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 January 31, 2009.

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 January 31, 2009 as filed with the SEC.

Overview of Our Business

Shoe Carnival, Inc. is one of the nation's largest family footwear retailers. As of August 1, 2009, we operated 314 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 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 2, 2009           304          10         1         313         78,000     3,413,000        (0.3 )%
August 1, 2009        313          2          1         314          6,000     3,419,000        (6.4 )%
Year-to-date 2009     304          12         2         314         84,000     3,419,000        (3.3 )%

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 )%
Year-to-date 2008     291          14         2         303        103,000     3,341,000        (3.0 )%

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           Twenty-six          Twenty-six
                                        Weeks Ended         Weeks Ended         Weeks Ended         Weeks Ended
                                      August 1, 2009      August 2, 2008      August 1, 2009      August 2, 2008
Net sales                                     100.0 %             100.0 %             100.0 %             100.0 %
Cost of sales (including buying,
    distribution and occupancy costs)          73.2                73.4                72.6                72.2
Gross profit                                   26.8                26.6                27.4                27.8
Selling, general and
    administrative expenses                    25.6                25.7                24.7                24.9
Operating income                                1.2                 0.9                 2.7                 2.9
Interest income                                 0.0                 0.0                 0.0                 0.0
Interest expense                                0.0                 0.0                 0.1                 0.0
Income before income taxes                      1.2                 0.9                 2.6                 2.9
Income tax expense                              0.6                 0.3                 1.0                 1.1
Net income                                      0.6 %               0.6 %               1.6 %               1.8 %

Operational Summary

While consumer spending and the overall economic environment remained challenging in the second quarter of fiscal 2009, we were able to improve our year-over-year gross and operating margins for the second quarter and, therefore, record earnings per share equal to last year. We believe these results demonstrate the strength of our business model and our ability to effectively manage the controllable aspects of our business, particularly operating expenses, inventory, and our marketing and merchandising strategies.

Our net sales declined in the second quarter of fiscal 2009, compared to the prior year, primarily due to a decline in customer traffic. Comparable store sales fell 6.4%. We believe the absence of government stimulus checks, which were provided to consumers during the second quarter last year, was one of the contributing factors for the decline in traffic. In addition, sales-tax-free holidays in nine of our states shifted from the second quarter, where they were reported in fiscal 2008, into the third quarter this year. The shift in these sales-tax-free holidays, which have historically created a significant incentive for the consumer to shop, accounted for approximately 2% of our comparable store sales decline for the second quarter of fiscal 2009.

We tightly controlled selling, general and administrative expenses during the second quarter of fiscal 2009. This resulted in year-over-year savings of $1.7 million, despite opening two new stores during the quarter and operating 11 more stores than the same period last year. Approximately 30% of this savings was due to shifting a portion of our advertising into the third quarter to coincide with the shift in sales-tax-free holidays.

We experienced a favorable start to the third quarter of fiscal 2009, as the consumer responded well to both our athletic and non-athletic product assortments to satisfy their back-to-school needs. While considerable uncertainty remains regarding discretionary spending by consumers after the back-to-school period, we remain optimistic about our sales trend for the third quarter of fiscal 2009. Our management team has been through many economic cycles and we will continue to conservatively manage the controllable aspects of our business until we have better clarity with respect to a sustained economic recovery.

Results of Operations for the Second Quarter Ended August 1, 2009

Net Sales

Net sales decreased $5.7 million to $152.8 million during the second quarter ended August 1, 2009, a 3.6% decrease from the prior year's second quarter net sales of $158.5 million. The decrease in net sales was due to a comparable store sales decline of 6.4% in addition to the loss of sales from the 13 stores closed since the beginning of the second quarter of last year. Approximately 2% of the comparable store sales decline was attributable to the sales-tax-free holiday shift that occurred in nine of our states. These sales-tax-free holidays shifted from the second quarter, where they were reported in fiscal 2008, into the third quarter this year. This combined decrease was partially offset by an $8.1 million increase in sales generated by the new stores opened since the beginning of the second quarter of fiscal 2008.

Gross Profit

Gross profit decreased $1.2 million to $40.9 million in the second quarter of fiscal 2009 from gross profit of $42.1 million in the comparable prior year period. The gross margin in the second quarter of fiscal 2009 increased 0.2% from the same period last year to 26.8%. The merchandise margin increased 0.4%, largely as a result of efforts during the first quarter to liquidate seasonal product and enter the second quarter of fiscal 2009 with a fresher product assortment requiring less promotional pricing. While occupancy costs increased as a result of operating an additional 11 stores at the end of the second quarter of fiscal 2009 compared to the prior year, we were able to more than offset this increase through cost savings initiatives within our buying and distribution functions. However, as a percentage of sales, these costs increased 0.2% relative to the second quarter of fiscal 2008 due to the decrease in net sales.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased $1.7 million in the second quarter of fiscal 2009 to $39.0 million, or 25.6% of sales, from $40.7 million, or 25.7% of sales, in the comparable prior year period. Even though we operated an additional 11 stores at the end of the second quarter of fiscal 2009 compared to the prior year period, we were able to achieve expense savings in a number of store-level categories including supplies, depreciation and advertising. Advertising decreased $468,000, primarily due to the shift in the sales-tax-free holidays.

Pre-opening costs included in selling, general and administrative expenses were $153,000, or 0.1% of sales, for the second quarter of fiscal 2009 as compared to $406,000, or 0.3% of sales, for the second quarter of fiscal 2008. We opened two stores in the second quarter of fiscal 2009 as compared to 12 stores in the second quarter of fiscal 2008.

Interest (Income) Expense, Net

We recorded net interest expense of $41,000 in the second quarter of fiscal 2009 as compared to net interest income of $3,000 in the second quarter of the prior year. As returns available on short-term investments fell to record lows, we held our excess funds in non-interest bearing deposit accounts to offset bank service fees.

Income Taxes

The effective income tax rate for the second quarter of fiscal 2009 increased to 47.3% from 34.3% for the second quarter of fiscal 2008. During the second quarter of both fiscal years, our rate was primarily impacted by the true up of the prior year estimated annual income tax rate.

Results of Operations for the Six Months Ended August 1, 2009

Net Sales

Net sales decreased $490,000 to $320.1 million during the six months ended August 1, 2009, from net sales of $320.6 million in the comparable prior year period. The decrease in net sales was due to a comparable store sales decline of 3.3% in addition to the loss of sales from the 13 stores closed since the beginning of fiscal 2008. Approximately 1% of the comparable store sales decline was attributable to the sales-tax-free holiday shift that occurred in nine of our states. These sales-tax-free holidays shifted from the second quarter, where they were reported in fiscal 2008, into the third quarter this year. This decrease was offset by a $17.3 million increase in sales generated by the new stores opened since the beginning of fiscal 2008.

Gross Profit

Gross profit decreased $1.6 million to $87.6 million in the first six months of fiscal 2009 from gross profit of $89.2 million in the comparable prior year period. The gross margin in the first half of fiscal 2009 decreased 0.4% from the same period last year to 27.4%. The merchandise margin decreased 0.4%, largely as a result of aggressive liquidation of non-athletic footwear in the first quarter of fiscal 2009. Both as a percentage of sales and in dollars, buying, distribution and occupancy costs remained flat with prior year. While occupancy costs increased on a year-over-year basis as a result of operating additional stores, we were able to offset this increase through cost savings initiatives within our buying and distribution functions.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased $908,000 to $79.1 million, or 24.7% of sales, in the first half of fiscal 2009 from $80.0 million, or 24.9% of sales, in the comparable prior year period. Even though we operated additional stores during the first half of fiscal 2009 compared to the prior year period, we were able to achieve expense savings in a number of store-level categories, including depreciation and advertising. These savings were partially offset by an increase of $583,000 in employee health care, incentives and benefits.

Pre-opening costs included in selling, general and administrative expenses were $634,000, or 0.2% of sales, for the first half of fiscal 2009 as compared to $440,000, or 0.1% of sales, for the first half of fiscal 2008. We opened 12 stores in the first six months of fiscal 2009 as compared to 14 stores in the first six months of fiscal 2008. 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.

We recorded net interest expense of $80,000 in the first half of fiscal 2009 as compared to net interest income of $7,000 in the first half of the prior year. As returns available on short-term investments fell to record lows, we held our excess funds for the majority of the first half of fiscal 2009 in non-interest bearing deposit accounts to offset bank service fees.

Income Taxes

The effective income tax rate for the first six months of fiscal 2009 increased to 39.2% from 37.7% compared to the same time period in 2008. The annual effective income tax rate is expected to be approximately 39.0%.

Liquidity and Capital Resources

Our primary sources of funds are cash flows from operations and borrowings under our revolving credit facility. Our net cash used in operations was $2.0 million in the first six months of fiscal 2009 as compared to net cash provided by operations of $13.8 million in the first six months of 2008. The change in operating cash flow, when comparing the two periods of each year, was primarily due to an increase in merchandise inventories, partially offset by related accounts payable. During the second quarter of fiscal 2008, given the adverse economic conditions, we lessened our historical back-to-school build up of inventory levels and as a result reduced our per-store inventories compared to the prior year period thus generating cash flow. We continued to reduce our per-store inventories in the second half of fiscal 2008. For the fiscal 2009 back-to-school season, we followed a more normalized inventory build cycle and did not reduce per-store inventories further on a year-over-year basis. Together with operating an additional 11 stores as compared to the second quarter of fiscal 2008, this increase in per-store inventories resulted in a use of cash in fiscal 2009.

Working capital increased to $159.1 million at August 1, 2009 from $147.9 million at August 2, 2008. Approximately $7.6 million of this increase was attributable to the merchandise inventories required to operate the additional 11 stores open on August 1, 2009 as compared to August 2, 2008. The current ratio at August 1, 2009 was 2.8 as compared to 2.7 at August 2, 2008. We had no interest bearing long-term debt as of the end of either period.

During the first half of fiscal 2009, we expended $5.5 million in cash for the purchase of property and equipment. Of this expenditure, $4.3 million was used for new stores, store remodeling and store relocation projects. An additional $685,000 was used to begin the remediation of our distribution center's material handling system. The remaining capital expenditures were used primarily for information technology and miscellaneous equipment purchases.

We opened 12 new stores during the first half of fiscal 2009 and we anticipate opening an additional four stores during the second half of the year. Capital expenditures of approximately $4.4 million to $6.2 million will be made during the second half of fiscal 2009. Our projected capital expenditures include a range of $300,000 to $2.3 million for further remediation of our distribution center's material handling system. The actual amount expended at the distribution center will be dictated by the level of remediation effort that can reasonably be undertaken during the second half of fiscal 2009. The remaining capital expenditures will be incurred for the opening of new stores, store remodels and various other store improvements, along with continued investments in technology and normal asset replacement activities. We currently anticipate receiving an additional $1.1 million in landlord incentives through the end of fiscal 2009. The 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 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. For fiscal 2009, our new stores will average proximately 9,700 square feet. Capital expenditures for a new store in fiscal 2009 are expected to average approximately $341,000 and tenant improvement allowances are expected to average $94,000. The average inventory investment in a new store is expected to range from $350,000 to $500,000 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 $68,000 per store in fiscal 2009.

As of August 1, 2009, our unsecured credit agreement provided for up to $95.0 million in cash advances and commercial and standby letters of credit. Borrowings under the revolving credit line are based on eligible inventory. The credit agreement contains the following covenants: (1) Total Shareholders' Equity, adjusted for the effect of any share repurchases, will not fall below . . .