Edgar Filing: CATO CORP

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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 July 30, 2011

OR

[ ]		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 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
(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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨ Accelerated filer þ Non-accelerated filer ¨ Smaller reporting company ¨

(Do not check if a smaller reporting company)

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

Yes

As of September 7, 2011, there were 27,707,496 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 July 30, 2011

				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 30, 2011 and July 31, 2010

	Condensed Consolidated Balance Sheets				3
		At July 30, 2011, July 31, 2010 and January 29, 2011

	Condensed Consolidated Statements of Cash Flows				4
		For the Six Months Ended July 30, 2011 and July 31, 2010

	Notes to Condensed Consolidated Financial Statements				5 – 16
		For the Three Months and Six Months Ended July 30, 2011 and July 31, 2010

	Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		17 – 23

	Item 3.		Quantitative and Qualitative Disclosures About Market Risk		24

	Item 4.		Controls and Procedures		24

PART II – OTHER INFORMATION

	Item 1.		Legal Proceedings		25

	Item 1A.		Risk Factors		25

	Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		25

	Item 3.		Defaults Upon Senior Securities		26

	Item 4.		Removed and Reserved		26

	Item 5.		Other Information		26

	Item 6.		Exhibits		26

	Signatures				27 - 32

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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 30, 2011		July 31, 2010		July 30, 2011		July 31, 2010
	(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)
	(Dollars in thousands, except per share data)
REVENUES
Retail sales	$	234,077	$	231,839	$	505,010	$	490,879
Other income (principally finance charges, late fees and
layaway charges)		2,729		2,862		5,456		5,785
Total revenues		236,806		234,701		510,466		496,664

COSTS AND EXPENSES, NET
Cost of goods sold (exclusive of depreciation shown below)		145,156		141,404		303,561		291,264
Selling, general and administrative (exclusive of depreciation
shown below)		58,955		62,340		122,271		130,421
Depreciation		5,371		5,277		10,775		10,547
Interest and other income		(949)		(957)		(1,906)		(1,849)
Cost and expenses, net		208,533		208,064		434,701		430,383

Income before income taxes		28,273		26,637		75,765		66,281

Income tax expense		10,170		9,659		27,141		24,269

Net income	$	18,103	$	16,978	$	48,624	$	42,012

Basic earnings per share	$	0.61	$	0.58	$	1.65	$	1.42

Diluted earnings per share	$	0.61	$	0.58	$	1.65	$	1.42

Dividends per share	$	0.230	$	0.185	$	0.415	$	0.35

Comprehensive income:
Net income	$	18,103	$	16,978	$	48,624	$	42,012
Unrealized gain (loss) on available-for-sale securities, net
of deferred income tax benefit		310		130		584		44
Comprehensive income	$	18,413	$	17,108	$	49,208	$	42,056

See notes to consolidated financial statements.

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THE CATO CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS


	July 30, 2011		July 31, 2010		January 29, 2011
	(Unaudited)		(Unaudited)		(Unaudited)
	(Dollars in thousands)
ASSETS
Current Assets:
Cash and cash equivalents	$	77,376	$	68,336	$	48,630
Short-term investments		190,533		165,755		181,395
Restricted cash and investments		4,801		2,547		4,826
Accounts receivable, net of allowance for doubtful accounts of
$2,654 , $3,233 and $2,985 at July 30, 2011, July 31, 2010 and
January 29, 2011 respectively		37,621		39,747		39,703
Merchandise inventories		117,225		105,157		144,028
Deferred income taxes		3,338		7,802		3,660
Prepaid expenses		3,739		5,352		3,199
Total Current Assets		434,633		394,696		425,441
Property and equipment – net		104,333		100,869		99,773
Other assets		9,434		7,499		7,545
Total Assets	$	548,400	$	503,064	$	532,759
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable	$	86,553	$	79,276	$	103,898
Accrued expenses		36,308		32,587		35,318
Accrued bonus and benefits		8,906		18,062		22,841
Accrued income taxes		23,145		22,493		11,861
Total Current Liabilities		154,912		152,418		173,918
Deferred income taxes		9,540		7,833		9,540
Other noncurrent liabilities (primarily deferred rent)		14,190		16,362		15,287

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 27,741,091 shares, 27,736,131 shares
and 27,758,123 shares at July 30, 2011, July 31, 2010 and
January 29, 2011, respectively		925		925		925
Convertible Class B common stock, $.033 par value per share,
15,000,000 shares authorized; issued 1,743,525 shares at July 30, 2011,
July 31, 2010 and January 29, 2011, respectively		58		58		58
Additional paid-in capital		70,203		66,584		68,537
Retained earnings		297,713		258,307		264,218
Accumulated other comprehensive income		859		577		276
Total Stockholders' Equity		369,758		326,451		334,014
Total Liabilities and Stockholders’ Equity	$	548,400	$	503,064	$	532,759

See notes to consolidated financial statements.

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THE CATO CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


		Six Months Ended
	July 30, 2011		July 31, 2010
	(Unaudited)		(Unaudited)
		(Dollars in thousands)

Operating Activities:
Net income	$	48,624	$	42,012
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation		10,775		10,547
Provision for doubtful accounts		882		1,499
Share-based compensation		1,302		1,213
Excess tax benefits from share-based compensation		(89)		(133)
Loss on disposal of property and equipment		415		220
Changes in operating assets and liabilities which provided
(used) cash:
Accounts receivable		1,200		(1,092)
Merchandise inventories		26,803		24,492
Prepaid and other assets		(2,437)		(2,145)
Accrued income taxes		11,373		11,686
Accounts payable, accrued expenses and other liabilities		(31,387)		(28,357)
Net cash provided by operating activities		67,461		59,942

Investing Activities:
Expenditures for property and equipment		(15,751)		(8,866)
Purchase of short-term investments		(79,623)		(111,454)
Sales of short-term investments		71,399		93,768
Change in restricted cash and investments		25		28
Net cash used in investing activities		(23,950)		(26,524)

Financing Activities:
Dividends paid		(12,243)		(10,304)
Repurchase of common stock		(2,897)		(5,840)
Proceeds from employee stock purchase plan		254		218
Excess tax benefits from share-based compensation		89		133
Proceeds from stock options exercised		32		326
Net cash used in financing activities		(14,765)		(15,467)

Net increase in cash and cash equivalents		28,746		17,951

Cash and cash equivalents at beginning of period		48,630		50,385
Cash and cash equivalents at end of period	$	77,376	$	68,336

See notes to 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 JULY 30, 2011 AND JULY 31, 2010

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 30, 2011 and July 31, 2010 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 unless otherwise noted. 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 29, 2011. Amounts as of January 29, 2011, have been derived from the audited balance sheet other than the retrospective application of the change in accounting principle.

On August 25, 2011, the Board of Directors maintained the quarterly dividend at $.23 per share or an annualized rate of $0.92 per share.

CHANGE IN ACCOUNTING PRINCIPLE:

The Company elected to change its method of accounting for inventory to the weighted average cost method from the retail method effective January 30, 2011. In accordance with ASC 250 “Accounting Changes and Error Corrections”, all periods have been retrospectively adjusted to reflect the period-specific effects of the change to the weighted average cost method. The Company believes that the weighted average cost method better matches cost of sales with related sales, as well as having an inventory valuation that more closely reflects the acquisition cost of inventory by valuing inventory on a unit basis versus the product department level under the retail method. The cumulative adjustment as of January 31, 2010, was an increase in inventory of $11,700,000 and an increase in retained earnings of $7,300,000.

Additionally, the Company has changed the classification for certain balance sheet items to conform to the 2011 presentation. This change in classification has reduced accounts payable and inventory by $1,600,000 as of January 29, 2011 and $500,000 as of July 31, 2010.

In addition, the Company has changed the classification of certain prior year income statement items to conform to the 2011 presentation. The change has no effect on net income; however, it does reduce retail sales by $26,000 and cost of goods sold by $98,000 and increases selling, general and administrative expense by $72,000 for the three months ended July 31, 2010. The change also reduces retail sales by $746,000, cost of goods sold by $339,000 and selling, general and administrative expense by $407,000 for the six months ended July 31, 2010.

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THE CATO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 30, 2011 AND JULY 31, 2010

As a result of this retrospective application of the change in accounting principle and the change in the classification of the Balance Sheet, the following items in the Company's Condensed Consolidated Balance Sheets have been adjusted as follows:




	January 29, 2011
	(Unaudited)
	(Dollars in thousands)
	As Previously Reported		Total Changes		As Adjusted
Merchandise inventories	$	132,020	$	12,008	$	144,028
Deferred income taxes		5,001		(1,341)		3,660
Total Current Assets		414,774		10,667		425,441
Total Assets		522,092		10,667		532,759
Accounts payable		105,526		(1,628)		103,898
Total Current Liabilities		175,546		(1,628)		173,918
Deferred income taxes		5,695		3,845		9,540
Retained earnings		255,768		8,450		264,218
Total Stockholders' Equity		325,564		8,450		334,014
Total Liabilities and Stockholders’ Equity	$	522,092	$	10,667	$	532,759



	July 31, 2010
	(Unaudited)
	(Dollars in thousands)
	As Previously Reported		Total Changes		As Adjusted
Merchandise inventories	$	95,720	$	9,437	$	105,157
Deferred income taxes		7,748		54		7,802
Total Current Assets		385,205		9,491		394,696
Total Assets		493,573		9,491		503,064
Accounts payable		79,802		(526)		79,276
Total Current Liabilities		152,944		(526)		152,418
Deferred income taxes		4,087		3,746		7,833
Retained earnings		252,037		6,270		258,307
Total Stockholders' Equity		320,181		6,270		326,451
Total Liabilities and Stockholders’ Equity	$	493,573	$	9,491	$	503,064

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THE CATO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 30, 2011 AND JULY 31, 2010


As a result of this retrospective application of the change in accounting principle and the change in the classification of the Income Statement, the following items in the Company's Condensed Consolidated Statements of Income and Condensed Consolidated Statement of Cash Flows have been adjusted as follows:

	Three Months Ended
	July 31, 2010
	(Unaudited)
	(Dollars in thousands, except per share data)
	As Previously Reported		Total Changes		As Adjusted
Retail Sales	$	231,865	$	(26)	$	231,839
Total Revenues		234,727		(26)		234,701
Cost of goods sold		143,039		(1,635)		141,404
Selling, general and administrative		62,268		72		62,340
Cost and expenses, net		209,627		(1,563)		208,064
Income before income taxes		25,100		1,537		26,637
Income tax expense		9,081		578		9,659
Net income	$	16,019	$	959	$	16,978
Basic earnings per share	$	0.54	$	0.04	$	0.58
Diluted earnings per share	$	0.54	$	0.04	$	0.58


	Six Months Ended
	July 31, 2010
	(Unaudited)
	(Dollars in thousands, except per share data)
	As Previously Reported		Total Changes		As Adjusted
Retail Sales	$	491,625	$	(746)	$	490,879
Total Revenues		497,410		(746)		496,664
Cost of goods sold		289,893		1,371		291,264
Selling, general and administrative		130,828		(407)		130,421
Cost and expenses, net		429,419		964		430,383
Income before income taxes		67,991		(1,710)		66,281
Income tax expense		24,912		(643)		24,269
Net income	$	43,079	$	(1,067)	$	42,012
Basic earnings per share	$	1.46	$	(0.04)	$	1.42
Diluted earnings per share	$	1.46	$	(0.04)	$	1.42

	Six Months Ended
	July 31, 2010
	(Unaudited)
	(Dollars in thousands)
	As Previously Reported		Total Changes		As Adjusted
Cash flow from operating activities:
Net income	$	43,079	$	(1,067)	$	42,012
Merchandise inventories		22,908		1,584		24,492
Accounts payable, accrued expenses
and other liabilities	$	(27,840)	$	(517)	$	(28,357)

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THE CATO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 30, 2011 AND JULY 31, 2010

NOTE 2 - EARNINGS PER SHARE:

ASC 260 – Earnings Per Share requires dual presentation of basic and diluted Earnings Per Share (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 Condensed Consolidated Statements of Income. While the Company’s certificate of incorporation provides the right for the Board of Directors to declare dividends on Class A shares without declaration of commensurate dividends on Class B shares, the Company has historically paid the same dividends to both Class A and Class B shareholders and the Board of Directors has resolved to continue this practice. Accordingly, the Company’s allocation of income for purposes of the EPS computation is the same for Class A and Class B shares and the EPS amounts reported herein are applicable to both Class A and Class B shares.

Basic EPS is computed as net income less earnings allocated to non-vested equity awards divided by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock options and the Employee Stock Purchase Plan.

		Three Months Ended				Six Months Ended
	July 30, 2011		July 31, 2010		July 30, 2011		July 31, 2010
	(Dollars in thousands, except share data and per share data)
Basic earnings per share:
Net earnings	$	18,103	$	16,978	$	48,624	$	42,012
Earnings allocated to non-vesting equity awards		(292)		(287)		(811)		(709)
Net earnings available to common stockholders	$	17,811	$	16,692	$	47,813	$	41,303

Basic weighted-average common shares outstanding		29,010,209		28,966,065		28,978,512		28,990,500

Basic earnings per share	$	0.61	$	0.58	$	1.65	$	1.42

Diluted earnings per share:
Net earnings	$	18,103	$	16,978	$	48,624	$	42,012
Earnings allocated to non-vesting equity awards		(292)		(287)		(810)		(709)
Net earnings available to common stockholders	$	17,811	$	16,692	$	47,814	$	41,303

Basic weighted-average common shares outstanding		29,010,209		28,966,065		28,978,512		28,990,500
Dilutive effect of stock options		5,932		12,710		5,635		12,109
Diluted weighted-average common shares outstanding		29,016,141		28,978,775		28,984,147		29,002,609

Diluted earnings per share	$	0.61	$	0.58	$	1.65	$	1.42

NOTE 3 - SUPPLEMENTAL CASH FLOW INFORMATION:

Income tax payments, net of refunds received, for the six months ended July 30, 2011 and July 31, 2010 were $15,780,000 and $13,315,000, respectively.

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THE CATO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 30, 2011 AND JULY 31, 2010

NOTE 4 – FINANCING ARRANGEMENTS:

As of July 30, 2011, the Company had an unsecured revolving credit agreement of $35.0 million. The revolving credit agreement is committed until August 2013. 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 30, 2011. There were no borrowings outstanding under this credit facility during the six months ended July 30, 2011 or July 31, 2010. Interest on any borrowings is based on LIBOR, which was 0.19% at July 30, 2011.

At July 30, 2011 and July 31, 2010 the Company had approximately $5.7 million and $10.3 million, 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 fashion specialty retail stores in 31 states at July 30, 2011, 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 30, 2011		Retail		Credit		Total	July 30, 2011		Retail		Credit		Total

Revenues	$	234,885	$	1,921	$	236,806	Revenues	$	506,592	$	3,874	$	510,466
Depreciation		5,367		4		5,371	Depreciation		10,767		8		10,775
Interest and other income		(949)		-		(949)	Interest and other income		(1,906)		-		(1,906)
Income before taxes		27,330		943		28,273	Income before taxes		74,183		1,582		75,765
Total assets		471,320		77,080		548,400	Total assets		471,320		77,080		548,400
Capital expenditures		11,319		41		11,360	Capital expenditures		15,665		86		15,751

Three Months Ended							Six Months Ended
July 31, 2010		Retail		Credit		Total	July 31, 2010		Retail		Credit		Total

Revenues	$	232,581	$	2,120	$	234,701	Revenues	$	492,322	$	4,342	$	496,664
Depreciation		5,272		5		5,277	Depreciation		10,536		11		10,547
Interest and other income		(957)		-		(957)	Interest and other income		(1,849)		-		(1,849)
Income before taxes		25,794		843		26,637	Income before taxes		64,810		1,471		66,281
Total assets		429,977		73,087		503,064	Total assets		429,977		73,087		503,064
Capital expenditures		4,842		-		4,842	Capital expenditures		8,866		-		8,866

The Company evaluates segment 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 JULY 30, 2011 AND JULY 31, 2010

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
		July 30, 2011		July 31, 2010		July 30, 2011		July 31, 2010

Bad debt expense	$	352	$	676	$	882	$	1,499
Payroll		247		239		489		474
Postage		187		197		388		425
Other expenses		188		160		525		462

Total expenses	$	974	$	1,272	$	2,284	$	2,860

NOTE 6 – STOCK BASED COMPENSATION:

As of July 30, 2011, 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 Amended and Restated Incentive Compensation Plan authorized 1,500,000 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 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	1,500,000	1,350,000	8,700,000
Options and/or restricted stock available for grant:
January 29, 2011	18,627	-	627,872	646,499
July 30, 2011	19,677	-	537,981	557,658

In accordance with ASC 718, the fair value of current restricted stock awards is estimated on the date of grant based on the market price of the Company’s stock and is amortized to compensation expense on a straight-line basis over the related vesting periods. As of July 30, 2011 and July 31, 2010, there was $7,346,000 and $7,312,000 of total unrecognized compensation cost related to nonvested restricted stock awards, which have a remaining weighted average vesting period of 2.7 years and 2.9 years, respectively. The total fair value of the shares recognized as compensation expense during the second quarter and six months ended July 30, 2011 was $790,000 and $1,257,000, respectively compared to $770,000 and $1,226,000 for the second quarter and six months ended July 31, 2010, respectively. These expenses are classified as a component of selling, general and administrative expenses in the Condensed Consolidated Statements of Income.

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THE CATO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 30, 2011 AND JULY 31, 2010

NOTE 6 – STOCK BASED COMPENSATION (CONTINUED):

The following summary shows the changes in the shares of restricted stock outstanding during the six months ended July 30, 2011:

			Weighted Average
	Number of		Grant Date Fair
	Shares		Value Per Share
Restricted stock awards at January 29, 2011	509,456	$	20.32
Granted	102,449		25.41
Vested	(123,423)		20.55
Forfeited or expired	(18,127)		21.19
Restricted stock awards at July 30, 2011	470,355	$	21.43

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 30, 2011 and July 31, 2010, the Company sold 12,006 and 12,729 shares to employees at an average discount of $3.74 and $3.03 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 $45,000 and $39,000 for the six months ended July 30, 2011 and July 31, 2010, respectively. These expenses are classified as a component of selling, general and administrative expenses.

The following is a summary of the changes in stock options outstanding during the six months ended July 30, 2011:

				Weighted
			Weighted	Average
			Average	Remaining		Aggregate
			Exercise	Contractual		Intrinsic
	Shares		Price	Term		Value(a)
Options outstanding at January 29, 2011	21,675	$	13.86	2.78 years	$	228,434
Granted	-
Forfeited or expired	1,050		12.00
Exercised	3,450		13.47
Outstanding at July 30, 2011	17,175	$	14.05	2.49 years	$	229,746
Vested and exercisable at July 30, 2011	17,175	$	14.05	2.49 years	$	229,746

(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.

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THE CATO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 30, 2011 AND JULY 31, 2010

NOTE 6 – STOCK BASED COMPENSATION (CONTINUED):

No options were granted in the first half of fiscal 2011 or fiscal 2010.

The total intrinsic value of options exercised during the second quarter and six months ended July 30, 2011 was $41,000.

During the second quarter of 2010, the Company completed amortizing its nonvested options. In accordance with ASC 718, the Company adjusted its related forfeiture assumption and recognized a reduction in share based compensation expense of $53,000 and $52,000 for the second quarter and six month period ended July 31, 2010. There was no share based compensation expense for the second quarter and six month period ended July 30, 2011.

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.

NOTE 7 – INCOME TAXES:

For the quarter ended July 30, 2011, the Company’s effective tax rate was 36.0% compared to 36.3% for the prior year quarter ended July 31, 2010. The current year quarter was impacted by the reduction of a reserve for certain unrecognized tax benefits from the closing of a state income tax audit. The effective income tax rate for the first six months of fiscal 2011 was 35.8% compared to 36.6% for the first six months of fiscal 2010. During the next 12 months, various taxing authorities’ statutes of limitations are expected to expire which could result in a potential reduction of unrecognized tax benefits. In addition, certain state examinations may close, the ultimate resolution of which could materially affect the effective tax rate. As a consequence, the balance in unrecognized tax benefits can be expected to fluctuate from period to period. It is reasonably possible such changes could be significant when compared to our total unrecognized tax benefits, but the amount of change is not currently estimable.

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THE CATO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 30, 2011 AND JULY 31, 2010

NOTE 8 – FAIR VALUE MEASUREMENTS:

The following tables set forth information regarding the Company’s financial assets that are measured at fair value (in thousands) as of July 30, 2011 and January 29, 2011.

				Quoted
				Prices in
				Active		Significant
				Markets for		Other		Significant
				Identical		Observable		Unobservable
		July 30,		Assets		Inputs		Inputs
Description		2011		Level 1		Level 2		Level 3

State/Municipal Bonds	$	142,938	$	-	$	142,938	$	-
Corporate Bonds		28,119		-		28,119		-
Auction Rate Securities (ARS)		3,450		-		-		3,450
Variable Rate Demand Notes (VRDN)		20,817		20,817		-		-
US Treasury Notes		2,679		2,679		-		-
Privately Managed Funds		1,909		-		-		1,909
Corporate Equities		473		473		-		-
Certificates of Deposit		100		100		-		-

Total	$	200,485	$	24,069	$	171,057	$	5,359

				Quoted
				Prices in
				Active		Significant
				Markets for		Other		Significant
				Identical		Observable		Unobservable
		January 29,		Assets		Inputs		Inputs
Description		2011		Level 1		Level 2		Level 3

State/Municipal Bonds	$	129,678	$	-	$	129,678	$	-
Corporate Bonds		34,288		-		34,288		-
Auction Rate Securities (ARS)		3,450		-		-		3,450
Variable Rate Demand Notes (VRDN)		19,308		19,308		-		-
Privately Managed Funds		1,925		-		-		1,925
Corporate Equities		480		480		-		-

Total	$	189,129	$	19,788	$	163,966	$	5,375

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THE CATO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 30, 2011 AND JULY 31, 2010

NOTE 8 – FAIR VALUE MEASUREMENTS (CONTINUED):

The Company’s investment portfolio was primarily invested in tax exempt variable rate demand notes (“VRDN”), corporate bonds, and governmental debt securities held in managed funds with underlying ratings of A or better at both July 30, 2011 and January 29, 2011. The underlying securities have contractual maturities which generally range from 62 days to 29 years. Although the Company’s investments in VRDN’s have underlying securities with contractual maturities longer than one year, the VRDN’s themselves have interest rate resets of 7 days and are considered short-term investments. These securities are classified as available-for-sale and are recorded as short-term investments on the accompanying Condensed Consolidated Balance Sheets at estimated fair value, with unrealized gains and losses reported net of taxes in accumulated other comprehensive income.

Additionally, at July 30, 2011 and January 29, 2011, the Company had $1.9 million of privately managed funds, $0.5 million of corporate equities and a single auction rate security (“ARS”) of $3.5 million which continues to fail its auction. All of these assets are recorded within Other assets in the Condensed Consolidated Balance Sheets.

Level 1 category securities are measured at fair value using quoted active market prices. Level 2 investment securities include corporate and municipal bonds for which quoted prices may not be available on active exchanges for identical instruments. Their fair value is principally based on market values determined by management with assistance of a third party pricing service.

The Company’s failed ARS is measured at fair value using Level 3 inputs at each reporting period. Due to the fact that there is no active market for this particular ARS, its fair value was determined through the use of a discounted cash flow analysis. The terms used in the analysis were based on management’s estimate of the timing of future liquidity, which assumes that the security will be called or refinanced by the issuer or settled with a broker dealer prior to maturity. The discount rates used in the discounted cash flow analysis were based on market rates for similar liquid tax exempt securities with comparable ratings and maturities. Due to the uncertainty surrounding the timing of future liquidity, the Company also considered a liquidity/risk value reduction. In estimating the fair value of this ARS, the Company also considered the financial condition and near-term prospects of the issuer, the probability that the Company will be unable to collect all amounts due according to the contractual terms of the security and whether the security has been downgraded by a rating agency. The Company’s valuation is sensitive to market conditions and management’s judgment and can change significantly based on the assumptions used.

The Company has two privately managed funds. The privately managed funds cannot be redeemed at net asset value at a specific date without advance notice. As a result, the Company has classified the investments as Level 3.

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THE CATO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 30, 2011 AND JULY 31, 2010

NOTE 8 – FAIR VALUE MEASUREMENTS (CONTINUED):

The following tables summarize the change in the fair value of the Company’s financial assets measured using Level 3 inputs during the first six months of fiscal 2011 and fiscal 2010 ($ in thousands):


		Fair Value Measurements Using Significant
		Unobservable Inputs (Level 3)
	Available-For-Sale
	Debt Securities		Other Investments
	ARS		Private Equity		Total
Beginning Balance at January 29, 2011	$	3,450	$	1,925	$	5,375
Total gains or (losses)
Included in earnings (or changes in net assets)		-		(16)		(16)
Ending Balance at July 30, 2011	$	3,450	$	1,909	$	5,359



		Fair Value Measurements Using Significant
		Unobservable Inputs (Level 3)
	Available-For-Sale
	Debt Securities		Other Investments
	ARS		Private Equity		Total
Beginning Balance at January 30, 2010	$	3,450	$	1,940	$	5,390
Total gains or (losses)
Included in other comprehensive income		-		22		22
Ending Balance at July 31, 2010	$	3,450	$	1,962	$	5,412

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THE CATO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 30, 2011 AND JULY 31, 2010

NOTE 9 – RECENT ACCOUNTING PRONOUNCEMENTS:

In January 2011, the Company adopted accounting guidance regarding changes to disclosure requirements for fair value measurements. For fair value measurements using significant unobservable inputs (Level 3), the guidance requires a reporting entity to present separate information about gross purchases, sales, issuances and settlements. The adoption of this guidance did not have a significant impact on the consolidated financial statement disclosures.

In June 2011, the Financial Accounting Standards Board amended its guidance on the presentation of comprehensive income in financial statements to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items that are recorded in other comprehensive income. The new accounting guidance requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. The provisions of this new guidance are effective for the Company the first quarter of 2012. The adoption of this guidance is not expected to have a material effect on operating results or financial position.

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THE CATO CORPORATION

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS