UNITED STATESSECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
For the quarterly period ended August 2, 2003
OR
For the transition period from to
Commission file number 0-3747
THE CATO CORPORATION AND SUBSIDIARIES
8100 Denmark Road, Charlotte, North Carolina 28273-5975
(704) 554-8510
Not Applicable
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.
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 126-2 of the Act).
As of August 19, 2003, there were 19,864,378 shares of Class A common stock and 5,637,834 shares of Class B common stock outstanding.
THE CATO CORPORATION
August 2, 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 SIX MONTHS ENDED AUGUST 2, 2003AND AUGUST 3, 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 August 2, 2003 and August 3, 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 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 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 second quarter and six months ended August 2, 2003 was $7,374,000 and $24,969,000, respectively. Total comprehensive income for the second quarter and six months ended August 3, 2002 was $12,234,000 and $30,224,000, 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 six months ended August 2, 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, all which incurred in the first quarter of fiscal 2003. For the six months ended August 3, 2002, the Company repurchased and accepted a combined total of 110,581 mature shares of Class A Common Stock for $2,260,264, or an average market price of $20.44 per share. In the second quarter of fiscal 2002, the Company repurchased 61,900 shares of Class A Common Stock for $1,115,764, or an average
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NOTE 1 – GENERAL (CONTINUED):
market price of $18.03 per share. Additionally, in the first quarter of fiscal 2002, the Company accepted in an option transaction from an officer for payment of an option exercise, 48,681 mature shares of Class A Common Stock for $1,144,500, or an average market price of $23.51 per share, the average fair market value on the date of the exchange.
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 21% discount off the then market value) for a total cost of $95,043,454 which 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. Both the repurchase of the shares from the co-founders and the new term loan facility will be recorded in the Company’s third quarter.
On August 29, 2003, the Company entered into 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 provide 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 expects to take a charge of approximately $2.8 million representing the present value of certain payments and benefits to Mr. Wayland Cato and Mr. Edgar Cato under the terms of the agreements. The charge will be approximately $1.8 million on an after-tax basis, or $.08 per diluted share for the third quarter and year. The benefits include compensation for three years commencing on the retirement date, life insurance coverage for three years, continuation of medical insurance coverage, and assistance with the relocation of their offices and are in consideration of the consulting services, non-competition covenants and confidentiality covenants, among other obligations of the retirees.
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 November 25, 2002 the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”, which elaborates on the disclosures to be made by a guarantor about its obligations under certain guarantees issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The interpretation expands on the accounting guidance of SFAS No. 5, “Accounting for Contingencies”, SFAS No. 57, “Related Party Disclosures”, and SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”. The interpretation also incorporates, without change, the provisions of FASB Interpretation No. 34, “Disclosure of Indirect Guarantees of Indebtedness of Others”, which it supersedes. The initial recognition and measurement provisions of Interpretation No. 45 apply on a prospective basis to guarantees issued or modified after December 31, 2002, regardless of the guarantor’s fiscal year-end. The disclosures are effective for financial statements of interim or annual periods ending after December 31, 2002. The Company adopted Interpretation No. 45 on February 2, 2003 and the impact of this Interpretation on the Company’s financial position or results of operations was not material and additional disclosure is not required.
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 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, “Accounting for
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NOTE 2 – RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED):
Stock-Based Compensation”, the Company’s net income and basic and diluted earnings per share amounts for the three months ended August 2, 2003 and August 3, 2002 and for the six months ended August 2, 2003 and August 3, 2002 would approximate the following proforma amounts (dollars in thousands, except per share data):
* determined using fair value method
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 improves 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. We do not expect the provisions of SFAS 150 to have a material impact on our financial position or results of operations.
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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.
NOTE 4 - SUPPLEMENTAL CASH FLOW INFORMATION:
Income tax payments, net of refunds received, for the six months ended August 2, 2003 and August 3, 2002 were $9,277,450 and $10,364,500, 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.
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. There were no borrowings outstanding during the six months ended August 2, 2003 or the fiscal year ended February 1, 2003.
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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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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 Second Quarter and First Six Months of 2003 with 2002.
Total retail sales for the second quarter were $188.2 million compared to last year’s second quarter sales of $186.9 million, a 1% increase. Same-store sales decreased 7% in the second quarter of fiscal 2003. For the six months ended August 2, 2003, total retail sales were $385.5 million compared to last year’s first six months sales of $383.5 million, a 1% increase, and same-store sales decreased 7% for the comparable six month period. The soft retail sales for the first six months of 2003 resulted from continued difficult economic conditions. The Company operated 1,051 stores at August 2, 2003 compared to 972 stores at the end of last year’s second quarter.
Other income for the second quarter of 2003 decreased 1% over the prior year’s comparable period. The decrease in the second quarter resulted primarily from decreased layaway fees. Other income for the first six months of 2003 was virtually equivalent to the comparable six month period last year.
Cost of goods sold were 70.5% and 67.4% of total retail sales for the second quarter and first six months of 2003, respectively, compared to 67.3% and 65.3% for prior year’s comparable three and six month periods, respectively. The increase in cost of goods sold as a percent of retail sales for the first six 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 $44.6 million, or 23.7% and $88.0 million, or 22.8% for the second quarter and first six months of this year, compared to $44.1
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RESULTS OF OPERATIONS – (CONTINUED):
million, or 23.6% and $89.4 million, or 23.3% of retail sales for prior year’s comparable three and six month periods, respectively. SG&A expenses as a percentage of retail sales increased 10 basis points for the second quarter of 2003 as compared to the prior year and decreased 50 basis points for the first six months of 2003, as compared to the prior year. The overall decrease in SG&A expenses for the first six months of 2003 results primarily from reduced incentive based performance bonus programs.
Depreciation expense was $4.6 million, or 2.4% and $9.0 million or 2.3% of retail sales, for the second quarter and first six months of fiscal 2003, compared to $3.3 million, or 1.7% and $6.4 million, or 1.6% of retail sales, for prior year’s comparable three and six month periods, respectively. The increase resulted primarily from the Company’s store development and depreciation of the Company’s enterprise-wide information system which was implemented in August 2002.
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.
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. 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
\
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STOCK OPTIONS (CONTINUED):
the stock options granted been determined consistent with SFAS No. 123, “Accounting for Stock-Based Compensation”, the Company’s net income and basic and diluted earnings per share amounts for the three months ended August 2, 2003 and August 3, 2002 and for the six months ended August 2, 2003 and August 3, 2002 would approximate the following proforma amounts (dollars in thousands, except per share data):
LIQUIDITY AND CAPITAL RESOURCES:
At August 2, 2003, the Company had working capital of $178.3 million, compared to $155.1 million at August 3, 2002 and $162.6 million at February 1, 2003. Cash provided by operating activities was $38.0 million for the six months ended August 2, 2003, compared to $47.7 million for last year’s comparable six 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 second quarter of 2003 versus after the end of second quarter 2002 partially offset by a decrease in inventories. At August 2, 2003, the Company had cash, cash equivalents, and short-term investments of $126.1 million, compared to $111.0 million at August 3, 2002 and $106.9 million at February 1, 2003.
Net cash used in investing activities totaled $.7 million for the first six months of 2003 compared to $9.1 million for the comparable period of 2002. Cash was used to fund capital expenditures for new, relocated and remodeled stores and for investments in technology. Additionally, the decrease in cash used was in part related to an increase in purchases of short-term investments offset by a
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LIQUIDITY AND CAPITAL RESOURCES (CONTINUED):
decrease in capital expenditures and an increase in the sale of short-term investments in fiscal 2003 as compared to fiscal 2002.
Expenditures for property and equipment totaled $9.1 million for the six months ended August 2, 2003, compared to $14.2 million of expenditures in last year’s first six months. The Company expects total capital expenditures to be approximately $31 million for the current fiscal year. The Company intends to open approximately 90 new stores, close 10 stores and to relocate 25 stores during the current fiscal year. For the six months ended August 2, 2003, the Company had opened 29 new stores and relocated 12 stores.
Net cash used in financing activities totaled $9.5 million for the first six months of 2003 compared to $6.8 million for the comparable period of 2002. The increase was due primarily to an increase in its share buyback program, increase in dividends paid and a reduction in proceeds from stock options exercised in fiscal 2003 as compared to fiscal 2002.
The Company does not use derivative financial instruments. At August 2, 2003, August 3, 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.
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.
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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 the Form 10-Q and located elsewhere herein regarding the Company’s financial position and business strategy may 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.
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THE CATO CORPORATIONCONTROL 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 August 2, 2003. Each has concluded that these controls and procedures are effective.
CHANGES IN INTERNAL CONTROLS:
The Company’s Chief Executive Officer and Chief Financial Officer (its principal executive officer and principal financial officer, respectively) have concluded, based on their evaluation as of a date within 90 days prior to the filing date of this report, that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
During 2002 and the first quarter of 2003, the Company made payments for the benefit of entities in which Mr. Wayland H. Cato, Jr., Chairman of the Board, and Mr. Edgar T. Cato, Former Vice Chairman of the Board and Co-founder and Director, have a material interest. The Company subsequently determined these payments were unrelated to the business of the Company. Amounts, including interest, have been repaid. In the course of the evaluation by the Chief Executive Officer and the Chief Financial Officer described above, the Company implemented a change in it internal controls to prevent the payment of similar expenses in the future. As a result of this change, all future payment requests for or on behalf of related parties will require the prior review by and approval of the Chief Financial Officer.
There have been no other significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of such evaluation.
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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
Following are the results of the matters voted upon at the Company’s Annual Meeting which was held on May 22, 2003.
Election of Directors:
Adoption of The Cato Corporation 2003 Employee Stock Purchase Plan
ITEM 5. OTHER INFORMATION
The Registrant announced on September 3, 2003 that it had entered into separate agreements, each dated as of August 29, 2003, with Mr. Wayland H. Cato, Jr., a founder of the Registrant and Chairman of the Board, and Mr. Edgar T. Cato, a founder of the Registrant and member of the Board of Directors. The agreements provide for the retirement of Mr. Wayland Cato and Mr. Edgar Cato from the Registrant and the Board of Directors effective January 31, 2004. Mr. Wayland Cato will be available to the Registrant for consulting services following his retirement.
The Registrant further announced that it expects to take a charge of approximately $2.8 million in its third quarter ending November 1, 2003, representing the present value of certain payments and benefits to Mr. Wayland Cato and Mr. Edgar Cato under the terms of the agreements. The charge will be approximately $1.8 million on an after-tax basis, or $.08 per diluted share for the third quarter ending November 1, 2003, and the fiscal year ending January 31, 2004.
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PART II OTHER INFORMATION (CONTINUED):
Copies of the agreements are filed with this Quarterly Report on Form 10-Q as Exhibits 10.1 and 10.2, respectively. A copy of the press release announcing the agreements is filed as Exhibit 99.1.
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K
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.