The Finish Line has become the latest party to receive a grand jury subpoena from the Office of the U.S. Attorney to produce documents relating to its merger with Genesco. The Finish Line said in a statement that it is complying with the request and does not believe that the company or its executives are targets of the investigation.
The Finish Line has also provided notice to Genesco Inc. that the ongoing investigation by the Office of the U.S. Attorney of alleged violations of federal fraud statutes in connection with the merger and the probable consequences that will follow from the investigation and the alleged violations that are the subject of the investigation constitute a “material breach of their merger agreement” and such violations “constitute a company Material Adverse Effect and, unless cured in accordance with the terms of the agreement, will cause a condition precedent to The Finish Line's obligation to close the Merger to fail.”
UBS, The Finish Lines financial backer in the merger deal first unveiled in June of this year, started the ball rolling down this road when it filed suit in the Southern District of New York to enable it to back out of its commitments to FINL in financing the merger. UBS charged that the merged entity would be on shaky financial ground, even going as far as to suggest it would be “insolvent.” A UBS lawyer apparently accused Genesco of concealing the state of its financial situation from FINL before the deal was completed, a charge Genesco, Inc. has vigorously denied.
Genesco Inc. reported third quarter results last week, 
and as expected by many, they reflect the general malaise affecting much of the sport footwear market.
Where Genesco is a bit more exposed this year is the ability to anniversary a very strong performance by the Journeys Group division last year when Heelys were flying off the shelves and fashion athletic footwear was all the rage. Fast forward one year and the market is dumping Heelys product at about half the prices seen last year and retailers across the spectrum are suggesting that the low-profile fashion athletic trend that was driven early by Journeys is now starting to slow in favor of performance footwear. Skate footwear was still seen as positive.
“Heelys, which performed strongly for us last year, were a significant problem in the third quarter of this year due largely to over-distribution relative to demand,” said Hal Pennington, chairman and CEO of Genesco Inc.
“First, they hurt comp sales, which we believe would have been slightly positive without them. In fact, our sales of Heelys were off $4.7 million for the quarter year-over-year, despite a higher inventory position.” He also pointed to “tough economic conditions” that have had a “negative impact on demand in the mall,” an absence a fresh compelling product trend in the market, and an “unusually warm fall in much of the country” that hindered sales of higher ticket fall product.
Pennington said Journeys took permanent markdowns on most Heely SKUs, offsetting gross margin gains in non-Heelys inventory. The Heelys impact to initial margin was estimated at $2.4 million and added $2.7 million of markdowns in the quarter.
To provide some sense of the magnitude of this change, the CEO said the average sales price for Heelys dropped from about $72 in second quarter to about $62 in third quarter. That will surely take a turn for the worse as Heelys opened up distribution to the family footwear channel and full-line sporting goods retailers were liquidating product at prices under $30 last week, according to retail point-of-sale data compiled by SportScanINFO.
Pennington said that Journeys, as well as Hat World and Underground Station, showed the effects of a difficult retail climate in the quarter. By contrast, he said both Johnston & Murphy and Dockers Footwear produced another set of strong quarterly results.
Journeys Group sales decreased 1.0% and comps were down 3%. Comps in the Journeys stores were down 3.4% compared to a 9% increase in Q3 last year. Footwear comp ASPs were down only 1.2% compared with a 5.3% drop in the second quarter this year, despite the Heelys impact. The improving trend in ASPs has reportedly continued into the fourth quarter so far.
Unit comps were down 4.6% in the quarter compared to a 3.6% decline in the previous quarter. On the men's side, Journeys saw continued strength with skate brands and sandals also performed well. Women's casual shoes were also called out as performing well for the quarter. The mix changed a bit, with accessories rising to 12% of sales this year from 9% last year. Men's footwear made up about 42% of sales for the quarter, and women's was about 41%.
The Journeys Kidz business posted a 7% comp store sales increase for the quarter on top of a 9% increase last year. GM also improved.
Hat World posted a 2% increase in comps for the quarter compared to a 1% decline last year, reflecting an improvement in both urban and regular doors.
Comps in the urban stores were still negative, but Genesco saw it as the “second consecutive quarterly improvement after a stretch of very difficult quarters in that market.” Major League Baseball remained the largest category, with core MLB product continuing to be strong. The branded category was also said to be “strong once again,” while NCAA product was seen as “challenging” and NFL was described as “a little soft” for the period. Warm weather throughout the quarter apparently reduced sales of knit hats across all product categories.
Underground Station Group comps declined 19% during the third quarter, exacerbating the impact of an 11% decline in last years third quarter. The business was still affected by the difficult Nike comparison early in the third quarter last year when the group was still getting Swoosh goods.
Last year, Nike contributed approximately 16% of Underground Station sales in the second quarter, approximately 17% of sales in the third quarter, and only 4% of sales in the fourth quarter.
Gross margin improved for the quarter in a reversal from the second quarter trend, but ASPs continued to be pressured due to the loss of Nike price points and of general product mix.
Women's footwear made up about 30% of Underground Station's footwear sales in the third quarter this year compared with 24% last year. On average, the women's footwear price points are lower, which also impacts ASPs.
GCO ended the quarter with 215 stores in the Underground Station Group.
Results for the quarter included $6.2 million pretax, or approximately 16 cents per diluted share, in litigation and other expenses related to GCOs proposed merger with The Finish Line, retail store asset impairment charges and costs related to the previously announced decision to close certain underperforming stores, primarily in the Underground Station Group.
>>> What remains to be seen is how Finish Line is working through the issues in the mall. The market wont get that answer until after the Holidays
