UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 10-Q
OR
For the transition period from __________________ to __________________
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 ___
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 126-2 of the Act).
As of November 18, 2003, there were 20,001,167 shares of Class A common stock and 500,350 shares of Class B common stock outstanding.
THE CATO CORPORATION
November 1, 2003
Table of Contents
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PART I FINANCIAL INFORMATION
THE CATO CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes to condensed consolidated financial statements.
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THE CATO CORPORATIONCONDENSED CONSOLIDATED BALANCE SHEETS
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THE CATO CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
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THE CATO CORPORATIONNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSFOR THE THREE MONTHS AND NINE MONTHS ENDED NOVEMBER 1, 2003AND NOVEMBER 2, 2002
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 November 1, 2003 and November 2, 2002 are unaudited. In the opinion of management, all adjustments (consisting solely of normal recurring 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 February 1, 2003.
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, net in the accompanying Statements of Consolidated 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 other income.
Total comprehensive income for the third quarter and nine months ended November 1, 2003 was $619,000 and $25,589,000, respectively. Total comprehensive income for the third quarter and nine months ended November 2, 2002 was $5,275,000 and $35,499,000, 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.
For the nine months ended November 1, 2003, the Company repurchased 165,000 shares of Class A Common Stock for $2,740,619, or an average market price of $16.61 per share and 5,137,484 of Class B Common Stock for $95,563,454, or an average market price of $18.60 per share.
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NOTE 1 — GENERAL (CONTINUED):
For the nine months ended November 2, 2002, the Company repurchased and accepted a combined total of 114,681 mature shares of Class A Common Stock for $2,331,187, or an average market price of $20.33 per share. In the third quarter of fiscal 2002, the Company repurchased 4,100 shares of Class A Common Stock for $70,923, or an average market price of $17.30 per share.
In May 2003, the Board of Directors increased the quarterly dividend by 7% from $.15 per share to $.16 per share.
On August 22, 2003, the Company repurchased 5,137,484 shares of Class B Common Stock from a limited partnership and trust affiliated with Wayland H. Cato, Jr., a Company founder and Chairman of the Board and a limited partnership affiliated with Edgar T. Cato, a Company founder and a member of the Board of Directors. Shares were purchased at $18.50 per share (a 10% discount to the closing price the day prior to the announced agreement) for a total cost of $95,043,454. Including related expenses of $520,000 for investment banking and related professional fees, the total cost was $95,563,454 or an average purchase price of $18.60 per share. The repurchase 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 interest rate at November 1, 2003 was 2.27%.
On August 29, 2003, the Company entered into retirement agreements with Mr. Wayland H. Cato, Jr., a Company founder and Chairman of the Board and Mr. Edgar T. Cato, a Company founder and a member of the Board of Directors. The agreements provided for the retirement of Mr. Wayland Cato and Mr. Edgar Cato from the Company and the Board of Directors effective January 31, 2004. Mr. Wayland Cato will be available to the Company for consulting services following his retirement. In the third quarter of fiscal 2003, the Company recognized an expense of $2.8 million representing the present value of certain payments and benefits under the terms of the agreements. The after-tax charge was $1.8 million or $.08 per diluted share for the third quarter and $.07 per diluted share for the nine months.
The provisions for income taxes are based on the Company’s estimated annual effective tax rate. As allowed by SFAS No. 109, “Accounting for Income Taxes”, deferred income taxes are calculated annually.
Certain reclassifications have been made to the condensed consolidated financial statements for prior periods to conform to the current period presentation.
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NOTE 2 – RECENT ACCOUNTING PRONOUNCEMENTS:
On December 31, 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”. SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation”, to provide for alternative methods of transition to SFAS No. 123’s fair value method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and APB Opinion No. 28, “Interim Financial Reporting”, to require disclosure in the summary of significant policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per-share in annual and interim financial statements. While SFAS No. 148 does not amend SFAS No. 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based compensation, regardless of whether they account for that compensation using the fair value method of SFAS No. 123 or the intrinsic value method of APB Opinion No. 25, “Accounting for Stock Issued to Employees”. SFAS No. 148’s amendment of the transition and the annual and interim disclosure requirements of SFAS No. 123 are effective for fiscal years ending after December 15, 2002.
The Company applies APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations in accounting for its stock option plans. Accordingly, no compensation expense has been recognized for stock-based compensation where the option price of the stock approximated the fair market value of the stock on the date of grant. Had compensation expense for the stock options granted been determined consistent with SFAS No. 123, the Company’s net income and basic and diluted earnings per share amounts for the three months ended November 1, 2003 and November 2, 2002 and for the nine months ended November 1, 2003 and November 2, 2002 would approximate the following proforma amounts (dollars in thousands, except per share data):
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NOTE 2 – RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED):
In January 2003, the FASB issued Interpretation No. 46 “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements”. This interpretation applies immediately to variable interest entities created after January 31, 2003 and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest it acquired before February 1, 2003. This interpretation may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The implementation of this interpretation had no effect on the Company’s financial position or results of operations.
In May 2003, the FASB issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS 150 changes the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. The new Statement requires that those instruments be classified as liabilities in statements of financial position. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and for all other instruments for interim periods beginning after June 15, 2003. The Company does not expect the provisions of SFAS 150 to have a material impact on our financial position or results of operations.
NOTE 3 — EARNINGS PER SHARE:
Earnings per share is calculated by dividing net income by the weighted-average number of Class A and Class B common shares outstanding during the respective periods. The weighted-average shares outstanding is used in the basic earnings per share calculation, while the weighted-average shares and common stock equivalents outstanding are used in the diluted earnings per share calculation.
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NOTE 4 — SUPPLEMENTAL CASH FLOW INFORMATION:
Income tax payments, net of refunds received, for the nine months ended November 1, 2003 and November 2, 2002 were $12,561,650 and $15,231,400, respectively.
NOTE 5 — FINANCING ARRANGEMENTS:
On August 22, 2003, the Company entered into a new $30 million five-year term loan facility, the proceeds of which were used to purchase Class B Common Stock from the Company’s founders. Payments are due in monthly installments of $500,000 plus accrued interest. Interest is based on LIBOR. The interest rate at November 1, 2003 was 2.27%.
On August 22, 2003, the Company entered into a new revolving credit agreement which provides for borrowings of up to $35 million. The revolving credit agreement is committed until August 22, 2006, unless extended. This agreement replaces a prior revolving credit agreement which was due to expire on October 31, 2004. The credit agreement contains various financial covenants and limitations, including the maintenance of specific financial ratios with which the Company was in compliance as of November 1, 2003. There were no borrowings outstanding under these credit facilities during the nine months ended November 1, 2003 or the fiscal year ended February 1, 2003. Interest is based on LIBOR. The interest rate at November 1, 2003 was 2.27%.
NOTE 6 – REPORTABLE SEGMENT INFORMATION:
The Company has two reportable segments: retail and credit. The following schedule summarizes certain segment information (in thousands):
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NOTE 6 – REPORTABLE SEGMENT INFORMATION (CONTINUED):
Income before income taxes for the three months and nine months ended November 1, 2003 included $2.8 million for certain retirement costs (Note 1) which have been allocated to the retail segment above.
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THE CATO CORPORATIONMANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION 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:
Comparison of Third Quarter and First Nine Months of 2003 with 2002.
Total retail sales for the third quarter were $153.2 million compared to last year’s third quarter sales of $158.2 million, a 3% decrease. Same-store sales decreased 10% in the third quarter of fiscal 2003. For the nine months ended November 1, 2003, total retail sales were $538.7 million compared to last year’s first nine months sales of $541.7 million, a 1% decrease, and same-store sales decreased 8% for the comparable nine month period. The decrease in sales for the first nine months of 2003 was due to a lower average retail sale and lower average transactions per store as a result of the continued difficult economic conditions. The Company operated 1,082 stores at November 1, 2003 compared to 992 stores at the end of last year’s third quarter.
Other income for the third quarter of 2003 decreased 1% over the prior year’s comparable period. The decrease in the third quarter resulted primarily from decreased layaway fees. Other income for the first nine months of 2003 was virtually equivalent to the comparable nine month period last year.
Cost of goods sold were 70.9% and 68.3% of total retail sales for the third quarter and first nine months of 2003, respectively, compared to 69.7% and 66.6% for prior year’s comparable three and nine month periods, respectively. The increase in cost of goods sold as a percent of retail sales for the first nine months of 2003 resulted primarily from lower than planned sales and additional markdowns taken to bring inventory levels in line with sales trends.
Selling, general and administrative (SG&A) expenses were $42.8 million, or 27.9% and $130.8 million, or 24.3% for the third quarter and first nine months of this year, compared to $40.5
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THE CATO CORPORATION MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS – (CONTINUED):
million, or 25.6% and $130.0 million, or 24.0% of retail sales for prior year’s comparable three and nine month periods, respectively. SG&A expenses as a percentage of retail sales increased 230 basis points for the third quarter of 2003 as compared to the prior year and increased 30 basis points for the first nine months of 2003, as compared to the prior year. The overall increase in SG&A expenses for the third quarter and first nine months of 2003 results primarily from $2.8 million costs related to the retirement agreements with the Company’s founders, partially offset by reduced incentive-based performance bonus programs.
Depreciation expense was $4.7 million, or 3.1% and $13.7 million or 2.6% of retail sales, for the third quarter and first nine months of fiscal 2003, compared to $4.1 million, or 2.6% and $10.5 million, or 1.9% of retail sales, for prior year’s comparable three and nine month periods, respectively. The increase resulted primarily from the Company’s new store development and depreciation of the Company’s enterprise-wide information system which was implemented in August 2002.
Income tax expense was $.5 million, or .3% and $14.8 million, or 2.8% of retail sales, for the third quarter and first nine months of fiscal 2003, compared to $3.1 million, or 2.0% and $20.4 million, or 3.8% of retail sales, for the prior year’s comparable three and nine month periods. The decrease resulted from lower pre-tax income.
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 judgement. 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 and reserves for inventory markdowns.
The Company evaluates the collectibility of accounts receivable and records allowances for doubtful accounts based on estimates of actual write-offs and the relative age of accounts. The Company’s self-insurance liabilities related to worker’s compensation, general and auto insurance liabilities are based on estimated costs of claims filed and claims incurred but not reported and data provided by outside actuaries. Merchandise inventories are stated at the lower of cost (first-in, first-out method) or market as determined by the retail method. Management makes estimates regarding markdowns based on customer demand which can impact inventory valuations. Historically, actual results have not significantly deviated from those determined using the estimates described above.
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THE CATO CORPORATION MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
STOCK OPTIONS:
LIQUIDITY AND CAPITAL RESOURCES:
At November 1, 2003, the Company had working capital of $105.3 million, compared to $153.5 million at November 2, 2002 and $162.6 million at February 1, 2003. Cash provided by operating activities was $43.9 million for the nine months ended November 1, 2003, compared to $52.4 million for last year’s comparable nine month period. The decrease in net cash provided by operating activities resulted primarily from a decrease in net income, payments related to accounts payable and other liabilities made prior to the end of third quarter of 2003 versus after the end of third quarter 2002 partially offset by a decrease in inventories. At November 1, 2003, the Company had cash, cash equivalents, and short-term investments of $57.1 million, compared to $104.2 million at November 2, 2002 and $106.9 million at February 1, 2003. The reduction in cash, cash equivalents, and short-term investments was primarily due to the repurchase of stock from the Company’s founders, partially funded by approximately $65 million of cash and liquidated short-term investments.
Net cash provided in investing activities totaled $19.0 million for the first nine months of 2003 compared to $34.4 million used for the comparable period of 2002. Cash was provided by the sale of
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LIQUIDITY AND CAPITAL RESOURCES (CONTINUED):
short-term investments partially offset by funding of capital expenditures for new, relocated and remodeled stores and for investments in technology.
Expenditures for property and equipment totaled $15.4 million for the nine months ended November 1, 2003, compared to $22.1 million of expenditures in last year’s first nine months. The Company expects total capital expenditures to be approximately $27 million for the current fiscal year. The Company intends to open approximately 87 new stores, relocate 24 stores, and close 6 stores during the current fiscal year. For the nine months ended November 1, 2003, the Company had opened 61 new stores, relocated 18 stores, and closed one store.
Net cash used in financing activities totaled $77.9 million for the first nine months of 2003 compared to $10.3 million for the comparable period of 2002. The increase was due primarily to the repurchase of stock from the Company’s founders partially offset by a new $30 million five-year term loan facility.
On August 22, 2003, the Company entered into a new $30 million five-year term loan facility, the proceeds of which were used to purchase Class B Common Stock from the Company’s founders. Payments are due in monthly installments of $500,000 plus accrued interest. Interest is based on LIBOR and was 2.27% at November 1, 2003.
On August 22, 2003, the Company entered into a new revolving credit agreement which provides for borrowings of up to $35 million. The revolving credit agreement is committed until August 22, 2006, unless extended. This agreement replaces a prior revolving credit agreement which was due to expire on October 31, 2004. The credit agreement contains various financial covenants and limitations, including the maintenance of specific financial ratios with which the Company was in compliance as of November 1, 2003. There were no borrowings outstanding under these credit facilities during the nine months ended November 1, 2003 or the fiscal year ended February 1, 2003.
The Company does not use derivative financial instruments. At November 1, 2003, November 2, 2002, and February 1, 2003, the Company’s investment portfolio was primarily invested in governmental 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 losses reported as accumulated other comprehensive gains or losses, net of applicable deferred taxes.
The Company believes that its cash, cash equivalents and short-term investments, together with cash flow 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 during fiscal 2003 and the foreseeable future.
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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 expected capital expenditures, intended store openings, closures and relocations and expected adequacy of liquidity during the current fiscal year and for the foreseeable future, are 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 apparel buying patterns; adverse weather conditions and inventory risks due to shifts in market demand. The Company does not undertake to publicly update or revise the forward-looking statements even if experience or future changes make it clear that the projected results expressed or implied therein will not be realized.
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THE CATO CORPORATIONCONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES:
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company is recorded, processed, summarized, and reported within the time periods specified in the appropriate rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer. The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the Company’s disclosure controls and procedures as of November 1, 2003. Each has concluded that these controls and procedures are effective.
CHANGES IN INTERNAL CONTROLS:
There have been no changes in the Company’s internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
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PART II OTHER INFORMATION (CONTINUED):
SIGNATURES PAGE AND CERTIFICATES
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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.