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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED FEBRUARY 3, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM
_____________________________ TO ____________________________________
COMMISSION FILE NO. 0-28784
HOT TOPIC, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 77-0198182
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
18305 E. SAN JOSE AVE. 91748
CITY OF INDUSTRY, CALIFORNIA (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (626) 839-4681
Securities registered pursuant to Section 12(b) of the Act: none
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
(Title of Class)
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 if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of 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 .
The number of shares outstanding of the registrant's Common Stock was
20,495,590 as of April 20, 2001.
The aggregate market value of Common Stock held by non-affiliates of
the registrant as of April 20, 2001 was approximately $622,088,000, based on the
closing price on that date of Common Stock on the Nasdaq National Stock Market.*
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's Definitive Proxy Statement for the
Annual Meeting of Shareholders to be held on June 7, 2001, to be filed with the
Securities and Exchange Commission (the "SEC") no later than 120 days after
February 3, 2001, are incorporated by reference into Part III of this Form 10-K
(Items 10 through 13).
- ------------
*Excludes 544,089 shares of Common Stock held by directors and officers and
shareholders whose beneficial ownership exceeds 10% of the shares outstanding on
April 20, 2001. Exclusion of shares held by any person should not be construed
to indicate that such person possesses the power, direct or indirect, to direct
or cause the direction of the management or policies of the Registrant, or that
such person is controlled by or under common control with the Registrant.
THE STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K THAT ARE
NOT HISTORICAL ARE 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, AS AMENDED (THE "EXCHANGE ACT"),
INCLUDING STATEMENTS REGARDING THE COMPANY'S EXPECTATIONS, BELIEFS, INTENTIONS
OR STRATEGIES REGARDING THE FUTURE. FORWARD-LOOKING STATEMENTS INCLUDE, WITHOUT
LIMITATION, STATEMENTS REGARDING THE EXTENT AND TIMING OF FUTURE REVENUES AND
EXPENSES AND CUSTOMER DEMAND, STATEMENTS REGARDING EXPECTED FINANCIAL RESULTS,
THE PROFITABILITY OF FUTURE SALES OF THE COMPANY'S PRODUCTS, NEW STORE OPENINGS
AND NEW STORE CONCEPTS. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT
ARE BASED ON INFORMATION AVAILABLE TO US AS OF THE DATE HEREOF AND WE ASSUME NO
OBLIGATION TO UPDATE ANY FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS
INVOLVE KNOWN OR UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH MAY CAUSE
OUR ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS, OR INDUSTRY RESULTS TO BE
MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS
EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD
CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE BUT ARE NOT LIMITED TO:
RELATIONSHIPS WITH MALL DEVELOPERS AND OPERATORS, THE AVAILABILITY OF CASH
AND/OR MALL SPACE FOR PLANNED EXPANSION, FLUCTUATIONS IN SALES AND STORE SALE
RESULTS, UNCERTAINTIES RELATED TO NEW STORE OPENINGS, NEW STORE CONCEPTS, MUSIC
AND FASHION TRENDS, COMPETITION FROM OTHER RETAILERS, SUCCESS OF JOINT VENTURES
AND RELATIONSHIPS WITH AND RELIANCE UPON THIRD PARTIES, UNCERTAINTIES GENERALLY
ASSOCIATED WITH SPECIALTY RETAILING, AND THE OTHER FACTORS REFERRED TO HEREIN
INCLUDING, BUT NOT LIMITED TO, THE ITEMS DISCUSSED IN PART I, ITEM 1 UNDER THE
CAPTION "CERTAIN RISK FACTORS RELATED TO THE COMPANY'S BUSINESS" AND IN PART II,
ITEM 7 UNDER THE CAPTION "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS."
PART I
ITEM 1. BUSINESS
GENERAL
Hot Topic, Inc. ("Hot Topic" or the "Company") is a rapidly growing,
mall-based specialty retailer of music-licensed and music-influenced apparel,
accessories and gift items for young men and women principally between the ages
of 12 and 22. The Company believes teenagers throughout the United States have
similar fashion preferences, largely as a result of the nationwide influence of
MTV, music distribution, movies and television programs. The Company opened its
first store in 1989, and operated 274 stores as of February 3, 2001 in 45 states
across the United States. The Company opened 26, 40, 50, 54 and 62 additional
stores during fiscal 1996, 1997, 1998, 1999 and 2000 respectively. The Company
also occasionally relocates or expands smaller existing stores. During fiscal
2000 the Company expanded or relocated four stores, three of which were near the
end of the lease term. The Company plans to open approximately 65 new Hot Topic
stores in the fiscal year ending February 2, 2002 ("fiscal 2001"), 18 of which
were open as of April 20, 2001. In addition, the Company plans to test a second
retail concept in fiscal 2001 with the trade name Torrid(TM). Torrid will offer
a selection of apparel, lingerie, shoes and accessories centered around various
lifestyles for plus-size women between the ages of 15 and 30. The Company plans
to open six of the Torrid stores in fiscal 2001, one of which was opened on
April 18, 2001. The Company also maintains a website, www.hottopic.com, through
which it markets its Hot Topic stores, store concept and sells certain of its
merchandise. The Company's net sales via the Internet continued to increase in
fiscal 2000 to almost two percent of total sales. In addition, on April 18, 2001
the Company also launched a website related to its test concept Torrid at
www.torrid.com.
2.
THE MARKET
The music-licensed apparel industry began in the 1960s with bootleggers
selling T-shirts at concert venues. Over the ensuing two decades, artists began
to realize the commercial potential of licensing their likenesses and logos to
T-shirt manufacturers and others who produced assorted merchandise. Management
believes that the single largest impact on the music industry during recent
years has been the success of MTV music network, which enables fans not only to
listen to the latest music and artists 24 hours a day, but also to experience a
full sight and sound package of appearance and attitude. According to industry
estimates, in 1999 MTV music network programming could be seen in more than 74
million households in the United States and in over 340 million households
worldwide. As a result, popular artists and fashions are much more visible today
than 30 years ago. Management believes that this increased visibility has
contributed to the increase in demand for music-licensed and music-influenced
apparel and accessories.
Hot Topic's target customers are young men and women between the ages
of 12 to 22 years old, who are passionate about music, music videos,
music-inspired fashion, and are avid MTV viewers. The Company believes its
music-oriented merchandise appeals to teenagers from diverse socio-economic
backgrounds, and that its customers are broadly representative of the teenage
population in the United States.
Teenagers represent both a growing part of the United States population
and an increasing source of purchasing power. According to the U.S. Department
of Commerce Bureau of the Census, the teenage population in the United States
reached approximately 31 million in 1999 and is expected to grow to
approximately 40 million by 2008, representing a projected growth rate close to
twice the rate of the overall population. By 2010, there will be likely more
teenagers in the United States than at any other time in history. The Company
also believes, based upon statistics released by an independent research firm,
that teenage spending has also been increasing annually, growing to an estimated
$153 billion in 1999.
BUSINESS STRATEGY
The Company's goal is to become the leading retailer of music-licensed
and music-influenced apparel and accessories for young men and women. The
principal elements of the Company's business strategy are as follows:
o FOCUS ON UNIQUE MUSIC-ORIENTED MERCHANDISE.
Management believes that fashions and products associated with popular
music artists have a significant influence on teenagers today, who often want to
emulate their favorite artists. The Company has developed a unique strategy
focused exclusively on offering music-licensed and music-influenced merchandise
in the mall environment. The Company believes most of the merchandise it offers
is not available elsewhere in the mall, and is often hard to find other than at
alternative shopping venues in major metropolitan areas. Accordingly, the
Company believes it is well positioned to capitalize on the growing teenage
population and demand for music-related merchandise.
o OFFER "EVERYTHING ABOUT THE MUSIC"
The Company's stores are designed to serve as a headquarters for
music-licensed and music-influenced apparel, accessories and gift items. The
Company's slogan, "Everything About The Music," reflects the Company's broad
assortment of products, which currently consists of over 10,000 Stock Keeping
Units ("SKUs") in approximately 20 different product categories. The Company
believes its selection of music-licensed merchandise is the most extensive
assortment available in a single mall store. The Company complements its
licensed merchandise with a unique and eclectic assortment of music-influenced
3.
apparel and accessories, and frequently introduces new items and categories in
response to changes in trends and demand. The Company believes it has a history
of being the first to offer the latest music fashions, which, together with its
assortment of merchandise, has made it a destination store for teenagers seeking
music-related products.
o PROMOTE MUSIC-INSPIRED CULTURE.
Hot Topic is committed to addressing the music-oriented lifestyles of
its customers by building a culture throughout the organization that reflects a
passion for music. Management diligently tracks alternative and rock music
trends by regularly monitoring new music, music video releases, and radio
station air play, visiting nightclubs around the country and attending concerts.
The Company also actively solicits feedback from its employees and customers.
The Company believes these activities enables it to react quickly to emerging
trends, and provide it with a competitive advantage over retailers who do not
devote the time and resources necessary to anticipate these trends.
o ACTIVELY MANAGE MERCHANDISE MIX.
Hot Topic does not dictate fashion trends, but rather seeks to identify
music artists and releases that will have strong appeal and related products
that will generate strong demand. The Company has developed a disciplined
approach to buying and a proactive inventory management program around this
strategy. The Company often tests new merchandise in a small number of stores
before chain-wide distribution, and orders a majority of its merchandise not
more than 60 days before delivery, enabling it to respond quickly to emerging
trends. In cases where it does not have return privileges with its vendors, Hot
Topic is aggressive in taking prompt markdowns to maintain a fresh merchandise
mix. By actively managing the mix of categories and products in its stores, the
Company believes it is able to capitalize on emerging trends and minimize its
dependence on any particular category. The Company believes that this approach
to managing its merchandise mix has contributed to its strong merchandise
margins and consistent markdown rates, which the Company believes are lower than
industry averages.
o CREATE AN ENTERTAINING STORE ENVIRONMENT.
The Company seeks to create a compelling shopping environment that
brings into the mall elements of the alternative urban shopping experience
sought by teenagers. The Company has always focused on the lifestyle and values
of the youth generation. Hot Topic stores are designed with an industrial theme
that incorporates dense merchandising and utilizes a professional sound system
playing alternative music releases to create a fun, high-energy store that teens
will consider "their place" to shop with friends. The Company believes that this
atmosphere enhances the Company's image as a source for music-inspired fashion
while encouraging customers to shop in its stores for longer periods of time.
Late in fiscal 2000, the Company tested a new store design in two locations in
California. Continuing to focus on the world of music and musicians as
inspiration, the objective of the new design is to provide a more kinetic and
industrial-club feel, while portraying a less gothic appearance than the
Company's previous store design. This new look was inspired by the markets,
clubs and old warehouse districts in London where the Company's designers toured
and created this new "industrial club" theme. The majority of the 65 new Hot
Topic stores opening in fiscal 2001 will be built in this new design.
o EMPHASIZE CUSTOMER SERVICE.
Hot Topic trains its store associates to provide value-added,
non-intrusive customer service. Sales associates are taught to greet each
customer, provide information about new music and fashion trends and suggest
merchandise that matches the customer's lifestyle and music preferences. The
Company strives to give its teenage customers the same level of respect and
attention that is generally given to adult customers at other retail stores and
to provide friendly and informed customer service for parents. The Company
4.
believes that a high level of product knowledge and a commitment to music
fashion create high credibility and differentiate the Company from other
teenage-focused retailers.
o DEVELOP PRIVATE LABEL PRODUCTS FOR MUSIC-ORIENTED LIFESTYLES.
The Company has developed private label product lines to complement and
supplement its other product offerings. The Company's private label product
lines include, among others, Morbid Threads (apparel and hosiery), MT2
(apparel), Morbid Metals (body jewelry), and Hot Topic label shoes. The Company
believes that these private label products differentiate it from its competition
and enhance customer loyalty through the development of a unique brand image.
The Company's Torrid stores also have a line of private label under the trade
name Torrid(TM).
o TEST NEW RETAIL CONCEPT CALLED TORRID
The Company is starting a second retail concept in fiscal 2001 with the
trade name Torrid(TM). Torrid will offer a selection of apparel, lingerie, shoes
and accessories centered around various lifestyles for plus-size women between
the ages of 15 and 30. The selection will include clubwear, streetwear,
rockabilly and renaissance, the majority of which will be exclusive to the
store. The Company plans to open six of the Torrid stores in fiscal 2001, one of
which was opened on April 18, 2001. In addition, in fiscal 2001, a selected
assortment of Torrid products will be available for purchase on-line at
www.torrid.com.
STORE LOCATIONS
As of February 3, 2001, the Company operated 274 stores in both
metropolitan and middle markets in 45 states across the United States. The
following chart sets forth, as of April 20, 2001, the number of stores that Hot
Topic operates in each state and the cities in which those stores are located.1
5.
HOT TOPIC, INC. STORES BY STATE AS OF APRIL 20, 2001
ARIZONA - 3 CONNECTICUT - 6 INDIANA - 6 MISSOURI - 4 NORTH DAKOTA - 1 TEXAS - 22
Phoenix Danbury Evansville Columbia Grand Forks Austin (2)
Tucson (2) Manchester Fort Wayne St .Louis (2) Beaumont
Milford Lafayette St. Peters OHIO - 7 Brownsville
CALIFORNIA - 46 Trumbull Mishawaka Cincinnati College Station
Arcadia Waterbury Muncie MONTANA - 1 Dayton Corpus Christi
Bakersfield Waterford Terre Haute Billings Elyria Dallas
Berkeley Mentor El Paso*
Brea (2) * DELAWARE - 1 KANSAS - 4 NEBRASKA - 2 North Olmstead Fort Worth
Capitola Wilmington Olathe Lincoln Niles Frisco
Carlsbad Topeka Omaha Parma Houston*
Cerritos FLORIDA - 13 Wichita (2) Humble
Chula Vista* Altamonte Springs NEVADA - 5 OKLAHOMA - 3 Irving
Citrus Heights Boynton Beach KENTUCKY - 3 Henderson Norman Katy
Concord Coral Springs Bowling Green Las Vegas (2) Oklahoma City (2) Laredo
Cupertino Jacksonville (2) Louisville Reno (2) Lewisville
Daly City Miami (2)* Paducah OREGON - 2 Lubbock
El Cajon Ocoee NEW HAMPSHIRE - 4 Portland (2) Mesquite
Escondido Orange Park* LOUISIANA - 3 Concord Plano
Fairfield Orlando Baton Rouge Manchester PENNSYLVANIA - 18 San Antonio (2)
Fresno St. Petersburg Metarie Nashua Altoona Woodlands
Glendale Tallahassee Monroe Salem Bensalem
Irvine* Tampa Camp Hill UTAH - 3
Laguna Hills MAINE - 1 NEW JERSEY - 10 Erie Orem
Lakewood GEORGIA - 5 Bangor Deptford Exton Salt Lake City
Milpitas Buford Eatontown Greensburg Sandy
Modesto Douglasville MARYLAND - 7 Elizabeth Harrisburg
Montclair Duluth Baltimore (2) Freehold King of Prussia VERMONT - 1
Montebello Kennesaw Columbia Mays Landing Lancaster Burlington
National City Macon Frederick Paramus Langhorne
Northridge Glen Burnie* Rockaway Media VIRGINIA - 3
Ontario HAWAII - 3 Hagerstown Toms River North Wales Dulles
Palm Desert Alea Towson Wayne Scranton Newport News
Palmdale Honolulu Woodbridge State College Springfield
Pleasanton Kahului MASSACHUSETTS - 6 W. Mifflin
Riverside Holyoke NEW MEXICO - 2 Wilkes-Barre WASHINGTON - 13
Sacramento IDAHO - 1 Marlborough Albuquerque (2) Williamsport Bellingham
San Diego (2)* Boise Natick York Burlington*
San Jose (2)* North Attleboro NEW YORK - 16 Everett
San Leandro IOWA - 4 Saugus Albany RHODE ISLAND - 1 Kennewick
Santa Ana Cedar Rapids Taunton Bay Shore Providence Lynnwood
Santa Monica Coralville Buffalo Olympia
Santa Rosa Des Moines MICHIGAN - 9 Clay SOUTH CAROLINA - 3 Puyallup
Thousand Oaks Sioux City Ann Arbor Johnson City Columbia* Seattle
Universal City Auburn Hills Lake Grove Greenville Silverdale
Valencia ILLINOIS - 10 Flint Massapequa North Charleston Spokane (2)
Ventura Aurora Grandville Middletown Tacoma
West Covina Bloomingdale Lansing New Hartford SOUTH DAKOTA - 2 Tukwila
Carbondale* Port Huron* Poughkeepsie Rapid City
COLORADO - 8 Champaign Portage Rochester Sioux Falls WEST VIRGINIA - 2
Broomfield Chicago Ridge Traverse City Staten Island Barboursville*
Colorado Springs (2) Joliet Troy Syracuse TENNESSEE - 6 Charleston
Denver Orland Park Victor Antioch
Fort Collins Rockford MINNESOTA - 7 West Nyack Clarksville WISCONSIN - 7
Littleton (2) Schaumburg* Bloomington White Plains Franklin Appleton
Westminister West Dundee Burnsville Goodlettsville Brookfield
Duluth NORTH CAROLINA - 7 Memphis Eau Claire
Mankato Cary Nashville Greendale
Minnetonka Concord Madison (2)
St. Cloud Fayetteville Wausau*
St. Paul Hickory
Pineville
Wilmington*
Winston
1. An asterisk next to the city indicates that a store has been opened in such
city during fiscal 2001. As of April 20, 2001, the Company had opened 17 new Hot
Topic stores and one new Torrid store in fiscal 2001. The Company closed one Hot
Topic store at the end of its lease term during fiscal 2001 (Victorville,
California), with plans to reopen the store in February 2002.
6.
EXPANSION STRATEGY
The following table provides a history of the Company's store expansion
over the last five fiscal years:
FISCAL YEAR
---------------------------------------------------
1996 1997 1998 1999 2000
---------------------------------------------------
(Number of stores)
Stores at beginning of year 42 68 108 158 212
New stores opened 26 40 50 54 62
---------------------------------------------------
Stores at end of year 68 108 158 212 274
---------------------------------------------------
All but two of the Company's stores are located in shopping malls. The
two non-mall stores are located in "street locations", one each in Denver,
Colorado and in Berkeley, California. The Company's expansion strategy is to
open stores in shopping malls and entertainment centers in both new and existing
markets throughout the United States. The Company believes it has developed a
store concept that is successful in both metropolitan and middle markets.
Further, as a result of the nationwide influence of MTV, music distribution,
movies, television programs, the Company believes that its 12 to 22 year-old
target customers have similar fashion preferences throughout the United States.
The Company opened 62 new stores in fiscal 2000 and expanded or
relocated four existing stores. During fiscal 2001, the Company plans to open
approximately 65 new Hot Topic stores and six new Torrid stores, in addition to
expanding or relocating seven existing smaller Hot Topic stores. The Company
selects and evaluates potential store locations based on a variety of criteria
including the sales and square footage of the mall, sales of anchor stores,
sales of teenage-oriented stores, foot traffic, number of teenagers in the trade
area, median family income and other factors relevant to the Company's unique
merchandising strategy. The Company looks at similar criteria for "street store"
locations. Model statements of operations are developed for each potential
location and are measured against target financial criteria. Hot Topic has a
real estate committee, consisting of its Chief Executive Officer and Chief
Operating Officer. The Company generally seeks potential store sites between
1,200 and 2,400 square feet. The average size of the Company's fiscal 2000
openings was 1,758 square feet. The Company's stores currently average
approximately 1,559 square feet.
STORE-LEVEL ECONOMICS
During fiscal 2000, the Company achieved average store net sales of
approximately $1,020,000 and average store net sales per square foot of
approximately $669. Store-level operating cash flow (defined as store operating
income before depreciation and excluding changes in working capital) for stores
open the entire year in fiscal 2000 were approximately $319,000, or 31% of
average net sales. Capital expenditures, including leasehold improvements,
furniture and fixtures and net of landlord construction allowances for the 62
stores opened in fiscal 2000 averaged approximately $179,000, initial gross
inventory requirements (which were partially financed by trade credit) averaged
$101,000, and pre-opening costs (which were expensed when incurred) averaged
$21,000. Inventory requirements vary at new stores depending on the season and
on current merchandise trends. In fiscal 2000, all of the Company's stores
generated positive store-level operating income, but there can be no assurance
this trend will continue. There also can be no assurance that in the future the
average store-level sales and operating cash flow will not vary from historical
results or that the total estimated capital expenditures for new stores will not
increase.
7.
MERCHANDISING
The Company's stores are designed to serve as a headquarters for
music-licensed and music-influenced apparel, accessories and gift items.
Music-licensed merchandise includes T-shirts, hats, posters, stickers, patches,
postcards, books, CDs, videos and other items. Music-influenced merchandise
includes woven and knit tops, skirts, pants, shorts, jackets, shoes, costume
jewelry, body jewelry, sunglasses, cosmetics and gift items. Approximately half
of the Company's products are music-licensed products, and the other half are
music-influenced products. A key strategy of the Company is to offer over 10,000
SKUs in 20 different product categories or "departments." On average, over 100
different licensed band t-shirts are carried in each store from current artists
such as Korn, Blink 182, Limp Bizkit, Deftones, Linkin Park, and Slip Knot as
well as rock and classic rock artists such as Pink Floyd, Nirvana, Pantera,
Metallica, Jimi Hendrix, The Doors, Beatles and Led Zeppelin. New items and
categories are regularly tested as customer demand and product trends evolve.
The Company does not dictate leading-edge fashion, but quickly reacts
to changes in trends and demand to keep Hot Topic stores fresh and exciting.
Further, the Company strives to identify music artists and releases that will
have strong appeal, and to quickly acquire related music-licensed products and
music-influenced merchandise, featured on music videos or otherwise, associated
with such artists and releases.
The following table sets forth the Company's four major merchandise
groups as an approximate percentage of net sales for fiscal years 2000, 1999 and
1998:
PERCENTAGE OF NET SALES
---------------------------------------
2000 1999 1998
---------------------------------------
Apparel, T-Shirts and Outerwear 51% 50% 50%
Gifts 15 16 19
Accessories 27 27 26
Intimate Apparel and Shoes 7 7 5
---------------------------------------
100% 100% 100%
The Company has five lines of private label merchandise to complement
and supplement current product offerings. The Company believes that Hot Topic
brands play an important part in differentiating its stores from those of its
competitors and provide the Company with higher margin opportunities as compared
to other merchandise. Management estimates that in both fiscal 2000 and fiscal
1999 Hot Topic brands accounted for approximately 25% of the Company's sales.
The Company's proprietary brands include Morbid Makeup (cosmetics), Morbid
Metals (body jewelry), Morbid Threads (men's and women's apparel and hosiery)
and MT:2 (men's and women's apparel). Shoes are also sold under the Hot Topic
label.
PURCHASING
The Company's purchasing staff consists of a Vice President, General
Merchandise Manager, two Divisional Merchandise Managers, nine Buyers and ten
Assistant Buyers. The purchasing staff reflects the Company's culture in that
its decisions and actions are influenced by a passion for music. In determining
which merchandise to buy, the purchasing staff spends considerable time viewing
music videos, reviewing industry album sales, monitoring alternative radio
station air play, consulting with sales associates, reviewing customer requests,
attending trade shows and reading music and fashion industry periodicals. In
addition, the staff regularly visits nightclubs, and attends concerts and other
events that attract young people. The Company also solicits input from its store
employees, in order to draw from many different experiences and perspectives.
8.
Approximately half of the Company's products are licensed products.
Artists typically license their likeness to a "master licensor". The master
licensor often retains the rights to market T-shirts and then may choose to
sub-license to manufacturers other categories of merchandise such as posters,
stickers and patches. Some artists also retain their licensing rights and
negotiate directly with licensees. Hot Topic buys its licensed merchandise from
master licensors, licensees and directly from artists. The Company currently
purchases licensed T-shirts from over 30 companies and other licensed products
from over 100 companies. Because of the Company's knowledge of teenage
consumers' music preferences and music-influenced fashion, licensors often seek
the Company's advice prior to licensing new artists or product designs. As a
result, the Company sometimes receives accommodations such as early shipments of
new releases, exclusive merchandise and vendors' acceptance of returns.
The Company buys its unlicensed, music-influenced merchandise from a
variety of manufacturers. The Company actively searches for new vendors that
offer unique and timely music-influenced products. As a result, the Company at
any given time has many different vendors of different sizes, including some
from which it has not previously purchased. Most of the products purchased from
the Company's vendors are sold under the labels of the manufacturers, and some
are sold under Hot Topic's private labels.
In order to reduce fashion risk and maintain the ability to respond
quickly to emerging trends, Hot Topic buys a majority of its merchandise not
more than 60 days in advance of delivery, and will often begin with small
purchases for testing prior to chain-wide distribution. The Company regularly
monitors store sales by merchandise classification, SKU, color and size to
determine types and amounts of products to purchase, to detect products and
trends that are emerging or declining, and to manage the product mix in its
stores to respond to the spending patterns of its customers. The Company also
works with its vendors to ensure that sources for new and private label products
are maintained and expanded.
During fiscal 2000, the Company had approximately 800 vendors, certain
of which have limited financial resources and production capabilities. No single
vendor accounted for more than 5% of the Company's merchandise purchases. The
Company believes that its relationships with its vendors are good.
ALLOCATION AND DISTRIBUTION OF MERCHANDISE
Allocation and distribution of the Company's inventory is addressed at
the store, merchandise classification and SKU levels using integrated third
party software. Most merchandise is ordered in bulk and then allocated to each
store based on inventory plans and SKU performance by using the Arthur
Allocation software system implemented during fiscal 1999. Buyers determine SKU
reorder quantities by using a proprietary automated software program which
considers sales history, projected sales, planned inventories by store, store
demographics, geographic preferences, store openings and planned markdown dates.
Prior to the implementation of the Arthur Allocation system, the Company used
proprietary software developed by Hot Topic to allocate merchandise to each
store.
The Company's Vice President of Planning and Allocation along with
two directors of Planning and Allocation and 16 inventory analysts work closely
with the merchandise buyers and store personnel to meet the requirements of
individual stores for appropriate merchandise in sufficient quantities.
Hot Topic's headquarters and distribution facility, consisting of
approximately 125,000 square feet, are located in City of Industry, California.
All merchandise is delivered by vendors to this facility, where it is inspected,
price marked, entered into the Company's allocation software system, picked and
boxed for shipment to the Company's stores. Merchandise is shipped to stores
each weekday, providing Hot Topic stores with a steady flow of reordered and new
merchandise. Minimal back stock is maintained in the Company's distribution
facility and at its stores, so that at all times almost all of the Company's
merchandise is available for sale on the floors of its stores.
9.
In March 2001, the Company entered into a lease for additional space
for future expansion of its headquarters and distribution facility in the City
of Industry, California. The additional 125,000 square feet is in the same
building as is its current headquarters and distribution center.
The original lease terms of the Company's headquarters and distribution
facility granted the Company the right of first refusal on the remaining 125,000
square feet of space in the building at 90% of the fair market lease rates for
such space. In February 2001, the Company was notified that the space would
become available in 2001 and was provided with comparable market lease rates.
The Company considered the terms and timing of leasing the additional space
against other possible alternatives and determined that it was in the Company's
best interest to lease the additional space under the negotiated terms. The
Company may sublease part of the additional space during part of fiscal 2001 but
believes it will begin utilizing all of the space in fiscal 2002. The Company
also believes that leasing the adjacent space is more efficient and cost
effective than its alternatives for expansion such as moving the entire facility
or acquiring additional separate space. The Company estimates that the operating
capacity gained from this additional space will allow for growth to up to 750
stores.
STORE OPERATIONS
Hot Topic's store operations are currently managed by six regional
managers and 46 district or area managers who each supervise approximately eight
stores. Individual stores are managed by a store manager and two or three
assistant managers. In addition to managers and assistant managers, a typical
store has approximately six to ten part-time sales associates, depending on the
season. The hiring and training of new employees are the responsibility of the
store manager and district manager; and the Company has established training and
operations procedures to assist them. Additionally, Hot Topic uses a customized,
automated telephone screening system licensed from a third party to help
evaluate potential new employees, which helps streamline the Company's interview
and hiring processes at the store level.
The Company strives to create a store environment that teenagers will
consider "their place" to shop with friends. Hot Topic seeks to hire sales
associates who fit the profile of its target customer -- energetic people who
are knowledgeable and passionate about music and music-inspired fashion. To
assist management in properly considering the preferences and opinions of its
target customers, selected sales associates accompany Hot Topic's buyers on
buying trips. Further, in return for feedback on fashion and other trends, sales
associates are reimbursed for the cost of attending concerts and frequenting
clubs, and are encouraged to communicate customer requests and their own
merchandise ideas to the buyers and management. Hot Topic encourages its sales
associates to dress and accessorize themselves with the same fashionable
merchandise that is sold in its stores. Management believes its music-based
culture and its interaction with and respect for sales associates has led to
associate turnover rates that the Company believes are lower than the industry
average.
The primary objective of sales associates is to provide superior,
informed customer service in order to maximize sales and minimize inventory
shrinkage. Store management is provided with daily store sales and weekly
category sales results so that performance can be measured against set goals.
Postage-paid "report cards" are provided in all stores for customers to grade
performance and make recommendations to Company management. The Company strives
to give its teenage customers the same level of respect and attention that is
generally given to adult customers at other retail stores. Associates are
trained to greet each customer, to inform the customer about new music fashion
trends and to suggest merchandise that matches the customer's lifestyle and
music preferences. Hot Topic also strives to provide friendly and informed
customer service for parents. The Company provides a listing of music artists'
national tour dates at each of its stores. The Company believes that its high
level of product knowledge and service differentiates Hot Topic from other
teenage-focused retailers.
10.
Store, district and area managers are compensated with a base salary
and may qualify to receive a quarterly bonus based on sales and inventory
shrinkage. Additionally, district and area managers may also qualify to receive
periodic stock option grants, and certain employees are eligible to participate
in the Company's Employee Stock Purchase Plan. The Company believes that its
continued success is dependent in part on its ability to attract, retain and
motivate qualified employees. In particular, the success of the Company's
expansion program will be dependent on its ability to promote and/or recruit
qualified district and store managers. To date, a significant number of its
store managers have been promoted from within the Company.
STORE ENVIRONMENT
Hot Topic stores are designed with an industrial theme that
incorporates dense merchandising. The latest music releases are played on a
professional sound system to create a high-energy and fun shopping environment.
The Company has always focused on the lifestyle and values of the youth
generation. The Company believes this atmosphere enhances the Company's image as
a source for music-inspired fashion while encouraging customers to shop in its
stores for longer periods of time. Late in fiscal 2000, the Company tested a new
store design in two locations in California. Continuing a focus on the world of
music and musicians as inspiration, the objective of the new design is to
provide a more kinetic and "industrial club" feel, while portraying a less
gothic appearance than the Company's previous store design. This new look was
inspired by the markets, clubs and old warehouse districts in London where the
Company's designers toured and created this new "industrial club" theme. The
majority of the 65 new Hot Topic stores to open in fiscal 2001 will be built
with this new design.
Stores are constructed and fixtured to maximize merchandising
flexibility, which enables the Company to highlight new product offerings and
create a compelling shopping environment. Bi-monthly Planograms are developed to
assist store managers in displaying merchandise in an exciting and dynamic
manner. In addition, sales associates are encouraged to wear the Company's
products, which the Company believes contributes to the overall atmosphere of
its stores.
MARKETING, PROMOTION AND INTERNET
The Company generally locates its stores in high traffic malls within
areas of high teenage population and relies on existing customers, sales
associates, store design and exciting music to attract new customers to its
stores. During fiscal 2000 the Company sponsored a major touring rock festival
called "Ozzfest." As a co-sponsor and major participant, the Company's name was
associated with all promotional activities at each venue. The Company
appreciated the opportunity to sponsor a national music tour, which reached many
of its target customers. The Company is planning to enter into a similar
sponsorship at Ozzfest in fiscal 2001.
As a part of the Company's marketing strategy, the Company maintains a
website, www.hottopic.com., through which it markets its stores and merchandise.
During fiscal 1999, the site was re-launched with a focus on e-commerce. The
site also includes posting boards, customer surveys, a gift registry and content
features including artist news and tour schedules. The Company's net sales via
the Internet continued to increase in fiscal 2000 comprising almost two percent
of the Company's total sales. In addition, in fiscal 2001, a selected assortment
of Torrid products will be available for purchase on-line at www.torrid.com.
MANAGEMENT INFORMATION SYSTEMS
Hot Topic's information systems provide integration of store,
merchandising, distribution and financial systems. These systems include SKU and
classification inventory tracking, purchase order management, open to buy,
merchandise distribution, automated ticket making, general ledger, sales audit,
11.
accounts payable and integrated financials. These systems operate on software
licensed from GERS Retail Systems ("GERS") running on an Oracle database
platform. Sales are updated daily in the merchandising reporting systems by
polling sales information from each store's point-of-sale ("POS") terminals. The
Company's POS system consists of registers providing price look-up, time and
attendance, e-mail and credit card and check authorization. Through automated
nightly two-way electronic communication with each store, sales information,
payroll hours and e-mail messages are uploaded to the host system and receiving,
price changes and system maintenance are downloaded through the POS system. The
Company evaluates information obtained through daily polling to implement
merchandising decisions regarding reorders, markdowns and allocation of
merchandise.
During fiscal 1999, after completing an evaluation of its long-term
management information system needs, the Company selected the new GERS hardware
and software for its stores, office and distribution center. The Company
implemented the host hardware and software systems at its office and
distribution center during the second half of fiscal 2000 and plans to install
certain POS upgrades at its stores in fiscal 2001. The Company estimates the
hardware, software, modifications, training and implementation will cost
approximately $5 to $6 million. Of that total amount, approximately $.5 million
was spent in fiscal 1999, $2.1 million was spent in fiscal 2000 and
approximately $2.5 to $3.0 million will be spent to implement the point of sale
upgrades to existing stores in fiscal 2001.
TRADEMARKS
The Company has registered on the Principal Register of the United
States Patent and Trademark Office its retail store service mark Hot Topic(R)
and various trademarks for merchandise including Hot Topic(R), Morbid
Make-Up(R), Morbid Scents(R), Morbid Metals(R), Morbid Adornments(R),
Tragedy(R), Misery(R), MT: 2(R) and Morbid Threads(R). Each federal registration
is renewable indefinitely if the mark is in use at the time of the renewal.
Applications have been made to register Everything About the Music(TM), Morbid
Threads(TM), Torrid(TM), Torrid & Design(TM) and Torrid Flaming Heart Design(TM)
in the United States. The Company is not aware of any claims of infringement or
other challenges to the Company's right to use its marks in the United States.
The Company also has additional registrations and pending applications in
foreign jurisdictions. All other trademarks, tradenames and servicemarks
referenced herein are the property of their respective owners.
COMPETITION
The teenage retail apparel and accessory industry is highly competitive
and the Company expects competition in its niche to increase. The Company
competes with other retailers for vendors, teenage and college age customers,
suitable retail locations and qualified employees and management personnel. Hot
Topic currently competes with street alternative and vintage clothing stores
located primarily in metropolitan areas and with other mall-based
teenage-focused retailers such as The Buckle, Claire's Stores, Inc., Charlotte
Russe, Delias Inc., d.e.m.o., Gadzooks, Inc., Millers Outpost, Inc., Pacific
Sunwear of California, Inc., Spencer Gifts, Inc., Urban Outfitters, Inc., The
Wet Seal, Inc., and, to a lesser extent, with music stores. Competition from
mail-order catalogs of apparel and accessories targeting the teen customer has
increased in recent years. Many of the Company's competitors are larger and have
substantially greater financial, marketing and other resources than the Company.
The principal factors of competition in the Company's business are merchandise
selection, customer service, store location and price.
EMPLOYEES
The Company employed approximately 1,009 full-time and 2,367 part-time
employees as of April 20, 2001. Of the Company's 3,376 employees, 298 were
corporate headquarters and distribution center personnel and 3,078 were store
12.
employees. The number of part-time employees fluctuates with seasonal needs.
None of the Company's employees are covered by collective bargaining agreements.
The Company considers its employee relations to be good.
EXECUTIVE OFFICERS AND KEY EMPLOYEES
The executive officers and key employees of the Company and their ages
at April 20, 2001 are as follows:
NAME AGE POSITION
- ------------------------- --- -----------------------------------------------
Elizabeth M. McLaughlin 40 Chief Executive Officer, President and Director
Jerry Cook 48 Chief Operating Officer
Jim McGinty 38 Chief Financial Officer
Jay A. Johnson 55 Senior Vice President of Strategic Analysis and
Investor Relations
Cindy Levitt 40 Vice President, General Merchandise Manager
Marc R. Bertone 44 Vice President, Real Estate and Construction
Alain Krakirian 35 Vice President, Planning and Allocation
Darrell Kinsley 38 Vice President, Store Operations
Patricia A. Bodner 38 Vice President, hottopic.com
Sue McPherson 33 Vice President, Distribution Center
Karen Talley 43 Divisional Vice President and Divisional
Merchandise Manager
ELIZABETH M. MCLAUGHLIN has served as Chief Executive Officer of the
Company since August 2000 and President since February 2000, and has served on
the Board since May 2000. From June 1996 through February 2000, Ms. McLaughlin
served as Senior Vice President and General Merchandise Manager of the Company.
From May 1993 through May 1996, Ms. McLaughlin was the Company's Vice
President, Operations. Prior to joining the Company, Ms. McLaughlin held various
positions with Millers Outpost, a privately-held teen retailer, where she served
as Divisional Merchandise Manager, Director of Store Operations, and Director of
Financial Planning and Budgeting. Prior to joining Millers Outpost, Ms.
McLaughlin held various financial analyst and store positions with The Broadway.
Ms. McLaughlin holds a B.A. degree in Economics from the University of
California at Irvine.
JERRY COOK has been Chief Operating Officer since February 2001. Mr.
Cook has 25 years of experience in retail. From February 1999 until joining the
Company, he was the President and Chief Operating Officer of Travel 2000, Inc.
>From 1995 to April 1998, Mr. Cook was Senior Vice President, Operations for The
Bombay Company, Inc. and from 1989 to 1995, Mr. Cook was the Vice President,
Stores and the Vice President, General Merchandising Manager of Woman's World
Stores. Prior to 1989, he held management positions with Barnes & Noble/B
Dalton, The Gap Stores and the Limited, Inc.
13.
JIM MCGINTY joined Hot Topic in August 2000 as its Vice President,
Finance and was promoted to Chief Financial Officer in February 2001. >From July
1996 to July 2000, Mr. McGinty was Vice President-Controller at Victoria's
Secret Stores, the leading brand and largest specialty retailer in the Limited,
Inc. From 1984 to 1996, he held various financial and accounting positions
within the Structure and Express divisions of the Limited, Inc. Mr. McGinty
holds a B.S. degree in accounting from Miami University in Oxford, Ohio.
JAY A. JOHNSON has served as the Senior Vice President, Strategic
Analysis and Investor Relations since February 2001. He also is the Company's
Assistant Secretary. From May 1995 to February 2001, he was the Chief Financial
Officer and Assistant Secretary of the Company. From January 1993 to May 1995,
he was Vice President/Chief Financial Officer of Frame-n-Lens Optical, Inc., a
national optical retailer with approximately 300 stores. From July 1978 to July
1992, Mr. Johnson held senior financial management positions at one
manufacturing and two retail companies. Mr. Johnson is a certified public
accountant.
CINDY LEVITT has been Vice President, General Merchandise Manager since
February 2000. Since 1989, Ms. Levitt has held senior buying positions at Hot
Topic. From June 1996 to February 2000, she served as the Divisional Merchandise
Manager, Apparel and Music.
MARC R. BERTONE has served as Vice President, Real Estate and
Construction, since August 1994. Mr. Bertone has 16 years of leasing and legal
experience, and from November 1988 to August 1994, served as Vice President and
General Counsel for The Wet Seal, Inc., a specialty retailer. Mr. Bertone was
admitted to the California Bar in June 1982 and is currently an inactive member.
ALAIN KRAKIRIAN has been Vice President, Planning and Allocation since
February 2000. From July 1997 through February 2000, Mr. Krakirian was the
Company's Director of Planning and Allocation. Mr. Krakirian was the Planning
Manager at Disney Stores from December 1996 to July 1997 and the Director of
Merchandise Planning and Allocation at Kids Mart from February 1996 to December
1996. From September 1991 to January 1996, Mr. Krakirian held various
merchandise control and planning positions at Clothestime Stores, including
Director of Merchandise Control and Information Office from October 1994 to
January 1996. Mr. Krakirian holds a B.S. degree in finance from the University
of LaVerne and an M.B.A. degree from Pepperdine University.
DARRELL KINSLEY has been Vice President, Store Operations since
February 2000. From June 1998 through February 2000, Mr. Kinsley was Regional
Director for the western United States. From February 1997 through June 1998, he
was Regional Director for the eastern United States. Mr. Kinsley joined the
Company in February 1995 as the District Manager for the eastern United States.
PATRICIA A. BODNER has been Vice President, hottopic.com since June
2000. Previously, Ms. Bodner was Chief Marketing Officer at allpets.com from
August 1999 through June 2000. Prior to allpets.com, Ms. Bodner held marketing
positions at Digital Lava Inc., a communications application services provider
for streaming media technology from May 1997 through July 1999. Between
September 1995 and January 1997, Ms. Bodner worked at Inscape, a multimedia
developer and publisher of CD-ROM games where she held various marketing
positions. Between June 1986 and September 1995, Ms. Bodner held various
marketing positions at companies including Bertelsmann Music Group, New Line
Cinema, and Warner Bros. Ms. Bodner holds a B.A. degree in French Studies from
the University of Wisconsin-Madison.
SUE MCPHERSON was promoted to Vice President, Distribution Center, in
February 2001 and was the Divisional Vice President, Distribution Center from
February 2000 to February 2001. Ms. McPherson joined the Company in 1989 as a
store employee in its first store while attending the University of Southern
California. From March 1995 to February 2000, she was the Director of the
Distribution Center. Ms. McPherson holds a B.S. degree in Business from the
University of Southern California.
14.
KAREN TALLEY has served as Divisional Vice President and Divisional
Merchandise Manager, Accessories since February 2000. Ms. Talley joined the
Company in 1993 as the Senior Accessory Buyer. She was the Company's Divisional
Merchandise Manager of Accessories from April 1996 to February 2000. Prior to
joining Hot Topic, Ms. Talley held buying positions at Jay Jacobs and Nordstrom.
CERTAIN RISK FACTORS RELATED TO THE COMPANY'S BUSINESS
In addition to risks identified elsewhere in this Annual Report, the
Company is subject to other risks, including the following:
IMPLEMENTATION AND MANAGEMENT OF AGGRESSIVE GROWTH STRATEGY
The Company's net sales and net income have grown significantly during
the past several years, primarily as a result of the opening of stores and, to a
lesser extent, the introduction of new products and categories. Sixty-two of the
Company's 274 stores opened as of February 3, 2001 had been open for less than
one full year. The Company intends to continue to pursue an aggressive growth
strategy for the foreseeable future, and its future operating results will
depend largely upon its ability to open and operate stores successfully and to
manage a larger business profitably. The Company anticipates opening
approximately 71 stores, including six Torrid stores, during fiscal 2001, which
will result in a significant increase in the number of stores operated by the
Company. Through fiscal 1994, all of the Company's stores were located in the
western United States. In fiscal 1995, the Company expanded into new markets by
opening stores in the northeastern and midwestern regions of the United States.
The Company plans to continue to enter new markets in various regions of the
United States, and approximately one-half of its stores opened in fiscal years
1996, 1997 and 1998 were in new markets. In fiscal 2000, the Company entered
three new states. Operation of a greater number of new stores and expansion into
new markets may present competitive and merchandising challenges that are
different from those currently encountered by the Company in its existing stores
and markets. In addition, there can be no assurance that the Company's expansion
within its existing markets will not adversely affect the individual financial
performance of the Company's existing stores or its overall results of
operations, or that new stores will achieve sales and profitability levels
consistent with existing stores. The Company will need to continually evaluate
the adequacy of its store management and management information and distribution
systems to manage its planned expansion. There can be no assurance that the
Company will anticipate all of the changing demands that its expanding
operations will impose on such systems, and the failure to adapt its systems and
procedures to such changing demands could have a material adverse effect on the
Company's business, results of operations and financial condition. There can be
no assurance that the Company will successfully achieve its expansion targets
or, if achieved, that planned expansion will result in profitable operations.
The Company's ability to open stores and the performance of such stores
will depend upon many factors, including and among others, the Company's ability
to identify and enter new markets, locate suitable store sites, negotiate
acceptable lease terms, hire and train store managers and sales associates and
obtain adequate capital resources on acceptable terms. Early in its history, the
Company encountered difficulties in leasing certain store sites. The Company
believes these difficulties were in part due to the Company's level of
capitalization, its limited operating history at such time, its then unproven
store concept, and apprehension on the part of mall operators concerning the
Company's teenage customers. In fiscal 1999, a major mall developer asserted
that the Company had violated a "use clause" applicable to certain or all of the
Company's leases with that developer. As a result, the developer ceased ongoing
discussions relating to potential new Hot Topic stores and told the Company that
no new leases would be entered into. Upon notice of the alleged violation, the
Company adjusted its merchandise mix in stores leased from that developer (and
to a somewhat lesser extent, in all other stores) and took certain other actions
to ensure ongoing "use clause" compliance. These actions and continuing
discussions with the developer resulted in an amended "use clause" for all
leases with the developer. In early 2000, the Company satisfied the concerns of
15.
the developer and resumed discussions with the developer concerning potential
new stores for fiscal 2000 and beyond. During the first quarter of fiscal 2000,
the first such lease was executed with the developer for a new store that opened
in fiscal 2000. There can be no assurance that the Company will not face similar
resistance from mall operators or others in the future. If the Company's
relations with mall operators or developers are ever again strained, the Company
may not grow as planned, may not reach certain revenue levels and other targets,
and may suffer a decline in stock price. Any restrictions on the Company's
ability to expand to new store sites or to offer a broad assortment of
merchandise could have a material adverse effect on the Company's business,
results of operations and financial condition.
FLUCTUATIONS IN COMPARABLE STORE SALES RESULTS
A variety of factors affect the Company's comparable store sales
including, among others, the timing of releases of new music-related products,
music and fashion trends, the general retail sales environment, the Company's
ability to efficiently source and distribute products, changes in the Company's
merchandise mix and the Company's ability to execute its business strategy
efficiently. The Company's comparable store sales results have fluctuated
significantly in the past and the Company believes that such fluctuations may
continue. The Company's comparable store sales results for fiscal 1996, 1997,
1998, 1999 and 2000 were 8.9%, 2.2%, 0.4%, 22.8% and 16.7% respectively. The
Company's comparable store sales results were 24.1%, 21.8%, 15.3% and 11.2% for
the first, second, third and fourth quarters, respectively, of fiscal 2000 and
15.3%, 16.9%, 26.1% and 27.1% for the first, second, third and fourth quarters
of fiscal 1999. Past comparable store sales results are not an indicator of
future results, and there can be no assurance that the Company's comparable
store sales results will not decrease in the future. The Company's comparable
store sales results could cause the price of the Common Stock to fluctuate
substantially.
DEPENDENCE ON AND CHANGES IN MUSIC AND FASHION TRENDS
The Company's profitability is largely dependent upon (i) the continued
popularity of alternative and rock music, music videos, and MTV among teenagers
and college age adults, (ii) the emergence of new artists and the success of
music releases and music-related products, (iii) the continuance of a
significant level of teenage spending on music-licensed and music-influenced
products, and (iv) the Company's ability to anticipate and keep pace with the
music, fashion and merchandise preferences of its customers. The popularity of
particular types of music, artists, styles and brands is subject to change. The
Company's failure to anticipate, identify and react appropriately to changing
trends, could lead to, among other things, excess inventories and higher
markdowns, and poor customer acceptance of its new store design, which could
have a material adverse effect on the Company's business results of operations
and financial condition, and on its image with its customers. There can be no
assurance that the Company's new products and new store design will be met with
the same level of acceptance as in the past or that the failure of the new
products and/or new store design will not have an adverse material effect on the
Company business, results of operations and financial condition.
IMPACT OF ECONOMIC CONDITIONS; MINIMUM WAGE RATES
Certain economic conditions affect the level of consumer spending on
merchandise offered by the Company, including, among others, business
conditions, interest rates, taxation and consumer confidence in future economic
conditions. The Company is also dependent upon the continued popularity of malls
as a shopping destination and the ability of mall anchor tenants and other
attractions to generate customer traffic for its stores. A decrease in mall
traffic would adversely affect the Company's growth, net sales, comparable store
sales results and profitability. In addition, a significant number of the
Company's stores are concentrated in the western United States, and as a result,
deterioration in economic conditions in that region could particularly affect
the Company's business, results of operations and financial condition.
16.
Changes to Federal minimum wage laws in each of 1996 and 1997 raised
the mandatory minimum wage. California, Washington, Massachusetts and other
states have also enacted increases in state-required minimum wages that are
higher than the Federal requirements. The most recent increases took effect on
January 1, 2001 in California, Connecticut, Massachusetts and Washington. The
Company operated a total of 70 stores in those states as of April 20, 2001.
Statutory increases in Federal and state minimum wages could adversely affect
the Company's profitability. The recent state increases in minimum wage and any
other such increases will raise minimum wages above current wage rates of
certain of the Company's employees, and competitive factors could require
corresponding increases in higher employee wage rates, any of which would
increase the Company's expenses and adversely affect results of operations.
QUARTERLY RESULTS AND SEASONALITY
The Company's quarterly results of operations have and are expected to
continue to fluctuate materially depending on, among other things, the timing of
store openings and related pre-opening and other startup expenses, net sales
contributed by new stores, increases or decreases in comparable store sales,
releases of new music and music-related products, shifts in timing of certain
holidays, changes in the Company's merchandise mix and overall economic
conditions. The Company's business is also subject to seasonal influences, with
heavier concentrations of sales during the Christmas, back-to-school and
Halloween seasons, and other periods when schools are not in session. The
Christmas holiday season remains the Company's single most important selling
season. The Company believes, however, that the importance of the summer
vacation and back-to-school seasons (which affect operating results in the
second and third quarters, respectively) and, to a lesser extent, the spring
break season (which affects operating results in the first quarter) and the
Halloween holiday. Furthermore, summer vacation, spring break and the
back-to-school season take place at somewhat different times in different parts
of the country, spreading the impact of these events on the Company's sales over
a longer period. As is the case with many retailers of apparel, accessories and
related merchandise, the Company typically experiences lower first fiscal
quarter net sales. The Company has experienced quarterly losses in the past and
may experience such losses in the future. Because of these fluctuations in net
sales and net income, the results of operations of any quarter are not
necessarily indicative of the results that may be achieved for a full fiscal
year or any future quarter.
DEPENDENCE ON KEY VENDORS
The Company's performance depends on its ability to purchase current
music-related merchandise in sufficient quantities at competitive prices. The
Company has many sources of merchandise. Its largest vendor, Changes
Manufacturing, supplied just under 5% of the Company's merchandise purchases in
fiscal 2000. Substantially all of the Company's music-licensed products are
available only from vendors that have exclusive license rights. In addition,
many of the Company's music-influenced products are supplied by small,
specialized vendors that create unique products primarily for the Company. The
Company's smaller vendors generally have limited resources, production
capacities and operating histories, and some of the Company's vendors have
limited the distribution of their merchandise in the past. The Company has no
long-term purchase contracts or other contractual assurances of continued
supply, pricing or access to new products. There can be no assurance that the
Company will be able to acquire desired merchandise in sufficient quantities on
terms acceptable to the Company in the future or that any inability to acquire
suitable merchandise, or the loss of one or more key vendors, will not have a
material adverse effect on the Company's business, results of operations and
financial condition.
17.
NEW TORRID STORES AND ASSOCIATED RISKS
The Company's ability to expand into new concepts has not been tested.
Accordingly, the operation of its Torrid stores and the sale of Torrid
merchandise on line at www.torrid.com, are subject to numerous risks, including
unanticipated operating problems, lack of experience, lack of customer
acceptance, new vendor relationships and competition from existing and new
retailers. For example, it may be that the Company will not be able to generate
sufficient customer interest in Torrid stores and Torrid products, or that this
concept may not be able to support the store format. There can be no assurance
that the Company's Torrid stores or Torrid website will achieve sales and
profitability levels that justify the Company's investment in this new retail
format. Establishing and increasing the number of Torrid stores also involve
other risks that could have a material adverse effect on the Company, including
(i) the risk of diversion of management's attention from the Company's core
business and products, (ii) difficulties with the hiring, retention and training
of management and personnel for the Torrid stores, (iii) risks associated with
new vendors and (iv) difficulties with locating and obtaining favorable store
sites and acceptable lease terms. Risks inherent in any new concept are
particularly acute in the Company's case with respect to Torrid, because this is
the first significant new venture by the Company. The Company has traditionally
concentrated its expansion efforts on increasing the number of and sales in Hot
Topic stores.
UNCERTAINTIES REGARDING IMPLEMENTATION OF NEW MANAGEMENT INFORMATION
SYSTEM
During fiscal 1999, after completing an evaluation of its long-term
management information system needs, the Company selected new hardware and
software for its stores, office and distribution center. The Company implemented
the host hardware and software systems at its office and distribution center
during the second half of fiscal 2000 and plans to install certain point-of-sale
upgrades at its stores in fiscal 2001. If the new information systems and
software do not work effectively, the Company may experience delays or failures
in its operations. These delays or failures could adversely impact the
promptness and accuracy of the Company's transaction processing, financial
accounting and reporting and ability to properly forecast earnings and cash
requirements. The Company's current and planned systems, transaction processing,
procedures and controls may not be adequate to support future operations. To
manage growth of its operations and personnel, the Company may need to continue
to improve its operational and financial systems, transaction processing,
procedures and controls.
DEPENDENCE ON KEY PERSONNEL
The Company's performance depends largely on the efforts and abilities
of senior management, especially Elizabeth McLaughlin, the Company's Chief
Executive Officer and President, who has been with the Company since 1993. Due
to the retirement of the Company's founder, Orval Madden, and his resignation
from the Board in April 2001, the Company remains reliant on Elizabeth
McLaughlin and her senior management team. The Company has a $2,000,000,
key-person life insurance policy on Ms. McLaughlin. However, the sudden loss of
Ms. McLaughlin's services or the services of other members of the management
team could have a material adverse effect on the Company's business, results of
operations and financial condition. Furthermore, there can be no assurance that
Ms. McLaughlin and the Company's existing management team will be able to manage
the Company or its growth or that the Company will be able to attract and retain
additional qualified personnel as needed in the future.
UNCERTAINTIES REGARDING DISTRIBUTION OF MERCHANDISE
The Company relies upon the United Parcel Service for its product
shipments, including shipments to and from all of its stores, and, accordingly,
is subject to the risks, including employee strikes and inclement weather,
associated with United Parcel Service's ability to provide delivery services to
meet the Company's shipping needs. The Company is also dependent upon temporary
employees to adequately staff its distribution facility, particularly during
busy periods, such as during the Christmas season and while multiple stores are
18.
opening. There can be no assurance that the Company will continue to receive
adequate assistance from its temporary employees, or that there will continue to
be sufficient sources of temporary employees.
FAILURE TO AUTHENTICATE LICENSING RIGHTS
The Company purchases licensed merchandise from a number of suppliers
who hold manufacturing and distribution rights under the terms of certain
licenses. The Company generally relies upon vendors' representations concerning
manufacturing and distribution rights and does not independently verify whether
these vendors legally hold adequate rights to licensed properties they are
manufacturing or distributing. If the Company acquires unlicensed merchandise,
it could be obligated to remove such merchandise from its stores, incur costs
associated with destruction of merchandise if the distributor is unwilling or
unable to reimburse the Company, and be subject to liability under various civil
and criminal causes of action, including actions to recover unpaid royalties and
other damages. Any of these results could have a material adverse effect on the
Company's business, results of operations and financial condition.
COMPETITION
The retail apparel and accessory industry is highly competitive. The
Company competes with other retailers for vendors and for teenage and college
age customers, suitable retail locations and qualified employees and management
personnel. Hot Topic currently competes with street alternative stores located
primarily in metropolitan areas and with other mall-based teenage-focused
retailers such as The Buckle, Charlotte Russe, Claire's Stores, Inc., Delias
Inc., d.e.m.o., Gadzooks, Inc., Millers Outpost, Inc., Pacific Sunwear of
California, Inc., Spencer Gifts, Inc., Urban Outfitters, Inc., The Wet Seal,
Inc., and, to a lesser extent, with music stores and mail order catalogs and
websites. Many of the Company's competitors are larger and have substantially
greater financial, marketing and other resources than the Company. Direct
competition with these and other retailers may increase significantly in the
future, which could require the Company, among other things, to lower its prices
and/or take other measures. Increased competition could have a material adverse
effect on the Company's business, results of operations and financial condition.
PRICE VOLATILITY
The Company's Common Stock is quoted on the Nasdaq National Market,
which has experienced and is likely to experience in the future significant
price and volume fluctuations, which could adversely affect the market price of
the Common Stock without regard to the operating performance of the Company. In
addition, the Company believes that factors such as quarterly fluctuations in
the financial results of the Company, fluctuations in the Company's comparable
store sales, announcements by other apparel, accessory and gift item retailers,
the trading volume of the Company's Common Stock in the public market, the
condition of the overall economy and the condition of the financial markets
could cause the price of the Common Stock to fluctuate substantially.
ANTI-TAKEOVER MATTERS
The Company's Amended and Restated Articles of Incorporation and
Amended and Restated Bylaws contain provisions that may have the effect of
delaying, deterring or preventing a takeover of the Company that shareholders
may consider being in their best interests. For instance, the Company's Amended
and Restated Articles of Incorporation and Amended and Restated Bylaws prohibit
shareholder action by written consent and include certain "fair price
provisions." Additionally, the Board of Directors has the authority to issue up
to 10,000,000 shares of "blank check" preferred stock having such rights,
preferences and privileges as designated by the Board of Directors without
shareholder approval.
19.
ITEM 2. PROPERTIES
The Company leases all of the Company's existing store locations, with
lease terms expiring between 2001 and 2010. The leases for most of the existing
stores are for ten-year years and provide for contingent rent based upon a
percent of sales in excess of specified minimums. Leases for future stores will
likely include similar contingent rent provisions.
The Company's headquarters office and distribution center are located
in City of Industry, California, and are occupied under the terms of a lease
covering approximately 125,000 square feet. The lease is for a five-year term,
with two options to extend the lease, each for a three-year period. The annual
base rent for the initial five-year term is approximately $525,000. This lease
will terminate on August 1, 2001. Beginning August 1, 2001, the Company will
double the size of its leased office and distribution center space, and has
entered into an amended lease with its existing landlord. The amended lease is
for a five-year term (from the beginning of the original lease) with two options
to extend the lease, each for a three-year period. The initial five-year term
will expire in April 2004. The annual base rent for the initial five-year term
is approximately $1,131,900 including the additional space.
The original lease terms of the Company's headquarters and distribution
facility granted the Company the right of first refusal on the remaining 125,000
square feet of space in the building at 90% of the fair market lease rates for
such space. In February 2001, the Company was notified that the space would
become available in 2001 and was provided with comparable market lease rates.
The Company considered the terms and timing of leasing the additional space
against other possible alternatives and determined that it was in the Company's
best interest to lease the additional space under the negotiated terms. The
Company may sublease part of the additional space during part of fiscal 2001 but
believes it will begin utilizing all of the space in fiscal 2002. The Company
also believes that leasing the adjacent space is more efficient and cost
effective than its alternatives for expansion such as moving the entire facility
or acquiring additional separate space. The Company believes the property
covered by the amended lease will allow for growth of to up to 750 stores.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
20.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Common Stock of the Company is traded on the NASDAQ National Market
under the symbol "HOTT". A two-for-one stock split of the Company's Common Stock
became effective December 27, 2000. The stock split was affected by way of a
stock dividend. The dividend was distributed to shareholders of record as of
December 14, 2000. This was the second two for one split for the Company, the
first split having occurred in December 1999. All share and per share amounts
have been restated to reflect the splits. The following table sets forth, for
the periods indicated, the high and low sales prices of the shares of Common
Stock of the Company, as reported on the NASDAQ National Market. Such quotations
represent inter-dealer prices without retail markup, markdown or commission and
may not necessarily represent actual transactions.
2000 FISCAL YEAR QUARTERS HIGH LOW
------------------------------------
First Quarter $ 17 15/16 $ 7 15/16
Second Quarter $ 17 27/32 $ 11 25/64
Third Quarter $ 19 3/4 $ 13 3/4
Fourth Quarter $ 26 11/16 $ 14 9/16
1999 FISCAL YEAR QUARTERS HIGH LOW
------------------------------------
First Quarter $ 4 3/4 $ 3 3/16
Second Quarter $ 7 25/32 $ 4 1/4
Third Quarter $ 9 3/8 $ 5 61/64
Fourth Quarter $ 13 11/32 $ 8 19/32
On April 20, 2001, the last sales price of the Common Stock as reported on the
NASDAQ National Market was $31.18 per share. As of April 20, 2001, there were
approximately 194 holders of record of the Company's Common Stock. This number
does not reflect the actual number of beneficial holders of the Company's Common
Stock, which the Company believes to be in excess of 8,000 holders.
The Company has not paid any cash dividends since inception and does
not anticipate paying any cash dividends in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and Notes thereto included
elsewhere in this Annual Report on Form 10-K.
21.
HOT TOPIC, INC. AND SUBSIDIARIES
SELECTED FINANCIAL DATA:
FISCAL YEAR
---------------------------------------------------------
2000 1999 1998 1997 1996
--------- --------- --------- --------- ---------
(In thousands, except per share data, number
of stores, comparable store sales and sales
per square foot)
STATEMENT OF OPERATIONS DATA:
Net sales $257,187 $168,949 $103,371 $ 70,532 $ 43,618
Cost of goods sold, including buying,
distribution and occupancy costs 154,298 103,998 65,855 44,417 27,049
--------- --------- --------- --------- ---------
Gross Margin 102,889 64,951 37,516 26,115 16,569
Selling, general and administrative expenses 67,917 44,749 29,077 19,862 12,846
--------- --------- --------- --------- ---------
Operating income 34,972 20,202 8,439 6,253 3,723
Interest income, net 1,925 933 931 901 382
--------- --------- --------- --------- ---------
Income before income taxes 36,897 21,135 9,370 7,154 4,105
Income taxes 13,652 7,634 3,367 2,611 1,535
--------- --------- --------- --------- ---------
Net income 23,245 $ 13,501 $ 6,003 $ 4,543 $ 2,570
Net income per share:
Basic $ 1.18 $ 0.73 $ 0.31 $ 0.24 $ 0.18
Diluted $ 1.09 $ 0.69 $ 0.30 $ 0.23 $ 0.16
Weighted average shares
outstanding
Basic 19,779 18,534 19,268 18,762 14,512
Diluted 21,379 19,594 19,824 19,760 15,596
SELECTED OPERATING DATA:
Number of stores at year end 274 212 158 108 68
Comparable stores sales increase (decrease) 16.7% 22.8% 0.4% 2.2% 8.9%
Average sales per square foot $ 669 $ 623 $ 542 $ 565 $ 578
Average sales per store (000s) $ 1,020 $ 909 $ 772 $ 769 $ 748
BALANCE SHEET DATA:
Working capital $ 61,253 $ 37,564 $ 28,432 $ 29,230 $ 29,247
Total assets 118,646 89,022 58,764 51,953 44,033
Long-term obligations including current portion 123 231 120 161 48
Shareholders' equity $ 99,291 $ 67,278 $ 48,749 $ 44,736 $ 39,069
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
Hot Topic is a mall-based specialty retailer of music-licensed and
music-influenced apparel, accessories and gift items for young men and women
principally between the ages of 12 and 22. The Company opened its first store in
1989, and operated 274 stores in 45 states across the United States as of
February 3, 2001. The Company opened 26 stores during fiscal 1996, most of which
were in new markets in the Midwest and Northeast adjacent to markets entered in
fiscal 1995; 40 stores during fiscal 1997, both in existing markets and in 12
additional states, 50 stores during fiscal 1998, both in existing markets and in
6 additional states; 54 stores during fiscal 1999, both in existing markets and
in 4 additional states; and; 62 stores during fiscal 2000, both in existing
markets and 3 additional states.
22.
The Company operates on a 52 or 53-week fiscal year, which ends on the
Saturday nearest to January 31. Fiscal 2000 was a 53-week year. Fiscal 1998 and
1999 were 52-week years.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
selected statement of operations data expressed as a percentage of net sales and
certain store data:
FISCAL YEAR
---------------------------------
2000 1999 1998
---------------------------------
Net sales 100.0% 100.0% 100.0%
Cost of goods sold, including buying,
distribution & occupancy costs 60.0% 61.6% 63.7%
Gross margin 40.0% 38.4% 36.3%
Selling, general and administrative expenses 26.4% 26.4% 28.1%
Operating income 13.6% 12.0% 8.2%
Interest income, net 0.7% 0.6% 0.9%
Income before income tax 14.3% 12.6% 9.1%
Provision for income taxes 5.3% 4.6% 3.3%
Net income 9.0% 8.0% 5.8%
Number of stores at year end 274 212 158
Comparable store sales increase 16.7% 22.8% 0.4%
23.
FISCAL 2000 COMPARED TO FISCAL 1999
Net sales increased approximately $88.3 million, or 52%, to $257.2
million in fiscal 2000 from $168.9 million in fiscal 1999. Net sales for the 62
stores opened during fiscal 2000 and for those stores not yet qualifying as
comparable stores contributed $62.8 million of the net sales increase.
Comparable store sales increased 16.7% in fiscal 2000 and contributed $25.5
million of the increase in net sales. The average store volume increased to
$1,020,000 from $909,000 in fiscal 1999. The sales mix in fiscal 2000 saw a
slight shift toward apparel and T-shirts, with this category contributing
approximately 51% of net sales in 2000 as compared to approximately 50% in 1999.
Gross margin increased approximately $38.0 million to $102.9 million in
fiscal 2000 from $64.9 million in fiscal 1999. As a percentage of net sales,
gross margin increased to 40.0% in fiscal 2000 from 38.4% in fiscal 1999. The
increase, as a percentage of sales, reflected the leveraging of occupancy
expense achieved from the significant increase in the average store sales volume
and an increase in merchandise margin. Merchandise margin increased
approximately 1.0%, as a percentage of sales compared to the prior year,
principally from an average higher initial markup and lower markdowns, shrinkage
and freight, all as a percentage of sales.
Selling, general and administrative expenses increased approximately
$23.2 million to $67.9 million during fiscal 2000 from $44.7 million during
fiscal 1999. As a percentage of net sales, selling, general and administrative
expense was 26.4% for fiscal 2000, the same percentage as in fiscal 1999. Many
of the fiscal 2000 selling, general and administrative expenses decreased as a
percent of net sales due to the operating leverage achieved through the
Company's larger store base and higher average store sales volume. This leverage
was off-set by higher performance based bonuses, development costs for the new
Torrid concept, higher store management payroll, increased benefit coverage and
continued investment in management infrastructure.
Operating income increased approximately $14.8 million to $35.0 million
during fiscal 2000 from $20.2 million during fiscal 1999. As a percentage of net
sales, operating income increased significantly to 13.6% in fiscal 2000 from
12.0% in fiscal 1999, principally from the larger store base, higher average
store sales and higher margins. Operating income on an average per store basis
was approximately $142,000 in fiscal 2000, up 30% from last year's $109,000.
Net interest income increased by $1.0 million to $1.9 million or 0.7%
of sales during fiscal 2000, from $0.9 million or 0.6% of sales during fiscal
1999, principally a result of higher average cash balances.
The Company's effective tax rate was 37.0% in fiscal 2000 and 36.1% in
fiscal 1999. The variance from an expected rate of approximately 40% in both
fiscal 2000 and 1999 is a result of a significant portion of each fiscal year's
interest income being non-taxable.
FISCAL 1999 COMPARED TO FISCAL 1998
Net sales increased approximately $65.5 million, or 63%, to $168.9
million in fiscal 1999 from $103.4 million in fiscal 1998. Net sales for the 54
stores opened during fiscal 1999 and for those stores not yet qualifying as
comparable stores contributed $44.7 million of the net sales increase.
Comparable store sales increased 22.8% in fiscal 1999 and contributed $20.8
million of the increase in net sales. The average store volume increased to
$909,000 from $772,000 in fiscal 1998. The sales mix in fiscal 1999 was
approximately the same as the mix in fiscal 1998, with apparel and T-shirts
contributing approximately 50% of net sales in each fiscal year.
24.
Gross margin increased approximately $27.4 million to $64.9 million in
fiscal 1999 from $37.5 million in fiscal 1998. As a percentage of net sales,
gross margin increased to 38.4% in fiscal 1999 from 36.3% in fiscal 1998. The
increase, as a percentage of sales, reflected the leveraging of occupancy
expense achieved from the significant increase in the average store sales volume
and an increase in merchandise margin. Merchandise margin increased
approximately 0.4% compared to the prior year, principally from an average
higher initial markup and lower merchandise markdowns, as a percentage of sales.
Selling, general and administrative expenses increased approximately
$15.6 million to $44.7 million during fiscal 1999 from $29.1 million during
fiscal 1998, but decreased as a percentage of net sales to 26.4% in fiscal 1999
from 28.1% in fiscal 1998. The decrease as a percentage of net sales was
primarily due to a reduction of corporate overhead expense as a percentage of
net sales due to the operating leverage achieved through the Company's larger
store base and to a reduction in the store payroll and operating expenses as a
percentage of sales due to the operating leverage achieved from the higher
average store sales.
Operating income increased approximately $11.8 million to $20.2 million
during fiscal 1999 from $8.4 million during fiscal 1998. As a percentage of net
sales, operating income increased significantly to 12.0% in fiscal 1999 from
8.2% in fiscal 1998, principally from the larger store base, higher average
store sales and higher margins.
Interest income, net, of $933,000 during fiscal 1999 was approximately
the same as the $931,000 during fiscal 1998.
The Company's effective tax rate was 36.1% in fiscal 1999 and 35.9% in
fiscal 1998. The variance from an expected rate of approximately 40% in both
fiscal 1999 and 1998 is a result of a significant portion of each fiscal year's
interest income being non-taxable.
QUARTERLY RESULTS AND SEASONALITY
The Company's quarterly results of operations may fluctuate materially
depending on, among other things, the timing of store openings and related
pre-opening and other startup expenses, net sales contributed by new stores,
increases or decreases in comparable store sales, releases of new music and
music-related products, shifts in timing of certain holidays, changes in the
Company's merchandise mix and overall economic conditions.
The Company's business is also subject to seasonal influences, with
heavier concentrations of sales during the Christmas, back-to-school, Halloween
seasons, and other periods when schools are not in session. The Christmas
holiday season remains the Company's single most important selling season. The
Company believes, however, that the importance of the summer vacation and
back-to-school seasons (which affect operating results in the second and third
quarters, respectively) and, to a lesser extent, the spring break season (which
affects operating results in the first quarter) and the Halloween holiday,
(reduces somewhat the Company's dependence on the Christmas holiday selling
season). Furthermore, summer vacation, spring break and the back-to-school
season take place at somewhat different times in different parts of the country,
spreading the impact of these events on the Company's sales over a longer
period. As is the case with many retailers of apparel, accessories and related
merchandise, the Company typically experiences lower first fiscal quarter net
sales.
The following table sets forth certain statement of operations and
operating data for each of the Company's last eight fiscal quarters. The
quarterly statement of operations data and selected operating data set forth
below were derived from unaudited financial statements of the Company, which in
the opinion of management of the Company contain all adjustments (consisting
25.
only of normal recurring adjustments) necessary for fair presentation thereof.
Results in any quarter are not necessarily indicative of results that may be
achieved for a full year.
The following table sets forth certain statement of operations and
operating data for each of the Company's last eight fiscal quarters. The
quarterly statement of operations data and selected operating data set forth
below were derived from unaudited financial statements of the Company, which in
the opinion of management of the Company contain all adjustments (consisting
only of normal recurring adjustments) necessary for fair presentation thereof.
Results in any quarter are not necessarily indicative of results that may be
achieved for a full year.
FISCAL YEAR 2000 FISCAL YEAR 1999
----------------------------------------- -----------------------------------------
(In thousands, except selected FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
operating and per share data) -------- -------- -------- -------- -------- -------- -------- --------
STATEMENT OF OPERATIONS DATA:
Net sales $44,839 $51,718 $72,203 $88,427 $28,286 $32,779 $47,964 $59,920
Gross Margin 16,769 19,287 29,210 37,623 9,746 11,413 19,019 24,773
Operating income 3,456 4,578 11,165 15,772 781 1,638 6,576 11,207
Net income $ 2,443 $ 3,121 $ 7,317 $10,364 $ 635 $ 1,152 $ 4,306 $ 7,408
Net income per share:
Basic $ 0.13 $ 0.16 $ 0.37 $ 0.51 $ 0.03 $ 0.06 $ 0.23 $ 0.40
Diluted $ 0.12 $ 0.15 $ 0.34 $ 0.48 $ 0.03 $ 0.06 $ 0.22 $ 0.36
Weighted average shares outstanding:
Basic 19,441 19,732 19,795 20,147 18,484 18,478 18,572 18,602
Diluted 21,016 21,294 21,426 21,784 18,848 19,264 19,678 20,588
SELECTED OPERATING DATA:
Comparable store sales increase 24.1% 21.8% 15.3% 11.2% 15.3% 16.9% 26.1% 27.1%
Stores open at end of period 224 247 267 274 168 184 198 212
LIQUIDITY AND CAPITAL RESOURCES
During the last three fiscal years, the Company's primary uses of cash
have been to finance store openings, purchase merchandise inventories, and in
fiscal 1999, to expand the headquarters and distribution facility. In fiscal
2000, an additional significant use of capital was used to secure the hardware
and software related to the host computer systems implemented during the third
quarter. The Company has satisfied its cash requirements exclusively from cash
flows from operations.
Cash flows provided by operating activities were $19.7 million, $25.8
million, and $9.3 million in fiscal 2000, 1999 and 1998, respectively. The
decrease in cash flows from operating activities in fiscal 2000 was primarily
attributable to the timing of the payment of estimated 2000 income tax
liabilities and the payment of February 2001 rents (payment required prior to
the fiscal 2000 year end of February 3, 2001).
Cash flows used in investing activities were $16.7 million, $15.8
million and $9.3 million in fiscal 2000, 1999 and 1998, respectively. Cash flows
used in investing activities relate primarily to store openings and, in 2000,
approximately $2.6 million was used for the hardware and software related to the
26.
new system implementation, and in 1999, $4.2 million was used for equipment and
leasehold improvements for the Company's new headquarters office and
distribution facility. The Company opened 62, 54 and 50 stores in fiscal 2000,
1999 and 1998, respectively.
Cash flows provided by (used in) financing activities were $8.7
million, $5.0 million and ($2.1) million in fiscal 2000, 1999 and 1998,
respectively. Cash flows related to the exercise of stock options represented
$8.8 million of the fiscal year 2000 financing activities.
The Company anticipates that it will spend approximately $20 million on
capital expenditures in fiscal 2001. Of that amount, approximately $13 to $15
million is needed for the construction of the planned 65 Hot Topic stores and 6
Torrid stores in fiscal 2001. During fiscal 2000, the Company's average capital
expenditures to open a store, including leasehold improvements and furniture and
fixtures, totaled approximately $179,000. The average initial gross inventory
for the new 2000 stores was approximately $101,000 (which was partially financed
by trade credit) and pre-opening costs averaged approximately $21,000 for these
stores. The Company expects the average total costs associated with opening a
store to increase moderately to approximately $200,000 in fiscal 2001 as a
result of the implementation of a new store design that was tested in two new
stores in the fourth quarter of fiscal 2000. Pre-opening costs are expensed as
incurred. The actual costs that the Company will incur in connection with
opening future stores cannot be predicted with precision because such costs will
vary based upon, among other things, geographic location, and the size of the
stores and the extent of the build-out required at the selected sites. Initial
inventory requirements vary at new stores depending on the season and current
merchandise trends.
During fiscal 1999, after completing an evaluation of its long-term
management information system needs, the Company selected new hardware and
software for its stores, office and distribution center. The Company implemented
the host hardware and software systems at its office and distribution center
during the third quarter of fiscal 2000 and plans to install certain point of
sale upgrades at its stores in fiscal 2001. During fiscal 2000, the Company
spent approximately $2.1 million for the hardware, software, modifications,
training and implementation of the host system. The Company presently estimates
the point of sale upgrades and currently planned enhancements and modifications
to the host system will cost approximately $2.5 to $3.0 million, substantially
all of which will be spent in fiscal 2001.
The Company believes that its existing cash balances and cash generated
from operations will be sufficient to fund its operations and planned expansion
through at least the next 12 months.
INFLATION
The Company does not believe that inflation has had a material adverse
effect on net sales or results of operations. The Company has generally been
able to pass on increased costs related to inflation through increases in
selling prices.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's market risks relevant to disclosure pursuant to Item 7A
are not material and are therefore not required.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The financial statements of the Company listed in Item 14(a) are
included herein on pages F-1 through F-14 and are incorporated herein by
reference.
27.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
See the section entitled "Executive Officers and Key Employees" in Part
I, Item 1 hereof for information regarding the Company's executive officers.
The information required by this item with respect to directors is
incorporated by reference to the information appearing under the caption
"Election of Directors," contained in the Company's Definitive Proxy Statement
which will be filed with the SEC within 120 days of fiscal year-end pursuant to
Regulation 14A in connection with the solicitation of proxies for the Company's
Annual Meeting of Shareholders to be held on June 7, 2001 (the "2001 Proxy
Statement").
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to
the information appearing under the caption "Executive Compensation" in the 2001
Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to
the information appearing under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the 2001 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to
the information appearing under the caption "Certain Transactions" in the 2001
Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
(a)(1) CONSOLIDATED FINANCIAL STATEMENTS
The following consolidated financial statements required by
this item are submitted in a separate section beginning on page F-1 of this
Annual Report on Form 10-K:
PAGE
Report of Ernst & Young LLP, Independent Auditors............................. F-1
---
Consolidated Balance Sheets as of February 3, 2001 and January 29, 2000....... F-2
---
Consolidated Statements of Operations for the years ended February 3, 2001,
January 29, 2000 and January 30, 1999................................ F-3
---
Consolidated Statements of Shareholders' Equity for the years ended
February 3, 2001, January 29, 2000 and January 30, 1999.............. F-4
---
Consolidated Statements of Cash Flows for the years ended February 3,
2001, January 29, 2000 and January 30, 1999.......................... F-5
---
Notes to Consolidated Financial Statements.................................... F-6
---
28.
(a)(2) FINANCIAL STATEMENT SCHEDULES
All financial statement schedules are omitted because they are
not required, are not applicable, or the information is included in the
consolidated financial statements or notes thereto.
(a)(3) EXHIBITS
The exhibits listed under Item 14(c) hereof are filed with, or
incorporated by reference into, this Annual Report on Form 10-K.
(b) REPORTS ON FORM 8-K
During the quarter ended February 3, 2001, the Company filed
one report on Form 8-K. On December 1, 2000, the Company filed a report on Form
8-K reporting, under Item 5, the announcement that its Board of Directors
approved a two-for-one stock split to be implemented as a 100% stock dividend to
each of the Company's shareholders of record as of December 14, 2000.
(c) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------ -----------------------
3.1 Amended and Restated Articles of Incorporation. (1)
3.2 Amended and Restated Bylaws.
4.1 Reference is made to Exhibits 3.1 and 3.2.
4.2 Specimen stock certificate. (1)
10.1 Form of Indemnity Agreement to be entered into between
Registrant and its directors and officers. (1)
10.2 1996 Equity Incentive Plan (the "1996 Plan"). (1)
10.3 Form of Nonstatutory Stock Option Agreement of Registrant
pursuant to the 1996 Plan. (1)
10.4 Form of Incentive Stock Option Agreement of Registrant
pursuant to the 1996 Plan. (1)
10.5 Non-Employee Directors' Stock Option Plan. (1)
10.6 Employee Stock Purchase Plan. (1)
10.7 401(k) Defined Contribution Plan of Registrant, effective as
of August 1, 1995. (1)
10.8 Industrial Real Estate Lease (Multi-Tenant Facility), dated
December 10, 1998, entered into between Registrant's wholly
owned subsidiary, Hot Topic Administration, Inc. and Majestic
Realty Co. and Patrician Associates, Inc. (2)
10.9 Guaranty of Lease, dated December 10, 1998, entered into
between the Registrant and Majestic Realty Co. and Patrician
Associates, Inc. (2)
10.10 First Amendment to Industrial Real Estate Lease, dated March
19, 2001, by and between Majestic - Fullerton Road, LLC, PFG
Fullerton Limited Partnership, and Hot Topic Administration,
Inc.
29.
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------ -----------------------
10.11 Employment Agreement dated January 22, 2001, between the
Registrant and Elizabeth McLaughlin.
10.12 Employment Offer Letter dated January 12, 2001, between the
Registrant and Jerry Cook.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney is contained on the signature page.
- ------------
(1) Filed as an exhibit to Registrant's Registration Statement on Form SB-2
(No. 333-5054-LA) and incorporated herein by reference.
(2) Filed as an exhibit to Registrant's Annual Report on Form 10-K for the
year ended January 30, 1999 and incorporated herein by reference
(10.8 and 10.9).
(d) FINANCIAL STATEMENT SCHEDULES
Reference is made to Item 14(a)(2).
30.
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Industry,
County of Los Angeles, State of California, on the 27th day of April 2001.
HOT TOPIC, INC.
By: /s/ Elizabeth M. McLaughlin
---------------------------
Elizabeth M. McLaughlin
Chief Executive Officer,
President and Director
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Elizabeth M. McLaughlin and Jim McGinty,
or either of them, his attorney-in-fact, each with the power of substitution,
for him in any and all capacities, to sign any amendments to this Report, and to
file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that each of said attorneys-in-fact, or his substitute or
substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
NAME POSITION DATE
- ----------------------------------- --------------------------------- --------------
/s/ ELIZABETH M. MCLAUGHLIN Chief Executive Officer, President April 27, 2001
- ----------------------------------- and Director (PRINCIPAL EXECUTIVE
Elizabeth M. McLaughlin OFFICER)
/s/ JIM MCGINTY Chief Financial Officer (PRINCIPAL April 27, 2001
- ----------------------------------- FINANCIAL AND ACCOUNTING OFFICER)
Jim McGinty
/s/ ROBERT M. JAFFE Chairman of the Board April 27, 2001
- -----------------------------------
Robert M. Jaffe
/s/ EDGAR F. BERNER Director April 27, 2001
- -----------------------------------
Edgar F. Berner
/s/ CORRADO FEDERICO Director April 27, 2001
- -----------------------------------
Corrado Federico
/s/ ANDREW SCHUON Director April 27, 2001
- -----------------------------------
Andrew Schuon
/s/BRUCE A. QUINNELL Director April 27, 2001
- -----------------------------------
Bruce A. Quinnell
31.
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Hot Topic, Inc.
We have audited the accompanying consolidated balance sheets of Hot Topic, Inc.
and subsidiaries as of February 3, 2001 and January 29, 2000, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended February 3, 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the consolidated 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Hot
Topic, Inc. and subsidiaries at February 3, 2001 and January 29, 2000, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended February 3, 2001 in conformity with accounting
principles generally accepted in the United States.
/S/ Ernst & Young LLP
----------------------
Ernst & Young
Los Angeles, California
March 9, 2001
Hot Topic, Inc. and Subsidiaries
Consolidated Balance Sheets
February 3, 2001 January 29, 2000
Assets
Current assets:
Cash and cash equivalents $ 51,287,698 $ 39,549,654
Inventory 21,335,515 15,366,745
Prepaid expenses and other 5,552,600 1,580,433
Deferred tax asset 943,742 721,161
------------- -------------
Total current assets 79,119,555 57,217,993
Leaseholds, fixtures and equipment, net 39,165,998 31,721,478
Deposits and other 100,662 82,986
Deferred tax asset 259,845 -
------------- -------------
Total assets $118,646,060 $ 89,022,457
============= =============
Liabilities and shareholders' equity Current liabilities:
Accounts payable $ 6,632,140 $ 6,215,011
Accrued payroll and related expenses 10,093,360 8,452,469
Accrued sales and other taxes payable 1,103,150 637,623
Federal and state income taxes payable - 4,288,815
Current portion of obligations under capital leases 37,691 59,736
------------- -------------
Total current liabilities 17,866,341 19,653,654
Deferred rent 1,403,576 1,104,709
Capital lease obligations, less current portion 84,869 170,767
Deferred tax liability - 815,796
Shareholders' equity:
Common shares, no par value;
50,000,000 shares authorized; 20,293,855 and 19,321,688
shares issued and outstanding at February 3, 2001 and
January 29, 2000, respectively 49,429,508 40,667,571
Deferred compensation - (6,727)
Retained earnings 49,861,766 26,616,687
Total shareholders' equity 99,291,274 67,277,531
------------- -------------
Total liabilities and shareholders' equity $118,646,060 $ 89,022,457
============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-2
Hot Topic, Inc. and Subsidiaries
Consolidated Statements of Income
Years ended
-----------
February 3, January 29, January 30,
2001 2000 1999
-------------- -------------- --------------
Net sales $ 257,187,317 $ 168,948,553 $ 103,370,683
Cost of goods sold, including buying,
distribution and occupancy costs 154,298,004 103,998,031 65,854,559
-------------- -------------- --------------
Gross margin 102,889,313 64,950,522 37,516,124
Selling, general and administrative expenses 67,917,723 44,748,988 29,077,124
-------------- -------------- --------------
Operating income 34,971,590 20,201,534 8,439,000
Interest income (1,955,414) (964,826) (951,119)
Interest expense 30,025 32,086 20,296
-------------- -------------- --------------
Income before income taxes 36,896,979 21,134,274 9,369,823
Provision for income taxes (Note 6) 13,651,900 7,633,600 3,366,900
-------------- -------------- --------------
Net income $ 23,245,079 $ 13,500,674 $ 6,002,923
============== ============== ==============
Net income per share:
Basic $ 1.18 $ 0.73 $ 0.31
============== ============== ==============
Diluted $ 1.09 $ 0.69 $ 0.30
============== ============== ==============
Shares used in computing net income
per share:
Basic 19,778,706 18,533,704 19,268,096
Diluted 21,379,418 19,594,724 19,823,188
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-3
Hot Topic, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity
Common Shares Total
----------------------------- Deferred Retained Shareholders'
Shares Amount Compensation Earnings Equity
------------- ------------- ------------- ------------- -------------
Balance at January 31, 1998 19,038,424 $ 37,700,992 ($ 78,511) $ 7,113,090 $ 44,735,571
Exercise of stock options 444,308 388,728 - - 388,728
Employee stock purchase plan 14,992 49,500 - - 49,500
Repurchase common stock (880,000) (2,968,565) - - (2,968,565)
Amortization of deferred compensation - - 35,892 - 35,892
Tax benefit from exercise of options - 505,097 - - 505,097
Net income - - - 6,002,923 6,002,923
------------- ------------- ------------- ------------- -------------
Balance at January 30, 1999 18,617,724 35,675,752 (42,619) 13,116,013 48,749,146
Exercise of stock options 964,192 4,187,278 - - 4,187,278
Employee stock purchase plan 15,772 60,469 - - 60,469
Repurchase common stock (276,000) (1,064,863) - - (1,064,863)
Amortization of deferred compensation - - 35,892 - 35,892
Tax benefit from exercise of options - 1,808,935 - - 1,808,935
Net income - - - 13,500,674 13,500,674
------------- ------------- ------------- ------------- -------------
Balance at January 29, 2000 19,321,688 40,667,571 (6,727) 26,616,687 67,277,531
Exercise of stock options 959,910 4,767,049 - - 4,767,049
Employee stock purchase plan 12,257 143,170 - - 143,170
Amortization of deferred compensation - - 6,727 - 6,727
Tax benefit from exercise of options - 3,851,718 - - 3,851,718
Net income - - - 23,245,079 23,245,079
------------- ------------- ------------- ------------- -------------
Balance at February 3, 2001 20,293,855 $ 49,429,508 - $ 49,861,766 $ 99,291,274
============= ============= ============= ============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-4
Hot Topic, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years ended
--------------------------------------------
February 3, January 29, January 30,
2001 2000 1999
------------- ------------- -------------
OPERATING ACTIVITIES
Net income $ 23,245,079 $ 13,500,674 $ 6,002,923
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 8,645,306 5,890,519 4,069,200
Deferred rent 298,867 360,998 234,889
Deferred compensation 6,727 35,892 35,892
Deferred taxes (1,298,222) (422,800) 124,198
Loss on disposal of fixed assets 501,427 10,072 -
Changes in operating assets and liabilities:
Inventory (5,968,770) (4,920,119) (2,810,030)
Prepaid expenses and other current assets (3,972,167) (140,147) (782,537)
Deposits and other assets (17,676) 3,936 (46,397)
Accounts payable 417,129 4,028,549 480,803
Accrued payroll and related expenses 1,712,434 4,601,036 1,409,150
Accrued sales and other taxes payable 465,527 254,881 118,883
Income taxes payable (4,288,815) 2,580,813 488,804
------------- ------------- -------------
Net cash provided by operating activities 19,746,846 25,784,304 9,325,778
INVESTING ACTIVITIES
Purchases of property and equipment (16,662,796) (15,763,802) (9,274,002)
------------- ------------- -------------
Net cash used in investing activities (16,662,796) (15,763,802) (9,274,002)
FINANCING ACTIVITIES
Payments on capital lease obligations (107,943) (36,541) (31,689)
Repurchase common shares - (1,064,863) (2,968,565)
Proceeds from employee stock purchases and
exercise of stock options, including related tax benefit 8,761,937 6,056,682 943,325
------------- ------------- -------------
Net cash provided by (used in) financing activities 8,653,994 4,955,278 (2,056,929)
------------- ------------- -------------
Increase (decrease) in cash and cash equivalents 11,738,044 14,975,780 (2,005,153)
Cash and cash equivalents at beginning of year 39,549,654 24,573,874 26,579,027
------------- ------------- -------------
Cash and cash equivalents at end of year $ 51,287,698 $ 39,549,654 $ 24,573,874
============= ============= =============
SUPPLEMENTAL INFORMATION
Cash paid during the year for interest $ 30,245 $ 32,086 $ 20,296
============= ============= =============
Cash paid during the year for income taxes $ 17,399,328 $ 3,674,209 $ 2,245,212
============= ============= =============
Capital lease obligations entered into for equipment $ - $ 171,885 $ -
============= ============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-5
Hot Topic, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
February 3, 2001
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS ACTIVITY
Hot Topic, Inc. (the Company) was incorporated in California in September 1988.
The Company sells music-licensed and music-influenced apparel, accessories and
gift items for young men and women through its retail stores. The Company
operates mall based retail stores throughout the United States. The consolidated
financial statements include the accounts of the Company and its wholly owned
subsidiaries. All intercompany accounts have been eliminated in consolidation.
FISCAL YEAR
The Company's fiscal year is on a 52-53 week basis and ends on the Saturday
nearest to January 31. The fiscal year ended February 3, 2001 is a 53-week year.
The years ended January 29, 2000 and January 30, 1999 were 52-week years.
REVENUE RECOGNITION
Retail merchandise sales are recognized at the point of sale less estimated
sales returns.
INCOME TAXES
The Company utilizes Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes," which prescribes the use of the liability method
to compute the difference between the tax basis of assets and liabilities and
the related financial reporting amounts using currently enacted tax laws and
rates.
NET INCOME PER SHARE
Net income per share has been computed in accordance with Financial Accounting
Standards Board (FASB) Statement No. 128, "Earnings per Share" (see Note 5). A
two-for-one stock split became effective December 27, 2000. All share and per
share amounts have been restated to reflect the split.
F-6
Hot Topic, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of less than
three months when purchased to be cash equivalents. The Company is potentially
exposed to a concentration of credit risk when cash deposits in banks are in
excess of federally insured limits, and as a result, the investment of cash
equivalents is at two financial institutions.
INVENTORY
Inventories and related cost of sales are accounted for by the retail method.
The cost of inventory is determined at the lower of the first-in, first-out
(FIFO) method or market.
STORE PRE-OPENING COSTS
Costs incurred in connection with the opening of a new store are expensed as
incurred.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost or in the case of capitalized
leases, at the present value of future minimum lease payments. Depreciation is
provided using the straight-line method over the estimated useful lives of the
assets (3-10 years). Leasehold improvements are amortized using the
straight-line method over the shorter of the lease term or ten years.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
LONG-LIVED ASSETS
The Company accounts for the impairment and disposition of long-lived assets in
accordance with Statement of Financial Accounting Standards (SFAS) No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of" (SFAS No. 121). In accordance with SFAS No. 121, long-lived
assets to be held are reviewed for events or changes in circumstances that
indicate that their carrying value may not be recoverable. At February 3, 2001,
the Company believes there has been no impairment of the value of such assets.
F-7
Hot Topic, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees using the intrinsic
value method as prescribed by Accounting Principle Board Opinion No. 25,
"Accounting for Stock Issued to Employees".
NEW ACCOUNTING PRONOUNCEMENT
Effective in 2001, accounting for gains or losses resulting from changes in the
value of derivatives would be changed depending on the use of the derivative and
whether they qualify for hedge accounting. The adoption of this new requirement
is not expected to have a material impact on the financial position or results
of operations of the Company.
2. LEASEHOLDS, FIXTURES AND EQUIPMENT
Leaseholds, fixtures and equipment are summarized as follows:
February 3, January 29,
2001 2000
------------- -------------
Furniture, fixtures and equipment $ 31,299,751 $ 25,396,222
Leasehold improvements 29,135,468 21,419,124
------------- -------------
60,435,219 46,815,346
Less accumulated depreciation and amortization (21,269,221) (15,093,868)
------------- -------------
$ 39,165,998 $ 31,721,478
============= =============
3. COMMITMENTS
LEASES
The Company has entered into lease agreements for retail and office space under
primarily noncancelable leases with terms ranging from three to approximately
ten years. The retail space leases provide for rents based upon the greater of
the minimum annual rental amounts or 5% to 8% of annual sales volume. Certain of
the leases provide for increasing minimum annual rental amounts. Rent expense is
recorded evenly over the term of the lease. Accordingly, deferred rent, as
reflected in the accompanying balance sheets, represents the difference between
rent expense accrued and amounts paid under the terms of the lease agreement.
Total rent expense for the years ended February 3, 2001, January 29, 2000 and
January 30, 1999 was $16,093,011, $10,364,345 and $7,505,514, respectively,
including contingent rentals of $2,694,146, $1,221,200 and $293,759,
respectively.
F-8
Hot Topic, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
3. COMMITMENTS (CONTINUED)
LEASES (CONTINUED)
The Company leases certain equipment under capital lease obligations. Cost and
accumulated depreciation of equipment under capital leases were $159,560 and
$53,282, respectively, at February 3, 2001, $291,151 and $49,440, respectively,
at January 29, 2000 and $168,930 and $49,137, respectively, at January 30, 1999.
Annual future minimum lease payments under operating and capital leases as of
February 3, 2001 are as follows:
Operating Capital
Fiscal year Leases Leases
- ------------ ------------- -------------
2002 $ 15,402,097 $ 45,211
2003 15,397,604 86,123
2004 15,276,081 -
2005 14,819,341 -
2006 14,593,500 -
Thereafter 45,952,654 -
------------- -------------
Total minimum lease payments $121,441,277 $ 131,334
============= =============
Less amounts representing interest - 8,774
------------- -------------
Present value of future minimum capital lease
payments - 122,560
Less amounts due in one year - 37,691
------------- -------------
Long-term portion of obligations under capital
leases - $ 84,869
============= =============
4. SHAREHOLDERS' EQUITY
Under the Company's long-term incentive plans (the Plans) the Company may grant
stock options to employees, directors or consultants of the Company as deemed
appropriate by the Board of Directors. The exercise price of options granted
under the Plan shall be determined by the Board of Directors at the date of
grant and shall not be lower than (i) 100% of the fair market value of the
Company's common stock on the date of grant for incentive stock options, (ii)
85% of the fair market value of the Company's common stock on the date of grant
for non-statutory stock options, and (iii) 110% of the fair market value of the
Company's common stock on the date of grant for persons possessing 10% or more
of the total combined voting power of all classes of stock of the Company.
Unless the Board of Directors declares otherwise, options vest over four years
and
F-9
Hot Topic, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
4. SHAREHOLDERS' EQUITY (CONTINUED)
generally expire ten years from the date of grant. An aggregate of 7,220,000
shares of common stock may be issued pursuant to the plans. During fiscal 2000,
the Plan was amended to increase the aggregate number of shares of common stock
authorized for issuance by 1,900,000 shares. As of February 3, 2001, 1,725,320
shares were available for future grants.
In June 1996, the Board of Directors adopted the Employee Stock Purchase Plan
(the Stock Purchase Plan). The Stock Purchase Plan provides for the issuance of
up to 600,000 shares of common stock to employees of the Company. Under the
Stock Purchase Plan, all eligible employees are granted identical rights to
purchase common stock for each Board-authorized offering under the Stock
Purchase Plan. Rights granted pursuant to any offering under the Stock Purchase
Plan terminate immediately upon cessation of an employee's employment for any
reason. In general, an employee may withdraw from participation in an offering
at any time during the purchase period for such offering. Rights granted under
the Stock Purchase Plan are not transferable and may be exercised only by the
person to whom such rights are granted. The initial offering under the Stock
Purchase Plan commenced October 24, 1996 and terminated December 31, 1996.
Subsequent offerings occur every six months commencing January 1, 1997.
Pro forma information regarding net income and earnings per share is required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that Statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for 2000,
1999 and 1998: weighted-average risk-free interest rates of 6%; dividend yields
of 0%; weighted-average volatility factors of the expected market price of the
Company's common stock of 0.84 for 2000, 0.80 for 1999 and 0.79 for 1998; and a
weighted average expected life of the option of 5 years. The weighted average
fair value of options granted during the year are $11.23, $5.01 and $3.67 per
share for fiscal 2000, 1999 and 1998, respectively.
F-10
Hot Topic, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
4. SHAREHOLDERS' EQUITY (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting periods. The Company's pro
forma information follows:
Years Ended
----------------------------------------------
February 3, January 29, January 30,
2001 2000 1999
-------------- -------------- --------------
Pro forma net income $ 20,671,693 $ 11,303,530 $ 4,495,809
Pro forma earnings per share
Basic $ 1.05 $ 0.61 $ 0.24
Diluted $ 0.97 $ 0.60 $ 0.23
A summary of the Company's stock option activity and related information
follows:
February 3, 2001 January 29, 2000 January 30, 1999
-------------------------- -------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------------ ------------ ------------ ------------ ------------ ------------
Outstanding at beginning
of year 2,653,124 $ 4.84 2,796,604 $ 5.12 2,249,240 $ 4.11
Granted 1,060,100 $ 11.23 1,024,400 $ 3.69 1,146,352 $ 5.41
Exercised (959,910) $ 4.97 (964,192) $ 4.35 (444,308) $ 0.88
Canceled (253,572) $ 4.46 (203,688) $ 5.22 (154,680) $ 4.81
------------ ------------ ------------ ------------ ------------ ------------
Outstanding at end of
year 2,499,742 $ 7.53 2,653,124 $ 4.84 2,796,604 $ 5.12
============ ============ ============ ============ ============ ============
Exercisable at end of
year 512,013 $ 5.23 546,284 $ 5.44 785,140 $ 4.28
Exercise prices for options outstanding as of February 3, 2001 ranged from $1.25
to $15.78. Of the 2,499,742 options outstanding at February 3, 2001, 705,775
have exercise prices ranging from $1.25 to $5.00, 738,367 have exercise prices
ranging from $5.25 to $6.97, 885,600 have exercise prices ranging from $8.38 to
$13.44 and 170,000 have exercise prices ranging from $14.63 to $15.78. The
weighted average remaining contractual life of those options is 8 years.
F-11
Hot Topic, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
5. NET INCOME PER SHARE
The Company computes net income per share pursuant to Statement of Financial
Accounting Standards No. 128, "Earnings Per Share" (SFAS 128). Basic net income
per share is computed based on the weighted average number of common shares
outstanding for the period. Diluted net income per share is computed based on
the weighted average number of common and potentially dilutive common stock
equivalents outstanding for the period.
A reconciliation of the numerator and denominator of basic earnings per share
and diluted earnings per share for the year ended, is as follows:
February 3, January 29, January 30,
2001 2000 1999
------------ ------------ ------------
Basic EPS Computation:
Numerator $23,245,079 $13,500,674 $ 6,002,923
Denominator:
Weighted average common
shares outstanding 19,778,706 18,533,704 19,268,096
------------ ------------ ------------
Total shares 19,778,706 18,533,704 19,268,096
------------ ------------ ------------
Basic EPS $ 1.18 $ 0.73 $ 0.31
============ ============ ============
Diluted EPS Computation:
Numerator $23,245,079 $13,500,674 $ 6,002,923
Denominator:
Weighted average common
shares outstanding 19,778,706 18,533,704 19,268,096
Incremental shares from assumed
conversion of options 1,600,712 1,061,020 555,092
------------ ------------ ------------
Total shares 21,379,418 19,594,724 19,823,188
------------ ------------ ------------
Diluted EPS $ 1.09 $ 0.69 $ 0.30
============ ============ ============
F-12
Hot Topic, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. INCOME TAXES
Following is the composition of the provision for income taxes for the years
ended:
February 3, January 29, January 30,
2001 2000 1999
------------- ------------- -------------
Current:
Federal $ 13,092,892 $ 6,873,075 $ 2,770,434
State 1,847,868 1,183,325 472,268
------------- ------------- -------------
14,940,760 8,056,400 3,242,702
Deferred:
Federal (1,069,096) (393,151) 127,057
State (219,764) (29,649) (2,859)
------------- ------------- -------------
(1,288,860) (422,800) 124,198
------------- ------------- -------------
Total income tax expense $ 13,651,900 $ 7,633,600 $ 3,366,900
============= ============= =============
Significant components of the Company's deferred tax assets and liabilities:
February 3, January 29,
2001 2000
------------ ------------
Current deferred tax assets:
Accrued vacation and other $ 345,876 $ 227,759
Inventory 650,928 445,380
State taxes 98,903 258,895
Other liabilities (151,965) (196,373)
------------ ------------
Total deferred tax assets 943,742 735,661
Valuation allowance for deferred
tax assets - (14,500)
------------ ------------
Net current deferred tax assets 943,742 721,161
Noncurrent deferred tax assets (liabilities):
Depreciation (76,357) (1,176,467)
Deferred rent 336,202 360,671
------------ ------------
Total noncurrent deferred tax assets
(liabilities) 259,845 (815,796)
------------ ------------
Net deferred tax (liability) asset $ 1,203,587 ($ 94,635)
============ ============
F-13
Hot Topic, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. INCOME TAXES (CONTINUED)
Reconciliation of provision for taxes to statutory tax rate for the years ended:
February 3, January 29, January 30,
2001 2000 1999
---------- ---------- ----------
Statutory federal rate 35.0% 35.0% 34.0%
Permanent differences (1.3) (1.3) (2.9)
State and local taxes, net of federal
benefit 2.7 2.8 3.3
Change in valuation allowance and
other items 0.6 (0.4) 1.5
---------- ---------- ----------
Effective income tax rate 37.0% 36.1% 35.9%
========== ========== ==========
7. EMPLOYEE BENEFIT PLAN
Effective January 1, 1995, the Company adopted the Hot Topic 401(k) Retirement
Savings Plan (the 401(k) Plan). All employees who have been employed by the
Company for at least one year of service, maintained a minimum of 1,000 hours
worked during the year and are at least 21 years of age are eligible to
participate. Employees may contribute to the 401(k) Plan up to 25% of their
current compensation, subject to a statutorily prescribed annual limit. The
Company may in its discretion contribute certain amounts to eligible employees'
accounts. The Company has not made any contributions to the 401(k) Plan.
F-14