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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 1, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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.
CITY OF INDUSTRY, CALIFORNIA 91748
(Address of principal executive offices) (Zip Code)
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 ____.
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in the Exchange Act Rule 12b-2). Yes [X] No [ ]
The aggregate market value of Common Stock held by non-affiliates of
the Registrant as of August 2, 2002 was approximately $479,567,559 based on the
closing price on that date of Common Stock on the Nasdaq National Stock Market.
All outstanding shares of voting stock, except for shares held by executive
officers and members of the Board of Directors and their affiliates are deemed
to be held by non-affiliates.
The number of shares outstanding of the Registrant's Common Stock was
31,401,862 as of April 14, 2003.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Registrant's Definitive Proxy Statement for the
Annual Meeting of Shareholders to be held on June 12, 2003, to be filed with the
Securities and Exchange Commission (the "SEC") no later than 120 days after
February 1, 2003, are incorporated by reference into Part III of this Form 10-K
(Items 10 through 13).
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING DISCLOSURE
THIS ANNUAL REPORT ON FORM 10-K CONTAINS VARIOUS 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 THE COMPANY AS OF THE DATE HEREOF AND THE COMPANY ASSUMES 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. SUCH RISKS,
UNCERTAINTIES AND OTHER FACTORS INCLUDE BUT ARE NOT LIMITED TO THE ITEMS
DISCUSSED IN PART I, ITEM 1 UNDER THE CAPTION "CERTAIN RISKS 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. and its wholly owned subsidiaries (collectively, the
"Company") is a mall-based specialty retailer operating the Hot Topic and Torrid
store concepts. Hot Topic offers a selection of music-licensed and
music-influenced apparel, accessories and gift items for young men and women
principally between the ages of 12 and 22. In the first half of fiscal 2001 (the
fiscal year ended February 2, 2002) the Company launched a second retail concept
with the opening of six stores under the trade name Torrid. Torrid offers a
selection of apparel, lingerie, shoes and accessories centered around various
lifestyles for plus-size females between the ages of 15 and 29. The Company
opened its first Hot Topic store in 1989 and at the end of fiscal 2002 (the
fiscal year ended February 1, 2003), the Company operated 418 Hot Topic stores
and 27 Torrid stores in 48 states. The Company also maintains two distinct
websites, www.hottopic.com ("hottopic.com") and www.torrid.com ("torrid.com")
which reflect the Hot Topic and Torrid store concepts and sell certain items of
merchandise.
The Company opened 74 Hot Topic and 21 Torrid stores during fiscal
2002. The Company also occasionally relocates, expands, or closes existing
stores. During fiscal 2002, the Company expanded or relocated 8 stores and
closed 2 stores (the closed stores' leases expired and were not renewed). The
Company plans to open approximately 70 new Hot Topic stores and 25 Torrid stores
in the fiscal year ending January 31, 2004 ("fiscal 2003"); and 10 of these new
Hot Topic stores and 5 of these new Torrid stores were open as of April 10,
2003.
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 during recent years, the music industry has been significantly
impacted by the availability and accessibility of the Internet and the
continuing success of MTV and other music television networks. These channels
2.
enable 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. The growing importance of the Internet is illustrated in a U.S. Census
Bureau report, stating that 80% of America's school-age children have Internet
access either at home or at school, regardless of their ethnic group or
household income. MTV music network reached 85 million households in the United
States in 2002, according to the Nielsen Media Research Report. As a result,
both emerging and well-known artists and the fashions they inspire are much more
visible today than ever before. Management believes that this increased
visibility has contributed to the increase in demand for music-licensed and
music-influenced apparel and accessories. The Company believes teenagers
throughout the United States have similar fashion preferences, largely as a
result of the nationwide influence of the Internet, MTV, music distribution,
movies, and television programs.
MTV and other music television networks have also achieved great
success with specialized programming. For instance, "The Osbournes" show on MTV
has drawn on average more than 4 million viewers to its regular time during
2002. Through the Company's continued sponsorship of the largest summer rock
tour, Ozzfest (headlined by Ozzy Osbourne), Hot Topic expects to benefit from
this broader audience.
Hot Topic's target customers are young men and women between the ages
of 12 and 22, who are passionate about music, music videos, and music-inspired
fashion. 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.
Torrid targets customers that are plus-size females ages 15 to 29, who
are influenced by music and pop-culture. The Company believes these young
plus-size customers wearing sizes 12 to 26 can now match the style, excitement
and selection available at other non-plus-size junior retailers with the
assortment found in Torrid. The Torrid specialty retail concept was inspired by
requests from young, female shoppers at Hot Topic stores and hottopic.com. After
analyzing customer feedback and researching the market demographics, the Torrid
concept was developed. Torrid was launched in the first half of fiscal 2001,
with the opening of six locations across the country and a website, torrid.com.
The performance of these first six stores prompted the expansion of an
additional 21 store openings in fiscal 2002.
Teenagers represent both a growing part of the United States population
and an increasing source of purchasing power. According to the U.S. Census
Bureau, it is estimated that the teenage population (ages 12-19) in the United
States reached approximately 32 million in 2002 and is expected to grow to
approximately 34 million by 2008, representing a projected growth rate close to
twice the rate of the overall population. By 2010, there are likely to be more
teenagers in the United States than at any other time in history. Teenage
spending has also increased annually. The average American teen spent
approximately $104 a week in 2002 according to Teen Research Unlimited, an
increase of $26 from $78 in 1998. In the past five years, teenage spending has
grown from an estimated $122 billion a year to $172 billion a year.
3.
HOT TOPIC BUSINESS STRATEGY
The Company's goal is to be a leading retailer of music-licensed and
music-influenced apparel, accessories and gift items for young men and women.
The principal elements for Hot Topic'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. The Company has
developed a unique strategy focused exclusively on offering music-licensed and
music-influenced merchandise in the mall environment. 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"
Hot Topic 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 Hot Topic's broad
assortment of products, which include over 10,000 Stock Keeping Units ("SKUs")
in approximately 20 different product categories. The Company believes Hot
Topic's selection of music-licensed merchandise is the most extensive assortment
available in a single mall store. Hot Topic complements its licensed merchandise
with a unique and eclectic assortment of music-influenced apparel and
accessories, and frequently introduces new items and categories in response to
changes in trends and demand. The Company believes Hot Topic has a history of
being the first to offer the latest music fashions, which, together with its
assortment of merchandise, has made Hot Topic 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.
Hot Topic also actively solicits feedback from its associates and customers. The
Company believes these activities enable 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 LISTENING TO THE CUSTOMER
Hot Topic does not dictate fashion trends, but rather seeks to identify
music artists and music trends that will influence products that will generate
customer demand. The Company has developed a disciplined approach to buying and
a dynamic inventory management process to support the merchandise strategy. The
Company regularly tests new merchandise in select Hot Topic 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. Hot
Topic is aggressive in taking prompt markdowns to maintain a fresh merchandise
mix. By actively managing the mix of categories and products in Hot Topic
stores, the Company believes it is able to capitalize on emerging trends and
minimize its dependence on any one particular category. The Company believes
that this approach to managing Hot Topic's merchandise mix has contributed to
its strong merchandise margins and consistent markdown rates. The Company
believes Hot Topic's markdown rate is lower than industry averages.
4.
o EMPHASIZE CUSTOMER SERVICE
Hot Topic trains its store associates to provide a value-added,
non-intrusive customer experience. Sales associates are trained to greet
customers, provide information about new music and fashion trends, and suggest
merchandise that meets the customer's lifestyle and music preferences. Hot Topic
provides its teenage customers the same level of respect and attention that is
afforded to adult customers at other retail stores, while also providing
friendly and informed customer service for parents. The Company believes that a
high level of employee product knowledge and a commitment to music fashion
create credibility and differentiate Hot Topic from other teenage-focused
retailers.
o CREATE AN ENTERTAINING STORE ENVIRONMENT
The Company seeks to create an exciting and compelling shopping
experience focusing on the lifestyles 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 Hot Topic's
image as a source for music-inspired fashion while encouraging customers to shop
in its stores for longer periods of time. Continuing to focus on the world of
music and musicians as inspiration, the objective of Hot Topic's current store
design is to provide a kinetic and industrial-club feel, while portraying a less
gothic appearance than the previous store design. The markets, clubs and old
warehouse districts in London inspired this new look. The Company plans to
continue to use this design for its Hot Topic store openings in fiscal 2003
consisting of approximately 70 new stores and 10 expanded or relocated stores.
TORRID BUSINESS STRATEGY
The Company's goal for its Torrid stores is to become a leading
specialty retailer of fashion forward plus-size young women's apparel and
accessories. The principal elements of the Company's business strategy for
Torrid are as follows:
o FOCUS ON FASHION FORWARD PLUS-SIZE APPAREL AND ACCESSORIES
THAT ARE MUSIC-INSPIRED
Torrid's merchandising team is focused on providing a fashion forward
merchandise assortment that reflects the influence of music and provides the
plus-size customer with fun, hip, trendy apparel and accessories. The Company
believes that Torrid is the first mall concept to offer a complete store
assortment of fashion forward apparel for plus-size young women.
o LISTENING TO THE CUSTOMER
Torrid does not dictate fashion trends, but rather listens to customers
and watches music pop-culture influences to determine emerging trends in order
to provide merchandise that will have strong customer appeal. Torrid, like Hot
Topic, receives direct feedback from Torrid store associates and customers. This
feedback has a direct influence on future purchases of Torrid merchandise.
5.
o EMPHASIZE CUSTOMER SERVICE AND CREATE A FUN, EXCITING STORE
ENVIRONMENT
Torrid trains its store associates to provide one-on-one service to
customers. Because the Company believes that the plus-size customer has been
previously unable to find the same fashion forward merchandise available to her
smaller friends, Torrid's customer service approach focuses on suggesting
outfits and ensuring the correct fit.
The Torrid store design is inspired by the New Orleans club
environment. It has an eclectic, textural, baroque feel that aims to provide the
plus-size customer with the sense that she has walked into a warm, sexy boutique
created exclusively to satisfy her fashion desires. The Company believes that
this atmosphere enhances the image Torrid is striving to build as a source of
music-inspired fashion for the plus-size female customer. The Company intends to
continue to refine this design and utilize it for the 25 Torrid stores it
expects to open in fiscal 2003.
Through a focus on customer service and a fashion forward merchandise
offering, Torrid seeks to create a compelling shopping environment that will be
sought after by the plus-size female customer. The Company believes that the
warm reception, great selection, and honest customer service by associates help
to create a comfortable and exciting environment that will be attractive and
welcoming to the Torrid customer.
STORE LOCATIONS
As of February 1, 2003, the Company operated 418 Hot Topic stores in
both metropolitan and middle markets in 48 states across the United States and
27 Torrid stores in 17 states. Between February 2, 2003 and April 10, 2003, the
Company opened an additional 10 Hot Topic stores and 5 Torrid stores. The
following chart sets forth, as of April 10, 2003, the number of Hot Topic and
Torrid stores the Company operates in each state in which those stores are
located:
6.
HOT TOPIC, INC.
STORES BY STATE
-------------------------------------------------------------------------------------
HOT TOPIC STORES TORRID STORES TOTAL COMPANY
---------------------------------- ------------------------------- -------------
OPEN AT NEW HT OPEN AT OPEN AT NEW TORRID OPEN AT OPEN AT
2/1/2003 FY03 TO DATE 4/10/2003 2/1/2003 FY03 TO DATE 4/10/2003 4/10/2003
-------- ------------ ---------- -------- ------------ --------- ---------
Alabama 2 2 0 0 2
Arizona 7 7 2 2 9
Arkansas 2 2 0 0 2
California 55 1 56 5 1 6 62
Colorado 11 11 1 1 12
Connecticut 6 6 0 0 6
Delaware 2 2 0 0 2
Florida 25 2 27 0 0 27
Georgia 10 10 0 0 10
Hawaii 3 3 0 0 3
Idaho 1 1 0 0 1
Illinois 14 14 2 2 16
Indiana 11 11 0 0 11
Iowa 8 8 0 0 8
Kansas 4 4 0 0 4
Kentucky 4 4 0 0 4
Louisiana 5 1 6 0 0 6
Maine 2 2 0 0 2
Maryland 11 11 2 2 13
Massachusetts 10 10 1 1 11
Michigan 16 16 0 1 1 17
Minnesota 11 11 0 0 11
Mississippi 1 1 0 0 1
Missouri 9 9 2 2 11
Montana 2 2 0 0 2
Nebraska 2 2 1 1 3
Nevada 4 4 1 1 5
New Hampshire 4 4 0 0 4
New Jersey 15 15 1 1 16
New Mexico 3 3 1 1 4
New York 20 20 3 3 23
North Carolina 8 8 0 0 8
North Dakota 1 1 0 0 1
Ohio 13 1 14 1 1 15
Oklahoma 5 5 0 0 5
Oregon 6 6 1 1 7
Pennsylvania 20 20 1 1 21
Rhode Island 1 1 0 0 1
South Carolina 3 3 0 0 3
South Dakota 2 2 0 0 2
Tennessee 9 2 11 0 1 1 12
Texas 31 2 33 1 2 3 36
Utah 4 4 0 0 4
Vermont 2 2 0 0 2
Virginia 9 1 10 0 0 10
Washington 14 14 0 0 14
West Virginia 2 2 0 0 2
Wisconsin 8 8 1 1 9
TOTAL 418 10 428 27 5 32 460
- -------------------------------------------------------------------------------------------------------
# OF STATES 48 7 48 17 4 19 48
- -------------------------------------------------------------------------------------------------------
7.
EXPANSION STRATEGY
The following table provides a history of the Company's store expansion
over the last five fiscal years:
FISCAL YEAR
----------------------------------------------------------
1998 1999 2000 2001 2002 2003
THROUGH
4-10-03
----------------------------------------------------------
(Number of stores)
Stores at beginning of year 108 158 212 274 352 445
Hot Topic stores closed* (1) (2)
New stores opened - Hot Topic 50 54 62 73 74 10
New stores opened - Torrid 6 21 5
----------------------------------------------------------
Stores at end of year 158 212 274 352 445 460
----------------------------------------------------------
----------------------------------------------------------
Hot Topic stores expanded or
relocated 0 0 5 7 8 0
----------------------------------------------------------
* Victorville, CA store closed in fiscal 2001 and re-opened in
first quarter of fiscal 2002. Parklane, NV and Bayfair, CA
store leases expired in fourth quarter of fiscal 2002 and were
not renewed.
The Company's expansion strategy is to open stores primarily in
shopping malls and selected 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 the Internet, MTV and other
music television networks, music distribution, movies and television programs,
the Company believes that its target customers have similar fashion preferences
throughout the United States.
The Company opened 74 new Hot Topic stores and 21 Torrid stores in
fiscal 2002 as well as expanded or relocated eight existing Hot Topic stores.
The Company closed two stores in fiscal 2002 that were at the end of their lease
terms. During fiscal 2003, the Company plans to open approximately 70 new Hot
Topic stores (10 of which the Company has opened in the first quarter of fiscal
2003) and 25 new Torrid stores (5 of which the Company has opened in the first
quarter of fiscal 2003), in addition to expanding or relocating approximately 10
existing Hot Topic stores. The Company has identified regional malls in major
metropolitan areas nationwide and in Puerto Rico and Alaska for potential new
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 merchandising strategy. The Company has a real estate committee,
consisting of its Chief Executive Officer, Chief Operating Officer, Chief
Merchandising Officer, Chief Financial Officer, Vice President, Store
Operations, and Vice President, Real Estate and Construction that evaluates
potential locations. The Company generally seeks potential store sites between
1,500 square feet and 2,200 square feet for Hot Topic stores, and between 2,200
square feet and 2,800 square feet for Torrid stores. In fiscal 2002, the average
store size of Hot Topic openings was 1,822 square feet and 2,713 square feet for
Torrid openings.
8.
Hot Topic stores currently average approximately 1,689 square feet and
Torrid stores currently average approximately 2,593 square feet.
STORE-LEVEL ECONOMICS
During fiscal 2002, the Company achieved average Hot Topic store net
sales of approximately $1,071,000 and average Hot Topic store net sales per
square foot of approximately $634. Average store-level operating cash flow
(defined as store operating income before depreciation and excluding changes in
working capital) for Hot Topic stores open the entire year in fiscal 2002 was
approximately $314,000, or 29% of average net sales. There can be no assurance
this trend will continue. There are no assurances 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.
HOT TOPIC MERCHANDISING
Hot Topic 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, intimate apparel, novelty accessories, compact discs and
albums. Music-influenced merchandise includes woven and knit tops, skirts,
pants, shorts, jackets, shoes, costume jewelry, body jewelry, sunglasses,
cosmetics, leather accessories and gift items. Additional licensed apparel and
accessories are influenced by television shows, cartoons and major motion
pictures. Approximately half of Hot Topic's products are licensed, and the other
half are music-influenced products. A key strategy of Hot Topic 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 Good Charlotte, System of a Down, Linkin Park, The Used and All
American Rejects as well as classic rock artists such as The Ramones, Nirvana,
Bob Marley, Iron Maiden, Metallica, The Doors and Led Zeppelin. New items and
categories are regularly tested as customer demand and product trends evolve.
In fiscal 2002, the Company hired a Chief Merchandising Officer. Hot
Topic's merchandising staff consists of a General Merchandise Manager, two
Divisional Merchandise Managers, ten buyers, three associate buyers and eleven
assistant buyers. The merchandising staff reflects the Company's culture in that
its decisions and actions are influenced by music. In determining which
merchandise to buy, the staff spends considerable time viewing music videos,
reviewing industry music sales, monitoring alternative radio station air play,
consulting with sales associates (to draw from their different experiences and
perspectives), reviewing customer requests, attending trade shows and reading
music and fashion industry periodicals. In addition, the merchandising staff
regularly visits nightclubs and attends concerts and other events that attract
young people.
The following table sets forth Hot Topic's four major merchandise
groups as an approximate percentage of net sales for fiscal years 2002, 2001 and
2000:
PERCENTAGE OF NET SALES
---------------------------------------
2002 2001 2000
---------------------------------------
Apparel and T-Shirts 51% 53% 51%
Gifts 15 15 15
Accessories 27 26 27
Intimate Apparel and Shoes 7 6 7
---------------------------------------
100% 100% 100%
=======================================
Approximately half of Hot Topic's products are licensed products.
Artists typically license their likeness to a "master licensor." The master
licensor often retains the rights to manufacture and market T-shirts and then
may choose to sub-license rights to manufacture and market other categories of
merchandise such as posters, stickers and patches. Some artists also retain
their licensing rights and negotiate directly with licensees. The Company buys
its licensed merchandise from master licensors, licensees and directly from
9.
artists. Hot Topic 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 often receives accommodations such as
early shipments of new releases, exclusive designs and merchandise, and advanced
lead times.
The Company buys its non-licensed, 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.
Hot Topic 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. The Company estimates that in fiscal 2002 Hot Topic brands
accounted for approximately 25% of the Company's sales, the same percentage as
in fiscal 2001. 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). Some shoes are also
sold under the Hot Topic label.
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 smaller test
purchases 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 by responding 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 2002, the Company had approximately 950 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.
TORRID MERCHANDISING
Torrid stores are designed to serve as the destination for fashion
forward apparel and accessories for plus-size young women. The Company believes
that the Torrid customer wants to wear the same merchandise as her smaller-sized
peers. Torrid's merchandise includes novelty T-shirts, fashion tops, pants,
shorts, skirts, dresses, jackets, intimate apparel, shoes, hosiery, accessories,
gifts, and beauty products. Torrid apparel is sized 12 to 26. Approximately 50%
of the products come from established branded vendors, including Dickies, Paris
Blues, Z Cavaricchi, Necessary Objects, Kikwear, Macgirl, Dollhouse, Fine and
Hot Kiss and more fashion forward vendors such as Serious, Lip Service, and
Tripp. The Company works with these and other vendors, to develop its own
plus-size apparel fit specifications for young women. The Company believes its
selection of fashion items from these and similar vendors gives the Torrid
customer an opportunity to buy the same or similar branded items that have
historically been available to other young women of the same age who are not
plus-size. Working together with vendors, fashion trends and customer requests
are researched, designed and manufactured for Torrid. Torrid, through its own
fit specialist, works with the manufacturers' design teams to help ensure that
quality standards are achieved and maintained.
During fiscal 2002, approximately 70% of Torrid's net sales were
generated in apparel merchandise categories and 30% of Torrid's sales were
produced in accessories, including intimate apparel and shoes.
10.
The Torrid merchandising staff consists of a Divisional Merchandise
Manager, two buyers, two associate buyers and two assistant buyers. The
Company's culture of soliciting and listening to customers and store associates
is evidenced by the Torrid merchandising staff's decisions and actions. The
merchandising staff spends considerable time visiting nightclubs, attending
concerts, attending trade shows and other events that attract young people.
Furthermore, the Company believes that Torrid's merchandising direction is
influenced by music and pop-culture. The range of music and music artists that
influence Torrid fashion is much broader than those influencing fashion at Hot
Topic, consistent with the broader target customer base of females ages 15 to
29. Merchandising decisions for Torrid are also influenced by emerging fashions
in the junior market.
Approximately 50% of Torrid merchandise is purchased from established
branded vendors. The remaining 50% is Torrid private label merchandise that
provides the customer with unique, fashion forward merchandise, often at more
competitive price points than branded merchandise. Private label merchandise
also often provides the Company with higher margin opportunities as compared to
other merchandise. In order to reduce fashion risk and maintain the ability to
respond quickly to emerging trends, Torrid buys a majority of its merchandise
not more than 90 days, and many times less than 60 days, in advance of delivery,
and will often begin with small purchases for testing.
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 store inventory plans and SKU performance using Arthur Allocation
software. Buyers and inventory analysts 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. The Company's Vice
President of Planning and Allocation, two directors of Planning and Allocation
and 26 inventory analysts work closely with the merchandise buyers and store
associates to meet the appropriate inventory requirements of each store.
Late in the fourth quarter of fiscal 2001, the Company began
construction to expand its existing headquarters and distribution facility
located in the City of Industry, California. The expansion was completed during
the second quarter of fiscal 2002 at an estimated cost of approximately $4.9
million, bringing the total square feet of the Company's headquarters and
distribution facility to approximately 250,000. All merchandise is delivered by
vendors to this facility, where it is inspected, allocated, picked, prepared and
boxed for shipment to the Company's stores. Merchandise is shipped to stores
each weekday, providing Hot Topic and Torrid stores with a steady flow of new
and reordered merchandise. Minimal back stock is maintained in the Company's
distribution facility and at its stores, so that most of the Company's
merchandise is available for sale on the selling floors of its stores.
HOT TOPIC STORE OPERATIONS
Hot Topic's store operations organization is currently managed by eight
regional directors and 63 district managers. On average, each district manager
supervises approximately five to 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. Hot Topic uses a customized, automated
telephone screening system licensed from a third party to help evaluate
potential new associates, which helps streamline the Company's interview and
hiring processes at the store level. The hiring and training of new associates
is the responsibility of the store manager and district manager. The Company has
established training and operating procedures to assist field management in the
supervision and training of all associates. The Company has also designed a
store manager training program, which is utilized to thoroughly train externally
hired managers.
11.
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, from time-to-time, 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 are encouraged to directly communicate customer requests and their own
merchandise and product ideas to the buyers and Hot Topic management. The
Company also offers a 40% employee discount on merchandise. Management believes
Hot Topic's music-based culture and its direct interaction with and respect for
sales associates is a significant factor in producing associate retention rates
that Management believes are higher than the industry average.
The primary objective of the sales associate position 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
category 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. Hot Topic provides a listing of music artists'
national tour dates at each of its stores. The Company believes that its high
level of associate product knowledge and customer service differentiates Hot
Topic from other teenage-focused retailers.
District managers, along with all members of the store teams, are
compensated with a base salary and may qualify to receive a quarterly bonus
based on store sales and inventory shrinkage results. Additionally, district and
store managers may also qualify to receive periodic stock option grants, and
certain associates 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 associates. 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. In
order to ensure new stores have a qualified pool of candidates, the Company has
assigned dedicated field recruiters to work with each region's management team.
TORRID STORE OPERATIONS
The Torrid store operations organization is currently supervised by one
regional director and six district managers. Individual stores are supervised by
one store manager and two or three assistant managers. In addition, each store
has six to ten part-time associates, depending on the season. Torrid uses a
customized, automated telephone screening system licensed from a third party to
help evaluate potential new associates, which helps streamline the Company's
interview and hiring processes at the store level. The store and district
managers are responsible for associate training, and the Company has established
training programs and operating procedures. The Company also has a store manager
training program which is utilized to quickly and thoroughly train externally
hired managers.
The Company strives to create a friendly, fashionable, high
energy-shopping environment in its Torrid stores. In order to establish a
lasting connection with customers, Torrid seeks sales associates who excel at
understanding and attending to the individual fashion needs of each Torrid
shopper. The primary objective of each sales associate is to provide superior,
informed customer service in order to maximize sales and minimize inventory
shrinkage. The Company also offers a 40% employee discount on merchandise.
12.
Store management is provided with daily store sales and category
results so that performance can be measured against set goals. Associates are
trained to greet each customer, to inform the customer about new fashion trends
and to suggest merchandise that matches the customer's lifestyle and fashion
preferences. The Company believes that its high level of product knowledge,
ability to offer appropriate wardrobe suggestions and individual customer
service differentiates Torrid from other retailers in the market. Additionally,
postage-paid "report cards" are provided in all stores for customers to grade
performance and make recommendations to Torrid management. The Company also
offers a frequent buyer program which provides an incentive for the consumer to
shop on a repeat basis.
Similar to Hot Topic stores, Torrid district and store managers are
compensated with a base salary and may qualify for quarterly bonuses based on
sales and inventory shrinkage results. District and store managers may also
qualify to receive periodic stock option grants, and certain associates are
eligible to participate in the Company's Employee Stock Purchase Plan. The
Company believes that Torrid's success is dependent in part on its ability to
attract, retain and motivate qualified associates. In particular, the success of
Torrid's expansion program is linked to its ability to promote and/or recruit
qualified district and store managers. In order to ensure new stores have a
qualified pool of candidates, the Company has dedicated regional recruiters who
focus on specific store staffing needs.
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 2002, 2001 and 2000 the Company co-sponsored a major
summer rock tour, Ozzfest (headlined by Ozzy Osbourne). As a sponsor, Hot
Topic's name was associated with all promotional activities at each venue. The
Company has entered into a similar sponsorship of Ozzfest in fiscal 2003.
The Company continues to operate its core website, hottopic.com, which
offers merchandise, tour dates, contests, job postings, store locations and
community features such as band reviews. In addition, the Company operates
torrid.com which also markets merchandise and offers job postings, store
locations and community features such as contests and advice columns. During the
second quarter of fiscal 2002, the Company relaunched its websites with improved
functionality in customer navigation and customer support. The Company's net
sales from Internet operations rose by 75% in fiscal 2002 compared to fiscal
2001 and contributed approximately 1.8% of total sales in fiscal 2002.
INFORMATION TECHNOLOGY
The Company's information systems provide integration of store,
merchandising, distribution, financial, and human resources. These systems
include SKU and classification inventory tracking, purchase order management,
open-to-buy, merchandise distribution, automated ticket making, general ledger,
sales audit, accounts payable, integrated financials and human
resources/payroll. Most of these systems operate on software licensed from GERS
Retail Systems 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/check authorization. Through automated nightly two-way electronic
communication with each store, sales information and payroll hours are uploaded
to the host system. The host system downloads price changes, performs system
maintenance and provides software updates to the stores. The Company evaluates
information obtained through nightly polling to implement merchandising
decisions, including product purchasing/reorders, markdowns and allocation of
merchandise on a daily basis.
13.
During fiscal 2002, the Company invested approximately $1.5 million in
a new Wide Area Network ("WAN") to connect all Company locations. The Company
expects this technology to improve efficiency and assist in communicating more
effectively with all store locations nationwide. All stores have real-time
e-mail connectivity available via the WAN.
In addition, in fiscal 2003 the Company plans to invest approximately
$4 million to enhance the functionality of its current GERS Retail Systems
software and to implement new financial system software from Lawson. As a result
of these enhancements, the Company expects to see improvements in functionality
and reporting capability which the Company believes will adequately support its
planned growth.
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), Tragedy(R), Misery(R), MT:2(R),
Morbid Threads(R), Everything About the Music(R), Torrid(R), and Torrid Flaming
Heart Design(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
Naturally Morbid(TM) and Torrid & 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.
HOT TOPIC 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, customers, suitable retail locations
and qualified associates. 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 Abercrombie & Fitch,
Aeropostale, American Eagle Outfitters, Anchor Blue (Millers Outpost), Charlotte
Russe Inc., Claire's Stores, Inc., Delias Inc., Gadzooks, Inc., Old Navy (a
division of Gap Inc.), Pacific Sunwear of California, Inc., Spencer Gifts, Inc.,
The Buckle, The Wet Seal, Inc., Urban Outfitters, Inc.; and, to a lesser extent,
with music stores. 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.
TORRID COMPETITION
Based on direct customer research conducted by the Company, it believes
that plus-size female teens and young women have historically shopped for
apparel at department stores, discount stores such as Target and specialty
stores such as Lane Bryant. The Company believes such stores generally target
more mature customers, which is also reflected in their store environments. The
Company is not aware of other exclusively mall-based chains that are
specifically targeting younger plus-size fashion forward customers. Torrid
competes with traditional department stores, local specialty stores and junior
teen retailers that offer a combination of junior and plus sizes, such as Deb
Shops. Torrid also competes with traditional plus size catalogs and web sites,
as well as Delias Inc. and Alloy, Inc. which carry both junior and junior plus
sizing. Many companies compete for the junior customers and additional
competitors may enter into the plus-size female market.
14.
EMPLOYEES
The Company employed approximately 1,500 full-time and 3,700 part-time
employees, which the Company refers to as associates, as of April 10, 2003. Of
the Company's 5,200 associates, approximately 475 were corporate headquarters
and distribution center personnel, 9 were regional directors, 69 were district
managers and 4,647 were store associates. The number of part-time associates
fluctuates with seasonal needs. None of the Company's associates are covered by
collective bargaining agreements. The Company believes that its relationships
with its associates are good.
EXECUTIVE OFFICERS AND KEY EMPLOYEES
The executive officers and key employees of the Company and their ages
at April 10, 2003 are as follows:
NAME AGE POSITION
- --------------------- ------ ------------------------------------------------------
Elizabeth McLaughlin 42 President, Chief Executive Officer and Director
Gerald Cook 50 Chief Operating Officer
Patricia Van Cleave 55 Chief Merchandising Officer
James McGinty 40 Chief Financial Officer and Secretary
Jane Cruz 43 Senior Vice President, Human Resources
Jay Johnson 57 Senior Vice President, Strategic Analysis and Investor
Relations
Cindy Levitt 42 Vice President, General Merchandise Manager
Darrell Kinsley 40 Vice President, Store Operations
John Neppl 46 Vice President, Real Estate and Construction
Alain Krakirian 37 Vice President, Planning and Allocation
Sue McPherson-Spissu 35 Vice President, Distribution Center and Internet
John Horwath 43 Vice President, Information Technology
George Wehlitz, Jr. 42 Vice President, Controller
Karen Kiefaber 45 Divisional Vice President and Divisional Merchandise
Manager, Accessories
ELIZABETH 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 and The Broadway. Ms. McLaughlin holds a B.A. degree in
Economics from the University of California at Irvine. Ms. McLaughlin is a
member of the Board of Visitors for the Anderson School at UCLA.
15.
GERALD COOK has been Chief Operating Officer of the Company since
February 2001. From February 1999 until joining the Company, he was the
President and Chief Operating Officer of Travel 2000, Inc. Subsequent to his
departing Travel 2000, Inc., that company filed for chapter 11 bankruptcy in
March 2001. 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. Mr. Cook holds a B.S.
degree in Business Administration from the University of Minnesota.
PATRICIA VAN CLEAVE has been Chief Merchandising Officer of the Company
since September 2002. From July 1998 to June 2001, she was the President and
CEO of Sundance Catalog Company. From May 1995 until joining Sundance, she was
the President of Cherokee. Prior to joining Cherokee, she was Executive Vice
President of Merchandising for apparel, fashion accessories and intimate apparel
for The Broadway. She came to The Broadway from The Bon Marche, a Seattle-based
division of Federated Department Stores where she was Senior Vice President,
General Merchandise Manager of Apparel. Prior to that she held management
positions for The Broadway Southwest, John Wanamaker, The May Company and
Daytons. Ms. Van Cleave holds a B.S. degree in Business and Textiles from the
University of Minnesota.
JAMES MCGINTY has served as Chief Financial Officer of the Company
since February 2001. Mr. McGinty also served as Secretary of the Company since
November 2002. Mr. 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
division of 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.
JANE CRUZ joined the Company in August 2001 as Senior Vice President,
Human Resources. Ms. Cruz has over 18 years of human resource experience. From
July 1996 to July 2001, Ms. Cruz held human resource management positions with
Universal Studios' Television and Networks Group, including most recently,
Senior Vice President, Human Resources. At Universal Studios her
responsibilities included both domestic and international operations. From
November 1994 to July 1996, Ms. Cruz was Director, Human Resources of EQE
International, an engineering consulting firm. She spent March 1983 through
November 1994 in various Human Resources positions with Viacom - Cable Division,
including Regional Director, Human Resources. Ms. Cruz has a B.S. in Economics
from the University of San Francisco and an M.B.A. from the University of
California, Berkeley.
JAY JOHNSON has served as Senior Vice President, Strategic Analysis and
Investor Relations of the Company since February 2001. From May 1995 to February
2001, he was the Chief Financial Officer 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 then 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. Mr. Johnson holds a B.S. degree in Accounting from the California
State University, Northridge.
CINDY LEVITT has been Vice President, General Merchandise Manager of
the Company since February 2000. From June 1996 to February 2000, she served as
the Company's Divisional Merchandise Manager, Apparel and Music. Since 1989, Ms.
Levitt has held senior buying positions at the Company. Prior to her career at
Hot Topic, Ms. Levitt held buying positions at The May Company.
16.
DARRELL KINSLEY has been Vice President, Store Operations of the
Company since February 2000. From June 1998 through February 2000, Mr. Kinsley
was the Company's Regional Director for the western United States. From February
1997 through June 1998, he was the Company's Regional Director for the eastern
United States. Mr. Kinsley joined the Company in February 1995 as the District
Manager for the eastern United States. Mr. Kinsley holds a business management
leadership certificate from the Anderson School of Business at the University of
California, Los Angeles.
JOHN NEPPL joined the Company in October 2001 as Vice President, Real
Estate and Construction. From January 1995 to September 2001, Mr. Neppl served
as Vice-President of Real Estate and Construction for Eastern Mountain Sports,
Inc., a specialty retailer based in New Hampshire. Mr. Neppl served as Director
of Real Estate at Miller's Outpost/Anchor Blue from October 1987 to December
1994. Mr. Neppl held various financial positions with Mervyn's department
stores, a division of Target Corporation, from October 1978 to September 1987.
Mr. Neppl received a B.S. in Accounting from Villanova University in 1978.
ALAIN KRAKIRIAN has been the Company's 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.
SUE MCPHERSON-SPISSU was promoted to the Company's Vice President,
Distribution Center and Internet in October 2001. Ms. McPherson-Spissu was the
Company's Vice-President, Distribution Center from February 2001 to October 2001
and was the Company's Divisional Vice President of Distribution Center from
February 2000 to February 2001. From March 1995 to February 2000, she was the
Company's Director of the Distribution Center. Ms. McPherson-Spissu joined the
Company in 1989 as a store associate in its first store while attending the
University of Southern California. Ms. McPherson-Spissu holds a B.S. degree in
Business from the University of Southern California.
JOHN HORWATH has been the Company's Vice President, Information
Technology since June 2001. Mr. Horwath has over 24 years of Information
Technology experience. From May 2000 until joining the Company, he was Director
of Information Technology at World Wide Restaurants, Inc. From August 1998 until
May 2000, Mr. Horwath was the Vice President and Chief Information Officer for
Wherehouse Entertainment, Inc. From February 1992 to July 1998, he was Regional
Vice President of Information Technology for PolyGram Holding, Inc. Prior to
1992, he held management positions with LA Gear, Inc., Pic`N'Save, Inc.,
Tutor/Saliba, Inc., and Kasler Corporation.
GEORGE WEHLITZ, JR. joined Hot Topic in February 2002 as its Vice
President, Controller. From August 2000 to February 2002, Mr. Wehlitz was Chief
Financial Officer at The Popcorn Factory, Inc., a catalog company for gourmet
popcorn gifts. From 1987 to 2000 Mr. Wehlitz held various financial related
positions, at the divisional and corporate level, for The Bombay Company, Inc.
Mr. Wehlitz holds a B.A. degree in Accounting from Texas Christian University
and is a Certified Public Accountant.
KAREN KIEFABER has served as Divisional Vice President and Divisional
Merchandise Manager, Accessories of the Company since February 2000. Ms.
Kiefaber 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 the Company, Ms. Kiefaber held buying positions
at Jay Jacobs and Nordstrom.
17.
COMPLIANCE WITH ENVIRONMENTAL REGULATIONS
To the Company's present knowledge, compliance with federal, state and
local provisions enacted or adopted for protection of the environment has had no
material effect upon its operations.
INTERNET WEBSITE
The Company makes available, free of charge through its investor
relations website at www.corporatewindow.com/fl/hott/frame.html, its annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after such
material is electronically filed with, or furnished to, the SEC.
18.
CERTAIN RISKS RELATED TO THE COMPANY'S BUSINESS
Before deciding to invest in the Company or to maintain or increase an
investment in the Company, readers should carefully consider the risks described
below, in addition to the other information contained in this Annual Report on
Form 10-K and in the Company's other filings with the SEC, including the
Company's Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. The
risks described below are not the only risks facing the Company. Additional
risks not presently known to the Company or that the Company currently deems
immaterial may also affect the Company's business. If any of these known or
unknown risks actually occur, the Company's business, financial condition and
results of operations could be seriously harmed, and the Company's stock price
could decline.
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 new stores and,
to a lesser extent, the introduction of new products. Ninety-five of the
Company's 445 stores opened as of February 1, 2003 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
profitably manage a larger business. The Company currently anticipates opening
approximately 95 stores, consisting of 70 Hot Topic and 25 Torrid stores, during
fiscal 2003, which will result in a significant increase in the number of stores
operated by the Company; 10 of these Hot Topic stores and 5 of these Torrid
stores have opened as of April 10, 2003. 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, as the number of Company stores
increases, the Company may face risks associated with market saturation of its
products and concepts. There can be no assurance that the Company's expansion
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.
In order to manage its planned expansion, among other things, the
Company will need to locate suitable store sites; negotiate acceptable lease
terms; obtain adequate capital resources on acceptable terms; source sufficient
levels of inventory; hire and train store managers and sales associates; and
integrate new stores into its existing operations. The Company will also need to
continually evaluate the adequacy of its management information and distribution
systems. There can be no assurance that the Company will anticipate all of the
changing demands that its expanding operations will impose on its business,
systems and procedures, and the Company's failure to adapt to such changing
demands could have a material adverse effect on the Company's results of
operations and financial condition. Further, 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.
RISKS ASSOCIATED WITH NEW TORRID CONCEPT
The Company's ability to expand into new concepts, and in particular
its Torrid concept, has not been fully tested. Accordingly, the operation of the
Company's Torrid stores and the sale of Torrid merchandise over the Internet are
subject to numerous risks, including unanticipated operating problems; lack of
experience; lack of customer acceptance; new vendor relationships; competition
from existing and new retailers; and diversion of management's attention from
the Company's Hot Topic concept. Among other things, the Torrid concept involves
implementation of a retail apparel concept which is subject to most of the same
risks as the Hot Topic concept, as well as additional risks inherent in a
dominantly apparel driven concept, including risks of difficulty in
merchandising, uncertainty of customer acceptance, fluctuations in apparel
styling and customer tastes, extreme competition with a less differentiated
19.
product offering and attendant mark-down risks. The Company may not be able to
generate continued customer interest in Torrid stores and products, and the
Torrid concept may not be able to support the store or Internet sales formats.
Risks inherent in any new concept are particularly acute with respect to Torrid,
because this is the first significant new venture by the Company, and the nature
of the Torrid business differs in certain respects from that of the Company's
Hot Topic business. There can be no assurance that the Company's Torrid stores
or website will achieve sales and profitability levels that justify the
Company's investment.
DEPENDENCE ON RELATIONSHIPS WITH MALL OPERATORS AND DEVELOPERS
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.
If the Company's relations with mall operators or developers become strained, or
the Company otherwise encounters difficulties in leasing store sites, the
Company may not grow as planned, may not reach certain revenue levels and other
operating targets.
FLUCTUATIONS IN COMPARABLE STORE SALES RESULTS
A variety of factors affect the Company's comparable store sales
including, among others, the timing of new music releases and music-related
products; music and fashion trends; the general retail sales environment and the
effect of the difficult overall economic 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 1999, 2000, 2001 and 2002 were 22.8%,
16.7%, 3.9% and 5.0%, respectively. The Company's comparable store sales results
were (0.5%), 0.6%, 6.3% and 9.7% for the first, second, third and fourth
quarters, respectively, of fiscal 2002 and 8.0%, 2.4%, 2.2% and 3.8% for the
first, second, third and fourth quarters, respectively, of fiscal 2001. 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 Company's stock price to fluctuate substantially.
DEPENDENCE ON AND CHANGES IN MUSIC AND FASHION TRENDS
The Company's financial performance is largely dependent upon the
continued popularity of alternative and rock music, Internet, music videos, and
MTV and other music television networks among teenagers and college age adults;
the emergence of new artists and the success of music releases and music-related
products; the continuance of a significant level of teenage spending on
music-licensed and music-influenced products; and 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, which could have a material adverse effect on
the Company's results of operations and financial condition, and on its image
with customers. There can be no assurance that the Company's new products will
be met with the same level of acceptance as in the past or that the failure of
any new products will not have an adverse material effect on the Company's
business, results of operations and financial condition.
IMPACT OF ECONOMIC CONDITIONS; WAGE RATE STRUCTURE AND BENEFITS
Certain economic conditions affect the level of consumer spending on
merchandise offered by the Company, including, among others, employment levels;
salary and wage levels; 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, the ability of mall anchor
20.
tenants and other attractions to generate customer traffic, and the development
of new malls. A continued slowdown in the United States economy as well as a
continued uncertain economic outlook could lower consumer spending levels and
cause a decrease in mall traffic or new mall development, each of which would
adversely affect the Company's growth, sales results and financial performance.
Changes in federal and state minimum wage laws or statutory employment
regulations could raise wages above current wage rates or change the wage
structure of certain of the Company's associates, and competitive factors could
require corresponding increases in higher associate wage rates. These factors,
as well as continued significant increased benefits cost primarily driven by
medical expenses, would increase the Company's expenses and adversely affect
results of operations.
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 and political conditions.
The Company's business is also subject to seasonal influences, with
heavier concentrations of sales during the back-to-school, Halloween and Holiday
(defined as the week of Thanksgiving through the first few days of January)
seasons, and other periods when schools are not in session. The Holiday season
has historically been 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) as well as Halloween (which
affects operating results in the third quarter), all reduce the Company's
dependence on the Holiday selling season. As is the case with many retailers of
apparel, accessories and related merchandise, the Company typically experiences
lower net sales in the first fiscal quarter relative to other quarters.
DEPENDENCE ON KEY VENDORS
The Company's financial performance depends on its ability to purchase
current music-related merchandise in sufficient quantities at competitive
prices. Although the Company has many sources of merchandise, 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 restricted 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. Any inability to acquire suitable merchandise, or the loss of one
or more key vendors, may have a material adverse effect on the Company's
business, results of operations and financial condition.
RISKS ASSOCIATED WITH INTERNET SALES
The Company sells merchandise over the Internet through the websites
hottopic.com and torrid.com. The Company's Internet operations are subject to
numerous risks, including, among other things, lack of experience; hiring,
retention and training of personnel to conduct the Company's Internet
operations; diversion of sales from the Company's stores; rapid technological
change, and the need to invest in additional computer hardware and software;
21.
liability for online content; failure of computer hardware and software,
including computer viruses, telecommunication failures, online security breaches
and similar disruptions; governmental regulation; and credit card fraud. There
can be no assurance that the Company's Internet operations will achieve sales
and profitability levels that justify the Company's investment.
UNCERTAINTIES REGARDING IMPLEMENTATION OF NEW INFORMATION SYSTEMS AND
SOFTWARE
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 installed certain point-of-sale
upgrades at its stores in fiscal 2001. In addition, in fiscal 2002 the Company
installed a new Wide Area Network at its locations. If these 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. 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, and in doing so, could incur substantial
additional expenses.
DEPENDENCE ON KEY PERSONNEL
The Company's financial 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.
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 Company's 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 United Parcel Service for its product
shipments, including shipments to and from a significant number of its stores,
and, accordingly, is subject to 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 associates to adequately staff its distribution facility,
particularly during busy periods such as the Holiday season and while multiple
stores are opening. There can be no assurance that the Company will continue to
receive adequate assistance from its temporary associates, or that there will
continue to be sufficient sources of temporary associates.
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.
22.
COMPETITION
The retail apparel and accessory industry is highly competitive. The
Company competes with other retailers for vendors, teenage and college age
customers, suitable store locations and qualified associates and management
personnel. Hot Topic currently competes with street alternative stores located
primarily in metropolitan areas; with other mall-based teenage-focused retailers
such as Abercrombie & Fitch, Aeropostale, American Eagle Outfitters, Anchor Blue
(Millers Outpost), Charlotte Russe Inc., Claire's Stores, Inc., Delias Inc.,
Gadzooks, Inc., Old Navy (a division of Gap Inc.), Pacific Sunwear of
California, Inc., Spencer Gifts, Inc., The Buckle, The Wet Seal, Inc., Urban
Outfitters, Inc.; and, to a lesser extent, with music stores and mail order
catalogs and websites. Torrid has additional competitors, such as Alloy, Inc.,
Deb Shops, Lane Bryant, and plus size departments in department stores and
discount stores as well as numerous potential competitors who may begin or
increase efforts to market and sell products competitive with Torrid's products.
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. Increased
competition could have a material adverse effect on the Company's business,
results of operations and financial condition.
EFFECTS OF WAR, TERRORISM OR OTHER CATASTROPHES
The effects of war or acts of terrorism could have a material adverse
effect on the Company's business, operating results and financial condition. The
terrorist attacks in New York and Washington, D.C. on September 11, 2001
disrupted commerce and intensified the uncertainty of the U.S. economy, a
condition which has persisted due to recent military actions in Afghanistan and
Iraq. The continued threat of terrorism and heightened security and military
action in response to this threat, or any future acts of terrorism, may cause
further disruptions and create further uncertainties. To the extent that such
disruptions or uncertainties negatively impact shopping patterns and/or mall
traffic, or adversely affect consumer confidence or the economy in general, the
Company's business, operating results and financial condition could be
materially and adversely affected.
In addition, California has recently experienced substantially
increased costs of electricity and gas caused by, among other things, disruption
in energy supplies. The Company's principal executive offices and a significant
number of its stores are located in California. If the Company experiences a
sustained disruption in energy supplies, or if electricity and gas costs in
California continue to increase, the Company's results of operations could be
materially and adversely affected. California is also subject to natural
disasters such as earthquakes and floods. A significant natural disaster or
other catastrophic event affecting the Company's facilities could have a
material adverse impact on its business, financial condition and operating
results.
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 Company's stock
price without regard to the Company's financial performance. In addition, the
Company believes that factors such as quarterly fluctuations in the Company's
financial results and comparable store sales; announcements by other apparel,
accessory and gift item retailers; the trading volume of the Company's stock;
changes in estimates of the Company's performance by securities analysts;
overall economic and political conditions; the condition of the financial
markets; and other events or factors could cause the Company's stock price to
fluctuate substantially.
23.
ANTI-TAKEOVER MATTERS; SHAREHOLDER DILUTION
The Company's Articles of Incorporation and Bylaws contain provisions
that may have the effect of delaying, deterring or preventing a takeover of the
Company. For instance, the Company's Articles of Incorporation include certain
"fair price provisions" generally prohibiting business combinations with
controlling or significant shareholders unless certain minimum price or
procedural requirements are satisfied, and the Company's Bylaws prohibit
shareholder action by written consent. Additionally, the Company's Board of
Directors has the authority to issue, without shareholder approval, up to
10,000,000 shares of "blank check" preferred stock having such rights,
preferences and privileges as designated by the Board of Directors. The issuance
of these shares could have a dilutive effect on the Company's shareholders, and
potentially prohibit a takeover of the Company by requiring the preferred
shareholders to approve such a transaction.
The Company also has a significant number of authorized and unissued
shares of its common stock available under its Articles of Incorporation. These
shares provide the Company with the flexibility to issue its common stock for
future business and financial purposes including stock splits, raising capital
and providing equity incentives to employees, officers and directors. However,
the issuance of these shares by the Company could result in dilution to the
Company's shareholders.
ITEM 2. PROPERTIES
The Company leases all of the Company's existing store locations, with
lease terms expiring between 2003 and 2013. At February 1, 2003, the Company had
a total of 784,623 leased store square feet (Hot Topic and Torrid stores) with
an average store size of 1,720 square feet (Hot Topic and Torrid stores). The
leases for most of the existing stores are for ten-year terms 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.
As of August 1, 2001, the Company doubled the size of its leased
headquarters and distribution center facility, located in City of Industry,
California, and entered into an amended lease with its existing landlord.
Construction to expand the Company's headquarters and distribution center
facility was completed during the second quarter of fiscal 2002. The amended
lease is for a five-year term (from the beginning of the original lease) and
will expire in April 2004. The Company has two options to extend the lease, each
for a three-year period. The annual base rent for the initial five-year term is
approximately $1,131,900 including the expanded space. The Company believes the
property covered by the amended lease will allow for growth of to up to 700
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.
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". The following table sets forth, for the periods
indicated, the high and low end of day closing sales prices of the shares of
24.
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.
2002 FISCAL YEAR QUARTERS HIGH LOW
----------------------
First Quarter $24.13 $19.83
Second Quarter $27.95 $15.27
Third Quarter $22.75 $14.86
Fourth Quarter $25.01 $20.89
2001 FISCAL YEAR QUARTERS HIGH LOW
----------------------
First Quarter $23.33 $15.46
Second Quarter $24.86 $17.01
Third Quarter $22.75 $15.00
Fourth Quarter $22.97 $16.17
On April 14, 2003, the last sales price of the Common Stock as reported
on the Nasdaq National Market was $23.03 per share. As of April 14, 2003, there
were approximately 200 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 10,750 holders.
On May 8, 2002, the Company announced that its Board of Directors
approved the repurchase of up to an aggregate of 1,000,000 shares of its Common
Stock during the period ending January 31, 2003. As of January 31, 2003, the
Company had completed the repurchase of 1,000,000 shares of its Common Stock at
a cost of $19.7 million, at an average price of $19.70 per common share.
The Company has not paid any cash dividends since inception and does
not anticipate paying any cash dividends in the foreseeable future.
Equity Compensation Plan information is cross-referenced from Item 12.
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.
25.
Fiscal Year
---------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(In thousands, except per share data, number of stores, comparable
store sales and sales per square foot)
Statement of Operations Data:
Net sales $443,250 $336,094 $257,187 $168,949 $103,371
Cost of goods sold, including buying, distribution
and occupancy costs 273,132 204,993 154,298 103,998 65,855
--------- --------- --------- --------- ---------
Gross margin 170,118 131,101 102,889 64,951 37,516
Selling, general and administrative expenses 115,634 86,950 67,917 44,749 29,077
--------- --------- --------- --------- ---------
Operating income 54,484 44,151 34,972 20,202 8,439
Interest income, net 1,371 1,884 1,925 933 931
--------- --------- --------- --------- ---------
Income before income taxes 55,855 46,035 36,897 21,135 9,370
Provision for income taxes 21,225 17,435 13,652 7,634 3,367
--------- --------- --------- --------- ---------
Net income $ 34,630 $ 28,600 $ 23,245 $ 13,501 $ 6,003
========= ========= ========= ========= =========
Net income per share:
Basic $ 1.10 $ 0.92 $ 0.78 $ 0.49 $ 0.21
Diluted $ 1.05 $ 0.86 $ 0.72 $ 0.46 $ 0.20
Weighted average shares outstanding:
Basic 31,351 30,978 29,668 27,801 28,902
Diluted 32,850 33,219 32,069 29,392 29,736
Selected Operating Data:
Number of stores at year end 445 352 274 212 158
Comparable stores sales increase 5.0% 3.9% 16.7% 22.8% 0.4%
Average sales per square foot $ 619 $ 636 $ 669 $ 623 $ 542
Average sales per store $ 1,064 $ 1,036 $ 1,020 $ 909 $ 772
Balance Sheet Data:
Cash and short-term investments $ 83,418 $ 71,310 $ 51,288 $ 39,550 $ 26,579
Working capital 90,379 82,370 61,253 37,564 28,432
Total assets 204,786 162,662 118,646 89,022 58,764
Long-term obligations including current portion 115 218 123 231 120
Shareholders' equity $160,929 $135,368 $ 99,291 $ 67,278 $ 48,749
26.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion of the results of operations, financial
condition and liquidity of the Company should be read in conjunction with the
information contained in the Consolidated Financial Statements and Notes thereto
included in Item 8. "Financial Statements and Supplementary Data" in this Form
10-K. These statements have been prepared in conformity with accounting
principles generally accepted in the United States and require Management to
make estimates and assumptions that affect amounts reported and disclosed in the
financial statements and related notes. Actual results could differ from these
estimates.
GENERAL
Hot Topic, Inc. and its wholly owned subsidiaries (collectively, the
"Company") is a mall-based specialty retailer operating the Hot Topic (includes
Hot Topic stores and hottopic.com) and Torrid (includes Torrid stores and
torrid.com) concepts. Hot Topic offers a selection of music-licensed and
music-influenced apparel, accessories and gift items for young men and women
principally between the ages of 12 and 22. In the first half of fiscal 2001 (the
fiscal year ended February 2, 2002) the Company launched a second retail concept
with the opening of six stores under the trade name Torrid. Torrid offers a
selection of apparel, lingerie, shoes and accessories centered around various
lifestyles for plus-size young women between the ages of 15 and 29. At the end
of fiscal 2002, the Company operated 418 Hot Topic stores and 27 Torrid stores
in 48 states and websites hottopic.com and torrid.com.
The Company considers a store comparable after it has been open for 15
full months. If a store is relocated or expanded by more than 15% in total
square footage, it is removed from the comparable store base and, similar to new
stores, becomes comparable after 15 full months. At the end of fiscal 2002, 321
of the Company's 418 Hot Topic stores were included in the comparable store
base, compared to 255 of the 346 stores open at the end of fiscal 2001. At the
end of fiscal 2002, 6 of the Company's 27 Torrid stores were included in the
comparable store base.
The Company operates on a 52 or 53-week fiscal year, which ends on the
Saturday nearest to January 31. Fiscal 2002 and 2001 were 52-week years. Fiscal
2000 was a 53-week year.
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
------------------------------
2002 2001 2000
---- ---- ----
Net sales 100.0% 100.0% 100.0%
Cost of goods sold, including buying,
distribution & occupancy costs 61.6% 61.0% 60.0%
------ ------ ------
Gross margin 38.4% 39.0% 40.0%
Selling, general and administrative expenses 26.1% 25.9% 26.4%
------ ------ ------
Operating income 12.3% 13.1% 13.6%
Interest income, net 0.3% 0.6% 0.7%
------ ------ ------
Income before income tax 12.6% 13.7% 14.3%
Provision for income taxes 4.8% 5.2% 5.3%
------ ------ ------
Net income 7.8% 8.5% 9.0%
====== ====== ======
Number of stores at year end 445 352 274
Comparable store sales increase 5.0% 3.9% 16.7%
27.
FISCAL 2002 COMPARED TO FISCAL 2001
Net sales increased approximately $107.2 million, or 31.9%, to $443.3
million in fiscal 2002 from $336.1 million in fiscal 2001. Net sales for the 74
Hot Topic stores opened during fiscal 2002 and for the other Hot Topic stores
not yet qualifying as comparable stores contributed $78.8 million of the net
sales increase. Comparable store sales for the Company increased 5.0% in fiscal
2002 and contributed $14.3 million of the increase in net sales. Net sales for
the 21 new Torrid stores and for the Torrid stores not yet qualifying as
comparable stores operating during fiscal 2002 contributed $9.4 million of the
net sales increase. Hottopic.com and torrid.com sales were approximately 1.8% of
total Company sales in fiscal 2002 and contributed $4.7 million (including
shipping and handling income) of the net sales increase.
The annual average Hot Topic store volume increased to $1.07 million in
fiscal 2002 from $1.04 million in fiscal 2001. Hot Topic sales of apparel
category merchandise, as a percentage of total net sales, were 51% in fiscal
2002 compared to 53% in fiscal 2001. The decrease in apparel was primarily due
to decreases in men's tops and bottoms partially offset by increases in sales of
music-related T-shirts and women's apparel (women's tops and bottoms). The sales
mix for Hot Topic in fiscal 2002 saw an increase in sales of accessories
merchandise (including gifts, intimate apparel and shoes) to 49% from 47% in
fiscal 2001 which contributed to the strong sales performance of accessories
merchandise in the third and fourth quarter of fiscal 2002.
Gross margin increased approximately $39.0 million to $170.1 million in
fiscal 2002 from $131.1 million in fiscal 2001. As a percentage of net sales,
gross margin decreased to 38.4% in fiscal 2002 from 39.0% in fiscal 2001. The
0.6% reduction in gross margin, as a percentage of net sales, was primarily due
to a 0.4% increase in store occupancy expenses and a 0.2% reduction in
merchandise margin. The increase in store occupancy costs primarily resulted
from higher common area charges and rent expenses. Torrid's larger store size
and increased store count resulted in the increase of rent expenses, as a
percentage of net sales. The Company's merchandise margin, as a percentage of
net sales, was lower in fiscal 2002 compared to fiscal 2001 principally from
higher markdowns partially offset by a higher initial markup and lower
shrinkage. The higher markdowns were primarily due to markdowns in men's tops
and bottoms for Hot Topic and higher Torrid markdowns related to minimum
purchases of merchandise required in excess of what was needed for the small
store base.
Selling, general and administrative expenses increased approximately
$28.7 million to $115.6 million during fiscal 2002 from $86.9 million during
fiscal 2001. As a percentage of net sales, selling, general and administrative
expenses were 26.1% for fiscal 2002 compared to 25.9% in fiscal 2001. The total
dollar increase in selling, general and administrative expenses was primarily
attributable to an increase in the number of retail stores from 352 at the end
of fiscal 2001 to 445 at the end of fiscal 2002 and the corresponding additional
payroll and other expenses required to support these additional stores. The
increase, as a percentage of net sales, was primarily attributable to higher
benefits cost, costs associated with the Company implementing a wide area
network, and an increase in performance based payroll, partially offset by the
leveraging of headquarters expenses.
Operating income increased approximately $10.3 million to $54.5 million
during fiscal 2002 from $44.2 million during fiscal 2001. As a percentage of net
sales, operating income was 12.3% in fiscal 2002 compared to 13.1% in fiscal
2001. Operating income on an average store basis was approximately $133,000 in
fiscal 2002 as compared to $137,000 in fiscal 2001.
28.
Net interest income decreased to $1.4 million in fiscal 2002 from $1.9
million in fiscal 2001, principally due to lower interest rates offset in part
by the additional interest earned from higher average cash balances.
The Company's effective tax rate was 38.0% in fiscal 2002 and 37.9% in
fiscal 2001. The higher rate for fiscal 2002 is principally attributable to
lower tax-exempt interest income as a percentage of pre-tax income, in fiscal
2002 as compared to fiscal 2001 and higher effective state income tax rates in
fiscal 2002.
FISCAL 2001 COMPARED TO FISCAL 2000
Net sales increased approximately $78.9 million, or 31%, to $336.1
million in fiscal 2001 from $257.2 million in fiscal 2000. Net sales for the 73
Hot Topic stores opened during fiscal 2001 and for the other Hot Topic stores
not yet qualifying as comparable stores contributed $65.8 million of the net
sales increase. Comparable store sales increased 3.9% in fiscal 2001 and
contributed $8.6 million of the increase in net sales. The six Torrid stores and
torrid.com contributed to approximately $4.5 million of the increase.
Hottopic.com sales were approximately one percent of total Company sales.
The annual average Hot Topic store volume increased to $1.04 million in
fiscal 2001 from $1.02 million in fiscal 2000. The sales mix for Hot Topic in
fiscal 2001 saw a slight shift toward apparel and T-shirts, with this category
contributing approximately 53% of net sales in 2001 as compared to approximately
51% in 2000.
The Company experienced lower sales increases during the September 2001
(0.6% comp increase) and October 2001 (4.4% comp decrease) periods. The Company
attributes this to reduced mall traffic primarily due to the events of September
11, 2001 relative to the balance of fiscal 2001.
Gross margin increased approximately $28.2 million to $131.1 million in
fiscal 2001 from $102.9 million in fiscal 2000. As a percentage of net sales,
gross margin decreased to 39.0% in fiscal 2001 from 40.0% in fiscal 2000. This
1.0% reduction in gross margin was due to a 0.5% increase in store occupancy
expenses, a 0.4% reduction in merchandise margin and a 0.1% increase in buying
expenses, all as a percentage of net sales. Occupancy expenses were 0.5% higher
primarily due to higher common area charges. The 0.4% reduction in merchandise
margin was a result of three major factors: merchandise mix changes at Hot Topic
from accessories toward increased apparel, with apparel achieving lower overall
merchandise margins compared to accessories; the leveraging of markdowns in
fiscal 2000 relative to the extra week of sales volume in 2000 compared to 2001
and higher Torrid markdowns. The higher Torrid markdowns were related to minimum
purchases of merchandise required in excess of what was needed for the small
store base. The remaining 0.1% increase was due to a rise in buying expense, as
a percent of net sales, primarily due to the addition of the Torrid
merchandising staffing in fiscal 2001.
Selling, general and administrative expenses increased approximately
$19.0 million to $86.9 million during fiscal 2001 from $67.9 million during
fiscal 2000. As a percentage of net sales, selling, general and administrative
expenses were 25.9% for fiscal 2001 compared to 26.4% in fiscal 2000. The total
dollar increase in selling, general and administrative expenses was primarily
attributable to an increase in the number of retail stores from 274 at the end
of fiscal 2000 to 352 at the end of fiscal 2001 and the corresponding additional
payroll and other expenses required to support these additional stores. The
decrease, as a percentage of net sales, was primarily attributable to leveraging
administrative expenses over the greater sales base in fiscal 2001 and lower
store operating expenses resulting from Management's efforts to control such
expenses. This leverage was partially offset by higher selling payroll expense
as a percentage of sales, due to slightly higher pay rates and increased benefit
coverage.
29.
Operating income increased approximately $9.2 million to $44.2 million
during fiscal 2001 from $35.0 million during fiscal 2000. As a percentage of net
sales, operating income was 13.1% in fiscal 2001 compared to 13.6% in fiscal
2000. Operating income on an average store basis was approximately $137,000 in
fiscal 2001.
Net interest income was $1.9 million in both fiscal 2001 and fiscal
2000, but it was a lower percentage of sales in fiscal 2001. Average cash
balances were higher in fiscal 2001 than in fiscal 2000 but interest rates were
significantly lower.
The Company's effective tax rate was 37.9% in fiscal 2001 and 37.0% in
fiscal 2000. The higher rate for fiscal 2001 is principally attributable to the
tax-exempt interest income that is a smaller percentage of pre-tax income in
2001 as compared to 2000 and higher effective state income tax rates in fiscal
2001.
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 and political conditions.
The Company's business is also subject to seasonal influences, with
heavier concentrations of sales during the back-to-school, Halloween and Holiday
seasons (defined as the week of Thanksgiving through the first few days of
January), and other periods when schools are not in session. The 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) as well as Halloween (which affects
operating results in the third quarter), all reduce the Company's dependence on
the Holiday selling season. Furthermore, summer vacation, back-to-school season
and spring break 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 relative to other quarters.
The following table sets forth certain statement of operations and
selected operating data for each of the Company's last eight fiscal quarters (13
week periods). 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.
30.
(In thousands, except selected
operating and per share data) FISCAL YEAR 2002 FISCAL YEAR 2001
------------------------------------------- -------------------------------------------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
----- ------ ----- ------ ----- ------ ----- ------
STATEMENT OF OPERATIONS DATA:
Net sales $ 79,909 $ 92,473 $122,590 $148,278 $ 62,927 $ 71,944 $ 92,080 $109,143
Gross margin 28,457 32,792 46,760 62,109 23,478 26,160 35,930 45,533
Operating income 5,530 6,658 15,908 26,388 4,743 6,342 13,236 19,830
Net income $ 3,683 $ 4,344 $ 10,048 $ 16,555 $ 3,347 $ 4,279 $ 8,507 $ 12,467
Net income per share:
Basic $ 0.12 $ 0.14 $ 0.32 $ 0.53 $ 0.11 $ 0.14 $ 0.27 $ 0.40
Diluted $ 0.11 $ 0.13 $ 0.31 $ 0.51 $ 0.10 $ 0.13 $ 0.26 $ 0.38
Weighted average shares outstanding:
Basic 31,473 31,712 31,127 31,093 30,611 30,900 31,104 31,295
Diluted 33,315 33,493 32,260 32,334 33,369 33,294 33,120 33,225
SELECTED OPERATING DATA:
Comparable store sales (0.5)% 0.6% 6.3% 9.7% 8.0% 2.4% 2.2% 3.8%
Stores open at end of period 379 415 437 445 296 322 347 352
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, upgrade
information systems, and expand its headquarters and distribution center. In
addition, during fiscal 2002, the Company used cash to repurchase common shares.
The Company has satisfied its cash requirements exclusively from cash flows from
operations, and, in earlier years, also from proceeds from the sale of equity
securities. The Company maintains a $1.0 million unsecured credit agreement for
the purpose of issuing letters of credit. At February 1, 2003, the Company had
$0.2 million of outstanding letters of credit under the credit agreement. The
letters of credit are primarily used for inventory purchases. At the end of
fiscal 2002, the Company had $83.4 million in cash, cash equivalents and
short-term investments, an increase of $12.1 million, or 17% compared to the
$71.3 million cash, cash equivalents and short-term investments balance at the
end of fiscal 2001. Working capital was $90.4 million, $82.4 million and $61.3
million for fiscal 2002, 2001 and 2000, respectively. The increase in working
capital for each of these fiscal years was primarily attributable to cash
provided by net income.
Net cash flows provided by operating activities were $55.1 million,
$38.7 million, and $19.7 million in fiscal 2002, 2001 and 2000, respectively.
The $16.4 million increase in cash flows from operating activities in fiscal
2002 as compared to fiscal 2001 was primarily attributable to the increases in
net income, accrued liabilities, depreciation and amortization, and income
taxes. These increases in cash flows were offset in part by higher prepaid
expenses and other current assets. The significant changes in net cash provided
by operating activities were due primarily to the Company's increase in store
growth to 445 stores at the end of fiscal 2002 (leases for two stores expired in
fiscal 2002 and were not renewed) compared to 352 stores at the end of fiscal
2001.
31.
Net cash flows used in investing activities were $29.6 million, $40.9
million and $17.4 million in fiscal 2002, 2001 and 2000, respectively. In fiscal
2002, approximately $23.6 million was used for the construction of 74 Hot Topic
stores, 21 Torrid stores, expansion and refurbishment of 8 Hot Topic stores and
progress payments for construction of stores opening in early fiscal 2003. The
Company used approximately $4.9 million for the expansion of its headquarters
and distribution center during fiscal 2002. The Company also used approximately
$5.4 million for computer hardware and software, which includes relaunching of
its websites and wide area network costs at its stores and headquarters during
fiscal 2002. The Company opened 95, 79, and 62 stores in fiscal 2002, 2001 and
2000, respectively. Cash flows used in investing activities in fiscal 2002 were
offset by $4.3 million due to net proceeds received from the sale of low-risk,
short-term investments.
Net cash flows used in financing activities were $9.1 million in fiscal
2002 compared to net cash flows provided by financing activities of $7.4 million
and $8.7 million in fiscal 2001 and 2000, respectively. The $16.5 million
decrease in fiscal 2002 compared to fiscal 2001 was due to the repurchase of
shares of the Company's Common Stock of $19.7 million offset by proceeds
received from the exercise of stock options and employee stock purchases, and
tax related benefit from the exercise of stock options of $3.2 million.
The Company anticipates that it will spend approximately $36 million on
capital expenditures in fiscal 2003, including approximately $27 million for
stores, $7 million for computer hardware and software and $2 million on its
headquarters and distribution center infrastructure. The $27 million for stores
is to be used for the construction of 70 Hot Topic stores and 25 Torrid stores,
expansion of approximately 10 existing Hot Topic stores and progress payments
for early fiscal 2004 new store openings.
During fiscal 2002, the Company's average capital expenditures for a
new Hot Topic store, including leasehold improvements and furniture and
fixtures, totaled approximately $193,000, net of landlord allowances. The
average initial gross inventory for the new Hot Topic stores opened in 2002 was
approximately $111,000 (which was partially financed by trade credit) and the
average pre-opening costs for a new Hot Topic store was approximately $20,000.
Initial inventory requirements vary at new stores depending on the season and
current merchandise trends. The Company expects the average total costs
associated with opening a Hot Topic store to be approximately the same in fiscal
2003 as those in fiscal 2002. Torrid stores are planned to be approximately
2,500 square feet compared to Hot Topic stores planned to be approximately 1,800
square feet. The costs associated with opening a new Torrid store will be higher
than a Hot Topic store due to the larger size of the Torrid stores. 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, store size, and the extent of the
build-out required at the selected sites.
As of February 1, 2003, the Company's aggregate capital and operating
lease obligations through 2013 are approximately $227 million, which includes
approximately $30 million for fiscal 2003, $29 million for fiscal 2004, $28
million for fiscal 2005, $28 million for fiscal 2006 and $112 million
thereafter. See Note 5 to the Company's Consolidated Financial Statements for
additional disclosure related to capital and operating lease obligations.
During fiscal 2002, the Company repurchased a portion of its shares in
the open market. Although no share repurchase program is currently in effect,
the Company's Board of Directors may determine it in the best interest of the
Company and its shareholders to make additional repurchases in the future.
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.
32.
CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of the Company's financial
condition and results of operations are based upon the Company's consolidated
financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States of America. The preparation
of these financial statements requires the Company to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosures of contingent assets and liabilities. On an
ongoing basis, the Company evaluates estimates, including those related
primarily to inventories, long-lived assets and contingencies. The Company bases
its estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
The Company believes the following critical accounting policies affect
the more significant judgments and estimates used in the preparation of its
consolidated financial statements. For a further discussion on the application
of these and other accounting policies, see Note 1 to the Company's audited
consolidated financial statements included elsewhere in this report.
INVENTORIES: Inventories and related cost of sales are accounted for by
the retail method. The cost of inventory is valued at the lower of average cost
or market, on a first-in, first-out (FIFO) basis, utilizing the retail method.
Each month, slow moving or seasonally obsolete merchandise is marked down. The
first markdown is typically to 50% of the original retail. In cases where the
merchandise does not sell after the first markdown, an additional markdown is
made in a subsequent month. Any marked down merchandise that does not sell is
marked down to a zero value and removed from the store, approximately three
months after the original markdown. In determining the lower of average cost or
market value of period ending inventories, consistently applied valuation
criteria is used. Consideration is given to a number of quantitative factors,
including anticipated subsequent permanent markdowns and aging of inventories.
VALUATION OF LONG-LIVED ASSETS: The Company assesses the impairment of
long-lived assets whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors considered important that could
trigger an impairment review include a significant underperformance relative to
expected historical or projected future operating results, a significant change
in the manner of the use of the asset or a significant negative industry or
economic trend. When the Company determines that the carrying value of
long-lived assets may not be recoverable based upon the existence of one or more
of the above indicators of impairment, the Company will measure any impairment
based on a projected discounted cash flow method using a discount rate
determined by our management. The Company has not historically had an impairment
of a long-lived asset.
REVENUE RECOGNITION: Sales are recognized upon the purchase by
customers at the Company's retail store locations and websites, less merchandise
returned by customers. The Company provides a reserve for projected merchandise
returns based on historical experience. Revenue from gift cards, gift
certificates and store merchandise credits is recognized at the time of
redemption.
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.
33.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is not a party to any derivative financial instruments. The
Company's exposure to market risk relates to changes in interest rates on its
investments with maturities of less than three months (which are considered to
be cash and cash equivalents) and its short-term investments with maturities in
excess of three months. Changes in interest rates affect the investment income
earned on those investments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and notes of the Company listed
in Item 15(a) are incorporated herein by reference.
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 February 1, 2003 pursuant to
Regulation 14A in connection with the solicitation of proxies for the Company's
Annual Meeting of Shareholders to be held on June 12, 2003 (the "2003 Proxy
Statement").
Certain other information required by this item is incorporated by
reference to the information appearing under the caption "Section 16(a)
Beneficial Ownership Reporting Compliance" in the 2003 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 2003
Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated by reference to
the information appearing under the captions "Security Ownership of Certain
Beneficial Owners and Management" and "Equity Compensation Plan Information" in
the 2003 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 2003
Proxy Statement.
34.
ITEM 14. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Based on their evaluation of the Company's disclosure controls
and procedures conducted within 90 days of the date of filing
this report on Form 10-K, the Company's Chief Executive
Officer and Chief Financial Officer have concluded that the
Company's disclosure controls and procedures (as defined in
Rules 13a-14(c) and 15d-14(c) promulgated under the Securities
Exchange Act of 1934) are effective.
(b) Changes in Internal Controls
There were no significant changes in the Company's internal
controls or in other factors that could significantly affect
these controls subsequent to the date of their evaluation.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, 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 1, 2003 and February 2, 2002................ F-2
Consolidated Statements of Income for the years ended February 1, 2003, February 2, 2002
and February 3, 2001.......................................................... F-3
Consolidated Statements of Shareholders' Equity for the years ended
February 1, 2003, February 2, 2002 and February 3, 2001................... F-4
Consolidated Statements of Cash Flows for the years ended February 1, 2003, February 2,
2002 and February 3, 2001..................................................... F-5
Notes to Consolidated Financial Statements............................................. F-6
(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 15(c) hereof are filed with,
and incorporated by reference into, this Annual Report on Form 10-K. Management
contracts or compensatory plans or arrangements required to be filed pursuant to
Item 15(c) are so identified therein.
(b) REPORTS ON FORM 8-K
Not applicable.
35.
(C) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------ -----------------------
3.1 Amended and Restated Articles of Incorporation. (1)
3.2 Amended and Restated Bylaws. (3)
4.1 Reference is made to Exhibits 3.1 and 3.2.
4.2 Specimen stock certificate. (1)
10.1a Form of Indemnity Agreement to be entered into between
Registrant and its directors and officers. (1)
10.2a 1996 Equity Incentive Plan (the "1996 Plan"). (1)
10.3a Form of Nonstatutory Stock Option Agreement of Registrant
pursuant to the 1996 Plan. (1)
10.4a Form of Incentive Stock Option Agreement of Registrant
pursuant to the 1996 Plan. (1)
10.5a Non-Employee Directors' Stock Option Plan. (1)
10.6a 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. (3)
10.11a Employment Offer Letter dated January 12, 2001, between the
Registrant and Gerald Cook. (3)
10.12a Form of Restricted Stock Bonus Agreement between the
Registrant and each of its non-employee directors as of
March 7, 2001 (with Robert Jaffe for 1,270 shares, and with
each of Bruce Quinnell, Edgar Berner, Andrew Schuon and
Corrado Federico for 1,058 shares) and as of September 24,
2001 (with Cynthia Cohen for 785 shares and vesting from
September 24, 2001) and as of January 28, 2002 (with W.
Scott Hedrick for 412 shares and vesting from January 28,
2002). (4)
10.13a Employment Offer Letter dated June 11, 2001, between the
Registrant and Jane Cruz. (5)
10.14a Employment Offer Letter dated August 14, 2002, between the
Registrant and Patricia Van Cleave.
36.
10.15a Employment Letter dated January 23, 2003, between the
Registrant and James McGinty.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney is contained on the signature page.
99.1 Certifications, dated April 18, 2003, required by Section
906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.ss.1350, as
adopted).
- ------------
(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.
(3) Filed as an exhibit to Registrant's Annual Report on Form 10-K for the
year ended February 3, 2001 and incorporated herein by reference.
(4) Filed as an exhibit to Registrant's Quarterly Report on Form 10-Q for
the quarter ended May 5, 2001 and incorporated herein by reference.
(5) Filed as an exhibit to Registrant's Annual Report on Form 10-K for the
year ended February 2, 2002 and incorporated herein by reference.
a DENOTES MANAGEMENT CONTRACT OR COMPENSATORY PLAN OR ARRANGEMENT.
(d) FINANCIAL STATEMENT SCHEDULES
Reference is made to Item 15(a)(2).
37.
SIGNATURES
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,
HOT TOPIC, INC.
By: /s/ Elizabeth McLaughlin
------------------------------
Elizabeth McLaughlin
Chief Executive Officer,
President and Director
April 18, 2003
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Elizabeth McLaughlin and James McGinty,
or either of them, his attorney-in-fact, each with the power of substitution,
for him or her 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 MCLAUGHLIN Chief Executive Officer, President and April 18, 2003
- ------------------------ Director (PRINCIPAL EXECUTIVE OFFICER)
Elizabeth McLaughlin
/s/ JAMES MCGINTY Chief Financial Officer (PRINCIPAL April 18, 2003
- ------------------------ FINANCIAL OFFICER)
James McGinty
/s/ GEORGE WEHLITZ, JR. Vice President, Controller (PRINCIPAL April 18, 2003
- ------------------------ ACCOUNTING OFFICER)
George Wehlitz, Jr.
/s/ BRUCE QUINNELL Chairman of the Board April 18, 2003
- ------------------------
Bruce Quinnell
/s/ EDGAR BERNER Director April 18, 2003
- ------------------------
Edgar Berner
/s/ CORRADO FEDERICO Director April 18, 2003
- ------------------------
Corrado Federico
/s/ ANDREW SCHUON Director April 18, 2003
- ------------------------
Andrew Schuon
/s/ CYNTHIA COHEN Director April 18, 2003
- ------------------------
Cynthia Cohen
/s/ W. SCOTT HEDRICK Director April 18, 2003
- ------------------------
W. Scott Hedrick
38.
CERTIFICATION
I, Elizabeth McLaughlin, certify that:
1. I have reviewed this annual report on Form 10-K of Hot Topic, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "EVALUATION DATE"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 18, 2003
/s/ Elizabeth McLaughlin
- ------------------------
ELIZABETH MCLAUGHLIN
Chief Executive Officer, President and Director
39.
CERTIFICATION
I, James McGinty, certify that:
1. I have reviewed this annual report on Form 10-K of Hot Topic, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "EVALUATION DATE"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 18, 2003
/s/ James McGinty
- -----------------
James McGinty
Chief Financial Officer
40.
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders of Hot Topic, Inc.
We have audited the accompanying consolidated balance sheets of Hot Topic, Inc.
and its subsidiaries as of February 1, 2003 and February 2, 2002, and the
related consolidated statements of income, shareholders' equity, and cash flows
for each of the three years in the period ended February 1, 2003. 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 its subsidiaries at February 1, 2003 and February 2, 2002, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended February 1, 2003 in conformity with
accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
Los Angeles, California
February 28, 2003
F-1
Hot Topic, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share amounts)
FEBRUARY 1, FEBRUARY 2,
2003 2002
--------- ---------
Current assets:
Cash and cash equivalents $ 50,449 $ 34,072
Short-term investments 32,969 37,238
Inventory 38,409 29,553
Prepaid expenses and other 7,866 5,435
Deferred tax assets 2,093 1,417
--------- ---------
Total current assets 131,786 107,715
Leaseholds, fixtures and equipment, net 72,146 53,926
Deposits and other 171 174
Deferred tax assets 683 847
--------- ---------
Total assets $204,786 $162,662
========= =========
Liabilities and shareholders' equity Current liabilities:
Accounts payable $ 15,407 $ 11,253
Accrued liabilities 19,524 11,966
Income taxes payable 6,453 2,096
Current portion of obligations under capital leases 23 30
--------- ---------
Total current liabilities 41,407 25,345
Deferred rent 2,358 1,761
Capital lease obligations, less current portion 92 188
Commitments and contingencies -- --
Shareholders' equity:
Preferred shares, no par value; 10,000,000 shares
authorized; no shares issued and outstanding -- --
Common shares, no par value; 150,000,000 shares authorized;
31,203,987 and 31,375,064 shares issued and outstanding at
February 1, 2003 and February 2, 2002, respectively 47,837 56,906
Retained earnings 113,092 78,462
--------- ---------
Total shareholders' equity 160,929 135,368
--------- ---------
Total liabilities and shareholders' equity $204,786 $162,662
========= =========
See notes to consolidated financial statements.
F-2
Hot Topic, Inc. and Subsidiaries
Consolidated Statements of Income
(In thousands, except per share amounts)
Years ended
--------------------------------------------
February 1, February 2, February 3,
2003 2002 2001
--------------------------------------------
Net sales $ 443,250 $ 336,094 $ 257,187
Cost of goods sold, including buying,
distribution and occupancy costs 273,132 204,993 154,298
------------------------------------------
Gross margin 170,118 131,101 102,889
Selling, general and administrative expenses 115,634 86,950 67,917
------------------------------------------
Operating income 54,484 44,151 34,972
Interest income (1,390) (1,912) (1,955)
Interest expense 19 28 30
------------------------------------------
Income before income taxes 55,855 46,035 36,897
Provision for income taxes 21,225 17,435 13,652
------------------------------------------
Net income $ 34,630 $ 28,600 $ 23,245
==========================================
Net income per share:
Basic $ 1.10 $ 0.92 $ 0.78
==========================================
Diluted $ 1.05 $ 0.86 $ 0.72
==========================================
Shares used in computing net income per share:
Basic 31,351 30,978 29,668
Diluted 32,850 33,219 32,069
See notes to consolidated financial statements.
F-3
Hot Topic, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity
(In thousands)
Common Shares Total
------------------------ Deferred Retained Shareholders'
Shares Amount Compensation Earnings Equity
------------------------------------------------------------------------
BALANCE AT JANUARY 29, 2000 28,983 $ 40,667 $ (7) $ 26,617 $ 67,277
Exercise of stock options 1,440 4,767 -- -- 4,767
Employee stock purchase plan 18 143 -- -- 143
Amortization of deferred compensation -- -- 7 -- 7
Tax benefit from exercise of stock options -- 3,852 -- -- 3,852
Net income -- -- -- 23,245 23,245
------------------------------------------------------------------------
BALANCE AT FEBRUARY 3, 2001 30,441 49,429 -- 49,862 99,291
Exercise of stock options 917 3,680 -- -- 3,680
Employee stock purchase plan 17 205 -- -- 205
Fractional shares purchased in 3-for-2 stock split - (6) -- -- -- (6)
Tax benefit from exercise of stock options -- 3,598 -- -- 3,598
Net income -- -- -- 28,600 28,600
------------------------------------------------------------------------
BALANCE AT FEBRUARY 2, 2002 31,375 56,906 -- 78,462 135,368
Exercise of stock options 797 4,942 -- -- 4,942
Employee stock purchase plan 22 418 -- -- 418
Restricted stock awards 10 153 -- -- 153
Repurchase of common stock (1,000) (19,700) -- -- (19,700)
Tax benefit from exercise of stock options -- 5,118 -- -- 5,118
Net income -- -- -- 34,630 34,630
------------------------------------------------------------------------
BALANCE AT FEBRUARY 1, 2003 31,204 $ 47,837 -- $ 113,092 $ 160,929
========================================================================
See notes to consolidated financial statements.
F-4
Hot Topic, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
Years ended
-----------------------------------------
February 1, February 2, February 3,
2003 2002 2001
-----------------------------------------
OPERATING ACTIVITIES
Net income $ 34,630 $ 28,600 $ 23,245
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 15,309 11,082 8,645
Deferred rent 597 358 299
Deferred compensation -- -- 7
Deferred taxes (512) (1,061) (1,298)
Loss on disposal of fixed assets 278 401 501
Changes in operating assets and liabilities:
Inventory (8,856) (8,217) (5,969)
Prepaid expenses and other current assets (2,431) 118 (3,972)
Deposits and other assets 3 (73) (17)
Accounts payable 4,155 4,620 417
Accrued liabilities 7,558 769 2,178
Income taxes payable 4,357 2,096 (4,289)
---------------------------------------
Net cash provided by operating activities 55,088 38,693 19,747
INVESTING ACTIVITIES
Purchases of property and equipment (33,879) (26,119) (16,663)
Purchases of short-term investments (41,837) (31,213) (23,769)
Proceeds from sale of short-term investments 46,105 16,476 23,059
---------------------------------------
Net cash used in investing activities (29,611) (40,856) (17,373)
FINANCING ACTIVIITIES
Payments on capital lease obligations (30) (28) (108)
Repurchase of common stock (19,700) (6) --
Proceeds from employee stock purchases and exercise of
stock options, including related tax benefit 10,630 7,483 8,762
---------------------------------------
Net cash provided (used) by financing activities (9,100) 7,449 8,654
---------------------------------------
Increase in cash and cash equivalents 16,377 5,286 11,028
Cash and cash equivalents at beginning of year 34,072 28,786 17,758
---------------------------------------
Cash and cash equivalents at end of year $ 50,449 $ 34,072 $ 28,786
=======================================
SUPPLEMENTAL INFORMATION
Cash paid during the year for interest $ 19 $ 28 $ 30
=======================================
Cash paid during the year for income taxes $ 12,317 $ 10,799 $ 17,399
=======================================
Capital lease obligations entered into for equipment $ -- $ 147 $ --
=======================================
See notes to consolidated financial statements.
F-5
Hot Topic, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
February 1, 2003
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS ACTIVITY
Hot Topic, Inc. and its wholly owned subsidiaries (collectively, the "Company")
is a mall-based specialty retailer operating the Hot Topic and Torrid store
concepts. Hot Topic offers a selection of music-licensed and music-influenced
apparel, accessories and gift items for young men and women principally between
the ages of 12 and 22. In the first half of fiscal 2001 (the fiscal year ended
February 2, 2002) the Company launched a second retail concept with the opening
of six stores under the trade name Torrid. Torrid offers a selection of apparel,
lingerie, shoes and accessories centered around various lifestyles for plus-size
females between the ages of 15 and 29. The Company opened its first Hot Topic
store in 1989 and at the end of fiscal 2002 (the fiscal year ended February 1,
2003), the Company operated 418 Hot Topic stores and 27 Torrid stores in 48
states. The Company also maintains two distinct websites, www.hottopic.com
("hottopic.com") and www.torrid.com ("torrid.com") which reflect the Hot Topic
and Torrid store concepts and sell certain items of merchandise. The Company has
one reportable segment given the similarities of the economic characteristics
among the store formats.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany transactions and
balances have been eliminated in consolidation.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year amounts to conform to
current year presentation.
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 years ended February 1, 2003, February 2, 2002
and February 3, 2001 were 52 weeks, 52 weeks and 53 weeks, respectively.
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.
SHORT-TERM INVESTEMENTS
Short-term investments with maturities in excess of three months consist
primarily of interest bearing tax exempt bonds that are highly liquid, low risk
with a minimum credit quality rating of A-1 (Standard and Poor's), SP-1 (Moody's
Investor Service) or equivalent, and are available for sale.
F-6
INVENTORY
Inventories and related cost of sales are accounted for by the retail method.
The cost of inventory is valued at the lower of average cost or market, on a
first-in, first-out (FIFO) basis.
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
calculated 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.
Expenditures for repairs that do not significantly extend the life of the asset
are expensed as incurred.
REVENUE RECOGNITION
Sales are recognized upon the purchase by customers at the Company's retail
store locations and websites, less merchandise returned by customers. The
Company provides a reserve for projected merchandise returns based on historical
experience. Revenue from gift cards, gift certificates and store merchandise
credits is recognized at the time of redemption.
STORE PRE-OPENING COSTS
Costs incurred in connection with the opening of a new store are expensed as
incurred.
SHIPPING AND HANDLING COSTS
The Company classifies shipping and handling cost in costs of goods sold,
including buying, distribution and occupancy costs in the accompanying
statements of income.
ADVERTISING COSTS
Advertising costs are expensed the first time the event occurs or as incurred.
Advertising expenses were $521,000, $334,000 and $323,000 for the years ended
February 1, 2003, February 2, 2002 and February 3, 2001, respectively.
INCOME TAXES
The Company utilizes Statement of Financial Accounting Standards ("SFAS") 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 7). A
three-for-two stock split became effective February 6, 2002. All share and per
share amounts have been restated to reflect the stock split and all previous
stock splits.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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.
F-7
LONG-LIVED ASSETS
Long-lived assets are reviewed for events or changes in circumstances that
indicate that their carrying value may not be recoverable. The review is based
on comparing the expected undiscounted cash flows to the carrying amount of such
assets. If it is determined that the carrying amount of the long-lived assets is
not recoverable, the Company will recognize an impairment loss, measured by the
future discounted cash flow method. At February 1, 2003, the Company believes
there has been no impairment of the value of such assets to date.
In August 2001, the Financial Accounting Standards Board issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets", which
establishes accounting and reporting standards for impairment and disposition of
long-lived assets, including discontinued operations. SFAS No. 144 became
effective for all financial statements issued for fiscal years beginning after
December 15, 2001 and, generally, its provisions are to be applied
prospectively. The adoption of SFAS No. 144 did not have a significant impact on
the Company's results of operations or financial condition.
STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees and directors using the
intrinsic value method as prescribed by Accounting Principle Board Opinion No.
25, "Accounting for Stock Issued to Employees" and provides the pro forma
disclosure provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation." As such, compensation expense for stock options issued to
employees is recorded on the date of the grant only if the current market price
of the underlying stock exceeded the exercise price.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment to FASB Statement No.
123." SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based
Compensation," to provide new guidance concerning the transition when a company
changes from the intrinsic value method to the fair value method of accounting
for employee stock-based compensation cost. SFAS No. 123, as amended by SFAS No.
148, also requires additional disclosure regarding such cost in annual financial
statements and interim financial statements. The amendment to SFAS No. 123 is
effective for fiscal years ending after December 15, 2002 and effective for
interim financial statements beginning after December 15, 2002. The Company does
not expect the adoption of SFAS No. 148 to have a material impact on its results
of operations or financial condition. The Company adopted the disclosure
requirements of SFAS No. 148 in the year ended February 1, 2003.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities", which addresses financial accounting and
reporting for costs associated with exit or disposal activities and supersedes
Emerging Issues Task Force ("EITF") Issue 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. Under Issue 94-3, a liability for an
exit cost, as defined in EITF 94-3, was recognized at the date of an entity's
commitment to an exit plan. SFAS No. 146 also establishes that the liability
should initially be measured and recorded at fair value. The provisions of SFAS
No. 146 are effective for exit or disposal activities that are initiated after
December 31, 2002. The Company does not expect the adoption of SFAS No. 146 to
have a material impact on its results of operations or financial condition.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
This Statement updates, clarifies and simplifies existing accounting
pronouncements. SFAS No. 145 is effective for fiscal years beginning after May
15, 2002. The Company does not expect the adoption of SFAS No. 145 to have a
material impact on its results of operations or financial condition.
F-8
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." This Statement addresses financial accounting and reporting
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. SFAS No. 143 is effective for financial
statements issued for fiscal years beginning after June 15, 2002. The Company
does not believe the adoption of SFAS No. 143 will have a material impact on its
results of operations or financial condition.
The Company adopted SFAS No. 141, "Business Combinations" and No. 142, "Goodwill
and Other Intangible Assets", on February 3, 2002. SFAS No. 141 addresses the
initial recognition and measurement of goodwill and other intangible assets
acquired in a business combination. SFAS No. 142 addresses the initial
recognition and measurement of intangible assets acquired outside of a business
combination, whether acquired individually or with a group of other assets, and
the accounting and reporting for goodwill and other intangibles subsequent to
their acquisition. SFAS Nos. 141 and 142 require all future business
combinations to be accounted for using the purchase method of accounting.
Goodwill will no longer be amortized, but instead will be subject to an
impairment test each reporting period. The adoption of SFAS Nos. 141 and 142 has
not had a material impact on Company's results of operations or financial
condition. The Company does not have any goodwill or amortization expense
related to such goodwill in its financial statements.
2. LEASEHOLDS, FIXTURES AND EQUIPMENT
Leaseholds, fixtures and equipment are summarized as follows (in thousands):
February 1, February 2,
2003 2002
---------- ----------
Furniture, fixtures and equipment $ 58,597 $ 43,482
Leasehold improvements 58,322 41,412
---------- ----------
116,919 84,894
Less accumulated depreciation and amortization (44,773) (30,968)
---------- ----------
$ 72,146 $ 53,926
========== ==========
3. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
February 1, February 2,
2003 2002
---------- ----------
Accrued payroll and related expenses $ 7,185 $ 5,324
Gift cards, gift certificates and
store merchandise credits 3,739 1,627
Sales and other taxes payable 2,169 1,013
Other 6,431 4,002
---------- ----------
$ 19,524 $ 11,966
========== ===========
F-9
4. BANK CREDIT AGREEMENT
The Company has an unsecured bank credit agreement for $1,000,000, which is used
for issuing letters of credit. The credit agreement expires in August 2003, and
the Company expects to renew the agreement under similar terms and conditions.
The letters of credit are primarily used for inventory purchases. At February 1,
2003, the Company has $186,000 of outstanding letters of credit under the credit
agreement.
5. COMMITMENTS AND CONTINGENTCIES
LEASES
The Company has entered into lease agreements for retail and office space, and
equipment under primarily noncancelable leases with terms ranging from
approximately three to 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 on a straight-line basis 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 agreements. Total rent expense for the
years ended February 1, 2003, February 2, 2002 and February 3, 2001 was
$30,966,000, $21,784,000 and $16,093,000, respectively, including contingent
rentals of $3,670,000, $3,164,000 and $2,694,000, respectively.
The Company has leased vehicles under capital lease obligations. Cost and
accumulated depreciation of equipment under capital leases were $147,000 and
$37,000, respectively, at February 1, 2003, $264,000 and $33,000, respectively,
at February 2, 2002 and $160,000 and $53,000, respectively, at February 3, 2001.
Annual future minimum lease payments under operating and capital leases as of
February 1, 2003 are as follows (in thousands):
Operating Capital
Fiscal year Leases Leases
- ------------ ------------ ----------
2003 $ 29,739 $ 45
2004 28,745 75
2005 28,541 -
2006 27,991 -
2007 26,544 -
Thereafter 85,559 -
------------ ----------
Total minimum lease payments $ 227,119 120
============
Less amounts representing interest 5
---------
Present value of future minimum capital lease payments 115
Less amounts due in one year 23
---------
Long-term portion of obligations under capital leases $ 92
=========
LITIGATION
The Company is involved in various matters of litigation during the ordinary
course of business. Management does not believe any such matters will have a
material impact on the financial condition or results of operations of the
Company.
F-10
6. SHAREHOLDERS' EQUITY
Stock Repurchase
- ----------------
On May 8, 2002, the Company announced that its Board of Directors approved the
repurchase of up to an aggregate of 1,000,000 shares of its common stock during
the period ending January 31, 2003. As of January 31, 2003, the Company had
completed the repurchase of 1,000,000 shares of its common stock at a cost of
$19.7 million, at an average price of $19.70 per common share.
Employee Stock Purchase Plan
- ----------------------------
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 900,000 shares of common stock to employees of the Company. 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.
Equity Incentive and Stock Option Plans
- ---------------------------------------
Under the Company's 1996 Equity Incentive Plan, the Company may grant stock
options, stock bonuses, restricted stock purchase rights and stock appreciation
rights to employees, directors or consultants of the Company, as deemed
appropriate by the Board of Directors. Under the Company's 1996 Non-Employee
Directors' Stock Option Plan and together with the 1996 Equity Incentive Plan
(the "Plans"), the Company may grant stock options to non-employee directors of
the Company. The exercise price of options granted under the Plans 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 generally expire ten years from the
date of grant. An aggregate of 10,830,000 shares of common stock may be issued
pursuant to the Plans. During fiscal 2000, the Plans were amended to increase
the aggregate number of shares of common stock authorized for issuance by
2,850,000 shares. As of February 1, 2003, 1,410,925 shares were available for
future grants. No options, under the Plans, have been granted to consultants.
The Company granted 5,616 and 9,844 shares of restricted common stock in the
year ended February 1, 2003 and February 2, 2002, respectively, to non-employee
directors under the 1996 Equity Incentive Plan. The 5,616 restricted shares
issued in fiscal 2002 will vest in the year ending January 31, 2004 and the
9,844 restricted shares issued in fiscal 2001 vested in the year ended February
1, 2003. All awarded common shares will remain restricted until such time the
recipient is no longer a member of the Company's Board of Directors. The value
of these grants is expensed over the vesting period and $142,000 and $130,000
was expensed in the years ended February 1, 2003 and February 2, 2002,
respectively.
Pro forma information regarding net income and earnings per share is required by
SFAS No. 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 fiscal
2002, 2001 and 2000: weighted average risk-free interest rates of 5% for fiscal
2002 and 2001, and 6% for fiscal 2000; dividend yields of 0%; weighted average
F-11
volatility factors of the expected market price of the Company's common stock of
0.61 for fiscal 2002 and 2001, and 0.84 for fiscal 2000; and a weighted average
expected life of the options of 5 years. The weighted average fair value of
options granted during the year are $12.80, $9.21 and $7.49 per share for fiscal
2002, 2001 and 2000, respectively.
For purposes of pro forma disclosures, the estimated fair value of the options,
based on the Black-Scholes option pricing model, is amortized to expense over
the options' vesting periods. The following is the pro forma information had the
fair value method under SFAS No. 123, as amended by SFAS No. 148, been adopted
(in thousands, except per share amounts):
Years Ended
----------------------------------------------------
February 1, 2003 February 2, 2002 February 3, 2001
---------------- ---------------- ----------------
Net Income
As reported $ 34,630 $ 28,600 $ 23,245
Add: Stock-based
compensation expense
included in reported net
income, net of related tax
effects -- -- --
Deduct: Total stock-based
compensation expense
determined under fair value
method for all awards, net
of related tax effects (4,101) (3,039) (2,573)
----------- ----------- -----------
Pro forma $ 30,529 $ 25,561 $ 20,672
========== =========== ===========
Basic earnings per share:
As reported $ 1.10 $ 0.92 $ 0.78
Pro forma $ 0.97 $ 0.83 $ 0.70
Diluted earnings per share:
As reported $ 1.05 $ 0.86 $ 0.72
Pro forma $ 0.93 $ 0.77 $ 0.64
F-12
A summary of the Company's stock option activity and related information
follows:
February 1, 2003 February 2, 2002 February 3, 2001
----------------------------- ------------------------------ -----------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
----------------------------- ------------------------------ -----------------------------
Outstanding at beginning of year 3,260,845 $ 8.77 3,749,613 $ 5.02 3,979,686 $ 3.23
Granted 929,650 $22.71 1,014,675 $16.35 1,590,150 $ 7.49
Exercised (797,019) $ 6.20 (917,159) $ 4.01 (1,439,865) $ 3.31
Canceled (142,182) $16.32 (586,284) $ 5.36 (380,358) $ 2.97
----------------------------- ------------------------------ -----------------------------
Outstanding at end of year 3,251,294 $13.05 3,260,845 $ 8.77 3,749,613 $ 5.02
============================= ============================== =============================
Exercisable at end of year 1,333,369 $ 7.59 1,139,881 $ 4.96 768,020 $ 3.49
============================= ============================== =============================
Exercise prices for the 3,251,294 options outstanding as of February 1, 2003
ranged from $2.27 to $26.70. The weighted average contractual life of those
options is 7.7 years. The following table summarizes information about stock
options outstanding as of February 1, 2003:
F-13
Outstanding Options
-------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Number Exercise Contractual Number Exercise
Range of Exercise Prices Outstanding Price Life Exercisable Price
- ----------------------------------------------------------------------------------------------- ----------------------------------
$2.27 - $4.46 543,265 $ 3.23 5.4 500,927 $ 3.29
$5.58 - $9.75 852,080 $ 6.97 7.2 474,399 $ 6.81
$10.13 - $16.95 888,674 $ 14.62 8.0 336,950 $14.32
$17.87 - $26.70 967,275 $ 22.49 9.1 21,093 $19.87
----------------------------------------------------- ---------------------------------
$2.27 - $26.70 3,251,294 $ 13.05 7.7 1,333,369 $ 7.59
====================================================== ==================================
The Company recorded tax benefits associated with the exercise of non-qualified
stock options. The tax benefits increased additional paid-in capital and
decreased income taxes payable in the amounts of $5,118,000, $3,598,000 and
$3,852,000 for the years ended February 1, 2003, February 2, 2002 and February
3, 2001, respectively.
7. NET INCOME PER SHARE
The Company computes net income per share pursuant to SFAS No. 128, "Earnings
Per Share". 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 shares and
potentially dilutive common stock equivalents outstanding for the period.
Reconciliation of the numerator and denominator of basic earnings per share and
diluted earnings per share for the years ended (in thousands, except per share
amounts):
February 1, February 2, February 3,
2003 2002 2001
----------- ----------- -----------
Basic Earnings Per Share Computation:
Numerator $34,630 $28,600 $23,245
Denominator:
Weighted average common
shares outstanding 31,351 30,978 29,668
-------- -------- --------
Total shares 31,351 30,978 29,668
======== ======== ========
Basic earnings per share $ 1.10 $ 0.92 $ 0.78
======== ======== ========
Diluted Earnings Per Share Computation:
Numerator $34,630 $28,600 $23,245
Denominator:
Weighted average common
shares outstanding 31,351 30,978 29,668
Incremental shares from assumed
conversion of options 1,499 2,241 2,401
-------- -------- --------
Total shares 32,850 33,219 32,069
======== ======== ========
Diluted earnings per share $ 1.05 $ 0.86 $ 0.72
======== ======== ========
F-14
8. INCOME TAXES
Composition of the provision for income taxes for the years ended (in
thousands):
February 1, February 2, February 3,
2003 2002 2001
------------ ------------ ------------
Current:
Federal $ 18,584 $ 15,727 $ 13,093
State 2,963 2,769 1,848
--------- --------- ---------
21,547 18,496 14,941
--------- --------- ---------
Deferred:
Federal (125) (859) (1,069)
State (197) (202) (220)
--------- --------- ---------
(322) (1,061) (1,289)
--------- --------- ---------
Total income tax expense $ 21,225 $ 17,435 $ 13,652
========= ========= =========
Significant components of the Company's deferred tax assets and liabilities as
of (in thousands):
February 1, February 2,
2003 2002
------------ ------------
Current deferred tax assets (liabilities):
Accrued vacation and other $ 835 $ 459
Inventory 496 649
State taxes 1,004 739
Other liabilities (242) (430)
-------- --------
Net current deferred tax assets 2,093 1,417
------- -------
Noncurrent deferred tax assets:
Depreciation 419 202
Deferred rent 264 645
-------- --------
Total noncurrent deferred tax assets 683 847
-------- --------
Net deferred tax assets $ 2,776 $ 2,264
======== ========
Reconciliation of the provision for income taxes to the statutory tax rate for
the years ended:
February 1, February 2, February 3,
2003 2002 2001
---------- ---------- ----------
Statutory federal rate 35.0% 35.0% 35.0%
Permanent differences (0.5) (1.0) (1.3)
State and local taxes, net of federal
benefit 3.7 3.4 2.7
Other items (0.2) 0.5 0.6
---------- ---------- ----------
Effective income tax rate 38.0% 37.9% 37.0%
========== ========== ==========
F-15
9. 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 at its discretion contribute certain amounts to eligible employees'
accounts. The Company has not made any contributions to the 401(k) Plan.
F-16