UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended October 28, 2006

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

For the transition period from                                         to                                         

Commission file number 1-31340

THE CATO CORPORATION

 

(Exact name of registrant as specified in its charter)

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

8100 Denmark Road, Charlotte, North Carolina 28273-5975

(Address of principal executive offices)

(Zip Code)

(704) 554-8510

Not Applicable

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

Yes þ      No o

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

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

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

Yes o      No þ

As of November 14, 2006, there were 30,829,215 shares of Class A common stock and 690,525 shares of Class B common stock outstanding.

 

 

THE CATO CORPORATION

FORM 10-Q

Quarter Ended October 28, 2006

Table of Contents

		Page
		No.
PART I — FINANCIAL INFORMATION (UNAUDITED)
Item 1. Financial Statements:
Condensed Consolidated Statements of Income and Comprehensive Income			2
For the Three Months and Nine Months Ended October 28, 2006 and October 29, 2005
Condensed Consolidated Balance Sheets			3
At October 28, 2006, October 29, 2005 and January 28, 2006
Condensed Consolidated Statements of Cash Flows			4
For the Nine Months Ended October 28, 2006 and October 29, 2005
Notes to Condensed Consolidated Financial Statements			5–12
For the Three Months and Nine Months Ended October 28, 2006 and October 29, 2005
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			13–19
Item 3. Quantitative and Qualitative Disclosures About Market Risk			20
Item 4. Controls and Procedures			20
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			21
Item 1A. Risk Factors			21
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			21
Item 3. Defaults upon Senior Securities			21
Item 4. Submission of Matters to a Vote of Security Holders			21
Item 5. Other Information			21
Item 6. Exhibits			21
Signatures			22-26
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

THE CATO CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND
COMPREHENSIVE INCOME

		Three Months Ended								Nine Months Ended
		October 28,				October 29,				October 28,				October 29,
		2006				2005				2006				2005
		(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)
		(Dollars in thousands, except per share data)
REVENUES
Retail sales		$	187,727			$	177,762			$	632,101			$	601,142
Other income (principally finance charges, late fees and layaway charges)			3,155				3,592				9,686				11,103
Total revenues			190,882				181,354				641,787				612,245
COSTS AND EXPENSES, NET
Cost of goods sold			127,229				119,869				413,087				396,729
Selling, general and administrative			51,472				51,231				157,801				151,328
Depreciation			5,169				5,094				15,561				15,158
Interest expense			10				10				30				172
Interest and other income			(2,131	)			(1,235	)			(5,624	)			(3,247	)
			181,749				174,969				580,855				560,140
Income before income taxes			9,133				6,385				60,932				52,105
Income tax expense			3,272				2,318				22,179				18,914
Net Income		$	5,861			$	4,067			$	38,753			$	33,191
Basic earnings per share		$	0.19			$	0.13			$	1.24			$	1.07
Basic weighted average shares			31,298,253				31,126,752				31,270,347				31,139,741
Diluted earnings per share		$	0.18			$	0.13			$	1.22			$	1.04
Diluted weighted average shares			31,846,241				31,771,535				31,795,150				31,798,500
Dividends per share		$	0.15			$	0.13			$	0.43			$	0.38
Comprehensive income:
Net income		$	5,861			$	4,067			$	38,753			$	33,191
Unrealized gains (losses) on available-for-sale securities, net of deferred income tax liability or benefit			78				(20	)			112				10
Net comprehensive income		$	5,939			$	4,047			$	38,865			$	33,201

See notes to condensed consolidated financial statements.

THE CATO CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

		October 28,				October 29,
		2006				2005				January 28,
		(Unaudited)				(Unaudited)				2006
		(Dollars in thousands)
ASSETS
Current Assets:
Cash and cash equivalents		$	21,428			$	18,288			$	21,734
Short-term investments			86,229				75,107				86,085
Accounts receivable, net of allowance for doubtful accounts of $3,585, $4,187 and $3,694 at October 28, 2006, October 29, 2005 and January 28, 2006, respectively			45,229				47,638				49,644
Merchandise inventories			110,078				103,435				103,370
Deferred income taxes			8,462				5,775				8,526
Prepaid expenses			2,438				2,919				2,318
Total Current Assets			273,864				253,162				271,677
Property and equipment – net			130,255				122,034				124,104
Other assets			11,150				10,941				10,855
Total Assets		$	415,269			$	386,137			$	406,636
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable		$	63,542			$	71,286			$	78,036
Accrued expenses			34,334				32,439				31,967
Accrued bonus and benefits			11,511				12,956				17,570
Accrued income taxes			5,803				3,457				4,990
Total Current Liabilities			115,190				120,138				132,563
Deferred income taxes			9,261				10,172				9,261
Other noncurrent liabilities (primarily deferred rent)			23,187				24,306				24,864
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 35,922,824 shares, 35,571,286 shares and 35,622,516 shares at October 28, 2006, October 29, 2005 and January 28, 2006, respectively			1,197				1,186				1,188
Convertible Class B common stock, $.033 par value per share, 15,000,000 shares authorized; issued 690,525 shares, at October 28, 2006, October 29, 2005 and January 28, 2006, respectively			23				23				23
Additional paid-in capital			41,318				37,841				39,244
Retained earnings			319,716				286,882				294,462
Accumulated other comprehensive income			190				81				78
Unearned compensation – restricted stock awards			—				(398	)			(229	)
			362,444				325,615				334,766
Less Class A common stock in treasury, at cost (5,093,609 Class A shares at October 28, 2006, and 5,055,840 Class A shares at October 29, 2005 and 5,093,840 Class A shares at January 28, 2006)			(94,813	)			(94,094	)			(94,818	)
Total Stockholders’ Equity			267,631				231,521				239,948
Total Liabilities and Stockholders’ Equity		$	415,269			$	386,137			$	406,636

See notes to condensed consolidated financial statements.

THE CATO CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

		Nine Months Ended
		October 28,				October 29,
		2006				2005
		(Unaudited)				(Unaudited)
		(Dollars in thousands)
OPERATING ACTIVITIES
Net income		$	38,753			$	33,191
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			15,561				15,158
Provision for doubtful accounts			2,111				3,519
Share-based compensation			983				512
Excess tax benefits from share-based compensation			(312	)			—
Deferred income taxes			64				6
Loss on disposal of property and equipment			1,323				1,516
Changes in operating assets and liabilities which provided (used) cash:
Accounts receivable			2,304				(268	)
Merchandise inventories			(6,708	)			(2,897	)
Prepaid and other assets			(416	)			(1,752	)
Accrued income taxes			1,125				(1,008	)
Accounts payable, accrued expenses and other liabilities			(20,327	)			(7,903	)
Net cash provided by operating activities			34,461				40,074
INVESTING ACTIVITIES
Expenditures for property and equipment			(23,169	)			(21,050	)
Purchases of short-term investments			(114,143	)			(56,689	)
Sales of short-term investments			114,110				70,180
Net cash used in investing activities			(23,202	)			(7,559	)
FINANCING ACTIVITIES
Change in cash overdrafts included in accounts payable			600				2,500
Dividends paid			(13,508	)			(11,808	)
Purchase of treasury stock			—				(2,812	)
Payments to settle long term debt			—				(22,000	)
Proceeds from employee stock purchase plan			395				416
Excess tax benefits from share-based compensation			312				—
Proceeds from stock options exercised			636				837
Net cash used in financing activities			(11,565	)			(32,867	)
Net decrease in cash and cash equivalents			(306	)			(352	)
Cash and cash equivalents at beginning of period			21,734				18,640
Cash and cash equivalents at end of period		$	21,428			$	18,288

See notes to condensed consolidated financial statements.

THE CATO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND NINE MONTHS ENDED OCTOBER 28, 2006 AND OCTOBER 29, 2005

NOTE 1 — GENERAL:

The condensed consolidated financial statements have been prepared from the accounting records of The Cato Corporation and its wholly-owned subsidiaries (the “Company”), and all amounts shown as of and for the periods ended October 28, 2006 and October 29, 2005 are unaudited. In the opinion of management, all adjustments considered necessary for a fair presentation have been completed, including reclassifying treasury Class B common stock to treasury Class A common stock. The results of the interim period may not be indicative of the results expected for the entire year.

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

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

Short-term investments are classified as available-for-sale. As they are available for current operations, they are classified in the Condensed Consolidated Balance Sheets as current assets. Available-for-sale securities are carried at fair value, with unrealized gains and temporary losses, net of income taxes, reported as a component of accumulated other comprehensive income. Other than temporary declines in fair value of investments are recorded as a reduction in the cost of the investments in the accompanying Condensed Consolidated Balance Sheets and a reduction of interest and other income in the accompanying Condensed Consolidated Statements of Income and Comprehensive Income. The cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. The amortization of premiums, accretion of discounts and realized gains and losses are included in interest and other income.

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

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

As of the date of this Form 10-Q filing, the Company has submitted insurance claims for losses attributable to Hurricanes Katrina, Rita and Wilma incurred during the third quarter of fiscal 2005. The total amount of the proceeds, which are uncertain at this time, will be classified as a reduction of selling, general and administrative expenses upon receipt. The Company anticipates these claims will be resolved in the fourth quarter of fiscal 2006.

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND NINE MONTHS ENDED OCTOBER 28, 2006 AND OCTOBER 29, 2005

NOTE 1 – GENERAL (CONTINUED):

On May 25, 2006, the Board of Directors increased the quarterly dividend by 15% from $.13 per share to $.15 per share, or an annualized rate of $.60 per share.

NOTE 2 — EARNINGS PER SHARE:

Basic EPS is computed as net income divided by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock options and other convertible securities. Unvested restricted stock is included in the computation of diluted EPS using the treasury stock method.

		Three Months Ended								Nine Months Ended
		October 28,				October 29,				October 28,				October 29,
		2006				2005				2006				2005
Weighted-average shares outstanding			31,298,253				31,126,752				31,270,347				31,139,741
Dilutive effect of :
Stock options			523,476				516,430				511,307				538,809
Restricted stock			24,512				128,353				13,496				119,950
Employee stock purchase plan			—				—				—				—
Weighted-average shares and common stock equivalents outstanding			31,846,241				31,771,535				31,795,150				31,798,500

NOTE 3 — SUPPLEMENTAL CASH FLOW INFORMATION:

Income tax payments, net of refunds received, for the nine months ended October 28, 2006 and October 29, 2005 were $21,121,000 and $19,668,000, respectively. Cash paid for interest for the nine months ended October 28, 2006 and October 29, 2005 was $-0- and $210,000, respectively.

NOTE 4 — FINANCING ARRANGEMENTS:

At October 28, 2006, the Company had an unsecured revolving credit agreement, which provided for borrowings of up to $35 million. The revolving credit agreement is committed until August 2008. This agreement replaced a prior revolving credit agreement which was due to expire in August 2006. The credit agreement contains various financial covenants and limitations, including the maintenance of specific financial ratios with which the Company was in compliance as of October 28, 2006. There were no borrowings outstanding under these credit facilities during the first nine months ended October 28, 2006 or October 29, 2005, or the fiscal year ended January 28, 2006.

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND NINE MONTHS ENDED OCTOBER 28, 2006 AND OCTOBER 29, 2005

NOTE 4 — FINANCING ARRANGEMENTS (CONTINUED):

On August 22, 2003, the Company entered into a new unsecured $30 million five-year term loan facility, the proceeds of which were used to purchase Class B Common Stock from the Company’s founders. Payments were due in monthly installments of $500,000 plus accrued interest based on LIBOR. On April 5, 2005, the Company repaid the remaining balance of $20.5 million on this term loan facility with no early prepayment penalty. With the early retirement of this loan, the Company had no outstanding debt as of October 28, 2006 and October 29, 2005.

At October 28, 2006 and October 29, 2005 the Company had approximately $2,151,000 and $1,484,000, 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 October 28, 2006, principally in the southeastern United States. The Company offers its own credit card to its customers and all related credit authorizations, payment processing, and collection efforts are performed by a separate subsidiary of the Company.

The following schedule summarizes certain segment information (in thousands):

Three Months Ended														Nine Months Ended
October 28, 2006		Retail				Credit				Total				October 28, 2006		Retail				Credit				Total
Revenues		$	188,171			$	2,711			$	190,882			Revenues		$	633,718			$	8,069			$	641,787
Depreciation			5,142				27				5,169			Depreciation			15,494				67				15,561
Interest and other income			(2,131	)			—				(2,131	)		Interest and other income			(5,624	)			—				(5,624	)
Income before taxes			7,948				1,185				9,133			Income before taxes			57,753				3,179				60,932
Total assets			345,075				70,194				415,269			Total assets			345,075				70,194				415,269
Capital expenditures			5,797				2				5,799			Capital expenditures			23,146				23				23,169

Three Months Ended														Nine Months Ended
October 29, 2005		Retail				Credit				Total				October 29, 2005		Retail				Credit				Total
Revenues		$	178,226			$	3,128			$	181,354			Revenues		$	602,522			$	9,723			$	612,245
Depreciation			5,069				25				5,094			Depreciation			15,076				82				15,158
Interest and other income			(1,235	)			—				(1,235	)		Interest and other income			(3,247	)			—				(3,247	)
Income before taxes			5,093				1,292				6,385			Income before taxes			48,486				3,619				52,105
Total assets			320,659				65,478				386,137			Total assets			320,659				65,478				386,137
Capital expenditures			9,366				—				9,366			Capital expenditures			21,048				2				21,050

The Company evaluates performance based on income before taxes. The Company does not allocate certain corporate expenses or income taxes to the credit segment.

The following schedule summarizes the direct expenses of the credit segment which are reflected in selling, general and administrative expenses (in thousands):

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND NINE MONTHS ENDED OCTOBER 28, 2006 AND OCTOBER 29, 2005

NOTE 5 – REPORTABLE SEGMENT INFORMATION (CONTINUED):

		Three Months Ended								Nine Months Ended
		October 28,				October 29,				October 28,				October 29,
		2006				2005				2006				2005
Bad debt expense		$	722			$	1,074			$	2,303			$	3,517
Payroll			246				251				760				801
Postage			239				223				780				820
Other expenses			292				263				980				884
Total expenses		$	1,499			$	1,811			$	4,823			$	6,022

NOTE 6 — STOCK BASED COMPENSATION:

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

As of October 28, 2006, the Company had three long-term compensation plans pursuant to which stock-based compensation was outstanding or could be granted. The Company’s 1987 Non-Qualified Stock Option Plan authorized 4,612,500 shares for the granting of options to officers and key employees. The 1999 Incentive Compensation Plan and 2004 Incentive Compensation Plan authorized 1,000,000 and 1,350,000 shares, respectively, for the granting of various forms of equity-based awards, including restricted stock and stock options to officers and key employees. The 1999 Plan has expired as to the ability to grant new awards.

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND NINE MONTHS ENDED OCTOBER 28, 2006 AND OCTOBER 29, 2005

NOTE 6 — STOCK BASED COMPENSATION (CONTINUED):

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

		1987				1999				2004
		Plan				Plan				Plan				Total
Options and/or restricted stock initially authorized			4,612,500				1,000,000				1,350,000				6,962,500
Options and/or restricted stock available for grant:
January 28, 2006			5,227				—				1,300,500				1,305,727
October 28, 2006			8,827				—				1,092,218				1,101,045

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

The following is a summary of the changes in stock options outstanding during the nine months ended October 28, 2006:

										Weighted Average
						Weighted Average				Remaining Contractual				Aggregate Intrinsic
		Shares				Exercise Price				Term				Value (a)
Options outstanding at January 28, 2006			1,343,400			$	8.23			3.05 years
Granted			—				—				—
Forfeited or expired			(10,500	)
Exercised			(64,275	)
Outstanding at October 28, 2006			1,268,625			$	8.08			2.17 years				$	18,612,870
Vested and exercisable at October 28, 2006			1,180,550			$	7.59			1.84 years				$	17,896,661

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

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND NINE MONTHS ENDED OCTOBER 28, 2006 AND OCTOBER 29, 2005

NOTE 6 — STOCK BASED COMPENSATION (CONTINUED):

		Nine Months Ended
		October 29,
		2005
Risk free interest rate			4.35	%
Expected life		5.0 years
Expected volatility			36.86	%
Expected dividend yield			2.62	%
Weighted-average grant date fair value per share		$	6.19

As of October 28, 2006, there was approximately $345,000 of total unrecognized compensation cost related to nonvested options, which is expected to be recognized over a remaining weighted-average vesting period of 1.92 years. The total intrinsic value of options exercised during the third quarter and nine months ended October 28, 2006 was approximately $75,000 and $853,000, respectively.

Effective January 29, 2006, the Company began recognizing share-based compensation expense ratably over the vesting period, net of estimated forfeitures. The Company recognized share-based compensation expense of $357,000 and $983,000 for the third quarter and nine month period ended October 28, 2006, respectively, which was classified as a component of selling, general and administrative expenses. No share-based compensation expense was recognized prior to January 29, 2006 except for the amortization of restricted stock grants.

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

		Three Months				Nine Months
		Ended				Ended
		October 29,				October 29,
		2005				2005
Net Income as Reported		$	4,067			$	33,191
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects			109				326
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects			(125	)			(387	)
Pro forma Net Income		$	4,051			$	33,130
Earnings per share:
Basic – as reported		$	.13			$	1.07
Basic – pro forma		$	.13			$	1.06
Diluted – as reported		$	.13			$	1.04
Diluted – pro forma		$	.13			$	1.04

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND NINE MONTHS ENDED OCTOBER 28, 2006 AND OCTOBER 29, 2005

NOTE 6 — STOCK BASED COMPENSATION (CONTINUED):

Prior to the adoption of SFAS No. 123R, the Company presented all benefits of tax deductions resulting from the exercise of share-based compensation as operating cash flows in the Statements of Cash Flows. SFAS No. 123R requires the benefits of tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. For the nine months ended October 28, 2006, the Company reported $312,000 of excess tax benefits as a financing cash inflow in addition to $1,031,000 in cash proceeds received from the exercise of stock options and Employee Stock Purchase Plan purchases.

The Company’s Employee Stock Purchase Plan allows eligible full-time employees to purchase a limited number of shares of the Company’s Class A Common Stock during each semi-annual offering period at a 15% discount through payroll deductions. During the nine months ended
October 28, 2006, the Company sold 21,982 shares to employees at an average discount of $3.17 per share under the Employee Stock Purchase Plan. The compensation expense recognized for the 15% discount given under the Employee Stock Purchase Plan was approximately $70,000 for the nine months ended October 28, 2006. Prior to the adoption of SFAS 123R, the discount was not required to be charged to expense.

In accordance with SFAS No. 123R, the fair value of current restricted stock awards is estimated on the date of grant based on the market price of the Company’s stock and is amortized to compensation expense on a straight-line basis over the related vesting periods. As of October 28, 2006, there was $4,364,000 of total unrecognized compensation cost related to nonvested restricted stock awards, which is expected to be recognized over a remaining weighted-average vesting period of 4.5 years. The total fair value of the shares recognized as compensation expense during the third quarter and nine months ended October 28, 2006 was $285,000 and $795,000, respectively.

The following summary shows the changes in the shares of restricted stock outstanding during the nine months ended October 28, 2006:

						Weighted Average
						Grant Date Fair
		Number of Shares				Value Per Share
Restricted stock awards at January 28, 2006			150,000			$	18.21
Granted			219,754				22.84
Vested			(150,000	)			18.21
Forfeited			(5,472	)			22.89
Restricted stock awards at October 28, 2006			214,282			$	22.84

NOTE 7 – RECENT ACCOUNTING PRONOUNCEMENTS:

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

THE CATO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE MONTHS AND NINE MONTHS ENDED OCTOBER 28, 2006 AND OCTOBER 29, 2005

NOTE 7 – RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED):

In June 2006, the FASB ratified the consensuses reached by the Emerging Issues Task Force in Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement (That is, Gross Versus Net Presentation).” Issue No. 06-3 requires disclosure of an entity’s accounting policy regarding the presentation of taxes assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer, including sales, use, value added and some excise taxes. We present such taxes on a net basis. The adoption of Issue No. 06-3, which is effective for interim and annual reporting periods beginning after December 15, 2006, will have no impact on the Company’s consolidated financial statements.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements” (SAB 108). SAB 108 addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. SAB 108 requires an entity to quantify misstatements using a balance sheet and income-statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. The adoption of SAB 108 is effective for fiscal years ending on or after November 15, 2006. The Company does not believe that the adoption of SAB108 will have a material impact to the financial statements.

In September 2006, FASB issued SFAS 157, “Fair Value Measurements”. SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosure of fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements and, accordingly, does not require any new fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the impact that the adoption of SFAS 157 will have on its financial statements.

THE CATO CORPORATION

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

FORWARD LOOKING INFORMATION:

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

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

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

CRITICAL ACCOUNTING POLICIES:

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

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

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

RESULTS OF OPERATIONS:

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

		Three Months Ended								Nine Months Ended
		October 28,				October 29,				October 28,				October 29,
		2006				2005				2006				2005
Total retail sales			100.0	%			100.0	%			100.0	%			100.0	%
Total revenues			101.7				102.0				101.5				101.9
Cost of goods sold			67.8				67.4				65.3				66.0
Selling, general and administrative			27.4				28.8				25.0				25.2
Depreciation			2.7				2.9				2.5				2.5
Interest expense			—				—				—				—
Interest and other income			(1.1	)			(0.7	)			(0.9	)			(0.5	)
Income before income taxes			4.9				3.6				9.6				8.7
Net income			3.1				2.3				3.5				5.5

Comparison of Third Quarter and First Nine Months of 2006 with 2005.

Total retail sales for the third quarter were $187.7 million compared to last year’s third quarter sales of $177.8 million, a 6% increase. Same-store sales were flat in the third quarter of fiscal 2006 compared to the third quarter of fiscal 2005. For the nine months ended October 28, 2006, total retail sales were $632.1 million compared to last year’s first nine months sales of $601.1 million, a 5% increase, and same-store sales were flat for the comparable nine 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 $190.9 million and $641.8 million for the third quarter and nine months ended October 28, 2006, respectively, compared to $181.4 million and $612.2 million for the third quarter and nine months ended October 29, 2005, respectively. The Company operated 1,270 stores at October 28, 2006 compared to 1,222 stores at the end of last year’s third quarter. For the first nine months of 2006 the Company opened 38 stores, relocated 15 stores and closed 12 stores. The Company plans to open approximately 60 stores and close approximately 20 stores during fiscal 2006.

Credit revenue of $2.7 million represented 1.4% of total revenues in the third quarter of 2006, compared to 2005 credit revenue of $3.1 million or 1.7% of total revenues. The reduction in credit revenue was due to lower finance charge and late fee income from lower sales under the Company’s proprietary credit card and improved collections compared to the prior year. Credit revenue is comprised of interest earned on the Company’s private label credit card portfolio and related fee income. Related expenses include principally bad debt expense, payroll, postage and other administrative expenses and totaled $1.5 million in the third quarter of 2006 compared to last year’s

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

RESULTS OF OPERATIONS – (CONTINUED):

third quarter expenses of $1.8 million. The decrease in costs was principally due to lower bad debt expense and payroll costs.

Other income in total, as included in total revenues was $3.2 million and $9.7 million for the third quarter and first nine months of fiscal 2006, compared to $3.6 million and $11.1 million for the prior year’s comparable three and nine months periods, respectively. The decrease resulted primarily from lower finance charges and late fee income.

Cost of goods sold was $127.2 million, or 67.8% of retail sales and $413.1 million or 65.3% of retail sales for the third quarter and first nine months of fiscal 2006, compared to $119.9 million, or 67.4% of retail sales and $396.7 million, or 66.0% of retail sales for the prior year’s comparable three and nine month periods, respectively. The overall increase in cost of goods sold as a percent of retail sales for the third quarter of fiscal 2006 resulted primarily from higher freight and occupancy costs, partially offset by lower procurement costs and lower markdowns. The overall decrease in cost of goods sold as a percent of retail sales for the first nine months of fiscal 2006 resulted primarily from lower procurement costs and lower markdowns. The reduction in procurement cost was primarily the result of increased direct sourcing and the reduction in markdowns was primarily due to improved inventory management and better sell-throughs of regular priced merchandise. Cost of goods sold includes merchandise costs, net of discounts and allowances, buying costs, distribution costs, occupancy costs, freight and inventory shrinkage. Net merchandise costs and in-bound freight are capitalized as inventory costs. Buying and distribution costs include payroll, payroll-related costs and operating expenses for the buying departments and distribution center. Occupancy expenses include rent, real estate taxes, insurance, common area maintenance, utilities and maintenance for stores and distribution facilities. Total gross margin dollars (retail sales less cost of goods sold) increased by 4.5% to $60.5 million and by 7.1% to $219.0 million for the third quarter and first nine months of fiscal 2006 compared to $57.9 million and $204.4 million for the prior year’s comparable three and nine month periods, respectively. Gross margin as presented may not be comparable to those of other entities.

Selling, general and administrative expenses (“SG&A”) primarily include corporate and store payroll, related payroll taxes and benefits, insurance, supplies, advertising, bank and credit card processing fees and bad debts. SG&A expenses were $51.5 million, or 27.4% of retail sales and $157.8 million, or 25.0% of retail sales for the third quarter and first nine months of fiscal 2006, compared to $51.2 million, or 28.8% of retail sales and $151.3 million, or 25.2% of retail sales for prior year’s comparable three and nine months periods, respectively. SG&A expenses as a percentage of retail sales decreased 140 basis points for the third quarter of fiscal 2006 as compared to the prior year and decreased 20 basis points for the first nine months of fiscal 2006, as compared to the prior year. The decline in SG&A expenses as a percentage of retail sales for the third quarter of fiscal 2006 was primarily attributable to a decrease in incentive based compensation expenses. The overall dollar increase in SG&A expenses for the third quarter of fiscal 2006 resulted primarily from increased worker’s compensation expenses and salary expense. For the first nine months of fiscal 2006, the

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

RESULTS OF OPERATIONS – (CONTINUED):

decrease in SG&A expenses as a percentage of retail sales resulted primarily from decreased incentive based compensation expenses and bad debt expense. The overall dollar increase in SG&A expenses for the first nine months of fiscal 2006 resulted primarily from increased salary expense.

Depreciation expense was $5.2 million, or 2.7% of retail sales and $15.6 million or 2.5% of retail sales, for the third quarter and first nine months of fiscal 2006, compared to $5.1 million, or 2.9% of retail sales and $15.2 million, or 2.5% of retail sales, for prior year’s comparable three and nine month periods, respectively.

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

Interest and other income was $2.1 million, or 1.1% of retail sales and $5.6 million, or 0.9% of retail sales for the third quarter and first nine months of fiscal 2006, compared to $1.2 million, or 0.7% of retail sales and to $3.2 million, or 0.5% of retail sales, for the prior year’s comparable three and nine month periods, respectively. The increase in the third quarter and first nine months of fiscal 2006 resulted primarily from higher interest rates and a refund settlement on third-party credit card fees of $0.5 million in the second quarter of fiscal 2006.

Income tax expense was $3.3 million, or 1.8% of retail sales and $22.2 million, or 3.5% of retail sales, for the third quarter and first nine months of fiscal 2006, compared to $2.3 million, or 1.3% of retail sales and $18.9 million, or 3.2% of retail sales, for the prior year’s comparable three and nine month periods. The third quarter increase resulted from higher pre-tax income. The effective income tax rate for the third quarter and first nine months of fiscal 2006 was 35.8% and 36.4% respectively, compared to 36.3% for the prior year’s comparable three and nine month periods.

As of the date of this Form 10-Q filing, the Company has submitted insurance claims for losses attributable to Hurricanes Katrina, Rita and Wilma incurred during the third quarter of fiscal 2005. The total amount of the proceeds, which are uncertain at this time, will be classified as a reduction of selling, general and administrative expenses upon receipt. The Company anticipates these claims will be resolved in the fourth quarter of fiscal 2006.

LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK:

The Company has consistently maintained a strong liquidity position. Cash provided by operating activities during the first nine months of fiscal 2006 was $34.5 million as compared to $40.1 million in the first nine months of fiscal 2005. These amounts enable the Company to fund its regular

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

LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK (CONTINUED):

operating needs, capital expenditure program, cash dividend payments and purchase of treasury stock. In addition, the Company maintains $35 million of unsecured revolving credit facilities for short-term financing of seasonal cash needs. There were no outstanding borrowings on these facilities at October 28, 2006.

Cash provided by operating activities for the first nine months of fiscal 2006 was primarily generated by earnings adjusted for depreciation and changes in working capital. The decrease of $5.6 million for the first nine months of fiscal 2006 as compared to the first nine months of fiscal 2005 was primarily due to higher payables reduction in fiscal 2006, partially offset by higher net income in fiscal 2006.

The Company believes that its cash, cash equivalents and short-term investments, together with cash flows from operations and borrowings available under its revolving credit agreement, will be adequate to fund the Company’s planned capital expenditures, dividends, purchase of treasury stock and other operating requirements for fiscal 2006 and for the foreseeable future beyond twelve months.

At October 28, 2006, the Company had working capital of $158.7 million compared to $133.0 million at October 29, 2005. Additionally, the Company had $1.9 million invested in privately managed investment funds at October 28, 2006, which are included in other assets on the Condensed Consolidated Balance Sheets.

At October 28, 2006, the Company had an unsecured revolving credit agreement, which provided for borrowings of up to $35 million. The revolving credit agreement is committed until August 2008. 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 October 28, 2006. There were no borrowings outstanding under these credit facilities during the first nine months ended October 28, 2006 or the fiscal year ended January 28, 2006.

On August 22, 2003, the Company entered into a new unsecured $30 million five-year term loan facility, the proceeds of which were used to purchase Class B Common Stock from the Company’s founders. Payments were due in monthly installments of $500,000 plus accrued interest. Interest was based on LIBOR. On April 5, 2005, the Company repaid the remaining balance of $20.5 million on this loan facility with no early prepayment penalty. With the early retirement of this loan, the Company had no outstanding debt as of October 28, 2006 and October 29, 2005.

At the October 28, 2006 and October 29, 2005, the Company had approximately $2.2 million and $1.5 million, respectively, of outstanding irrevocable letters of credit relating to purchase commitments.

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

LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK (CONTINUED):

Expenditures for property and equipment totaled $23.2 million in the first nine months of fiscal 2006, compared to $21.1 million in last year’s first nine months. The expenditures for the first nine months of 2006 were primarily for store development and investments in new technology. In fiscal 2006, the Company is planning to invest approximately $27.0 — $30.0 million for capital expenditures. This includes expenditures to open 60 new stores, relocate 20 stores and remodel 10 stores.

Net cash used in investing activities totaled $23.2 million in the first nine months of fiscal 2006 compared to $7.6 million provided for the comparable period of 2005. The increase was due primarily to the net increase in purchases over sales of short-term investments.

On May 25, 2006, the Board of Directors increased the quarterly dividend by 15% from $.13 per share to $.15 per share, or an annualized rate of $.60 per share.

The Company does not use derivative financial instruments. At October 28, 2006, the Company’s investment portfolio was primarily invested in governmental and other debt securities with maturities less than 36 months. These securities are classified as available-for-sale and are recorded on the balance sheet at fair value, with unrealized gains and temporary losses reported net of taxes as accumulated other comprehensive income. Other than temporary declines in fair value of investments are recorded as a reduction in the cost of investments in the accompanying Condensed Consolidated Balance Sheets.

THE CATO CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK:

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

ITEM 4. CONTROLS AND PROCEDURES:

We carried out an evaluation, with the participation of our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures as of October 28, 2006. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of October 28, 2006, our disclosure controls and procedures, as defined in Rule 13a-15(e), under the Securities Exchange Act of 1934 (the “Exchange Act”), were effective to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING:

No change in the Company’s internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) has occurred during the Company’s fiscal quarter ended October 28, 2006 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II OTHER INFORMATION

THE CATO CORPORATION

ITEM 1. LEGAL PROCEEDINGS

     Not Applicable

ITEM 1A. RISK FACTORS

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

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

     Not Applicable

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     Not Applicable

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

     Not Applicable

ITEM 5. OTHER INFORMATION

     Not Applicable

ITEM 6. EXHIBITS

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

PART II OTHER INFORMATION

THE CATO CORPORATION

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

				THE CATO CORPORATION
December 1, 2006   Date				/s/ John P. D. Cato   John P. D. Cato
				Chairman, President and
				Chief Executive Officer
December 1, 2006   Date				/s/ Robert M. Sandler   Robert M. Sandler
				Senior Vice President
				Controller
				principal financial officer