ITEM 1. BUSINESS
General
Francesca’s Holdings Corporation was incorporated in Delaware
in 2007. We are a holding company and all of our business operations are conducted through our subsidiaries. Our principal
executive office is located at 8760 Clay Road, Houston, Texas 77080, our telephone number is (713) 864-1358 and our fax number
is (713) 426-2751. We maintain a website at
www.francescas.com
. We may post information that is important to our investors
on our website. Information included or referred to on, or otherwise accessible through, our website is not intended to form part
or be incorporated by reference into this report. Except where the context otherwise requires or where otherwise indicated, the
terms “francesca’s
®
,” “we,” “us,”
“our,” “the Company,” and “our business” refer to Francesca’s Holdings Corporation and
its consolidated subsidiaries as a combined entity.
We operate on a fiscal calendar which, in a given fiscal year,
consists of a 52- or 53-week period ending on the Saturday closest to January 31st. The reporting periods contained in our audited
consolidated financial statements included in this Annual Report on Form 10-K contain 52 weeks of operations in fiscal year 2018,
which ended on February 2, 2019, 53 weeks of operations in fiscal year 2017, which ended on February 3, 2018, and 52 weeks of operations
in fiscal year 2016, which ended on January 28, 2017.
Our Company
francesca’s
®
is a specialty retailer which operates a nationwide-chain of boutiques providing customers a unique, fun and personalized shopping
experience. The merchandise assortment we offer is a diverse and balanced mix of apparel, jewelry, accessories and gifts. We aim
to offer a differentiated shopping experience and quality, on-trend merchandise at a compelling value, across a wide variety of
geographic markets and shopping venues. As of February 2, 2019, francesca’s
®
operated 727 boutiques in 47 states and the District of Columbia and also served its customers through
www.francescas.com
,
our ecommerce website.
Recent Developments
We
have developed a turnaround plan to stabilize and then grow our business. This plan includes strategies aimed at
enhancing our financial performance, which has declined primarily as a result of our continued comparable sales declines.
See “Our Growth Strategy” below for additional information. In fiscal year 2018, comparable sales declined 14%
and in fiscal year 2017 comparable sales declined 11%. In each case, we believe the declines were primarily the result of
our inability to successfully implement merchandise planning, buying and promotional policies to leverage our strength
of delivering on-trend merchandise at a compelling value, causing declines in both conversion rates and boutique
traffic. Additionally, the growth in our expense structure has outpaced our revenues. As a result, our ability to generate
cash from operations was adversely impacted in fiscal year 2018 and we ended the year with $20.1 million in cash and cash
equivalents and approximately $10.0 million in borrowings under our
Asset Based Revolving Credit Facility (as defined
below)
.
Subsequent to fiscal year 2018, we borrowed an
additional $5.0 million under our Asset Based Revolving Credit Facility while waiting for the receipt of an income tax refund
from the IRS.
As of May 2, 2019, our estimated cash and cash
equivalents were approximately $13.0 million which included the receipt of
$8.5 million income tax refund from the IRS
we received on April 22, 2019. Additionally, the estimated cash balance as of May 2, 2019 reflects a $5.0 million payment on
our Asset Based Revolving Credit Facility, bringing the outstanding balance back down to $10.0 million and our estimated
additional availability to $14.6 million as of that date.
We also
incurred an operating loss of $33.5 million in fiscal 2018 as compared to operating income of $30.0 million in fiscal 2017.
Our operating loss for fiscal year 2018 includes a non-cash asset impairment charge, a full valuation allowance on our net
deferred tax assets, professional fees associated with the Company’s turnaround plan and evaluation of strategic and
financial alternatives discussed below and reversal of stock-based compensation in connection with our Chief
Executive Officer’s (“CEO”) resignation. See below under Item 7. Management’s Discussion and Analysis
of Financial Condition and Results of Operations, “Results of Operations,” for additional information.
In
addition, as previously disclosed, in January 2019, our Board of Directors initiated a review of our strategic and financial alternatives
to maximize value.
We retained Rothschild & Co and other advisors to assist in the review of these alternatives. There
can be no assurance that the exploration of strategic and financial alternatives will result in any transaction or other result
that enhances value. Also as previously disclosed, we have not set a timetable for the completion of the review process, and we
do not intend to comment on the process unless a specific transaction or other alternative is approved by our Board of Directors,
the process is concluded, or it is otherwise determined that further disclosure is appropriate or required by law.
In addition, in February 2019, Mr. Steve Lawrence resigned from
his position as our President and CEO and Mr. Michael Prendergast of Alvarez & Marsal was appointed as our Interim CEO. Also,
in February 2019, our Senior Vice President and Chief Merchandising Officer departed the Company
.
We are in the beginning stages of a formal search for a permanent CEO and either a general merchandising manager or a Chief Merchandising
Officer, but are confident that we currently have an experienced interim leadership team in place to execute on our turnaround
plan.
Our Philosophy
Our operating philosophy is grounded in the following and we
believe differentiates us from our competitors:
|
·
|
On-trend Merchandise Delivered at a Compelling Value
. Our boutiques aim to carry a broad and shallow selection of quality
on-trend apparel, jewelry, accessories and gifts at attractive prices that ‘surprise and delight’ our customers. Our
buyers closely monitor the marketplace to identify and source proven fashion trends we believe will appeal to our core customers.
We have a unique assortment as we primarily offer items under our proprietary labels. We also carry a small selection of third-party,
nationally recognized brands that we use opportunistically in certain categories. We offer a broad selection of merchandise, but
intentionally purchase relatively smaller quantities of individual items for each boutique. We frequently replenish our boutiques
with new merchandise, keeping the shopping experience fresh and exciting for our customers. The short lead times of our vendors
maximizes our speed to market, as it generally takes four to twelve weeks from the time an order is placed to the time merchandise
is available on the boutique floor. These short lead times enable us to make more informed buying decisions by allowing us to react
quickly to fashion trends. This approach, combined with our balanced merchandise mix of approximately 50% apparel and 50% jewelry,
accessories and gifts, is designed to encourage frequent visits by our customers and mitigate the seasonal fluctuations in sales
and merchandise margin.
|
|
·
|
Differentiated Shopping Experience.
Each of our retail locations is designed and merchandised to feel like an upscale
yet affordable boutique. Merchandise presentations, including display windows, tables and walls, are refreshed frequently to keep
our boutiques new and exciting. Each boutique feels individualized and our boutique associates strive to provide a personalized
and intimate guest experience by creating a high-touch service environment which increases guest engagement and enhances the shopping
experience. We believe these attributes, along with our strategy of carrying a broad selection but relatively limited quantities
of individual styles, create an atmosphere that appeals to our customers and differentiates us in the marketplace.
|
|
·
|
Flexible Boutique Format and Rigorous Real Estate Selection Process
. Our boutique format typically works across a wide
variety of shopping venues, market sizes, climates and demographics. Our boutiques are leased from third parties with initial lease
terms of five to ten years and have an average size of 1,452 square feet, which is meaningfully smaller than most specialty retailers.
Our flexible real estate format, coupled with the performance of our boutiques, has historically enhanced our ability to secure
prominent, highly visible locations in regional malls, lifestyle centers, street locations, strip centers and outlet centers. The
selection of the location of our boutiques benefits from our rigorous real estate selection process, with all boutique locations
measured against specific financial and geographic criteria, including the calibration of occupancy costs against projected sales
for new boutiques.
|
|
·
|
Solid and Scalable Infrastructure.
We have invested in systems, controls and human resources to support our operations.
In recent years, we have made significant improvements in our ecommerce and IT systems as well as the infrastructure of our buying,
planning and allocation, real estate, boutique operations, and finance departments. For instance, we believe that we have developed
an integrated sourcing, distribution and merchandising process that is scalable. This includes buyers who work closely with an
established and diverse group of vendors to identify on-trend, quality merchandise for our boutiques, as well as delivery, distribution
and merchandising processes that enable us to execute a broad and shallow merchandising approach
.
|
Our Growth Strategy
We believe we can grow our revenues and earnings by executing
on our turnaround plan that includes the following strategies:
|
·
|
Improve Merchandise to be More On-Trend and Better Aligned with Customer Demand.
We plan to increase comparable sales
by having customer demand drive our merchandise assortment. In recent years, we have not successfully executed demand based, fast
fashion merchandising processes. Going forward, we plan to return to merchandising policies that allow us to better react to customer
demands. Additionally, we will be guided by a deliberate category hierarchy focused on three types of merchandise: fashion, seasonal
and core to ensure that our merchandise offerings are balanced and relevant to our customers. We believe this merchandising strategy
will improve our conversion rates as we better meet our customers’ expectations which will then lead to increased traffic.
|
|
·
|
Renewed Emphasis on Demand Based, Fast Fashion Principles in Merchandise Planning and Buying.
We believe merchandise
planning and buying processes that better emphasize demand based, fast fashion principles will help drive comparable sales. We
believe successfully implementing these principles will enable us to invest further in merchandise that is resonating with our
customers and adjust accordingly when merchandise is not resonating with our customers. We expect this will result in improved
sales and a steady flow of on-trend merchandise into our boutiques and ecommerce site. Our turnaround plan includes the following
strategies that will help us better implement to those principles:
|
|
o
|
We are updating and adding robust analytics to our planning and buying processes in order to more quickly react to fashion
trends and the resonance of our merchandise with our customers.
|
|
o
|
We are increasing the flexibility of our planning such that a greater portion of our merchandise will be open to buy in season,
enabling our style selection and inventory investments to better respond to customer demand.
|
|
o
|
We are activating a wide scale testing strategy to help evaluate promotional strategies with the goal to expand impactful wins
to all boutiques.
|
|
·
|
Right Size Our Expense Structure.
At the end of fiscal 2018 and in early fiscal 2019, we reduced selling, general and
administrative costs by implementing targeted reductions across the entire organization, including workforce reductions in both
our corporate office and field management, which we expect will provide us with approximately $15.0 million in annualized savings
before costs to achieve. We plan to continue to look for further efficiencies in selling, general and administrative costs in the
remainder of fiscal 2019. For example, in February 2019, we instituted a robust and detailed expense controls and review process.
We believe these actions will have a direct impact on our profitability in both the short and long term.
|
|
·
|
Increase Boutique Team Productivity.
We believe through focused monitoring of our boutique labor and sales metrics we
can better utilize our sales associates’ time without sacrificing the customer experience. For example, certain tasks that
were previously performed by our associates after boutique hours will now be completed when our boutiques are open but during the
windows that our data shows that the boutique traffic is lighter. Additionally, our use of an enhanced scheduling tool, that will
be continuously reviewed and refined, should better align boutique payroll expense to sales levels.
|
|
·
|
Optimize Existing Real Estate Fleet
. While we believe we have an opportunity to grow our boutique base in the
United States based on our flexible boutique format and the financial characteristics of our boutiques, we are currently
focused on optimizing our existing real estate fleet. In particular, we are focusing on optimizing the lease expense
structure for our existing boutiques, with an emphasis towards calibrating occupancy costs with sales levels and negotiating
with landlords for early lease terminations or rent concessions for underperforming boutiques and early lease extensions for
our best performing boutiques. Additionally, we continue to regularly review our existing boutiques for opportunistic
closures to increase the overall health of our fleet without incurring material write-offs associated with such closures. In
fiscal 2019, we expect to open approximately four new boutiques and close at least 20 underperforming boutiques.
|
Our History
In 1999, our Company was founded and we opened our first boutique
in Houston, Texas. Initially, we focused on selling fashion jewelry, accessories and selected home décor. As our boutique
base grew across the United States we expanded our merchandise offering to include apparel, which has become our largest category.
In July 2011, we became a publicly-traded company.
Our Market
Our distinct boutique environment and carefully selected merchandise
focused on quality, on-trend offerings at a compelling value attracts a wide demographic. Our unique merchandise combination of
apparel, jewelry, accessories and gifts allows us to participate in a number of large market segments. While our broad assortment
appeals to women of varying ages and diverse backgrounds, from the value-conscious to the more affluent, our core guest is a fashion-conscious
woman between the ages of 18 and 35. She tends to be college educated and has moderate to high disposable income. She enjoys shopping
for the latest fashion and is attracted to our upscale boutique shopping environment, compelling value proposition and personalized
customer service. We believe she spends a higher proportion of her income on fashion than the general population.
Our Merchandise Offering and Merchandising
Strategy
We offer a broad and shallow selection of fashion apparel, jewelry,
accessories and gifts targeted to our core customer, who seeks on-trend, quality merchandise at attractive prices. We use the term
broad and shallow to refer to a diverse merchandise assortment with smaller quantities of each item than most specialty retailers. In
addition to our broad assortment, we deliver new merchandise to our boutiques every week offering our customer constant newness.
We have a balanced assortment of merchandise categories with 50% of our fiscal year 2018 sales generated by non-apparel items.
Our wide range of apparel, jewelry and accessories fills the
various casual and dressy fashion needs of our customers and our selection of gifts range from fun to elegant. The majority of
our merchandise is sold under our proprietary labels and we also sell a select assortment of third-party, nationally recognized
brands. Our ecommerce website features the same merchandise offered in our boutiques coupled with on-line exclusives. Additionally,
our ecommerce inventory is now available to order in-boutique in the same transaction as in-boutique purchases or in a separate
transaction. The table below shows the approximate breakdown of our fiscal year 2018 net sales by merchandise category:
Apparel
47% of Net Sales
|
|
Jewelry
25% of Net Sales
|
|
Accessories
16% of Net Sales
|
|
Gifts
12% of Net Sales
|
Dresses, Fashion Tops, Sweaters, Cardigans and Wraps, Bottoms, Outerwear and Jackets, Tees and Tanks, Intimates
|
|
Necklaces, Earrings, Bracelets, Rings
|
|
Handbags, Clutches, Wallets, Shoes, Belts, Hats, Scarves, Sunglasses, Watches, Beauty, Hair Accessories
|
|
Fragrance, Candles, Bath and Body, Home Accessories, Books, Wall Art, Nail Polish, Miscellaneous Items
|
As discussed above, we believe we can improve our conversion
and traffic rates and our flow of on-trend merchandise by implementing our strategies of customer demand driving our merchandise
assortment and our renewed emphasis on demand based, fast fashion principles in merchandise planning and buying.
Our buying team is responsible for selecting and sourcing our
merchandise. Each merchandise category has a set of dedicated buyers. Our planning and allocation team assists in managing inventory
levels and allocating items to boutiques. Both the buying and planning and allocation teams are currently reporting to an interim
General Merchandise Manager with a tenured and broad range of retail experience. The teams hold weekly meetings to review merchandise
performance and identify new fashion trends. Our buyers also make regular trips to important industry markets and trade shows.
We have access to the expertise of hundreds of designers employed by our large vendor base who provide us with a large selection
of new styles for review. Our buyers collaborate with vendors to place special orders and to modify presented styles based on current
fashion trends and their in-depth knowledge of our customers’ preferences, which means most of our merchandise is typically
unique to francesca’s. Before placing an order, every item is evaluated for style, quality, fit, value and profitability
to ensure it meets standards consistent with the francesca’s
®
brand.
Every item is also evaluated to confirm that it fits within our category hierarchy comprised of fashion, seasonal or core categories.
In order to clear slow moving inventory, in addition to normal promotional and markdown activities, we regularly mark certain merchandise
out-of-stock and dispose of such inventory at a pace suitable for our merchandising strategy.
Our Sourcing Strategy
Our renewed emphasis on a demand based, fast fashion model in
merchandise planning and buying, combined with the short production lead times of our vendors, maximizes our speed to market. We
primarily use vendors based in the United States that source from both domestic and overseas markets and it generally takes four
to twelve weeks from the time an order is placed to the time merchandise is available on the boutique floor. These short lead times
enable us to make more informed buying decisions in terms of customers’ merchandise expectations, and to quickly react to
changing fashion trends. This also supports our merchandise strategy of offering a broad and shallow assortment that is consistently
refreshed.
We do not own or operate any manufacturing facilities. We have
relationships with a diverse base of more than 500 vendors and transact business on a purchase-order-by-purchase order basis. In
fiscal year 2018, we sourced approximately 93% of our merchandise from 200 vendors while our top 10 vendors sourced approximately
28% of our merchandise, with no single vendor accounting for more than 5% of our purchases. We believe that the loss of any single
current vendor would not result in a material disruption to our business.
We do not enter into exclusive contracts with our vendors and
we continue to optimize our vendor network. This provides us with access to an even more extensive variety of merchandise
from a greater number of vendors at competitive prices. We believe our vendors view us as an important customer given our market
position. Our vendors utilize a network of domestic and overseas factories, providing them access to significant capacity.
Each of our vendors is required to adhere to our vendor standards,
which are designed to ensure that our vendors conduct their business in a legal, ethical and responsible manner. This also includes
the requirement that all of our vendors comply with the applicable laws and regulations of the United States, those of the respective
country of manufacture or exportation and all state and local laws and regulations. To date, we have not experienced any significant
impact from the trading polices of the United States or its trading partners.
Our Sales Channels
We conduct business through our boutiques and our ecommerce
website,
www.francescas.com
. We do not incorporate the information contained on, or accessible through, our investor relations
website into this Annual Report on Form 10-K, and it should not be considered a part of this Annual Report on Form 10-K.
Boutiques
As of February 2, 2019, we operated 727 boutiques under the
name francesca’s
®
in 47 states throughout the United States and the District
of Columbia. Our long-term strategy depends on our ability to successfully operate existing and new boutiques in a timely and cost-effective
manner. Under the turnaround plan, our current priority is to implement the strategies discussed above under “Our Growth
Strategy” to enhance comparable sales and profitability and, as such, we are only planning to open approximately four new
boutiques in fiscal year 2019 and plan to close at least 20 underperforming boutiques as we continue to optimize our existing boutique
fleet. We plan to resume boutique openings in the future as appropriate once the desired results of our turnaround plan are achieved.
The following list shows the number of boutiques operated by state as of February 2, 2019.
State
|
|
Number of Boutiques
|
|
State
|
|
Number of Boutiques
|
Alabama
|
|
13
|
|
Montana
|
|
2
|
Arizona
|
|
12
|
|
Nebraska
|
|
5
|
Arkansas
|
|
9
|
|
Nevada
|
|
9
|
California
|
|
62
|
|
New Hampshire
|
|
6
|
Colorado
|
|
14
|
|
New Jersey
|
|
28
|
Connecticut
|
|
10
|
|
New Mexico
|
|
3
|
Delaware
|
|
4
|
|
New York
|
|
28
|
District of Columbia*
|
|
2
|
|
North Carolina
|
|
21
|
Florida
|
|
53
|
|
North Dakota
|
|
4
|
Georgia
|
|
20
|
|
Ohio
|
|
25
|
Idaho
|
|
2
|
|
Oklahoma
|
|
8
|
Illinois
|
|
34
|
|
Oregon
|
|
7
|
Indiana
|
|
16
|
|
Pennsylvania
|
|
29
|
Iowa
|
|
7
|
|
Rhode Island
|
|
4
|
Kansas
|
|
7
|
|
South Carolina
|
|
11
|
Kentucky
|
|
10
|
|
South Dakota
|
|
2
|
Louisiana
|
|
12
|
|
Tennessee
|
|
18
|
Maine
|
|
2
|
|
Texas
|
|
77
|
Maryland
|
|
15
|
|
Utah
|
|
3
|
Massachusetts
|
|
21
|
|
Virginia
|
|
23
|
Michigan
|
|
20
|
|
Washington
|
|
15
|
Minnesota
|
|
15
|
|
West Virginia
|
|
3
|
Mississippi
|
|
7
|
|
Wisconsin
|
|
13
|
Missouri
|
|
15
|
|
Wyoming
|
|
1
|
*
Not considered a state.
Boutique Design and Environment
The differentiated shopping experience offered through our boutiques
is central to the francesca’s
®
brand. Our boutiques are designed and
merchandised to deliver a warm and inviting atmosphere that creates a boutique shopping experience. We also aim to provide a personalized
in-boutique guest experience by creating a high-touch service environment with a focus on engaging, connecting and inspiring our
customers. Although we strive to maintain a relatively consistent look and feel in all of our boutiques, the intricacies of each
boutique’s physical properties, geographic market and shopping venue make each feel different and in tune with its local
clientele.
Our boutiques typically range in size from 1,000 to 2,000 square
feet, with an average size of 1,452 square feet as of February 2, 2019. Our locations typically have a boutique front that is at
least 25 feet wide, which we adorn with visually appealing architectural lighting, signage and display window presentations. Inside,
we use a variety of color palettes and soft lighting. Each boutique’s merchandise presentation, including display windows,
tables and walls, is refreshed frequently to keep our shopping experience new and exciting. We believe by constantly changing our
visual merchandising and presentation, we give our customers a reason to shop our boutiques frequently, building customer loyalty.
Our boutique managers also share best-practices with each other. We believe these grass-root interactions improve the sense of
community among our boutique managers and enhance the shopping experience for our customers.
Staffing in our boutiques consists of a boutique manager, an
assistant manager and part-time associates. Our compensation structure includes a bonus component payable upon the achievement
of certain financial goals. We endeavor to hire boutique personnel that are friendly and customer-service driven individuals. In
addition to training programs for visual merchandising, customer service and operations, boutique managers benefit from ongoing
field-level support and training updates as well as guides and manuals. As discussed above under “Our Growth Strategy,”
a core component of our growth strategy is to increase the productivity of our in-boutique teams.
Boutique Openings, Closures and Remodels
During fiscal year 2017, we opened 60 boutiques with an average
size of approximately 1,597 square feet. These boutiques generated average sales of approximately $578,000 in the first year and
paid back our net investment, on average, in approximately three and a half years. Our average pre-tax net investment consisted
of $236,000 in average boutique build-out costs (net of $57,000 average tenant allowance) and $58,000 in average inventory. The
payback period for boutiques opened in fiscal year 2017 was significantly longer compared to the payback period for boutiques opened
in prior years primarily due to a decrease in overall boutique profitability as well as increasing boutique build-out costs, partly
as a result of opening more boutiques in outlet centers, which are generally larger in size compared to boutiques in other venues.
The table below indicates certain historical information regarding
our boutiques as of the end of each of the periods indicated below:
|
|
Fiscal
Year
2018
|
|
|
Fiscal
Year
2017
|
|
|
Fiscal
Year
2016
|
|
|
Fiscal
Year
2015
|
|
|
Fiscal
Year
2014
|
|
Mall
|
|
|
350
|
|
|
|
351
|
|
|
|
334
|
|
|
|
313
|
|
|
|
278
|
|
Non-mall
(1)
|
|
|
377
|
|
|
|
370
|
|
|
|
337
|
|
|
|
303
|
|
|
|
261
|
|
Total boutiques
|
|
|
727
|
|
|
|
721
|
|
|
|
671
|
|
|
|
616
|
|
|
|
539
|
|
Boutiques opened
|
|
|
32
|
|
|
|
60
|
|
|
|
64
|
|
|
|
83
|
|
|
|
88
|
|
Boutiques closed
|
|
|
26
|
|
|
|
10
|
|
|
|
9
|
|
|
|
6
|
|
|
|
-
|
|
Boutique remodels
|
|
|
81
|
|
|
|
17
|
|
|
|
32
|
|
|
|
25
|
|
|
|
50
|
|
Total approximate gross square feet at the end of the period
|
|
|
1,055,000
|
|
|
|
1,024,000
|
|
|
|
933,000
|
|
|
|
843,000
|
|
|
|
728,000
|
|
Average square feet per boutique at the end of the period
(2)
|
|
|
1,452
|
|
|
|
1,420
|
|
|
|
1,391
|
|
|
|
1,368
|
|
|
|
1,350
|
|
Net sales per average square foot for the period
(3)
|
|
$
|
404
|
|
|
$
|
482
|
|
|
$
|
545
|
|
|
$
|
543
|
|
|
$
|
545
|
|
|
(1)
|
Non-mall includes boutiques in lifestyle centers, street
locations, strip centers and outlet centers.
|
|
(2)
|
Average square feet per boutique is calculated by dividing
total gross square feet at the end of the period by the number of boutiques open at the end of the period.
|
|
(3)
|
Net sales per average square foot is calculated by dividing
net sales for the period by the average total square feet during the period. For purposes of providing net sales per square- foot
measure, we use average square feet during the period as opposed to total gross square feet at the end of the period. Average
square feet is calculated as (a) the sum of total gross square feet at the beginning of the period and total gross square
feet at the end of each fiscal quarter within the period, divided by (b) the number of fiscal quarters within the period
plus one (which, for a fiscal year, is five). There may be variations in the way in which some of our competitors and other retailers
calculate sales per square foot or similarly titled measures. As a result, average square feet and net sales per average square
foot for the period may not be comparable to similar data made available by other retailers.
|
Our flexible boutique format has enabled us to successfully
open boutiques across a variety of shopping venues, market sizes, climates and demographics. Our real estate committee has consistently
utilized a disciplined approach to site selection, which analyzes the prospective shopping venue for factors such as overall shopping
venue productivity, competitive environment and specific sales of other retailers deemed most relevant as well as the configuration
of available space for potential new boutique locations. When selecting a location for a new boutique, we seek prominent locations
in high-traffic areas of the shopping venue and in close proximity to other retailers targeting similar customers. We also evaluate
each new boutique location based on projected sales and determine whether the capital investment and estimated boutique four-wall
contribution satisfies our targeted return threshold, occupancy costs, and boutique contribution. We believe these attributes have
provided us, and will continue to provide us, with a wide scope of real estate opportunities and enhances our ability to profitably
expand our boutique base. Our current priority is to implement the strategies of our turnaround plan discussed above under “Our
Growth Strategy” to enhance comparable sales and profitability and, as such, we are only planning to open approximately four
new boutiques in fiscal year 2019 and plan to close at least 20 underperforming boutiques as we continue to optimize our existing
boutique fleet. We plan to resume boutique openings in the future as appropriate when the desired results are achieved under our
turnaround plan.
We continuously review the overall economic performance of
our boutiques. As part of our economic review process, we evaluate a variety of factors such as expected future revenue and
contribution margin, applicable market conditions, our co-tenancy requirements, unamortized portion of leasehold
improvements, our ability to terminate the underlying lease obligation and related cost of any such early termination. As a
result of such review, we closed 26 underperforming boutiques during fiscal year 2018, with the bulk of such closures
occurring in January 2019, and we plan to close at least 20 underperforming boutiques in fiscal year 2019. For fiscal year
2019, we are focused on optimizing our existing real estate fleet by focusing on optimizing the lease expense structure for
our existing boutiques, with an emphasis towards calibrating occupancy costs and sales levels, negotiating with landlords for
early lease terminations or rent concessions for underperforming boutiques and early extensions for our best
performing boutiques, as appropriate.
In fiscal year 2018, we started a boutique remodel program where
we refreshed 81 high-volume existing boutiques. We view this refresh program as an important investment to continually enhance
the customer shopping experience. We believe the 2018 refreshes will help improve our comparable sales during fiscal year 2019.
While we have decided to put a pause on this program in fiscal year 2019 due to the recent challenges in our business, we currently
intend to reinitiate this program in fiscal year 2020.
Ecommerce
Our ecommerce operations consists of our
www.francescas.com
website. Through our website, our customers are able to purchase individual items, shop the latest jewelry, gift or fashion merchandise
and special promotions, create a wish list, sign up for our customer email list, connect and follow us on social media sites such
as Facebook, Twitter, Instagram and Pinterest, as well as obtain current information on our boutique locations. This channel enables
us to further build our brand, address the growing preference for online shopping and reach customers in all areas where we currently
do not have a boutique. We recognize the growing preference for online shopping and we plan to make investments in our website
and supporting functions that will further enhance our customers’ shopping experience as well as establish the framework
for our long-term ecommerce strategies. During fiscal 2018, we invested in a warehouse management system to support our ecommerce
operations. During fiscal year 2019, we plan to focus on “Our Growth Strategy” as described above and we do not plan
to make any significant new investments to our ecommerce operations. We believe there is significant potential to expand this channel
over time with our current infrastructure.
Omni Channel Customer Experience
We have made significant investments in our technology systems
and enabled certain omni channel capabilities, including “buy-online and ship-to-boutique” and “buy-in-boutique
and ship-to-home,” which offer a consistent and seamless shopping experience both in-boutique or online. We believe that
the line between our boutiques and ecommerce channels are disappearing as customers increasingly interact with us both in-boutique
and online. We are focused on leveraging the best of both channels to create an exceptional and seamless omni channel shopping
experience for our customers.
Marketing and Advertising
We have historically focused on organic, viral and in-boutique
marketing to increase customer loyalty and build our brand image. By locating our boutiques in prominent, high-traffic locations
and our limited use of traditional radio and print advertising, we encourage people to ‘discover’ francesca’s
®
. We believe that many of our customers develop a personal connection with
our boutiques and become our ambassadors in the local community by spreading the word about francesca’s
®
.
Our boutique managers are passionate about francesca’s
®
and contribute
to our marketing effort by participating in shopping center or community sponsored marketing events. We also use email communications,
our website and, increasingly, social networking sites, such as Facebook, Twitter, Instagram and Pinterest and fashion related
blogs to achieve our marketing goals. We plan to continue to focus our investments in the appropriate marketing programs to build
customer loyalty. In 2018, we launched a nationwide customer loyalty program, franRewards™, where members may receive free
gifts, discounts as well as early access to certain promotions. Our loyalty program is aimed at driving traffic into our boutiques,
better understand our customers’ purchasing pattern as well as support various strategic initiatives.
Distribution
We distribute most of our merchandise from our distribution
center (located within our corporate headquarters) in Houston, Texas. Our current facility occupies approximately 218,000 square
feet, consisting of approximately 165,000 square feet of warehouse and distribution space, which services our boutiques and ecommerce,
and approximately 53,000 square feet of office space for our corporate headquarters. Our merchandise is generally received, inspected,
managed, stored and distributed through our distribution warehouse. The majority of our merchandise is pre-ticketed and pre-sorted
by our vendors which allows us to efficiently ship from our distribution center directly to our boutiques, thereby reducing labor
costs. Due to the relatively small size of our boutiques, we ship smaller packages of fresh merchandise weekly. Hence, we are able
to utilize third party shipping vendors to effectively distribute merchandise on a continuous basis, ensuring successful execution
of our broad and shallow merchandising strategy. We believe that our current facilities will be sufficient to support our growth
plans for several years.
Management Information
Systems
Our management information technology systems provide support
and timely information to our management team. We believe our current systems provide us with operational efficiencies, scalability,
management control and timely reporting that allows us to identify and respond to operating trends in our business. We use a combination
of customized and industry-standard software systems to support boutique point-of-sale, merchandise planning and buying, ecommerce,
inventory management, financial reporting and administrative functions.
We recently deployed new technologies to enhance our omni-channel
and customer engagement capabilities as part of our long-term strategic plan. In fiscal year 2017, we completed our legacy point-of-sale
system replacement and the implementation of a new customer relationship management system. In October 2018, we completed the implementation
of a new warehouse management system for ecommerce. These new systems will enhance our visibility into our customers’ preferences,
merchandise products and supply chain which we expect will result in improved customer service, improved operational efficiency,
enhanced management analytics and increased inventory synergies between our ecommerce and our boutique channels.
We will remain diligent in our efforts to maintain the functionality
and performance of our existing enterprise applications and infrastructure to support the Company’s turnaround and growth
plans.
Competition
The women’s apparel, jewelry, accessories and gifts market
is large, fragmented and highly competitive. Our largest competitors include national and regional department stores, value retailers,
specialty retailers, mass merchants and internet-based retailers. Due to the breadth of our merchandise, it is difficult to identify
companies that compete with us in every product category. We generally compete with individual, often owner-operated specialty
shops in each of the markets that we operate as well as broadly merchandised department stores and certain specialty stores. We
also face intense competition from the ecommerce platforms of our brick and mortar competitors, as well as internet-based retailers
due to the continuing shift in customer demand away from brick and mortar to ecommerce. We may also face new competitors and increased
competition from existing competitors as we expand into new markets and increase our presence in existing markets.
The principal basis upon which we compete is by offering a differentiated
shopping experience through quality, on-trend merchandise at attractive prices in a warm and inviting boutique environment with
personalized customer service. Our manageable boutique size and flexible but disciplined real estate strategy provide us with a
competitive advantage that is not easily replicated by our major competitors. Our success also depends in substantial part on our
ability to respond quickly to fashion trends so that we can meet the changing demands of our customers.
Intellectual Property
We have registered our trademark francesca’s
®
with the United States Patent and Trademark Office. We own domain names, including
www.francescas.com
, and we own unregistered
copyright rights in our website content. We believe our trademarks have value, and we diligently protect them against infringement.
For instance, we have filed applications to register our trademark internationally. We will also continue to file new applications
as appropriate to protect our intellectual property rights.
Regulation and Legislation
We are subject to labor and employment laws, laws governing
advertising and promotions, privacy laws, product and other safety regulations, consumer protection regulations, environmental
requirements and other laws that regulate retailers and govern the promotion and sale of merchandise and the operation of boutiques
and warehouse facilities. We monitor changes in these laws and believe that we are in compliance with applicable laws in all material
respects.
Insurance
We use insurance for a number of risk management activities,
including workers’ compensation, general liability, automobile liability, cyber security and employee-related health care
benefits, a portion of which is paid by the employees. We evaluate our insurance requirements on an ongoing basis and believe we
maintain adequate levels of coverage.
Our Employees
As of February 2, 2019, we had 5,955 total employees. None of
our employees are represented by a labor union and we have had no labor-related work stoppages as of February 2, 2019. Our relationship
with our employees is one of the keys to our success and we believe that relationship is satisfactory.
Seasonality
Our wide-range of merchandise and our strategy of carrying a
broad selection but limited quantities of each item reduce our overall seasonality relative to other specialty retailers. Nevertheless,
our business is seasonal in nature and demand is generally the highest in the fourth fiscal quarter due to the year-end holiday
season and lowest in the first fiscal quarter. As a result of this seasonality and generally because of variation in consumer spending
habits, we experience fluctuations in net sales and working capital requirements during the year. See “Management’s
Discussion and Analysis of Financial Condition and Results of Operations—Seasonality” for more information.
Privacy Policy
In the course of our business, we collect information about
our customers, including customer data submitted to us in connection with purchases of our merchandise at boutiques as well as
from our ecommerce website. We respect the privacy of our customers and take steps to safeguard the confidentiality of the information
that they provide to us.
Securities and Exchange
Commission Filings
We maintain a website at
www.francescas.com
. We
provide, free of charge, access to various reports that we file with, or furnish to, the SEC through our website, as soon as reasonably
practicable after they have been filed or furnished with the SEC. These reports include, but not limited to, our Annual Reports
on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports. The SEC maintains
a website that contains reports, proxy and information statements, and other information regarding our filings at
http://www.sec.gov
.
ITEM 1A. RISK FACTORS
If any of the following risks actually occurs, our business,
financial condition, results of operation, cash flow and prospects could be materially and adversely affected. As a result, the
trading price of our common stock could decline.
We have recently experienced a significant decline in
our operating margins and our inability to maintain or improve our operating margins could adversely affect our business, financial
condition and results of operations.
In fiscal year 2018, we had an operating loss for the first
time as a public company. We aim to increase our operating margins through enhancements to our merchandise offerings, continued
cost disciplines, improved productivity in our boutiques and the optimization of the lease expense structure for our existing boutiques.
There can be no assurance that these measures will be successful. Further, our fiscal year 2018 operating loss has resulted in
less cash from operations making it more difficult for us to successfully operate our business and execute our turnaround plan.
For example, we have paused our boutique remodel program that we initiated in fiscal year 2018 even though we view this refresh
program as an important investment to continually enhance the customer shopping experience we strive to achieve. Additionally,
it has made it difficult for us to capitalize on our opportunities to improve our infrastructure. For example, with respect to
our infrastructure, if we do not have the funds to adequately refine and improve our various ordering, tracking and allocation
systems, we may not be able to react quickly enough to changing trends and customer demand or reduce inventory shrinkage. If we
are not able to successfully execute our turnaround plan, we may not be able to achieve our goals with respect to operating margins.
As a result, our operating margins may stagnate or further decline, which could adversely affect our ability to make necessary
improvements to our business, which would negatively impact our business, financial condition and results of operations.
We have recently experienced a significant decline in
our comparable sales and our inability to maintain or increase our comparable sales could adversely impact our net sales and financial
condition.
Our comparable sales significantly declined in fiscal years
2017 and 2018 as compared to prior year periods. We may not be able to sustain or increase comparable sales. If our future comparable
sales further decline or fail to meet market expectations, our profitability could be harmed or become nonexistent. The aggregate
comparable sales levels of our boutiques have fluctuated in the past and can be expected to fluctuate in the future. A variety
of factors affect comparable sales, including fashion trends, competition, current national and regional economic conditions, pricing,
changes in customer shopping patterns, changes in our merchandise mix, prior period comparable sales levels, inventory shrinkage,
the timing and amount of markdowns, the success of our marketing programs, the success of our merchandising initiatives, holiday
timing and weather conditions. These factors, among others, may cause our comparable sales results to be materially lower than
in recent periods, which would harm our business, results of operations and financial condition.
A continuation of negative financial trends could result
in our inability to continue as a going concern.
Our financial statements have been prepared on the basis that
our business will continue as a going concern for a period of 12 months following the date that our financial statements were issued
on May 3, 2019. Our ability to fund our operations and to continue as a going concern depends upon the following: meeting our projected
future operating results including the successful implementation of our turnaround plan; the borrowing availability of our Asset
Based Revolving Credit Facility; the absence of any material adverse effects in consumer traffic and conversion rates that may
arise due to factors both within and outside of our control. Additionally, if we do not achieve our projected operating results,
we could violate one or more of our debt covenants, our liquidity could be adversely impacted and we may need to seek additional
sources of funding. There is no assurance that we will be able to maintain our borrowing base availability of our Asset Based Revolving
Credit Facility, raise additional capital to fund our operations, or that debt or equity financing will be available in sufficient
amounts or on acceptable terms. If our operating results fail to improve, then our financial condition could render us unable to
continue as a going concern.
Our liquidity has been adversely impacted by our negative
operating results and there is no assurance that we will have sufficient liquidity to continue operations.
We experienced significant declines in comparable sales, net
sales and gross profit in fiscal year 2018. The decrease in comparable sales was primarily driven by the decline in boutique traffic
and conversion rates. If we were to continue to experience such declines in sales or increases in costs, we may be required to
draw on a significant portion of our Asset Based Revolving Credit Facility, to the extent we have availability, and may require
additional sources of financing to fund our operations. We cannot provide any assurance that we will be able to secure sufficient
funding or achieve positive results through our growth strategy. If we are unable to generate or obtain the requisite amount of
financing needed to fund our planned operations or execute our growth strategy, our liquidity and ability to continue operations
could be materially adversely affected.
The value of our deferred tax assets may not
be realizable to the extent our future profits are less than we have projected, which may have a material adverse effect on our
results of operations and our financial condition.
We evaluate the realizability of our deferred income tax assets
and assess the need for a valuation allowance on an ongoing basis. In evaluating our deferred income tax assets, we consider
whether it is more likely than not that the deferred income tax assets will be realized. Based on available positive and negative
evidence, including past operating results, estimates of future income, future reversals of existing taxable temporary differences
and tax planning strategies, we determined that it is more-likely-than-not that we will not realize our deferred tax assets in
future periods and, therefore, a full valuation allowance was established at February 2, 2019. Accordingly, we recorded a valuation
allowance of $17.1 million on our net deferred tax asset in fiscal year 2018. Our assessment of the realizability of our deferred
income tax assets requires significant judgment.
There are no assurances that we will not increase or decrease
the valuation allowances in future periods against deferred tax assets and liabilities. Any additional valuation allowance
or the failure to reverse our current valuation allowance could have a material adverse effect on our results of operations and
financial conditions.
We will require capital to fund our business, which may
not be available to us on satisfactory terms or at all. We plan to use cash from operations and our Asset Based Revolving Credit
Facility to fund our operations and execute our strategy. If we are unable to maintain sufficient levels of cash flow, we may not
meet our expectations or we may require additional financing which could adversely affect our financial health and impose covenants
that limit our business activities.
We currently primarily depend on cash flow from operations and
our Asset Based Revolving Credit Facility to fund our business. Availability under our Asset Based Revolving Credit Facility is
subject to a customary borrowing base comprised of: (a) a specified percentage of our credit card accounts (as defined in
the agreement); and (b) a specified percentage of our eligible inventory (as defined in the agreement), and reduced by (c) certain
customary reserves and adjustments (as defined in the agreement). If our business does not generate sufficient cash flow from operations
to fund our operations and execute on strategy, and sufficient funds are not otherwise available to us from our Asset Based Revolving
Credit Facility, we may need additional equity or debt financing. If such financing is not available to us, or is not available
on satisfactory terms, our ability to continue operations could be materially and adversely affected. If we raise additional capital
by issuing equity securities or securities convertible into equity securities, your ownership would be diluted.
We cannot assure you that our exploration of strategic
and financing alternatives will result in a transaction and/or financing or that any such transaction or financing would be successful,
and the process of exploring strategic and financing alternatives or its conclusion could adversely impact our business and our
stock price.
In January 2019, we announced that our board of directors had
initiated a review of its strategic and financial alternatives to maximize value. This process is ongoing and we engaged Rothschild
& Co. and other advisors to assist in the process.
There can be no assurances that the strategic and financing
alternatives process will result in the announcement or consummation of any strategic or financing transaction, or that any resulting
plans or transactions will yield additional value for shareholders. Any potential transaction would be dependent on a number of
factors that may be beyond our control, including, among other things, market conditions, industry trends, the interest of third
parties in any potential transaction with the Company.
The process of exploring strategic and financial alternatives
could adversely impact our business, financial condition and results of operations. We could incur substantial expenses associated
with identifying and evaluating potential strategic and financing alternatives, including those related to equity compensation,
severance pay and legal, accounting and financial advisory fees. In addition, the process may be time consuming and disruptive
to our business operations, could divert the attention of management and the board of directors from our business, could negatively
impact our ability to attract, retain and motivate key employees, and could expose us to potential litigation in connection with
this process or any resulting transaction. The public announcement of a strategic or financing alternative may also yield a negative
impact on operating results if prospective or existing vendors are reluctant to commit to new or renewal orders or if existing
vendors decide to shift their business to a competitor. Further, speculation regarding any developments related to the review of
strategic or financial alternatives and perceived uncertainties related to the future of the Company could cause our stock price
to fluctuate significantly.
Our success depends on our ability to anticipate, identify
and respond quickly to new and changing fashion trends, customer preferences and other factors, and our inability to anticipate,
identify and respond to these changes and trends could have a material adverse effect on our business, financial condition and
results of operations.
Our core market, which is comprised of apparel, jewelry, accessories
and gifts for women from 18 to 35-year old, is subject to rapidly shifting fashion trends, customer tastes and demands. Accordingly,
our success is dependent on our ability to anticipate, identify and respond to the latest fashion trends and customer demands,
and to translate such trends and demands into appropriate, saleable product offerings in a timely manner. In fiscal years 2017
and 2018, we believe we did not execute on policies that best enabled us to anticipate, identify and respond to these trend and
demands, which we believe was the primary contributor to the decline in our comparable sales. Our merchandise buying and planning
and allocation teams, including previously our former Chief Merchandising Officer and currently our interim general merchandise
manager, are primarily responsible for performing this analysis and making product purchase decisions. Our failure to anticipate,
identify or react swiftly and appropriately to new and changing styles, trends or desired image preferences or to accurately anticipate
and forecast demand for certain product offerings is likely to lead to lower demand for our merchandise, which could cause, among
other things, sales declines, disposing excess inventories and a greater number of markdowns resulting in a decreased merchandise
margin. Further, if we are not able to anticipate, identify and respond to changing fashion trends and customer preferences, we
may lose customers and market share to those of our competitors who are able to better anticipate, identify and respond to such
trends and preferences. Because our success depends on our brand image, our business could be materially adversely affected if
new product offerings are not accepted by our customers. Our new product offerings may not be met with the same level of acceptance
as our past product offerings and we may not be able to adequately respond to fashion trends in a timely manner or the preferences
of our customers. If we do not accurately forecast or analyze fashion trends and sales levels, our business, financial condition
and results of operations will be adversely affected.
If we are not able to successfully maintain a broad and
shallow merchandise assortment, we may be unable to attract a sufficient number of customers to our boutiques or sell sufficient
quantities of our merchandise through our ecommerce website, which could result in excess inventories and markdowns.
We use the term broad and shallow to refer to a diverse merchandise
assortment with relatively small inventory of each product. We believe that our strategy to offer our customers a broad and shallow
merchandise assortment is important to the success of our business. Among other things, we believe that this strategy creates a
constant sense of newness and scarcity value, which drives repeat boutique visits and increased sales. We believe that this strategy
helps us reduce markdowns. There can be no assurance that we will be able to continue to adequately stock our boutiques with a
sufficiently broad and shallow assortment of merchandise. As we have increased order volumes in connection with opening new boutiques
and the expansion of our ecommerce website and begun to emphasize the congruence of our merchandise offerings throughout our boutiques,
it has become increasingly difficult for us to accurately forecast the optimal amount of merchandise to order from our vendors.
For example, in fiscal year 2018, there were certain products that resonated with customers, but we had not ordered enough of those
products to capitalize on their popularity. If we are unable to successfully offer a broad and shallow merchandise assortment,
customers may choose to visit our boutiques or our ecommerce website less frequently, our brand could be impaired, our market share
may decline and our results of operations will deteriorate. Further, any failure to maintain a broad and shallow merchandise assortment
could lead to excess inventories which could lead to markdowns and increased marked out-of-stock charges and promotions, which
would result in a decrease in our merchandise margin.
Our short-term business strategy depends in large part
upon our ability to successfully implement our planned improvements to merchandising, reducing expenses across all areas, increasing
boutique team productivity and optimizing our existing real estate portfolio.
Our business short-term strategy is focused on improving our
merchandise assortment, reducing expenses across all areas of operations, increasing boutique team productivity and rationalizing
our real estate portfolio, with the goal of reducing the number of marginally profitable boutiques, through rent reductions or
boutique closures, in an effort to increase the comparable sales and overall profitability of our remaining boutique footprint.
As is the case with any strategy, our turnaround plan could result in unintended consequences that make executing the turnaround
plan more challenging. For example, our focus on increasing boutique team productivity may make it more difficult for us to continue
to offer a personalized shopping experience for our customers, which may in turn have a negative impact on our conversion rates.
The estimated costs and benefits associated with these initiatives may vary materially based on various factors including: timing
in execution, availability of funds to support execution, customer response to merchandise assortments, our leadership being able
to continue to motivate and manage our employees, outcome of negotiations with landlords, and changes in management’s assumptions
and projections. As a result of these events and circumstances, delays and unexpected costs may occur, which could result in our
not realizing all, or any portion of, the anticipated benefits of our short-term business strategy.
We may not be able to efficiently source and distribute
the merchandise quantities necessary to support our operations.
Our success depends on our ability to source and distribute
merchandise efficiently. The sourcing of our merchandise is dependent, in part, on our relationships with our vendors and our vendors’
confidence in our business. If we are unable to maintain these relationships, we may not be able to continue to source merchandise
at competitive prices that appeal to our customers. If we do not succeed in maintaining good relationships with our vendors and
cannot identify new vendors to meet the demand for additional merchandise production, the Company could see its costs go up or
the delivery time on its new orders substantially increase.
Increases in the cost of the raw materials or other inputs
used in the production of our merchandise could result in the loss of suppliers, increase our cost of goods sold and occupancy
costs and adversely affect our financial results.
The success of our business is in part driven by the compelling
price-value proposition we offer our customers. If the costs of the raw materials, particularly cotton, leather and synthetics,
used in producing our merchandise increase, our vendors would look to pass these cost increases along to us. The price and availability
of such raw materials may fluctuate significantly, depending on many factors which are outside of our control, including commodity
prices, crop yields and weather patterns. If our vendors attempt to pass any cost increases on to us and we refuse to pay the increases,
we could lose certain vendors as suppliers, resulting in the risk that we could not fill our orders in a timely manner or at all.
If we pay the increases, we could either attempt to raise retail prices, which could adversely affect our sales and our brand image,
or choose not to raise prices, which could adversely affect the profitability of our merchandise sales.
Changes in laws affecting our supply chain 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.
If we are unable to effectively operate, replace or upgrade
any of our existing information technology systems, our operations could be disrupted which could adversely affect our financial
results.
The efficient operation of our business is significantly dependent
on our information technology systems, including our ability to operate them effectively and successfully implementing new systems
and controls, including, for example, the replacement of our legacy point-of-sale system and introduction of new customer relationship
system which we completed in fiscal year 2017, as well as our implementation of a new warehouse management system for ecommerce
in fiscal year 2018. Any failure of these systems to operate effectively or any difficulty in implementing any future information
technology systems changes could disrupt and adversely impact the promptness and accuracy of our merchandise distribution, transaction
processing, financial accounting and reporting, including the implementation of our internal controls over financial reporting,
the efficiency of our operations and our ability to properly forecast earnings and cash requirements. Any resulting disruptions
could harm our business, prospects, financial condition and results of operations.
Our business is sensitive to consumer spending and economic
conditions.
Consumer purchases of discretionary retail items and specialty
retail products, which include our apparel, jewelry, accessories and gifts, may be adversely affected by national and regional
economic conditions such as employment levels, salary and wage levels, the availability of consumer credit, inflation, high interest
rates, high tax rates, high fuel prices and consumer confidence with respect to current and future economic conditions. Consumer
purchases may decline during recessionary periods or at other times when unemployment is higher or disposable income is lower.
These risks may be exacerbated for retailers like us that focus significantly on selling discretionary fashion merchandise. Consumer
willingness to make discretionary purchases may decline, may stall or may be slow to increase due to national and regional economic
conditions. Our financial performance is particularly susceptible to economic and other conditions in regions or states where we
have a significant number of boutiques. There remains considerable uncertainty and volatility in the national and global economy.
Further or future slowdowns or disruptions in the economy could adversely affect mall traffic and new mall and shopping center
development and could materially and adversely affect us and our business strategy. We may not be able to sustain or increase our
current net sales if there is a decline in consumer spending.
A deterioration of economic conditions and future recessionary
periods may exacerbate the other risks faced by our business, including those risks we encounter as we attempt to execute our
business plans. Such risks could be exacerbated individually or collectively.
We operate in the highly competitive specialty retail
apparel and accessories industry and the size and resources of some of our competitors may allow them to compete more effectively
than we can, which could adversely impact market share.
We face intense competition in the specialty retail apparel
and accessories industry. We compete on the basis of a combination of factors, including price, breadth, quality and style of merchandise,
as well as our in-boutique experience and level of customer service, our brand image and our ability to anticipate, identify and
respond to new and changing fashion trends. While we believe that we compete primarily with specialty retailers and internet businesses
that specialize in women’s apparel and accessories, we also face competition from department stores, mass merchandisers and
value retailers. We believe our primary competitors include specialty apparel and accessories retailers that offer their own private
labels. We also face intense competition from the ecommerce platforms of our brick and mortar competitors, as well as internet-based
retailers due to the continuing shift in customer demand away from brick and mortar to ecommerce. Our expansion into markets served
by our competitors and entry of new competitors or expansion of existing competitors into our markets could have an adverse effect
on our business.
We also compete with a wide variety of large and small retailers
for customers, vendors, suitable boutique locations and personnel. The competitive landscape we face, particularly among specialty
retailers, is subject to rapid change as new competitors emerge and existing competitors change their product offerings. We cannot
provide assurance that we will be able to compete successfully and navigate the shifts in our market.
Many of our competitors are, and many of our potential competitors
may be, larger and have greater name recognition and access to greater financial, marketing and other resources. Therefore, these
competitors may be able to adapt to changes in trends and customer desires more quickly, devote greater resources to the marketing
and sale of their products, generate greater brand recognition or adopt more aggressive pricing policies than we can. As a result,
we may lose market share, which could reduce our sales and adversely affect our results of operations. Many of our competitors
also utilize advertising and marketing media, including advertising through the use of direct mail, newspapers, magazines, billboards,
television and radio, which may provide them with greater brand recognition than we have given our very limited use of traditional
advertising.
Our competitors may also sell certain products or substantially
similar products through the internet or through outlet centers or discount stores, increasing the competitive pressure for those
products. Additionally, the internet and other new technologies facilitate competitive entry and comparison shopping. We cannot
assure you that we will continue to be able to compete successfully against existing or future competitors. Our expansion into
markets served by our competitors and entry of new competitors or expansion of existing competitors into our markets could have
a material adverse effect on us. Competitive forces and pressures may also intensify if our presence in the retail marketplace
grows.
We do not possess exclusive rights to many of the elements that
comprise our in-boutique experience and merchandise offerings. Some specialty retailers offer a personalized shopping experience
that in certain ways is similar to the one we strive to provide to our customers. Our competitors may seek to emulate facets of
our business strategy and in-boutique experience, which could result in a reduction of any competitive advantage or special appeal
that we might possess. Some of our merchandise offerings are sold to us on a non-exclusive basis. As a result, our current and
future competitors, especially those with greater financial, marketing or other resources, may be able to duplicate or improve
upon some or all of the elements of our in-boutique experience or merchandise offerings that we believe are important in differentiating
our boutiques and our customers’ shopping experience. If our competitors were to duplicate or improve upon some or all of
the elements of our in-boutique experience or product offerings, our competitive position and our business could suffer.
Our ability to attract customers to our boutiques depends
on locating our boutiques in suitable locations. Conditions or changes affecting boutique locations, including any further decrease
in customer traffic, could cause our sales to be less than historical values and less than expected.
Boutique locations and related sales and customer traffic may
be adversely affected by, among other things, economic conditions in a particular area, competition from nearby retailers or online
retailers selling similar merchandise, changing lifestyle choices of consumers in a particular market and the closing or decline
in popularity of other businesses located near our boutiques. Additionally, many of our boutiques are located in shopping malls
and other retail centers that benefit from the ability of “anchor” retail tenants, generally large department centers,
and other attractions, to generate sufficient levels of consumer traffic in the vicinity of our boutiques. We, along with
numerous other retailers, including anchor retail tenants, have announced the closure of a significant number of stores, mainly
in mall and anchor store locations. Changes in areas around our boutique locations or changes in consumer shopping patterns, including
a continued shift of consumer spending from brick-and-mortar to online, that result in reductions in customer foot traffic or otherwise
render the locations unsuitable could cause our sales to be less than historical values and less than expected. In addition, we
may have to respond to these changes by closing additional stores, increasing markdowns or increasing promotions to reduce excess
inventory in certain boutiques, which could have a material adverse effect on our margins and operating results.
Our business depends on a strong brand image, and if we
are not able to maintain and enhance our brand, particularly in new markets where we have limited brand recognition, we may be
unable to attract a sufficient number of customers to our boutiques or sell sufficient quantities of our merchandise.
We believe that our brand image and brand awareness is an important
factor to the success of our business. We also believe that maintaining and enhancing our brand image particularly in newer markets
where we have limited brand recognition is important to maintaining and expanding our customer base. Maintaining and enhancing
our brand image may require us to make substantial investments in areas such as merchandising, marketing, boutique operations,
community relations, boutique promotions and employee training. These investments may be substantial and may not ultimately be
successful. If they are not successful, our financial condition and results of operations could be materially adversely affected.
Our use of traditional advertising channels is limited
and if we fail to adequately connect with our customer base, our business could be adversely affected.
We have historically focused on organic, viral and in-boutique
marketing to capture the interest of our customers and drive them to our boutiques and website. We limit our use of traditional
advertising channels, such as newspapers, magazines, billboards, television, direct mail and radio, which are used by some of our
competitors. Although we continue to work to strengthen and evolve our marketing programs, including through the use of investments
in influencers in digital and social media, there is no guarantee that such efforts will be successful. While we expect to decrease
our marketing spend in fiscal 2019, we do expect to further increase our use of digital advertising, including social media, such
as Facebook, Instagram, Pinterest and Twitter, in the future. If our marketing efforts are not successful, there may be no immediately
available or cost effective alternative marketing channel for us to use to build or maintain brand awareness. Failure to successfully
connect with our target customers in new and existing markets could harm our business, results of operations and financial condition.
We depend on our senior management personnel and may not
be able to retain or replace these individuals or recruit additional personnel, which could harm our business.
Our future success is substantially dependent on establishing
and maintaining an experienced senior management team. We are currently experiencing a Chief Executive Officer transition. On January
29, 2019 Mr. Steven P. Lawrence, our former President and Chief Executive Officer, announced his resignation effective February
1, 2019. On February 4, 2019, our board of directors appointed Mr. Michael Prendergast of Alvarez & Marsal as our Interim Chief
Executive Officer. In February 2019, both our Senior Vice President and Chief Merchandising Officer and Senior Vice President,
Merchandise Planning and Allocation departed the Company and in April 2019, our Senior Vice President and General Counsel resigned.
Our business could be adversely affected if we are unable to find a suitable permanent replacements or if the search for such replacement
is not completed timely. The loss of services of one or more of our senior management could impair our ability to manage our business
effectively and could have an adverse effect on our business, as we may not be able to find suitable individuals to replace them
on a timely basis or at all. Any departures of key personnel could be viewed in a negative light by investors and analysts, which
could cause our common stock price to decline. We do not maintain key person insurance on any employee.
In addition to our senior management, we have other employees
in positions, including those employees responsible for our merchandising and operations departments that, if vacant, could cause
a temporary disruption in our business until such positions are filled.
Our ability to successfully open and operate new boutiques
in a timely and cost-effective manner is subject to a number of risks.
While we are currently focused on optimizing our existing real
estate fleet and do not currently intend to open more than four new boutiques in the foreseeable future, we believe we will have
an opportunity to grow our boutique base in the United States and that our long-term strategy depends upon our ability to successfully
open new boutiques. The success of this strategy will depend largely upon our ability to optimize our existing real estate fleet
and improve our operating margins, our ability to find a sufficient number of suitable locations, our ability to recruit, hire
and train qualified personnel to operate our new boutiques and our ability to scale our infrastructure to successfully integrate
our new boutiques.
Our ability to successfully open and operate new boutiques depends
on many factors that may be outside of our control including, among others, our ability to:
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optimize our existing real estate fleet and improve our operating margins;
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identify desirable boutique locations, primarily in malls, lifestyle centers, street locations and strip centers, as well as
other types of shopping venues and outlet malls, which may be difficult and costly, particularly, in an improving real estate environment
and as customer shopping patterns evolve;
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negotiate acceptable lease terms, including favorable levels of tenant allowances, which may be difficult, particularly in
an improving real estate environment;
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maintain out-of-pocket, build-out costs in line with our boutique economic model, including by receiving expected levels of
tenant allowances for a portion of our construction expenses, and managing these construction expenses at reasonable levels, which
may be difficult, particularly in an improving real estate environment;
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efficiently source and distribute additional merchandise;
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hire, train and retain a growing workforce of boutique managers, boutique associates and other personnel;
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successfully integrate new boutiques into our existing control structure and operations, including our information technology
systems;
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efficiently expand the operations of our distribution facility to meet the needs of a growing boutique network;
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identify and satisfy the merchandise and other preferences of our customers in new geographic areas and markets; and
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address competition, merchandising, marketing, distribution and other challenges encountered in connection with expansion into
new geographic areas and markets.
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We may open new boutiques in or near the areas where we have
existing boutiques. To the extent that we open boutiques in markets where we already have existing boutiques, we may experience
reduced net sales at those existing boutiques. Also, as we expand into new geographic areas, we will need to successfully identify
and satisfy the fashion preferences of customers in those areas. We will need to address competition, merchandising, marketing,
distribution and other challenges encountered in connection with any expansion and our limited brand recognition in new markets
may limit our expansion strategy and cause our business and growth to suffer. New geographic areas may also have different
operational characteristics, including employment and labor, logistics, real estate and legal requirements which may divert financial,
operation and managerial resources from our existing operations.
Finally, newly opened boutiques may not be received as well
as, or achieve net sales, profitability levels or payback period on our net investment comparable to those of, our existing boutiques
in our estimated time periods, or at all. If our boutiques fail to achieve, or are unable to sustain, acceptable net sales and
profitability levels, our business may be materially harmed and we may incur significant costs associated with closing or relocating
boutiques. Our current expansion plans are only estimates, and the actual number of boutiques we open or close each year and the
actual number of suitable locations for our new boutiques could differ significantly from these estimates. If we fail to successfully
open and operate new boutiques and execute our long-term growth plans, the price of our common stock could decline.
If we are unable to find, train and retain key personnel,
including new boutique employees that reflect our brand image and embody our culture, we may not be able to grow or sustain our
operations.
Our success depends in part upon our ability to attract, motivate
and retain a sufficient number of boutique employees, including boutique managers, who understand and appreciate our customers,
brand and corporate culture, and are able to adequately and effectively represent our culture and establish credibility with our
customers. Like most retailers, we experience significant employee turnover rates, particularly among boutique employees. Our current
operations require us to continuously hire and train personnel. If we are unable to hire and retain boutique personnel capable
of consistently providing a high level of customer service, as demonstrated by their enthusiasm for our culture, understanding
of our customers and knowledge of the merchandise we offer, the performance of our existing and new boutiques could be materially
adversely affected and our brand image may be negatively impacted. There is a high level of competition for experienced, qualified
personnel in the retail industry and we compete for personnel with a variety of companies looking to hire for retail positions.
Our initiative to decrease expenses and to increase boutique team productivity may make it more difficult for us to retain employees.
Historically, we have prided ourselves on our commitment to employee growth and development and we focus on promoting from within
our team. If we have challenges in staffing our new boutiques, particularly at the boutique manager level, it could have an adverse
effect on our ability to maintain a cohesive and consistently strong team, which in turn could have an adverse impact on our business.
If we are unable to attract, train and retain employees in the future, we may not be able to serve our customers effectively, thus
reducing our ability to profitably operate our new and existing boutiques.
Union attempts to organize our employees could negatively
affect our business.
None of our employees are currently subject to a collective
bargaining agreement. However, in the future, unions may attempt to organize all or part of our employee base at certain boutiques
or within certain regions. Responding to such organization attempts may distract management and employees and may have a negative
financial impact on individual boutiques, or on our business as a whole.
We have one corporate headquarters and distribution facility
and have not yet implemented disaster recovery procedures. Disruptions to the operations at that location have in the past, and
could in the future, have an adverse effect on our business operations.
Our corporate headquarters and our only distribution facility
are located in Houston, Texas. Our distribution facility supports both our boutiques and our ecommerce. Most of our merchandise
is shipped from our vendors to the distribution facility and then packaged and shipped from our distribution facility to our boutiques
and our ecommerce customers. The success of our boutiques depends on the timely receipt of merchandise because they must receive
merchandise in a timely manner in order to stay current with the fashion preferences of our customers. The efficient flow of our
merchandise requires that we have adequate capacity and uninterrupted service in our distribution facility to support both our
current level of operations, and the anticipated increased levels that may follow from our growth plans. We believe that our current
distribution facility is capable of supporting our growth plans for several years.
If we encounter difficulties associated with our distribution
facility or if it were to shut down for any reason, including fire, hurricanes, floods, or other natural disaster or severe weather,
we could face inventory shortages resulting in “out-of-stock” conditions in our boutiques, and delays in shipments
to our customers, resulting in significantly higher costs and longer lead times associated with distributing our merchandise. See
“
The current geographic concentration of our boutiques creates an exposure to local economies, regional downturns and
severe weather or other catastrophic occurrences that may materially adversely affect our financial condition and results of operations
”
below. 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, causing further disruption and expense to our business and operations. For example,
in August 2017, Hurricane Harvey hit south Texas which resulted in the shutdown of corporate headquarters for a few days and disruption
in our supply chain for several weeks.
We recognize the need for, and are in the early stages of, developing
disaster recovery, business continuity and document retention plans that would allow us to be operational despite casualties or
unforeseen events impacting our corporate headquarters or distribution center. Without disaster recovery, business continuity and
document retention plans, if we encounter difficulties or disasters with our distribution facility or at our corporate headquarters,
our critical systems, operations and information may not be restored in a timely manner, or at all, and this could have an adverse
effect on our business.
Our business requires that we lease substantial amounts
of space and we may not be able to continue to lease space on terms as favorable as the leases negotiated in the past and the costs
of exiting leases at boutiques we have identified for closure may be greater than we estimate or could be greater than the funds
we raise to address closure costs, if necessary.
We do not own any real estate. Instead, we lease all of our
boutique locations, as well as our corporate headquarters and distribution facility in Houston, Texas. Our boutiques are leased
from third parties, with initial lease terms of five to ten years. Many of our lease agreements also have additional five-year
renewal options. We believe that we have been able to negotiate favorable rental rates and tenant allowances over the last few
years due, in large part, to the strength of our reputation as tenants, the state of the economy and higher than usual vacancy
rates in a number of regional malls and shopping centers. These trends may not continue, including as a result of our effort to
optimize our lease expense structure for existing and boutiques, and there is no guarantee that we will be able to continue to
negotiate such favorable terms. Many of our leases have early cancellation clauses, which permit the lease to be terminated by
us or the landlord if certain sales levels are not met in specific periods or if the shopping venue does not meet specified occupancy
standards. In addition to fixed minimum lease payments, most of our boutique leases provide for additional rental payments based
on a percentage of sales, or “percentage rent,” if sales at the respective boutiques exceed specified levels, as well
as the payment of common area maintenance charges, real property insurance and real estate taxes. Many of our lease agreements
have defined escalating rent provisions over the initial term and any extensions. Increases in our already substantial occupancy
costs and difficulty in identifying economically suitable new boutique locations could have significant negative consequences,
which include:
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requiring that a greater portion of our available cash be applied to pay our rental obligations, thus reducing cash available
for other purposes and reducing our profitability;
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increasing our vulnerability to general adverse economic and industry conditions; and
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limiting our flexibility in planning for, or reacting to changes in, our business or in the industry in which we compete.
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We depend on cash flow from operations to pay our lease expenses
and to fulfill our other cash needs. If our business does not generate sufficient cash flow from operating activities to fund these
expenses and needs and sufficient funds are not otherwise available to us, we may not be able to service our lease expenses, grow
our business, respond to competitive challenges or fund our other liquidity and capital needs, which could harm our business. Additional
sites that we lease may be subject to long-term non-cancelable leases if we are unable to negotiate our current standard lease
terms. If an existing or future boutique 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.
Moreover, even if a lease has an early cancellation clause, we may not satisfy the contractual requirements for early cancellation
under that lease. If we are not able to enter into new leases or renew existing leases on terms acceptable to us, this could have
an adverse effect on our results of operations.
In connection with our strategy to optimize our real estate
portfolio, our preferred approach to closing boutiques is to enter into lease termination agreements with respect to the leases
at such boutiques, rather than to assign leases or to sublease the boutique premises because it allows us to avoid the risk of
future liability under the leases. The costs of terminating the leases for boutiques we close may be greater than we currently
estimate, in which case we may need to borrow under our Asset Based Revolving Credit Facility. Further the cost to fund such liabilities
is often significant and is funded through cash flow from operations. In addition, we could encounter difficulty raising the funds
necessary to cover a part of the costs of terminating the leases for boutiques we intend to close. Such circumstances could materially
adversely affect our business, financial condition or results of operations.
Our ability to obtain merchandise on a timely basis at
competitive prices could suffer as a result of any deterioration or change in our vendor relationships or events that adversely
affect our vendors or their ability to obtain financing for their operations.
We have many important vendor relationships that we believe
provide us with a competitive advantage. We do not own or operate any manufacturing facilities. Instead, we purchase our merchandise
from third-party vendors. Our top 10 vendors sourced approximately 28% of our merchandise in fiscal year 2018 with no single vendor
accounting for more than 5% of our purchases. Our business and financial performance depend in large part on our ability to evaluate
merchandise quickly for style and then modify any undesirable designs or to improve the quality, look, and fit of the item. We
do not have long-term contracts with any of these vendors and we generally operate without any contractual assurances of continued
supply, pricing or access to new products. Rather, we receive and review samples almost daily for fit and fashion evaluation. Maintaining
positive working relationships with our vendors is an important element of our business. Any of our vendors could discontinue supplying
us with desired products in sufficient quantities for a variety of reasons.
The benefits we currently experience from our vendor relationships
could be adversely affected if our vendors:
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choose to stop providing merchandise samples to us or otherwise discontinue selling merchandise to us;
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raise the prices they charge us;
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change pricing terms to require us to pay on delivery or upfront, including as a result of changes in the credit relationships
some of our vendors have with their various lending institutions;
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reduce our access to styles, brands and merchandise by entering into broad exclusivity arrangements with our competitors or
otherwise in the marketplace;
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sell similar merchandise to our competitors with similar or better pricing, many of whom already purchase merchandise in significantly
greater volume and, in some cases, at lower prices than we do;
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lose confidence in our business;
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lengthen their lead times; or
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initiate or expand sales of apparel and accessories to retail customers directly through their own stores, catalogs or on the
internet and compete with us directly.
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We historically have established good working relationships
with many small- to mid-sized vendors that often have limited resources, production capacities and operating histories. Market
and economic events that adversely impact our vendors could impair our ability to obtain merchandise in sufficient quantities.
Such events include difficulties or problems associated with our vendors’ business, finances, labor, ability to import merchandise,
costs, production, insurance and reputation. There can be no assurance that we will be able to acquire desired merchandise in sufficient
quantities on acceptable terms or at all in the future, especially if we need significantly different amounts of inventory in connection
with any changes in our business needs. We may need to develop new relationships with larger vendors, as our current vendors may
be unable to supply us with needed quantities and we may not be able to find similar merchandise on the same terms from larger
vendors. If we are unable to acquire suitable merchandise in sufficient quantities, at acceptable prices with adequate delivery
times due to the loss of or a deterioration or change in our relationship with one or more of our key vendors or events harmful
to our vendors occur, it may adversely affect our business and results of operations.
A failure in our ecommerce operations could significantly
disrupt our business and lead to reduced sales, growth prospects and reputational damage.
While accounting for only 9.0% and 7.0% of our net sales in
fiscal years 2018 and 2017, respectively, our ecommerce operations is growing and is an important element of our brand and relationship
with our customers. While we do not plan to make any significant investments in our ecommerce operations in fiscal year 2019, further
expanding ecommerce is an important part of our strategy. In addition to changing consumer preferences, shifting traffic patterns
and related customer acquisition costs and buying trends in our ecommerce, we are vulnerable to certain additional risks and uncertainties
associated with ecommerce sales, including rapid changes in technology, diversion of sales from our boutiques, credit card fraud,
website downtime and other technical failures, security breaches, consumer privacy concerns, changes in state tax regimes and government
regulation of internet activities. Our failure to successfully respond to these risks and uncertainties could reduce our ecommerce
sales, increase our costs, diminish our growth prospects, and damage our brand, which could negatively impact our results of operations
and stock price. Our lack of investment in our ecommerce operations in the short-term may exacerbate these risks.
There is no guarantee that we will be able to further expand
our ecommerce operations. Many of our competitors already have ecommerce businesses that are substantially larger and more developed
than ours, which places us at a competitive disadvantage. Moreover, online shopping has benefitted from technology improving the
online shopping experience and, in many cases, has resulted in a shift of consumer spending from brick-and-mortar to online where
competition is even greater since “pure play” internet retailers do not have significant occupancy costs and boutique
payroll expenses like we do. If we are unable to further expand our ecommerce operations, our growth plans will suffer and
the price of our common stock could decline.
System security risk issues, including our failure to
protect our customers’ privacy and disruption of our internal operations or information technology systems, could harm our
reputation and adversely affect our financial results and stock price.
Experienced computer programmers and hackers, or even internal
users, may be able to penetrate or create systems disruptions or cause shutdowns of our network security or that of third-party
companies with which we have contracted to provide services. We generally collect and store customer information for marketing
purposes and any compromise of customer information could subject us to customer or government litigation and harm our reputation,
which could adversely affect our business and growth. Breaches of our system or of third party companies with which we have contracted
to provide services, which would compromise our customers’ private information, might cause our customers to lose confidence
in our ability to protect their personal information, which could cause them to discontinue usage of our website or stop shopping
with us altogether. The loss of confidence from a significant data security breach involving employees could also hurt our reputation,
cause employee recruiting and retention challenges, increase our labor costs and adversely affect our business and financial results.
Moreover, we could incur significant expenses or disruptions of our operations in connection with system failures or data breaches.
An increasing number of websites and retailers, including several large internet companies and retailers, have disclosed breaches
of their security, some of which have involved sophisticated and highly targeted attacks on portions of their sites. Because the
techniques used to obtain unauthorized access, disable or degrade service or sabotage systems, change frequently and often are
not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative
measures. Sophisticated hardware and operating system software and applications that we buy or license from third-parties may contain
defects in design or manufacture, including “bugs” and other problems that could unexpectedly interfere with the security
and operation of the systems. The costs to us to eliminate or alleviate security problems, viruses and bugs, or any problems associated
with the outsourced services provided to us, could be significant, and efforts to address these problems could result in interruptions,
delays or cessation of service that may impede our sales, distribution or other critical functions.
Almost all states have adopted breach of data security statutes
or regulations that require notification to consumers if the security of their personal information is breached, and at least one
state has adopted regulations requiring every company that maintains or stores personal information to adopt a comprehensive written
information security program. Governmental focus on data security may lead to additional legislative action, and the increased
emphasis on information security may lead customers to request that we take additional measures to enhance security or restrict
the manner in which we collect and use customer information to gather insights into customer behavior and craft our marketing programs.
As a result, we may have to modify our business systems and practices with the goal of further improving data security, which would
result in reduced net sales, increased expenditures and operating complexity. Any compromise of our security or accidental loss
or theft of customer data in our possession or in the possession of third parties with which we have contracted to provide services
could result in a violation of applicable privacy and other laws, significant legal and financial exposure and damage to our reputation,
which could adversely impact our business, results of operations and stock price.
Our inability or failure to recognize, respond to and
effectively manage the accelerated impact of social media could materially adversely impact our business.
There has been a marked increase in the use of social media
platforms, including weblogs (blogs), social media websites (such as Facebook, Snapchat, Twitter and Instagram), and other forms
of internet-based communications which allow individuals access to a broad audience of consumers and other interested persons. Many
social media platforms immediately publish the content to their subscribers and participants posts, often without filters or checks
on accuracy of the content posted. The dissemination of information online could harm our business, prospects, financial condition
and results of operations, regardless of the information’s accuracy. The harm may be immediate without affording us
an opportunity for redress or correction.
Other risks associated with the use of social media include
improper disclosure of proprietary information, negative comments about our business, fraud and out-of-date information. The
inappropriate use of social media by our customers or employees could increase our costs, lead to litigation or result in negative
publicity that could damage our reputation.
The current geographic concentration of our boutiques
creates an exposure to local economies, regional downturns and severe weather or other catastrophic occurrences that may materially
adversely affect our financial condition and results of operations.
We operated 77 boutiques in Texas as of February 2, 2019, making
Texas our largest market, representing approximately 11% of our total boutiques. We also have boutique concentration in California,
Florida and the Northeast region, operating 62 boutiques, 53 boutiques and 128 boutiques in these regions, respectively, as of
February 2, 2019. As a result, our business is currently more susceptible to regional conditions than the operations of more geographically
diversified competitors, and we are vulnerable to economic downturns in those regions. Any unforeseen events or circumstances that
negatively affect these areas could materially adversely affect our sales and profitability. These factors include, among other
things, changes in demographics and population and severe weather or natural disasters.
Further, our corporate headquarters and only distribution center
are currently located at a single facility in Houston, Texas. Our single distribution center receives, stores and distributes merchandise
to all of our boutiques and fulfills all sales for our ecommerce website. Most of our computer equipment and senior management,
including critical resources dedicated to merchandising and financial and administrative functions, are located at our corporate
headquarters. As described elsewhere in the risk factors in this report, we do not currently have adequate disaster recovery systems
and plans at our corporate headquarters and distribution facility. As a result, our business may be more susceptible to regional
natural disasters, severe weather and catastrophes than the operations of more geographically diversified competitors. See “
We
have one corporate headquarters and distribution facility and have not yet implemented disaster recovery procedures. Disruptions
to the operations at that location could have an adverse effect on our business operations
” above.
A substantial number of our boutiques are located in the northeastern
and southeastern United States. These regions of the United States, Texas and other states along the Gulf Coast, in particular,
are prone to severe weather conditions. For example, hurricanes have passed through these regions and caused extensive damage.
Adverse weather conditions impacting these regions of the United States generally could harm our business, results of operations
and financial condition. Severe weather can also result in weather-related supply disruptions, which could impact our ability
to supply boutiques as was the case of Hurricane Harvey which hit south Texas in August 2017 and caused shutdown of our corporate
headquarters for a few days and disrupted our supply chain for several weeks. Weather conditions can affect our net sales
because inclement weather may discourage travel or require temporary boutique closures, thereby reducing customer traffic. Unseasonably
warmer weather during typically colder months or unreasonably colder weather during typically warmer months can also affect the
seasonal composition and demand for our merchandise, which could harm our business, results of operations and financial condition.
All of our boutique locations expose us to additional diverse
risks, given that natural disasters or other unanticipated catastrophes, such as telecommunications failures, cyber-attacks, fires
or terrorist attacks, can occur anywhere and could cause disruptions in our operations. Extensive or multiple disruptions in our
operations, whether at our boutiques or our corporate headquarters and distribution center, due to natural disasters, severe weather or
other catastrophes could have an adverse effect on our business, results of operations and stock price.
Our results may be adversely affected by fluctuations
in energy costs.
Energy costs have fluctuated dramatically in the past and may
fluctuate in the future. These fluctuations may result in an increase in our transportation costs for distribution, utility costs
for our retail boutiques and costs to purchase product from our vendors. A continual rise in energy costs could adversely affect
consumer spending and demand for our merchandise and increase our operating costs and we may be unable to pass along to our customers
such increased cost, all of which could have a material adverse effect on our business, results of operations and stock price.
Our net sales and merchandise inventory fluctuate on a
seasonal basis, leaving our operating results susceptible to adverse changes in seasonal shopping patterns, weather and related
risks.
Due to the seasonal nature of the retail industry, we have historically
experienced and expect to continue to experience some fluctuations in our net sales and net income (loss). Our net sales and earnings
are typically highest in the fourth fiscal quarter due to the year-end holiday season. Net sales during this period cannot be used
as an accurate indicator of annual results. Likewise, as is the case with many retailers of apparel, jewelry, accessories and gifts,
we typically experience lower net sales in the first fiscal quarter relative to other quarters. If for any reason, including for
example poor weather conditions, soft economic environments or loss of consumer confidence, our net sales were below seasonal norms
or expectations during typically higher-volume time periods, our net sales, inventory levels and results of operations could be
adversely affected. In order to prepare for these higher-volume periods, we must order and keep in stock significantly more merchandise
than we carry during other parts of the year. This inventory build-up may require us to expend cash faster than is generated by
our operations during these periods. Any unanticipated decrease in demand for our merchandise during peak shopping periods, such
as our back-to-school assortment in fiscal year 2017 that did not resonate with customers, could result in excess inventory levels
which could require us to sell or dispose excess inventory at a substantial markdown, which could have an adverse effect on our
business, profitability and brand image. We have experienced, and may continue to experience variability in net sales as a result
of a variety of other factors, including the timing of new boutique openings and closing of underperforming boutiques, customer
response to our product offerings, boutique events, other marketing activities, sales tax holidays and other holidays, which may
cause our results of operations to fluctuate on a quarterly basis and relative to corresponding periods in prior years.
If our vendors fail to comply with applicable laws, including
a failure to use acceptable labor practices, or if our vendors suffer disruptions in their businesses, we could suffer adverse
business consequences.
Our vendors source the merchandise sold in our boutiques and
our ecommerce website from manufacturers both inside and outside of the United States. Although each of our purchase orders is
subject to our vendor manuals or policies, which require compliance with labor, immigration, manufacturing and product safety,
environmental and other laws, we do not supervise, control or audit our vendors or the manufacturers that produce the merchandise
we sell. The violation, or perception of any violation, of any labor, immigration, manufacturing safety or other laws by any of
our vendors or their U.S. and non-U.S. manufacturers, such as use of child labor, or the divergence of the labor practices followed
by any of our vendors or these manufacturers from those generally accepted in the United States, could damage our brand image or
subject us to boycotts by our customers or activist groups.
Any event causing a sudden disruption of manufacturing or imports,
including the imposition of additional import restrictions, could interrupt, or otherwise disrupt the shipment of finished products
to us by our vendors and materially harm our operations. Political and financial instability outside the United States, strikes,
adverse weather conditions or natural disasters that may occur or acts of war or terrorism in the United States or worldwide, may
affect the production, shipment or receipt of merchandise. These factors, which are beyond our control, could materially hurt our
business, financial condition and results of operations or may require us to modify our current business practices or incur increased
costs.
Changes in laws, including employment laws, tax laws,
imposition of new tariffs and laws related to our merchandise could make conducting our business more expensive or otherwise cause
us to change the way we do business.
We are subject to numerous regulations, including taxation,
labor and employment, truth-in-advertising, consumer protection, product safety, environmental and zoning and occupancy laws and
ordinances that regulate retailers generally or govern the promotion and sale of merchandise and the operation of boutiques and
warehouse facilities. If these regulations were to change or were violated by our management, employees or vendors, the costs of
certain goods could increase, or we could experience delays in shipments of our goods, be subject to fines, penalties or other
liabilities or suffer reputational harm, which could reduce demand for our merchandise and hurt our business and results of operations.
In addition to increased regulatory compliance requirements,
changes in laws could make the ordinary conduct of our business more expensive or require us to change the way we do business.
Laws related to employee benefits and treatment of employees, including laws related to limitations on employee hours, immigration
laws, child labor laws, supervisory status, leaves of absence, mandated health benefits or overtime pay, could also negatively
impact us, such as by increasing compensation and benefits costs for overtime and medical expenses. Moreover, changes in product
safety or other consumer protection laws (including the implementation of new privacy protection laws) could lead to increased
costs to us for some merchandise, or additional labor costs associated with readying merchandise for sale. It is often difficult
for us to plan and prepare for potential changes to applicable laws, and future actions or payments related to these changes could
be material to us.
We may incur additional indebtedness in the future, which
may require us to use a substantial portion of our cash flow to service debt and limit our financial and operating flexibility
in important ways.
We may incur additional indebtedness in the future. Any borrowings
under any future debt financing will require interest payments and need to be repaid or refinanced, could require us to divert
funds identified for other purposes to debt service and would create additional cash demands and could impair our liquidity position
and add financial risk for us. Diverting funds identified for other purposes for debt service may adversely affect our business
and growth prospects. If we cannot generate sufficient cash flow from operations to service our debt, we may need to refinance
our debt, dispose of assets or issue equity to obtain necessary funds. We do not know whether we would be able to take any of
these actions on a timely basis, on terms satisfactory to us, or at all.
Our level of indebtedness has important consequences to you
and your investment in our common stock. For example, our level of indebtedness may:
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require us to use a substantial portion of our cash flow from operations to pay interest and principal on our debt, which would
reduce the funds available to us for working capital, capital expenditures and other general corporate purposes;
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limit our ability to pay future dividends;
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limit our ability to obtain additional financing for working capital, capital expenditures, expansion plans and other investments,
which may limit our ability to implement our business strategy;
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heighten our vulnerability to downturns in our business, the specialty apparel and accessories retail industry or in the general
economy and limit our flexibility in planning for, or reacting to, changes in our business and the specialty apparel and accessories
retail industry; or
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prevent us from taking advantage of business opportunities as they arise or successfully carrying out our plans to expand our
boutique base and product offerings.
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Our business may not generate sufficient cash flow from operations
and future borrowings may not be available to us in amounts sufficient to enable us to make payments on our indebtedness or to
fund our operations.
The terms of our Asset Based Revolving Credit Facility
do, and the terms of any additional debt financing may, restrict our current and future operations, which could adversely affect
our ability to manage our operations and respond to changes in our business.
Our Asset Based Revolving Credit Facility contains, and any
additional debt financing we may incur would likely contain, covenants that restrict our operations, including limitations on our
ability to incur additional debt, grant liens, make certain investments, acquisitions loans and advances, sell assets, pay
dividends or make distributions or other restricted payments, prepay other indebtedness, engage in mergers or consolidations, change
the business conducted by Francesca’s Collections and its subsidiaries, engage in certain transactions with affiliates,
enter into agreements that restrict dividends from subsidiaries or amend certain charter documents and material agreements governing
subordinated and junior indebtedness. A failure by us to comply with the covenants or financial ratios contained in our Asset Based
Revolving Credit Facility or any additional debt financing we may incur could result in an event of default, which could adversely
affect our ability to respond to changes in our business and manage our operations. Upon the occurrence of an event of default,
the lenders could elect to declare all amounts outstanding to be due and payable and exercise other remedies. If the indebtedness
under our Asset Based Revolving Credit Facility or any additional debt financing we may incur were to be accelerated, our future
financial condition could be materially adversely affected.
We are involved on an ongoing basis in litigation arising
in the ordinary course of business or otherwise that could distract management from our business activities and result in significant
liability or damage to our brand.
We face the risk of litigation and other claims against us.
We are involved on an ongoing basis in litigation arising in the ordinary course of our business or otherwise, which may include
class actions involving consumers, shareholders or employees, and claims relating to employees, commercial disputes, landlord-tenant
disputes, intellectual property issues, product-oriented allegations and slip and fall claims. These actions and claims can raise
complex factual and legal issues that are subject to risks and uncertainties and could require significant management time. Litigation
and other actions and claims against us could result in unexpected expenses and liabilities, which could materially adversely affect
our operations and our reputation.
We may be unable to protect our trademarks or other intellectual
property rights.
We believe that our trademarks are integral to our boutique
design, our ecommerce and our success in building our brand image and customer loyalty. We rely on trademark registrations and
common law trademark rights to protect the distinctiveness of our brand and have registered those trademarks that we believe are
important to our business with the United States Patent and Trademark Office. We cannot provide assurance that these registrations
will prevent imitation of our name, merchandising concept, boutique design or private label merchandise, or the infringement of
our other intellectual property rights by others. In most cases, the merchandise we sell is purchased on a non-exclusive basis
from vendors that also sell to our competitors. While we use our brand name on these items, our competitors may seek to replicate
aspects of our business strategy and in-boutique experience, thereby diluting the experience we offer and adversely affecting our
brand and competitive position. Imitation of our name, concept, boutique design or merchandise in a manner that projects lesser
quality or carries a negative connotation of our brand image could have an adverse effect on our business, financial condition
and results of operations.
We are not aware of any claims of infringement upon or challenges
to our right to use any of our brand names or trademarks in the United States. Nevertheless, we cannot be certain that the actions
we have taken to establish and protect our trademarks will be adequate to prevent imitation of our merchandise by others or to
prevent others from seeking to block sales of our merchandise as a violation of the trademarks or proprietary rights of others.
Although we cannot currently estimate the likelihood of success of any such lawsuit or ultimate resolution of such a conflict,
such a controversy could have an adverse effect on our business, financial condition and results of operations. If disputes arise
in the future, we may not be able to successfully resolve these types of conflicts to our satisfaction.
We are currently in the process of registering our trademarks
in several foreign countries to seek protection outside the United States. However, international protection of our brand image
and the use of these marks may be unavailable or could be limited. Also, other entities may have rights to trademarks that contain
portions of our marks or may have registered similar or competing marks for merchandise in foreign countries in which our vendors
source our merchandise. There may also be other prior registrations of trademarks identical or similar to our trademarks in other
foreign countries of which we are not aware. Accordingly, it may be possible for others to prevent the manufacture of our branded
goods in certain foreign countries or the sale or exportation of our branded goods from certain foreign countries to the United
States. If we were unable to reach a licensing arrangement with these parties, our vendors may be unable to manufacture our merchandise
in those countries. Our inability to register our trademarks or purchase or license the right to use our trademarks or logos in
these jurisdictions could limit our ability to obtain supplies from less costly markets or penetrate new markets should our business
plan change to include selling our merchandise in those foreign jurisdictions.
Litigation may be necessary to protect our trademarks and other
intellectual property rights or to enforce these rights. Any litigation or claims brought by us could result in substantial costs
and diversion of our resources, which could have a material adverse effect on our business, financial condition, results of operations
or cash flows.
We may be subject to liability and other risks if we,
our vendors or the manufacturers of our merchandise infringe upon the trademarks or other intellectual property rights of third
parties, including the risk that we could acquire merchandise from our vendors without the full right to sell it.
We purchase merchandise that may be subject to design copyrights,
design patents or otherwise may incorporate protected intellectual property. While we are not involved in the manufacture of any
of the merchandise we purchase from our vendors for sale to our customers, we may be subject to liability if our vendors or the
manufacturers of our merchandise infringe upon the trademarks or other intellectual property rights of third parties. We do not
independently investigate whether our vendors or the manufacturers with whom they do business legally hold intellectual property
rights to the merchandise we purchase. Third parties may bring legal claims, or threaten to bring legal claims, against us that
their intellectual property rights are being infringed or violated by our use of intellectual property. Litigation or threatened
litigation could be costly and distract our senior management from operating our business. If we were to be found liable for any
such infringement, we could be required to pay substantial damages and could be subject to injunctions preventing further infringement.
Any payments we are required to make and any injunctions with which we are required to comply as a result of infringement claims
could be costly and thereby adversely affect our financial results.
If a third party claims to have licensing rights with respect
to merchandise we purchased from a vendor, or if we acquire unlicensed merchandise, we may be obligated to remove this merchandise
from our boutiques, incur costs associated with this removal if the distributor or vendor is unwilling or unable to reimburse us
and be subject to liability under various civil and criminal causes of action, including actions to recover unpaid royalties and
other damages and injunctions. Additionally, we will be required to purchase new merchandise to replace any we remove.
We rely upon independent third-party transportation providers
for substantially all of our merchandise shipments.
We currently rely upon independent third-party transportation
providers for substantially all of our merchandise shipments, including shipments to all of our boutiques and our direct customers.
Our use of outside delivery services for shipments is subject to risks, including increases in fuel prices, which would increase
our shipping costs, and employee strikes and inclement weather, which may impact a shipper’s ability to provide delivery
services that adequately meet our shipping needs. If we change shipping companies, we could face logistical difficulties that could
adversely impact deliveries and we would incur costs and expend resources in connection with such change. Moreover, we may not
be able to obtain terms as favorable as those received from the independent third-party transportation providers we currently use,
which would increase our costs.
Disruptions in transportation, including disruptions at
shipping ports through which our merchandise are imported, could prevent us from timely distribution and delivery of merchandise,
which could reduce our net sales and operating margin.
From time to time, shipping ports experience capacity constraints,
labor strikes, work stoppages or other disruptions that may delay the delivery of imported products. A lengthy contract dispute
may lead to protracted delays in the movement of our merchandise, which could further delay the delivery of merchandise to our
boutiques and impact net sales and operating margin. Other conditions outside of our control, such as adverse weather conditions
or acts of terrorism, could significantly disrupt operations at shipping ports or otherwise impact transportation of the imported
merchandise we sell.
Future disruptions in transportation services or at a shipping
port at which our merchandise are received may result in delays in the transportation of such merchandise to our distribution center
and may ultimately delay the distribution to our boutiques resulting in reduced net sales and / or profitability.
Our ability to source our merchandise efficiently and
profitably could be hurt if new trade restrictions are imposed, existing trade restrictions become more burdensome, or the countries
where our merchandise are sourced experience political instability.
We currently purchase all of our inventory from domestic vendors,
who source our merchandise both domestically and internationally. We believe most of the merchandise sourced by our vendors was
produced outside the United States. These vendors, to the extent they obtain merchandise from outside of the United States, are
subject to trade restrictions, including tariffs, safeguards or quotas, changes to which could increase the cost or reduce the
supply of merchandise available to us. Under the World Trade Organization Agreement, effective January 1, 2005, the United
States and other World Trade Organization member countries removed quotas on goods from World Trade Organization members, which
in certain instances we believe afford our vendors greater flexibility in importing textile and apparel products from World Trade
Organization countries from which they source our merchandise. However, as the removal of quotas resulted in an import surge from
China, the United States imposed safeguard quotas on a number of categories of goods and apparel from China, and may impose additional
quotas in the future. These and other trade restrictions could have a significant impact on our vendors’ sourcing patterns
in the future. The extent of this impact, if any, and the possible effect on our purchasing patterns and costs, cannot be determined
at this time. We cannot predict whether any of the countries in which our vendors’ merchandise is currently manufactured
or may be manufactured in the future will be subject to additional trade restrictions imposed by the United States or foreign governments,
nor can we predict the likelihood, type or effect of any restrictions. Trade restrictions, including increased tariffs or quotas,
embargoes, safeguards and customs restrictions against items we offer in our boutiques, as well as United States or foreign labor
strikes, work stoppages or boycotts, could increase the cost or reduce the supply of merchandise to our vendors, and we would expect
the costs to be passed along in increased prices to us, which could hurt our profitability.
Additionally, political instability or acts of terrorism, significant
fluctuations in the value of the U.S. dollar against foreign currencies and restrictions on the transfer of funds between the U.S.
and foreign jurisdictions, any of which if they effect the countries where our merchandise are sourced, could adversely affect
our merchandise flow and, consequently, cause our sales to decline.
Increases in the minimum wage could have an adverse effect
on our financial results.
From time to time, legislative proposals are made to increase
the federal minimum wage in the United States, as well as the minimum wage in a number of individual states and municipalities. Legislation
to increase the minimum wage has been approved or is being contemplated in some states in which we operate. Base wage rates for
many of our employees are at or slightly above the minimum wage. As federal or state minimum wage rates increase, we may need to
increase not only the wage rates of our minimum wage employees, but also the wages paid to our other hourly employees as well.
Any increase in the cost of our labor could have an adverse effect on our operating costs, financial condition and results of operations.
Our inability to comply with the continued listing requirements
of the Nasdaq Stock Market could result in our common stock being delisted, which could adversely affect the market price
and liquidity of our securities and could have other adverse effects.
On February 1, 2019, we received a letter from the Listing Qualifications
staff of Nasdaq indicating that, based upon the closing bid price of the Company’s common stock for the last 30 consecutive
business days, the Company no longer meets the requirement of the Nasdaq Global Select Market to maintain a minimum bid price of
$1 per share, as set forth in Nasdaq Listing Rule 5450(a)(1).
In accordance with Nasdaq Listing Rule 5810(c)(3)(A), we have
been provided a period of 180 calendar days, or until July 31, 2019, in which to regain compliance. In order to regain compliance
with the minimum bid price requirement, the closing bid price of our common stock must be at least $1 per share for a minimum of
ten consecutive business days during this 180-day period. In the event that we do not regain compliance within this 180-day period,
we may be eligible to transfer to the Nasdaq Capital Market and seek an additional compliance period of 180 calendar days if we
(i) meet the continued listing requirement for market value of publicly held shares and all other initial listing standards for
the Nasdaq Capital Market, with the exception of the bid price requirement, and (ii) provide written notice to Nasdaq of our intent
to cure the deficiency during this second compliance period, including by effecting a reverse stock split, if necessary. However,
if it appears to the Nasdaq staff that we will not be able to cure the deficiency, or if we are otherwise not eligible, Nasdaq
will provide notice to us that we will not be eligible for the additional compliance period and our common stock will be subject
to delisting. We would then be entitled to appeal the determination to a Nasdaq Listing Qualifications Panel and request a hearing.
We are considering our available options to regain compliance, including whether to effect a reverse stock split. There can be
no assurance that we will be able to regain compliance with the minimum bid price requirement or maintain compliance with the other
Nasdaq listing requirements. If we do not regain compliance with the Nasdaq continuing listing requirements, our common stock will
be delisted from the Nasdaq Global Select Market (or Nasdaq Capital Market, if applicable) and it could be more difficult
to buy or sell our securities and to obtain accurate quotations, and the price of our common stock could suffer a material decline.
In addition, a delisting would impair our ability to raise capital through the public markets, could deter broker-dealers from
making a market in or otherwise seeking or generating interest in our securities and might deter certain institutions and persons
from investing in our securities at all.
Anti-takeover provisions of Delaware law and our certificate
of incorporation and bylaws could delay and discourage takeover attempts that stockholders may consider to be favorable.
Our amended and restated certificate of incorporation and amended
and restated bylaws contain provisions that make it difficult for our stockholders to change the composition of our board of directors,
preventing them from changing the composition of management. The same provisions may discourage, delay or prevent a merger or acquisition
that our stockholders may consider favorable. These provisions, among other things:
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establish a staggered, or classified, board of directors so that not all members of our board of directors are elected at one
time;
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prohibit cumulative voting in the election of directors;
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authorize the issuance by our board of directors of “blank check” preferred stock, the terms of which may be established
and the shares of which may be issued without stockholder approval, and which may include super-majority voting, special approval,
dividend or other rights or preferences superior to the rights of the holders of common stock;
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limit the persons who may call special meetings of stockholders;
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prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;
and
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establish advance notice requirements for stockholder nominations for elections to our board of directors or for proposing
matters that can be acted upon by stockholders at stockholder meetings.
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Further, if we effect a reverse stock split in order to regain
compliance with the Nasdaq’s minimum bid price requirement discussed above without also correspondingly reducing the number
of authorized but unissued shares of our common stock, the increased number of authorized but unissued shares of our common stock
may make any effort towards a change of control more difficult. These anti-takeover provisions and other provisions under Delaware
law could substantially impede the ability of our common stockholders to benefit from a change in control and, as a result, could
materially adversely affect the market price of our common stock and your ability to realize any potential change-in-control premium.