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CATO > SEC Filings for CATO > Form 10-K/A on 10-Apr-2014All Recent SEC Filings

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Form 10-K/A for CATO CORP


10-Apr-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations:

Results of Operations

The table below sets forth certain financial data of the Company expressed as a percentage of retail sales for the years indicated:

                                                February 1,   February 2,    January
     Fiscal Year Ended                             2014          2013        28, 2012
     Retail sales …………………………………………………………..       100.0  %      100.0  %     100.0  %
     Other revenue…………………………………………………………           1.0           1.1          1.2
     Total revenues ……………………………………………………….       101.0         101.1        101.2
     Cost of goods sold …………………………………………………..     62.7          62.3         62.4
     Selling, general and
     administrative………………………………….                 27.0          26.2         26.0
     Depreciation …………………………………………………………           2.4           2.4          2.4
     Interest and other income
     ……………………………………………                            (0.4)         (0.4)        (0.4)
     Income before income taxes
     …………………………………………                              9.3          10.6         10.9
     Net income …………………………………………………………..           6.0  %        6.6  %       7.0  %

Fiscal 2013 Compared to Fiscal 2012

Retail sales decreased by 2.5% to $910.5 million in fiscal 2013 compared to $933.8 million in fiscal 2012. The fiscal year ended February 1, 2014 contained 52 weeks versus 53 weeks in fiscal year ended February 2, 2013. The decrease in retail sales in fiscal 2013 was largely attributable to one fewer week of sales and a same-store sales decrease of 3% from fiscal 2012, partially offset by sales from new stores. Same-store sales includes stores that have been open more than 15 months. Stores that have been relocated or expanded are also included in the same-store sales calculation after they have been open more than 15 months. E-commerce sales were less than 1% of sales in fiscal 2013 and are not included in the same-store sales calculation. There were no e-commerce sales in fiscal 2012. The method of calculating same-store sales varies across the retail industry. As a result, our same-store sales calculation may not be comparable to similarly titled measures reported by other companies. Total revenues, comprised of retail sales and other revenue (principally finance charges and late fees on customer accounts receivable and layaway fees), decreased by 2.5% to $920.0 million in fiscal 2013 compared to $944.0 million in fiscal 2012. The Company operated 1,320 stores at February 1, 2014 compared to 1,310 stores operated February 2, 2013.

In fiscal 2013, the Company opened 32 new stores, relocated five stores and closed 22 stores. The Company also launched its online shopping website, which is operated in-house.

Other revenue in total decreased to $9.5 million from $10.3 million in fiscal 2012. The decrease resulted primarily from lower credit revenue and finance charges and layaway charges.

Credit revenue of $6.2 million represented 0.7% of total revenue in fiscal 2013, a decrease compared to fiscal 2012 credit revenue of $6.9 million or 0.7% of total revenue. The slight decrease in credit revenue was primarily due to reductions in finance and late charge income as a result of lower accounts receivable balances. Credit revenue is comprised of interest earned on the Company's private label credit card portfolio and related fee income. Related expenses include principally bad debt expense, payroll, postage and other administrative expenses and totaled $3.6 million in fiscal 2013 compared to $3.9 million in fiscal 2012. The decrease in these expenses was principally due to a reduction in bad debt expense of $0.3 million. See Note 14 of Notes to Consolidated Financial Statements for a schedule of credit-related expenses. Total credit segment income before taxes decreased $ 0.4 million from $ 3.0 million in fiscal 2012 to $ 2.6 million in fiscal 2013 due to lower credit revenue. Total credit income of $2.6 million in fiscal 2013 represented 3.1% of total income before taxes of $84.3 million compared to total credit income of $3.0 million in fiscal 2012 which represented 3.0% of fiscal 2012 total income before taxes.


Cost of goods sold was $571.2 million, or 62.7% of retail sales, in fiscal 2013 compared to $582.0 million, or 62.3% of retail sales, in fiscal 2012. The increase in cost of goods sold as a percent of retail sales resulted primarily from higher occupancy costs. Cost of goods sold includes merchandise costs, net of discounts and allowances, buying costs, distribution costs, occupancy costs, freight and inventory shrinkage. Net merchandise costs and in-bound freight are capitalized as inventory costs. Buying and distribution costs include payroll, payroll-related costs and operating expenses for the buying departments and distribution center. Occupancy expenses include rent, real estate taxes, insurance, common area maintenance, utilities and maintenance for stores and distribution facilities. Total gross margin dollars (retail sales less cost of goods sold and excluding depreciation) decreased by 3.6% to $339.3 million in fiscal 2013 from $351.8 million in fiscal 2012. Gross margin as presented may not be comparable to that of other companies.

Selling, general and administrative expenses ("SG&A"), which primarily include corporate and store payroll, related payroll taxes and benefits, insurance, supplies, advertising, bank and credit card processing fees and bad debts were $245.9 million in fiscal 2013 compared to $244.3 million in fiscal 2012, an increase of 0.6%. As a percent of retail sales, SG&A was 27.0% compared to 26.2% in the prior year. The overall dollar increase in SG&A resulted primarily from an increase in store impairment charges and incentive compensation, partially offset by a decrease in payroll costs and advertising costs.

Depreciation expense was $21.8 million in fiscal 2013 compared to $22.5 million in fiscal 2012. Depreciation expense decreased from fiscal 2012 due to older stores and IT projects being fully depreciated, partially offset by investments in store development, information technology investments, and the home office expansion.

Interest and other income decreased to $3.3 million in fiscal 2013 compared to $3.8 million in fiscal 2012 was due to lower interest income driven by lower interest rates. Miscellaneous income and interest income were lower compared to fiscal 2012. See Note 2 of Notes to Consolidated Financial Statements for further details.

Income tax expense was $30.0 million, or 3.3% of retail sales in fiscal 2013 compared to $37.3 million, or 4.0% of retail sales in fiscal 2012. The decrease resulted from a lower effective tax rate combined with lower pre-tax income. The effective tax rate was 35.6% in fiscal 2013 compared to 37.7% in fiscal 2012, due to a correction of an out of period adjustment in fiscal 2012.

Fiscal 2012 Compared to Fiscal 2011

Retail sales increased by 1.4% to $933.8 million in fiscal 2012 compared to $920.6 million in fiscal 2011. The fiscal year ended February 2, 2013 contained 53 weeks versus 52 weeks in fiscal year ended January 28, 2012. The increase in retail sales in fiscal 2012 was largely attributable to sales from new store development partially offset by same-store sales decline. Same-store sales decreased 4.0% from fiscal 2011. Total revenues, comprised of retail sales and other revenue (principally finance charges and late fees on customer accounts receivable and layaway fees), increased by 1.3% to $944.0 million in fiscal 2012 compared to $931.5 million in fiscal 2011. The Company operated 1,310 stores at February 2, 2013 compared to 1,288 stores operated January 28, 2012.

In fiscal 2012, the Company opened 34 new stores, relocated nine stores and closed 12 stores.

Other revenue in total, as included in total revenues in fiscal 2012, decreased to $10.3 million from $10.8 million in fiscal 2011. The decrease resulted primarily from lower credit revenue and finance charges and layaway charges.

Credit revenue of $6.9 million represented 0.7% of total revenue in fiscal 2012, a decrease compared to 2011 credit revenue of $7.7 million or 0.8% of total revenue. The slight decrease in credit revenue was primarily due to reductions in finance and late charge income as a result of lower accounts receivable balances. Credit revenue is comprised of interest earned on the Company's private label credit card portfolio and related fee income. Related expenses include principally bad debt expense, payroll, postage and other administrative expenses and totaled $3.9 million in fiscal 2012 compared to $4.4 million in fiscal 2011. The decrease in these expenses was principally due to a reduction in bad debt expense of $0.5 million. See Note 14 of Notes to Consolidated Financial Statements for a schedule of credit-related expenses. Total credit segment income before taxes decreased $ 0.2 million from $ 3.2 million in 2011 to $ 3.0 million in 2012 due to lower credit revenue. Total credit income of $3.0 million in 2012 represented 3.0% of total income before taxes of $99.0 million compared to total credit income of $3.2 million in 2011 which represented 3.2% of 2011 total income before taxes.


Cost of goods sold was $582.0 million, or 62.3% of retail sales, in fiscal 2012 compared to $574.2 million, or 62.4% of retail sales, in fiscal 2011. The slight decrease in cost of goods sold as a percent of retail sales resulted primarily from lower procurement costs offset by higher store occupancy costs. Total gross margin dollars (retail sales less cost of goods sold and excluding depreciation) increased by 1.6% to $351.8 million in fiscal 2012 from $346.4 million in fiscal 2011. Gross margin as presented may not be comparable to that of other companies.

Selling, general and administrative expenses ("SG&A"), which primarily include corporate and store payroll, related payroll taxes and benefits, insurance, supplies, advertising, bank and credit card processing fees and bad debts were $244.3 million in fiscal 2012 compared to $239.0 million in fiscal 2011, an increase of 2.2%. As a percent of retail sales, SG&A was 26.2% compared to 26.0% in the prior year. The overall dollar increase in SG&A resulted primarily from an increase in payroll costs, professional fees, losses on asset disposals, and store impairments partially offset by a decrease in accrued incentive compensation.

Depreciation expense was $22.5 million in fiscal 2012 compared to $21.8 million in fiscal 2011. Depreciation expense increased from fiscal 2011 due to an increase in the Company's store count and related investments in store development, information technology investments, and the completion of the home office expansion.

Interest and other revenue remained flat at $3.8 million in fiscal 2012 compared to $3.8 million in fiscal 2011. Miscellaneous income and interest income were lower compared to fiscal 2011, partially offset by an increase in gains on the sales of investments. See Note 2 of Notes to Consolidated Financial Statements for further details

Income tax expense was $37.3 million, or 4.0% of retail sales in fiscal 2012 compared to $35.4 million, or 3.8% of retail sales in fiscal 2011. The increase resulted from a higher effective tax rate partially offset by lower pre-tax income. The effective tax rate was 37.7% in fiscal 2012 compared to 35.3% in fiscal 2011, due to higher state taxes and a correction of an immaterial prior period error. See Note 1 of Notes to Consolidated Financial Statements for further details.

Off-Balance Sheet Arrangements

Other than operating leases in the ordinary course of business, the Company is not a party to any off-balance sheet arrangements.

Critical Accounting Policies

The Company's accounting policies are more fully described in Note 1 to the Consolidated Financial Statements. As disclosed in Note 1 of Notes to Consolidated Financial Statements, the preparation of the Company's financial statements in conformity with generally accepted accounting principles in the United States ("GAAP") requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements. The most significant accounting estimates inherent in the preparation of the Company's financial statements include the allowance for doubtful accounts, inventory shrinkage, the calculation of potential asset impairment, workers' compensation, general and auto insurance liabilities, reserves relating to self-insured health insurance, and uncertain tax positions.


The Company's critical accounting policies and estimates are discussed with the Audit Committee.

Allowance for Doubtful Accounts

The Company evaluates the collectability of accounts receivable and records an allowance for doubtful accounts based on the accounts receivable aging and estimates of actual write-offs. The allowance is reviewed for adequacy and adjusted, as necessary, on a quarterly basis. The Company also provides for estimated uncollectible late fees charged based on historical write-offs. The Company's financial results can be significantly impacted by changes in bad debt write-off experience and the aging of the accounts receivable portfolio.

Merchandise Inventories

The Company's inventory is valued using the weighted-average cost method and is stated at the lower of cost or market. Physical inventories are conducted throughout the year to calculate actual shrinkage and inventory on hand. Estimates based on actual shrinkage results are used to estimate inventory shrinkage, which is accrued for the period between the last physical inventory and the financial reporting date. The Company regularly reviews its inventory levels to identify slow moving merchandise and uses markdowns to clear slow moving inventory.

Lease Accounting

The Company recognizes rent expense on a straight-line basis over the lease term as defined in ASC 840 - Leases. Our lease agreements generally provide for scheduled rent increases during the lease term or rent holidays, including rental payments commencing at a date other than the date of initial occupancy. We include any rent escalation and rent holidays in our straight-line rent expense. In addition, we record landlord allowances for normal tenant improvements as deferred rent, which is included in other noncurrent liabilities in the consolidated balance sheets. This deferred rent is amortized over the lease term as a reduction of rent expense. Also, leasehold improvements are amortized using the straight-line method over the shorter of their estimated useful lives or the related lease term. See Note 1 to the Consolidated Financial Statements for further information on the Company's accounting for its leases.

Impairment of Long-Lived Assets

The Company primarily invests in property and equipment in connection with the opening and remodeling of stores and in computer software and hardware. The Company periodically reviews its store locations and estimates the recoverability of its assets, recording an impairment charge for the amount by which carrying value exceeds fair value, if necessary, when the Company decides to close the store or otherwise determines that future estimated undiscounted cash flows associated with those assets will not be sufficient to recover the carrying value. This determination is based on a number of factors, including the store's historical operating results and cash flows, estimated future sales growth, real estate development in the area and perceived local market conditions that can be difficult to predict and may be subject to change. In addition, the Company regularly evaluates its computer-related and other long-lived assets and may accelerate depreciation over the revised useful life if the asset is expected to be replaced or has limited future value. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation or amortization are removed from the accounts, and any resulting gain or loss is reflected in income for that period.


Insurance Liabilities

The Company is primarily self-insured for health care, workers' compensation and general liability costs. These costs are significant primarily due to the large number of the Company's retail locations and associates. The Company's self-insurance liabilities are based on the total estimated costs of claims filed and estimates of claims incurred but not reported, less amounts paid against such claims, and are not discounted. Management reviews current and historical claims data in developing its estimates. The Company also uses information provided by outside actuaries with respect to health care, workers' compensation and general liability claims. If the underlying facts and circumstances of the claims change or the historical experience upon which insurance provisions are recorded is not indicative of future trends, then the Company may be required to make adjustments to the provision for insurance costs that could be material to the Company's reported financial condition and results of operations. Historically, actual results have not significantly deviated from estimates.

Uncertain Tax Positions

The Company records liabilities for uncertain tax positions principally related to state income taxes as of the balance sheet date. These liabilities reflect the Company's best estimate of its ultimate income tax liability based on the tax codes, regulations, and pronouncements of the jurisdictions in which we do business. Estimating our ultimate tax liability involves significant judgments regarding the application of complex tax regulations across many jurisdictions. Despite the Company's belief that the estimates and judgments are reasonable, differences between the estimated and actual tax liabilities can and do exist from time to time. These differences may arise from settlements of tax audits, expiration of the statute of limitations, or the evolution and application of the various jurisdictional tax codes and regulations. Any differences will be recorded in the period in which they become known and could have a material effect on the results of operations in the period the adjustment is recorded.

Revenue Recognition

While the Company's recognition of revenue is predominantly derived from routine retail transactions and does not involve significant judgment, revenue recognition represents an important accounting policy of the Company. As discussed in Note 1 to the Consolidated Financial Statements, the Company recognizes sales from stores at the point of purchase when the customer takes possession of the merchandise and pays for the purchase, generally with cash or credit. E-Commerce sales are recorded when the risk of loss is transferred to the customer. Sales from purchases made with Cato credit, gift cards and layaway sales are also recorded when the customer takes possession of the merchandise. Gift cards are recorded as deferred revenue within accrued expenses until they are redeemed or forfeited. Layaway sales are recorded as deferred revenue within accrued expenses until the customer takes possession or forfeits the merchandise. Gift cards do not have expiration dates. A provision is made for estimated product returns based on sales volumes and the Company's experience; actual returns have not varied materially from amounts provided historically.

The Company recognizes income on unredeemed gift cards ("gift card breakage") as a component of other income. Gift card breakage is determined after 60 months when the likelihood of the remaining balances being redeemed is remote based on our historical redemption data and there is no legal obligation to remit the remaining balances to relevant jurisdictions. Gift card breakage income is analyzed and recognized on a quarterly basis and is not expected to be material.

Finance revenue on the Company's private label credit card portfolio is recognized as earned under the interest method. Late fees are recognized as earned, less provisions for estimated uncollectible fees.


Liquidity, Capital Resources and Market Risk

The Company has consistently maintained a strong liquidity position. Cash provided by operating activities during fiscal 2013 was $93.0 million as compared to $80.4 million in fiscal 2012. These amounts have enabled the Company to fund its regular operating needs, capital expenditure program, cash dividend payments and selective repurchases of the Company's common stock. In addition, the Company maintains $35.0 million of unsecured revolving credit facilities for short-term financing of seasonal cash needs, none of which was outstanding at February 1, 2014.

Cash provided by operating activities for these periods was primarily generated by earnings adjusted for depreciation, deferred taxes, and changes in working capital. The increase of $12.6 million for fiscal 2013 over fiscal 2012 is primarily due to an increase in accounts payable and a decrease in prepaid and other assets, partially offset by a decrease in net income.

The Company believes that its cash, cash equivalents and short-term investments, together with cash flows from operations and borrowings available under its revolving credit agreement, will be adequate to fund the Company's proposed capital expenditures, dividends and other operating requirements for fiscal 2014 and for the foreseeable future.

At February 1, 2014, the Company had working capital of $269.6 million compared to $230.6 million and $272.1 million at February 2, 2013 and January 28, 2012, respectively. Additionally, the Company had $1.0 million, $1.0 million, and $2.0 million invested in privately managed investment funds and other miscellaneous equities for fiscal years 2013, 2012, and 2011, respectively, which are reported under Other assets in the Consolidated Balance Sheets.

At February 1, 2014, the Company had an unsecured revolving credit agreement, which provided for borrowings of up to $35.0 million less the balance of revocable credits discussed below. The revolving credit agreement is committed until August 2015. The credit agreement contains various financial covenants and limitations, including the maintenance of specific financial ratios with which the Company was in compliance as of February 1, 2014. There were no borrowings outstanding under this credit facility during the fiscal year ended February 1, 2014 or the fiscal year ended February 2, 2013.

The Company had approximately $0.4 million, $2.9 million, and $2.3 at February 1, 2014, February 2, 2013, and January 28, 2012, respectively, of outstanding revocable letters of credit relating to purchase commitments.

Expenditures for property and equipment totaled $31.5 million, $45.2 million and $35.9 million in fiscal 2013, 2012 and 2011, respectively. The expenditures for fiscal 2013 were primarily for store development, investments in new technology, general office expansion, and land aquisition. In fiscal 2014, the Company is planning to invest approximately $44.5 million in capital expenditures. This includes expenditures to open 30 new Cato stores, 10 new It's Fashion stores, 24 new Versona Accessories stores, the relocation of 13 stores and the remodeling of 10 Cato stores. In addition, the Company has planned for additional investments in technology and the renovation of the current office space.

Net cash used in investing activities totaled $32.9 million for fiscal 2013 compared to net cash provided by investing activities of $2.1 million for fiscal 2012 and net cash used in investing activities of $59.7 million used for fiscal 2011. The increase in cash used was due primarily to expenditures for property and equipment and purchases of short-term investments, partially offset by sales of short-term investments.

On February 27, 2014, the Board of Directors set the quarterly dividend at $0.30 per share.


The Company does not use derivative financial instruments.

See Note 4, "Fair Value Measurements," for information regarding the Company's financial assets that are measured at fair value.

The Company's investment portfolio was primarily invested in corporate bonds and tax-exempt and taxable governmental debt securities held in managed accounts with underlying ratings of A or better at February 1, 2014. The state, municipal and corporate bonds have contractual maturities which range from 14 days to 12.8 years. The U.S. Treasury Notes and Certificates of Deposit have contractual maturities which range from 12 days to 1.6 years. These securities are classified as available-for-sale and are recorded as Short-term investments, Restricted cash and investments and Other assets on the accompanying Consolidated Balance Sheets. These assets are carried at fair value with unrealized gains and losses reported net of taxes in Accumulated other comprehensive income.

Additionally, at February 1, 2014, the Company had $0.4 million of privately managed funds, $0.6 million of corporate equities and a single auction rate security ("ARS") of $3.1 million which continues to fail its auction. All of these assets are recorded within Other assets in the Consolidated Balance Sheets. At February 2, 2013, the Company had $0.6 million of privately managed funds, $0.5 million of corporate equities, and a single ARS of $3.5 million, all of which are recorded within Other assets in the Consolidated Balance Sheets.

Level 1 category securities are measured at fair value using quoted active market prices. Level 2 investment securities include corporate and municipal bonds for which quoted prices may not be available on active exchanges for identical instruments. Their fair value is principally based on market values determined by management with assistance of a third party pricing service. Since quoted prices in active markets for identical assets are not available, these prices are determined by the pricing service using observable market information such as quotes from less active markets and/or quoted prices of securities with similar characteristics, among other factors.

The ARS of $3,450,000 par value was issued by the Wake County, NC Industrial Facilities & Pollution Control Financing Authority. The security is an obligation of Duke Energy Progress and has a credit rating of Aa2. The Company has collected all interest payments when due since the security was purchased and continues to expect that it will receive all interest due on the security in full and on a timely basis in the future.

During the fourth quarter of fiscal 2013, the ARS yield was substantially less than the comparative bond discount rate for two consecutive periods. As a result, the Company wrote down the ARS to approximate fair value as determined by publicly available data of recent sales for the security to third parties. This resulted in a loss of $310,500 included in interest and other income (or changes in net assets) with respect to its ARS Portfolio as of February 1, 2014.

The Company's failed ARS is recorded at $3,139,500 which approximates fair value using Level 3 inputs. Because there is no active market for this particular ARS, its fair value was analyzed through the use of a discounted cash flow analysis and observations from previous trades. The terms used in the . . .

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