UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
   
þx QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period endedAugust 2, 2008
OR
For the quarterly period ended          November 1, 2008          
OR
   
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________to__________________
For the transition period from ____________ to ____________
Commission file number1-31340
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) (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.
Yesþx            Noo
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þAccelerated filer oNon-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company o
Large accelerated filerþ                      Accelerated filer¨                      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).
Yeso            Noþx
As of August 19,November 18, 2008, there were 27,821,12627,643,692 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 2,November 1, 2008
Table of Contents
     
  Page 
  No. 
    
     
Financial Statements:    
     
  2 
3
4
5 — 12
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations13 — 18
Item 3.Quantitative and Qualitative Disclosures About Market Risk19
Item 4.Controls and Procedures19
PART II — OTHER INFORMATION    
     
3
At November 1, 2008, November 3, 2007, and February 2, 2008    
  Item 1. 
4
For the Nine Months Ended November 1, 2008 and November 3, 2007
5 - 12
For the Three Months and Nine Months Ended November 1, 2008 and November 3, 2007
13 - 19
  20 
     
Risk Factors  20 
     
Unregistered Sales of Equity Securities and Use of Proceeds20
    
  Item 3.Defaults Upon Senior Securities20
   
Submission of Matters to a Vote of Security Holders20
Item 5.Other Information  21 
     
Exhibits  21 
     
21
    
 Signatures21
21
21
  22 — 26
23 - 27 
 Exhibit 31.1EX-31.1
 Exhibit 31.2EX-31.2
 Exhibit 32.1EX-32.1
 Exhibit 32.2EX-32.2

 


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  Three Months Ended Nine Months Ended 
 August 2, August 4, August 2, August 4,  November 1, November 3, November 1, November 3, 
 2008 2007 2008 2007  2008 2007 2008 2007 
 (Unaudited) (Unaudited) (Unaudited) (Unaudited)  (Unaudited) (Unaudited) (Unaudited) (Unaudited) 
 (Dollars in thousands, except per share data)  (Dollars in thousands, except per share data) 
REVENUES
  
Retail sales $230,957 $218,973 $456,748 $443,107  $179,838 $181,870 $636,585 $624,977 
Other income (principally finance charges, late fees and layaway charges) 2,911 2,961 5,948 6,056  2,947 2,968 8,895 9,024 
                  
Total revenues 233,868 221,934 462,696 449,163  182,785 184,838 645,480 634,001 
                  
  
COSTS AND EXPENSES, NET
  
Cost of goods sold (exclusive of depreciation shown below) 148,020 147,514 289,640 290,936  127,172 126,080 416,811 417,015 
Selling, general and administrative (exclusive of depreciation shown below) 63,580 52,463 119,896 103,599  50,908 51,303 170,804 154,903 
Depreciation 5,657 5,623 11,267 11,014  5,614 5,684 16,881 16,698 
Interest and other income  (1,709)  (2,316)  (3,609)  (4,209)  (2,183)  (2,176)  (5,792)  (6,385)
                  
 215,548 203,284 417,194 401,340  181,511 180,891 598,704 582,231 
                  
 
Income before income taxes 18,320 18,650 45,502 47,823  1,274 3,947 46,776 51,770 
  
Income tax expense 6,229 6,140 16,558 16,642  451 1,011 17,009 17,654 
                  
  
Net Income $12,091 $12,510 $28,944 $31,181  $823 $2,936 $29,767 $34,116 
                  
  
Basic earnings per share $0.42 $0.39 $0.99 $0.99  $0.03 $0.09 $1.02 $1.08 
                  
  
Basic weighted average shares 29,113,017 31,897,365 29,104,465 31,624,979  29,108,130 31,891,308 29,105,686 31,713,755 
                  
  
Diluted earnings per share $0.41 $0.39 $0.99 $0.97  $0.03 $0.09 $1.02 $1.07 
                  
  
Diluted weighted average shares 29,200,726 32,189,903 29,180,499 32,040,169  29,223,218 31,988,081 29,188,880 32,020,584 
                  
  
Dividends per share $0.165 $0.165 $0.33 $0.315  $.165 $.165 $.495 $0.48 
                  
  
Comprehensive income:  
Net income $12,091 $12,510 $28,944 $31,181  $823 $2,936 $29,767 $34,116 
Unrealized gains (losses) on available-for-sale securities, net of deferred income tax expense  (84)  (49)  (320)  (21)  (208) 215  (528) 193 
                  
  
Net comprehensive income $12,007 $12,461 $28,624 $31,160  $615 $3,151 $29,239 $34,309 
                  
See notes to condensed consolidated financial statements.

2


THE CATO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
                        
 August 2, August 4,    November 1, November 3, February 2, 
 2008 2007 February 2,  2008 2007 2008 
 (Unaudited) (Unaudited) 2008  (Unaudited) (Unaudited)   
 (Dollars in thousands)  (Dollars in thousands) 
ASSETS
  
Current Assets:  
Cash and cash equivalents $45,371 $19,929 $21,583  $35,959 $20,187 $21,583 
Short-term investments 107,952 150,387 92,995  99,869 126,797 92,995 
Accounts receivable, net of allowance for doubtful accounts of $3,195, $3,226 and $3,263 at August 2, 2008, August 4, 2007 and February 2, 2008, respectively 44,026 45,533 45,282 
Accounts receivable, net of allowance for doubtful accounts of $3,633, $3,194 and $3,263 at November 1, 2008, November 3, 2007 and February 2, 2008, respectively 43,267 44,470 45,282 
Merchandise inventories 96,864 99,236 118,679  110,282 114,066 118,679 
Deferred income taxes 6,904 7,522 6,756  7,024 7,415 6,756 
Prepaid expenses 7,880 7,197 7,755  7,660 7,208 7,755 
              
Total Current Assets 308,997 329,804 293,050  304,061 320,143 293,050 
Property and equipment — net 119,952 126,573 123,190  120,859 125,377 123,190 
Other assets 4,482 4,279 4,552  4,317 4,617 4,552 
              
Total Assets $433,431 $460,656 $420,792  $429,237 $450,137 $420,792 
       
        
LIABILITIES AND STOCKHOLDERS’ EQUITY
  
Current Liabilities:  
Accounts payable $83,899 $82,879 $110,848  $89,595 $88,169 $110,848 
Accrued expenses 34,052 29,438 27,617  35,343 34,646 27,617 
Accrued bonus and benefits 6,830 1,426 2,543  5,265 1,881 2,543 
Accrued income taxes 18,433 6,437 7,928  14,320 2,259 7,928 
              
Total Current Liabilities 143,214 120,180 148,936  144,523 126,955 148,936 
Deferred income taxes 1,707 8,817 1,707  1,707 8,817 1,707 
Other noncurrent liabilities (primarily deferred rent) 20,758 23,286 22,779  21,064 23,266 22,779 
  
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 36,281,440 shares, 36,089,761 shares, and 36,109,263 shares at August 2, 2008, August 4, 2007 and February 2, 2008, respectively 1,209 1,203 1,204 
Convertible Class B common stock, $.033 par value per share, 15,000,000 shares authorized; issued 1,743,525 shares, 1,743,525 shares and 1,743,525 shares at August 2, 2008, August 4, 2007 and February 2, 2008, respectively 58 58 58 
Class A common stock, $.033 par value per share, 50,000,000 shares authorized; issued 36,304,025 shares, 36,100,759 shares, and 36,109,263 shares at November 1, 2008, November 3, 2007 and February 2, 2008, respectively 1,210 1,203 1,204 
Convertible Class B common stock, $.033 par value per share, 15,000,000 shares authorized; issued 1,743,525 shares, 1,743,525, shares and 1,743,525 shares at November 1, 2008, November 3, 2007 and February 2, 2008, respectively 58 58 58 
Additional paid-in capital 60,147 56,913 58,685  61,025 57,639 58,685 
Retained earnings 359,323 349,276 340,088  355,276 346,901 340,088 
Accumulated other comprehensive income 389 204 709  182 418 709 
              
 421,126 407,654 400,744  417,751 406,219 400,744 
Less Class A common stock in treasury, at cost (8,461,615 shares, 5,299,500 shares and 8,461,615 shares at August 2, 2008, August 4, 2007 and February 2, 2008, respectively)  (153,374)  (99,281)  (153,374)
Less Class A common stock in treasury, at cost (8,660,233 shares, 6,128,015 shares and 8,461,615 shares at November 1, 2008, November 3, 2007 and February 2, 2008, respectively)  (155,808)  (115,120)  (153,374)
              
Total Stockholders’ Equity 267,752 308,373 247,370  261,943 291,099 247,370 
              
Total Liabilities and Stockholders’ Equity $433,431 $460,656 $420,792  $429,237 $450,137 $420,792 
              
See notes to condensed consolidated financial statements.

3


THE CATO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                
 Six Months Ended  Nine Months Ended 
 August 2,  August 4,  November 1, November 3, 
 2008  2007  2008 2007 
 (Unaudited)  (Unaudited)  (Unaudited) (Unaudited) 
 (Dollars in thousands)  (Dollars in thousands) 
OPERATING ACTIVITIES
     
     
Net income $28,944  $31,181  $29,767 $34,116 
     
Adjustments to reconcile net income to net cash provided by operating activities:     
Depreciation 11,267  11,014  16,881 16,698 
Provision for doubtful accounts 1,462  1,134  2,689 1,812 
Share-based compensation 1,064  812  1,654 1,282 
Excess tax benefits from share-based compensation  (41)  (5,450)  (65)  (5,460)
Deferred income taxes    
Loss on disposal of property and equipment 2,510  326  2,819 500 
Changes in operating assets and liabilities which provided (used) cash:     
Accounts receivable  (206)  (709)  (674)  (324)
Merchandise inventories 21,815  16,682  8,397 1,852 
Prepaid and other assets  (55)  (541) 330  (890)
Accrued income taxes 10,546  6,528  6,457 2,360 
Accounts payable, accrued expenses and other liabilities  (18,246)  (3,346)  (12,518) 5,651 
           
     
Net cash provided by operating activities 59,060  57,631  55,737 57,597 
           
     
INVESTING ACTIVITIES
     
Expenditures for property and equipment  (10,540)  (9,568)  (17,370)  (14,288)
Purchases of short-term investments  (99,820)  (206,024)  (121,616)  (154,470)
Sales of short-term investments 84,395  154,310  113,945 126,669 
           
Net cash provided by (used in) investing activities  (25,965)  (61,282)
 
Net cash used in investing activities  (25,041)  (42,089)
           
     
FINANCING ACTIVITIES
     
Change in cash overdrafts included in accounts payable    (500)   (500)
Dividends paid  (9,710)  (9,961)  (14,579)  (15,279)
Purchase of treasury stock    (4,468)
Purchases of treasury stock  (2,434)  (18,314)
Proceeds from employee stock purchase plan 233  233  411 461 
Excess tax benefits from share-based compensation 41  5,450  65 5,460 
Proceeds from stock options exercised 129  7,993  217 8,018 
           
     
Net cash used in financing activities  (9,307)  (1,253)  (16,320)  (20,154)
           
     
Net increase (decrease) in cash and cash equivalents 23,788   (4,904) 14,376  (4,646)
     
Cash and cash equivalents at beginning of period 21,583  24,833  21,583 24,833 
           
     
Cash and cash equivalents at end of period $45,371  $19,929  $35,959 $20,187 
           
See notes to condensed consolidated financial statements.

4


THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIXNINE MONTHS ENDED AUGUST 2,NOVEMBER 1, 2008 AND AUGUST 4,NOVEMBER 3, 2007
 
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 2,November 1, 2008 and August 4,November 3, 2007 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.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 February 2, 2008.
The year-end condensed consolidated balance sheet data presented for fiscal year ended February 2, 2008 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.
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.
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 estimated 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 August 28,December 4, 2008, the Board of Directors maintained the quarterly dividend at $.165 per share or an annualized rate of $.66 per share. The dividend will be payable on January 5, 2009 to shareholders of record of the Company at the close of business on December 22, 2008.

5


THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIXNINE MONTHS ENDED AUGUST 2,NOVEMBER 1, 2008 AND AUGUST 4,NOVEMBER 3, 2007
 
NOTE 2 — EARNINGS PER SHARE:
SFAS No. 128,Earnings Per Share, requires dual presentation of basic EPS and diluted EPS on the face of all income statements for all entities with complex capital structures. The Company has presented one basic EPS and one diluted EPS amount for all common shares in the accompanying Condensed Consolidated Statements 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 the Employee Stock Purchase Plan and the potential vestings of restricted stock computed using the treasury stock method.
                                
 Three Months Ended Six Months Ended Three Months Ended Nine Months Ended 
 August 2, August 4, August 2, August 4, November 1, November 3, November 1, November 3, 
 2008 2007 2008 2007 2008 2007 2008 2007 
  
Weighted-average shares outstanding 29,113,017 31,897,365 29,104,465 31,624,979  29,108,130 31,891,308 29,105,686 31,713,755 
Dilutive effect of: 
Dilutive effect of : 
Stock options 17,168 234,982 15,956 365,822  15,922 40,486 14,313 254,722 
Restricted stock 70,541 57,035 60,078 48,674  99,166 55,100 68,881 50,524 
Employee stock purchase plan  521  694   1,187  1,583 
                  
Weighted-average shares and common stock equivalents outstanding 29,200,726 32,189,903 29,180,499 32,040,169  29,223,218 31,988,081 29,188,880 32,020,584 
                  
NOTE 3 — SUPPLEMENTAL CASH FLOW INFORMATION:
Income tax payments, net of refunds received, for the sixnine months ended August 2,November 1, 2008 and August 4,November 3, 2007 were $6,938,000$10,345,000 and $10,040,000,$15,216,000, respectively.
NOTE 4 — FINANCING ARRANGEMENTS:
At August 2,November 1, 2008, the Company had an unsecured revolving credit agreement, which providedprovides for borrowings of up to $35 million. The revolving credit agreement is committed until August 2010. 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 AugustNovember 1, 2008. There were no borrowings outstanding under this credit facility during the first nine months ended November 1, 2008 or November 3, 2007, respectively, or the fiscal year ended February 2, 2008. Interest on any borrowings is based on LIBOR, which was 2.58% at November 1, 2008.

6


THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIXNINE MONTHS ENDED AUGUST 2,NOVEMBER 1, 2008 AND AUGUST 4,NOVEMBER 3, 2007
 
NOTE 4 — FINANCING ARRANGEMENTS (CONTINUED):
2008. There were no borrowings outstanding under this credit facility during the first six months ended August 2, 2008 or August 4, 2007, respectively, or the fiscal year ended February 2, 2008. Interest on any borrowings is based on LIBOR, which was 2.46% at August 2, 2008.
At August 2,November 1, 2008 and August 4,November 3, 2007 the Company had approximately $4,771,000$5,921,000 and $6,620,000,$2,544,000, 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 2,November 1, 2008, 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
August 2, 2008
 Retail Credit Total Six Months Ended
August 2, 2008
 Retail Credit Total
 
Revenues $231,401  $2,467  $233,868  Revenues $457,710  $4,986  $462,696 
Depreciation  5,646   11   5,657  Depreciation  11,246   21   11,267 
Interest and other income  (1,709)     (1,709) Interest and other income  (3,609)     (3,609)
Income before taxes  17,309   1,011   18,320  Income before taxes  43,628   1,874   45,502 
Total assets  361,874   71,557   433,431  Total assets  361,874   71,557   433,431 
Capital expenditures  4,893      4,893  Capital expenditures  10,540      10,540 
                                        
Three Months Ended
August 4, 2007
 Retail Credit Total Six Months Ended
August 4, 2007
 Retail Credit Total
Three Months Ended Nine Months Ended      
November 1, 2008 Retail Credit Total November 1, 2008 Retail Credit Total
                          
Revenues $219,374 $2,560 $221,934  Revenues $444,005 $5,158 $449,163  $180,213  $2,572  $182,785  Revenues $637,923  $7,557  $645,480 
Depreciation 5,597 26 5,623 Depreciation 10,964 50 11,014   5,604   10   5,614  Depreciation  16,850   31   16,881 
Interest and other income  (2,316)   (2,316) Interest and other income  (4,209)   (4,209)  (2,183)     (2,183) Interest and other income  (5,792)     (5,792)
Income before taxes 17,549 1,101 18,650 Income before taxes 45,567 2,256 47,823   726   548   1,274  Income before taxes  44,354   2,422   46,776 
Total assets 393,081 67,575 460,656  Total assets 393,081 67,575 460,656   356,555   72,682   429,237  Total assets  356,555   72,682   429,237 
Capital expenditures 5,532 106 5,638 Capital expenditures 9,449 119 9,568   6,830      6,830  Capital expenditures  17,370      17,370 
                          
Three Months Ended Nine Months Ended      
November 3, 2007 Retail Credit Total November 3, 2007 Retail Credit Total
                          
Revenues $182,215  $2,623  $184,838  Revenues $626,220  $7,781  $634,001 
Depreciation  5,656   28   5,684  Depreciation  16,620   78   16,698 
Interest and other income  (2,176)     (2,176) Interest and other income  (6,385)     (6,385)
Income before taxes  2,803   1,144   3,947  Income before taxes  48,370   3,400   51,770 
Total assets  380,967   69,170   450,137  Total assets  380,967   69,170   450,137 
Capital expenditures  4,720      4,720  Capital expenditures  14,169   119   14,288 
The Company evaluates performance based on income before taxes. The Company does not allocate certain corporate expenses or income taxes to the credit segment.

7


THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIXNINE MONTHS ENDED AUGUST 2,NOVEMBER 1, 2008 ANDAUGUST 4, NOVEMBER 3, 2007
 
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 Nine Months Ended 
 Three Months Ended Six Months Ended  November 1, November 3, November 1, November 3, 
 August 2, August 4, August 2, August 4,  2008 2007 2008 2007 
 2008 2007 2008 2007  
Bad debt expense $696 $676 $1,462 $1,134  $1,227 $678 $2,689 $1,812 
Payroll 254 245 507 487  249 251 756 738 
Postage 240 235 513 513  237 235 750 748 
Other expenses 255 277 609 718  301 287 909 1,005 
                  
 
Total expenses $1,445 $1,433 $3,091 $2,852  $2,014 $1,451 $5,104 $4,303 
                �� 
NOTE 6 — STOCK BASED COMPENSATION:
As of August 2,November 1, 2008, 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   
 1987 1999 2004   Plan Plan Plan Total 
 Plan Plan Plan Total 
Options and/or restricted stock initially authorized 5,850,000 1,500,000 1,350,000 8,700,000  5,850,000 1,500,000 1,350,000 8,700,000 
Options and/or restricted stock available for grant:  
February 2, 2008 12,277  1,006,033 1,018,310  12,277  1,006,033 1,018,310 
August 2, 2008 12,877  866,488 879,365 
November 1, 2008 18,627  865,528 884,155 
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.

8


THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIXNINE MONTHS ENDED AUGUST 2,NOVEMBER 1, 2008 ANDAUGUST 4, NOVEMBER 3, 2007
 
NOTE 6 — STOCK BASED COMPENSATION (CONTINUED):
The following is a summary of the changes in stock options outstanding during the sixnine months ended August 2,November 1, 2008:
                
 Weighted   
 Weighted Average   
                 Average Remaining Aggregate 
 Weighted Average   Exercise Contractual Intrinsic 
 Weighted Average Remaining Contractual Aggregate Intrinsic Shares Price Term Value (a) 
 Shares Exercise Price Term Value (a) 
Options outstanding at February 2, 2008 139,075 $12.41 4.64 $494,087  139,075 $12.41 4.64 $494,087 
Granted      
Forfeited or expired  (600) $8.71   (7,250) $17.78 
Exercised  (14,475) $8.93   (23,125) $9.40 
      
Outstanding at August 2, 2008 124,000 $12.83 4.58 $415,299 
Vested and exercisable at August 2, 2008 94,825 $12.16 4.10 $380,727 
Outstanding at November 1, 2008 108,700 $12.69 4.35 $393,748 
Vested and exercisable at November 1, 2008 88,825 $12.22 4.03 $363,503 
 
(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 2007 or in the first halfnine months of fiscal 2008.
As of August 2,November 1, 2008, there was approximately $112,000$85,400 of total unrecognized compensation cost related to nonvested options, which is expected to be recognized over a remaining weighted-average vesting period of 1.050.73 years. The total intrinsic value of options exercised during the secondthird quarter and sixnine months ended August 2,November 1, 2008 was approximately $80,000$70,000 and $119,000,$189,000, respectively.
Effective with the adoption of SFAS No. 123R,Share—BasedShare-Based Payment, the Company began recognizing share-based compensation expense ratably over the vesting period, net of estimated forfeitures. The Company recognized share-based compensation expense for nonvested options of $23,000 and $46,000$69,000 for the secondthird quarter and sixnine month period ended August 2,November 1, 2008, respectively compared to $29,000$470,000 and $60,000$1,282,000 for the secondthird quarter and sixnine month period ending August 4,November 3, 2007, respectively. These expenses wereare 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 sixnine months ended August 2,November 1, 2008 and August 4,November 3, 2007, the Company reported $41,000$65,000 and $5,450,000$5,460,000 of excess tax benefits as a financing cash inflow respectively, in addition to $362,000$217,000 and $8,226,000$411,000 in cash proceeds received from the exercise of stock options and Employee Stock Purchase Plan purchases, respectively.

9


THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIXNINE MONTHS ENDED AUGUST 2,NOVEMBER 1, 2008 ANDAUGUST 4, NOVEMBER 3, 2007
 
NOTE 6 — STOCK BASED COMPENSATION (CONTINUED):
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 sixnine months ended August 2,November 1, 2008 and August 4,November 3, 2007, the Company sold 18,15831,132 and 12,46325,535 shares to employees at an average discount of $2.15$2.26 and $3.30$3.19 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 $39,000$70,000 and $41,000$81,000 for the sixnine months ended August 2,November 1, 2008 and August 4,November 3, 2007, 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. As of August 2,November 1, 2008 and August 4,November 3, 2007, there was $6,342,000$5,860,000 and $5,786,000$5,330,000 of total unrecognized compensation cost related to nonvested restricted stock awards, which have a remaining weighted-average vesting period of 3.453.17 years and 4.013.76 years, respectively. The total fair value of the shares recognized as compensation expense during the secondthird quarter and sixnine months ended August 2,November 1, 2008 was $514,000$511,000 and $950,000$1,447,000 compared to $397,000 and $698,000$1,095,000 for the secondthird quarter and sixnine months ended August 4,November 3, 2007.
The following summary shows the changes in the shares of restricted stock outstanding during the sixnine months ended August 2,November 1, 2008:
        
         Weighted Average 
 Weighted Average  Number of Grant Date Fair 
 Number of Grant Date Fair  Shares Value Per Share 
 Shares Value Per Share  
Restricted stock awards at February 2, 2008 301,967 $22.56  301,967 $22.56 
Granted 150,795 16.61  156,795 16.32 
Vested     
Forfeited  (11,250) 23.88   (16,290) 19.58 
        
Restricted stock awards at August 2, 2008 441,512 $20.50 
Restricted stock awards at November 1, 2008 442,472 20.46 

10


THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIXNINE MONTHS ENDED AUGUST 2,NOVEMBER 1, 2008 ANDAUGUST 4, NOVEMBER 3, 2007
 
NOTE 7 — INCOME TAXES:
For the quarter ended August 2,November 1, 2008, the Company’s effective tax rate was 34%35.4%. During the next 12 months, various taxing authorities’ statutes of limitations will expire which could result in a potential reduction of unrecognized tax benefits. In addition, certain federal and state examinations may close, the ultimate resolution of which could materially affect the effective tax rate.
NOTE 8 — FAIR VALUE MEASUREMENTS:
In September 2006, the 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. Applicable provisions of SFAS 157 were adopted by the Company effective February 3, 2008. In February 2008, the FASB issued FASB Staff Position 157-2,Effective date of FASB Statement No. 157, which delayed for one year the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. The Company has not yet determined the impact on its financial statements of the February 1, 2009 adoption of SFAS No. 157-2 as it pertains to non-financial assets and liabilities.
The following table sets forth information regarding the Company’s financial assets that are measured at fair value (in thousands).
                                
 Fair Value Measurements at Reporting Date Using Fair Value Measurements at Reporting Date Using 
 Quoted Market     Quoted Market     
 Prices in Active Significant   Prices in Active Significant   
 Market for Other Significant Market for Other Significant 
 Identical Observable Unobservable Identical Observable Unobservable 
 Assets/Liabilities Inputs Inputs November 1, Assets/Liabilities Inputs Inputs 
Description August 2, 2008 (Level 1) (Level 2) (Level 3) 2008 (Level 1) (Level 2) (Level 3) 
Assets:  
Short term investments $107,952 $103,552 $4,400   $99,869 $92,519 $7,350  
Other Assets 2,700 501 2,199   2,516 329 2,187  
The Company’s investment portfolio was primarily invested in tax exempt auction rate securities and governmental debt securities held in managed funds. These securities are classified as available-for-sale as they are highly liquid and are recorded on the balance sheet at estimated fair value, with unrealized gains and temporary losses reported net of taxes as accumulated other comprehensive income. Additionally, as of November 1, 2008, the Company had $2.2 million invested in privately managed investment funds and $0.3 million of other miscellaneous equities which are reported within other noncurrent assets in the Condensed Consolidated Balance Sheets.
As of August 2,November 1, 2008, the Company held $56.3$48.1 million in auction rate securities (“ARS”) and variable rate demand notes (“VRDN”) issued by tax exempt municipal authorities and agencies and rated A or better. The underlying securities have contractual maturities which generally range from seven to thirtythirty-two years. The ARS’ and VRDN’s are recorded at estimated fair value and classified as available for sale due to the expected resetting of the interest rates every 7 to 35 days via the auction process.available-for-sale. Of the $56.3$48.1 million in ARS, $4.4ARS’ and VRDN’s, $7.4 million failed their last

11


THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND NINE MONTHS ENDED NOVEMBER 1, 2008 AND NOVEMBER 3, 2007
NOTE 8 — FAIR VALUE MEASUREMENTS (CONTINUED):
auctions as of August 2,November 1, 2008. The Company has experienced continued reductions in its failed ARS and reasonably expects all remainingthe last ARS to either experience a successful auctionsauction or be called within a year and so has classified themit as a short term investments.

11


THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED AUGUST 2,investment. During the month of November 2008, ANDAUGUST 4, 2007
NOTE 8 — FAIR VALUE MEASUREMENTS (CONTINUED):the Company’s brokerage firm repurchased at par $3.9 million of the aforementioned failed ARS’.
The Company classified these failed ARS securities as Level 2 items under SFAS 157 since they were not trading within ARS auctions and there is not an actively quoted market price for these securities. Additionally, the Company valued these failed ARS investments at par using a number of market based inputs to estimate the fair value, including;including: (i) the underlying credit quality of the issuer and insurer and the probability of default of the issue,issue; (ii) the Company’s experience and observations with ARS investments that were similar in many material aspects such as credit quality, yield, coupon or term to the remaining failed securities,securities; (iii) the present value of future principal and interest payments discounted at rates reflecting current market conditions, reflecting the Company’s determination that the effects on the ARS’sARS’ estimated fair value of the increased penalty interest being paid by the non-auctioning bonds, as offset by a liquidity/risk value reduction, would render the fair values materially the same as their carrying value (par),; (iv) the timing of expected future cash flows,flows; and (v) the likelihood of repurchase at par for each security.
NOTE 9 — RECENT ACCOUNTING PRONOUNCEMENTS:
In February 2007, the FASB issued SFAS 159,The Fair Value Option for Financial Assets and Financial Liabilities. SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 applies to all entities that elect the fair value option. SFAS 159 was effective for the Company on February 3, 2008. The adoption of SFAS 159 did not have an impact on the Company’s financial position, results of operations or cash flows.
On June 14, 2007, the FASB reached consensus on EITF Issue No. 06-11,Accounting for Income Tax Benefits of Dividends on Share-Based Payment. EITF Issue No. 06-11 requires that a realized income tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to associates for equity classified nonvested equity shares, nonvested equity share units, and outstanding equity share options should be recognized as an increase to additional paid-in capital. The amount recognized in additional paid-in capital for the realized income tax benefit from dividends on those awards should be included in the pool of excess tax benefits available to absorb tax deficiencies on share-based payment awards. EITF Issue No. 06-11 is effective for fiscal years beginning on or after December 15, 2007. The impact of the Company’s adoption of EITF Issue No. 06-11 was immaterial.
In June 2008, the FASB issued FSP No. EITF 03-6-1,Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. EITF 03-6-1 requires that unvested share-based payments that contain nonforfeitable rights to dividends are participating securities and they shall be included in the computation of EPS pursuant to the two class method. EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008. The Company is in the process of evaluating the impact that the adoption of EITF 03-6-1 will have on its financial statements.

12


THE CATO CORPORATION
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION 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 2008 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 including, but not limited to, the continuation or worsening of (i) the current adverse or recessionary conditions affecting the U.S. and global economies and consumer spending and (ii) the current adverse conditions in the U.S. and global credit markets; uncertainties regarding the impact of any governmental responses to the foregoing adverse economic and credit market 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 2, 2008 (fiscal 2007), 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.

13


THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION 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 included in the Company’s Annual Report on Form 10-K. As disclosed in Note 1 of Notes to Consolidated Financial Statements, the preparation of the Company’s financial statements in conformity with generally accepted accounting principles 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 group health insurance, reserves for inventory markdowns, calculation of asset impairment, shrinkage accrual and reserves for uncertain tax positions.
The Company’s critical accounting policies and estimates are discussed with the Audit Committee.
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 Three Months Ended Nine Months Ended 
 August 2, August 4, August 2, August 4, November 1, November 3, November 1, November 3, 
 2008 2007 2008 2007 2008 2007 2008 2007 
  
Total retail sales  100.0%  100.0%  100.0%  100.0%  100.0%  100.0%  100.0%  100.0%
Total revenues 101.3 101.3 101.3 101.4  101.6 101.6 101.4 101.4 
Cost of goods sold 64.1 67.4 63.4 65.7  70.7 69.3 65.5 66.7 
Selling, general and administrative 27.5 23.9 26.2 23.4  28.3 28.2 26.8 24.8 
Depreciation 2.5 2.6 2.5 2.5  3.1 3.1 2.7 2.6 
Interest and other income  (0.7)  (1.1)  (0.8)  (1.0)  (1.2)  (1.2)  (0.9)  (1.0)
Income before income taxes 7.9 8.5 10.0 10.8  0.7 2.2 7.3 8.3 
Net income 5.2 5.7 6.3 7.0  0.5 1.6 4.7 5.5 

14


THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
 
RESULTS OF OPERATIONS — (CONTINUED):
Comparison of SecondThird Quarter and First SixNine Months of 2008 with 2007.
Total retail sales for the secondthird quarter were $231.0$179.8 million compared to last year’s secondthird quarter sales of $219.0$181.9 million, a 5% increase.1.2% decrease. Same-store sales increased 2%decreased 2.4% in the secondthird quarter of fiscal 2008. For the sixnine months ended August 2,November 1, 2008, total retail sales were $456.7$636.6 million compared to last year’s first sixnine months sales of $443.1$625.0 million, a 1.9% increase, and same-store sales remained flatdecreased 0.6% for the comparable sixnine 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 $233.9$182.8 million and $462.7$645.5 million for the secondthird quarter and sixnine months ended August 2,November 1, 2008, respectively, compared to $221.9$184.8 million and $449.2$634.0 million for the secondthird quarter and sixnine months ended August 4,November 3, 2007, respectively. The Company operated 1,2871,305 stores at August 2,November 1, 2008 compared to 1,3061,321 stores at the end of last year’s secondthird quarter. For the first sixnine months of 2008 the Company opened 3257 new stores, relocated 4 stores and closed 6370 stores.
Credit revenue of $2.5$2.6 million represented 1.1%1.4% of total revenues in the secondthird quarter of 2008, compared to 2007 credit revenue of $2.6 million or 1.2%1.4% of total revenues. The slight reduction in creditCredit revenue wasremained flat for the comparable periods due to lower finance charge andincome offset by slightly higher late fee income from lower sales under the Company’s proprietary credit card, partially offset by improved collections compared to the prior year.card. 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$2.0 million in the secondthird quarter of 2008, flat compared to last year’s secondthird quarter expenses of $1.4$1.5 million. BadThe increase was due to a $0.5 million charge to bad debt expense was higheras other administrative expenses remained flat compared to the secondthird quarter and first six months of 2007, partially offset by lower administrative expenses.2007.
Other income in total, as included in total revenues, was $2.9 million and $5.9$8.9 million for the secondthird quarter and first sixnine months of fiscal 2008, compared to $3.0 million and $6.1$9.0 million for the prior year’s comparable three and six month period,nine months periods, respectively. The slight overall decrease resulted primarily from lower finance charges offset by an increase in layaway charges.

15


THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
RESULTS OF OPERATIONS — (CONTINUED):
Cost of goods sold was $148.0$127.2 million, or 64.1%70.7% of retail sales and $289.6$416.8 million or 63.4%65.5% of retail sales for the secondthird quarter and first sixnine months of fiscal 2008, compared to $147.5$126.1 million, or 67.4%69.3% of retail sales and $290.9$417.0 million, or 65.7%66.7% of retail sales for the prior year’s comparable three and sixnine month period,periods, respectively. The overall increase in cost of goods sold as a percent of retail sales for the third quarter of fiscal 2008 resulted primarily from higher markdowns and buying and occupancy costs. The overall decrease in cost of goods sold as a percent of retail sales for the second quarter and first sixnine months of fiscal 2008 resulted primarily from lower markdowns partially offset by higher occupancy costs. The decrease in markdowns was primarily attributable to tight inventory management and higher 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.

15


THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS — (CONTINUED):
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) decreased by 5.6% to $52.7 million in the third quarter and increased by 15.9%5.7% to $82.9$219.8 million and by 9.8% to $167.1 million forin the second quarter and first sixnine months of fiscal 2008 compared to $71.5$55.8 million and $152.2$208.0 million for the prior year’s comparable three and sixnine 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 $63.6$50.9 million, or 27.5%28.3% of retail sales and $119.9$170.8 million, or 26.2%26.8% of retail sales for the secondthird quarter and first sixnine months of fiscal 2008, compared to $52.5$51.3 million, or 23.9%28.2% of retail sales and $103.6$154.9 million, or 23.4%24.8% of retail sales for prior year’s comparable three and six month period,nine months periods, respectively. SG&A expenses as a percentage of retail sales increased 36010 basis points for the secondthird quarter of fiscal 2008 as compared to the prior year and increased 280200 basis points for the first sixnine months of fiscal 2008, as compared to the prior year. The increase in SG&A expenses as a percentage of retail sales and the overall dollar increase for the secondthird quarter of fiscal 2008 and the first six months of fiscal 2008 was primarily attributable to anincreased operating costs from new stores, higher bad debt expense and costs associated with store closings offset by the reversal of accrued incentive compensation from the first half of the year. The overall dollar decrease in SG&A expenses for the third quarter of fiscal 2008 resulted primarily from the reduction in accrued incentive-based compensation partially offset by higher store operating expenses. For the first nine months of fiscal 2008, the increase in incentive based compensationSG&A expenses as a percentage of retail sales and the closure of 47 underperformingoverall dollar increase in SG&A expense resulted primarily from increased operating costs from new stores, higher medical and worker’s compensation costs, accrued incentive compensation, increased bad debt expense and group health insurance expenses.the costs associated with store closings.

16


THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
RESULTS OF OPERATIONS — (CONTINUED):
Depreciation expense was $5.7$5.6 million, or 2.5%3.1% of retail sales and $11.3$16.9 million or 2.5%2.6% of retail sales, for the secondthird quarter and first sixnine months of fiscal 2008, compared to $5.6$5.7 million, or 2.6%3.1% of retail sales and $11.0$16.7 million, or 2.5%2.7 % of retail sales, for prior year’s comparable three and sixnine month periods, respectively.
Interest and other income was $1.7$2.2 million, or 0.7%1.2% of retail sales and $3.6$5.8 million, or 0.8%0.9% of retail sales for the secondthird quarter and first sixnine months of fiscal 2008, compared to $2.3$2.2 million, or 1.1%1.2% of retail sales and $4.2$6.4 million, or 1.0% of retail sales, for the prior year’s comparable three and sixnine month periods, respectively. The decrease in the first nine months of fiscal 2008 resulted primarily from lower interest rates and lower investment balances.
Income tax expense was $6.2$0.5 million, or 0.3% of retail sales and $17.0 million, or 2.7% of retail sales, and $16.6 million, or 3.6% of retail sales, for the secondthird quarter and first sixnine months of fiscal 2008, compared to $6.1$1.0 million, or 2.8%0.6% of retail sales and $16.6$17.7 million, or 3.8%2.8% of retail sales, for the prior year’s comparable three and sixnine month periods. The slight increasedecrease for the secondthird quarter resulted from lower pre-tax income offset by a higher effective tax rate primarily due to lower tax credits. The effective income tax rate for the secondthird quarter of fiscal 2008 was 34.0%35.4% compared to 32.9%25.6% for the secondthird quarter of 2007. The decrease for the sixnine month period resulted from lower pre-tax income offset by a higher effective tax rate. The effective income tax rate for the first sixnine months of fiscal 2008 was 36.4% compared to 34.8%34.1% for the sixnine months of fiscal 2007.

16


THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS (CONTINUED)
LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK:
The Company has consistently maintained a strong liquidity position. Cash provided by operating activities during the first sixnine months of fiscal 2008 was $59.1$55.7 million as compared to $57.6 million in the first sixnine months of fiscal 2007. 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 2,November 1, 2008.
Cash provided by operating activities for the first sixnine months of fiscal 2008 was primarily generated by earnings adjusted for depreciation and changes in working capital.capital items. The increasedecrease of $1.5$1.9 million for the first sixnine months of fiscal 2008 as compared to the first sixnine months of fiscal 2007 was primarily due to an increasea decrease in net income and accounts payable, accrued expenses and other liabilities, partially offset by inventories, accrued income taxes and excess tax benefits offset by a decrease in accounts payable, accrued expenses and other liabilities and net income in fiscal 2008.

17


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, share repurchasespurchase of treasury stock and other operating requirements for fiscal 2008 and for the foreseeable future.
At August 2,November 1, 2008, the Company had working capital of $165.8$159.5 million compared to $209.6$193.2 million at August 4,November 3, 2007. Additionally, the Company had $2.2 million and $1.9 million invested in privately managed investment funds at August 2,November 1, 2008 and August 4,November 3, 2007, respectively, which are included in other assets on the Condensed Consolidated Balance Sheets.
At August 2,November 1, 2008, the Company had an unsecured revolving credit agreement, which providedprovides for borrowings of up to $35 million. The revolving credit agreement is committed until August 2010. 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 2,November 1, 2008. There were no borrowings outstanding under thisthese credit facilityfacilities during the first sixnine months ended August 2,November 1, 2008 or the fiscal year ended February 2, 2008.
At August 2,November 1, 2008 and August 4,November 3, 2007, the Company had approximately $4.8$5.9 million and $6.6$2.5 million, respectively, of outstanding irrevocable letters of credit relating to purchase commitments.
Expenditures for property and equipment totaled $10.5$17.4 million in the first sixnine months of fiscal 2008, compared to $9.6$14.3 million in last year’s first sixnine months. The expenditures for the first sixnine months of 2008 were primarily for store development and investments in new technology. For the full fiscal 2008 year, the Company is planningexpects to invest approximately $22.3$19.7 million for capital expenditures. This includes expenditures to openfor 70 planned new stores and to relocate 9 stores.

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THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS (CONTINUED)
LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK (CONTINUED):
Net cash used in investing activities totaled $26.0$25.0 million in the first sixnine months of fiscal 2008 compared to $61.3$42.1 million used inprovided for the comparable period of 2007. The decrease was due primarily to the net decrease in purchases over sales of short-term investments.
On August 28,December 4, 2008, the Board of Directors maintained the quarterly dividend at $.165 per share or an annualized rate of $.66 per share. The dividend will be payable on January 5, 2009 to shareholders of record of the Company at the close of business on December 22, 2008.
On August 30,31, 2007, the Board authorized an increase in the Company’s share repurchase program of two million shares. There is no specified expiration date by which any shares included in this authorization must be purchased. For the nine months ended November 1, 2008, the Company has repurchased or accepted 198,618 shares at a cost of $2,433,785. At August 2,November 1, 2008, 394,660196,042 shares remain available for repurchase in open authorizations. No shares were repurchased in the first six months of fiscal 2008.authorizations .

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THE CATO CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
The Company does not use derivative financial instruments.
LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK (CONTINUED):
At August 2,November 1, 2008, 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. The Company does not use derivative financial instruments.
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. As of November 1, 2008, the Company had no other than temporary declines in investments.
The Company had 76 stores closed due to Hurricane Gustav. Of those 76 stores, only two were closed over thirty days and were reopened in November 2008. The Company is in the process of determining any loss due to damages incurred.business interruption losses.

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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 2,November 1, 2008. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of August 2,November 1, 2008, 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)13a-15(f)) has occurred during the Company’s fiscal quarter ended August 2,November 1, 2008 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 2, 2008. 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
     Not ApplicableThe following table summarizes the Company’s purchases of its common stock for the three months ended November 1, 2008:
ISSUER PURCHASES OF EQUITY SECURITIES
                 
          Total Number of  Maximum Number (or 
          Shares Purchased as  Approximate Dollar Value) 
  Total Number      Part of Publicly  of Shares that may 
  Of Shares  Average Price  Announced Plans or  Yet be Purchased Under 
Period Purchased  Paid per Share (2)  Programs (1)  The Plans or Programs (1) 
                 
August 2008    $        
September 2008             
October 2008  198,618   12.25   198,618     
              
Total  198,618  $12.25   198,618  196,042 shares
    
(1)On August 31, 2007, the Company’s board of directors authorized an increase in the share repurchase program of two million shares. At the third quarter ending November 1, 2008, the Company had 196,042 million shares remaining in open authorizations. There is no specified expiration date for the Company’s repurchase program. During the month of November 2008, the Company repurchased 100 additional shares at a cost of $1,203.
(2)Prices include trading costs.
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 and approved at the Company’s Annual Meeting which was held on May 22, 2008.
Election of Directors:
                 
          Voting Power
  For Withheld For Withheld
Mr. Robert W. Bradshaw, Jr.  22,933,323   4,839,103   38,625,048   4,839,103 
Mr. Grant L. Hamrick  26,837,554   934,872   42,529,279   934,872 
Ratification of Independent Auditor:
                     
          Voting Power
For Against Abstain For Against Abstain
27,738,240  28,573   5,612   43,429,965   28,573   5,612 
Amended and Restated 2004 Incentive Compensation Plan:
                         
          Broker Voting Power
For Against Abstain Non Vote For Against Abstain
26,158,751  808,203   11,187   794,285   41,850,476   808,203   11,187 

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PART II OTHER INFORMATION (CONTINUED)
THE CATO CORPORATIONNot Applicable
ITEM 5. OTHER INFORMATION
     Not Applicable

21


ITEM 6. EXHIBITS
   
Exhibit No. Item
 
3.1 Registrant’s Restated Certificate of Incorporation 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)333-96283).
 
3.2 Registrant’s By Laws incorporated by reference to Exhibit 99.2 to Form 8-K of the Registrant filedFiled December 10, 2007.
 
4.1 Rights Agreement dated December 18, 2003, incorporated by reference to Exhibit 4.1 to Form 8-A12G of the Registrant filed December 22, 2003 and as amended in Form 8-A12B/A filed January 6, 2004.
 
10.1 Registrant’s Amended and Restated 2004 Incentive Compensation Plan, incorporated by reference to Definitive Proxy Statement on Schedule 14A of the Registrant Filed April 11, 2008.

10.2Letter Agreement between the Registrant and Mr. John Howe, Executive Vice President and Chief Financial Officer, incorporated by reference to Exhibit 99.1 to Form 8-K of the Registrant Filed September 3, 2008.

31.1 Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer.
 
31.2 Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer.
 
32.1 Section 1350 Certification of Principal Executive Officer.
 
32.2 Section 1350 Certification of Principal 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
  
SeptemberDecember 10, 2008 /s/ John P. D. Cato
  
Date John P. D. Cato

Chairman, President and
Chief Executive Officer
   
SeptemberDecember 10, 2008 /s/ John R. Howe
  
Date John R. Howe

Executive Vice President
Chief Financial Officer

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