Factors That May Effect Future Results

This Quarterly Report on Form 10-Q contains forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, 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; the effects and duration of the current economic downturn and the ailing credit markets; changes in the overall retail environment and more specifically in the apparel and footwear retail sectors; our ability to generate increased sales at our stores; 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; the impact of disruptions in our distribution or information technology operations; the effectiveness of our inventory management; the impact of hurricanes or other natural disasters on our stores, as well as on consumer confidence and purchasing in general; risks associated with the seasonality of the retail industry; our ability to successfully execute our growth strategy, including the availability of desirable store locations at acceptable lease terms, our ability to open new stores in a timely and profitable manner and the availability of sufficient funds to implement our growth plans; 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, Brazil, Spain and East Asia, the primary manufacturers of footwear; and the continued favorable trade relations between the United States and China and the other countries which are the major manufacturers of footwear. For a more detailed discussion of certain risk factors see the "Risk Factors" section of our Annual Report on Form 10-K for the fiscal year ended February 2, 2008.

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 PART I, ITEM 1 FINANCIAL STATEMENTS of this Quarterly Report on Form 10-Q, as well as our Annual Report on Form 10-K for the fiscal year ended February 2, 2008 as filed with the SEC.

Overview of Our Business

Shoe Carnival, Inc. is one of the nation's largest family footwear retailers. As of November 1, 2008, we operated 310 stores in 29 states primarily 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.

Critical Accounting Policies

It is necessary for us to include certain judgments in our reported financial results. These judgments involve estimates that are inherently uncertain and actual results could differ materially from these estimates. The accounting policies that require the more significant judgments 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 events such as these occur, the assets subject to impairment are adjusted to estimated fair value and, if applicable, 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 judgment and if actual results or market conditions differ from those anticipated, additional losses may be recorded.

Income Taxes - We calculate income taxes in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes" ("SFAS No. 109") and account for uncertain tax positions in accordance with Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of Financial Accounting Standards Board ("FASB") Statement No. 109" ("FIN 48"). Under SFAS No. 109, 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 estimated tax rates in effect in the years when those temporary differences are expected to reverse. Under FIN 48, we are required to make many subjective assumptions and judgments regarding our income tax exposures. Interpretations of and guidance surrounding income tax laws and regulations are often complex, ambiguous and change over time. As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in the consolidated financial statements.

Insurance Reserves - We use a combination of self-insurance and third-party insurance for workers' compensation, employee medical and general liability insurance. These plans have stop-loss provisions that protect us from individual and aggregate losses over specified dollar values. When estimating our self-insured liabilities, we consider a number of factors, including historical claims experience, severity factors, statistical trends and, in certain instances, valuation assistance provided by independent third-parties. We will continue to evaluate our self-insured liabilities and the underlying assumptions on a quarterly basis and make adjustments as needed. The ultimate cost of these claims may be greater than or less than the established accruals. While we believe that the recorded amounts are adequate, there can be no assurance that changes to management's estimates will not occur due to limitations inherent in the estimating process. In the event we determine an accrual should be increased or reduced, we will record such adjustments in the period in which such determination is made.

Results of Operations Summary Information

                                    Number of Stores                Store Square Footage
                      Beginning                          End of      Net           End        Comparable
Quarter Ended         Of Period    Opened      Closed    Period     Change      of Period    Store Sales
May 3, 2008              291          2          0        293        16,000     3,254,000       (4.9 )%
August 2, 2008           293         12          2        303        87,000     3,341,000       (1.0 )%
November 1, 2008         303          8          1        310        62,000     3,403,000       (5.0 )%
Year-to-date 2008        291         22          3        310       165,000     3,403,000       (3.7 )%

May 5, 2007              271          7          0        278        66,000     3,128,000       (3.7 )%
August 4, 2007           278          6          0        284        59,000     3,187,000       (7.1 )%
November 3, 2007         284         11          2        293        78,000     3,265,000       (5.0 )%
Year-to-date 2007        271         24          2        293       203,000     3,265,000       (5.0 )%

Comparable store sales for the periods indicated include stores that have been open for 13 full months prior to the beginning of the period, including those stores that have been relocated or remodeled. Therefore, stores opened or closed during the periods indicated are not included in comparable store sales.

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

                                             Thirteen             Thirteen            Thirty-nine          Thirty-nine
                                            Weeks Ended          Weeks Ended          Weeks Ended          Weeks Ended
                                         November 1, 2008     November 3, 2007     November 1, 2008     November 3, 2007
Net sales                                          100.0 %              100.0 %              100.0 %              100.0 %
Cost of sales (including buying,
    distribution and occupancy costs)               72.8                 70.9                 72.4                 71.5
Gross profit                                        27.2                 29.1                 27.6                 28.5
Selling, general and
    administrative expenses                         24.9                 25.1                 24.9                 24.9
Operating income                                     2.3                  4.0                  2.7                  3.6
Interest income                                      0.0                 (0.1 )                0.0                 (0.1 )
Interest expense                                     0.0                  0.1                  0.0                  0.0
Income before income taxes                           2.3                  4.0                  2.7                  3.7
Income tax expense                                   0.8                  1.6                  1.0                  1.3
Net income                                           1.5 %                2.4 %                1.7 %                2.4 %

Operational Summary

Labor Day marked the end of our all important back-to-school season. While we generated slightly positive comparable store sales in August, sales for the balance of the third quarter declined as the consumer once again retreated to a conservative shopping pattern. This trend led to lower customer traffic and a comparable store sales decrease of 5.0% during the third quarter of fiscal 2008.

Despite the challenging economic climate, we achieved an increase in the average net price of our footwear and achieved higher average purchases per ticket, both in terms of dollars spent and units purchased. Our merchants remained focused on inventory control and were able to decrease our per store inventory levels by 8% compared to the prior year. The anticipated increase in the cost of footwear materialized in the third quarter and we were successful in passing most of these costs through to the consumer. However, due to the promotional nature of the footwear industry during the third quarter, these increased costs outweighed the higher average net price we were able to achieve on our footwear sales. This contributed to lower merchandise margins during the third quarter as compared to the prior year.

Despite the protracted economic downturn, we believe we have the management discipline, correct operating strategies and financial strength to maintain profitable operations on an annual basis. We also believe these strengths will enable us to continue expanding our market share to enhance shareholder value. Raising the net realized price of our footwear, putting downward pressure on inventory levels to improve turnover, controlling expenses and continuing to maintain a strong balance sheet with a healthy cash position will remain our priorities through fiscal 2009.

Results of Operations for the Third Quarter Ended November 1, 2008

Net Sales

Net sales decreased $3.8 million to $170.1 million during the third quarter ended November 1, 2008, a 2.2% decrease from net sales of $173.9 million in the third quarter ended November 3, 2007. The decrease in net sales was primarily due to a 5.0% decrease in comparable store sales, which was partially offset by a $4.6 million increase in sales generated by the 38 new stores opened since July of fiscal 2007, net of sales lost from the eight stores which were closed during this same period.

Gross Profit

Gross profit decreased $4.3 million to $46.3 million in the third quarter of fiscal 2008 from gross profit of $50.6 million in the comparable prior year period. Our gross profit margin in the third quarter of fiscal 2008 decreased to 27.2% from 29.1% in the comparable prior year period. During the quarter, heavy promotions were necessary in the women's non-athletic category to keep inventory turning at an acceptable level. This was the primary cause of the 1.1% decrease in our merchandise margin compared to the prior year. Additionally, we experienced a 0.8% increase in occupancy costs, as a percentage of sales, primarily as a result of the lower comparable store sales and an increase in costs due to the additional stores we operated in the third quarter of 2008.

Selling, General and Administrative Expenses

In the third quarter of fiscal 2008, selling, general and administrative expenses decreased $1.2 million to $42.4 million, or 24.9% of sales, from $43.6 million, or 25.1% of sales, in the comparable prior year period. The $1.2 million in savings was primarily the result of a $1.5 million reduction in advertising costs from our decision to decrease advertising during non-peak periods along with a $1.0 million decrease in the expense for employee incentives and benefits. These decreases were partially offset by $1.6 million of additional costs incurred from the operation and support of the net new stores opened since July of fiscal 2007.

Pre-opening costs were $386,000, or 0.2% of sales, for the third quarter of fiscal 2008 as compared to $407,000, or 0.2% of sales, for the third quarter of fiscal 2007. We opened eight stores in the third quarter of fiscal 2008 as compared to 11 stores in the third quarter of fiscal 2007. Pre-opening costs, such as advertising, payroll and supplies, incurred prior to the opening of a new store are charged to expense in the period they are incurred. The total amount of pre-opening expense incurred will vary by store depending on the specific market and the promotional activities involved.

Interest (Income) Expense, Net

We recorded net interest income of $20,000 in the third quarter of fiscal 2008 as compared to net interest expense of $14,000 in the third quarter of the prior year. This increase in interest income was primarily the result of an increase in the cash available for short-term investment.

Income Taxes

The effective income tax rate for the third quarter of fiscal 2008 decreased to 34.0% from 39.5% for the same time period in fiscal 2007. The reduction in rate was primarily due to the decrease in our federal taxable rate from the maximum of 35% to approximately 33.6% based on our projected reduction in taxable income. This adjustment to lower the year-to-date federal rate was reflected in our third quarter income tax expense.

Net Income

Net income for the third quarter of fiscal 2008 decreased to $2.6 million, or $0.21 per diluted share, from $4.2 million, or $0.33 per diluted share, in the third quarter of fiscal 2007.

Our average diluted shares outstanding at the end of the third quarter of fiscal 2008 were 12.5 million or approximately 1.9% lower than the 12.8 million average diluted shares outstanding at the end of the third quarter last year. This decrease was primarily due to the 1.2 million shares repurchased in fiscal 2007 as part of our $50.0 million share repurchase program.

Results Of Operations for the Nine Months Ended November 1, 2008

Net Sales

Net sales decreased $3.6 million to $490.7 million during the nine months ended November 1, 2008, from net sales of $494.3 million in the comparable prior year period. The decrease in net sales was primarily due to a 3.7% decrease in comparable store sales, which was partially offset by a $13.5 million increase in sales generated by the 47 new stores opened since February 3, 2007, net of sales lost from the eight stores which were closed during this same period.

Gross Profit

Gross profit decreased $5.1 million to $135.5 million in the first nine months of fiscal 2008 from gross profit of $140.6 million in the comparable prior year period. Our gross profit margin in the first nine months of fiscal 2008 decreased to 27.6% from 28.5% in the comparable prior year period. The merchandise margin decreased 0.4%, while buying, distribution and occupancy costs increased 0.5% as a percentage of sales. We experienced a 0.6% increase in occupancy costs, as a percentage of sales, primarily as a result of the lower comparable store sales and an increase in costs due to the additional stores we operated throughout the year. This increase, as a percentage of sales, was partially offset by a 0.2% decline in distribution costs. Our distribution costs, both as a percentage of sales and in dollars, declined primarily as a result of costs associated with the conversion to our new distribution center during the first quarter of the prior year.

Selling, general and administrative expenses decreased $697,000 to $122.4 million in the first nine months of fiscal 2008 from $123.1 million in the comparable prior year period. For both periods, selling, general and administrative expenses represented 24.9% of sales. The $697,000 in savings was primarily the result of a $4.2 million reduction in advertising costs along with a $1.3 million decrease in expense for employee incentives and benefits. Our decision to lower advertising costs was based on current market trends, store performance and an overall decrease in advertising during non-peak periods. These decreases were partially offset by $4.1 million of additional costs incurred from the operation and support of the net new stores opened since February of fiscal 2007.

Pre-opening costs were $826,000, or 0.2% of sales, for the first nine months of fiscal 2008 as compared to $963,000, or 0.2% of sales, for the first nine months of fiscal 2007. We opened 22 stores in the first nine months of fiscal 2008 as compared to 24 stores in the first nine months of fiscal 2007. Pre-opening costs, such as advertising, payroll and supplies, incurred prior to the opening of a new store are charged to expense in the period they are incurred. The total amount of pre-opening expense incurred will vary by store depending on the specific market and the promotional activities involved.

Store closing costs included in selling, general and administrative expenses were $1.1 million, or 0.2% of sales, for the first nine months of fiscal 2008 as compared to $525,000, or 0.1% of sales, for the first nine months of fiscal 2007. Three stores were closed during the first nine months of fiscal 2008 and two stores were closed during the first nine months of fiscal 2007. We expect to close nine stores during the remainder of fiscal 2008 as compared to three stores in the last quarter of fiscal 2007. We will continue to evaluate underperforming stores for possible closing on a routine basis, which may result in the identification of additional store closings for the current or future fiscal years. The timing and actual amount of expense recorded in closing a store can vary significantly depending in part on the period in which management commits to a closing plan, the remaining basis in the fixed assets to be disposed of at closing and the amount of any lease buyout.

Interest (Income) Expense, Net

We recorded net interest income of $27,000 in the first nine months of fiscal 2008 as compared to net interest income of $432,000 in the first nine months of the prior year. This decrease in interest income was primarily the result of a decline in the cash available for short-term investment.

Income Taxes

The effective income tax rate for the first nine months of fiscal 2008 increased to 36.6% from 35.0% compared to the same time period in 2007. Our federal income tax rate was lower than last year due to lower taxable income while our state tax rate was higher than last year because during fiscal 2007 we experienced a one-time reduction in state income taxes from state incentives related to the investment in our new distribution center.

Net Income

For the first nine months of fiscal 2008, net income decreased to $8.4 million, or $0.67 per diluted share, from $11.7 million, or $0.87 per diluted share, in the first nine months of fiscal 2007.

Our average diluted shares outstanding at the end of the first nine months of fiscal 2008 were 12.5 million or approximately 6.6% lower than the 13.4 million average diluted shares outstanding at the end of the first nine months last year. This decrease was primarily due to the 1.2 million shares repurchased in fiscal 2007 as part of our $50.0 million share repurchase program.

Our primary sources of funds are cash flows from operations and borrowings under our revolving credit facility. Our net cash provided by operations was $10.8 million in the first nine months of fiscal 2008 as compared to net cash used in operations of $2.3 million in the first nine months of 2007, for an increase of net cash provided by operations of $13.1 million. This difference, when comparing the two periods of each year, was primarily due to a reduction in inventory on a per store basis and the timing of payments for accounts payable and accrued liabilities partially offset by a decrease in net income.

Working capital decreased to $150.4 million at November 1, 2008 from $154.5 million at November 3, 2007 primarily as a result of our reduction in inventory. The current ratio at November 1, 2008 was 3.3 compared to 3.4 at November 3, 2007. We had no long-term debt at November 1, 2008 compared to $14.2 million at November 3, 2007.

We expended $12.6 million in cash during the first nine months of fiscal 2008 for the purchase of property and equipment. Of this amount, $10.2 million was used for new stores, store remodeling and store relocation projects. The remaining capital expenditures were used primarily for information technology and miscellaneous equipment purchases. Additional capital expenditures of approximately $5.0 million will be made over the course of fiscal 2008 for the opening of new stores, store remodels and various other store improvements. During the nine months ended November 1, 2008, we received $817,000 in lease incentives from our landlords and we anticipate receiving a total of $2.0 million in lease incentives from our landlords for fiscal 2008.

During the first nine months of fiscal 2008, we opened 22 new stores. This compares to 24 store openings in the first nine months of fiscal 2007. We anticipate opening two additional stores and closing nine stores during the remainder of fiscal 2008. Throughout the year, our actual amount of cash required for capital expenditures for store operations depends in part on the number of new stores opened, the amount of lease incentives, if any, received from landlords and the number of stores 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 current store prototype uses between 6,500 and 12,000 square feet depending . . .