CERTAIN RISKS RELATED TO OUR BUSINESS
Before deciding to invest in Hot Topic, Inc. or to maintain or increase an investment in Hot Topic, Inc., readers should carefully consider the risks described below, in addition to the other information contained in this Quarterly Report on Form 10-Q and in our other filings with the SEC, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Definitive Proxy Statement on Form DEFM14A filed on May 10, 2013 and Current Reports on Form 8-K. The risks described below are not the only risks we face. Additional risks that are not presently known to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks actually occur, our business, financial condition and results of operations could be seriously harmed, and our stock price could decline. The risks described below include certain changes to the “Risk Factors” set forth in our Annual Report on Form 10-K filed on March 22, 2013.
RISKS RELATED TO THE PROPOSED MERGER
There are risks and uncertainties associated with the Merger
There are a number of risks and uncertainties relating to the Merger. For example:
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the Merger may not be consummated (including as a result of a legal injunction) or may not be consummated as currently anticipated;
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there can be no assurance that approval of our shareholders and the requisite regulatory approvals will be obtained;
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there can be no assurance other conditions to the closing of the Merger will be satisfied or waived or that other events will not intervene to delay or result in the termination of the Merger;
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if the Merger is not completed, the share price of our common stock may change to the extent that the current market price of our common stock reflects an assumption that the Merger will be completed;
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failure of the Merger to close, or a delay in its closing, may have a negative impact on our ability to pursue alternative strategic transactions or our ability to implement alternative business plans;
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under certain circumstances, if the Merger Agreement is terminated, we will be required to pay Sycamore a $21 million termination fee or reimburse Sycamore for up to $4.5 million of expenses;
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pending the closing of the Merger, the Merger Agreement restricts us from engaging in certain actions without Sycamore’s approval, which could prevent us from pursuing opportunities that may arise prior to the closing of the Merger;
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any delay in completing, or the failure to complete, the Merger could have a negative impact on our business, stock price and our relationships with our customers or suppliers; and
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the attention of our management may be directed to transaction-related considerations and may be diverted from the day-to-day operations of our business and pursuit of our strategic initiatives.
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We have incurred, and will continue to incur, significant costs, expenses and fees for professional services and other transaction costs in connection with the Merger, and many of these fees and costs are payable by us whether or not the Merger is consummated.
Our executive officers and directors may have interests that are different from, or in addition to, those of our shareholders generally
Our executive officers and directors may have interests in the Merger that are different from, or are in addition to, those of our shareholders generally. These interests include direct or indirect ownership of our common stock and stock options, the acceleration of stock options and restricted stock upon consummation of the Merger, certain arrangements between certain of our executive officers and Parent, and other interests. In addition, our executive officers may have certain rights to severance and other payments in the event that their employment is terminated following the consummation of the Merger. The interests of our director and executive officers in the proposed Merger are described in more detail in the proxy statement regarding the proposed Merger that we filed with the SEC on May 10, 2013.
The Merger Agreement limits our ability to pursue alternative transactions to the Merger
The Merger Agreement contains “no shop” provisions that, subject to limited exceptions, limit our ability to discuss, facilitate or commit to third-party acquisition proposals to acquire all or a significant part of the company. In addition, we are required to pay a $21 million termination fee if we terminate the Merger Agreement under certain circumstances. These provisions place conditions on our ability to pursue offers from third parties that could result in greater value to our shareholders. The obligation to make the termination fee payment also could discourage a third party from pursuing an alternative acquisition proposal.
Hot Topic will no longer exist as a public company following the Merger and its shareholders will forego any increase in its value
If the Merger is completed, we will no longer exist as a public company and our shareholders will forego any increase in the Company’s value that might have otherwise resulted from our possible future growth.
We are subject to litigation initiated in connection with the Merger, which could be time consuming and divert our resources and the attention of our management
As described in “NOTE 13 – Commitment and Contingencies” in the accompanying financial statements and in "Item 1 - Legal Proceedings," we and the individual members of our board of directors have been named as defendants in certain lawsuits relating to the Merger Agreement and the proposed Merger. The lawsuits generally allege that the our directors breached their fiduciary duties by engaging in a flawed sales process, by approving an inadequate price, and by agreeing to provisions that would allegedly preclude another interested buyer from making a financially superior proposal to acquire the company. The lawsuits also allege that the company, Sycamore and related entities aided and abetted the alleged breaches of fiduciary duties by the directors. Plaintiffs seek to enjoin the proposed transaction, declaratory relief, and attorneys’ fees. Although we believe that these suits are without merit, the defense of these suits may be expensive and may divert management’s attention and resources, which could adversely affect our business.
CERTAIN OTHER RISKS TO OUR BUSINESS
Our success relies on popularity of music, pop culture and fashion trends, and our ability to react to them
Our financial performance is largely dependent upon the continued popularity of apparel, accessories and other merchandise inspired by music, film, television, pop culture, and fashion trends, particularly among teenagers and young adults. The popularity of such products is influenced by the internet; music videos and music television networks; the emergence of new artists; the success and timing of music releases, movies and television shows; music/pop culture-related products and fashion trends. The popularity of particular types of music, movies, television shows, artists, actors, styles, trends and brands is constantly changing. Our failure to anticipate, identify and react appropriately to changing trends and preferences of our customers could lead to, among other things, excess inventories and higher markdowns. There can be no assurance that the products we sell will be accepted by our customers
which may cause us to lose customers and market share to those of our competitors who are better able to anticipate and respond to such trends and preferences
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Our business largely depends on a strong brand image, and if we are not able to maintain and enhance our brands, particularly in new markets or with new concepts where we have limited brand recognition, we may be unable to increase or maintain our level of sales
We believe that our brands’ image and awareness has contributed significantly to the success of our business. We also believe that maintaining and enhancing our brands’ image, particularly in new markets where we have limited brand recognition, or developing new brands through new concepts, is important to maintaining and expanding our customer base. Maintaining and enhancing our brands’ image and developing brands through new concepts may require us to make substantial investments in areas such as merchandising, marketing, store operations, community relations, store graphics, catalog distribution and employee training, which could adversely affect our cash flow and which may not ultimately be successful. Failure to successfully market our brands in new and existing markets, and to develop new brands or concepts, could harm our business, results of operations and financial condition.
We depend on a small number of key licensed products for a portion of our earnings and lower than expected sales of those products or the inability to obtain new licensed products could adversely affect our revenues
We license from others the rights to produce and/or sell certain products that contain a third party’s trademarks, designs and other intellectual property. If the popularity of those licensed products diminishes or if we are unable to obtain new licensed products with comparable consumer demand, our sales could decline. Furthermore, if we are unable to obtain favorable terms from licensors, our operational results may suffer. We may not be able to prevent a licensor from choosing not to renew a license with us and/or from licensing a product to one of our competitors.
Our access to merchandise could be hurt by changes in vendors’ business condition
Our financial performance depends on our ability to obtain our merchandise in sufficient quantities at competitive prices. We depend on independent contractors and vendors to manufacture much of our merchandise. Substantially all of our music/pop culture-licensed products are available from vendors that have exclusive license rights. In addition, we rely on small, specialized vendors who generally have limited resources, production capacities and operating histories. Lack of access to capital, as a result of the current economic conditions or otherwise, and changes in vendors’ compliance and certification procedures may cause our vendors to delay, reduce or eliminate shipment of products we otherwise would sell in our stores. We generally do not have long-term purchase contracts or other contractual assurances of continued supply, pricing or access to new products. There can be no assurance that we will be able to acquire desired merchandise in sufficient quantities on acceptable terms in the future.
We may be unable to obtain, maintain and protect the intellectual property rights necessary to operate our business, and may be subject to claims that we are infringing, misappropriating or otherwise violating the intellectual property rights of third parties
We rely on a combination of trademark, trade secret, copyright and domain name law to protect our intellectual property. In particular, we believe our trademarks, trade names and domain names are valuable assets. However, there can be no assurance that our intellectual property rights will be sufficient to distinguish our products and services from those of our competitors and to provide us with a competitive advantage. From time to time, third parties may use names and logos similar to ours, may apply to register trademarks or domain names similar to ours, and may infringe or otherwise violate our intellectual property rights. There can be no assurance that our intellectual property rights can be successfully asserted against such third parties or will not be invalidated, circumvented or challenged. If we are unable to prevent our competitors from using names, logos and domain names similar to ours, consumer confusion could result, the perception of our brand and products could be negatively affected, and our business and reputation could be damaged as a result. We may also be subject to claims that our activities or the products we sell infringe, misappropriate or otherwise violate the intellectual property rights of others. Any such claims can be time consuming and costly to defend, even if the claims are without merit. Such claims may also require us to enter into costly settlement or license agreements (which could, for example, prevent us from using our trademarks in certain geographies or in connection with certain products and services), pay costly damage awards, and face a temporary or permanent injunction prohibiting us from marketing or providing the affected products and services.
Opening, remodeling, relocating and closing stores may not achieve the anticipated benefits and could create challenges we may not be able to adequately meet
We depend on our ability to open new stores, manage our existing store base, ensure that the performance of our remodeled and relocated stores is at acceptable levels, and close underperforming stores. In order to open, remodel and relocate stores, among other things, we need to locate suitable store sites, negotiate acceptable lease terms, obtain or maintain adequate capital resources on acceptable terms, source sufficient levels of inventory, hire and train store managers and sales associates, integrate new or relocated stores into our existing operations and maintain adequate distribution center space and information technology systems. Moving or expanding store locations and operating stores in new markets, especially markets outside the continental United States, present competitive, merchandising and regulatory challenges we do not have experience in or know how to face. There can be no assurance that moving or expanding store locations and operating stores in new markets will not adversely affect the individual financial performance of our existing stores or our overall results of operations. In the event that the number of our stores increases, we may face risks associated with market saturation of our products and concepts. Similarly, there can be no assurance that remodeling or relocating existing stores will not adversely affect either the individual financial performance of the store prior to the change or our overall results of operations. Furthermore, there can be no assurance that we will successfully achieve our remodel or expansion targets or, if achieved, that planned remodel or expansion will result in profitable operations.
Expanding our operations to include new concepts presents risks
We have expanded our business beyond the Hot Topic and Torrid concepts to include, in fiscal 2012, our Blackheart test concept. We may implement other new concepts in the future. Starting and operating new concepts presents new and challenging risks and uncertainties, including, among others, unanticipated operational problems, lack of experience, lack of customer acceptance, the inability to market a new concept effectively, new vendor relationships, competition from existing and new retailers, and diversion of management’s attention from our existing concepts. If we do not operate Blackheart or any new concept effectively, it could materially impact our business.
Our business strategy requires innovating and improving our operations, and we may not be able to do this sufficiently to effectively prevent a negative impact on our business and financial results
To be successful we must innovate our products, our stores, and the shopping experience for our customers. Such innovation involves risks, including that we will not properly anticipate the need for or rate of change, that we are not able to successfully bring about such change, that we will not be able to produce anticipated results, and that our customers will not be receptive to the change. Such innovation also involves significant capital expenditures and other costs that we may not be able to recover if the innovation is not favorably received by our customers.
Failure of our vendors to use acceptable ethical business practices could negatively impact our business
We require and expect our vendors and manufacturers to operate in compliance with applicable laws, rules and regulations regarding working conditions, employment practices, the environment and intellectual property. However, we do not control their labor and other business practices. Further, we do not inspect our manufacturers’ operations and would not be immediately aware of any noncompliance by our vendors with applicable domestic or international laws and standards, including our internal standards. If one of our vendors or manufacturers violates labor or other laws or implements labor or other business practices that are regarded as unethical, the shipment of merchandise to us could be interrupted, orders could be canceled, relationships could be terminated and our reputation could be damaged.
Technology and other risks associated with our internet sales could hinder our overall financial performance
We sell merchandise over the internet through websites we control and affiliated websites controlled by others. Our internet sales generate a significant portion of our total sales and are dependent on our ability to drive internet traffic to our websites. Our internet operations are subject to numerous risks and pose risks to our overall business, including the inability to successfully establish partnerships that are instrumental in driving traffic to our websites; diversion of sales from our stores; liability for online content; computer and consumer privacy concerns; rapid technological changes; the need to invest in additional computer hardware and software to support sales; hiring, retention and training of personnel; failure of computer hardware and software, including computer viruses, telecommunication failures, online security breaches and similar disruptions; governmental regulations; and credit card fraud. There can be no assurance that our internet operations will achieve sales and profitability levels that justify our investment in them.
We materially rely on eCommerce, information and other technology systems, including such technology provided by third parties
We believe our dependence on eCommerce, information and other technology systems, including technology provided by third parties, will increase in the future, and it is possible we may not be able to obtain, maintain or use such systems as quickly or as effectively as needed. Implementing new systems, modifying existing systems, and restoring such systems and technology following a shut-down could present technological and operational challenges which we are unprepared for. We continue to evaluate the adequacy of the eCommerce, information and other technology systems we use to operate our business. Our failure to adapt to changing technological needs could have a material adverse effect on our results of operations and financial condition. We have agreements with third-party providers to maintain eCommerce and information technology systems, including content. We would be negatively impacted if such third parties fail to provide such services, including by way of malfunction of third-party sites, hardware, software and other equipment; service outages of third-party sites; third-party claims of data privacy violations, security breaches and intellectual property infringement; and poor integration of our technology into their software and services.
System security risk issues and system failures could disrupt our internal operations or information technology services provided to customers
Computer hacking attacks, as well as computer malware, denial-of-service attacks and viruses, have become increasingly prevalent in recent years. Using such methods and others, experienced computer programmers, hackers and other users may be able to penetrate our network security and misappropriate our confidential information or that of third parties, create system disruptions or cause shutdowns. As a result, we could incur significant expenses addressing problems created by security breaches of our network. Moreover, we could incur significant loss of revenue and increased expenses in connection with system failures. In addition, hardware and operating system software and applications that we procure from third parties may contain defects in design or manufacture, including “bugs” and other problems that could unexpectedly interfere with the operation of the system. The costs to us to eliminate or alleviate security problems, viruses and bugs could be significant, and the efforts to address these problems could result in interruptions, delays or cessation of service that may impede our sales, distribution or other critical functions. In addition, our systems are not fully redundant and could be subject to failure. Our disaster recovery planning may not be sufficient, and we may not have adequate insurance coverage to compensate us for any significant casualty loss.
We are responsible for maintaining the privacy of personally identifiable information of our customers
Through our sale transactions, loyalty programs and other methods, we obtain personally identifiable information about our customers which is subject to federal, state and international privacy laws. These laws are constantly changing. If we fail to comply with these laws, we may be subject to fines, penalties or other adverse actions. We are highly dependent on the use of credit cards to complete sale transactions in our stores and through our websites, and if we fail to comply with Payment Card Industry (PCI) Data Security Standards, we may become subject to limitations on our ability to accept credit cards. Moreover, third parties may seek to access this information through improper means such as computer hacking, malware and viruses. Any incidents involving unauthorized access or improper use of our customers’ personally identifiable information could damage our reputation and brand and result in legal or regulatory action against us.
Our performance is dependent on attracting and retaining a large and growing number of qualified team members
Many of those team members are in entry-level or part-time positions with historically high rates of turnover. Our ability to meet our labor needs while controlling our costs is subject to external factors such as unemployment levels, minimum wage legislation, health care legislation and changing demographics. In addition, our labor costs are influenced by health care and workers’ compensation costs, both of which have been rising in recent years. If we cannot hire enough qualified employees, or if there is a disruption in the supply of personnel we hire from third-party providers, especially during our peak season or certain high-volume events, our customer service levels and our operations could be negatively impacted.
We may be subject to unionization, work stoppages, slowdowns or increased labor costs
Currently, none of our employees are represented by a union. However, our employees have the right under the National Labor Relations Act to form or affiliate with a union. If some or all of our workforce were to become unionized and the terms of the collective bargaining agreement were significantly different from our current compensation arrangements, it could increase our costs and adversely impact our profitability. Moreover, participation in labor unions could put us at increased risk of labor strikes and disruption of our operations.
Loss of key people or an inability to hire necessary and significant personnel could hurt our business
Our ability to achieve and maintain operating efficiency and to anticipate and effectively respond to changing trends and consumer preferences depends in part on our ability to retain and attract senior management and other key personnel in our operations, merchandising, music and other departments. Competition for these personnel is intense, and we cannot be sure that we will be able to retain or attract qualified personnel as needed. The sudden loss of the services of key people could have a material adverse effect on our business, results of operations and financial condition.
Our supply chain has risks and uncertainties that could affect our sales and business
The merchandise we sell is obtained from vendors and manufacturers in the United States and outside of the country. Generally, this product is shipped to our distribution centers in California and Tennessee, and from our distribution centers to our stores or directly to our customers using Federal Express and the United States Postal Service. Certain products we sell are imported and subject to delivery delays based on availability and port capacity. Our reliance on Federal Express and the United States Postal Service for shipments is subject to risks associated with their ability to provide delivery services that meet our shipping needs and our ability to obtain such services at an affordable cost. We are also dependent upon the ability to hire temporary associates to adequately staff our distribution centers, particularly during busy periods such as the holiday season. We may not be able to achieve or maintain operating efficiencies using two distribution centers that are located approximately 2,000 miles apart.
In addition, if we encounter difficulties associated with our distribution centers or if they were to shut down for any reason, including fire, hurricanes or other natural disaster, we could face inventory shortages resulting in “out-of-stock” conditions in our stores, and delays in shipments to our customers, resulting in significantly higher costs and longer lead times associated with distributing our merchandise. Also, most of our computer equipment and senior management, including critical resources dedicated to merchandising, financial and administrative functions are located at our corporate headquarters. Our management and our operations and distribution staff would need to find an alternative location if our corporate headquarters were shut down for any reason, causing further disruption and expense to our business and operations. Our disaster recovery planning may not be sufficient, and our critical systems, operations and information may not be restored in a timely manner, or at all, which could have an adverse effect on our business.
Risks associated with contracting directly with manufacturers for merchandise could hinder our financial performance
We are sourcing a greater percentage of our merchandise directly from manufacturers. We have limited experience in sourcing and importing merchandise directly from manufacturers. We may encounter administrative challenges and operational difficulties with the manufacturers from which we may source our merchandise. Operational difficulties could include reductions in the availability of production capacity, errors in complying with merchandise specifications, insufficient quality control and failures to meet production deadlines. A manufacturer’s failure to ship merchandise to us on a timely basis or to meet the required quality standards could cause supply shortages that could result in lost sales. If a manufacturer conducts its operations in a manner that is illegal or regarded as unethical, it could affect our business and our reputation could be damaged.
We could acquire merchandise without full rights to sell it, which could inhibit sales and lead to disputes or litigation
We purchase licensed merchandise from vendors who represent that they hold manufacturing and distribution rights to such merchandise. We also contract directly with licensors to obtain the manufacturing and distribution rights. We do not independently verify whether these vendors legally hold adequate rights to the licensed properties they are manufacturing, distributing or licensing. If we license merchandise that we have not legally obtained the rights to sell, we could be obligated to remove such merchandise from our stores, incur costs associated with destruction of merchandise and be subject to liability under various civil and criminal causes of action, including actions to recover unpaid royalties and other damages. As we expand our efforts to contract directly with manufacturers and licensors for licensed merchandise, we may incur difficulties securing the necessary manufacturing and distribution rights. Even when we have secured the rights needed to sell such products in the United States, we may not be able to secure the rights to sell the products outside of the United States.
There are litigation and other claims against us from time to time, which could distract management from our business activities and could lead to adverse consequences to our business and financial condition
We are involved from time to time with litigation and other claims against us. Often these cases can raise complex factual and legal issues, which are subject to risks and uncertainties and which could require significant management time. Although we do not currently believe that the outcome of any current matter of litigation or claim against us will have a material adverse effect on our overall financial condition, we have, in the past, incurred unexpected expense in connection with litigation matters. In the future, adverse settlements, judgments or resolutions may negatively impact earnings. Injunctions against us could have an adverse effect on our business by requiring us to do or prohibiting us from doing certain things. We may in the future be the target of material litigation, including class-action and securities litigation, which could result in substantial costs and divert our management’s attention and resources.
Uncertainty in the global capital and credit markets may materially impair the liquidity of a portion our cash and investment portfolio
We hold cash, cash equivalents and short-term and long-term investments, including an auction rate security (discussed in more detail in “NOTE 6 – Short-Term and Long-Term Investments” contained in the accompanying financial statements). Continued failures of auctions for the auction rate security we hold limit our ability to liquidate this investment and is expected to continue failing for some period of time. Although the money market funds and municipal bonds we hold are highly rated and are comprised of high-quality, liquid instruments, if the financial markets trading the underlying assets experience a disruption, we may need to temporarily rely on other forms of liquidity. In addition, a risk exists that our cash and investments may not always be optimally managed and this may affect our profitability and results of operations.
Our charter documents and other circumstances could prevent a takeover or cause dilution of our existing shareholders, which could be detrimental to existing shareholders
Our Articles of Incorporation and Bylaws contain provisions that may have the effect of delaying, deterring or preventing a takeover of Hot Topic, Inc. For instance, our Articles of Incorporation include certain “fair price provisions” generally prohibiting business combinations with controlling or significant shareholders unless certain minimum price or procedural requirements are satisfied, and our Bylaws prohibit shareholder action by written consent. Additionally, our Board has the authority to issue, without shareholder approval, up to 10,000,000 shares of “blank check” preferred stock having such rights, preferences and privileges as designated by the Board. The issuance of these shares could have a dilutive effect on shareholders and potentially prohibit a takeover of Hot Topic, Inc. by requiring the preferred shareholders to approve such a transaction. We also have a significant number of authorized and unissued shares of our common stock available under our Articles of Incorporation. These shares provide us with the flexibility to issue our common stock for future business and financial purposes including stock splits, raising capital and providing equity incentives to employees, officers and directors. The issuance of these shares could result in dilution to our shareholders.
We are required to make significant lease payments for our store leases and corporate offices and one of our distribution centers, which may strain our cash flow
We lease all of our retail store locations as well as our corporate headquarters and one of distribution centers. We do not own any real estate except for our distribution center in LaVergne, Tennessee. The leases for most of the existing stores are for approximately ten-year terms and provide for minimum rent payments as well as contingent rent based upon a percentage of sales in excess of the specified minimums. Our costs under these leases are a significant amount of our expenses. In fiscal 2012, 2011 and 2010, our total rent expense was $54.7 million, $52.3 million and $52.6 million, respectively. In addition, rent expenses could escalate when multi-year leases are renewed at the expiration of their lease term. These expenses are significant and recurring, which places a consistent strain on our cash flow. Additional sites that we lease are likely to be subject to similar long-term leases. If an existing or future store is not profitable, and we decide to close it, we may nonetheless be committed to perform our obligations under the applicable lease including, among other things, paying the base rent for the balance of the lease term. We depend on cash flows from operations to pay our rent expenses and to fulfill our other cash needs. If our business does not generate sufficient cash flows from operating activities, and sufficient funds are not otherwise available to us from borrowings under our available revolving credit facility or from other sources, we may not be able to service our rent expenses, respond to competitive challenges or to fund our other liquidity and capital needs, which would harm our business.
We are dependent upon shopping malls, strip centers and outlet centers remaining popular as shopping destinations, and maintaining good relationships with shopping mall, strip center and outlet center operators
The global economic downturn and other factors have diminished the ability of shopping mall, strip center and outlet center operators to operate profitably and, in some cases, forced them to declare bankruptcy or cease operations entirely. The ongoing slowdown in the United States economy, uncertain economic outlook, and other factors could continue to curtail shopping mall, strip center and outlet center development, decrease customer traffic, reduce the number of hours landlords keep their shopping malls, strip centers and outlet centers open, cause landlords to lower their operational standards and negatively impact our lease contracts. Consolidation of ownership of shopping malls, strip centers and outlet centers may give landlords more leverage in negotiations and adversely affect our ability to negotiate favorable lease terms. Such consolidation may result in increased lease costs. We believe we have favorable relationships with landlords and developers, however if this changes it could inhibit our ability to negotiate with them and may make it more difficult for us to manage our leases, including for us to expand, remodel or relocate to certain sites. If our relations with landlords or developers become strained, or we otherwise encounter difficulties in leasing store sites, we may not be able to open stores in malls, strip centers and outlet centers we would otherwise be interested in maintaining stores; we may not be able to negotiate lease terms favorable to the company; and we may be inhibited in our ability to close underperforming stores.
We face intense competition
The apparel, music and accessory categories within the retail industry in which we operate are highly competitive. Increased competition could have a material adverse effect on our business, results of operations and financial condition. Our competitors, particularly big-box retailers, may have the ability to sell merchandise at substantially lower prices than we are able to sell such merchandise. This may cause us to incur greater than anticipated price reductions and unanticipated increases in our inventories for such products. It may also cause us to elect not to sell such products, despite the fact the products would otherwise attract customers and sell well in our stores.
Furthermore, many of our competitors have greater financial, marketing and other resources than we currently do, and therefore may be able to devote greater resources to the marketing and sale of their products, generate national brand recognition or adopt more aggressive pricing policies than we can, which would put us at a competitive disadvantage. Moreover, we do not possess exclusive rights to many of the elements that comprise our in-store experience and product offerings. Our competitors may seek to emulate facets of our business strategy and in-store experience, which could result in a reduction of any competitive advantage or special appeal that we might possess. In addition, most of our products are sold to us on a non-exclusive basis. As a result, our current and future competitors may be able to duplicate or improve on some or all of our in-store experience or product offerings that we believe are important in differentiating our stores and our customers’ shopping experience. If our competitors were to duplicate or improve on some or all of our in-store experience or product offerings, our competitive position and our business could suffer.
Timing, seasonal issues and other fluctuations outside of our control could negatively impact our financial performance for given periods
Our business, particularly our Hot Topic division, is subject to seasonal influences that affect our comparable sales. There are heavier concentrations of sales during the back-to-school, Halloween and holiday (defined as the week of Thanksgiving through the first few days of January) seasons and other periods when schools are not in session. Our results of operations may fluctuate materially depending on, among other things, the timing of store openings and related pre-opening and other startup expenses; net sales contributed by new stores; increases or decreases in comparable sales; timing, popularity of and our ability to obtain, certain pop culture-related licenses, including on an exclusive basis; releases of new music, movies and television shows; releases of new music/pop culture-related products; our ability to efficiently source and distribute products; changes in our merchandise mix and the challenges involved in getting the right mix into stores at the right time; shifts in timing of certain holidays; weather conditions; and overall economic conditions.
Our profitability could be adversely affected by volatile commodity prices, including petroleum and cotton
The profitability of our business depends to a certain degree upon the price of certain commodities, including petroleum and cotton products. We are affected by changes in such prices to the extent that such commodities are part of the costs of delivery of merchandise to our stores and to the extent that the commodities are used in the production of our merchandise. Higher gasoline prices may also affect the willingness of consumers to drive to our stores.
Significant fluctuation in the value of the United States dollar or foreign exchange rates may affect our profitability
Substantially all of our foreign purchases of merchandise have been negotiated and paid for in United States dollars. As a result, our sourcing operations may be adversely affected by significant fluctuation in the value of the United States dollar against foreign currencies, restrictions on the transfer of funds and other trade disruptions. A portion of our revenues come from foreign markets. Changes in foreign exchange rates applicable to these markets may adversely affect our revenues, even if the volume of sales remains the same. We may not be able to repatriate revenues earned in foreign markets.
Recording impairment charges for certain underperforming stores may negatively impact our future financial condition or results of operations, and closing stores might not have a positive impact on our operating results
We are required to assess, and where appropriate, record a charge for, the impairment of underperforming assets. This may negatively impact our reported and future financial condition and results of operations. In addition, we continue to close stores that do not meet our expectations of profitability which may cause us to impair or accelerate the depreciation of certain store assets and incur additional amounts for lease termination, severance and other closing costs. There can be no assurance that we will not incur future impairment charges and store closure expenses for underperforming assets or that store closures will have a significant positive impact on our operating results.
Changes in laws, including employment laws and laws related to our merchandise, could make conducting our business more expensive or change the way we do business
Changes in laws and any future changes could make our operations more expensive or require us to change the way we do business. Changes in federal and state minimum wage laws could require us to change our entire wage structure for stores. Other laws related to treatment of employees, including laws related to employee benefits and privacy, could also negatively impact us, such as by increasing medical insurance costs and related expenses. Changes in product safety or other consumer protection laws, and private-party enforcement of existing laws, could lead to increased costs to us for certain merchandise, additional labor costs associated with readying merchandise for sale, or serve as the basis for litigation. Changes in laws affecting our supply chain, including the effect of the California Transparency in Supply Chain Act of 2012 and portions of the Dodd-Frank Wall Street Reform and Consumer Protection Act relating to conflict minerals, may adversely affect the sourcing, availability and pricing of certain materials which may be used in the manufacture of some of our products. In addition, we may incur additional legal and other costs to comply with the annual disclosure requirements, including costs related to determining the source of any of the relevant minerals and metals which may be used in our products.
For example, in March 2010, the Patient Protection and Affordable Care Act, or the Affordable Care Act, and the Health Care Education Reconciliation Act of 2010, or the Reconciliation Act, were signed into law. The Affordable Care Act and the Reconciliation Act include a number of health care provisions taking effect over several years, including expanded dependent coverage, incentives for business to provide health care benefits, a prohibition on denial of coverage and denial of claims on pre-existing conditions, a prohibition on limiting essential benefits, and other expansion of health care benefits and coverage. Some of the associated taxes and fees, as well as certain health care changes required by these acts, are expected to result in increased health care costs for us. The costs of such legislation may adversely impact our results of operations.
A disruption of imports may increase our costs and reduce our supply of merchandise
We receive apparel and other merchandise from foreign sources, both purchased directly in foreign markets and indirectly through domestic vendors with foreign sources. As a result of our reliance on international vendors and manufacturers, we are subject to the risks generally associated with global trade and doing business abroad, which include foreign and domestic laws and regulations, political unrest, disruptions or delays in cross-border shipments and changes in economic conditions in countries in which our merchandise is manufactured. In addition, disease outbreaks, terrorist acts or military conflicts could increase the risks of doing business with suppliers who rely on foreign markets. Trade restrictions in the form of tariffs or quotas, or both, that are applicable to the merchandise we sell also could affect the importation of the merchandise and increase the cost and reduce the supply of products available to us. Further, changes in tariffs or quotas for merchandise imported from individual foreign countries could lead us to shift our sources of supply among various countries. Any shift we might undertake in the future could result in a disruption of our sources of supply and lead to a reduction in our revenues and earnings. Supply chain security initiatives undertaken by the United States or foreign governments that impede the normal flow of product could also negatively impact our business.
We incur costs associated with regulatory compliance, and this cost could be significant
There are numerous regulatory requirements for public companies that we comply with or may be required to comply with in the future and compliance with these rules could result in the diversion of management’s time and attention, which could be disruptive to normal business operations. These regulations may include more stringent accounting standards, taxation requirements (including changes in applicable income tax rate, new tax laws and revised tax law interpretations), trade restrictions, regulations regarding financial matters, privacy and data security, environmental regulations, advertising, safety and product liability. We may in the future be required to adopt International Financial Reporting Standards, and doing so could be time-consuming and cause us to incur significant expense. If we do not satisfactorily or timely comply with these requirements, possible consequences could include sanction or investigation by regulatory authorities such as the SEC or the NASDAQ Stock Market; fines and penalties; incomplete or late filing of our periodic reports, including our annual report on Form 10-K or quarterly reports on Form 10-Q or civil or criminal liability.
Government or consumer concerns about product safety could result in regulatory actions, recalls or changes to laws, which could harm our reputation, increase costs or reduce sales
We are subject to regulation by the Consumer Product Safety Commission and similar state and international regulatory authorities, and our products could be subject to involuntary recalls and other actions by these authorities. We purchase merchandise from suppliers domestically as well as outside the United States. One or more of our suppliers might not adhere to product safety requirements or our quality control standards, and we might not identify the deficiency before such merchandise is received by our customers. Issues of product safety could result in a recall of products we sell. Additionally, regulatory authorities, including the Consumer Product Safety Commission, have undertaken reviews of product safety and are in the process of enacting or are considering various proposals for more stringent laws and regulations. In particular, the Consumer Product Safety Improvement Act of 2008, which imposes significant requirements on the sale of consumer products and enhanced penalties for noncompliance. Such regulations contain provisions which have uncertain applicability to products we sell, and such lack of certainty may inhibit our willingness carry products or cause us to carry product we otherwise would not. These regulations could result in delays in getting products to our stores, lost sales, the rejection of our products by consumers, damage to our reputation or material increases in our costs, and may have a material adverse effect on our business. Moreover, individuals and organization may assert legal claims for our non-compliance with consumer product rules and regulations, and we may be subject to lawsuits relating to these claims. There is a risk that these claims or liabilities may exceed or fall outside the scope of indemnities provided by third parties or outside the coverages of our insurance policies.
Economic conditions could decrease consumer spending and reduce our sales
Certain economic conditions could affect the level of consumer spending on merchandise we offer, including, among others, employment levels; salary and wage levels, particularly of teens and college-age adults; interest rates; availability of consumer credit; taxation; and consumer confidence in future economic conditions. For example, the global economic downturn has significantly reduced consumer spending levels and mall customer traffic in general. The ongoing slowdown in the United States economy and uncertain economic outlook could continue to cause lower consumer spending levels and mall customer traffic which could adversely affect our sales results and financial performance. In addition, we are highly dependent on a significant level of teenage and college-age spending on music/pop culture-licensed and music/pop culture-influenced products, and we likely would be adversely affected if economic conditions limited such spending.
War, terrorism and other catastrophes could negatively impact our customers, places where we do business and our expenses
The continued threat of terrorism, heightened security and military action in response to this threat, any future acts of terrorism, and significant natural disasters or other catastrophic events may cause disruptions and create uncertainties that affect our business. To the extent that such disruptions or uncertainties negatively impact shopping patterns and/or shopping mall traffic, or adversely affect consumer confidence or the economy in general, our business, operating results and financial condition could be materially and adversely affected. A significant natural disaster or other catastrophic event affecting our facilities could materially affect our supply chain, our information system and other aspects of our operations.
Our stock price could fluctuate substantially for reasons outside of our control
Our common stock is quoted on the NASDAQ Stock Market, which has experienced, and is likely to experience in the future, significant price and volume fluctuations, which could adversely affect our stock price without regard to our financial performance. In addition, we believe that factors such as quarterly fluctuations in our financial results and comparable sales; announcements by other apparel, accessory, music and gift item retailers; the trading volume of our stock; changes in estimates of our performance by securities analysts; litigation; overall economic and political conditions, including the global economic downturn; the condition of the financial markets, including the credit crisis; and other events or factors outside of our control could cause our stock price to fluctuate substantially.
Environmental risks associated with the retail industry may result in significant costs and decreased sales
We are exposed to risks arising out of environmental matters and existing and potential laws relating to the protection of the environment. Adverse and unexpected weather conditions, including such conditions caused by the global climate change phenomena, earthquakes and other natural disasters could affect our supply chain, mall traffic and customer interest in our products. We receive apparel and other merchandise from foreign sources, both purchased directly in foreign markets and indirectly through domestic vendors with foreign sources. Stricter global and domestic greenhouse gas emission requirements may cause our vendors to incur higher costs, including increased transportation costs. There is a risk that we may occupy retail space that may require remediation to comply with environmental laws. In addition to potential liability for remediation costs, the cleanup process may cause our stores to be closed for an extended period of time, resulting in loss of sales.
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