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CATO CORP - Quarter Report: 2007 August (Form 10-Q)

The Cato Corporation
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
     
x
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
   
For the quarterly period ended           August 4, 2007          
 
   
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          
THE CATO CORPORATION
 
(Exact name of registrant as specified in its charter)
     
Delaware   56-0484485
 
(State or other jurisdiction   (I.R.S. Employer
of incorporation or organization)   Identification No.)
8100 Denmark Road, Charlotte, North Carolina 28273-5975
 
(Address of principal executive offices)
(Zip Code)
(704) 554-8510
 
(Registrant’s telephone number, including area code)
Not Applicable
 
(Former name, former address and former fiscal year,
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 x       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 x       Accelerated filer o       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 x
As of August 21, 2007, there were 30,790,488 shares of Class A common stock and 1,743,525 shares of Class B common stock outstanding.
 
 

 


 

THE CATO CORPORATION
FORM 10-Q
Quarter Ended August 4, 2007
Table of Contents
         
    Page  
    No.  
       
 
       
       
 
       
    2  
For the Three Months and Six Months Ended August 4, 2007 and July 29, 2006
       
 
       
    3  
At August 4, 2007, July 29, 2006, and February 3, 2007
       
 
       
    4  
For the Six Months Ended August 4, 2007 and July 29, 2006
       
 
       
    5 - 11  
For the Three Months and Six Months Ended August 4, 2007 and July 29, 2006
       
 
       
    12 - 17  
 
       
    18  
 
       
    18  
 
       
       
 
       
    19  
 
       
    19  
 
       
    19  
 
       
    19  
 
       
    19  
 
       
    19  
 
       
    20  
 
       
    21 - 25  
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

 


Table of Contents

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  
    August 4,     July 29,     August 4,     July 29,  
    2007     2006     2007     2006  
    (Unaudited)     (Unaudited)     (Unaudited)     (Unaudited)  
    (Dollars in thousands, except per share data)  
REVENUES
                               
Retail sales
  $ 218,973     $ 214,633     $ 443,107     $ 444,374  
Other income (principally finance charges, late fees and layaway charges)
    2,961       3,212       6,056       6,531  
 
                       
Total revenues
    221,934       217,845       449,163       450,905  
 
                       
 
                               
COSTS AND EXPENSES, NET
                               
Cost of goods sold
    147,514       143,746       290,936       285,858  
Selling, general and administrative
    52,463       51,772       103,599       106,349  
Depreciation
    5,623       5,223       11,014       10,391  
Interest and other income
    (2,316 )     (1,940 )     (4,209 )     (3,492 )
 
                       
 
                               
 
    203,284       198,801       401,340       399,106  
 
                       
 
                               
Income before income taxes
    18,650       19,044       47,823       51,799  
 
                               
Income tax expense
    6,140       6,951       16,642       18,907  
 
                       
 
                               
Net Income
  $ 12,510     $ 12,093     $ 31,181     $ 32,892  
 
                       
 
                               
Basic earnings per share
  $ 0.39     $ 0.39     $ 0.99     $ 1.05  
 
                       
 
                               
Basic weighted average shares
    31,897,365       31,267,637       31,624,979       31,250,921  
 
                       
 
                               
Diluted earnings per share
  $ 0.39     $ 0.38     $ 0.97     $ 1.04  
 
                       
 
                               
Diluted weighted average shares
    32,189,903       31,803,875       32,040,169       31,765,992  
 
                       
 
                               
Dividends per share
  $ 0.165     $ 0.15     $ 0.315     $ 0.28  
 
                       
 
                               
Comprehensive income:
                               
Net income
  $ 12,510     $ 12,093     $ 31,181     $ 32,892  
Unrealized gains (losses) on available-for-sale securities, net of deferred income tax expense
    (49 )     56       (21 )     34  
 
                       
 
                               
Net comprehensive income
  $ 12,461     $ 12,149     $ 31,160     $ 32,926  
 
                       
See notes to condensed consolidated financial statements.

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Table of Contents

THE CATO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
                         
    August 4,     July 29,     February 3,  
    2007     2006     2007  
    (Unaudited)     (Unaudited)        
    (Dollars in thousands)  
ASSETS
                       
Current Assets:
                       
Cash and cash equivalents
  $ 19,929     $ 21,809     $ 24,833  
Short-term investments
    150,387       94,171       98,709  
Accounts receivable, net of allowance for doubtful accounts of $3,226, $3,589 and $3,554 at August 4, 2007, July 29, 2006 and February 3, 2007, respectively
    45,533       46,436       45,958  
Merchandise inventories
    99,236       91,989       115,918  
Deferred income taxes
    7,522       8,506       7,508  
Prepaid expenses
    7,197       2,464       6,587  
 
                 
Total Current Assets
    329,804       265,375       299,513  
 
                       
Property and equipment — net
    126,573       130,422       128,461  
Other assets
    4,279       11,201       4,348  
 
                 
Total Assets
  $ 460,656     $ 406,998     $ 432,322  
 
                 
 
                       
LIABILITIES AND STOCKHOLDERS’ EQUITY
                       
Current Liabilities:
                       
Accounts payable
  $ 82,879     $ 58,210     $ 77,046  
Accrued expenses
    29,438       32,433       29,526  
Accrued bonus and benefits
    1,426       10,342       10,756  
Accrued income taxes
    6,437       7,779       5,721  
 
                 
Total Current Liabilities
    120,180       108,764       123,049  
 
                       
Deferred income taxes
    8,817       9,261       8,817  
Other noncurrent liabilities (primarily deferred rent)
    23,286       23,230       23,663  
 
                       
Commitments and contingencies:
                       
 
                       
Stockholders’ Equity:
                       
Preferred stock, $100 par value per share, 100,000 shares authorized, none issued
                 
Class A common stock, $.033 par value per share, 50,000,000 shares authorized; issued 36,089,761 shares, 35,909,497 shares and 35,955,815 shares at August 4, 2007, July 29, 2006 and February 3, 2007, respectively
    1,203       1,197       1,199  
Convertible Class B common stock, $.033 par value per share, 15,000,000 shares authorized; issued 1,743,525 shares, 690,525 shares and 690,525 shares at August 4, 2007, July 29, 2006 and February 3, 2007, respectively
    58       23       23  
Additional paid-in capital
    56,913       40,668       42,475  
Retained earnings
    349,276       318,556       327,684  
Accumulated other comprehensive income
    204       112       225  
 
                 
 
    407,654       360,556       371,606  
Less Class A common stock in treasury, at cost (5,299,500 shares at August 4, 2007, 5,093,609 at July 29, 2006 and 5,093,609 at February 3, 2007)
    (99,281 )     (94,813 )     (94,813 )
 
                 
Total Stockholders’ Equity
    308,373       265,743       276,793  
 
                 
Total Liabilities and Stockholders’ Equity
  $ 460,656     $ 406,998     $ 432,322  
 
                 
See notes to condensed consolidated financial statements.

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Table of Contents

THE CATO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                 
    Six Months Ended  
    August 4,     July 29,  
    2007     2006  
    (Unaudited)     (Unaudited)  
    (Dollars in thousands)  
OPERATING ACTIVITIES
               
 
Net income
  $ 31,181     $ 32,892  
 
               
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
    11,014       10,391  
Provision for doubtful accounts
    1,134       1,627  
Share-based compensation
    812       626  
Excess tax benefits from share-based compensation
    (5,450 )     (284 )
Deferred income taxes
          20  
Loss on disposal of property and equipment
    326       569  
Changes in operating assets and liabilities which provided (used) cash:
               
Accounts receivable
    (709 )     1,581  
Merchandise inventories
    16,682       11,381  
Prepaid and other assets
    (541 )     (493 )
Accrued income taxes
    6,528       3,073  
Accounts payable, accrued expenses and other liabilities
    (3,346 )     (28,930 )
 
           
 
               
Net cash provided by operating activities
    57,631       32,453  
 
           
 
               
INVESTING ACTIVITIES
               
Expenditures for property and equipment
    (9,568 )     (17,370 )
Purchases of short-term investments
    (206,024 )     (95,287 )
Sales of short-term investments
    154,310       87,235  
 
           
 
               
Net cash used in investing activities
    (61,282 )     (25,422 )
 
           
 
               
FINANCING ACTIVITIES
               
Change in cash overdrafts included in accounts payable
    (500 )     805  
Dividends paid
    (9,961 )     (8,798 )
Purchase of treasury stock
    (4,468 )      
Proceeds from employee stock purchase plan
    233       206  
Excess tax benefits from share-based compensation
    5,450       284  
Proceeds from stock options exercised
    7,993       547  
 
           
 
               
Net cash used in financing activities
    (1,253 )     (6,956 )
 
           
 
               
Net increase in cash and cash equivalents
    (4,904 )     75  
 
               
Cash and cash equivalents at beginning of period
    24,833       21,734  
 
           
 
               
Cash and cash equivalents at end of period
  $ 19,929     $ 21,809  
 
           
See notes to condensed consolidated financial statements.

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THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED AUGUST 4, 2007
AND JULY 29, 2006
 
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 August 4, 2007 and July 29, 2006 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 February 3, 2007.
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.
Merchandise inventories are stated at the lower of cost (first-in, first-out method) or market as determined by the retail inventory method.
On May 24, 2007, the Board of Directors increased the quarterly dividend by 10% from $.15 per share to $.165 per share, or an annualized rate of $.66 per share.

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THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED AUGUST 4, 2007
AND JULY 29, 2006
 
NOTE 2 — EARNINGS PER SHARE:
FASB No. 128 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 statement of income. While the Company’s articles of incorporation provide 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 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  
    August 4,     July 29,     August 4,     July 29,  
    2007     2006     2007     2006  
Weighted-average shares outstanding
    31,897,365       31,267,637       31,624,979       31,250,921  
Dilutive effect of :
   
Stock options
    234,982       522,683       365,822       509,122  
Restricted stock
    57,035       13,260       48,674       5,704  
Employee stock purchase plan
    521       295       694       245  
 
                       
Weighted-average shares and common stock equivalents outstanding
    32,189,903       31,803,875       32,040,169       31,765,992  
 
                       
NOTE 3 — SUPPLEMENTAL CASH FLOW INFORMATION:
Income tax payments, net of refunds received, for the six months ended August 4, 2007 and
July 29, 2006 were $10,040,000 and $15,875,000, respectively. Cash paid for interest for the six months ended August 4, 2007 and July 29, 2006 were zero for both periods ended, respectively.
NOTE 4 — FINANCING ARRANGEMENTS:
At August 4, 2007, 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. 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 August 4,

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THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED AUGUST 4, 2007 AND
JULY 29, 2006
 
NOTE 4 — FINANCING ARRANGEMENTS (CONTINUED):
2007. There were no borrowings outstanding under this credit facility during the first six months ended August 4, 2007 or July 29, 2006, respectively, or the fiscal year ended February 3, 2007. Interest on any borrowings is based on LIBOR, which was 5.33% at August 4, 2007.
At August 4, 2007 and July 29, 2006 the Company had approximately $6,620,000 and $5,227,000, 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 August 4, 2007, 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            
August 4, 2007   Retail   Credit   Total   August 4, 2007   Retail   Credit   Total
Revenues
  $ 219,374     $ 2,560     $ 221,934     Revenues   $ 444,005     $ 5,158     $ 449,163  
Depreciation
    5,597       26       5,623     Depreciation     10,964       50       11,014  
Interest and other income
    (2,316 )           (2,316 )   Interest and other income     (4,209 )           (4,209 )
Income before taxes
    17,549       1,101       18,650     Income before taxes     45,567       2,256       47,823  
Total assets
    393,081       67,575       460,656     Total assets     393,081       67,575       460,656  
Capital expenditures
    5,532       106       5,638     Capital expenditures     9,449       119       9,568  
 
                                                   
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  
The Company evaluates performance based on income before taxes. The Company does not allocate certain corporate expenses or income taxes to the credit segment.

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THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED AUGUST 4, 2007 AND
JULY 29, 2006
 
NOTE 5 — REPORTABLE SEGMENT INFORMATION (CONTINUED):
The following schedule summarizes the direct expenses of the credit segment which are reflected in selling, general and administrative expenses (in thousands):
                                 
    Three Months Ended     Six Months Ended  
    August 4,     July 29,     August 4,     July 29,  
    2007     2006     2007     2006  
Bad debt expense
  $ 676     $ 600     $ 1,134     $ 1,581  
Payroll
    245       262       487       514  
Postage
    235       245       513       541  
Other expenses
    277       324       718       689  
 
                       
 
Total expenses
  $ 1,433     $ 1,431     $ 2,852     $ 3,325  
 
                       
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 and 2007 includes 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 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 August 4, 2007, 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 5,850,000 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.

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THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED AUGUST 4, 2007 AND
JULY 29, 2006
 
NOTE 6 — STOCK BASED COMPENSATION (CONTINUED):
The following table presents the number of options and shares of restricted stock initially authorized and available for grant under each of the plans:
                                 
    1987     1999     2004        
    Plan     Plan     Plan     Total  
Options and/or restricted stock initially authorized
    5,850,000       1,000,000       1,350,000       8,200,000  
Options and/or restricted stock available for grant:
                               
February 3, 2007
    9,277             1,091,618       1,100,895  
August 4, 2007
    9,277               999,358       1,008,635  
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 August 4, 2007:
                                 
                Weighted        
          Weighted     Average        
          Average     Remaining     Aggregate  
            Exercise     Contractual     Intrinsic  
    Shares     Price     Term     Value (a)  
Options outstanding at February 3, 2007
    1,236,675     $ 8.01     1.86 years   $ 18,363,084  
Granted
                         
Forfeited or expired
    (2,400 )                        
Exercised
    (1,080,725 )   $ 7.40                  
 
                             
Outstanding at August 4, 2007
    153,550     $ 12.26     4.98 years   $ 1,515,460  
Vested and exercisable at August 4, 2007
    94,800     $ 10.65     3.73 years   $ 1,104,135  
 
(a)  
The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option.
No options were granted in fiscal 2006 or first half of fiscal 2007.
As of August 4, 2007, there was approximately $229,000 of total unrecognized compensation cost related to nonvested options, which is expected to be recognized over a remaining weighted-average vesting period of 1.93 years. The total intrinsic value of options exercised during the second quarter and six months ended August 4, 2007 was approximately $15,136,000 and $15,308,000, respectively.
Effective with the adoption of SFAS No. 123R, the Company began recognizing share-based compensation expense ratably over the vesting period, net of estimated forfeitures.

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THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED AUGUST 4, 2007 AND
JULY 29, 2006
 
NOTE 6 — STOCK BASED COMPENSATION (CONTINUED):
The Company recognized share-based compensation expense of $438,000 and $799,000 for the second quarter and six month period ended August 4, 2007, respectively, compared to $382,000 and $626,000 for the second quarter and six month period ending July 29, 2006, respectively. These expenses were classified as a component of selling, general and administrative expenses.
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 August 4, 2007 and July 29, 2006, the Company reported $5,450,000 and $284,000 of excess tax benefits as a financing cash inflow in addition to $8,226,000 and $753,000 in cash proceeds received from the exercise of stock options and Employee Stock Purchase Plan purchases, respectively.
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 August 4, 2007 and July 29, 2006, the Company sold 12,463 and 11,852 shares to employees at an average discount of $3.30 and $3.07 per share, respectively, under the Employee Stock Purchase Plan. The compensation expense recognized for the 15% discount given under the Employee Stock Purchase Plan was approximately $41,000 and $36,000 for the six months ended August 4, 2007 and July 29, 2006, respectively.
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 net of estimated forfeitures. As of August 4, 2007 and July 29, 2006, there was $5,786,000 and $4,692,000 of total unrecognized compensation cost related to nonvested restricted stock awards, which have a remaining weighted-average vesting period of 4.01 years and 4.75 years, respectively. The total fair value of the shares recognized as compensation expense during the second quarter and six months ended August 4, 2007 was $397,000 and $698,000 compared to $339,000 and $510,000 for the second quarter and six months ended July 29, 2006.

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THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED AUGUST 4, 2007 AND
JULY 29, 2006
 
NOTE 6 — STOCK BASED COMPENSATION (CONTINUED):
The following summary shows the changes in the shares of restricted stock outstanding during the six months ended August 4, 2007:
                 
            Weighted Average  
    Number of     Grant Date Fair  
    Shares     Value Per Share  
Restricted stock awards at February 3, 2007
    214,882     $ 22.92  
Granted
    100,226       21.87  
Vested
           
Forfeited
    (6,466 )     22.75  
 
           
Restricted stock awards at August 4, 2007
    308,642     $ 22.59  
NOTE 7 — INCOME TAXES:
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 adopted Financial Standards Accounting Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109,” on February 4, 2007. As a result of the implementation of FASB Interpretation No. 48, the Company recognized a transition adjustment increasing beginning retained earnings by $362,000. At February 4, 2007, the Company had approximately $6,200,000 of unrecognized tax benefits, approximately $4,200,000 of which would affect the effective tax rate if recognized. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of February 4, 2007, the Company had approximately $3,900,000 of accrued interest and penalties related to uncertain tax positions. The tax years after 2003 remain open to examination by the major taxing jurisdictions to which the Company is subject.
As of August 4, 2007, there have been no significant changes in unrecognized tax benefits.
NOTE 8 — RECENT ACCOUNTING PRONOUNCEMENTS:
In September 2006, FASB issued SFAS 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosure of fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements and, accordingly does not require any new fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the impact that the adoption of SFAS 157 will have on its financial statements.

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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 fiscal 2007 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 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 fiscal year ended February 3, 2007 (fiscal 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 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.

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THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
CRITICAL ACCOUNTING POLICIES:
The Company’s accounting policies are more fully described in Note 1 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the Fiscal Year Ended February 3, 2007. As disclosed in Note 1, the preparation of the Company’s financial statements in conformity with generally accepted accounting principles 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 receivable, reserves relating to workers’ compensation, general and auto insurance liabilities, reserves for inventory markdowns, shrinkage accrual, calculation of asset impairment and reserves for uncertain tax positions.
The Company’s critical accounting policies and estimates are discussed with the Audit Committee.

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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  
    August 4,     July 29,     August 4,     July 29,  
    2007     2006     2007     2006  
Total retail sales
    100.0 %     100.0 %     100.0 %     100.0 %
Total revenues
    101.3       101.5       101.4       101.5  
Cost of goods sold
    67.4       67.0       65.7       64.3  
Selling, general and administrative
    23.9       24.1       23.4       23.9  
Depreciation
    2.6       2.4       2.5       2.4  
Interest and other income
    (1.1 )     (0.9 )     (1.0 )     (0.8 )
Income before income taxes
    8.5       8.9       10.8       11.7  
Net income
    5.7       5.6       7.0       7.4  
Comparison of Second Quarter and First Six Months of 2007 with 2006.
Total retail sales for the second quarter were $219.0 million compared to last year’s second quarter sales of $214.6 million, a 2% increase. Same-store sales decreased 1% in the second quarter of fiscal 2007. For the six months ended August 4, 2007, total retail sales were $443.1 million compared to last year’s first six months sales of $444.4 million, and same-store sales decreased 3% 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 $221.9 million and $449.2 million for the second quarter and six months ended August 4, 2007, respectively, compared to $217.8 million and $450.9 million for the second quarter and six months ended July 29, 2006, respectively. The Company operated 1,306 stores at August 4, 2007 compared to 1,259 stores at the end of last year’s second quarter. For the first six months of 2007 the Company opened 31 stores, relocated 10 stores and closed one store. The Company plans to open approximately 70 stores and close approximately 15 stores during its full fiscal 2007 year.
Credit revenue of $2.6 million represented 1.2% of total revenues in the second quarter of 2007, compared to 2006 credit revenue of $2.7 million or 1.2% of total revenues. The slight reduction in credit revenue was due to lower finance charge and late fee income from lower sales under the Company’s proprietary credit card, partially offset by 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 2007, flat to last year’s second quarter expenses of $1.4 million. Bad debt expense was higher compared to the second quarter of 2006, partially offset by lower payroll and administrative expenses.

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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 $3.0 million and $6.1 million for the second quarter and first six months of fiscal 2007, compared to $3.2 million and $6.5 million for the prior year’s comparable three and six month period, respectively. The decrease resulted primarily from lower finance charges.
Cost of goods sold was $147.5 million, or 67.4% of retail sales and $290.9 million or 65.7% of retail sales for the second quarter and first six months of fiscal 2007, compared to $143.7 million, or 67.0% of retail sales and $285.9 million, or 64.3% of retail sales for the prior year’s comparable three and six month period, respectively. The overall increase in cost of goods sold as a percent of retail sales for the second quarter and first six months of 2007 resulted primarily from higher markdowns and occupancy costs, partially offset by lower procurement costs. The reduction in procurement costs was primarily the result of increased direct sourcing. The increase in markdowns was primarily due to lower 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 1.0% to $71.5 million and decreased by 4.1% to $152.2 million for the second quarter and first six months of fiscal 2007, compared to $70.9 million and $158.5 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 $52.5 million, or 23.9% of retail sales and $103.6 million, or 23.4% of retail sales for the second quarter and first six months of fiscal 2007, compared to $51.8 million, or 24.1% of retail sales and $106.3 million, or 23.9% of retail sales for prior year’s comparable three and six month period, respectively. SG&A expenses as a percentage of retail sales decreased 20 basis points for the second quarter of fiscal 2007 as compared to the prior year and decreased 50 basis points for the first six months of fiscal 2007 as compared to the prior year. The decline in SG&A expenses as a percentage of retail sales for the second quarter of fiscal 2007 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 2007 resulted primarily from increased corporate and store payroll expenses. For the first six months of fiscal 2007, the decrease in SG&A expenses as a percentage of retail sales and the overall dollar decrease in SG&A expenses resulted primarily from decreased incentive based compensation expenses, partially offset by increased payroll, workers’ compensation and group health insurance expenses.
Depreciation expense was $5.6 million, or 2.6% of retail sales and $11.0 million or 2.5% of retail sales, for the second quarter and first six months of fiscal 2007, compared to $5.2 million, or 2.4% of retail sales and $10.4 million, or 2.4% of retail sales, for prior year’s comparable three and six month periods, respectively.

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THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
RESULTS OF OPERATIONS — (CONTINUED):
Interest and other income was $2.3 million, or 1.1% of retail sales and $4.2 million, or 1.0% of retail sales for the second quarter and first six months of fiscal 2007, compared to $1.9 million, or 0.9% of retail sales and $3.5 million, or 0.8% of retail sales, for the prior year’s comparable three and six month periods, respectively. The increase in fiscal 2007 resulted primarily from higher interest rates and higher investment balances.
Income tax expense was $6.1 million, or 2.8% of retail sales and $16.6 million, or 3.8% of retail sales, for the second quarter and first six months of fiscal 2007, compared to $7.0 million, or 3.3% of retail sales and $18.9 million, or 4.3% of retail sales, for the prior year’s comparable three and six month periods. The decrease for the second quarter and six month period resulted from lower pre-tax income and a lower effective tax rate primarily due to higher tax credits. The effective income tax rate for the second quarter and first six months of fiscal 2007 was 32.9% and 34.8%, respectively, compared to 36.5% for the prior year’s comparable three and six month periods.
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 2007 was $57.6 million as compared to $32.5 million in the first six months of fiscal 2006. 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 a $35 million unsecured revolving credit facility for short-term financing of seasonal cash needs. There were no outstanding borrowings on this facility at August 4, 2007.
Cash provided by operating activities for the first six months of fiscal 2007 was primarily generated by earnings adjusted, for depreciation and changes in working capital. The increase of $25.2 million for the first six months of fiscal 2007 as compared to the first six months of fiscal 2006 was primarily due to a decrease in inventories and an increase in accounts payable and other liabilities in fiscal 2007, partially offset by higher excess tax benefits in fiscal 2007.
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 2007 and for the foreseeable future.
At August 4, 2007, the Company had working capital of $209.6 million compared to $156.6 million at July 29, 2006. Additionally, the Company had $1.9 million invested in privately managed investment funds at August 4, 2007 and July 29, 2006, which are included in other assets on the Condensed Consolidated Balance Sheets.

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THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK (CONTINUED):
At August 4, 2007, 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. 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 August 4, 2007. There were no borrowings outstanding under this credit facility during the first six months ended August 4, 2007 or the fiscal year ended February 3, 2007.
At August 4, 2007 and July 29, 2006, the Company had approximately $6.6 million and $5.2 million, respectively, of outstanding irrevocable letters of credit relating to purchase commitments.
Expenditures for property and equipment totaled $9.6 million in the first six months of fiscal 2007, compared to $17.4 million in last year’s first six months. The expenditures for the first six months of 2007 were primarily for store development and investments in new technology. For the full fiscal 2007 year, the Company is planning to invest approximately $29.7 million for capital expenditures. This includes expenditures to open 70 new stores, relocate 21 stores and remodel 15 stores.
Net cash used in investing activities totaled $61.3 million in the first six months of fiscal 2007 compared to $25.4 million provided for the comparable period of 2006. The increase was due primarily to the purchase of short-term investments.
On May 24, 2007, the Board of Directors increased the quarterly dividend by 10% from $.15 per share to $.165 per share, or an annualized rate of $.66 per share.
On August 31, 2007, the Board authorized an increase in the Company’s share repurchase program of two million shares. There is no expiration on shares authorized in the program.
The Company does not use derivative financial instruments. At August 4, 2007, 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.

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THE CATO CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK:
The Company is subject to market rate risk from exposure to changes in interest rates based on its financing, investing and cash management activities, but the Company does not believe such exposure is material.
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 August 4, 2007. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of August 4, 2007, 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 (as defined in Exchange Act Rule 13a — 15(f)) has occurred during the Company’s fiscal quarter ended August 4, 2007 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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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 February 3, 2007. 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 and adversely affect our business, financial condition or results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
     The following table summarized the Company’s purchases of its common stock for the three months ended August 4, 2007:
ISSUER PURCHASES OF EQUITY SECURITIES
                                 
                    Total Number of     Maximum Number  
                    Shares Purchased as     (or Approximate Dollar  
    Total Number             Part of Publicly     Value) of Shares that may  
    Of Shares     Average Price     Announced Plans or     Yet be Purchased Under  
Period   Purchased (1)     Paid per Share     Programs (2)     The Plans or Programs (2)  
May 2007
    0       0.00       0          
June 2007
    205,891       21.70       0          
July 2007
    0       0.00       0          
Total
    205,891       21.70       0     1.557 million shares
     
(1)  
Includes 205,891 shares tendered as partial payment of the exercise price of an employee stock option and the related tax withholding.
(2)  
On August 31, 2007, the Company’s board of directors authorized an increase in the share repurchase program of two million shares. At the second quarter ending August 4, 2007, the Company had 1,557 million shares remaining in open authorizations. There is no expiration date for the Company’s repurchase program. During the month of August 2007, the Company repurchased 306,500 shares at a cost of $5,926,567
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
     Not Applicable

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PART II  OTHER INFORMATION (CONTINUED)
THE CATO CORPORATION
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 24, 2007.
 
   
Election of Directors:
                                 
                    Voting Power  
    For     Withheld     For     Withheld  
Mr. George S. Currin
    16,680,839       13,434,219       22,895,564       13,434,219  
Mr. A. F. Sloan
    28,485,173       1,629,885       34,699,898       1,629,885  
Mr. D. Harding Stowe
    28,773,564       1,341,494       34,988,289       1,341,494  
 
                               
Ratification of Independent Auditor:
                               
 
                               
                    Voting Power  
    For     Withheld     For     Withheld  
 
    30,072,251       42,805       36,286,976       42,805  
ITEM 5. OTHER INFORMATION
   
Not Applicable
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 (SEC File No. 333—96283).
 
   
3.2
  Registrant’s By Laws incorporated by reference to Exhibit 4.2 to Form S-8 of the Registrant filed February 7, 2000 (SEC File No. 333—96283).
 
   
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.
 
   

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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 12, 2007
  /s/ John P. D. Cato
 
   
Date
  John P. D. Cato
Chairman, President and
Chief Executive Officer
 
   
September 12, 2007
  /s/ Thomas W. Stoltz
 
   
Date
  Thomas W. Stoltz
Executive Vice President
Chief Financial Officer
 
   
September 12, 2007
  /s/ John R. Howe
 
   
Date
  John R. Howe
Senior Vice President
Controller

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