Cato Fashion - 10-Q quarterly report FY

 

 

(Exact name of registrant as specified in its charter)

8100 Denmark Road, Charlotte, North Carolina 28273-5975

(Address of principal executive offices)
(Zip Code)

(704) 554-8510

(Registrant’s telephone number, including area code)

Not Applicable

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

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

Yes þ No o

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

Yes þ No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

As of November 15, 2005, there were 30,478,796 shares of Class A common stock and 690,525 shares of Class B common stock outstanding.

 

 

See notes to condensed consolidated financial statements.

See notes to condensed consolidated financial statements.

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 October 29, 2005 and October 30, 2004 are unaudited. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All such adjustments are of a normal, recurring nature. The results of the interim period may not be indicative of the entire year.

The interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 29, 2005.

The Company restated its Condensed Consolidated Balance Sheet and statements of cash flows for the nine months ended October 30, 2004 and its Condensed Consolidated Statements of Income for the three months and nine months ended October 30, 2004 as a result of correcting its lease accounting practices.

The Company historically straight-lined lease expense over the period from the open date of the store through the initial non-cancelable lease term expiration. However, in accordance with FASB issued Statement No. 13 (“SFAS 13”), “Accounting for Leases,” as amended, FASB issued Technical Bulletin No. 88-1 (“FTB 88-1”), “Issues Relating to Accounting for Leases,” and FASB issued Technical Bulletin No. 85-3 (“FTB 85-3”), “Accounting for Operating Leases with Scheduled Rent Increases.” As a result, the Company corrected its lease accounting practices to recognize lease expense on a straight-line basis over the lease term which begins on the date the Company obtains control of the property and includes any renewal periods for which failure to renew imposes a penalty on the lessee such that renewal is determined to be reasonably assured. Likewise, the Company corrected its practices to amortize landlord allowances on a straight-line basis over the lease term. These corrections to the Company’s lease accounting practices reduced net income by $50,000 and $110,000 for the three months and nine months ended October 30, 2004, respectively, and had no impact on diluted earnings per share.

As a result of the restatement, the Company’s financial results have been restated as follows (in thousands, except per share data):

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.

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. The cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. The amortization of premiums, accretion of discounts and realized gains and losses are included in interest and other income.

During the third quarter of 2005, the Company revised its process for determining the amount of accounts receivable that should be written off each period. This change in process was consistent with industry and regulatory guidelines and resulted in an acceleration of the account receivable write-offs of approximately $1,700,000. This write-off reduced the Allowance for Doubtful Accounts in the third quarter of 2005. This change in process had no affect on the current period’s earnings and management does not expect that the change will have a material affect on the Company’s future earnings or financial position.

Net comprehensive income for the third quarter and nine months ended October 29, 2005 was $4,047,000 and $33,201,000, respectively. Net comprehensive income for the third quarter and nine months ended October 30, 2004 was $1,771,000 and $26,782,000, respectively. Net comprehensive income is composed of net income and net unrealized gains and losses on available-for-sale securities, net of tax.

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

On May 26, 2005, the Board of Directors approved a three-for-two stock split in the form of a stock dividend of the Company’s Class A and Class B common stock effective June 27, 2005. Furthermore, on May 26, 2005, the Board of Directors increased the quarterly dividend by 11% from $.175 per share to $.195 per share, or an annualized rate of $.78 per share on a pre-split basis. On a post-split basis, the annualized rate is $.52 per share. The dividend for the third quarter was paid on September 26, 2005 on a post-split basis at a quarterly rate of $.13 per share. Prior year basic and diluted earnings per share have been adjusted for the three-for-two stock split.

During the third quarter of 2005, the Company repurchased 148,300 shares of Class A common stock for $2,807,228, or an average price per share of $18.93.

FASB No. 128 requires dual presentation of basic EPS and diluted EPS on the face of all income statements for all entities with complex capital structures. Basic EPS is computed as net income divided by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock options and other convertible securities. Unvested restricted stock is included in the computation of diluted EPS using the treasury stock method. There was an insignificant number of shares withheld from the computation of diluted EPS due to anti-dilutive effects for the nine months ended October 29, 2005 and October 30, 2004. The shares reflected below have been adjusted for the three-for-two stock split completed on June 27, 2005.

Income tax payments, net of refunds received, for the nine months ended October 29, 2005 and October 30, 2004 were $19,668,000 and $12,221,000, respectively. Cash paid for interest for the nine months ended October 29, 2005 and October 30, 2004 were $210,000 and $543,000, respectively.

The Company has an unsecured revolving credit agreement, which provides for borrowings of up to $35 million. This revolving credit agreement was entered into on August 22, 2003 and is committed until August 2008. The credit agreement contains various financial covenants and limitations, including the maintenance of specific financial ratios. There were no borrowings outstanding during the nine months ended October 29, 2005 or the fiscal year ended January 29, 2005. Interest is based on LIBOR, which was 4.08% on October 29, 2005.

On August 22, 2003, the Company entered into a new unsecured $30 million five-year term loan facility, the proceeds of which were used to purchase Class B Common Stock from the Company’s founders. Payments are due in monthly installments of $500,000 plus accrued interest. Interest is based on LIBOR, which was 4.08% on October 29, 2005. On April 5, 2005, the Company repaid the remaining balance of $20.5 million on this term loan facility with no early prepayment penalty. With the early retirement of this loan, the Company had no outstanding debt as of April 5, 2005.

The Company had approximately $1,484,000 and $1,817,000 at October 29, 2005 and October 30, 2004, respectively, of outstanding irrevocable letters of credit relating to purchase commitments.

The Company has two reportable segments: retail and credit. The Company operated its women’s fashion specialty retail stores in 31 states at October 29, 2005, principally in the southeastern United States. The Company offers its own credit card to its customers and all related credit authorizations, payment processing, and collection efforts are performed by a separate subsidiary of the Company.

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

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

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

The Company applies APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its stock option plans. The exercise price for all options awarded under the Company’s stock option plans has been equal to the fair market value of the underlying common stock on the date of grant. Accordingly, no compensation expense has been recognized for options granted under the plans. Had compensation expense for the stock options granted been determined consistent with SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” the Company’s net income and basic and diluted earnings per share amounts for the third quarter and nine months ended October 29, 2005 and October 30, 2004 as adjusted for the three-for-two stock split on June 27, 2005 would approximate the following pro forma amounts (dollars in thousands, except per share data):

In December 2004, the Financial Accounting Standards Board issued SFAS No. 123 (revised) “Share-Based Payment.” This statement eliminates the alternative to account for share-based compensation transactions using APB Opinion No. 25 and will require that compensation expense be measured based on the grant-date fair value of the award and recognized over the requisite service periods for awards that vest. SFAS No. 123 (revised) will also require a change in the classification of certain tax benefits from options deduction to financing rather than operating cash flows. The Company is currently evaluating the impact of this statement, which will be effective as of the beginning of the Company’s 2006 fiscal year as a result of the deferral of the effective date by the Securities and Exchange Commission. However, the Company does not expect the adoption of this statement to have a material impact on its consolidated financial statements.

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 for the third quarter were $177.8 million compared to last year’s third quarter sales of $163.6 million, a 9% increase. Same-store sales increased 4% in the third quarter of fiscal 2005. For the nine months ended October 29, 2005, total retail sales were $601.1 million compared to last year’s first nine months sales of $565.9 million, a 6% increase, and same-store sales increased 1% for the comparable nine month period. Total revenue, comprised of retail sales and other income (principally, finance charges and late fees on customer accounts receivable and layaway fees), were $181.4 million and $612.2 million for the third quarter and nine months ended October 29, 2005, respectively, compared to $167.5 million and $577.6 million for the third quarter and nine months ended October 30, 2004, respectively. The Company operated 1,222 stores at October 29, 2005 compared to 1,149 stores at the end of last year’s third quarter. For the first nine months of 2005 the Company opened 52 stores, relocated 11 stores and closed seven stores.

Credit revenue of $3.1 million, represented 1.7% of total revenues in the third quarter of 2005, compared to 2004 credit revenue of $3.6 million or 2.1% of total revenues. The reduction in credit revenue was due to lower finance charge and late fee income from lower proprietary credit sales penetration, various terms changes, and the accelerated write-off of certain accounts due to the change in write-off from the Recency method to the Contractual method. Credit revenue is comprised of interest earned on the Company’s private label credit card portfolio and related fee income. Related expenses include principally bad debt expense, payroll, postage and other administrative expenses and totaled $1.8 million in the third quarter of 2005 compared to last year’s third quarter expenses of $2.0 million. The decrease in costs was principally due to lower bad debt expense and payroll costs.

Other income in total, as included in total revenues in the third quarter of 2005, decreased slightly to $3.6 million from $3.9 million in the third quarter of 2004. The decrease resulted primarily from lower finance charge income.

Cost of goods sold was $119.9 million, or 67.4% of retail sales and $396.7 million or 66.0% of retail sales for the third quarter and first nine months of fiscal 2005, compared to $115.6 million, or 70.7% of retail sales and $384.2 million, or 67.9% of retail sales for the prior year’s comparable three and nine months periods, respectively. The overall decrease in cost of goods sold as a percent of retail sales for the third quarter and first nine months of 2005 resulted primarily from lower procurement costs and lower markdowns. The reduction in procurement cost is primarily the result of increased direct sourcing and the reduction in markdowns is primarily due to tighter inventory control and better sale throughs of regular priced merchandise. Cost of goods sold includes merchandise costs, net of discounts and allowances, buying costs, distribution costs, occupancy costs, freight and inventory shrinkage. Net merchandise costs and in-bound freight are capitalized as inventory costs. Buying and distribution costs include payroll, payroll-related costs and operating expenses for the buying departments and distribution center. Occupancy expenses include rent, real estate taxes, insurance, common area maintenance, utilities and maintenance for stores and distribution facilities. Total gross margin dollars (retail sales less cost of goods sold) increased by 20.7% to $57.9 million and by 12.5% to $204.4 million for the third quarter and first nine months of fiscal 2005 compared to $48.0 million and $181.6 million for the prior year’s comparable three and nine month periods, respectively. Gross margin as presented may not be comparable to those of other entities as they may include internal transfer costs in selling, general and administrative expenses while the Company classifies them as cost of goods sold.

Selling, general and administrative expenses (SG&A) primarily include corporate and store payroll, related payroll taxes and benefits, insurance, supplies, advertising, bank and credit card processing fees and bad debts. SG&A expenses were $51.2 million, or 28.8% of retail sales and $151.3 million, or 25.2% of retail sales for the third quarter and first nine months of fiscal 2005, compared to $44.4 million, or 27.2% of retail sales and $137.5 million, or 24.3% of retail sales for prior year’s comparable three and nine months periods, respectively. SG&A expenses as a percentage of retail sales increased 160 basis points for the third quarter of fiscal 2005 as compared to the prior year and increased 90 basis points for the first nine months of fiscal 2005, as compared to the prior year. The percentage increase and overall dollar increase in SG&A expenses for the third quarter and first nine months of fiscal 2005 resulted primarily from increased incentive based performance bonuses, increased selling-related expenses and infrastructure expenses attributable to the Company’s store growth.

Depreciation expense was $5.1 million, or 2.9% of retail sales and $15.2 million or 2.5% of retail sales, for the third quarter and first nine months of fiscal 2005, compared to $5.1 million, or 3.1% of retail sales and $15.2 million, or 2.7% of retail sales, for prior year’s comparable three and nine month periods, respectively.

Interest expense was $0.0 million, or 0.0% of retail sales and $0.2 million or 0.0% of retail sales, for the third quarter and first nine months of fiscal 2005, compared to $0.2 million or 0.1% of retail sales and $0.5 million or 0.1% of retail sales for the prior year’s comparable three and nine month periods, respectively. The interest was on a $30.0 million five-year term loan facility entered into on August 22, 2003, the proceeds of which were used to purchase Class B Common Stock from the Company’s founders. On April 5, 2005, the Company repaid the remaining outstanding balance of $20.5 million on this loan facility with no early prepayment penalty. With the early retirement of this loan, the Company had no outstanding debt as of April 5, 2005.

Interest and other income was $1.2 million, or 0.7% of retail sales and $3.2 million or 0.5% of retail sales, for the third quarter and first nine months of fiscal 2005, compared to $0.7 million, or 0.4% of retail sales and $1.8 million, or 0.3% of retail sales, for the prior year’s comparable three and nine month periods, respectively. The increase in the third quarter and first nine months of fiscal 2005 resulted primarily from higher interest rates.

Income tax expense was $2.3 million, or 1.3% of retail sales and $18.9 million, or 3.2% of retail sales, for the third quarter and first nine months of fiscal 2005, compared to $1.0 million, or 0.6% of retail sales and $15.2 million, or 2.7% of retail sales, for the prior year’s comparable three and nine month periods. The third quarter increase resulted from higher pre-tax income. The effective income tax rate for the third quarter and first nine months of fiscal 2005 was 36.3%, unchanged from fiscal 2004.

During the third quarter of 2005, the Company experienced extensive damage to 12 stores located in the U.S. Gulf Coast as a result of Hurricanes Katrina, Rita and Wilma. The Company recorded a write-off of $749,515 for inventory and damages to store assets. The Company has property insurance that covers most damages as well as business interruption insurance. Since the Company’s stores are widely dispersed, lost sales due to closed stores are generally limited and are often offset by increased sales in other stores. Therefore, these hurricanes have not had a material impact in the aggregate on the Company’s financial position, liquidity or results of operations.

The Company has consistently maintained a strong liquidity position. Cash provided by operating activities during the first nine months of 2005 was $40.1 million as compared to $52.1 million in the first nine months of 2004. These amounts have enabled the Company to fund its regular operating needs, capital expenditure program, cash dividend payments, purchase of treasury stock and to prepay the term loan used to repurchase the Company’s Class B Common Stock. In addition, the Company maintains $35 million of unsecured revolving credit facilities for short-term financing of seasonal cash needs, none of which was outstanding at October 29, 2005.

The decrease in net cash provided by operating activities for the first nine months of 2005 is primarily the result of an increase in prepaid and other assets and a decrease in accrued income taxes and accounts payable and the prepayment of the term loan offset by a smaller decrease in merchandise inventories 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 planned capital expenditures, dividends, purchase of treasury stock and other operating requirements for fiscal 2005 and for the foreseeable future beyond twelve months.

At October 29, 2005, the Company had working capital of $133.0 million compared to $129.5 million at October 30, 2004. Additionally, the Company had $1.9 million invested in privately managed investment funds at October 29, 2005, which are included in other assets of the Condensed Consolidated Balance Sheets.

At October 29, 2005, the Company has an unsecured revolving credit agreement, which provides for borrowings of up to $35 million. The revolving credit agreement is committed until August 2008. 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 October 29, 2005. There were no borrowings outstanding under these credit facilities during the first nine months ended October 29, 2005 or the fiscal year ended January 29, 2005.

On August 22, 2003, the Company entered into a new unsecured $30 million five-year term loan facility, the proceeds of which were used to purchase Class B Common Stock from the Company’s founders. Payments are due in monthly installments of $500,000 plus accrued interest. Interest is based on LIBOR, which was 4.08% on October 29, 2005. On April 5, 2005, the Company repaid the remaining balance of $20.5 million on this loan facility with no early prepayment penalty. With the early retirement of this loan, the Company had no outstanding debt as of April 5, 2005.

The Company had approximately $1.5 million and $1.8 million at the October 29, 2005 and October 30, 2004, respectively, of outstanding irrevocable letters of credit relating to purchase commitments.

Expenditures for property and equipment totaled $21.1 million for first nine months ended October 29, 2005, compared to $18.6 million in last year’s first nine months. The expenditures for the first nine months of 2005 were primarily for store development and investments in new technology. For the full year fiscal 2005, the Company is planning to invest approximately $29 million for capital expenditures. This includes expenditures to open 83 new stores and relocate 19 stores and close 12 stores. In addition, the Company plans to remodel nine stores and has planned for additional investments in technology scheduled to be implemented over the remainder of the fiscal year.

Net cash used in investing activities totaled $7.6 million for the first nine months of 2005 compared to $34.4 million used for the comparable period of 2004. The decrease was due primarily to the sale of short-term investments.

On May 26, 2005, the Board of Directors approved a three-for-two stock split in the form of a stock dividend of the Company’s Class A and Class B common stock effective June 27, 2005. Additionally, on May 26, 2005, the Board of Directors increased the quarterly dividend by 11% from $.175 per share to $.195 per share, or an annualized rate of $.78 per share on a pre-split basis. On a post-split basis, the annualized rate is $.52 per share. The dividend for the third quarter was paid on September 26, 2005 on a post-split basis at a quarterly rate of $.13 per share.

The Company does not use derivative financial instruments. At October 29, 2005, the Company’s investment portfolio was primarily invested in governmental and other debt securities with maturities less than 36 months. These securities are classified as available-for-sale and are recorded on the balance sheet at fair value, with unrealized gains and temporary losses reported net of taxes as accumulated other comprehensive income. Other than temporary declines in fair value of investments are recorded as a reduction in the cost of investments in the accompanying Condensed Consolidated Balance Sheets.

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

This Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). All statements other than statements of historical facts included in this Form 10-Q, including statements regarding the Company’s planned capital expenditures, intended store openings, closures, relocations and remodelings, its planned investments in technology and the expected adequacy of the Company’s liquidity, constitute forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. Forward-looking statements involve risks and uncertainties that could cause the Company’s actual results to differ materially depending on a variety of important factors, including, but not limited to the following: general economic conditions; competitive factors and pricing pressures; the Company’s ability to predict fashion trends; consumer buying patterns; the effect of weather conditions, natural disasters, terrorist acts or other unforeseen events that could disrupt the Company’s operations or consumer activity; inventory risk due to shifts in market demand; and other factors discussed from time to time in the Company’s most recent reports on Form 10-K, 10-Q or 8-K filed with, or furnished to, the SEC, and the Company’s press releases, all of which may be accessed via the Company’s website, www.catocorp.com. The Company does not undertake any obligation to update any forward-looking statements.

As of October 29, 2005, an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in its reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission rules and forms.

During the quarter ended October 29, 2005, there has been no change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

     The Board of Directors had authorized the repurchase of 7,581,025 shares from time to time when, in the opinion of management, market conditions warrant. As of October 29, 2005, 1,594,544 shares remain open to purchase.

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.