Key Risk Factors
Key risk factors related to the Company
We are subject to inventory management risks, changes in weather, changes in customer preferences and fashion trends.
We are subject to various risks related to inventory replenishment and optimization. For example, we are subject to risks related to seasonality, launching new products, rapid changes in product cycles and prices, defective goods, changes in consumer demand and spending patterns, amongst other factors. Demand for our products may change significantly between the time of purchase from our suppliers and sale to our retail customers, which may reduce our ability to sell our products held in inventory. Collection set-up is one of our main strategic differentials in relation to the market and, therefore, the appeal of brands owned by third-parties, product selection, fabric quality and climate changes are considered as strategic risks for us during our collection building process.
We are unable to guarantee that we will correctly select new products to be manufactured or imported or that our initial estimate of the demand for any given product will be maintained or accurate. Certain products that we purchase may require longer delivery times and our suppliers may not accept returns or exchanges of these products. Lastly, we may be unable to sell our products in sufficient quantities or during peak selling seasons, which would cause inefficiency in our inventory volume. The occurrence of any of the above factors may adversely affect our results of operations.
One of the risks related to the management of inventory is weather conditions. Prolonged periods of higher temperatures during the winter or lower temperatures during the summer may leave a part of our inventory incompatible with such unexpected weather conditions. In this way, periods of altered climate can compel us to sell the excess of our inventories at discounted prices, thus reducing our margins, which may materially adversely affect us. This may be more significant in cases of winter collections, which have higher average prices.
Another risk to inventory management is seasonality. Our sales are typically disproportionately higher in the fourth quarter of each year due to increased sales during Christmas and Black Friday seasons, and we expect this seasonality to continue in the future. For the year ended in December 31, 2018, 33.5% of our net revenue was generated in the fourth quarter. As a result, any economic downturn, disruption to our business or our suppliers or other circumstances affecting our business in the last quarter of any year would have a disproportionate negative effect on our financial condition and results of operations.
In addition, in order to prepare for seasonal sales, we must purchase and hold a considerably larger quantity of items in our inventory than we hold during other times of the year and hire temporary staff for our brick-and-mortar stores. Any unplanned decrease or misappropriation of demand for our products during this peak shopping season, or even in the number of temporary employees contracted, may compel us to sell the surplus inventory at a substantially lower price, which would adversely affect our results of operations and financial condition. Such fluctuations in our results of operations and financial condition may affect the market value of our common shares.
With regards to fashion trends and our customers’ preferences, we compete with several other apparel companies on the basis of price, quality, brand availability, customer service, promotions, store location and layout. We believe that the sale of differentiated products and customer satisfaction are among the most challenging goals of our business. Our products must appeal to a customer base whose preferences cannot be predicted precisely and are subject to rapid change.
We are exposed to risks related to customer financing and lending through our partnership.
We have an exclusive partnership agreement with Banco Bradescard S.A. to offer our clients financial services, including credit cards and personal loans. Our partnership is responsible for financing approximately 22% of our sales, including installment payments. The financing policies and definitions of financial services offered to our customers are set by our partner, who may impose rules that restrict lending to our customers, adversely affecting our business and expansion strategy.
If economic conditions in Brazil further deteriorate due to, among other factors, economic slowdown, Real devaluation, inflation, rising interest rates or rising unemployment rates a higher percentage of our customers who are more sensitive to such factors may default, increasing our losses and provisions for doubtful accounts, which would cause our partner to restrict lending to our customers. In addition, our operating results and financial condition may be adversely affected if consumer credit demand declines and the Brazilian government implements restrictive consumer credit policies.
Failure to properly handle credit card fraud can result in significant losses, damage our reputation and brand, which may adversely affect us. If our relationship with our partner terminates early, we may be subject to contractual fines and penalties, and our net revenue from financial services may be adversely affected.
We may face difficulties in opening new stores and/or operating our existing stores, which could adversely affect our sales and results of operations.
Our growth depends on our ability to successfully open new stores and/or continue operating our existing stores, which are subject to various risks and uncertainties, many of which are beyond our control, including, but not limited to, the availability of desirable locations for stores and the availability and accuracy of demographic and market data as well as our ability to determine demand for our products, satisfy the fashion preferences of our customers, obtain the necessary governmental licenses and permits, negotiate lease agreements on reasonable terms, efficiently build and equip new stores, source sufficient levels of inventory to meet the needs of our stores, successfully integrate new stores into our existing systems and operations, keep pace with new and existing competitors, identify strategic points of sales, complete construction projects and remodeling of the stores, our ability to attract, hire, train and retain qualified personnel and manage our expansion process.
Potential openings of new stores in Brazilian states may result in competition, marketing and distribution challenges; also, when new store openings take place in markets where we already have stores, we may experience a reduction in the net revenue of pre-existing stores in these markets due to sales dislocation, which may adversely affect us.
Potential expansion, building and remodeling of new and existing stores, as the case may be, may deteriorate our net income margins until such investments reach maturity and, as a result, we may not be able to maintain the same net revenue growth and profit per square meter, which may adversely affect our business, sales and results of operations.
We are highly dependent on information technology systems to operate our business.
We are highly dependent on the functionality, availability, integrity and operational stability of data centers and various systems (our own or those provided by third parties), including points-of-sales in stores, credit, logistics and communications systems and various other software programs used to control inventory and generate commercial and financial performance reports. In addition, our e-commerce platform (website and app) is an important channel to introduce our business, identity and brands to our consumers, and a source of interaction and information for consumers of our products. We rely on information technology systems to process, transmit and store electronic data, as well as to communicate with customers and suppliers, and we may suffer interruptions due to factors beyond our control, such as natural disasters, hacker attacks, telecommunication failures, computer viruses and malicious software, among other factors. In the event of failures, disruptions or breaches, we may lose data or be unable to conduct business transactions, which may impact our net revenue, adversely affect the availability and accuracy of our transaction processing and financial accounting reports, and materially adversely affect us.
To achieve our growth strategy, we may need to continually improve our operating and financial systems, transaction processing, procedures and controls, leading to additional expenses or integration issues, which could adversely affect our results of operations.
Information technology systems are subject to constant upgrades and if we are not able to properly upgrade them, our operations may be harmed, which may adversely affect us
Acquisitions and investments in new companies and businesses, as well as the failure of an acquisition or investment to produce the anticipated results or the inability to fully integrate an acquired company may adversely affect our business.
We may from time to time acquire or invest in companies or businesses. The success of such acquisitions or investments is based on our ability to make accurate assumptions regarding the valuation, operations, growth potential, integration and other factors related to the respective business. We are unable to guarantee that our acquisitions or investments will produce the results that we expect at the time we enter into agreements or that we will complete a given transaction. Furthermore, new acquisitions may result in difficulties in the integration of acquired companies and may result in the diversion of our capital and our management’s attention from other business opportunities. We may not be able to successfully integrate operations that we acquire, including their personnel, financial systems, distribution or operating procedures, which may adversely affect our business. The integration of any acquired business and their financial results may adversely affect our operating results.