the Board of Directors” in our definitive

 

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proxy statement (to be filedhereafter) in connection with our 2009 Annual Meeting of Stockholders andpossibly elsewhere in the proxy statement (or will be filed by amendment tothis Report).

 

**ITEM 14.****      ****PRINCIPAL ACCOUNTING FEESAND SERVICES**

 

The information required bythis Item is incorporated herein by reference to the information under thecaption entitled “Ratification of Independent Registered Public Accounting Firm”in our definitive proxy statement (to be filed hereafter) in connection withour 2009 Annual Meeting of Stockholders and possibly elsewhere in the proxystatement (or will be filed by amendment to this Report).

 

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**PART IV**

 

**ITEM 15.****      ****EXHIBITS, FINANCIALSTATEMENT SCHEDULES**

 

(a)(1)      Financial Statements

 

See accompanying FinancialStatements beginning on page F-1.

 

(a)(2)      Financial Statement Schedules

 

All schedules for whichprovision is made in the applicable accounting regulations of the SEC are notrequired under the related instructions, are inapplicable or the information isincluded in the Financial Statements, and therefore, have been omitted.

 

(a)(3)      Exhibits

 

**Exhibit Index**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                          |
|----------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                  |       | Second Amended and  Restated Certificate of Incorporation, as amended by the Certificate of  Amendment dated June 22, 2006 (incorporated by reference to  Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the  quarter ended July 29, 2006)                                                                                      |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                     |
| 3.2                  |       | Amended and Restated  By-laws (incorporated by reference to Exhibit 4.2 to the Company’s  Registration Statement on Form S-8 (File No. 333-125611) filed with  the SEC on June 8, 2005)                                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                     |
| 4.1                  |       | Specimen certificate for  shares of common stock, $.01 par value (incorporated by reference to  Exhibit 4.1 to Amendment No. 2 to the Company’s Registration  Statement on Form S-1 (File No. 333-123028) filed with the SEC on  April 29, 2005)                                                                                           |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                     |
| *10.1                |       | Amended and Restated  Employment Agreement by and between R. Edward Anderson and Citi  Trends, Inc., dated as of December 30, 2005 (incorporated by  reference to Exhibit 10.1 to the Company’s Current Report on  Form 8-K filed with the SEC on December 30, 2005)                                                                       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                     |
| *10.2                |       | Amended and Restated  Employment Agreement by and between George Bellino and Citi  Trends, Inc., dated as of December 30, 2005 (incorporated by  reference to Exhibit 10.2 to the Company’s Current Report on  Form 8-K filed with the SEC on December 30, 2005)                                                                           |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                     |
| 10.3                 |       | The Loan and Security  Agreement, dated as of April 2, 1999, by and between Congress Financial  Corporation (Southwest) and Allied Fashion, Inc. (incorporated by  reference to Exhibit 10.4 to the Company’s Registration Statement on  Form S-1 (File No. 333-123028) filed with the SEC on  February 28, 2005)                     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                     |
| 10.4                 |       | First Amendment to Loan  and Security Agreement, dated as of June 28, 2000, by and between  Congress Financial Corporation (Southwest) and Allied Fashion, Inc.  (incorporated by reference to Exhibit 10.5 to the Company’s Registration  Statement on Form S-1 (File No. 333-123028) filed with the SEC on  February 28, 2005)      |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                     |
| 10.5                 |       | Second Amendment to Loan  and Security Agreement, dated as of November 30, 2000, by and between  Congress Financial Corporation (Southwest) and Allied Fashion, Inc.  (Incorporated by reference to Exhibit 10.6 to the Company’s Registration  Statement on Form S-1 (File No. 333-123028) filed with the SEC on  February 28, 2005) |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                     |
| 10.6                 |       | Third Amendment to Loan  and Security Agreement, dated as of January 2003, by and between  Congress Financial Corporation (Southwest) and Citi Trends, Inc.  (incorporated by reference to Exhibit 10.7 to the Company’s Registration  Statement on Form S-1 (File No. 333-123028) filed with the SEC on  February 28, 2005)          |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                     |
| 10.7                 |       | Fourth Amendment to Loan  and Security Agreement, dated as of February 9, 2005, by and between  Congress Financial Corporation (Southwest) and Citi Trends, Inc.  (incorporated by reference to Exhibit 10.8 to the Company’s Registration  Statement on Form S-1 (File No. 333-123028) filed with the SEC on  February 28, 2005)     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                     |
| 10.8                 |       | Fifth Amendment to the  Loan and Security Agreement, dated as of May 18, 2006, by and between  Wachovia Capital Finance (formerly Congress Financial Corporation) and Citi  Trends, Inc. (incorporated by reference to Exhibit 10.1 to the  Company’s Quarterly Report on Form 10-Q for the quarter ended  July 29, 2006)                  |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                     |
| 10.9                 |       | Lease Agreement, dated as  of September 30, 2004, by and between Meyer Warehouse, LLC, as landlord,  and Citi Trends, Inc., as tenant (incorporated by reference to  Exhibit 10.9 to the Company’s Registration Statement on Form S-1  (File No. 333-123028) filed with the SEC on February 28, 2005)                                 |

 

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| 10.10  |   | $3.0 Million Loan  Agreement between Citi Trends, Inc. and Bank of America dated  June 16, 2006 (incorporated by reference to Exhibit 10.1 to the  Company’s Quarterly Report on Form 10-Q for the quarter ended  July 29, 2006)                                                                                           |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.11  |   | Amendment No. 1 dated  August 28, 2006 to $3.0 Million Loan Agreement between Citi  Trends, Inc. and Bank of America dated June 16, 2006 (incorporated  by reference to Exhibit 10.12 to the Company’s Annual Report on  Form 10-K for the year ended February 3, 2007)                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| *10.12 |   | Allied Fashion, Inc.  Amended and Restated 1999 Stock Option Plan (as previously amended and  restated effective as of June 17, 2004) (incorporated by reference to  Exhibit 2.2 to the Company’s Registration Statement on Form S-8  (File No. 333-125611) filed with the SEC on June 8, 2005)                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| *10.13 |   | Amendment to the 1999  Allied Fashion Inc. Stock Option Plan (as previously amended and restated  effective as of June 17, 2004) (incorporated by reference to  Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the  quarter ended October 28, 2006)                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| *10.14 |   | Citi Trends, Inc.  2005 Amended and Restated Long-Term Incentive Plan (incorporated by reference  to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for  the quarter ended August 2, 2008)                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| *10.15 |   | Form of Restricted  Stock Award Agreement for Employees (incorporated by reference to  Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the  quarter ended August 2, 2008)                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| *10.16 |   | Form of Restricted  Stock Award Agreement for Directors (incorporated by reference to  Exhibit 10.19 to the Company’s Annual Report on Form 10-K for the  year ended February 3, 2007)                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| *10.17 |   | Form of Stock Option  Agreement for Employees (incorporated by reference to Exhibit 10.20 to  the Company’s Annual Report on Form 10-K for the year ended  February 3, 2007)                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| *10.18 |   | Form of Stock Option  Agreement for Directors (incorporated by reference to Exhibit 10.21 to  the Company’s Annual Report on Form 10-K for the year ended  February 3, 2007)                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| *10.19 |   | Offer Letter to Ivy Council  dated December 6, 2006 (incorporated by reference to Exhibit 10.24  to the Company’s Annual Report on Form 10-K for the year ended  February 2, 2008)                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| *10.20 |   | Offer Letter to Bruce D.  Smith dated April 2, 2007 (incorporated by reference to Exhibit 10.1  to the Company’s Quarterly Report on Form 10-Q for the quarter ended  May 5, 2007)                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| *10.21 |   | Employment Non-Compete,  Non-Solicit and Confidentiality Agreement between the Company and Bruce D.  Smith dated April  2, 2007 (incorporated by reference to Exhibit 10.2  to the Company’s Quarterly Report on Form 10-Q forthe quarter ended May 5, 2007)                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.22  |   | Credit Agreement dated  March 26, 2008 among Citi Trends, Inc., as Borrower, the  Subsidiaries of the Borrower identified therein, as the Guarantors, and Bank  of America, N.A., as Lender (incorporated by reference to Exhibit 10.25  to the Company’s Annual Report on Form 10-K for the year ended  February 2, 2008) |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| *10.23 |   | Employment Agreement  between the Company and Elizabeth Feher dated April 2, 2008 (incorporated  by reference to Exhibit 10.2 to the Company’s Quarterly Report on  Form 10-Q for the quarter ended May 3, 2008)                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| *10.24 |   | Employment Non-Compete,  Non-Solicit and Confidentiality Agreement between the Company and Elizabeth  Feher dated April 2, 2008 (incorporated by reference to  Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the  quarter ended May 3, 2008)                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.25  |   | UBS Offer Letter dated  October 8, 2008, together with Acceptance Form of Citi  Trends, Inc. (incorporated by reference to Exhibit 10.1 to the  Company’s Quarterly Report on Form 10-Q for the quarter ended  November 1, 2008)                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| *10.26 |   | Employment Agreement  between the Company and R. David Alexander, Jr. dated December 5,  2008                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| *10.27 |   | Employment Non-Compete,  Non-Solicit and Confidentiality Agreement between the Company and R. David  Alexander, Jr. dated December 5, 2008                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| 10.28  |   | First Amendment to Credit  Agreement, dated as of March 25, 2009, by and between Citi  Trends, Inc. and Bank of America, N.A.                                                                                                                                                                                                                  |

 

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| 23.1   |   | Consent of KPMG LLP                                                                                                                                                                                         |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                        |
| 31.1   |   | Certification of R. David  Alexander, Jr., President and Chief Executive Officer, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                           |
|   |   |                                                                                                                                                                                                        |
| 31.2   |   | Certification of Bruce D.  Smith, Chief Financial Officer, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002                                                                       |
|   |   |                                                                                                                                                                                                        |
| 32.1   |   | Certification of R. David  Alexander, Jr., President and Chief Executive Officer, pursuant to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|   |   |                                                                                                                                                                                                        |
| 32.2   |   | Certification of Bruce D.  Smith, Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                              |

 

 

----

*       Indicates management contract or compensatoryplan or arrangement.

 

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**SIGNATURES**

 

Pursuant to the requirementsof Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|   |                | CITI TRENDS, INC. |
|--------|---------------------|-------------------|
|   |                | (Registrant)      |
|   |                |              |
| Date   | April 15, 2009 | By                | /s/  R. David Alexander, Jr. |   | /s/ Bruce D. Smith |
|   |                |              | R. David  Alexander, Jr. |   | Bruce D. Smith |
|   |                |              | President and Chief  Executive Officer (Principal Executive Officer) |   | Senior Vice President and  Chief Financial Officer (Principal Financial and Accounting Officer) |

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, this report has been signed below bythe following persons on behalf of the registrant and in the capacities and onthe dates indicated.

 
| **Signature**                     | ** ** | **Title**                                                             | ** ** | **Date**             |
|-----------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------|
| ** **                        | ** ** | ** **                                                            | ** ** | ** **           |
| /s/ R. David  Alexander, Jr. |       | President and Chief  Executive Officer                                |       | April 15,  2009 |
| R. David  Alexander, Jr.     |       | (Principal Executive  Officer) and Director                           |       |                 |
|                              |       |                                                                  |       |                 |
|                              |       |                                                                  |       |                 |
| /s/ Bruce D. Smith                |       | Senior Vice President and                                             |       | April 15,  2009 |
| Bruce D. Smith                    |       | Chief Financial Officer  (Principal Financial and Accounting Officer) |       |                 |
|                              |       |                                                                  |       |                 |
| /s/ R. Edward Anderson            |       | Executive Chairman of the  Board of Directors                         |       | April 15,  2009 |
| R. Edward Anderson                |       |                                                                  |       |                 |
|                              |       |                                                                  |       |                 |
| /s/ Brian P. Carney               |       | Director                                                              |       | April 15,  2009 |
| Brian P. Carney                   |       |                                                                  |       |                 |
|                              |       |                                                                  |       |                 |
| /s/ Lawrence E. Hyatt             |       | Director                                                              |       | April 15,  2009 |
| Lawrence E. Hyatt                 |       |                                                                  |       |                 |
|                              |       |                                                                  |       |                 |
| /s/ John S. Lupo                  |       | Director                                                              |       | April 15,  2009 |
| John S. Lupo                      |       |                                                                  |       |                 |
|                              |       |                                                                  |       |                 |
| /s/ Patricia M. Luzier            |       | Director                                                              |       | April 15,  2009 |
| Patricia M. Luzier                |       |                                                                  |       |                 |

 

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**Citi Trends, Inc.Index to Financial Statements**

 

FINANCIAL STATEMENTS AS OFAND FOR THE YEARS ENDED JANUARY 31, 2009, FEBRUARY 2, 2008 AND FEBRUARY 3, 2007

 
| Management’s Annual Report on Internal Control Over  Financial Reporting                                                       | F-2    |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                |   |
| Report of Independent Registered Public Accounting  Firm                                                                            | F-3    |
|                                                                                                                                |   |
| Balance  Sheets as of January 31, 2009 and February 2, 2008                                                               | F-4    |
|                                                                                                                                |   |
| Statements of Income for the Years Ended  January 31, 2009, February 2, 2008 and February 3, 2007                    | F-5    |
|                                                                                                                                |   |
| Statements of Cash Flows for the Years Ended  January 31, 2009, February 2, 2008 and February 3, 2007                | F-6    |
|                                                                                                                                |   |
| Statements of Stockholders’ Equity for the Years Ended  January 31, 2009, February 2, 2008 and February 3, 2007 | F-7    |
|                                                                                                                                |   |
| Notes to Financial Statements for the Years Ended  January 31, 2009, February 2, 2008 and February 3, 2007           | F-8    |

 

F-1

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**MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVERFINANCIAL REPORTING**

 

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting, as defined in Rule 13a-15(f) of the SecuritiesExchange Act of 1934. Under the supervision and with the participation ofmanagement, including our chief executive officer and chief financial officer,we assessed the effectiveness of our internal control over financial reportingas of January 31, 2009, based on the criteria described in *Internal Control—Integrated Framework,*issued by the Committee of Sponsoring Organizations of the Treadway Commission(“COSO”). Based on this assessment, our management concluded that our internalcontrol over financial reporting was effective based on those criteria as of January 31,2009.

 

Our independent registeredpublic accounting firm, KPMG LLP, audited the effectiveness of our internalcontrol over financial reporting as of January 31, 2009, as stated intheir attestation report which is included herein.

 

F-2

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**Table ofContents**

** **

**Report of IndependentRegistered Public Accounting Firm**

** **

The Board of Directorsand Stockholders

Citi Trends, Inc.:

 

We have audited the accompanying balance sheets ofCiti Trends, Inc. (the Company) as of January 31, 2009 and February 2,2008, and the related statements of income, stockholders’ equity, and cashflows for fiscal years ended January 31, 2009, February 2, 2008, and February 3,2007. We also have audited the Company’s internal control over financialreporting as of January 31, 2009, based on criteria established in *Internal Control — Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO). TheCompany’s management is responsible for these financial statements, formaintaining effective internal control over financial reporting, and for itsassessment of the effectiveness of internal control over financial reporting,included in the accompanying Management’s Annual Report on Internal ControlOver Financial Reporting. Our responsibility is to express an opinion on thesefinancial statements and an opinion on the Company’s internal control overfinancial reporting based on our audits.

 

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audits to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement and whether effective internal control over financialreporting was maintained in all material respects. Our audits of the financialstatements included examining, on a test basis, evidence supporting the amountsand disclosures in the financial statements, assessing the accountingprinciples used and significant estimates made by management, and evaluatingthe overall financial statement presentation. Our audit of internal controlover financial reporting included obtaining an understanding of internal controlover financial reporting, assessing the risk that a material weakness exists,and testing and evaluating the design and operating effectiveness of internalcontrol based on the assessed risk. Our audits also included performing suchother procedures as we considered necessary in the circumstances. We believethat our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, andthat receipts and expenditures of the company are being made only in accordancewith authorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

 

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

In our opinion, the financial statements referred toabove present fairly, in all material respects, the financial position of CitiTrends, Inc., as of January 31, 2009 and February 2, 2008, andthe results of its operations and its cash flows for each of the fiscal yearsended January 31, 2009, February 2, 2008, and February 3, 2007,in conformity with U.S. generally accepted accounting principles. Also in ouropinion, Citi Trends, Inc., maintained, in all material respects,effective internal control over financial reporting as of January 31,2009, based on criteria established in *Internal Control —Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission.

 

As discussed in note 2 to the financialstatements, effective February 3, 2008, the Company adopted the methods offair value as described in SFAS No. 157, *FairValue Measurements,*and**as discussed in note 7 to the financialstatements, effective February 4, 2007, the Company adopted theprovisions of Financial Accounting Standards Board Interpretation No. 48, *Accounting for Uncertainty in Income Taxes-aninterpretation of FAS 109*.

 

 

/s/KPMG LLP

April 14,2009

Jacksonville,Florida

CertifiedPublic Accountants

 

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**Citi Trends, Inc.**

**Balance Sheets**

**January 31, 2009 and February 2, 2008**

**(in thousands, except per share and share amounts)**

 
| ** **                                                                                                                                                                                                                                                                                              | ** ** | **January 31,** | ** ** | **February 2,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                              | ** ** | **2009**             | ** ** | **2008**             | ** ** |
| **Assets**                                                                                                                                                                                                                                                                                              |       |                 |       |                 |       |
| Current assets:                                                                                                                                                                                                                                                                                         |       |                 |       |                 |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                               |       | $                    | 33,516     |                 | $          | 6,203 |   |
| Investment securities                                                                                                                                                                                                                                                                                   |       | —               |       | 56,165               |       |
| Inventory                                                                                                                                                                                                                                                                                               |       | 86,259               |       | 82,420               |       |
| Prepaid and other current assets                                                                                                                                                                                                                                                                        |       | 10,625               |       | 5,888                |       |
| Deferred tax asset                                                                                                                                                                                                                                                                                      |       | 3,447                |       | 2,838                |       |
| Total current assets                                                                                                                                                                                                                                                                                    |       | 133,847              |       | 153,514              |       |
| Property and equipment, net                                                                                                                                                                                                                                                                             |       | 58,861               |       | 52,207               |       |
| Investment securities                                                                                                                                                                                                                                                                                   |       | 43,825               |       | —               |       |
| Goodwill                                                                                                                                                                                                                                                                                                |       | 1,371                |       | 1,371                |       |
| Deferred tax asset                                                                                                                                                                                                                                                                                      |       | 2,480                |       | 2,756                |       |
| Other assets                                                                                                                                                                                                                                                                                            |       | 405                  |       | 329                  |       |
| Total assets                                                                                                                                                                                                                                                                                            |       | $                    | 240,789    |                 | $          | 210,177 |   |
|                                                                                                                                                                                                                                                                                                    |       |                 |       |                 |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                                                                                                          |       |                 |       |                 |       |
| Current liabilities:                                                                                                                                                                                                                                                                                    |       |                 |       |                 |       |
| Accounts payable                                                                                                                                                                                                                                                                                        |       | $                    | 52,295     |                 | $          | 43,566 |   |
| Accrued expenses                                                                                                                                                                                                                                                                                        |       | 11,478               |       | 11,864               |       |
| Accrued compensation                                                                                                                                                                                                                                                                                    |       | 7,514                |       | 5,225                |       |
| Current portion of capital lease  obligations                                                                                                                                                                                                                                                           |       | 1,403                |       | 1,580                |       |
| Income tax payable                                                                                                                                                                                                                                                                                      |       | 682                  |       | 1,155                |       |
| Layaway deposits                                                                                                                                                                                                                                                                                        |       | 564                  |       | 635                  |       |
| Total current liabilities                                                                                                                                                                                                                                                                               |       | 73,936               |       | 64,025               |       |
| Capital lease obligations, less current  portion                                                                                                                                                                                                                                                        |       | —               |       | 1,403                |       |
| Other long-term liabilities                                                                                                                                                                                                                                                                             |       | 8,646                |       | 6,602                |       |
| Total liabilities                                                                                                                                                                                                                                                                                       |       | 82,582               |       | 72,030               |       |
|                                                                                                                                                                                                                                                                                                    |       |                 |       |                 |       |
| Stockholders’ Equity:                                                                                                                                                                                                                                                                              |       |                 |       |                 |       |
| Common stock, $0.01 par value. Authorized  32,000,000 shares; 14,698,852 shares issued as of January 31, 2009 and  14,265,471 shares issued as of February 2, 2008; 14,533,102 shares  outstanding as of January 31, 2009 and 14,099,721 shares outstanding as  of February 2, 2008 |       | 145                  |       | 142                  |       |
| Paid in capital                                                                                                                                                                                                                                                                                         |       | 70,950               |       | 68,276               |       |
| Retained earnings                                                                                                                                                                                                                                                                                       |       | 87,277               |       | 69,894               |       |
| Treasury stock, at cost; 165,750 shares as  of January 31, 2009 and February 2, 2008                                                                                                                                                                                                          |       | (165                 | )          | (165                 | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                                                         |       | 158,207              |       | 138,147              |       |
|                                                                                                                                                                                                                                                                                                    |       |                 |       |                 |       |
| Commitments and contingencies (note 9)                                                                                                                                                                                                                                                                  |       |                 |       |                 |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                                                         |       | $                    | 240,789    |                 | $          | 210,177 |   |

 

See accompanying notes tofinancial statements

 

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**Citi Trends, Inc.**

**Statements of Income**

**Years Ended January 31, 2009, February 2, 2008 and February 3,2007**

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

 
| ** **                                    | ** ** | **Fiscal 2008** | ** ** | **Fiscal 2007** | ** ** | **Fiscal 2006** | ** ** |
|-----------------------------------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|
| Net sales                                     |       | $                    | 488,202    |                 | $          | 437,515              |       | $ | 381,918 |   |
| Cost of sales                                 |       | 301,867              |       | 278,783              |       | 235,744              |       |
| Gross profit                                  |       | 186,335              |       | 158,732              |       | 146,174              |       |
| Selling, general and administrative  expenses |       | 147,009              |       | 127,470              |       | 107,535              |       |
| Depreciation and amortization                 |       | 16,261               |       | 12,583               |       | 8,326                |       |
| Income from operations                        |       | 23,065               |       | 18,679               |       | 30,313               |       |
| Interest income                               |       | 2,495                |       | 2,383                |       | 2,014                |       |
| Interest expense                              |       | (307                 | )          | (469                 | )          | (359                 | )          |
| Income before income tax expense              |       | 25,253               |       | 20,593               |       | 31,968               |       |
| Income tax expense                            |       | 7,870                |       | 6,379                |       | 10,617               |       |
| Net income                                    |       | $                    | 17,383     |                 | $          | 14,214               |       | $ | 21,351 |   |
| Basic net income per common share             |       | $                    | 1.23       |                 | $          | 1.02                 |       | $ | 1.57 |   |
| Diluted net income per common share           |       | $                    | 1.22       |                 | $          | 1.00                 |       | $ | 1.51 |   |
| Weighted average number of shares outstanding |       |                 |       |                 |       |                 |       |
| Basic                                         |       | 14,131               |       | 13,946               |       | 13,575               |       |
| Diluted                                       |       | 14,269               |       | 14,223               |       | 14,138               |       |

 

See accompanying notes tofinancial statements

 

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**Citi Trends, Inc.**

**Statements of Cash Flows**

**Years Ended January 31, 2009, February 2, 2008 and February 3,2007**

**(in thousands)**

 
| ** **                                                                              | ** ** | **Fiscal 2008** | ** ** | **Fiscal 2007** | ** ** | **Fiscal 2006** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|
| Operating activities:                                                                   |       |                 |       |                 |       |                 |       |
| Net income                                                                              |       | $                    | 17,383     |                 | $          | 14,214               |       | $ | 21,351 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:      |       |                 |       |                 |       |                 |       |
| Depreciation and amortization                                                           |       | 16,261               |       | 12,583               |       | 8,326                |       |
| Deferred income taxes                                                                   |       | (333                 | )          | (1,401               | )          | (2,248               | )          |
| Loss on disposal of property and equipment                                              |       | 110                  |       | 59                   |       | 90                   |       |
| Noncash stock-based compensation expense                                                |       | 2,024                |       | 1,496                |       | 842                  |       |
| Excess tax benefits from stock-based  payment arrangements                              |       | (1,218               | )          | (3,516               | )          | (12,249              | )          |
| Changes in assets and liabilities:                                                      |       |                 |       |                 |       |                 |       |
| Inventory                                                                               |       | (3,839               | )          | (9,060               | )          | (19,339              | )          |
| Prepaid and other current assets                                                        |       | (4,072               | )          | (1,078               | )          | (1,710               | )          |
| Other assets                                                                            |       | (76                  | )          | (51                  | )          | (85                  | )          |
| Accounts payable                                                                        |       | 8,729                |       | (3,328               | )          | 6,189                |       |
| Accrued expenses and other long-term  liabilities                                       |       | 1,658                |       | 3,813                |       | 4,442                |       |
| Accrued compensation                                                                    |       | 2,289                |       | (969                 | )          | 1,214                |       |
| Income tax payable                                                                      |       | 745                  |       | 3,820                |       | 12,031               |       |
| Layaway deposits                                                                        |       | (71                  | )          | 59                   |       | 258                  |       |
| Net cash provided by operating activities                                               |       | 39,590               |       | 16,641               |       | 19,112               |       |
|                                                                                    |       |                 |       |                 |       |                 |       |
| Investing activities:                                                                   |       |                 |       |                 |       |                 |       |
| Purchases of investment securities                                                      |       | (4,000               | )          | (33,989              | )          | (49,476              | )          |
| Sales/redemptions of investment securities                                              |       | 15,675               |       | 43,780               |       | 37,978               |       |
| Insurance proceeds received                                                             |       | —               |       | —               |       | 269                  |       |
| Purchases of property and equipment                                                     |       | (23,025              | )          | (30,095              | )          | (15,652              | )          |
| Net cash used in investing activities                                                   |       | (11,350              | )          | (20,304              | )          | (26,881              | )          |
|                                                                                    |       |                 |       |                 |       |                 |       |
| Financing activities:                                                                   |       |                 |       |                 |       |                 |       |
| Excess tax benefits from stock-based  payment arrangements                              |       | 1,218                |       | 3,516                |       | 12,249               |       |
| Repayments on long-term debt and capital  lease obligations                             |       | (1,580               | )          | (1,768               | )          | (786                 | )          |
| Cash used to settle equity instruments  granted under stock-based payment arrangements  |       | (1,040               | )          | —               |       | (896                 | )          |
| Proceeds from the exercise of stock options                                             |       | 475                  |       | 411                  |       | 914                  |       |
| Net cash (used in) provided by financing  activities                                    |       | (927                 | )          | 2,159                |       | 11,481               |       |
| Net increase (decrease) in cash and cash  equivalents                                   |       | 27,313               |       | (1,504               | )          | 3,712                |       |
|                                                                                    |       |                 |       |                 |       |                 |       |
| Cash and cash equivalents:                                                              |       |                 |       |                 |       |                 |       |
| Beginning of period                                                                     |       | 6,203                |       | 7,707                |       | 3,995                |       |
| End of period                                                                           |       | $                    | 33,516     |                 | $          | 6,203                |       | $ | 7,707 |   |
|                                                                                    |       |                 |       |                 |       |                 |       |
| Supplemental disclosures of cash flow  information:                                     |       |                 |       |                 |       |                 |       |
| Cash paid for interest                                                                  |       | $                    | 285        |                 | $          | 446                  |       | $ | 321 |   |
| Cash paid for income taxes                                                              |       | $                    | 7,458      |                 | $          | 3,961                |       | $ | 834 |   |
| Supplemental disclosures of noncash  financing and investing activities:                |       |                 |       |                 |       |                 |       |
| Purchases of property and equipment  financed through capital leases                    |       | $                    | —     |                 | $          | —               |       | $ | 4,809 |   |
| Paid in capital for the exercise of stock  options satisfied by the surrender of shares |       | $                    | 43         |                 | $          | 45                   |       | $ | 23 |   |
| Cumulative effect of adoption of FIN 48                                                 |       | $                    | —     |                 | $          | 301                  |       | $ | — |   |

 

See accompanying notes tofinancial statements

 

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** **

**CitiTrends, Inc.**

**Statements of Stockholders’ Equity**

**YearsEnded January 31, 2009, February 2, 2008 and February 3, 2007**

**(inthousands, except share amounts)**

 
| ** **                                                                    | ** ** | **Common Stock** | ** ** | **Paid in** | ** ** | **Retained** | ** ** | **Treasury Stock** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------|------------|------------------|------------|--------------|------------|-------------------------|------------|------------|------------|
| ** **                                                                    | ** ** | **Shares**            | ** ** | **Amount**       | ** ** | **Capital**  | ** ** | **Earnings**            | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Total** | ** ** |
| Balances—January 28, 2006                                                |       | 13,179,765            |       | $                | 132        |         | $          | 49,754                  |       | $          | 34,028     |   | 165,750 |   | $ | (165 | ) | $ | 83,749 |   |
| Exercise of stock options                                                     |       | 792,672               |       | 8                |       | 929          |       |                    |       |       |       |   |   | 937 |   |
| Tax benefit of stock options exercised                                        |       |                  |       |             |       | 12,249       |       |                    |       |       |       |   |   | 12,249 |   |
| Stock-based compensation expense                                              |       |                  |       |             |       | 842          |       |                    |       |       |       |   |   | 842 |   |
| Net share settlement of options                                               |       |                  |       |             |       | (919         | )          |                    |       |       |       |   |   | (919 | ) |
| Net income                                                                    |       |                  |       |             |       |         |       | 21,351                  |       |       |       |   |   | 21,351 |   |
| Balances—February 3, 2007                                                |       | 13,972,437            |       | 140              |       | 62,855       |       | 55,379                  |       | 165,750    |       | (165 | ) | 118,209 |   |
| Cumulative effect of adoption of FIN 48                                       |       |                  |       |             |       |         |       | 301                     |       |       |       |   |   | 301 |   |
| Exercise of stock options                                                     |       | 228,563               |       | 2                |       | 454          |       |                    |       |       |       |   |   | 456 |   |
| Tax benefit of stock options exercised                                        |       |                  |       |             |       | 3,516        |       |                    |       |       |       |   |   | 3,516 |   |
| Issuance of nonvested shares to employees and  directors under incentive plan |       | 69,866                |       |             |       |         |       |                    |       |       |       |   |   | — |   |
| Forfeiture of nonvested shares by employees  and directors                    |       | (5,395                | )          |             |       |         |       |                    |       |       |       |   |   | — |   |
| Stock-based compensation expense                                              |       |                  |       |             |       | 1,496        |       |                    |       |       |       |   |   | 1,496 |   |
| Net share settlement of options                                               |       |                  |       |             |       | (45          | )          |                    |       |       |       |   |   | (45 | ) |
| Net income                                                                    |       |                  |       |             |       |         |       | 14,214                  |       |       |       |   |   | 14,214 |   |
| Balances—February 2, 2008                                                |       | 14,265,471            |       | 142              |       | 68,276       |       | 69,894                  |       | 165,750    |       | (165 | ) | 138,147 |   |
| Exercise of stock options                                                     |       | 246,823               |       | 3                |       | 515          |       |                    |       |       |       |   |   | 518 |   |
| Tax benefit of stock options exercised                                        |       |                  |       |             |       | 1,218        |       |                    |       |       |       |   |   | 1,218 |   |
| Issuance of nonvested shares to employees and  directors under incentive plan |       | 212,751               |       |             |       |         |       |                    |       |       |       |   |   | — |   |
| Forfeiture of nonvested shares by employees  and directors                    |       | (20,929               | )          |             |       |         |       |                    |       |       |       |   |   | — |   |
| Stock-based compensation expense                                              |       |                  |       |             |       | 2,024        |       |                    |       |       |       |   |   | 2,024 |   |
| Net share settlement of options                                               |       |                  |       |             |       | (1,003       | )          |                    |       |       |       |   |   | (1,003 | ) |
| Net share settlement of nonvested shares                                      |       | (5,264                | )          |             |       | (80          | )          |                    |       |       |       |   |   | (80 | ) |
| Net income                                                                    |       |                  |       |             |       |         |       | 17,383                  |       |       |       |   |   | 17,383 |   |
| Balances—January 31, 2009                                                |       | 14,698,852            |       | $                | 145        |         | $          | 70,950                  |       | $          | 87,277     |   | 165,750 |   | $ | (165 | ) | $ | 158,207 |   |

 

See accompanying notes tofinancial statements

 

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**Citi Trends, Inc.**

**Notes to Financial StatementsJanuary 31, 2009, February 2, 2008 and February 3, 2007**

 

**(1)     Organization and Business**

 

Citi Trends, Inc. (the “Company”)is a rapidly growing, value-priced retailer of urban fashion apparel andaccessories for the entire family. As of January 31, 2009, the Companyoperated 357 stores in 22 states.

 

**(2)     Summary of Significant Accounting Policies**

 

*(a)  Fiscal Year*

 

The Company’s fiscal yearends on the Saturday closest to January 31 of each year. The years ended January 31,2009, February 2, 2008 and February 3, 2007 are referred to as fiscal2008, fiscal 2007 and fiscal 2006, respectively, in the accompanying financialstatements. Fiscal year 2006 is comprised of 53 weeks.  Fiscal years 2008and 2007 are each comprised of 52 weeks.

 

*(b)  Cash and Cash Equivalents*

 

For purposes of the balancesheets and statements of cash flows, the Company considers all highly liquidinvestments with maturities at date of purchase of three months or less to becash equivalents.

 

*(c)  Investment Securities*

 

The Company’s investmentsecurities are carried at fair value and consist of investments in municipalauction rate securities (“ARS”) issued by student loan funding organizations.During the fourth quarter of fiscal 2008, the Company reclassified the ARS fromavailable-for-sale to trading securities. Unrealized gains and losses, net of deferred income taxes (benefits), oninvestments the Company designates as available-for-sale are excluded fromearnings and are credited or charged directly to other comprehensive income, aseparate component of stockholders’ equity. If any unrealized losses are deemedother than temporary, such unrealized losses are recognized as realized losses.Investments that the Company designates as trading securities are reported atfair value, with unrealized gains or losses resulting from changes in fair valuerecognized in earnings.  See Note 4 forfurther detailed discussion.

 

*(d)  Inventory*

 

Inventory is stated at thelower of cost (first-in, first-out basis) or market as determined by the retailinventory method, less a provision for estimated inventory shrinkage. Under theretail inventory method, the cost value of inventory and gross margins aredetermined by calculating a cost-to-retail ratio and applying it to the retailvalue of inventory.

 

*(e)  Property and Equipment, net*

 

Property and equipment, netare stated at cost less accumulated depreciation and amortization. Equipmentunder capital leases is stated at the present value of the required minimumlease payments per the applicable lease agreement. Depreciation andamortization are computed using the straight-line method over the lesser of theestimated useful lives (primarily three to five years for computer equipmentand furniture, fixtures and equipment, five years for leasehold improvements,seven years for major purchased software systems, and fifteen to twenty yearsfor buildings and building improvements) of the related assets or the relevantlease term, as defined in Statement of Financial Accounting Standards (“SFAS”) No. 13,*Accounting for Leases*.

 

*(f)  Goodwill*

 

Goodwill represents the excessof the purchase price over the fair value of assets acquired.  Pursuant toSFAS No. 142, goodwill acquired in a purchase business combination anddetermined to have an indefinite useful life is not amortized, but insteadtested for impairment at least annually. The Company performed this analysis atthe end of fiscal 2008 and fiscal 2007 and no impairment was indicated foreither year.

 

*(g)  Impairment of Long-Lived Assets*

 

In accordance with SFAS No. 144,*Accounting for the Impairment or Disposal ofLong-Lived Assets,* if facts and circumstances indicate that along-lived asset, including property and equipment, may be impaired, thecarrying value is reviewed. If this review indicates that the carrying value ofthe asset will not be recovered as determined based on projected undiscountedcash flows related to 

 

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the asset over its remaininglife, the carrying value of the asset is reduced to its estimated fair value.Impairment losses in the future are dependent on a number of factors such assite selection and general economic trends, and thus could be significantlydifferent from historical results. To the extent the Company’s estimates fornet sales, gross profit and store expenses are not realized, future assessmentsof recoverability could result in impairment charges.

 

*(h)  Stock-Based Compensation*

 

The Company recognizescompensation expense associated with all stock options and nonvested restrictedstock based on the grant-date fair value estimated in accordance with SFAS No. 123(revised 2004), *Share-Based Payment*(“SFAS No. 123R”), as interpreted by SEC Staff Accounting Bulletin No. 107.  The fair values of options issued pursuant tothe stock based compensation plans are estimated at each grant date using theBlack-Scholes Merton option pricing model, while grants of nonvested restrictedstock are valued based on the stock price on the grant date. See Note 8for additional information on the Company’s stock-based compensation plans.

 

*(i)  Revenue Recognition*

 

Revenue from retail salesnet of sales taxes is recognized at the time the customer takes possession ofand pays for merchandise, less an allowance for returns. The Company allows forreturns up to ten days after the date of sales and the Company reduces revenuesfor each fiscal year for returns in the ten days after the year ends. Revenuefrom layaway sales is recognized when the customer has paid for and receivedthe merchandise. If the merchandise is not fully paid for within sixty days,the customer is given a store credit for merchandise payments made, less are-stocking fee and a layaway service charge. Layaway service charges, whichare non-refundable, are recognized in revenue when collected. All sales arefrom cash, check or major credit card company transactions. The Company doesnot offer company-sponsored customer credit accounts or gift cards.

 

*(j)  Cost of Sales*

 

Cost of sales includes thecost of inventory sold during the period and transportation costs, includinginbound freight and freight from the distribution centers to the stores, net ofdiscounts and allowances. Distribution center costs, store occupancy expensesand advertising expenses are not considered components of cost of sales and areincluded as part of selling, general and administrative expenses.

 

*(k)  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 as stockoptions and nonvested restricted stock.

 

Thefollowing table provides a reconciliation of the number of average commonshares outstanding used to calculate basic earnings per share to the number ofcommon shares and common stock equivalents outstanding used in calculating dilutedearnings per share for fiscal 2008, 2007 and 2006:

 
| ** **                                                                | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|---------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Average number of common shares outstanding                               |       | 14,131,077 |       | 13,946,342 |       | 13,574,718 |       |
| Incremental shares from assumed exercises  of stock options               |       | 137,711    |       | 276,887    |       | 563,345    |       |
| Average number of common shares and common  stock equivalents outstanding |       | 14,268,788 |       | 14,223,229 |       | 14,138,063 |       |

 

In accordance with SFAS No. 128,*Earnings per Share*, the Companycalculates the dilutive effect of stock-based compensation arrangements usingthe treasury stock method.  This method assumes that the proceeds theCompany receives from the exercise of stock options are used to repurchasecommon shares in the market.  The adoption of SFAS No. 123R requiresthe Company to include as assumed proceeds the amount of compensation costattributed to future services and not yet recognized, and the amount of taxbenefits, if any, that would be credited to additional paid-in capital assumingexercise of outstanding options and vesting of nonvested restrictedstock.  For fiscal 2008, 2007 and 2006, respectively, there were 95,000,61,000 and 23,000 options outstanding to purchase shares of common stockexcluded from the calculation of diluted earnings per share because ofantidilution.  There were no shares ofnonvested restricted stock included in the calculation of diluted earnings pershare for fiscal 2008, 2007 and 2006, because of antidilution.

 

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*(l)  Advertising*

 

The Company expensesadvertising as incurred. Advertising expense for fiscal 2008, 2007 and 2006 wasapproximately $2.5 million, $2.5 million and $1.9 million, respectively.

 

*(m)  Operating Leases*

 

The Company leases all ofits store properties and accounts for the leases as operating leases inaccordance with SFAS No. 13*.*Many lease agreements contain tenant improvement allowances, rent holidays,rent escalation clauses and/or contingent rent provisions. For purposes ofrecognizing incentives and minimum rent expense on a straight-line basis overthe terms of the leases, the Company uses the date of initial possession tobegin amortization, which is generally when the Company enters the space andbegins to make improvements in preparation of intended use.

 

For scheduled rentescalation clauses during the lease terms or for rental payments commencing “rentholidays” at a date other than the date of initial occupancy, the Companyrecords minimum rent expense on a straight-line basis over the terms of theleases. For tenant improvement allowances a deferred rent liability is recordedon the balance sheet and amortized over the terms of the leases.

 

Certain leases provide forcontingent rents that are not measurable at inception. These contingent rentsare primarily based on a percentage of net sales that are in excess of apredetermined level. These amounts are excluded from minimum rent and areincluded in the determination of total rent expense when it is probable thatthe expense has been incurred and the amount is reasonably estimable.

 

In March 2005, theFinancial Accounting Standards Board (“FASB”) issued FASB interpretation (“FIN”)47, *Accounting for Conditional AssetRetirement Obligations,* which is an interpretation of SFAS No. 143,*Accounting for Asset Retirement Obligations.*This interpretation clarifies terminology within SFAS No. 143 and requiresan entity to recognize a liability for the fair value of a conditional assetretirement obligation when incurred if the liability’s fair value can bereasonably estimated. The Company had a liability of $482,000 and $420,000 asof January 31, 2009 and February 2, 2008, respectively, which isincluded in other long-term liabilities on the accompanying balance sheets andrepresents estimated expenses that would be incurred upon the termination ofthe Company’s operating leases*.*

 

*(n)  Store Opening and Closing Costs*

 

New and relocated storeopening period costs are charged directly to expense when incurred. When theCompany decides to close or relocate a store, the Company records an expensefor the present value of expected future rent payments, net of sublease income,if any, in the period that a store closes or relocates. All store opening andclosing costs are included in selling, general and administrative expenses onthe statements of income.

 

*(o)  Income Taxes*

 

Income taxes are accountedfor under the asset and liability method. Deferred tax assets and liabilitiesare recognized for the future tax consequences attributable to differencesbetween the financial statement carrying amounts of existing assets andliabilities and their respective tax bases and operating loss and tax creditcarryforwards. Deferred tax assets and liabilities are measured using enactedtax rates expected to apply to taxable income in the years in which thosetemporary differences are expected to be recovered or settled. The effect ondeferred tax assets and liabilities of a change in tax rates is recognized inincome in the period that includes the enactment date.

 

*(p)  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 useassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

 

The most significantestimates made by management include those made in the valuation of inventory,investment securities, stock-based compensation, property and equipment, andincome taxes. Management periodically evaluates estimates used in thepreparation of the financial statements for continued reasonableness.Appropriate adjustments, if any, to the estimates used are made prospectivelybased on such periodic evaluations.

 

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*(q)  Business Reporting Segments*

 

The Company is avalue-priced retailer of urban fashion apparel and accessories for the entirefamily. The Company’s executive officers review performance and the allocationof resources on a store by store basis. Because the Company operates onebusiness activity and the level of review by the Company’s executive officersis on a store by store basis, the Company has determined that its operationsare within one reportable segment. Accordingly, financial information onindustry segments is not applicable. All sales and assets are located withinthe United States.

 

*(r)  Other Comprehensive Income*

 

As discussed in Note 4,other comprehensive income included a temporary unrealized loss on investmentsecurities during interim periods of 2008. The unrealized loss, totaling $1,544,000 (net of tax) as of the end ofthe third quarter of 2008, was reclassified to net income in the fourthquarter. The Company did not have any components of other comprehensive incomefor fiscal 2007 and 2006.  There was noaccumulated comprehensive income as of January 31, 2009, February 2,2008 or February 3, 2007.

 

*(s)  Recent Accounting Pronouncements*

 

In May 2008, the FASBissued SFAS No. 162, *The Hierarchy of GenerallyAccepted Accounting Principles.* SFAS No. 162 identifies thesources of accounting principles and the framework for selecting the principlesto be used in the preparation of financial statements of nongovernmentalentities that are presented in conformity with generally accepted accountingprinciples in the United States.  SFAS No. 162was effective November 15, 2008 and did not have a significant impact onthe Company’s financial statements.

 

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,*whichprovided 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 adopted the provisions of SFAS No. 157with respect to its financial assets and financial liabilities only in fiscal2008. The adoption of this statement did not have a material impact on theCompany’s financial statements. Effective February 1, 2009, the Company adopted SFAS No. 157for non-financial assets and non-financial liabilities, and it did not have amaterial impact on the Company’s financial statements.  In October 2008, the FASB issued StaffPosition No. FAS 157-3, *Determining the Fair Valueof a Financial Asset When the Market for That Asset is Not Active* (“FSPFAS 157-3”), which clarified the application of SFAS No. 157 in caseswhere a market is not active. The Company has considered the guidance providedby FSP FAS 157-3 in its determination of fair values as of January 31,2009, and the impact was not material.

 

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 adoption of SFAS No. 159 did not have amaterial impact on the Company’s financial statements since the Company did notelect to apply the fair value option for any of its eligible financialinstruments or other items on the effective date of adoption.

 

In December 2007, theSEC issued Staff Accounting Bulletin 110, *Share-Based Payment*(“SAB 110”).  SAB 110 allows forcontinued use of the simplified method for estimating the expected term of “plainvanilla” share option grants under specified conditions.  The expected term used to value a shareoption grant under the simplified method is the mid-point between the vestingdate and the contractual term of the share option.  SAB 110 eliminates the December 31, 2007sunset provision previously specified in SAB 107.  SAB 110 is effective for share option grantsmade on or after January 1, 2008. The Company has utilized the simplified method for estimating theexpected term of its stock option grants under SAB 107 and SAB 110 and willcontinue to utilize this simplified method until the Company has sufficienthistorical exercise data to provide a reasonable basis to estimate the expectedterm.

 

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**(3)****              Property andEquipment, net**

 

Thecomponents of property and equipment as of January 31, 2009 and February 2,2008 are as follows (in thousands):

 
| ** **                                | ** ** | **January 31,** | ** ** | **February 2,** | ** ** |
|-------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                | ** ** | **2009**             | ** ** | **2008**             | ** ** |
| Land                                      |       | $                    | 858        |                 | $          | 858 |   |
| Buildings                                 |       | 15,295               |       | 4,708                |       |
| Leasehold improvements                    |       | 37,681               |       | 31,992               |       |
| Furniture, fixtures and equipment         |       | 47,525               |       | 35,293               |       |
| Computer equipment                        |       | 15,433               |       | 13,519               |       |
| Construction in progress                  |       | 194                  |       | 7,799                |       |
|                                      |       | 116,986              |       | 94,169               |       |
| Accumulated depreciation and amortization |       | (58,125              | )          | (41,962              | )          |
|                                      |       | $                    | 58,861     |                 | $          | 52,207 |   |

 

Technology equipment heldunder capital leases and related accumulated depreciation was $8.4 million and$7.1 million, respectively, as of January 31, 2009 and $8.4 million and$5.5 million, respectively, as of February 2, 2008.

 

**(4)     FairValue Measurements**

 

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

 

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

 

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

 

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

 

As of January 31, 2009,the Company had $43.8 million (at par value) of investments in municipalauction rate securities (“ARS”) issued by student loan funding organizations.The ARS are classified as trading securities in noncurrent assets and arereflected at estimated fair value. These securities are high-grade (at leastAA-rated with one or more rating agencies) and approximately 79% are eitherguaranteed by the Department of Education under the Federal Family EducationLoan Program (37%) or backed by insurance companies, AMBAC AssuranceCorporation (31%) or MBIA Insurance Corporation (11%). Historically, liquidityfor investors in ARS was provided via an auction process that reset theinterest rate every 35 days, allowing investors to either roll over theirinvestments or sell them at par value. Beginning in February 2008, therewas insufficient demand for these types of investments during the auctions and,as a result, these securities became illiquid. Although the auctions for thesecurities have failed, certain issuers did redeem, at par value, $8.2 millionof ARS held by the Company, and one of the Company’s investment bankspurchased, at par value, $4.0 million of ARS held by the Company.  In addition, the Company has not experiencedany defaults and continues to earn and receive interest on all of theinvestments still owned by the Company.

 

There was insufficientobservable market information available as of January 31, 2009 todetermine the fair value of the Company’s ARS. Accordingly, the Companyestimated Level 3 fair values for these securities based on assumptions thatmarket participants would use in their estimates of fair value. Theseassumptions included, among other things, discounted cash flow projections, thetiming of expected future successful auctions or redemptions, collateralizationof the underlying securities and the creditworthiness of the issuers andinsurance companies.  Based on this Level3 valuation, the ARS investments were valued at $38.9 million as of January 31,2009, representing a $4.9 million decline from par value. Prior to fiscal 2008,the ARS were valued at par value due to the frequent resets that historicallyoccurred through the auction process.

 

In November 2008, theCompany accepted an offer (the “Right”) from UBS AG (“UBS”) allowing theCompany to sell at par value the remaining ARS to UBS at anytime during atwo-year period from June 30, 2010 through July 2, 2012.  In accepting the Right, the 

 

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Company granted UBS theauthority to sell or auction the ARS at par value at any time up until theexpiration date of the Right and released UBS from any claims relating to themarketing and sale of ARS.  The ARS willcontinue to earn interest until they are liquidated.  The obligations of UBS under the Right arenot secured by its assets and do not require UBS to obtain any financing topurchase the ARS.  UBS has disclaimed anyassurance that it will have sufficient financial resources to satisfy itsobligations under the Right.  If UBS doesnot have sufficient funding to buy back the ARS and no alternative buyers arelocated either through the auction process, issuer redemptions or other means,then the Company may not be able to access cash by selling these securitieswithout incurring a loss of principal.

 

The Right represents a put option and is recognizedas an instrument separate from the ARS. The Company elected to account for this Right at fair value under SFAS No. 159.  TheRight was valued using a discounted cash flow approach that includes estimatesof interest rates and the credit risk associated with UBS.  This valuation is based on unobservableinputs, therefore, represents a Level 3 fair value.  A $4.9 million gain associated with the Rightwas recorded in selling, general and administrative expenses, together with the$4.9 million ARS impairment charge discussed above.  The Company expects that subsequent changesin the value of the Right will largely offset the subsequent fair valuemovements of the ARS, subject to the continued expected performance by UBS ofits obligations under the Right. Prior to the acceptance of the Right, the ARSwere classified as available-for-sale, and the Company recorded a temporaryunrealized loss of $1,544,000 (net of tax) in other comprehensive income as ofthe end of the third quarter of 2008. Upon acceptance of the Right to sell the ARS, the ARS were reclassifiedto trading securities and the related unrealized loss was reclassified to netincome in the fourth quarter.

 

The following table providesa summary of changes in fair value of the Company’s investment securities forthe year ended January 31, 2009 (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           |       |
| Sales/redemptions of auction rate  securities                    |       | (3,500           | )          | (12,175          | )          |
| Purchases of auction rate securities                             |       | 4,000            |       | —           |       |
| Losses included in earnings                                      |       | —           |       | (4,901           | )          |
| Recognition of put option                                        |       | —           |       | 4,901            |       |
| Reclassification of interest receivable to  other current assets |       | —           |       | (665             | )          |
| Balance as of January 31, 2009                              |       | $                | —     |             | $          | 43,825 |   |

 

Investment securitiesincluded in the January 31, 2009 balance sheet consist of ARS valued at$38,924,000 and the put option valued at $4,901,000, both of which areclassified as noncurrent assets due to the expectation that liquidity will notoccur during the next twelve months.  Asof February 2, 2008, ARS investments, totaling $56,165,000, wereclassified as current assets due to the successful history of ARS auctions upuntil that time which had provided liquidity every 35 days.

 

**(5)     RevolvingLines of Credit**

 

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.  This new facility has a term of364 days, has an unused commitment fee equal to 0.15%, and has one restrictivefinancial covenant (consolidated 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 consolidated 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.

 

OnMarch 25, 2009, the credit facility with Bank of America was amended toextend the expiration date to March 24, 2010 and to lower the commitmentto $20 million, reflecting the Company’s year end cash position and the factthat there have been no borrowings under the facility.  In addition, changes were made to the pricingof the facility, including an increase in the unused commitment fee to 0.25%and an amendment of  the interest rates. Loans under the facility now bear interestat either (a) a rate equal to the highest of (i) the Federal FundsRate plus 0.50%, (ii) LIBOR plus 1.0% and (iii) Bank of America’sprime rate, plus an applicable margin; or (b) a rate equal to LIBOR plusan applicable margin. The applicable margin is dependent on the Company’sconsolidated leverage ratio and ranges from 0.75% to 1.25% for loans bearinginterest at the rate described under (a) above and from 1.75% to 2.25% forloans bearing interest at the rate described under (b) above.

 

The Company previously had a$25 million revolving line of credit with Wachovia Capital Finance secured bysubstantially all of the Company’s assets and pursuant to which the Companypaid customary fees. This secured line of credit expired on April 2, 2007and was not renewed.

 

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**(6)     CapitalLease Obligations**

 

The Company has capitallease obligations that financed the purchase of certain technology equipment.These obligations have a maturity date of December 2009. All of theseobligations are secured by the technology equipment.  The lease agreementcontains cross default provisions which result in a default on the lease if theCompany is out of compliance with any other borrowing agreements.

 

As of January 31, 2009and February 2, 2008, capital lease obligations consist of the following(in thousands):

 
| ** **                                                                                                                                                                                                                                                 | ** ** | **January 31,** | ** ** | **February 2,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                                                                                                                                                                                                                 | ** ** | **2009**             | ** ** | **2008**             | ** ** |
| Capital lease obligations issued to finance  purchase of technology equipment; payable in monthly installments averaging  approximately $124 in 2009, with a maturity date of December 2009;  interest rate of 11.3%; secured by technology equipment |       | $                    | 1,403      |                 | $          | 2,983 |   |
| Less current portion of capital lease  obligations                                                                                                                                                                                                         |       | 1,403                |       | 1,580                |       |
| Noncurrent portion of capital lease  obligations                                                                                                                                                                                                           |       | $                    | —     |                 | $          | 1,403 |   |

 

As of January 31, 2009,annual capital lease obligation maturities are as follows (in thousands):

 
| **Fiscal Year**                                                      | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------|------------|------------|------------|
| 2009                                                                      |       | $          | 1,475      |   |
| Less portion attributable to future  interest payments (at rate of 11.3%) |       | (72        | )          |
|                                                                      |       | $          | 1,403      |   |

 

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**(7)     IncomeTaxes**

 

Incometax expense for fiscal 2008, 2007 and 2006 consists of the following (inthousands):

 
| ** **               | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current:                 |       |     |       |     |       |     |       |
| Federal                  |       | $        | 7,258      |     | $          | 6,667    |       | 10,893 |   |
| State                    |       | 945      |       | 1,113    |       | 1,972    |       |
| Total current            |       | 8,203    |       | 7,780    |       | 12,865   |       |
| Deferred:                |       |     |       |     |       |     |       |
| Federal                  |       | (190     | )          | (1,080   | )          | (1,733   | )          |
| State                    |       | (143     | )          | (321     | )          | (515     | )          |
| Total deferred           |       | (333     | )          | (1,401   | )          | (2,248   | )          |
| Total income tax expense |       | $        | 7,870      |     | $          | 6,379    |       | $ | 10,617 |   |
|                          |            |          |            |          |            |          |            |  |  |  |

 

Incometax expense computed using the federal statutory rate is reconciled to thereported income tax expense as follows for fiscal 2008, 2007 and 2006 (inthousands):

 
| ** **                                            | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|-------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Statutory rate applied to income before  income taxes |       | $        | 8,839      |     | $          | 7,208    |       | $ | 10,869 |   |
| State income taxes, net of federal benefit            |       | 985      |       | 870      |       | 1,371    |       |
| State tax credits                                     |       | (439     | )          | (395     | )          | (410     | )          |
| Secondary offering expense                            |       | —   |       | 211      |       | —   |       |
| Tax exempt interest                                   |       | (811     | )          | (834     | )          | (677     | )          |
| General business credits                              |       | (786     | )          | (697     | )          | (403     | )          |
| Other                                                 |       | 82       |       | 16       |       | (133     | )          |
| Income tax expense                                    |       | $        | 7,870      |     | $          | 6,379    |       | $ | 10,617 |   |

 

The components of deferredtax assets and deferred tax liabilities as of January 31, 2009 and February 2,2008 are as follows (in thousands):

 
| ** **                            | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets:                  |       |     |       |     |       |
| Deferred rent amortization            |       | $        | 1,526      |     | $          | 1,335 |   |
| Inventory capitalization              |       | 1,807    |       | 1,574    |       |
| Book and tax depreciation differences |       | 1,412    |       | 1,801    |       |
| Vacation liability                    |       | 459      |       | 358      |       |
| State tax credits                     |       | 591      |       | 482      |       |
| Stock options                         |       | 980      |       | 917      |       |
| Other                                 |       | 100      |       | 80       |       |
| Total deferred tax assets             |       | 6,875    |       | 6,547    |       |
|                                  |       |     |       |     |       |
| Deferred tax liabilities:             |       |     |       |     |       |
| Prepaid expenses                      |       | (622     | )          | (665     | )          |
| Goodwill                              |       | (326     | )          | (288     | )          |
| Total deferred tax liabilities        |       | (948     | )          | (953     | )          |
| Net deferred tax asset                |       | $        | 5,927      |     | $          | 5,594 |   |

 

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The Company adopted FASBInterpretation No. 48, *Accounting for Uncertaintyin Income Taxes - an interpretation of FASB Statement No. 109* (“FIN48”) on February 4, 2007.  FIN 48clarifies the accounting and disclosure for uncertain tax positions.  FIN 48 requires that each tax position bereviewed and assessed with recognition and measurement of the tax benefit basedon a “more-likely-than-not” standard with respect to the ultimate outcome,regardless of whether this assessment is favorable or unfavorable.  TheCompany performed a review and assessment of all tax positions and duringfiscal year 2007 recorded a net benefit to retained earnings and a decrease tocurrent liabilities of $301,000 in accordance with FIN 48.  The Company files income tax returns in U.S.federal and state jurisdictions where it does business and is subject toexaminations by the IRS and other taxing authorities.  As of January 31,2009, there were no benefits taken on the Company’s income tax returns that donot qualify for financial statement recognition under FIN 48.   Under FIN 48, if a tax position does notmeet the minimum statutory threshold to avoid payment of penalties andinterest, a company is required to recognize an expense for the amount of theinterest and penalty in the period in which the company claims or expects toclaim the position on its tax return.  For financial statement purposes,FIN 48 allows companies to elect whether to classify such charges as eitherincome tax expense or another expense classification.  Should such expensebe incurred in the future, the Company will classify such interest as acomponent of interest expense and penalties as a component of income taxexpense.

 

In assessing therealizability of deferred tax assets, management considers whether it is morelikely than not that some portion or all of the deferred tax assets will not berealized. The ultimate realization of deferred tax assets is dependent upon thegeneration of future taxable income during the periods in which those temporarydifferences become deductible. Management considers the scheduled reversal ofdeferred tax liabilities, projected future taxable income, and tax planningstrategies in making this assessment. Based upon the level of historicaltaxable income and projections for future taxable income over the periods inwhich the deferred tax assets are deductible and income tax credits may beutilized, management believes it is more likely than not that the Company willrealize the benefits of these deductible differences.  Income tax creditsgenerated but not yet utilized by the Company may be carried forward forperiods ranging from 10 to 15 years. As such, a valuation allowance fordeferred tax assets was not considered necessary as of January 31, 2009 orFebruary 2, 2008. The Company has $846,000 of tax credit carryforwards forone state, available for use through 2022, and tax credit carryforwards of$63,000 for another state, available for use through 2018. The Company filesincome tax returns with the U.S. federal government and various statejurisdictions. With a few exceptions, the Company is no longer subject to U.S.federal and state income tax examinations by tax authorities for years prior tofiscal 2005.

 

**(8)     Stockholders’Equity**

 

*SecondaryOfferings*

 

On January 31, 2006,the Company completed a secondary offering of shares of the Company’s commonstock by certain of its stockholders that was priced at $42.25 per share. The offering consisted of 1,926,250 shares of the Company’s common stock. All of the shares were sold by stockholders of the Company and, as a result,the Company did not receive any of the proceeds from the offering.  Inconnection with the offering, certain of the Company’s stockholders exercisedoptions which were then sold in the offering for which the Company receivedapproximately $473,000.  The Company incurred expenses in fiscal 2005 inconnection with the secondary offering of approximately $525,000.

 

On June 18, 2007, theCompany completed another secondary offering of shares of the Company’s commonstock by certain of its stockholders that was priced at $37.92 per share.  The offering consisted of 2,455,250 shares ofthe Company’s common stock.  All of the shares were sold by stockholdersof the Company and, as a result, the Company did not receive any of theproceeds from the offering.  In connection with the offering, certain ofthe Company’s stockholders exercised options which were then sold in theoffering for which the Company received approximately $50,000.  TheCompany incurred expenses in fiscal 2007 in connection with the secondaryoffering of approximately $600,000.

 

*Stock-BasedCompensation*

 

On March 8, 2005, theCompany adopted the 2005 Citi Trends, Inc. Long-Term IncentivePlan,  (the “Incentive Plan”), which became effective upon theconsummation of the Company’s initial public offering in May 2005.  The Incentive Plan superseded and replaced the 1999 Allied Fashion Stock OptionPlan (the “1999 Plan”).  The 1999 Plan provided for the grant of incentiveand nonqualified options to key employees and directors. The Board of Directorsdetermined the exercise price of the option grants.  The option grantsgenerally vested in equal installments over four years from the date of grantand are generally exercisable up to ten years from the date of grant, which isthe contractual life of the options. The Company authorized up to 1,950,000shares of common stock for issuance under the 1999 Plan. In August 2006,the 1999 Plan was amended to permit the exercise price of stock options to besatisfied through net share settlements.

 

The Incentive Plan providesfor the grant of incentive and nonqualified options, nonvested restricted stockand other forms of stock-based compensation to key employees anddirectors.  The Board of Directors determines the exercise prices of theoption grants which are generally equal to the closing market price of theCompany’s stock on the date of grant.  Option grants generally vest inequal 

 

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installments over four yearsfrom the date of grant for employees and over one to three years for directorsand are generally exercisable up to ten years from the date ofgrant.   Under the Incentive Plan, the Company may issue up to1,300,000 shares of common stock upon the exercise of stock options and otherequity incentive awards.  In August 2006, the Incentive Plan wasamended to permit the exercise price of stock options to be satisfied throughnet share settlements, and in May 2008, the Incentive Plan was amended topermit the lapsing of restrictions on restricted stock at any time in the eventof a change in control of the Company.

 

Effective January 29,2006, the Company began recording compensation expense associated with allstock options and other forms of equity compensation in accordance with SFAS No. 123R.The Company selected the “Modified Prospective” transition approach foradoption of SFAS No. 123R. Under the Modified Prospective approach, priorperiods are not restated. Compensation expense for the unvested portions ofgrants awarded prior to January 29, 2006 are recognized over the grants’remaining service periods using the compensation cost calculated previously forpro-forma disclosure under APB Opinion No. 25 . For awards granted after January 28,2006, the Company is recognizing compensation expense based on the grant-datefair value calculated in accordance with SFAS No. 123R.

 

Under SFAS No. 123R,the fair value of each option award is estimated on the date of grant using theBlack-Scholes Merton option pricing model, which uses the assumptions noted inthe following table. Expected volatility is based on estimated futurevolatility of the Company’s common stock price. Having completed its initialpublic offering in May 2005, the Company has limited historical dataregarding the price of its publicly traded shares.  To estimate futurevolatility of the Company’s stock price, the stock price volatility of similarentities for which shares have been publicly traded for a period of seven yearsor more was measured (seven years is used because the weighted average expectedlife of the Company’s stock options is between six and seven years). TheCompany uses historical data to estimate forfeitures used in the model. Theexpected term of options granted is based on guidance provided by the SEC StaffAccounting Bulletins 107 and 110 (“simplified method” for “plain vanilla”options).  The simplified method (available for entities which do not havesufficient historical exercise data available for making a refined estimate ofexpected term) assumes a 10 year contractual term with vesting at a rate of 25%per year. Accordingly, expected term = ((vesting term + original contractualterm)/2). The risk-free interest rate for the periods which corresponds withthe expected life of the option is based on the U.S. Treasury yield curve forthe vesting period in effect at the time of grant.

 

No options were granted infiscal 2008 or 2007.   The fair value ofoptions granted during fiscal 2006 was estimated using the following weightedaverage assumptions:

 
| ** **                               | ** ** | **2006**  | ** ** |
|------------------------------------------|------------|-----------|------------|
| Expected dividend yield                  |       | 0.00      | %          |
| Expected volatility                      |       | 50.00     | %          |
| Risk-free interest rate                  |       | 4.71      | %          |
| Weighted-average expected life, in years |       | 6.2 years |       |

 

A summary of the status ofstock options under the Company’s stock option plans and changes during fiscal2008 is presented in the table below:

 
| ** **                                              | ** ** | **2008**    | ** ** |
|---------------------------------------------------------|------------|-------------|------------|
| ** **                                              | ** ** | ** **  | ** ** | ** ** | ** ** | **Wtd. Avg.** | ** ** | ** ** | ** ** |
| ** **                                              | ** ** | ** **  | ** ** | **Wtd. Avg.** | ** ** | **Remaining** | ** ** | **Aggregate** | ** ** |
| ** **                                              | ** ** | ** **  | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **                                              | ** ** | **Options** | ** ** | **Price** | ** ** | **Term (Years)** | ** ** | **Value** | ** ** |
|                                                    |       |        |       |   |   |   |   |   |   |
| Outstanding as of February 3, 2008                 |       | 560,141     |       | $ | 9.48 |   | 5.0 |   | $ | 5,190,425 |   |
| Granted                                                 |       | —      |       | — |   | — |   | — |   |
| Exercised                                               |       | (246,823    | )          | 2.10 |   | 2.5 |   | — |   |
| Net shares settled                                      |       | (77,643     | )          | 0.38 |   | 2.8 |   | — |   |
| Forfeited                                               |       | (26,825     | )          | 26.63 |   | 6.7 |   | — |   |
|                                                    |       |        |       |   |   |   |   |   |   |
| Outstanding as of January 31, 2009                 |       | 208,850     |       | $ | 19.38 |   | 5.8 |   | $ | 391,632 |   |
|                                                    |       |        |       |   |   |   |   |   |   |
| Vested or expected to vest as of  January 31, 2009 |       | 192,747     |       | $ | 18.51 |   | 5.7 |   | $ | 391,632 |   |
|                                                    |       |        |       |   |   |   |   |   |   |
| Exercisable as of January 31, 2009                 |       | 154,170     |       | $ | 15.94 |   | 5.4 |   | $ | 391,632 |   |

 

F-17

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As of January 31, 2009,the range of exercise prices was $0.38 to $44.03.  As of February 2,2008, the range of exercise prices and weighted-average remaining contractuallife of outstanding options was $0.38 to $44.03 and 5.0 years,respectively.  As of February 3, 2007, the range of exercise pricesand weighted-average remaining contractual life of outstanding options was$0.38 to $44.03 and 5.7 years, respectively.

 

There were no optionsgranted in fiscal 2008 or 2007. The weighted average grant-date fair value ofoptions granted during fiscal 2006 was $22.03 per share, or approximately$2,074,000.  Cash received from options exercised totaled $475,000,$411,000 and $914,000 in fiscal 2008, 2007 and 2006, respectively.  Theintrinsic value of options exercised was approximately $4,578,000, $8,136,000and $32,823,000 in fiscal 2008, 2007 and 2006, respectively.

 

Prior to the adoption ofSFAS No. 123R, the Company presented all tax benefits resulting from theexercise of stock options as operating cash flows in the statements of cashflows. SFAS No. 123R requires that cash flows resulting from taxdeductions in excess of the cumulative compensation cost recognized for optionsexercised (“excess tax benefits”) be classified as financing cash flows. Excesstax benefits realized from the exercise of stock options was approximately $1.2million, $3.5 million and $12.2 million in fiscal 2008, 2007 and 2006,respectively.

 

The Company recognized$811,000, $931,000 and $842,000 in compensation expense for option grantsduring fiscal 2008, 2007 and 2006, respectively. As of January 31, 2009,the total compensation cost related to stock option awards that will beincurred in future periods amounts to $612,000.  The weighted-averageperiod over which this amount is expected to be recognized is 15.7months.  The Company’s stock option plans allow the Company to issue newshares from shares authorized for issuance or repurchase shares on the openmarket to complete employee stock option exercises.  The Company does notcurrently plan to repurchase shares.

 

The Company’s Incentive Planallows for grants of nonvested restricted stock.  Shares granted to employees vest in equalinstallments over four years from the date of grant.  Shares issued to directors vest one year fromthe date of grant.  The Company recordscompensation expense on a straight line basis over the requisite service periodof the stock recipients which is equal to the vesting period of the stock.  Total compensation cost is calculated basedon the closing market price on the date of grant times the number of sharesgranted.  Using an estimated forfeiturerate equal to 8.5%, the Company expects to recognize $3,435,000 in futurecompensation expense from the grants of nonvested stock over the requisiteservice period.  During fiscal 2008 and2007, compensation expense arising from nonvested stock grants totaled$1,213,000 and $565,000, respectively.

 

A summary of activityrelated to nonvested stock grants during the year ended January 31, 2009is as follows:

 
| ** **                         | ** ** | **Nonvested** | ** ** | **Wtd. Avg. Grant** | ** ** |
|------------------------------------|------------|---------------|------------|-------------------------------|------------|
| ** **                         | ** ** | **Shares**    | ** ** | **Date Fair Value** | ** ** |
| Outstanding as of February 3, 2008 |       | 64,471        |       | $                             | 40.14      |   |
| Granted                            |       | 212,751       |       | 17.62                         |       |
| Vested                             |       | (18,983       | )          | 40.17                         |       |
| Forfeited                          |       | (20,929       | )          | 28.95                         |       |
| Outstanding as of January 31, 2009 |       | 237,310       |       | $                             | 20.87      |   |

 

**(9)     Commitmentsand Contingencies**

 

The Company leases itsstores under operating leases, which generally have an initial term of fiveyears with renewal options. Future minimum rent payments under operating leaseshaving noncancelable lease terms as of January 31, 2009 are as follows (inthousands):

 
| **Fiscal Year:**               | ** ** | ** ** | ** ** |
|-------------------------------------|------------|------------|------------|
| 2009                                |       | $          | 22,801     |   |
| 2010                                |       | 19,887     |       |
| 2011                                |       | 16,228     |       |
| 2012                                |       | 11,008     |       |
| 2013                                |       | 5,359      |       |
| Thereafter                          |       | 3,820      |       |
| Total future minimum lease payments |       | $          | 79,103     |   |

 

Certain operating leasesprovide for fixed monthly rents, while others provide for contingent rentscomputed as a percentage of net sales and others provide for a combination ofboth fixed monthly rents and contingent rents computed as a percentage of netsales.

 

F-18

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Table of Contents

 

Rent expense was $23.1million, $19.3 million and $16.0 million for fiscal 2008, 2007 and 2006(including $1.6 million, $1.9 million and $2.5 million of percentage rent),respectively.

 

TheCompany from time to time is involved in various legal proceedings incidentalto the conduct of its business, including claims by customers, employees orformer employees.  While litigation is subject to uncertainties and theoutcome of any litigated matter is not predictable, the Company is not aware ofany legal proceedings pending or threatened against it that it expects to havea material adverse effect on its financial condition, results of operations orliquidity.

 

**(10)  Valuation and Qualifying Accounts**

 

The following table summarizesthe allowance for inventory shrinkage (in thousands): 

 
| ** **                              | ** ** | **Inventory** | ** ** |
|-----------------------------------------|------------|---------------|------------|
| ** **                              | ** ** | **Shrinkage** | ** ** |
| ** **                              | ** ** | **Reserve**   | ** ** |
| Balance as of January 28, 2006          |       | $             | 1,906      |   |
| Additions charged to costs and expenses |       | 6,398         |       |
| Deductions                              |       | (6,035        | )          |
| Balance as of February 3, 2007          |       | 2,269         |       |
| Additions charged to costs and expenses |       | 8,374         |       |
| Deductions                              |       | (8,109        | )          |
| Balance as of February 2, 2008          |       | 2,534         |       |
| Additions charged to costs and expenses |       | 7,331         |       |
| Deductions                              |       | (7,885        | )          |
| Balance as of January 31, 2009          |       | $             | 1,980      |   |

 

Additions charged to costs andexpenses are the result of estimated inventory shrinkage. Deductions representactual inventory shrinkage incurred from physical inventories taken during thefiscal year.

 

F-19

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Table of Contents

 

**(11)****      ****Unaudited Quarterly Resultsof Operations**

 
| ** **                                                                   | ** ** | **Quarter Ended**                                                                    | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **Jan. 31**                                                                          | ** ** | **Nov. 1** | ** ** | **Aug. 2** | ** ** | **May 3,** | ** ** | **Feb. 2** | ** ** | **Nov. 3** | ** ** | **Aug. 4** | ** ** | **May 5,** | ** ** |
| ** **                                                                   | ** ** | **2009**                                                                                  | ** ** | **2008** | ** ** | **2008** | ** ** | **2008** | ** ** | **2008** | ** ** | **2007** | ** ** | **2007** | ** ** | **2007** | ** ** |
| ** **                                                                   | ** ** | **(in thousands, except per share and share amounts)** | ** ** |
| **Statement of Income Data:**                                                |       |                                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net sales                                                                    |       | $                                                                                         | 146,603    |   | $ | 104,948 |   | $ | 115,655 |   | $ | 120,996 |   | $ | 134,571 |   | $ | 99,542 |   | $ | 96,826 |   | $ | 106,576 |   |
| Cost of sales                                                                |       | 90,695                                                                                    |       | 66,208 |   | 70,731 |   | 74,233 |   | 87,145 |   | 65,026 |   | 61,734 |   | 64,878 |   |
|                                                                         |       |                                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross profit                                                                 |       | 55,908                                                                                    |       | 38,740 |   | 44,924 |   | 46,763 |   | 47,426 |   | 34,516 |   | 35,092 |   | 41,698 |   |
| Selling, general and administrative expenses                                 |       | 37,409                                                                                    |       | 36,482 |   | 36,877 |   | 36,241 |   | 32,892 |   | 32,455 |   | 31,548 |   | 30,575 |   |
| Depreciation and amortization                                                |       | 4,346                                                                                     |       | 4,134 |   | 4,078 |   | 3,703 |   | 3,488 |   | 3,265 |   | 3,009 |   | 2,821 |   |
|                                                                         |       |                                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from operations                                                |       | 14,153                                                                                    |       | (1,876 | ) | 3,969 |   | 6,819 |   | 11,046 |   | (1,204 | ) | 535 |   | 8,302 |   |
| Interest income (expense), net                                               |       | 229                                                                                       |       | 696 |   | 482 |   | 781 |   | 583 |   | 415 |   | 415 |   | 501 |   |
|                                                                         |       |                                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss) before income taxes                                            |       | 14,382                                                                                    |       | (1,180 | ) | 4,451 |   | 7,600 |   | 11,629 |   | (789 | ) | 950 |   | 8,803 |   |
| Income tax expense (benefit)                                                 |       | 4,326                                                                                     |       | (493 | ) | 1,605 |   | 2,432 |   | 3,251 |   | (276 | ) | 323 |   | 3,081 |   |
|                                                                         |       |                                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (loss)                                                            |       | $                                                                                         | 10,056     |   | $ | (687 | ) | $ | 2,846 |   | $ | 5,168 |   | $ | 8,378 |   | $ | (513 | ) | $ | 627 |   | $ | 5,722 |   |
|                                                                         |       |                                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (loss) per common share:                                          |       |                                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic (1)                                                                    |       | $                                                                                         | 0.71       |   | $ | (0.05 | ) | $ | 0.20 |   | $ | 0.37 |   | $ | 0.60 |   | $ | (0.04 | ) | $ | 0.05 |   | $ | 0.41 |   |
| Diluted (1)                                                                  |       | $                                                                                         | 0.70       |   | $ | (0.05 | ) | $ | 0.20 |   | $ | 0.36 |   | $ | 0.59 |   | $ | (0.04 | ) | $ | 0.04 |   | $ | 0.40 |   |
| Weighted average shares used to compute net  income (loss) per common share: |       |                                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                        |       | 14,240,602                                                                                |       | 14,141,132 |   | 14,095,135 |   | 14,047,841 |   | 14,033,557 |   | 14,022,549 |   | 13,922,130 |   | 13,807,134 |   |
| Diluted                                                                      |       | 14,289,848                                                                                |       | 14,141,132 |   | 14,278,985 |   | 14,216,580 |   | 14,187,870 |   | 14,022,549 |   | 14,249,255 |   | 14,218,634 |   |

 

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(1)             Net income (loss) per share is computedindependently for each period presented. As a result, the total of the pershare earnings for the four quarters may not equal the annual amount.

 

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