Table of Contents
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 August 3, 2019
OR
[ ]
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 or organization)
(I.R.S. Employer Identification No.)
8100 Denmark Road, Charlotte, North Carolina28273-5975
(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)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Class A - Common Stock, par value $.033 per share
CATO
New York Stock Exchange
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 has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ☑Accelerated filer ☐ Non-accelerated filer ☐Smaller reporting company ☐ Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
As of August 3, 2019, there were 23,002,629 shares of Class A common stock and 1,763,652 shares of Class B common stock outstanding.
Quarter Ended August 3, 2019
Page No.
PART I – FINANCIAL INFORMATION (UNAUDITED)
Item 1.
Financial Statements (Unaudited):
Condensed Consolidated Statements of Income and Comprehensive Income
3
For the Three Months and Six Months Ended August 3, 2019 and August 4, 2018
Condensed Consolidated Balance Sheets
4
At August 3, 2019 and February 2, 2019
Condensed Consolidated Statements of Cash Flows
5
For the Six Months Ended August 3, 2019 and August 4, 2018
Condensed Consolidated Statements of Stockholders’ Equity
6
Notes to Condensed Consolidated Financial Statements
7 – 21
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
22 – 28
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
29
Item 4.
Controls and Procedures
PART II – OTHER INFORMATION
Legal Proceedings
30
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
31
Item 5.
Other Information
Item 6.
Exhibits
Signatures
32
2
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND
COMPREHENSIVE INCOME
(UNAUDITED)
Three Months Ended
Six Months Ended
August 3, 2019
August 4, 2018
(Dollars in thousands, except per share data)
REVENUES
Retail sales
$
210,357
206,848
438,423
442,873
Other revenue (principally finance charges, late fees and
layaway charges)
2,224
2,069
4,510
4,344
Total revenues
212,581
208,917
442,933
447,217
COSTS AND EXPENSES, NET
Cost of goods sold (exclusive of depreciation shown below)
130,372
129,801
266,455
272,088
Selling, general and administrative (exclusive of depreciation
shown below)
66,066
68,892
132,056
134,851
Depreciation
3,836
4,152
7,679
8,376
Interest and other income
(1,693)
(1,431)
(2,829)
(2,185)
Cost and expenses, net
198,581
201,414
403,361
413,130
Income before income taxes
14,000
7,503
39,572
34,087
Income tax expense
2,134
1,021
6,450
4,195
Net income
11,866
6,482
33,122
29,892
Basic earnings per share
0.48
0.26
1.34
1.20
Diluted earnings per share
Comprehensive income:
Unrealized gain (loss) on available-for-sale securities, net of
deferred income taxes of $262 and $388 for the three and
six months ended August 3, 2019 and $98 and ($24) for
the three and six months ended August 4, 2018, respectively
859
314
1,271
(78)
Comprehensive income
12,725
6,796
34,393
29,814
See notes to condensed consolidated financial statements (unaudited).
CONDENSED CONSOLIDATED BALANCE SHEETS
February 2, 2019
ASSETS
(Dollars in thousands)
Current Assets:
Cash and cash equivalents
26,011
24,603
Short-term investments
207,366
182,711
Restricted cash
2,137
606
Restricted short-term investments
1,718
3,196
Accounts receivable, net of allowance for doubtful accounts of
$889 and $842 at August 3, 2019 and February 2, 2019, respectively
27,479
28,137
Merchandise inventories
99,952
119,585
Prepaid expenses and other current assets
4,651
11,750
Total Current Assets
369,314
370,588
Property and equipment – net
89,567
94,304
Noncurrent deferred income taxes
10,821
11,209
Other assets
22,676
21,805
Right-of-Use assets – net
164,988
-
Total Assets
657,366
497,906
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable
67,718
84,282
Accrued expenses
44,452
45,658
Accrued bonus and benefits
10,360
11,146
Accrued income taxes
1,332
Current lease liability
55,747
Total Current Liabilities
179,609
141,086
Other noncurrent liabilities
22,822
39,984
Lease liability
120,317
Stockholders' Equity:
Preferred stock, $100 par value per share, 100,000 shares
authorized, none issued
Class A common stock, $0.033 par value per share, 50,000,000
shares authorized; issued 23,002,629 shares and 22,838,149 shares
at August 3, 2019 and February 2, 2019, respectively
772
767
Convertible Class B common stock, $0.033 par value per share,
15,000,000 shares authorized; issued 1,763,652 shares and 1,763,652 shares
59
Additional paid-in capital
108,057
105,580
Retained earnings
224,536
210,507
Accumulated other comprehensive income/(loss)
1,194
(77)
Total Stockholders' Equity
334,618
316,836
Total Liabilities and Stockholders' Equity
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Operating Activities:
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for doubtful accounts
366
127
Purchase premium and premium amortization of investments
(168)
277
Share-based compensation
2,196
2,422
Loss on disposal of property and equipment
344
414
Changes in operating assets and liabilities which provided
(used) cash:
Accounts receivable
292
(6,844)
19,633
17,065
Prepaid and other assets
22,909
11,453
1,022
Accounts payable, accrued expenses and other liabilities
(42,524)
(7,749)
Net cash provided by operating activities
45,181
56,455
Investing Activities:
Expenditures for property and equipment
(2,217)
(1,879)
Purchase of short-term investments
(106,518)
(111,245)
Sales of short-term investments
85,364
43,328
Purchase of other assets
(74)
(107)
Sales of other assets
9
Net cash (used)/provided in investing activities
(23,436)
(69,899)
Financing Activities:
Dividends paid
(16,291)
(16,338)
Repurchase of common stock
(2,834)
(10,461)
Proceeds from employee stock purchase plan
319
284
Proceeds from stock options exercised
189
Net cash (used) in financing activities
(18,806)
(26,326)
Net increase/(decrease) in cash, cash equivalents, and restricted cash
2,939
(39,770)
Cash, cash equivalents, and restricted cash at beginning of period
25,209
81,264
Cash, cash equivalents, and restricted cash at end of period
28,148
41,494
Non-cash activity:
Accrued other assets and property and equipment
1,395
507
Accrued treasury stock
949
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Convertible
Accumulated
Class A
Class B
Additional
Other
Total
Common
Paid-in
Retained
Comprehensive
Stockholders'
Stock
Capital
Earnings
Income
Equity
Balance — February 2, 2019
21,256
Unrealized gains on available-for-sale securities, net of deferred
income tax liability of $126
412
Dividends paid ($0.33 per share)
(8,118)
Class A common stock sold through employee stock purchase
plan — 20,676 shares
1
307
308
Class B common stock sold through stock option plans —
- shares
Class A common stock issued through restricted stock grant plans —
355,609 shares
11
624
10
645
Repurchase and retirement of treasury shares – 208,041 shares
(7)
(2,827)
Balance — May 4, 2019
106,511
220,828
335
328,505
income tax liability of $262
(8,173)
plan — 5,402 shares
67
(9,170) shares
1,479
15
1,494
Repurchase and retirement of treasury shares – -shares
Balance — August 3, 2019
Balance — February 3, 2018
774
58
99,948
225,894
(321)
326,353
23,410
income tax benefit of ($122)
(392)
(8,186)
plan — 19,763 shares
267
342,341 shares
534
8
553
Repurchase and retirement of treasury shares – 52,904 shares
(2)
(758)
(760)
Balance — May 5, 2018
783
100,749
240,368
(713)
341,245
income tax liability of $98
(8,152)
plan — 2,791 shares
70
71
8,051 shares
190
13,224 shares
1,797
18
1,815
Repurchase and retirement of treasury shares – 423,200 shares
(14)
(10,635)
(10,649)
Balance — August 4, 2018
770
102,806
228,081
(399)
331,316
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED AUGUST 3, 2019 AND AUGUST 4, 2018
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 August 3, 2019 and August 4, 2018 are unaudited. In the opinion of management, all adjustments considered necessary for a fair statement have been included. All such adjustments are of a normal, recurring nature unless otherwise noted. The results of the interim period may not be indicative of the results expected for 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 2, 2019. Amounts as of February 2, 2019 have been derived from the audited balance sheet, but do not include all disclosures required by accounting principles generally accepted in the United States of America.
On August 29, 2019, the Board of Directors maintained the quarterly dividend at $0.33 per share.
Recently Adopted Accounting Policies
In 2016, the FASB issued Accounting Standard Codification (“ASC”) 842 - Leases, with amendments issued in 2018. The guidance requires lessees to recognize most leases on the balance sheet but does not change the manner in which expenses are recorded in the income statement. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases.
The Company utilized a comprehensive approach to assess the impact of this guidance on its financial statements and related disclosures, including the increase in the assets and liabilities on its balance sheet and the impact on its current lease portfolio from a lessee perspective. The Company completed its comprehensive review of its lease portfolio, which includes mostly store leases impacted by the new guidance. The Company reviewed its internal controls over leases and as a result the Company enhanced these controls; however, these changes are not considered material. In addition, the Company implemented a new software platform, and corresponding controls, for administering its leases and facilitating compliance with the new guidance.
The Company elected the transition package of practical expedients that is permitted by the standard. The package of practical expedients allows the Company to not reassess previous accounting conclusions regarding whether existing arrangements are or contain leases, the classification of existing leases, and the treatment of initial direct costs. The Company did not elect the hindsight transition practical expedient allowed for by the new standard, which allows entities to use hindsight when determining lease term and impairment of right-of-use assets.
The Company adopted ASC 842 utilizing the modified retrospective approach as of February 3, 2019. The modified retrospective approach the Company selected provides a method of transition allowing recognition of existing leases as of the beginning of the period of adoption (i.e., February 3, 2019), and which does not require the adjustment of comparative periods. The adoption had a material impact on the Company’s financial statements, resulting in an increase of 40% to each of its total assets and total liabilities on its balance sheet, but had no impact to retained earnings as of the beginning of 2019. See Note 12 for further information.
7
NOTE 2 - EARNINGS PER SHARE:
Accounting Standard Codification (“ASC”) 260 – Earnings Per Share requires dual presentation of basic and diluted Earnings Per Share (“EPS”) on the face of all income statements for all entities with complex capital structures. The Company has presented one basic EPS and one diluted EPS amount for all common shares in the accompanying Condensed Consolidated Statements of Income and Comprehensive Income. While the Company’s certificate of incorporation provides the right for the Board of Directors to declare dividends on Class A shares without declaration of commensurate dividends on Class B shares, the Company has historically paid the same dividends to both Class A and Class B shareholders and the Board of Directors has resolved to continue this practice. Accordingly, the Company’s allocation of income for purposes of the EPS computation is the same for Class A and Class B shares and the EPS amounts reported herein are applicable to both Class A and Class B shares.
Basic EPS is computed as net income less earnings allocated to non-vested equity awards 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 the Employee Stock Purchase Plan.
Numerator
Net earnings
(Earnings)/loss allocated to non-vested equity awards
(451)
(192)
(1,148)
(816)
Net earnings available to common stockholders
11,415
6,290
31,974
29,076
Denominator
Basic weighted average common shares outstanding
23,789,070
24,131,481
23,772,883
24,166,539
Diluted weighted average common shares outstanding
Net income per common share
NOTE 3 – ACCUMULATED OTHER COMPREHENSIVE INCOME:
The following table sets forth information regarding the reclassification out of Accumulated other comprehensive income (in thousands) for the three months ended August 3, 2019:
Changes in Accumulated Other
Comprehensive Income (a)
Unrealized Gains
and (Losses) on
Available-for-Sale
Securities
Beginning Balance at May 4, 2019
Other comprehensive income before
reclassification
829
Amounts reclassified from accumulated
other comprehensive income (b)
Net current-period other comprehensive income
Ending Balance at August 3, 2019
(a) All amounts are net-of-tax. Amounts in parentheses indicate a debit/reduction to other comprehensive income.
(b) Includes $39 impact of accumulated other comprehensive income reclassifications into Interest and other income for net gains on available-for-sale securities. The tax impact of this reclassification was $9.
The following table sets forth information regarding the reclassification out of Accumulated other comprehensive income (in thousands) for the six months ended August 3, 2019:
Beginning Balance at February 2, 2019
1,232
39
(b) Includes $51 impact of accumulated other comprehensive income reclassifications into Interest and other income for net gains on available-for-sale securities. The tax impact of this reclassification was $12.
NOTE 3 – ACCUMULATED OTHER COMPREHENSIVE INCOME (CONTINUED):
The following table sets forth information regarding the reclassification out of Accumulated other comprehensive income (in thousands) for the three months ended August 4, 2018:
Beginning Balance at May 5, 2018
reclassifications
260
54
Ending Balance at August 4, 2018
(b) Includes $71 impact of Accumulated other comprehensive income reclassifications into Interest and other income for net gains on available-for-sale securities. The tax impact of this reclassification was $17.
The following table sets forth information regarding the reclassification out of Accumulated other comprehensive income (in thousands) for the six months ended August 4, 2018:
Beginning Balance at February 3, 2018
(131)
53
(b) Includes $70 impact of Accumulated other comprehensive income reclassifications into Interest and other income for net gains on available-for-sale securities. The tax impact of this reclassification was $17.
NOTE 4 – FINANCING ARRANGEMENTS:
As of August 3, 2019, the Company had an unsecured revolving credit agreement to borrow $35.0 million less the balance of any revocable letters of credit as discussed below. On May 24, 2019, the Company extended its revolving credit agreement through May 2022. 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 August 3, 2019. There were no borrowings outstanding under this credit facility during the periods ended August 3, 2019 or February 2, 2019. The weighted average interest rate under the credit facility was zero at August 3, 2019 due to no borrowings outstanding.
At August 3, 2019 and February 2, 2019, the Company had no outstanding revocable letters of credit relating to purchase commitments.
NOTE 5 – REPORTABLE SEGMENT INFORMATION:
The Company has determined that it has four operating segments, as defined under ASC 280-10, including Cato, It’s Fashion, Versona and Credit. As outlined in ASC 280-10, the Company has two reportable segments: Retail and Credit. The Company has aggregated its three retail operating segments, including e-commerce, based on the aggregation criteria outlined in ASC 280-10, which states that two or more operating segments may be aggregated into a single reportable segment if aggregation is consistent with the objective and basic principles of ASC 280-10, which require the segments to have similar economic characteristics, products, production processes, clients and methods of distribution.
The Company’s retail operating segments have similar economic characteristics and similar operating, financial and competitive risks. They are similar in nature of product, as they all offer women’s apparel, shoes and accessories. Merchandise inventory for the Company’s retail operating segments is sourced from the same countries and some of the same vendors, using similar production processes. Merchandise for the Company’s operating segments is distributed to retail stores in a similar manner through the Company’s single distribution center and is subsequently distributed to clients in a similar manner.
The Company operates its women’s fashion specialty retail stores in 31 states as of August 3, 2019, 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.
NOTE 5 – REPORTABLE SEGMENT INFORMATION (CONTINUED):
The following schedule summarizes certain segment information (in thousands):
Retail
Credit
Revenues
$211,672
$909
$212,581
$441,114
$1,819
$442,933
Income/(Loss) before
income taxes
13,501
499
38,680
892
Capital expenditures
1,222
2,217
$207,971
$946
$208,917
$445,305
$1,912
$447,217
4,146
8,364
12
7,077
426
33,019
1,068
1,204
1,879
Total assets as of August 3, 2019
$610,282
$47,084
$657,366
Total assets as of February 2, 2019
454,143
43,763
The Company evaluates segment performance based on income before taxes. The Company does not allocate certain corporate expenses or income taxes to the credit segment.
The following schedule summarizes the direct expenses of the credit segment, which are reflected in Selling, general and administrative expenses (in thousands):
Payroll
164
195
392
Postage
117
128
241
251
Other expenses
129
191
372
Total expenses
410
514
927
832
NOTE 6 – STOCK-BASED COMPENSATION:
As of August 3, 2019, the Company had two long-term compensation plans pursuant to which stock-based compensation was outstanding or could be granted. The 2018 Incentive Compensation Plan and 2013 Incentive Compensation Plan are for the granting of various forms of equity-based awards, including restricted stock and stock options for grant, to officers, directors and key employees. Effective May 24, 2018, shares for grant were no longer available under the 2013 Incentive Compensation Plan.
The following table presents the number of options and shares of restricted stock initially authorized and available for grant under each of the plans as of August 3, 2019:
2013
2018
Plan
Options and/or restricted stock initially authorized
1,500,000
4,725,000
6,225,000
Options and/or restricted stock available for grant:
4,167,712
In accordance with ASC 718, the fair value of current restricted stock awards is estimated on the date of grant based on the market price of the Company’s stock and is amortized to compensation expense on a straight-line basis over the related vesting periods. As of August 3, 2019 and February 2, 2019, there was $14,622,000 and $11,989,000, respectively, of total unrecognized compensation expense related to nonvested restricted stock awards, which had a remaining weighted-average vesting period of 2.2years and 2.2years, respectively. The total compensation expense during the three and six months ended August 3, 2019 was $1,495,000 and $2,140,000, respectively, compared to $1,821,000 and $2,367,000, respectively, for the three and six months ended August 4, 2018. These expenses are classified as a component of Selling, general and administrative expenses in the Condensed Consolidated Statements of Income and Comprehensive Income.
The following summary shows the changes in the shares of unvested restricted stock outstanding during the six months ended August 3, 2019:
Weighted Average
Number of
Grant Date Fair
Shares
Value Per Share
Restricted stock awards at February 2, 2019
771,851
24.22
Granted
361,170
14.89
Vested
(129,108)
34.44
Forfeited or expired
(36,396)
19.77
Restricted stock awards at August 3, 2019
967,517
19.54
13
NOTE 6 – STOCK BASED-COMPENSATION (CONTINUED):
The Company’s Employee Stock Purchase Plan allows eligible full-time employees to purchase a limited number of shares of the Company’s Class A Common Stock during each semi-annual offering period at a 15% discount through payroll deductions. During the six months ended August 3, 2019 and August 4, 2018, the Company sold 26,078 and 22,554 shares to employees at an average discount of $2.16 and $2.22 per share, respectively, under the Employee Stock Purchase Plan. The compensation expense recognized for the 15% discount given under the Employee Stock Purchase Plan was approximately $56,000 and $50,000 for the six months ended August 3, 2019 and August 4, 2018, respectively. These expenses are classified as a component of Selling, general and administrative expenses.
NOTE 7 – FAIR VALUE MEASUREMENTS:
The following tables set forth information regarding the Company’s financial assets and liabilities that are measured at fair value (in thousands) as of August 3, 2019 and February 2, 2019:
Quoted
Prices in
Active
Significant
Markets for
Identical
Observable
Unobservable
Assets
Inputs
Description
Level 1
Level 2
Level 3
Assets:
State/Municipal Bonds
45,843
Corporate Bonds
94,221
U.S. Treasury/Agencies Notes and Bonds
43,420
Cash Surrender Value of Life Insurance
10,111
Asset-backed Securities (ABS)
25,500
Corporate Equities
718
Certificates of Deposit
101
219,914
819
208,984
Liabilities:
Deferred Compensation
(10,182)
Total Liabilities
14
54,346
90,891
17,236
9,093
23,334
690
195,691
791
185,807
(8,908)
The Company’s investment portfolio was primarily invested in corporate bonds and tax-exempt and taxable governmental debt securities held in managed accounts with underlying ratings of A or better at August 3, 2019 and February 2, 2019. The state, municipal and corporate bonds have contractual maturities which range from 2 days to 17.0 years. The U.S. Treasury Notes and Certificates of Deposit have contractual maturities which range from 28 days to 2.5 years. These securities are classified as available-for-sale and are recorded as Short-term investments, Restricted cash and Restricted short-term investments on the accompanying Condensed Consolidated Balance Sheets. These assets are carried at fair value with unrealized gains and losses reported net of taxes in Accumulated other comprehensive income. The asset-backed securities are bonds comprised of auto loans and bank credit cards that carry AAA ratings. The auto loan asset-backed securities are backed by static pools of auto loans that were originated and serviced by captive auto finance units, banks or finance companies. The bank credit card asset-backed securities are backed by revolving pools of credit card receivables generated by account holders of cards from American Express, Citibank, JPMorgan Chase, Capital One and Discover.
Additionally, at August 3, 2019, the Company had $0.7 million of corporate equities and deferred compensation plan assets of $10.1 million. At February 2, 2019, the Company had $0.7 million of corporate equities and deferred compensation plan assets of $9.1 million. All of these assets are recorded within Other assets in the Condensed Consolidated Balance Sheets.
Level 1 category securities are measured at fair value using quoted active market prices. Level 2 investment securities include corporate bonds, municipal bonds and asset-backed securities for which quoted prices may not be available on active exchanges for identical instruments. Their fair value is principally based on market values determined by management with assistance of a third-party pricing service. Since quoted prices in active markets for identical assets are not available, these prices are determined by the pricing service using observable market information such as quotes from less active markets and/or quoted prices of securities with similar characteristics, among other factors.
Deferred compensation plan assets consist of life insurance policies. These life insurance policies are valued based on the cash surrender value of the insurance contract, which is determined based on such factors as the
fair value of the underlying assets and discounted cash flow and are therefore classified within Level 3 of the valuation hierarchy. The Level 3 liability associated with the life insurance policies represents a deferred compensation obligation, the value of which is tracked via underlying insurance funds’ net asset values, as recorded in Other noncurrent liabilities in the Condensed Consolidated Balance Sheet. These funds are designed to mirror mutual funds and money market funds that are observable and actively traded.
The following tables summarize the change in fair value of the Company’s financial assets and liabilities measured using Level 3 inputs as of August 3, 2019 and February 2, 2019 (in thousands):
Fair Value
Measurements Using
Significant Unobservable
Asset Inputs (Level 3)
Cash Surrender Value
Additions
706
Total gains or (losses)
Included in interest and other income (or changes in net assets)
312
Included in other comprehensive income
Liability Inputs (Level 3)
(827)
Total (gains) or losses
(447)
16
8,900
596
(403)
Ending Balance at February 2, 2019
(8,951)
(105)
148
17
NOTE 8 – RECENT ACCOUNTING PRONOUNCEMENTS:
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which modifies the measurement of expected credit losses of certain financial instruments. Topic 326 is effective for annual reporting periods beginning after December 15, 2019 with early adoption permitted. The Company is currently assessing the impact of the ASU on its financial statements.
NOTE 9 – INCOME TAXES:
The Company had an effective tax rate for the first six months of 2019 of 16.3% compared to 12.3% for the first six months of 2018. The increase in the effective tax rate for the first six months was primarily due to more taxable interest income, more non-deductible IRS Section 162(m) compensation, and a release of reserves for uncertain tax positions due to state audit settlements in the first quarter of 2018.
NOTE 10 – COMMITMENTS AND CONTINGENCIES:
The Company is, from time to time, involved in routine litigation incidental to the conduct of its business, including litigation regarding the merchandise that it sells, litigation regarding intellectual property, litigation instituted by persons injured upon premises under its control, litigation with respect to various employment matters, including alleged discrimination and wage and hour litigation, and litigation with present or former employees.
Although such litigation is routine and incidental to the conduct of the Company’s business, as with any business of its size with a significant number of employees and significant merchandise sales, such litigation could result in large monetary awards. Based on information currently available, management does not believe that any reasonably possible losses arising from current pending litigation will have a material adverse effect on the Company’s condensed consolidated financial statements. However, given the inherent uncertainties involved in such matters, an adverse outcome in one or more such matters could materially and adversely affect the Company’s financial condition, results of operations and cash flows in any particular reporting period. The Company accrues for these matters when the liability is deemed probable and reasonably estimable.
NOTE 11 – REVENUE RECOGNITION:
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 from stores are also recorded when the customer takes possession of the merchandise. E-commerce sales are recorded when the risk of loss is transferred to the customer. Gift cards are recorded as deferred revenue until they are redeemed or forfeited. Layaway sales are recorded as deferred revenue until the customer takes possession or forfeits the merchandise. Gift cards do not have expiration dates. A provision is made for estimated merchandise returns based on sales volumes and the Company’s experience; actual returns have not varied materially from historical amounts. A provision is made for estimated write-offs associated with sales made with the Company’s proprietary credit card. Amounts related to shipping and handling billed to customers in a sales
transaction are classified as Other revenue and the costs related to shipping product to customers (billed and accrued) are classified as Cost of goods sold.
The Company offers its own proprietary credit card to customers. All credit activity is performed by the Company’s wholly-owned subsidiaries. None of the credit card receivables are secured. The Company estimated uncollectible amounts of $,455000 and $,458000 for the six months ended August 3, 2019 and August 4, 2018, respectively, on sales purchased on the Company’s proprietary credit card of $.138 million and $.141 million for the six months ended August 3, 2019 and August 4, 2018, respectively.
The following table provides information about receivables and contract liabilities from contracts with customers (in thousands):
Balance as of
Proprietary Credit Card Receivables, net
15,657
15,980
Gift Card Liability
5,427
7,721
NOTE 12 – LEASES:
The Company determines whether an arrangement is a lease at inception. The Company has operating leases for stores, offices and equipment. Its leases have remaining lease terms of one year to 10 years, some of which include options to extend the lease term for up to five years, and some of which include options to terminate the lease within one year. The Company considers these options in determining the lease term used to establish its right-of-use assets and lease liabilities. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.
As most of the Company’s leases do not provide an implicit rate, it uses its estimated incremental borrowing rate based on the information available at commencement date of the lease in determining the present value of lease payments.
The components of lease cost are shown below (in thousands):
Operating lease cost (a)
16,665
26,397
Variable lease cost (b)
508
1,114
ASC 840 prepaid rent expense (c)
37
6,012
(a) Includes right-of-use asset amortization of ($1) million and ($3) million for the three months and six months end August 3, 2019, respectively.
(b) Primarily related to monthly percentage rent for stores not presented on the balance sheet.
(c) Related to ASC 840 rent expense due to prepaid rent on the balance sheet as of February 3, 2019.
19
Supplemental cash flow information and non-cash activity related to the Company’s operating leases are as follows (in thousands):
Operating cash flow information:
Cash paid for amounts included in the measurement of lease liabilities
25,418
Right-of-use assets obtained in exchange for lease obligations
602
Weighted-average remaining lease term and discount rate for the Company’s operating leases are as follows:
As of
Weighted-average remaining lease term
2.6 years
Weighted-average discount rate
4.65%
Maturities of lease liabilities by fiscal year for the Company’s operating leases are as follows (in thousands):
Fiscal Year
2019 (a)
29,342
2020
57,071
2021
42,659
2022
27,421
2023
19,096
Thereafter
18,024
Total lease payments
193,613
Less: Imputed interest
17,549
Present value of lease liabilities
176,064
(a) Excluding the 6 months ended August 3, 2019.
As of February 2, 2019, the minimum rental commitments under non-cancelable operating leases are (in thousands):
20
2019
69,601
51,943
35,196
21,242
12,986
2,643
Total minimum lease payments
193,611
A summary of rent expense for the fiscal years ended February 2, 2019 and February 3, 2018 was as follows (in thousands):
February 3, 2018
Rent Expense
69,872
70,971
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING INFORMATION:
The following information should be read along with the unaudited Condensed Consolidated Financial Statements, including the accompanying Notes appearing in this report. Any of the following are “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended: (1) statements in this Form 10-Q that reflect projections or expectations of our future financial or economic performance; (2) statements that are not historical information; (3) statements of our beliefs, intentions, plans and objectives for future operations, including those contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”; (4) statements relating to our operations or activities for our fiscal year ending February 1, 2020 (“fiscal 2019”) and beyond, including, but not limited to, statements regarding expected amounts of capital expenditures and store openings, relocations, remodels and closures; and (5) statements relating to our future contingencies. When possible, we have attempted to identify forward-looking statements by using words such as “will,” “expects,” “anticipates,” “approximates,” “believes,” “estimates,” “hopes,” “intends,” “may,” “plans,” “could,” “would,” “should” and any variations or negative formations of such words and similar expressions. We can give no assurance that actual results or events will not differ materially from those expressed or implied in any such forward-looking statements. Forward-looking statements included in this report are based on information available to us as of the filing date of this report, but subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from those contemplated by the forward-looking statements. Such factors include, but are not limited to, the following: any actual or perceived deterioration in the conditions that drive consumer confidence and spending, including, but not limited to, levels of unemployment, fuel, energy and food costs, wage rates, tax rates, interest rates, home values, consumer net worth and the availability of credit; changes in laws, regulations or governmental policies affecting our business, including tariffs; uncertainties regarding the impact of any governmental actions regarding, or responses to, the foregoing conditions; competitive factors and pricing pressures; our ability to predict and respond to rapidly changing fashion trends and consumer demands; adverse weather or similar conditions that may affect our sales or operations; inventory risks due to shifts in market demand, including the ability to liquidate excess inventory at anticipated margins; and other factors discussed under “Risk Factors” in Part I, Item 1A of our annual report on Form 10-K for the fiscal year ended February 2, 2019 (“fiscal 2018”), as amended or supplemented, and in other reports we file with or furnish to the Securities and Exchange Commission (“SEC”) from time to time. We do not undertake, and expressly decline, any obligation to update any such forward-looking information contained in this report, whether as a result of new information, future events, or otherwise.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
CRITICAL ACCOUNTING POLICIES:
The Company’s accounting policies are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the fiscal year ended February 2, 2019. As disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the preparation of the Company’s financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”) 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, inventory shrinkage, the calculation of potential asset impairment, workers’ compensation, general and auto insurance liabilities, reserves relating to self-insured health insurance, and uncertain tax positions.
The Company’s critical accounting policies and estimates are discussed with the Audit Committee.
23
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:
Total retail sales
100.0
%
Other revenue
1.1
1.0
101.1
101.0
Cost of goods sold (exclusive of depreciation)
62.0
62.8
60.8
61.4
Selling, general and administrative (exclusive of depreciation)
31.4
33.3
30.1
30.4
1.8
2.0
1.9
(0.8)
(0.7)
(0.6)
(0.5)
Income/(loss) before income taxes
6.7
3.6
9.0
7.7
Net income/(loss)
5.6
3.1
7.6
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RESULTS OF OPERATIONS (CONTINUED):
Comparison of the Three and Six Months ended August 3, 2019 with August 4, 2018
Total retail sales for the second quarter were $210.4 million compared to last year’s second quarter sales of $206.8 million, a 1.7% increase. The Company’s sales increase in the second quarter of fiscal 2019 is primarily due to a 4% increase in same-store sales partially offset by closed stores. For the six months ended August 3, 2019, total retail sales were $438.4 million compared to last year’s comparable six month sales of $442.9 million. Sales in the first six months of fiscal 2019 decreased slightly primarily due to closed stores, partially offset by a 1% increase in same-store sales. Same-store sales include stores that have been open more than 15 months. Stores that have been relocated or expanded are also included in the same-store sales calculation after they have been open more than 15 months. The method of calculating same-store sales varies across the retail industry. As a result, our same-store sales calculation may not be comparable to similarly titled measures reported by other companies. E-commerce sales were less than 3% of sales for the six months ended August 3, 2019 and are included in the same-store sales calculation. Total revenues, comprised of retail sales and other revenue (principally finance charges and late fees on customer accounts receivable, gift card breakage and layaway fees), were $212.6 million and $442.9 million for the three and six months ended August 3, 2019, compared to $208.9 million and $447.2 million for the three and six months ended August 4, 2018, respectively. The Company operated 1,299 stores at August 3, 2019 compared to 1,350 stores at the end of last year’s second quarter. During the first six months of fiscal 2019, the Company closed 12 stores. In total, the Company currently expects to open up to 12 stores and close about 50 stores in fiscal 2019.
Credit revenue of $0.9 million represented 0.4% of total revenues in the second quarter of fiscal 2019, compared to 2018 credit revenue of $0.9 million or 0.5% 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 principally include payroll, postage and other administrative expenses and totaled $0.4 million in the second quarter of fiscal 2019, compared to last year’s second quarter expense of $0.5 million.
Other revenue in total, as included in total revenues, was $2.2 million and $4.5 million for the three and six months ended August 3, 2019, compared to $2.1 million and $4.3 million for the prior year’s comparable three and six month periods. The overall increase in the three and six months ended August 3, 2019 is primarily due to increases in e-commerce shipping revenues.
Cost of goods sold was $130.4 million, or 62.0% of retail sales and $266.5 million, or 60.8% of retail sales for the three and six months ended August 3, 2019, compared to $129.8 million, or 62.8% of retail sales and $272.1 million, or 61.4% of retail sales for the comparable three and six month periods of fiscal 2018. The overall decrease in cost of goods sold as a percent of retail sales for the second quarter of fiscal 2019 resulted primarily from less markdowns. In addition, occupancy costs as a percent of retail sales decreased. 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 costs 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 exclusive of depreciation) increased by 3.9% to $80.0 million for the second quarter of fiscal 2019 and increased by 0.7% to $172.0 million for the first six months of fiscal 2019 compared to $77.0 million and $170.8 million for the prior year’s comparable three and six months of fiscal 2018. Gross margin as presented may not be comparable to those of other entities.
25
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. SG&A expenses were $66.1 million, or 31.4% of retail sales and $132.1 million, or 30.1% of retail sales for the second quarter and first six months of fiscal 2019, respectively, compared to $68.9 million, or 33.3% of retail sales and $134.9 million, or 30.4% of retail sales for the prior year’s comparable three and six month periods. The decrease in SG&A expense for the second quarter and the first six months of fiscal 2019 was primarily attributable to lower insurance cost, partially offset by higher incentive compensation.
Depreciation expense was $3.8 million, or 1.8% of retail sales and $7.7 million, or 1.8% of retail sales for the second quarter and first six months of fiscal 2019, respectively, compared to $4.2 million, or 2.0% of retail sales and $8.4 million or 1.9% of retail sales for the comparable three and six month periods of fiscal 2018, respectively.
Interest and other income was $1.7 million, or 0.8% of retail sales and $2.8 million, or 0.6% of retail sales for the three and six months ended August 3, 2019, respectively, compared to $1.4 million, or 0.7% of retail sales and $2.2 million, or 0.5% of retail sales for the comparable three and six month periods of fiscal 2018, respectively. The increase for the first six months of fiscal 2019 compared to 2018 is primarily attributable to an increase in short-term investments.
Income tax expense was $2.1 million and $6.5 million for the second quarter and first six months of fiscal 2019, respectively, compared to income tax expense of $1.0 million and $4.2 million for the comparable three and six month periods of fiscal 2018, respectively. For the first six months of 2019, the Company’s effective tax rate was 16.3%. The increase in the 2019 tax rate was primarily due to higher pre-tax earnings, more taxable income, more non-deductible IRS Section 162(m) compensation and an increase in state income taxes due to less credits in 2019 and a release of reserves for uncertain tax positions due to state audit settlements in the first quarter of 2018.
LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK:
The Company has consistently maintained a strong liquidity position. Cash provided by operating activities during the first six months of fiscal 2019 was $45.2 million as compared to $56.5 million in the first six months of fiscal 2018. These amounts enable the Company to fund its regular operating needs, capital expenditure program, cash dividend payments and share repurchases. In addition, the Company maintains a $35.0 million unsecured revolving credit facility for short-term financing of seasonal cash needs. There were no outstanding borrowings on this facility at August 3, 2019 and February 2, 2019.
Cash provided by operating activities for the first six months of fiscal 2019 was primarily generated by earnings adjusted for depreciation and changes in working capital. The decrease of $11.3 million for the first six months of fiscal 2019 as compared to the first six months of fiscal 2018 was primarily due to a decrease in accounts payable and accrued expenses, partially offset by a decrease in inventory and accounts receivable and an increase in net income.
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 regular operating requirements, expected capital expenditures, dividends and share repurchases for fiscal 2019 and the next 12 months.
26
At August 3, 2019, the Company had working capital of $189.7 million compared to $229.5 million at February 2, 2019.
At August 3, 2019 and February 2, 2019, the Company had an unsecured revolving credit agreement, which provides for borrowings of up to $35.0 million, less the value of revocable letters of credit discussed below. The revolving credit agreement is committed until May 2022. 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 August 3, 2019. There were no borrowings outstanding under the credit facility as of August 3, 2019 and February 2, 2019.
Expenditures for property and equipment totaled $2.2 million in the first six months of fiscal 2019, compared to $1.9 million in last fiscal year’s first six months. The expenditures for the first six months of fiscal 2019 were primarily for additional investments in home office, distribution center, cars and information technology. For the full fiscal 2019 year, the Company expects to invest approximately $13.0 million for capital expenditures.
Net cash used by investing activities totaled $23.4 million in the first six months of fiscal 2019 compared to net cash used of $69.9 million by investing activities in the comparable period of 2018. The decrease in net cash used in 2019 is primarily attributable to the decrease in net purchases of short-term investments.
Net cash used in financing activities totaled $18.8 million in the first six months of fiscal 2019 compared to $26.3 million used in the comparable period of fiscal 2018. The decrease was primarily due to lower share repurchase amounts.
As of August 3, 2019, the Company had 1,810,961 shares remaining in open authorizations under its share repurchase program.
The Company does not use derivative financial instruments.
27
See Note 7, Fair Value Measurements.
RECENT ACCOUNTING PRONOUNCEMENTS:
See Note 8, Recent Accounting Pronouncements.
28
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 3. 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 activities, but the Company does not believe such exposure is material.
ITEM 4. CONTROLS AND PROCEDURES:
We carried out an evaluation, with the participation of our Principal Executive Officer and Principal Financial Officer, of the effectiveness of our disclosure controls and procedures as of August 3, 2019. Based on this evaluation, our Principal Executive Officer and Principal Financial Officer concluded that, as of August 3, 2019, our disclosure controls and procedures, as defined in Rule 13a-15(e), under the Securities Exchange Act of 1934 (the “Exchange Act”), were effective to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING:
No change in the Company’s internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) has occurred during the Company’s fiscal quarter ended August 3, 2019 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS:
ITEM 1A. RISK FACTORS:
In addition to the other information in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for our fiscal year ended February 2, 2019. These risks could materially affect our business, financial condition or future results; however, they are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition or results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS:
The following table summarizes the Company’s purchases of its common stock for the three months ended August 3, 2019:
ISSUER PURCHASES OF EQUITY SECURITIES
Total Number of
Maximum Number
Shares Purchased as
(or Approximate Dollar
Total Number
Average
Part of Publicly
Value) of Shares that may
Fiscal
of Shares
Price Paid
Announced Plans or
Yet be Purchased Under
Period
Purchased
per Share (1)
Programs (2)
The Plans or Programs (2)
May 2019
June 2019
July 2019
1,810,961
(1)Prices include trading costs.
(2)As of May 4, 2019, the Company’s share repurchase program had 1,810,961 shares remaining in open authorizations. During the second quarter ending August 3, 2019, the Company did not repurchase or retire any shares under this program. As of the second quarter ended August 3, 2019, the Company had 1,810,961 shares remaining in open authorizations. There is no specified expiration date for the Company’s repurchase program.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES:
ITEM 4. MINE SAFETY DISCLOSURES:
ITEM 5. OTHER INFORMATION:
ITEM 6. EXHIBITS:
Exhibit No.
Item
Registrant’s Restated Certificate of Incorporation dated March 6, 1987, incorporated by reference to Exhibit 4.1 to Form S-8 of the Registrant filed February 7, 2000 (SEC File No. 333-96283).
3.2
Registrant’s By Laws, incorporated by reference to Exhibit 99.2 to Form 8-K of the Registrant Filed December 10, 2007.
31.1*
Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer.
31.2*
Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer.
32.1*
Section 1350 Certification of Principal Executive Officer.
32.2*
Section 1350 Certification of Principal Financial Officer.
101.1*
The following materials from Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended August 3, 2019, formatted in XBRL: (i) Condensed Consolidated Statements of Income and Comprehensive Income for the Three Months and Six Months Ended August 3, 2019 and August 4, 2018; (ii) Condensed Consolidated Balance Sheets at August 3, 2019 and February 2, 2019; (iii) Condensed Consolidated Statements of Cash Flows for the Six Months Ended August 3, 2019 and August 4, 2018; (iv) Condensed Consolidated Statements of Stockholders’ Equity for the Six Months Ended August 3, 2019 and August 4, 2018; and (v) Notes to Condensed Consolidated Financial Statements.
* Submitted electronically herewith.
SIGNATURES
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.
August 30, 2019
/s/ John P. D. Cato
Date
John P. D. Cato
Chairman, President and
Chief Executive Officer
/s/ John R. Howe
John R. Howe
Executive Vice President
Chief Financial Officer