Business Context and Reporting Period
Company: The Cato Corporation (CATO CORP)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Quarter and nine months ended October 30, 2010
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 through a wholly-owned subsidiary, offering a proprietary credit card to customers.
Key Financial Metrics
| Metric (in thousands) | 3 Months Ended Oct 30, 2010 | 9 Months Ended Oct 30, 2010 |
|---|---|---|
| Total Revenues | $200,784 | $698,194 |
| Retail Sales | $197,985 | $689,610 |
| Net Income | $6,736 | $49,815 |
| Diluted EPS | $0.23 | $1.69 |
| Operating Cash Flow (9 Months) | $60,425 | |
| Cash and Cash Equivalents | $36,786 (as of Oct 30, 2010) | |
| Short-term Investments | $188,097 (as of Oct 30, 2010) | |
| Working Capital | $234,600 (as of Oct 30, 2010) | |
| Debt | No borrowings outstanding under $35.0M credit facility |
Material Changes vs. Prior Period
- Revenue Growth: Total retail sales increased 3.7% in the third quarter and 5.4% for the nine-month period compared to the prior year. Same-store sales increased 1.9% (Q3) and 3.9% (9 months), driven by better sell-throughs of regular-priced merchandise.
- Profitability: Net income rose significantly, from $2,983,000 to $6,736,000 in the third quarter, and from $38,455,000 to $49,815,000 for the nine-month period. Gross margin dollars increased 8.9% (Q3) and 12.1% (9 months) due to lower markdowns and higher sales leverage.
- Expenses: Cost of goods sold as a percentage of retail sales decreased to 63.5% (Q3) and 60.3% (9 months) from 65.2% and 62.6% in the prior year. SG&A expenses as a percentage of sales decreased 1.2% in the third quarter due to lower accrued incentive compensation.
- Tax Rate: The effective tax rate increased to 32.7% (Q3) and 36.1% (9 months) compared to 30.2% and 33.7% in the prior year, primarily due to favorable tax resolutions in the prior year that did not recur.
- Store Count: The Company operated 1,281 stores at October 30, 2010, down from 1,291 in the prior year quarter. During the first nine months of 2010, the Company opened 29 new stores, relocated 4, and closed 19.
Guidance, Outlook, and Risks
- Capital Expenditures: The Company expects to invest approximately $19.6 million in capital expenditures for fiscal 2010, including opening approximately 40 new stores and relocating five.
- Dividends: On December 2, 2010, the Board maintained the quarterly dividend at $0.185 per share (annualized rate of $0.74).
- Share Repurchases: As of October 30, 2010, 442,942 shares remained available for repurchase. The Company repurchased 253,000 shares for approximately $5.7 million during the nine-month period.
- Liquidity: The Company maintains a $35.0 million unsecured revolving credit facility (extended to August 2013) with no outstanding borrowings. Management believes cash flows and investments are adequate to fund operations and growth.
- Risks and Contingencies:
- Failed Auction Rate Security (ARS): The Company holds a $3.5 million ARS that continues to fail its auction. It is valued using Level 3 inputs (discounted cash flow) and is sensitive to management's assumptions regarding liquidity timing.
- Market Conditions: Risks include general economic conditions, consumer spending patterns, competitive pricing pressures, and inventory risks.
- Tax Uncertainty: The balance in unrecognized tax benefits may fluctuate as statutes of limitations expire or state examinations close.
Investor Verification Checklist
- Same-Store Sales Sustainability: Verify if the 3.9% same-store sales growth for the nine-month period can be sustained given the competitive retail environment.
- Failed ARS Valuation: Review the assumptions used to value the $3.5 million failed Auction Rate Security, as its liquidity is uncertain and valuation relies on management estimates.
- Effective Tax Rate Volatility: Monitor future effective tax rates, as the current rate is elevated compared to the prior year due to the absence of one-time favorable tax resolutions.
- Capital Allocation: Track the execution of the $19.6 million capital expenditure plan and the impact of new store openings on future profitability.
- Credit Segment Performance: Assess the trend in credit revenue and bad debt expenses, noting the recent decrease in credit revenue due to lower finance charges.