UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended February 3, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] REGISTRANT: THE CATO CORPORATION COMMISSION FILE NUMBER O-3747 State of Incorporation: Delaware I.R.S. Employer Identification Number: 56-0484485 Address of Principal Executive Offices: Registrant's Telephone Number: 704/554-8510 8100 Denmark Road Charlotte, North Carolina 28273-5975 SECURITIES REGISTERED PURSUANT TO SECURITIES REGISTERED PURSUANT SECTION 12(b) OF THE ACT: TO SECTION 12(g) OF THE ACT: NONE CLASS A COMMON STOCK Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of The Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark, if disclosure of delinquent filers pursuant to Item 405 of the Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] As of March 29, 1996, there were 23,215,897 shares of Class A Common Stock and 5,264,317 shares of Convertible Class B Common Stock outstanding. The aggregate market value of the Registrant's Class A Common Stock held by Non- affiliates of the Registrant as of March 29, 1996 was approximately $181,502,633 based on the last reported sale price per share on the NASDAQ National Market System on that date. Documents incorporated by reference: Portions of the proxy statement dated April 26, 1996, relating to the 1996 annual meeting of shareholders are incorporated by reference into the following part of this annual report: Part III - Items 10, 11, 12 and 13 THE CATO CORPORATION FORM 10-K TABLE OF CONTENTS Page Part I: Item 1. Business.............................................Pages 2-9 Item 2. Properties...........................................Page 9 Item 3. Legal Proceedings....................................Page 9 Item 4. Results of Votes of Security Holders.................Page 9 Part II: Item 5. Market for Registrant's Common Equity and Related Stockholder Matters..................................Page 10 Item 6. Selected Financial Data..............................Page 11 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................Pages 12-15 Item 8. Financial Statements and Supplementary Data..........Page 16 Item 9. Disagreements on Accounting and Financial Disclosures................................Page 16 Part III: Item 10. Directors and Executive Officers.............................................Pages 17-19 Item 11. Executive Compensation...............................Page 20 Item 12. Security Ownership of Certain Beneficial Owners and Management.....................Page 20 Item 13. Certain Relationships and Related Transactions.................................Page 20 Part IV: Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K..............................Page 21 Page 2 PART I Item 1. Business: General The Company, founded in 1946, operated 550 women's apparel specialty stores at February 3, 1996 under the names "Cato," "Cato Fashions" and "Cato Plus" in 22 states, principally in non- metropolitan markets in the South and Southeast. The Company's merchandising strategy is to provide a wide variety of value- priced merchandise in misses, junior and large sizes for the fashion conscious low- to middle-income female customer, aged 18 to 50. Additionally, the Company offers clothing and accessories for girls ages 4 - 14 in selected locations. With the objective of offering head-to-toe dressing for its customers, the Company's stores feature a broad assortment of apparel and accessories, including casual and dressy sportswear, dresses, careerwear, coats, hosiery, shoes, costume jewelry, handbags and millinery. A substantial portion of the Company's merchandise is sold under its private labels and is produced by various vendors in accordance with the Company's specifications. Most stores range in size from 4,800 to 8,000 square feet and are located primarily in strip shopping centers anchored by major discount stores. The Company emphasizes customer service and coordinated merchandise presentations in an appealing store environment. The Company offers its own credit card and layaway plan. Credit and layaway sales represented 32% of retail sales in fiscal 1995. In addition to its Cato Stores, the Company operated 121 off-price family apparel and accessories stores at February 3, 1996 under the name "It's Fashion!" These stores are managed separately from the Cato stores with respect to merchandising and store operations but use the same administration, distribution and financial systems as the Cato stores. Business The Company's objective is to be the leading women's apparel specialty retailer for fashion conscious low- to middle-income females in its markets. Management believes the Company's success is dependent upon its ability to differentiate its stores from department stores, mass merchandise discount stores and competing women's specialty stores. The key elements of the Company's business strategy are: Merchandise Assortment. The Company's stores offer a wide assortment of apparel and accessory items in regular and large sizes and emphasize color, product coordination and selection. Value Pricing. The Company offers quality merchandise that is generally priced below comparable merchandise offered by department stores and higher- end specialty apparel chains but is generally more fashionable than merchandise offered by discount stores. Page 3 Item 1. Business: (continued) Strip Shopping Center Locations. The Company locates its stores principally in strip centers convenient to our customers anchored by major discount stores, such as Wal-Mart and Kmart, that attract large numbers of potential customers. Customer Service. Store managers and sales associates are trained to provide prompt and courteous service and to assist customers in merchandise selection and wardrobe coordination. Credit and Layaway Programs. The Company offers its own credit and a layaway plan to make the purchase of its merchandise more convenient. Expansion. The Company plans to open new stores and relocate or expand existing stores in small to medium-sized towns and selected metropolitan areas, principally in the South and Southeast. Merchandising Merchandising The Company offers a broad selection of apparel and accessories to suit the various lifestyles of the fashion conscious low - to middle-income female, aged 18 to 50. In addition, the Company features a value pricing strategy, product quality and consistent merchandise flow providing color and product coordination. The Company's merchandise lines include dressy and casual sportswear, dresses, careerwear, coats, shoes, lingerie, hosiery, costume jewelry, handbags and millinery. Clothing and accessories for girls ages 4 - 14 are offered in selected stores. Most of the Company's merchandise is sold under its private labels. In fiscal 1995, approximately 29% of Cato stores' retail sales represented merchandise for large size customers. This merchandise is marketed in its stores under two formats: as a distinct display area in "Cato" and "Cato Fashions" stores and as a separate department in the combined "Cato Fashions" and "Cato Plus" stores. Page 4 Item 1. Business: (continued) As a part of its merchandising strategy, members of the Company's merchandising staff frequently visit selected stores, monitor the merchandise offerings of other retailers, regularly communicate with store operations personnel and frequently confer with key vendors. The Company tests most new fashion-sensitive items in selected stores to aid it in determining their appeal before making a substantial purchasing commitment. The Company also takes aggressive markdowns on slow-selling merchandise and does not carry over merchandise to the next season. Purchasing, Allocation and Distribution Although the Company purchases merchandise from approximately 1,500 suppliers, most of its merchandise is purchased from approximately 100 primary vendors. In fiscal 1995, purchases from the Company's largest vendor accounted for approximately 7% of the Company's total purchases. No other vendor accounted for more than 4% of total purchases. The Company is not dependent on its largest vendor or any other vendor for merchandise purchases and the loss of any single vendor or group of vendors would not have a material adverse affect on the Company's operating results or financial condition. A substantial portion of the Company's merchandise is sold under its private labels and is produced by various vendors in accordance with the Company's specifications. The Company purchases most of its merchandise from domestic importers and vendors, which typically minimizes the time necessary to purchase and obtain shipments in order to enable the Company to react to merchandise trends in a more timely fashion. Although a significant portion of the Company's merchandise is manufactured overseas, principally in the Far East, any economic, political or social unrest in that region is not expected to have a material adverse effect on the Company's ability to obtain adequate supplies of merchandise. An important component of the Company's strategy is the allocation of merchandise to individual stores based on an analysis of historical and current sales trends by merchandise category, customer profiles and climatic conditions. A computerized merchandise control system provides current information on the sales activity of each merchandise style in the Company's stores. Point-of-sale terminals in the stores collect and transmit sales and inventory information to the Company's central computer, permitting timely response to sales trends on a store-by-store basis. All merchandise is shipped directly to the Company's distribution center in Charlotte, North Carolina where it is inspected and allocated by the merchandise distribution staff for shipment to individual stores. The flow of merchandise from receipt at the distribution center to shipment is controlled by an on-line computer system. Shipments are made by common carrier, and each store receives at least one shipment per week. Page 5 Item 1. Business: (continued) Advertising The Company uses direct mail, local newspapers, radio and in- store promotional advertising as its primary advertising media. Weekly newspaper advertisements typically promote specific items or merchandise at promotional prices. The Company uses radio advertising in selected broadcast areas that include high concentrations of its stores. The Company's total advertising expenditures were approximately 2.0% of retail sales in fiscal 1995. Store Operations The Company's store operations management team consists of an executive vice president, nine regional vice presidents and 50 district managers. Regional vice presidents receive a salary plus a bonus based on achieving targeted goals for sales, payroll expense, shrinkage control and store profitability. District managers receive a salary plus a bonus based on achieving targeted objectives for district sales increases and shrinkage control. Stores are staffed with a manager, two assistant managers and additional part-time sales associates depending on the size of the stores and seasonal personnel needs. Store managers receive a salary and all other store personnel are paid on an hourly basis. Store managers and assistant managers are eligible for monthly and semi-annual bonuses based on achieving targeted goals for their store's sales increases and shrinkage control. The Company has training programs at each level of store operations. New store managers are trained in training stores managed by experienced personnel who have achieved superior results in meeting the Company's goals for store sales, payroll expense and shrinkage control. The type and extent of district manager training varies depending on whether the manager is promoted from within or recruited from outside the Company. All district managers receive at a minimum a one-week orientation program at the Company's home office. Store Locations Most of the Company's stores are located in the South and Southeast in small to medium-sized towns, with populations of 10,000 to 50,000 and retail trade areas of 25,000 to 100,000. Approximately 120 stores, operating under the name "Cato" or "Cato Fashions," average approximately 4,000 square feet. Substantially all of the remaining stores are combination "Cato Fashions" and "Cato Plus" stores, ranging in size from 4,800 to 8,000 square feet. These combination stores have two distinct signs and selling areas but use a common sales staff and service desk. Page 6 Item 1. Business: (continued) All of the Company's stores are leased. Approximately 90% are located in strip shopping centers, 2% in downtown locations and 8% in enclosed shopping malls. Where lease terms are acceptable and a potential location meets the Company's demographic and other site-selection criteria, the Company locates stores in strip shopping centers anchored by major discount stores, such as Wal-Mart and Kmart stores. The Company's strip center locations provide ample parking and shopping convenience for its customers. The Company's store development activities consist of opening new stores, expanding certain existing stores and relocating other existing stores to more desirable locations in the same market area. The following table sets forth information with respect to the Company's development activities for its Cato stores since fiscal 1991. Cato Store Development (Excluding It's Fashion Stores) Number of Stores Beginning of Number Number Number of Stores Fiscal Year Year Opened Closed End of Year 1991...... 472 6 47 431 1992...... 431 33 26 438 1993...... 438 65 13 490 1994...... 490 57 9 538 1995...... 538 19 7 550 The Company intends to open approximately 20 new stores and to relocate or expand approximately 15 existing stores in fiscal 1996. The Company anticipates that 10 of the 20 new stores to be opened in fiscal 1996 will be off-price "Its Fashion!" stores. The Company periodically reviews its store base to determine whether any particular store should be closed based on its sales trends and profitability. The Company intends to continue this review process and to close underperforming stores or relocate them to more desirable locations in their existing markets. Page 7 Item 1. Business: (continued) Credit and Layaway Credit Card Program The Company offers its own credit card, which accounted for approximately 23% of retail sales in fiscal 1995. The Company's net bad debt expense in fiscal 1995 was 2.7% of credit sales. Customers applying for the Company's credit card are approved for credit if they have a satisfactory credit record and meet a minimum income test. Customers are required to make minimum monthly payments based on their account balances. If the balance is not paid in full each month, the Company charges a finance charge based on the allowable rates in the customer's state of residence. Layaway Plan Under the Company's layaway plan, merchandise is set aside for customers who agree to make periodic payments. The Company adds a nonrefundable administrative fee to each layaway sale. If no payment is made for nine weeks, the customer is considered to have defaulted, and the merchandise is returned to the selling floor and again offered for sale, often at a reduced price. All payments made by customers who subsequently default on their layaway purchase are returned to the customer upon request, less the administrative fee and a restocking fee. Layaway sales represented approximately 9% of retail sales in fiscal 1995. It's Fashion Stores The Company operated 121 off-price stores at February 3, 1996 in 11 states in the South and Southeast under the name "It's Fashion!" These stores are smaller than the Cato stores, ranging in size from 3,000 to 4,000 square feet, and offer limited selections of first-quality family apparel and accessories at prices ranging from 20% to 80% off regular retail prices. The Company's credit and layaway plans are not available in these stores. Most of the merchandise for these stores is purchased at close-out prices from manufacturers with excessive inventories due to overruns or order cancellations. The It's Fashion stores are managed separately from the Cato stores with respect to merchandising and store operations but use the same administrative, distribution and financial systems as the Cato stores. Sales from It's Fashion stores represented 12% of the Company's retail sales during fiscal 1995. As part of its planned expansion program, the Company currently intends to open approximately 10 new It's Fashion stores in fiscal 1996. Page 8 Management Information Systems The Company's systems provide daily financial and merchandising information that is used by management to enhance the timeliness and effectiveness of purchasing and pricing decisions. Management uses a daily report comparing actual sales with planned sales and a weekly best seller/worst seller report to monitor and control purchasing decisions. Weekly reports are also produced which reflect sales, weeks of supply of inventory and other critical data by product categories, by store and by various levels of responsibility reporting. Purchases are made based on projected sales but can be modified to accommodate unexpected increases or decreases in demand for a particular item. Sales information is projected by merchandise category and, in some cases, is further projected and actual performance measured by stockkeeping unit. Merchandise allocation models are used to distribute merchandise to individual stores based upon historical sales trends, climatic differences, customer demographic differences and targeted inventory turnover rates. Competition The women's retail apparel industry is highly competitive. The Company believes that the principal competitive factors in its industry include merchandise assortment and presentation, fashion, price, store location and customer service. The Company competes with retail chains that operate similar women's apparel specialty stores. In addition, the Company competes with local apparel specialty stores, mass merchandise chains, discount store chains, and to some degree, with major department stores. To the extent that the Company opens stores in larger cities and metropolitan areas, competition is expected to be more intense in those markets. Many of the Company's competitors have substantially greater financial, marketing and other resources than the Company. Regulation A variety of laws affect the revolving credit program offered by the Company. The Federal Consumer Credit Protection Act (Truth-in Lending) and Regulation Z promulgated thereunder require written disclosure of information relating to such financing, including the amount of the annual percentage rate and the finance charge. The Federal Fair Credit Reporting Act also requires certain disclosures to potential customers concerning credit information used as a basis to deny credit. The Federal Equal Credit Opportunity Act and Regulation B promulgated thereunder prohibit discrimination against any credit applicant based on certain specified grounds. The Federal Trade Commission has adopted or proposed various trade regulation rules dealing with unfair credit and collection practices and the preservation of consumers' claims and defenses. The Company is also subject to the provisions of the Fair Debt Collection Practices Act, which regulates the manner in which the Company collects payments on revolving credit accounts. In addition, various state laws regulate collection practices, require certain disclosures to credit customers and limit the finance charges, late fees and other charges which may be imposed by the Company. Page 9 Employees As of February 3, 1996, the Company employed approximately 6,600 full-time and part-time employees. The Company also employs additional part-time employees during the peak retailing seasons. The Company is not a party to any collective bargaining agreements and considers that its employee relations are good. Item 2. Properties: The Company's distribution center and general offices are located in a Company-owned building of approximately 492,000 square feet located on a 15-acre tract in Charlotte, North Carolina. The Company's automated merchandise handling and distribution activities occupy approximately 418,000 square feet of this building and its general offices and corporate training center are located in the remaining 74,000 square feet. Substantially all of the Company's retail stores are leased from unaffiliated parties. Most of the leases have an initial term of five years, with two to three five-year renewal options. Substantially all of the leases provide for fixed rentals plus a percentage of sales in excess of a specified volume. Item 3. Legal Proceedings: There are no material pending legal proceedings to which the registrant or its subsidiaries is a party, or to which any of their property is subject. Item 4. Results of Votes of Security Holders: None. Page 10 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters: Market & Dividend Information The Company's Class A Common Stock trades in the over-the- counter market under the NASDAQ National Market System symbol CACOA. Below is the market range and dividend information for the four quarters of fiscal 1995 and 1994. _________________________________________________________________ Price 1995 High Low Dividend ...... ...... ...... .......... First quarter $ 8 1/4 $ 5 $ .04 Second quarter 8 7/8 7 1/8 .04 Third quarter 8 1/4 5 1/8 .04 Fourth quarter 7 3/4 5 3/4 .04 Price 1994 High Low Dividend ....... ...... ....... .......... First quarter $ 21 1/2 $ 9 1/2 $ .025 Second quarter 14 3/4 9 1/2 .04 Third quarter 12 1/4 8 1/2 .04 Fourth quarter 9 3/4 5 1/2 .04 _________________________________________________________________ As of March 29, 1996 the approximate number of holders of the Company's Class A Common stock was 4,500 and there were 16 record holders of the Company's Class B Common Stock. Page 11 Item 6. Selected Financial Data: THE CATO CORPORATION SELECTED FINANCIAL DATA Fiscal Year Ended February 3, January 28, January 29, January 30, February 1, 1996 1995 1994 1993 1992 ----------- ----------- ----------- ----------- ---------- (In thousands, except per share and selected operating data) Statement of Operations Data: Retail sales $ 476,638 $ 463,737 $ 407,878 $ 331,262 $ 265,115 Other income 13,357 12,449 12,021 9,494 8,707 Total revenues 489,995 476,186 419,899 340,756 273,822 Cost of goods sold, including occupancy, distribution and buying 341,144 324,309 275,090 220,663 180,552 Gross margin percent, including occupancy, distribution and buying 28.4 % 30.1 % 32.6 % 33.4 % 31.9 % Selling, general and administrative 122,699 116,144 100,760 85,667 70,523 Depreciation 7,785 6,844 5,465 4,148 4,342 Interest 292 377 250 1,213 3,299 Income before income taxes 18,075 28,512 38,334 29,065 15,106 Income tax expense 6,055 10,407 13,532 10,597 5,589 Net income $ 12,020 $ 18,105 $ 24,802 $ 18,468 $ 9,517 Earnings per common and common equivalent share(1) $ .42 $ .62 $ .84 $ .71 $ .43 Cash dividends paid per share (1) $ .16 $ .145 $ .088 $ .04 $ - Selected Operating Data: Stores open at end of period 671 646 575 505 487 Average sales per store $ 721,000 $ 749,000 $ 744,000 $ 663,000 $ 527,000 Average sales per square foot of selling space $ 158 $ 172 $ 187 $ 173 $ 142 Comparable store sales increase (decrease) (5) % 1 % 8 % 19 % 20 % Balance Sheet Data: Working capital $ 102,169 $ 94,581 $ 91,569 $ 53,862 $ 33,186 Total assets 209,895 201,322 178,603 122,225 94,930 Long-term debt - - - - 24,891 Total stockholders' equity $ 149,682 $ 141,508 $ 127,533 $ 78,216 $ 30,479 (1) All per share amounts reflect a three-for-two stock split effected June 28, 1993. Page 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations: RESULTS OF OPERATIONS The table below sets forth certain financial data of the Company expressed as a percentage of retail sales for the periods indicated: _________________________________________________________________ Fiscal Year Ended FEBRUARY 3, JANUARY 28, JANUARY 29, 1996 1995 1994 Retail sales 100% 100% 100% Other income 2.8 2.7 2.9 Total revenues 102.8 102.7 102.9 Cost of goods sold, including occupancy, distribution and buying 71.6 69.9 67.4 Selling, general and administrative 25.7 25.0 24.7 Depreciation 1.6 1.6 1.3 Selling, general, administrative and depreciation 27.3 26.6 26.0 Income before income taxes 3.8 6.1 9.4 Net income 2.5% 3.9% 6.1% FISCAL 1995 COMPARED TO FISCAL 1994 Retail sales increased by 3% to $476.6 million in fiscal 1995, which included fifty-three weeks, from $463.7 million in fiscal 1994, which included fifty-two weeks. Same-store sales decreased 5% from the prior year on a fifty-two week basis. Total revenues, comprised of retail sales and other income (principally finance charges on customer accounts receivable, interest income and layaway fees), increased by 3% to $490.0 million in fiscal 1995 from $476.2 million in fiscal 1994. The Company operated 671 stores at February 3, 1996, compared to 646 stores operated at January 28, 1995. The increase in retail sales in the current year resulted from the Company's store development activity. In fiscal 1995, the Company increased its selling square footage approximately 5% by opening 37 new stores, relocating or expanding 29 stores while closing 12 existing stores. The decrease in same-store sales in fiscal 1995 resulted primarily from competitive pressures and a general price compression in the women's apparel retail sector. Page 13 Other income in fiscal 1995 increased 7% over fiscal 1994. The increase resulted primarily from increased earnings on cash equivalents and short-term investments and from higher finance charge income partially offset by decreased layaway service charges. Cost of goods sold, including occupancy, distribution and buying, was $341.1 million, or 71.6% of retail sales, in fiscal 1995, compared to $324.3 million, or 69.9% of retail sales, in fiscal 1994. The increase in cost of goods sold as a percent of retail sales resulted primarily from higher levels of markdowns taken in fiscal 1995. Inventory levels throughout the year were higher than needed for the sales levels achieved, resulting in markdowns above plan and erosion of merchandise margins. The extremely competitive and promotional environment prevailing throughout the woman's apparel retail sector produced a price compression resulting in a 5% decrease in the average unit selling price for the year. Total gross margin dollars (retail sales less cost of goods sold) decreased by 3% to $135.5 million in fiscal 1995 from $139.4 million in fiscal 1994. Selling, general and administrative expenses (SG&A) were $122.7 million in fiscal 1995, compared to $116.1 million in fiscal 1994, an increase of 6%. As a percent of retail sales, SG&A was 25.7% compared to 25.0% of retail sales in the prior year. The overall increase in SG&A resulted primarily from increased selling-related expenses and by increased infrastructure expenses brought about by the Company's store development activities. Depreciation expense was $7.8 million in fiscal 1995, compared to $6.8 million in fiscal 1994. The 14% increase in fiscal 1995 resulted primarily from additions to property and equipment for the expansion of the Company's distribution facility and for store development. FISCAL 1994 COMPARED TO FISCAL 1993 Retail sales increased by 14% to $463.7 million in fiscal 1994 from $407.9 million in fiscal 1993. Same-store sales increased 1% over fiscal 1993. Total revenues increased 13% to $476.2 million in fiscal 1994 from $419.9 million in fiscal 1993. The Company operated 646 stores at January 28, 1995 compared to 575 stores operated at January 29, 1994. The increase in retail sales in fiscal 1994 resulted primarily from the Company's store development activities. In fiscal 1994, the Company increased selling square footage by approximately 20% by opening 80 new stores, relocating 30 stores, and expanding 20 stores while closing 9 existing stores. Other income in fiscal 1994 increased by 4% over fiscal 1993. The increase resulted primarily from higher finance charge income and by increased earnings on cash equivalents and short- term investments. Cost of goods sold, including occupancy, distribution and buying, was $324.3 million, or 69.9% of retail sales, in fiscal 1994, compared to $275.1 million, or 67.4% of retail sales, in fiscal 1993. The increase in cost of goods sold as a percent of retail sales resulted primarily from higher levels of promotional markdowns taken in fiscal 1994. During fiscal 1994, inventory levels were consistently higher than were needed for the sales levels achieved, resulting in markdowns above plan and a decrease in merchandise margins. Total gross margin dollars increased by 5% to $139.4 million in fiscal 1994 from $132.8 million in fiscal 1993. Page 14 SG&A expenses were $116.1 million in fiscal 1994, compared to $100.8 million in fiscal 1993, an increase of 15%. As a percent of retail sales, SG&A was 25.0% compared to 24.7% of retail sales in the prior year. The overall increase in SG&A resulted primarily from increased selling-related expenses and increased infrastructure expenses brought about by the Company's store development program. Depreciation expense was $6.8 million in fiscal 1994, compared to $5.5 million in fiscal 1993. The 25% increase in fiscal 1994 resulted primarily from additions to property and equipment from the Company's store development activities. LIQUIDITY AND CAPITAL RESOURCES At February 3, 1996, the Company had working capital of $102.2 million compared to $94.6 million at January 28, 1995. Cash provided by operating activities was $14.9 million in fiscal 1995, compared to $33.4 million in fiscal 1994. The decrease in cash provided by operating activities in fiscal 1995 resulted primarily from higher merchandise inventory levels, increased accounts receivable balances and by lower net income. At February 3, 1996, the Company had $47.9 million in cash, cash equivalents and short-term investments, compared to $46.2 million at January 28, 1995. In February 1996, the Company entered into a new unsecured revolving credit agreement. The facility provides for borrowings of up to $20 million and an additional letter of credit facility of $15 million. The revolving credit agreement is committed until May 1999 and the letter of credit facility is renewable annually. The credit agreement contains various financial covenants and limitations, including maintenance of specific financial ratios and a limitation on capital expenditures of $25 million per year, or $60 million, during the length of the agreement. The agreement replaces a revolving credit and term loan agreement which was committed until May 1998, and provided for borrowings of up to $35 million and an additional annually renewable letter of credit facility of $15 million. The Company feels the terms of the new revolving credit agreement better support the Company's future working capital needs and the agreement contains more flexibility as to financial covenant requirements. In fiscal 1994, the Company entered into an agreement with a lessor to lease up to $25 million of new store fixtures, point-of- sales devices and warehouse equipment. In January 1995, the Company leased $10 million of assets under this agreement and in fiscal 1995 the Company leased an additional $9.5 million of qualifying assets. The operating leases are for a term of seven years but may be cancelled annually upon proper notice to the lessor. Upon notice of cancellation, the Company would be obligated to purchase the equipment at a prescribed termination value from the lessor. Expenditures for property and equipment totaled $9.4 million, $25.5 million and $17.2 million in fiscal 1995, 1994 and 1993, respectively. The expenditures for fiscal 1995 included, in addition to store development expenditures, costs relating to the installation of new point-of-sale terminals in the Company's stores. The Company is currently planning very modest store development in fiscal 1996, pending more favorable business trends. The Company intends to open approximately 20 new stores and to relocate or expand 15 stores in fiscal 1996. The Company is currently planning approximately $9.6 million of capital expenditures for fiscal 1996. Page 15 The Company believes that its cash, cash equivalents and short-term investments, together with cash flow from operations and borrowings available under its revolving credit agreement, will be adequate to fund the Company's proposed capital expenditures and other operating requirements. Page 16 Item 8. Financial Statements and Supplementary Data: The response to this Item is submitted in a separate section of this report. Item 9. Disagreements on Accounting and Financial Disclosures: None. Page 17 PART III Item 10. Directors and Executive Officers: The directors and executive officers of the Company and their ages as of March 31, 1996 are as follows: Name Age Position Wayland H. Cato, Jr. * ++ 73 Chairman of the Board of Directors and Chief Executive Officer Edgar T. Cato 71 Vice Chairman of the Board of Directors Linda McFarland Jenkins 48 President and Chief Operating Officer and Director John P. Derham Cato 45 Executive Vice President, President and General Manager - It's Fashion! Division and Director Alan E. Wiley 49 Executive Vice President, Secretary, Chief Financial and Administrative Officer and Director Howard A. Severson 48 Executive Vice President, Assistant Secretary, Chief Real Estate and Store Development Officer and Director Clarice Cato Goodyear * + + 49 Executive Vice President and Assistant Secretary and Director David Kempert 46 Executive Vice President - Chief Store Operations Officer Diane V. Missel 47 Executive Vice President - General Merchandise Manager Patrick J. McIntyre 51 Senior Vice President - Chief Information Officer Stephen R. Clark 53 Senior Vice President - Human Resources and Assistant Secretary Thomas E. Cato 41 Vice President - Divisional Merchandise Manager, Accessories and Shoes and Director Robert W. Bradshaw, Jr. * + 62 Director George S. Currin * + 59 Director Paul Fulton * + 62 Director Grant L. Hamrick * + 57 Director Robert L. Kirby * + 65 Director James H. Shaw * + 67 Director A.F. (Pete) Sloan * + 66 Director * Members of Compensation Committee + Members of Audit and Stock Option Committees ++ Member of Audit Committee Page 18 Wayland H. Cato, Jr. is Chairman of the Board of Directors and has been a director of the Company since 1946. Since 1960, he has served as the Company's Chief Executive Officer. Edgar T. Cato is the Vice Chairman of the Board of Directors and has been a director of the Company since 1946. Mr. Edgar T. Cato is the brother of Mr. Wayland H. Cato, Jr. Linda McFarland Jenkins joined the Company in June 1990. She currently serves as President and Chief Operating Officer and has been a director since 1991. Prior to joining the Company, she was Senior Vice President - General Merchandise Manager of J.B. Ivey & Company, a Charlotte, North Carolina based regional department store chain, where she was employed for 11 years. John P. Derham Cato has been employed as an officer of the Company since 1981 and has served as a director since 1986. He currently serves as Executive Vice President, President and General Manager - It's Fashion! Division. Mr. John Cato is a son of Mr. Wayland H. Cato, Jr. Alan E. Wiley joined the Company in July 1992. He currently serves as Executive Vice President, Secretary, Chief Financial and Administrative Officer and has been a director since 1994. From 1981 through 1990 he held senior administrative and financial positions with British American Tobacco, U.S. in various companies of their specialty retail division. From 1990 until joining the Company, he was President and majority stockholder of Gibbs-Louis, Inc., an Orlando, Florida based women's specialty store chain. In May 1992, Gibbs-Louis, Inc. filed a petition pursuant to the U.S. Bankruptcy Code and was liquidated in June 1992. Howard A. Severson has been an officer of the Company since 1985. He currently serves as Executive Vice President, Assistant Secretary, Chief Real Estate and Store Development Officer and has been a director since March 1995. Prior to joining the Company, Mr. Severson served for five years as the Director of Real Estate for Minnesota Fabric Company, a Charlotte based retail fabric store chain. Clarice Cato Goodyear has been employed by the Company since 1975 and has served as a director and officer of the Company since 1979. She currently serves as Executive Vice President and Assistant Secretary. Ms. Goodyear is a daughter of Mr. Wayland H. Cato, Jr. David Kempert joined the Company as Executive Vice President - Chief Store Operations Officer in August 1989. From 1982 until 1989, he was employed by The Gap Stores, an apparel specialty chain, where his most recent position was Zone Vice President of the Northeast Region. Diane V. Missel has been an officer of the Company since 1995. She currently serves as Executive Vice President - General Merchandise Manager. From 1993 until 1995 she was employed by Motherhood Maternity as Senior Vice President and General Merchandise Manager. From 1986 until 1993, she worked in her latest position as the President of both Ups 'N Downs and Capezio - - - both divisions of U.S. Shoe. Patrick J. McIntyre has been an officer of the Company since 1988. He currently serves as Senior Vice President - Chief Information Officer. He was previously employed for seven years as Vice President of Management Information Services at The Higbee Company, a Cleveland, Ohio based regional department store chain. Page 19 Stephen R. Clark has been an officer of the Company since 1994. He currently serves as Senior Vice President, Human Resources. From 1990 until 1994, he was employed by Gantos, a women's specialty apparel retailer, as Vice President, Human Resources. Thomas E. Cato has been employed by the Company since 1977, has served as an officer since 1986 and has been a director since 1993. He currently serves as Vice President, Divisional Merchandise Manager - Accessories and Shoes. Mr. Thomas Cato is a son of Mr. Wayland H. Cato, Jr. Robert W. Bradshaw, Jr. has been a director of the Company since 1994. Since 1961, he has been engaged in the private practice of law with Robinson, Bradshaw & Hinson, P.A. and as a shareholder, officer and director of the firm. The law firm serves as General Counsel to the Company. George S. Currin has been a director of the Company since 1973. From 1978 to 1989, Mr. Currin was the President and Chief Executive Officer and a director of Southeastern Savings Bank, Inc. Since 1989, he has served as Chairman and Managing Director of Fourth Stockton Company and Chairman of Currin - Patterson Properties LLC. Paul Fulton has been a director of the Company since 1994. From July 1988 to December 1993, Mr. Fulton served as President of Sara Lee Corporation. Since January 1994, Mr. Fulton has served as Dean of the Kenan-Flagler Business School of the University of North Carolina at Chapel Hill. Mr. Fulton is currently a director of Sonoco Products, NationsBank Corporation, Bassett Furniture Industries, Inc., and Winston Hotels, Inc. Grant L. Hamrick has been a director of the Company since 1994. From 1961 to 1985, Mr. Hamrick was employed by the public accounting firm Price Waterhouse and served as Managing Partner of the Charlotte, North Carolina office. Since 1989, Mr. Hamrick has served as Senior Vice President and Chief Financial Officer for American City Business Journals, Inc. Robert L. Kirby has been a director of the Company since 1992. Mr. Kirby served as Executive Vice President of NationsBank of North Carolina from 1983 to 1988 and as President and as director of NationsBank of Florida from 1988 until his retirement in 1990. James H. Shaw has been a director of the Company since 1989. Mr. Shaw was Chairman of Consolidated Ivey's, a regional department store chain, from 1988 until his retirement in 1989, Chairman and Chief Executive Officer of J.B. Ivey & Company from 1986 to 1988 and Chairman and Chief Executive Officer of Ivey's Carolinas from 1983 to 1986. A.F. (Pete) Sloan has been a director of the Company since 1994. Mr. Sloan was Chairman of the Board of Lance, Inc. where he was employed from 1955 until his retirement in 1990. Mr. Sloan is currently a director of Lance, Inc., Bassett Furniture Industries, Inc., PCA International, Inc., and Richfood, Inc. Page 20 Item 11. Executive Compensation: Incorporated by reference to Registrant's proxy statement for 1996 annual stockholders' meeting. Item 12. Security Ownership of Certain Beneficial Owners and Management: Incorporated by reference to Registrant's proxy statement for 1996 annual stockholders' meeting. Item 13. Certain Relationships and Related Transactions: Incorporated by reference to Registrant's proxy statement for 1996 annual stockholders' meeting. Page 21 PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1.& 2. LIST OF FINANCIAL STATEMENTS AND SCHEDULE The response to this portion of Item 14 is submitted as a separate section of this report. (a) 3. LIST OF EXHIBITS See Exhibit Index at page 46 of this annual report. (b) REPORTS ON FORM 8-K No reports on Form 8-K were filed during the quarter ended February 3, 1996. Page 22 ANNUAL REPORT ON FORM 10-K ITEM 8, ITEM 14(A), (1) AND (2), (C) AND (D) FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA LIST OF FINANCIAL STATEMENTS CERTAIN EXHIBITS FINANCIAL STATEMENT SCHEDULE YEAR ENDED FEBRUARY 3, 1996 THE CATO CORPORATION CHARLOTTE, NORTH CAROLINA Page 23 ITEM 14(A) 1. AND 2. LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE THE CATO CORPORATION The following consolidated financial statements of The Cato Corporation are included in Item 8: Reports of Independent Auditors..............................................Pages 24-25 Consolidated Statements of Income................................................Page 26 Consolidated Balance Sheets...........................Page 27 Consolidated Statements of Cash Flows.................Page 28 Consolidated Statements of Stockholders'Equity........Page 29 Notes to Consolidated Financial Statements..........Pages 30 - 44 The following consolidated financial statement schedule of the Cato Corporation is included in Item 14 (d): SCHEDULE II-Valuation and qualifying accounts..............Page 45 All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. Page 24 INDEPENDENT AUDITORS' REPORT TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF THE CATO CORPORATION We have audited the accompanying consolidated balance sheet of The Cato Corporation (the Company) as of February 3, 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for the fiscal year then ended. Our audit also included the financial statement schedule listed in the Index at Item 14(a) as it relates to the fiscal year ended February 3, 1996. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit. The financial statements and financial statement schedule of the Company for the years ended January 28, 1995 and January 29, 1994 were audited by other auditors whose report dated March 10, 1995 expressed an unqualified opinion on those statements and schedule. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the February 3, 1996 consolidated financial statements present fairly, in all material respects, the financial position of the Company at February 3, 1996, and the results of its operations and its cash flows for the fiscal year then ended in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein. DELOITTE & TOUCHE LLP Charlotte, North Carolina March 15, 1996 Page 25 REPORT OF INDEPENDENT AUDITORS BOARD OF DIRECTORS AND STOCKHOLDERS THE CATO CORPORATION We have audited the accompanying consolidated balance sheet of The Cato Corporation as of January 28, 1995 and the related consolidated statements of income, stockholders' equity, and cash flows for each of the two years in the period ended January 28, 1995. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Cato Corporation at January 28, 1995 and the consolidated results of its operations and its cash flows for each of the two years in the period ended January 28, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. ERNST & YOUNG LLP Charlotte, North Carolina March 10, 1995 Page 26 THE CATO CORPORATION CONSOLIDATED STATEMENTS OF INCOME Fiscal Year Ended February 3, January 28, January 29, 1996 1995 1994 ---------- ----------- ---------- (In thousands, except per share data) Revenues Retail sales $ 476,638 $ 463,737 $ 407,878 Other income (principally finance and layaway charges) 13,357 12,449 12,021 --------- -------- --------- Total revenues 489,995 476,186 419,899 Costs and Expenses Cost of goods sold, including occupancy, distribution and buying 341,144 324,309 275,090 Selling, general and administrative 122,699 116,144 100,760 Depreciation 7,785 6,844 5,465 Interest 292 377 250 -------- -------- --------- Total operating expenses 471,920 447,674 381,565 -------- -------- --------- Income Before Income Taxes 18,075 28,512 38,334 Income tax expense 6,055 10,407 13,532 ------- ------- -------- Net Income $ 12,020 $ 18,105 $ 24,802 ========= ======== ========= Earnings Per Common and Common Equivalent Share $ .42 $ .62 $ .84 ========= ======== ========= Dividends Per Share $ .16 $ .145 $ .088 ========= ======== ========= See notes to consolidated financial statements. Page 27 THE CATO CORPORATION CONSOLIDATED BALANCE SHEETS February 3, January 28, 1996 1995 ------------ ---------- (In thousands) Assets Current Assets: Cash and cash equivalents $ 26,183 $ 23,963 Short-term investments 21,711 22,263 Accounts receivable, net of allowance for doubtful accounts of $3,401,000 at 39,792 37,926 February 3, 1996 and January 28, 1995 Merchandise inventories 58,440 54,674 Deferred income taxes 1,825 2,053 Prepaid expenses 2,486 2,602 ----------- --------- Total Current Assets 150,437 143,481 Property and Equipment 54,364 53,146 Other Assets 5,094 4,695 ----------- --------- Total Assets $ 209,895 $ 201,322 =========== ========= Liabilities and Stockholders' Equity Current Liabilities: Accounts payable $ 36,482 $ 36,159 Accrued expenses 10,458 11,832 Income taxes 1,328 909 --------- --------- Total Current Liabilities 48,268 48,900 Deferred Income Taxes 4,491 4,192 Other Noncurrent Liabilities 7,454 6,722 Stockholders' Equity: Class A Common Stock, $.033 par value per share, 50,000,000 shares authorized; 23,204,647 shares issued at February 3, 1996 and 23,132,327 shares issued and outstanding at January 28, 1995 773 770 Convertible Class B Common Stock, $.033 par value per share, 15,000,000 shares authorized; 5,264,317 shares issued and outstanding at February 3, 1996 and January 28, 1995 176 176 Preferred Stock, $100 par value per share, 100,000 shares authorized, none issued - - Additional paid-in capital 62,665 62,278 Retained earnings 86,291 78,284 --------- ------- 149,905 141,508 Less Class A Common Stock in treasury, at cost (40,000 shares at February 3, 1996) 223 - --------- ------- Total Stockholders' Equity 149,682 141,508 Total Liabilities and Stockholders' Equity $ 209,895 $ 201,322 ========= ========== See notes to consolidated financial statements. Page 28 THE CATO CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Fiscal Year Ended ------------------------------------ February 3, January 28, January 29, 1996 1995 1994 ----------- ----------- ----------- (In thousands) Operating Activities Net income $ 12,020 $ 18,105 $ 24,802 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 7,785 6,844 5,465 Amortization of investment premiums 280 235 720 Deferred income taxes 216 575 1,161 Loss on disposal of property and equipment - 352 - Changes in operating assets and liabilities: Increase in accounts receivable (1,866) (1,112) (9,077) (Increase) decrease in merchandise inventories (3,766) 1,140 (22,072) Increase in other assets (283) (1,040) (1,294) Increase (decrease) in accrued income taxes 419 909 (1,198) Increase in accounts payable and other liabilities 93 7,386 7,995 ------- ------- ------- Net cash provided by operating activities 14,898 33,394 6,502 ------- ------- ------- Investing Activities Expenditures for property and equipment (9,415) (25,484) (17,214) Proceeds from sale of property and equipment - 378 - Purchases of short-term investments (10,442) (11,882) (34,081) Sales of short-term investments 11,566 9,145 16,577 -------- -------- -------- Net cash used in investing activities (8,291) (27,843) (34,718) -------- -------- -------- Financing Activities Dividends paid (4,554) (4,115) (2,499) Purchase of treasury stock (223) - - Proceeds from employee stock purchase plan 381 435 - Proceeds from stock options exercised 9 91 1,459 Proceeds from sale of common stock - - 24,262 Income tax benefit from stock options exercised - - 1,293 Repayments of life insurance policy loans - - (203) -------- -------- --------- Net cash provided by (used in) financing activities (4,387) (3,589) 24,312 -------- ------- --------- Net Increase (Decrease) in Cash and Cash Equivalents 2,220 1,962 (3,904) Cash and Cash Equivalents at Beginning of Year 23,963 22,001 25,905 ------- ------- ------- Cash and Cash Equivalents at End of Year $ 26,183 $ 23,963 $ 22,001 ========= ========= ========= See notes to consolidated financial statements. Page 29 THE CATO CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY CONVERTIBLE CLASS A CLASS B ADDITIONAL COMMON COMMON PAID-IN RETAINED TREASURY STOCK STOCK CAPITAL EARNINGS STOCK -------- -------- -------- -------- -------- (In thousands) Balance - January 30, 1993 $ 608 $ 176 $ 41,715 $ 42,532 $ 6,815 Net income 24,802 Dividends paid ($.088 per share) (2,499) Sale of Class A Common Stock - 1,012,500 shares 34 24,228 Class A Common Stock sold through stock option plans - 178,550 shares 6 1,193 Treasury shares sold through stock options plans - 23,300 shares 249 (11) Retirement of treasury stock - 5,778,970 shares (192) (6,612) (6,804) Three-for-two stock split - 9,395,385 shares of Class A Common Stock 313 (313) Income tax benefit from stock options exercised 1,293 Shares converted from Class B Common Stock to Class A Common Stock - 18,000 shares - - -------- ------- -------- ------- ------- Balance - January 29, 1994 769 176 61,753 64,835 - Net income 18,105 Dividends paid ($.145 per share) (4,115) Class A Common Stock sold through employee stock purchase plan - 41,769 shares 1 434 Class A Common Stock sold through stock option plans - 12,350 shares - 91 Unrealized losses on available for sale securities, net of deferred income tax benefit of $311,000 (541) -------- ------- -------- ------- ------ Balance - January 28, 1995 770 176 62,278 78,284 - Net income 12,020 Dividends paid ($.16 per share) (4,554) Class A Common Stock sold through employee stock purchase plan - 68,720 shares 3 378 Class A Common Stock sold through stock option plans - 3,600 shares - 9 Purchase of treasury shares - 40,000 shares 223 Unrealized gains on available for sale securities, net of deferred income taxes of $311,000 541 ------- ------- -------- -------- -------- Balance - February 3, 1996 $ 773 $ 176 $ 62,665 $ 86,291 $ 223 ======= ======= ======== ======== ======== See notes to consolidated financial statements. Page 30 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies: Principles of Consolidation - The consolidated financial statements include the accounts of the Company and its wholly- owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Description of Business and Fiscal Year - The Company has principally one segment of business - operation of women's apparel specialty stores. The Company's stores operate under the names Cato, Cato Fashions, Cato Plus and It's Fashion! and are located primarily in strip shopping centers in non-metropolitan markets in the South and Southeastern United States. The Company's fiscal year ends on the Saturday nearest January 31. The fiscal year ended February 3, 1996 included fifty-three weeks and the fiscal years ending January 28, 1995 and January 29, 1994 included fifty-two weeks. Use of Estimates - The preparation of the Company's financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash Equivalents and Short-Term Investments - Cash equivalents consist of highly liquid investments with original maturities of three months or less. Investments with original maturities beyond three months are classified as short-term investments. The fair value of short-term investments are based on quoted market prices. The Company's short-term investments held at February 3, 1996 and January 28, 1995 are classified as available-for-sale. Available for sale securities are carried at fair value, with unrealized gains and losses, net of income taxes, reported as an adjustment to retained earnings. The amortized 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 other income. Accounts Receivable - Accounts receivable include customer trade accounts, customer layaway receivables and miscellaneous trade receivables. Customer receivables related to layaway sales are reflected net of a reserve for unrealized profit. Net layaway receivables totaled approximately $2,679,000 and $2,019,000 at February 3, 1996 and January 28, 1995, respectively. Supplemental Cash Flow Information - Interest paid during the fiscal years ended February 3, 1996, January 28, 1995 and January 29, 1994 was $375,000, $202,000 and $271,000, respectively. Income tax payments, net of refunds received, for the fiscal years ended February 3, 1996, January 28, 1995 and January 29, 1994 were $5,577,000, $8,495,000 and $12,828,000, respectively. Inventories - Merchandise inventories are stated at the lower of cost (first-in, first-out method) or market as determined by the retail method. Page 31 Property and Equipment - Property and equipment are recorded at cost. Maintenance and repairs are charged to operations as incurred; renewals and betterments are capitalized. Depreciation of property and equipment is provided on the straight-line method over the estimated useful lives of the related assets. Retail Sales - Revenues from retail sales (including layaway transactions) are recognized at the time of the sale, net of returns, and exclude sales taxes. Advertising - Advertising costs are expensed in the period in which they are incurred. Advertising expense was $8,803,000, $9,046,000 and $7,350,000 for the fiscal years ended February 3, 1996, January 28, 1995 and January 29, 1994, respectively. Earnings Per Common and Common Equivalent Share - Earnings per share have been computed based on the weighted average number of Class A and Class B common shares and common stock equivalents outstanding during the respective periods. Common stock equivalents represent the dilutive effect of the assumed exercise of outstanding stock options. The number of shares used in the earnings per common and common equivalent share computations were 28,597,323, 29,113,091 and 29,655,394 for the fiscal years ended February 3, 1996, January 28, 1995 and January 29, 1994, respectively. All per share amounts reflect a three-for-two stock split effected June 28, 1993. Income Taxes - The Company and its subsidiaries file a consolidated federal income tax return. Income taxes are provided based on the liability method of accounting, whereby deferred income taxes are provided for temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. Store Opening Costs - Costs relating to the opening of new stores or the relocating or expanding of existing stores are expensed as incurred. Closed Store Lease Obligations - At the time stores are closed, provision is made for the rentals required to be paid over the remaining lease terms. Rentals due the Company under non-cancelable subleases are offset against the related obligations in the year the sublease is signed. There is no offset for assumed sublease revenues. Reclassifications - Certain reclassifications have been made to the consolidated financial statements for prior fiscal years to conform with classifications used as of February 3, 1996. Page 32 2. Short-Term Investments: Short-term investments at February 3, 1996 include the following: Unrealized Estimated Security Type Cost Gains (Losses) Fair Value - - -------------- ---- ----- -------- ---------- (In thousands) Obligations of states and political subdivisions $ 17,285 $ 86 $ (5) $ 17,366 Corporate debt securities 2,000 - (44) 1,956 --------- ------- -------- ---------- Subtotal 19,285 86 (49) 19,322 Equity securities 2,426 - (37) 2,389 --------- ------- -------- ---------- Total $ 21,711 $ 86 $ (86) $ 21,711 ========= ======= ======== ========== Short-term investments at January 28, 1995 include the following: Unrealized Estimated Security Type Cost (Losses) Fair Value - - ------------- ------ ---------- ---------- (In thousands) Obligations of states and political subdivisions $ 16,567 $ (120) $ 16,447 Corporate debt securities 2,000 (160) 1,840 --------- ---------- -------- Subtotal 18,567 (280) 18,287 Equity securities 4,548 (572) 3,976 --------- --------- -------- Total $ 23,115 $ (852) $ 22,263 ========= ========= ======== The unrealized losses at January 28, 1995 of $541,000, net of an income tax benefit of $311,000, is included in stockholders' equity as an adjustment to retained earnings. Page 33 The amortized cost and estimated fair value of debt and marketable equity securities at February 3, 1996, by contractual maturity, are shown below: Estimated Security Type Cost Fair Value - - ------------- ------- ---------- (In thousands) Due in one year or less $ 13,607 $ 13,647 Due in one year through three years 5,678 5,675 --------- ---------- Subtotal 19,285 19,322 Equity securities 2,426 2,389 --------- ---------- Total $ 21,711 $ 21,711 ========= ========== Page 34 3. Accounts Receivable: Accounts receivable consist of the following: February 3, January 28, 1996 1995 ----------- ----------- (In thousands) Customer accounts- principally deferred payment accounts $ 41,331 $ 38,291 Miscellaneous trade receivables 1,862 3,036 -------- -------- Total 43,193 41,327 Less allowance for doubtful accounts 3,401 3,401 -------- -------- Accounts receivable - net $ 39,792 $ 37,926 ======== ======== Finance charge and late charge revenue on customer deferred payment accounts were $6,535,000 $6,324,000 and $5,539,000 for the fiscal years ended February 3, 1996, January 28, 1995 and January 29, 1994, respectively, and the provision for doubtful accounts was $2,918,000, $2,888,000 and $1,352,000, for the fiscal years ended February 3, 1996, January 28, 1995 and January 29, 1994, respectively. The provision for doubtful accounts is classified as a component of selling, general and administrative expenses. Page 35 4. Property and Equipment: Property and equipment consist of the following: February 3, January 28, 1996 1995 ----------- ----------- (In thousands) Land and improvements $ 1,853 $ 763 Buildings 15,481 6,751 Leasehold improvements 16,182 12,811 Fixtures and equipment 57,096 49,897 Construction in progress 2,449 14,352 --------- ----------- Total 93,061 84,574 Less accumulated depreciation 38,697 31,428 --------- ----------- Property and equipment - net $ 54,364 $ 53,146 ========= =========== Page 36 5. Accrued Expenses: Accrued expenses consist of the following: February 3, January 28, 1996 1995 ----------- ----------- (In thousands) Accrued bonus and retirement savings plan contributions $ 1,742 $ 1,787 Accrued payroll and related items 2,819 4,472 Closed stores 687 486 Property taxes 1,207 1,018 Contingent rent 604 735 Advertising 253 267 Accrued credit expenses 384 306 Accrued data processing expenses 234 280 Accrued heath care plan contributions 428 285 Other 2,100 2,196 ---------- --------- Total accrued expenses $ 10,458 $ 11,832 ========== ========= Page 37 6. Financing Arrangements: In February 1996, the Company entered into a new unsecured revolving credit agreement which provides for borrowings of up to $20 million and an additional letter of credit facility of $15 million. The revolving credit agreement is committed until May 1999 and the letter of credit facility is renewable annually. The revolving credit agreement contains various financial covenants, including the maintenance of specific financial ratios. The agreement replaces an unsecured revolving credit and term loan agreement, which was committed until May 1998, and provided $35 million of available borrowings and a $15 million letter of credit facility. There were no borrowings outstanding under the prior agreement at February 3, 1996 or January 28, 1995. The Company had approximately $6,137,000 and $8,607,000 at February 3, 1996 and January 28, 1995, respectively, of outstanding irrevocable letters of credit relating to purchase commitments. Upon satisfaction of the terms of the letters of credit, the Company is obligated to pay the issuing bank the dollar amount of the commitment. Page 38 7. Stockholders' Equity: The holders of Class A Common Stock are entitled to one vote per share, whereas the holders of Class B Common Stock are entitled to ten votes per share. Each share of Class B Common Stock may be converted at any time into one share of Class A Common Stock. Subject to the rights of the holders of any shares of Preferred Stock that may be outstanding at the time, in the event of liquidation, dissolution or winding up of the Company, holders of Class A Common Stock are entitled to receive a preferential distribution of $1.00 per share of the net assets of the Company. Cash dividends on the Class B Common Stock cannot be paid unless cash dividends of at least an equal amount are paid on the Class A Common Stock. The Company's charter provides that shares of Class B Common Stock may be transferred only to certain "Permitted Transferees" consisting generally of the lineal descendants of holders of Class B Stock, trusts for their benefit, corporations and partnerships controlled by them and the Company's employee benefit plans. Any transfer of Class B Common Stock in violation of these restrictions, including a transfer to the Company, results in the automatic conversion of the transferred shares of Class B Common Stock held by the transferee into an equal number of shares of Class A Common Stock. In June 1993, the Company effected a three-for-two stock split in the form of a stock dividend. The split resulted in the issuance of 9,395,385 shares of Class A Common Stock to Class A and B shareholders. All references in the financial statements to average numbers of shares outstanding and related prices, per share amounts and stock option plan data reflect the split. In October 1993, the Company registered 250,000 shares of Class A Common Stock available for issuance under an Employee Stock Purchase Plan (the "Plan"). Under the terms of the Plan, substantially all employees may purchase Class A Common Stock through payroll deductions of up to 10% of their salary. The Class A Common Stock is purchased at the lower of 85% of market value on the first or last business day of a six-month payment period. Additionally, each April 15, employees are given the opportunity to make a lump sum purchase of up to $10,000 worth of Class A Common Stock at 85% of market value. The number of shares purchased by participants through the plan were 68,720 shares and 41,769 shares for the years ended February 3, 1996 and January 28, 1995, respectively. In 1987, the Company adopted an Incentive Stock Option Plan and a Non-Qualified Stock Option Plan for key employees of the Company. In 1991, the Board of Directors of the Company amended the 1987 option plans increasing the number of shares reserved under the plans from 2,100,000 shares to 3,150,000 shares. In 1994, the Board of Directors increased the number of shares issuable under the plans to 3,900,000 shares of which 825,000 shares are issuable under the Incentive Stock Option Plan and 3,075,000 shares are issuable under the Non-Qualified Stock Option Plan. The purchase price of the shares under option must be at least 100 percent of the fair market value of Class A Common Stock at the date of the grant and must be exercisable not later than 10 years after the date of the grant unless otherwise expressly authorized by the Board of Directors. Page 39 Option plan activity for the three fiscal years ended February 3, 1996 is set forth below: Number of Price Per Shares Share --------- --------------- Outstanding options, January 30, 1993 2,501,550 $ 1.33 - 13.17 Granted 226,750 17.50 - 23.06 Exercised (224,750) 1.50 - 13.17 Cancelled (50,700) 1.50 - 19.17 ---------- Outstanding options, January 29, 1994 2,452,850 1.33 - 23.06 Granted 584,500 6.75 - 17.13 Exercised (12,350) 3.25 - 8.00 Cancelled (32,700) 3.25 - 20.67 ----------- Outstanding options, January 28, 1995 2,992,300 1.33 - 23.00 Granted 883,250 6.19 - 8.13 Exercised (3,600) 1.33 - 8.00 Cancelled (854,150) 6.19 - 23.00 ------------ Outstanding options, February 3, 1996 3,017,800 $ 1.42 - $8.42 ============ =============== Exercisable at February 3, 1996 1,881,950 $ 1.42 - $8.42 ============ =============== Outstanding options at February 3, 1996 covered 927,918 shares of Class B Common Stock and 2,089,882 shares of Class A Common Stock. Outstanding options at January 28, 1995 covered 927,918 shares of Class B Common Stock and 2,064,382 shares of Class A Common Stock. Options available to be granted under the option plans were 358,600 shares at February 3, 1996 and 387,700 shares at January 28, 1995. Page 40 8. Employee Benefit Plans: The Company has a defined contribution retirement savings plan (401(k)) which covers all employees who meet minimum age and service requirements. The 401(k) plan allows participants to contribute up to 16% of their annual compensation. The Company is obligated to make a minimum contribution and further Company contributions, at the discretion of the Board of Directors, are based on a formula of percentages of pre-tax profits. The Company's contributions for the years ended February 3, 1996, January 28, 1995 and January 29, 1994 were approximately $961,000, $1,278,000 and $2,272,000, respectively. The Company has an Employee Stock Ownership Plan (ESOP), which covers substantially all employees who meet minimum age and service requirements. The Board of Directors determines contributions to the ESOP. No contributions were made to the ESOP for the years ended February 3, 1996, January 28, 1995 and January 29, 1994, respectively. Page 41 9. Leases: The Company has operating lease arrangements for store facilities and equipment. Facility leases generally are for periods of five years with renewal options, and most provide for additional contingent rentals based on a percentage of store sales in excess of stipulated amounts. Equipment leases are generally for three-to seven-year periods. During the years ended February 3, 1996 and January 28, 1995, the Company entered into an agreement with a lessor to lease $9.5 and $10 million, respectively, of store fixtures, point-of-sale devices and warehouse equipment. These leases, which are being accounted for as operating leases, are for terms of seven years but may be cancelled annually upon proper notice to the lessor. Upon notice of cancellation, the Company would be obligated to purchase the equipment at a prescribed termination value from the lessor. If the Company cancelled the leases on their next anniversary dates, the purchase price for the equipment would be approximately $16,941,000. The minimum commitments relating to future payments under non- cancelable operating leases are (in thousands): Fiscal Year ----------- 1996 $ 28,450 1997 21,956 1998 16,101 1999 11,289 2000 7,038 2001 and thereafter 13,924 ------- Total minimum lease payments $ 98,758 The following schedule shows the composition of total rental expense for all leases: Fiscal Year Ended --------------------------------------------- February 3, January 28, January 29, 1996 1995 1994 ----------- ----------- ----------- (In thousands) Minimum rentals $ 28,666 $ 24,817 $ 20,180 Contingent rent 363 658 872 -------- -------- -------- Total rental expense $ 29,029 $ 25,475 $ 21,052 ======== ======== ======== Page 42 10. Income Taxes: The provisions for income taxes consist of the following: Fiscal Year Ended ----------------------------------------------------------- February 3, January 28, January 29, 1996 1995 1994 ------------ ----------- ----------- (In thousands) Current income taxes: Federal $ 4,976 $ 9,681 $ 10,488 State 863 151 590 ------- ------- -------- Total 5,839 9,832 11,078 ------- ------- -------- Deferred income taxes: Federal 861 518 1,061 State (645) 57 100 ------- ------- -------- Total 216 575 1,161 ------- ------- -------- Allocation of tax benefit to capital for stock options exercised - - 1,293 Total income tax -------- -------- -------- expense $ 6,055 $ 10,407 $ 13,532 ======== ======== ======== The components of the provision for deferred income taxes are as follows: Fiscal Year Ended ---------------------------------- February January January 3, 28, 29, 1996 1995 1994 -------- ------- ------- (In thousands) Depreciation $ 1,244 $ 901 $ 74 Provision for doubtful accounts (34) (86) 206 Restructuring expenses 30 18 418 Inventory valuation (274) (50) (41) Self-insurance reserve - (12) 113 Change in tax rate - - 13 Other (750) (196) 378 -------- ------- -------- Total $ 216 $ 575 $ 1,161 ======== ======== ======== Page 43 Significant components of the Company's deferred tax assets and liabilities as of February 3, 1996 and January 28, 1995 are as follows: February 3, January 28, 1996 1995 ----------- ----------- (In thousands) Deferred tax assets: Bad debt reserve $ 1,362 $ 1,329 Inventory valuation 709 435 Unrealized losses on short- term investments - 311 Reserves 507 992 -------- --------- Total deferred tax assets 2,578 3,067 -------- --------- Deferred tax liabilities: Tax over book depreciation 5,425 4,607 Other, net (181) 599 -------- --------- Total deferred tax liabilities 5,244 5,206 -------- --------- Net deferred tax liabilities $ 2,666 $ 2,139 ======== ========= The reconciliation of the Company's effective income tax rate with the statutory rate is as follows: Fiscal Year Ended ------------------------------------------------------- February 3, January 28, January 29, 1996 1995 1994 ----------- ----------- ----------- Federal income tax rate 35.0% 35.0% 35.0% State income taxes 2.8 0.5 1.3 Other (4.3) 1.0 (1.0) ----------- ------------ ----------- Effective income tax rate 33.5% 36.5% 35.3% =========== ============= =========== Page 44 11. Quarterly Financial Data (Unaudited): Summarized quarterly financial results are as follows (in thousands, except per share data): First Second Third Fourth Fiscal 1995 Qtr Qtr Qtr Qtr - - ----------- ------- -------- -------- -------- Retail Sales $ 114,461 $ 114,739 $ 105,825 $ 141,613 Total revenues 117,850 109,331 145,059 117,755 Cost of goods sold, including occupancy, distribution and buying 75,276 82,256 80,097 103,515 Net income (loss) 7,498 2,963 (1,492) 3,051 Earnings (loss) per common and common equivalent share $ .26 $ .10 $ (.05) $ .11 Fiscal 1994 - - ------------ Retail Sales $ 110,105 $ 110,196 $ 109,111 $ 134,325 Total revenues 113,131 113,263 112,212 137,580 Cost of goods sold, including occupancy, distribution and buying 70,781 77,020 77,505 99,003 Net income 8,210 4,325 2,799 2,771 Earnings per common and common equivalent share $ .28 $ .15 $ .10 $ .10 Page 45 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS ---------------------------------- Allowance Reserve for for Doubtful Rental Accounts Commitments (a) (b) ----------- ----------- (In thousands) Balance at January 30, 1993 $ 3,750 $ 167 Additions charged to costs and expenses 1,352 268 Additions (Deductions) charged to other accounts 605 (d) 269 (e) Deductions (2,545)(c) (414) ------------ ----------- Balance at January 29, 1994 3,162 290 Additions charged to costs and expenses 2,888 825 Additions (Deductions) charged to other accounts 843 (d) - Deductions (3,492) (c) (700) ------------- ----------- Balance at January 28, 1995 3,401 415 Additions charged to costs and expenses 2,918 1,199 Additions (Deductions) charged to other accounts 758 (d) - Deductions (3,676) (c) ( 955) ------------ ---------- Balance at February 3, 1996 $ 3,401 $ 659 ============ ========== (a) Deducted from trade accounts receivable. (b) Provision for the difference between costs and revenues from noncancelable subleases over the lease terms of closed stores. (c) Uncollectible accounts written off. (d) Recoveries of amounts previously written off. (e) Transferred from restructuring reserve. Page 46 EXHIBIT INDEX Designation of Exhibit Page - - -------------- --------- 22 Subsidiaries of the Registrant 47 23 Consents of Independent Auditors 48 - 49 Page 47 EXHIBIT 22 SUBSIDIARIES OF THE REGISTRANT Name of State of Name under which Subsidiary Incorporation Subsidiary does Business - - ---------- ------------- ----------------------- C.H.W. Corporation Delaware C.H.W. Corporation Providence Insurance Company A Bermudian Company Providence Insurance Limited Company Limited Page 48 EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-41314) pertaining to The Cato Corporation Employee Incentive Stock Option Plan, in the Registration Statement (Form S-8 No. 33-41315) pertaining to The Cato Corporation Non-qualified Stock Option Plan, and in the Registration Statement (Form S-8 No. 33-69844) pertaining to The Cato Corporation Employee Stock Purchase Plan, of our report dated March 15, 1996, with respect to the consolidation financial statements and financial statement schedule of The Cato Corporation included in the Annual Report on Form 10-K for the year ended February 3, 1996. DELOITTE & TOUCHE LLP Charlotte, North Carolina April 25, 1996 Page 49 EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-41314) pertaining to the Cato Corporation Employee Incentive Stock Option Plan, in the Registration Statement (Form S-8 No. 33-41315) pertaining to the Cato Corporation Non-Qualified Stock Option Plan, and in the Registration Statement (Form S-8 No. 33-69844) pertaining to the Cato Corporation Employee Stock Purchase Plan, of our report dated March 10, 1995, with respect to the consolidated financial statements and schedule of the Cato Corporation included in the Annual Report (Form 10-K) for the year ended February 3, 1996. ERNST & YOUNG LLP Charlotte, North Carolina April 25, 1996 Page 50 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Cato has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The Cato Corporation By /s/ Wayland H. Cato, Jr. By /s/ Robert M. Sandler ----------------------------- ------------------------- Wayland H. Cato, Jr. Robert M. Sandler Chairman of the Board of Senior Vice President - Directors and Controller Chief Executive Officer By /s/ Alan E. Wiley ----------------------------- Alan E. Wiley Executive Vice President- Secretary, Chief Financial and Administrative Officer Date: April 25, 1996 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated: /s/ Wayland H. Cato, Jr. /s/ Robert W. Bradshaw, Jr. ------------------------ ---------------------------- Wayland H. Cato, Jr. Robert W. Bradshaw, Jr. (Director) (Director) /s/ Edgar T. Cato /s/ George S. Currin ----------------------- ----------------------------- Edgar T. Cato George S. Currin (Director) (Director) /s/ Linda McFarland Jenkins /s/ Paul Fulton ------------------------ ----------------------------- Linda McFarland Jenkins Paul Fulton (Director) (Director) /s/ John P. Derham Cato /s/ Grant L. Hamrick ------------------------ ------------------------------ John P. Derham Cato Grant L. Hamrick (Director) (Director) /s/ Alan E. Wiley /s/ Robert L. Kirby ------------------------ ------------------------------- Alan E. Wiley Robert L. Kirby (Director) (Director) /s/ Howard A. Severson ------------------------ ------------------------------- Howard A. Severson James H. Shaw (Director) (Director) /s/ A.F. (Pete) Sloan ------------------------ ------------------------------- Clarice Cato Goodyear A.F. (Pete) Sloan (Director) (Director) /s/ Thomas E. Cato ------------------------- Thomas E. Cato (Director)