CATO CORP - Quarter Report: 2006 July (Form 10-Q)

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended            July 29, 2006

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 1-31340

(Exact name of registrant as specified in its charter)

Delaware		56-0484485
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

8100 Denmark Road, Charlotte, North Carolina 28273-5975
(Address of principal executive offices)
(Zip Code)

(704) 554-8510

Not Applicable
if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o           Accelerated filer þ           Non-Accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

As of August 15, 2006, there were 30,814,830 shares of Class A common stock and 690,525 shares of Class B common stock outstanding.

 

 

THE CATO CORPORATION

FORM 10-Q

Quarter Ended July 29, 2006

Table of Contents

		Page
		No.
PART I — FINANCIAL INFORMATION (UNAUDITED)
Item 1. Financial Statements:
Condensed Consolidated Statements of Income and Comprehensive Income			2
For the Three Months and Six Months Ended July 29, 2006 and July 30, 2005
Condensed Consolidated Balance Sheets			3
At July 29, 2006, July 30, 2005 and January 28, 2006
Condensed Consolidated Statements of Cash Flows			4
For the Six Months Ended July 29, 2006 and July 30, 2005
Notes to Condensed Consolidated Financial Statements			5–11
For the Three Months and Six Months Ended July 29, 2006 and July 30, 2005
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			12–18
Item 3. Quantitative and Qualitative Disclosures About Market Risk			19
Item 4. Controls and Procedures			19
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			20
Item 1A. Risk Factors			20
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			20
Item 3. Defaults upon Senior Securities			20
Item 4. Submission of Matters to a Vote of Security Holders			20
Item 5. Other Information			20
Item 6. Exhibits			21
Signatures			22-26

PART I FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

THE CATO CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND
COMPREHENSIVE INCOME

		Three Months Ended								Six Months Ended
		July 29,				July 30,				July 29,				July 30,
		2006				2005				2006				2005
		(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)
		(Dollars in thousands, except per share data)
REVENUES
Retail sales		$	214,633			$	208,316			$	444,374			$	423,380
Other income (principally finance charges, late fees and layaway charges)			3,212				3,648				6,531				7,511
Total revenues			217,845				211,964				450,905				430,891
COSTS AND EXPENSES, NET
Cost of goods sold			143,746				140,426				285,858				276,860
Selling, general and administrative			51,762				50,765				106,329				100,097
Depreciation			5,223				5,025				10,391				10,064
Interest expense			10				10				20				162
Interest and other income			(1,940	)			(1,071	)			(3,492	)			(2,012	)
			198,801				195,155				399,106				385,171
Income before income taxes			19,044				16,809				51,799				45,720
Income tax expense			6,951				6,102				18,907				16,596
Net Income		$	12,093			$	10,707			$	32,892			$	29,124
Basic earnings per share		$	0.39			$	0.34			$	1.05			$	0.94
Basic weighted average shares			31,267,637				31,188,146				31,250,921				31,146,236
Diluted earnings per share		$	0.38			$	0.34			$	1.04			$	0.92
Diluted weighted average shares			31,803,875				31,828,039				31,765,992				31,811,183
Dividends per share		$	0.15			$	0.13			$	0.28			$	0.247
Comprehensive income:
Net income		$	12,093			$	10,707			$	32,892			$	29,124
Unrealized gains on available-for-sale securities, net of deferred income tax expense			56				70				34				30
Net comprehensive income		$	12,149			$	10,777			$	32,926			$	29,154

See notes to condensed consolidated financial statements.

THE CATO CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

		July 29,				July 30,				January 28,
		2006				2005				2006
		(Unaudited)				(Unaudited)
		(Dollars in thousands)
ASSETS
Current Assets:
Cash and cash equivalents		$	21,809			$	23,884			$	21,734
Short-term investments			94,171				86,140				86,085
Accounts receivable, net of allowance for doubtful accounts of $3,589, $5,955 and $3,694 at July 29, 2006, July 30, 2005 and January 28, 2006, respectively			46,436				48,229				49,644
Merchandise inventories			91,989				84,904				103,370
Deferred income taxes			8,506				5,764				8,526
Prepaid expenses			2,464				2,180				2,318
Total Current Assets			265,375				251,101				271,677
Property and equipment – net			130,422				118,599				124,104
Other assets			11,201				10,818				10,855
Total Assets		$	406,998			$	380,518			$	406,636
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable		$	58,210			$	64,272			$	78,036
Accrued expenses			32,433				29,951				31,967
Accrued bonus and benefits			10,342				8,161				17,570
Accrued income taxes			7,779				10,252				4,990
Total Current Liabilities			108,764				112,636				132,563
Deferred income taxes			9,261				10,172				9,261
Other noncurrent liabilities (primarily deferred rent)			23,230				23,732				24,864
Commitments and contingencies:
Stockholders’ Equity:
Preferred stock, $100 par value per share, 100,000 shares authorized, none issued			¾				¾				¾
Class A common stock, $.033 par value per share, 50,000,000 shares authorized; issued 35,909,497 shares, 30,650,431 shares and 35,622,516 shares at July 29, 2006, July 30, 2005 and January 28, 2006, respectively			1,197				1,021				1,188
Convertible Class B common stock, $.033 par value per share, 15,000,000 shares authorized; issued 690,525 shares, 5,597,834 shares and 690,525 shares at July 29, 2006, July 30, 2005 and January 28, 2006, respectively			23				187				23
Additional paid-in capital			40,668				37,635				39,244
Retained earnings			318,556				286,890				294,462
Accumulated other comprehensive income			112				101				78
Unearned compensation – restricted stock awards			¾				(569	)			(229	)
			360,556				325,265				334,766
Less Class A and Class B common stock in treasury, at cost (5,093,609 Class A and –0– Class B shares at July 29, 2006, and 231 Class A and 4,907,309 Class B at July 30, 2005 and 5,093,840 Class A and –0– Class B at January 28, 2006)			(94,813	)			(91,287	)			(94,818	)
Total Stockholders’ Equity			265,743				233,978				239,948
Total Liabilities and Stockholders’ Equity		$	406,998			$	380,518			$	406,636

See notes to condensed consolidated financial statements.

THE CATO CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

		Six Months Ended
		July 29,				July 30,
		2006				2005
		(Unaudited)				(Unaudited)
		(Dollars in thousands)
OPERATING ACTIVITIES
Net income		$	32,892			$	29,124
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			10,391				10,064
Provision for doubtful accounts			1,627				2,443
Share-based compensation			626				341
Excess tax benefits from share-based compensation			(284	)			¾
Deferred income taxes			20				17
Loss on disposal of property and equipment			569				690
Changes in operating assets and liabilities which provided (used) cash:
Accounts receivable			1,581				217
Merchandise inventories			11,381				15,634
Prepaid and other assets			(493	)			(890	)
Accrued income taxes			3,073				5,787
Accounts payable, accrued expenses and other liabilities			(28,930	)			(24,485	)
Net cash provided by operating activities			32,453				38,942
INVESTING ACTIVITIES
Expenditures for property and equipment			(17,370	)			(11,684	)
Purchases of short-term investments			(95,287	)			(44,877	)
Sales of short-term investments			87,235				47,355
Net cash used in investing activities			(25,422	)			(9,206	)
FINANCING ACTIVITIES
Change in cash overdrafts included in accounts payable			805				4,195
Dividends paid			(8,798	)			(7,734	)
Payments to settle long term debt			¾				(22,000	)
Proceeds from employee stock purchase plan			206				230
Excess tax benefits from share-based compensation			284				¾
Proceeds from stock options exercised			547				817
Net cash used in financing activities			(6,956	)			(24,492	)
Net increase in cash and cash equivalents			75				5,244
Cash and cash equivalents at beginning of period			21,734				18,640
Cash and cash equivalents at end of period		$	21,809			$	23,884

See notes to condensed consolidated financial statements.

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 29, 2006 AND JULY 30, 2005

NOTE 1 — GENERAL:

The condensed consolidated financial statements have been prepared from the accounting records of The Cato Corporation and its wholly-owned subsidiaries (the “Company”), and all amounts shown as of and for the periods ended July 29, 2006 and July 30, 2005 are unaudited. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All such adjustments are of a normal, recurring nature. The results of the interim period may not be indicative of the results expected for the entire year.

The interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2006.

Cash equivalents consist of highly liquid investments with original maturities of three months or less. Investments with original maturities beyond three months are classified as short-term investments. The fair values of short-term investments are based on quoted market prices.

Short-term investments are classified as available-for-sale. As they are available for current operations, they are classified in the Condensed 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 fair value of investments are recorded as a reduction in the cost of the investments in the accompanying Condensed Consolidated Balance Sheets and a reduction of interest and other income in the accompanying Condensed 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.

During the third quarter of fiscal 2005, the Company revised its process for determining the amount of accounts receivable that should be written off each period. This change in process was consistent with industry and regulatory guidelines and resulted in an acceleration of accounts receivable write-off of approximately $1,700,000. This write-off reduced the gross Accounts Receivable balance and the Allowance for Doubtful Accounts in the third quarter of 2005. Accordingly, this change in process had no effect on the current period’s earnings and management does not expect that the change will have a material effect on the Company’s future earnings or financial position.

Net comprehensive income for the second quarter and six months ended July 29, 2006 was $12,149,000 and $32,926,000, respectively. Net comprehensive income for the second quarter and six months ended July 30, 2005 was $10,777,000 and $29,154,000, respectively. Net comprehensive income is composed of net income and net unrealized gains and losses on available-for-sale securities, net of tax.

Merchandise inventories are stated at the lower of cost (first-in, first-out method) or market as determined by the retail inventory method.

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 29, 2006 AND JULY 30, 2005

NOTE 1 — GENERAL (CONTINUED):

On May 25, 2006, the Board of Directors increased the quarterly dividend by 15% from $.13 per share to $.15 per share, or an annualized rate of $.60 per share. Prior year basic and diluted earnings and dividends per share have been adjusted for the three-for-two stock split in the form of a stock dividend of the Company’s Class A and Class B common stock effected June 27, 2005.

NOTE 2 — EARNINGS PER SHARE:

Basic EPS is computed as net income 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 other convertible securities. Unvested restricted stock is included in the computation of diluted EPS using the treasury stock method.

		Three Months Ended								Six Months Ended
		July 29,				July 30,				July 29,				July 30,
		2006				2005				2006				2005
Weighted-average shares outstanding			31,267,637				31,188,146				31,250,921				31,146,236
Dilutive effect of :
Stock options			522,683				520,120				509,122				549,145
Restricted stock			13,260				119,773				5,704				115,802
Employee stock purchase plan			295				¾				245				¾
Weighted-average shares and common stock equivalents outstanding			31,803,875				31,828,039				31,765,992				31,811,183

NOTE 3 — SUPPLEMENTAL CASH FLOW INFORMATION:

Income tax payments, net of refunds received, for the six months ended July 29, 2006 and July 30, 2005 were $15,875,000 and $10,504,000, respectively. Cash paid for interest for the six months ended July 29, 2006 and July 30, 2005 were $-0- and $209,000, respectively.

NOTE 4 — FINANCING ARRANGEMENTS:

At July 29, 2006, the Company had an unsecured revolving credit agreement, which provided for borrowings of up to $35 million. The revolving credit agreement is committed until August 2008. This agreement replaced a prior revolving credit agreement which was due to expire in August 2006. 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 July 29, 2006. There were no borrowings outstanding under these credit facilities during the first six months ended July 29, 2006 or July 30, 2005, respectively, or the fiscal year ended January 28, 2006.

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 29, 2006 AND JULY 30, 2005

NOTE 4 — FINANCING ARRANGEMENTS (CONTINUED):

On August 22, 2003, the Company entered into a new unsecured $30 million five-year term loan facility, the proceeds of which were used to purchase Class B Common Stock from the Company’s founders. Payments were due in monthly installments of $500,000 plus accrued interest based on LIBOR. On April 5, 2005, the Company repaid the remaining balance of $20.5 million on this term loan facility with no early prepayment penalty. With the early retirement of this loan, the Company had no outstanding debt as of July 29, 2006.

At July 29, 2006 and July 30, 2005 the Company had approximately $5,227,000 and $4,883,000, respectively, of outstanding irrevocable letters of credit relating to purchase commitments.

NOTE 5 — REPORTABLE SEGMENT INFORMATION:

The Company has two reportable segments: retail and credit. The Company operated its women’s fashion specialty retail stores in 31 states at July 29, 2006, principally in the southeastern United States. The Company offers its own credit card to its customers and all related 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):

Three Months Ended														Six Months Ended
July 29, 2006		Retail				Credit				Total				July 29, 2006		Retail				Credit				Total
Revenues		$	215,177			$	2,668			$	217,845			Revenues		$	445,547			$	5,358			$	450,905
Depreciation			5,203				20				5,223			Depreciation			10,352				39				10,391
Interest and other income			(1,940	)			—				(1,940	)		Interest and other income			(3,492	)			—				(3,492	)
Income before taxes			17,827				1,217				19,044			Income before taxes			49,805				1,994				51,799
Total assets			337,564				69,434				406,998			Total assets			337,564				69,434				406,998
Capital expenditures			4,601				4				4,605			Capital expenditures			17,348				22				17,370

Three Months Ended														Six Months Ended
July 30, 2005		Retail				Credit				Total				July 30, 2005		Retail				Credit				Total
Revenues		$	208,706			$	3,258			$	211,964			Revenues		$	424,296			$	6,595			$	430,891
Depreciation			4,996				29				5,025			Depreciation			10,006				58				10,064
Interest and other income			(1,071	)			—				(1,071	)		Interest and other income			(2,012	)			—				(2,012	)
Income before taxes			15,567				1,242				16,809			Income before taxes			43,393				2,327				45,720
Total assets			315,492				65,026				380,518			Total assets			315,492				65,026				380,518
Capital expenditures			4,951				2				4,953			Capital expenditures			11,682				2				11,684

The Company evaluates performance based on income before taxes. The Company does not allocate certain corporate expenses or income taxes 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 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 29, 2006 AND JULY 30, 2005

NOTE 5 — REPORTABLE SEGMENT INFORMATION (CONTINUED):

		Three Months Ended								Six Months Ended
		July 29,				July 30,				July 29,				July 30,
		2006				2005				2006				2005
Bad debt expense		$	600			$	1,179			$	1,581			$	2,443
Payroll			262				254				514				550
Postage			245				292				541				597
Other expenses			324				262				689				620
Total expenses		$	1,431			$	1,987			$	3,325			$	4,210

NOTE 6 — STOCK BASED COMPENSATION:

Effective January 29, 2006, the Company began recording compensation expense associated with stock options and other forms of equity compensation in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment, as interpreted by SEC Staff Accounting Bulletin No. 107. Prior to January 29, 2006, the Company had accounted for stock options according to the provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, and therefore no related compensation expense was recorded for awards granted with no intrinsic value at the date of the grant. The Company adopted the modified prospective transition method provided under SFAS No. 123R, and, consequently, has not adjusted results from prior periods to retroactively reflect compensation expense. Under this transition method, compensation cost associated with stock options recognized in fiscal 2006 includes: 1) quarterly amortization related to the remaining unvested portion of all stock option awards granted prior to January 29, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123; and 2) quarterly amortization related to all stock option awards granted subsequent to January 29, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R.

As of July 29, 2006, the Company had three long-term compensation plans pursuant to which stock-based compensation was outstanding or could be granted. The Company’s 1987 Non-Qualified Stock Option Plan authorized 4,612,500 shares for the granting of options to officers and key employees. The 1999 Incentive Compensation Plan and 2004 Incentive Compensation Plan authorized 1,000,000 and 1,350,000 shares, respectively, for the granting of various forms of equity-based awards, including restricted stock and stock options to officers and key employees. The 1999 Plan has expired as to the ability to grant new awards.

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 29, 2006 AND JULY 30, 2005

NOTE 6 — STOCK BASED COMPENSATION (CONTINUED):

The following table presents the number of options and shares of restricted stock initially authorized and available to grant under each of the plans:

		1987				1999				2004
		Plan				Plan				Plan				Total
Options and/or restricted stock initially authorized			4,612,500				1,000,000				1,350,000				6,962,500
Options and/or restricted stock available for grant:
January 28, 2006			5,227				—				1,300,500				1,305,727
July 29, 2006			5,227				—				1,082,996				1,088,223

Stock option awards outstanding under the Company’s current plans were granted at exercise prices which were equal to the market value of the Company’s stock on the date of grant, vest over five years and expire no later than ten years after the grant date.

The following is a summary of the changes in stock options outstanding during the six months ended July 29, 2006:

						Weighted				Weighted
						Average				Average				Aggregate
						Exercise				Remaining				Intrinsic
		Shares				Price				Contractual Term				Value (a)
Options outstanding at January 28, 2006			1,343,400			$	8.23			3.05 years
Granted			—				—				—
Forfeited or expired			(900	)
Exercised			(57,625	)
Outstanding at July 29, 2006			1,284,875			$	8.18			2.49 years				$	18,433,699
Vested and exercisable at July 29, 2006			1,178,400			$	7.58			2.09 years				$	17,617,916

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions. No options were granted in the first half of fiscal 2006. There were 15,750 options granted in the first quarter and none in the second quarter of fiscal 2005, respectively.

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 29, 2006 AND JULY 30, 2005

NOTE 6 — STOCK BASED COMPENSATION (CONTINUED):

		Six Months Ended
		July 30,
		2005
Risk free interest rate			4.14	%
Expected life		5.0		years
Expected volatility			37.63	%
Expected dividend yield			2.57	%
Weighted-average grant date fair value		$	6.260

As of July 29, 2006, there was approximately $389,000 of total unrecognized compensation cost related to nonvested options, which is expected to be recognized over a remaining weighted-average vesting period of 2.25 years. The total intrinsic value of options exercised during the second quarter and six months ended July 29, 2006 was approximately $558,000 and $778,000, respectively.

Effective January 29, 2006, the Company recognized share-based compensation expense ratably over the vesting period, net of estimated forfeitures. The Company recognized share-based compensation expense of $382,000 and $626,000 for the second quarter and six month period ended July 29, 2006, respectively, which was classified as a component of selling, general and administrative expenses. No share-based compensation expense was recognized prior to January 29, 2006 except for the amortization of restricted stock grants.

Had stock-based compensation costs been determined based on the fair value at the grant dates, consistent with SFAS No. 123R prior to January 29, 2006, the Company’s net income and earnings per share would have been adjusted to the pro forma amounts indicated below:

		Three Months				Six Months
		Ended				Ended
		July 30,				July 30,
		2005				2005
Net Income as Reported		$	10,707			$	29,124
Add: Stock-Based employee compensation expense included in reported net income, net of related tax effects			109				217
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects			(130	)			(258	)
Pro forma Net Income		$	10,686			$	29,083
Earnings per share:
Basic – as reported		$	.34			$	.94
Basic – pro forma		$	.34			$	.93
Diluted – as reported		$	.34			$	.92
Diluted – pro forma		$	.34			$	.91

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 29, 2006 AND JULY 30, 2005

NOTE 6 — STOCK BASED COMPENSATION (CONTINUED):

Prior to the adoption of SFAS No. 123R, the Company presented all benefits of tax deductions resulting from the exercise of share-based compensation as operating cash flows in the Statements of Cash Flows. SFAS No. 123R requires the benefits of tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. For the six months ended July 29, 2006, the Company reported $284,000 of excess tax benefits as a financing cash inflow in addition to $753,000 in cash proceeds received from the exercise of stock options and Employee Stock Purchase Plan purchases.

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 six months ended July 29, 2006, the Company sold 11,852 shares to employees at an average discount of $3.07 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 $36,000 for the six months ended July 29, 2006. Prior to the adoption of SFAS 123R, the discount was not required to be charged to expense.

In accordance with SFAS No. 123R, 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 the related vesting periods. As of July 29, 2006, there was $4,692,000 of total unrecognized compensation cost related to nonvested restricted stock awards, which is expected to be recognized over a remaining weighted-average vesting period of 4.75 years. The total fair value of the shares recognized as compensation expense during the second quarter and six months ended July 29, 2006 was $339,000 and $510,000, respectively.

The following summary shows the changes in the shares of restricted stock outstanding during the six months ended July 29, 2006:

						Weighted Average
		Number of				Grant Date Fair
		Shares				Value Per Share
Restricted stock awards at January 28, 2006			150,000			$	18.21
Granted			219,754				22.84
Vested			(150,000	)			18.21
Forfeited			(2,250	)			22.89
Restricted stock awards at July 29, 2006			217,504			$	22.84

NOTE 7 — RECENT ACCOUNTING PRONOUNCEMENTS:

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109.” This Interpretation prescribes the recognition threshold a tax position is required to meet before being recognized in the financial statements. The Interpretation also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods and disclosure of uncertain tax positions. The Interpretation is effective for fiscal years beginning after December 15, 2006. The Company is in the process of evaluating the impact of the adoption of this Interpretation on the Company’s consolidated financial statements.

THE CATO CORPORATION
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

FORWARD LOOKING INFORMATION:

The following information should be read along with the unaudited Condensed Consolidated Financial Statements, including the accompanying Notes appearing in this report. Any of the following are “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended: (1) statements in this Form 10-Q that reflect projections or expectations of our future financial or economic performance; (2) statements that are not historical information; (3) statements of our beliefs, intentions, plans and objectives for future operations, including those contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (4) statements relating to our operations or activities for the remainder of fiscal 2006 and beyond, including, but not limited to, statements regarding expected amounts of capital expenditures and store openings, relocations, remodelings and closures; and (5) statements relating to our future contingencies. When possible, we have attempted to identify forward-looking statements by using words such as “expects,” “anticipates,” “approximates,” “believes,” “estimates,” “hopes,” “intends,” “may,” “plans,” “should” and variations of such words and similar expressions. We can give no assurance that actual results or events will not differ materially from those expressed or implied in any such forward-looking statements. Forward-looking statements included in this report are based on information available to us as of the filing date of this report, but subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from those contemplated by the forward-looking statements. Such factors include, but are not limited to, the following: general economic conditions; competitive factors and pricing pressures; our ability to predict fashion trends; consumer apparel buying patterns; adverse weather conditions; inventory risks due to shifts in market demand; and other factors discussed under “Risk Factors” in Part I, Item 1A of our annual report on Form 10-K for the year fiscal year ended January 28, 2006, as amended or supplemented, and in other reports we file with or furnish to the SEC from time to time. We do not undertake, and expressly decline, any obligation to update any such forward-looking information contained in this report, whether as a result of new information, future events, or otherwise.

As used herein, the terms “we,” “our,” “us” (or similar terms), the “Company” or “Cato” include The Cato Corporation and its subsidiaries, except that when used with reference to common stock or other securities described herein and in describing the positions held by management of the Company, such terms include only The Cato Corporation. Our website is located at www.catocorp.com. We make available free of charge, through our website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and other reports (including amendments to these reports) filed or furnished pursuant to Section 13(a) or 15(d) under the Securities Exchange Act of 1934. These reports are available as soon as reasonably practicable after we electronically file those materials with the SEC. We also post on our website the charters of our Audit, Compensation and Corporate Governance and Nominating Committees; our Corporate Governance Guidelines, Code of Business Conduct and Ethics; and any amendments or waivers thereto; and any other corporate governance materials contemplated by SEC or New York Stock Exchange regulations. The documents are also available in print to any shareholder who requests by contacting our corporate secretary at our company offices.

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

CRITICAL ACCOUNTING POLICIES:

We have prepared the financial statements and accompanying notes included in Item 1 of this report in conformity with United States generally accepted accounting principles in the United States of America. This requires us to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. These estimates and assumptions are based on historical experience, analysis of current trends, and various other factors that we believe to be reasonable under the circumstances. Actual results could differ from those estimates under different assumptions or conditions.

We periodically reevaluate our accounting policies, assumptions, and estimates and make adjustments when facts and circumstances warrant. Historically, actual results have not differed materially from those determined using required estimates. Our critical accounting policies are discussed in the management’s discussion and analysis of financial condition and results of operations and notes accompanying the consolidated financial statements that appear in our Annual Report on Form 10-K for the fiscal year ended January 28, 2006. Except as disclosed in the financial statements and accompanying notes, there were no material changes in, or additions to, our critical accounting policies or in the assumptions or estimates we used to prepare the financial information appearing in this report.

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

RESULTS OF OPERATIONS:

The following table sets forth, for the periods indicated, certain items in the Company’s unaudited Condensed Consolidated Statements of Income and Comprehensive Income as a percentage of total retail sales:

		Three Months Ended								Six Months Ended
		July 29,				July 30,				July 29,				July 30,
		2006				2005				2006				2005
Total retail sales			100.0	%			100.0	%			100.0	%			100.0	%
Total revenues			101.5				101.7				101.5				101.8
Cost of goods sold			67.0				67.4				64.3				65.4
Selling, general and administrative			24.1				24.4				23.9				23.6
Depreciation			2.4				2.4				2.4				2.4
Interest expense			—				—				—				—
Interest and other income			(0.9	)			(0.5	)			(0.8	)			(0.4	)
Income before income taxes			8.9				8.0				11.7				10.8
Net income			5.6				5.1				7.4				6.9

Comparison of Second Quarter and First Six Months of 2006 with 2005.

Total retail sales for the second quarter were $214.6 million compared to last year’s second quarter sales of $208.3 million, a 3% increase. Same-store sales decreased 1% in the second quarter of fiscal 2006. For the six months ended July 29, 2006, total retail sales were $444.4 million compared to last year’s first six months sales of $423.4 million, a 5% increase, and same-store sales were flat for the comparable six month period. Total revenues, comprised of retail sales and other income (principally, finance charges and late fees on customer accounts receivable and layaway fees), were $217.8 million and $450.9 million for the second quarter and six months ended July 29, 2006, respectively, compared to $212.0 million and $430.9 million for the second quarter and six months ended July 30, 2005, respectively. The Company operated 1,259 stores at July 29, 2006 compared to 1,197 stores at the end of last year’s second quarter. For the first six months of 2006 the Company opened 21 stores, relocated 11 stores and closed six stores. The Company plans to open approximately 60 stores and close approximately 15 stores during fiscal 2006.

Credit revenue of $2.7 million represented 1.2% of total revenues in the second quarter of 2006, compared to 2005 credit revenue of $3.3 million or 1.5% of total revenues. The reduction in credit revenue was due to lower finance charge and late fee income from lower sales under the Company’s proprietary credit card and improved collections compared to the prior year. 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 $1.4 million in the second quarter of 2006 compared to last year’s second quarter expenses of $2.0 million. The decrease in costs was principally due to lower bad debt expense and payroll costs.

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

RESULTS OF OPERATIONS – (CONTINUED):

Other income in total, as included in total revenues was $3.2 million and $6.5 million for the second quarter and first six months of fiscal 2006, compared to $3.6 million and $7.5 million for the prior year’s comparable three and six months periods, respectively. The decrease resulted primarily from lower finance charges and late fee income.

Cost of goods sold was $143.7 million, or 67.0% of retail sales and $285.9 million or 64.3% of retail sales for the second quarter and first six months of fiscal 2006, compared to $140.4 million, or 67.4% of retail sales and $276.9 million, or 65.4% of retail sales for the prior year’s comparable three and six months periods, respectively. The overall decrease in cost of goods sold as a percent of retail sales for the second quarter and first six months of 2006 resulted primarily from lower procurement costs and lower markdowns. The reduction in procurement cost was primarily the result of increased direct sourcing and the reduction in markdowns was primarily due to improved inventory management and better sell-throughs of regular priced merchandise. 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) increased by 4.4% to $70.9 million and by 8.2% to $158.5 million for the second quarter and first six months of fiscal 2006 compared to $67.9 million and $146.5 million for the prior year’s comparable three and six month periods, respectively. Gross margin as presented may not be comparable to those of other entities.

Selling, general and administrative expenses (“SG&A”) primarily include corporate and store payroll, related payroll taxes and benefits, insurance, supplies, advertising, bank and credit card processing fees and bad debts. SG&A expenses were $51.8 million, or 24.1% of retail sales and $106.3 million, or 23.9% of retail sales for the second quarter and first six months of fiscal 2006, compared to $50.8 million, or 24.4% of retail sales and $100.1 million, or 23.6% of retail sales for prior year’s comparable three and six months periods, respectively. SG&A expenses as a percentage of retail sales decreased 30 basis points for the second quarter of fiscal 2006 as compared to the prior year and increased 30 basis points for the first six months of fiscal 2006, as compared to the prior year. The decline in SG&A expenses as a percentage of retail sales for the second quarter of fiscal 2006 was primarily attributable to a decrease in incentive based compensation expenses. The overall dollar increase in SG&A expenses for the second quarter of fiscal 2006 resulted primarily from increased worker’s compensation expenses and salary expense. For the first six months of fiscal 2006, the increase in SG&A expenses as a percentage of retail sales and the overall dollar increase in expenses resulted primarily from increased incentive based compensation expenses and selling related expenses attributable to the Company’s store growth.

Depreciation expense was $5.2 million, or 2.4% of retail sales and $10.4 million or 2.4% of retail sales, for the second quarter and first six months of fiscal 2006, compared to $5.0 million, or 2.4% of retail sales and $10.1 million, or 2.4% of retail sales, for prior year’s comparable three and six month periods, respectively.

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

RESULTS OF OPERATIONS – (CONTINUED):

The Company had no interest expense for the second quarter of fiscal 2006 or fiscal 2005, except for accretion resulting from the amortization of the retirement liability created upon the co-founders’ retirement in January 2004. The decline for the six month period was attributable to the early retirement of the remaining balance of $20.5 million on the Company’s unsecured loan facility, paid on April 5, 2005.

Interest and other income was $1.9 million, or 0.9% of retail sales and $3.5 million, or 0.8% of retail sales for the second quarter and first six months of fiscal 2006, compared to $1.1 million, or 0.5% of retail sales and to $2.0 million, or 0.4% of retail sales, for the prior year’s comparable three and six month periods, respectively. The increase in the second quarter and first six months of fiscal 2006 resulted primarily from higher interest rates and a refund settlement on third-party credit card fees of $0.5 million in the second quarter of fiscal 2006.

Income tax expense was $7.0 million, or 3.3% of retail sales and $18.9 million, or 4.3% of retail sales, for the second quarter and first six months of fiscal 2006, compared to $6.1 million, or 2.9% of retail sales and $16.6 million, or 3.9% of retail sales, for the prior year’s comparable three and six month periods. The second quarter increase resulted from higher pre-tax income. The effective income tax rate for the second quarter and first six months of fiscal 2006 was 36.5%, compared to 36.3% for the prior year’s comparable three and six month periods.

As of the date of this Form 10-Q filing, the Company has submitted insurance claims for losses attributable to Hurricanes Katrina, Rita and Wilma incurred during the third quarter of fiscal 2005. The total amount of the proceeds, which are uncertain at this time, will be classified against selling, general and administrative expenses.

LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK:

The Company has consistently maintained a strong liquidity position. Cash provided by operating activities during the first six months of fiscal 2006 was $32.4 million as compared to $38.9 million in the first six months of fiscal 2005. These amounts enable the Company to fund its regular operating needs, capital expenditure program, cash dividend payments and purchase of treasury stock. In addition, the Company maintains $35 million of unsecured revolving credit facilities for short-term financing of seasonal cash needs. There were no outstanding borrowings on these facilities at July 29, 2006.

Cash provided by operating activities for the first six months of fiscal 2006 was primarily generated by earnings adjusted for depreciation and changes in working capital. The decrease of $6.5 million for the first six months of fiscal 2006 as compared to the first six months of fiscal 2005 was primarily due to a more moderate decline in inventories and a relatively higher payables reduction in fiscal 2006, partially offset by higher net income in fiscal 2006.

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK (CONTINUED):

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 planned capital expenditures, dividends, purchase of treasury stock and other operating requirements for fiscal 2006 and for the foreseeable future beyond twelve months.

At July 29, 2006, the Company had working capital of $156.6 million compared to $138.5 million at July 30, 2005. Additionally, the Company had $1.9 million invested in privately managed investment funds at July 29, 2006, which are included in other assets on the Condensed Consolidated Balance Sheets.

At July 29, 2006, the Company had an unsecured revolving credit agreement, which provided for borrowings of up to $35 million. The revolving credit agreement is committed until August 2008. This agreement replaced a prior revolving credit agreement which was due to expire in August 2006. 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 July 29, 2006. There were no borrowings outstanding under these credit facilities during the first six months ended July 29, 2006 or the fiscal year ended January 28, 2006.

On August 22, 2003, the Company entered into a new unsecured $30 million five-year term loan facility, the proceeds of which were used to purchase Class B Common Stock from the Company’s founders. Payments were due in monthly installments of $500,000 plus accrued interest. Interest was based on LIBOR. On April 5, 2005, the Company repaid the remaining balance of $20.5 million on this loan facility with no early prepayment penalty. With the early retirement of this loan, the Company had no outstanding debt as of July 29, 2006.

At the July 29, 2006 and July 30, 2005, the Company had approximately $5.2 million and $4.9 million, respectively, of outstanding irrevocable letters of credit relating to purchase commitments.

Expenditures for property and equipment totaled $17.4 million in the first six months of fiscal 2006, compared to $11.7 million in last year’s first six months. The expenditures for the first six months of 2006 were primarily for store development and investments in new technology. In fiscal 2006, the Company is planning to invest approximately $30.0 — $33.0 million for capital expenditures. This includes expenditures to open 60 new stores, relocate 22 stores and remodel 15 stores. The decrease in previously disclosed capital expenditure expectations of $44 million is primarily attributable to technology projects deferred to fiscal 2007 and reduced store openings previously projected at approximately 90 new stores.

Net cash used in investing activities totaled $25.4 million in the first six months of fiscal 2006 compared to $9.2 million provided for the comparable period of 2005. The increase was due primarily to the purchase of short-term investments.

THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK (CONTINUED):

On May 25, 2006, the Board of Directors increased the quarterly dividend by 15% from $.13 per share to $.15 per share, or an annualized rate of $.60 per share. Prior year basic and diluted earnings per share have been adjusted for the three-for-two stock split in the form of a stock dividend of the Company’s Class A and Class B common stock effected June 27, 2005.

The Company does not use derivative financial instruments. At July 29, 2006, the Company’s investment portfolio was primarily invested in governmental and other debt securities with maturities less than 36 months. These securities are classified as available-for-sale and are recorded on the balance sheet at fair value, with unrealized gains and temporary losses reported net of taxes as accumulated other comprehensive income. Other than temporary declines in fair value of investments are recorded as a reduction in the cost of investments in the accompanying Condensed Consolidated Balance Sheets.

THE CATO CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK:

The Company is subject to market rate risk from exposure to changes in interest rates based on its financing, investing and cash management activities.

ITEM 4. 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 July 29, 2006. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of July 29, 2006, 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 Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING:

No change in the Company’s internal control over financial reporting has occurred during the Company’s fiscal quarter ended July 29, 2006 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II OTHER INFORMATION

THE CATO CORPORATION

ITEM 1. LEGAL PROCEEDINGS

     Not Applicable

ITEM 1A. RISK FACTORS

     In addition to the other information in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for our fiscal year ended January 28, 2006. These risks could materially affect our business, financial condition or future results; however, they are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition or results of operations.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

     Not Applicable

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     Not Applicable

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Following are the results of the matters voted upon at the Company’s Annual Meeting which was held on May 25, 2006.

Election of Directors:

		For				Withheld				Voting Power For				Voting Power Withheld
Mr. John P. D. Cato			27,881,605				988,347				34,055,605				988,347
Mr. William H. Grigg			14,220,220				14,649,732				20,394,220				14,649,732
Mr. James H. Shaw			27,849,509				1,020,218				34,023,734				1,020,218

Ratification of Independent Autitor:

		For				Withheld				Voting Power For				Voting Power Withheld
			28,654,043				215,908				34,828,043				215,908

ITEM 5. OTHER INFORMATION

     Not Applicable

PART II OTHER INFORMATION (CONTINUED)

THE CATO CORPORATION

ITEM 6. EXHIBITS

Exhibit No.		Item
3.1		Registrant’s Restated Certificate of Incorporation of the Registrant dated March 6, 1987, incorporated by reference to Exhibit 4.1 to Form S-8 of the Registrant filed February 7, 2000.
3.2		Registrant’s By Laws, incorporated by reference to Exhibit 4.2 to Form S-8 of the Registrant Filed February 7, 2000.
31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1		Section 1350 Certification of Chief Executive Officer.
32.2		Section 1350 Certification of Chief Financial Officer.

PART II OTHER INFORMATION

THE CATO CORPORATION

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		THE CATO CORPORATION
September 5, 2006		/s/ John P. D. Cato
Date		John P. D. Cato Chairman, President and Chief Executive Officer
September 5, 2006		/s/ Reynolds C. Faulkner
Date		Reynolds C. Faulkner Executive Vice President Chief Financial Officer
September 5, 2006		/s/ Robert M. Sandler
Date		Robert M. Sandler Senior Vice President Controller