GCO

Business Context and Reporting Period

Company: Genesco Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: October 28, 2006 (Third Quarter of Fiscal 2007)
Business Overview: Genesco is a leading retailer of branded footwear and headwear, operating approximately 1,925 retail stores (including Journeys, Underground Station, Hat World, and Johnston & Murphy) and distributing footwear under the Johnston & Murphy and Dockers brands to over 1,000 wholesale accounts.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 15.2% in the third quarter and 12.1% for the nine-month period compared to the prior year, driven primarily by new store openings and a 31% increase in Licensed Brands sales.
• Profitability: Net earnings decreased slightly in the quarter ($15.9M vs. $16.1M) but increased for the nine-month period ($32.3M vs. $31.4M). Operating income remained relatively flat in the quarter due to restructuring charges.
• Margin Pressure: Gross margin percentage decreased slightly to 49.8% in the quarter (from 51.1%) due to promotional activity in the Hat World Group and increased markdowns in Journeys and Underground Station.
• Segment Performance:
  • Journeys Group: Sales up 20.4%; Operating income up 17.2%.
  • Underground Station Group: Sales down 8.9%; Operating loss of $0.6M (vs. $2.0M income prior year) due to store closures and weak demand for athletic shoes.
  • Johnston & Murphy Group: Sales up 14.1%; Operating income more than doubled to $3.2M.
  • Licensed Brands: Sales up 30.9% driven by Dockers Footwear performance.
• Liquidity: Cash and cash equivalents declined from $60.5M at the start of the fiscal year to $18.6M, primarily due to seasonal inventory build-up ($113.7M increase) and stock repurchases.

Guidance, Outlook, and Risks

• Capital Expenditures: Total capital expenditures for Fiscal 2007 are expected to be approximately $67.9 million, supporting the opening of roughly 210 new stores and 119 major renovations.
• Debt Facility: On December 1, 2006, the company entered into a new $200 million revolving credit facility, replacing the previous $105 million facility. Borrowings are secured by non-real estate assets.
• Restructuring: The company continues to close or convert Jarman stores to Underground Station locations. A pretax charge of $1.1 million was recorded in the quarter for asset impairments and lease terminations.
• Legal and Environmental: The company has accrued $5.7 million for environmental contingencies (New York and Michigan sites). A California employment class action was settled favorably in the prior year, resulting in a credit, but new claims regarding payroll checks are being defended.
• Supply Chain Risk: Nike products will no longer be distributed through Underground Station stores, representing approximately 13% of that segment's prior fiscal year sales. Management does not anticipate a material impact in Fiscal 2007.

Investor Verification Checklist

• Inventory Levels: Verify the sustainability of the $113.7 million increase in inventory and the associated cash burn against seasonal sales expectations.
• Underground Station Turnaround: Monitor the impact of the loss of Nike distribution and the conversion of Jarman stores on the segment's ability to return to profitability.
• Debt Covenants: Review the terms of the new $200 million credit facility, specifically the "Adjusted Excess Availability" thresholds that trigger financial covenants.
• Environmental Accruals: Assess the adequacy of the $5.7 million environmental provision given the uncertainty of remediation costs at the New York and Michigan sites.
• Share Repurchases: Confirm the remaining authorization ($18.7 million) and the company's commitment to returning capital to shareholders amidst seasonal cash flow needs.