Business Context and Reporting Period
Company: Genesco Inc.
Filing Type: Form 10-K (Annual Report)
Fiscal Year End: January 29, 2005
Business Overview: Genesco is a leading retailer of branded footwear and headwear, and a wholesaler of branded footwear. The company operates five reportable segments: Journeys, Underground Station Group, Hat World, Johnston & Murphy, and Dockers Footwear. As of January 29, 2005, the company operated 1,618 retail stores across the U.S., Puerto Rico, and Canada.
Key Financial Metrics
| Metric | Fiscal 2005 | Fiscal 2004 |
|---|---|---|
| Net Sales | $1,112.7 million | $837.4 million |
| Gross Margin | $551.1 million (49.5% of sales) | $388.8 million (46.4% of sales) |
| Earnings from Continuing Operations | $48.5 million | $29.0 million |
| Net Earnings | $48.2 million | $28.1 million |
| Diluted EPS (Net Earnings) | $1.91 | $1.20 |
| Operating Cash Flow | $99.8 million | $68.6 million |
| Long-Term Debt | $161.3 million | $86.3 million |
| Working Capital | $176.2 million | $197.6 million |
| Cash and Cash Equivalents | $60.1 million | $81.5 million |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 32.9% to $1.1 billion, driven primarily by the acquisition of Hat World Corporation (April 2004) and Cap Connection Ltd. (July 2004), which added 533 and 19 stores respectively. Comparable store sales for all footwear concepts increased 3%.
- Profitability: Net earnings increased 71.5% to $48.2 million. Gross margin percentage improved to 49.5% from 46.4%, aided by the Hat World acquisition, improved sourcing, and reduced markdowns.
- Debt Structure: Long-term debt increased to $161.3 million from $86.3 million. This increase was due to a new $100 million term loan utilized to fund the Hat World acquisition.
- Segment Performance:
- Journeys: Sales up 11.3%; Operating income up 9.8% to $60.1 million.
- Hat World: Contributed $216.3 million in sales and $30.5 million in operating income (14.1% margin) for the ten months following acquisition.
- Johnston & Murphy: Operating income surged 125.7% to $9.2 million due to improved margins and retail sales growth, despite a 4% decline in wholesale sales.
- Underground Station Group: Operating income declined 14.9% to $7.0 million due to increased expenses and store closures/conversions.
Guidance, Outlook, Risks, and Unusual Items
- Restatement of Financial Statements: The company restated financial statements for Fiscal 2004, 2003, and the first three quarters of 2005. This was due to a material weakness in internal controls regarding the accounting for leases and leasehold improvements (amortization periods, landlord incentives, and rent holidays). The restatement reduced retained earnings by $2.5 million as of the beginning of Fiscal 2003.
- Internal Control Weakness: Management and the independent auditor (Ernst & Young LLP) concluded that internal controls over financial reporting were not effective as of January 29, 2005, due to the lease accounting issues. Corrective actions were implemented subsequent to year-end.
- Legal and Environmental Contingencies:
- Environmental: The company has accrued $5.5 million for environmental remediation related to former facilities in New York and Michigan. A $3.0 million insurance settlement was received in Q3 2005.
- Patent Litigation: Summary judgment was granted in favor of Genesco in a patent infringement case regarding Johnston & Murphy shoes; the case is stayed pending appeal.
- Employment Lawsuit: A putative class action in California alleges wage and hour violations seeking $40 million plus punitive damages. Genesco intends to defend vigorously.
- Future Outlook: The company plans to open 196 new retail stores in Fiscal 2006. Capital expenditures for Fiscal 2006 are expected to be approximately $47.0 million. The company froze its defined benefit pension plan effective January 1, 2005.
Investor Verification Checklist
- Restatement Impact: Verify the specific adjustments made to prior period earnings and balance sheet items due to the lease accounting error (Note 2).
- Internal Control Remediation: Monitor the effectiveness of new review procedures implemented to address the material weakness in lease accounting.
- Environmental Liabilities: Track the status of the New York and Michigan remediation projects and the adequacy of the $5.5 million accrual.
- Debt Covenants: Review compliance with the $175 million credit facility covenants, specifically the lease-adjusted debt to EBITDAR ratio.
- Store Expansion: Assess the execution of the plan to open 196 new stores in Fiscal 2006 and the associated capital expenditure requirements.
- Convertible Debt: Note that the 4 1/8% Convertible Subordinated Debentures became convertible in Q4 2005 as the stock price trigger was met.