CATO

Business Context and Reporting Period

Company: The Cato Corporation (CATO CORP)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Quarter and six months ended August 1, 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 to customers.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability: Net income increased 38% for the quarter and 22% for the six-month period compared to the prior year, driven by improved gross margins and reduced selling, general, and administrative (SG&A) expenses.
• Sales Performance: Retail sales decreased 2% in the quarter but increased 1.5% for the six-month period. Same-store sales decreased 3% in the quarter but remained flat for the six-month period.
• Cost Management: Cost of goods sold (COGS) as a percentage of retail sales improved to 63.7% (quarter) and 61.6% (six months) from 64.1% and 63.4% in the prior year, attributed to lower markdowns and freight charges.
• SG&A Expenses: SG&A expenses decreased 240 basis points as a percentage of retail sales for the quarter, primarily due to lower workers' compensation and group health insurance expenses and the closure of underperforming stores.
• Tax Rate: The effective tax rate decreased to 29.7% for the quarter (from 34.0% prior year) and 33.9% for the six months (from 36.4% prior year) due to settlements of various state tax audits.

Guidance, Outlook, and Risks

• Store Activity: The Company expects to open approximately 46 stores, relocate 2, and close approximately 42 stores in fiscal 2009. As of August 1, 2009, the Company operated 1,285 stores.
• Capital Expenditures: Planned capital expenditures for fiscal 2009 are approximately $16.1 million, primarily for new store development and technology investments.
• Dividends: The Board maintained the quarterly dividend at $0.165 per share (annualized $0.66).
• Share Repurchases: The Company repurchased 2,569 shares in the quarter. Approximately 693,373 shares remain available for repurchase under open authorizations.
• Liquidity: The Company maintains a $35 million unsecured revolving credit facility with $33.3 million available. No borrowings were outstanding. Management believes cash flows and available credit are adequate for foreseeable needs.
• Investment Risk: The Company holds $102.5 million in variable rate demand notes (VRDN) and auction rate securities (ARS). One ARS of $3.5 million failed its last auction as of July 23, 2009, and has been reclassified as a long-term investment due to liquidity uncertainty.
• Forward-Looking Risks: Risks include adverse economic conditions, consumer spending patterns, competitive pricing pressures, and inventory risks.

Investor Verification Checklist

• Auction Rate Security (ARS) Exposure: Verify the status and valuation of the $3.5 million failed ARS and the potential impact on liquidity if the security cannot be called or refinanced.
• Same-Store Sales Trend: Monitor the divergence between the 3% same-store sales decline in the quarter versus the flat six-month trend to assess recent consumer demand.
• Inventory Management: Confirm that the reduction in markdowns and improved gross margins are sustainable and not the result of under-stocking that could lead to lost sales.
• Insurance Costs: Verify the sustainability of the reduction in workers' compensation and group health insurance expenses, which drove the SG&A improvement.
• State Tax Audit Settlements: Assess the likelihood of future tax rate fluctuations as other state tax audits are resolved or statutes of limitations expire.