SCVL Shoe Carnival Inc

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Factors That May Affect 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 continental United States in which our stores are located and the impact of the ongoing economic crisis in Puerto Rico on sales at, and cash flows of, our stores located in Puerto Rico; the effects and duration of economic downturns and unemployment rates; 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; our ability to successfully manage and execute our marketing initiatives and maintain positive brand perception and recognition; 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; the impact of unauthorized disclosure or misuse of personal and confidential information about our customers, vendors and employees; our ability to manage our third-party vendor relationships; 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, including our entry into major new markets, and the availability of sufficient funds to implement our growth plans; higher than anticipated costs or impairment charges associated with the closing of underperforming stores; our ability to successfully grow our e-commerce sales; the inability of manufacturers to deliver products in a timely manner; changes in the political and economic environments in China, Brazil, Europe and East Asia, where the primary manufacturers of footwear are located; the impact of regulatory changes in the United States and the countries where our manufacturers are located; the continued favorable trade relations between the United States and China and the other countries which are the major manufacturers of footwear; the resolution of litigation or regulatory proceedings in which we are or may become involved; our ability to meet our labor needs while controlling costs; and future stock repurchases under our stock repurchase program and future dividend payments. 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 30, 2016.

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 thereto 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 30, 2016 as filed with the SEC.

Overview of Our Business

Shoe Carnival, Inc. is one of the nation’s largest family footwear retailers, providing the convenience of shopping at any of our over 400 store locations or online at shoecarnival.com. Our stores combine competitive pricing with a fun and promotional, in-store marketing effort that encourages customer participation and injects fun and surprise into every shopping experience. We believe this fun and 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. A similar customer experience is reflected in our e-commerce site through special promotions and limited time sales, along with relevant fashion stories featured on our home page.

Our objective is to be the destination retailer-of-choice for a wide range of consumers seeking value 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 in four general categories - women’s, men’s, children’s and athletics. Our traditional store carries approximately 27,100 pairs of shoes. In addition to footwear, our stores carry selected accessory items such as socks, belts, shoe care items, handbags, jewelry, scarves and wallets. Our e-commerce site offers customers an opportunity to choose from a large selection of products in all of the same categories of footwear with a depth of sizes and colors that may not be available in some of our smaller stores, and introduces our concept to consumers who are new to Shoe Carnival, in both existing and new markets.

Critical Accounting Policies

It is necessary for us to include certain judgments in our reported financial results.  These judgments involve estimates based in part on our historical experience and incorporate the impact of the current general economic climate and company-specific circumstances.  However, because future events and economic conditions are inherently uncertain, our actual results could differ materially from these estimates.  Our accounting policies that require more significant judgments include those with respect to merchandise inventories, valuation of long-lived assets, insurance reserves and income taxes and are discussed in our Annual Report on Form 10-K for the fiscal year ended January 30, 2016.

There have been no material changes to our critical accounting policies and estimates disclosed in our Annual Report on Form 10-K for the fiscal year ended January 30, 2016. See Note 3 to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for information on recently issued accounting pronouncements.

Comparable store sales for the periods indicated include stores that have been open for 13 full months after such store’s grand opening 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. We include e-commerce sales in our comparable store sales. Due to our multi-channel retailer strategy, we view the e-commerce sales as an extension of our physical stores.

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

Executive Summary for Second Quarter Ended July 30, 2016

Unseasonable weather early in the second quarter had a negative impact on sales, particularly in our seasonal product categories. As weather normalized in June, we experienced a rebound in sales and ended the month with a low mid-single digit increase in comparable store sales. Although we continued to see positive results in sales of seasonable product late in the second quarter, our customers shopped closer to need during the key back-to-school sales period, an ongoing trend we have seen over the past several years, and we ended the second quarter with a comparable store sales increase of 0.5 percent. Although sales for the second quarter were below expectation, we ended the quarter with inventories down 2.5 percent on a per store basis, which leaves us well positioned for the second half of fiscal 2016 and the holiday selling season. Additional highlights for the second quarter of fiscal 2016 are as follows:

Results of Operations for the Second Quarter Ended July 30, 2016

Net Sales

Net sales increased $4.1 million to $231.9 million during the second quarter of fiscal 2016, a 1.8% increase over the prior year's second quarter net sales of $227.8 million. Of this increase in net sales, $5.8 million was attributable to the sales generated by the 25 new stores we opened since the beginning of the second quarter of fiscal 2015 and $1.2 million was attributable to the 0.5% increase in comparable store sales. Slower than anticipated athletic sales and a mid single-digit decline in store traffic limited our comparable store sales increase during the second quarter. Despite the decrease in traffic, we benefited from a combination of higher conversion rates, average sales per transaction, average units per transaction and average units retail. The increase in sales was partially offset by a loss in sales of $2.9 million from 13 stores closed since the beginning of the second quarter of fiscal 2015.

Gross Profit

Gross profit increased to $67.2 million during the second quarter of fiscal 2016 compared to gross profit of $66.3 million for the second quarter of fiscal 2015. Our gross profit margin decreased to 29.0% compared to 29.1% in the second quarter of fiscal 2015. Our merchandise margin decreased 0.4% primarily due to expenses related to our multi-channel sales initiatives. Buying, distribution and occupancy costs decreased 0.3% as a percentage of sales during the second quarter of fiscal 2016 compared to the same period last year primarily due to leveraging expenses against a higher sales base and a decrease in freight costs.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $2.2 million in the second quarter of fiscal 2016 to $60.6 million. As a percentage of sales, these expenses increased to 26.1% in the second quarter of fiscal 2016 from 25.6% in the second quarter of fiscal 2015. Significant changes in expenses between the comparative periods included the following:

probability of the vesting of performance-based stock awards and the net impact of the related adjustments on stock-based compensation expense.

Pre-opening costs included in selling, general and administrative expenses were $353,000 in the second quarter of fiscal 2016 compared to $166,000 in the second quarter last year. We opened nine new stores in the second quarter of fiscal 2016 compared to five new stores in the second quarter of fiscal 2015. 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 in which 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 in selling, general and administrative expenses were $74,000 in the second quarter of fiscal 2016. Store closing costs were $724,000, or 0.3% as a percentage of sales, in the second quarter last year. No stores were closed in the second quarter of fiscal 2016 compared to six stores in the second quarter of fiscal 2015.

Income Taxes

The effective income tax rate for the second quarter of fiscal 2016 was 38.0% as compared to 38.8% for the same time period in fiscal 2015. Our provision for income tax expense is based on the current estimate of our annual effective tax rate and is adjusted as necessary for quarterly events.

Results of Operations for Six Month Period Ended July 30, 2016

Net Sales

Net sales increased $11.8 million to $492.4 million for the six-month period ended July 30, 2016, a 2.5% increase compared to net sales of $480.6 million for the six-month period ended August 1, 2015. Of the $11.8 million increase in net sales, approximately $11.6 million was attributable to the 32 new stores we opened since the beginning of fiscal 2015 and $7.5 million was attributable to our increase in comparable store sales. These increases were partially offset by a loss of $7.3 million in sales from the 19 stores closed since the beginning of fiscal 2015. Comparable store sales for the six-month period ended July 30, 2016, increased 1.6%.

Gross Profit

Gross profit increased $1.8 million to $142.8 million in the first six months of fiscal 2016. The gross profit margin for the first six months of fiscal 2016 decreased to 29.0% from 29.3% as reported in the comparable prior year period. The merchandise margin decreased 0.7% primarily due to expenses related to our multi-channel sales initiatives. Buying, distribution and occupancy costs decreased $532,000 during the first six months of fiscal 2016, or 0.4% as a percentage of sales, compared to the same period last year primarily due to leveraging expenses against a higher sales base and a decrease in freight costs.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $2.8 million in the first six months of fiscal 2016 to $118.8 million, but as a percentage of sales remained flat at 24.1% compared to the first six months of fiscal 2015. Significant changes in expense between the comparative periods included the following:

In the first six months of fiscal 2016, pre-opening costs included in selling, general and administrative expenses were $463,000, or 0.1% as a percentage of sales, compared to $593,000, or 0.1% as a percentage of sales, in the same period last year. 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 in which 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 $296,000, or 0.1% as a percentage of sales, in the first six months of fiscal 2016. Store closing costs and a non-cash impairment charge of long-lived assets were $1.2 million, or 0.3% as a percentage of sales, in the first six months of last year. We closed four stores in the first six months of fiscal 2016 and 12 stores were closed in the first six months of fiscal 2015.

Income Taxes

The effective income tax rate for the first six months of fiscal 2016 was 38.1% compared to 38.8% for the same period in fiscal 2015. Our provision for income tax expense is based on the current estimate of our annual effective tax rate and is adjusted as necessary for quarterly events. The decrease in the effective income tax rate between periods was primarily due to changes in state tax rates.

Liquidity and Capital Resources

We anticipate that our existing cash and cash flows from operations will be sufficient to fund our planned store expansion along with other capital expenditures, working capital needs, potential dividend payments, potential share repurchases under our share repurchase program, and various other commitments and obligations, as they arise, for at least the next 12 months.

Cash Flow - Operating Activities

Our net cash provided by operating activities was $12.6 million in the first six months of fiscal 2016 compared to net cash used in operating activities of $3.1 million in the first six months of fiscal 2015. These amounts reflect our income from operations adjusted for non-cash items and working capital changes. The year-over-year change in operating cash flow was primarily driven by the timing of payments for accounts payable and accrued liabilities.

Working capital decreased to $269.9 million at July 30, 2016, from $284.6 million at August 1, 2015, primarily due to an increase in accounts payable offset by increases in cash and inventory compared to the second quarter of the prior year. The current ratio was 3.0 as of July 30, 2016, compared to 3.4 at August 1, 2015 .

Cash Flow - Investing Activities

Our cash outflows for investing activities are primarily for capital expenditures. During the first six months of fiscal 2016, we expended $11.9 million for the purchase of property and equipment, of which $11.7 million was for new stores, remodeling and relocations. During the first six months of fiscal 2015, we expended $16.7 million for the purchase of property and equipment, of which $11.3 million was for new stores, remodeling and relocations. The remaining capital expenditures in both periods were for continued investments in technology and normal asset replacement activities.

Cash Flow - Financing Activities

Cash outflows for financing activities have represented cash dividend payments and share repurchases. Shares of our common stock can be either acquired as part of a publicly announced repurchase program or withheld by us in connection with employee payroll tax withholding upon the vesting of restricted stock awards. Our cash inflows from financing activities have represented proceeds from the issuance of shares as a result of stock option exercises and purchases under our Employee Stock Purchase Plan.

During the first six months of fiscal 2016, net cash used in financing activities was $27.9 million compared to net cash used in financing activities of $2.4 million in the first six months of fiscal 2015. The increase in cash used in financing activities between the two respective periods was primarily attributable to the common stock purchased under our share repurchase program during the first six months of fiscal 2016. No shares were purchased under our share repurchase program during the first six months of fiscal 2015.

Capital Expenditures

Capital expenditures for fiscal 2016, including actual expenditures during the first six months, are expected to be between $20 million and $21 million. Approximately half of our total capital expenditures are expected to be used for new stores and the other half will be used for store relocations and remodels. Lease incentives to be received from landlords during fiscal 2016, including actual amounts received during the first six months, are expected to be approximately $4 to $5 million. The actual amount of cash required for capital expenditures for store operations depends in part on the number of new stores opened and relocated, the amount of lease incentives, if any, received from landlords and the number of stores remodeled.

Store Openings and Closings

We utilize a formalized review process in our evaluation of potential new store sites as well as for decisions surrounding leases on existing store locations. Our approach is both qualitative and quantitative in nature. We look to continually enhance this process and utilize real estate specific software tools for portfolio analysis. These enhancements aid us in identifying the best possible locations for future expansion and identifying potential store closings and relocations. We believe this will enable us to realize positive long-term financial performance of our portfolio.

In fiscal 2016, we anticipate opening approximately 20 new stores, including seven small-market stores. We opened 12 stores in the first six months of fiscal 2016, including three small-market stores. Pre-opening expenses, including rent, freight, advertising, salaries and supplies, are expected to total approximately $1.9 million for fiscal 2016, or an average of $96,000 per store. During fiscal 2015, we opened 20 new stores and expended $1.9 million on pre-opening expenses, or an average of $96,000 per store. The opening of new stores is 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.

We closed four stores during the first six months of fiscal 2016. Twelve stores were closed during the first six months of fiscal 2015. Currently, we have six additional store closings scheduled for the third and fourth quarters of fiscal 2016. 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 cost incurred in terminating the lease. We will continue to review our annual store growth rate based on our view of the internal and external opportunities and challenges in the marketplace.

Dividends

On June 16, 2016, our Board of Directors approved the payment of our second quarter cash dividend to our shareholders.  The dividend of $0.07 per share was paid on July 18, 2016 to shareholders of record as of the close of business on July 5, 2016.

The declaration and payment of any future dividends are at the discretion of the Board of Directors and will depend on our results of operations, financial condition, business conditions and other factors deemed relevant by our Board of Directors.

Credit Facility

Our unsecured credit agreement provides for up to $50.0 million in cash advances and commercial and standby letters of credit with borrowing limits based on eligible inventory. It contains covenants which stipulate: (1) Total Shareholders’ Equity, adjusted for the effect of any share repurchases, will not fall below that of the prior fiscal year-end; (2) the ratio of funded debt plus rent to EBITDA plus rent will not exceed 2.5 to 1.0; and (3) cash dividends for a fiscal year will not exceed 30% of consolidated net income for the immediately preceding fiscal year, and in no event may the total distributions in any fiscal year exceed 25% of the prior year’s ending net worth. We were in compliance with these covenants as of July 30, 2016. Should a default condition be reported, the lenders may preclude additional borrowings and call all loans and accrued interest at their discretion. There were no borrowings outstanding under the credit facility and letters of credit outstanding were $1.3 million at July 30, 2016. As of July 30, 2016, $48.7 million was available to us for additional borrowings under the credit facility.

Share Repurchase Program

On December 9, 2015, our Board of Directors authorized a new share repurchase program for up to $50 million of outstanding common stock, effective January 1, 2016. The purchases may be made in the open market or through privately negotiated transactions, from time-to-time through December 31, 2016, and in accordance with applicable laws, rules and regulations. On January 21, 2016, we entered into a stock repurchase plan for the purpose of repurchasing shares of our common stock in accordance with guidelines specified under Rule 10b5-1 of the Exchange Act. After its expiration, we entered into another such plan on June 28, 2016 (collectively, the “Rule 10b5-1 Plans”). The Rule 10b5-1 Plans were established pursuant to, and as part of, our share repurchase program and permit shares to be repurchased in accordance with pre-determined criteria when repurchases would otherwise be prohibited, such as during self-imposed blackout periods, or under insider trading laws. The share repurchase program may be amended, suspended or discontinued at any time and does not commit us to repurchase shares of our common stock. We have funded, and intend to continue to fund, the share repurchase program from cash on hand, and any shares acquired will be available for stock-based compensation awards and other corporate purposes. The actual number and value of the shares to be purchased will depend on the performance of our stock price and other market conditions.

During the second quarter of fiscal 2016, we repurchased 966,828 shares of common stock at a total cost of $23.6 million under the new share repurchase program. As of July 30, 2016, approximately 1.2 million shares at an aggregate cost of $29.5 million had been repurchased under the new share repurchase program. The amount that remained available under the share repurchase program at July 30, 2016 was $20.5 million.

Seasonality and Quarterly Results

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 the opening of 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. To prepare for our peak shopping seasons, we must order and keep in stock significantly more merchandise than we would carry during other parts of the year. Any unanticipated decrease in demand for our products during these peak shopping seasons could require us to sell excess inventory at a substantial markdown, which could reduce our net sales and gross margins and negatively affect our profitability. Our operating results depend significantly upon the sales generated during these periods.