Cato Corporation
Annual Report 2003

Plain-text annual report

2003 a n n u a l r e p o r t C o m p a ny P r o f i l e Fi n a n c i a l H i g h l i g h t s The Cato Corporation is a leading specialty retailer of value-priced women’s fashion apparel operating two divisions, “Cato” and “It’s Fashion!”. The Company currently operates over 1,100 a p p a re l s p e c i a l t y s t o re s principally in the southeastern United States. Cato, the core division, pr imar ily of fer s exclusive merchandise with fashion and quality comparable to mall specialty stores at low prices, ever y day. Most Cato stores range from 4,000 to 6,000 square feet and are located primarily in strip shopping center s anchored by national discounter s or market dominant grocer y stores. It’s Fashion!, the off-price division, provides family fashion apparel and accessories with stores ranging from 3,000 to 4,000 square feet. The Company is headquartered in Charlotte, North Carolina. Fiscal Year 2003 2002 2001 2000 1999 (Dollars in thousands, except per share data) FOR THE YEAR ENDED Retail sales Total revenues Comparable store sales $731,770 $732,742 $685,653 $648,482 $585,085 747,267 748,331 699,321 662,537 598,240 increase (decrease) (7)% 0% 1% 3% 4% Income before income taxes 49,277 71,839 66,286 60,042 51,975 Net income 31,389 45,833 43,086 39,027 33,931 Net income as a percent of retail sales 4.3% 6.3% 6.3% 6.0% 5.8% Cash dividends paid per share Basic earnings per share Diluted earnings per share .63 1.36 1.33 .585 1.80 1.77 Number of stores 1,102 1,022 Number of stores opened Number of stores closed Net increase in number of stores 87 7 80 90 5 85 .53 1.71 1.66 937 85 7 78 .425 1.56 1.53 859 65 15 50 .28 1.28 1.26 809 83 6 77 AT YEAR END Cash, cash equivalents and investments $ 71,402 $106,936 $ 84,695 $ 83,112 $ 87,275 Working capital 112,908 162,609 139,633 125,724 124,988 Current ratio Total assets 2.0 2.7 2.7 2.4 2.5 351,573 383,410 332,041 310,742 285,789 Stockholders’ equity 194,111 270,164 234,698 207,757 188,780 A M e s s a ge t o O u r S h a re h o l d e r s In last year’s shareholder letter, my message was about Cato’s ability to consistently deliver growth, improve earnings, and increase value to you and our customers. At that time, Cato had begun to experience declining comp store sales. Unfortunately, that trend continued for the remainder of the year and created a challenging backdrop from which to grow earnings. The Company has faced ongoing retail pricing pressure and an economy in which many people remain unemployed. However, even in this difficult environment, Cato earned $31.4 million, a high rate of return on sales for our industry segment, and $1.33 per share. We remain committed to our sound strategies, which have served us well. We are focused on executing these strategies to deliver fashion, quality, and value to our customers, grow profitably, and increase long-term shareholder value. During 2003, we strengthened the Company’s foundation with a number of significant accomplishments. We invested $21 million in stores, systems, and infrastructure to support growth and further improve the efficiency of our business. We continued our store expansion program by opening 87 new stores in existing and new markets. We increased the capacity of the current distribution center to serve 2,000 stores. Our strong cash position enabled us to repurchase 20% of our outstanding shares at a favorable price and increase our quarterly dividend by 7% as we paid $14.5 million in dividends during the year. We have returned a portion of profits to shareholders through dividends for 12 consecutive years while our dividend has increased fourfold since 1997. In 2004, we will continue to invest in the future by undertaking several major initiatives. We are installing a state-of-the-art store register system that will reduce costs and provide internet capability to the stores. We have improved our store construction process to reduce the cost of new stores. We are implementing an in-house payroll and human resource system to provide better control and more efficient processing. Our merchandise processing and store allocation systems have been enhanced to enable us to better tailor size and color assortments by store. And we continue to invest in the fashion content, quality, fit, and construction of our merchandise to provide exceptional value to our customers. We expect difficult economic conditions to continue in many of our markets as our customers face employment concerns and rising costs including gas, food and healthcare. The initiatives undertaken to lower operating costs and the investments made in infrastructure and technology will help Cato maintain profitability in difficult economic times and deliver increased earnings in good economic times. We will continue to refine and strengthen our business for the long term. We remain committed to our long-term goal of growing both earnings and dividends at an annual rate of 10% while delivering fashion and value to our customers and value to you as shareholders. John P. Derham Cato Chairman, President and Chief Executive Officer Mr. Wayland H. Cato, Jr., a Company co-founder and former Chief Executive Officer, retired as Chairman of the Board in January 2004 and has been named Chairman Emeritus. Mr. Cato has served on the Board since 1946, held the position of Chief Executive Officer from 1960 to 1999, and has served as Chairman since 1970. Mr. Edgar T. Cato retired from the Board of Directors in January 2004. Mr. Cato is a co-founder of the Company and former Vice Chairman of the Board and has served on the Board since 1946. He has been named Vice Chairman Emeritus. The Board of Directors and the entire Cato organization express our appreciation for their years of service and contributions to the growth of our Company. They have left a legacy that we are proud to continue. Page 1 C o m m i t m e n t t o Va l u e Cato has developed a strong niche in the women’s apparel segment by providing high quality fashion apparel at an exceptional value. We continue to strengthen our market positioning by further improving the quality of merchandise and finding more ways to provide value to our customers. We continue to invest in our merchandising area. The enterprise-wide merchandise system implemented in 2002 is providing better information to our merchandise organization. As we tailor our store allocations by size and color, we will improve our ability to have the right merchandise in the right store for our customers. Our product development function continues to improve the quality of our merchandise by reviewing over 12,000 styles each year to ensure they meet our strict guidelines of construction, color, and fit. Also, we continue to identify more styles that can be directly sourced at better margins. Page 2 C o m m i t m e n t t o G r o w t h In 2003, we opened 87 new stores, relocated 28 stores, and remodeled 15 stores. We entered two new states and now operate in 28 states. Over the last 7 years, we have added 517 new stores, relocated 166 stores and remodeled 292 stores, all funded through cash generated by operations. We assess our store base every year and close stores that do not meet our standards. In 2003, we closed 7 stores and have closed 70 stores over the last 7 years. In 2004, we will continue to open stores in our core geography as well as in new markets in the Northeast, Midwest and West. Our strong financial position enables us to continue our store expansion with 90 new stores planned in 2004. s t o r e g r o w t h number of stores (at year end) 2 0 1 1 2 2 0 1 7 3 9 9 5 8 9 0 8 2 3 7 3 9 6 97 98 99 00 01 02 03 Page 3 M A NAG E M E N T E X E C U T I V E G RO U P B OA R D O F D I R E C TO R S John P. Derham Cato Chairman, President and Chief Executive Officer Michael O. Moore Executive Vice President, Chief Financial Officer and Secretary John P. Derham Cato Chairman, President and Chief Executive Officer Michael O. Moore Executive Vice President, Chief Financial Officer and Secretary B. Allen Weinstein Thomas E. Cato Executive Vice President, Chief Merchandising Officer Vice President, Divisional Merchandise Manager of the Cato Division C. David Birdwell Executive Vice President, President and General Manager of the It’s Fashion! Division Howard A. Severson Executive Vice President, Chief Real Estate and Store Development Officer Michael T. Greer Senior Vice President, Director of Stores of the Cato Division Robert C. Brummer Senior Vice President, Human Resources Robert W. Bradshaw, Jr. 1,3 Of Counsel—Robinson, Bradshaw & Hinson, P.A. George S. Currin 1,2 Chairman and Managing Director of The Fourth Stockton Company LLC and Chairman Currin-Patterson Properties LLC Grant L. Hamrick 3 Retired Senior Vice President, Chief Financial Officer American City Business Journals James H. Shaw 1,2 Retired Chairman and Chief Executive Officer Ivey’s Department Stores A. F. (Pete) Sloan2,3 Retired Chairman and Chief Executive Officer Lance, Inc. 1 Member of the Corporate Governance and Nominating Committee 2 Member of the Compensation Committee 3 Member of the Audit Committee Page 4 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K ¥ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Ñscal year ended January 31, 2004 or n TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 1-31340 The Cato Corporation Registrant Delaware State of Incorporation 8100 Denmark Road Charlotte, North Carolina 28273-5975 Address of Principal Executive OÇces 56-0484485 I.R.S. Employer IdentiÑcation Number 704/554-8510 Registrant's Telephone Number Securities registered pursuant to Section 12(b) of the Act: Class A Common Stock Preferred Share Purchase Rights Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the Registrant (1) has Ñled all reports required to be Ñled 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 Ñle such reports), and (2) has been subject to such Ñling requirements for the past 90 days. Yes ¥ No n Indicate by check mark, if disclosure of delinquent Ñlers 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 deÑnitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes ¥ No n Indicate by check mark whether the registrant is an accelerated Ñler (as deÑned in Rule 12b-2 of the Act). Yes ¥ No n The aggregate market value of the Registrant's Class A Common Stock held by Non-aÇliates of the Registrant as of August 1, 2003, the last business day of the Company's most recent second quarter, was $450,939,578 based on the last reported sale price per share on the New York Stock Exchange (NYSE) on that date. As of March 29, 2004, there were 20,130,848 shares of Class A Common Stock and 470,350 shares of Convertible Class B Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the proxy statement relating to the 2004 annual meeting of shareholders are incorporated by reference into the following part of this annual report: Part III Ì Items 10, 11, 12, 13 and 14 THE CATO CORPORATION FORM 10-K TABLE OF CONTENTS PART I Business ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 1. Properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 2. Legal Proceedings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 3. Item 4. Submission of Matters to a Vote of Security HoldersÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 4A. Executive OÇcers of the Registrant ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Selected Financial Data ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 6. Item 7. Management's Discussion and Analysis of Financial Condition and Results PART II Page 3 Ó 7 7 7 7 7 Ó 8 9 10 Item 7A. Quantitative and Qualitative Disclosures about Market RiskÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 8. Item 9. of Operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11 Ó 17 17 Financial Statements and Supplementary Data ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18 Ó 40 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 9A. Controls and Procedures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 41 41 PART III Item 10. Directors and Executive OÇcers of the Registrant ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 41 Ó 42 42 Item 11. Executive CompensationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 12. Security Ownership of Certain BeneÑcial Owners and Management and Related Stockholder Matters ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 13. Certain Relationships and Related Transactions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Principal Accountant Fees and Services ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 14. 42 43 43 PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 43 Ó 52 1 The following discussion and analysis should be read along with the Consolidated Financial Statements, including the accompanying Notes appearing later in this report. 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 Annual Report on Form 10-K that reÖect projections or expectations of our future Ñnancial 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 ""Business'', ""Properties'', ""Legal Proceedings'', ""Controls and Procedures'' and ""Management's Discussion and Analysis of Financial Condition and Results of Operations''; (4) statements relating to our operations or activities for 2004 and beyond; and (5) statements relating to our future contingencies. Words such as ""expects'', ""anticipates'', ""approximates'', ""believes'', ""estimates'', ""hopes'', ""intends'', ""may'', ""plans'', ""should'' and variations of such words and similar expressions are intended to identify such forward-looking statements. No assurance can be given that actual results or events will not diÅer materially from those projected, estimated, assumed or anticipated in any such forward-looking statements. Forward-looking statements included in this report are based on information available to us as of the Ñling date of this report, and we assume no obligation to update any such forward-looking information contained in this report. 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 Ñled or furnished pursuant to Section 13(a) or 15(d) under the Securities Exchange Act. These reports are available as soon as reasonably practicable after we electronically Ñle 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 (""NYSE'') regulations. The documents are also available in print to any shareholder who requests by contacting our corporate secretary at our company oÇces. 2 Item 1. Business: General PART I The Company, founded in 1946, operated 1,102 women's fashion specialty stores at January 31, 2004, under the names ""Cato,'' ""Cato Fashions,'' ""Cato Plus'' and ""It's Fashion!'' in 28 states, principally in the southeastern United States. The Company oÅers quality fashion apparel and accessories at low prices, everyday in junior/missy and plus sizes. Additionally, the Company oÅers clothing for girls ages 7 Ó 16 in selected locations. The Company's stores feature a broad assortment of apparel and accessories, including casual and dressy sportswear, dresses, careerwear, coats, shoes, costume jewelry and handbags. A major portion of the Company's merchandise is sold under its private labels and is produced by various vendors in accordance with the Company's strict speciÑcations. Most stores range in size from 4,000 to 6,000 square feet and are located primarily in strip shopping centers anchored by national discounters or market-dominant grocery stores. The Company emphasizes friendly customer service and coordinated merchandise presenta- tions in an appealing store environment. The Company oÅers its own credit card and layaway plan. Credit and layaway sales represented 15% of retail sales in Ñscal 2003. See Note 14 to the Consolidated Financial Statements, ""Reportable Segment Information'' for a discussion of segment information. Business The Company's primary objective is to be the leading fashion 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 diÅerentiate 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 oÅer a wide assortment of apparel and accessory items in regular and plus sizes and emphasize color, product coordination and selection. Value Pricing. The Company oÅers quality merchandise that is generally priced below comparable merchandise oÅered by department stores and mall specialty apparel chains, but is generally more fashionable than merchandise oÅered by discount stores. Management believes that the Company has positioned itself as the everyday low price leader in its market segment. Strip Shopping Center Locations. The Company locates its stores principally in convenient strip centers anchored by national discounters or market-dominant grocery stores 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 oÅers its own credit card and a layaway plan to make the purchase of its merchandise more convenient. Expansion. The Company plans to continue to expand into northern, midwestern and western adjacent states, as well as continuing to ""Ñll-in'' existing southeastern core geography. Merchandising Merchandising The Company oÅers a broad selection of high quality and exceptional value apparel and accessories to suit the various lifestyles of the fashion conscious low-to-middle income female, ages 18 to 50. In addition, the Company oÅers on-trend fashion in exciting colors with consistent Ñt and quality. The Company's merchandise lines include dressy, career, and casual sportswear, dresses, coats, shoes, lingerie, costume jewelry and handbags. Apparel for girls ages 7 Ó 16 is oÅered in selected stores. The 3 Company primarily oÅers exclusive merchandise with fashion and quality comparable to mall specialty stores at low prices, every day. The collaboration of the merchandising team with an expanded in-house product development and direct sourcing function has enhanced merchandise oÅerings delivering quality exclusive products at lower costs. The product development and direct sourcing operations provide research on emerging fashion and color trends, technical services and direct sourcing options. As a part of its merchandising strategy, members of the Company's merchandising staÅ frequently visit selected stores, monitor the merchandise oÅerings of other retailers, regularly communicate with store operations associates 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 Ñscal 2003, purchases from the Company's largest vendor accounted for approximately 7% of the Company's total purchases. No other vendor accounted for more than 3% 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 eÅect on the Company's operating results or Ñnancial 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 strict speciÑcations. 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 signiÑcant 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 eÅect 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 sales trends by merchandise category, customer proÑles and climatic conditions. A merchandise control system provides current information on the sales activity of each merchandise style in each of the Company's stores. Point-of-sale terminals in the stores collect and transmit sales and inventory information to the Company's central database, 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 then allocated by the merchandise distribution staÅ for shipment to individual stores. The Öow of merchandise from receipt at the distribution center to shipment to stores is controlled by an on-line system. Shipments are made by common carrier, and each store receives at least one shipment per week. Advertising The Company uses radio, graphics and a website as its primary advertising media. The Company uses radio advertising in selected trade areas. The Company's total advertising expenditures were approximately .8% of retail sales in Ñscal 2003. Store Operations The Company's store operations management team consists of 2 directors of stores, 3 territorial managers, 16 regional managers and 111 district managers. Regional managers receive a salary plus a bonus based on achieving targeted goals for sales, payroll, shrinkage control and store proÑtability. District managers receive a salary plus a bonus based on achieving targeted objectives for district sales increases and shrinkage control. Stores are staÅed with a manager, two assistant managers and additional part-time sales associates 4 depending on the size of the store and seasonal personnel needs. Store managers receive a salary and all other store personnel are paid on an hourly basis. Store managers, assistant managers and sales associates are eligible for monthly and semi-annual bonuses based on achieving targeted goals for their store's sales increases and shrinkage control. The Company is constantly improving its training programs to develop associates. Nearly 80% of store and Ñeld management are promoted from within, allowing the Company to internally staÅ an expanding store base. The Company has training programs at each level of store operations. New store managers are trained in training stores managed by experienced associates 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 district 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 corporate oÇce. Store Locations Most of the Company's stores are located in the southeastern United States in a variety of markets ranging from small towns to large metropolitan areas with trade area populations of 20,000 or more. Stores range in size from 4,000 to 6,000 square feet and average approximately 4,000 square feet. All of the Company's stores are leased. Approximately 93% are located in strip shopping centers and 7% in enclosed shopping malls. The Company locates stores in strip shopping centers anchored by a national discounter, primarily Wal-Mart Supercenters, or market-dominant grocery 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 in new and existing markets, and relocating selected 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 since Ñscal 1999. Fiscal Year Store Development Number of Stores Beginning of Year Number Opened Number Closed Number of Stores End of Year 1999 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 732 809 859 937 1,022 83 65 85 90 87 6 15 7 5 7 809 859 937 1,022 1,102 In Fiscal 2003 the Company relocated 28 stores, downsized one store and remodeled 15 stores. In Fiscal 2004 the Company plans to open approximately 90 new stores, relocate 27 stores, close 10 stores, and remodel 15 stores. The Company periodically reviews its store base to determine whether any particular store should be closed based on its sales trends and proÑtability. The Company intends to continue this review process to close underperforming stores. The seven closed in 2003 were not material to the Company's results of operations. Credit and Layaway Credit Card Program The Company oÅers its own credit card, which accounted for approximately 10% of retail sales in Ñscal 2003. The Company's net bad debt expense in Ñscal 2003 was 7.8% of credit sales. Customers applying for the Company's credit card are approved for credit if they have a satisfactory credit record and meet minimum income criteria. Customers are required to make minimum monthly 5 payments based on their account balances. If the balance is not paid in full each month, the Company assesses the customer a Ñnance charge. If payments are not received on time, the customer is assessed a late fee. 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 four weeks, the customer is considered to have defaulted, and the merchandise is returned to the selling Öoor and again oÅered 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. The Company defers recognition of layaway sales and its related fees to the accounting period when the customer picks up layaway merchandise. Layaway sales represented approximately 5% of retail sales in Ñscal 2003, 2002 and 2001. Management Information Systems The Company's systems provide daily Ñnancial and merchandising information that is used by manage- ment to enhance the timeliness and eÅectiveness of purchasing and pricing decisions. Management uses a daily report comparing actual sales with planned sales and a weekly ranking report to monitor and control purchasing decisions. Weekly reports are also produced which reÖect 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 modiÑed 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 stock keeping unit (SKU). Merchandise allocation models are used to distribute merchandise to individual stores based upon historical sales trends, climatic diÅerences, customer demo- graphic diÅerences 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 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. Regulation A variety of laws aÅect the revolving credit program oÅered 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 Ñnancing, including the amount of the annual percentage rate and the Ñnance 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 speciÑed 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 that regulates the manner in which the Company collects payments on revolving credit accounts. Additionally, the Gramm-Leach-Bliley Act requires the Company to disclose, initially and annually, to its customers, the Company's privacy policy as it relates to a customer's non-public personal information. 6 Associates As of January 31, 2004, the Company employed approximately 9,100 full-time and part-time associates. The Company also employs additional part-time associates during the peak retailing seasons. The Company is not a party to any collective bargaining agreements and considers that its associate relations are good. Item 2. Properties: The Company's distribution center and general oÇces 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 oÇces and corporate training center are located in the remaining 74,000 square feet. A building of approximately 24,000 square feet located on a 2-acre tract adjacent to the Company's existing location is used for receiving and staging shipments prior to processing. Substantially all of the Company's retail stores are leased from unaÇliated parties. Most of the leases have an initial term of Ñve years, with two to three Ñve-year renewal options. Substantially all of the leases provide for Ñxed rentals plus a percentage of sales in excess of a speciÑed volume. Item 3. Legal Proceedings: There are no material pending legal proceedings to which the Company and its subsidiaries is a party, or to which any of the Company's property is subject. Item 4. Submission of Matters to a Vote of Security Holders: None. Item 4A. Executive OÇcers of the Registrant: The executive oÇcers of the Company and their ages as of March 31, 2004 are as follows: Name Age Position John P. Derham Cato ÏÏÏÏÏÏ 53 Michael O. Moore ÏÏÏÏÏÏÏÏÏ 53 B. Allen WeinsteinÏÏÏÏÏÏÏÏÏ 57 C. David Birdwell ÏÏÏÏÏÏÏÏÏ 64 Howard A. Severson ÏÏÏÏÏÏÏ 56 Michael T. Greer ÏÏÏÏÏÏÏÏÏÏ 41 Robert C. BrummerÏÏÏÏÏÏÏÏ 59 Chairman, President and Chief Executive OÇcer Executive Vice President, Chief Financial OÇcer and Secretary Executive Vice President, Chief Merchandising OÇcer of the Cato Division Executive Vice President, President and General Manager of the It's Fashion! Division Executive Vice President, Chief Real Estate and Store Development OÇcer Senior Vice President, Director of Stores of the Cato Division Senior Vice President, Human Resources John P. Derham Cato has been employed as an oÇcer of the Company since 1981 and has been a director of the Company since 1986. Since January 2004, he has served as Chairman, President and Chief Executive OÇcer. From May 1999 to January 2004, he served as President, Vice Chairman of the Board and Chief Executive OÇcer. From June 1997 to May 1999, he served as President, Vice Chairman of the Board and Chief Operating OÇcer. From August 1996 to June 1997, he served as Vice Chairman of the Board and Chief Operating OÇcer. From 1989 to 1996, he managed the Company's oÅ-price division, serving as Executive Vice President and as President and General Manager of the It's Fashion! Division from 1993 to August 1996. Mr. John Cato is currently a director of Ruddick Corporation. 7 Michael O. Moore has been employed by the Company as Executive Vice President, Chief Financial OÇcer and Secretary since July 1998 and has been a director of the Company since 2002. Mr. Moore served as Vice President, Chief Financial OÇcer for Party Experience from 1997 to 1998, Executive Vice President, Chief Financial OÇcer of David's Bridal from 1994 to 1997, and was employed by Bloomingdales from 1984 to 1994 serving as Senior Vice President, Chief Financial OÇcer from 1990 to 1994. B. Allen Weinstein joined the Company as Executive Vice President, Chief Merchandising OÇcer of the Cato Division in August 1997. From 1995 to 1997, he was Senior Vice President Ì Merchandising of Catherines Stores Corporation. From 1981 to 1995, he served as Senior Vice President of Merchandising for Beall's, Inc. C. David Birdwell joined the Company as Executive Vice President, President and General Manager of the It's Fashion! Division in October 1996. From 1994 to 1996, he was employed as President/General Merchandise Manager of Allied Stores, a family apparel chain headquartered in Savannah, Georgia. In 1993, he was Executive Vice President/General Merchandise Manager of Ambers, Inc., based in Dallas, Texas. From 1989 to 1992, he was employed as a Chartered Financial Consultant with JeÅerson Pilot, based in Greensboro, North Carolina. From 1985 to 1989, he was President/CEO of Maxway Stores, a discount chain headquartered in Sanford, North Carolina. Howard A. Severson has been employed by the Company since 1985. Since January 1993, he has served as Executive Vice President, Chief Real Estate and Store Development OÇcer and Assistant Secretary. From 1993 to 2001 Mr. Severson also served as a director. From August 1989 through January 1993, Mr. Severson served as Senior Vice President Ì Chief Real Estate OÇcer. Michael T. Greer has been employed by the Company since 1985. Since February 2004, he has served as Senior Vice President, Director of Stores of the Cato Division. From 2002 to 2003 Mr. Greer served as Vice President, Director of Stores of the It's Fashion! Division. From 1999 to 2001 he served as Territorial Vice President of Stores of the Cato Division and from 1996 to 1999 he served as Regional Vice President of Stores of the Cato Division. From 1985 to 1995, Mr. Greer held various store operational positions in the Cato Division. Robert C. Brummer joined the Company as Senior Vice President, Human Resources and Assistant Secretary in January 2001. From 1999 through 2000, he was employed by Sleepy's, a beddings specialty retailer as Vice President, Human Resources and Payroll. From 1997 through 1998, he was Vice President, Human Resources and Loss Prevention for The Party Experience, a party supplies specialty retailer. From 1995 until 1997, he was Vice President, Human Resources and Loss Prevention for No Body Beats The Wiz, an electronics specialty store chain. 8 PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities: Market & Dividend Information The Company's Class A Common Stock trades on the New York Stock Exchange (NYSE) under the symbol CTR. Below is the market range and dividend information for the four quarters of Ñscal 2003 and 2002. 2003 Price High Low Dividend First quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Second quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Third quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fourth quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $20.50 24.10 25.11 21.57 $16.28 18.20 19.95 18.84 $.15 .16 .16 .16 2002 Price High Low Dividend First quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Second quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Third quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fourth quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $27.21 27.44 19.95 21.80 $19.91 18.00 14.18 17.33 $.135 .15 .15 .15 As of March 29, 2004 the approximate number of record holders of the Company's Class A Common Stock was 1,227 and there were 4 record holders of the Company's Class B Common Stock. 9 Item 6. Selected Financial Data: Certain selected Ñnancial data for the Ñve Ñscal years ended January 31, 2004 have been derived from audited Ñnancial statements. The Ñnancial statements for the Ñscal year ended January 31, 2004 were audited by PricewaterhouseCoopers, LLP. The Ñnancial statements for each of the four Ñscal years ended February 1, 2003 were audited by Deloitte & Touche LLP. The Ñnancial statements and independent auditors' reports for the three most recent Ñscal years are contained elsewhere in this report. All data set forth below are qualiÑed by reference to, and should be read in conjunction with, the Company's Consolidated Financial Statements (including the Notes thereto) and ""Management's Discussion and Analysis of Financial Condition and Results of Operations'' appearing elsewhere in this annual report. Fiscal Year 2003 2002 2001 2000 1999 (Dollars in thousands, except per share data and selected operating data) STATEMENT OF OPERATIONS DATA: Retail salesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $731,770 15,497 Other incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 747,267 Total revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 508,401 Cost of goods soldÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gross margin ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 223,369 Gross margin percent ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Selling, general and administrative ÏÏÏÏÏÏÏÏÏÏÏÏ Selling, general and administrative percent of 174,202 30.5% retail sales ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ DepreciationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before income taxes and cumulative eÅect of accounting change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before cumulative eÅect of accounting 23.8% 18,695 (3,308) 49,277 17,888 $732,742 15,589 748,331 496,345 236,397 $685,653 13,668 699,321 466,366 219,287 $648,482 14,055 662,537 445,407 203,075 $585,085 13,155 598,240 403,655 181,430 32.3% 32.0% 31.3% 31.0% 168,914 162,082 154,150 140,741 23.1% 23.6% 14,913 (3,680) 10,886 (6,299) 23.8% 9,492 (6,554) 24.0% 8,639 (6,770) 71,839 26,006 66,286 23,200 60,042 21,015 51,975 18,191 change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 31,389 45,833 43,086 39,027 33,784 Cumulative eÅect of accounting change, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 31,389 1.36 Basic earnings per shareÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1.33 Diluted earnings per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ .63 Cash dividends paid per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Ì $ 45,833 1.80 $ 1.77 $ .585 $ Ì $ 43,086 1.71 $ 1.66 $ .53 $ Ì $ 39,027 1.56 $ 1.53 $ .425 $ 147 $ 33,931 1.28 $ 1.26 $ .28 $ SELECTED OPERATING DATA: Stores open at end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,102 Average sales per store(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $692,000 171 Average sales per square foot of selling space ÏÏÏ $ (7)% Comparable store sales increase (decrease) ÏÏÏÏ 1,022 $753,000 184 $ 937 $767,000 186 $ 859 $781,000 187 $ 809 $756,000 177 $ 0% 1% 3% 4% BALANCE SHEET DATA: Cash, cash equivalents and short-term investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 71,402 112,908 351,573 194,111 Working capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $106,936 162,609 383,410 270,164 $ 84,695 139,633 332,041 234,698 $ 83,112 125,724 310,742 207,757 $ 87,275 124,988 285,789 188,780 (1) Calculated using an estimated annual sales volume for new stores. 10 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations: Results of Operations The table below sets forth certain Ñnancial data of the Company expressed as a percentage of retail sales for the years indicated: Fiscal Year Ended January 31, 2004 February 1, 2003 February 2, 2002 Retail sales ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cost of goods soldÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Selling, general and administrative ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Depreciation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100.0% 2.1 102.1 69.5 23.8 2.6 (0.5) 6.7 4.3% 100.0% 2.1 102.1 67.7 23.1 2.0 (0.5) 9.8 6.3% 100.0% 2.0 102.0 68.0 23.6 1.6 (0.9) 9.7 6.3% Fiscal 2003 Compared to Fiscal 2002 Retail sales were essentially Öat to last year at $731.8 million in Ñscal 2003 compared to $732.7 million in Ñscal 2002. Total revenues, comprised of retail sales and other income (principally Ñnance charges and late fees on customer accounts receivable and layaway fees), were also Öat to last year at $747.3 million in Ñscal 2003 compared to $748.3 million in Ñscal 2002. The Company operated 1,102 stores at January 31, 2004 compared to 1,022 stores operated at February 1, 2003. The Öat retail sales in Ñscal 2003 were attributable to the soft economy. In Ñscal 2003, the Company opened 87 new stores, relocated 28 stores, remodeled 15 stores and closed 7 stores. Credit revenue of $14.5 million, represented 1.9% of total revenue in Ñscal 2003. This is comparable to 2002 credit revenue of $14.0 million or 1.9% of total revenue. 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 $9.7 million in Ñscal 2003 compared to $8.5 million in Ñscal 2002. The increase in costs was principally due to higher bad debt expense in Ñscal 2003. See Note 14 of the Consolidated Financial Statements for a schedule of credit related expenses. Total credit income before taxes decreased $0.8 million from $5.5 million in 2002 to $4.7 million in 2003 due to the increased costs partially oÅset by increased credit revenue. Total credit income in 2003 represented 9.6% of income before taxes of $49.3 million Other income in total, as included in total revenues in Ñscal 2003, decreased slightly to $15.5 million from $15.6 million in Ñscal 2002. The decrease resulted primarily from a decline in layaway fees. Cost of goods sold was $508.4 million, or 69.5% of retail sales, in Ñscal 2003 compared to $496.3 million, or 67.7% of retail sales, in Ñscal 2002. The increase in cost of goods sold as a percent of retail sales resulted primarily from lower than planned sales and additional markdowns to bring inventory in line with sales trends. 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. Pursuant to Emerging Task Force Issue No. 02-16, as described in ""Recent Accounting Pronouncements'' below, certain vendor allowances have been classiÑed in cost of goods sold totaling $1.2 million in Ñscal 2003, previously recorded as a reduction in selling, general and administrative expenses. Total gross margin dollars (retail sales less cost of goods sold) decreased by 6% to $223.4 million in Ñscal 2003 from $236.4 million in Ñscal 2002. Gross margin as presented may not be comparable to those of other entities as they may include 11 internal transfer costs in selling, general and administrative expenses while the Company classiÑes them as cost of goods sold. Selling, general and administrative expenses (SG&A) primarily include corporate and store payroll, related payroll taxes and beneÑts, insurance, supplies, advertising, bank and credit card processing fees and bad debts and were $174.2 million in Ñscal 2003 compared to $168.9 million in Ñscal 2002, an increase of 3%. As a percent of retail sales, SG&A was 23.8% compared to 23.1% in the prior year. The overall increase in SG&A resulted primarily from increased selling-related expenses and increased infrastructure expenses attributable to the Company's store development activities. Depreciation expense was $18.7 million in Ñscal 2003 compared to $14.9 million in Ñscal 2002. The 25% increase in Ñscal 2003 resulted primarily from the Company's store development and the enterprise-wide information system which was implemented in August 2002. Interest and other income, net was $3.3 million in Ñscal 2003 compared to $3.7 million in Ñscal 2002. The 11% decrease in Ñscal 2003 resulted primarily from the Company's lower cash and short-term investment position following the repurchase of $98.3 million of Company stock in Ñscal 2003. Income tax expense was $17.9 million, or 2.4% of retail sales in Ñscal 2003 compared to $26.0, or 3.5% of retail sales in Ñscal 2002. The decrease resulted from lower pre-tax income. The eÅective tax rate was 36.3% in Ñscal 2003 compared to 36.2% in Ñscal 2002. The Company expects the eÅective rate in 2004 to be in the range of 35% to 37%. Fiscal 2002 Compared to Fiscal 2001 Retail sales increased by 7% to $732.7 million in Ñscal 2002 from $685.7 million in Ñscal 2001. Total revenues increased by 7% to $748.3 million in Ñscal 2002 from $699.3 million in Ñscal 2001. The Company operated 1,022 stores at February 1, 2003 compared to 937 stores operated at February 2, 2002. The increase in retail sales in Ñscal 2002 resulted from the Company's continuation of an everyday low pricing strategy, improved merchandise oÅerings, and an increase in store development activity. In Ñscal 2002, the Company increased its number of stores 9% by opening 90 new stores, relocating 26 stores, remodeling 24 stores and closing 5 stores. Credit revenues increased $0.8 million from $13.2 million in 2001 to $14.0 million in 2002 mainly due to increased credit sales volume. Credit revenues represented 1.9% of total revenues in both 2002 and 2001. Related expenses totaled $8.5 million in 2002 compared to $9.7 million in 2001 principally due to lower bad debt expenses in 2002. Total credit income before taxes increased $2.0 million from $3.5 million in 2001 to $5.5 million in 2002 as a result of the increase in credit revenues and reduction in costs described above. Total credit income in 2002 represents 7.6% of income before taxes of $71.8 million. Other income in total, as included in total revenues in Ñscal 2002, increased $1.9 million or 14% over Ñscal 2001. The increase resulted primarily from increased Ñnance and layaway charges. Cost of goods sold was $496.3 million, or 67.7% of retail sales, in Ñscal 2002 compared to $466.4 million, or 68.0% of retail sales, in Ñscal 2001. The decrease in cost of goods sold as a percent of retail sales resulted primarily from maintaining timely and aggressive markdowns on slow moving merchandise and improving inventory Öow and sourcing. Total gross margin dollars increased by 8% to $236.4 million in Ñscal 2002 from $219.3 million in Ñscal 2001. SG&A expenses were $168.9 million in Ñscal 2002 compared to $162.1 million in Ñscal 2001, an increase of 4%. As a percent of retail sales, SG&A was 23.1% compared to 23.6% in the prior year. The overall increase in SG&A resulted primarily from increased selling-related expenses and increased infrastructure expenses attributable to the Company's store development activities. Depreciation expense was $14.9 million in Ñscal 2002 compared to $10.9 million in Ñscal 2001. The 37% increase in Ñscal 2002 resulted primarily from the Company's store development and the implementation of an enterprise-wide information system. 12 Interest and other income, net was $3.7 million in Ñscal 2002 compared to $6.3 million in Ñscal 2001. The 41% decrease in Ñscal 2002 resulted primarily from the Company's write-down of a $1.8 million decline in market value on investments deemed to be other than temporary. Income tax expense was $26.0 million, or 3.5% of retail sales in Ñscal 2002 compared to $23.2 million, or 3.4% of retail sales in Ñscal 2001. The increase resulted from higher pre-tax income. OÅ Balance Sheet Arrangements The Company is not a party to any oÅ-balance sheet arrangements that have, or are reasonably likely to have, a current or future material eÅect on the Company's Ñnancial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources. Critical Accounting Policies The Company's accounting policies are more fully described in Note 1 to the Consolidated Financial Statements. As disclosed in Note 1 of Notes to Consolidated Financial Statements, the preparation of the Company's Ñnancial statements in conformity with generally accepted accounting principles requires manage- ment to make estimates and assumptions about future events that aÅect the amounts reported in the Ñnancial statements and accompanying notes. Future events and their eÅects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will diÅer from those estimates, and such diÅerences may be material to the Ñnancial statements. The most signiÑcant accounting estimates inherent in the preparation of the Company's Ñnancial statements include the allowance for doubtful accounts receivable, reserves relating to workers' compensation, general and auto insurance liabilities, reserves for inventory markdowns, calculation of asset impairment, shrink accrual and tax contingency reserves. The Company's critical accounting estimates are discussed with the Audit Committee. Allowance for Doubtful Accounts The Company evaluates the collectibility of accounts receivable and records an allowance for doubtful accounts based on estimates of actual write-oÅs and the accounts receivable aging roll rates over the prior Ñve months. The allowance is reviewed for adequacy and adjusted, as necessary, on a monthly basis. The Company also provides for estimated uncollectible late fees charged based on historical write-oÅs. The Company's Ñnancial results can be signiÑcantly impacted by changes in bad debt write-oÅ experience and the aging of the accounts receivable portfolio. Insurance Liabilities The Company is primarily self-insured for health care, property loss, workers' compensation and general liability costs. These costs are signiÑcant primarily due to the large number of the Company's retail locations and employees. The Company's self-insurance liabilities are based on the total estimated costs of claims Ñled and estimates of claims incurred but not reported, less amounts paid against such claims, and are not discounted. Management reviews current and historical claims data in developing its estimates. The Company also uses information provided by outside actuaries with respect to workers' compensation and general liability claims. If the underlying facts and circumstances of the claims change or the historical experience upon which insurance provisions are recorded is not indicative of future trends, then the Company may be required to adjust the provision for insurance costs which could be material to the Company's reported Ñnancial condition and results of operations. Historically, actual results have not signiÑcantly deviated from estimates. Revenue Recognition While the Company's recognition of revenue is predominantly derived from routine retail transactions and does not involve signiÑcant judgement, revenue recognition represents an important accounting policy of the Company. As discussed in Note 1 to the Consolidated Financial Statements, the Company recognizes 13 sales at the point of purchase when the customer takes possession of the merchandise and pays for the purchase, generally with cash or credit. Sales from purchases made with Cato credit, gift cards and layaway sales are also recorded when the customer takes possession of the merchandise. Gift cards, layaway deposits and merchandise credits granted to customers are recorded as deferred revenue until they are redeemed or forfeited. A provision is made for estimated product returns based on sales volumes and the Company's experience; actual returns have not varied materially from amounts provided historically. Credit revenue on the Company's private label credit card portfolio is recognized as earned under the interest method. Late fees are recognized as earned, less provisions for estimated uncollectible fees. Impairment of Long-Lived Assets The Company primarily invests in property and equipment in connection with the opening and remodeling of stores and in computer software and hardware. Most of the Company's store leases give the Company the option to terminate the lease if certain speciÑed sales volumes are not achieved during the Ñrst few years of the lease. The Company periodically reviews its store locations and estimates the recoverability of its assets, recording an impairment charge, if necessary, when the Company decides to close the store or otherwise determines that future undiscounted cash Öows associated with those assets will not be suÇcient to recover the carrying value. This determination is based on a number of factors, including the store's historical operating results and cash Öows, estimated future sales growth, real estate development in the area and perceived local market conditions that can be diÇcult to predict and may be subject to change. In addition, the Company regularly evaluates its computer-related and other long-lived assets and may accelerate depreciation over the revised useful life if the asset is expected to be replaced or has limited future value. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation or amortization are removed from the accounts, and any resulting gain or loss is reÖected in income for that period. Tax Reserves The Company provides for estimated liabilities for potential income and other tax assessments for which actual settlement may diÅer materially from amounts provided. Merchandise Inventories The Company's inventory is valued using the retail method of accounting and is stated at the lower of cost (Ñrst-in, Ñrst-out method) or market. Under the retail inventory method, the valuation of inventory at cost and resulting gross margin are calculated by applying an average cost to retail ratio to the retail value of inventory. The retail inventory method is an averaging method that has been widely used in the retail industry. Inherent in the retail method are certain signiÑcant estimates including initial merchandise markup, markdowns and shrinkage, which signiÑcantly impact the ending inventory valuation at cost and the resulting gross margins. Physical inventories are conducted throughout the year to calculate actual shrinkage and inventory on hand. Estimates based on actual shrinkage results are used to estimate inventory shrinkage which is accrued for the period between the last inventory and the Ñnancial reporting date. The Company continuously reviews its inventory levels to identify slow moving merchandise and uses markdowns to clear slow moving inventory. General economic environment for retail apparel sales could result in an increase in the level of markdowns, which would result in lower inventory values and increases to cost of goods sold as a percentage of net sales in future periods. Management makes estimates regarding markdowns based on inventory levels on hand and customer demand, which may impact inventory valuations. Markdown exposure with respect to inventories on hand is limited due to the fact that seasonal merchandise is not carried forward. Historically, actual results have not signiÑcantly deviated from those determined using the estimates described above. 14 Liquidity, Capital Resources and Market Risk The Company believes that its cash, cash equivalents and short-term investments, together with cash Öows 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 over the next twelve months. The Company has consistently maintained a strong liquidity position. Cash provided by operating activities during Ñscal 2003 was $65.7 million as compared to $63.7 million in Ñscal 2002. These amounts have enabled the Company to fund its regular operating needs, capital expenditure program, cash dividend payments and any repurchase of the Company's Common Stock. In addition, the Company maintains $35 million of unsecured revolving credit facilities for short-term Ñnancing of seasonal cash needs. At January 31, 2004, the Company had working capital of $112.9 million compared to $162.6 million at February 1, 2003. The increase in net cash provided by operating activities in Ñscal 2003 is primarily the result of an increase in depreciation expense of $3.8 million due to store expansion and an enterprise-wide merchandise and Ñnance system; an increase of deferred income taxes of $4.9 million; a reduction in accounts receivable from weak sales and strong collection eÅorts of $1.9 million; and a reduction of merchandise inventories of $9.2 million. OÅsetting these increases in net cash provided by operating activities was a decrease in net income of $14.4 million and decrease of $1.3 million in accounts payable, accrued expenses and other liabilities. Additionally, the Company had $1.6 million invested in privately managed investment funds at January 31, 2004, which are reported under other assets of the consolidated balance sheets. At January 31, 2004, 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 2006. This agreement replaced a prior revolving credit agreement which was due to expire in October 2004. The credit agreement contains various Ñnancial covenants and limitations, including the maintenance of speciÑc Ñnancial ratios with which the Company was in compliance as of January 31, 2004. There were no borrowings outstanding under these credit facilities during the Ñscal year ended January 31, 2004 or February 1, 2003. The Company had approximately $5.4 million and $6.5 million at January 31, 2004 and February 1, 2003, respectively, of outstanding irrevocable letters of credit relating to purchase commitments. Expenditures for property and equipment totaled $20.6 million, $29.0 million and $25.7 million in Ñscal 2003, 2002 and 2001, respectively. The expenditures for Ñscal 2003 were primarily for store development, store remodels and investments in new technology. In Ñscal 2004, the Company is planning to invest approximately $33 million for capital expenditures. This includes expenditures to open 90 new stores, relocate 27 stores and close 10 stores. In addition, the Company plans to remodel 15 stores and has planned for additional investments in technology scheduled to be implemented over the next 12 months. During 2003, the Company repurchased 5,137,484 shares of Class B Common Stock from a limited partnership and trust aÇliated with Wayland H. Cato, Jr., a Company founder and Chairman of the Board, and a limited partnership aÇliated with Edgar T. Cato, a Company founder and a member of the Board of Directors. Shares were purchased at $18.50 per share for a total cost of $95,043,454. Including related expenses of $520,000 for investment banking and related professional fees, the total cost was $95,563,454 or an average purchase price of $18.60 per share. The repurchase was funded by the Company through a new $30 million Ñve-year term loan facility and approximately $65 million of cash and liquidated short-term investments. Payments on the new term loan are due in monthly installments of $500,000 plus accrued interest. Interest is based on LIBOR. The LIBOR rate at January 31, 2004 was 1.10%. Additionally, during 2003, the Company repurchased 165,000 shares of Class A Common Stock for $2,740,619, or an average market price of $16.61 per share. During 2002, the Company repurchased 66,000 shares of Class A Common Stock for $1,186,687, or an average purchase price of $17.98 per share. Additionally, in Ñscal 2002, the Company accepted in an option transaction from an oÇcer for payment of an option exercise, 48,681 mature shares of Class A Common Stock for $1,144,500 or $23.51 per share, the average fair market value on the date of exchange. 15 During 2003, the Company entered into retirement agreements with Mr. Wayland H. Cato, Jr., a Company founder and Chairman of the Board and Mr. Edgar T. Cato, a Company founder and a member of the Board of Directors. The agreements provided for the retirement of Mr. Wayland Cato and Mr. Edgar Cato from the Company and the Board of Directors eÅective January 31, 2004. The Company recognized an expense of $2.8 million representing the present value of certain payments and beneÑts under the terms of the agreements. The after-tax charge was $1.8 million or $.08 per diluted share in Ñscal 2003. During Ñscal 2003, the Company increased its quarterly dividend by 7% from $.15 per share to $.16 per share. Over the course of 2002, the Board of Directors increased the quarterly dividend by 11% from $.135 per share to $.15 per share. The Company does not use derivative Ñnancial instruments. At January 31, 2004, the Company's investment portfolio was invested in governmental and other debt securities with maturities of up to 36 months. These securities are classiÑed 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 Consolidated Balance Sheets and a reduction of interest and other income, net in the accompanying Statements of Consolidated Income. The following table shows the Company's obligations and commitments as of January 31, 2004, to make future payments under contractual obligations (in thousands): Contractual Obligations Total 2004 2005 2006 2007 2008 Payments Due During One Year Fiscal Period Ending Merchandise letters of credit ÏÏÏÏÏÏ Operating leases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Loan paymentÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 5,365 121,126 27,500 $ 5,365 40,482 6,000 $ Ì $ Ì $ Ì $ Ì 6,740 3,500 32,488 6,000 16,249 6,000 25,167 6,000 Total Contractual ObligationsÏÏÏÏÏÏ $153,991 $51,847 $38,488 $31,167 $22,249 $10,240 Recent Accounting Pronouncements On December 31, 2002, the FASB issued SFAS No. 148, ""Accounting for Stock-Based Compensa- tion Ì Transition and Disclosure''. SFAS No. 148 amends SFAS No. 123, ""Accounting for Stock-Based Compensation'', to provide for alternative methods of transition to SFAS No. 123's fair value method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and APB Opinion No. 28, ""Interim Financial Reporting'', to require disclosure in the summary of signiÑcant policies of the eÅects of an entity's accounting policy with respect to stock-based employee compensation on reported net income and earnings per-share in annual and interim Ñnancial statements. While SFAS No. 148 does not amend SFAS No. 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based compensation, regardless of whether they account for that compensation using the fair value method of SFAS No. 123 or the intrinsic value method of APB Opinion No. 25, ""Accounting for Stock Issued to Employees''. SFAS No. 148's amendment of the transition and annual disclosure requirements of SFAS No. 123 are eÅective for Ñscal years ending after December 15, 2002. The implementation of this Statement did not aÅect the Company's Ñnancial position or results of operations. In March 2003, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 02-16, ""Accounting by a Customer (Including a Reseller) for Cash Considerations Received from a Vendor''. EITF Issue No. 02-16 provides guidance on how cash considerations received by a customer or reseller should be classiÑed in the customer's statement of earnings. EITF Issue No. 02-16 is eÅective for all transactions with vendors after December 31, 2002. The adoption of EITF Issue No. 02-16 did not have a material impact on the Company's consolidated Ñnancial position or results of operations. This Annual Report includes ""forward-looking statements'' within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. All statements other than statements of historical facts 16 included in this Annual Report, including, but not limited to, statements regarding the Company's planned capital expenditures, store openings, closures, relocations and remodelings and the expected adequacy of the Company's liquidity, constitute forward-looking statements. Although the Company believes that the expectations reÖected in such forward-looking statements are reasonable, it can give no assurance that such expectations prove to be correct. Forward-looking statements involve risks and uncertainties that could cause the Company's actual results to diÅer materially depending on a variety of important factors, including, but not limited to, general economic conditions, competitive factors and pricing pressures. The Company does not undertake any obligation to update any forward-looking statements. Item 7A. 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 Ñnancing, investing and cash management. 17 Item 8. Financial Statements and Supplementary Data: INDEX TO FINANCIAL STATEMENTS AND SCHEDULE Report of Independent Auditors ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Report of Predecessor Auditor (Deloitte & Touche LLP) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statements of Income for the Ñscal years ended January 31, 2004, February 1, 2003 and February 2, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Balance Sheets at January 31, 2004 and February 1, 2003ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statements of Cash Flows for the Ñscal years ended January 31, 2004, February 1, 2003 and February 2, 2002ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statements of Stockholders' Equity for the Ñscal years ended January 31, 2004, February 1, 2003 and February 2, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Notes to Consolidated Financial Statements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Schedule I Ì Report of Predecessor Public Accountant (Deloitte & Touche LLP) on Financial Page 19 20 21 22 23 24 25 Statement Schedule ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ S-1 Schedule II Ì Valuation and Qualifying Accounts and Reserves for the Ñscal years ended January 31, 2004, February 1, 2003 and February 2, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ S-2 18 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders of The Cato Corporation In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, of stockholders' equity, and of cash Öows present fairly, in all material respects, the Ñnancial position of The Cato Corporation and its Subsidiaries at January 31, 2004, and the results of their operations and their cash Öows for the year then ended in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the Ñnancial statement schedule for the year ended January 31, 2004 listed in the index at Item 15 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated Ñnancial statements. These Ñnancial statements and Ñnancial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these Ñnancial statements based on our audit. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the Ñnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the Ñnancial statements, assessing the accounting principles used and signiÑcant estimates made by management, and evaluating the overall Ñnancial statement presentation. We believe that our audit provides a reasonable basis for our opinion. The Ñnancial statements of the Company as of February 1, 2003 and for each of the two years in the period ended February 1, 2003 were audited by other auditors whose report dated April 21, 2003 expressed an unqualiÑed opinion on those statements. /s/ PricewaterhouseCoopers LLP Charlotte, North Carolina March 31, 2004 19 PREDECESSOR AUDITOR (DELOITTE & TOUCHE LLP) To the Board of Directors and Stockholders of The Cato Corporation We have audited the accompanying consolidated balance sheet of The Cato Corporation and subsidiaries (the Company) as of February 1, 2003, and the related consolidated statements of income, stockholders' equity, and cash Öows for each of the two years in the period ended February 1, 2003. Our audits also included the Ñnancial statement schedule listed in the index at Item 15(a) for each of the two-years in the period ended February 1, 2003. These Ñnancial statements and the Ñnancial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these Ñnancial statements and the Ñnancial statement schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the Ñnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the Ñnancial statements. An audit also includes assessing the accounting principles used and signiÑcant estimates made by management, as well as, evaluating the overall Ñnancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated Ñnancial statements present fairly, in all material respects, the Ñnancial position of the Company at February 1, 2003, and the results of its operations and its cash Öows for each of the two years in the period ended February 1, 2003, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such Ñnancial statement schedule, when considered in relation to the basic consolidated Ñnancial statements taken as a whole, presents fairly in all material respects the information set forth herein. /s/ Deloitte & Touche LLP Charlotte, North Carolina April 21, 2003 20 THE CATO CORPORATION CONSOLIDATED STATEMENTS OF INCOME January 31, 2004 Fiscal Year Ended February 1, 2003 (Dollars in thousands, except per share data) February 2, 2002 REVENUES Retail sales ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 731,770 Other income (principally Ñnance charges, late fees and layaway $ 732,742 $ 685,653 charges) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15,497 15,589 13,668 Total revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 747,267 748,331 699,321 COSTS AND EXPENSES, NET Cost of goods sold ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Selling, general and administrative ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Depreciation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 508,401 174,202 18,695 (3,308) 496,345 168,914 14,913 (3,680) 466,366 162,082 10,886 (6,299) 697,990 676,492 633,035 Income before income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 49,277 17,888 Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 31,389 Basic earnings per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1.36 71,839 26,006 45,833 1.80 66,286 23,200 43,086 1.71 $ $ $ $ Basic weighted average shares ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23,140,581 25,465,543 25,193,610 Diluted earnings per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1.33 $ 1.77 $ 1.66 Diluted weighted average shares ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23,559,541 25,947,457 25,888,636 Dividends per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ .63 $ .585 $ .53 See notes to consolidated Ñnancial statements. 21 THE CATO CORPORATION CONSOLIDATED BALANCE SHEETS January 31, 2004 February 1, 2003 (Dollars in thousands) ASSETS Current Assets: Cash and cash equivalentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Short-term investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts receivable, net of allowance for doubtful accounts of $6,335 at January 31, 2004 and $6,099 at February 1, 2003.ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Merchandise inventories ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Prepaid expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Current Assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Property and equipment Ì net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 23,857 47,545 $ 32,065 74,871 52,714 97,292 284 5,708 227,400 114,367 9,806 54,116 93,457 1,392 4,990 260,891 113,307 9,212 Total Assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $351,573 $383,410 LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrued expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrued income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Current portion of long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Current Liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other noncurrent liabilities (primarily deferred rent) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 76,387 27,815 4,290 6,000 114,492 10,203 21,500 11,267 $ 66,620 28,776 2,886 Ì 98,282 6,310 Ì 8,654 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; 26,015,868 and 25,218,678 shares issued at January 31, 2004 and February 1, 2003, respectively ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Convertible Class B common stock, $.033 par value per share, 15,000,000 shares authorized; 5,607,834 and 6,085,149 shares issued at January 31, 2004 and February 1, 2003, respectivelyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additional paid-in capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accumulated other comprehensive gainsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unearned compensation Ì restricted stock awards ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì 867 840 187 99,676 252,828 58 (1,593) 203 94,947 235,904 253 (2,375) 352,023 329,772 Less Class A and Class B common stock in treasury, at cost (5,906,179 Class A and 5,137,484 Class B shares at January 31, 2004 and 5,741,179 Class A and 0 Class B shares at February 1, 2003, respectively) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (157,912) (59,608) Total Stockholders' Equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 194,111 270,164 Total Liabilities and Stockholders' EquityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $351,573 $383,410 See notes to consolidated Ñnancial statements. 22 THE CATO CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS January 31, 2004 Fiscal Year Ended February 1, 2003 (Dollars in thousands) February 2, 2002 OPERATING ACTIVITIES Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amortization of investment premiums ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for doubtful accounts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Write-down of investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Compensation expense related to restricted stock awards ÏÏÏÏÏÏÏÏÏ Loss on disposal of property and equipment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Changes in operating assets and liabilities which provided (used) cash: Accounts receivable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Merchandise inventoriesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Prepaid and other assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrued income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts payable, accrued expenses and other liabilitiesÏÏÏÏÏÏÏÏ $ 31,389 $ 45,833 $ 43,086 18,695 4 6,098 Ì 5,001 782 798 14,913 66 4,764 1,800 70 750 870 10,886 160 5,913 Ì 422 295 480 (4,696) (3,835) (1,312) 1,404 11,419 (6,587) (13,050) (470) 2,066 12,704 (11,234) (1,246) 367 (1,525) (547) Net cash provided by operating activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 65,747 63,729 47,057 INVESTING ACTIVITIES Expenditures for property and equipment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchases of short-term investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Sales of short-term investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (20,553) (18,462) 45,589 (28,953) (46,281) 13,735 (25,684) (35,878) 51,194 Net cash provided (used) in investing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,574 (61,499) (10,368) FINANCING ACTIVITIES Dividends paidÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchases of treasury stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds of long term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Payments to settle long term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from employee stock purchase plan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from stock options exercised ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (14,465) (98,304) 30,000 (2,500) 507 4,233 (14,890) (1,187) Ì Ì 509 3,631 (13,400) (11,729) Ì Ì 443 4,568 Net cash used in Ñnancing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (80,529) (11,937) (20,118) Net increase (decrease) in cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and cash equivalents at beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (8,208) 32,065 (9,707) 41,772 16,571 25,201 Cash and cash equivalents at end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 23,857 $ 32,065 $ 41,772 See notes to consolidated Ñnancial statements. 23 THE CATO CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Class A Common Common Stock Stock Convertible Class B Additional Accumulated Other Unearned Compensation Restricted Paid-in Capital Retained Comprehensive Earnings Income (Loss) Stock Awards Total Treasury Stockholders' Stock Equity Balance Ì February 3, 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ *Comprehensive income: Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unrealized gains on available-for-sale securities, net of deferred income taxes of $171. ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dividends paid ($.53 per share) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Class A common stock sold through employee stock purchase plan Ì 38,463 shares ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Class A common stock sold through stock option plans Ì 329,850 shares ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Class B common stock sold through stock option plans Ì 448,332 shares ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax beneÑt from stock options exercised ÏÏÏÏÏÏ Purchase of treasury shares Ì 774,750 shares ÏÏÏÏÏÏÏÏ Surrender of shares for stock options Ì 92,600 shares Unearned compensation Ì restricted stock awards ÏÏÏÏ Balance Ì February 2, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ *Comprehensive income: Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unrealized gains on available-for-sale securities, net of deferred income taxes of $448. ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dividends paid ($.585 per share) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Class A common stock sold through employee stock purchase plan Ì 32,487 shares ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Class A common stock sold through stock option plans Ì 171,600 shares ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Class B common stock sold through stock option plans Ì 172,500 shares ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax beneÑt from stock options exercised ÏÏÏÏÏÏ Purchase of treasury shares Ì 66,000 shares ÏÏÏÏÏÏÏÏÏ Surrender of shares for stock options Ì 48,681 shares Restricted stock awards Ì 100,000 shares ÏÏÏÏÏÏÏÏÏÏÏ Unearned compensation Ì restricted stock awards ÏÏÏÏ Balance Ì February 1, 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ *Comprehensive income: Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unrealized losses on available-for-sale securities, net of deferred income tax beneÑt of $111. ÏÏÏÏÏÏÏÏÏ Dividends paid ($.63 per share) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Class A common stock sold through employee stock purchase plan Ì 28,306 shares ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Class A common stock sold through stock option plans Ì 288,250 shares ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax beneÑt from stock options exercised ÏÏÏÏÏÏ Purchase of treasury shares Ì 5,302,484 shares ÏÏÏÏÏÏ Shares reclassiÑed from Class B to Class A Ì 477,315 shares ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unearned compensation Ì restricted stock awards ÏÏÏÏ $821 $179 $76,778 $175,275 $(884) $ (689) $ (43,723) $207,757 (Dollars in thousands) 43,086 (13,400) 317 1 11 15 442 2,961 3,406 3,361 43,086 317 (13,400) 443 2,972 3,421 3,361 (11,729) (1,825) 295 (11,729) (1,825) 295 833 194 86,948 204,961 (567) (394) (57,277) 234,698 45,833 (14,890) 820 45,833 820 (14,890) 509 1,553 1,316 1,906 (1,187) (1,144) Ì 750 (1,187) (1,144) (2,731) 750 1 6 508 1,547 1,310 1,906 2,728 6 3 840 203 94,947 235,904 253 (2,375) (59,608) 270,164 31,389 (14,465) (195) 31,389 (195) (14,465) 507 2,867 1,366 (98,304) Ì 782 (98,304) 782 1 10 506 2,857 1,366 16 (16) Balance Ì January 31, 2004.ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $867 $187 $99,676 $252,828 $ 58 $(1,593) $(157,912) $194,111 * Total comprehensive income for the years ended January 31, 2004, February 1, 2003 and February 2, 2002 was $31,194, $46,653 and $43,403, respectively. See notes to consolidated Ñnancial statements. 24 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of SigniÑcant Accounting Policies: Principles of Consolidation: The consolidated Ñnancial statements include the accounts of The Cato Corporation and its wholly-owned subsidiaries (""the Company''). All signiÑcant intercompany accounts and transactions have been eliminated. Description of Business and Fiscal Year: The Company has two business segments Ì the operation of women's fashion specialty stores and a credit card division. The apparel specialty stores operate under the names ""Cato'', ""Cato Fashions'', ""Cato Plus'' and ""It's Fashion!'' and are located primarily in strip shopping centers in the southeastern United States. The Company's Ñscal year ends on the Saturday nearest January 31. Use of Estimates: The preparation of the Company's Ñnancial statements in conformity with account- ing principles generally accepted in the United States requires management to make estimates and assumptions that aÅect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Ñnancial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could diÅer from those estimates. SigniÑcant accounting estimates reÖected in the Company's Ñnancial statements include the allowance for doubtful accounts receivable, reserves relating to workers' compensation, general and auto insurance liabilities, reserves for inventory markdowns, calculation of asset impairment, shrink accrual and tax contingency reserves. Cash and 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 classiÑed as short-term investments. The fair values of short-term investments are based on quoted market prices. The Company's short-term investments are all classiÑed as available-for-sale. As they are available for current operations, they are classiÑed in 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 Consolidated Balance Sheets and a reduction of interest and other income, net in the accompanying Statements of Consolidated 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, net. Concentration of Credit Risk: Financial instruments that potentially subject the Company to a concentration of credit risk principally consist of cash equivalents and accounts receivable. The Company places its cash equivalents with high credit qualiÑed institutions and, by practice, limits the amount of credit exposure to any one institution. Concentrations of credit risks with respect to accounts receivable are limited due to the dispersion across diÅerent geographies of the Company's customer base. Supplemental Cash Flow Information: Income tax payments, net of refunds received, for the Ñscal years ended January 31, 2004, February 1, 2003 and February 2, 2002 were $12,643,000, $21,982,000 and $24,841,000, respectively. Inventories: Merchandise inventories are stated at the lower of cost (Ñrst-in, Ñrst-out method) or market as determined by the retail method. Property and Equipment: Property and equipment are recorded at cost. Maintenance and repairs are charged to operations as incurred; renewals and betterments are capitalized. The Company accounts for its software development costs in accordance with the American Institute of CertiÑed Public Accountants Statement of Position (""SOP'') 98-1, ""Accounting for the Costs of Computer Software Developed or 25 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Obtained for Internal Use''. Depreciation is provided on the straight-line method over the estimated useful lives of the related assets, as follows: ClassiÑcation Land improvementsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ BuildingsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Leasehold improvements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fixtures, equipment and software ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Estimated Useful Lives 10 years 30 Ó 40 years 5 Ó 10 years 3 Ó 10 years Impairment of Long-Lived Assets The Company primarily invests in property and equipment in connection with the opening and remodeling of stores and in computer software and hardware. Most of the Company's store leases give the Company the option to terminate the lease if certain speciÑed sales volumes are not achieved during the Ñrst few years of the lease. The Company periodically reviews its store locations and estimates the recoverability of its assets, recording an impairment charge, if necessary, when the Company decides to close the store or otherwise determines that future undiscounted cash Öows associated with those assets will not be suÇcient to recover the carrying value. This determination is based on a number of factors, including the store's historical operating results and cash Öows, estimated future sales growth, real estate development in the area and perceived local market conditions that can be diÇcult to predict and may be subject to change. In addition, the Company regularly evaluates its computer-related and other long-lived assets and may accelerate depreciation over the revised useful life if the asset is expected to be replaced or has limited future value. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation or amortization are removed from the accounts, and any resulting gain or loss is reÖected in income for that period. Revenue Recognition The Company recognizes sales at the point of purchase when the customer takes possession of the merchandise and pays for the purchase, generally with cash or credit. Sales from purchases made with Cato credit, gift cards and layaway sales are also recorded when the customer takes possession of the merchandise. Gift cards, layaway deposits and merchandise credits granted to customers are recorded as deferred revenue until they are redeemed or forfeited. A provision is made for estimated product returns based on sales volumes and the Company's experience; actual returns have not varied materially from amounts provided historically. Credit revenue on the Company's private label credit card portfolio is recognized as earned under the interest method. Late fees are recognized as earned, less provisions for estimated uncollectible fees. Cost of Goods Sold: 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 our buying departments and distribution center. Occupancy expenses include rent, real estate taxes, insurance, common area maintenance, utilities and maintenance for stores and distribution facilities. Buying, distribution, occupancy and internal transfer costs are treated as period costs and are not capitalized as part of inventory. Credit Sales: The Company oÅers its own credit card to customers. All credit activity is performed by the Company's wholly-owned subsidiaries. None of the credit card receivables are secured. Finance income is recognized as earned under the interest method and late charges are recognized in the month in which they are assessed, net of provisions for estimated uncollectible amounts. The Company evaluates the collectibility 26 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) of accounts receivable and records an allowance for doubtful accounts based on estimates of actual write-oÅs and the accounts receivable. Advertising: Advertising costs are expensed in the period in which they are incurred. Advertising expense was $5,638,000, $5,299,000 and $4,563,000 for the Ñscal years ended January 31, 2004, February 1, 2003 and February 2, 2002, respectively. Earnings Per Share: FASB No. 128 requires dual presentation of basic EPS and diluted EPS on the face of all income statements for all entities with complex capital structures. Basic EPS is computed as net income divided by the weighted average number of common shares outstanding for the period. Diluted EPS reÖects the potential dilution that could occur from common shares issuable through stock options, warrants and other convertible securities. Unvested restricted stock is included in the computation of diluted EPS using the treasury stock method for Ñscal 2003 and had no impact on Ñscal 2002 and 2001, respectively. The weighted-average number of shares used in the basic earnings per share computations was 23,140,581, 25,465,543, and 25,193,610 for the Ñscal years ended January 31, 2004, February 1, 2003, and February 2, 2002, respectively. The weighted-average number of shares representing the dilutive eÅect of stock options was 418,960, 481,914 and 695,026 for the Ñscal years ended January 31, 2004, February 1, 2003 and February 2, 2002, respectively. The weighted-average number of shares used in the diluted earnings per share computations was 23,559,541, 25,947,457, and 25,888,636 for the Ñscal years ended January 31, 2004, February 1, 2003 and February 2, 2002, respectively. There were an immaterial number of shares withheld in the computation of diluted earnings per share due to potential anti-dilutive eÅects for the Ñscal years 2003, 2002 and 2001. Vendor Allowances: The Company receives certain allowances from vendors primarily related to purchase discounts and markdown and damage allowances. All allowances are reÖected in cost of goods sold as earned, generally as the related products are sold. The Company does not receive cooperative advertising allowances. In January 2003, the Emerging Issues Task Force (""EITF'') issued EITF 02-16, ""Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.'' Under this EITF, cash consideration received from a vendor is presumed to be a reduction of the purchase cost of merchandise and should be reÖected as a reduction of cost of sales or revenue unless it can be demonstrated this oÅsets an incremental expense, in which case it can be netted against that expense. The adoption of EITF 02-16 did not have a material eÅect on the Company's Ñnancial position or results of operations for Ñscal year ended January 31, 2004 or February 1, 2003. Income Taxes: The Company Ñles a consolidated federal income tax return. Income taxes are provided based on the asset and liability method of accounting, whereby deferred income taxes are provided for temporary diÅerences between the Ñnancial reporting basis and the tax basis of the Company's assets and liabilities. Store Opening and Closing Costs: Costs relating to the opening of new stores or the relocating or expanding of existing stores are expensed as incurred. The Company evaluates all long-lived assets for impairment. A portion of construction, design, and site selection costs are capitalized to new, relocated and remodeled stores. Closed Store Lease Obligations: At the time stores are closed, provisions are made for the rentals required to be paid over the remaining lease terms reduced by sublease rentals. Insurance: The Company is self-insured with respect to employee healthcare, workers' compensation and general liability. The Company's self-insurance liabilities are based on the total estimated cost of claims Ñled and estimates of claims incurred but not reported, less amounts paid against such claims, and are not discounted. Management reviews current and historical claims data in developing its estimates. The Company 27 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) has stop-loss insurance coverage for individual claims in excess of $250,000 for employee healthcare, $350,000 for worker's compensation and $200,000 for general liability. Employee health claims are funded through a VEBA trust to which the Company makes periodic contributions. Contributions to the VEBA trust were $8,995,000, $8,970,000 and $9,090,000 in Ñscal 2003, 2002 and 2001, respectively. Accrued healthcare was $1,380,000 and $1,125,000 and assets held in VEBA trust were $924,000 and $576,000 at January 31, 2004 and February 1, 2003, respectively. The Company paid worker's compensation and general liability claims of $3,019,000, $2,609,000 and $3,114,000 in Ñscal years 2003, 2002 and 2001, respectively. Including claims incurred, but not yet paid, the Company recognized an expense of $3,764,000, $3,284,000 and $3,385,000 in Ñscal 2003, 2002 and 2001, respectively. Accrued workers' compensation and general liabilities was $3,968,000 and $3,222,000 at January 31, 2004 and February 1, 2003, respectively. The Company had no outstanding letters of credit relating to such claims at January 31, 2004 or at February 1, 2003. Fair Value of Financial Instruments: The Company's carrying values of Ñnancial instruments, such as cash, cash equivalents, and debt, approximate their fair values due to their short terms to maturity and/or their variable interest rates. Stock-based Compensation: The Company applies APB Opinion No. 25, ""Accounting for Stock Issued to Employees'', and related interpretations in accounting for its stock option plans. The exercise price for all options awarded under the Company's Stock Option Plans has been equal to the fair market value of the underlying common stock on the date of grant. Accordingly, no compensation expense has been recognized for options granted under the Plans. Had compensation expense for Ñscal 2003, 2002, and 2001 stock options granted been determined consistent with SFAS No. 148, ""Accounting for Stock-Based Compensation Ì Transition and Disclosure'', the Company's net income and basic and diluted earnings per share amounts for Ñscal 2003, 2002 and 2001 would approximate the following proforma amounts (dollars in thousands, except per share data): January 31, 2004 February 1, 2003 February 2, 2002 Net Income as Reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $31,389 $45,833 $43,086 Add: Stock-Based employee compensation expense included in reported net income, net of related tax eÅects ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax eÅects ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 782 750 295 (1,308) (1,490) (1,888) Pro forma Net IncomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $30,863 $45,093 $41,493 Earnings per share: Basic Ì as reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basic Ì pro forma ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted Ì as reportedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted Ì pro formaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ $ $ 1.36 1.33 1.33 1.30 $ $ $ $ 1.80 1.77 1.77 1.74 $ $ $ $ 1.71 1.65 1.66 1.60 The weighted-average fair value of each option granted during Ñscal 2003, 2002 and 2001 is estimated at $5.84, $8.29 and $8.19 per share, respectively. The fair value of each option grant is estimated using the Black- Scholes option-pricing model with the following assumptions for grants issued in 2003, 2002 and 2001, respectively: expected dividend yield of 3.01%, 3.29% and 2.62%; expected volatility of 44.34%, 57.06% and 59.84%, adjusted for expected dividends; risk-free interest rate of 3.29%, 2.60% and 4.36%; and an expected life of 5 years for 2003, 2002 and 2001. The eÅects of applying SFAS 148 in this proforma disclosure are not indicative of future amounts. 28 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Recent Accounting Pronouncements On December 31, 2002, the FASB issued SFAS No. 148, ""Accounting for Stock-Based Compensa- tion Ì Transition and Disclosure''. SFAS No. 148 amends SFAS No. 123, ""Accounting for Stock-Based Compensation'', to provide for alternative methods of transition to SFAS No. 123's fair value method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and APB Opinion No. 28, ""Interim Financial Reporting'', to require disclosure in the summary of signiÑcant policies of the eÅects of an entity's accounting policy with respect to stock-based employee compensation on reported net income and earnings per-share in annual and interim Ñnancial statements. While SFAS No. 148 does not amend SFAS No. 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based compensation, regardless of whether they account for that compensation using the fair value method of SFAS No. 123 or the intrinsic value method of APB Opinion No. 25, ""Accounting for Stock Issued to Employees''. SFAS No. 148's amendment of the transition and annual disclosure requirements of SFAS No. 123 are eÅective for Ñscal years ending after December 15, 2002. The implementation of this Statement did not aÅect the Company's Ñnancial position or results of operations and the Company's adopted the disclosure requirements beginning with the Ñrst quarter of Ñscal 2003. In March 2003, the Emerging Issues Task Force (EITF) reached a Ñnal consensus on Issue No. 02-16, ""Accounting by a Customer (Including a Reseller) for Cash Considerations Received from a Vendor''. EITF Issue No. 02-16 provides guidance on how cash considerations received by a customer or reseller should be classiÑed in the customer's statement of earnings. EITF Issue No. 02-16 is eÅective for all transactions with vendors after December 31, 2002. The adoption of EITF Issue No. 02-16 did not have a material impact on the Company's consolidated Ñnancial position or results of operations. ReclassiÑcations: Certain reclassiÑcations have been made to the consolidated Ñnancial statements for prior Ñscal years to conform with presentation for Ñscal 2003. 2. Interest and Other Income, Net The components of Interest and other income, net are shown below in gross amounts (in thousands): January 31, 2004 February 1, 2003 February 2, 2002 Dividend income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Miscellaneous income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (Gain)/loss investment salesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (2) (1,704) (1,235) 306 (673) $ (10) (3,046) (2,342) 21 1,697 $ (10) (4,316) (2,011) 38 0 Interest and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(3,308) $(3,680) $(6,299) 29 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) 3. Short-Term Investments: Short-Term investments at January 31, 2004 and February 1, 2003 include the following (in thousands): Security Type: Debt Securities issued by January 31, 2004 Unrealized Estimated Gain/(Loss) Fair Value Cost February 1, 2003 Unrealized Estimated Gain/(Loss) Fair Value Cost U.S. Treasury & other U.S. government corporations and agencies: With unrealized gainÏÏÏÏÏÏ $ Ì $ Ì $ Ì $ 1,000 $ 87 $ 1,087 Debt Securities issued by states of the United States and political subdivisions of the states: With unrealized gainÏÏÏÏÏÏ With unrealized (loss) ÏÏÏÏ Corporate debt securities: 37,777 7,500 146 (345) 37,923 7,155 36,355 26,643 443 (244) 36,798 26,399 With unrealized gainÏÏÏÏÏÏ With unrealized (loss) ÏÏÏÏ Ì 2,500 Ì (33) Ì 2,467 3,626 6,833 128 Ì 3,754 6,833 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $47,777 $(232) $47,545 $74,457 $ 414 $74,871 The accumulated unrealized gains in short-term investments at January 31, 2004 of $148,000, net of a deferred income tax liability of $84,000 oÅset by the accumulated unrealized losses in equity investments of $206,000, net of a deferred income tax beneÑt of $117,000 and the accumulated unrealized gains of February 1, 2003 of $265,000, net of a deferred income tax liability of $149,000 oÅset by the accumulated unrealized losses in equity investments of $12,000 net of a deferred income tax beneÑt of $6,000 are reÖected in accumulated other comprehensive gains (losses) in the Consolidated Balance Sheets. All unrealized losses disclosed were in a loss position for less than 12 months. The Company's short-term investments are all classiÑed as available-for-sale. As they are available for current operations, they are classiÑed in 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 Consolidated Balance Sheets and a reduction of interest and other income, net in the accompanying Statements of Consolidated 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, net. As reported in our footnote 2 to our Ñnancial statements, the Company had realized gains of $673 in Ñscal 2003 and realized losses of $1,697 in Ñscal 2002. 30 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) The amortized cost and estimated fair value of debt securities at January 31, 2004, by contractual maturity, are shown below (in thousands): Security Type Cost Due in one year or less ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due in one year through three years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 8,621 39,156 Estimated Fair Value $ 8,605 38,940 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $47,777 $47,545 Additionally, the Company had $1.6 million invested in privately managed investment funds at January 31, 2004, which are reported under other assets in the Consolidated Balance Sheets. 4. Accounts Receivable: Accounts receivable consist of the following (in thousands): Customer accounts Ì principally deferred payment accountsÏÏÏÏÏÏÏÏÏÏÏ Miscellaneous trade receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $55,480 3,569 TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Less allowance for doubtful accountsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 59,049 6,335 $56,853 3,362 60,215 6,099 Accounts receivable Ì net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $52,714 $54,116 January 31, 2004 February 1, 2003 Finance charge and late charge revenue on customer deferred payment accounts totaled $14,169,000, $13,672,000 and $12,951,000 for the Ñscal years ended January 31, 2004, February 1, 2003 and February 2, 2002, respectively, and the allowance for doubtful accounts was $6,098,000, $4,764,000 and $5,913,000, for the Ñscal years ended January 31, 2004, February 1, 2003 and February 2, 2002, respectively. The allowance for doubtful accounts is classiÑed as a component of selling, general and administrative expenses in the accompanying Consolidated Statements of Income. 5. Property and Equipment: Property and equipment consist of the following (in thousands): Land and improvements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Buildings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Leasehold improvements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fixtures, equipment and software ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Construction in progress ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Less accumulated depreciation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ January 31, 2004 February 1, 2003 $ 2,019 17,751 39,354 155,394 2,534 217,052 102,685 $ 2,019 17,751 34,697 143,080 2,246 199,793 86,486 Property and equipment Ì net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $114,367 $113,307 Construction in progress primarily represents investments in technology and a carton sortation system for the distribution center scheduled to be implemented over the next 12 months. 31 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) 6. Accrued Expenses: Accrued expenses consist of the following (in thousands): January 31, 2004 February 1, 2003 Accrued bonus and retirement savings plan contributions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrued payroll and related items ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrued advertising ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Closed store lease obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Property and other taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrued insurance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,784 4,348 976 616 8,719 5,348 5,024 $ 6,233 4,265 762 1,004 7,593 4,347 4,572 TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $27,815 $28,776 7. Financing Arrangements: At January 31, 2004, the Company had an unsecured revolving credit agreement which provided for borrowings of up to $35 million. A new revolving credit agreement was entered into on August 22, 2003 and is committed until August 2006. The credit agreement contains various Ñnancial covenants and limitations, including the maintenance of speciÑc Ñnancial ratios with which the Company was in compliance as of January 31, 2004. There were no borrowings outstanding during the Ñscal year ended January 31, 2004 or February 1, 2003. Interest is based on LIBOR, which was 1.10% on January 31, 2004. On August 22, 2003, the Company entered into a new unsecured $30 million Ñve-year term loan facility, the proceeds of which were used to purchase Class B Common Stock from the Company's founders. Payments are due in monthly installments of $500,000 plus accrued interest. Interest is based on LIBOR, which was 1.10% on January 31, 2004. The Company had approximately $5,365,000 and $6,496,000 at January 31, 2004 and February 1, 2003, respectively, of outstanding irrevocable letters of credit relating to purchase commitments. 8. 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 beneÑt, corporations and partnerships controlled by them and the Company's employee beneÑt 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. During 2003, the Company repurchased 5,137,484 shares of Class B Common Stock from a limited partnership and trust aÇliated with Wayland H. Cato, Jr., a Company founder and Chairman of the Board, 32 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) and a limited partnership aÇliated with Edgar T. Cato, a Company founder and a member of the Board of Directors. Shares were purchased at $18.50 per share for a total cost of $95,043,454. Including related expenses of $520,000 for investment banking and related professional fees, the total cost was $95,563,454 or an average purchase price of $18.60 per share. The repurchase was funded by the Company through a new $30 million Ñve-year term loan facility and approximately $65 million of cash and liquidated short-term investments. Payments on the new term loan are due in monthly installments of $500,000 plus accrued interest. Interest is based on LIBOR. The LIBOR rate at January 31, 2004 was 1.10%. Additionally, during 2003, the Company repurchased 165,000 shares of Class A Common Stock for $2,740,619, or an average market price of $16.61 per share. 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''). In May 1998, the shareholders approved an amendment to the Plan to increase the maximum number of Class A shares of Common Stock authorized to be issued from 250,000 to 500,000 shares. The ""1993'' Plan expired October 1, 2003. In May 2003, the shareholders approved a new 2003 Employee Stock Purchase Plan with 250,000 Class A shares of Common Stock authorized. 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, up to a maximum market value of $25,000 per year. The Class A Common Stock is purchased at the lower of 85% of market value on the Ñrst 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 of Class A Common Stock at 85% of market value. The number of shares purchased by participants through the plan were 28,306 shares, 32,487 shares and 38,463 shares for the years ended January 31, 2004, February 1, 2003 and February 2, 2002, respectively. In December 2003, the Board of Directors authorized a dividend of one preferred share purchase right (a ""Right'') for each share of Class A Common Stock and Class B Common Stock, each par value $.03 1/3 per share (""Common Shares''), of the Company outstanding at the close of business on January 7, 2004 (the ""Record Date''). In connection with the authorization of Rights, the Company entered into a Rights Agreement, dated as of December 18, 2003 (the ""Rights Agreement''), with Wachovia Bank, National Association, a national banking association, as Rights Agent (the ""Rights Agent''). The Company has an Incentive Stock Option Plan and a Non-QualiÑed Stock Option Plan for key employees of the Company. Total shares issuable under the plans are 3,900,000, of which 825,000 shares are issuable under the Incentive Stock Option Plan and 3,075,000 shares are issuable under the Non-QualiÑed Stock Option Plan. The purchase price of the shares under the option must be at least 100 percent of the fair market value of Class A Common Stock at the date of the grant. Options granted under these plans vest over a 5-year period and expire 10 years after the date of the grant unless otherwise expressly authorized by the Board of Directors. In August 1999, the Board of Directors adopted the 1999 Incentive Compensation Plan, of which 1,000,000 shares are issuable. No awards may be granted after July 31, 2004 and shares must be exercised within 10 years of the grant date unless otherwise authorized by the Board of Directors. In August 1999, the Board of Directors granted under the 1999 Incentive Compensation Plan, restricted stock awards of 100,000 shares of Class B Common Stock, with a per share fair value of $11.81 to a key executive. In May 2002, the Board of Directors approved and granted under the 1999 Incentive Compensation Plan restricted stock awards of 100,000 shares of Class B Common Stock, with a per share fair value of $27.31 to a key executive. These stock awards cliÅ vest after four years and the unvested portion is included in stockholders' equity as unearned compensation in the accompanying Ñnancial statements. The charge to compensation expense for these stock awards was $782,000, $750,000 and $295,000 in Ñscal 2003, 2002 and 2001, respectively. 33 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Option plan activity for the three Ñscal years ended January 31, 2004 is set forth below: Options Range of Option Prices Weighted Average Price Outstanding options, February 3, 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Granted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ExercisedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cancelled ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,537,382 21,750 (778,182) (25,700) $ 4.94 Ó $14.59 12.66 Ó 18.91 4.94 Ó 14.59 7.69 Ó 14.59 $ 9.68 16.17 8.20 11.61 Outstanding options, February 2, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Granted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ExercisedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cancelled ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,755,250 45,500 (344,100) (14,700) 4.94 Ó 18.91 18.05 Ó 26.76 4.94 Ó 17.63 8.25 Ó 12.28 Outstanding options, February 1, 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Granted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ExercisedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cancelled ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,441,950 19,500 (288,250) (18,800) 4.94 Ó 26.76 16.65 Ó 21.29 4.94 Ó 18.86 8.25 Ó 18.86 10.39 20.89 8.11 11.27 11.20 17.66 9.94 12.75 Outstanding options, January 31, 2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,154,400 $ 5.13 Ó $26.76 $11.54 The following tables summarize stock option information at January 31, 2004: Range of Exercise Prices $ 5.13 Ó $ 7.69 8.25 Ó 9.59 10.66 Ó 12.72 13.06 Ó 26.76 Options 57,300 364,000 287,600 445,500 $ 5.13 Ó $26.76 1,154,400 Options Outstanding Weighted Average Remaining Contractual Life Weighted Average Exercise Price 1.27 years 3.63 years 5.66 years 5.32 years 4.67 years Options Exercisable $ 7.67 8.28 12.44 14.12 $11.54 Range of Exercise Prices $ 5.13 Ó $ 7.69 9.59 8.25 Ó 10.66 Ó 12.72 13.06 Ó 26.76 Options 57,300 357,800 190,400 352,750 $ 5.13 Ó $26.76 958,250 Weighted Average Exercise Price $ 7.67 8.26 12.46 13.34 $10.93 34 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Outstanding options at January 31, 2004 covered 702,000 shares of Class B Common Stock and 452,400 shares of Class A Common Stock. Outstanding options at February 1, 2003 covered 717,000 shares of Class B Common Stock and 724,950 shares of Class A Common Stock. Options available to be granted under the option plans were 406,600 at January 31, 2004 and 421,618 at February 1, 2003. In May 2003, the Board of Directors increased the quarterly dividend by 7% from $.15 per share to $.16 per share. Total comprehensive income for the years ended January 31, 2004, February 1, 2003 and February 2, 2002 is as follows (in thousands): Fiscal Year Ended Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unrealized gains (losses) on available-for-sale securities ÏÏÏ Income tax eÅect ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unrealized gains (losses) net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ January 31, 2004 February 1, 2003 February 2, 2002 $31,389 (306) 111 (195) $45,833 1,268 (448) $43,086 488 (171) 820 317 Total comprehensive income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $31,194 $46,653 $43,403 The net unrealized gain/loss on investments held reÖected in comprehensive income for the periods presented were net of reclassiÑcation adjustments for gains/(losses) reported in income in the amounts of $429, ($1,083) and $0 for Ñscal years 2003, 2002 and 2001, respectively, net of income taxes. 9. Employee BeneÑt Plans: The Company has a deÑned 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 60% of their annual compensation up to the maximum elective deferral, designated by the IRS. The Company is obligated to make a minimum contribution to cover plan administrative expenses. Further Company contributions are at the discretion of the Board of Directors. The Company's contributions for the years ended January 31, 2004, February 1, 2003 and February 2, 2002 were approximately $1,764,000, $1,906,000 and $2,596,000, 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 contribu- tions to the ESOP. No contributions were made to the ESOP for the years ended January 31, 2004, February 1, 2003 or February 2, 2002. The Company is primarily self-insured for healthcare, workers' compensation and general liability costs. These costs are signiÑcant primarily due to the large number of the Company's retail locations and employees. The Company's self-insurance liabilities are based on the total estimated costs of claims Ñled and estimates of claims incurred but not reported, less amounts paid against such claims, and are not discounted. Management reviews current and historical claims data in developing its estimates. If the underlying facts and circum- stances of the claims change or the historical trend is not indicative of future trends, then the Company may be required to record additional expense or a reduction to expense which could be material to the reported Ñnancial condition and results of operations. The Company has stop-loss insurance coverage for individual claims in excess of $250,000. Employee health claims are funded through a VEBA trust to which the Company makes periodic contributions. Contributions to the VEBA trust were $8,995,000, $8,970,000 and $9,090,000 in Ñscal 2003, 2002 and 2001, respectively. Accrued healthcare was $1,380,000 and $1,125,000 and assets held in the VEBA trust were $924,000 and $576,000 at January 31, 2004 and February 1, 2003, respectively. 35 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) 10. Leases: The Company has operating lease arrangements for store facilities and equipment. Facility leases generally are Ñxed rate for periods of Ñve years with renewal options and most provide for additional contingent rentals based on a percentage of store sales in excess of stipulated amounts. For leases with landlord capital improvement funding, the funded amount is booked as a deferred liability and amortized over the term of the lease. Equipment leases are generally for one to three year periods. The minimum rental commitments under non-cancelable operating leases are (in thousands): Fiscal Year 2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2008 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 40,482 32,488 25,167 16,249 6,740 Total minimum lease paymentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $121,126 The following schedule shows the composition of total rental expense for all leases (in thousands): Fiscal Year Ended January 31, 2004 February 1, 2003 February 2, 2002 Minimum rentals ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Contingent rent ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $39,998 165 $37,848 389 $37,117 471 Total rental expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $40,163 $38,237 $37,588 11. Related Party Transactions: The Company leases certain of its stores from entities in which Mr. George S. Currin, a director of the Company, has an ownership interest. Rent expense and related charges totaling $872,607, $883,367, and $785,936 were paid in Ñscal 2003, 2002 and 2001, respectively, under these leases. During 2000, 2001, 2002 and the Ñrst quarter of 2003, the Company made payments for the beneÑt of entities in which Mr. Wayland H. Cato, Jr., Chairman of the Board, and Mr. Edgar T. Cato, Former Vice Chairman of the Board and Co-Founder and Director, have a material interest. The Company subsequently determined these payments were unrelated to the business of the Company. Amounts, including interest, have been repaid. In the course of the evaluation by the Chief Executive OÇcer and the Chief Financial OÇcer described above, the Company implemented a change in its internal controls to prevent the payment of similar expenses in the future. As a result of this change, any payment requests for or on behalf of related parties require the prior review by and approval of the Chief Financial OÇcer. 36 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) 12. Income Taxes: The provision for income taxes consists of the following (in thousands): Fiscal Year Ended Current income taxes: January 31, 2004 February 1, 2003 February 2, 2002 Federal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $12,550 337 $24,572 1,364 $22,309 469 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,887 25,936 22,778 Deferred income taxes: Federal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,457 544 5,001 63 7 70 376 46 422 Total income tax expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $17,888 $26,006 $23,200 SigniÑcant components of the Company's deferred tax assets and liabilities as of January 31, 2004 and February 1, 2003 are as follows (in thousands): January 31, 2004 February 1, 2003 Deferred tax assets: Bad debt reserve ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Inventory valuationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Write-down of short-term investmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Restricted stock options ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Capital loss carryover ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ReservesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,426 946 Ì 428 669 3,872 764 $ 2,338 1,739 669 407 Ì 2,972 Ì Total deferred tax assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,105 8,125 Deferred tax liabilities: Tax over book depreciation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unrealized gains on short-term investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17,974 33 1,017 Total deferred tax liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19,024 11,682 143 1,218 13,043 Net deferred tax liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,919 $ 4,918 Certain of the Company's deferred tax assets have a limited life and realization of these assets is not assured. The capital loss carryover expires in 2008. 37 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) The reconciliation of the Company's eÅective income tax rate with the statutory rate is as follows: Fiscal Year Ended January 31, 2004 February 1, 2003 February 2, 2002 Federal income tax rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EÅective income tax rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 35.0% 1.3 0.0 36.3% 35.0% 1.2 0.0 36.2% 35.0% 0.9 (0.9) 35.0% 13. Quarterly Financial Data (Unaudited): Summarized quarterly Ñnancial results are as follows (in thousands, except per share data): Fiscal 2003 First Second Third Fourth Retail sales ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cost of goods sold ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gross margin ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basic earnings per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $197,304 201,210 126,998 70,306 27,444 17,482 .69 .68 $ $ $188,218 191,993 132,616 55,602 12,137 7,731 .30 .30 $ $ $153,171 157,129 108,557 44,614 1,251 797 .04 .04 $ $ $193,077 196,935 140,230 52,847 8,445 5,379 .26 .26 $ $ Fiscal 2002 First Second Third Fourth Retail sales ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cost of goods sold ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gross margin ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basic earnings per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $196,617 200,491 124,460 72,157 28,683 18,300 .72 .71 $ $ $186,900 190,715 125,854 61,046 19,213 12,258 .48 .47 $ $ $158,217 162,228 110,188 48,029 8,507 5,427 .21 .21 $ $ $191,008 194,897 135,843 55,165 15,436 9,848 .39 .38 $ $ 14. Reportable Segment Information: The Company has two reportable segments: retail and credit. The Company operates its women's fashion specialty retail stores in 28 states, principally in southeastern United States. The Company oÅers its own credit card to its customers and all credit authorizations, payment processing, and collection eÅorts are performed by a separate subsidiary of the Company. 38 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) The following schedule summarizes certain segment information (in thousands): Fiscal 2003 Retail Credit Total Revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ DepreciationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Capital expenditures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $732,796 18,617 (3,308) 44,553 289,200 20,549 $14,471 78 Ì 4,724 62,373 4 $747,267 18,695 (3,308) 49,277 351,573 20,553 Fiscal 2002 Retail Credit Total Revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ DepreciationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Capital expenditures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $734,352 14,851 (3,680) 66,375 310,173 28,953 $13,979 62 Ì 5,464 73,237 Ì $748,331 14,913 (3,680) 71,839 383,410 28,953 Fiscal 2001 Retail Credit Total Revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ DepreciationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Capital expenditures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $686,092 10,821 (6,299) 62,786 263,909 25,684 $13,229 65 Ì 3,500 68,132 Ì $699,321 10,886 (6,299) 66,286 332,041 25,684 The accounting policies of the segments are the same as those described in the summary of signiÑcant accounting policies. The Company evaluates performance based on proÑt or loss from operations before income taxes. The Company does not allocate certain corporate expenses or income taxes to the segments. The following schedule summarizes the credit segment and related direct expenses which are reÖected in selling, general and administrative expenses (in thousands): January 31, 2004 February 1, 2003 February 2, 2002 Bad debt expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Payroll ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ PostageÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $6,098 1,101 1,131 1,339 Total expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $9,669 $4,764 1,117 1,121 1,451 $8,453 $5,913 1,126 1,127 1,498 $9,664 15. Commitments and Contingencies: Workers compensation and general liability claims are settled through a claims administrator and are limited by stop-loss insurance coverage for individual claims in excess of $350,000 and $200,000, respectively. The Company paid claims of $3,019,000, $2,609,000 and $3,114,000 in Ñscal 2003, 2002 and 2001, respectively. Including claims incurred, but not yet paid, the Company recognized an expense of $3,764,000, $3,284,000 and $3,385,000 in Ñscal 2003, 2002 and 2001, respectively. Accrued workers' compensation and 39 THE CATO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) general liabilities was $3,968,000 and $3,222,000 at January 31, 2004 and February 1, 2003, respectively. The Company had no outstanding letters of credit relating to such claims at January 31, 2004 or at February 1, 2003. See Note 7 for letters of credit related to purchase commitments, Note 9 for 401(k) plan contribution obligations and Note 10 for lease commitments. The Company does not have any guarantees with third parties. The Company has placed a $2 million deposit with Cedar Hill National Bank (""Cedar Hill''), a wholly owned subsidiary, as security and collateral for the payment of amounts due from Cato West LLC, a wholly owned subsidiary, to Cedar Hill. The deposit has no set term. The deposit was made at the request of the OÇce of the Comptroller of the Currency because the receivable is not settled immediately and Cedar Hill has a risk of loss until payment is made. Cato West purchases receivables from Cedar Hill on a daily basis (generally one day in arrears). In the event Cato West fails to transfer to Cedar Hill the purchase price for any receivable within two business days, Cedar Hill shall have the right to withdraw any amount necessary from the account established by the Company to satisfy the amount due Cedar Hill from Cato West. Although the amount of potential future payments is limited to the amount of the deposit, Cedar Hill may require, at its discretion, the Company to increase the amount of the deposit with no limit on the increase. The deposit is based upon the amount of payments that would be due from Cato West to Cedar Hill for the highest credit card sales weekends of the year that would remain unpaid until the following business day. The Company has no obligations related to the deposit at year-end. No recourse provisions exist nor are any assets held as collateral that would reimburse the Company if Cedar Hill withdraws a portion of the deposit. The Company is a defendant in legal proceedings considered to be in the normal course of business and none of which, singularly or collectively, are considered to be material to the Company as a whole. 40 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure: EÅective September 16, 2003, The Cato Corporation (the ""Company'') dismissed Deloitte & Touche LLP as its principal independent accountants from the engagement to perform the audit of the Ñnancial statements of the Company for the Ñscal year ending January 31, 2004. Deloitte & Touche LLP had served as the Company's principal independent accountants since 1995. The decision to dismiss Deloitte & Touche LLP was made by the Audit Committee of the Board of Directors of the Company. The audit reports of Deloitte & Touche LLP on the Ñnancial statements of the Company for the Ñscal years ended February 1, 2003 and February 2, 2002 contained no adverse opinion or disclaimer of opinion, nor were they qualiÑed or modiÑed as to uncertainty, audit scope, or accounting principles. In connection with the audits of the Ñnancial statements of the Company for the Ñscal years ended February 1, 2003 and February 2, 2002 and through the date hereof, the Company had no disagreement with Deloitte & Touche LLP on any matter of accounting principles or practices, Ñnancial statement disclosure, or auditing scope or procedure, which disagreement, if not resolved to the satisfaction of Deloitte & Touche LLP, would have caused them to make reference to such disagreement in their reports for such periods; and there were no reportable events as deÑned in Item 304(a)(1)(v) of Regulation S-K. Deloitte & Touche LLP was provided a copy of the above disclosures and was requested to furnish the Company with a letter addressed to the Securities and Exchange Commission stating whether it agreed with the above statements and, if not, stating in what respects it did not agree. A letter from Deloitte & Touche LLP was attached as Exhibit 16 to the Company's Form 8-K, Ñled September 23, 2003, as amended by Form 8-K/A, Ñled October 6, 2003. On September 16, 2003, the Company engaged the accounting Ñrm of PricewaterhouseCoopers LLP as independent accountants to audit the Company's Ñnancial statements for the Ñscal year ending January 31, 2004. The decision to engage PricewaterhouseCoopers LLP was made by the Audit Committee of the Board of Directors of the Company. During the Ñscal years ended February 1, 2003 and February 2, 2002 and through the date hereof, the Company did not consult with PricewaterhouseCoopers LLP regarding any of the matters or reportable events set forth in Item 304(a)(2)(i) and (ii) of the Regulation S-K. Item 9A. Controls and Procedures: Evaluation of disclosure controls and procedures. As of January 31, 2004, an evaluation of the eÅectiveness of the Company's disclosure controls and procedures (as deÑned in Rule 13(a)-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the ""Exchange Act'')) was performed under the supervision and with the participation of the Company's management, including the Chief Executive OÇcer and Chief Finance OÇcer. Based on that evaluation, the Company's Chief Executive OÇcer and Chief Financial OÇcer have concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures were eÅective to ensure that information required to be disclosed by the Company in its reports that it Ñles or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods speciÑed in the Securities Exchange Commission rules and forms. Changes in internal control over Ñnancial reports. During the Company's fourth Ñscal quarter of 2003, there has been no change in the Company's internal controls over Ñnancial reporting (as deÑned in Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange Act) that has materially aÅected, or is reasonably likely to materially aÅect, the Company's internal controls over Ñnancial reporting. PART III Item 10. Directors and Executive OÇcers of the Registrant: Information contained under the captions ""Election of Directors,'' ""Meetings and Committees'' and ""Section 16(a) BeneÑcial Ownership Reporting and Compliance'' in the Registrant's Proxy Statement for its 41 2004 annual stockholders' meeting (the ""2004 Proxy Statement'') is incorporated by reference in response to this Item 10. The information in response to this Item 10 regarding executive oÇcers of the Company is contained in Item 1, Part I hereof under the caption ""Executive OÇcers'' of the Registrant''. Code of Ethics and Code of Business Conduct and Ethics The Company has adopted a written Code of Ethics (the ""Code of Ethics'') that applies to the Company's Chairman, President, and Chief Executive OÇcer, Executive Vice President, Chief Financial OÇcer and Secretary, and Senior Vice President, Controller. The Company has adopted a Code of Business Conduct and Ethics (the ""Code of Conduct'') that applies to all employees, oÇcers, and directors of the Company. The Code of Ethics and Code of Conduct are available on the Company's website at www.catocorp.com, under the ""Corporate Governance'' caption and print copies are available to any shareholder that requests a copy. Any amendments to the Code of Ethics or Code of Conduct, or any waivers of the Code of Ethics, or any waiver of the Code of Conduct for directors or executive oÇcers, will be disclosed on the Company's website promptly following the date of such amendment or waiver. Item 11. Executive Compensation: Incorporated by reference to Registrant's Proxy Statement for 2004. Item 12. Security Ownership of Certain BeneÑcial Owners and Management and Related Stockholder Matters Equity Compensation Plan Information. The following table provides information about stock options outstanding and shares available for future awards under all of Cato's equity compensation plans. The information is as of January 31, 2004. (a) (b) Plan Category Equity compensation plans approved by security holder ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Equity compensation plans not approved by security holders ÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Number of securities to be issued upon exercise of outstanding options, warrants and rights(1) Weighted-average exercise price of outstanding options, warrants and rights(1) 1,154,400 Ì 1,154,400 $11.54 Ì $11.54 (c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reÖected in column (a))(2) 669,087 Ì 669,087 (1) This column contains information regarding employee stock options only; there are no warrants or stock appreciation rights outstanding. (2) Includes the following: 406,600 shares available for grant under the Company's stock incentive plan, referred to as the ""1999'' Incentive Plan. Under this plan, non-qualiÑed stock options may be granted to key employees. No awards may be granted after 2004. Additionally, 14,318 shares available for grant under the Company's stock incentive plan, referred to as the ""1987'' Non-qualiÑed Stock Option Plan. Stock options have terms of 10 years, vest evenly over 5 years, and are assigned an exercise price of not less than the fair market value of the Company's stock on the date of grant; and 248,169 shares available under the 2003 Employee Stock Purchase Plan. Eligible employees may participate in the purchase of designated shares of the Company's common stock. The purchase price of this stock is equal to 85% of the lower of the closing price at the beginning or the end of each semi-annual stock purchase period. 42 Information contained under ""Security Ownership of Certain BeneÑcial Owners and Management and Related Stockholder Matters'' in the 2004 Proxy Statement is incorporated by reference in response to this Item. Item 13. Certain Relationships and Related Transactions: Information contained under the caption ""Certain Transactions'' in the 2004 Proxy Statement is incorporated by reference in response to this Item. Item 14. Principal Accountant Fees and Services: The information required by this Item is incorporated herein by reference to the section entitled ""Audit Fees'' in the 2004 Proxy Statement. PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K: (a) The following documents are Ñled as part of this report: (1) Financial Statements: Report of Independent Auditors (PricewaterhouseCoopers LLP) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Report of Predecessor Auditor (Deloitte & Touche LLP) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statements of Income for the Ñscal years ended January 31, 2004, February 1, 2003 and February 2, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Balance Sheets at January 31, 2004 and February 1, 2003ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statements of Cash Flows for the Ñscal years ended January 31, 2004, February 1, 2003 and February 2, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statements of Stockholders' Equity for the Ñscal years ended January 31, 2004, February 1, 2003 and February 2, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Notes to Consolidated Financial Statements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Page 19 20 21 22 23 24 25 (2) Financial Statement Schedules: The following report and Ñnancial statement schedules are Ñled herewith: Predecessor Independent Auditors' Consent ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Schedule II Ì Valuation and Qualifying Accounts and Reserves ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ S-1 S-2 All other schedules are omitted as the required information is inapplicable or the information is presented in the consolidated Ñnancial statements or related notes thereto. 43 (3) Index to Exhibits: The following exhibits are Ñled with this report or, as noted, incorporated by reference herein. Exhibit Number Description of Exhibit 3.1 3.2 4.1 4.2 10.1 10.2 10.3 10.4 10.5 16.1 21 23.1 23.2 31.1 31.2 32.1 32.2 Registrant's Restated CertiÑcate of Incorporation of the Registrant dated March 6, 1987, incorporated by reference to Form S-8 of the Registrant Ñled February 7, 2000. Registrant's By Laws incorporated by reference to Form S-8 of the Registrant Filed February 7, 2000. Loan Agreement, dated as of August 22, 2003, between the Registrant and Branch Banking and Trust Company (Not Ñled herewith. The Registrant hereby agrees to furnish a copy of this agreement to the Securities and Exchange Commission upon request.) Share Rights Agreement dated December 18, 2003, incorporated by reference to Form 8-A12G of the Registrant Ñled December 22, 2003 and as amended in Form 8-A12B/A Ñled on January 6, 2004. Employment Agreement dated May 20, 1999 between The Cato Corporation and John P. Derham Cato, incorporated by reference to Form 10-K of the Registrant for the Ñscal year ended January 29, 2000. 1999 Incentive Compensation Plan dated August 26, 1999, incorporated by reference to Form S-8 of the Registrant Ñled February 7, 2000. Agreement, dated as of August 29, 2003, between the Registrant and Wayland H. Cato, Jr., incorporated by reference to Form 8-K of the Registrant Ñled on July 22, 2003. Agreement, dated as of August 29, 2003, between the Registrant and Edgar T. Cato, incorporated by reference to Form 8-K of the Registrant Ñled on July 22, 2003. Retirement Agreements between Registrant and Wayland H. Cato, Jr. and Edgar T. Cato dated August 29, 2003 incorporated by reference to Form 10-Q of the Registrant for quarter ended August 2, 2003. Change in the Registrants Independent Accountants from Deloitte & Touche, LLP to PricewaterhouseCoopers, LLP eÅective September 16, 2003, incorporated by reference to Form 8-K of the Registrant Ñled September 23, 2003 and as amended in Form 8-K/A Ñled on October 6, 2003. Subsidiary of Registrant. Consent of Independent Accountants. Consent of Predecessor Independent Accountants. CertiÑcation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Chief Executive OÇcer. CertiÑcation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Chief Financial OÇcer. CertiÑcation pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Chief Executive OÇcer. CertiÑcation pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Chief Financial OÇcer. (b) Reports on Form 8-K: Form 8-K was Ñled on November 18, 2003 disclosing the November 18, 2003 Press Release regarding the Company's Ñnancial results for the third quarter of 2003. Form 8-A was Ñled on December 22, 2003 disclosing that on December 4, 2003 the Board of Directors of the Company adopted a Stockholder Rights Plan. Pursuant to General Instruction B on Form 8-K, any reports previously or in the future submitted under Items 9 and 12 are not deemed to be ""Ñled'' for the purpose of Section 18 of the Securities Exchange Act of 1934, as amended (the ""Exchange Act''), and the Company is not subject to the liabilities of that section. The Company is not incorporating, and will not incorporate, by reference these reports into a Ñling under the Securities Act of 1933, as amended, or the Exchange Act. 44 EXHIBIT INDEX Designation of Exhibit Page 46 Subsidiaries of the RegistrantÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21 23.1 Consent of Independent Accountants ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 47 23.2 Consent of Predecessor Independent AccountantsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ S-1 45 SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21 Name of Subsidiary State of Incorporation/Organization Name under which Subsidiary does Business CHW LLC Providence Insurance Company, Delaware A Bermudian Company CHW LLC Providence Insurance Company, Limited CatoSouth LLC Cato of Texas L.P. Cato Southwest, Inc. CaDel LLC CatoWest LLC Cedar Hill National Bank catocorp.com, LLC North Carolina Texas Delaware Delaware Nevada A Nationally Chartered Bank Delaware Limited CatoSouth LLC Cato of Texas L.P. Cato Southwest, Inc. CaDel LLC CatoWest LLC Cedar Hill National Bank catocorp.com, LLC 46 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in Registration Statement No. 333-96283 on Form S-8 pertaining to The Cato Corporation 1999 Incentive Compensation Plan, in Registration Statement No. 33-41314 on Form S-8 pertaining to The Cato Corporation 1987 Incentive Stock Option Plan, in Registration Statement No. 33-41315 on Form S-8 pertaining to The Cato Corporation 1987 NonqualiÑed Stock Option Plan, and in Registration Statement Nos. 33-69844 and 333-96285 on Forms S-8 pertaining to The Cato Corporation 1993 Employee Stock Purchase Plan, of our report dated March 31, 2004 relating to the Ñnancial statements and Ñnancial statement schedules, which appears in this Form 10-K. /s/ PricewaterhouseCoopers LLP Charlotte, North Carolina April 22, 2004 47 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. SIGNATURES By /s/ JOHN P. DERHAM CATO By /s/ MICHAEL O. MOORE The Cato Corporation Michael O. Moore Executive Vice President Chief Financial OÇcer and Secretary John P. Derham Cato Chairman, President and Chief Executive OÇcer By /s/ ROBERT M. SANDLER Robert M. Sandler Senior Vice President Controller Date: April 22, 2004 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/ JOHN P. DERHAM CATO /s/ GEORGE S. CURRIN John P. Derham Cato (Director) George S. Currin (Director) /s/ MICHAEL O. MOORE /s/ GRANT L. HAMRICK Michael O. Moore (Director) Grant L. Hamrick (Director) /s/ THOMAS E. CATO /s/ JAMES H. SHAW Thomas E. Cato (Director) James H. Shaw (Director) /s/ ROBERT W. BRADSHAW, JR. /s/ A.F. (PETE) SLOAN Robert W. Bradshaw, Jr. (Director) A.F. (Pete) Sloan (Director) 48 EXHIBIT 31.1 CHIEF EXECUTIVE OFFICER CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, John P. Derham Cato, Chairman, President and Chief Executive OÇcer of The Cato Corporation, certify that: 1. I have reviewed this Annual Report on Form 10-K of The Cato Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the Ñnancial statements, and other Ñnancial information included in this report, fairly present in all material respects the Ñnancial condition, results of operations and cash Öows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying oÇcer and I are responsible for establishing and maintaining disclosure controls and procedures (as deÑned in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the eÅectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the eÅectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; c) Disclosed in this report any change in the registrant's internal control over Ñnancial reporting that occurred during the registrant's most recent Ñscal quarter (the registrant's fourth Ñscal quarter in the case of an annual report) that has materially aÅected, or is reasonably likely to materially aÅect, the registrant's internal control over Ñnancial reporting; and 5. The registrant's other certifying oÇcer and I have disclosed, based on our most recent evaluation of internal control over Ñnancial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All signiÑcant deÑciencies and material weaknesses in the design or operation of internal control over Ñnancial reporting which are reasonably likely to adversely aÅect the registrant's ability to record, process, summarize and report Ñnancial information; and b) Any fraud, whether or not material, that involves management or other employees who have a signiÑcant role in the registrant's internal controls over Ñnancial reporting. Date: April 22, 2004 /s/ John P. Derham Cato John P. Derham Cato Chairman, President and Chief Executive OÇcer 49 EXHIBIT 31.2 CHIEF FINANCIAL OFFICER CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Michael O. Moore, Executive Vice President, Chief Financial OÇcer and Secretary of The Cato Corporation, certify that: 1. I have reviewed this Annual Report on Form 10-K of The Cato Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the Ñnancial statements, and other Ñnancial information included in this report, fairly present in all material respects the Ñnancial condition, results of operations and cash Öows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying oÇcer and I are responsible for establishing and maintaining disclosure controls and procedures (as deÑned in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the eÅectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the eÅectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; c) Disclosed in this report any change in the registrant's internal control over Ñnancial reporting that occurred during the registrant's most recent Ñscal quarter (the registrant's fourth Ñscal quarter in the case of an annual report) that has materially aÅected, or is reasonably likely to materially aÅect, the registrant's internal control over Ñnancial reporting; and 5. The registrant's other certifying oÇcer and I have disclosed, based on our most recent evaluation of internal control over Ñnancial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All signiÑcant deÑciencies and material weaknesses in the design or operation of internal control over Ñnancial reporting which are reasonably likely to adversely aÅect the registrant's ability to record, process, summarize and report Ñnancial information; and b) Any fraud, whether or not material, that involves management or other employees who have a signiÑcant role in the registrant's internal controls over Ñnancial reporting. Date: April 22, 2004 /s/ Michael O. Moore Michael O. Moore Executive Vice President Chief Financial OÇcer and Secretary 50 EXHIBIT 32.1 CERTIFICATION OF PERIODIC REPORT I, John P. Derham Cato, Chairman, President and Chief Executive OÇcer of The Cato Corporation, certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that on the date of this CertiÑcation: 1. the Annual Report on Form 10-K of the Company for the annual period ended January 31, 2004 (the ""Report'') fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. the information contained in the Report fairly presents, in all material respects, the Ñnancial condition and results of operations of the Company. Dated: April 22, 2004 /s/ John P. Derham Cato John P. Derham Cato Chairman, President and Chief Executive OÇcer 51 EXHIBIT 32.2 CERTIFICATION OF PERIODIC REPORT I, Michael O. Moore, Executive Vice President, Chief Financial OÇcer and Secretary of The Cato Corporation, certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that on the date of this CertiÑcation: 1. the Annual Report on Form 10-K of the Company for the annual period ended January 31, 2004 (the ""Report'') fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. the information contained in the Report fairly presents, in all material respects, the Ñnancial condition and results of operations of the Company. Dated: April 22, 2004 /s/ Michael O. Moore Michael O. Moore Executive Vice President Chief Financial OÇcer and Secretary 52 EXHIBIT 23.2 PREDECESSOR INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 333-96283 on Form S-8 pertaining to The Cato Corporation 1999 Incentive Compensation Plan, in Registration Statement No. 33-41314 on Form S-8 pertaining to The Cato Corporation 1987 Incentive Stock Option Plan, in Registration Statement No. 33-41315 on Form S-8 pertaining to The Cato Corporation 1987 NonqualiÑed Stock Plan, and in Registration Statement Nos. 33-69844 and 333-96285 on Forms S-8 pertaining to The Cato Corporation 1993 Employee Stock Purchase Plan, of our report dated April 21, 2003, with respect to the consolidated Ñnancial statements and Ñnancial statement schedule of the Cato Corporation included in and incorporated by reference in the Annual Report on Form 10-K for the year ended January 31, 2004. /s/ Deloitte & Touche LLP Charlotte, North Carolina April 22, 2004 S-1 VALUATION AND QUALIFYING ACCOUNTS Allowance for Doubtful Accounts(a) Balance at February 3, 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additions charged to costs and expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additions charged to other accounts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deductions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 5,422 5,913 1,052(d) (6,419)(e) Balance at February 2, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additions charged to costs and expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additions charged to other accounts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deductions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance at February 1, 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additions charged to costs and expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additions charged to other accounts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deductions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,968 4,763 887(d) (5,519)(e) 6,099 6,098 858(d) (6,720)(e) SCHEDULE II Reserve for Rental Commitments(b) (In thousands) $ 1,649 691 Ì (1,263) 1,077 1,000 Ì (1,121) 956 1,062 Ì (1,402) Allowance for Sales Returns(c) $ Ì Ì Ì Ì Ì 390 Ì Ì 390 10 Ì Ì Balance at January 31, 2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 6,335 $ 616 $400 (a) Deducted from trade accounts receivable. (b) Provision for the diÅerence between costs and revenues from non-cancelable subleases over the lease terms of closed stores. (c) Gross margin revenue on return sales. (d) Recoveries of amounts previously written oÅ. (e) Uncollectible accounts written oÅ. S-2 C o r p o r a t e I n fo r m a t i o n A copy of the Company’s Annual Report to the Securities and Exchange Independent Auditor PricewaterhouseCoopers LLP Commission (Form 10-K) for the Charlotte, North Carolina 28202 fiscal year ended January 31, 2004 is available to shareholders without charge upon written request to Mr. Michael O. Moore, Executive Corporate Counsel Robinson, Bradshaw & Hinson, P.A. Charlotte, North Carolina 28246 Vice President, Chief Financial Officer and Secretary, The Cato Corporation, Transfer Agent and Registrar Wachovia Bank, N.A. P.O. Box 34216, Charlotte, North Securities Transfer Department, CMG-5 Carolina 28234. Charlotte, North Carolina 28288 Corporate Headquarters The Cato Corporation 8100 Denmark Road Annual Meeting Notice The Annual Meeting of Shareholders 11:00 a.m., Thursday, May 27, 2004 Charlotte, North Carolina 28273-5975 Corporate Office, 8100 Denmark Road, Telephone: (704) 554-8510 Charlotte, NC 28273-5975 Mailing Address P.O. Box 34216 Charlotte, North Carolina 28234 M a rk e t & D i v i d e n d I n fo r m a t i o n The Company’s Class A Common Stock trades on the New York Stock Exchange (NYSE) under the symbol CTR. Below is the market range and dividend information for the four quarters of 2003 and 2002. 2003 First quarter Second quarter Third quarter Fourth quarter 2002 First quarter Second quarter Third quarter Fourth quarter Price High Low Dividend $20.50 $16.28 $.15 24.10 25.11 21.57 18.20 19.95 18.84 .16 .16 .16 Price High Low Dividend $27.21 $19.91 $.135 27.44 19.95 21.80 18.00 14.18 17.33 .15 .15 .15 As of March 29, 2004 the approximate number of record holders of the Company’s Class A Common Stock was 1,227 and there were 4 record holders of the Company’s Class B Common Stock. v a l u e . s t y l e . e x p r e s s i o n T H E C A T O C O R P O R A T I O N 8100 Denmark Road Charlotte, NC 28273-5975 www.catocorp.com 

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