10-K 1 hsni-123113x10k.htm 10-K HSNI-12.31.13- 10K



 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________________________________________________________________________________________
FORM 10-K
 ______________________________________________________________________________________________
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2013
Commission File No. 001-34061
________________________________________________________________________________________________ 
HSN, INC.
(Exact name of registrant as specified in its charter)
________________________________________________________________________________________________ 
Delaware
  
26-2590893
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
1 HSN Drive, St. Petersburg, Florida
33729
(Address of principal executive offices)
(Zip Code)
(727) 872-1000
(Registrant’s telephone number, including area code)
________________________________________________________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of exchange on which registered
Common Stock, par value $0.01
 
Series A Junior Participating
Preferred Stock Purchase Rights
 
NASDAQ Global Select Market

NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act: None
________________________________________________________________________________________________
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes x    No  ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     Yes ¨    No  x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, an Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registration was required to submit and post such files).   Yes x    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company as defined in Rule 12b-2 of the Exchange Act.
 
 
Large accelerated filer
 
x
 
Accelerated filer
 
¨
 
 
Non-accelerated filer
 
¨
 
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ¨    No  x
The aggregate market value of the registrant’s outstanding common stock held by non-affiliates as of June 30, 2013 (the registrant’s most recently completed second fiscal quarter), was $1,759,570,690 (based on a closing price of $53.72 per share for the registrant’s common stock on the NASDAQ Global Select Market).
As of February 18, 2014, the registrant had 53,122,005 shares of common stock, $0.01 par value per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 2014 Annual Meeting of Shareholders to be filed with the U.S. Securities and Exchange Commission no later than 120 days after the end of the registrant’s 2013 fiscal year end are incorporated by reference into Items 10, 11, 12, 13 and 14 of Part III of this Form 10-K.
 




TABLE OF CONTENTS
 
 
 
 
 
 
Page
 
PART I
 
 
 
 
ITEM 1.
ITEM 1A.
ITEM 1B.
ITEM 2.
ITEM 3.
ITEM 4.
 
 
 
 
PART II
 
 
 
 
ITEM 5.
ITEM 6.
ITEM 7.
ITEM 7A.
ITEM 8.
ITEM 9.
ITEM 9A.
ITEM 9B.
 
 
 
 
PART III
 
 
 
 
ITEM 10.
ITEM 11.
ITEM 12.
ITEM 13.
ITEM 14.
 
 
 
 
PART IV
 
 
 
 
ITEM 15.






FORWARD-LOOKING STATEMENTS
This annual report on Form 10-K contains certain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), which are based on management’s exercise of business judgment, as well as assumptions made by and information currently available to management. When used in this document, the words “may,” “will,” “anticipate,” “believe,” “estimate,” “expect,” “intend” and words of similar import, are intended to identify any forward-looking statements. These forward-looking statements include, among other things, statements relating to the following: HSNi’s future financial performance, HSNi’s business prospects and strategy, anticipated trends and prospects in the various markets in which HSNi’s businesses operate and other similar matters. These forward-looking statements relate to expectations concerning matters that are not historical fact and are based on management’s current expectations and assumptions about future events, which are inherently subject to uncertainties, risks and changes in circumstances that are difficult to predict. Although we believe our expectations are based on reasonable estimates and assumptions, they are not guarantees of performance.
Should one or more of these uncertainties, risks or changes in circumstances materialize, or should underlying assumptions prove incorrect, our actual results could differ materially from those anticipated in these forward-looking statements. Factors that could cause or contribute to such differences include but are not limited to those described under “Risk Factors,” and the following:
the influence of the macroeconomic environment and its impact on consumer confidence and spending levels;
changes in our relationships with pay television operators, vendors, manufacturers and other third parties;
changes in product shipping promotions or delivery costs particularly if we are unable to offset them;
any technological or regulatory developments that could negatively impact the way we do business, including developments requiring us to collect and remit state and local sales and use taxes;
risks associated with possible systems failures and/or security breaches, including, any security breach that results in the theft, transfer or unauthorized disclosure of customer, employee or company information, or the failure to comply with various laws applicable to HSNi in the event of such a breach;
HSNi’s business prospects and strategy, including whether HSNi’s initiatives will be effective; and
our ability to offer new or alternative products and services through various platforms in a cost effective manner and consumer acceptance of these products and services;
risks associated with acquisitions including the ability to successfully integrate new businesses and achieve expected benefits and results;
the loss of any key member of our senior management team.
Other unknown or unpredictable factors that could also adversely affect HSNi’s business, financial condition and results of operations may arise from time to time.
You should not place undue reliance on these forward-looking statements. All written or oral forward-looking statements that are made or are attributable to us are expressly qualified in their entirety by this cautionary notice. Such forward-looking statements speak only to the date such statements are made and we do not undertake to update, revise or otherwise publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof, or to reflect the occurrence of any unanticipated events. Although we believe that our expectations are based on reasonable assumptions, we can give no assurance that our expectations will materialize. Historical results should not be considered an indication of future performance.

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PART I
ITEM 1.
BUSINESS
Unless otherwise indicated in this Annual Report or the context otherwise requires, all references in this Annual Report to “HSNi,” the “Company,” “us,” “our” or “we” are to HSN, Inc. and/or its subsidiaries and affiliates.
Business Overview
HSNi is an interactive multi-channel retailer offering customers innovative and differentiated experiences through various platforms including television, online, mobile, catalogs and in retail and outlet stores through the eight brands of its two operating segments, HSN and Cornerstone.
HSN is an interactive entertainment and lifestyle retailer offering a curated assortment of exclusive products and top brand names to its customers primarily through television home shopping programming on the HSN television networks, through its business-to-consumer digital commerce site HSN.com, through mobile applications and through its outlet stores. HSN incorporates entertainment, inspiration and personalities to provide an entirely unique shopping experience.
Cornerstone is comprised of interactive, aspirational home and apparel lifestyle brands, including Ballard Designs, Chasing Fireflies, Frontgate, Garnet Hill, Grandin Road, Improvements and TravelSmith. Cornerstone operates eight separate e-commerce sites, distributes approximately 320 million catalogs annually and operates 10 retail and outlet stores. For financial information about our operating segments, please refer to Note 6 to our audited consolidated financial statements, as well as to Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations," each of which are included elsewhere in this document.
Our principal offices are located at 1 HSN Drive, St. Petersburg, Florida 33729 and our main telephone number is 727-872-1000. Our website is located at http://www.hsni.com.
History
HSNi’s predecessor company began broadcasting television home shopping programming from its studios in St. Petersburg, Florida in 1981 and, by 1985, was broadcasting this programming through a national network of cable and local television stations 24 hours a day, seven days a week. The company continued to broaden its national distribution network through a combination of cable, satellite and broadcast systems and, as of December 31, 2013, the HSN television networks reached approximately 95.0 million residential homes in the United States.
The company began conducting business online in 1994 and formally launched HSN.com, the online shopping portal for the HSN television network, in 1999.
The company acquired Improvements, a catalog featuring thousands of innovative home, patio and outdoor products, in June 2001, and significantly grew its catalog business through the acquisition of Cornerstone Brands, Inc., with its portfolio of leading print catalogs and related websites, in April 2005.
HSNi was incorporated in Delaware in May 2008 in connection with the spin-off of several businesses previously owned by IAC/InterActiveCorp, or IAC. HSNi was formed to hold HSN and Cornerstone, the businesses that previously comprised most of IAC’s retailing segment. The spin-off from IAC (the "Spin-off") occurred on August 20, 2008 and, in connection with the Spin-off, HSNi's shares began trading on the NASDAQ Global Select Market under the symbol "HSNI."
In early 2012, the Company initiated efforts to strengthen its portfolio of aspirational home and apparel lifestyle catalog brands. This resulted in the acquisition of Chasing Fireflies, LLC, a leading direct-to-consumer premium children's and family's lifestyle brand, in April 2012. This was followed by the divestitures of Smith+Noble, a brand specializing in window treatments, in May 2012 and The Territory Ahead, a brand specializing in casual apparel for men and women, in July 2012.
What We Do
HSNi markets and sells a wide range of third party and proprietary private label merchandise directly to consumers through HSN, which includes the HSN television networks and digital platforms, including mobile, as well as through Cornerstone’s portfolio of catalogs and digital platforms, including mobile.


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HSNi is committed to providing customers with an evolving variety of quality products at reasonable prices and from brands that resonate with its customers. Products offered through HSN include jewelry, fashion (apparel & accessories), beauty & health, and home & other (including household, home design, electronics, culinary and other). Featured products include proprietary label products and third party-branded products, some of which are produced exclusively for HSN, as well as merchandise generally available through other retailers. Cornerstone primarily offers home and outdoor furnishings, in addition to women and children's apparel with the majority produced exclusively for its Cornerstone brands.
HSN
Overview
HSN includes the HSN television networks; its related website, HSN.com; its mobile applications and a limited number of outlet stores. The HSN television network broadcasts live, customer interactive home shopping programming 24 hours a day, seven days a week. HSN2, which debuted in August 2010, is a network that primarily distributes taped programming on a limited distribution basis. HSN’s programming is intended to promote sales and customer loyalty through a combination of product quality, value and selection, coupled with product information, entertainment and interactive experiences. Programming is divided into separately televised segments, most of which have hosts who present and convey information regarding featured products, sometimes with the assistance of a celebrity, industry expert, representative from the product vendor or someone retained to aid in the sale of the products. HSN also produces entertainment such as live concerts to entertain and engage with customers and promote certain products. HSN.com is a business-to-consumer digital commerce site that sells all of the merchandise offered on the HSN television networks, together with complementary products and select merchandise sold exclusively on HSN.com. HSN provides seamless experiences across all digital platforms and optimizes each unique platform by delivering exclusive content both at HSN.com and on mobile phones and tablets, including the iPad, iPhone and Android and Windows devices. The HSN strategy is to create immersive experiences, offer differentiated products and leverage technology to build seamless relationships with its customers across all of its platforms. HSN fosters social communities as part of the HSN experience to encourage customers to share their product finds, thoughts and reviews with their friends via Facebook, Twitter, Pinterest and Instagram.
Reach
HSN produces live programming for the HSN television network primarily from its studios in St. Petersburg, Florida, and distributes this programming by means of satellite uplink facilities, which it owns and operates, to two transponders (one for the HSN high definition feed along with HSN2 and the other for the HSN standard definition feed) on the same satellite. The satellite transponders are leased on a full-time basis; one satellite transponder is leased through January 2015 and the other is leased through May 2019. Each satellite transponder lease provides for continued carriage of the HSN television networks on a replacement transponder and/or replacement satellite, as applicable, in the event of a failure of the transponder and/or satellite. HSN has also designed business continuity and disaster recovery plans intended to ensure its continued satellite transmission capability on a temporary basis in the event of inclement weather or a natural or other disaster.

As of December 31, 2013 and 2012, the HSN television networks reached approximately 95.0 million homes of the approximately 115.6 million and 114.2 million homes, respectively, in the United States with a television set. Television households reached by the HSN television networks as of December 31, 2013 and 2012 primarily include approximately 64.1 million and 64.0 million households capable of receiving cable and/or telephone company ("Telco") transmissions, respectively, and approximately 30.9 million and 31.0 million direct broadcast satellite system, or DBS, households, respectively.

Pay Television Distribution

HSN has entered into multi-year distribution and affiliation agreements with cable television, Telco and DBS operators, collectively referred to in this document as pay television operators, in the United States to carry the HSN television networks, as well as to promote the networks by carrying related commercials and distributing related marketing materials to their respective subscriber bases. HSN currently has contracts with many local and national pay television operators to distribute HSN television programming.

HSN’s larger pay television operators include Comcast, DirecTV, Echostar/DISH and Time Warner Cable.

In exchange for this carriage and related promotional and other efforts, HSN generally pays these pay television operators a fee consisting of commissions based on a percentage of the net merchandise sales to their subscriber bases and/or a per subscriber fee. In some cases, pay television operators receive additional compensation in the form of commission guarantees in exchange for their commitments to deliver a specified number of subscribers, channel placement incentives and advertising insertion time on the HSN television network.

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HSN typically negotiates multi-year agreements that require HSN to pay monthly or annual fees. Distribution and affiliation agreements with pay television operators expire from time to time and renewal and negotiation processes may be lengthy. At any given time in the ordinary course of business HSN is likely to be engaged in renewal and/or negotiation processes with one or more pay television operators. In some cases, renewals are not agreed upon prior to the expiration of a given agreement and the HSN television network continues to be carried by the relevant pay television operator without an effective affiliation agreement in place or via month-to-month contracts. HSN expects that any extension of agreements that have expired will be on terms that, when taken as a whole, are commercially reasonable to HSN and competitive with the economics of other pay television operators.
Broadcast Television Distribution
As of December 31, 2013, HSN also had affiliation agreements with 86 broadcast television stations for leased carriage of the HSN television network with terms ranging from several weeks to several years. In exchange for this carriage, HSN pays the broadcast television stations hourly or monthly fixed rates or commissions based on a percentage of the net merchandise sales to their viewership bases. HSNi’s subsidiary, Ventana Television, Inc. also owns 26 broadcast television stations that carry the HSN television networks on a full-time basis.
HSN.com
HSN also includes HSN.com, a transactional e-commerce site that sells merchandise offered on the HSN television networks, as well as select merchandise sold exclusively on HSN.com. HSN.com provides customers with additional content to support and enhance HSN television programming. For example, HSN.com provides users with an online program guide, value-added video of product demonstrations, live streaming video of the HSN television network, customer-generated product reviews and additional information about HSN show hosts and guest personalities. HSN.com offers customers a content-rich experience that houses more than 50,000 product and how-to videos.
Digital Distribution
HSN has applications for the iPhone, iPad and Android and Windows devices. These applications are highly video-centric, customized experiences that allow users to order merchandise, stream live video from HSN and watch previously-aired content from the network’s video library while simultaneously browsing related products. Among other things, these applications also allow customers to create their own personalized channels, select their favorite brands or categories of merchandise and compile videos focused on these preferences. Mobile devices represent our fastest growing sales channel.

Cornerstone

Cornerstone consists of a portfolio of aspirational home and apparel brands, prominent in the direct marketing and retail space, including catalog distribution and related websites. Although there is some overlap in the product offerings, the home brands are comprised of Frontgate, Ballard Designs, Grandin Road and Improvements. The apparel brands are comprised of Garnet Hill, TravelSmith and Chasing Fireflies. There are also 10 retail and outlet stores located throughout the United States.

Frontgate features premium, high quality, luxury bed, bath, kitchen, outdoor, patio, garden and pool furnishings and accessories. Ballard Designs features European‑inspired bed, bath, dining and office furnishings and accessories, as well as rugs, shelving and architectural accents for the home. Grandin Road offers an affordable style assortment of products ranging from occasional furniture, accessories, holiday décor and outdoor furniture and Improvements features thousands of innovative home, patio and outdoor products.
Garnet Hill offers apparel and accessories for women and children as well as bed and bath furnishings and soft goods. TravelSmith offers travel wear for men and women and related accessories. Chasing Fireflies is a leading children's and family lifestyle brand offering keepsake-quality apparel, gifts and accessories.
The Cornerstone brands generally incorporate on-site photography and real-life settings, coupled with related editorial content describing the merchandise and depicting situations in which it may be used. Branded catalogs are designed and produced in-house, which enables each individual brand to control the production process and reduces the amount of lead time required to produce a given catalog.

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New editions of full-color catalogs are mailed to customers several times each year, with a total annual circulation in 2013 of approximately 320 million catalogs. The timing and frequency of catalog circulation varies by brand and depends upon a number of factors, including the timing of the introduction of new products, marketing campaigns and promotions and inventory levels, among other factors.
Cornerstone also operates websites for each of its featured brands, such as Frontgate.com, BallardDesigns.com, Chasing-Fireflies.com, GarnetHill.com, GrandinRoad.com, TravelSmith.com, Improvementscatalog.com and Wish-Works.com. These websites serve as additional storefronts for products featured in related print catalogs, as well as provide customers with additional content and product assortments to support and enhance their shopping experience. Additional content provided by these websites, which differs across the various websites, includes decorating tips, measuring information, online design centers, gift registries and travel centers, as well as a feature that allows customers to browse the related catalog online. In addition, a growing number of customers use mobile devices to shop the Cornerstone brands.
Supply
HSN and Cornerstone purchase products by way of short- and long-term contracts and purchase orders, including products made to their respective specifications, as well as name brand merchandise and lines from third party partners, typically with certain exclusive rights. The terms of these contracts and purchase orders vary depending upon the underlying products, the retail channel in which the products will ultimately be sold and the method of sale. In some cases, these contracts provide for the payment of additional amounts to partners in the form of commissions, the amount of which is based upon the achievement of agreed upon sales targets, among other milestones. In addition, in the case of some purchases, HSNi may have certain return, extended payment and/or termination rights. The mix and source of products generally depends upon a variety of factors, including price and availability, and HSNi manages inventory levels through periodic, ongoing analyses of anticipated and current sales. No single vendor accounted for more than 10% of HSNi’s consolidated net sales in 2013, 2012 or 2011.
Marketing and Merchandising
HSNi offers our customers a broad assortment of differentiated products in a compelling, informative and entertaining format that will inspire them to regularly engage and shop with us. For example, HSN frequently collaborates with experts from a variety of fields to present special events on the HSN television network featuring HSN products and relevant expert content. HSN has also begun producing live entertainment as a way to further engage with our customers. These events are staged at HSN’s television studios or elsewhere. Certain special events are also featured on HSN.com and HSN2 for a limited period of time following their live broadcast on the HSN television network. HSN also has integrated a gamification strategy into its e-commerce platform to promote customer loyalty and engagement. In addition, HSN.com has over 50,000 video demonstrations of products and how-to videos.

In an effort to promote its own differentiated brand, HSN seeks to provide its customers with unique products that can only be purchased through HSN. HSN frequently partners with leading personalities and brands to develop product lines exclusive to HSN and believes that these affiliations enhance the awareness of the HSN brand among consumers, as well as increase the extent to which HSN and/or products sold through HSN are featured in the media. In some cases, vendors have agreed to market their HSN affiliation to their existing customers (e.g., notifying customers when their products will be featured on the HSN television network).
HSN engages in co-promotional partnerships with major media companies. These are done primarily because they offer us editorial authority while they also secure print advertising in national fashion, style and/or lifestyle publications to market HSN to prospective customers in its target demographics. HSN also engages in search engine marketing and targeted offline advertising. As part of HSN's entertainment strategy, it participates in innovative joint marketing and promotional partnerships with major motion picture companies as well as well-known recording artists. HSN also creates strategic alliances with world-class, consumer brands in an effort to reach new prospects through relevant brand integrations and occasion-based event marketing. These promotions are designed to not only generate additional revenue and create brand awareness, but to also provide unique experiences for our customers in our continued effort to drive customer engagement as well as position HSN as a proven and powerful marketing vehicle.
The Cornerstone brands differentiate themselves by offering customers an assortment of innovative proprietary and branded apparel and home products. In many cases, Cornerstone seeks to secure exclusive distribution rights for certain products. Cornerstone employs in-house designers and partners with leading manufacturers and designers to aid in the development of its unique, exclusive product assortment. The Cornerstone brands use their respective websites and e-mail marketing to promote special offers, including cross-promotions for other Cornerstone brands. In addition, Cornerstone partners with third parties to offer promotional events such as sweepstakes and/or enter into other advertising agreements.

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HSNi believes that these affiliations enhance the awareness of the Cornerstone brands among consumers as well as strengthen its various brands overall.
Order Entry, Fulfillment and Customer Service
HSNi provides customers with convenient options in connection with the purchase, payment and shipment of merchandise, some of which may vary by brand, business or product. Merchandise may be purchased online, through mobile devices, or ordered using toll free phone numbers through live sales and service agents. HSN also offers the convenience of an automated attendant system and, in limited markets, remote control ordering capabilities through pay television set-top boxes. Cornerstone’s catalog orders can also be made via submission of traditional catalog sales order forms.
In addition to traditional payment options, such as credit and certain debit cards, payment options include private label credit cards, Paypal and, in the case of HSN, Flexpay. By utilizing Flexpay, customers may pay for select merchandise in two to six interest-free, monthly credit or debit card payments. HSN also offers its customers the convenience of ordering products under its Autoship program, through which customers may arrange to have products automatically shipped and billed at scheduled intervals. Standard and express shipping options are available and customers may generally return most merchandise for a full refund or exchange in accordance with applicable return policies (which vary by brand and business). Returns generally must be received within specified time periods after purchase, ranging from a minimum of thirty days to a maximum of one year, depending upon the applicable policy.
HSNi seeks to fulfill customer orders and process returns quickly and accurately from a network of fulfillment centers. For HSN, these centers are located in Tennessee, California, Virginia and New York, and for Cornerstone, the fulfillment centers are located in Ohio, Arizona and Washington. HSNi contracts with several third party carriers and other fulfillment partners to ensure the reliable and timely delivery of products to its customers and processing of returns.
Through HSN.com and the various websites operated by Cornerstone or through HSNi’s common carriers, customers can also generally track the status of their orders, confirm information regarding shipping and, in some cases, confirm the availability of inventory and establish and manage personal accounts. Customers may communicate directly with customer service via e-mail or by telephone with call center representatives available seven days a week.
Government Regulation
We market and offer a broad range of merchandise through television, online, catalogs and other channels. The manner in which we promote and sell merchandise, including claims and representations made in connection with these efforts, is regulated by a wide variety of federal, state and local laws, regulations, rules, policies and procedures. Some examples of these that affect the manner in which we sell and promote merchandise or otherwise operate our businesses include, but are not limited to, the following:
The Federal Trade Commission’s regulations related to the sale of products and/or commercial contacts with our customers or potential customers, such as the Telemarketing Sales Rule and Do Not Call;
The Food and Drug Administration’s regulations regarding marketing claims that can be made about cosmetic beauty products and over-the-counter drugs, which include products for treating acne or medical products, and claims that can be made about food products;
Regulations related to product safety issues and product recalls including, but not limited to, the Consumer Product Safety Act, the Consumer Product Safety Improvement Act of 2008, the Federal Hazardous Substance Act, the Flammable Fabrics Act and regulations promulgated pursuant to these acts; and
Various state laws, regulations and interpretations regarding the obligations of retailers with respect to the collection of sales tax on internet sales.
These laws, regulations, rules, policies and procedures are subject to change at any time. Unfavorable changes applicable to us could decrease demand for merchandise offered by us, increase costs which we may not be able to offset, subject us to additional liabilities and/or otherwise adversely affect our businesses.
Since October 1996, HSN has been subject to a consent order issued by the Federal Trade Commission, or FTC, which terminates on the later of April 15, 2019, or 20 years from the most recent date that the United States or the FTC files a complaint in federal court alleging any violation thereunder. Pursuant to this consent order, we are prohibited from making claims for specified categories of products, including claims that a given product can cure, treat or prevent any disease or have an effect on the structure or function of the human body, unless we have competent and reliable scientific evidence to substantiate such claims. Violation of this consent order may result in the imposition of significant civil penalties for non-compliance and related redress to consumers and/or the issuance of an injunction enjoining us from engaging in prohibited

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activities. The FTC may periodically investigate our business and operations on an ongoing basis for purposes of determining our compliance with the consent order.
Online sales must comply with a variety of federal and state laws dealing with, amongst other things, privacy, intellectual property, taxation, the provision of online payment services and electronic contracts. While U.S. Supreme Court decisions generally restrict the imposition of obligations to collect state and local sales and use taxes with respect to sales from out-of-state retailers, an increasing number of states have adopted or are considering laws that would impose obligations on out-of-state retailers to collect taxes on their behalf. Congress is also considering legislation allowing states to require out-of-state sellers to collect sales and use taxes. An unfavorable change in U.S. Supreme Court guidance related to sales tax or a successful assertion by one or more states may result in material tax liabilities, interest and penalties. A change in state law or federal laws, our business model, business strategy or marketing initiatives may require us to collect sales tax in states for which we do not currently collect such tax. These developments, should they occur, may result in a decrease in future sales, may limit our ability to compete effectively or may otherwise harm our business.
While we believe that the practices of our businesses have been structured in a manner to ensure compliance with these laws and regulations; federal, state or local regulatory authorities may take a contrary position. Our failure to comply with these laws and regulations could result in proceedings against us, tax assessments, fines and penalties and/or a diminution of our reputation, each of which could adversely affect our financial condition, results of operations and businesses.
Intellectual Property
We regard our intellectual property rights, including patents, service marks, trademarks, domain names, copyrights and trade secrets, as important to our success. Our businesses also rely heavily upon software, informational databases and other systemic components that are necessary to manage and support our operations. We rely on a combination of laws and contractual restrictions with employees, customers, suppliers, licensees, affiliates and other third parties to establish and protect these proprietary rights. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use trade secrets or copyrighted intellectual property without authorization which, if discovered, might require legal action to correct. In addition, third parties may independently and lawfully develop substantially similar intellectual properties.
We have generally registered and continue to apply to register, or secure by contract when appropriate, our trademarks and service marks as they are developed and used, and reserve and register domain names as we deem appropriate. We consider the protection of our trademarks to be important for purposes of brand maintenance and reputation. While we vigorously protect our trademarks, service marks and domain names, effective trademark protection may not be available or may not be sought in every country in which products and services are made available, and contractual disputes may affect the use of marks governed by private contract. Similarly, not every variation of a domain name may be available or be registered, even if available. Our failure to protect our intellectual property rights in a meaningful manner or challenges to related contractual rights could result in dilution of brand names and/or limit our ability to control marketing on or through the internet using our various domain names either of which could adversely affect our business, financial condition and results of operations.
Some of our businesses have been granted patents and/or have patent applications pending with the United States Patent and Trademark Office and/or foreign patent authorities for various proprietary technologies and other inventions. We consider applying for patents or for other appropriate statutory protection when we develop or identify new or improved proprietary technologies or inventions, and will continue to consider the appropriateness of filing for patents to protect future proprietary technologies and inventions as circumstances may warrant. The issuance or assessment of the validity of any patent involves complex legal and factual questions, and the breadth of claims allowed is uncertain. Accordingly, any patent application filed may not result in a patent being issued or existing or future patents may not be adjudicated valid by a court or be afforded adequate protection against competitors with similar technology. In addition, third parties may create new products or methods that achieve similar results without infringing upon patents that we own. Likewise, the issuance of a patent to us does not mean that our processes or inventions will not be found to infringe upon patents or other rights previously issued to third parties.
From time to time, we are subject to legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of the trademarks, copyrights, patents and other intellectual property rights of third parties. In addition, litigation may be necessary in the future to enforce our intellectual property rights, protect trade secrets or determine the validity and scope of proprietary rights claimed by others. Any litigation of this nature, regardless of outcome or merit, could result in substantial costs and diversion of management and technical resources, any of which could adversely affect our business, financial condition and results of operations. Patent litigation tends to be particularly protracted and expensive.

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Competition
HSNi brands and businesses operate in a highly competitive environment. These brands and businesses are in direct competition for consumers with traditional and online retailers (both television and internet retailers), ranging from large department stores to specialty shops, electronic retailers, direct marketing retailers, mail order and catalog companies, infomercial retailers, wholesale clubs and discount retailers. In addition, the HSN television networks compete for access to customers and audience share with other conventional forms of entertainment and content. The price and availability of programming for pay television systems affect the availability of distribution for HSN television programming. Principal competitive factors for HSNi brands and businesses include: (i) brand recognition, (ii) value, quality and selection of merchandise, (iii) customer experience, including customer service and reliability of fulfillment and delivery services and (iv) convenience and accessibility of sales channels.
Employees
As of January 24, 2014, HSNi employed approximately 6,800 employees. No HSNi employees are represented by unions or other similar organizations and HSNi considers its relations with its employees to be good.
Available Information

We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy and information statements and amendments to reports filed or furnished pursuant to Sections 13(a), 14 and 15(d) of the Securities Exchange Act of 1934, as amended. The public may read and copy these materials at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at www.sec.gov that contains reports, proxy and information statements and other information regarding HSN, Inc. and other companies that file materials with the SEC electronically.
Our website is located at http://www.hsni.com. We make available free of charge, on or through the website, our annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after electronically filing such reports with the SEC.
Information relating to corporate governance, including our Code of Business Conduct and Ethics and our Corporate Governance Guidelines, is also available on our website at http://www.hsni.com/governance.cfm. The code of conduct complies with Item 406 of SEC Regulation S-K and the rules of the NASDAQ Global Select Market. Any changes to the code of conduct that affect the provisions required by Item 406 of Regulation S-K, and any waivers of the code of conduct for our executive officers, directors or senior financial officers, will also be disclosed on our website.
The content of our website is not a part of this Annual Report or any other report filed with the SEC.
 

8



ITEM 1A.
RISK FACTORS
The risks and uncertainties described below are not the only risks that may have a material adverse effect on HSNi. There exist additional risks and uncertainties that could adversely affect our business and our results. If any of the following risks actually occur, our business, financial condition or results of operations could be negatively affected, and the market price for our shares could decline. Further, to the extent that any of the information contained in this Annual Report on Form 10-K constitutes forward-looking statements, the risk factors set forth below also are cautionary statements identifying important factors that could cause the actual results of HSNi to differ materially from those expressed in any forward-looking statements made by or on behalf of HSNi.
Risks Related to Our Business

Our long-term success depends, in large part, on our continued ability to attract new and retain existing customers in a cost-effective manner.
In an effort to attract and retain customers, we engage in various marketing and merchandising initiatives, which involve the expenditure of considerable funds and resources, particularly in the case of the production and distribution of HSN television programming, Cornerstone catalogs and continuously updating our digital strategy. We have spent, and expect to continue to spend, increasing amounts of money on, and devote greater resources to, certain of these initiatives, particularly in connection with the growth and maintenance of our brands generally, as well as in the continuing efforts of our businesses to increasingly engage customers through digital channels. These initiatives, however, may not resonate with existing customers or consumers generally or may not be cost-effective. In addition, we believe that costs associated with the production and distribution of HSN television programming, paper and printing costs for Cornerstone catalogs and costs associated with digital marketing, including search engine marketing (primarily the purchase of relevant keywords) are likely to increase in the foreseeable future and, if significant, could have an adverse effect on our business, financial condition and results of operations to the extent that they do not result in corresponding increases in sales.

The retail business environment is subject to intense competition, and we may not be able to effectively compete for customers.

We operate in a rapidly evolving and highly competitive retail business environment. We have numerous and varied competitors at the national and local levels, ranging from large department stores to specialty shops, electronic retailers, direct marketing retailers, wholesale clubs, discount retailers, other televised shopping retailers such as QVC and ShopHQ, infomercial retailers, internet retailers, and mail-order and catalog companies. Many of our current and potential competitors have greater resources, longer histories, more customers and greater brand recognition than we do. They may secure better terms from vendors, adopt more aggressive pricing, offer free or subsidized shipping and devote more resources to technology, fulfillment and marketing. Other companies also may enter into business combinations or alliances that strengthen their competitive positions.

We also compete for access to customers and audience share with other providers of televised, online and hard copy entertainment and content. Our inability to compete effectively with regard to the assortment, price, shipping terms and quality of the merchandise we offer for sale or to keep pace with competitors in our marketing, service, location, reputation, credit availability and technologies, could have a material adverse effect.
We depend on relationships with pay television operators and adverse changes in these relationships could result in an interruption, material decrease or even the cessation of carriage of the HSN television networks.
We are dependent upon the pay television operators with whom we enter into distribution and affiliation agreements to carry the HSN television networks. We currently have contracts with many local and national pay television operators to distribute HSN television programming. Some of HSN’s larger pay television operators include Comcast, DirecTV, Echostar/DISH and Time Warner Cable. The two largest pay television operators represent 43% of our subscribers. The cessation of carriage of the HSN television networks by a major pay television operator or a significant number of smaller pay television operators for a prolonged period of time could adversely affect our business, financial condition and results of operations. While we believe that we will be able to continue to successfully manage the distribution process in the future, certain changes in distribution levels, as well as increases in fees payable for carriage, could occur notwithstanding these efforts.
We typically seek to enter into long-term distribution and affiliation agreements with these major pay television operators; however, in some cases, renewals are not agreed upon prior to the expiration of a given agreement and the HSN television networks continue to be carried by the relevant pay television operator without an effective agreement in place. We currently provide service to approximately 50% of our total subscribers pursuant to month-to-month contracts or contracts that

9



have expired. In addition, another 16% of our subscribers are represented by contracts that expire within one year. Renewal and negotiation processes with pay television operators are typically lengthy. No assurance can be given that we will be successful in negotiating renewals with all these operators or that the financial and other terms of renewal will be on acceptable terms. The failure to successfully renew or negotiate new distribution and affiliation agreements covering a material portion of the existing cable and satellite households on acceptable terms could adversely affect our growth, sales revenue and earnings.
Our revenues and profit margin are negatively influenced by economic conditions that impact consumer spending. If macroeconomic conditions do not continue to improve or if conditions worsen, our business could be adversely affected.
Retailers generally are particularly sensitive to adverse economic and business conditions, in particular to the extent they result in a loss of consumer confidence, rising unemployment, increased taxes and decreases in consumer spending, particularly discretionary spending. Our customers anticipate and respond to adverse changes in economic conditions. If macroeconomic conditions do not continue to improve or if conditions worsen, our business could be adversely affected.
The failure to attract and retain television viewers and secure a suitable programming tier of carriage and channel placement for the HSN television network programming could result in a decrease in revenue.
We are dependent, in part, upon the continued ability of HSN to compete effectively for television viewers. Effectively competing for television viewers is dependent, in substantial part, on the ability of HSN to secure placement of the HSN television networks within a suitable programming tier and to effectively compete against others for the leisure and entertainment time of consumers. The advent of digital compression technologies and the adoption of digital cable has resulted in increased channel capacity. In addition, there are now more programming options available to the viewing public in the form of new television networks and time-shifted viewing (e.g., personal video recorders, video-on-demand, interactive television and streaming video over broadband internet connections as well as increased access to various media through wireless devices). These have the potential to reduce the viewing of our content. New technologies have been and will continue to be developed that increase the number of entertainment choices available and the manners in which they are delivered. Our failure to effectively anticipate or adapt to emerging technologies or changes in consumer behavior could have an adverse impact on our competitive position, business and results of operations.

A prolonged or permanent inability to broadcast the HSN television networks would result in lost customers and lost sales.
Our success is dependent upon the continued ability of HSN to transmit the HSN television networks to broadcast and pay television operators from its satellite uplink facilities, which transmission is subject to the Federal Communications Commission (“FCC”) compliance. HSN has entered into two satellite transponder leases to provide for continued carriage of the HSN television networks on a replacement transponder and/or replacement satellite, as applicable, in the event of a failure of the transponder and/or satellite. Although we believe that every reasonable measure is being taken to ensure continued satellite transmission capability, termination or interruption of satellite transmissions may occur. Any such disruption could have a material adverse effect on our competitive position, business and results of operations.
System interruption and the lack of integration and redundancy in our systems and infrastructures may adversely affect our ability to operate websites, process and fulfill transactions, respond to customer inquiries and generally maintain cost-efficient operations.
We use the internet, mobile devices, social networking and other online activities to connect with our customers. Our success depends, in part, on our ability to maintain the integrity of our systems and infrastructures, including websites, information and related systems, call centers and fulfillment facilities. We may experience occasional system interruptions, including those caused by system conversions, that make some or all systems or data unavailable or prevent our businesses from efficiently providing services or fulfilling orders. We also rely on affiliate and third-party computer systems, broadband and other communications systems and service providers in connection with the provision of services generally, as well as to facilitate, process and fulfill transactions. Any interruptions, outages or delays in our systems and infrastructures, our businesses, our affiliates and/or third parties, or deterioration in the performance of these systems and infrastructures, could impair our ability to provide services, fulfill orders and/or process transactions. Fire, flood, power loss, telecommunications failure, hurricanes, tornadoes, earthquakes, acts of war or terrorism, acts of God and similar events or disruptions may damage or interrupt computer, broadband or other communications systems and infrastructures at any time. In addition, we have observed an increase in the number of cyber attacks that include gaining access to digital systems for purposes of corrupting data or causing operational disruption. Any of these events could cause system interruption, delays and loss of critical data, and could prevent us from providing services, fulfilling orders and/or processing transactions which could have an adverse impact on our competitive position, business and results of operations. While we have backup systems for certain aspects of our operations, these systems are not fully redundant and disaster recovery planning is not sufficient for all eventualities. In addition, we may not have adequate insurance coverage to compensate for losses from a major interruption.

10



The processing, storage, use and disclosure of personal data could give rise to liabilities as a result of governmental regulation, conflicting legal requirements or differing views of personal privacy rights.
In the processing of consumer transactions, we receive, transmit and store a large volume of personally identifiable information and other user data. The sharing, use, disclosure and protection of this information are governed by the privacy and data security policies maintained by us. Moreover, there are federal, state and international laws regarding privacy and the storing, sharing, use, disclosure and protection of personally identifiable information and user data. Specifically, personally identifiable information is increasingly subject to legislation and regulations in numerous jurisdictions around the world, the intent of which is to protect the privacy of personal information that is collected, processed and transmitted in or from the governing jurisdiction. We could be adversely affected if legislation or regulations are expanded to require changes in business practices or privacy policies, or if governing jurisdictions interpret or implement their legislation or regulations in ways that negatively affect our business, financial condition and results of operations.
We are subject to online and other cyber security risks and cyber incidents, including security and data breaches and identity theft.
To succeed, we must be able to provide for secure transmission of confidential information over public networks. We have observed an increased number of cyber attacks that include attempts to gain unauthorized access to digital systems for purposes of misappropriating assets or sensitive information. Our failure, and/or the failure by the various third party vendors and service providers with which we do business, to comply with applicable privacy policies or federal, state or similar international laws and regulations or any compromise of security that results in the unauthorized release of personally identifiable information or other user data could damage the reputation of our businesses, discourage potential users from trying our products and services and/or result in fines and/or proceedings by governmental agencies and/or consumers, one or all of which could adversely affect our business, financial condition and results of operations. Any penetration of network security or other misappropriation or misuse of personal consumer information could cause interruptions in the operations of our businesses and subject us to increased costs, litigation and other liabilities. Security and data breaches could also significantly damage our reputation with consumers and third parties with whom we do business. We may be required to expend significant capital and other resources to protect against and remedy any potential or existing security and data breaches and their consequences. We also face risks associated with security and data breaches affecting third parties with which we are affiliated or otherwise conduct business online.
We could be subject to additional sales tax liability, including liability for past sales.
U.S. Supreme Court decisions restrict the imposition of obligations to collect state and local sales taxes with respect to sales from out-of-state retailers.  As a result, approximately 39% of our revenue is not currently subject to sales tax or its equivalent. However, an increasing number of states have adopted or are considering laws that attempt to impose obligations on out-of-state retailers to collect taxes on their behalf.  Congress is also considering legislation allowing states to require out-of-state sellers to collect sales and use taxes.  It is not possible to predict with any degree of certainty the outcome of these initiatives or the impact of these initiatives on our business and marketing strategies that we are considering or may consider in the future.

An unfavorable change in U.S. Supreme Court guidance related to sales tax, or a successful assertion by one or more states may result in material tax liabilities, interest and penalties.  A change in state or federal laws, or our business model, business strategy, or marketing initiatives may require us to collect sales tax on transactions in which we do not currently collect such tax.  These developments, should they occur, may result in a decrease in future sales, may decrease our ability to compete, or otherwise harm our business. 

11



Increased delivery costs, particularly if we are unable to offset them by increasing prices without a detrimental effect on customer demand, and the extent to which we offer shipping promotions to our customers, could adversely impact our profits.
We are impacted by increases in shipping rates charged by various shipping vendors relating to the procurement of merchandise from vendors and manufacturers, the shipment of merchandise to customers and the mailing of catalogs, which over the past few years have experienced volatility in comparison to historical levels. Variations in the mix and quantity of products we sell impact the cost to ship our products as do the shipping promotions we frequently offer to drive revenues. We currently expect that shipping and postal rates will continue to increase as well as the trend towards free shipping in the direct-to-consumer marketplace. In the case of deliveries to customers, we have negotiated favorable shipping rates, which increase at agreed upon levels over time, with one independent, third party shipping company pursuant to a long-term contract. If this relationship were to terminate or if the shipping company was unable to fulfill its obligations under the contract for any reason, particularly during peak shipping seasons, we would have to work with other shipping companies to deliver merchandise to customers, which could be at less favorable rates and could cause a disruption in our business. A significant increase in shipping promotions as well as any increase in shipping rates and related fuel and other surcharges passed on to us by our shipping company may adversely impact profits given that we may not be able to pass these increased costs directly to customers or offset them by increasing prices without a detrimental effect on customer demand.
We depend on relationships with vendors, manufacturers and other third parties; any adverse changes in these relationships could result in a failure to meet customer expectations which could result in lost sales.
We purchase merchandise from a wide variety of third party vendors, manufacturers and other sources pursuant to short- and long-term contracts and purchase orders. Our ability to identify and establish relationships with these parties, as well as access quality merchandise in a timely and efficient manner on acceptable terms and at acceptable costs, can be challenging. In particular, we purchase a significant amount of merchandise from vendors and manufacturers abroad and have experienced (and expect to continue to experience) increased costs for goods sourced in these markets. We depend on the ability of vendors and manufacturers in the U.S. and abroad to produce and deliver goods that meet applicable quality standards, which is impacted by a number of factors not within the control of these parties, such as political or financial instability, trade restrictions, tariffs, currency exchange rates and transport capacity and costs, among others. In particular, Cornerstone is dependent, in significant part, upon independent, third party manufacturers to produce its private label merchandise.
Our failure to identify new vendors and manufacturers, maintain relationships with a significant number of existing vendors and manufacturers and/or access quality merchandise in a timely and efficient manner could cause us to miss customer delivery dates or delay scheduled promotions, which would result in the failure to meet customer expectations and could cause customers to cancel orders or cause us to be unable to source merchandise in sufficient quantities, which could result in lost sales.
The unanticipated loss of certain larger vendors could negatively impact our sales and profitability on a short term basis.
It is possible that one or more of our larger vendors could experience financial difficulties, including bankruptcy, or otherwise could elect to cease doing business with us. While we have periodically experienced the loss of a major vendor, if a major vendor or a number of our current larger vendors ceased doing business with us, this could materially and adversely impact our sales and profitability.
We may not be able to accurately predict and/or respond in a timely manner to evolving customer preferences and trends and industry standards, which could result in excess inventory, related markdowns and lost sales.
Our success depends, in significant part, on our ability to accurately predict, and respond in a timely manner to, changes in customer preferences and fashion, lifestyle and other trends and industry standards. While product mix and price points are continuously monitored and adjusted in an attempt to satisfy consumer demand and respond to changing economic and business conditions, we may not be successful in these efforts, and any sustained failure could result in excess inventory and related markdowns.
In addition, e-commerce is characterized by evolving industry standards, frequent new service and product introductions and enhancements, as well as changing customer demands and increase privacy and data security needs. If we are not able to adapt quickly enough and/or in a cost-effective manner to these changes it could result in lost sales which would negatively impact our results of operations.

12



We are currently the subject of a consent order issued by the FTC and violation of this consent order could result in significant civil penalties and/or an injunction enjoining HSN from engaging in prohibited activities, among other penalties or remedies.
In October 1996, HSN became subject to a consent order issued by the FTC which terminates on the later of April 15, 2019, or 20 years from the most recent date that the United States or the FTC files a complaint in federal court alleging any violation thereunder. Pursuant to this consent order, HSNi (including its subsidiaries and affiliates) is prohibited from making claims for specified categories of products, including claims that a given product can cure, treat or prevent any disease or have an effect on the structure or function of the human body, unless it has competent and reliable scientific evidence to substantiate such claims. Violation of this consent order may result in the imposition of significant civil penalties for non-compliance and related redress to consumers and/or the issuance of an injunction enjoining us from engaging in prohibited activities. The FTC periodically investigates our business and operations on an ongoing basis for purposes of determining its compliance with the consent order.
We may be subject to claims for representations made in connection with the sale and promotion of merchandise or for harm experienced by customers who purchase merchandise from us.
The manner in which we sell and promote merchandise and related claims and representations made in connection with these efforts is regulated by federal, state and local law. We may be exposed to potential liability from claims by consumers or from federal, state and local regulators and law enforcement agencies, including, but not limited to, for personal injury, product safety, wrongful death and damage to personal property relating to merchandise sold and misrepresentation of merchandise features and benefits. In certain instances, we have the right to seek indemnification for related liabilities from our vendors and may require such vendors to carry minimum levels of product liability and errors and omissions insurance. These vendors, however, may be unable to obtain suitable coverage or maintain this coverage on acceptable terms; this insurance may provide inadequate coverage against all potential claims or may not even be available with respect to a particular claim. If insurance is insufficient or unavailable, our vendor may have insufficient resources to cover their indemnification obligations, or if our vendor ceases to do business, our results of operations would be negatively impacted. Even if vendors can satisfy their financial obligations, our brand and reputation could be negatively impacted.
Failure to effectively manage our Flexpay program could result in unplanned losses.
HSN offers Flexpay, a program which customers may pay for certain merchandise in two to six interest-free, monthly credit or debit card installments. This is an effective tool for driving sales, primarily for higher-priced items. We maintain allowances for estimated losses resulting from the inability of customers to make required payments. While actual losses due to the inability of customers to make required payments have historically been within estimates, they may increase in a given period or exceed related estimates. As Flexpay usage continues to grow, we may experience these losses at greater rates, which will require us to maintain greater allowances for doubtful accounts of estimated losses than we have historically. To the extent that Flexpay losses exceed historical levels, our results of operations may be negatively impacted.
We may fail to protect our intellectual property rights within the full scope and manner available to us under applicable law or statute or may be accused of infringing upon the intellectual property rights of third parties.
We regard our intellectual property rights, including patents, service marks, trademarks and domain names, copyrights and trade secrets, as critical to our success. We rely heavily upon software, databases and other systemic components that are necessary to manage and support our business operations.

We are subject to legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of the trademarks, copyrights, patents and other intellectual property rights of third parties. In addition, litigation may be necessary in the future to enforce our intellectual property rights, protect trade secrets or to determine the validity and scope of proprietary rights claimed by others. Any litigation of this nature, regardless of outcome or merit, could result in substantial costs and diversion of management and technical resources, any of which could adversely affect our business, financial condition and results of operations. Patent litigation tends to be particularly protracted and expensive. Our failure to protect our intellectual property rights in a meaningful manner or challenges to related contractual rights could result in erosion of brand names and limit our ability to control marketing on or through the internet using our various domain names or otherwise, which could adversely affect our business, financial condition and results of operations.

13



Failure to comply with existing laws, rules and regulations, or to obtain and maintain required licenses and rights could subject us to additional liabilities.
We market and provide a broad range of merchandise through television, digital, catalogs and other channels. As a result, we are subject to a wide variety of statutes, rules, regulations, policies and procedures in various jurisdictions which are subject to change at any time, including laws regarding product safety, consumer protection, privacy, the regulation of retailers generally, the importation, sale and promotion of merchandise and the operation of retail stores and warehouse facilities, as well as laws and regulations applicable to the internet and businesses engaged in digital commerce, such as those regulating the sending of unsolicited, commercial electronic mail. Our failure to comply with these laws and regulations could result in fines and/or proceedings against us by governmental agencies and/or consumers, which could adversely affect our business, financial condition and results of operations. Moreover, unfavorable changes in the laws, rules and regulations applicable to us could decrease demand for merchandise offered by us, negatively impact our marketing efforts, increase costs, subject us to additional liabilities and/or otherwise adversely affect our businesses.
Restrictive covenants in our debt instruments could limit our flexibility to respond to current market conditions or otherwise restrict our business activities.
The existence of, and limitations on the availability of, our debt could have important consequences. The existence of debt could, among other things:
require a substantial portion of our cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness;
limit our ability to use cash flow or obtain additional financing for future working capital, capital expenditures or other general corporate purposes;
increase our vulnerability to general economic and industry conditions; or
expose us to the risk of increased interest rates for that portion of our borrowings under our credit facilities that are at variable interest rates.
Our credit facility includes restrictive financial and non-financial covenants. Limitations imposed as a part of the debt, such as the availability of credit and the existence of restrictive covenants may, among other things, make it difficult for us to satisfy our financial obligations; and/or limit our ability to respond to business opportunities.
There are risks associated with our acquisitions.
Mergers and acquisitions entail a number of risks including, among other things, higher than anticipated acquisition costs and expenses, the difficulty and expense of integrating the operations and personnel of the companies and the loss of key employees and customers as a result of changes in management. We may not be successful in overcoming these risks or any other problems encountered in connection with any acquisition.
Acquisition valuations require us to make certain estimates and assumptions to determine the fair value of the acquired entities (including the underlying assets and liabilities). If our estimates or assumptions used to value acquired assets and liabilities are not accurate, we may be exposed to losses that may be material.

Risks Related to Our Common Stock
The shareholders’ rights plan adopted by the Board of Directors in December 2008 may inhibit takeovers that would otherwise be beneficial to shareholders.
In the fourth quarter of 2008, our Board of Directors approved the creation of a Series A Junior Participating Preferred Stock, adopted a shareholders’ rights plan and declared a dividend of one right for each outstanding share of common stock held by our shareholders. Initially, these rights, which trade with the shares of our common stock, are not exercisable. Under the rights plan, these rights will be exercisable if a person or group acquires or commences a tender or exchange offer for 15% or more of our common stock (except for certain grandfathered persons to which higher thresholds apply). If the rights become exercisable, each right will permit the holder, other than the “acquiring person,” to purchase from us shares of common stock at a 50% discount to the then prevailing market price. As a result, the rights will cause substantial dilution to a person or group that becomes an “acquiring person” on terms not approved by our Board of Directors. The existence of these rights may prevent, discourage or delay us from being acquired, even if such acquisition would be beneficial to our shareholders.

14



The market price and trading volume of our common stock may be volatile and may face negative pressure.
Our stock price has experienced, and could continue to experience in the future, substantial volatility as a result of many factors, including persistent adverse macroeconomic conditions, broad market fluctuations and public perception of the prospects for the retail industry. Our failure to meet market expectations would also likely result in a decline in the market price of our stock. These and other factors may result in short-term or long-term negative pressure on the value of our common stock.
 
ITEM 1B.
UNRESOLVED STAFF COMMENTS
Not applicable.
 
ITEM 2.
PROPERTIES
HSNi owns its corporate headquarters in St. Petersburg, Florida, which consist of approximately 600,000 square feet of office space and include executive offices, television studios, showrooms, broadcast facilities and administrative offices for HSN. HSN leases the HSN fulfillment centers in Piney Flats, Tennessee; Fontana, California; Roanoke, Virginia; and Ronkonkoma, New York; as well as four outlet stores and other properties in various locations in the United States for administrative offices and data centers pursuant to leases that expire in 2014 through 2023. Cornerstone owns an office and storage facility in Franconia, New Hampshire. Otherwise, Cornerstone leases its properties, consisting of administrative offices, retail outlets, fulfillment centers and photo centers in West Chester, Ohio; Phoenix, Arizona; and Tukwila, Washington. Cornerstone also has 10 retail stores and outlets and other administrative offices in various locations throughout the United States, all pursuant to leases with expiration dates ranging from 2014 to 2020.

HSNi believes that the duration of each lease is adequate and does not anticipate any future problems renewing or obtaining suitable leases for its principal properties. HSNi believes that its principal properties, whether owned or leased, are currently adequate for the purposes for which they are used and are suitably maintained for these purposes. From time to time, HSNi considers various alternatives related to its long term facilities needs. While HSNi management believes existing facilities are adequate to meet its short term needs, it may become necessary to lease or acquire additional or alternative space to accommodate future growth.

ITEM 3.
LEGAL PROCEEDINGS
In the ordinary course of business, we are involved in various legal matters arising out of our operations. These matters may relate to claims involving property, personal injury, contract, intellectual property (including patent infringement), sales tax, regulatory compliance and other claims. As of the date of this filing, we are not a party to any legal proceedings that are reasonably expected to have a material adverse effect on our business, results of operations, financial condition or cash flows; however, litigation matters are subject to inherent uncertainties and the results of these matters cannot be predicted with certainty. An unfavorable resolution of one or more of these matters could have a material adverse effect on our business, results of operations, financial condition or cash flows. Moreover, any claims or regulatory actions against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources.

See Note 13 – Commitments and Contigencies in Part II, Item 8 for additional information regarding legal matters in which we are involved.

ITEM 4.
MINE SAFETY DISCLOSURES
Not Applicable.

PART II
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

15



Market and Dividend Information
Our common stock trades on the NASDAQ Global Select Market under the symbol HSNI. The table below sets forth the high and low per share sales prices of our common stock, as reported by the NASDAQ Global Select Market, and the dividends declared for the periods indicated.
 
 
Sales Price
 
 
Fiscal 2013
 
High
 
Low
 
Dividends
Fourth Quarter
 
$
63.54

 
$
50.03

 
$
0.25

Third Quarter
 
$
65.00

 
$
52.79

 
$
0.18

Second Quarter
 
$
58.56

 
$
50.76

 
$
0.18

First Quarter
 
$
60.87

 
$
49.14

 
$
0.18

Fiscal 2012
 
 
Fourth Quarter
 
$
55.97

 
$
47.47

 
$
0.18

Third Quarter
 
$
49.71

 
$
39.67

 
$
0.125

Second Quarter
 
$
41.73

 
$
35.74

 
$
0.125

First Quarter
 
$
38.79

 
$
34.74

 
$
0.125


During the fourth quarters of 2013 and 2012, our Board of Directors approved increases in our quarterly cash dividend of 39% and 44%, respectively. In February 2014, our Board of Directors approved a quarterly cash dividend of $0.25 per share payable March 19, 2014 to shareholders of record as of March 5, 2014. We currently expect to continue to declare and pay quarterly dividends of an amount similar to our past declaration. However, any determination to pay cash dividends will be at the discretion of our Board of Directors and will depend upon our operating results, financial condition and capital requirements, general business conditions and such other factors that the Board of Directors considers relevant. Our credit agreement limits the amount of and our ability to pay cash dividends.

Holders
As of January 28, 2014, there were 1,612 shareholders of record of our common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of shareholders, we are not able to estimate the total number of beneficial shareholders represented by these record holders.

Issuer Purchases of Equity Security
On September 27, 2011, our Board of Directors authorized us to repurchase up to 10 million shares of our common stock. Under the terms of the share repurchase program, HSNi will repurchase its common stock from time to time through privately negotiated or open market transactions, including pursuant to a trading plan in accordance with Rule 10b5-1 and Rule 10b-18 under the Securities Exchange Act of 1934, as amended, or by any combination of such methods. The timing of any repurchases and actual number of shares repurchased will depend on a variety of factors, including the stock price, corporate and regulatory requirements, restrictions under the company’s debt obligations and other market and economic conditions. The repurchase program may be suspended or discontinued by HSNi at any time.
During the quarter ended December 31, 2013, we repurchased approximately 0.2 million shares at an average price of $51.99 per share. Below is a summary of our common stock repurchases during the fourth quarter of 2013, as well as the number of shares still available for purchase as of December 31, 2013:

Period
 
Number of
Shares Purchased
 
Average Price
Paid Per Share
 
Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
 
Maximum Number
of Shares that May
Yet Be Purchased
under the Plans or
Programs
October 1, 2013 - October 31, 2013
 
168,313

 
$
51.96

 
168,313

 
1,032,446

November 1, 2013 - November 30, 2013
 
21,500

 
$
52.29

 
21,500

 
1,010,946

December 1, 2013 - December 31, 2013
 

 
$

 

 
1,010,946

 
 
189,813

 
 
 
189,813

 
 


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Performance Graph
The graph depicted below compares the five-year performance of our common stock with the cumulative total return on the S&P 500 Retailing Index and the Russell 2000 Index from December 31, 2008 through December 31, 2013.

*Assumes $100 invested on 12/31/08, including reinvestment of dividends.

 
 
12/31/2008
 
12/31/2009
 
12/31/2010
 
12/31/2011
 
12/31/2012
 
12/31/2013
HSN, Inc.
 
100.00

 
277.72

 
421.60

 
500.51

 
770.13

 
883.59

S&P 500 Retailing Index
 
100.00

 
154.37

 
197.92

 
211.12

 
270.86

 
397.30

Russell 2000 Index
 
100.00

 
127.17

 
161.32

 
154.59

 
179.86

 
249.69


ITEM 6.
SELECTED FINANCIAL DATA
The following table presents selected consolidated financial data for HSNi. The information in this table is not necessarily indicative of future performance and should be read in conjunction with “Management's Discussion and Analysis of Financial Condition and Results of Operations,” and our audited consolidated financial statements and related notes included herein.
For information about the shares used in computing earnings per share, see Note 10 of Notes to Consolidated Financial Statements.
 

17



 
 
Year Ended December 31,
 
 
2013
 
2012
 
2011
 
2010
 
2009
 
 
(In thousands, except per share data)
Statement of Operations Data:
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
3,403,983

 
$
3,266,739

 
$
3,069,356

 
$
2,884,308

 
$
2,635,959

Operating income
 
282,654

 
258,744

 
239,042

 
198,803

 
163,540

Income from continuing operations
 
178,449

 
136,497

 
127,652

 
100,441

 
77,309

Net income (1)
 
178,449

 
130,675

 
123,070

 
98,523

 
72,488

Income from continuing operations per share:
 
 
 
 
 
 
 
 
 
 
Basic
 
$
3.33

 
$
2.42

 
$
2.18

 
$
1.75

 
$
1.37

Diluted
 
$
3.25

 
$
2.36

 
$
2.10

 
$
1.69

 
$
1.35

Net income per share:
 
 
 
 
 
 
 
 
 
 
Basic
 
$
3.33

 
$
2.32

 
$
2.10

 
$
1.72

 
$
1.29

Diluted
 
$
3.25

 
$
2.25

 
$
2.03

 
$
1.65

 
$
1.26

Shares used in computing earnings per share:
 
 
 
 
 
 
 
 
 
 
Basic
 
53,640

 
56,314

 
58,636

 
57,414

 
56,383

Diluted
 
54,857

 
57,956

 
60,689

 
59,546

 
57,330

Dividends declared per common share
 
$
0.79

 
$
0.555

 
$
0.125

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
Balance Sheet Data (end of period):
 
 
 
 
 
 
 
 
 
 
Working capital
 
$
391,147

 
$
384,868

 
$
505,901

 
$
451,406

 
$
332,964

Total assets
 
1,337,923

 
1,331,952

 
1,394,973

 
1,345,743

 
1,218,650

Total debt, including current maturities
 
240,625

 
250,000

 
239,111

 
308,758

 
338,722

Other long-term liabilities, including deferred income taxes
 
104,606

 
94,988

 
101,947

 
100,107

 
90,372


(1)
Loss from discontinued operations for the periods presented includes the income and losses for The Territory Ahead and Smith+Noble, two brands sold by Cornerstone in 2012.

18





ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this annual report. Historical results and trends which might appear should not be taken as indicative of future operations. Our results of operations and financial condition, as reflected in the accompanying consolidated financial statements and related notes, are subject to management’s evaluation and interpretations of business conditions, changing market conditions and other factors.
Management Overview
HSNi offers innovative, differentiated retail experiences and markets and sells a wide range of third party and proprietary merchandise directly to consumers through its two operating segments, HSN and Cornerstone. HSN's business platforms include (i) the television home shopping programming broadcast on the HSN television networks; (ii) the HSN.com website; (iii) mobile applications; and (iv) outlet stores. Cornerstone's business platforms include (i) catalogs, consisting primarily of the Cornerstone portfolio of leading print catalogs which includes Ballard Designs, Chasing Fireflies, Frontgate, Garnet Hill, Grandin Road, Improvements and TravelSmith; (ii) websites, consisting primarily of the eight branded websites operated by Cornerstone; (iii) retail and outlet stores; and (iv) mobile devices.
Sources of Revenue
HSN revenue includes merchandise sales originating from the live television broadcasts of its programming 24 hours per day, seven days a week; HSN2, a network that primarily distributes taped programming on a limited distribution basis; the HSN.com website; mobile handheld devices; and through outlet stores. HSN also sells merchandise through its "Autoship" program under which customers receive scheduled merchandise shipments according to a pre-determined calendar.
Cornerstone sells private label and third party merchandise through its assortment of catalogs, digital sites and retail and outlet stores. Cornerstone consists of the brands of Ballard Designs, Chasing Fireflies, Frontgate, Garnet Hill, Grandin Road, Improvements and TravelSmith.
Products
HSNi sells a wide array of merchandise across its various channels of distribution. HSN merchandise categories primarily consist of jewelry, fashion (apparel & accessories), beauty & health, and home & other (including household, home design, electronics, culinary and other). HSN manages its product mix to provide a balance between satisfying existing customer demand, generating interest from potential viewers and customers, providing new merchandise to its viewership and maximizing airtime and internet efficiency. Cornerstone merchandise categories generally consist of home and outdoor furnishings and apparel & accessories.
HSNi management believes that merchandise diversification, combined with an interactive multi-channel distribution strategy, appeals to a broader segment of potential customers and is an important part of its overall business strategy. HSNi is continually developing new merchandise offerings from existing, potential and future suppliers, to supplement its existing product lines.

19



Results of Operations
Net Sales
Net sales primarily relate to the sale of merchandise, including shipping and handling fees, and are reduced by incentive discounts and actual and estimated sales returns. Sales taxes collected are not included in net sales. Digital sales include sales placed through our internet websites and our mobile applications, including tablets and smart phones.
Revenue is recorded when delivery to the customer has occurred. Delivery is considered to have occurred when the customer takes title and assumes the risks and rewards of ownership, which is on the date of shipment. HSNi’s sales policy allows customers to return virtually all merchandise for a full refund or exchange, subject to pre-established time restrictions.
 
 
 
Year Ended December 31,
 
 
2013
 
Change
 
2012
 
Change
 
2011
 
 
(Dollars in thousands)
HSN
 
$
2,312,382

 
2%
 
$
2,265,026

 
5%
 
$
2,160,341

Cornerstone
 
1,091,601

 
9%
 
1,001,713

 
10%
 
909,015

Total HSNi net sales
 
$
3,403,983

 
4%
 
$
3,266,739

 
6%
 
$
3,069,356


HSNi net sales in 2013 increased 4%, or $137.2 million, due to 2% sales growth at HSN and 9% sales growth at Cornerstone. Digital sales grew 9% with penetration increasing 200 basis points to 46.5%, up from 44.5% in the prior year. The number of units shipped in 2013 increased 4% to 62.0 million and the average price point decreased 1% to $62.37.
HSNi net sales in 2012 increased 6%, or $197.4 million, due to 5% sales growth at HSN and 10% sales growth at Cornerstone. Digital sales grew 13% with penetration increasing 270 basis points to 44.5%, up from 41.8% in the prior year. The number of units shipped in 2012 increased 8% to 59.6 million and the average price point decreased 2% to $62.92.
HSN
    
HSN net sales in 2013 increased 2%, or $47.4 million. Sales grew in beauty & health, home design and household, offset by lower sales in jewelry, culinary and electronics. HSN repositioned the jewelry and culinary businesses in 2013 through changes in product and brand assortment and, as a result, dedicated lower airtime to these product categories. Digital sales grew 7% and penetration increased 160 basis points to 37.0%, up from 35.4% in the prior year. Digital sales were tempered in the first quarter by the launch of the digital site redesign across all HSN digital platforms while HSN implemented its new technology and our customers acclimated themselves with the new website design and capabilities. The return rate decreased 80 basis points to 18.7% from 19.5% in the prior year primarily due to the shift in product mix to categories with lower return rates as well as experiencing lower than historical return rates in many of its product categories. The gross units shipped increased 5% to 46.9 million while average price point decreased 4% to $58.21 primarily due to an increase in clearance activity and changes in product mix.

HSN net sales in 2012 increased 5%, or $104.7 million, driven by sales growth in home design, household, beauty and culinary, offset by lower sales in jewelry. During 2012, HSN focused on several key initiatives targeted at customer acquisition and retention.  Pricing strategies and product selection were designed to appeal to potential and current customers with lower overall price points and product selection to drive higher volumes; we offered entertainment events designed to reinforce our  brand and company awareness in the marketplace; we continued to invest in digital marketing initiatives to appeal to the growing number of digital consumers; and we provided our customers with payment alternatives designed to make the shopping experience with HSN easier and flexible. As a result of these and other initiatives, the number of units shipped increased 8% to 44.7 million and average price point decreased 4% to $60.57. Digital sales grew 10% with penetration increasing 160 basis points to 35.4%, up from 33.8% in the prior year. Shipping and handling revenues decreased 4% driven by an increase in shipping and handling promotions, particularly in the second half of the year. The return rate decreased 50 basis points to 19.5% from 20.0% in the prior year.


20



Divisional product mix at HSN is provided in the table below:
 
 
Year Ended December 31,
 
 
2013
 
2012
 
2011
Jewelry
 
11.1
%
 
13.1
%
 
14.0
%
Fashion (apparel & accessories)
 
13.9
%
 
13.1
%
 
13.3
%
Beauty & Health
 
24.5
%
 
22.7
%
 
22.9
%
Home & Other (including household, home design, electronics, culinary and other)
 
50.5
%
 
51.1
%
 
49.8
%
Total
 
100.0
%
 
100.0
%
 
100.0
%
Cornerstone
    
Cornerstone net sales in 2013 increased 9%, or $89.9 million. The increase in net sales was driven by sales growth in the home brands. Digital sales grew 11% with penetration increasing 150 basis points to 66.5%, up from 65.0% in the prior year. The return rate decreased 50 basis points to 12.9% due primarily to changes in product mix. Catalog circulation increased 5% compared to the prior year.
Cornerstone's net sales in 2012 increased 10% in 2012, or $92.7 million, compared to the prior year. Fiscal year 2012 included 52 weeks compared to fiscal year 2011 which included 53 weeks. Excluding the incremental sales from the additional week in 2011, net sales increased 12% primarily due to strength in the home brands, the addition of Chasing Fireflies to the portfolio in April 2012 and an increase in catalog circulation. Digital sales grew 18% with penetration increasing 430 basis points to 65.0%, up from 60.7% in the prior year. The return rate decreased 130 basis points to 13.4% due to changes in product mix and a heightened focus on quality assurance efforts. Catalog circulation increased 10% compared to the prior year.
The brand mix at Cornerstone is provided in the table below:
 
 
Year Ended December 31,
 
 
2013
 
2012
 
2011
Home brands (Ballard Designs, Frontgate, Grandin Road and Improvements)
 
73.9
%
 
71.8
%
 
71.5
%
Apparel brands (Chasing Fireflies, Garnet Hill and TravelSmith) (a)
 
26.1
%
 
28.2
%
 
28.5
%
Total
 
100.0
%
 
100.0
%
 
100.0
%
(a) Chasing Fireflies was acquired in April 2012.
 
 
 
 
 
 
Cost of Sales and Gross Profit
Cost of sales consists primarily of the cost of products sold, shipping and handling costs and compensation and other employee-related costs for personnel engaged in warehouse functions. Cost of products sold includes merchandise cost, inbound freight and duties and certain allocable general and administrative costs, including certain warehouse costs.

 
 
Year Ended December 31,
 
 
2013
 
Change
 
2012
 
Change
 
2011
 
 
(Dollars in thousands)
Gross profit:
 
 
HSN
 
$
796,705

 
1%
 
$
786,650

 
6%
 
$
741,308

HSN gross margin
 
34.5
%
 
(20 bp)
 
34.7
%
 
40 bp
 
34.3
%
Cornerstone
 
$
433,110

 
9%
 
$
397,074

 
11%
 
$
358,954

Cornerstone gross margin
 
39.7
%
 
10 bp
 
39.6
%
 
10 bp
 
39.5
%
HSNi
 
$
1,229,815

 
4%
 
$
1,183,724

 
8%
 
$
1,100,262

HSNi gross margin
 
36.1
%
 
(10 bp)
 
36.2
%
 
40 bp
 
35.8
%
bp = basis points

HSN
Gross profit for HSN in 2013 increased 1%, or $10.1 million, compared to the prior year. Gross margin decreased 20 basis points to 34.5% primarily due to lower shipping margins due to increases in shipping and handling promotions and shipping costs.

21



Gross profit for HSN in 2012 increased 6%, or $45.3 million, compared to the prior year. Gross margin improved 40 basis points to 34.7% from 34.3%. The margin increase was primarily attributable to an increase in product margins driven by product mix but were largely offset by the decrease in shipping margins primarily due to an increase in shipping promotions. The increase was also due to lower transaction costs related to debit card fees.
    
Cornerstone
Gross profit for Cornerstone in 2013 increased 9%, or $36.0 million, compared to the prior year. Gross margin increased 10 basis points from 39.6% to 39.7% primarily due to an increase in product margins driven by product mix and selective price increases.
Gross profit for Cornerstone in 2012 increased 11%, or $38.1 million, compared to the prior year. Gross margin improved 10 basis points to 39.6% from 39.5% in the prior year. The margin was positively impacted by lower inbound freight costs in the home brands, lower return rates and lower inventory reserves, offset by a decrease in net shipping margins driven by the increase in shipping promotions.
    
Selling and Marketing Expense
Selling and marketing expense consists primarily of advertising and promotional expenditures, compensation and other employee-related costs (including stock-based compensation) for personnel engaged in customer service, sales and merchandising, production and programming functions and on-air distribution costs. Advertising and promotional expenditures primarily include catalog production and distribution costs and online marketing, including fees paid to search engines and third-party distribution partners.

 
 
Year Ended December 31,
 
 
2013
 
Change
 
2012
 
Change
 
2011
 
 
(Dollars in thousands)
HSN
 
$
392,715

 
2%
 
$
385,243

 
4%
 
$
368,915

As a percentage of HSN net sales
 
17.0
%
 
0 bp
 
17.0
%
 
(10 bp)
 
17.1
%
Cornerstone
 
$
303,079

 
9%
 
$
277,079

 
12%
 
$
247,501

As a percentage of Cornerstone net sales
 
27.8
%
 
10 bp
 
27.7
%
 
50 bp
 
27.2
%
HSNi
 
$
695,794

 
5%
 
$
662,322

 
7%
 
$
616,416

As a percentage of HSNi net sales
 
20.4
%
 
10 bp
 
20.3
%
 
20 bp
 
20.1
%
    
HSNi's selling and marketing expense in 2013 increased 5%, or $33.5 million, and was 20.4% of net sales compared to 20.3% in the prior year. The increase was primarily due to additional catalog costs associated with a 5% increase in Cornerstone's catalog circulation and increases in employee-related and digital marketing costs.

HSNi's selling and marketing expense in 2012 increased 7%, or $45.9 million, and was 20.3% of net sales compared to 20.1% in 2011. The increase was primarily due to additional catalog costs associated with a 10% increase in Cornerstone's catalog circulation and increases in employee-related and digital marketing costs.
    

22



General and Administrative Expense
General and administrative expense consists primarily of compensation and other employee-related costs (including stock-based compensation) for personnel engaged in finance, legal, tax, human resources, information technology and executive management functions, bad debts, facilities costs and fees for professional services.
 
 
Year Ended December 31,
 
 
2013
 
Change
 
2012
 
Change
 
2011
 
 
(Dollars in thousands)
HSN
 
$
154,434

 
(5)%
 
$
162,417

 
7%
 
$
151,813

As a percentage of HSN net sales
 
6.7
%
 
(50 bp)
 
7.2
%
 
20 bp
 
7.0
%
Cornerstone
 
$
56,344

 
(9)%
 
$
62,236

 
9%
 
$
57,169

As a percentage of Cornerstone net sales
 
5.2
%
 
(100 bp)
 
6.2
%
 
(10 bp)
 
6.3
%
HSNi
 
$
210,778

 
(6)%
 
$
224,653

 
7%
 
$
208,982

As a percentage of HSNi net sales
 
6.2
%
 
(70 bp)
 
6.9
%
 
10 bp
 
6.8
%
HSNi’s general and administrative expense in 2013 decreased 6%, or $13.9 million, and was 6.2% of net sales compared to 6.9% in the prior year. The decrease in expense was primarily due to a $7.8 million sales tax settlement at Cornerstone that occurred in the prior year and lower bad debt expense related to HSN's extended payment program ("Flexpay"), partially offset by an increase in employee-related costs. There was also an increase in severance-related costs that was offset by a decrease in stock-based compensation expense.
Additionally, Cornerstone recognized non-cash fair value adjustments in the fourth quarter of 2013 related to a contingent consideration obligation and certain intangible assets associated with its 2012 acquisition of Chasing Fireflies. The net impact of the reduction of the contingent consideration obligation and the intangible asset impairment charge was a reduction of expense of $0.6 million which is included in "General and administrative expenses."
HSNi’s general and administrative expense in 2012 increased 7%, or $15.7 million, and was 6.9% of net sales compared to 6.8% in the prior year. The increase in expense was primarily due to a $7.8 million sales tax settlement at Cornerstone, an increase in bad debt expense due to higher usage of Flexpay and technology-related costs, partially offset by a $6.1 million decrease in stock-based compensation.
Depreciation and Amortization
 
 
 
Year Ended December 31,
 
 
2013
 
Change
 
2012
 
Change
 
2011
 
 
(Dollars in thousands)
HSN
 
$
28,372

 
7%
 
$
26,486

 
(4)%
 
$
27,652

Cornerstone
 
12,217

 
6%
 
11,519

 
41%
 
8,170

HSNi
 
$
40,589

 
7%
 
$
38,005

 
6%
 
$
35,822

As a percentage of HSNi net sales
 
1.2
%
 
0 bp
 
1.2
%
 
0 bp
 
1.2
%

Depreciation and amortization in 2013 increased 7%, or $2.6 million, compared to the prior year. The increase was primarily due to the incremental depreciation associated with recent capital expenditures for information and digital technology.

Depreciation and amortization in 2012 increased 6%, or $2.2 million, compared to the prior year. The increase was primarily due to depreciation on leasehold improvements and equipment related to a new leased Cornerstone warehouse facility opened in 2012 and amortization of intangibles acquired in the second quarter related to the Chasing Fireflies acquisition, partially offset by certain fixed assets becoming fully depreciated during 2012.

    

23



Adjusted EBITDA
Adjusted EBITDA is a non-GAAP measure and is defined in Note 6 of Notes to Consolidated Financial Statements.

 
 
Year Ended December 31,
 
 
2013
 
Change
 
2012
 
Change
 
2011
 
 
(Dollars in thousands)
HSN
 
$
261,292

 
4%
 
$
250,836

 
7%
 
$
235,164

As a percentage of HSN net sales
 
11.3
%
 
20 bp
 
11.1
%
 
20 bp
 
10.9
%
Cornerstone
 
$
76,574

 
4%
 
$
73,441

 
9%
 
$
67,595

As a percentage of Cornerstone net sales
 
7.0
%
 
(30 bp)
 
7.3
%
 
(10 bp)
 
7.4
%
HSNi
 
$
337,866

 
4%
 
$
324,277

 
7%
 
$
302,759

As a percentage of HSNi net sales
 
9.9
%
 
0 bp
 
9.9
%
 
0 bp
 
9.9
%

HSNi's Adjusted EBITDA in 2013 increased 4%, or $13.6 million, and was 9.9% of net sales, consistent with the prior year. The increase in Adjusted EBITDA was due to a 4% increase in net sales, partially offset by a 4% increase in operating expenses (excluding non-cash charges and $7.8 million sales tax settlement in the prior year). HSN's Adjusted EBITDA increased 4%, or $10.5 million, primarily due to a 2% increase in net sales, partially offset by a 20 basis point decline in gross margin. HSN's operating expenses (excluding non-cash charges) were 23.2% of net sales compared to 23.7% in the prior year. Decreases in HSN's professional services fees and bad debt expense were offset by increases in employee-related and digital marketing costs. Cornerstone's Adjusted EBITDA increased 4%, or $3.1 million, primarily due to a 9% increase in net sales, partially offset by a 10% increase in operating expenses (excluding non-cash charges and a $7.8 million sales tax settlement in the prior year). The increase in operating expenses was largely due to catalog costs associated with the 5% increase in circulation; employee-related costs; the incremental expenses from the addition of Chasing Fireflies to the portfolio in April 2012 and investments in digital marketing.
HSNi's Adjusted EBITDA in 2012 increased 7%, or $21.5 million, and was 9.9% of net sales, consistent with the prior year. The increase in Adjusted EBITDA was primarily due to a 6% increase in net sales and a 40 basis point improvement in gross margin, partially offset by an 8% increase in operating expenses (excluding non-cash charges and a $7.8 million sales tax settlement). HSN's Adjusted EBITDA increased 7%, or $15.7 million, primarily due to a 5% increase in net sales and a 40 basis point improvement in gross margin, partially offset by a 6% increase in operating expenses (excluding non-cash charges) primarily for employee-related costs, digital and brand marketing and bad debt expense. Cornerstone's Adjusted EBITDA increased 9%, or $5.8 million, primarily due to the acquisition of Chasing Fireflies in April 2012.
Operating Income

 
 
Year Ended December 31,
 
 
2013
 
Change
 
2012
 
Change
 
2011
 
 
(Dollars in thousands)
HSN
 
$
221,184

 
4%
 
$
212,503

 
10%
 
$
192,928

As a percentage of HSN net sales
 
9.6
%
 
20 bp
 
9.4
%
 
50 bp
 
8.9
%
Cornerstone
 
$
61,470

 
33%
 
$
46,241

 
—%
 
$
46,114

As a percentage of Cornerstone net sales
 
5.6
%
 
100 bp
 
4.6
%
 
(50 bp)
 
5.1
%
HSNi
 
$
282,654

 
9%
 
$
258,744

 
8%
 
$
239,042

As a percentage of HSNi net sales
 
8.3
%
 
40 bp
 
7.9
%
 
10 bp
 
7.8
%
HSNi's operating income in 2013 increased 9%, or $23.9 million, and was 8.3% of net sales compared to 7.9% in the prior year. The increase was primarily due to 4% growth in net sales offset by a 2% increase in operating expenses. The increase in operating expenses was primarily due to increases in employee-related costs, catalog costs and digital marketing, partially offset by a $7.8 million unfavorable sales tax settlement at Cornerstone in the prior year and decreases in professional services fees and bad debt expenses at HSN.
HSNi's operating income in 2012 increased 8%, or $19.7 million, and was 7.9% of net sales compared to 7.8% in the prior year. The increase was primarily due to 6% growth in net sales and 40 basis point improvement in gross margin, partially offset by a 7% increase in operating expenses primarily for Cornerstone's catalog circulation and $7.8 million sales tax settlement, digital marketing and technology costs, and employee-related costs.

24



    
Other Income (Expense)

 
 
Year Ended December 31,
 
 
2013

Change

2012

Change

2011
 
 
(Dollars in thousands)
Interest income
 
$
205

 
(64)%
 
$
564

 
(17)%
 
$
679

Interest expense
 
(6,718
)
 
(68)%
 
(20,811
)
 
(35)%
 
(31,963
)
Loss on debt extinguishment
 

 
NA
 
(18,627
)
 
NA
 

Total other expense, net
 
$
(6,513
)
 
(83)%
 
$
(38,874
)
 
24%
 
$
(31,284
)
As a percentage of HSNi net sales
 
0.2
%
 
(100 bp)
 
1.2
%
 
20 bp
 
1.0
%

Interest Expense
On April 24, 2012, HSNi entered into a $600 million five-year syndicated credit agreement (“Credit Agreement”) which replaced the credit agreement that was set to expire in July 2013.  On July 31, 2012, HSNi drew $250 million from its delayed draw term loan under the Credit Agreement. The proceeds of the term loan were used to fully redeem the $240 million 11.25% Senior Notes due 2016 (“Senior Notes”) on August 1, 2012 as discussed below. As a result of these refinancing transactions, interest expense decreased 68% in 2013, or $14.1 million.

    Interest expense in 2012 was primarily related to the Senior Notes which bore interest at 11.25% through the August 1, 2012 redemption date and the $250 million term loan outstanding under the Credit Agreement. Interest expense in 2011 primarily related to the Senior Notes and the $69.8 million term loan outstanding under the prior credit agreement.

Loss on Debt Extinguishment

On August 1, 2012, HSNi fully redeemed its $240 million Senior Notes. The Senior Notes were redeemed for $253.5 million, or 105.625% of the principal amount.  HSNi reported approximately $18.6 million in “Loss on debt extinguishment” primarily associated with redemption of the Senior Notes in the third quarter of 2012.  These charges resulted from the redemption premium of $13.5 million and $5.1 million related to the write-off of unamortized issuance costs and original issue discount.
Income Tax Provision
For the years ended December 31, 2013, 2012 and 2011, HSNi recorded tax provisions from continuing operations of $97.7 million, $83.4 million and $80.1 million, respectively, which represent effective tax rates of 35.4%, 37.9% and 38.6%, respectively.
The change in the effective tax rate in 2013 from the prior periods was primarily due to discrete tax benefits of $3.7 million realized in the third quarter of 2013 and the favorable tax treatment of the fair value adjustments related to the 2012 acquisition of Chasing Fireflies recorded in the fourth quarter of 2013.  Excluding the impact of these items, the 2013 effective tax rate for continuing operations would have been 37%. The adjusted rate of 37% in 2013, as well as the 2012 and 2011 tax rates, are higher than the federal statutory rate of 35% due principally to state income taxes.
Discontinued Operations
In May 2012, substantially all of the assets and certain liabilities of Smith+Noble, a Cornerstone brand specializing in window treatments, were sold for $5.5 million. The operating results for Smith+Noble are included in “Loss from discontinued operations, net of tax” in the consolidated statements of operations for all periods presented. Cornerstone recorded an after-tax loss on the sale of $0.1 million in the second quarter of 2012, which is included in “Loss from discontinued operations, net of tax” in the accompanying consolidated statements of operations.

In July 2012, substantially all of the assets and certain liabilities of The Territory Ahead, a Cornerstone brand specializing in casual apparel for men and women, were sold for approximately $1.1 million. The operating results for The Territory Ahead are included in “Loss from discontinued operations, net of tax” in the consolidated statements of operations for all periods presented. An impairment charge of $5.9 million was recorded in the second quarter of 2012 to reduce the carrying

25



value of the net assets to their estimated net realizable value and is included in “Loss from discontinued operations, net of tax” in the accompanying consolidated statements of operations.
Liquidity and Capital Resources
As of December 31, 2013, HSNi had $196.4 million of cash and cash equivalents, down from $222.1 million as of December 31, 2012.
Net cash provided by operating activities attributable to continuing operations was $231.9 million in 2013 compared to $147.4 million in 2012, an increase of $84.5 million. This increase was primarily due to improved operating performance and changes in working capital. Working capital improved primarily as a result of lower inventory receipts, effective inventory management and the timing of collection of credit card receivables, offset by the timing of income tax payments.

Inventory receipts were particularly high in 2012 as both HSN and Cornerstone were increasing their inventory balances to support sales growth. HSN's sales growth in 2013 was lower than expected resulting in additional clearance activity and a reduction in inventory receipts. However, these measures have resulted in inventory in 2013 decreasing by 17% compared to prior year and aged inventories being at their lowest levels since 2010. Cornerstone continued to grow its inventory in 2013 to support its future sales growth. Cornerstone's inventory increased 26% in 2013 and 10% in 2012.

Consistent with prior years, HSN continued to increase its offering of Flexpay, an installment program which allows customers to pay for select merchandise in two to six interest-free, monthly payments. This program increases the Company's cash requirements as the sales proceeds get delayed by using the Flexpay alternative. Despite the increased usage of Flexpay, the Company did not experience any deterioration in the aging of Flexpay receivables or had an increase in its write-offs of receivables in 2013.
Net cash used in investing activities attributable to continuing operations in 2013 was $61.1 million. Capital expenditures in 2013 was $52.0 million and was primarily for investments in information and digital technology. HSNi also made an advance payment of $9.1 million for warehouse improvement projects.
Net cash used in financing activities attributable to continuing operations in 2013 was $196.4 million. During 2013, HSNi repurchased 2.7 million shares of common stock for $146.9 million at an average cost of $53.67. HSNi also paid dividends totaling $0.79 per common share resulting in $42.3 million in payments during 2013. Repayments of $9.4 million of HSNi's term loan were made in 2013. HSNi had a cash inflow of $8.4 million from the proceeds from stock option exercises and a cash outflow of $14.4 million to cover withholding taxes for stock-based awards. Additionally, in 2013 HSNi had $10.4 million of excess tax benefits from stock-based awards.

HSNi's $600 million Credit Agreement is secured by 100% of the voting equity securities of HSNi's U.S. subsidiaries and 65% of the voting equity securities of HSNi's first-tier foreign subsidiaries. This Credit Agreement replaced the credit agreement that was set to expire in July 2013. Certain HSNi subsidiaries have unconditionally guaranteed HSNi's obligations under the Credit Agreement.  The Credit Agreement, which includes a $350 million revolving credit facility and a $250 million term loan, may be increased up to $850 million subject to certain conditions and expires April 24, 2017. HSNi drew $250 million from its term loan on July 31, 2012 to fund the redemption of the Senior Notes, as discussed below. As of December 31, 2013, $240.6 million was outstanding under the term loan. HSNi capitalized $5.5 million in financing costs related to the Credit Agreement and is amortizing these costs to interest expense over the Credit Agreement's five-year term.
The Credit Agreement contains various covenants, limitations and events of default customary for similar facilities including a maximum leverage ratio of 3.00x and a minimum interest coverage ratio of 3.00x. HSNi was in compliance with all such covenants as of December 31, 2013, with a leverage ratio of 0.73x and an interest coverage ratio of 60.68x.

Loans under the Credit Agreement bear interest at a per annum rate equal to LIBOR plus a predetermined margin that ranges from 1.50% to 2.25% or the Base Rate (as defined in the Credit Agreement) plus a predetermined margin that ranges from 0.50% to 1.25%.  HSNi can elect to borrow at either LIBOR or the Base Rate and the predetermined margin is based on HSNi's leverage ratio. The term loan interest rate as of December 31, 2013 was 1.66%.  HSNi pays a commitment fee ranging from 0.25% to 0.40% (based on the leverage ratio) on the unused portion of the revolving credit facility. 
The amount available under the Credit Agreement is reduced by the amount of commercial and standby letters of credit issued under the revolving credit facility, which totaled $31.7 million as of December 31, 2013. The ability to draw funds under the revolving credit facility is dependent upon meeting the aforementioned financial covenants, which may limit HSNi’s ability to draw the full amount of the facility. As of December 31, 2013, the additional amount that could be borrowed under

26



the revolving credit facility, in consideration of the financial covenants and outstanding letters of credit, was approximately $318.3 million.
To reduce our future exposure to rising interest rates under our credit facility, we entered into a forward-starting swap in December 2012 that effectively converts $187.5 million of our variable rate term loan to a fixed-rate of 0.8525%, resulting in an all-in fixed rate of 2.3525% (based on HSNi's leverage ratio as of December 31, 2013), beginning January 2014 through April 2017. For additional information related to our interest rate swaps, refer to Note 8 of Notes to Consolidated Financial Statements.
On July 28, 2008, HSNi issued $240 million of 11.25% Senior Notes due 2016. The Senior Notes were fully redeemed on August 1, 2012 for $253.5 million, or 105.625% of the principal amount. HSNi drew $250 million from its term loan on July 31, 2012 and used its cash on hand to fund the redemption. HSNi reported approximately $18.6 million in pre-tax charges primarily associated with redemption of the Senior Notes. These charges resulted from the redemption premium of $13.5 million and $5.1 million related to the write-off of unamortized issuance costs and original issue discount.
HSNi does not currently have any material commitments for capital expenditures; however, management does anticipate that HSNi will need to make capital and other expenditures in connection with the development and expansion of its operations. HSNi’s ability to fund its cash and capital needs will be affected by its ongoing ability to generate cash from operations, the overall capacity and terms of its financing arrangements as discussed above, and access to the capital markets. HSNi believes that its cash on hand, its anticipated operating cash flows, its available unused portion of the revolving credit facility and its access to capital markets will be sufficient to fund its operating needs, capital, investing and other commitments and contingencies for the foreseeable future.
On September 27, 2011, HSNi’s Board of Directors approved a share repurchase program which allows HSNi to purchase 10 million shares of its common stock from time to time through privately negotiated and/or open market transactions. The timing of any repurchases and actual number of shares repurchased will depend on a variety of factors, including the stock price, corporate and regulatory requirements, restrictions under HSNi’s debt obligations and other market and economic conditions. The repurchase program may be suspended or discontinued by HSNi at any time. For the year ended December 31, 2013, HSNi repurchased approximately 2.7 million shares at a cost of $146.9 million at an average cost of $53.67 per share. As of December 31, 2013, approximately 1.0 million shares remained authorized for repurchase under the program.
In February 2014, HSNi's Board of Directors approved a cash dividend of $0.25 per common share. The dividend will be paid on March 19, 2014 to HSNi's record holders as of March 5, 2014.
Contractual Obligations and Commercial Commitments
The following table presents HSNi’s contractual obligations as of December 31, 2013:

 
 
Payments Due by Period
Contractual Obligations
 
Total
Amounts
Committed
 
Less Than
1 Year
 
1 - 3 Years
 
3 - 5 Years
 
More Than
5  Years
 
 
(In thousands)
Long-term debt, including current maturities
 
$
240,625

 
$
12,500

 
$
35,938

 
$
192,187

 
$

Interest on debt (a)
 
16,422

 
5,187

 
9,828

 
1,407

 

Operating leases
 
103,407

 
24,756

 
38,285

 
26,666

 
13,700

Purchase obligations (b)
 
141,678

 
73,610

 
68,016

 
52

 

Total contractual obligations
 
$
502,132

 
$
116,053

 
$
152,067

 
$
220,312

 
$
13,700


(a)
Includes interest on variable rate debt estimated using the rate in effect as of December 31, 2013 through January 31, 2014, at which time the forward-starting interest rate swap goes into effect. An all-in fixed rate of 2.3525% based on HSNi's leverage ratio as of December 31, 2013 is then assumed from February 1, 2014 through April 2017, the date of expiration of the variable rate debt.
(b)
The purchase obligations primarily relate to contracts with pay television operators and include obligations for future cable distribution and commission guarantees.


27



 
 
Amount of Commitments Expiration Per Period
Commercial Commitments
 
Total
Amounts
Committed
 
Less Than
1 Year
 
1 - 3 Years
 
3 - 5 Years
 
More Than
5 Years
 
 
(In thousands)
Letters of credit and surety bonds (c)
 
$
35,711

 
$
35,561

 
$
150

 
$

 
$


(c)
The letters of credit (“LOCs”) primarily consist of trade LOCs which are used for inventory purchases. Trade LOCs are guarantees of payment based upon the delivery of goods. The surety bonds primarily consist of custom bonds which relate to the import of merchandise into the United States.

We issue inventory purchase orders in the normal course of business, which represent authorizations to purchase that are cancelable by their terms. We do not consider purchase orders to be firm inventory commitments; therefore, they are excluded from the table above. If we choose to cancel a purchase order, we may be obligated to reimburse the vendor for unrecoverable outlays incurred prior to cancellation.

At December 31, 2013, we had $1.1 million, including penalties and interest, recorded for uncertain tax positions. We are not able to reasonably estimate the timing of payments in future periods; therefore, the liability of $1.1 million has not been included in the contractual obligations table above.

Off-Balance Sheet Arrangements
Other than the items described above, HSNi does not have any material off-balance sheet arrangements as of December 31, 2013.
Seasonality
HSNi is affected by seasonality, although historically our business has exhibited less seasonality than many other retail businesses. Our sales levels are generally higher in the fourth quarter. Reported revenues in the fourth quarter were 30% of total reported annual revenues in 2013, 2012 and 2011, respectively.

Non-GAAP Measure
HSNi reports Adjusted EBITDA as a supplemental measure to generally accepted accounting principles ("GAAP"). This measure is one of the primary metrics by which HSNi evaluates the performance of its businesses, on which its internal budgets are based and by which management is compensated. HSNi believes that investors should have access to the same information that it uses in analyzing its results.
Adjusted EBITDA is defined as operating income excluding, if applicable: (1) non-cash charges including: (a) stock-based compensation expense, (b) amortization of intangibles, (c) depreciation and gains and losses on asset dispositions, and (d) goodwill, long-lived asset and intangible asset impairments; (2) pro forma adjustments for significant acquisitions; and (3) other significant items. Significant items, while periodically affecting our results, may vary significantly from period to period and have a disproportionate effect in a given period, thereby affecting the comparability of results. Adjusted EBITDA is not a measure determined in accordance with GAAP, and should not be considered in isolation or as a substitute for operating income, net income or any other measure determined in accordance with GAAP. Adjusted EBITDA is used as a measurement of operating efficiency and overall financial performance and HSNi believes it to be a helpful measure for those evaluating companies in the retail and media industries. Adjusted EBITDA has certain limitations in that it does not take into account the impact to HSNi's consolidated statements of operations of certain expenses, including stock-based compensation, amortization of intangibles, depreciation, gains and losses on asset dispositions, asset impairment charges, acquisition-related accounting and other significant items.

Items That Are Excluded From HSNi's Non-GAAP Measure
Stock-based compensation expense consists principally of expense associated with the grants of restricted stock, restricted stock units, stock options and stock appreciation rights. These expenses are not paid in cash, and HSNi includes the related shares in its calculations of diluted shares outstanding. Upon vesting of restricted stock and restricted stock units and the exercise of certain stock options and stock appreciation rights, the awards can be settled, at HSNi's discretion, on a net basis, with HSNi remitting the required tax withholding amount from its current funds.

28



Amortization of intangibles is a non-cash expense relating primarily to acquisitions. At the time of an acquisition, the intangible assets of the acquired company, such as distribution agreements, customer relationships and merchandise agreements, are valued and amortized over their estimated lives.
Depreciation, gains and losses on asset dispositions and long-lived asset impairment charges are non-cash items relating to our long-lived assets and have been excluded from Adjusted EBITDA.
Goodwill and intangible asset impairment charges are also non-cash expenses that have been excluded from Adjusted EBITDA.
Other Significant Items represent transactions that may vary significantly from period to period and have a disproportionate effect in a given period, thereby affecting the comparability of results.

Reconciliation of Adjusted EBITDA
See Note 6 of Notes to Consolidated Financial Statements for the reconciliation between Adjusted EBITDA and net income for the years ended December 31, 2013, 2012 and 2011.

Critical Accounting Policies and Estimates
The following disclosure is provided to supplement the descriptions of HSNi's accounting policies contained in Note 2 of Notes to Consolidated Financial Statements in regard to significant areas of judgment. HSNi's management is required to make certain estimates and assumptions during the preparation of its consolidated financial statements in accordance with GAAP. These estimates and assumptions impact the reported amount of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements. They also impact the reported amount of net income during any period. Actual results could differ from those estimates. Because of the size of the financial statement elements to which they relate, some of HSNi's accounting policies and estimates have a more significant impact on its consolidated financial statements than others. The following is a discussion of some of HSNi's more significant accounting policies and estimates.

Recoverability of Long-Lived Assets
HSNi reviews the carrying value of all long-lived assets, primarily property and equipment and definite-lived intangible assets, for impairment whenever triggering events or changes in circumstances indicate that the carrying value of an asset may be impaired. Impairment is considered to have occurred whenever the carrying value of a long-lived asset exceeds the sum of the undiscounted cash flows that is expected to result from the use and eventual disposition of the asset. The impairment is measured by comparing the fair value of the asset to its carrying value. Our valuation methodologies include, but are not limited to, discounting the future cash flows from the asset being tested. Significant judgments include determining if a triggering event has occurred, determining the future cash flows from the assets and applying the appropriate discount rate when measuring the fair value. The determination of cash flows is based upon assumptions that may not occur.
Impairment of Goodwill and Indefinite-Lived Intangible Assets
HSNi assesses the impairment of goodwill and identifiable indefinite-lived intangible assets, principally trademarks and trade names, at least annually during the fourth quarter and whenever events or changes in circumstances indicate that the carrying value of an asset may be impaired. In performing this review, HSNi has the option of performing a qualitative assessment to determine whether it is more likely than not that the fair values of the reporting unit and/or indefinite-lived intangible assets are less than the carrying values. In performing the qualitative assessment, HSNi considers various factors including (but not limited to): macroeconomic, industry and market conditions; cost factors affecting the business; the overall financial performance of the business; any relevant changes in management, strategies or customers; and any sustained decreases in its stock price. If HSNi determines based on this assessment that it is not more likely that the fair value is less than its carrying value, then the goodwill and/or the indefinite-lived intangible assets are deemed to be not impaired and no further testings is required until the next annual test date (or sooner if conditions or events before that date raise concerns of potential impairment in the business). If HSNi determines that it is more likely than not that the fair value is less than its carrying value, then the quantitative goodwill and/or indefinite-lived intangible asset impairment tests must be completed.

If necessary, HSNi performs a quantitative assessment of the fair values of its goodwill and intangible assets. In performing this review, HSNi is required to make an assessment of the fair value of its intangible assets. If it is determined that the implied fair value of goodwill and/or indefinite-lived intangible assets is less than the carrying amount, an impairment charge, equal to the excess, is recorded. HSNi determines the fair value of its reporting units by using a discounted cash flow

29



analysis with consideration of an equity analysis based on the trading value of its common stock. HSNi utilizes the relief from royalty method to assess fair values of its trademarks and trade names.
In assessing fair value, HSNi considers, among other indicators, differences between estimated and actual cash flows and revenue streams and changes in the related discount, royalty and terminal growth rates. Determining these rates requires the exercise of significant judgments. These factors used in the determination of fair value are sensitive to, among other things, changes in the retail consumer market and the general economy.
Returns Reserves
Net sales from HSNi primarily consist of merchandise sales and are reduced by incentive discounts and sales returns. HSNi's sales policy allows customers to return virtually all merchandise for a full refund or exchange, subject to pre-established time restrictions. Allowances for returned merchandise and other adjustments (including reimbursed shipping and handling costs) are provided based upon past experience. Actual levels of product returns may vary from these estimates. HSNi's estimated return rates were 17.0%, 17.8% and 18.5% in 2013, 2012 and 2011, respectively.
Allowance for Doubtful Accounts
HSNi makes judgments as to its ability to collect outstanding receivables and provide allowances when it has determined that all or a portion of the receivable will not be collected. HSNi determines its allowance by considering a number of factors, including the length of time accounts receivable are past due, its previous loss history and the condition of the general economy. HSNi writes off accounts receivable when they are determined to be uncollectible.
Income Taxes
Estimates of deferred income taxes and the significant items giving rise to the deferred tax assets and liabilities are shown in Note 12 of Notes to Consolidated Financial Statements, and reflect management's assessment of actual future taxes to be paid on items reflected in the consolidated financial statements, giving consideration to both timing and the probability of realization. Actual income taxes could vary from these estimates due to future changes in income tax law, state income tax apportionment, as well as actual operating results of HSNi that vary significantly from anticipated results. Valuation allowances are related to items for which it is more likely than not that the tax benefit will not be realized. In assessing the adequacy of a recorded valuation allowance, we consider all positive and negative information and a variety of factors including the scheduled reversal of deferred tax liabilities, historical and projected future taxable income and feasible tax planning strategies. HSNi recognizes liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on its technical merits. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. This measurement step is inherently difficult and requires subjective estimations of such amounts to determine the probability of various possible outcomes. HSNi considers many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes.
Inventory Valuation
Inventories are valued at the lower of cost or market, cost being determined based upon the first-in, first-out method. Market is determined on the basis of net realizable value, giving consideration to obsolescence and other factors. Net realizable value is estimated by HSNi based upon historical sales data, the age of inventory, the quantity of goods on hand and the ability to return merchandise to vendors. The actual net realizable value may vary from estimates due to changes in customer tastes or viewing habits, or judgmental decisions made by merchandising personnel when ordering new products.

30



Stock-Based Compensation
We measure compensation cost for stock-based awards at fair value and recognize compensation over the service period for awards expected to vest. We consider many factors when estimating expected forfeitures, including types of awards, employee class and historical experience. HSNi grants performance-based equity awards whose value is based on the extent to which certain pre-established performance goals are achieved during a three-year period. Each reporting period prior to the vesting of these awards, management must apply significant judgment when estimating the expected future achievement of the designated performance metrics. The estimation of stock awards that will ultimately vest and the estimation of the value of the performance-based awards require judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. The fair value of restricted stock units is determined based on the number of shares granted and the closing price of our common stock at the grant date. The fair value of stock options, stock appreciation rights and options granted under our employee stock purchase plan are estimated on the grant date using the Black-Scholes option pricing model. This model incorporates various assumptions, including expected volatility and expected term. Expected stock price volatilities are estimated based on HSNi's historical experience and the historical and implied volatilities of comparable publicly-traded companies. The expected term of awards granted is based on analyses of historical employee termination rates and option exercise patterns, giving consideration to expectations of future employee behavior. Actual results and future estimates may differ substantially from our current estimates.

ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At December 31, 2013 and 2012, HSNi’s outstanding long-term debt was $240.6 million and $250.0 million, respectively, all of which pays interest at a variable rate, generally tied to LIBOR. Changes in interest rates on our variable rate debt could affect our earnings. We are managing our future interest rate exposure through a forward-starting interest rate swap with a notional amount of $187.5 million and a fixed rate of 0.8525% that takes effect January 2014. A hypothetical 100 basis point increase in interest rates on the portion of our variable rate debt that is not effectively hedged by the fixed-rate interest rate swap would increase our annual interest expense by approximately $0.6 million in 2014.


31




ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements


32



Report of Independent Registered Certified Public Accounting Firm
The Board of Directors and Shareholders of HSN, Inc.
We have audited the accompanying consolidated balance sheets of HSN, Inc. and subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2013. Our audits also included the financial statement schedule listed in the Index as Schedule II. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of HSN, Inc. and subsidiaries at December 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), HSN, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated February 20, 2014, expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP
Tampa, Florida
February 20, 2014


33



HSN, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
 
 
 
Years Ended
December 31,
 
 
2013
 
2012
 
2011
Net sales
 
$
3,403,983

 
$
3,266,739

 
$
3,069,356

Cost of sales
 
2,174,168

 
2,083,015

 
1,969,094

Gross profit
 
1,229,815

 
1,183,724

 
1,100,262

Operating expenses:
 
 
 
 
 
 
Selling and marketing
 
695,794

 
662,322

 
616,416

General and administrative
 
210,778

 
224,653

 
208,982

Depreciation and amortization
 
40,589

 
38,005

 
35,822

Total operating expenses
 
947,161

 
924,980

 
861,220

Operating income
 
282,654

 
258,744

 
239,042

Other income (expense):
 
 
 
 
 
 
Interest income
 
205

 
564

 
679

Interest expense
 
(6,718
)
 
(20,811
)
 
(31,963
)
Loss on debt extinguishment
 

 
(18,627
)
 

Total other expense, net
 
(6,513
)
 
(38,874
)
 
(31,284
)
Income from continuing operations before income taxes
 
276,141

 
219,870

 
207,758

Income tax provision
 
(97,692
)
 
(83,373
)
 
(80,106
)
Income from continuing operations
 
178,449

 
136,497

 
127,652

Loss from discontinued operations, net of tax
 

 
(5,822
)
 
(4,582
)
Net income
 
$
178,449

 
$
130,675

 
$
123,070

 
 
 
 
 
 
 
Income from continuing operations per share:
 
 
 
 
 
 
Basic
 
$
3.33

 
$
2.42

 
$
2.18

Diluted
 
$
3.25

 
$
2.36

 
$
2.10

Net income per share:
 
 
 
 
 
 
Basic
 
$
3.33

 
$
2.32

 
$
2.10

Diluted
 
$
3.25

 
$
2.25

 
$
2.03

Shares used in computing earnings per share:
 
 
 
 
 
 
Basic
 
53,640

 
56,314

 
58,636

Diluted
 
54,857

 
57,956

 
60,689

Dividends declared per common share
 
$
0.79

 
$
0.555

 
$
0.125


The accompanying notes are an integral part of these consolidated financial statements.


34



HSN, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)

 
 
Years Ended
December 31,
 
 
2013
 
2012
 
2011
Net income
 
$
178,449

 
$
130,675

 
$
123,070

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
Change in fair value of derivative instrument
 
825

 
(471
)
 

Other comprehensive income (loss), net of tax
 
825

 
(471
)
 

Comprehensive income
 
$
179,274

 
$
130,204

 
$
123,070


The accompanying notes are an integral part of these consolidated financial statements.

35




HSN, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
 
 
December 31,
 
 
2013
 
2012
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
196,433

 
$
222,092

Accounts receivable, net of allowance of $16,863 and $14,537, respectively
 
265,115

 
249,890

Inventories
 
327,319

 
330,936

Deferred income taxes
 
29,761

 
27,603

Prepaid expenses and other current assets
 
48,630

 
46,172

Total current assets
 
867,258

 
876,693

Property and equipment, net
 
178,720

 
171,303

Intangible assets, net
 
262,460

 
266,876

Goodwill
 
9,858

 
9,858

Other non-current assets
 
19,627

 
7,222

TOTAL ASSETS
 
$
1,337,923

 
$
1,331,952

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable, trade
 
$
255,627

 
$
267,061

Current maturities of long-term debt
 
12,500

 
9,375

Accrued expenses and other current liabilities
 
207,984

 
215,389

Total current liabilities
 
476,111

 
491,825

Long-term debt, less current maturities
 
228,125

 
240,625

Deferred income taxes
 
88,034

 
79,002

Other long-term liabilities
 
16,572

 
15,986

Total liabilities
 
808,842

 
827,438

Commitments and contingencies (Note 13)
 

 

SHAREHOLDERS’ EQUITY:
 
 
 
 
Preferred stock $0.01 par value; 25,000,000 authorized shares; no issued shares
 

 

Common stock $0.01 par value; 300,000,000 authorized shares; 53,002,368 and 54,853,684 issued shares as of December 31, 2013 and 2012, respectively
 
530

 
549

Additional paid-in capital
 
1,810,072

 
1,964,760

Accumulated deficit
 
(1,281,875
)
 
(1,460,324
)
Accumulated other comprehensive income (loss)
 
354

 
(471
)
Total shareholders’ equity
 
529,081

 
504,514

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
 
$
1,337,923

 
$
1,331,952


The accompanying notes are an integral part of these consolidated financial statements.

36



HSN, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In thousands)
 
 
 
Preferred
Stock
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Deficit
 
Accumulated
Other
Comprehensive
(Loss) Income
 
Total
 
 
Shares
 
Amount
 
Shares
 
Amount
 
Balance as of December 31, 2010
 

 
$

 
57,967

 
$
580

 
$
2,189,952

 
$
(1,714,069
)
 
$

 
$
476,463

Net income
 

 

 

 

 

 
123,070

 

 
123,070

Stock-based compensation expense for equity awards
 

 

 

 

 
18,908

 

 

 
18,908

Cash dividend declared on common stock
 

 

 

 

 
(7,384
)
 

 


 
(7,384
)
Issuance of common stock from stock-based compensation awards, including tax benefit of $9,330
 

 

 
1,238

 
12

 
6,689

 

 

 
6,701

Repurchases of common stock
 

 

 
(791
)
 
(8
)
 
(28,053
)
 
 
 
 
 
(28,061
)
Balance as of December 31, 2011
 

 

 
58,414

 
584

 
2,180,112

 
(1,590,999
)
 

 
589,697

Net income
 

 

 

 

 

 
130,675

 

 
130,675

Other comprehensive loss
 

 

 

 

 

 

 
(471
)
 
(471
)
Stock-based compensation expense for equity awards
 

 

 

 

 
14,440

 

 

 
14,440

Cash dividend declared on common stock
 

 

 

 

 
(31,049
)
 

 

 
(31,049
)
Issuance of common stock from stock-based compensation awards, including tax benefit of $18,900
 

 

 
1,901

 
19

 
21,797

 

 

 
21,816

Repurchases of common stock
 

 

 
(5,461
)
 
(54
)
 
(220,540
)
 

 

 
(220,594
)
Balance as of December 31, 2012
 

 

 
54,854

 
549

 
1,964,760

 
(1,460,324
)
 
(471
)

504,514

Net income
 

 

 

 

 

 
178,449

 

 
178,449

Other comprehensive income
 

 

 

 

 

 

 
825

 
825

Stock-based compensation expense for equity awards
 

 

 

 

 
14,043

 

 

 
14,043

Cash dividend declared on common stock
 

 

 

 

 
(42,281
)
 

 

 
(42,281
)
Issuance of common stock from stock-based compensation awards, including tax benefit of $9,788
 

 

 
885

 
9

 
20,416

 

 

 
20,425

Repurchases of common stock
 

 

 
(2,737
)
 
(28
)
 
(146,866
)
 

 

 
(146,894
)
Balance as of December 31, 2013
 

 
$

 
53,002

 
$
530

 
$
1,810,072

 
$
(1,281,875
)
 
$
354

 
$
529,081


The accompanying notes are an integral part of these consolidated financial statements.


37



HSN, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
 
Years Ended December 31,
 
 
2013
 
2012
 
2011
Cash flows from operating activities attributable to continuing operations:
 
 
 
 
 
 
Net income
 
$
178,449

 
$
130,675

 
$
123,070

Loss from discontinued operations, net of tax
 

 
(5,822
)
 
(4,582
)
Income from continuing operations
 
178,449

 
136,497

 
127,652

Adjustments to reconcile income from continuing operations to net cash provided by operating activities attributable to continuing operations:
 
 
 
 
 
 
Depreciation and amortization
 
40,589

 
38,005

 
35,822

Stock-based compensation expense
 
14,043

 
19,056

 
26,401

Loss on debt extinguishment
 

 
18,627

 

Amortization of debt issuance costs
 
1,130

 
1,777

 
2,941

Deferred income taxes
 
6,370

 
(2,146
)
 
2,238

Bad debt expense
 
22,773

 
24,186

 
19,758

Excess tax benefits from stock-based awards
 
(10,360
)
 
(19,004
)
 
(9,835
)
Fair value adjustment to contingent consideration obligation
 
(3,600
)
 

 

Asset impairment
 
3,040

 

 

Other
 
1,140

 
764

 
2,343

Changes in assets and liabilities:
 
 
 
 
 
 
Accounts receivable
 
(38,211
)
 
(51,995
)
 
(46,201
)
Inventories
 
3,617

 
(36,117
)
 
(1,385
)
Prepaid expenses and other assets
 
(6,318
)
 
(3,724
)
 
(3,213
)
Accounts payable, accrued expenses and other current liabilities
 
19,245

 
21,487

 
8,834

Net cash provided by operating activities attributable to continuing operations
 
231,907

 
147,413

 
165,355

Cash flows from investing activities attributable to continuing operations:
 
 
 
 
 
 
Capital expenditures
 
(51,952
)
 
(45,803
)
 
(42,069
)
Acquisition of business, net of cash received
 

 
(22,875
)
 

Advance payment of capital expenditure
 
(9,100
)
 

 

Proceeds from sale of discontinued operations
 

 
6,580

 

Net cash used in investing activities attributable to continuing operations
 
(61,052
)
 
(62,098
)
 
(42,069
)
Cash flows from financing activities attributable to continuing operations:
 
 
 
 
 
 
Redemption of Senior Notes
 

 
(253,500
)
 
(69,841
)
Borrowing under term loan
 

 
250,000

 

Repayments of long-term debt
 
(9,375
)
 

 

Payments of debt issuance costs
 

 
(4,607
)
 

Repurchase of common stock
 
(146,894
)
 
(221,835
)
 
(26,821
)
Cash dividends paid
 
(42,281
)
 
(31,049
)
 
(7,384
)
Proceeds from issuance of common stock
 
8,396

 
20,688

 
8,845

Tax withholdings related to stock-based awards
 
(14,395
)
 
(18,209
)
 
(11,430
)
Excess tax benefits from stock-based awards
 
10,360

 
19,004

 
9,835

Payment of contingent consideration obligation
 
(2,172
)
 

 

Net cash used in financing activities attributable to continuing operations
 
(196,361
)
 
(239,508
)
 
(96,796
)
Total cash (used in) provided by continuing operations
 
(25,506
)
 
(154,193
)
 
26,490

Cash flows from discontinued operations:
 
 
 
 
 
 
Net cash (used in) provided by operating activities attributable to discontinued operations
 
(153
)
 
(5,361
)
 
1,309

Net cash used in investing activities attributable to discontinued operations
 

 
(162
)
 
(250
)
Total cash (used in) provided by discontinued operations
 
(153
)
 
(5,523
)
 
1,059

Net (decrease) increase in cash and cash equivalents
 
(25,659
)
 
(159,716
)
 
27,549

Cash and cash equivalents at beginning of period
 
222,092

 
381,808

 
354,259

Cash and cash equivalents at end of period
 
$
196,433

 
$
222,092

 
$
381,808

The accompanying notes are an integral part of these consolidated financial statements.

38



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—ORGANIZATION
Company Overview
HSN, Inc. (“HSNi”) is an interactive multi-channel retailer that markets and sells a wide range of third party and private label merchandise directly to consumers through various platforms including (i) television home shopping programming broadcast on the HSN television networks; (ii) catalogs, which consist primarily of the Cornerstone portfolio of leading print catalogs which includes, Ballard Designs, Chasing Fireflies, Frontgate, Garnet Hill, Grandin Road, Improvements and TravelSmith; (iii) websites, which consist primarily of HSN.com and the eight branded websites operated by Cornerstone; (iv) retail and outlet stores; and (v) mobile devices. HSNi’s television home shopping business, related digital sales and outlet stores are referred to herein as “HSN” and all catalog operations, including related digital sales and stores, are collectively referred to herein as “Cornerstone.” Smith+Noble, a Cornerstone brand that specialized in window treatments, was sold in May 2012 and The Territory Ahead, a Cornerstone brand that specialized in casual apparel, was sold in July 2012.
HSN offerings primarily consist of jewelry, fashion (apparel & accessories), beauty & health, and home & other (including household, home design, electronics, culinary and other). Merchandise offered by Cornerstone primarily consists of home furnishings (including indoor/outdoor furniture, home décor, tabletop, textiles, window treatments and other home related goods) and apparel & accessories.
Basis of Presentation
HSNi was incorporated in Delaw