TABLE OF CONTENTS
INDEX
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PART I — FINANCIAL INFORMATION
The accompanying Notes are an integral part of these Consolidated Financial Statements.
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Genesco Inc.and Consolidated Subsidiaries
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Note 1Summary of Significant Accounting Policies
Interim Statements
The consolidated financial statements contained in this report are unaudited but reflect all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the results for the interim periods of the fiscal year ending February 1, 2003 (“Fiscal 2003”) and of the fiscal year ended February 2, 2002 (“Fiscal 2002”). The results of operations for any interim period are not necessarily indicative of results for the full year. The financial statements should be read in conjunction with the financial statements and notes thereto included in the annual report on Form 10-K.
Nature of Operations
The Company’s businesses include the design or sourcing, marketing and distribution of footwear principally under the Johnston & Murphy and Dockersbrands and the operation at November 2, 2002 of 980 Jarman, Journeys, Journeys Kidz, Johnston & Murphy and Underground Station retail footwear stores and leased departments. The Company ended its license to market footwear under the Nautica label, effective January 31, 2001. The Company sold Nautica — branded footwear for the first six months of Fiscal 2002 in order to fill existing customer orders and sell existing inventory (see Note 2).
Basis of Presentation
All subsidiaries are included in the consolidated financial statements. All significant intercompany transactions and accounts have been eliminated.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Financial Statement Reclassifications
Certain reclassifications have been made to conform prior years’ data to the current year presentation.
Cash and Cash Equivalents
Included in cash and cash equivalents at February 2, 2002 and November 2, 2002, are cash equivalents of $34.6 million and $1.0 million, respectively. Cash equivalents are highly-liquid debt instruments having an original maturity of three months or less.
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Genesco Inc.and Consolidated SubsidiariesNotes to Consolidated Financial Statements
Note 1Summary of Significant Accounting Policies, Continued
Inventories
Inventories of wholesaling companies are stated at the lower of cost or market, with cost determined principally by the first-in, first-out method. Retail inventories are stated at the lower of cost or market with cost determined under the retail inventory method.
Plant, Equipment and Capital Leases
Plant, equipment and capital leases are recorded at cost and depreciated or amortized over the estimated useful life of related assets. Depreciation and amortization expense are computed principally by the straight-line method over estimated useful lives:
Leasehold improvements and properties under capital leases are amortized on the straight-line method over the shorter of their useful lives or their related lease terms.
Impairment of Long-Term Assets
The Company periodically assesses the realizability of its long-lived assets and evaluates such assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Asset impairment is determined to exist if estimated future cash flows, undiscounted and without interest charges, are less than carrying amount.
Postretirement Benefits
Substantially all full-time employees are covered by a defined benefit pension plan. The Company also provides certain former employees with limited medical and life insurance benefits. The Company funds at least the minimum amount required by the Employee Retirement Income Security Act.
Revenue Recognition
Retail sales are recorded at the point of sale and are net of actual returns. Wholesale revenue is recorded net of estimated returns when the related goods have been shipped and legal title has passed to the customer.
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Shipping and Handling Costs
Shipping and handling costs are charged to cost of sales in the period incurred.
Preopening Costs
Costs associated with the opening of new stores are expensed as incurred.
Advertising Costs
Advertising costs are predominantly expensed as incurred. Advertising costs were $16.9 million and $15.8 million for the first nine months of Fiscal 2003 and 2002, respectively.
Environmental Costs
Environmental expenditures relating to current operations are expensed or capitalized as appropriate. Expenditures relating to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments and/or remedial efforts are probable and the costs can be reasonably estimated and are evaluated independently of any future claims for recovery. Generally, the timing of these accruals coincides with completion of a feasibility study or the Company’s commitment to a formal plan of action. Costs of future expenditures for environmental remediation obligations are not discounted to their present value.
Income Taxes
Deferred income taxes are provided for all temporary differences and operating loss and tax credit carryforwards limited, in the case of deferred tax assets, to the amount the Company believes is more likely than not to be realized in the foreseeable future.
Capitalized Interest
Statement of Financial Accounting Standards (SFAS) No. 34, “Capitalization of Interest Cost” requires capitalizing interest cost as a part of the historical cost of acquiring certain assets, such as assets that are constructed or produced for a company’s own use. The Company capitalized $0.4 million of interest cost in the first nine months of Fiscal 2003 in connection with the Company’s new distribution center.
Earnings Per Common Share
Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities to issue common stock were exercised or converted to common stock (see Note 7).
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Other Comprehensive Income
Statement of Financial Accounting Standards (SFAS) No. 130, “Reporting Comprehensive Income” requires, among other things, the Company’s minimum pension liability adjustment and unrealized gains or losses on foreign currency forward contracts to be included in other comprehensive income net of tax.
Business Segments
Statement of Financial Accounting Standards (SFAS) No. 131, “Disclosures about Segments of an Enterprise and Related Information” requires that companies disclose “operating segments” based on the way management disaggregates the company for making internal operating decisions (see Notes 2 and 9).
Derivative Instruments and Hedging Activities
The Company implemented Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities” in the first quarter of Fiscal 2002. This statement establishes accounting and reporting standards for derivative instruments and for hedging activities. SFAS 133 requires an entity to recognize all derivatives as either assets or liabilities in the consolidated balance sheet and to measure those instruments at fair value. Under certain conditions, a derivative may be specifically designated as a fair value hedge or a cash flow hedge. The accounting for changes in the fair value of a derivative are recorded each period in current earnings or in other comprehensive income depending on the intended use of the derivative and the resulting designation. For the first nine months ended November 2, 2002, the Company recorded an unrealized gain on foreign currency forward contracts of $1.7 million in accumulated other comprehensive loss, before taxes.
In order to reduce exposure to foreign currency exchange rate fluctuations in connection with inventory purchase commitments for its Johnston & Murphy division, the Company enters into foreign currency forward exchange contracts for Euro to make Euro denominated payments with a maximum hedging period of twelve months. Derivative instruments used as hedges must be effective at reducing the risk associated with the exposure being hedged. The settlement terms of the forward contracts correspond with the payment terms for the merchandise inventories. As a result, there is no hedge ineffectiveness to be reflected in earnings. At February 2, 2002 and November 2, 2002, the Company had approximately $12.1 million and $1.0 million, respectively, of such contracts outstanding. Forward exchange contracts at November 2, 2002 have an average remaining term of approximately one month. The loss based on spot rates under these contracts at February 2, 2002 was $0.3 million and the gain based on spot rates under these contracts at November 2, 2002 was less than $50,000. The Company monitors the credit quality of the major national and regional financial institutions with which it enters into such contracts.
The Company estimates that the majority of net-hedging gains will be reclassified from accumulated other comprehensive loss into earnings through lower cost of sales within the twelve months between November 2, 2002 and November 1, 2003.
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Note 2Restructurings
Johnston & Murphy Plant Closing and Reductions in Operating Expenses
On January 31, 2002, the Company’s board of directors approved a plan to streamline operations and reduce operating expenses. The plan included closing the Company’s last remaining manufacturing plant and eliminating approximately 40 positions from its Nashville headquarters workforce. At the same time, the Company recognized the impairment of assets used in 12 underperforming stores, primarily in the Jarman group.
In connection with the plant closing, employee severance and asset impairments, the Company recorded a pretax charge to earnings of $5.4 million ($3.4 million net of tax) in the fourth quarter of Fiscal 2002. The charge includes $0.3 million in plant asset write-downs, $3.7 million of other costs, including primarily employee severance and facility shutdown costs and $1.0 million of retail store asset impairments. See Note 6 to the Consolidated Financial Statements. Also included in the charge was a $0.4 million inventory write-down, primarily related to inventory of product offerings affected by the plant closing, which is reflected in gross margin on the income statement.
The Company ended operations in the manufacturing plant during the third quarter of Fiscal 2003.
Nautica Footwear License Cancellation
The Company ended its license to market footwear under the Nautica label, effective January 31, 2001. The Company’s net sales for the first six months of Fiscal 2002 include sales of Nautica – branded footwear to fill existing customer orders and sell existing inventory.
In connection with the termination of the Nautica Footwear license agreement, the Company recorded a pretax charge to earnings of $4.4 million ($2.7 million net of tax) in the fourth quarter of Fiscal 2001. The charge included contractual obligations to Nautica Apparel for the license cancellation and other costs, primarily severance (see Note 6). Also included in the charge was a $1.0 million inventory write-down which is reflected in gross margin on the income statement.
During the second quarter of Fiscal 2002, the Company recorded a restructuring gain of $0.3 million in connection with the successful completion of activities related to the Nautica Footwear license agreement’s termination. The gain included a $0.1 million reversal of the earlier inventory write-down, because the Company was able to liquidate its Nautica Footwear inventories at better prices than it initially expected. The reversal is reflected in gross margin on the income statement.
The Nautica footwear business contributed sales of approximately $0.1 million and $6.1 million in the third quarter and nine months of Fiscal 2002 and an operating gain of $0.1 million in the third quarter of Fiscal 2002 and an operating loss of ($0.5) million in the nine months of Fiscal 2002.
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Note 3Accounts Receivable
The Company’s footwear wholesaling business sells primarily to independent retailers and department stores across the United States. Receivables arising from these sales are not collateralized. Credit risk is affected by conditions or occurrences within the economy and the retail industry. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information. One customer accounted for 15% of the Company’s trade receivables balance as of November 2, 2002 and no other customer accounted for more than 10% of the Company’s trade receivables balance as of November 2, 2002.
Note 4Inventories
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Note 5Plant, Equipment and Capital Leases, Net
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Note 6Provision for Discontinued Operations and Restructuring Reserves
Provision for Discontinued Operations
Restructuring Reserves
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Note 7Earnings Per Share
The amount of the dividend on the convertible preferred stock per common share obtainable on conversion of the convertible preferred stock is higher than basic earnings per share for the period. Therefore, conversion of the convertible preferred stock is not reflected in diluted earnings per share, because it would have been antidilutive. The shares convertible to common stock for Series 1, 3 and 4 preferred stock would have been 30,654, 38,324 and 24,946, respectively.
The weighted shares outstanding reflects the effect of the stock buy back programs of up to 7.5 million shares announced by the Company in Fiscal 1999 – 2003. The Company has repurchased 7.0 million shares as of November 2, 2002.
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Note 8Legal Proceedings
New York State Environmental Proceedings
The Company was a defendant in a civil action filed by the State of New York against the City of Gloversville, New York, and 33 other private defendants. The action arose out of the alleged disposal of certain hazardous material directly or indirectly into a municipal landfill and sought recovery for the costs of investigating and performing remedial actions and damage to natural resources. The Company paid approximately $0.2 million in October 2002, in exchange for a release from further liability related to the site.
In 1995, the Company received notice from the New York State Department of Environmental Conservation (the “Department”) that it deemed remedial action to be necessary with respect to certain contaminants in the vicinity of a knitting mill operated by a former subsidiary of the Company from 1965 to 1969, and that it considered the Company a potentially responsible party. In August 1997, the Department and the Company entered into a consent order whereby the Company assumed responsibility for conducting a remedial investigation and feasibility study (“RIFS”) and implementing an interim remediation measure with regard to the site, without admitting liability or accepting responsibility for any future remediation of the site. In conjunction with the consent order, the Company entered into an agreement with the owner of the site providing for a release from liability for property damage and for necessary access to the site, for payments totaling $400,000. The Company estimates that the cost of conducting the RIFS and implementing the interim remedial measure will be in the range of $3.9 million to $4.1 million, $3.7 million of which the Company has already paid. The Company believes that it has adequately reserved for the costs of conducting the RIFS and implementing the interim remedial measure contemplated by the consent order, but there is no assurance that the consent order will ultimately resolve the matter. The Company has not ascertained what responsibility, if any, it has for any contamination in connection with the facility or what other parties may be liable in that connection and is unable to predict whether its liability, if any, beyond that voluntarily assumed by the consent order will have a material effect on its financial condition or results of operations.
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Note 8Legal Proceedings, Continued
Whitehall Environmental Sampling
Pursuant to a work plan approved by the Michigan Department of Environmental Quality (“MDEQ”) the Company has performed sampling and analysis of soil, sediments, surface water, groundwater and waste management areas at the Company’s Volunteer Leather Company facility in Whitehall, Michigan. On June 29, 1999, the Company submitted a remedial action plan (the “Plan”) for the site to MDEQ and subsequently amended it to include additional upland remediation to bring the property into compliance with regulatory standards for non-industrial uses. The Company, with the approval of MDEQ, previously installed horizontal wells to capture groundwater from a portion of the site and treat it by air sparging. The Plan proposed continued operation of this system for an indefinite period and monitoring of groundwater samples to ensure that the system is functioning as intended.
On June 30, 1999, the City of Whitehall filed an action against the Company in the circuit court for the City of Muskegon alleging that the Company’s and its predecessors’ past wastewater management practices have adversely affected the environment, and seeking injunctive relief under Parts 17 and 201 of the Michigan Natural Resources Environmental Protection Act (“MNREPA”) to require the Company to correct the alleged pollution, primarily lake sediment contamination. Further, the City alleged violations of City ordinances prohibiting blight and litter, and that the Whitehall Volunteer Leather plant constitutes a public nuisance. The Company, the City of Whitehall and MDEQ settled their disagreement over lake sediments for a lump sum payment of $3.35 million by the Company in the first quarter of Fiscal 2003. In connection with the settlement, the City’s lawsuit has been dismissed with prejudice.
The Company believes it has fully provided for the Plan, which remains subject to MDEQ approval. Although the Company does not expect remediation of the site to have a material effect on its financial condition or results of operations, there can be no assurance that the Plan, as amended, will be approved, and the Company is unable to predict whether any further remediation that might ultimately be required would have such an effect.
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Note 9Business Segment Information
The Company currently operates four reportable business segments (not including corporate): Journeys, comprised of Journeys and Journeys Kidz retail footwear operations; Jarman, comprised of the Jarman and Underground Station retail footwear operations; Johnston & Murphy, comprised of Johnston & Murphy retail operations and wholesale distribution; and Licensed Brands, comprised of Dockers Footwear. All the Company’s segments sell footwear products at either retail or wholesale.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies.
The Company’s reportable segments are based on the way management organizes the segments in order to make operating decisions and assess performance along types of products sold. Journeys and Jarman sell primarily branded products from other companies while Johnston & Murphy and Licensed Brands sell primarily the Company’s owned and licensed brands.
Corporate assets include cash, deferred income taxes, prepaid pension cost, deferred note expense and fixed assets of the Company’s discontinued leather segment. The Company does not allocate certain costs to each segment in order to make decisions and assess performance. These costs include corporate overhead, interest expense, interest income, restructuring gains and other charges. Other includes severance, litigation and expenses related to discontinuation of work related to an acquisition.
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Note 9Business Segment Information, Continued
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion and the notes to the Consolidated Financial Statements include certain forward-looking statements, other than those made solely with respect to historical fact. Actual results could differ materially from those reflected by the forward-looking statements in this discussion and a number of factors may adversely affect the forward looking statements and future results, liquidity and capital resources. These factors include:
Forward-looking statements reflect the expectations of the Company at the time they are made, and investors should rely on them only as expressions of opinion about what may happen in the future and only at the time they are made. The Company undertakes no obligation to update any forward-looking statement. Although the Company believes it has an appropriate business strategy and the resources necessary for its operations, predictions about future revenue and margin trends are inherently unreliable and the Company may alter its business strategies to address changing conditions.
Significant Developments
Share Repurchase Program
In total, the Company’s board of directors has authorized the repurchase of 7.5 million shares of the Company’s common stock since the third quarter of Fiscal 1999, including an additional 300,000 shares in August 2002. The purchases may be made on the open market or in privately negotiated transactions. As of December 6, 2002, the Company had repurchased 7.0 million shares at a cost of $69.4 million pursuant to all authorizations.
On January 31, 2002, the Company’s board of directors approved a plan to streamline operations and reduce operating expenses. The plan included closing the Company’s last remaining manufacturing plant and eliminating approximately 40 positions from its Nashville headquarters
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workforce. At the same time, the Company recognized the impairment of assets used in 12 underperforming stores, primarily in the Jarman group.
The Company ended its license to market footwear under the Nautica label, effective January 31, 2001. The Company’s net sales for the first nine months of Fiscal 2002 included $6.1 million of sales of Nautica – branded footwear to fill existing customer orders and sell existing inventory.
In connection with the termination of the Nautica Footwear license agreement, the Company recorded a pretax charge to earnings of $4.4 million ($2.7 million net of tax) in the fourth quarter of Fiscal 2001. The charge included contractual obligations to Nautica Apparel for the license cancellation and other costs, primarily severance. See Note 6 to the Consolidated Financial Statements. Also included in the charge was a $1.0 million inventory write-down, which is reflected in gross margin on the income statement.
The Company currently operates four reportable business segments (not including the corporate segment): Journeys, comprised of the Journeys and Journeys Kidz retail footwear operations; Jarman, comprised of the Jarman and Underground Station retail footwear operations; Johnston & Murphy, comprised of Johnston & Murphy retail operations and wholesale distribution; and Licensed Brands, comprised of Dockers Footwear.
Results of Operations – Third Quarter Fiscal 2003 Compared to Fiscal 2002
The Company’s net sales in the third quarter ended November 2, 2002 increased 14.9% to $213.2 million from $185.5 million in the third quarter ended November 3, 2001. Gross margin increased 17.6% to $100.8 million in the third quarter this year from $85.7 million in the same period last year and increased as a percentage of net sales from 46.2% to 47.3%, reflecting primarily lower overall markdowns in the Company’s retail operations combined with the increasing significance of the Company’s retail operations relative to its wholesale operations. Selling and administrative expenses in the third quarter this year increased 16.3% from the third quarter last year and increased
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as a percentage of net sales from 38.1% to 38.6%. Explanations of the changes in results of operations are provided by business segment in discussions following these introductory paragraphs.
Earnings before income taxes and discontinued operations (“pretax earnings”) for the third quarter ended November 2, 2002 were $16.5 million compared to $12.9 million for the third quarter ended November 3, 2001.
Net earnings for the third quarter ended November 2, 2002 were $10.1 million ($0.41 diluted earnings per share) compared to $7.3 million ($0.30 diluted earnings per share) for the third quarter ended November 3, 2001. Net earnings for the third quarter ended November 3, 2001 included a $0.7 million ($0.03 diluted earnings per share) charge to earnings (net of tax) for additional environmental clean-up costs at the Company’s former Volunteer leather tannery in Whitehall, Michigan. See Note 8 to the Consolidated Financial Statements. The Company recorded an effective income tax rate of 38.7% in the third quarter this year, compared to 37.9% in the same period past year.
Journeys
Net sales from Journeys increased 17.1% for the third quarter ended November 2, 2002 compared to the same period last year. The increase reflects primarily a 22% increase in average Journeys stores operated (i.e., the sum of the number of stores open on the first day of the fiscal quarter and the last day of each fiscal month during the quarter divided by four) along with a 1% increase in comparable store sales. Unit sales increased 22% during the third quarter of Fiscal 2003, primarily reflecting the increase in average stores operated, offset by a 5% decline in the average price per pair, reflecting changes in product mix. There were 601 stores, including 34 Journeys Kidz stores, in the Journeys segment at the end of the third quarter of Fiscal 2003, compared to 513 stores, including 12 Journeys Kidz stores, at the end of the third quarter last year.
Journeys’ operating income for the third quarter of Fiscal 2003 increased 22.1% to $15.5 million compared to $12.7 million for the third quarter last year. The increase was due to increased sales, increased gross margin as a percentage of net sales, reflecting changes in product mix, and to decreased expenses as a percentage of net sales, reflecting lower bonus accruals.
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Jarman
Net sales from the Jarman division (including Underground Station stores) increased 23.1% for the third quarter of Fiscal 2003 compared to the third quarter last year, reflecting both a 15% increase in comparable store sales and a 4% increase in average stores operated. The average price per pair of shoes increased 1% in the third quarter of Fiscal 2003, primarily reflecting decreased markdowns. Unit sales increased 23% during the same period.
Jarman operated 228 stores at the end of the third quarter of Fiscal 2003, including 108 Underground Station stores. The Company had operated 225 stores in the Jarman division at the end of the third quarter last year, including 91 Underground Station stores.
Jarman operating income for the third quarter this year was $2.6 million compared to an operating loss of $0.3 million for the third quarter last year. The increase was due to increased sales, improved gross margin from lower markdowns and decreased expenses as a percentage of net sales.
Johnston & Murphy
Johnston & Murphy net sales decreased 1.1% to $40.4 million for the third quarter this year from $40.8 million for the third quarter last year, reflecting a 17% reduction in wholesale sales offset by a 4% increase in comparable store sales and a 3% increase in average stores operated for Johnston & Murphy retail operations. Retail operations accounted for 67.4% of Johnston & Murphy segment sales in the third quarter this year, up from 61.2% in the third quarter last year. At the end of the third quarter this year, there were 151 Johnston & Murphy stores and factory stores compared to 148 Johnston & Murphy stores and factory stores at the end of the third quarter last year. The average price per pair of shoes for Johnston & Murphy retail decreased 9% in the third quarter this year, primarily due to changes in product mix, while unit sales increased 21% during the same period. Unit sales for the Johnston & Murphy wholesale business increased 7% in the third quarter of Fiscal 2003 while the average price per pair of shoes decreased 15% for the same period, primarily reflecting increased promotional pricing activity and product mix changes.
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Johnston & Murphy operating income for the third quarter this year decreased 65% compared to the third quarter last year, primarily due to increased expenses as a percentage of net sales, which includes $0.9 million of increased advertising expense.
Licensed Brands
Licensed Brands’ net sales increased 25.2% to $22.5 million for the third quarter of Fiscal 2003 from $18.0 million for the third quarter of Fiscal 2002. The sales increase reflected a 26% increase in net sales of Dockers Footwear. Unit sales for the Licensed Brands wholesale businesses increased 21% for the third quarter this year and the average price per pair of shoes increased 2% for the same period.
Licensed Brands’ operating income for the third quarter this year increased 64.8% from $2.0 million for the third quarter last year to $3.3 million, primarily due to increased sales and increased gross margin as a percentage of net sales.
The operating gain related to Nautica Footwear was $0.1 million for the third quarter of Fiscal 2002. For additional information regarding the Company’s decision to exit the Nautica Footwear business, see “Significant Developments – Nautica Footwear License Cancellation.”
Corporate and Interest Expenses
Corporate and other expenses for the third quarter ended November 2, 2002 were $3.8 million compared to $2.2 million for the third quarter ended November 3, 2001. This year’s corporate and other expenses included charges of $0.2 million, primarily severance charges. Excluding the listed items from Fiscal 2003, corporate and other expenses were $3.6 million in the third quarter this year versus $2.2 million in the third quarter last year, an increase of 63.2%. The increase is attributable primarily to increased expenses related to the new distribution center, increased bonus accruals reflecting operating performance for the year and increased insurance costs.
Interest expense was flat at $2.2 million for the third quarter this year compared to the third quarter last year. Borrowings under the Company’s revolving credit facility during the three months ended November 2, 2002 averaged $220,000 compared to $55,000 for the same period last year.
Interest income was flat at $0.1 million for the third quarter this year compared to the third quarter last year.
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Results of Operations – Nine Months Fiscal 2003 Compared to Fiscal 2002
The Company’s net sales in the nine months ended November 2, 2002 increased 10.5% to $578.6 million from $523.7 million in the nine months ended November 3, 2001. Gross margin increased 11.4% to $273.8 million in the first nine months this year from $245.9 million in the same period last year and increased as a percentage of net sales from 46.9% to 47.3%. Selling and administrative expenses in the first nine months this year increased 13.5% from the first nine months last year and increased as a percentage of net sales from 39.0% to 40.1%. Explanations of the changes in results of operations are provided by business segment in discussions following these introductory paragraphs.
Earnings before income taxes and discontinued operations (“pretax earnings”) for the nine months ended November 2, 2002 were $36.0 million compared to $36.1 million for the nine months ended November 3, 2001. Pretax earnings for the nine months ended November 3, 2001 included a $0.3 million restructuring gain related to the termination of the Nautica Footwear license agreement.
Net earnings for the nine months ended November 2, 2002 were $22.3 million ($0.92 diluted earnings per share) compared to $21.8 million ($0.90 diluted earnings per share) for the nine months ended November 3, 2001. The Company recorded an effective income tax rate of 38.1% in the first nine months this year, reflecting $0.1 million of favorable adjustments to previous years’ tax returns recognized during the second quarter, compared to 37.6% in the same period past year. Without the adjustments, this year’s rate would have been 38.4% for the nine months.
Net sales from Journeys increased 14.9% for the nine months ended November 2, 2002 compared to the same period last year. The increase reflects primarily a 24% increase in average Journeys stores operated (i.e., the sum of the number of stores open on the first day of the fiscal year and the last day of each fiscal month during the nine months divided by ten) offset by a 1% decrease in comparable store sales. Unit sales increased 22% in the first nine months of Fiscal 2003, primarily reflecting the increase in average stores operated, offset by a 7% decline in the average price per pair, reflecting changes in product mix and increased markdowns.
Journeys’ operating income for the first nine months of Fiscal 2003 decreased 2.8% to $31.2 million compared to $32.1 million for the first nine months ended last year. The decrease was due to decreased gross margin as a percentage of net sales, reflecting increased markdowns, and to increased expenses as a percentage of net sales.
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Net sales from the Jarman division (including Underground Station stores) increased 28.6% for the first nine months of Fiscal 2003 compared to the same period last year, reflecting both a 17% increase in comparable store sales and an 6% increase in average stores operated. The average price per pair of shoes increased 1% in the first nine months of Fiscal 2003, primarily reflecting changes in product mix and decreased markdowns. Unit sales increased 29% during the same period.
Jarman operating income for the first nine months of Fiscal 2003 was $6.4 million compared to a loss of $0.4 million for the same period last year. The increase was due to increased sales, improved margin from lower markdowns and decreased expenses as a percentage of net sales.
Johnston & Murphy net sales decreased 2.3% to $122.3 million for the first nine months of Fiscal 2003 from $125.1 million for the first nine months of last year, reflecting primarily a 15.6% decrease in wholesale sales for Johnston & Murphy offset by a 1% increase in comparable sales and a 2% increase in average stores operated for Johnston & Murphy retail operations. Retail operations accounted for 68.7% of Johnston & Murphy segment sales in the first nine months this year, up from 63.8% in the first nine months last year. The average price per pair of shoes for Johnston & Murphy retail decreased 10% in the first nine months this year, primarily due to increased markdowns and changes in product mix, while unit sales increased 19% during the same period. Unit sales for the Johnston & Murphy wholesale business increased 3% in the first nine months of Fiscal 2003, while the average price per pair of shoes decreased 15% for the same period, reflecting primarily increased promotional activities and product mix changes.
Johnston & Murphy operating income for the nine months ended November 2, 2002 decreased 43.6% primarily due to increased promotional pricing activity and increased expenses as a percentage of net sales which includes $1.5 million of increased advertising expense.
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Licensed Brands’ net sales decreased 4.6% to $59.5 million for the first nine months of Fiscal 2003 from $62.4 million for the first nine months last fiscal year. The sales decrease reflected the closing of the Nautica Footwear division, which accounted for $6.1 million in sales in the same nine months last fiscal year partially offset by a 5.6% increase in net sales of Dockers Footwear. Unit sales for the Licensed Brands wholesale businesses decreased 12% for the first nine months this year, while the average price per pair of shoes increased 8% for the same period, reflecting last year’s liquidation of Nautica Footwear inventory in connection with the closing of that business.
Licensed Brands’ operating income for the nine months ended November 2, 2002 increased 6.0% from $7.0 million for the first nine months ended November 3, 2001 to $7.4 million, primarily due to increased gross margin as a percentage of net sales as a result of lower markdowns and less promotional activity.
The operating loss related to Nautica Footwear was $0.5 million for the first nine months of Fiscal 2002. For additional information regarding the Company’s decision to exit the Nautica Footwear business, see “Significant Developments – Nautica Footwear License Cancellation.”
Corporate and other expenses for the nine months ended November 2, 2002 were $9.7 million compared to $8.5 million for the nine months ended November 3, 2001. This year’s corporate and other expenses included charges of $0.6 million, primarily professional fees relating to consideration of a possible strategic acquisition and severance charges. Corporate and other expenses in the first nine months last year included other charges of $0.5 million, primarily severance and litigation charges, offset by a $0.3 million gain relating to the Nautica restructuring. Excluding the listed items from both periods, corporate and other expenses were $9.1 million in the first nine months this year versus $8.3 million in the first nine months last year, an increase of 9.5%. The increase is attributable primarily to increased bonus accruals reflecting operating performance for the year and increased expenses related to the new distribution center.
Interest expense decreased 3.6% from $6.5 million in the nine months ended November 3, 2001 to $6.3 million for the nine months ended November 2, 2002, due to capitalized interest of $0.4 million for the Company’s new distribution center. See Note 1 to the Consolidated Financial Statements. Borrowings under the Company’s revolving credit facility during the nine months ended November 2, 2002 averaged $73,000 compared to $18,000 for the same period last year.
Interest income decreased 42% from $1.0 million in the first nine months last year to $0.6 million in the first nine months this year due to decreases in interest rates.
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Liquidity and Capital Resources
The following table sets forth certain financial data at the dates indicated.
Working Capital
The Company’s business is seasonal, with the Company’s investment in inventory and accounts receivable normally reaching peaks in the spring and fall of each year. Historically, cash flow from operations has been generated principally in the fourth quarter of each fiscal year.
Cash used in operating activities was $7.4 million in the first nine months of Fiscal 2003 compared to cash used in operating activities of $23.4 million in the first nine months of Fiscal 2002, primarily due to changes in accounts payable levels. Accounts payable grew by $12.5 million more in the first nine months of Fiscal 2003 than in the same period last year. This increased rate of growth is primarily due to timing changes in buying patterns and increased seasonal purchases reflecting the growth in the Company’s retail businesses by 94 stores since the third quarter of last year. Another factor in the improved operating cash flow was $3.9 million in lower tax payments this year.
The $56.9 million increase in inventories at November 2, 2002 from February 2, 2002 levels reflects increases in retail inventory to support seasonal growth and the net increase of 72 stores in the first nine months this year.
Accounts receivable at November 2, 2002 increased $4.7 million compared to February 2, 2002, primarily due to increased wholesale sales in the third quarter this year versus the fourth quarter last year.
Cash provided (or used) due to changes in accounts payable and accrued liabilities are as follows:
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The difference in cash provided by changes in accounts payable for the first nine months this year compared to the first nine months last year reflects changes in buying patterns, inventory levels and payment terms negotiated with individual vendors. The difference in cash used for changes in accrued liabilities between the two periods was due primarily to lower tax and incentive compensation accruals this year, resulting from the Company’s lack of improved earnings.
On July 16, 2001, the Company entered into a revolving credit agreement with five banks, providing for loans or letters of credit of up to $75.0 million. The agreement, as amended September 6, 2001, expires July 16, 2004. The average revolving credit borrowings for the first nine months this year were $73,000 compared to $18,000 for the same period last year.
Capital Expenditures
Total capital expenditures in Fiscal 2003 are expected to be approximately $37.1 million. These include expected retail expenditures of $20.6 million to open approximately 61 Journeys stores, 21 Journeys Kidz stores, 4 Johnston & Murphy stores and factory stores and 10 Underground Station stores and to complete 46 major store renovations, including 8 conversions of Jarman stores to Underground Station stores. The planned amount of capital expenditures in Fiscal 2003 for wholesale operations and other purposes was approximately $16.5 million, including approximately $1.4 million for new systems to improve customer service and support the Company’s growth and $13.8 million for a new distribution center to support the Company’s retail growth. The Company expects a total cost of approximately $29.1 million, including capitalized interest of $0.5 million, for the distribution center, including capital expenditures of $14.4 million in Fiscal 2002 and $14.2 million in the first nine months of Fiscal 2003. The Company expects annual depreciation of approximately $2.0 million on the new distribution center when completed.
Future Capital Needs
The Company expects that cash on hand and cash provided by operations will be sufficient to fund all of its planned capital expenditures through Fiscal 2003, including costs associated with construction of the new distribution center. The Company may borrow under its credit facility from time to time, particularly in the fall, to support seasonal working capital requirements. The approximately $3.3 million of costs associated with the prior restructurings and discontinued operations that are expected to be incurred during the next twelve months are also expected to be funded from cash on hand.
In August 2002, the Company’s board of directors authorized the repurchase, from time to time, of up to 300,000 shares of the Company’s common stock. There are 515,100 shares remaining to be repurchased under this and prior authorizations as of December 6, 2002. Any purchases would be funded from available cash. The Company has repurchased a total of 7.0 million shares at a cost of $69.4 million under a series of authorizations since Fiscal 1999. The Company has repurchased 286,000 shares this year at a cost of $4.0 million as of December 6, 2002.
There were $6.1 million of letters of credit outstanding and $5.0 million in borrowings under the revolving credit agreement at November 2, 2002, leaving availability under the revolving credit agreement of $63.3 million. The revolving credit agreement requires the Company to meet certain financial ratios and covenants, including minimum tangible net worth, fixed charge coverage and debt to EBITDAR ratios. The Company was in compliance with these financial covenants at November 2, 2002.
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The Company’s revolving credit agreement restricts the payment of dividends and other payments with respect to capital stock (including repurchases), however the Company may make payments with respect to preferred stock. At November 2, 2002, $27.7 million was available for such payments related to common stock. The aggregate of annual dividend requirements on the Company’s Subordinated Serial Preferred Stock, $2.30 Series 1, $4.75 Series 3 and $4.75 Series 4, and on its $1.50 Subordinated Cumulative Preferred Stock is $294,000.
Environmental and Other Contingencies
The Company is subject to certain loss contingencies related to environmental proceedings and other legal matters, including those disclosed in Note 8 to the Company’s Consolidated Financial Statements. The Company has made provisions for certain of these contingencies, including approximately $2.0 million reflected in Fiscal 2002 and $2.6 million reflected in Fiscal 2001. The Company monitors these matters on an ongoing basis and on a quarterly basis management reviews the Company’s reserves and accruals in relation to each of them, adjusting provisions as management deems necessary in view of changes in available information. Changes in estimates of liability are reported in the periods when they occur. Consequently, management believes that its reserve in relation to each proceeding is a reasonable estimate of the probable loss connected to the proceeding, or in cases in which no reasonable estimate is possible, the minimum amount in the range of estimated losses, based upon its analysis of the facts and circumstances as of the close of the most recent fiscal quarter. However, because of uncertainties and risks inherent in litigation generally and in environmental proceedings in particular, there can be no assurance that future developments will not require additional reserves to be set aside, that some or all reserves may not be adequate or that the amounts of any such additional reserves or any such inadequacy will not have a material adverse effect upon the Company’s financial condition or results of operations.
Financial Market Risk
The following discusses the Company’s exposure to financial market risk related to changes in interest rates and foreign currency exchange rates.
Outstanding Debt of the Company — The Company’s outstanding long-term debt of $103.2 million 5 1/2% convertible subordinated notes due April 2005 bears interest at a fixed rate. Accordingly, there is no immediate impact on the Company’s interest expense from fluctuations in market interest rates.
Cash and Cash Equivalents — The Company’s cash and cash equivalent balances are invested in institutional money market funds or financial instruments with original maturities of three months or less. The Company does not have significant exposure to changing interest rates on invested cash at November 2, 2002. Consequently, the Company considers the interest rate market risk implicit in these investments at November 2, 2002, to be low.
Foreign Currency Exchange Rate Risk — Most purchases by the Company from foreign sources are denominated in U.S. dollars. To the extent that import transactions are denominated in other currencies, it is the Company’s practice to hedge its risks through the purchase of forward foreign exchange contracts. At November 2, 2002, the Company had $1.0 million of foreign exchange contracts for Euro. The Company’s policy is not to speculate in derivative instruments for profit on exchange rate price fluctuations and it does not hold any derivative instruments for trading
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purposes. Derivative instruments used as hedges must be effective at reducing the risk associated with the exposure being hedged and must be designated as a hedge at the inception of the contract. The gain on contracts outstanding at November 2, 2002 was less than $50,000 based on current spot rates. As of November 2, 2002, a 10.0% adverse change in foreign currency exchange rates from market rates would decrease the fair value of the contracts by approximately $0.1 million.
Accounts Receivable — The Company’s accounts receivable balance at November 2, 2002 is concentrated in its two wholesale businesses, which sell primarily to department stores and independent retailers across the United States. One customer accounted for 15.0% of the Company’s trade accounts receivable balance as of November 2, 2002. The Company monitors the credit quality of its customers and establishes an allowance for doubtful accounts based upon factors surrounding credit risk, historical trends and other information; however, credit risk is affected by conditions or occurrences within the economy and the retail industry.
Summary — Based on the Company’s overall market interest rate and foreign currency rate exposure at November 2, 2002, the Company believes that the effect, if any, of reasonably possible near-term changes in interest rates or fluctuations in foreign currency exchange rates on the Company’s consolidated financial position, result of operations or cash flows for Fiscal 2003 would not be material.
New Accounting Principles
In July 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities"(“SFAS 146”), which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)”. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002, with earlier application encouraged. The Company does not expect that the adoption of the Statement will have a significant impact on the Company’s financial position or results of operations.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company incorporates by reference the information regarding market risk to appear under the heading “Financial Market Risk” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Item 4. Controls and Procedures
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PART II — OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
Exhibits
99.1Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Reports on Form 8-K
The Company filed a current report on Form 8-K on November 19, 2002 disclosing Regulation FD disclosures.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Genesco Inc.
/s/ James S. Gulmi
James S. GulmiChief Financial OfficerDecember 13, 2002
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CERTIFICATIONS
I, Hal N. Pennington, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Genesco Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions);
6. The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
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I, James S. Gulmi, certify that:
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