SHOE CARNIVAL INC - Quarter Report: 2005 April (Form 10-Q)

Factors That May Effect Future Results

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.  For a more detailed discussion of certain risk factors, see “BUSINESS - Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended January 29, 2005.

General

Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to provide information to assist the reader in better understanding and evaluating our financial condition and results of operations.  We encourage you to read this in conjunction with our condensed consolidated financial statements and the notes to those statements included in Item 1 of this Quarterly Report on Form 10-Q, as well as our Annual Report on Form 10-K for fiscal year ended January 29, 2005 as filed with the SEC.  The discussion following gives effect to the restatement discussed in Note 4 to the condensed consolidated financial statements.

Overview

Shoe Carnival, Inc. is one of the nation’s largest and fastest-growing family footwear retailers.  As of April 30, 2005, we operated 260 stores in 24 states in the Midwest, South and Southeast regions of the United States.  We offer a distinctive shopping experience, a broad merchandise assortment and value to our customers while maintaining an efficient store level cost structure. 

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.

11

Critical Accounting Policies

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.  A valuation allowance has been provided for certain state operating losses recorded as a deferred tax asset.  We anticipate that future taxable income, and prior year taxable income during loss carryback periods, will not be sufficient 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.

Results of Operations

		Number of Stores												Store Square Footage						Comparable Store Sales Increase (Decrease)
Quarter Ended		Beginning Of Period			Opened			Closed			End of Period			Net Change			End of Period
April 30, 2005			255			5			0			260			52,000			2,987,000			5.5	%
May 1, 2004			237			11			0			248			114,000			2,866,000			(2.2	)%

12

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

		Thirteen Weeks Ended April 30, 2005			Thirteen Weeks Ended May 1, 2004
Net sales			100.0	%		100.0	%
Cost of sales (including buying, distribution and occupancy costs)			70.4			70.9
Gross profit			29.6			29.1
Selling, general and administrative expenses			23.6			23.9
Operating income			6.0			5.2
Interest expense			.1			.1
Income before income taxes			5.9			5.1
Income tax expense			2.2			2.0
Net income			3.7	%		3.1	%

Net Sales

Net sales increased $15.2 million to $160.7 million in the first quarter of 2005, a 10.5% increase over net sales of $145.5 million in the first quarter of 2004.  The increase was attributable to the sales generated by the 27 new stores opened in 2004 and 2005 (net of four stores closed in fiscal 2004) in addition to a comparable store sales increase of 5.5%.  We believe that the first quarter comparable store sales increase is most directly attributable to our continued focus on improving the fashion of our product offering.  We are pleased with the introduction of our new “Red Nose” advertising campaign during the first quarter.  This campaign playfully captures the vibrant and fun atmosphere of our stores, while also depicting the current fashion and styles a customer can expect from shopping with us.  We believe this type of image campaign will yield the long-term benefits we desire.

Gross Profit

Gross profit increased $5.2 million to $47.6 million in the first quarter of 2005, a 12.5% increase over gross profit of $42.4 million in the comparable prior year period.  Our gross profit margin for the first quarter of 2005 increased to 29.6% from 29.1% in the prior year.  This increase in profit margin resulted from a 0.2% increase in the merchandise gross profit margin coupled with a 0.3% reduction in buying, distribution and occupancy costs.  The reduction in buying, distribution and occupancy costs was primarily a result of leveraging occupancy costs against a higher sales base.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $3.1 million to $37.9 million in the first quarter of 2005 from $34.8 million in the comparable prior year period.  As a percentage of sales, these expenses decreased to 23.6% from 23.9% in the prior year primarily driven by the decrease in pre-opening costs and partially offset by higher health care costs.  Total pre-opening costs in the first quarter of 2005 were $193,000 or 0.1% of sales, as compared to $729,000 or 0.5% of sales in the first quarter of 2004.  We opened five new stores in the first quarter of 2005 versus opening 11 new stores in the first quarter of 2004. 

13

Interest Expense

The decrease in net interest expense to $133,000 in the first quarter of 2005 from $194,000 in the first quarter of 2004 resulted primarily from lower average borrowings.

Income Taxes

The effective income tax rate for the first quarter of 2005 decreased to 38.6% from 39.0% in the first quarter of 2004 due to lower state income taxes.  We expect our income tax rate for the fiscal year to be in the range of 38.5% to 39.0%.

Liquidity and Capital Resources

Our primary sources of funds are cash flows from operations and borrowings under our revolving credit facility.  Net cash used in operating activities was $5.2 million for the first quarter of 2005 as compared with net cash provided by operating activities of $1.0 million for the first quarter of 2004.  The change was primarily due to the timing related to the payment of accounts payable partially offset by the reduction in inventory levels during the first quarter of 2005.

Working capital increased to $129.4 million at April 30, 2005 from $124.2 million at May 1, 2004.  The current ratio at April 30, 2005 was 3.4 as compared to 3.3 at May 1, 2004.  Long-term debt as a percentage of total capital (long-term debt plus shareholders’ equity) at April 30, 2005 was 7.6% as compared to 14.9% at May 1, 2004.

Currently, we expect to open between 12 and 14 stores during fiscal 2005 and close six.  During the first quarter, five stores were opened versus 11 during the first quarter of the prior year.  No stores were closed during the first quarter in either the current or prior year.  We expect to open five or six stores and close one store in the second quarter.

Our current store prototype uses between 8,000 and 12,000 square feet depending upon, among other factors, the location of the store and the population base the store is expected to service.  Capital expenditures for a new store in 2005 are expected to average approximately $350,000 and lease incentives received from landlords are expected to average $22,000.  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 $47,000 per store in 2005 with individual stores experiencing variances in expenditure levels based on the specific market.

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 April 30, 2005 were $13.5 million and $5.8 million, respectively.  As of April 30, 2005, $50.7 million was available to us for additional borrowings under the credit facility.

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

Seasonality

Our quarterly results of operations have fluctuated and are expected to continue to fluctuate in the future primarily as a result of seasonal variances and the timing of sales and costs associated with opening new stores.  Non-capital expenditures, such as advertising and payroll, incurred prior to opening a new store are charged to expense as incurred.  Therefore, our results of operations may be adversely affected in any quarter in which we incur pre-opening expenses related to the opening of new stores. 

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

14

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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 $21,000 for the first three months of 2005 and $66,000 for the first three months of 2004.

ITEM 4.

CONTROLS AND PROCEDURES

Our Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation as of April 30, 2005, 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 April 30, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

15

SHOE CARNIVAL, INC.
PART II - OTHER INFORMATION

ITEM 6.

EXHIBITS

	(a)		Exhibits
		3-A	Restated Articles of Incorporation of Registrant (incorporated herein by reference from the same exhibit number to the Registrant’s Annual Report on Form 10-K for the year ended February 2, 2002)
		3-B	By-laws of Registrant, as amended to date (incorporated herein by reference from the same exhibit number to the Registrant’s Annual Report on Form 10-K for the year ended February 2, 2002)
		4	(i) Amended and Restated Credit Agreement and Promissory Notes dated April 16, 1999, between Registrant and Mercantile Bank National Association, First Union National Bank and Old National Bank (incorporated herein by reference from exhibit 4(I) to the Registrant’s Annual Report on Form 10-K for the year ended January 30, 1999)
			(ii) Amendment to Amended and Restated Credit Agreement and Promissory Notes dated March 24, 2000, between Registrant and Mercantile Bank National Association, First Union National Bank and Old National Bank (incorporated herein by reference from the same exhibit number to the Registrant’s Annual Report on Form 10-K for the year ended January 29, 2000)
			(iii) Second Amendment to Amended and Restated Credit Agreement and Promissory Notes dated November 8, 2000, between Registrant and Firstar Bank N.A., First Union National Bank, Old National Bank and LaSalle Bank National Association (incorporated herein by reference from the same exhibit number to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended October 28, 2000)
			(iv) Third Amendment to Amended and Restated Credit Agreement and Promissory Notes dated March 18, 2002, between Registrant and U.S. Bank National Association, First Union National Bank, Old National Bank and LaSalle Bank National Association (incorporated herein by reference from the same exhibit number to the Registrant’s Annual Report on Form 10-K for the year ended February 2, 2002)
			(v) Fourth Amendment to Amended and Restated Credit Agreement and Promissory Notes dated March 12, 2003, between Registrant and U.S. Bank National Association, Wachovia Bank National Association, Old National Bank and LaSalle Bank National Association (incorporated herein by reference from the same exhibit number to the Registrant’s Annual Report on Form 10-K for the year ended February 1, 2003)
			(vi) Fifth Amendment to Amended and Restated Credit Agreement and Promissory Notes dated April 5, 2004, between Registrant and U.S. Bank National Association, Wachovia Bank National Association, Old National Bank and LaSalle Bank National Association (incorporated herein by reference from the same exhibit number to the Registrant’s Annual Report on Form 10-K for the year ended January 31, 2004)
			(vii) Assignment Agreement dated June 1, 2004 among LaSalle Bank National Association as Assignor, Fifth Third Bank (Southern Indiana) as Assignee, Registrant as Borrower and U.S. Bank National Association as Agent relating to the Amended and Restated Credit Agreement as further amended (incorporated herein by reference from the same exhibit number to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended May 1, 2004)

16

	(a)		Exhibits
			(viii) Sixth Amendment to Amended and Restated Credit Agreement and Notes dated April 5, 2005, between Registrant and U.S. Bank National Association, Wachovia Bank National Association, Fifth Third Bank (Southern Indiana) and Old National Bank (incorporated herein by reference from the same exhibit number to the Registrant’s Current Report on Form 8-K filed on April 11, 2005)
		31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
		31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
		32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
		32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

17

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.

Date:  June 9, 2005	SHOE CARNIVAL, INC.
	(Registrant)
	By:	/s/ W. KERRY JACKSON
		W. Kerry Jackson
		Executive Vice President and
		Chief Financial Officer

18