Business context and reporting period
Cato Corporation’s unaudited Form 10-Q covers the 13 weeks ended April 30, 2016, compared with the 13 weeks ended May 2, 2015. Cato operates women’s apparel specialty stores, primarily in the southeastern United States, and a proprietary credit-card business. It reported 1,372 stores at quarter-end. The filing period is 2016 Q1, notwithstanding the request metadata indicating 2015 Q1.
Financial performance and position
| Metric | Quarter ended April 30, 2016 | Prior-year quarter | Change |
|---|---|---|---|
| Retail sales | $285.5 million | $281.6 million | +1.4% |
| Total revenue | $288.0 million | $283.9 million | +1.4% |
| Income before taxes | $50.2 million | $48.0 million | +4.6% |
| Net income | $35.9 million | $31.1 million | +15.4% |
| Diluted EPS | $1.29 | $1.11 | +$0.18 |
| Operating cash flow | $36.2 million | $29.8 million | +$6.4 million |
- Same-store sales were flat. E-commerce was less than 2% of sales and included in same-store sales.
- Gross margin dollars rose 2.1% to $121.5 million. Cost of goods sold declined to 57.4% of retail sales from 57.7%; SG&A increased to 24.9% from 24.4%, and depreciation rose to 2.0% from 1.9% of retail sales.
- Net income was 12.6% of retail sales, versus 11.0% a year earlier. The effective tax rate fell to 28.5% from 35.2%.
- At April 30, cash and cash equivalents were $56.0 million, short-term investments $242.4 million, and working capital $317.9 million. Total assets were $648.8 million and stockholders’ equity $434.2 million. The company had no outstanding borrowings and no debt reported on its balance sheet.
- Capital expenditures were $6.0 million. Investing cash outflow was $32.3 million, largely reflecting purchases of short-term investments; financing cash outflow was $14.9 million, including $8.3 million of dividends and $7.1 million of share repurchases.
Material changes and unusual items
- Interest and other income increased to $2.9 million from $0.6 million, primarily because Cato changed its gift-card breakage estimate. The change shortened the dormancy period used to recognize breakage from 60 to 24 months and added $2.4 million of income in the quarter.
- Lower merchandise costs from regular-price sales and lower freight costs helped reduce cost of goods sold as a percentage of sales; higher buying and occupancy costs partly offset the benefit. SG&A growth reflected higher store expenses and incentive compensation, partly offset by lower advertising.
- The lower tax rate reflected favorable adjustments from foreign and domestic tax initiatives. Together with the breakage estimate change, this is relevant when assessing the sustainability of earnings growth.
- Cato revised the January 30, 2016 balance-sheet classification of $13.6 million of uncertain tax benefits from accrued income taxes to other noncurrent liabilities. Management said the revision was immaterial, with no effect on earnings or cash flows.
- On May 19, 2016, the board increased the quarterly dividend from $0.30 to $0.33 per share.
Outlook, risks, and contingencies
- Management expected fiscal 2016 capital expenditures of approximately $26 million and plans for approximately 23 store openings, 16 relocations, and 17 closures. In Q1, it opened one store, relocated two, and closed one.
- Management stated that cash, investments, operating cash flows, and available revolving credit were expected to cover regular operating needs, capital expenditures, dividends, and repurchases for fiscal 2016 and the next 12 months. The $35 million unsecured revolving facility runs through August 2018; there were no borrowings and Cato was in compliance with its financial covenants.
- Identified risks include consumer spending and confidence, competition and pricing pressure, changing fashion trends, adverse weather, and inventory risk. Management said interest-rate market risk was not material. No legal proceedings were reported as applicable in this filing.
- Disclosure controls were assessed as effective, and the company reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of the earnings and EPS increase is repeatable after excluding the $2.4 million gift-card breakage recognition and the favorable tax adjustments.
- Whether flat same-store sales and higher SG&A as a share of sales persist, and whether planned store openings, relocations, and closures meet management’s expectations.
- The quality and liquidity of the substantial investment portfolio, including its fair-value assumptions and maturities, and the effect of continued investment purchases on cash balances.
- Whether operating cash generation remains sufficient to fund capital spending, dividends, and repurchases; also verify execution of the higher dividend and remaining repurchase authorization.
- The treatment and implications of the tax-liability reclassification, and the company’s eventual assessment of pending accounting standards noted in the filing.