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 2, 2008
Business Overview: Cato operates women's fashion specialty retail stores in 31 states, primarily in the southeastern United States. As of August 2, 2008, the company operated 1,287 stores. The company also operates a credit segment offering a proprietary credit card.

Key Financial Metrics

Margins (as % of Retail Sales):
- Gross Margin: 35.9% (Q2 2008) vs 32.6% (Q2 2007)
- SG&A: 27.5% (Q2 2008) vs 23.9% (Q2 2007)
- Net Income Margin: 5.2% (Q2 2008) vs 5.7% (Q2 2007)

Material Changes vs. Prior Period

• Revenue Growth: Total retail sales increased 5% in the second quarter and 3% for the first six months compared to the prior year. Same-store sales increased 2% in the quarter but remained flat for the six-month period.
• Profitability: Net income decreased slightly in the quarter ($12.1M vs $12.5M) and for the six months ($28.9M vs $31.2M) despite revenue growth.
• Expense Pressure: Selling, General, and Administrative (SG&A) expenses increased significantly as a percentage of sales (up 360 basis points in the quarter). This was driven by higher incentive-based compensation, costs associated with closing 47 underperforming stores, and increased worker's compensation and health insurance expenses.
• Cost of Goods Sold (COGS): COGS as a percentage of sales improved (decreased) due to lower markdowns and higher sell-through of regular-priced merchandise, offset by higher occupancy costs.
• Store Count: The company closed 63 stores and opened 32 stores in the first six months of 2008, resulting in a net decrease in store count.

Guidance, Outlook, and Risks

• Capital Expenditures: The company plans to invest approximately $22.3 million in capital expenditures for fiscal 2008, including opening 70 new stores and relocating 9.
• Dividends: The Board maintained the quarterly dividend at $0.165 per share (annualized $0.66).
• Share Repurchases: No shares were repurchased in the first six months of 2008. Approximately 394,660 shares remain available under open authorizations.
• Liquidity: The company maintains a strong liquidity position with $45.4 million in cash and $108.0 million in short-term investments. A $35 million unsecured revolving credit facility is available with no outstanding borrowings.
• Investment Risk (Auction Rate Securities): The company holds $56.3 million in auction rate securities (ARS). As of August 2, 2008, $4.4 million of these failed their last auctions. The company classifies these as short-term investments, expecting successful auctions or calls within a year, but values them at par based on credit quality and market inputs.
• Contingency: The company had 76 stores closed due to Hurricane Gustav and is in the process of determining potential losses from damages.

Investor Verification Checklist

• SG&A Efficiency: Verify the sustainability of the increased SG&A ratio (27.5% vs 23.9% prior year) and the impact of store closures on future operating leverage.
• Auction Rate Securities Liquidity: Assess the risk associated with the $4.4 million in failed ARS auctions and the company's ability to liquidate these assets if needed.
• Hurricane Gustav Impact: Monitor updates on the financial impact of the 76 store closures due to Hurricane Gustav.
• Same-Store Sales Trend: Confirm if the flat same-store sales for the six-month period indicate a broader consumer slowdown despite the quarterly uptick.
• Inventory Management: Review the effectiveness of inventory controls that led to reduced markdowns and improved gross margins.