CATO CORP - 10-Q Quarterly 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.

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

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


	Page
	No.
PART I — FINANCIAL INFORMATION (UNAUDITED)

Item 1. Financial Statements:

Condensed Consolidated Statements of Income		2
For the Three Months and Six Months Ended July 31, 2004 and August 2, 2003

Condensed Consolidated Balance Sheets		3
At July 31, 2004, August 2, 2003 and January 31, 2004

Condensed Consolidated Statements of Cash Flows		4
For the Six Months Ended July 31, 2004 and August 2, 2003

Notes to Condensed Consolidated Financial Statements		5–8
For the Three Months and Six Months Ended July 31, 2004 and August 2, 2003

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		9–17

Item 3. Quantitative and Qualitative Disclosures About Market Risk		17

Item 4. Controls and Procedures		17

PART II — OTHER INFORMATION

Item 1. Legal Proceedings		18

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		18

Item 3. Defaults upon Senior Securities		18

Item 4. Submission of Matters to a Vote of Security Holders		18-19

Item 5. Other Information		19

Item 6. Exhibits		19

Signatures		20


	Three Months Ended						Six Months Ended
	July 31,			August 2,			July 31,			August 2,
	2004			2003			2004			2003
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
	(Dollars in thousands, except per share data)
REVENUES
Retail sales	$	197,068		$	188,218		$	402,261		$	385,522
Other income (principally finance, late, and layaway charges)		3,816			3,775			7,824			7,681

Total revenues		200,884			191,993			410,085			393,203


COSTS AND EXPENSES
Cost of goods sold		136,051			132,616			268,395			259,614
Selling, general and administrative		47,387			44,565			93,210			88,010
Depreciation		5,091			4,562			10,070			9,013
Interest expense		167			1			329			4
Interest and other income		(656	)		(1,888	)		(1,162	)		(3,018	)

Costs and expenses		188,040			179,856			370,842			353,623


INCOME BEFORE INCOME TAXES		12,844			12,137			39,243			39,580

Income tax expense		4,662			4,406			14,245			14,368


NET INCOME	$	8,182		$	7,731		$	24,998		$	25,212


BASIC EARNINGS PER SHARE	$	.40		$	.30		$	1.22		$	.99


DILUTED EARNINGS PER SHARE	$	.39		$	.30		$	1.20		$	.98


DIVIDENDS PER SHARE	$	.175		$	.16		$	.335		$	.31


	July 31,			August 2,			January 31,
	2004			2003			2004
	(Unaudited)			(Unaudited)
	(Dollars in thousands)
ASSETS
Current Assets
Cash and cash equivalents	$	29,439		$	59,836		$	23,857
Short-term investments		76,494			66,255			47,545
Accounts receivable — net		50,260			53,092			52,714
Merchandise inventories		86,355			79,998			97,292
Deferred income taxes		243			1,530			284
Prepaid expenses		5,804			5,651			5,708

Total Current Assets		248,595			266,362			227,400
Property and equipment — net		114,783			113,131			114,367
Other assets		10,194			9,617			9,806

Total	$	373,572		$	389,110		$	351,573

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Accounts payable	$	68,527		$	52,304		$	76,387
Accrued expenses		33,832			27,698			27,815
Income taxes		10,693			8,012			4,290
Current portion of long-term debt		6,000			—			6,000

Total Current Liabilities		119,052			88,014			114,492
Deferred income taxes		10,203			6,310			10,203
Long-term debt		18,500			—			21,500
Other noncurrent liabilities		11,709			8,700			11,267

Commitments and contingencies

Total Liabilities		159,464			103,024			157,462
Shareholders’ Equity:
Preferred stock, $100 par value per share, 100,000 shares authorized, none issued		—			—			—
Class A common stock, $.033 par value per share, 50,000,000 shares authorized; issued 26,147,346 shares, 25,612,313 shares and 26,015,868 shares at July 31, 2004, August 2, 2003 and January 31, 2004, respectively		872			854			867
Convertible Class B common stock, $.033 par value per share, 15,000,000 shares authorized; issued 5,597,834 shares, 5,796,078 shares and 5,607,834 shares at July 31, 2004, August 2, 2003 and January 31, 2004, respectively		186			193			187
Additional paid-in capital		101,134			96,087			99,676
Retained earnings		270,949			253,226			252,828
Accumulated other comprehensive gains		131			10			58
Unearned compensation — restricted stock awards		(1,252	)		(1,935	)		(1,593	)

		372,020			348,435			352,023
Less Class A and Class B common stock in treasury, at cost (5,906,179 Class A and 5,137,484 Class B shares at July 31, 2004 and January 31, 2004, 5,906,179 Class A and - -0- Class B shares at August 2, 2003)		(157,912	)		(62,349	)		(157,912	)

Total Shareholders’ Equity		214,108			286,086			194,111

Total	$	373,572		$	389,110		$	351,573


	Six Months Ended
	July 31,			August 2,
	2004			2003
	(Unaudited)			(Unaudited)
	(Dollars in thousands)
OPERATING ACTIVITIES

Net income	$	24,998		$	25,212

Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		10,070			9,013
Amortization of investment premiums		—			4
Compensation expense related to restricted stock awards		341			440
Loss on disposal of property and equipment		1,363			243
Changes in operating assets and liabilities which provided (used) cash:
Accounts receivable		2,454			1,024
Merchandise inventories		10,937			13,459
Other assets		(484	)		(1,066	)
Accounts payable and other liabilities		(1,444	)		(15,485	)
Accrued income taxes		6,403			5,126


Net cash provided by operating activities		54,638			37,970


INVESTING ACTIVITIES

Expenditures for property and equipment		(11,765	)		(9,080	)
Purchases of short-term investments		(42,651	)		(7,686	)
Sales of short-term investments		13,775			16,055


Net cash (used) in investing activities		(40,641	)		(711	)


FINANCING ACTIVITIES

Dividends paid		(6,877	)		(7,874	)
Purchases of treasury stock		—			(2,741	)
Payments to settle long-term debt		(3,000	)		—
Proceeds from employee stock purchase plan		226			245
Proceeds from stock options exercised		1,236			882


Net cash (used) in financing activities		(8,415	)		(9,488	)


Net increase in cash and cash equivalents		5,582			27,771

Cash and cash equivalents at beginning of period		23,857			32,065


Cash and cash equivalents at end of period	$	29,439		$	59,836

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


Three Months Ended									Six Months Ended
July 31, 2004	Retail			Credit		Total			July 31, 2004	Retail			Credit		Total
Revenues	$	197,359		$	3,525	$	200,884		Revenues	$	403,050		$	7,035	$	410,085
Depreciation		5,072			19		5,091		Depreciation		10,031			39		10,070
Interest and other income		(656	)		—		(656	)	Interest and other income		(1,162	)		—		(1,162	)
Income before taxes		11,533			1,311		12,844		Income before taxes		36,823			2,420		39,243
Total assets		310,985			62,587		373,572		Total assets		310,985			62,587		373,572
Capital expenditures		4,699			83		4,782		Capital expenditures		11,680			85		11,765

Three Months Ended									Six Months Ended
August 2, 2003	Retail			Credit		Total			August 2, 2003	Retail			Credit		Total
Revenues	$	188,415		$	3,578	$	191,993		Revenues	$	386,013		$	7,190	$	393,203
Depreciation		4,543			19		4,562		Depreciation		8,974			39		9,013
Interest and other income		(1,888	)		—		(1,888	)	Interest and other income		(3,018	)		—		(3,018	)
Income before taxes		11,065			1,071		12,136		Income before taxes		37,541			2,039		39,580
Total assets		312,928			76,182		389,110		Total assets		312,928			76,182		389,110
Capital expenditures		4,678			—		4,678		Capital expenditures		9,080			—		9,080

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

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

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

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

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


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

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

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

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

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

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

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

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

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

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

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

Income tax expense was $4.7 million, or 2.4% of retail sales and $14.2 million, or 3.5% of retail sales, for the second quarter and first six months of fiscal 2004, compared to $4.4 million, or 2.3% of retail sales and $14.4 million, or 3.7% of retail sales, for the prior year’s comparable three and six month periods. The second quarter increase resulted from higher pre-t


x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 31, 2004

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


Delaware		56-0484485

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


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


Total expenses	$	2,195	$	2,488	$	4,576	$	5,112