CATO CORP 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING INFORMATION: The following information should be read along with the unaudited Condensed Consolidated Financial Statements, including the accompanying Notes appearing in this report. Any of the following are “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended: (1) statements in this Form 10-Q that reflect projections or expectations of our future financial or economic performance; (2) statements that are not historical information; (3) statements of our beliefs, intentions, plans and objectives for future operations, including those contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”; (4) statements relating to our operations or activities for our fiscal year ending January 30, 2021 (“fiscal 2020”) and beyond, including, but not limited to, statements regarding expected amounts of capital expenditures and store openings, relocations, remodels and closures and statements regarding the potential impact of the COVID-19 pandemic and related responses and mitigation efforts on our business, results of operations and financial condition; and (5) statements relating to our future contingencies. When possible, we have attempted to identify forward-looking statements by using words such as “will,” “expects,” “anticipates,” “approximates,” “believes,” “estimates,” “hopes,” “intends,” “may,” “plans,” “could,” “would,” “should” and any variations or negative formations of such words and similar expressions. We can give no assurance that actual results or events will not differ materially from those expressed or implied in any such forward-looking statements. Forward-looking statements included in this report are based on information available to us as of the filing date of this report, but subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from those contemplated by the forward-looking statements. Such factors include, but are not limited to, the following: any actual or perceived deterioration in the conditions that drive consumer confidence and spending, including, but not limited to, prevailing social, economic, political and public health conditions and uncertainties, levels of unemployment, fuel, energy and food costs, wage rates, tax rates, interest rates, home values, consumer net worth and the availability of credit; changes in laws, regulations or governmental policies affecting our business, including tariffs; uncertainties regarding the impact of any governmental actions regarding, or responses to, the foregoing conditions; competitive factors and pricing pressures; our ability to predict and respond to rapidly changing fashion trends and consumer demands; our ability to successfully implement our new store development strategy to increase new store openings and our ability of any such new stores to grow and perform as expected; adverse weather, public health threats (including the COVID-19 pandemic) or similar conditions that may affect our sales or operations; inventory risks due to shifts in market demand, including the ability to liquidate excess inventory at anticipated margins; and other factors discussed under “Risk Factors” in Part I, Item 1A of our annual report on Form 10-K for the fiscal year ended February 1, 2020 (“fiscal 2019”), as amended or supplemented, and in other reports we file with or furnish to the Securities and Exchange Commission (“SEC”) from time to time. We do not undertake, and expressly decline, any obligation to update any such forward-looking information contained in this report, whether as a result of new information, future events, or otherwise. 24 THE CATO CORPORATION MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) CRITICAL ACCOUNTING POLICIES: The Company’s accounting policies are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the fiscal year ended February 1, 2020. As disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” 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. 25 THE CATO CORPORATION MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) RESULTS OF OPERATIONS: The following table sets forth, for the periods indicated, certain items in the Company's unaudited Condensed Consolidated Statements of Income as a percentage of total retail sales: Three Months Ended Nine Months Ended October 31, 2020 November 2, 2019 October 31, 2020 November 2, 2019 Total retail sales 100.0 % 100.0 % 100.0 % 100.0 % Other revenue 1.1 1.1 1.3 1.1 Total revenues 101.1 101.1 101.3 101.1 Cost of goods sold (exclusive of depreciation) 73.3 62.6 78.6 61.3 Selling, general and administrative (exclusive of depreciation) 34.8 34.2 35.8 31.3 Depreciation 2.4 2.0 2.7 1.8 Interest and other income (0.5) (0.9) (0.9) (0.7) Income/(loss) before income taxes (8.9) 3.2 (14.9) 7.3 Net income/(loss) (2.4) 3.2 (9.5) 6.2 26 THE CATO CORPORATION MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) RESULTS OF OPERATIONS (CONTINUED): COVID-19 Update The COVID-19 pandemic has created, and may continue to create, challenges and uncertainties for our business. In the first quarter of fiscal 2020, the pandemic resulted in state and local orders mandating store closures and other measures to mitigate the spread of the virus. Recently reported increases in infection rates in many areas and the onset of cooler weather raise the possibility of increased or renewed governmental measures to reduce public activity and gatherings in order to mitigate the spread of the virus, as well as continued adverse effect on consumer confidence. Responses by customers, government and the private sector have and will likely continue to adversely impact our business operations for the remainder of fiscal 2020 and possibly beyond. The extent to which the COVID-19 pandemic ultimately impacts the Company’s business, financial condition, results of operations, cash flows, and liquidity may differ from management’s current estimates due to inherent uncertainties regarding the duration and further spread of the outbreak, its severity, actions taken to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Beginning March 19, 2020, the Company temporarily closed all Cato, It’s Fashion, It’s Fashion Metro and Versona stores. In addition, the Company suspended its quarterly dividend, significantly reduced capital expenditures and reduced its SG&A expense through the reduction of non-payroll expenses, as well as furloughed associates and in certain instances eliminated positions primarily at its corporate office. Beginning on May 1, 2020, the Company began to re-open stores based on the pertinent state and local orders. As of June 15, 2020, all stores have re-opened. Although all stores have re-opened, stores are operating at reduced hours and stores may be temporarily closed or subject to further operating restrictions in compliance with local regulations or in response to public health guidance due to COIVD-19. There is significant uncertainty around the duration, breadth and severity of continued business disruptions related to COVID-19, as well as its impact on the U.S. economy, consumer willingness to visit malls and shopping centers, and associate staffing for our stores. At this time, the possible effects of national, state or local action, legislation, guidelines or programs that attempt to mitigate the spread of COVID-19 or address its economic effects on our customers, suppliers or the Company are also uncertain. While the Company currently anticipates that our results for the remainder of fiscal 2020 will be adversely impacted, the extent to which COVID-19 impacts the Company’s results will depend on future developments, which are highly uncertain, including possible new information and understanding about the severity of COVID-19, related potential economic impacts to customers and suppliers, and the effect of actions taken to contain it or mitigate its impact. Comparison of the Three and Nine Months ended October 31, 2020 with November 2, 2019 Total retail sales for the third quarter were $149.2 million compared to last year’s third quarter sales of $189.4 million, a 21% decrease. The Company’s sales decrease in the third quarter of fiscal 2020 is primarily due to a 23% decrease in same-store sales, partially offset by sales from new store openings. Sales in the third quarter were negatively impacted by reduced operating hours compared to 2019, higher amounts of markdowns and temporary store closings due to COVID-19 cases and hurricanes. For the nine months ended October 31, 2020, total retail sales were $414.3 million compared to last year’s comparable nine month sales of $627.8 million, a 34% decrease. Sales in the first nine months of fiscal 2020 decreased primarily due to a 35% decrease in same-store sales, partially offset by sales from new store openings. Sales for the nine months ended October 31, 2020 were negatively impacted primarily by store closures in the first quarter, phased re-opening of stores in the second quarter, reduced store hours and high amounts of markdowns. Same-store 27 THE CATO CORPORATION MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) sales include 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. 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. E-commerce sales were less than 6% of sales for the nine months ended October 31, 2020 and are included in the same-store sales calculation. Total revenues, comprised of retail sales and other revenue (principally finance charges and late fees on customer accounts receivable and layaway fees), were $150.8 million and $419.7 million for the three and nine months ended October 31, 2020, compared to $191.5 million and $634.5 million for the three and nine months ended November 2, 2019, respectively. The Company operated 1,347 stores at October 31, 2020 compared to 1,298 stores at the end of last year’s third quarter. During the first nine months of fiscal 2020, the Company closed 10 stores. In total, the Company opened 76 stores, which had leases prior to the COVID-19 pandemic, and expects to close approximately 40 stores in fiscal 2020. Credit revenue of $0.6 million represented 0.4% of total revenues in the third quarter of fiscal 2020, compared to 2019 credit revenue of $0.9 million or 0.5% of total revenues. Credit revenue is comprised of interest earned on the Company’s private label credit card portfolio and related fee income. Related expenses principally include payroll, postage and other administrative expenses and totaled $0.4 million in the third quarter of fiscal 2020, compared to last year’s third quarter expense of $0.4 million. Other revenue in total, as included in total revenues, was $1.6 million and $5.4 million for the three and nine months ended October 31, 2020, respectively, compared to $2.2 million and $6.7 million for the prior year’s comparable three and nine month periods. The overall decrease in the three and nine months ended October 31, 2020 is primarily due to decreases in finance and layaway charges, partially offset by increases in e-commerce shipping revenues. Cost of goods sold was $109.4 million, or 73.3% of retail sales and $325.7 million, or 78.6% of retail sales for the three and nine months ended October 31, 2020, respectively, compared to $118.6 million, or 62.6% of retail sales and $385.1 million, or 61.3% of retail sales for the comparable three and nine month periods of fiscal 2019. The overall increase in cost of goods sold as a percent of retail sales for the third quarter of fiscal 2020 resulted primarily from an increase in markdown sales due to liquidating spring and summer merchandise, goods marked out of stock, and deleveraging occupancy, distribution and buying 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 costs 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 exclusive of depreciation) decreased by 43.7% to $39.8 million for the third quarter of fiscal 2020 and decreased by 63.5% to $88.5 million for the first nine months of fiscal 2020, compared to $70.7 million and $242.7 million for the prior year’s comparable three and nine months of fiscal 2019. Gross margin as presented may not be comparable to those of other entities. Selling, general and administrative expenses (“SG&A”) primarily include corporate and store payroll, related payroll taxes and benefits, insurance, supplies, advertising, bank and credit card processing fees. SG&A expenses were $51.9 million, or 34.8% of retail sales and $148.4 million, or 35.8% of retail sales for the third quarter and first nine months of fiscal 2020, respectively, compared to $64.7 million, or 34.2% of retail sales and $196.7 million, or 31.3% of retail sales for the prior year’s comparable three and nine month periods. The overall decrease in SG&A expense for the third quarter is primarily attributable to lower store expenses due to reduced store operating hours, lower corporate expenses and elimination of incentive compensation, partially offset by an increase in store impairment charges. For the first nine months of fiscal 2020, the overall 28 THE CATO CORPORATION MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) decrease in SG&A expense was primarily attributable to lower store expenses due to stores being closed, phased store re-opening in the second quarter, reduced store operating hours, lower corporate expenses and reduction of incentive compensation, partially offset by higher store impairment charges. Depreciation expense was $3.6 million, or 2.4% of retail sales and $11.1 million, or 2.7% of retail sales for the third quarter and first nine months of fiscal 2020, respectively, compared to $3.8 million, or 2.0% of retail sales and $11.5 million or 1.8% of retail sales for the comparable three and nine month periods of fiscal 2019, respectively. Interest and other income was $0.8 million, or 0.5% of retail sales and $3.6 million, or 0.9% of retail sales for the three and nine months ended October 31, 2020, respectively, compared to $1.7 million, or 0.9% of retail sales and $4.5 million, or 0.7% of retail sales for the comparable three and nine month periods of fiscal 2019, respectively. The decrease for the first nine months of fiscal 2020 compared to 2019 is primarily attributable to a decrease in short-term investments and lower interest rates. Income tax benefit was $9.7 million and $22.7 million for the third quarter and first nine months of fiscal 2020, respectively, compared to income tax expense of $0.1 million and $6.5 million for the comparable three and nine month periods of fiscal 2019, respectively. For the first nine months of 2020, the Company’s effective tax rate was 36.7% (Benefit) compared to 14.3% (Expense) for the first nine months of 2019. The increase in the 2020 year-to-date tax rate was primarily due to the federal net operating loss carryback provisions of the Coronavirus Aid, Relief and Economic Security Act (CARES Act) and release of reserves for uncertain tax positions due to expiration of statute of limitations, offset by valuation allowances against state income net operating losses, less income tax credits, and an increase in the reserves for uncertain tax positions specific to state income taxes recorded in the first quarter of 2020. The Company assessed the likelihood that deferred tax assets related to state net operating loss carryforwards will be realized in light of the adverse impact on the Company's financial statements and operations due to COVID-19. Based on this assessment, the Company concluded that it is more likely than not that the company will not be able to realize the state net operating losses and, accordingly, has recorded a valuation allowance against the existing deferred tax assets. The annual effective tax rate for the current fiscal year is impacted by the ability to carryback federal net operating losses due to the CARES Act, partially offset by changes in management’s judgment regarding the ability to realize deferred tax assets, primarily state income net operating losses generated in the current fiscal year. The Company has factored the realizability of these deferred tax assets generated as a result of projected current year losses into its estimated annual effective rate for the current year. To the extent that actual results and/or events differ from the predicted results, the Company may continue to see effects on the annual effective tax rate. LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK: 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 regular operating requirements and expected capital expenditures for fiscal 2020 and the next 12 months. Cash used by operating activities during the first nine months of fiscal 2020 was $26.1 million as compared to $49.3 million provided in the first nine months of fiscal 2019. Cash used by operating activities for the first nine months of fiscal 2020 was primarily attributable to net losses adjusted for depreciation and changes in 29 THE CATO CORPORATION MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) working capital. The decrease in cash provided of $75.4 million for the first nine months of fiscal 2020 as compared to the first nine months of fiscal 2019 was primarily due to a net loss versus net income, an increase in accounts receivable primarily related to income taxes and an increase in prepaid expenses, partially offset by lower merchandise inventories and store impairment charges. At October 31, 2020, the Company had working capital of $117.8 million compared to $163.5 million at February 1, 2020. The decrease in working capital is primarily due to reduction in short-term investments and lower inventories, partially offset by higher accounts receivables and lower accrued liabilities. At October 31, 2020 and February 1, 2020, the Company had an unsecured revolving credit agreement, which provides for borrowings of up to $35.0 million, less the value of revocable letters of credit discussed below. The revolving credit agreement is committed until May 2023. 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 October 31, 2020. There were no borrowings outstanding under the credit facility as of October 31, 2020 and February 1, 2020. Expenditures for property and equipment totaled $11.2 million in the first nine months of fiscal 2020, compared to $4.9 million in last fiscal year’s first nine months. The expenditures for the first nine months of fiscal 2020 were primarily for additional investments in stores, distribution center and information technology. For the full fiscal 2020 year, the Company expects to invest approximately $13.0 million for capital expenditures. Net cash provided by investing activities totaled $57.9 million in the first nine months of fiscal 2020 compared to $22.2 million used in investing activities in the comparable period of 2019. The increase in net cash provided in 2020 is primarily attributable to the increase in net sales of short-term investments, partially offset by expenditures for property and equipment. Net cash used in financing activities totaled $24.3 million in the first nine months of fiscal 2020 compared to $28.9 million used in the comparable period of fiscal 2019. The decrease was primarily due to lower dividend payments, partially offset by higher share repurchase amounts. As of October 31, 2020, the Company had 691,856 shares remaining in open authorizations under its share repurchase program. The Company temporarily suspended dividends in the first quarter of 2020. The Company does not use derivative financial instruments. 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 October 31, 2020 and February 1, 2020. The state, municipal and corporate bonds have contractual maturities which range from two weeks to five years. The U.S. Treasury Notes and Certificates of Deposit have contractual maturities which range from two weeks to three years. These securities are classified as available-for-sale and are recorded as Short-term investments, Restricted cash and Restricted short-term investments on the accompanying Condensed Consolidated Balance Sheets. These assets are carried at fair value with unrealized gains and losses reported net of taxes in Accumulated other comprehensive income. The asset-backed securities are bonds comprised of auto loans and bank credit cards that carry AAA ratings. The auto loan asset-backed securities are backed by static pools of auto loans that were originated and serviced by captive auto finance units, banks or finance companies. The bank credit card asset-backed securities are backed by revolving pools of credit card receivables generated by account holders of cards from American Express, Citibank, JPMorgan Chase, Capital One and Discover. 30 THE CATO CORPORATION MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Additionally, at October 31, 2020, the Company had $1.5 million of corporate equities and deferred compensation plan assets of $10.5 million. At February 1, 2020, the Company had $0.7 million of corporate equities and deferred compensation plan assets of $10.5 million. All of these assets are recorded within Other assets in the Condensed Consolidated Balance Sheets. See Note 7, Fair Value Measurements. RECENT ACCOUNTING PRONOUNCEMENTS: See Note 8, Recent Accounting Pronouncements. 31 THE CATO CORPORATION QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK: The Company is subject to market rate risk from exposure to changes in interest rates based on its financing, investing and cash management activities, but the Company does not believe such exposure is material.