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CATO CORP - Quarter Report: 2004 July (Form 10-Q)

THE CATO CORPORATION
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

     
x
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
   
For the quarterly period ended           July 31, 2004          
 
   
OR
 
   
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________ to __________________

Commission file number           1-31340          

THE CATO CORPORATION


(Exact name of registrant as specified in its charter)
     
Delaware   56-0484485

 
(State or other jurisdiction
of incorporation)
  (I.R.S. Employer
Identification No.)

8100 Denmark Road, Charlotte, North Carolina 28273-5975


(Address of principal executive offices)
(Zip Code)

(704) 554-8510


(Registrant’s telephone number, including area code)

Not Applicable


(Former name, former address and former fiscal year,
if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x     No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes x     No o

As of August 17, 2004, there were 20,242,167 shares of Class A common stock and 460,350 shares of Class B common stock outstanding.

 


 

THE CATO CORPORATION

FORM 10-Q

July 31, 2004

Table of Contents

         
    Page
    No.
PART I — FINANCIAL INFORMATION (UNAUDITED)
       
 
       
Item 1. Financial Statements:
       
 
       
Condensed Consolidated Statements of Income
    2  
For the Three Months and Six Months Ended July 31, 2004 and August 2, 2003
       
 
       
Condensed Consolidated Balance Sheets
    3  
At July 31, 2004, August 2, 2003 and January 31, 2004
       
 
       
Condensed Consolidated Statements of Cash Flows
    4  
For the Six Months Ended July 31, 2004 and August 2, 2003
       
 
       
Notes to Condensed Consolidated Financial Statements
    5–8  
For the Three Months and Six Months Ended July 31, 2004 and August 2, 2003
       
 
       
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
    9–17  
 
       
Item 3. Quantitative and Qualitative Disclosures About Market Risk
    17  
 
       
Item 4. Controls and Procedures
    17  
 
       
PART II — OTHER INFORMATION
       
 
       
Item 1. Legal Proceedings
    18  
 
       
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    18  
 
       
Item 3. Defaults upon Senior Securities
    18  
 
       
Item 4. Submission of Matters to a Vote of Security Holders
    18-19  
 
       
Item 5. Other Information
    19  
 
       
Item 6. Exhibits
    19  
 
       
Signatures
    20  

 


 

Page 2

PART I FINANCIAL INFORMATION

THE CATO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME

                                 
    Three Months Ended
  Six Months Ended
    July 31,   August 2,   July 31,   August 2,
    2004   2003   2004   2003
    (Unaudited)
  (Unaudited)
  (Unaudited)
  (Unaudited)
    (Dollars in thousands, except per share data)
REVENUES
                               
Retail sales
  $ 197,068     $ 188,218     $ 402,261     $ 385,522  
Other income (principally finance, late, and layaway charges)
    3,816       3,775       7,824       7,681  
 
   
 
     
 
     
 
     
 
 
Total revenues
    200,884       191,993       410,085       393,203  
 
   
 
     
 
     
 
     
 
 
 
                               
COSTS AND EXPENSES
                               
Cost of goods sold
    136,051       132,616       268,395       259,614  
Selling, general and administrative
    47,387       44,565       93,210       88,010  
Depreciation
    5,091       4,562       10,070       9,013  
Interest expense
    167       1       329       4  
Interest and other income
    (656 )     (1,888 )     (1,162 )     (3,018 )
 
   
 
     
 
     
 
     
 
 
Costs and expenses
    188,040       179,856       370,842       353,623  
 
   
 
     
 
     
 
     
 
 
 
                               
INCOME BEFORE INCOME TAXES
    12,844       12,137       39,243       39,580  
 
                               
Income tax expense
    4,662       4,406       14,245       14,368  
 
   
 
     
 
     
 
     
 
 
 
                               
NET INCOME
  $ 8,182     $ 7,731     $ 24,998     $ 25,212  
 
   
 
     
 
     
 
     
 
 
 
                               
BASIC EARNINGS PER SHARE
  $ .40     $ .30     $ 1.22     $ .99  
 
   
 
     
 
     
 
     
 
 
 
                               
DILUTED EARNINGS PER SHARE
  $ .39     $ .30     $ 1.20     $ .98  
 
   
 
     
 
     
 
     
 
 
 
                               
DIVIDENDS PER SHARE
  $ .175     $ .16     $ .335     $ .31  
 
   
 
     
 
     
 
     
 
 

See accompanying notes to condensed consolidated financial statements.

 


 

Page 3

THE CATO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS

                         
    July 31,   August 2,   January 31,
    2004   2003   2004
    (Unaudited)
  (Unaudited)
   
    (Dollars in thousands)
ASSETS
                       
Current Assets
                       
Cash and cash equivalents
  $ 29,439     $ 59,836     $ 23,857  
Short-term investments
    76,494       66,255       47,545  
Accounts receivable — net
    50,260       53,092       52,714  
Merchandise inventories
    86,355       79,998       97,292  
Deferred income taxes
    243       1,530       284  
Prepaid expenses
    5,804       5,651       5,708  
 
   
 
     
 
     
 
 
Total Current Assets
    248,595       266,362       227,400  
Property and equipment — net
    114,783       113,131       114,367  
Other assets
    10,194       9,617       9,806  
 
   
 
     
 
     
 
 
Total
  $ 373,572     $ 389,110     $ 351,573  
 
   
 
     
 
     
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
                       
Current Liabilities
                       
Accounts payable
  $ 68,527     $ 52,304     $ 76,387  
Accrued expenses
    33,832       27,698       27,815  
Income taxes
    10,693       8,012       4,290  
Current portion of long-term debt
    6,000             6,000  
 
   
 
     
 
     
 
 
Total Current Liabilities
    119,052       88,014       114,492  
Deferred income taxes
    10,203       6,310       10,203  
Long-term debt
    18,500             21,500  
Other noncurrent liabilities
    11,709       8,700       11,267  
 
Commitments and contingencies
                       
 
   
 
     
 
     
 
 
Total Liabilities
    159,464       103,024       157,462  
Shareholders’ Equity:
                       
Preferred stock, $100 par value per share, 100,000 shares authorized, none issued
                 
Class A common stock, $.033 par value per share, 50,000,000 shares authorized; issued 26,147,346 shares, 25,612,313 shares and 26,015,868 shares at July 31, 2004, August 2, 2003 and January 31, 2004, respectively
    872       854       867  
Convertible Class B common stock, $.033 par value per share, 15,000,000 shares authorized; issued 5,597,834 shares, 5,796,078 shares and 5,607,834 shares at July 31, 2004, August 2, 2003 and January 31, 2004, respectively
    186       193       187  
Additional paid-in capital
    101,134       96,087       99,676  
Retained earnings
    270,949       253,226       252,828  
Accumulated other comprehensive gains
    131       10       58  
Unearned compensation — restricted stock awards
    (1,252 )     (1,935 )     (1,593 )
 
   
 
     
 
     
 
 
 
    372,020       348,435       352,023  
Less Class A and Class B common stock in treasury, at cost (5,906,179 Class A and 5,137,484 Class B shares at July 31, 2004 and January 31, 2004, 5,906,179 Class A and
-0- Class B shares at August 2, 2003)
    (157,912 )     (62,349 )     (157,912 )
 
   
 
     
 
     
 
 
Total Shareholders’ Equity
    214,108       286,086       194,111  
 
   
 
     
 
     
 
 
Total
  $ 373,572     $ 389,110     $ 351,573  
 
   
 
     
 
     
 
 

See accompanying notes to condensed consolidated financial statements.

 


 

Page 4

THE CATO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

                 
    Six Months Ended
    July 31,   August 2,
    2004   2003
    (Unaudited)
  (Unaudited)
    (Dollars in thousands)
OPERATING ACTIVITIES
               
 
               
Net income
  $ 24,998     $ 25,212  
 
               
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
    10,070       9,013  
Amortization of investment premiums
          4  
Compensation expense related to restricted stock awards
    341       440  
Loss on disposal of property and equipment
    1,363       243  
Changes in operating assets and liabilities which provided (used) cash:
               
Accounts receivable
    2,454       1,024  
Merchandise inventories
    10,937       13,459  
Other assets
    (484 )     (1,066 )
Accounts payable and other liabilities
    (1,444 )     (15,485 )
Accrued income taxes
    6,403       5,126  
 
   
 
     
 
 
 
               
Net cash provided by operating activities
    54,638       37,970  
 
   
 
     
 
 
 
               
INVESTING ACTIVITIES
               
 
               
Expenditures for property and equipment
    (11,765 )     (9,080 )
Purchases of short-term investments
    (42,651 )     (7,686 )
Sales of short-term investments
    13,775       16,055  
 
   
 
     
 
 
 
               
Net cash (used) in investing activities
    (40,641 )     (711 )
 
   
 
     
 
 
 
               
FINANCING ACTIVITIES
               
 
               
Dividends paid
    (6,877 )     (7,874 )
Purchases of treasury stock
          (2,741 )
Payments to settle long-term debt
    (3,000 )      
Proceeds from employee stock purchase plan
    226       245  
Proceeds from stock options exercised
    1,236       882  
 
   
 
     
 
 
 
               
Net cash (used) in financing activities
    (8,415 )     (9,488 )
 
   
 
     
 
 
 
               
Net increase in cash and cash equivalents
    5,582       27,771  
 
               
Cash and cash equivalents at beginning of period
    23,857       32,065  
 
   
 
     
 
 
 
               
Cash and cash equivalents at end of period
  $ 29,439     $ 59,836  
 
   
 
     
 
 

See accompanying notes to condensed consolidated financial statements.

 


 

Page 5

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 31, 2004
AND AUGUST 2, 2003 (UNAUDITED)


NOTE 1 — GENERAL:

The condensed consolidated financial statements have been prepared from the accounting records of The Cato Corporation and its wholly-owned subsidiaries (the “Company”), and all amounts shown as of and for the periods ended July 31, 2004 and August 2, 2003 are unaudited. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. The results of the interim period may not be indicative of the entire year.

The interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2004.

Cash equivalents consist of highly liquid investments with original maturities of three months or less. Investments with original maturities beyond three months are classified as short-term investments. The fair values of short-term investments are based on quoted market prices.

The Company’s short-term investments are classified as available-for-sale. As they are available for current operations, they are classified in the Condensed Consolidated Balance Sheets as current assets. Available-for-sale securities are carried at fair value, with unrealized gains and temporary losses, net of income taxes, reported as a component of accumulated other comprehensive income. Other than temporary declines in fair value of investments are recorded as a reduction in the cost of the investments in the accompanying Condensed Consolidated Balance Sheets and a reduction of interest and other income in the accompanying Condensed Consolidated Statements of Income. The cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. The amortization of premiums, accretion of discounts and realized gains and losses are included in interest and other income.

Total comprehensive income for the second quarter and six months ended July 31, 2004 was $8,070,000 and $25,071,000, respectively. Total comprehensive income for the second quarter and six months ended August 2, 2003 was $7,374,000 and $24,969,000, respectively. Total comprehensive income is composed of net income and net unrealized gains and losses on available-for-sale securities.

Merchandise inventories are stated at the lower of cost (first-in, first-out method) or market as determined by the retail inventory method.

In May 2004, the Board of Directors increased the quarterly dividend by 9% from $.16 per share to $.175 per share.

 


 

Page 6

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 31, 2004
AND AUGUST 2, 2003 (UNAUDITED)


NOTE 1 – GENERAL (CONTINUED):

The provisions for income taxes are based on the Company’s estimated annual effective tax rate.

Certain reclassifications have been made to the condensed consolidated financial statements for prior periods to conform to the current period presentation.

NOTE 2 — EARNINGS PER SHARE:

FASB No. 128 requires dual presentation of basic EPS and diluted EPS on the face of all income statements for all entities with complex capital structures. Basic EPS is computed as net income divided by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock options and other convertible securities. Unvested restricted stock is included in the computation of diluted EPS using the treasury stock method. There was an insignificant number of shares withheld from the computation of diluted EPS due to potential anti-dilutive effects for the six months ended July 31, 2004 and August 2, 2003.

                                 
    Three Months Ended
  Six Months Ended
    July 31,   August 2,   July 31,   August 2,
    2004
  2003
  2004
  2003
Weighted-average shares outstanding
    20,515,017       25,478,008       20,527,831       25,458,696  
Dilutive effect of stock options
    365,014       410,325       363,001       391,925  
 
   
 
     
 
     
 
     
 
 
Weighted-average shares and common stock equivalents (stock options) outstanding
    20,880,031       25,888,333       20,890,832       25,850,621  
 
   
 
     
 
     
 
     
 
 

NOTE 3 — SUPPLEMENTAL CASH FLOW INFORMATION:

Income tax payments, net of refunds received, for the six months ended July 31, 2004 and August 2, 2003 were $7,866,100 and $9,277,450, respectively.

 


 

Page 7

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 31, 2004
AND AUGUST 2, 2003 (UNAUDITED)


NOTE 4 — FINANCING ARRANGEMENTS:

At July 31, 2004, the Company had an unsecured revolving credit agreement which provided for borrowings of up to $35 million. This revolving credit agreement was entered into on August 22, 2003 and is committed until August 2006. The credit agreement contains various financial covenants and limitations, including the maintenance of specific financial ratios. There were no borrowings outstanding during the six months ended July 31, 2004 or the fiscal year ended January 31, 2004. Interest is based on LIBOR, which was 1.50% on July 31, 2004.

On August 22, 2003, the Company entered into a new unsecured $30 million five-year term loan facility, the proceeds of which were used to purchase Class B Common Stock from the Company’s founders. The amounts outstanding under the loan totaled $24.5 million as of July 31, 2004. Payments are due in monthly installments of $500,000 plus accrued interest. Interest is based on LIBOR, which was 1.50% on July 31, 2004.

The Company had approximately $4,707,000 and $6,742,000 at July 31, 2004 and August 2, 2003, respectively, of outstanding irrevocable letters of credit relating to purchase commitments.

NOTE 5 – REPORTABLE SEGMENT INFORMATION:

The Company has two reportable segments: retail and credit. The Company operated its women’s fashion specialty retail stores in 28 states at July 31, 2004, principally in the southeastern United States. The Company offers its own credit card to its customers and all credit authorizations, payment processing, and collection efforts are performed by a separate subsidiary of the Company.

The following schedule summarizes certain segment information (in thousands):

                                                         
Three Months Ended                           Six Months Ended            
July 31, 2004
  Retail
  Credit
  Total
  July 31, 2004
  Retail
  Credit
  Total
Revenues
  $ 197,359     $ 3,525     $ 200,884     Revenues   $ 403,050     $ 7,035     $ 410,085  
Depreciation
    5,072       19       5,091     Depreciation     10,031       39       10,070  
Interest and other income
    (656 )           (656 )   Interest and other income     (1,162 )           (1,162 )
Income before taxes
    11,533       1,311       12,844     Income before taxes     36,823       2,420       39,243  
Total assets
    310,985       62,587       373,572     Total assets     310,985       62,587       373,572  
Capital expenditures
    4,699       83       4,782     Capital expenditures     11,680       85       11,765  
 
                                                       
Three Months Ended                           Six Months Ended            
August 2, 2003
  Retail
  Credit
  Total
  August 2, 2003
  Retail
  Credit
  Total
Revenues
  $ 188,415     $ 3,578     $ 191,993     Revenues   $ 386,013     $ 7,190     $ 393,203  
Depreciation
    4,543       19       4,562     Depreciation     8,974       39       9,013  
Interest and other income
    (1,888 )           (1,888 )   Interest and other income     (3,018 )           (3,018 )
Income before taxes
    11,065       1,071       12,136     Income before taxes     37,541       2,039       39,580  
Total assets
    312,928       76,182       389,110     Total assets     312,928       76,182       389,110  
Capital expenditures
    4,678             4,678     Capital expenditures     9,080             9,080  

 


 

Page 8

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 31, 2004
AND AUGUST 2, 2003 (UNAUDITED)


NOTE 5 – REPORTABLE SEGMENT INFORMATION (CONTINUED):

The Company evaluates performance based on profit or loss from operations before income taxes. The Company does not allocate certain corporate expenses or income taxes to the segments.

The following schedule summarizes the direct expenses of the credit segment which are reflected in selling, general and administrative expenses (in thousands):

                                 
    Three Months Ended
  Six Months Ended
    July 31,   August 2,   July 31,   August 2,
    2004
  2003
  2004
  2003
Bad debt expense
  $ 1,247     $ 1,545     $ 2,669     $ 3,172  
Payroll
    294       277       572       548  
Postage
    260       275       576       608  
Other expenses
    394       391       759       784  
 
   
 
     
 
     
 
     
 
 
 
                               
Total expenses
  $ 2,195     $ 2,488     $ 4,576     $ 5,112  
 
   
 
     
 
     
 
     
 
 

 


 

Page 9

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


RESULTS OF OPERATIONS:

The following table sets forth, for the periods indicated, certain items in the Company’s unaudited Condensed Consolidated Statements of Income as a percentage of total retail sales:

                                 
    Three Months Ended
  Six Months Ended
    July 31,   August 2,   July 31,   August 2,
    2004
  2003
  2004
  2003
Total retail sales
    100.0 %     100.0 %     100.0 %     100.0 %
Total revenues
    101.9       102.0       101.9       101.9  
Cost of goods sold
    69.0       70.5       66.7       67.4  
Selling, general and administrative
    24.0       23.7       23.2       22.8  
Depreciation
    2.6       2.4       2.5       2.3  
Interest expense
    0.1       0.0       0.1       0.0  
Interest and other income
    (0.3 )     (1.0 )     (0.3 )     (0.8 )
Income before income taxes
    6.5       6.4       9.7       10.2  
Net income
    4.1       4.1       6.2       6.5  

Comparison of Second Quarter and First Six Months of 2004 with 2003.

Total retail sales for the second quarter were $197.1 million compared to last year’s second quarter sales of $188.2 million, a 5% increase. Same-store sales decreased 1% in the second quarter of fiscal 2004. For the six months ended July 31, 2004, total retail sales were $402.3 million compared to last year’s first six months sales of $385.5 million, a 4% increase, and same-store sales decreased 2% for the comparable six month period. Total revenue, comprised of retail sales and other income (principally, finance charges and late fees on customer accounts receivable and layaway fees), were $200.9 million and $410.1 million for the second quarter and six months ended July 31, 2004, respectively, compared to $192.0 million and $393.2 million for the second quarter and six months ended August 2, 2003, respectively. The Company operated 1,132 stores at July 31, 2004 compared to 1,051 stores at the end of last year’s second quarter. For the first six months of 2004 the Company opened 30 stores and relocated 17 stores.

Credit revenue of $3.5 million, represented 1.8% of total revenues in the second quarter of 2004. This is comparable to 2003 credit revenue of $3.6 million or 1.9% of total revenues. Credit revenue is comprised of interest earned on the Company’s private label credit card portfolio and related fee income. Related expenses include principally bad debt expense, payroll, postage and other administrative expenses and totaled $2.2 million in the second quarter of 2004 compared to last year’s second quarter expenses of $2.5 million. The decrease in costs was principally due to lower bad debt expense. Total credit income for the second quarter before taxes increased $0.2 million from $1.1 million in 2003 to $1.3 million in 2004 due to reduced operating costs.

 


 

Page 10

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


RESULTS OF OPERATIONS – (CONTINUED):

Other income in total, as included in total revenues in the second quarter of 2004, remained flat at $3.8 million compared to the second quarter of 2003.

Cost of goods sold was $136.1 million, or 69.0% of retail sales and $268.4 million or 66.7% of retail sales for the second quarter and first six months of fiscal 2004, compared to $132.6 million, or 70.5% of retail sales and $259.6 million, or 67.4% of retail sales for the prior year’s comparable three and six months periods, respectively. The overall dollar increase in cost of goods sold resulted primarily from increased freight and occupancy costs. The overall decrease in cost of goods sold as a percent of retail sales for the second quarter and first six months of 2004 resulted primarily from lower markdowns. Cost of goods sold includes merchandise costs, net of discounts and allowances, buying costs, distribution costs, occupancy costs, freight and inventory shrinkage. Net merchandise costs and in-bound freight are capitalized as inventory costs. Buying and distribution costs include payroll, payroll-related costs and operating expenses for the buying departments and distribution center. Occupancy expenses include rent, real estate taxes, insurance, common area maintenance, utilities and maintenance for stores and distribution facilities. Total gross margin dollars (retail sales less cost of goods sold) increased by 9.7% to $61.0 million and by 6.3% to $133.9 million for the second quarter and first six months of fiscal 2004 compared to $55.6 million and $125.9 million for the prior year’s comparable three and six month periods, respectively. Gross margin as presented may not be comparable to those of other entities as they may include internal transfer costs in selling, general and administrative expenses while the Company classifies them as cost of goods sold.

Selling, general and administrative expenses (SG&A) primarily include corporate and store payroll, related payroll taxes and benefits, insurance, supplies, advertising, bank and credit card processing fees and bad debts. Selling, general and administrative (SG&A) expenses were $47.4 million, or 24.0% of retail sales and $93.2 million, or 23.2% of retail sales for the second quarter and first six months of fiscal 2004, compared to $44.6 million, or 23.7% of retail sales and $88.0 million, or 22.8% of retail sales for prior year’s comparable three and six months periods, respectively. SG&A expenses as a percentage of retail sales increased 30 basis points for the second quarter of fiscal 2004 as compared to the prior year and increased 40 basis points for the first six months of fiscal 2004, as compared to the prior year. The overall dollar increase in SG&A expenses for the second quarter and first six months of fiscal 2004 resulted primarily from increased selling-related expenses and increased infrastructure expenses attributable to the Company’s store growth and from increased incentive based performance bonus programs.

 


 

Page 11

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


RESULTS OF OPERATIONS – (CONTINUED):

Depreciation expense was $5.1 million, or 2.6% of retail sales and $10.1 million or 2.5% of retail sales, for the second quarter and first six months of fiscal 2004, compared to $4.6 million, or 2.4% of retail sales and $9.0 million, or 2.3% of retail sales, for prior year’s comparable three and six month periods, respectively. The 12% increase for the first six months of fiscal 2004 resulted primarily from the Company’s new store growth.

Interest expense was $0.2 million, or 0.1% of retail sales and $0.3 million or 0.1% of retail sales, for the second quarter and first six months of fiscal 2004, compared to $0.0 for the prior year’s comparable three and six month periods, respectively. The increase in fiscal 2004 resulted from interest payments on a new $30.0 million five-year term loan facility entered into on August 22, 2003, the proceeds of which were used to purchase Class B Common Stock from the Company’s founders.

Interest and other income was $0.7 million, or 0.3% of retail sales and $1.2 million or 0.3% of retail sales, for the second quarter and first six months of fiscal 2004, compared to $1.9 million, or 1.0% of retail sales and $3.0 million, or 0.8% of retail sales, for the prior year’s comparable three and six month periods, respectively. The decrease in the second quarter and first six months of fiscal 2004 resulted primarily from the Company’s lower cash and short-term investment position following the repurchase of $98.3 million of Company stock in fiscal 2003 and a one-time gain of $0.8 million on the sale of investments in the second quarter of fiscal 2003.

Income tax expense was $4.7 million, or 2.4% of retail sales and $14.2 million, or 3.5% of retail sales, for the second quarter and first six months of fiscal 2004, compared to $4.4 million, or 2.3% of retail sales and $14.4 million, or 3.7% of retail sales, for the prior year’s comparable three and six month periods. The second quarter increase resulted from higher pre-tax income. The effective income tax rate for the second quarter and first six months of fiscal 2004 was 36.3%, unchanged from fiscal 2003.

CRITICAL ACCOUNTING POLICIES:

The preparation of the Company’s financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements. The most significant accounting estimates inherent in the preparation of the Company’s financial statements include the allowance for doubtful accounts receivable, reserves relating to workers’ compensation, general and auto insurance liabilities, reserves for inventory markdowns, calculation of asset impairment, shrink accrual and tax contingency reserves.

The Company’s critical accounting estimates are discussed with the Audit Committee.

 


 

Page 12

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


CRITICAL ACCOUNTING POLICIES – (CONTINUED):

Allowance for Doubtful Accounts

The Company evaluates the collectibility of accounts receivable and records an allowance for doubtful accounts based on estimates of actual write-offs and the accounts receivable aging roll rates over the prior five months. The allowance is reviewed for adequacy and adjusted, as necessary, on a monthly basis. The Company also provides for estimated uncollectible late fees charged based on historical write-offs. The Company’s financial results can be significantly impacted by changes in bad debt write-off experience and the aging of the accounts receivable portfolio. Historically, actual results have not significantly deviated from estimates.

Insurance Liabilities

The Company is primarily self-insured for health care, property loss, workers’ compensation and general liability costs. These costs are significant primarily due to the large number of the Company’s retail locations and employees. The Company’s self-insurance liabilities are based on the total estimated costs of claims filed and estimates of claims incurred but not reported, less amounts paid against such claims, and are not discounted. Management reviews current and historical claims data in developing its estimates. The Company also uses information provided by outside actuaries with respect to workers’ compensation and general liability claims. If the underlying facts and circumstances of the claims change or the historical experience upon which insurance provisions are recorded is not indicative of future trends, then the Company may be required to adjust the provision for insurance costs, which could be material to the Company’s reported financial condition and results of operations. Historically, actual results have not significantly deviated from estimates.

Revenue Recognition

While the Company’s recognition of revenue is predominantly derived from routine retail transactions and does not involve significant judgment, revenue recognition represents an important accounting policy of the Company. The Company recognizes sales at the point of purchase when the customer takes possession of the merchandise and pays for the purchase, generally with cash or credit. Sales from purchases made with Cato credit, gift cards and layaway sales are also recorded when the customer takes possession of the merchandise. Gift cards, layaway deposits and merchandise credits granted to customers are recorded as deferred revenue until they are redeemed or forfeited. A provision is made for estimated product returns based on sales volumes and the Company’s experience; actual returns have not varied materially from amounts provided historically.

Credit revenue on the Company’s private label credit card portfolio is recognized as earned under the interest method. Late fees are recognized as earned, less provisions for estimated uncollectible fees.

 


 

Page 13

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


CRITICAL ACCOUNTING POLICIES – (CONTINUED):

Impairment of Long-Lived Assets

The Company primarily invests in property and equipment in connection with the opening, relocating and remodeling of stores and in computer software and hardware. Most of the Company’s store leases give the Company the option to terminate the lease if certain specified sales volumes are not achieved during the first few years of the lease. The Company periodically reviews its store locations and estimates the recoverability of its assets, recording an impairment charge, if necessary, when the Company decides to close the store or otherwise determines that future undiscounted cash flows associated with those assets will not be sufficient to recover the carrying value. This determination is based on a number of factors, including the store’s historical operating results and cash flows, estimated future sales growth, real estate development in the area and perceived local market conditions that can be difficult to predict and may be subject to change. In addition, the Company regularly evaluates its computer-related and other long-lived assets and may accelerate depreciation over the revised useful life if the asset is expected to be replaced or has limited future value. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation or amortization are removed from the accounts, and any resulting gain or loss is reflected in income for that period.

Tax Reserves

The Company records an estimated tax liability or tax benefit for income and other taxes based on what it determines will likely be paid in the various tax jurisdictions in which it operates. Management uses its best judgment in the determination of these amounts. However, the liabilities ultimately realized and paid are dependent upon various matters, including resolution of tax audits, and may differ from amounts recorded. An adjustment to the estimated liability would be recorded as a provision or benefit to income tax expense in the period in which it becomes probable that the amount of the actual liability differs from the recorded amount.

Merchandise Inventories

The Company’s inventory is valued using the retail method of accounting and is stated at the lower of cost (first-in, first-out method) or market. Under the retail inventory method, the valuation of inventory at cost and resulting gross margin are calculated by applying an average cost to retail ratio to the retail value of inventory. The retail inventory method is an averaging method that has been widely used in the retail industry. Inherent in the retail method are certain significant estimates including initial merchandise markup, markdowns and shrinkage, which significantly impact the ending inventory valuation at cost and the resulting gross margins. Physical inventories are conducted throughout the year to calculate actual shrinkage and inventory on hand. Estimates based on actual

 


 

Page 14

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


CRITICAL ACCOUNTING POLICIES – (CONTINUED):

shrinkage results are used to estimate inventory shrinkage, which is accrued for the period between the last inventory and the financial reporting date. The Company continuously reviews its inventory levels to identify slow moving merchandise and uses markdowns to clear slow moving inventory. General economic environment for retail apparel sales could result in an increase in the level of markdowns, which would result in lower inventory values and increases to cost of goods sold as a percentage of net sales in future periods. Management makes estimates regarding markdowns based on inventory levels on hand and customer demand, which may impact inventory valuations. Markdown exposure with respect to inventories on hand is limited due to the fact that seasonal merchandise is not carried forward. Historically, actual results have not significantly deviated from those determined using the estimates described above.

STOCK OPTIONS:

The Company applies APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations in accounting for its stock option plans. The exercise price for all options awarded under the Company’s stock option plans has been equal to the fair market value of the underlying common stock on the date of grant. Accordingly, no compensation expense has been recognized for options granted under the plans. Had compensation expense for the stock options granted been determined consistent with SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”, the Company’s net income and basic and diluted earnings per share amounts for the three months and six months ended July 31, 2004 and August 2, 2003 would approximate the following proforma amounts (dollars in thousands, except per share data):

                                 
    Three Months Ended
  Six Months Ended
    July 31,   August 2,   July 31,   August 2,
    2004
  2003
  2004
  2003
Net Income as Reported
  $ 8,182     $ 7,731     $ 24,998     $ 25,212  
Add: Stock-Based employee compensation expense included in reported net income, net of related tax effects
    109       124       217       280  
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects
    (118 )     (255 )     (248 )     (546 )
 
   
 
     
 
     
 
     
 
 
 
                               
Pro forma Net Income
  $ 8,173     $ 7,600     $ 24,967     $ 24,946  
 
   
 
     
 
     
 
     
 
 
 
                               
Earnings per share:
                               
Basic – as reported
  $ .40     $ .30     $ 1.22     $ .99  
Basic – pro forma
  $ .40     $ .30     $ 1.22     $ .98  
Diluted – as reported
  $ .39     $ .30     $ 1.20     $ .98  
Diluted – pro forma
  $ .39     $ .29     $ 1.20     $ .97  

 


 

Page 15

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK:

The Company believes that its cash, cash equivalents and short-term investments, together with cash flows from operations and borrowings available under its revolving credit agreement, will be adequate to fund the Company’s proposed capital expenditures and other operating requirements for fiscal 2004 and the long term.

The Company has consistently maintained a strong liquidity position. Cash provided by operating activities during the first six months of 2004 was $54.6 million as compared to $38.0 million in the first six months of 2003. These amounts have enabled the Company to fund its regular operating needs, capital expenditure program, cash dividend payments and any repurchase of the Company’s Common Stock. In addition, the Company maintains $35 million of unsecured revolving credit facilities for short-term financing of seasonal cash needs.

At July 31, 2004, the Company had working capital of $129.5 million compared to $178.3 million at August 2, 2003. The decline in working capital resulted primarily from the repurchase of Class B Common Stock from the Company’s founders for $95.6 million, partially offset by the proceeds of a new $30 million five-year term loan facility entered into in the third quarter of fiscal 2003. The increase in net cash provided by operating activities for the first six months of 2004 is primarily the result of an increase in depreciation expense of $1.1 million due to store expansion; an increase in loss and disposal of property and equipment of $1.1 million; a reduction in accounts receivable from strong collection efforts of $1.4 million; and an increase of accounts payable and other liabilities of $14.0 million and an increase of $1.3 million in accrued income taxes. Offsetting these increases in net cash provided by operating activities was a decrease in net income of $0.2 million and an increase of $2.5 million in merchandise inventories.

Additionally, the Company had $1.8 million invested in privately managed investment funds at July 31, 2004, which are reported under other assets of the consolidated balance sheets.

At July 31, 2004, the Company had an unsecured revolving credit agreement, which provided for borrowings of up to $35 million. The revolving credit agreement is committed until August 2006. The credit agreement contains various financial covenants and limitations, including the maintenance of specific financial ratios. There were no borrowings outstanding under these credit facilities during the six months ended July 31, 2004 or the fiscal year ended January 31, 2004.

The Company had approximately $4.7 million and $6.7 million at July 31, 2004 and August 2, 2003, respectively, of outstanding irrevocable letters of credit relating to purchase commitments.

Expenditures for property and equipment totaled $11.8 million for the six months ended July 31, 2004, compared to $9.1 million in last year’s first six months. The expenditures for the first six months of 2004 were primarily for store development and investments in new technology. In fiscal

 


 

Page 16

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK (CONTINUED):

2004, the Company is planning to invest approximately $30 million for capital expenditures. This includes expenditures to open 80 new stores and relocate 29 stores. In addition, the Company plans to remodel 15 stores and has planned for additional investments in technology scheduled to be implemented over the remainder of the fiscal year.

Net cash used in investing activities totaled $40.6 million for the first six months of 2004 compared to $.7 million for the comparable period of 2003. The increase was due primarily to the purchase of short-term investments.

In May 2004, the Board of Directors increased the quarterly dividend by 9% from $.16 per share to $.175 per share.

The Company’s previously reported repurchase in August 2003 of 5,137,484 shares of Class B Common Stock from entities affiliated with Wayland H. Cato, Jr., and Edgar T. Cato, was funded by the Company through a new $30 million five-year term loan facility and approximately $65 million of cash and liquidated short-term investments. Payments on the new term loan are due in monthly installments of $500,000 plus accrued interest. Interest is based on LIBOR. The LIBOR rate at July 31, 2004 was 1.50%. As of July 31, 2004, the outstanding balance on the loan facility was $24.5 million.

The Company does not use derivative financial instruments. At July 31, 2004, the Company’s investment portfolio was invested in governmental and other debt securities with maturities of up to 36 months. These securities are classified as available-for-sale and are recorded on the balance sheet at fair value with unrealized gains and temporary losses reported net of taxes as accumulated other comprehensive income. Other than temporary declines in fair value of investments are recorded as a reduction in the cost of investments in the accompanying Consolidated Balance Sheets and a reduction of interest and other income in the accompanying Statements of Consolidated Income.

 


 

Page 17

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK:

The Company is subject to market rate risk from exposure to changes in interest rates based on its financing, investing and cash management.

FORWARD LOOKING STATEMENTS:

Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. All statements other than statements of historical facts included in this Form 10-Q including statements regarding the Company’s planned capital expenditures, intended store openings, closures, relocations and remodelings, its planned investments in technology and the expected adequacy of the Company’s liquidity, constitute forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. Forward-looking statements involve risks and uncertainties that could cause the Company’s actual results to differ materially depending on a variety of important factors, including, but not limited to the following: general economic conditions; competitive factors and pricing pressures; the Company’s ability to predict fashion trends; consumer buying patterns; weather conditions and inventory risk due to shifts in market demand, and other factors discussed from time to time in the Company’s SEC reports and press releases, which may be accessed via the Company’s website, www.catofashions.com. The Company does not undertake any obligation to update any forward-looking statements.

CONTROLS AND PROCEDURES:

As of July 31, 2004, an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in its reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission rules and forms.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTS:

During the Company’s first six months of 2004, there has been no change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 


 

Page 18

PART II OTHER INFORMATION

THE CATO CORPORATION

ITEM 1. LEGAL PROCEEDINGS

     None

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

     None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     Following are the results of the matters voted upon at the Company’s Annual Meeting which was held on May 27, 2004.

     Election of Directors:

                                 
    For
  Withheld
  Voting Power For
  Voting Power Withheld
Mr. George Currin
    11,028,381       7,527,246       15,248,031       7,527,246  
Mr. A. F. (Pete) Sloan
    15,956,110       2,599,517       20,175,760       2,599,517  

     Adoption of The Cato Corporation 2004 Incentive Compensation Plan:

                         
For
  Withheld
  Voting Power For
  Voting Power Withheld
12,589,450
    4,313,964       16,809,100       4,313,964  

     Amendment to the 1999 Incentive Compensation Plan:

                         
For
  Withheld
  Voting Power For
  Voting Power Withheld
16,056,439
    2,499,187       20,276,089       2,499,187  

     Amendment to the 1987 Non-Qualified Stock Option Plan:

                         
For
  Withheld
  Voting Power For
  Voting Power Withheld
16,058,290
    2,497,336       20,277,990       2,497,336  

 


 

Page 19

PART II OTHER INFORMATION

THE CATO CORPORATION

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (CONTINUED):

     Ratification of Independent Auditor:

                         
For
  Withheld
  Voting Power For
  Voting Power Withheld
17,890,550
    665,077       22,110,200       665,077  

ITEM 5. OTHER INFORMATION

     None

ITEM 6. EXHIBITS

     (A)

     
Exhibit No.
  ITEM
31.1
  Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2
  Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1
  Section 1350 Certification of Chief Executive Officer.
32.2
  Section 1350 Certification of Chief Financial Officer.

 


 

Page 20

PART II OTHER INFORMATION

THE CATO CORPORATION

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

     
  THE CATO CORPORATION
 
   
September 2, 2004   /s/ John P. Derham Cato

 
 
 
Date   John P. Derham Cato
  Chairman, President and
  Chief Executive Officer
 
   
September 2, 2004   /s/ Michael O. Moore

 
 
 
Date   Michael O. Moore
  Executive Vice President
  Chief Financial Officer and Secretary
 
   
September 2, 2004   /s/ Robert M. Sandler

 
 
 
Date   Robert M. Sandler
  Senior Vice President
  Controller