CATO

Business Context and Reporting Period

Company: The Cato Corporation (CATO CORP)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Three months ended May 2, 2009 (Fiscal Q1 2009)
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 May 2, 2009, the Company operated 1,285 stores.

Key Financial Metrics

Margins (as % of Retail Sales):
- Gross Margin: 40.4% (Q1 2009) vs. 37.3% (Q1 2008)
- SG&A Expenses: 27.2% (Q1 2009) vs. 24.9% (Q1 2008)
- Net Income Margin: 7.9% (Q1 2009) vs. 7.5% (Q1 2008)

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 5.3% year-over-year, driven by a 5.4% increase in retail sales. Same-store sales increased 3.0%.
• Profitability: Net income rose 11.6% to $18.8 million. Gross margin dollars increased 14.1% to $96.1 million, primarily due to lower markdowns and tighter inventory management.
• Expense Trends: SG&A expenses increased 14.7% in dollars (27.2% of sales vs. 24.9% prior year), attributed to higher incentive-based compensation, legal reserves, and closed store expenses.
• Investment Portfolio: Short-term investments grew significantly from $76.1 million to $115.7 million. The Company holds $75.6 million in variable rate demand notes (VRDN) and auction rate securities (ARS), including a $3.5 million ARS that failed its last auction and was reclassified as a long-term investment.
• Cash Flow: Net cash provided by operating activities increased 28.9% to $30.0 million. Net cash used in investing activities was $25.7 million, primarily due to net purchases of short-term investments.

Guidance, Outlook, and Risks

• Store Activity: The Company opened 8 stores and closed 4 stores in Q1 2009. For the full fiscal year 2009, it expects to open approximately 46 stores, relocate 2, and close approximately 39.
• Capital Expenditures: Planned capital expenditures for fiscal 2009 are approximately $16.8 million.
• Dividends: The Board maintained the quarterly dividend at $0.165 per share (annualized $0.66).
• Share Repurchases: No shares were repurchased in Q1 2009. Approximately 695,942 shares remain available under open authorizations.
• Liquidity: The Company maintains a $35 million unsecured revolving credit facility (committed through August 2010) with no outstanding borrowings. Management believes current cash, investments, and operating cash flows are adequate for foreseeable needs.
• Risks: Key risks include adverse economic conditions affecting consumer spending, credit market conditions, competitive pricing pressures, and inventory risks. The Company notes that the failed ARS security is valued at par based on credit quality and expected repurchase, but liquidity risks associated with ARS remain a factor.

Investor Verification Checklist

• Failed Auction Security: Verify the valuation methodology and liquidity status of the $3.5 million failed auction rate security (ARS) reclassified as a long-term asset.
• SG&A Efficiency: Monitor the trend of SG&A expenses as a percentage of sales, which increased 230 basis points year-over-year.
• Store Count Strategy: Track the net store count impact given the plan to close 39 stores while opening 46 in fiscal 2009.
• Inventory Management: Confirm the sustainability of the reduced markdowns and improved gross margins in a recessionary environment.
• Dividend Sustainability: Assess the coverage of the $0.165 quarterly dividend against free cash flow, noting the significant cash outflow for short-term investment purchases.