Cato Corp: Form 10-Q for the period ended Oct 28, 2023

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 February 3, 2024 (“fiscal 2023”) 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, as well as the potential impact of supply chain disruptions, inflationary

pressures and other economic or market conditions on our business, results of operations and financial

condition and statements regarding new store development strategy; 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, the availability of credit and

inflation; changes in laws, regulations or government policies affecting our business, including but not

limited to tariffs; uncertainties regarding the impact of any governmental action 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 global 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; adverse

developments or volatility affecting the financial services industry or broader financial markets; 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 January 28, 2023 (“fiscal 2022”), 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.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES:

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 January 28, 2023. 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

calculation of potential asset impairment, reserves relating to self-insured health insurance, workers’

compensation, general and auto insurance liabilities, uncertain tax positions, the allowance for customer

credit losses, and inventory shrinkage.

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

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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 28, 2023

October 29, 2022

October 28, 2023

October 29, 2022

Total retail sales

100.0

100.0

100.0

100.0

Other revenue

1.0

1.0

0.9

0.9

Total revenues

101.0

101.0

100.9

100.9

Cost of goods sold (exclusive of depreciation)

67.5

70.7

65.4

67.5

Selling, general and administrative (exclusive

of depreciation)

39.4

35.1

35.1

31.8

Depreciation

1.6

1.6

1.4

1.5

Interest and other income

(1.0)

(1.3)

(0.7)

(0.8)

Income (loss) before income taxes

(6.6)

(5.2)

(0.3)

1.0

Net income (loss)

(3.9)

(2.5)

(0.1)

0.5

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RESULTS OF OPERATIONS (CONTINUED):

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is

intended to provide information to assist readers in better understanding and evaluating our financial

condition and results of operations. We recommend reading this MD&A in conjunction with our Condensed

Consolidated Financial Statements and the Notes to those statements included in the “Financial Statements”

section of this Quarterly Report on Form 10-Q, as well as our 2022 Annual Report on Form 10-K.

Recent Developments

Inflationary Cost Pressure and High Interest Rates

Despite some reduction in inflationary pressures from last year, wages, operating supplies, and service

costs continue to be negatively impacted by the current inflationary environment. In addition, our

customers’ disposable income is impacted by increased costs related to fuel, food, housing, including rent,

and other consumable products relative to flattening wage rates, which negatively impact our customers’

willingness to purchase discretionary items such as apparel, jewelry and shoes.

In response, the Federal Reserve began raising, and is committed to continue raising, interest rates until

inflationary pressures subside to acceptable levels. Though the Federal Reserve has paused raising rates,

it has indicated it is committed to reducing inflation to its targeted levels. These high interest rates have

adversely affected the availability and cost of credit for both businesses and our customers. Increasing

costs related to revolving credit, auto loans and mortgages continue to negatively impact our customers’

discretionary income. Our customers’ willingness to purchase our products may continue to be

negatively impacted by these inflationary pressures and high interest rates.

We believe high prices and interest rates negatively impacted the first three quarters of fiscal 2023 and

will likely continue to have a negative impact on consumer behavior and, by extension, our results of

operations and financial condition during the remainder of fiscal 2023.

Comparison of the Three and Nine Months ended October 28, 2023 with October 29, 2022

Total retail sales for the third quarter were $156.7 million compared to last year’s third quarter sales of $174.9

million, a 10% decrease. The Company’s sales decrease in the third quarter of fiscal 2023 was primarily due

to an 8% decrease in same-store sales and closed stores, partially offset by sales from new stores. For the nine

months ended October 28, 2023, total retail sales were $528.2 million compared to last year’s comparable

nine month sales of $574.9 million, an 8% decrease. The decrease in sales in the first nine months of fiscal

2023 was due primarily to a 6% decrease in same-store sales and closed stores, partially offset by sales from

new stores. Same-store 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 5% of total sales for the nine months ended October 28, 2023 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 $158.3

million and $533.2 million for the three and nine months ended October 28, 2023, compared to $176.6

million and $580.2 million for the three and nine months ended October 29, 2022, respectively. The

Company operated 1,245 stores at October 28, 2023 compared to 1,317 stores at the end of last year’s third

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quarter. During the first nine months of fiscal 2023, the Company opened nine stores and closed 44 stores.

The Company currently expects to close approximately 110 stores in total in fiscal 2023.

Credit revenue of $0.7 million represented 0.4% of total revenues in the third quarter of fiscal 2023,

compared to 2022 credit revenue of $0.6 million or 0.3% 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 2023, compared to last year’s third quarter expense of $0.4 million.

Other revenue, a component of total revenues, was $1.6 million and $5.0 million for the three and nine

months ended October 28, 2023, respectively, compared to $1.7 million and $5.4 million for the prior year’s

comparable three and nine month periods. The decrease in Other revenue for both the three and nine months

was due to decreases in gift card breakage and e-commerce shipping revenue partially offset by increases in

finance charges and late fees associated with the Company’s proprietary credit card.

Cost of goods sold was $105.8 million, or 67.5% of retail sales and $345.5 million, or 65.4% of retail sales

for the three and nine months ended October 28, 2023, respectively, compared to $123.8 million, or 70.7% of

retail sales and $387.7 million, or 67.5% of retail sales for the comparable three and nine month periods of

fiscal 2022. The overall decrease in cost of goods sold as a percent of retail sales for the third quarter and

first nine months of fiscal 2023 resulted primarily from lower ocean freight costs and increased sales of

regular priced goods, partially offset by deleveraging of occupancy 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 0.6% to $50.9 million for

the third quarter of fiscal 2023 and by 2.4% to $182.6 million for the first nine months of fiscal 2023,

compared to $51.2 million and $187.1 million for the prior year’s comparable three and nine months of fiscal

2022, respectively. 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 $61.8 million, or 39.4% of retail sales and $185.3 million, or 35.1% of retail sales for the third

quarter and first nine months of fiscal 2023, respectively, compared to $61.4 million, or 35.1% of retail sales

and $182.6 million, or 31.8% of retail sales for the prior year’s comparable three and nine month periods,

respectively. The increase in SG&A for the third quarter and first nine months of fiscal 2023 was primarily

due to higher payroll and insurance expense.

Depreciation expense was $2.5 million, or 1.6% of retail sales and $7.4 million, or 1.4% of retail sales for the

third quarter and first nine months of fiscal 2023, respectively, compared to $2.9 million, or 1.6% of retail

sales and $8.4 million or 1.5% of retail sales for the comparable three and nine month periods of fiscal 2022,

respectively.

Interest and other income was $1.5 million, or 1.0% of retail sales and $3.8 million, or 0.7% of retail sales for

the three and nine months ended October 28, 2023, respectively, compared to $2.3 million, or 1.3% of retail

sales and $4.6 million, or 0.8% of retail sales for the comparable three and nine month periods of fiscal 2022,

respectively. The decrease for the third quarter and first nine months of fiscal 2023 compared to fiscal 2022

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was primarily attributable to the Company’s receipt of a Business Recovery Grant from the state of North

Carolina in 2022, partially offset by higher amounts earned on investments due to higher interest rates.

Income tax benefit was $4.3 million and $0.8 million for the third quarter and first nine months of fiscal

2023, respectively, compared to a tax benefit of $4.7 million and a tax expense of $3.0 million for the

comparable three and nine month periods of fiscal 2022, respectively. For the first nine months of fiscal

2023, the Company’s effective tax rate was 60.4% compared to 49.7% for the first nine months of fiscal

2022. The change in the 2023 year-to-date effective tax rate was primarily due to increases in foreign rate

differential and the release of reserves for uncertain tax positions, offset by decreases in Global Intangible

Low-taxed Income (GILTI), state income taxes, non-deductible officer’s compensation, and foreign tax

credits, as percentages on a pre-tax loss.

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 2023 and the next 12

months.

Cash provided by operating activities during the first nine months of fiscal 2023 was $11.7 million as

compared to $19.3 million provided in the first nine months of fiscal 2022. The decrease in cash provided of

$7.6 million for the first nine months of fiscal 2023 as compared to the first nine months of fiscal 2022 was

primarily due to a net loss in 2023 compared to net income in 2022, and higher accounts receivable, partially

offset by lower accounts payable and accrued liabilities.

At October 28, 2023, the Company had working capital of $76.8 million compared to $74.7 million at

January 28, 2023.

The increase in working capital was primarily attributable to a decrease in current lease

liability and an increase in cash, partially offset by a decrease in inventory and short-term investments.

As of October 28, 2023, the Company has an unsecured revolving credit line, which provides for borrowings

of up to $35.0 million, less the balance of any revocable letters of credit related to purchase commitments,

and is committed through May 2027. The revolving credit agreement contains various financial covenants

and limitations, including the maintenance of specific financial ratios. On October 24, 2023, the Company

amended the revolving credit agreement to link the calculation of the Company’s EBITDAR coverage ratio

to the amount of the Company’s cash and investments. Though the effect of the amendment reduced the

minimum EBITDAR coverage ratio for the quarter ended October 28, 2023 and is expected to do so going

forward, the Company was in compliance with the amended credit agreement for the quarter ended October

28, 2023 and also would have been in compliance without giving effect to the amendment. There were no

borrowings outstanding, nor any outstanding letters of credit that reduced borrowing availability, as of

October 28, 2023. The weighted average interest rate under the credit facility was zero at October 28, 2023

due to no borrowings outstanding.

Expenditures for property and equipment totaled $10.3 million in the first nine months of fiscal 2023,

compared to $14.4 million in last fiscal year’s first nine months. The decrease in expenditures for property

and equipment was primarily due to finishing projects related to investments in the distribution center and

information technology. For the full fiscal 2023 year, the Company expects to invest approximately $12.0

million for capital expenditures.

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Net cash provided by investing activities totaled $6.1 million in the first nine months of fiscal 2023 compared

to $0.2 million net cash provided in the comparable period of 2022. The increase in net cash provided in

2023 was primarily due to a decrease in capital expenditures.

Net cash used in financing activities totaled $12.7 million in the first nine months of fiscal 2023 compared to

$22.2 million used in the comparable period of fiscal 2022. The decrease in net cash used in fiscal 2023 was

primarily due to lower stock repurchases.

On November 16, 2023, the Board of Directors maintained the quarterly dividend at $0.17 per share.

As of October 28, 2023, the Company had 909,653 shares remaining in open authorizations under its share

repurchase program.

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 28,

2023 and January 28, 2023. The state, municipal and corporate bonds have contractual maturities which

range from four days to 3.1 years. The U.S. Treasury Notes have contractual maturities which range from 79

days to 2.3 years. These securities are classified as available-for-sale and are recorded as Short-term

investments, Restricted cash and Other assets 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.

Additionally, at October 28, 2023, the Company had $0.8 million of corporate equities and deferred

compensation plan assets of $9.0 million. At January 28, 2023, the Company had $0.9 million of corporate

equities and deferred compensation plan assets of $9.3 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.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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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.

We carried out an evaluation, with the participation of our Principal Executive Officer and Principal Financial

Officer, of the effectiveness of our disclosure controls and procedures as of October 28, 2023. Based on this

evaluation, our Principal Executive Officer and Principal Financial Officer concluded that, as of October 28,

2023, our disclosure controls and procedures, as defined in Rule 13a-15(e), under the Securities Exchange

Act of 1934 (the “Exchange Act”), were effective to ensure that information we are required to disclose in the

reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported

within the time periods specified in the SEC’s rules and forms and that such information is accumulated and

communicated to our management, including our Principal Executive Officer and Principal Financial Officer,

as appropriate to allow timely decisions regarding required disclosure.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING:

No change in the Company’s internal control over financial reporting (as defined in Exchange Act Rule 13a-

15(f)) has occurred during the Company’s fiscal quarter ended October 28, 2023 that has materially affected,

or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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In addition to the other information in this report, you should carefully consider the factors discussed in Part I,

“Item 1A. Risk Factors” in our Annual Report on Form 10-K for our fiscal year ended January 28, 2023.

These risks could materially affect our business, financial condition or future results; however, they are not

the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem

to be immaterial may also materially adversely affect our business, financial condition or results of

operations.

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