| JO-ANN STORES INC Item 1A Risk Factors Our business and financial performance is subject to various risks and uncertainties |
| In addition to the factors discussed elsewhere in this Report, the following risks and uncertainties could materially adversely affect our business, prospects, financial condition, and results of operations |
| Other factors not 10 _________________________________________________________________ [53]Table of Contents presently known to us, or that we presently believe are not material, could also affect our business and financial performance |
| Economic Risks Changes in economic conditions could have a material adverse effect on our business, revenue and profitability In general, our sales represent discretionary spending by our customers |
| Discretionary spending is affected by many factors, including, among other things, general business conditions, interest rates, the availability of consumer credit, taxation, weather and consumer confidence in future economic conditions |
| Our customers’ purchases of discretionary items, including our products, could decline during periods when disposable income is lower (for example, as a result of higher energy prices) or during periods of actual or perceived unfavorable economic conditions |
| If this occurs, our revenues and profitability will decline |
| In addition, our sales could be adversely affected by a downturn in the economic conditions in the markets in which we operate |
| A prolonged economic downturn could have a material adverse effect on our business, financial condition, and results of operations |
| If customer interest in fabric and craft products declines, our revenues may decline The success of our business depends on our customers purchasing our fabric and craft products |
| Our products are not necessities and compete with numerous other leisure activities and other forms of entertainment |
| If our customers’ interest in fabric and craft products declines, that decline would result in the reduction of our revenues and have a negative impact on our business and prospects |
| The inability of the Company and our vendors to develop and introduce new products which excite our customers also could adversely affect our operating results |
| In addition, changes in demographic and societal trends could have a material adverse effect on our business and prospects |
| Changes in interest rates could adversely impact profitability We are subject to market risk from exposure to changes in interest rates which affect our financing, investing and cash management activities |
| Changes in interest rates could have a negative impact on our profitability |
| External Business Risks Competition could negatively impact our operations Competition is intense in the retail fabric and craft industry |
| This competition could result in the reduction of our prices and a loss of market share |
| We must remain competitive in the areas of quality, price, selection, customer service and convenience |
| The location and atmosphere of retail stores are additional competitive factors in the retail business |
| Our primary competition is comprised of specialty fabric retailers and specialty craft retailers such as Michaels Stores, Inc, a national chain which operates craft and framing stores, Hobby Lobby, a regional chain which operates craft stores, Hancock Fabrics, Inc, a national chain which operates fabric stores, and AC Moore Arts & Crafts, Inc, a regional chain which operates craft stores in the eastern United States |
| We also compete with mass merchants, including Wal-Mart, that dedicate a portion of their selling space to a limited selection of fabrics, craft supplies and seasonal and holiday merchandise |
| Some of our competitors have stores nationwide, several operate regional chains and numerous others are local merchants |
| Some of our competitors, particularly the mass merchants, are larger and have greater financial resources than we do |
| Our sales are also impacted by store liquidations of our competitors |
| In addition, alternative methods of selling fabrics and crafts, such as over the Internet, could result in additional competitors in the future and increased price competition since our customers could more readily comparison shop |
| Moreover, we ultimately compete against alternative sources of entertainment and leisure activities of our customers that are unrelated to the fabric and crafts industry |
| Given their limited resources and lack of financial flexibility, many of these firms are susceptible to cash flow issues, production difficulties, quality control issues, and problems in delivering agreed-upon quantities on schedule |
| We cannot assure that we would be able, if necessary, to return products to these suppliers and obtain refunds of our purchase price or obtain reimbursement or indemnification from them if their products prove defective |
| These suppliers may be unable to withstand a downturn in economic conditions |
| Significant failures on the part of our key suppliers could have a material adverse effect on our operating results |
| In addition, many of these suppliers require extensive advance notice of our requirements in order to supply products in the quantities we desire |
| This long lead time requires us to place orders far in advance of the time when certain products will be offered for sale, exposing us to shifts in demand |
| Our dependence on foreign suppliers subjects us to possible delays in receipt of merchandise and to the risks involved in foreign operations In fiscal 2006, we purchased approximately one-third of our products directly from manufacturers located in foreign countries |
| A majority of our foreign suppliers are located in Hong Kong, China and Taiwan |
| In addition, many of our domestic suppliers purchase a portion of their products from foreign suppliers |
| Because a large percentage of our products are manufactured or sourced abroad, we are required to order these products further in advance than would be the case if products were manufactured domestically |
| Foreign manufacturing is also subject to a number of other risks, including work stoppages; transportation delays and interruptions; epidemics; political instability; economic disruptions; the imposition of tariffs, duties, quotas, import and export controls and other trade restrictions; changes in governmental policies and other events |
| If any of these events occur, it could result in a material adverse effect on our business, financial condition, results of operations and prospects |
| In addition, reductions in the value of the US dollar or revaluation of the Chinese currency, or other foreign currencies, could ultimately increase the prices that we pay for our products |
| All of our products manufactured overseas and imported into the United States are subject to duties collected by the United States Customs Service |
| We may be subjected to additional duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of import privileges if we or our suppliers are found to be in violation of US laws and regulations applicable to the importation of our products |
| We also depend on letters of credit with respect to imports |
| Our inability to obtain letters of credit could have a material adverse effect on our business |
| Our business depends on shopping center traffic and our ability to identify suitable store locations Our stores generally are located in strip shopping centers and “big box” shopping centers |
| Our sales are dependent in part on a high volume of shopping center traffic |
| Shopping center traffic may be adversely affected by, among other things, economic downturns, the closing of anchor stores, new shopping centers or other retail developments, or changes in customer shopping preferences |
| A decline in the popularity of shopping center shopping among our target customers could have a material adverse effect on customer traffic and reduce our sales and net earnings |
| To take advantage of customer traffic and the shopping preferences of our customers, we need to maintain or acquire stores in desirable locations and competition for suitable store locations is intense |
| We cannot assure that desirable store locations will continue to be available |
| The seasonality of our sales may negatively impact our operating results Our business is seasonal, with a significant amount of sales and earnings occurring in the third and fourth fiscal quarters |
| Our best quarter in terms of sales and profitability historically has been the fourth quarter |
| In addition, excluding the effects of new store openings, our inventories and related short-term financing needs have been seasonal, with the greatest requirements occurring primarily during our third fiscal 12 _________________________________________________________________ [55]Table of Contents quarter as we increase our inventory in preparation for our peak selling season |
| Weak sales during the second half of the year will negatively impact our operating results and cash flow generation |
| Increases in transportation costs due to transportation industry challenges and rising fuel costs may negatively impact our operating results We rely upon various means of transportation, including shipments by air, sea and truck, to deliver products to our distribution centers from vendors and from our distribution centers to our stores |
| Labor shortages in the transportation industry could negatively affect transportation costs and our ability to supply our stores in a timely manner |
| In addition, long-term disruptions to the national and international transportation infrastructure that lead to delays or interruptions of service could adversely affect our business |
| In particular, our business is highly dependent on the trucking industry to deliver products to our distribution centers and our stores |
| Our operating results may be adversely affected if we are unable to secure adequate trucking resources to fulfill our delivery schedules to the stores, particularly as we deliver our fall and Christmas seasonal merchandise |
| The price of oil has risen significantly in the last year |
| This increase and any future increases may result in an increase in our transportation costs for distribution to our stores, as well as our vendors’ transportation costs, which could decrease our operating profits |
| Our business could be negatively impacted by changes in the labor market and our cost of doing business could increase as a result of changes in federal, state or local regulation Our performance is dependent on attracting and retaining a large and growing number of quality associates |
| Many of those associates are in entry level or part-time positions with historically high rates of turnover |
| Our ability to meet labor needs while controlling our costs is subject to external factors such as unemployment levels, prevailing wage rates, minimum wage legislation, workers compensation costs and changing demographics |
| Changes that adversely impact our ability to attract and retain quality associates could adversely affect our performance |
| Unanticipated changes in the federal or state minimum wage or living wage requirements or changes in other wage or workplace regulations, including, for example, health care mandate regulations, could adversely affect our financial condition and operating results |
| Operational Business Risks The loss of key executives and failure to attract qualified management could limit our growth and negatively impact our operations Our future success depends in large part on our ability to recruit and retain our senior management team |
| During fiscal 2006, we had significant turnover in our executive management personnel |
| Our chief financial officer, general counsel, executive vice president — merchandising and marketing, and our executive vice president — human resources all left the Company |
| In addition, we have commenced a search for a new chief executive officer and announced that our current chief executive officer will resign as a Company employee upon the selection of his successor |
| Searches also currently are underway for a new chief financial officer and a new head merchant, but it is unlikely that these positions will be filled until the new chief executive officer is selected |
| We named a replacement for our general counsel in November 2005 |
| Our inability to promptly recruit and retain highly qualified individuals to fill the open executive positions could materially adversely impact the management and operation of our business, which would impact our financial condition and results of operations |
| In addition, our continued success depends upon our ability to attract and retain qualified management, administrative and store personnel to support our future growth |
| Our inability to do so may have a material adverse effect on our business and prospects |
| Our Repair Plan strategy execution may disrupt our business |
| In addition, the strategy may not be successful Beginning in the fourth quarter of fiscal 2006, we undertook a series of related initiatives (the “Repair Plan”) to make fundamental improvements in our business, profitability and cash flows |
| The Repair Plan 13 _________________________________________________________________ [56]Table of Contents strategy contains four major components: inventory reduction, adjustment of store merchandise assortments, gross margin rate restoration, and expense reduction |
| See “Recent Developments and Business Update” contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below for further discussion |
| This Repair Plan strategy may lead to disruptions in our business |
| These disruptions could adversely affect our business operations and our financial performance |
| While we believe any disruptions would be short-term, we cannot assure that the impact (whether short-term or long-term) from these disruptions would not be material |
| In addition, if our Repair Plan strategy is not successful, or if we do not execute the strategy effectively, our business operations and financial performance could be adversely affected |
| Failure to manage inventory effectively will negatively impact sales and earnings We strive to ensure the merchandise we offer remains fresh and compelling to our customers |
| However, due to the nature of our business, we purchase much of our inventory well in advance of each selling season |
| If we are not successful at predicting our sales trends and misjudge consumer preferences or demands, we will experience lower sales than expected and will have excess inventory that may need to be held for a long period of time, written down or sold at prices lower than expected in order to clear excess inventory at the end of a selling season |
| These actions would reduce our operating performance |
| Conversely, if we underestimate consumer demand, we may not be able to provide products to our customers to meet their demand |
| Shortages of key items could also have a material adverse impact on our business, financial condition and results of operations |
| In addition, inventory shrink (inventory theft or loss) rates can significantly impact our business performance and financial results |
| We devote substantial efforts to minimize inventory shrink |
| Failure to manage inventory shrink rates could materially adversely affect our business, financial condition and results of operations |
| Failure to adequately maintain our perpetual inventory and automated replenishment systems We currently operate perpetual inventory, automated replenishment, and weighted average cost inventory systems |
| We believe these are necessary to adequately forecast, manage, and analyze our inventory levels, monitor our gross margin, and manage merchandise ordering quantities |
| If we fail to adequately support and maintain these systems, it could have a material adverse impact on our financial condition and results of operations |
| Inability to provide new and improved product selection Our products appeal to a broad range of consumers whose preferences cannot be predicted with certainty and are subject to rapid change |
| Our success depends, in large part, upon our ability to anticipate, identify and respond to changing product trends and consumer demand in a timely manner |
| The retailing industry fluctuates according to changing tastes and seasons, and merchandise usually must be ordered well in advance, frequently before consumer tastes are evidenced by consumer purchases |
| In addition, in order to ensure sufficient quantities and selection of products, we are required to maintain substantial levels of inventory, especially prior to peak selling seasons when we build up our inventory |
| We cannot assure that we will be able to continue to offer an assortment of products that will appeal to our customers or that will satisfy consumer demands in the future |
| The failure to continue to identify and stock our stores with appealing products could result in reduced sales and thus have a material adverse effect on our business and financial performance |
| Failure to grow sales may impact operations Our comparable same-store sales have fluctuated significantly in the past, on both an annual and a quarterly basis, and we expect them to continue to fluctuate in the future |
| A variety of factors affect our same-store sales results, including, among other things, fashion trends, the highly competitive retail store sales environment, new competing stores (ours or competitors in proximity to existing stores), economic 14 _________________________________________________________________ [57]Table of Contents conditions, timing and effectiveness of promotional events, changes in our merchandise mix, calendar shifts and weather conditions |
| Annual revenue growth is driven by the opening of new stores and increased same-store sales |
| We cannot provide assurance that we can continue to open stores or increase same-store sales |
| Our failure to manage our new store growth, and overall store transition strategy, would have a negative impact on our operations Our growth is dependent, in large part, upon our ability to successfully add new stores and close smaller traditional store locations |
| Our superstores accounted for 41 percent of our total fiscal 2006 net sales |
| Our growth strategy contemplates the development of additional superstores and an increasing percentage of our revenues coming from our superstores |
| The success of this strategy will depend upon a number of factors, summarized as follows: Store specific risks • our ability to saturate existing markets and penetrate new markets; • the availability of desirable locations and the negotiation of acceptable leases for these sites; • the availability of management resources in a particular area; • the timely construction, fixturing, merchandising, and hiring and training of store personnel; • the closure of unsuccessful stores may result in the retention of liability for expensive leases; General risks • our ability to generate sufficient cash flow from operations; • the availability of working capital; • our ability to obtain financing; • the expansion of our logistics systems to support new stores; • the maintenance or upgrade of our information processing systems and the integration of those systems at new stores; • a significant portion of our management’s time and energy may be consumed with issues unrelated to advancing our core business strategy, which could result in a deterioration of our operating results; • our suppliers may be unable to meet the increased demand of additional stores in a timely manner; • the inability to expand our existing distribution centers or use third-party distribution centers on a cost-effective basis to provide merchandise for sale by our new stores, and; • general economic conditions and specific retail economic conditions |
| Our failure to open new stores on a timely basis, obtain acceptance in markets in which we currently have limited or no presence, attract qualified management and personnel or appropriately adjust operational systems and procedures would have an adverse effect on our growth and profitability prospects |
| There can be no assurance that we will be able to successfully implement our store transition strategy |
| Not all of our superstores are producing acceptable levels of sales and operating profit |
| If our superstore strategy is not successful, this will negatively impact our effort to diversify into the crafts business and affect our sales growth and profitability capabilities |
| The loss of, or disruption in, or our inability to efficiently operate our distribution network could have a negative impact on our business We operate three distribution centers to support our business |
| If complications arise with any one facility or any facility is severely damaged or destroyed, the other distribution centers may not be able to 15 _________________________________________________________________ [58]Table of Contents support the resulting additional distribution demands |
| This may adversely affect our ability to receive and deliver inventory on a timely basis |
| The majority of our inventory is shipped directly from suppliers to our distribution centers where the inventory is then processed, sorted, picked, and shipped to our stores |
| We rely in large part on the orderly operation of this receiving and distribution process, which depends on adherence to shipping schedules and effective management of our distribution network |
| Although we believe that our receiving and distribution process is efficient and well positioned to support our expansion plans, we cannot assure that we have anticipated all issues or that events beyond our control, such as disruptions in operations due to fire or other catastrophic events, labor disagreements or shipping problems, will not result in delays in the delivery of merchandise to our stores |
| Moreover, our third distribution center, located in Opelika, Alabama recently started up operations |
| If we encounter significant start up problems at this center, such problems could have a material adverse effect on our business operations and financial performance |
| The efficient operation of our business is dependent on our information systems |
| Our failure to maintain and upgrade our management information systems could compromise our competitive position We depend on a variety of information systems for the efficient functioning of our business |
| In particular, we rely on our information systems to effectively process transactions, manage inventory, purchase, sell and ship goods on a timely basis and maintain cost-efficient operations |
| The failure of our information systems to perform as designed could disrupt our business and harm sales and profitability |
| 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 “hackers” or other causes |
| We cannot assure that our systems will be adequate to support future growth |
| In addition, costs and potential problems and interruptions associated with the implementation of new or upgraded systems and technology or with maintenance or adequate support of existing systems could also disrupt or reduce the efficiency of our operations |
| We also rely heavily on our information technology staff |
| If we cannot meet our staffing needs in this area, we may not be able to fulfill our technology or business initiatives while continuing to provide maintenance on existing systems |
| Excessive technological change affects the effectiveness of the adoption of, and could adversely affect the realization of business benefits from, technology |
| Conversely, not implementing sufficient technological changes could also compromise the operation of our business |
| Our existing indebtedness could restrict our operations, making us more vulnerable to adverse economic conditions We have and will continue to have a significant amount of debt |
| Our existing level of indebtedness could have negative consequences |
| For example, it could: • make it more difficult for us to satisfy our obligations; • reduce the availability of our cash flow from operations to fund working capital, capital expenditures, acquisitions and other general corporate requirements because we will have to dedicate a significant portion of our cash flow from operations to payments of our indebtedness; • limit our ability to borrow funds to pay for future working capital, capital expenditures, acquisitions and other general corporate requirements; • limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; • place us at a disadvantage compared to our competitors that have less debt; and • make us more vulnerable to negative changes in economic and industry conditions |
| 16 _________________________________________________________________ [59]Table of Contents Our ability to make payments on our indebtedness depends upon our ability to generate cash flow in the future |
| Our ability to generate that cash flow depends upon, among other things, our future operating performance and our ability to refinance indebtedness when necessary |
| To some extent, each of these factors depends upon economic, financial, competitive and other factors beyond our control |
| If we cannot generate enough cash from operations to make payments on our indebtedness, we will need to refinance our indebtedness, obtain additional financing, or sell assets |
| We do not anticipate any issues in generating sufficient cash flow, but we cannot assure that this will be the case, nor can we assure that we will be able to obtain acceptable financing to satisfy our debt obligations |
| We may not be able to finance future needs or adapt our business plan to changes because of restrictions placed on us by our senior bank credit facility and indenture The indenture governing our senior subordinated notes and our senior bank credit facility contain restrictive and financial covenants, which limit our ability to borrow money, make investments, redeem or make payments on our capital stock, incur liens and take other actions |
| We currently are in compliance with all of these covenants and do not foresee any issues in continuing to comply with these covenants |
| However, our ability to remain in compliance with these covenants and tests may be affected by unanticipated events or events beyond our control |
| If we fail to meet these tests or breach any of the covenants, the lenders under the senior bank credit facility or the holders of the notes could declare all amounts outstanding under their indebtedness, including accrued interest, to be immediately due and payable |
| A declaration of acceleration under the senior bank credit facility would constitute a default under the indenture, and a default under the indenture would constitute a default under the senior bank credit facility |
| We believe that we have sufficient credit availability to finance our operations and capital needs; however, we cannot assure that the operating and financial restrictions in our credit facilities will not adversely affect and limit or prohibit our ability to finance future acquisitions, or longer term capital needs |
| We could incur more debt Our management currently believes that the cash generated by operations, together with the borrowing availability under the senior bank credit facility, will be sufficient to meet our working capital needs during fiscal 2007 |
| However, if we are unable to generate sufficient cash from operations, we may be required to adopt one or more alternatives to raise cash, such as incurring additional indebtedness, selling assets, raising additional debt or equity capital or restructuring |
| If adequate financing is unavailable or is unavailable on acceptable terms, we may be unable to maintain, develop or enhance our operations, including the opening of new stores, or the introduction of new products and services, to take advantage of future opportunities or respond to competitive pressures |
| Failure to adequately maintain the security of our electronic and other confidential information could materially adversely affect our financial condition and results of operations We are dependent upon automated information technology processes |
| Any failure to maintain the security of our data and our employees’ and customers’ confidential information, including via the penetration of our network security and the misappropriation of confidential information, could put us at a competitive disadvantage, result in deterioration in our employees’ and customers’ confidence in us, and thus have a material adverse impact on our business, financial condition and results of operations |
| Failure to comply with various regulations may result in damage to our business Our policies and procedures are designed to comply with all applicable laws and regulations, including those imposed by the SEC and NYSE With recent high profile business failures on accounting-related issues, additional legal and regulatory requirements such as the Sarbanes-Oxley Act have increased the complexity of the regulatory environment |
| Also, various aspects of our operations are subject to federal, state, local and foreign laws, rules and regulations, any of which may change from time to time |
| Additionally, we are regularly 17 _________________________________________________________________ [60]Table of Contents involved in various litigation matters that arise in the ordinary course of our business, including liability claims and allegations that we have infringed on third-party intellectual property rights |
| Litigation or regulatory developments could adversely affect our business operations and financial performance |
| Also, failure to comply with the various regulations may result in damage to our reputation, civil and criminal liability, fines and penalties, increased cost of regulatory compliance, and restatements of financial statements |
| Other Factors The foregoing list of risk factors is not all inclusive |
| Other factors and unanticipated events could adversely affect our business |
| We do not undertake to revise or update these risks to reflect events or circumstances that occur after the date of this report |