SHOE CARNIVAL INC - Quarter Report: 2004 July (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Common Stock, $.01 par value, 12,829,605 shares outstanding as of September 1, 2004

See notes to condensed consolidated financial statements.

See notes to condensed consolidated financial statements.

See notes to condensed consolidated financial statements.

See notes to condensed consolidated financial statements.

SHOE CARNIVAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited

Note 1 - Basis of Presentation

In our opinion, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to present fairly our financial position and the results of our operations and our cash flows for the periods presented. Certain information and disclosures normally included in notes to consolidated financial statements have been condensed or omitted according to the rules and regulations of the Securities and Exchange Commission, although we believe that the disclosures are adequate to make the information presented not misleading. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. The condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto contained in our Annual Report on Form 10-K for fiscal year ended January 31, 2004.

Net income per share of common stock is based on the weighted average number of shares and common share equivalents outstanding during the period. The following table presents a reconciliation of our basic and diluted weighted average common shares outstanding as required by Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share":

For the quarters ended July 31, 2004 and August 2, 2003, 320,500 and 299,400 options, respectively, were not included in the computation of diluted shares because the options' exercise prices were greater than the average market price for the period. For the six months ended July 31, 2004 and August 2, 2003, 310,700 and 300,400 options, respectively, were not included in the computation of diluted shares because the options' exercise prices were greater than the average market price for the period.

SFAS No. 123, "Accounting for Stock-Based Compensation", requires that companies either recognize compensation expense for grants of stock options and other equity instruments based on fair value, or provide pro forma disclosure of net income and net income per share in the notes to the financial statements. At July 31, 2004, we had three stock-based compensation plans: the 1993 Stock Option and Incentive Plan, the Outside Directors Stock Option Plan and the 2000 Stock Option and Incentive Plan. We account for these plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. Accordingly, no compensation cost has been recognized under SFAS No. 123 for our stock option plans. Had compensation cost for the awards under those plans been determined based on

the grant date fair values, consistent with the method required under SFAS No. 123, our net income and net income per share would have been reduced to the pro forma amounts indicated below:

The weighted-average fair value of options granted was $8.43 for the six months ended July 31, 2004 and $6.91 for the six months ended August 2, 2003. The fair value of these options was estimated at grant date using Black-Scholes option pricing model with the following weighted average assumptions:

Under Item 1.01, "Entry into a Material Definitive Agreement", we disclosed a stock option grant made in connection with the promotion of an executive officer. This disclosure incorporated by reference the full text of the stock option plan and provided as exhibits the Form of Notice of Grant of Stock Option and Option Agreement for incentive and non-qualified stock option grants. Under Items 2.05 and 2.06, "Costs Associated with Exit or Disposal Activities" and "Material Impairments", we disclosed the recent closing of a store and the plan to close another store. The expected closing expenses and cash outlay for both stores are $460,000 and $339,000, respectively. Both closings are expected to be recorded in the third quarter.

Certain amounts in the condensed consolidated financial statements have been reclassified to conform to the current presentation.

Our stores combine competitive pricing with a highly promotional, in-store marketing effort that encourages customer participation and creates a fun and exciting shopping experience. We believe this highly promotional atmosphere results in various competitive advantages, including increased multiple unit sales; the building of a loyal, repeat customer base; the creation of word-of-mouth advertising; and enhanced sell through of in-season goods. Our objective is to be the destination store-of-choice for a wide range of consumers seeking moderately priced, current season name brand and private label footwear. Our product assortment includes dress and casual shoes, sandals, boots and a wide assortment of athletic shoes for the entire family. We believe that by offering a wide selection of both athletic and non-athletic footwear, we are able to reduce our exposure to shifts in fashion preferences between those categories. Our ability to identify and react to fashion changes is a key factor in our sales and earnings performance.

Our marketing effort targets middle income, value-conscious consumers seeking name brand footwear for all age groups. We believe that by offering a wide selection of popular styles of name brand merchandise at competitive prices, we generate broad customer appeal. Our cost-efficient store operations and real estate strategy enable us to price products competitively and earn attractive store level returns. Low labor costs are achieved by housing merchandise directly on the selling floor in an open-stock format, enabling customers who choose to serve themselves. This reduces the staffing required to assist customers and reduces store level labor costs as a percentage of sales. We prefer to locate stores predominantly in strip shopping centers in order to take advantage of lower occupancy costs and maximize our exposure to value-oriented shoppers.

It is necessary for us to include certain judgements in our reported financial results. These judgements involve estimates that are inherently uncertain and actual results could differ materially from these estimates. The accounting policies that require the more significant judgements are:

Merchandise Inventories - Merchandise inventories are stated at the lower of cost or market using the first-in, first-out (FIFO) method. In determining market value, we estimate the future sales price of items of merchandise contained in the inventory as of the balance sheet date. Factors considered in this determination include, among others, current and recently recorded sales prices, the length of time product has been held in inventory and quantities of various product styles contained in inventory. The ultimate amount realized from the sale of certain product could differ materially from our estimates. We also estimate a shrinkage reserve for the period between the last physical count and the balance sheet date. The estimate for the shrinkage reserve can be affected by changes in merchandise mix and changes in actual shrinkage trends.

Valuation of Long-Lived Assets - We review long-lived assets whenever events or circumstances indicate the carrying value of an asset may not be recoverable and annually when no such event has occurred. We evaluate the ongoing value of assets associated with retail stores that have been open longer than one year. When undiscounted cash flows estimated to be generated by those assets are less than the carrying value of those assets, impairment losses are recorded. When events such as these occur, the impaired assets are adjusted to estimated fair value and an impairment loss is recorded in selling, general and administrative expenses. Our assumptions and estimates used in the evaluation of impairment, including current and future economic trends for stores, are subject to a high degree of judgement and if actual results or market conditions differ from those anticipated, additional losses may be recorded.

Deferred Income Taxes - We calculate income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", which requires the use of the asset and liability method. Under this method, deferred tax assets and liabilities are recognized based on the difference between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the tax rates in effect in the years when those temporary differences are expected to reverse. Inherent in the measurement of these deferred balances are certain judgments and interpretations of existing tax law and other published guidance as applied to our operations. No valuation allowance has been provided for the deferred tax assets. We anticipate that future taxable income, and prior year taxable income during loss carryback periods, will be able to recover the full amount of deferred tax assets. Our effective tax rate considers our judgment of expected tax liabilities in the various taxing jurisdictions within which we are subject to tax. We have also been involved in tax audits. At any given time, multiple tax years are subject to audit by various taxing authorities.

The following table sets forth our results of operations expressed as a percentage of net sales for the periods indicated:

Net sales increased $12.3 million to $283.6 million in the first half of 2004, a 4.5% increase over net sales of $271.3 million in the comparable prior year period. The increase was attributable to the sales generated by the 50 new stores opened in fiscal 2003 and the first half of 2004 (net of seven store closings), partially offset by a 2.8% decrease in comparable store sales.

We believe net sales for the second quarter were negatively impacted by slower consumer spending in June and July in addition to sales tax free holidays in several states being shifted from the end of July last year to the beginning of August this year. The aforementioned, combined with the effect of our first quarter shift in advertising strategies and the decision to reduce the number of entire stock "buy one, get one at half price" promotions, resulted in the year to date sales for both comparable stores and new stores to be below our expectations.

Gross profit increased $1.3 million to $38.3 million in the second quarter of 2004, a 3.5% increase over gross profit of $37.0 million in the comparable prior year period. Our gross profit margin increased to 27.7% from 27.5%. As a percentage of sales, the merchandise gross profit margin increased 0.9%, but due to lower sales productivity during the quarter we deleveraged our buying, distribution and occupancy costs by 0.7%.

Gross profit increased $2.9 million to $80.7 million in the first half of 2004, a 3.7% increase over gross profit of $77.8 million in the comparable prior year period. Our gross profit margin decreased to 28.5% from 28.7% for the first six months of 2003. As a percentage of sales, the merchandise gross profit margin increased 0.5%, but buying, distribution and occupancy costs increased 0.7% as a result of lower sales productivity.

Selling, general and administrative expenses increased $588,000 to $34.9 million in the second quarter of 2004 from $34.3 million in the comparable prior year period. As a percentage of sales, these expenses decreased to 25.3% from 25.5% last year. During the second quarter of 2004, we opened two stores as compared to 11 stores opened in the second quarter of 2003. Total pre-opening costs in the second quarter of 2004 were $147,000 or 0.1% of sales, as compared to $828,000 or 0.6% of sales, for the second quarter of 2003. As a percentage of sales, store selling expenses increased 0.1% despite a 0.5% reduction in pre-opening costs. However, we were able to leverage general and administrative expenses as a percentage of sales by 0.3% by holding actual expenses to a level below that of the prior year comparative period.

Selling, general and administrative expenses increased $2.8 million to $69.7 million in the first half of 2004 from $66.9 million in the comparable prior year period. As a percentage of sales, these expenses decreased to 24.6% from 24.7% last year. Total pre-opening costs in the first half of 2004 were $876,000 or 0.3% of sales, as compared to $1.6 million or 0.6% of sales, in the first half of 2003. Thirteen stores were opened in the first half of 2004 and 24 stores were opened in the first half of 2003.

Net interest expense increased to $178,000 in the second quarter of 2004 from $176,000 in the second quarter of the prior year. For the first six months of 2004, net interest expense increased to $371,000 from $342,000 for the first six months of 2003. The increase experienced in both periods was primarily as a result of higher average borrowings.

Our primary sources of funds are cash flows from operations and borrowings under our revolving credit facility. Net cash provided by operating activities was $3.8 million for the first six months of 2004 as compared with $746,000 for the first six months of 2003.

Working capital increased to $135.8 million at July 31, 2004 from $113.2 million at August 2, 2003. The current ratio at July 31, 2004 was 2.8 as compared to 2.5 at August 2, 2003. Long-term debt as a percentage of total capital (long-term debt plus shareholders' equity) at July 31, 2004 was 17.6% as compared to 16.8% at August 2, 2003.

The increase in working capital was primarily due to the increase in merchandise inventories. Merchandise inventories increased $18.7 million to $190.7 million at July 31, 2004 compared with $172.0 million at August 2, 2003. While this represents a 10.9% increase to merchandise inventories it resulted in only a 1.6% increase on a per store basis.

Capital expenditures, net of lease incentives of $392,000, were $6.7 million in the first half of 2004. Of these expenditures, $3.4 million was incurred for new stores, $1.8 million for store remodeling and relocation and all other expenditures totaled $1.5 million.

During the first half of 2004, we opened 13 new stores with two of these opening in the second quarter, bringing the total stores in operation to 250 at July 31, 2004. We anticipate opening nine stores in the second half of the current fiscal year. Of the 24 stores opened during the first half of 2003, 11 stores were opened in the second quarter.

Our current store prototype uses between 8,000 and 15,000 square feet depending upon, among other factors, the location of the store and the population base the store is expected to service. Net capital expenditures for a new store in 2004 are expected to average approximately $310,000. The average inventory investment in a new store is expected to range from $450,000 to $750,000 depending on the size and sales expectation of the store and the timing of the new store opening. Pre-opening expenses, such as advertising, salaries and supplies, are expected to average approximately $80,000 per store for fiscal year 2004 with individual stores experiencing variances in expenditure levels based on the specific market.

The actual amount of cash requirements for capital expenditures depends in part on the number of new stores we open, the amount of lease incentives, if any, received from landlords and the number of stores relocated and remodeled. The opening of new stores will be dependent upon, among other things, the availability of desirable locations, the negotiation of acceptable lease terms and general economic and business conditions affecting consumer spending in areas we target for expansion.

Our unsecured credit facility provides for up to $70 million in cash advances on a revolving basis and commercial letters of credit. Borrowings under the revolving credit line are based on eligible inventory. Borrowings and letters of credit outstanding under the credit facility at July 31, 2004 were $32.5 million and $9.8 million, respectively. As of July 31, 2004, $27.7 million was available to us for additional borrowings under the credit facility.

We anticipate existing cash and cash flow from operations, supplemented by borrowings under the credit facility, will be sufficient to fund planned expansion and other operating cash requirements for at least the next 12 months.

We have three distinct selling periods: Easter, back-to-school and Christmas.

This report on Form 10-Q contains forward-looking statements that involve a number of risks and uncertainties. A number of factors could cause our actual results, performance, achievements or industry results to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. These factors include, but are not limited to: general economic conditions in the areas of the United States in which our stores are located; changes in the overall retail environment and more specifically in the apparel and footwear retail sectors; the potential impact of national and international security concerns on the retail environment; changes in our relationships with key suppliers; the impact of competition and pricing; changes in weather patterns, consumer buying trends and our ability to identify and respond to emerging fashion trends; risks associated with the seasonality of the retail industry; the availability of desirable store locations at acceptable lease terms and our ability to open new stores in a timely and profitable manner; higher than anticipated costs associated with the closing of underperforming stores; the inability of manufacturers to deliver products in a timely manner; changes in the political and economic environments in the People's Republic of China, a major manufacturer of footwear; and the continued favorable trade relations between the United States and China and other countries which are the major manufacturers of footwear.

We are exposed to market risk in that the interest payable under our credit facility is based on variable interest rates and therefore is affected by changes in market rates. We do not use interest rate derivative instruments to manage exposure to changes in market interest rates. A 1% change in the weighted average interest rate charged under the credit facility would have resulted in interest expense fluctuating by approximately $128,000 for the first six months of 2004 and $109,000 for the first six months of 2003.

Our Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation as of July 31, 2004, that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by us in such reports is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

There have been no changes in our internal control over financial reporting that occurred during the quarter ended July 31, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Messrs. Mark L. Lemond and James A. Aschleman were elected at the annual meeting to serve as our Directors for a three-year term. Mr. Lemond received 10,434,364 votes in favor, no votes were cast against and 989,493 abstentions were recorded with respect to such appointment. Mr. Aschleman received 10,112,300 votes in favor, no votes were cast against and 1,311,557 abstentions were recorded with respect to such appointment.

In addition, the following Directors continue in office until the annual meeting of shareholders in the year indicated:

The appointment of Deloitte & Touche LLP as our auditor for 2004 was ratified. Votes of 11,351,970 were cast in favor, 70,282 votes were cast against, 1,605 abstentions were recorded, and no broker non-votes were recorded with respect to such ratification.

ITEM 6.   EXHIBITS

SHOE CARNIVAL, INC.
SIGNATURE

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