| HAROLDS STORES INC ITEM 1A RISK FACTORS We must improve our financial performance and become consistently profitable |
| For six years through 2003, the Company reported operating losses and deficit cash flows from operating activities |
| During this period, the Company restructured, resulting in store closings and reductions of personnel |
| In 2004 we had a slight operating profit before preferred dividends |
| However, in 2005 the Company returned to an operating loss |
| In addition, we have limited cash flow from operating activities to finance expansion or additional investment |
| Our future depends upon our ability to improve our financial performance and become consistently profitable |
| While we believe our strategic initiatives that are in place will result in improvements in financial performance, there can be no assurance that we will achieve sustained profitability and cash flow from operations |
| Our performance will depend on our ability to respond to changes in customer demands and fashion trends in a timely manner |
| We have historically experienced fluctuations in customer response to our merchandise assortments |
| Our future performance depends on our ability to consistently anticipate, assess and react to the changing demands of our customer base |
| Failure to anticipate fashion trends which are appropriate for our customer base, maintain proper inventory levels and creatively present merchandise in a way that is appealing to our customers on a consistent basis will be detrimental to our sales gross margins |
| As primarily a private label merchandiser, we assume certain risks, including long product lead times and high initial purchase commitments that amplify the consequences of any miscalculation that we might make in anticipating fashion trends or interpreting them for our customers |
| We can provide no assurance that we will be able to identify and offer merchandise that appeals to our customer base or that the introduction of new merchandise categories will be successful or profitable |
| A search is being conducted for her replacement, but there can be no assurances that her departure and related replacement will not cause disruption to the trend and design function |
| See "e Item 1 - Business Developments in 2005 "e |
| Our future success will depend upon brand awareness and the effectiveness of our marketing programs |
| Our future success will depend upon our ability to effectively define, evolve and promote our brand |
| In order to achieve and maintain significant brand name recognition, we will need to increase investments in the development of the brand through various means, including customer research, advertising and promotional events, direct mail marketing and internet marketing |
| We can provide no assurance that the marketing strategies we implement and the investments we make will be successful in building significant brand awareness or attracting new customers |
| Our business is highly competitive and depends on consumer spending patterns |
| The specialty retail industry is highly competitive |
| We compete with national and local department stores, specialty and discount store chains, independent retail stores and internet businesses that market similar lines of merchandise |
| We face a variety of competitive challenges including: - anticipating and quickly responding to changing consumer demands; - maintaining favorable brand recognition and effectively marketing our products to consumers in several diverse market segments; - developing innovative, high-quality products in sizes, colors and styles that appeal to consumers of varying age groups and tastes; - sourcing merchandise efficiently; - competitively pricing our products and achieving customer perception of value; and - providing strong and effective marketing support |
| Our business is sensitive to a number of factors that influence the levels of consumer spending, including political and economic conditions such as recessionary environments, the levels of disposable consumer income, consumer debt, interest rates and consumer confidence |
| Declines in consumer spending on apparel and accessories could have an adverse effect on our operating results |
| We experience fluctuations in our comparable store sales and margins |
| Our future success depends, in part, upon our ability to improve sales, as well as both gross margins and operating margins |
| Our comparable store sales have fluctuated significantly in the past on an annual, quarterly and monthly basis, and we expect that they will continue to fluctuate in the future |
| A variety of factors affect comparable store sales, including fashion trends, the Companyapstas ability to interpret these trends, competition, current economic conditions, timely delivery of new merchandise and promotional events, changes in our merchandise mix, the success of marketing programs and weather conditions |
| These factors may cause our comparable store sales results to differ materially from prior periods and from expectations |
| Our ability to deliver healthy comparable store sales results and margins depends in large part on accurately forecasting demand and fashion trends, selecting effective marketing techniques, providing an appropriate mix of merchandise for our customer base, managing inventory effectively and using more effective pricing strategies |
| Our failure to effectively manage new store openings could lower our sales and profitability |
| Our growth strategy is dependent upon opening new stores and operating them profitably |
| We will open two stores in 2006 |
| Our ability to open new stores and operate them profitably depends upon a number of factors, some of which may be beyond our control |
| These factors include: - the ability to identify new store locations, negotiate suitable leases and build out the stores in a timely and cost efficient manner; - the ability to hire and train skilled associates; - the ability to integrate new stores into our existing operations; and - the ability to increase sales at new store locations |
| Our growth will also depend on our ability to process increased merchandise volume resulting from new store openings through our inventory management systems and distribution facilities in a timely manner |
| If we fail to manage new store openings in a timely and cost efficient manner, our growth may decrease |
| Our success is dependent on the performance of our vendors and service providers |
| Our business depends on the performance of third parties, including manufacturers and foreign buying agents, telecommunications service providers, the United States Postal Service, United Parcel Service, shipping companies, landlords, paper manufacturers, printers, photographers, creative designers and models and credit card processing companies |
| Any interruptions or delays in these services could materially and adversely affect our business and financial condition |
| Although we believe that, in general, the goods and services we obtain from third parties could be purchased from other sources, identifying and obtaining substitute goods and services could result in delays and increased costs |
| We do not maintain supply contracts with any of our private label or other merchandise vendors |
| Rather, we acquire merchandise via purchase orders that terminate upon completion of the order |
| If any significant merchandise vendor or buying agent were to suddenly discontinue its relationship with us, for any reason, we could experience temporary delivery delays until a substitute supplier could be found |
| Our reliance on foreign sources of production could be adversely affected by political developments |
| While we purchase merchandise from domestic and foreign suppliers, a majority of our merchandise is purchased through foreign suppliers |
| We source a substantial portion of our ladies &apos merchandise through the Orient via our agency relationship with Eralda |
| While numerous factories are utilized to support this relationship, there exists the risk inherent in such a large agency relationship and consolidation of sourcing efforts within one primary region of the world |
| Any event causing a sudden disruption of manufacturing or imports from those countries, or the imposition of additional import restrictions, could have a material adverse effect on our operations |
| We cannot predict with certainty whether any of the foreign countries in which our products are currently manufactured or any of the countries in which we may manufacture our products in the future will be subject to future import restrictions by the US government, including the likelihood, type or degree of effect of any such new trade restriction |
| Trade restrictions, including increased tariffs or quotas, on apparel or other items sold by us could affect the importation of such merchandise and could increase the cost or reduce the supply of merchandise available to us and adversely affect our business, financial condition, results or operations and liquidity |
| Our merchandise flow may also be adversely affected by financial or political instability in any of the countries in which our goods are manufactured, the potential impact of natural disasters and public health concerns, particularly on our foreign sourcing offices and manufacturing operations of our vendors, if they affect the production, shipment or receipt of merchandise from such countries |
| Merchandise flow may also be adversely affected by significant fluctuation in the value of the US dollar against foreign currencies or restrictions on the transfer of funds |
| Our business is subject to a number of external costs that we are unable to control |
| Our business is subject to a number of external costs we are unable to control, including labor costs, insurance costs, printing, paper and postage expenses, shipping charges associated with distributing merchandise to our customers and stores, retail store facility rental and construction costs, and inventory acquisition costs, including product costs, quota and customs charges |
| Any increase in these or other external costs could adversely affect our financial position, results of operations and cash flows |
| We have substantial debt that could adversely impact cash availability for growth and operations and may increase our vulnerability to general adverse economic and industry conditions including rising interest rates |
| As of January 28, 2006, we had approximately dlra19 million of indebtedness |
| While the vast majority of our debt does not have required principal payments, interest payments on this debt could have an adverse impact on our earnings and cash flows for as long as the indebtedness is outstanding |
| Our increased indebtedness could have important consequences, including the following: - our ability to obtain additional financing for working capital, capital expendtures or general corporate purposes may be impaired; - we must use a portion of our cash flow from operations to make interest payments on our primary lending facility, which will reduce the funds available to us for other purposes such as capital expenditures; - our financial position is affected, in part, by fluctuations in interest rates |
| Our primary lending facility with Wells Fargo Retail Finance II, LLC has a floating interest rate |
| In addition, dlra5 million of the dlra7 million in investor participation loans through this facility bears interest at the bank rate of LIBOR plus 2dtta5prca, plus an additional 4dtta0prca |
| Increased interest rates will adversely affect our financial results and cash flow by increasing the amount of interest expense we are required to pay; - we may have a higher level of indebtedness than many of our competitors, which may put us at a competitive disadvantage and reduce our flexibility in planning for, or responding to, changing conditions in our industry, including increased competition; and - we are more vulnerable to general economic downturns and adverse developments in our business |
| If our cash flows and capital resources are insufficient to fund our debt obligations, we may be forced to reduce or delay capital expensiture, sell assets, seek additional capital or restructure or refinance our indebtedness |
| Our success depends to a significant extent upon our ability to retain key personnel and to continue to attract talented new personnel |
| The loss of the services of one or more of our current members of senior management, or our failure to attract talented new employees, could have an adverse effect on our business |
| We are dependent on a single distribution facility |
| Our distribution functions for all of our stores are handled from a single facility in Norman, Oklahoma |
| Any significant interruption in the operation of the distribution facility due to natural disasters, accidents, system failures or unforeseen causes could delay or impair our ability to distribute merchandise to our stores, which would cause sales to decline |
| We depend on information systems to operate our website, process transactions, respond to customer inquiries, manage inventory, purchase, sell and ship goods on a timely basis and maintain cost-efficient operations |
| Any material disruption or slowdown of our systems could cause information to be lost or delayed which could have a negative impact on our business |
| We may experience operational problems with our information systems as a result of system failures, viruses, computer "e hackers "e or other causes |
| We cannot assure that our systems will be adequate to support future growth |
| Our financial resources are limited, and we may not be able to attract additional sources of financing |
| Other than our secured bank credit facility which supports our investments in inventory and accounts receivable, our principal sources of financing from 2001 through 2006 have been from Inter-Him, NV ( "e Inter-Him "e ), an entity controlled by Ronald de Waal, Howard Lester, one of our directors, and other directors who have invested an aggregate of dlra15 million in shares of preferred stock and have participated in dlra7 million of our bank financing |
| The terms of the preferred stock permit the holders to elect a majority of our directors and the consent of the holders of the preferred stock is required for any significant actions, including additional financing |
| We are substantially dependent on the support of Ronald de Waal as the owner of Inter-Him and controlling shareholder of the Company for financial support beyond that cash which is generated from operations and our working capital facility |
| Without additional financial support, our ability to make investments in store remodeling, store expansions and major capital improvements are significantly limited |
| Our outstanding preferred stock limits our ability to achieve financial returns for our holders of common stock |
| As of January 28, 2006, we have outstanding three series of preferred stock with an aggregate liquidation value of dlra16dtta9 million |
| Holders of preferred stock are entitled to annual dividends in the aggregate amount of approximately dlra1dtta5 million before any dividends are paid on common stock, and these dividends reduce the amount of our net income applicable to our shares of common stock |
| Until we achieve net income in excess of the aggregate dividends payable to holders of preferred stock, we will continue to report net losses per share of common stock |
| We do not expect to pay dividends on our common stock |
| Due to our weak financial performance and restrictions under our existing credit agreement and preferred stock terms, we do not expect to pay dividends on our common stock for the foreseeable future |
| Ronald de Waal, through his ownership of Inter-Him, NV, which owns a majority of our outstanding preferred stock, controls the Company |
| We are effectively controlled by Ronald de Waal by reason of his ownership of Inter-Him, NV which owns a majority of our outstanding preferred stock |
| Holders of the preferred stock have the ability to elect a majority of the board of directors and otherwise control the policies and strategy of the Company |
| The financial and business objectives of Mr |
| de Waal and the other holders of preferred stock as it relates to the Company may be different from those that might be beneficial to holders of common stock |
| Holders of the common stock are dependent on the fiduciary duties of the Board of Directors, a majority of whom are elected by the holders of preferred stock, to protect their interests |
| Our Interim Chief Executive Officer is the subject of pending SEC enforcement actions arising from employment with a prior employer |
| On August 25, 2005 the Securities and Exchange Commission ( "e SEC "e ) filed a civil complaint in the United States District Court, District of South Carolina, Spartanburg Division against our Interim Chief Executive Officer, Leonard Snyder, and certain other former officers of One Price Clothing Stores, Inc |
| ( "e One Price "e ), alleging various violations of the federal securities laws relating to alleged overstatements of One Priceapstas inventory levels in 2003 |
| The SECapstas complaint seeks injunctive relief, unspecified disgorgement, civil penalties and an order barring each defendant from serving as an officer or director of other public companies |
| Snyder was the Chief Executive Officer of One Price before his resignation in September 2003 |
| One Price operated a chain of discount retail clothing stores and filed a voluntary bankruptcy petition in February 2004 |
| The SECapstas complaint is a public document and the SEC has issued a press release relating to its allegations which is available on the SECapstas website |
| The Board of Directors of the Company engaged independent counsel to evaluate the case against Mr |
| Snyder and made the determination that it was in the best interest of the Company for Mr |
| Snyder has advised the Board that he denies the SEC allegations |
| This action, if resolved adversely to Mr |
| Snyder, may affect his ability to continue to serve as an officer or director of a public company |
| We may be unsuccessful in locating a permanent Chief Executive Officer and Chief Merchandising Officer |
| Because of our recent operating performance and dependence on two investors for incremental financing for investments in store remodeling, store expansions and major capital improvements, we may have difficulty hiring a permanent Chief Executive Officer and Chief Merchandising Officer |
| If we are unable to fill these positions, we may not be able to achieve improvements in our operating performance |
| If we do fill these positions, we may be required to offer significant consideration to attract qualified personnel |