Item 1. Business:
General
The Company, founded in 1946, operated 1,281 fashion specialty stores at February 1, 2020, in 31 states, principally in the southeastern United States, under the names “Cato,” “Cato Fashions,” “Cato Plus,” “It’s Fashion,” “It’s Fashion Metro” and “Versona.” The Cato concept seeks to offer quality fashion apparel and accessories at low prices every day, in junior/missy and plus sizes. The Cato concept’s stores and e-commerce websites feature a broad assortment of apparel and accessories, including dressy, career, and casual sportswear, dresses, coats, shoes, lingerie, costume jewelry and handbags. A major portion of the Cato concept’s merchandise is sold under its private label and is produced by various vendors in accordance with the concept’s specifications. The It’s Fashion and It’s Fashion Metro concepts offer fashion with a focus on the latest trendy styles for the entire family at low prices every day. The Versona concept’s stores and e-commerce website offer quality fashion apparel items, jewelry and accessories at exceptional values every day. The Company’s stores range in size from 2,100 to 19,000 square feet and are located primarily in strip shopping centers anchored by national discounters or market-dominant grocery stores. The Company emphasizes friendly customer service and coordinated merchandise presentations in an appealing store environment. The Company offers its own credit card and layaway plan. Credit and layaway sales under the Company’s plan represented 7% of retail sales in fiscal 2019. See Note 14 to the Consolidated Financial Statements, “Reportable Segment Information,” for a discussion of information regarding the Company’s two reportable segments: retail and credit.
Business
The Company’s primary objective is to be the leading fashion specialty retailer for fashion and value in its markets. Management believes the Company’s success is dependent upon its ability to differentiate its stores from department stores, mass merchandise discount stores and competing specialty stores. The key elements of the Company’s business strategy are:
Merchandise Assortment. The Company’s stores offer a wide assortment of on-trend apparel and accessory items in primarily junior/missy, plus sizes, mens and kids sizes, infant to boys size 20 and girls size 16 with an emphasis on color, product coordination and selection. Colors and styles are coordinated and presented so that outfit selection is easily made.
Value Pricing. The Company offers quality merchandise that is generally priced below comparable merchandise offered by department stores and mall specialty apparel chains, but is generally more fashionable than merchandise offered by discount stores. Management believes that the Company has positioned itself as the every day low price leader in its market segment.
Strip Shopping Center Locations. The Company locates its stores principally in convenient strip centers anchored by national discounters or market-dominant grocery stores that attract large numbers of potential customers.
Customer Service. Store managers and sales associates are trained to provide prompt and courteous
service and to assist customers in merchandise selection and wardrobe coordination.
Credit and Layaway Programs. The Company offers its own credit card and a layaway plan to make the purchase of its merchandise more convenient for its customers.
Merchandising
Merchandising
The Company seeks to offer a broad selection of high quality and exceptional value apparel and accessories to suit the various lifestyles of fashion and value-conscious customers. In addition, the Company strives to offer on-trend fashion in exciting colors with consistent fit and quality.
The Company’s merchandise lines include dressy, career, and casual sportswear, dresses, coats, shoes, lingerie, costume jewelry, handbags, men’s wear and lines for kids and infants. The Company primarily offers exclusive merchandise with fashion and quality comparable to mall specialty stores at low prices, every day.
The Company believes that the collaboration of its merchandising and design teams with an expanded in-house product development and direct sourcing function has enhanced merchandise offerings and delivers quality, exclusive on-trend styles at lower prices. The product development and direct sourcing operations provide research on emerging fashion and color trends, technical services and direct sourcing options.
As a part of its merchandising strategy, members of the Company’s merchandising and design staff frequently attend trade shows to stay abreast of latest trends and styles, visit selected stores to monitor the merchandise offerings of other retailers, regularly communicate with store operations associates and frequently confer with key vendors. The Company also takes aggressive markdowns on slow-selling merchandise and typically does not carry over merchandise to the next season.
Purchasing, Allocation and Distribution
Although the Company purchases merchandise from approximately 580 suppliers, most of its merchandise is purchased from approximately 100 primary vendors. In fiscal 2019, purchases from the Company’s largest vendor accounted for approximately 8% of the Company’s total purchases. The Company is not dependent on its largest vendor or any other vendor for merchandise purchases, and the loss of any single vendor or group of vendors would not have a material adverse effect on the Company’s operating results or financial condition. A substantial portion of the Company’s merchandise is sold under its private labels and is produced by various vendors in accordance with the Company’s strict specifications. The Company sources a majority of its merchandise directly from manufacturers overseas, primarily in Southeast Asia. These manufacturers have a dependence on materials that are primarily sourced from China. The Company purchases its remaining merchandise from domestic importers and vendors, which typically minimizes the time necessary to purchase and obtain shipments; however, these vendors are dependent on materials primarily sourced from China. The Company opened its own overseas sourcing operations in the fall of 2014, replacing the Company’s former sourcing agent in 2015. Although a significant portion of the Company’s merchandise is manufactured overseas, primarily in Southeast Asia, the Company does not expect that any economic, political, public health or social unrest in any one country would have a material adverse effect on the Company’s ability to obtain adequate supplies of merchandise. However, the Company can give no assurance that any changes or disruptions in its merchandise supply chain would not materially and adversely affect the Company. See “Risk Factors - Risks Relating To Our Business - Because we source a significant portion of our merchandise directly and indirectly from overseas, we are subject to risks associated with international operations and risks that affect the prevailing social, economic, political, public health and other conditions in the areas from which we source merchandise; changes, disruptions, cost changes or other problems affecting the Company’s merchandise supply chain could materially and adversely affect the Company’s business, results of operations and financial condition.”
An important component of the Company’s strategy is the allocation of merchandise to individual stores based on an analysis of sales trends by merchandise category, customer profiles and climatic
conditions. A merchandise control system provides current information on the sales activity of each merchandise style in each of the Company’s stores. Point-of-sale terminals in the stores collect and transmit sales and inventory information to the Company’s central database, permitting timely response to sales trends on a store-by-store basis.
All merchandise is shipped directly to the Company’s distribution center in Charlotte, North Carolina, where it is inspected and then allocated by the merchandise distribution staff for shipment to individual stores. The flow of merchandise from receipt at the distribution center to shipment to stores is controlled by an on-line system. Shipments are made by common carrier, and each store receives at least one shipment per week. The centralization of the Company’s distribution process also subjects it to risks in the event of damage to or destruction of its distribution facility or other disruptions affecting the distribution center or the flow of goods into or out of Charlotte, North Carolina. See “Risk Factors - Risks Relating To Our Business - A disruption or shutdown of our centralized distribution center or transportation network could materially and adversely affect our business and results of operations.”
Advertising
The Company uses television, in-store signage, graphics, a Company website, two e-commerce websites and social media as its primary advertising media. The Company’s total advertising expenditures were approximately 0.7% of retail sales for fiscal years 2019, 2018 and 2017.
Store Operations
The Company’s store operations management team consists of one director of stores, four territorial managers, 16 regional managers and 138 district managers. Regional managers receive a salary plus a bonus based on achieving targeted goals for sales, payroll and shrinkage control. District managers receive a salary plus a bonus based on achieving targeted objectives for district sales increases and shrinkage control. Stores are typically staffed with a manager, two assistant managers and additional part-time sales associates depending on the size of the store and seasonal personnel needs. In general, store managers are paid a salary or on an hourly basis as are all other store personnel. Store managers, assistant managers and sales associates are eligible for monthly and semi-annual bonuses based on achieving targeted goals for their store’s sales increases and shrinkage control.
The Company constantly strives to improve its training programs to develop associates. Over 80% of store and field management are promoted from within, allowing the Company to internally staff its store base. The Company has training programs at each level of store operations. New store managers are trained in training stores managed by experienced associates who have achieved superior results in meeting the Company’s goals for store sales, payroll expense and shrinkage control. The type and extent of district manager training varies depending on whether the district manager is promoted from within or recruited from outside the Company.
Store Locations
Most of the Company’s stores are located in the southeastern United States in a variety of markets
ranging from small towns to large metropolitan areas with trade area populations of 20,000 or more. Stores average approximately 4,500 square feet in size.
All of the Company’s stores are leased. Approximately 97% are located in strip shopping centers and 3% in enclosed shopping malls. The Company typically locates stores in strip shopping centers anchored by a national discounter, primarily Walmart Supercenters, or market-dominant grocery stores. The Company’s strip center locations provide ample parking and shopping convenience for its customers.
The Company’s store development activities consist of opening new stores in new and existing markets, relocating selected existing stores to more desirable locations in the same market area and
closing underperforming stores. The following table sets forth information with respect to the Company’s development activities since fiscal 2015:
The Company periodically reviews its store base to determine whether any particular store should be
closed based on its sales trends and profitability. The Company intends to continue this review process to identify underperforming stores.
Credit and Layaway
Credit Card Program
The Company offers its own credit card, which accounted for 3.3% of retail sales in fiscal 2019, 2018 and 2017. The Company’s net bad debt expense was 3.2%, 3.8% and 3.8% of credit sales in fiscal 2019, 2018 and 2017, respectively.
Customers applying for the Company’s credit card are approved for credit if they have a satisfactory credit record and the Company has considered the customer’s ability to make the required minimum payment. Customers are required to make minimum monthly payments based on their account balances. If the balance is not paid in full each month, the Company assesses the customer a finance charge. If payments are not received on time, the customer is assessed a late fee subject to regulatory limits.
Layaway Plan
Under the Company’s layaway plan, merchandise is set aside for customers who agree to make periodic payments. The Company adds a nonrefundable administrative fee to each layaway sale. If no payment is made within four weeks, the customer is considered to have defaulted, and the merchandise is returned to the selling floor and again offered for sale, often at a reduced price. All payments made by customers who subsequently default on their layaway purchase are returned to the customer upon request, less the administrative fee and a restocking fee.
The Company defers recognition of layaway sales to the accounting period when the customer picks up and completely pays for layaway merchandise. Administrative fees are recognized in the period in which the layaway is initiated. Recognition of restocking fees occurs in the accounting period when the customer defaults on the layaway purchase. Layaway sales represented approximately 4.1%, 4.0% and 4.0% of retail sales in fiscal 2019, 2018 and 2017, respectively.
Information Technology Systems
The Company’s information technology systems provide daily financial and merchandising information that is used by management to enhance the timeliness and effectiveness of purchasing and pricing decisions. Management uses a daily report comparing actual sales with planned sales and a weekly ranking report to monitor and control purchasing decisions. Weekly reports are also produced which reflect sales, weeks of supply of inventory and other critical data by product categories, by store
and by various levels of responsibility reporting. Purchases are made based on projected sales, but can be modified to accommodate unexpected increases or decreases in demand for a particular item.
Sales information is projected by merchandise category and, in some cases, is further projected and actual performance measured by stock keeping unit (SKU). Merchandise allocation models are used to distribute merchandise to individual stores based upon historical sales trends, climatic differences, customer demographic differences and targeted inventory turnover rates.
Competition
The women’s retail apparel industry is highly competitive. The Company believes that the principal competitive factors in its industry include merchandise assortment and presentation, fashion, price, store location and customer service. The Company competes with retail chains that operate similar women’s apparel specialty stores. In addition, the Company competes with mass merchandise chains, discount store chains, major department stores, off-price retailers and internet-based retailers. Although we believe we compete favorably with respect to the principal competitive factors described above, many of our direct and indirect competitors are well-established national, regional or local chains, and some have substantially greater financial, marketing and other resources. The Company expects its stores in larger cities and metropolitan areas to face more intense competition.
Seasonality
Due to the seasonal nature of the retail business, the Company has historically experienced and expects to continue to experience seasonal fluctuations in its revenues, operating income and net income. Results of a period shorter than a full year may not be indicative of results expected for the entire year. Furthermore, the seasonal nature of our business may affect comparisons between periods. See Note 13 of Notes to the Consolidated Financial Statements for information regarding our quarterly results of operations for the last two fiscal years.
Regulation
A variety of laws affect the revolving credit card program offered by the Company. The Credit Card Accountability Responsibility and Disclosure Act of 2009 (“The Act”) amended the Truth in Lending Act to establish fair and transparent practices relating to the extension of credit under an open end consumer credit plan. The Act contained provisions addressing matters such as change in terms, notices, limits on fees, rate increases, payment allocation and account disclosures. The Act requires creditors to provide consumers with account disclosures that are timely and in a form that is readily understandable. The Federal Fair Credit Reporting Act also requires certain disclosures to potential customers concerning credit information used as a basis to deny credit. The Federal Equal Credit Opportunity Act and Regulation B promulgated thereunder prohibit lenders from discrimination against any credit applicants, establish guidelines for gathering and evaluating credit information and require written notification when credit is denied. Regulation AA, Unfair, Deceptive or Abusive Acts or Practices, establishes consumer complaint procedures and defines unfair or deceptive practices in extending credit to consumers. The Federal Trade Commission has adopted or proposed various trade regulation rules dealing with unfair credit and collection practices and the preservation of consumers’ claims and defenses. The Company is also subject to the U.S. Patriot Act and the Bank Secrecy Act, which require the Company to monitor account holders and account transactions, respectively. Additionally, the Gramm-Leach-Bliley Act requires the Company to disclose to its customers the Company’s privacy policy as it relates to a customer’s non-public personal information.
As of February 1, 2020, the Company’s position is that its overseas subsidiaries will not invest undistributed earnings indefinitely. Future unremitted earnings when distributed are expected to be either distributions of global intangible low-taxed income (“GILTI”)-previously taxed income or eligible for a 100% dividends received deduction. The withholding tax rate on any unremitted earnings is zero and state
income taxes on such earnings are considered immaterial. Therefore, the Company has not provided deferred U.S. income taxes on approximately $3.5 million of earnings from non-U.S. subsidiaries.
Associates
As of February 1, 2020, the Company employed approximately 10,060 full-time and part-time associates. The Company also employs additional part-time associates during the peak retailing seasons. The Company is not a party to any collective bargaining agreements and considers its associate relations to be good.
Item 1A.
Item 1A. Risk Factors:
An investment in our common stock involves numerous types of risks. You should carefully consider the following risk factors, in addition to the other information contained in this report, including the disclosures under “Forward-looking Information” above in evaluating our Company and any potential investment in our common stock. If any of the following risks or uncertainties occur or persist, our business, financial condition and operating results could be materially and adversely affected, the trading price of our common stock could decline and you could lose all or a part of your investment in our common stock. The risks and uncertainties described in this section are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also materially and adversely affect our business operating results and financial condition.
Risks Relating To Our Business:
An outbreak of disease or similar public health threat, or fear of such an event, could have a material adverse impact on the Company's business, operating results and financial condition.
An outbreak of disease or similar public health threat (including the global coronavirus outbreak), or fear of such an event, could have a material adverse impact on the Company's business, financial condition and operating results. Potential financial impacts associated with the actual or feared occurrence of such an event include, but are not limited to, (i) lower net sales in markets affected by the actual or potential outbreak, whether due to reductions in store traffic and customer demand, labor shortages, or both, (ii) lower net sales caused by the delay of inventory production and fulfillment, (iii) and potential incremental costs associated with mitigating the effects of such an actual or potential event, including increased freight and logistics costs and other expenses.
The spread of COVID-19 has caused public health officials to recommend, and in some cases mandate, precautions to mitigate the spread of the virus, especially when congregating in heavily populated areas, such as malls and shopping centers. We temporarily closed all Cato, Its Fashion, Its Fashion Metro and Versona stores for an expected period of two weeks beginning March 19, 2020. There is significant uncertainty around the duration, breadth and severity of these store closures and other business disruptions related to COVID-19, as well as its impact on the global and U.S. economy, consumer willingness to visit malls and shopping centers, and appropriate associate staffing levels for our stores once they re-open. The extent to which COVID-19 impacts our results will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of COVID-19 and the actions taken to contain it or treat its impact. We are also unable to predict the outcome or effect of national, state or local legislation that attempts to address the economic effects of COVID-19 on our customers, suppliers or the Company.
We currently believe our first quarter results of operations will be negatively impacted by these developments. Given the many uncertainties and far reaching consequences of potential developments, we cannot assure that the COVID-19 outbreak and the many related impacts will not require extended or additional store closures and other disruptions to our business or will not materially and adversely affect our business, results of operations and financial condition in the first quarter of fiscal 2020 and beyond.
Unusual weather, natural disasters, public health threats or similar events may adversely affect our sales or operations.
Extreme changes in weather, natural disasters, public health threats or similar events can influence customer trends and shopping habits. For example, heavy rainfall or other extreme weather conditions over a prolonged period might make it difficult for our customers to travel to our stores and thereby reduce our sales and profitability. Our business is also susceptible to unseasonable weather conditions. For example, extended periods of unseasonably warm temperatures during the winter season or cool weather during the summer season could render a portion of our inventory incompatible with those unseasonable conditions. Reduced sales from extreme or prolonged unseasonable weather conditions would adversely affect our business. The occurrence or threat of extreme weather, natural disasters, power outages, terrorist acts, outbreaks of flu or other communicable diseases (such as the global coronavirus) or other catastrophic events could reduce customer traffic in our stores and likewise disrupt our ability to conduct operations, which could materially and adversely affect us.
Because we source a significant portion of our merchandise directly and indirectly from overseas, we are subject to risks associated with international operations and risks that affect the prevailing social, economic, political, public health and other conditions in the areas from which we source merchandise; changes, disruptions, cost changes or other problems affecting the Company’s merchandise supply chain could materially and adversely affect the Company’s business, results of operations and financial condition.
A significant amount of our merchandise is manufactured overseas, principally in East Asia. We directly import some of this merchandise and indirectly import the remaining merchandise from domestic vendors who acquire the merchandise from foreign sources. Further, our third-party vendors are dependent on materials primarily sourced from China. As a result, political unrest, labor disputes, terrorism, public health threats, including but not limited to communicable diseases (such as the global coronavirus), financial or other forms of instability or other events resulting in the disruption of trade from countries affecting our supply chain, increased security requirements for imported merchandise, or the imposition of, or changes in, laws, regulations or changes in duties, quotas, tariffs, taxes or governmental policies regarding these matters or other factors affecting the availability or cost of imports, could cause significant delays or interruptions in the supply of our merchandise or increase our costs. Our costs are also affected by currency fluctuations, and changes in the value of the dollar relative to foreign currencies may increase our cost of goods sold. Any of these factors could have a material adverse effect on our business and results of operations. In addition, increased energy and transportation costs have caused us significant cost increases from time to time, and future adverse changes in these costs or the disruption of the means by which merchandise is transported to us could cause additional cost increases or interruptions of our supply chain which could be significant. Further, we are subject to increased costs or potential disruptions impacting any port or trade route through which our products move or we may be subject to increased costs and delays if forced to route freight through different ports than the ones through which our products typically move. If we are forced to source merchandise from other countries or other domestic vendors with foreign sources in different countries, those goods may be more expensive or of a different or inferior quality from the ones we now sell.
The inability of third-party vendors to produce goods on time and to the Company’s specification may adversely affect the Company’s business, results of operations and financial condition.
Our dependence on third-party vendors to manufacture and supply our merchandise subjects us to numerous risks that our vendors will fail to perform as we expect. For example, the deterioration in any of our key vendors’ financial condition, their failure to ship merchandise in a timely manner that meets our specifications, or other failures to follow our vendor guidelines or comply with applicable laws and regulations, including compliant labor, environmental practices and product safety, could expose us to operational, quality, competitive, reputational and legal risks. If we are not able to timely or adequately replace the merchandise we currently source with merchandise produced elsewhere, or if our vendors fail to perform as we expect, our business, results of operations and financial condition could be adversely
affected. Activities conducted by us or on our behalf outside the United States further subject us to numerous U.S. and international regulations and compliance risks, as discussed below under “Our business operations subject us to legal compliance and litigation risks, as well as regulations and regulatory enforcement priorities, which could result in increased costs or liabilities, divert our management’s attention or otherwise adversely affect our business, results of operations and financial condition.”
Our ability to attract consumers and grow our revenues is dependent on the success of our store location strategy and our ability to successfully open new stores as planned.
Our sales are dependent in part on the location of our stores in shopping centers where we believe our consumers and potential consumers shop. In addition, our ability to grow our revenues has been substantially dependent on our ability to secure space for and open new stores in attractive locations. Shopping Centers where we currently operate existing stores or seek to open new stores may be adversely affected by, among other things, general economic downturns or those particularly affecting the commercial real estate industry, the closing of anchor stores, changes in tenant mix and changes in customer shopping preferences. To take advantage of consumer traffic and the shopping preferences of our consumers, we need to maintain and acquire stores in desirable locations where competition for suitable store locations is intense. A decline in customer popularity of the strip shopping centers where we generally locate our stores or in availability of space in desirable centers and locations, or an increase in the cost of such desired space, limiting our ability to open new stores, could adversely affect consumer traffic and reduce our sales and net earnings or increase our operating costs.
Our ability to open and operate new stores depends on many factors, some of which are beyond our control. These factors include, but are not limited to, our ability to identify suitable store locations, negotiate acceptable lease terms, secure necessary governmental permits and approvals and hire and train appropriate store personnel. In addition, our continued expansion into new regions of the country where we have not done business before may present new challenges in competition, distribution and merchandising as we enter these new markets. Our failure to successfully and timely execute our plans for opening new stores or the failure of these stores to perform up to our expectations could adversely affect our business, results of operations and financial condition.
If we are unable to anticipate, identify and respond to rapidly changing fashion trends and customer demands in a timely manner, our business and results of operations could materially suffer.
Customer tastes and fashion trends, particularly for women’s apparel, are volatile, tend to change rapidly and cannot be predicted with certainty. Our success depends in part upon our ability to consistently anticipate, design and respond to changing merchandise trends and consumer preferences in a timely manner. Accordingly, any failure by us to anticipate, identify, design and respond to changing fashion trends could adversely affect consumer acceptance of our merchandise, which in turn could adversely affect our business, results of operations and our image with our customers. If we miscalculate either the market for our merchandise or our customers’ tastes or purchasing habits, we may be required to sell a significant amount of unsold inventory at below-average markups over cost, or below cost, which would adversely affect our margins and results of operations.
Fluctuating comparable sales or our inability to effectively manage inventory may negatively impact our gross margin and our overall results of operations.
Comparable sales are expected to continue to fluctuate in the future. Factors affecting comparable sales include fashion trends, customer preferences, calendar and holiday shifts, competition, weather, actual or potential public health threats and economic conditions. In addition, merchandise must be ordered well in advance of the applicable selling season and before trends are confirmed by sales. If we are not able to accurately predict customers’ preferences for our fashion items, we may have too much inventory, which may cause excessive markdowns. If we are unable to accurately predict demand for our
merchandise, we may end up with inventory shortages, resulting in missed sales. A decrease in comparable sales or our inability to effectively manage inventory may adversely affect our gross margin and results of operations.
Existing and increased competition in the women’s retail apparel industry may negatively impact our business, results of operations, financial condition and market share.
The women’s retail apparel industry is highly competitive. We compete primarily with discount stores, mass merchandisers, department stores, off-price retailers, specialty stores and internet-based retailers, many of which have substantially greater financial, marketing and other resources than we have. Many of our competitors offer frequent promotions and reduce their selling prices. In some cases, our competitors are expanding into markets in which we have a significant market presence. In addition, our competitors also compete for the same retail store space. As a result of this competition, we may experience pricing pressures, increased marketing expenditures, increased costs to open new stores, as well as loss of market share, which could materially and adversely affect our business, results of operations and financial condition.
The operation of our sourcing offices in Asia may present increased legal and operational risks.
In October 2014, we established our own sourcing offices in Asia. Our experience with legal and regulatory practices and requirements in Asia is limited. If our sourcing offices are unable to successfully oversee merchandise production to ensure that product is produced on time and within the Company’s specifications, our business, brand, reputation, costs, results of operations and financial condition could be materially and adversely affected. Further, the activities conducted by our sourcing offices outside the United States subject us to foreign operational risks, as well as U.S. and international regulations and compliance risks, as discussed elsewhere in this “Risk Factors” section, in particular below under “Our business operations subject us to legal compliance and litigation risks, as well as regulations and regulatory enforcement priorities, which could result in increased costs or liabilities, divert our management’s attention or otherwise adversely affect our business, results of operations and financial condition.”
Any actual or perceived deterioration in the conditions that drive consumer confidence and spending may materially and adversely affect consumer demand for our apparel and accessories and our results of operations.
Consumer spending habits, including spending for our apparel and accessories, are affected by, among other things, prevailing social, economic, political and public health conditions and uncertainties (such as matters under debate in the U.S. from time to time regarding budgetary, spending and tax policies, the potential outcome of 2020 political elections in the U.S. and the impact of the global coronavirus outbreak), levels of employment, fuel, energy and food costs, salaries and wage rates and other sources of income, tax rates, home values, consumer net worth, the availability of consumer credit, consumer confidence and consumer perceptions of adverse changes in or trends affecting any of these conditions. Any perception that these conditions may be worsening or continuing to trend negatively may significantly weaken many of these drivers of consumer spending habits. Adverse perceptions of these conditions or uncertainties regarding them also generally cause consumers to defer purchases of discretionary items, such as our merchandise, or to purchase cheaper alternatives to our merchandise, all of which may also adversely affect our net sales and results of operations. In addition, numerous events, whether or not related to actual economic conditions, such as downturns in the stock markets, acts of war or terrorism, political unrest or natural disasters, outbreaks of disease or similar events, may also dampen consumer confidence, and accordingly, lead to reduced consumer spending. Any of these events could have a material adverse effect on our business, results of operations and financial condition.
Fluctuations in the price, availability and quality of inventory may result in higher cost of goods, which the Company may not be able to pass on to its customers.
Vendors are increasingly passing on higher production costs, which may impact our ability to maintain or grow our margins. The price and availability of raw materials may be impacted by demand, regulation, weather and crop yields, currency value fluctuations, as well as other factors. Additionally, manufacturers have and may continue to have increases in other manufacturing costs, such as transportation, labor and benefit costs. These increases in production costs result in higher merchandise costs to the Company. Due to the Company’s limited flexibility in price point, the Company may not be able to pass on those cost increases to the consumer, which could have a material adverse effect on our results of operations and financial condition.
A failure or disruption relating to our information technology systems could adversely affect our business.
We rely on our existing information technology systems for merchandise operations, including merchandise planning, replenishment, pricing, ordering, markdowns and product life cycle management. In addition to merchandise operations, we utilize our information technology systems for our distribution processes, as well as our financial systems, including accounts payable, general ledger, accounts receivable, sales, banking, inventory and fixed assets. Despite the precautions we take, our information systems may be vulnerable to disruption or failure from numerous events, including but not limited to, natural disasters, severe weather conditions, power outages, technical malfunctions, cyber-attacks, acts of war or terrorism, similar catastrophic events or other causes beyond our control or that we fail to anticipate. Any disruption or failure in the operation of our information technology systems, our failure to continue to upgrade or improve such systems, or the cost associated with maintaining, repairing or improving these systems, could adversely affect our business, results of operations and financial condition. Modifications and/or upgrades to our current information technology systems may also disrupt our operations.
A disruption or shutdown of our centralized distribution center or transportation network could materially and adversely affect our business and results of operations.
The distribution of our products is centralized in one distribution center in Charlotte, North Carolina and distributed through our network of third-party freight carriers. The merchandise we purchase is shipped directly to our distribution center, where it is prepared for shipment to the appropriate stores and subsequently delivered to the stores by our third-party freight carriers. If the distribution center or our third-party freight carriers were to be shut down or lose significant capacity for any reason, including but not limited to, any of the causes described under “A failure or disruption relating to our information technology systems could adversely affect our business,” our operations would likely be seriously disrupted. Such problems could occur as the result of any loss, destruction or impairment of our ability to use our distribution center, as well as any broader problem generally affecting the ability to ship goods into our distribution center or deliver goods to our stores. As a result, we could incur significantly higher costs and longer lead times associated with distributing our products to our stores during the time it takes for us to reopen or replace the distribution center and/or our transportation network. Any such occurrence could adversely affect our business, results of operations and financial condition.
Changes to accounting rules and regulations may adversely affect our reported results of operations and financial condition.
In an effort to provide greater comparability of financial reporting in an increasing global environment, accounting regulatory authorities have been in discussions for many years regarding efforts to either converge U.S. Generally Accepted Accounting Principles with International Financial Reporting Standards (“IFRS”), have U.S. companies provide supplemental IFRS-based information or continue to work toward a single set of globally accepted accounting standards. If implemented, these potential changes in accounting rules or regulations could significantly impact our future reported results of operations and financial position. Changes in accounting rules or regulations and varying interpretations of existing accounting rules and regulations have significantly affected our reported financial statements and those of other participants in the retail industry in the past and may continue to do so in the future.
For example, changes to lease accounting standards effective for the Company beginning in fiscal 2019 required the Company to capitalize operating leases in its financial statements. These changes required us to record a significant amount of lease-related assets and liabilities on our balance sheet, resulting in an increase of 40% to each of our total assets and total liabilities on our balance sheet, and required us to make other changes to the recording and classification of lease-related expenses on our statements of income and cash flows. These changes could lead to the perception by investors that we are highly leveraged and also change the calculation of numerous financial metrics and measures of our performance and financial condition. These and future changes to accounting rules or regulations may adversely affect our reported results of operations and financial position or perceptions of our performance and financial condition.
If the Company is unable to successfully integrate new businesses into its existing business, the Company’s financial condition and results of operations will be adversely affected.
The Company’s long-term business strategy includes opportunistic growth through the development of new store concepts. This growth may require significant capital expenditures and management attention. The Company may not realize any of the anticipated benefits of a new business and integration costs may exceed anticipated amounts. We have incurred substantial financial commitments and fixed costs related to our retail stores that we will not be able to recover if our stores are not successful and that could potentially result in impairment charges. If we cannot successfully execute our growth strategies, our financial condition and results of operations may be adversely impacted.
A security breach that results in unauthorized disclosure of employee, Company or customer information could adversely affect our costs, reputation and results of operations, and efforts to mitigate these risks may continue to increase our costs.
The protection of employee, Company and customer data is critical to the Company. Any security breach, mishandling, human or programming error or other event that results in the misappropriation, loss or other unauthorized disclosure of employee, Company or customer information, including but not limited to credit card data or other personally identifiable information, could severely damage the Company's reputation, expose it to remediation and other costs and the risks of legal proceedings, disrupt its operations and otherwise adversely affect the Company's business and financial condition. Despite measures the Company takes to protect confidential information, which are ongoing and may continue to increase our costs, there is no assurance that such measures will prevent the compromise of such information. The security of certain of this information also depends on the ability of third-party service providers, such as those we use to process credit and debit card payments as described below under “We are subject to payment-related risks,” to properly handle and protect such information. If any such compromise or unauthorized disclosure of this information were to occur, it could have a material adverse effect on the Company's reputation, business, operating results, financial condition and cash flows.
We are subject to payment-related risks.
We accept payments using a variety of methods, including third-party credit cards, our own branded credit cards, debit cards, gift cards and physical bank checks. For existing and future payment methods we offer to our customers, we may become subject to additional regulations and compliance requirements (including obligations to implement enhanced authentication processes that could result in increased costs and reduce the ease of use of certain payment methods), as well as fraud. For certain payment methods, including credit and debit cards, we pay interchange and other fees, which may increase over time, raising our operating costs and lowering profitability. We rely on third-party service providers for payment processing services, including the processing of credit and debit cards. In each case, it could disrupt our business if these third-party service providers become unwilling or unable to provide these services to us. We are also subject to payment card association operating rules, including data security rules, certification requirements and rules governing electronic funds transfers, which could change or be reinterpreted to
make it difficult or impossible for us to comply. If we fail to comply with these rules or requirements, or if our data security systems are breached or compromised, we may be liable for card-issuing banks’ costs, subject to fines and higher transaction fees. In addition, we may lose our ability to accept credit and debit card payments from our customers and process electronic funds transfers or facilitate other types of payments, and our business and operating results could be adversely affected.
The Company’s failure to successfully operate its e-commerce websites or fulfill customer expectations could adversely impact customer satisfaction, our reputation and our business.
Although the Company's e-commerce platform provides another channel to drive incremental sales, provide existing customers the on-line shopping experience and introduce the Company to a new customer base, it also exposes us to numerous risks. We are subject to potential failures in the efficient and uninterrupted operation of our websites, customer contact center or our distribution center, including system failures caused by telecommunication system providers, order volumes that exceed our present system capabilities, electrical outages, mechanical problems and human error. Our e-commerce platform may also expose us to greater potential for security or data breaches involving the unauthorized disclosure of customer information, as discussed above under “A security breach that results in unauthorized disclosure of employee, Company or customer information could adversely affect our costs, reputation and results of operations, and efforts to mitigate these risks may continue to increase our costs.” We are also subject to risk related to delays or failures in the performance of third parties, such as shipping companies, including delays associated with labor strikes or slowdowns or adverse weather conditions. If the Company does not successfully meet the challenges of operating e-commerce websites or fulfilling customer expectations, the Company's business and sales could be adversely affected.
Adverse litigation matters may adversely affect our business and our financial condition.
From time to time the Company is involved in litigation and other claims against our business. Primarily these arise from our normal course of business but are subject to risks and uncertainties, and could require significant management time. The Company’s periodic evaluation of litigation-related matters may change our assessment in light of the discovery of facts with respect to legal actions pending against us, not presently known to us or by determination of judges, juries or other finders of fact. We may also be subjected to legal matters not yet known to us. Adverse decisions or settlements of disputes may negatively impact our business, reputation and financial condition.
Failure to attract, train, and retain skilled personnel could adversely affect our business and our financial condition.
Like most retailers, we experience significant associate turnover rates, particularly among store sales associates and managers. Because our continued store growth will require the hiring and training of new associates, we must continually attract, hire and train new store associates to meet our staffing needs. A significant increase in the turnover rate among our store sales associates and managers would increase our recruiting and training costs, as well as possibly cause a decrease in our store operating efficiency and productivity. We compete for qualified store associates, as well as experienced management personnel, with other companies in our industry or other industries, many of whom have greater financial resources than we do.
In addition, we depend on key management personnel to oversee the operational divisions of the Company for the support of our existing business and future expansion. The success of executing our business strategy depends in large part on retaining key management. We compete for key management personnel with other retailers, and our inability to attract and retain qualified personnel could limit our ability to continue to grow.
If we are unable to retain our key management and store associates or attract, train, or retain other skilled personnel in the future, we may not be able to service our customers effectively or execute our business strategy, which could adversely affect our business, operating results and financial condition.
Our business operations subject us to legal compliance and litigation risks, as well as regulations and regulatory enforcement priorities, which could result in increased costs or liabilities, divert our management’s attention or otherwise adversely affect our business, results of operations and financial condition.
Our operations are subject to federal, state and local laws, rules and regulations, as well as U.S. and foreign laws and regulations relating to our activities in foreign countries from which we source our merchandise and operate our sourcing offices. Our business is also subject to regulatory and litigation risk in all of these jurisdictions, including foreign jurisdictions that may lack well-established or reliable legal systems for resolving legal disputes. Compliance risks and litigation claims have arisen and may continue to arise in the ordinary course of our business and include, among other issues, intellectual property issues, employment issues, commercial disputes, product-oriented matters, tax, customer relations and personal injury claims. International activities subject us to numerous U.S. and international regulations, including but not limited to, restrictions on trade, license and permit requirements, import and export license requirements, privacy and data protection laws, environmental laws, records and information management regulations, tariffs and taxes and anti-corruption laws, such as the Foreign Corrupt Practices Act, violations of which by employees or persons acting on the Company’s behalf may result in significant investigation costs, severe criminal or civil sanctions and reputational harm. These and other liabilities to which we may be subject could negatively affect our business, operating results and financial condition. These matters frequently raise complex factual and legal issues, which are subject to risks and uncertainties and could divert significant management time. The Company may also be subject to regulatory review and audits, which results may have the potential to materially and adversely affect our business, results of operations and financial condition. In addition, governing laws, rules and regulations, and interpretations of existing laws are subject to change from time to time. Compliance and litigation matters could result in unexpected expenses and liability, as well as have an adverse effect on our operations and our reputation.
New legislation or regulation and interpretation of existing laws and regulations related to data privacy could increase our costs of compliance, technology and business operations. The interpretation of existing or new laws to existing technology and practices can be uncertain and may lead to additional compliance risk and cost.
If we fail to protect our trademarks and other intellectual property rights or infringe the intellectual property rights of others, our business, brand image, growth strategy, results of operations and financial condition could be adversely affected.
We believe that our “Cato”, “It’s Fashion”, “It’s Fashion Metro” and “Versona” trademarks are integral to our store designs, brand recognition and our ability to successfully build consumer loyalty. Although we have registered these trademarks with the U.S. Patent and Trademark Office (“PTO”) and have also registered, or applied for registration of, additional trademarks with the PTO that we believe are important to our business, we cannot assure that these registrations will prevent imitation of our trademarks, merchandising concepts, store designs or private label merchandise or the infringement of our other intellectual property rights by others. Infringement of our names, concepts, store designs or merchandise generally, or particularly in a manner that projects lesser quality or carries a negative connotation of our image could adversely affect our business, financial condition and results of operations.
In addition, we cannot assure that others will not try to block the manufacture or sale of our private label merchandise by claiming that our merchandise violates their trademarks or other proprietary rights. In the event of such a conflict, we could be subject to lawsuits or other actions, the ultimate resolution of
which we cannot predict; however, such a controversy could adversely affect our business, financial condition and results of operations.
We may experience market conditions that could adversely impact the valuation and liquidity of, and our ability to access, our short-term investments and cash and cash equivalents.
Our short-term investments and cash equivalents are primarily comprised of investments in federal, state, municipal and corporate debt securities. The value of those securities may be impacted by factors beyond our control, such as changes to credit ratings, rates of default, collateral value, discount rates, and strength and quality of market credit and liquidity, and changes in the underlying economic, financial and other conditions that drive these factors. As federal, state and municipal entities struggle with declining tax revenues and budget deficits, we cannot be assured of our ability to timely access these investments if the market for these issues declines. Similarly, the default by issuers could adversely affect our financial condition, results of operations and ability to execute our business strategy. In addition, we have significant amounts of cash and cash equivalents at financial institutions that are in excess of the federally insured limits. An economic downturn or development of adverse conditions affecting the financial sector and stability of financial institutions could cause us to experience losses on our deposits.
Our ability to access credit markets and our revolving line of credit may be impacted by factors beyond our control such as changes in credit rating and collateral, as well as potential disruptions in the Capital markets. This may adversely affect our results of operation and our ability to execute our business strategy. Similarly, our ability to access credit markets at favorable terms could be adversely impacted due to changes in credit ratings, collateral and potential disruptions in the Capital markets. This may adversely affect our financial condition, results of operations and our ability to execute our business strategy.
Maintaining and improving our internal control over financial reporting and other requirements necessary to operate as a public company may strain our resources, and any material failure in these controls may negatively impact our business, the price of our common stock and market confidence in our reported financial information.
As a public company, we are subject to the reporting requirements of the Securities Exchange Act of 1934, the Sarbanes-Oxley Act of 2002, the rules of the SEC and New York Stock Exchange and certain aspects of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and related rule-making that has been and may continue to be implemented over the next several years under the mandates of the Dodd-Frank Act. The requirements of these rules and regulations have, and may continue to, increase our compliance costs and place significant strain on our personnel, systems and resources. To satisfy the SEC’s rules implementing the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, we must continue to document, test, monitor and enhance our internal control over financial reporting, which is a costly and time-consuming effort that must be re-evaluated frequently. We cannot give assurance that our disclosure controls and procedures and our internal control over financial reporting, as defined by applicable SEC rules, will be adequate in the future. Any failure to maintain the effectiveness of internal control over financial reporting or to comply with the other various laws and regulations to which we are and will continue to be subject, or to which we may become subject in the future, as a public company could have an adverse material impact on our business, our financial condition and the price of our common stock. In addition, our efforts to comply with these requirements, particularly with new requirements under the Dodd-Frank Act that have yet to be implemented, could significantly increase our compliance costs.
Risks Relating To The Market Value Of Our Common Stock:
Our operating results are subject to seasonal and quarterly fluctuations, which could adversely affect the market price of our common stock.
Our business varies with general seasonal trends that are characteristic of the retail apparel industry. As a result, our stores typically generate a higher percentage of our annual net sales and profitability in the first and second quarters of our fiscal year compared to other quarters. Accordingly, our operating results for any one fiscal period are not necessarily indicative of results to be expected from any future period, and such seasonal and quarterly fluctuations could adversely affect the market price of our common stock.
The interests of a principal shareholder may limit the ability of other shareholders to influence the direction of the Company.
As of March 27, 2020, John P. D. Cato, Chairman, President and Chief Executive Officer, beneficially controlled approximately 46.1% of the voting power of our common stock. As a result, Mr. Cato may be able to control or significantly influence substantially all matters requiring approval by the shareholders, including the election of directors and the approval of mergers and other business combinations or other significant Company transactions. Mr. Cato may have interests that differ from those of other shareholders, and may vote in a way with which other shareholders disagree or perceive as adverse to their interests. In addition, the concentration of voting power held by Mr. Cato could have the effect of preventing, discouraging or deferring a change in control of the Company, which could depress the market price of our common stock.
Conditions in the stock market generally, or particularly relating to our industry, Company or common stock, may materially and adversely affect the market price of our common stock and make its trading price more volatile.
The trading price of our common stock at times has been, and is likely to continue to be, subject to significant volatility. A variety of factors may cause the price of the common stock to fluctuate, perhaps substantially, including, but not limited to, those discussed elsewhere in this report, as well as the following: low trading volume; general market fluctuations resulting from factors not directly related to our operations or the inherent value of our common stock; announcements of developments related to our business; fluctuations in our reported operating results; general conditions or trends affecting or perceived to affect the fashion and retail industry; conditions or trends affecting or perceived to affect the domestic or global economy or the domestic or global credit or capital markets; changes in financial estimates or the scope of coverage given to our Company by securities analysts; negative commentary regarding our Company and corresponding short-selling market behavior; adverse customer relations developments; significant changes in our senior management team; and legal proceedings. Over the past several years the stock market in general, and the market for shares of equity securities of many retailers in particular, have experienced extreme price fluctuations that have at times been unrelated to the operating performance of those companies. Such fluctuations and market volatility based on these or other factors may materially and adversely affect the market price of our common stock.
Item 1B.
Item 1B. Unresolved Staff Comments:
None.
Item 2.
Item 2. Properties:
The Company’s distribution center and general offices are located in a Company-owned building of approximately 552,000 square feet located on a 15-acre tract in Charlotte, North Carolina. The Company’s automated merchandise handling and distribution activities occupy approximately 418,000 square feet of this building and its general offices and corporate training center are located in the remaining 134,000 square feet. A building of approximately 24,000 square feet located on a 2-acre tract adjacent to the Company’s existing location is used for receiving and distribution of store and office operating supplies. The Company also owns approximately 185 acres of land in York County, South Carolina as a potential new site for our distribution center.
Item 3.
Item 3. Legal Proceedings:
From time to time, claims are asserted against the Company arising out of operations in the ordinary
course of business. The Company currently is not a party to any pending litigation that it believes is likely to have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Item 3A. Executive Officers of the Registrant:
The executive officers of the Company and their ages as of March 27, 2020 are as follows:
Name
Age
Position
John P. D. Cato
Chairman, President and Chief Executive Officer
John R. Howe
Executive Vice President, Chief Financial Officer
Michael T. Greer
Executive Vice President, Director of Stores
Gordon Smith
Executive Vice President, Chief Real Estate and
Store Development Officer
John P. D. Cato has been employed as an officer of the Company since 1981 and has been a director of the Company since 1986. Since January 2004, he has served as Chairman, President and Chief Executive Officer. From May 1999 to January 2004, he served as President, Vice Chairman of the Board and Chief Executive Officer. From June 1997 to May 1999, he served as President, Vice Chairman of the Board and Chief Operating Officer. From August 1996 to June 1997, he served as Vice Chairman of the Board and Chief Operating Officer. From 1989 to 1996, he managed the Company’s off-price concept, serving as Executive Vice President and as President and General Manager of the It’s Fashion concept from 1993 to August 1996. Mr. Cato is a former director of Harris Teeter Supermarkets, Inc., formerly Ruddick Corporation.
John R. Howe has been employed by the Company since 1986. Since September 2008, he has served as Executive Vice President, Chief Financial Officer. From June 2007 until September 2008, he served as Senior Vice President, Controller. From 1999 to 2007, he served as Vice President, Assistant Controller. From 1997 to 1999, he served as Assistant Vice President, Budgets and Planning. From 1995 to 1997, he served as Director, Budgets and Planning. From 1990 to 1995, he served as Assistant Tax Manager. From 1986 to 1990, Mr. Howe held various positions within the finance area.
Michael T. Greer has been employed by the Company since 1985. Since May 2006, he has served as Executive Vice President, Director of Stores of the Company. From November 2004 until May 2006, he served as Senior Vice President, Director of Stores of the Company. From February 2004 until November 2004, he served as Senior Vice President, Director of Stores of the Cato concept. From 2002 to 2003 Mr. Greer served as Vice President, Director of Stores of the It’s Fashion concept. From 1999 to 2001 he served as Territorial Vice President of Stores of the Cato concept and from 1996 to 1999 he served as Regional Vice President of Stores of the Cato concept. From 1985 to 1995, Mr. Greer held various store operational positions in the Cato concept.
Gordon Smith has been employed by the Company since 1989. Since July 2011, he has served as Executive Vice President, Chief Real Estate and Store Development Officer. From February 2008 until July 2011 Mr. Smith served as Senior Vice President, Real Estate. From October 1989 to February 2008, Mr. Smith served as Assistant Vice President, Corporate Real Estate.
Item 4.
Item 4. Mine Safety Disclosures:
No matters requiring disclosure.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities:
Market & Dividend Information
The Company’s Class A Common Stock trades on the New York Stock Exchange (“NYSE”) under the symbol CATO.
As of March 27, 2020, the approximate number of record holders of the Company’s Class A Common Stock was 5,000 and there were 2 record holders of the Company’s Class B Common Stock.
Stock Performance Graph
The following graph compares the yearly change in the Company’s cumulative total shareholder return on the Company’s Common Stock (which includes Class A Stock and Class B Stock) for each of the Company’s last five fiscal years with (i), the Dow Jones U.S. Retailers, Apparel Index and (ii) the Russell 2000 Index.
THE CATO CORPORATION
STOCK PERFOMANCE TABLE
(BASE 100 - IN DOLLARS)
LAST TRADING DAY OF THE FISCAL YEAR
THE CATO CORPORATION
DOW JONES U.S. RETAILERS, APPL INDEX
RUSSELL 2000
INDEX
1/30/2015
1/29/2016
1/27/2017
2/2/2018
2/1/2019
1/31/2020
The graph assumes an initial investment of $100 on January 30, 2015, the last trading day prior to the commencement of the Company’s 2015 fiscal year, and that all dividends were reinvested.
Issuer Purchases of Equity Securities
The following table summarizes the Company’s purchases of its common stock for the three months ended February 1, 2020:
(1) Prices include trading costs.
(2) During the fourth quarter ended February 1, 2020, the Company repurchased and retired 335,100 shares under this program for approximately $5,390,314 or an average market price of $16.09 per share. As of the fourth quarter ended February 1, 2020, the Company had 1,346,522 shares remaining in open authorizations. There is no specified expiration date for the Company’s repurchase program.
Item 6.
Item 6. Selected Financial Data:
Certain selected financial data for the five fiscal years ended February 1, 2020 have been derived
from the Company’s audited financial statements. The financial statements and Independent Registered Public Accounting Firm’s integrated audit reports for the most recent fiscal years are contained elsewhere in this report. All data set forth below are qualified by reference to, and should be read in conjunction with, the Company’s Consolidated Financial Statements (including the Notes thereto) and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this annual report.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations:
COVID-19 Update
The spread of COVID-19 has caused public health officials to recommend, and in some cases mandate, precautions to mitigate the spread of the virus, especially when congregating in heavily populated areas, such as malls and shopping centers. Responses by customers, government and the private sector may adversely impact our business operations. At this time, it is impossible to predict the impact of the COVID-19 pandemic as this unprecedented situation continues to evolve rapidly.
The Company temporarily closed all Cato, Its Fashion, Its Fashion Metro and Versona stores for an expected period of two weeks beginning March 19, 2020. There is significant uncertainty around the duration, breadth and severity of these store closures and other 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 once they re-open. The Company is also unable to predict the outcome or effect of national, state or local legislation that attempts to address the economic effects of COVID-19 on our customers, suppliers or the Company.
The Company continues to assess the potential impact of COVID-19, which remains uncertain and fluid at this time. Primarily in response to potential disruption in the Capital markets, the Company drew $30 million on its $35 million line of credit on March 16, 2020. The additional $30 million enhances the Company’s liquidity position with over $200 million of cash and short-term investments.
While the Company currently anticipates that our future results, primarily the first quarter of 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 and cannot be predicted, including new information which may emerge concerning the severity of COVID-19 and the actions taken to contain it or mitigate its impact.
Fiscal 2019 Compared to Fiscal 2018
Retail sales decreased by 0.6% to $816.2 million in fiscal 2019 compared to $821.1 million in fiscal 2018. The decrease in retail sales in fiscal 2019 was largely attributable to closed stores, partially offset by a 2% increase in same-store sales. 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. In fiscal 2019 and fiscal 2018, e-commerce sales were less than 3% of total sales and same-store sales. 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, gift card breakage, shipping charges for e-commerce purchases and layaway fees), decreased by 0.5% to $825.3 million in fiscal 2019 compared to $829.7 million in fiscal 2018. The Company operated 1,281 stores at February 1, 2020 compared to 1,311 stores operated at February 2, 2019.
In fiscal 2019, the Company opened five new stores and closed 35 stores.
Other revenue in total increased to $9.2 million in fiscal 2019 from $8.6 million in fiscal 2018. The increase resulted primarily from increased shipping charges for e-commerce purchases and an increase in gift card breakage income, partially offset by lower finance charges.
Credit revenue of $3.6 million represented 0.4% of total revenue in fiscal 2019, a $0.2 million decrease compared to fiscal 2018 credit revenue of $3.8 million or 0.5% of total revenue. The 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 payroll, postage and other administrative expenses and totaled $1.8 million in fiscal 2019 compared to $1.9 million in fiscal 2018. See Note 14 of Notes to Consolidated Financial Statements for a schedule of credit-related expenses. Total credit segment income before taxes decreased $0.1 million to $1.8 million in fiscal 2019 from $1.9 million in fiscal 2018. Total credit income of $1.8 million in fiscal 2019 represented 4.2% of total income before taxes of $43.2 million compared to total credit income of $1.9 million in fiscal 2018, which represented 5.7% of fiscal 2018 total income before taxes of $33.1 million.
Cost of goods sold was $508.9 million, or 62.4% of retail sales, in fiscal 2019 compared to $522.5 million, or 63.6% of retail sales, in fiscal 2018. The decrease in cost of goods sold as a percentage of sales resulted primarily from higher penetration of regular price sales. 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) increased by 2.9% to $307.3 million in fiscal 2019 from $298.6 million in fiscal 2018. 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 $263.8 million in fiscal 2019 compared to $262.6 million in fiscal 2018, an increase of 0.5%. As a percent of retail sales, SG&A was 32.3% compared to 32.0% in the prior year. The increase in SG&A as a percent of sales resulted primarily from an increase in incentive compensation, partially offset by lower insurance costs and lower store impairment charges.
Depreciation expense was $15.5 million in fiscal 2019 compared to $16.5 million in fiscal 2018. Depreciation expense decreased from fiscal 2018 due to fully depreciated older stores and previous impairments of leasehold improvements and fixtures, partially offset by store development and information technology expenditures.
Interest and other income increased to $6.1 million in fiscal 2019 compared to $5.0 million in fiscal 2018. The increase is primarily due to an increase in interest income due to more short-term investments.
Income tax expense was $7.3 million, or 0.9% of retail sales in fiscal 2019 compared to $2.6 million, or 0.3% of retail sales in fiscal 2018. The dollar increase resulted primarily from higher pre-tax earnings, more taxable interest income, more non-deductible IRS section 162(m) compensation and a valuation allowance to reduce deferred tax assets associated with state income tax credits. The effective tax rate was 16.9% in fiscal 2019 compared to 7.8% in fiscal 2018. See Note 12 to the Consolidated Financial Statements, “Income Taxes,” for further details.
Fiscal 2018 Compared to Fiscal 2017
Retail sales decreased by 2.5% to $821.1 million in fiscal 2018 compared to $842.0 million in fiscal 2017. The decrease in retail sales in fiscal 2018 was largely attributable to flat same-store sales, non-comparable store sales and an additional week of sales in 2017. Fiscal 2018 had 52 weeks versus 53 weeks in fiscal 2017. 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. In fiscal 2018 and fiscal 2017, e-commerce sales were less than 3% of total sales and same-store sales. 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, gift card breakage and layaway fees), decreased by 2.4% to $829.7 million in fiscal 2018 compared to $850.0 million in fiscal 2017. The Company operated 1,311 stores at February 2, 2019 compared to 1,351 stores operated at February 3, 2018.
In fiscal 2018, the Company relocated one store and closed 40 stores.
Other revenue in total increased to $8.6 million in fiscal 2018 from $8.0 million in fiscal 2017. The increase resulted primarily from increased shipping charges for e-commerce purchases and gift card breakage being classified in other revenue due to the adoption of ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“Topic 606”), partially offset by lower finance charges and lower layaway charges.
Credit revenue of $3.8 million represented 0.5% of total revenue in fiscal 2018, a $0.4 million decrease compared to fiscal 2017 credit revenue of $4.2 million or 0.5% of total revenue. The 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 $1.9 million in fiscal 2018 compared to $3.0 million in fiscal 2017. See Note 14 of Notes to Consolidated Financial Statements for a schedule of credit-related expenses. Total credit segment income before taxes increased $0.7 million to $1.9 million in fiscal 2018 from $1.2 million in fiscal 2017 due to bad debt expense being included in retail sales in fiscal 2018, in accordance with Topic 606, partially offset by lower credit revenue. Total credit income of $1.9 million in fiscal 2018 represented 5.7% of total income before taxes of $33.1 million compared to total credit income of $1.2 million in fiscal 2017, which represented 7.5% of fiscal 2017 total income before taxes of $16.0 million.
Cost of goods sold was $522.5 million, or 63.6% of retail sales, in fiscal 2018 compared to $553.1 million, or 65.7% of retail sales, in fiscal 2017. The decrease in cost of goods sold as a percentage of sales resulted primarily from increased sales of regular priced product and decreased 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 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) increased by 3.3% to $298.6 million in fiscal 2018 from $288.9 million in fiscal 2017. 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 $262.6 million in fiscal 2018 compared to $266.4 million in fiscal 2017, a decrease of 1.4%. As a percent of retail sales, SG&A was 32.0% compared to 31.6% in the prior year. The increase in SG&A as a percent of sales resulted primarily from an increase in incentive bonuses, partially offset by lower impairment expenses, professional fees and litigation.
Asset impairment charges decreased to $1,548,000 in fiscal 2018 compared to $7,698,000 in fiscal 2017
due to fewer stores being impaired in 2018 and a lower average impairment per store. The impairment charges are related to lower estimated future cash flows resulting from significantly lower sales and income. See Note 1 to the Consolidated Financial Statements for further discussion.
Depreciation expense was $16.5 million in fiscal 2018 compared to $19.6 million in fiscal 2017. Depreciation expense decreased from fiscal 2017 due to older stores and previous impairments of leasehold improvements and fixtures, partially offset by store development and information technology expenditures.
Interest and other income decreased slightly to $5.0 million in fiscal 2018 compared to $5.1 million in fiscal 2017. The decrease is primarily attributable to classifying gift card breakage in Other Revenue in 2018 due to the adoption of Topic 606.
Income tax expense was $2.6 million, or 0.3% of retail sales in fiscal 2018 compared to $7.4 million, or 0.9% of retail sales in fiscal 2017. The dollar decrease resulted primarily from one-time tax expenses in 2017 resulting from the 2017 Tax Cut and Jobs Act (the “Tax Act”) for the deemed repatriation tax and reduction of the net deferred tax assets to reflect the reduction of the U.S. statutory rate, partially offset by higher pre-tax income. The SEC Staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act. We recognized the provisional tax impacts related to deemed repatriated earnings and revaluation of our deferred tax assets, and included those amounts in our Consolidated Financial Statements for the year ended February 3, 2018. As of February 2, 2019, the accounting for income tax effects of the Tax Act has been completed. The effective tax rate was 7.8% in fiscal 2018 compared to 46.5% in fiscal 2017. See Note 12 to the Consolidated Financial Statements, “Income Taxes,” for further details.
Off-Balance Sheet Arrangements
None.
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 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 net realizable value. 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
In 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Codification (“ASC”) 842 - Leases, with amendments issued in 2018. The guidance requires lessees to recognize most leases on the balance sheet but does not change the manner in which expenses are recorded in the income statement. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases.
The Company adopted ASC 842 utilizing the modified retrospective approach as of February 3, 2019. The modified retrospective approach the Company selected provides a method of transition allowing recognition of existing leases as of the beginning of the period of adoption (i.e., February 3, 2019), and which does not require the adjustment of comparative periods. The adoption had a material impact on the Company’s financial statements, resulting in an increase of 40% to each of its total assets and total liabilities on its balance sheet, but had no impact to retained earnings as of the beginning of 2019. See Note 11 for further information.
The Company elected the transition package of practical expedients that is permitted by the standard. The package of practical expedients allows the Company to not reassess previous accounting conclusions regarding whether existing arrangements are or contain leases, the classification of existing leases, and the treatment of initial direct costs. The Company did not elect the hindsight transition practical expedient allowed for by the new standard, which allows entities to use hindsight when determining lease term and impairment of right-of-use assets.
Impairment of Long-Lived Assets
The Company invests in leaseholds, right-of-use assets and equipment primarily 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 long-lived assets, which primarily relate to Fixtures and equipment, Leasehold improvements, Right-of-use assets net of Lease liabilities and Information technology equipment and software. An impairment charge is recorded for the amount by which the carrying value exceeds the estimated fair value when the Company determines that projected cash flows associated with those long-lived 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 projected cash flows, which include future sales growth projections. The Company assesses the fair value of each lease by considering market rents and any lease terms that may adjust market rents under certain conditions such as the loss of an anchor tenant or a leased space in a shopping center not meeting certain criteria. Further, in determining when to close a store, the Company considers real estate development in the area and perceived local market conditions, which can be difficult to predict and may be subject to change. In addition, the Company regularly evaluates its 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 healthcare, 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 healthcare, 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 primarily 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
The Company recognizes sales at the point of purchase when the customer takes possession of the merchandise and pays for the purchase, generally with cash or credit. Sales from purchases made with Cato credit, gift cards and layaway sales from stores are also recorded when the customer takes possession of the merchandise. E-commerce sales are recorded when the risk of loss is transferred to the customer. Gift cards are recorded as deferred revenue until they are redeemed or forfeited. Layaway sales are recorded as deferred revenue until the customer takes possession or forfeits the merchandise. Gift cards do not have expiration dates. A provision is made for estimated merchandise returns based on sales volumes and the Company’s experience; actual returns have not varied materially from historical amounts. A provision is made for estimated write-offs associated with sales made with the Company’s proprietary credit card. Amounts related to shipping and handling billed to customers in a sales transaction are classified as Other revenue and the costs related to shipping product to customers (billed and accrued) are classified as Cost of goods sold.
In accordance with Topic 606, in fiscal 2019 and 2018, the Company recognized $921,000 and $591,000, respectively, of income on unredeemed gift cards (“gift card breakage”) as a component of Other Revenue on the Consolidated Statements of Income and Comprehensive Income. Under Topic 606, the Company recognizes gift card breakage using an expected breakage percentage based on redeemed gift cards. In fiscal 2017, the Company recognized $1,380,000 of gift card breakage as a component of Other income on the Consolidated Statements of Income and Comprehensive Income. See Note 2 for further information on miscellaneous income.
The Company offers its own proprietary credit card to customers. All credit activity is performed by the Company’s wholly-owned subsidiaries. None of the credit card receivables are secured. The Company estimated uncollectible amounts of $700,000 and $897,000 for the twelve months ended
February 1, 2020 and February 2, 2019, respectively, on the Company’s proprietary credit card sales of $26.6 million and $27.4 million for the twelve months ended February 1, 2020 and February 2, 2019, respectively.
Liquidity, Capital Resources and Market Risk
The Company has consistently maintained a strong liquidity position. Cash provided by operating activities during fiscal 2019 was $53.4 million as compared to $60.2 million in fiscal 2018. 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.
Cash provided by operating activities for these periods was primarily generated by earnings adjusted for depreciation, share-based compensation and changes in working capital. The decrease of $6.8 million for fiscal 2019 compared to fiscal 2018 is primarily due to uses of cash for operating lease right-of-use assets and lease liabilities, partially offset by increased net income and accrued income taxes.
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, including store openings, dividends and other operating requirements for fiscal 2020 and for the foreseeable future.
At February 1, 2020, the Company had working capital of $163.5 million compared to $229.5 million and $233.4 million at February 2, 2019 and February 3, 2018, respectively. The decrease in working capital is primarily attributable to the adoption of ASC 842 which requires the current portion of lease liability to be recorded in current liabilities.
At February 1, 2020, the Company had an unsecured revolving credit agreement, which provided for borrowings of up to $35.0 million less the balance of any revocable letters of credit discussed below. The revolving credit agreement is committed until May 2022. 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, 2020. There were no borrowings outstanding under this credit facility as of the fiscal year ended February 1, 2020 or the fiscal year ended February 2, 2019.
The Company had no outstanding revocable letters of credit relating to purchase commitments at February 1, 2020, February 2, 2019 and February 3, 2018.
Expenditures for property and equipment totaled $8.3 million, $4.4 million and $11.1 million in fiscal 2019, 2018 and 2017, respectively. The expenditures for fiscal 2019 were primarily for investments in new technology, stores, automobile and home office improvements. In fiscal 2020, the Company is planning to invest approximately $20.0 million in capital expenditures.
Net cash used in investing activities totaled $22.6 million for fiscal 2019 compared to $71.1 million used for fiscal 2018 and $67.7 million used in fiscal 2017. In fiscal 2019, the cash used was due primarily to the purchase of short-term investments, other assets and capital expenditures, partially offset by the sale of short-term investments.
Net cash used by financing activities totaled $41.5 million compared to net cash used of $45.2 million for fiscal 2018 and $72.0 million for fiscal 2017. The decrease in cash used by financing activities was primarily due to a decrease in share repurchases.
On February 27, 2020, the Board of Directors maintained the quarterly dividend at $0.33 per share, which was paid on March 24, 2020.
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, 2020. The state, municipal and corporate bonds and asset-backed securities have contractual maturities which range from five days to 7.5 years. The U.S. Treasury Notes and Certificates of Deposit have contractual maturities which range from 1 month to 2.75 years. These securities are classified as available-for-sale and are recorded as Short-term investments, Restricted cash, Restricted short-term 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. 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 February 1, 2020, the Company had $0.7 million of corporate equities, which are recorded within Other assets in the Consolidated Balance Sheets. At February 2, 2019, the Company had $0.7 million of corporate equities, 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.
Deferred compensation plan assets consist primarily of life insurance policies. These life insurance policies are valued based on the cash surrender value of the insurance contract, which is determined based on such factors as the fair value of the underlying assets and discounted cash flow and are therefore classified within Level 3 of the valuation hierarchy. The Level 3 liability associated with the life insurance policies represents a deferred compensation obligation, the value of which is tracked via underlying insurance funds’ net asset values, as recorded in Other noncurrent liabilities in the Consolidated Balance Sheets. These funds are designed to mirror the return of existing mutual funds and money market funds that are observable and actively traded.
(1)In addition to the amounts shown in the table above, $7.9 million of unrecognized tax benefits have been recorded as liabilities in accordance with ASC 740 and we are uncertain if or when such amounts may be settled. See Note 12, Income Taxes, of the Consolidated Financial Statements for additional information.
Recent Accounting Pronouncements
See Note 1, Summary of Significant Accounting Policies, Recently Adopted Accounting Policies and Recently Issued Accounting Pronouncements.
Item 7A.
Item 7A.
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.
Item 8.
Item 8.
Financial Statements and Supplementary Data:
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of The Cato Corporation
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of The Cato Corporation and its subsidiaries (the “Company”) as of February 1, 2020 and February 2, 2019, and the related consolidated statements of income and comprehensive income, of stockholders’ equity and of cash flows for each of the three years in the period ended February 1, 2020, including the related notes and financial statement schedule in the accompanying index (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of February 1, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of February 1, 2020 and February 2, 2019, and the results of its operations and its cash flows for each of the three years in the period ended February 1, 2020 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of February 1, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Change in Accounting Principle
As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for leases as of February 3, 2019.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Charlotte, North Carolina
March 27, 2020
We have served as the Company’s auditor since 2003.
THE CATO CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND
COMPREHENSIVE INCOME
See notes to consolidated financial statements.
THE CATO CORPORATION
CONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements.
THE CATO CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
See notes to consolidated financial statements.
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies:
Principles of Consolidation: The Consolidated Financial Statements include the accounts of The Cato Corporation and its wholly-owned subsidiaries (the “Company”). All significant intercompany accounts and transactions have been eliminated.
Description of Business and Fiscal Year: The Company has two reportable segments - the operation of a fashion specialty stores segment (“Retail Segment”) and a credit card segment (“Credit Segment”). The apparel specialty stores operate under the names “Cato,” “Cato Fashions,” “Cato Plus,” “It’s Fashion,” “It’s Fashion Metro” and “Versona,” including e-commerce websites. The stores are located primarily in strip shopping centers principally in the southeastern United States. The Company’s fiscal year ends on the Saturday nearest January 31 of the subsequent year.
Use of Estimates: The preparation of the Company’s financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant accounting estimates reflected in 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.
Cash and Cash Equivalents: Cash and cash equivalents consist of highly liquid investments with original maturities of three months or less.
Short-Term Investments: Investments with original maturities beyond three months are classified as short-term investments. See Note 3 for the Company’s estimated fair value of, and other information regarding, its short-term investments. The Company’s short-term investments are all classified as available-for-sale. As they are available for current operations, they are classified on the Consolidated Balance Sheets as Current Assets. Available-for-sale securities are carried at fair value, with unrealized gains and temporary losses, net of income taxes, reported as a component of Accumulated other comprehensive income. Other than temporary declines in the fair value of investments are recorded as a reduction in the cost of the investments in the accompanying Consolidated Balance Sheets and a reduction of Interest and other income in the accompanying Consolidated Statements of Income and Comprehensive Income. The cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. The amortization of premiums, accretion of discounts and realized gains and losses are included in Interest and other income.
Restricted Cash and Restricted Short-term Investments: The Company had $3.9 million and $3.8 million in escrow at February 1, 2020 and February 2, 2019, respectively, as security and collateral for administration of the Company’s self-insured workers’ compensation and general liability coverage, which is reported as Restricted cash and Restricted short-term investments on the Consolidated Balance Sheets.
Supplemental Cash Flow Information: Income tax payments, net of refunds received, for the fiscal years ended February 1, 2020, February 2, 2019 and February 3, 2018 were a payment of $4,681,000, a refund of $407,000 and a payment of $4,356,000, respectively.
Inventories: Merchandise inventories are stated at the net realizable value as determined by the weighted-average cost method.
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Property and Equipment: Property and equipment are recorded at cost, including land. Maintenance and repairs are expensed to operations as incurred; renewals and betterments are capitalized. Depreciation is determined on the straight-line method over the estimated useful lives of the related assets excluding leasehold improvements. Leasehold improvements are amortized over the shorter of the estimated useful life or lease term. For leases with renewal periods at the Company’s option, the Company generally uses the original lease term plus reasonably assured renewal option periods (generally one five-year option period) to determine estimated useful lives. Typical estimated useful lives are as follows:
Estimated
Classification
Useful Lives
Land improvements
10 years
Buildings
30-40 years
Leasehold improvements
5-10 years
Fixtures and equipment
3-10 years
Information technology equipment and software
3-10 years
Aircraft
20 years
Impairment of Long-Lived Assets: The Company invests in leaseholds, right-of use assets and equipment primarily 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 long-lived assets, which primarily relate to Fixtures and equipment, Leasehold improvements, Right-of-use assets net of Lease liabilities and Information technology equipment and software. An impairment charge is recorded for the amount by which the carrying value exceeds the estimated fair value when the Company determines that projected cash flows associated with those long-lived 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 projected cash flows, which include future sales growth projections. The Company assesses the fair value of each lease by considering market rents and any lease terms that may adjust market rents under certain conditions such as the loss of an anchor tenant or a leased space in a shopping center not meeting certain criteria. Further, in determining when to close a store, the Company considers real estate development in the area and perceived local market conditions, which can be difficult to predict and may be subject to change. Asset impairment charges of $146,000, $1,548,000 and $7,698,000 were incurred in fiscal 2019, fiscal 2018 and fiscal 2017, respectively. In addition, the Company regularly evaluates its 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. In 2019, the Company impaired the remaining book value related to an investment in a solar partnership.
Other Assets: Other assets are comprised of long-term assets, primarily insurance contracts related to deferred compensation assets and land held for investment purposes.
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Leases: In 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Codification (“ASC”) 842 - Leases, with amendments issued in 2018. The guidance requires lessees to recognize most leases on the balance sheet but does not change the manner in which expenses are recorded in the income statement. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases.
The Company utilized a comprehensive approach to assess the impact of this guidance on its financial statements and related disclosures, including the increase in the assets and liabilities on its balance sheet and the impact on its current lease portfolio from a lessee perspective. The Company completed its comprehensive review of its lease portfolio, which includes mostly store leases impacted by the new guidance. The Company reviewed its internal controls over leases and, as a result, the Company enhanced these controls; however, these changes are not considered material. In addition, the Company implemented a new software platform, and corresponding controls, for administering its leases and facilitating compliance with the new guidance.
The Company elected the transition package of practical expedients that is permitted by the standard. The package of practical expedients allows the Company to not reassess previous accounting conclusions regarding whether existing arrangements are or contain leases, the classification of existing leases, and the treatment of initial direct costs. The Company did not elect the hindsight transition practical expedient allowed for by the new standard, which allows entities to use hindsight when determining lease term and impairment of right-of-use assets.
The Company adopted ASC 842 utilizing the modified retrospective approach as of February 3, 2019. The modified retrospective approach the Company selected provides a method of transition allowing recognition of existing leases as of the beginning of the period of adoption (i.e., February 3, 2019), and which does not require the adjustment of comparative periods. The adoption had a material impact on the Company’s financial statements, resulting in an increase of 40% to each of its total assets and total liabilities on its balance sheet, but had no impact to retained earnings as of the beginning of 2019. See Note 11 for further information.
The Company determines the classification of leases consistent with ASC 840 - Leases for fiscal years 2018 and 2017. The Company leases all of its retail stores. Most lease agreements contain construction allowances and rent escalations. For purposes of recognizing incentives and minimum rental expenses on a straight-line basis over the terms of the leases, including renewal periods considered reasonably assured, the Company begins amortization as of the initial possession date which is when the Company enters the space and begins to make improvements in preparation for intended use.
Revenue Recognition: The Company recognizes sales at the point of purchase when the customer takes possession of the merchandise and pays for the purchase, generally with cash or credit. Sales from
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
purchases made with Cato credit, gift cards and layaway sales from stores are also recorded when the customer takes possession of the merchandise. E-commerce sales are recorded when the risk of loss is transferred to the customer. Gift cards are recorded as deferred revenue until they are redeemed or forfeited. Layaway sales are recorded as deferred revenue until the customer takes possession or forfeits the merchandise. Gift cards do not have expiration dates. A provision is made for estimated merchandise returns based on sales volumes and the Company’s experience; actual returns have not varied materially from historical amounts. A provision is made for estimated write-offs associated with sales made with the Company’s proprietary credit card. Amounts related to shipping and handling billed to customers in a sales transaction are classified as Other revenue and the costs related to shipping product to customers (billed and accrued) are classified as Cost of goods sold.
In accordance with ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“Topic 606”), in fiscal 2019 and 2018, the Company recognized $921,000 and $591,000, respectively, of income on unredeemed gift cards (“gift card breakage”) as a component of Other Revenue on the Consolidated Statements of Income and Comprehensive Income. Under Topic 606, the Company recognizes gift card breakage using an expected breakage percentage based on redeemed gift cards. In fiscal 2017, the Company recognized $1,380,000 of gift card breakage as a component of Other income on the Consolidated Statements of Income and Comprehensive Income. See Note 2 for further information on miscellaneous income.
The Company offers its own proprietary credit card to customers. All credit activity is performed by the Company’s wholly-owned subsidiaries. None of the credit card receivables are secured. The Company estimated uncollectible amounts of $700,000 and $897,000 for the twelve months ended February 1, 2020 and February 2, 2019, respectively, on sales purchased on the Company’s proprietary credit card of $26.6 million and $27.4 million for the twelve months ended February 1, 2020 and February 2, 2019, respectively.
The following table provides information about receivables and contract liabilities from contracts with customers (in thousands):
Cost of Goods Sold: 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 our buying departments and distribution center. Occupancy expenses include rent, real estate taxes, insurance, common area maintenance, utilities and maintenance for stores and distribution facilities. Buying, distribution, occupancy and internal transfer costs are treated as period costs and are not capitalized as part of inventory. The direct costs associated with shipping goods to customers are recorded as a component of Cost of goods sold.
Advertising: Advertising costs are expensed in the period in which they are incurred. Advertising expense was approximately $5,600,000, $5,546,000 and $5,558,000 for the fiscal years ended February 1, 2020, February 2, 2019 and February 3, 2018, respectively.
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Stock Repurchase Program: For fiscal year ended February 1, 2020, the Company had 1,346,522 shares remaining in open authorizations. There is no specified expiration date for the Company’s repurchase program. Share repurchases are recorded in Retained earnings, net of par value. Through March 27, 2020, the Company repurchased 600,330 shares for $8,859,676, to offset dilution from its equity compensation plans.
Earnings Per Share: ASC 260 - Earnings Per Share, requires dual presentation of basic EPS and diluted EPS on the face of all income statements for all entities with complex capital structures. The Company has presented one basic EPS and one diluted EPS amount for all common shares in the accompanying Consolidated Statements of Income and Comprehensive Income. While the Company’s certificate of incorporation provides the right for the Board of Directors to declare dividends on Class A shares without declaration of commensurate dividends on Class B shares, the Company has historically paid the same dividends to both Class A and Class B shareholders and the Board of Directors has resolved to continue this practice. Accordingly, the Company’s allocation of income for purposes of EPS computation is the same for Class A and Class B shares and the EPS amounts reported herein are applicable to both Class A and Class B shares.
Basic EPS is computed as net income less earnings allocated to non-vested equity awards divided by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock options and the Employee Stock Purchase Plan.
The following table reflects the basic and diluted EPS calculations for the fiscal years ended February 1, 2020, February 2, 2019 and February 3, 2018:
Vendor Allowances: The Company receives certain allowances from vendors primarily related to purchase discounts and markdown and damage allowances. All allowances are reflected in Cost of goods sold as earned when the related products are sold. Cash consideration received from a vendor is presumed to be a reduction of the purchase cost of merchandise and is reflected as a reduction of inventory. The Company does not receive cooperative advertising allowances.
Income Taxes: The Company files a consolidated federal income tax return. Income taxes are provided based on the asset and liability method of accounting, whereby deferred income taxes are provided for temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities.
Unrecognized tax benefits for uncertain tax positions are established in accordance with ASC 740 when, despite the fact that the tax return positions are supportable, the Company believes these positions
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
may be challenged and the results are uncertain. The Company adjusts these liabilities in light of changing facts and circumstances. Potential accrued interest and penalties related to unrecognized tax benefits within operations are recognized as a component of Income before income taxes.
In addition, the Tax Cuts and Jobs Act implemented a new minimum tax on global intangible low-taxed income (“GILTI”). The Company has elected to account for GILTI tax in the period in which it is incurred, which is included as a component of its current year provision for income taxes.
Store Opening Costs: Costs relating to the opening of new stores or the relocating or
expanding of existing stores are expensed as incurred. A portion of construction, design, and site selection costs are capitalized to new, relocated and remodeled stores.
Closed Store Lease Obligations: At the time stores are closed, provisions are made for the rentals
required to be paid over the remaining lease terms on a discounted cash flow basis, reduced by any expected sublease rentals.
Insurance: The Company is self-insured with respect to employee health care, workers’ compensation and general liability. The Company’s self-insurance liabilities are based on the total estimated cost 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 has stop-loss insurance coverage for individual claims in excess of $325,000 for employee healthcare, $350,000 for workers’ compensation and $250,000 for general liability.
Fair Value of Financial Instruments: The Company’s carrying values of financial instruments, such as cash and cash equivalents, short-term investments, restricted cash and short-term investments, approximate their fair values due to their short terms to maturity and/or their variable interest rates.
Stock Based Compensation: The Company records compensation expense associated with restricted stock and other forms of equity compensation in accordance with ASC 718 - Compensation - Stock Compensation. Compensation cost associated with stock awards recognized in all years presented includes: 1) amortization related to the remaining unvested portion of all stock awards based on the grant date fair value and 2) adjustments for the effects of actual forfeitures versus initial estimated forfeitures.
Subsequent Events: The spread of COVID-19 has caused public health officials to recommend, and in some cases mandate, precautions to mitigate the spread of the virus, especially when congregating in heavily populated areas, such as malls and shopping centers. Responses by customers, government and the private sector may adversely impact our business operations. At this time, it is impossible to predict the impact of the COVID-19 pandemic as this unprecedented situation continues to evolve rapidly.
The Company temporarily closed all Cato, Its Fashion, Its Fashion Metro and Versona stores for an expected period of two weeks beginning March 19, 2020. There is significant uncertainty around the duration, breadth and severity of these store closures and other 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 once they re-open. The Company is also unable to predict the outcome or effect of national, state or local legislation that attempts to address the economic effects of COVID-19 on our customers, suppliers or the Company.
The Company continues to assess the potential impact of COVID-19, which remains uncertain and fluid at this time. Primarily in response to potential disruption in the Capital markets, the Company drew $30 million on its $35 million line of credit on March 16, 2020. The additional $30 million enhances the Company’s liquidity position with over $200 million of cash and short-term investments.
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Recently Adopted Accounting Policies
See Lease accounting policy above for information related to the adoption of ASC 842 - Leases.
Recently Issued Accounting Pronouncements
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326), which modifies the measurement of expected credit losses of certain financial instruments. Topic 326 is effective for annual reporting periods beginning after December 15, 2019 with early adoption permitted. The Company anticipates the ASU will not have a material impact on its financial statements.
3. Short-Term Investments:
At February 1, 2020, the Company’s investment portfolio was primarily invested in corporate and governmental debt securities held in managed accounts. These securities are classified as available-for-sale as they are highly liquid and are recorded on the Consolidated Balance Sheets at estimated fair value, with unrealized gains and temporary losses reported net of taxes in Accumulated other comprehensive income.
The table below reflects gross accumulated unrealized gains (losses) in short-term investments at February 1, 2020 and February 2, 2019 (in thousands):
Accumulated other comprehensive income on the Consolidated Balance Sheets reflects the accumulated unrealized net gains in short-term investments in addition to unrealized gains from equity investments and restricted cash investments. The table below reflects gross accumulated unrealized gains in these investments at February 1, 2020 and February 2, 2019 (in thousands):
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4. Fair Value Measurements:
The following tables set forth information regarding the Company’s financial assets that are measured at fair value as of February 1, 2020 and February 2, 2019 (in thousands):
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
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
February 1, 2020. The state, municipal and corporate bonds and asset-backed securities have contractual maturities which range from five days to 7.5 years. The U.S. Treasury Notes and Certificates of Deposit have contractual maturities which range from 1 month to 2.75 years. These securities are classified as available-for-sale and are recorded as Short-term investments, Restricted cash, Restricted short-term 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. 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 February 1, 2020, the Company had $0.7 million of corporate equities, which are recorded within Other assets in the Consolidated Balance Sheets. At February 2, 2019, the Company had $0.7 million of corporate equities, 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.
Deferred compensation plan assets consist primarily of life insurance policies. These life insurance policies are valued based on the cash surrender value of the insurance contract, which is determined based on such factors as the fair value of the underlying assets and discounted cash flow and are therefore classified within Level 3 of the valuation hierarchy. The Level 3 liability associated with the life insurance policies represents a deferred compensation obligation, the value of which is tracked via underlying insurance funds’ net asset values, as recorded in Other noncurrent liabilities in the Consolidated Balance Sheets. These funds are designed to mirror the return of existing mutual funds and money market funds that are observable and actively traded.
The following tables summarize the change in fair value of the Company’s financial assets and liabilities measured using Level 3 inputs as of February 1, 2020 and February 2, 2019 (in thousands):
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Finance charge and late charge revenue on customer deferred payment accounts totaled $3,605,000, $3,814,000 and $4,222,000 for the fiscal years ended February 1, 2020, February 2, 2019 and February 3, 2018, respectively, and charges against the allowance for doubtful accounts were approximately $524,000, $470,000 and $690,000 for the fiscal years ended February 1, 2020, February 2, 2019 and February 3, 2018, respectively. Expenses relating to the allowance for doubtful accounts are classified as a component of Selling, general and administrative expense in the accompanying Consolidated Statements of Income and Comprehensive Income.
8. Financing Arrangements:
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of February 1, 2020, the Company had an unsecured revolving credit agreement to borrow $35.0 million less the balance of any revocable credits discussed below. The revolving credit agreement is committed until May 2022. 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, 2020. There were no borrowings outstanding under this credit facility as of February 1, 2020, February 2, 2019 or February 3, 2018. At February 1, 2020, the weighted average interest rate under the credit facility was zero due to no borrowings outstanding at the end of the year. Subsequent to February 1, 2020, the Company drew against the line of credit. See Note 1 for further information.
At February 1, 2020, February 2, 2019 and February 3, 2018, the Company had no outstanding revocable letters of credit relating to purchase commitments.
9. Stockholders’ Equity:
The holders of Class A Common Stock are entitled to one vote per share, whereas the holders of Class B Common Stock are entitled to ten votes per share. Each share of Class B Common Stock may be converted at any time into one share of Class A Common Stock. Subject to the rights of the holders of any shares of Preferred Stock that may be outstanding at the time, in the event of liquidation, dissolution or winding up of the Company, holders of Class A Common Stock are entitled to receive a preferential distribution of $1.00 per share of the net assets of the Company. Cash dividends on the Class B Common Stock cannot be paid unless cash dividends of at least an equal amount are paid on the Class A Common Stock.
The Company’s certificate of incorporation provides that shares of Class B Common Stock may be transferred only to certain “Permitted Transferees” consisting generally of the lineal descendants of holders of Class B Common Stock, trusts for their benefit, corporations and partnerships controlled by them and the Company’s employee benefit plans. Any transfer of Class B Common Stock in violation of these restrictions, including a transfer to the Company, results in the automatic conversion of the transferred shares of Class B Common Stock held by the transferee into an equal number of shares of Class A Common Stock.
On March 24, 2020, the Company paid a quarterly dividend of $0.33 per share.
10. Employee Benefit Plans:
The Company has a defined contribution retirement savings plan (“401(k) plan”) which covers all associates who meet minimum age and service requirements. The 401(k) plan allows participants to contribute up to 75% of their annual compensation up to the maximum elective deferral, designated by the IRS. The Company is obligated to make a minimum contribution to cover plan administrative expenses. Further Company contributions are at the discretion of the Board of Directors. The Company’s contributions for the years ended February 1, 2020, February 2, 2019 and February 3, 2018 were approximately $1,499,000, $1,442,000 and $1,207,000, respectively.
The Company has a trusteed, non-contributory Employee Stock Ownership Plan (“ESOP”), which covers substantially all associates who meet minimum age and service requirements. The amount of the Company’s discretionary contribution to the ESOP is determined annually by the Compensation Committee of the Board of Directors and can be made in Company Class A Common stock or cash. The Company has chosen to contribute cash and the plan purchases stock on the open market consistent with prior years. The Committee approved a contribution of approximately $7,198,000 for the year ended February 1, 2020. The Company’s contribution was $1,229,000 and $1,026,000 for the years ended February 2, 2019 and February 3, 2018, respectively.
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company is primarily self-insured for healthcare. 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. Management reviews current and historical claims data in developing its estimates. If the underlying facts and circumstances of the claims change or the historical trend is not indicative of future trends, then the Company may be required to record additional expense or a reduction to expense which could be material to the Company’s reported financial condition and results of operations. The Company funds healthcare contributions to a third-party provider.
11. Leases:
We determine whether an arrangement is a lease at inception. We have operating leases for stores, offices and equipment. Our leases have remaining lease terms of one year to 10 years, some of which include options to extend the lease term for up to five years, and some of which include options to terminate the lease within one year. We consider these options in determining the lease term used to establish our right-of-use assets and lease liabilities. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants.
As most of our leases do not provide an implicit rate, we use our estimated incremental borrowing rate based on the information available at commencement date of the lease in determining the present value of lease payments.
The components of lease cost are shown below (in thousands):
Supplemental cash flow information and non-cash activity related to our operating leases are as follows (in thousands):
Weighted-average remaining lease term and discount rate for our operating leases are as follows:
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of
February 1, 2020
Weighted-average remaining lease term
3.2 years
Weighted-average discount rate
4.47%
Maturities of lease liabilities by fiscal year for our operating leases are as follows (in thousands):
Fiscal Year
$
66,498
55,571
39,407
28,376
17,520
Thereafter
25,962
Total lease payments
233,334
Less: Imputed interest
23,001
Present value of lease liabilities
$
210,333
As of February 2, 2019, the minimum rental commitments under non-cancelable operating leases are (in thousands):
Fiscal Year
$
69,601
51,943
35,196
21,242
12,986
Thereafter
2,643
Total minimum lease payments
$
193,611
The following schedule shows the composition of total rental expense for all leases (in thousands):
12. Income Taxes:
Unrecognized tax benefits for uncertain tax positions, primarily recorded in Other noncurrent liabilities, are established in accordance with ASC 740 when, despite the fact that the tax return positions are supportable, the Company believes these positions may be challenged and the results are uncertain. The Company adjusts these liabilities in light of changing facts and circumstances. As of February 1, 2020, the Company had gross unrecognized tax benefits totaling approximately $7.9 million, of which approximately $10.1 million (inclusive of interest) would affect the effective tax rate if recognized. The Company had approximately $3.3 million, $3.2 million and $2.8 million of interest and penalties accrued related to uncertain tax positions as of February 1, 2020, February 2, 2019 and February 3, 2018, respectively. The Company recognizes interest and penalties related to the resolution of uncertain tax
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
positions as a component of income tax expense. The Company recognized $574,000, $1,023,000 and $986,000 of interest and penalties in the Consolidated Statements of Income and Comprehensive Income for the years ended February 1, 2020, February 2, 2019 and February 3, 2018, respectively. The Company is no longer subject to U.S. federal income tax examinations for years before 2016. In state and local tax jurisdictions, the Company has limited exposure before 2009. During the next 12 months, various state and local taxing authorities’ statutes of limitations will expire and certain state examinations may close, which could result in a potential reduction of unrecognized tax benefits for which a range cannot be determined.
A reconciliation of the beginning and ending amount of gross unrecognized tax benefits is as follows (in thousands):
The provision for income taxes consists of the following (in thousands):
Significant components of the Company’s deferred tax assets and liabilities as of February 1, 2020 and February 2, 2019 are as follows (in thousands):
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of February 1, 2020, the Company had $1.2 million of state tax credits to offset future state income tax expense, which are set to expire by fiscal 2023. Based on the available evidence, the Company has recorded a valuation allowance of $1.1 million for the portion it expects to not be realized.
As of February 1, 2020, the Company’s position is that its overseas subsidiaries will not invest undistributed earnings indefinitely. Future unremitted earnings when distributed are expected to be either distributions of GILTI-previously taxed income or eligible for a 100% dividends received deduction. The withholding tax rate on any unremitted earnings is zero and state income taxes on such earnings are considered immaterial. Therefore, the Company has not provided deferred U.S. income taxes on approximately $3.5 million of earnings from non-U.S. subsidiaries.
The reconciliation of the Company’s effective income tax rate with the statutory rate is as follows:
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
13. Quarterly Financial Data (Unaudited):
Summarized quarterly financial results are as follows (in thousands, except per share data):
14. Reportable Segment Information:
The Company has determined that it has four operating segments, as defined under ASC 280-10, including Cato, It’s Fashion, Versona and Credit. As outlined in ASC 280-10, the Company has two reportable segments: Retail and Credit. The Company has aggregated its three retail operating segments, including e-commerce, based on the aggregation criteria outlined in ASC 280-10, which states that two or more operating segments may be aggregated into a single reportable segment if aggregation is consistent with the objective and basic principles of ASC 280-10, which require the segments have similar economic characteristics, products, production processes, clients and methods of distribution.
The Company’s retail operating segments have similar economic characteristics and similar operating, financial and competitive risks. They are similar in terms of product offered, as they all offer women’s apparel, shoes and accessories. Merchandise inventory of the Company’s retail operating segments is
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
sourced from the same countries and some of the same vendors, using similar production processes. Merchandise for the Company’s retail operating segments is distributed to retail stores in a similar manner through the Company’s single distribution center and is subsequently distributed to clients in a similar manner.
The Company offers its own credit card to its customers and all credit authorizations, payment processing, and collection efforts are performed by a separate subsidiary of the Company.
The following schedule summarizes certain segment information (in thousands):
Fiscal 2019
Retail
Credit
Total
Revenues
$
821,730
$
3,605
$
825,335
Depreciation
15,484
15,485
Interest and other income
6,065
-
6,065
Income before taxes
41,386
1,821
43,207
Capital expenditures
8,287
8,306
Fiscal 2018
Retail
Credit
Total
Revenues
$
825,850
$
3,814
$
829,664
Depreciation
16,441
16,463
Interest and other income
4,991
-
4,991
Income before taxes
31,149
1,902
33,051
Capital expenditures
4,315
4,354
Fiscal 2017
Retail
Credit
Total
Revenues
$
845,759
$
4,222
$
849,981
Depreciation
19,604
19,643
Interest and other income
5,111
-
5,111
Income before taxes
14,762
1,211
15,973
Capital expenditures
11,047
11,096
Retail
Credit
Total
Total assets as of February 1, 2020
$
636,503
$
48,473
$
684,976
Total assets as of February 2, 2019
454,143
43,763
497,906
The accounting policies of the segments are the same as those described in the Summary of Significant Accounting Policies in Note 1. The Company evaluates performance based on profit or loss from operations before income taxes. The Company does not allocate certain corporate expenses to the credit segment.
The following schedule summarizes the direct expenses of the credit segment which are reflected in Selling, general and administrative expenses (in thousands):
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
February 1, 2020
February 2, 2019
February 3, 2018
Bad debt expense
$
-
$
-
$
Payroll
Postage
Other expenses
Total expenses
$
1,783
$
1,890
$
2,972
15. Stock Based Compensation:
As of February 1, 2020, the Company had two long-term compensation plans pursuant to which stock-based compensation was outstanding. The 2018 Incentive Compensation Plan and 2013 Incentive Compensation Plan are for the granting of various forms of equity-based awards, including restricted stock and stock options for grant, to officers, directors and key employees. Effective May 24, 2018, shares for grant were no longer available under the 2013 Incentive Compensation Plan.
The following table presents the number of options and shares of restricted stock initially authorized and available for grant under each of the plans as of February 1, 2020:
Plan
Plan
Total
Options and/or restricted stock initially authorized
1,500,000
4,725,000
6,225,000
Options and/or restricted stock available for grant:
February 2, 2019
-
4,514,151
4,514,151
February 1, 2020
-
4,192,667
4,192,667
In accordance with ASC 718, the fair value of current restricted stock awards is estimated on the date of grant based on the market price of the Company’s stock and is amortized to compensation expense on a straight-line basis over a five-year vesting period. As of February 1, 2020, there was $11,900,000 of total unrecognized compensation expense related to unvested restricted stock awards, which is expected to be recognized over a remaining weighted-average vesting period of 2.2 years. The total grant date fair value of the shares recognized as compensation expense during the twelve months ended February 1, 2020, February 2, 2019 and February 3, 2018 was $4,559,000, $4,833,000 and $4,093,000, respectively. The expenses are classified as a component of Selling, general and administrative expenses in the Consolidated Statements of Income and Comprehensive Income.
The following summary shows the changes in the shares of unvested restricted stock outstanding during the years ended February 1, 2020, February 2, 2019 and February 3, 2018:
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Weighted Average
Number of
Grant Date Fair
Shares
Value Per Share
Restricted stock awards at January 28, 2017
561,323
$
32.22
Granted
191,919
22.44
Vested
(125,761)
26.40
Forfeited or expired
(32,302)
31.52
Restricted stock awards at February 3, 2018
595,179
$
30.33
Granted
354,385
16.20
Vested
(139,669)
29.87
Forfeited or expired
(38,044)
24.34
Restricted stock awards at February 2, 2019
771,851
$
24.22
Granted
361,170
14.89
Vested
(129,108)
34.44
Forfeited or expired
(61,351)
19.61
Restricted stock awards at February 1, 2020
942,562
$
19.55
The Company’s Employee Stock Purchase Plan allows eligible full-time employees to purchase a limited number of shares of the Company’s Class A Common Stock during each semi-annual offering period at a 15% discount through payroll deductions. During the twelve month period ended February 1, 2020, the Company sold 48,626 shares to employees at an average discount of $2.27 per share under the Employee Stock Purchase Plan. The compensation expense recognized for the 15% discount given under the Employee Stock Purchase Plan was approximately $111,000, $101,000 and $86,000 for fiscal years 2019, 2018 and 2017, respectively. These expenses are classified as a component of Selling, general and administrative expenses.
16. Commitments and Contingencies:
The Company is, from time to time, involved in routine litigation incidental to the conduct of our business, including litigation regarding the merchandise that we sell, litigation regarding intellectual property, litigation instituted by persons injured upon premises under our control, litigation with respect to various employment matters, including alleged discrimination and wage and hour litigation, and litigation with present or former employees.
Although such litigation is routine and incidental to the conduct of our business, as with any business of our size with a significant number of employees and significant merchandise sales, such litigation could result in large monetary awards. Based on information currently available, management does not believe that any reasonably possible losses arising from current pending litigation will have a material adverse effect on our Consolidated Financial Statements. However, given the inherent uncertainties involved in such matters, an adverse outcome in one or more such matters could materially and adversely affect the Company’s financial condition, results of operations and cash flows in any particular reporting period. The Company accrues for these matters when the liability is deemed probable and reasonably estimable.
17. Accumulated Other Comprehensive Income:
The following table sets forth information regarding the reclassification out of Accumulated other comprehensive income (in thousands) as of February 1, 2020:
THE CATO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Changes in Accumulated Other
Comprehensive Income (a)
Unrealized Gains
and (Losses) on
Available-for-Sale
Securities
Beginning Balance at February 2, 2019
$
(77)
Other comprehensive income/(loss) before
reclassification
1,224
Amounts reclassified from accumulated
other comprehensive income (b)
Net current-period other comprehensive income/(loss)
1,500
Ending Balance at February 1, 2020
$
1,423
(a) All amounts are net-of-tax. Amounts in parentheses indicate a debit/reduction to other comprehensive income (“OCI”).
(b) Includes $359 impact of accumulated other comprehensive income reclassifications into Interest and other income for net gains on available-for-sale securities. The tax impact of this reclassification was $83. Amounts in parentheses indicate a debit/reduction to OCI.
The following table sets forth information regarding the reclassification out of Accumulated other comprehensive income (in thousands) as of February 2, 2019:
Changes in Accumulated Other
Comprehensive Income (a)
Unrealized Gains
and (Losses) on
Available-for-Sale
Securities
Beginning Balance at February 3, 2018
$
(321)
Other comprehensive income/(loss) before
reclassification
Amounts reclassified from accumulated
other comprehensive income (b)
(34)
Net current-period other comprehensive income/(loss)
Ending Balance at February 2, 2019
$
(77)
(a) All amounts are net-of-tax. Amounts in parentheses indicate a debit/reduction to OCI.
(b) Includes ($45) impact of accumulated other comprehensive income reclassifications into Interest and other income for net gains on available-for-sale securities. The tax impact of this reclassification was ($11). Amounts in parentheses indicate a debit/reduction to OCI.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure:
None.
Item 9A.
Item 9A.
Controls and Procedures:
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
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 February 1, 2020. Based on this evaluation, our Principal Executive Officer and Principal Financial Officer concluded that, as of February 1, 2020, 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.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of February 1, 2020 based on the Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this evaluation, management concluded that our internal control over financial reporting was effective as of February 1, 2020.
PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the effectiveness of our internal control over financial reporting as of February 1, 2020, as stated in its report which is included herein.
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 February 1, 2020 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B.
Other Information:
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance:
Information contained under the captions “Election of Directors,” “Meetings and Committees,” “Corporate Governance Matters” and “Delinquent Section 16(a) Reports” in the Registrant’s Proxy Statement for its 2020 annual stockholders’ meeting (the “2020 Proxy Statement”) is incorporated by reference in response to this Item 10. The information in response to this Item 10 regarding executive officers of the Company is contained in Item 3A, Part I hereof under the caption “Executive Officers of the Registrant.”
Item 11.
Item 11.
Executive Compensation:
Information contained under the captions “2019 Executive Compensation,” “Fiscal Year 2019 Director Compensation,” “Corporate Governance Matters-Compensation Committee Interlocks and Insider Participation” in the Company’s 2020 Proxy Statement is incorporated by reference in response to this Item.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters:
Equity Compensation Plan Information
The following table provides information about stock options outstanding and shares available for future awards under all of Cato’s equity compensation plans. The information is as of February 1, 2020.
(a)
Number of Securities to be Issued upon Exercise of Outstanding Options, Warrants and Rights (1)
(b)
Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights (1)
(c)
Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a)) (2)
Plan Category
Equity compensation plans approved
by security holders
-
-
4,258,876
Equity compensation plans not
approved by security holders
-
-
-
Total
-
-
4,258,876
(1)
This column contains information regarding employee stock options only; there are no outstanding warrants or stock appreciation rights.
(2)
Includes the following:
Under the Company’s stock incentive plan, referred to as the 2018
Incentive Compensation Plan, 4,192,667 shares are available for grant. Under this plan, non-qualified stock options may be granted to key associates.
Under the 2013 Employee Stock Purchase Plan, 66,209 shares are available. Eligible associates may participate in the purchase of designated shares of the Company’s common stock. The purchase price of this stock is equal to 85% of the lower of the closing price at the beginning or the end of each semi-annual stock purchase period.
Information contained under “Security Ownership of Certain Beneficial Owners and Management” in the 2020 Proxy Statement is incorporated by reference in response to this Item.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence:
Information contained under the caption “Certain Relationships and Related Person Transactions,” “Corporate Governance Matters-Director Independence” and “Meetings and Committees” in the 2020 Proxy Statement is incorporated by reference in response to this Item.
Item 14.
Item 14.
Principal Accountant Fees and Services:
Information contained under the captions “Ratification of Independent Registered Public Accounting Firm-Audit Fees” and “-Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Service by the Independent Registered Public Accounting Firm” in the 2020 Proxy Statement is incorporated by reference in response to this item.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules:
(a) The following documents are filed as part of this report:
(1) Financial Statements:
All other schedules are omitted as the required information is inapplicable or the information is presented in the Consolidated Financial Statements or related Notes thereto.
(3) Index to Exhibits: The following exhibits listed in the Index below are filed with this report or, as noted, incorporated by reference herein. The Company will supply copies of the following exhibits to any shareholder upon receipt of a written request addressed to the Corporate Secretary, The Cato Corporation, 8100 Denmark Road, Charlotte, NC 28273 and the payment of $.50 per page to help defray the costs of handling, copying and postage. In most cases, documents incorporated by reference to exhibits to our registration statements, reports or proxy statements filed by the Company with the Securities and Exchange Commission are available to the public over the Internet from the SEC’s web site at http://www.sec.gov.
*Management contract or compensatory plan required to be filed under Item 15 of this report and Item 601 of Regulation S-K.
** Filed or submitted electronically herewith.
Item 16.
Form 10-K Summary:
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Cato has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
The Cato Corporation
By
/s/ JOHN P. D. CATO
By
/s/ JOHN R. HOWE
John P. D. Cato
Chairman, President and
Chief Executive Officer
John R. Howe
Executive Vice President
Chief Financial Officer
By
/s/ JEFFREY R. SHOCK
Jeffrey R. Shock
Senior Vice President
Controller
Date: March 27, 2020
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 27, 2020 by the following persons on behalf of the Registrant and in the capacities indicated:
/s/ JOHN P. D. CATO
John P. D. Cato
(President and Chief Executive Officer
(Principal Executive Officer) and Director)
/s/ BAILEY W. PATRICK
Bailey W. Patrick
(Director)
/s/ JOHN R. HOWE
John R. Howe
(Executive Vice President
Chief Financial Officer (Principal Financial Officer))
/s/ THOMAS B. HENSON
Thomas B. Henson
(Director)
/s/ JEFFREY R. SHOCK
Jeffrey R. Shock
(Senior Vice President
Controller (Principal Accounting Officer))
/s/ BRYAN F. KENNEDY III
Bryan F. Kennedy III
(Director)
/s/ THOMAS E. MECKLEY
Thomas E. Meckley
(Director)
/s/ D. HARDING STOWE
D. Harding Stowe
(Director)
/s/ THERESA J. DREW
Theresa J. Drew
(Director)
/s/ PAMELA L. DAVIES
Pamela L. Davies
(Director)