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Form 10-K for BROWN SHOE CO INC


2-Apr-2013

Annual Report


ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

Business Overview

We are a global footwear company, with annual net sales of $2.6 billion, that puts consumers and their needs first, by targeting family, healthy living and contemporary fashion platforms. Our mission is to inspire people to feel good and live better...feet first! We offer the consumer a powerful portfolio of footwear stores and global footwear brands. As both a retailer and a wholesaler, we have a perspective on the marketplace that enables us to serve consumers from different vantage points. We believe our diversified business model provides us with synergies by spanning consumer segments, categories and distribution channels. A combination of talent acquisition, thoughtful planning and rigorous execution is key to our success in optimizing our business and brand portfolio.

Retail

In our retail business, our focus is on meeting the needs of a well-defined consumer by providing an assortment of trend-right, brand-name fashion and athletic footwear at a great price coupled with engaging marketing programs and exclusive products. Our family platform includes Famous Footwear, which is one of America's leading family branded footwear retailers with 1,055 stores. Our Specialty Retail segment operates 222 retail stores in the United States and Canada, primarily under the Naturalizer name, including 26 stores in China. Our Specialty Retail segment also includes Shoes.com and our other e-commerce businesses, with the exception of Famous.com, which is included in our Famous Footwear segment.

Wholesale

Our wholesale business is consumer focused and we believe our success is dependent upon our ability to strengthen consumers' preference for our brands by offering compelling style, quality, differentiated brand promises and innovative marketing campaigns. Our healthy living and contemporary fashion platforms are comprised of the Dr. Scholl's Shoes, Naturalizer, Sam Edelman, Franco Sarto, LifeStride, Avia, Via Spiga, Ryka, Fergie, Carlos, Vera Wang, Nevados and Vince brands. Through these brands we offer our customers a diversified portfolio, each designed and targeted to a specific consumer segment within the marketplace. We are able to showcase many of our brands in our retail stores, leveraging our wholesale and retail platforms, sharing consumer insights across our businesses and testing new and innovative products.

Financial Highlights

2012 was a year of solid performance. We continue to successfully execute and deliver, due in part to our portfolio realignment initiatives. In 2012 we hit several milestones at Famous Footwear, by achieving record-breaking sales as well as our highest annual operating profit, both on a 52-week basis. We also strengthened our balance sheet, by reducing short-term borrowings by $96.0 million and reduced our selling and administrative expenses by $18.3 million. We continued to successfully execute and deliver under our portfolio realignment initiatives.

The following is a summary of the financial highlights for 2012:


Consolidated net sales increased $15.3 million, or 0.6%, to $2,598.1 million in 2012, compared to $2,582.8 million last year. Net sales of our Famous Footwear segment increased $58.0 million, while we experienced decreases at our Wholesale Operations and Specialty Retail segments of $25.7 million and $17.1 million, respectively.

Consolidated operating earnings were $61.6 million in 2012, compared to $35.6 million last year.

Consolidated net earnings attributable to Brown Shoe Company, Inc. were $27.5 million, or $0.64 per diluted share, in 2012, compared to $24.6 million, or $0.56 per diluted share, last year.

Our accounting period is based upon a traditional retail calendar, which ends on the Saturday nearest January 31. Periodically, this results in a fiscal year that includes 53 weeks. Our 2012 fiscal year included 53 weeks, while both our 2011 and 2010 fiscal years had only 52 weeks. The difference in the number of weeks included in our fiscal years can affect annual comparisons. The inclusion of the 53rd week resulted in an increase to net sales in our retail divisions of $21.2 million with an immaterial impact on net earnings in 2012.

The following items should be considered in evaluating the comparability of our results:

Portfolio realignment - Our portfolio realignment initiatives include selling The Basketball Marketing Company, Inc. ("TBMC") (markets and sells footwear bearing the AND 1 brand name, which was acquired with American Sporting Goods Corporation ("ASG")); exiting certain women's specialty and private label brands; exiting the children's wholesale business; closing two U.S. distribution centers; closing or relocating numerous underperforming or poorly aligned retail stores; closing facilities in China; and other infrastructure changes. The termination of the Etienne Aigner license agreement is also considered part of the Company's portfolio realignment initiatives. We incurred costs of $29.9 million ($19.3 million after-tax, or $0.45 per diluted share) related to our portfolio realignment initiatives during 2012. In 2011, we sold TBMC for a gain of $20.6 million ($14.0 million after-tax, or $0.32 per diluted share). Also in 2011, we incurred costs related to portfolio realignment initiatives of $19.2 million ($12.0 million after-tax, or $0.28 per diluted share). There were no corresponding charges in 2010. See Note 4 to the consolidated financial statements for additional information.

Incentive plans - Our selling and administrative expenses were higher by $17.6 million during 2012, compared to last year, due to higher anticipated payments under our cash and stock-based incentive plans. Our selling and administrative expenses were lower by $20.6 million during 2011, compared to 2010, due to lower anticipated payments under our cash and stock-based incentive plans.

Organizational change - During 2012, we incurred costs of $2.3 million ($1.4 million after-tax, or $0.03 per diluted share) related to an organizational change made at our corporate headquarters, with no corresponding costs in 2011 or 2010. See Note 4 to the consolidated financial statements for additional information related to this change.

ASG acquisition and integration costs - We incurred costs of $0.7 million ($0.4 million after-tax, or $0.01 per diluted share) during 2012 related to the integration of ASG. In 2011, we incurred costs related to the acquisition and integration of ASG of $6.5 million ($4.5 million after-tax, or $0.11 per diluted share) and in 2010 we incurred costs related to the acquisition of ASG of $1.1 million ($0.7 million after-tax, or $0.02 per diluted share). All of these costs were recorded within restructuring and other special charges, net. See Note 2 and Note 4 to the consolidated financial statements for additional information.

ERP stabilization - During 2011, our results were negatively impacted during the stabilization of our new ERP system (implemented in 2010) due to increases in allowances and customer charge backs, margin related to lost sales and incremental stabilization costs. We estimate that the impact of these items reduced earnings before income taxes by $12.8 million ($7.8 million after-tax, or $0.18 per diluted share), net of a $3.3 million recovery from a third-party service provider, in 2011.

Acquisition related cost of goods sold adjustment - During 2011, we incurred costs of $4.2 million ($2.5 million after-tax, or $0.05 per diluted share), associated with the impact to cost of goods sold of the inventory fair value adjustment in connection with the acquisition of ASG, with no corresponding costs during 2012 or 2010. See Note 2 to the consolidated financial statements for additional information related to these costs.

Loss on early extinguishment of debt - During 2011, we incurred expenses of $1.0 million ($0.6 million after-tax, or $0.02 per diluted share) to extinguish our senior notes prior to maturity in 2012. There were no corresponding charges in 2012 or 2010.

Information technology initiatives - We incurred expenses of $6.8 million ($4.6 million after-tax, or $0.10 per diluted share) in 2010, related to the implementation of our ERP system that replaced select internally developed and certain other third-party applications. These expenses were included in restructuring and other special charges, net. See Note 4 to the consolidated financial statements for additional information.

Our debt-to-capital ratio, as defined in the Liquidity and Capital Resources - Working Capital and Cash Flow section, decreased to 41.6% as of February 2, 2013, compared to 49.1% at January 28, 2012, primarily due to our $96.0 million decrease in borrowings under our revolving credit agreement. Our current ratio, as defined in the Liquidity and Capital Resources - Working Capital and Cash Flow section, was 1.65 to 1 at February 2, 2013, compared to 1.55 to 1 at January 28, 2012. Inventories at February 2, 2013 were $533.3 million, down from $561.8 million at January 28, 2012, primarily driven by tight inventory management across our wholesale portfolio and the impact of Wholesale Operations brands we are exiting in conjunction with our portfolio realignment initiatives.


Outlook for 2013

We're pleased to have wrapped up a strong 2012. However, like many other peers, we continue to monitor consumer activity and reaction to changes in tax rates and other economic uncertainties. We expect same-store sales at Famous Footwear will grow in the low single digit percentage range in 2013 and that our Wholesale Operations net sales will decrease in the low to mid single digit percentage range in 2013.

Following are the consolidated results and the results by segment for 2012, 2011 and 2010:

CONSOLIDATED RESULTS
                                       2012                     2011                      2010
                                                % of                     % of                        % of
($ millions)                               Net Sales                Net Sales                   Net Sales
Net sales                      $ 2,598.1      100.0%    $ 2,582.8      100.0%   $ 2,504.1          100.0%
Cost of goods sold               1,587.7       61.1%      1,586.2       61.4%     1,500.5           59.9%
Gross profit                     1,010.4       38.9%        996.6       38.6%     1,003.6           40.1%
Selling and administrative
expenses                           919.0       35.4%        937.3       36.3%       923.0           36.9%
Restructuring and other
special charges, net                24.0        0.9%         23.7        0.9%         7.9            0.3%
Impairment of intangible
assets                               5.8        0.2%            -           -           -               -
Operating earnings                  61.6        2.4%         35.6        1.4%        72.7            2.9%
Interest expense                   (23.4 )    (0.9)%        (26.1 )    (1.0)%       (19.7 )        (0.8)%
Loss on early extinguishment
of debt                                -           -         (1.0 )    (0.0)%           -               -
Interest income                      0.3        0.0%          0.6        0.0%         0.2            0.0%
Earnings before income taxes
from continuing operations          38.5        1.5%          9.1        0.4%        53.2            2.1%
Income tax provision               (11.3 )    (0.4)%         (0.4 )    (0.1)%       (16.1 )        (0.6)%
Net earnings from continuing
operations                          27.2        1.1%          8.7        0.3%        37.1            1.5%
Discontinued operations:
Earnings from operations of
subsidiary, net of tax                 -           -          1.7        0.1%           -               -
Gain on sale of subsidiary,
net of tax                             -           -         14.0        0.5%           -               -
Net earnings from discontinued
operations                             -           -         15.7        0.6%           -               -
Net earnings                        27.2        1.1%         24.4        0.9%        37.1            1.5%
Net loss attributable to
noncontrolling interests            (0.3 )    (0.0)%         (0.2 )    (0.1)%        (0.1 )        (0.0)%
Net earnings attributable to
Brown Shoe Company, Inc.       $    27.5        1.1%    $    24.6        1.0%   $    37.2            1.5%

Net Sales

Net sales increased $15.3 million, or 0.6%, to $2,598.1 million in 2012, compared to $2,582.8 million last year. Famous Footwear experienced an increase in net sales during 2012 as compared to last year, partially offset by decreases in Wholesale Operations and Specialty Retail net sales during 2012. Our Famous Footwear segment reported a $58.0 million increase in net sales, reflecting a 4.5% same-store sales increase, on a 52-week basis. Our Wholesale Operations segment reported a $25.7 million, or 3.0%, decrease in net sales, primarily attributable to brands that we are exiting in conjunction with our portfolio realignment initiatives. The net sales of our Specialty Retail segment decreased $17.1 million, primarily due to a lower store count and lower net sales at Shoes.com, partially offset by a same-store sales increase of 0.6%.

Net sales increased $78.7 million, or 3.1%, to $2.6 billion in 2011, compared to $2.5 billion in 2010. Wholesale Operations experienced an increase in net sales during 2011 as compared to 2010, partially offset by decreases in Famous Footwear and Specialty Retail net sales during 2011. Our Wholesale Operations segment reported a $116.5 million, or 15.4%, increase in net sales (excluding $19.7 million of net sales attributable to TBMC that are reflected in net earnings from discontinued operations), primarily as a result of the acquisition of ASG during 2011, which contributed $135.5 million in net sales. Our Famous Footwear segment reported a $30.2 million decrease in net sales, reflecting a 1.2% same-store sales decrease and a lower store count. The net sales of our Specialty Retail segment decreased $7.6 million, primarily due to a decrease in store count, partially offset by a same-store sales increase of 1.7%.

Same-store sales changes are calculated by comparing the sales in stores that have been open at least 13 months. Relocated stores are treated as new stores, and closed stores are excluded from the calculation. Sales change from new and closed stores, net, reflects the


change in net sales due to stores that have been opened or closed during the period and are thereby excluded from the same-store sales calculation. E-commerce sales for those e-commerce websites that function as an extension of a retail chain are included in the same-store sales calculation.

Gross Profit

Gross profit increased $13.8 million, or 1.4%, to $1,010.4 million in 2012, compared to $996.6 million last year resulting from higher gross profit rates at our Famous Footwear and Specialty Retail segments. As a percent of net sales, our gross profit rate increased to 38.9% in 2012, from 38.6% last year. The increase in gross profit rate was primarily due to lower inventory markdowns at our Famous Footwear segment. Our Specialty Retail segment experienced a higher gross profit rate driven by an increased sales mix of higher-margin footwear. Our Wholesale Operations gross profit rate decreased due to higher inventory markdowns and customer allowances. Retail and wholesale net sales were 67.5% and 32.5%, respectively, in 2012 compared to 66.3% and 33.7% in 2011. Gross profit rates in our retail businesses are higher than in wholesale.

Gross profit decreased $7.0 million, or 0.7%, to $996.6 million in 2011, compared to $1.0 billion in 2010 resulting from a lower gross profit rate at our Famous Footwear and Specialty Retail segments. As a percent of net sales, our gross profit rate decreased to 38.6% in 2011, from 40.1% in 2010. The decrease in gross profit rate was primarily due to Famous Footwear's lower toning footwear sales and increased promotional activity. Our Specialty Retail segment experienced a lower gross profit rate due to lower sales of high-margin products, such as toning footwear and boots in 2011 as compared to 2010. Our Wholesale Operations gross profit rate was flat as compared to 2010. While our Wholesale Operations segment benefited from the acquisition of ASG in 2011, the segment also experienced higher product costs and inventory markdowns in 2011. Gross profit rate at our Wholesale Operations segment was also negatively impacted by the stabilization of our ERP system, including higher customer allowances, chargebacks and air freight charges (estimated to be $11.9 million), the impact to cost of goods sold of the inventory fair value adjustment in connection with the acquisition of ASG ($4.2 million) and other cost of goods sold adjustments associated with our portfolio realignment ($1.6 million). Retail and wholesale net sales were 66.3% and 33.7%, respectively, in 2011 compared to 69.9% and 30.1% in 2010.

We classify warehousing, distribution, sourcing and other inventory procurement costs in selling and administrative expenses. Accordingly, our gross profit and selling and administrative expenses rates, as a percent of net sales, may not be comparable to other companies.

Selling and Administrative Expenses

Selling and administrative expenses decreased $18.3 million, or 2.0%, to $919.0 million in 2012 compared to $937.3 million last year and increased $14.3 million, or 1.6%, in 2011 compared to $923.0 million in 2010.

Selling and administrative expenses decreased $18.3 million in 2012 compared to last year primarily due to our portfolio realignment actions, partially offset by new store and other investments, higher cash and stock-based incentive costs and the impact of a 53rd week in fiscal 2012. As a percent of net sales, selling and administrative expenses decreased to 35.4% in 2012 from 36.3% last year.

Selling and administrative expenses increased $14.3 million in 2011 compared to 2010 primarily due to the inclusion of ASG's selling and administrative expenses ($41.2 million) and higher information systems related costs associated with our new ERP platform. We also experienced higher selling and merchandising costs, partially offset by lower incentive plan costs due to lower expected payouts under both cash and stock-based plans ($20.6 million). As a percent of net sales, selling and administrative expenses decreased to 36.3% in 2011 from 36.9% in 2010.

Restructuring and Other Special Charges, Net

Restructuring and other special charges, net, increased $0.3 million to $24.0 million during 2012, compared to $23.7 million last year as a result of the following items (see Note 4 to the consolidated financial statements for additional information related to these charges and recoveries):

Portfolio realignment - We incurred charges of $21.0 million in 2012 as compared to $17.2 million during 2011 related to our portfolio realignment initiatives.

Organizational changes - We incurred costs of $2.3 million 2012, related to corporate organizational changes, with no corresponding costs in 2011.

Acquisition and integration related costs - We incurred $0.7 million related to the integration of ASG in 2012 as compared to $6.5 million during 2011 related to the acquisition and integration of ASG.

As a percent of net sales, restructuring and other special charges, net, remained consistent at 0.9% from 2011 to 2012, reflecting the above named factors.


Restructuring and other special charges, net, increased $15.8 million to $23.7 million during 2011, compared to $7.9 million in 2010 as a result of the following items:

Portfolio realignment - We incurred charges of $17.2 million during 2011 related to our portfolio realignment initiatives with no corresponding charges in 2010.

Acquisition and integration related costs - We incurred $6.5 million of costs during 2011 related to the acquisition and integration of ASG, which we purchased on February 17, 2011, with $1.1 million in corresponding charges in 2010.

Information technology initiatives - We incurred no charges during 2011 related to our ERP system with $6.8 million in corresponding charges in 2010. Subsequent to going live on our ERP system in the fourth quarter of 2010, all expenses related to our ERP system were reflected in selling and administrative expenses.

As a percent of net sales, restructuring and other special charges, net increased to 0.9% in 2011, from 0.3% in 2010, reflecting the above named factors.

Impairment of Intangible Assets

During 2012, the Company terminated the Etienne Aigner license agreement due to a dispute with the licensor. In conjunction with the termination, the Company recognized an impairment charge of $5.8 million to reduce the remaining unamortized value of the licensed trademark intangible asset to zero.

Operating Earnings

Operating earnings increased $26.0 million, or 73.3%, to $61.6 million in 2012, compared to $35.6 million last year due to lower selling and administrative expenses and higher gross profit, partially offset by an intangible impairment charge, as discussed above.

We reported operating earnings of $35.6 million in 2011 compared to $72.7 million in 2010 due to the increase in restructuring and other special charges, net and selling and administrative expenses and the decrease in gross profit, all partially offset by an increase in net sales, as discussed above.

Interest Expense

Interest expense decreased $2.7 million, or 10.6%, to $23.4 million in 2012 compared to $26.1 million last year and increased $6.4 million, or 33.1%, in 2011 compared to $19.7 million in 2010. The decrease in interest expense in 2012 was primarily due to lower average borrowings under our Credit Agreement as compared to 2011.

The increase in interest expense in 2011 was primarily due to higher average borrowings under our Credit Agreement and the increase in long-term debt in connection with the refinancing of our senior notes in early 2011 as a result of the additional capital needed in connection with our acquisition of ASG and the repurchase of 2.5 million shares of our common stock.

Loss on Early Extinguishment of Debt

During 2011, we redeemed all of our senior notes due in 2012. We incurred certain debt extinguishment costs to retire these notes prior to maturity totaling $1.0 million, of which $0.6 million was non-cash charges related to unamortized debt issuance costs and $0.4 million represented cash paid for tender premiums. We did not incur such costs in 2012 or 2010.

Income Tax Provision

Our consolidated effective tax rate on continuing operations was a provision of 29.4% in 2012 compared to 3.6% in 2011 and 30.4% in 2010. Our consolidated effective tax rate is generally below the federal statutory rate of 35% because our foreign earnings are subject to lower statutory tax rates.

In 2012, we recognized pretax earnings in both our domestic operations and foreign jurisdictions. Our overall effective tax rate was less than the domestic statutory rate due to the mix of earnings in lower rate international jurisdictions. Our foreign tax jurisdictions have lower tax rates than domestic. These factors resulted in an overall effective tax provision rate of 29.4% in 2012.

In 2011, we incurred a pretax loss in our domestic operations and pretax earnings in foreign jurisdictions. Our domestic effective tax rate was less than the statutory rate due to the impact of non-deductible permanent items applied to the domestic loss and the impact of the earnings mix between domestic and international tax jurisdictions. Our foreign tax jurisdictions have lower tax rates than domestic. These factors resulted in an overall effective tax provision rate of 3.6% on continuing operations in 2011.

In 2010, we experienced pretax earnings in both our domestic operations and foreign jurisdictions. This mix of domestic and foreign pretax earnings resulted in an overall effective tax provision rate of 30.4% in 2010.


See Note 6 to the consolidated financial statements for additional information regarding our tax rates.

Net Earnings from Continuing Operations

We reported net earnings from continuing operations of $27.2 million in 2012 compared to $8.7 million in 2011 and $37.1 million in 2010, as a result of the factors described above.

Net Earnings from Discontinued Operations

During 2011, we sold TBMC, which markets and sells footwear bearing the AND 1 brand-name. The operations of TBMC and the gain on sale of this subsidiary were reported as discontinued operations. We reported net earnings from discontinued operations, net of tax, totaling $15.7 million in 2011, of which $1.7 million related to the operating results of TBMC, net of tax, and $14.0 million related to the gain on sale of the subsidiary, net of tax.

Net Earnings Attributable to Brown Shoe Company, Inc.

We reported net earnings attributable to Brown Shoe Company, Inc. of $27.5 million in 2012, compared to $24.6 million last year and $37.2 million in 2010.

Geographic Results

We have both domestic and foreign operations. Domestic operations include the nationwide operation of our Famous Footwear and Specialty Retail footwear stores, the wholesale distribution of footwear to numerous retail customers and the operation of our e-commerce websites. Foreign operations primarily consist of wholesale operations in the Far East and Canada, retailing operations in Canada and China and the operation of our international e-commerce websites. In addition, we license certain of our trademarks to third parties who distribute and/or operate retail locations internationally. The Far East operations include first-cost transactions, where footwear is sold at foreign ports to customers who then import the footwear into the United States and other countries. The breakdown of domestic and foreign net sales and earnings before income taxes was as follows:

                       2012                       2011                       2010
                                                         (Loss)
                            Earnings                   Earnings                   Earnings
                              Before                     Before                     Before
                              Income                     Income                     Income
 ($ millions) Net Sales        Taxes     Net Sales       Taxes      Net Sales        Taxes
                      $            $             $            $             $            $
 Domestic       2,295.8         10.5       2,259.9        (11.1 )     2,179.7         23.8
 Foreign          302.3         28.0         322.9         20.2         324.4         29.4
                      $            $             $            $             $            $
                2,598.1         38.5       2,582.8          9.1       2,504.1         53.2

The pretax profitability on foreign sales is higher than on domestic sales because of a lower cost structure and the inclusion in domestic earnings of the unallocated corporate administrative and other costs.

We recognized earnings before income taxes both domestically and in foreign jurisdictions in 2012. Our domestic earnings reflected increases in net sales at our Famous Footwear segment, a decrease in selling and administrative expenses and an increase in gross profit, all partially offset by an intangible impairment charge.

We incurred a domestic loss before income taxes and had foreign earnings before income taxes in 2011. Our domestic loss reflected decreases in net sales at our Famous Footwear and Specialty Retail segments, a decrease in gross profit, an . . .

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