CATO

Business Context and Reporting Period

Company: The Cato Corporation (CATO CORP)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended August 4, 2007
Business Overview: The Company operates women's fashion specialty retail stores in 31 states, primarily in the southeastern United States. It also operates a credit segment offering a proprietary credit card. As of August 4, 2007, the Company operated 1,306 stores.

Key Financial Metrics

Note: Working capital calculated as Current Assets ($329,804) minus Current Liabilities ($120,180) for Aug 4, 2007.

Material Changes vs. Prior Period

• Revenue: Total retail sales increased 2% in the second quarter to $219.0 million but decreased slightly for the six-month period to $443.1 million compared to $444.4 million in the prior year. Same-store sales decreased 1% in the quarter and 3% for the six-month period.
• Profitability: Net income increased 3.5% in the quarter but decreased 5.2% for the six-month period. The effective tax rate decreased to 32.9% (quarter) and 34.8% (six months) from 36.5% in the prior year, driven by higher tax credits.
• Cost Structure: Cost of goods sold (COGS) as a percentage of retail sales increased to 67.4% (quarter) and 65.7% (six months) due to higher markdowns and occupancy costs, partially offset by lower procurement costs from direct sourcing.
• Liquidity: Cash provided by operating activities for the six months ended August 4, 2007, increased significantly to $57.6 million from $32.5 million in the prior year, primarily due to a decrease in inventories and an increase in accounts payable.
• Investments: Short-term investments increased to $150.4 million from $94.2 million a year ago, reflecting strong cash generation and investment activity.

Guidance, Outlook, and Management Commentary

• Store Expansion: The Company plans to open approximately 70 stores and close approximately 15 stores during fiscal 2007. In the first six months, 31 stores were opened, 10 relocated, and 1 closed.
• Capital Expenditures: Planned capital expenditures for fiscal 2007 are approximately $29.7 million, covering new store openings, relocations, and remodels. Actual expenditures for the first six months were $9.6 million.
• Dividends: On May 24, 2007, the Board increased the quarterly dividend by 10% to $0.165 per share (annualized $0.66).
• Share Repurchases: On August 31, 2007, the Board authorized an additional 2 million shares for repurchase. There is no expiration date on the program. As of the end of the quarter, 1.557 million shares remained available under open authorizations.
• Outlook: Management believes cash, cash equivalents, short-term investments, and the $35 million revolving credit facility (currently unused) are adequate to fund operations, capital expenditures, and dividends for the foreseeable future.
• Risks: Key risks include general economic conditions, competitive pricing pressures, ability to predict fashion trends, and inventory risks due to shifts in market demand.

Investor Verification Checklist

• Same-Store Sales Decline: Verify the reasons for the 1% (quarter) and 3% (six-month) decline in same-store sales despite the increase in total store count.
• Markdown Pressure: Assess the impact of increased markdowns on gross margins and future inventory valuation.
• Capital Allocation: Review the balance between the increased dividend, share repurchase program, and capital expenditures for store expansion.
• Credit Segment Performance: Monitor the credit segment's bad debt expense relative to credit revenue, as bad debt expense increased in the quarter despite flat total expenses.
• Inventory Management: Confirm the sustainability of the inventory reduction strategy that drove the increase in operating cash flow.