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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 JANUARY 31, 2004
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. 91748
CITY OF INDUSTRY, CALIFORNIA (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (626) 839-4681
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of Registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K ___.
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in 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 1, 2003 was approximately $906,507,545 based on the
closing price on that date of the Registrant's 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. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
The number of shares outstanding of the Registrant's Common Stock was
48,229,024 as of March 31, 2004.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Registrant's Definitive Proxy Statement for the
Annual Meeting of Shareholders to be held on June 17, 2004 to be filed with the
Securities and Exchange Commission (the "SEC") no later than 120 days after
January 31, 2004, 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
THE COMPANY'S 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/pop culture-licensed and
music/pop culture-influenced apparel, accessories and gift items for young men
and women principally between the ages of 12 and 22. In fiscal 2001, 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 2003 (the fiscal year ended January 31, 2004), the Company
operated 502 Hot Topic stores in 49 states throughout the United States and
Puerto Rico and 52 Torrid stores. 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 merchandise
similar to that sold in the respective stores.
The Company opened 84 Hot Topic and 25 Torrid stores during fiscal
2003. The Company also occasionally relocates, expands, or closes existing
stores. During fiscal 2003, the Company expanded or relocated four stores. The
Company plans to open approximately 80 new Hot Topic stores and 25 Torrid stores
in the fiscal year ending January 29, 2005 ("fiscal 2004"); and 15 of these new
Hot Topic stores were open as of March 31, 2004.
THE MARKET
The music-licensed apparel industry began in the 1960s with bootleggers
selling tee shirts at concert venues. Over the ensuing two decades, artists
began to realize the commercial potential of licensing their likenesses and
logos to tee 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 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 television reached 79 million households in the
United States in 2003, according to Viacom International, Inc., MTV's parent
2.
company. 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 a rise in demand for music/pop
culture-licensed and music/pop culture-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 and other music television networks, music distribution, movies and
television programs.
Hot Topic's target customers are young men and women between the ages
of 12 and 22, who are passionate about music, music videos, pop culture trends
and music-inspired fashion. The Company believes its music/pop
culture-influenced merchandise appeals to teenagers from diverse socio-economic
backgrounds and that its customers are broadly representative of the teenage
population in the United States.
Teenagers represent both a growing part of the United States population
and an increasing source of purchasing power. The U.S. Census Bureau estimates
that the teenage population (ages 12-19) in the United States reached
approximately 33 million in 2003 and is expected to grow to approximately 34
million by 2008. By 2008, 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 $103 a week in 2003
according to Teen Research Unlimited, an increase of $25 from $78 in 1998. In
the past four years, teenage spending has grown from an estimated $155 billion a
year in 2000 to $175 billion a year in 2003.
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. Torrid's target customers are plus-size females ages 15 to
29, who are influenced by fashion trends, pop culture and music. The Company
believes the Torrid assortment allows young plus-size customers wearing sizes 12
to 26 to match the style, excitement and selection available at other
non-plus-size junior retailers.
HOT TOPIC BUSINESS STRATEGY
The Company's goal for its Hot Topic stores is to be a leading retailer
of music/pop culture-licensed and music/pop culture-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/POP CULTURE-ORIENTED MERCHANDISE
Management believes that fashions and products associated with popular
music artists and pop culture trends have a significant influence on teenagers.
The Company has developed a unique strategy focused exclusively on offering
music/pop culture-licensed and music/pop culture-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/pop
culture-influenced merchandise.
O OFFER "EVERYTHING ABOUT THE MUSIC" AND POP CULTURE
Hot Topic stores are designed to serve as a headquarters for music/pop
culture-licensed and music/pop culture-influenced apparel, accessories and gift
items. Hot Topic's slogan, "Everything About The Music" and its ability to
relate and understand the relevant pop culture trends are reflected in the broad
assortment of products. The Company believes Hot Topic's selection of music/pop
culture-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/pop culture-influenced apparel and accessories,
and frequently responds to changes in trends and demand by introducing new items
and categories. The Company believes Hot Topic has a history of being the first
to offer the latest music/pop culture fashions, which has made Hot Topic a
destination store for teenagers.
3.
O PROMOTE MUSIC-INSPIRED CULTURE
Hot Topic is committed to addressing the music-inspired 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 LISTEN TO THE CUSTOMER
Hot Topic does not dictate fashion trends, but rather seeks to identify
music artists, music and pop culture trends that can directly influence the
in-store product assortment. The Company has developed a disciplined approach to
buying and a dynamic inventory planning and allocation process to support its
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 to 90 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 merchandise
category. The Company believes 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.
O EMPHASIZE CUSTOMER SERVICE AND THE IN-STORE EXPERIENCE
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/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.
The Company also seeks to create an exciting and compelling shopping
environment 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/pop culture-inspired fashion while encouraging
customers to shop in its stores for longer periods of time.
TORRID BUSINESS STRATEGY
The Company's goal for its Torrid stores is to become a leading
specialty retailer of fashion forward plus-size young womens 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 TREND, MUSIC AND POP CULTURE-INSPIRED
Torrid's merchandising team is focused on providing a fashion forward
merchandise assortment that reflects the influence of current trends from
fashion, pop culture and music. These influences provide the inspiration for
hip, trendy apparel and accessories that the junior plus-size customer relates
to. 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.
4.
O LISTEN TO THE CUSTOMER
Torrid does not dictate fashion trends, but rather listens to customers
and watches fashion direction, music, and pop culture influences to determine
emerging trends. These trends 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.
O EMPHASIZE CUSTOMER SERVICE AND THE IN-STORE EXPERIENCE
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.
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 younger plus-size female customer. The Company believes that
the warm reception, up to the minute fashion offerings, and helpful customer
service by associates help to create a welcoming and exciting environment that
will be attractive to, and preferred by, the Torrid customer.
STORE LOCATIONS
As of January 31, 2004, the Company operated 499 Hot Topic stores in 49
states and 52 Torrid stores in 22 states in both metropolitan and middle
markets. The Company also opened three Hot Topic stores in Puerto Rico in 2003.
Between February 1, 2004 and March 31, 2004, the Company opened an additional 15
Hot Topic stores and closed one Hot Topic store (the closed store's lease
expired and was not renewed). The following chart sets forth, as of March 31,
2004, the number of Hot Topic and Torrid stores the Company operates in each
state in which those stores are located:
5.
HOT TOPIC, INC.
STORES BY STATE
-------------------------------------------------------------------------------------------------
HOT TOPIC STORES TORRID STORES TOTAL COMPANY
--------------------------------------------- --------------------------------- ---------------
OPEN AT NEW HT CLOSED HT OPEN AT OPEN AT NEW TORRID OPEN AT OPEN AT
1/31/04 FY04 TO DATE 2/29/04 3/31/04 1/31/04 FY04 TO DATE 3/31/04 3/31/04
------- ------------ ------- ------- ------- ------------ ------- -------
Alabama 2 1 3 3
Alaska 1 1 1
Arizona 13 13 2 2 15
Arkansas 2 2 2
California 61 (1) 60 18 18 78
Colorado 11 11 1 1 12
Connecticut 7 7 7
Delaware 2 2 2
Florida 31 31 1 1 32
Georgia 10 1 11 11
Hawaii 3 3 3
Idaho 1 1 2 2
Illinois 16 16 2 2 18
Indiana 12 12 1 1 13
Iowa 8 8 8
Kansas 5 5 5
Kentucky 5 5 5
Louisiana 7 7 7
Maine 2 2 2
Maryland 12 12 2 2 14
Massachusetts 12 12 1 1 13
Michigan 20 1 21 1 1 22
Minnesota 11 11 1 1 12
Mississippi 2 2 2
Missouri 11 1 12 2 2 14
Montana 3 3 3
Nebraska 2 2 1 1 3
Nevada 5 5 2 2 7
New Hampshire 4 4 4
New Jersey 15 15 2 2 17
New Mexico 5 5 1 1 6
New York 25 25 3 3 28
North Carolina 9 1 10 10
North Dakota 1 1 1
Ohio 21 1 22 1 1 23
Oklahoma 7 7 7
Oregon 6 6 2 2 8
Pennsylvania 22 22 1 1 23
Rhode Island 1 1 1
South Carolina 3 2 5 5
South Dakota 2 2 2
Tennessee 14 14 2 2 16
Texas 40 2 42 4 4 46
Utah 5 1 6 6
Vermont 2 2 2
Virginia 11 2 13 13
Washington 17 17 17
West Virginia 3 1 4 4
Wisconsin 9 9 1 1 10
TOTAL 499 15 (1) 513 52 52 565
- --------------------------------------------------------------------------------------------------------------------
# OF STATES 49 12 49 22 22 49
- --------------------------------------------------------------------------------------------------------------------
Puerto Rico 3 3 3
- --------------------------------------------------------------------------------------------------------------------
6.
EXPANSION STRATEGY
The following table provides a history of the Company's store expansion
over the last five fiscal years:
FISCAL YEAR
-----------------------------------------------
1999 2000 2001 2002 2003 2004
THROUGH
3-31-04
-----------------------------------------------
(Number of stores)
Stores at beginning of year 158 212 274 352 445 554
Hot Topic stores closed* (1) (2) (1)
New stores opened - Hot Topic 54 62 73 74 84 15
New stores opened - Torrid 6 21 25 0
-----------------------------------------------
Stores at end of year 212 274 352 445 554 568
-----------------------------------------------
-----------------------------------------------
Hot Topic stores expanded or
relocated 0 5 7 8 4 2
-----------------------------------------------
* 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.
Cupertino, CA store lease expired in first quarter of fiscal 2004
and was 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 opened 84 new Hot Topic stores
and 25 Torrid stores in fiscal 2003 as well as expanded or relocated four
existing Hot Topic stores. During fiscal 2004, the Company plans to open
approximately 80 new Hot Topic stores and 25 new Torrid stores. Additionally,
the Company plans to expand or relocate approximately ten existing stores. The
Company has identified regional malls nationwide and in Puerto Rico for
potential new stores.
The Company evaluates potential store locations based on a variety of
criteria including the sales productivity of the mall, sales of anchor stores,
sales of teenage-oriented and plus-size stores, age demographics in the trade
area, median family income and other economic factors relevant to the Company's
merchandising strategy. The Company has a real estate committee that meets
regularly to evaluate and select store 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. Hot Topic stores currently average approximately 1,700 square feet and
Torrid stores currently average approximately 2,600 square feet.
STORE-LEVEL ECONOMICS
During fiscal 2003, the Company achieved average Hot Topic store net
sales of approximately $1,132,000 and average Hot Topic store net sales per
square foot of approximately $660. There can be no assurance these results will
continue. In addition, the Company cannot guarantee that future average
store-level sales will not vary from historical results.
HOT TOPIC MERCHANDISING
Hot Topic stores are designed to serve as a headquarters for music/pop
culture-licensed and music/pop culture-influenced apparel, accessories and gift
items. Music/pop culture-licensed merchandise includes tee shirts, hats,
posters, stickers, patches, postcards, books, novelty accessories, compact discs
and albums. Music/pop culture-influenced merchandise includes woven and knit
tops, skirts, pants, shorts, jackets, shoes, costume jewelry, body jewelry,
sunglasses, cosmetics, leather accessories and gift items. Approximately half of
7.
Hot Topic's products are music/pop culture-licensed and the other half are
music/pop culture-influenced products. A key strategy of Hot Topic is to offer a
diverse product assortment in 22 different categories or "departments." On
average, over 120 different licensed band tee shirts are carried in each store
from current artists such as Good Charlotte, AFI, Dropkick Murphys, ICP and
Linkin Park as well as classic rock artists such as The Ramones, Nirvana, Bob
Marley, Rolling Stones, Metallica, The Doors and Led Zeppelin. New items and
categories are regularly tested as customer demand and product trends evolve.
During fiscal 2003, 52% of Hot Topic's net sales were generated in
apparel merchandise categories and 48% of Hot Topic's net sales were produced in
non-apparel merchandise categories (including accessories, gifts, intimate
apparel and shoes).
Hot Topic's merchandising staff consists of a General Merchandise
Manager, Divisional Merchandise Managers, and a staff of buyers and assistant
buyers sufficient to manage all product categories. The merchandising staff
reflects the Company's culture in that its decisions and actions are influenced
by music and pop culture. 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.
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 2003 Hot Topic brands
accounted for approximately 25% of the Company's sales, the same percentage as
in fiscal 2002. 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 to 90 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 theme and classification, Stock Keeping
Units (SKUs), 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 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 types of merchandise as her
smaller-sized peers. Torrid's merchandise includes novelty tee 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, LEI, Necessary Objects, Kikwear,
Macgirl, 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 with vendors, current 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.
8.
During fiscal 2003, 71% of Torrid's net sales were generated in apparel
merchandise categories and 29% of Torrid's net sales were produced in
non-apparel merchandise categories (including accessories, gifts, intimate
apparel and shoes).
The Torrid merchandising staff consists of a Divisional Merchandise
Manager and a staff of buyers and assistant buyers sufficient to manage all
product categories. 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, researching international fashion trends, attending trade shows and
other events that attract young people. Furthermore, the Company believes that
Torrid's merchandising direction is influenced by emerging fashion trends in the
junior market, pop culture and music. 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.
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.
PLANNING AND ALLOCATION OF MERCHANDISE
Planning and allocation 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 JDA's Advanced
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 headquarters and distribution facility located in the
City of Industry, California is approximately 250,000 square feet. 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 and
its internet customers. 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. No single vendor accounted for more than 5% of
the Company's merchandise purchases during fiscal 2003.
The Company is currently evaluating the distribution center space
needed to support its planned growth. Among other things, the Company may
determine to expand its distribution operations to an additional distribution
center facility.
HOT TOPIC/TORRID STORE OPERATIONS
The Company's store operations organizations are both managed by a Vice
President of Store Operations, regional directors and district managers. On
average, each district manager supervises approximately five to eight stores. A
store manager and two or three assistant managers manage individual stores. In
addition to managers and assistant managers, a typical store has approximately
six to ten part-time sales associates, depending on the season. The hiring and
training of new 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.
9.
The Company strives to create a store environment that customers will
consider "their place" to shop with friends. The Company seeks to hire sales
associates who fit the profile of its target customer - energetic people who are
knowledgeable and passionate about music and pop culture-inspired fashion. To
consider the preferences and opinions of its target customers, selected store
associates, from time to time, accompany buyers on buying trips. Further, in
return for feedback on fashion and other trends, store 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
the Company's management. Management believes that the Company's 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. Associates are
trained to greet each customer, to inform the customer about new music and
fashion trends and to suggest merchandise that matches the customer's lifestyle,
music and fashion preferences. The Company believes that its high level of
associate product knowledge and customer service differentiates it from other
specialty retailers.
District managers, along with all members of the store teams, have a
base compensation rate and may qualify to receive a quarterly bonus primarily
based on store sales 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.
MARKETING, PROMOTION AND INTERNET
The Company generally locates its stores in high traffic malls within
areas of high teenage and young adult population and relies on existing
customers, sales associates, store design and exciting music to attract new
customers to its stores. During fiscal 2003, 2002 and 2001 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 2004.
The Company continues to operate its websites, which offer merchandise,
tour dates, contests, job postings, store locations and community features such
as band reviews and advice columns. The Company's net sales from Internet
operations rose by 80% in fiscal 2003 compared to fiscal 2002 and contributed
approximately 2.6% of total sales in fiscal 2003.
INFORMATION TECHNOLOGY
The Company's information systems provide integration of store,
merchandising, distribution, financial, and human resources. Software licensed
from GERS Retail Systems is used for SKU and classification inventory tracking,
purchase order management, open-to-buy, merchandise distribution, automated
ticket making, and sales audit. The Company's financial systems are licensed
from Lawson Software and are used for general ledger, accounts payable, and
asset management as integrated financials. 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.
10.
The Company's Wide Area Network ("WAN") is used to connect all Company
locations with real-time e-mail and several Intranet applications to improve
operating efficiency. In addition, this technology has improved operating
efficiency in such areas as credit card authorization, store-to-store transfer,
product lookup, product location and several other applications to eliminate
paper distribution and paperwork.
The Company has invested approximately $5 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. In
addition, the Company is investing approximately $6 million in the
implementation of a new warehouse management software system, a new Internet
order management software system, and a new customer loyalty software system.
These investments will help support the Company's 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
Flaming Heart Design(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 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., Forever 21, 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. Some 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, connection to the music industry, 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 Delia's Corp. 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.
11.
EMPLOYEES
The Company employed approximately 1,740 full-time and 5,020 part-time
employees, which the Company refers to as associates, as of March 31, 2004. Of
the Company's 6,760 associates, approximately 515 were headquarters and
distribution center personnel and the remainder are field management and 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 March 31, 2004 are as follows:
NAME AGE POSITION
- -------------------- ----- -----------------------------------------------------
Elizabeth McLaughlin 43 Chief Executive Officer and Director
Gerald Cook 51 President, Hot Topic
Patricia Van Cleave 56 President, Torrid
James McGinty 41 Chief Financial Officer and Secretary
Jane Cruz 44 Senior Vice President, Human Resources
Cindy Boden 49 Vice President, Torrid Store Operations
Tricia Higgins 36 Vice President, Internet
John Horwath 44 Vice President, Information Technology
Darrell Kinsley 41 Vice President, Hot Topic Store Operations
Alain Krakirian 38 Vice President, Planning and Allocation
Cindy Levitt 43 Vice President, Hot Topic General Merchandise Manager
Sue McPherson-Spissu 36 Vice President, Distribution Center and E-Commerce
John Neppl 47 Vice President, Real Estate and Construction
George Wehlitz, Jr. 43 Vice President, Finance
ELIZABETH MCLAUGHLIN has served as Chief Executive Officer of the
Company since August 2000, and has served on the Board of Directors since May
2000. She also served as President of the Company from August 2000 through
September 2003. 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.
12.
GERALD COOK has been President, Hot Topic since September 2003. Prior
to September 2003, he had 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 President, Torrid since September 2003.
Prior to September 2003, she had 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 has 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. 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. degree in Economics from the University of San Francisco and an M.B.A. from
the University of California, Berkeley.
CINDY BODEN has been Vice President, Torrid Store Operations since
October 2003. Prior to October 2003, Ms. Boden held Regional Director positions
with Hot Topic both in the Northeast and the Midwest regions. From 1993 to 1997,
Ms. Boden was a Regional Manager for County Seat stores. From 1990 to 1992, she
held the position of Regional Manager for Millers Outpost stores. Prior to
Millers Outpost, she was a District Manager for Brookstone for five years. Ms.
Boden holds a B.S. degree in Textiles and Clothing with a minor in Business
Administration from the University of Minnesota at Mankato.
TRICIA HIGGINS has been Vice President, Internet since February 2004.
Prior to February 2004, she was the Company's Director, Internet since June
2002. Prior to joining the Company, she was Director, Contact Center Operations
for Cooking.com. From 1997 to August 2000, Ms. Higgins was Director, Retail
Operations for the Williams-Sonoma, Pottery Barn and Hold Everything divisions
of Williams-Sonoma, Inc. From 1994 to July 1997, she held various positions with
The Disney Stores, Inc. in Retail Operations and New Business Development. Ms.
Higgins holds a B.A. degree in Psychology from Indiana University.
JOHN HORWATH has been the Company's Vice President, Information
Technology since June 2001. 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
13.
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.
DARRELL KINSLEY has been Vice President, Hot Topic Store Operations
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 and was responsible for the expansion into the
East Coast. Mr. Kinsley holds a business management leadership certificate from
the Anderson School of Business at the University of California, Los Angeles.
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.
CINDY LEVITT has been Vice President, Hot Topic General Merchandise
Manager 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. Ms. Levitt holds
a degree in Fashion Merchandising from Orange Coast College.
SUE MCPHERSON-SPISSU was promoted to the Company's Vice President,
Distribution Center and E-Commerce 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 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. degree in Accounting from Villanova University.
GEORGE WEHLITZ, JR. has been the Company's Vice President, Finance
since August 2003. He joined the Company 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.
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.
14.
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. The Company
also makes available its Standards of Business Ethics at
www.corporatewindow.com/fl/hott/frame.html.
15.
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. Of the Company's 554
stores opened as of January 31, 2004, 109 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 105 stores, consisting of 80 Hot Topic and 25 Torrid stores,
during fiscal 2004, which will result in a significant increase in the number of
stores operated by the Company; 15 of these Hot Topic stores have opened as of
March 31, 2004. 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;
integrate new stores into its existing operations; and obtain adequate
distribution center space. The Company is currently evaluating the distribution
center space needed to support its planned growth. Among other things, the
Company may determine to expand its distribution operations to an additional
distribution center facility. 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 and fashion driven concept, including risks of difficulty in
merchandising, uncertainty of customer acceptance, fluctuations in fashion
trends and customer tastes, extreme competition with a less differentiated
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.
16.
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 and 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/pop
culture-related products; music and fashion trends; the general retail sales
environment and the effect of the 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 2000, 2001,
2002 and 2003 were 16.7%, 3.9%, 5.0% and 7.4%, respectively. The Company's
comparable store sales results were 2.6%, 5.2%, 10.8%, and 8.5% for the first,
second, third and fourth quarters, respectively, of fiscal 2003 and (0.5%),
0.6%, 6.3% and 9.7% for the first, second, third and fourth quarters,
respectively, of fiscal 2002. 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. Changes in 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, the 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/pop culture-related products; the continuance of a significant level of
teenage spending on music/pop culture-licensed and music/pop culture-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, trends 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
tenants and other attractions to generate customer traffic, and the development
of new malls. A slowdown in the United States economy as well as an 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.
17.
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 its
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/pop culture-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/pop culture-related merchandise in sufficient quantities at
competitive prices. Although the Company has many sources of merchandise,
substantially all of the Company's music/pop culture-licensed products are
available only from vendors that have exclusive license rights. In addition,
many of the Company's music/pop culture-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, 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; 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.
18.
UNCERTAINTIES REGARDING IMPLEMENTATION OF NEW INFORMATION SYSTEMS AND
SOFTWARE
Over the past several years, the Company has made improvements to
existing hardware and software systems, as well as implemented new systems. For
example, the Company has invested approximately $5 million to enhance the
functionality of its current GERS Retail Systems software and to implement new
financial system software from Lawson. In addition, the Company is investing
approximately $6 million in the implementation of a new warehouse management
software system, a new Internet order management software system, and a new
customer loyalty software system. 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, 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.
COMPETITION
The retail apparel and accessory industry is highly competitive. The
Company competes with other retailers for vendors, teenage and young adult
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
19.
(Millers Outpost), Charlotte Russe Inc., Claire's Stores, Inc., Forever 21, 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, Delia's Corp., 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. Some 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, a few years ago, California 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.
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.
20.
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 its existing store locations, with lease
terms expiring between 2004 and 2014. At January 31, 2004, the Company had a
total of 998,628 leased store square feet (Hot Topic and Torrid stores) with an
average store size of 1,788 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.
The Company leases its headquarters and distribution center facility,
located in City of Industry, California. Construction to expand the Company's
headquarters and distribution center facility was completed during the second
quarter of fiscal 2002. The Company's lease expires April 2004 and the Company
is negotiating a long-term lease extension, effective May 2004. The annual base
rent for the lease extension is approximately $1,110,000. The Company believes
the property covered by the lease extension will allow for growth of up to 700
stores. The Company is currently evaluating the distribution center space needed
to support its planned growth. Among other things, the Company may determine to
expand its distribution operations to an additional distribution center
facility.
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.
21.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
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
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.
2003 FISCAL YEAR QUARTERS HIGH LOW
-------------------------------------------------------------
First Quarter $16.35 $14.01
Second Quarter $19.67 $15.69
Third Quarter $29.25 $18.33
Fourth Quarter $31.85 $26.60
2002 FISCAL YEAR QUARTERS HIGH LOW
-------------------------------------------------------------
First Quarter $16.09 $13.22
Second Quarter $18.63 $10.18
Third Quarter $15.17 $9.91
Fourth Quarter $16.67 $13.93
On August 12, 2003, the Company announced that its Board of Directors
approved a three-for-two stock split (in the form of a dividend) of its common
stock. On the effective date of September 2, 2003, shareholders received a
dividend of one additional share for every two shares they owned at the close of
business on the record date of August 21, 2003. The prices listed in the above
table have been adjusted for the split.
On March 31, 2004, the last sales price of the Common Stock as reported
on the Nasdaq National Market was $26.45 per share. As of March 31, 2004, 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 24,000 holders.
On March 19, 2004, the Company announced that its Board of Directors
approved the repurchase of up to an aggregate of 2,000,000 shares of its Common
Stock during the period ending January 28, 2005.
The Company has not paid any cash dividends since inception and does
not anticipate paying any cash dividends in the foreseeable future.
Please see Item 12 for information about the Company's equity
compensation plans.
22.
ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes selected financial data for each of the
five fiscal years in the period ended January 31, 2004. This 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.
Fiscal Year
---------------------------------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
(In thousands, except per share data, number of
stores, comparable store sales and sales per
square foot)
Statement of Operations Data:
Net sales $572,039 $443,250 $336,094 $257,187 $168,949
Cost of goods sold, including buying,
distribution and occupancy costs 351,542 273,132 204,993 154,298 103,998
--------- --------- --------- --------- ---------
Gross margin 220,497 170,118 131,101 102,889 64,951
Selling, general and administrative expenses 143,952 115,634 86,950 67,917 44,749
--------- --------- --------- --------- ---------
Operating income 76,545 54,484 44,151 34,972 20,202
Interest income, net 1,318 1,371 1,884 1,925 933
--------- --------- --------- --------- ---------
Income before income taxes 77,863 55,855 46,035 36,897 21,135
Provision for income taxes 29,821 21,225 17,435 13,652 7,634
--------- --------- --------- --------- ---------
Net income $ 48,042 $ 34,630 $ 28,600 $ 23,245 $ 13,501
========= ========= ========= ========= =========
Net income per share:
Basic $ 1.01 $ 0.74 $ 0.62 $ 0.52 $ 0.32
Diluted $ 0.97 $ 0.70 $ 0.57 $ 0.48 $ 0.31
Weighted average shares outstanding:
Basic 47,479 47,027 46,467 44,502 41,701
Diluted 49,588 49,276 49,829 48,104 44,088
Selected Operating Data:
Number of stores at year end 554 445 352 274 212
Comparable stores sales 7.4% 5.0% 3.9% 16.7% 22.8%
Average sales per square foot $ 619 $ 619 $ 636 $ 669 $ 623
Average sales per store $ 1,106 $ 1,064 $ 1,036 $ 1,020 $ 909
Balance Sheet Data:
Cash and short-term investments $128,205 $ 83,418 $ 71,310 $ 51,288 $ 39,550
Working capital 141,839 90,287 82,370 61,253 37,564
Total assets 281,592 204,786 162,662 118,646 89,022
Long-term obligations including current portion -- 115 218 123 231
Shareholders' equity $223,905 $160,929 $135,368 $ 99,291 $ 67,278
23.
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/pop culture-licensed
and music/pop culture-influenced apparel, accessories and gift items for young
men and women principally between the ages of 12 and 22. In fiscal 2001, 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 2003, the Company operated 502 Hot
Topic stores and 52 Torrid stores in 49 states throughout the United States and
Puerto Rico 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 2003, 401
of the 502 Hot Topic stores were included in the comparable store base, compared
to 321 of the 418 stores open at the end of fiscal 2002. At the end of fiscal
2003, 22 of the 52 Torrid stores were included in the comparable store base,
compared to 6 of the 27 stores open at the end of fiscal 2002.
The Company operates on a 52 or 53-week fiscal year, which ends on the
Saturday nearest to January 31. Fiscal 2003, 2002 and 2001 were 52-week fiscal
years.
24.
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
---------------------------
2003 2002 2001
------ ------ ------
Net sales 100.0% 100.0% 100.0%
Cost of goods sold, including buying,
distribution & occupancy costs 61.5% 61.6% 61.0%
------ ------ ------
Gross margin 38.5% 38.4% 39.0%
Selling, general and administrative expenses 25.1% 26.1% 25.9%
------ ------ ------
Operating income 13.4% 12.3% 13.1%
Interest income, net 0.2% 0.3% 0.6%
------ ------ ------
Income before income tax 13.6% 12.6% 13.7%
Provision for income taxes 5.2% 4.8% 5.2%
------ ------ ------
Net income 8.4% 7.8% 8.5%
====== ====== ======
Number of stores at year end 554 445 352
Comparable store sales 7.4% 5.0% 3.9%
FISCAL 2003 COMPARED TO FISCAL 2002
Net sales increased approximately $128.7 million, or 29.1%, to $572.0
million in fiscal 2003 from $443.3 million in fiscal 2002. Net sales for the 84
Hot Topic stores opened during fiscal 2003 and for the other Hot Topic stores
not yet qualifying as comparable stores contributed $71.5 million of the net
sales increase. Comparable store sales for the Company increased 7.4% in fiscal
2003 and contributed $29.1 million of the increase in net sales. Net sales for
the 25 new Torrid stores and for the other Torrid stores not yet qualifying as
comparable stores operating during fiscal 2003 contributed $20.3 million of the
net sales increase. Hottopic.com and torrid.com sales were approximately 2.6% of
total Company sales in fiscal 2003 and contributed $7.9 million (including
shipping and handling income) of the net sales increase.
The annual average Hot Topic store volume increased to $1.13 million in
fiscal 2003 from $1.07 million in fiscal 2002. Hot Topic sales of apparel
category merchandise, as a percentage of total net sales, were 52% in fiscal
2003 compared to 51% in fiscal 2002. The increase in apparel was primarily due
to increases in men's novelty tee shirts and men's music-related tee shirts
partially offset by decreases in women's apparel (women's bottoms and novelty
tees), men's fashion tops and men's bottoms. The sales mix for Hot Topic in
fiscal 2003 saw a decrease in sales of non-apparel merchandise (including
accessories, gifts, intimate apparel and shoes) to 48% from 49% in fiscal 2002.
Gross margin increased approximately $50.4 million to $220.5 million in
fiscal 2003 from $170.1 million in fiscal 2002. As a percentage of net sales,
gross margin increased to 38.5% in fiscal 2003 from 38.4% in fiscal 2002. The
0.1% improvement in gross margin, as a percentage of net sales, was primarily
due to a 0.4% decrease in distribution expenses and a 0.1% decrease in
depreciation and store occupancy, offset by a 0.4% reduction in merchandise
margin. The decrease in distribution expenses of 0.4% in fiscal 2003 resulted
from significant savings in freight costs, due to change in shipping method to
stores, and labor costs, due to productivity improvements. Store depreciation
decreased 0.2% in fiscal 2003 as compared to fiscal 2002 as a result of leverage
gained from higher comparable store sales. This decrease in depreciation was
partially offset by a 0.1% increase in store occupancy resulting from higher
rent expenses and common area charges. 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 2003 compared to fiscal 2002 principally from lower initial markup and
higher shrinkage partially offset by lower markdowns.
25.
Selling, general and administrative expenses increased approximately
$28.4 million to $144.0 million during fiscal 2003 from $115.6 million during
fiscal 2002. As a percentage of net sales, selling, general and administrative
expenses were 25.1% for fiscal 2003 compared to 26.1% in fiscal 2002. The total
dollar increase in selling, general and administrative expenses was primarily
attributable to an increase in the number of retail stores from 445 at the end
of fiscal 2002 to 554 at the end of fiscal 2003 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 the
decreases in total store payroll and administrative salary expense of 1.2%
resulting from leverage gained from higher comparable store sales and
controlling payroll costs, and a decrease in pre-opening expenses of 0.1%,
offset by an increase in administrative performance based payroll expenses of
0.4%.
Operating income increased approximately $22.0 million to $76.5 million
during fiscal 2003 from $54.5 million during fiscal 2002. As a percentage of net
sales, operating income was 13.4% in fiscal 2003 compared to 12.3% in fiscal
2002. Operating income on an average store basis was approximately $152,000 in
fiscal 2003 as compared to $133,000 in fiscal 2002.
Net interest income decreased to $1.3 million in fiscal 2003 from $1.4
million in fiscal 2002, 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 38.3% in fiscal 2003 and 38.0% in
fiscal 2002. The higher rate for fiscal 2003 is principally attributable to
lower tax-exempt interest income as a percentage of pre-tax income in fiscal
2003 as compared to fiscal 2002.
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 tee 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 non-apparel
merchandise (including accessories, gifts, intimate apparel and shoes) to 49%
from 47% in fiscal 2001 which resulted from 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
26.
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 of 0.3%, costs associated with implementing a wide area network of
0.2%, and an increase in store performance based payroll of 0.1%, partially
offset by the leveraging of headquarters expenses of 0.4%
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.
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.
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/pop culture-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.
27.
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.
(In thousands, except selected
operating and per share data) FISCAL YEAR 2003 FISCAL YEAR 2002
--------------------------------------------- ----------------------------------------------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
--------- --------- --------- --------- --------- --------- --------- ---------
STATEMENT OF OPERATIONS DATA:
Net sales $100,657 $115,728 $161,546 $194,108 $ 79,909 $ 92,473 $122,590 $148,278
Gross margin 35,614 41,641 63,033 80,209 28,457 32,792 46,760 62,109
Operating income 6,755 9,334 24,417 36,039 5,530 6,658 15,908 26,388
Net income $ 4,410 $ 5,890 $ 15,271 $ 22,471 $ 3,683 $ 4,344 $ 10,048 $ 16,555
Net income per share:
Basic $ 0.09 $ 0.12 $ 0.32 $ 0.47 $ 0.08 $ 0.09 $ 0.22 $ 0.35
Diluted $ 0.09 $ 0.12 $ 0.31 $ 0.45 $ 0.07 $ 0.09 $ 0.21 $ 0.34
Weighted average shares outstanding:
Basic 46,968 47,360 47,656 47,932 47,210 47,568 46,691 46,639
Diluted 48,567 49,127 49,917 50,342 49,973 50,240 48,390 48,501
SELECTED OPERATING DATA:
Comparable stores sales 2.6% 5.2% 10.8% 8.5% (0.5)% 0.6% 6.3% 9.7%
Stores open at end of period 468 497 540 554 379 415 437 445
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 $5.0 million unsecured credit agreement for
the purpose of issuing letters of credit. At January 31, 2004, the Company had
$0.1 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 2003, the Company had $128.2 million in cash, cash equivalents and
short-term investments, an increase of $44.8 million, or 54%, compared to the
$83.4 million at the end of fiscal 2002. Working capital was $141.8 million,
$90.3 million and $82.4 million for fiscal 2003, 2002 and 2001, respectively.
The increase in working capital for each of these fiscal years was primarily
attributable to cash provided by net income.
28.
Net cash flows provided by operating activities were $72.3 million,
$60.3 million, and $42.4 million in fiscal 2003, 2002 and 2001, respectively.
The $12.0 million increase in cash flows from operating activities in fiscal
2003 as compared to fiscal 2002 was primarily attributable to the increases in
net income, deferred taxes and depreciation and amortization, offset in part by
an increase in inventory and a decrease in accounts payable and income taxes
payable. The significant changes in net cash provided by operating activities
were due primarily to the Company's increase in store growth to 554 stores at
the end of fiscal 2003 compared to 445 stores at the end of fiscal 2002.
Net cash flows used in investing activities were $81.9 million, $37.1
million and $43.0 million in fiscal 2003, 2002 and 2001, respectively. In fiscal
2003, approximately $23.4 million was used for the construction of 84 Hot Topic
stores, 25 Torrid stores, expansion and refurbishment of four Hot Topic stores
and progress payments for construction of stores opening in early fiscal 2004.
The Company used approximately $11.2 million on computer hardware and software
and $1.1 million on its headquarters and distribution center infrastructure. The
Company opened 109, 95, and 79 stores in fiscal 2003, 2002 and 2001,
respectively. The increase in net cash used in investing activities was also due
to a net increase ($43.0 million) in purchases of short-term investments.
Net cash flows provided by financing activities were $8.3 million in
fiscal 2003 compared to net cash flows used in financing activities of $14.3
million and net cash flows provided by financing activities of $3.7 million in
fiscal 2002 and 2001, respectively. The $22.7 million increase in fiscal 2003
compared to fiscal 2002 was principally a result of a $3.0 million increase from
proceeds received from the exercise of stock options and employee stock
purchases, and $19.7 million of cash was used to repurchase Company common stock
in fiscal 2002.
The Company anticipates that it will spend approximately $42 million on
capital expenditures in fiscal 2004, including approximately $27 million for
stores, $11 million for computer hardware and software and $4 million on its
headquarters and distribution center infrastructure. The $27 million for stores
is to be primarily used for the construction of 80 Hot Topic stores and 25
Torrid stores, expansion of approximately 10 existing stores and progress
payments for early fiscal 2005 new store openings.
During fiscal 2003, the Company's average capital expenditures for a
new Hot Topic store, including leasehold improvements and furniture and
fixtures, totaled approximately $169,000, net of landlord allowances. The
average initial gross inventory for the new Hot Topic stores opened in 2003 was
approximately $120,000 (which was partially financed by trade credit) and the
average pre-opening costs for a new Hot Topic store was approximately $18,000.
Initial inventory requirements vary at new stores depending on the season and
current merchandise trends. The Company expects the average total cost per
square foot associated with opening a Hot Topic store to be approximately the
same in fiscal 2004 as those in fiscal 2003. Hot Topic stores are planned to be
approximately 1,700 square feet compared to Torrid stores which are planned to
be approximately 2,400 square feet. The costs associated with opening a new
Torrid store will be higher than a Hot Topic store due to the larger size of the
Torrid stores. The actual costs that the Company will incur in connection with
opening future stores cannot be predicted with precision because such costs will
vary based upon, among other things, geographic location, store size, and the
extent of the build-out required at the selected sites.
The following table summarizes the Company's contractual obligations as
of January 31, 2004, and the timing and effect that such commitments are
expected to have on the Company's liquidity and capital requirements in future
periods:
29.
PAYMENTS DUE BY PERIOD ($ IN THOUSANDS)
----------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS TOTAL WITHIN 1 YEAR 2-3 YEARS 4-5 YEARS MORE THAN 5 YEARS
------------ ------------ ------------ ------------ --------------
OPERATING LEASES $ 276,249 $ 36,548 $ 72,040 $ 67,045 $ 100,616
PURCHASE OBLIGATIONS 50,310 50,310 -- -- --
LETTERS OF CREDIT AND OTHER OBLIGATIONS 688 688 -- -- --
------------ ------------ ------------ ------------ --------------
TOTAL CONTRACTUAL OBLIGATIONS $ 327,247 $ 87,546 $ 72,040 $ 67,045 $ 100,616
============ ============ ============ ============ ==============
See Note 5 to the Company's consolidated financial statements for
additional disclosure related to operating lease obligations.
On May 8, 2002, the Company announced that its Board of Directors
approved the repurchase of up to an aggregate of 1,500,000 shares of its Common
Stock during the period ending January 31, 2003. As of January 31, 2003, the
Company had completed the repurchase of 1,500,000 shares of its Common Stock at
a cost of $19.7 million, at an average price of $13.13 per common share. On
March 19, 2004, the Company announced that its Board of Directors approved the
repurchase of up to an aggregate of 2,000,000 shares of its Common Stock during
the period ending January 28, 2005.
The Company believes that its existing cash balances and cash generated
from operations will be sufficient to fund its operations, planned expansion and
repurchase of Company Common Stock through at least the next 12 months.
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
typically 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 are used. Consideration is given to a number of quantitative
factors, including anticipated subsequent permanent markdowns and aging of
inventories. To the extent the Company's estimated markdowns at year-end prove
to be insufficient, additional future markdowns will need to be recorded.
30.
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 management. The Company has not historically had an impairment of
a long-lived asset. In the event future store performance is lower than
forecasted results, future cash flows may be lower than expected which could
result in future impairment charges. While the Company believes recently opened
stores will provide sufficient cash flow, material changes in results could
result in future impairment charges.
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. As the reserve for merchandise returns
is based on estimates the actual returns could differ from the reserve, which
could impact sales. Revenue from gift cards, gift certificates and store
merchandise credits is recognized at the time of redemption.
SELF-INSURANCE: The Company is self-insured for medical insurance
coverage and workers compensation insurance coverage. Both programs have maximum
exposure limits. The Company maintains a liability for estimated claims based on
historical claims experience and other actuarial assumptions.
INFLATION
The Company does not believe that inflation has had a material adverse
effect on its net sales or results of operations. The Company has generally been
able to pass on increased costs related to inflation through increases in
selling prices.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company 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 the Company
considers 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.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Based on their evaluation of the Company's disclosure controls and
procedures conducted prior to 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 as of the end of the
period covered by this report.
31.
(b) Changes in Internal Control Over Financial Reporting
There were no changes in the Company's internal control over financial
reporting that occurred during the Company's fourth fiscal quarter that
have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting.
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 January 31, 2004 pursuant to
Regulation 14A in connection with the solicitation of proxies for the Company's
Annual Meeting of Shareholders to be held on June 17, 2004 (the "2004 Proxy
Statement").
Certain other information required by this item is incorporated by
reference to the information appearing under the captions "Section 16(a)
Beneficial Ownership Reporting Compliance" and "Standards of Business Ethics" in
the 2004 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 2004
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 2004 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 2004
Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference to the
information appearing under the caption "Ratification of Selection of
Independent Auditors" in the 2004 Proxy Statement.
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:
32.
PAGE
Report of Ernst & Young LLP, Independent Auditors.................... F-1
Consolidated Balance Sheets as of January 31, 2004 and
February 1, 2003............................................... F-2
Consolidated Statements of Income for the years ended January
31, 2004, February 1, 2003 and February 2, 2002................ F-3
Consolidated Statements of Shareholders' Equity for the years ended
January 31, 2004, February 1, 2003 and February 2, 2002........ F-4
Consolidated Statements of Cash Flows for the years ended January
31, 2004, February 1, 2003 and February 2, 2002................ 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
On November 5, 2003, the Company filed a report on Form 8-K furnishing,
under Item 12, information related to its sales for the third quarter of fiscal
2003 (quarter ended November 1, 2003). On November 19, 2003, the Company filed a
report on Form 8-K furnishing, under Item 12, information related to its results
for the third quarter of fiscal 2003.
(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)
10.7a 401(k) Defined Contribution Plan of Registrant, effective
as of August 1, 1995. (1)
33.
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------ -----------------------
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 1,905 shares, and
with each of Bruce Quinnell, Edgar Berner, Andrew Schuon
and Corrado Federico for 1,587 shares) and as of September
24, 2001 (with Cynthia Cohen for 1,178 shares and vesting
from September 24, 2001) and as of January 28, 2002 (with
W. Scott Hedrick for 618 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. (6)
10.15a Employment Letter dated January 23, 2003, between the
Registrant and James McGinty. (6)
23.1 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney is contained on the signature page.
31.1 Certification, dated April 5, 2004, of Registrant's Chief
Executive Officer required by Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification, dated April 5, 2004, of Registrant's Chief
Financial Officer required by Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certifications, dated April 5, 2004, of Registrant's Chief
Executive Officer and Chief Financial Officer required by
Section 906 of the Sarbanes-Oxley Act of 2002.
____________
(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.
34.
(6) Filed as an exhibit to Registrant's Annual Report on Form 10-K for the
year ended February 1, 2003 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).
35.
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 and Director
April 5, 2004
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 and Director April 5, 2004
------------------------ (PRINCIPAL EXECUTIVE OFFICER)
Elizabeth McLaughlin
/s/ JAMES MCGINTY Chief Financial Officer (PRINCIPAL April 5, 2004
------------------------ FINANCIAL OFFICER)
James McGinty
/s/ GEORGE WEHLITZ, JR. Vice President, Finance (PRINCIPAL April 5, 2004
------------------------ ACCOUNTING OFFICER)
George Wehlitz, Jr.
/s/ BRUCE QUINNELL Chairman of the Board April 5, 2004
------------------------
Bruce Quinnell
/s/ EDGAR BERNER Director April 5, 2004
------------------------
Edgar Berner
/s/ CORRADO FEDERICO Director April 5, 2004
------------------------
Corrado Federico
/s/ ANDREW SCHUON Director April 5, 2004
------------------------
Andrew Schuon
/s/ CYNTHIA COHEN Director April 5, 2004
------------------------
Cynthia Cohen
/s/ W. SCOTT HEDRICK Director April 5, 2004
------------------------
W. Scott Hedrick
36.
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 January 31, 2004 and February 1, 2003, and the
related consolidated statements of income, shareholders' equity, and cash flows
for each of the three years in the period ended January 31, 2004. These
consolidated 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 financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Hot Topic, Inc.
and its subsidiaries at January 31, 2004 and February 1, 2003, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended January 31, 2004 in conformity with accounting
principles generally accepted in the United States.
/s/ Ernst & Young LLP
Los Angeles, California
February 27, 2004
F-1
Hot Topic, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share amounts)
JANUARY 31, FEBRUARY 1,
2004 2003
---------- ----------
Assets
Current assets:
Cash and cash equivalents $ 11,886 $ 13,139
Short-term investments 116,319 70,279
Inventory 51,937 38,409
Prepaid expenses and other 10,654 7,866
Deferred tax assets 2,259 2,093
---------- ----------
Total current assets 193,055 131,786
Leaseholds, fixtures and equipment, net 88,348 72,146
Deposits and other 189 171
Deferred tax assets -- 683
---------- ----------
Total assets $ 281,592 $ 204,786
========== ==========
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 15,841 $ 15,407
Accrued liabilities 28,133 19,639
Income taxes payable 7,242 6,453
---------- ----------
Total current liabilities 51,216 41,499
Deferred rent 3,155 2,358
Deferred tax liability 3,316 --
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; 48,120,989 and 46,805,980 shares
issued and outstanding at January 31, 2004 and
February 1, 2003, respectively 62,972 47,837
Retained earnings 161,134 113,092
Accumulated other comprehensive loss (201) --
---------- ----------
Total shareholders' equity 223,905 160,929
---------- ----------
Total liabilities and shareholders' equity $ 281,592 $ 204,786
========== ==========
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
------------------------------------
January 31, February 1, February 2,
2004 2003 2002
---------- ---------- ----------
Net sales $ 572,039 $ 443,250 $ 336,094
Cost of goods sold, including buying,
distribution and occupancy costs 351,542 273,132 204,993
---------- ---------- ----------
Gross margin 220,497 170,118 131,101
Selling, general and administrative expenses 143,952 115,634 86,950
---------- ---------- ----------
Operating income 76,545 54,484 44,151
Interest income (1,358) (1,390) (1,912)
Interest expense 40 19 28
---------- ---------- ----------
Income before income taxes 77,863 55,855 46,035
Provision for income taxes 29,821 21,225 17,435
---------- ---------- ----------
Net income $ 48,042 $ 34,630 $ 28,600
========== ========== ==========
Net income per share:
Basic $ 1.01 $ 0.74 $ 0.62
========== ========== ==========
Diluted $ 0.97 $ 0.70 $ 0.57
========== ========== ==========
Shares used in computing net income per share:
Basic 47,479 47,027 46,467
Diluted 49,588 49,276 49,829
See notes to consolidated financial statements.
F-3
Hot Topic, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity
(In thousands)
Accumulated
Common Shares Other Total
----------------------- Retained Comprehensive Shareholders'
Shares Amount Earnings Income (Loss) Equity
---------- ---------- ---------- ---------- ----------
BALANCE AT FEBRUARY 3, 2001 45,662 $ 49,429 $ 49,862 $ -- $ 99,291
Exercise of stock options 1,376 3,680 -- -- 3,680
Employee stock purchase plan 25 205 -- -- 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 47,063 56,906 78,462 -- 135,368
Exercise of stock options 1,195 4,942 -- -- 4,942
Employee stock purchase plan 33 418 -- -- 418
Restricted stock awards 15 153 -- -- 153
Repurchase of common stock (1,500) (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 46,806 47,837 113,092 -- 160,929
Exercise of stock options 1,261 7,696 -- -- 7,696
Employee stock purchase plan 46 666 -- -- 666
Restricted stock awards 8 180 -- -- 180
Fractional shares purchased in 3-for-2 stock split -- (23) -- -- (23)
Tax benefit from exercise of stock options -- 6,616 -- -- 6,616
Comprehensive income:
Net income -- -- 48,042 -- 48,042
Unrealized loss on marketable securities, net -- -- -- (201) (201)
----------
Total comprehensive income 47,841
---------- ---------- ---------- ---------- ----------
BALANCE AT JANUARY 31, 2004 48,121 $ 62,972 $ 161,134 $ (201) $ 223,905
========== ========== ========== ========== ==========
See notes to consolidated financial statements.
F-4
Hot Topic, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
Years Ended
-------------------------------------
January 31, February 1, February 2,
2004 2003 2002
--------- --------- ---------
OPERATING ACTIVITIES
Net income $ 48,042 $ 34,630 $ 28,600
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 18,793 15,309 11,082
Tax benefit from exercise of stock options 6,616 5,118 3,598
Stock-based compensation 155 142 130
Deferred rent 797 597 358
Deferred taxes 4,075 (322) (1,061)
Loss on disposal of fixed assets 656 278 401
Changes in operating assets and liabilities:
Inventory (13,528) (8,856) (8,217)
Prepaid expenses and other current assets (2,787) (2,431) 118
Deposits and other assets (18) 3 (73)
Accounts payable 434 4,155 4,620
Accrued liabilities 8,519 7,528 741
Income taxes payable 548 4,166 2,096
--------- --------- ---------
Net cash provided by operating activities 72,302 60,317 42,393
INVESTING ACTIVITIES
Purchases of property and equipment (35,654) (33,879) (26,119)
Proceeds from sale of short-term investments 52,906 46,105 16,476
Net purchase of short-term investments (99,146) (49,296) (33,398)
--------- --------- ---------
Net cash used in investing activities (81,894) (37,070) (43,041)
FINANCING ACTIVITIES
Repurchase of common stock (23) (19,700) (6)
Proceeds from employee stock purchases and
exercise of stock options 8,362 5,370 3,755
--------- --------- ---------
Net cash provided (used) by financing activities 8,339 (14,330) 3,749
--------- --------- ---------
Increase (decrease) in cash and cash equivalents (1,253) 8,917 3,101
Cash and cash equivalents at beginning of year 13,139 4,222 1,121
--------- --------- ---------
Cash and cash equivalents at end of year $ 11,886 $ 13,139 $ 4,222
========= ========= =========
SUPPLEMENTAL INFORMATION
Cash paid during the year for interest $ 40 $ 19 $ 28
========= ========= =========
Cash paid during the year for income taxes $ 18,614 $ 12,317 $ 10,799
========= ========= =========
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
January 31, 2004
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 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 2003(the fiscal year ended January 31, 2004), the
Company operated 502 Hot Topic stores and 52 Torrid stores in 49 states
throughout the United States and Puerto Rico. 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 January 31, 2004, February 1, 2003
and February 2, 2002 were 52-week years.
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.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company considers carrying amounts of cash and cash equivalents,
receivables, and accounts payable to approximate fair value because of the short
maturity of these financial instruments.
Amounts outstanding under the unsecured bank credit agreement are held at their
estimated fair values because they accrue interest at rates which generally
fluctuate with interest rate trends.
F-6
SHORT-TERM INVESTMENTS
Short-term investments with maturities in excess of three months consist
primarily of interest bearing 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.
Other Comprehensive Loss items consist of fluctuations in the fair market value
of certain short-term investments. Other Comprehensive Income was lower than net
income for fiscal year ended January 31, 2004 as a result of Other Comprehensive
Loss items aggregating $201,000. Other Comprehensive Loss items are reported in
the Shareholders' Equity section of the Consolidated Balance Sheet.
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. Shipping and handling revenues
from our websites are included as a component of net sales.
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 costs 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 $1,065,000, $521,000, and $334,000 for the years ended
January 31, 2004, February 1, 2003 and February 2, 2002, 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.
F-7
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 September 2, 2003. 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.
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 January 31, 2004, 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
Statement of Financial Accounting Standards No. 148 ("SFAS 148"), "Accounting
for Stock-Based Compensation--Transition and Disclosure an Amendment of FASB
Statement No. 123", amends the disclosure requirements of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), to require more prominent disclosures in both annual and interim
financial statements regarding the method of accounting for stock-based employee
compensation and the effect of the method used on reported results.
The Company accounts for stock-based awards to employees and directors using the
intrinsic value method of accounting in accordance with Accounting Principles
Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees." 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.
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
2003, 2002, and 2001: weighted average risk-free interest rates of 5%; dividend
yields of 0%; weighted average volatility factors of the expected market price
of the Company's common stock of .40 for fiscal 2003, and 0.61 for fiscal 2002
and 2001; and a weighted average expected life of the options of 5 years. The
weighted average fair value of options granted during the year are $6.70, $8.53,
and $6.14 per share for fiscal 2003, 2002 and 2001, respectively.
F-8
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
-----------------------------------------
January 31, February 1, February 2,
2004 2003 2002
----------- ----------- -----------
Net income
As reported $ 48,042 $ 34,630 $ 28,600
Add: Stock-based
compensation expense
included in reported
net income, net of
related tax effects 96 88 81
Deduct: Total stock-
based compensation
expense determined
under fair value
method for all awards,
net of related tax
effects (5,166) (4,189) (3,120)
----------- ----------- -----------
Pro forma $ 42,972 $ 30,529 $ 25,561
=========== =========== ===========
Basic earnings per share:
As reported $ 1.01 $ 0.74 $ 0.62
Pro forma $ 0.91 $ 0.65 $ 0.55
Diluted earnings per share:
As reported $ 0.97 $ 0.70 $ 0.57
Pro forma $ 0.88 $ 0.62 $ 0.51
NEW ACCOUNTING PRONOUNCEMENTS
During April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 ("SFAS 149"), "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities." SFAS 149 amends and clarifies accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under Statement 133. SFAS 149 is effective
for contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The guidance should be applied
prospectively. The adoption of SFAS 149 did not have any material impact on the
Company's operating results or financial condition as the Company does not have
any derivative instruments that are affected by FAS 149.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." In general, a variable interest
entity is a corporation, partnership, trust, or any other legal structure used
for business purposes that either (a) does not have equity investors with voting
rights or (b) has equity investors that do not provide sufficient financial
resources for the entity to support its activities. FIN 46 requires certain
variable interest entities to be consolidated by the primary beneficiary of the
entity if the investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. The consolidation requirements of FIN 46 apply immediately to
variable interest entities created after January 31, 2003. The consolidation
requirements apply to older entities in the first fiscal year or interim period
F-9
beginning after June 15, 2003. Certain of the disclosure requirements apply in
all financial statements issued after January 31, 2003, regardless of when the
variable interest entity was established. The Company does not currently have
any variable interest entities and the adoption of the provisions of FIN 46 did
not have a material impact on the Company's results of operations or financial
condition.
Beginning in 2003, the Company adopted the provisions of Emerging Issues Task
Force("EITF") Issue No. 02-16, "Accounting by a Customer (Including a Reseller)
for Cash Consideration Received from a Vendor." Issue No. 02-16 provides
guidance on how a reseller should characterize the cash consideration received
from a vendor and when and how the cash consideration should be recorded on its
income statements. Issue No. 02-16 requires that the cash consideration received
from the vendor be considered as a reduction of cost of sales when recognized in
the reseller's income statement. If the cash consideration received from a
vendor is the direct, specific and incremental reimbursement of costs incurred
by the reseller to sell the vendor's products, the cash consideration should be
treated as a reduction of such selling costs. Historically, the Company has only
received money from vendors when product sell-through was below expectations and
markdowns were required to be taken. Amounts received are treated as a reduction
of cost of sales when received as the goods are typically sold prior to the
receipt of vendor money.
2. LEASEHOLDS, FIXTURES AND EQUIPMENT
Leaseholds, fixtures and equipment are summarized as follows (in thousands):
January 31, February 1,
2004 2003
----------- -----------
Furniture, fixtures and equipment $ 78,476 $ 58,597
Leasehold improvements 72,507 58,322
----------- -----------
150,983 116,919
Less accumulated depreciation and amortization (62,635) (44,773)
----------- -----------
$ 88,348 $ 72,146
=========== ===========
3. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
January 31, February 1,
2004 2003
----------- -----------
Accrued payroll and related expenses $ 9,833 $ 7,185
Gift cards, gift certificates and
store merchandise credits 5,713 3,739
Accrued percentage rents 4,012 1,642
Other 8,575 7,073
----------- -----------
$ 28,133 $ 19,639
=========== ===========
4. BANK CREDIT AGREEMENT
The Company has an unsecured bank credit agreement for $5,000,000, which is used
for issuing letters of credit. The credit agreement expires in August 1, 2004
and the Company expects to renew the agreement under similar terms and
conditions. The letters of credit are primarily used for inventory purchases. At
January 31, 2004, the Company had $56,000 of outstanding letters of credit under
the credit agreement.
F-10
5. COMMITMENTS AND CONTINGENCIES
LEASES
The Company has entered into lease agreements for retail and office space,
vehicles, 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 January 31, 2004, February 1, 2003 and February 2, 2002 was
$39,403,000, $30,966,000, and $21,784,000, respectively, including contingent
rentals of $4,866,000, $3,670,000, and $3,164,000, respectively.
Annual future minimum lease payments under operating leases as of January 31,
2004 are as follows (in thousands):
Operating
Fiscal Year Leases
- ------------ ---------
2004 $ 36,548
2005 36,288
2006 35,752
2007 34,596
2008 32,449
Thereafter 100,616
---------
Total minimum lease payments $276,249
=========
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.
6. SHAREHOLDERS' EQUITY
Stock Split
On August 12, 2003, the Company announced that its Board of Directors approved a
three-for-two stock split (in the form of a dividend) of its common stock. On
the effective date of September 2, 2003, shareholders received a dividend of one
additional share for every two shares they owned at the close of business on the
record date of August 21, 2003. All share and per share amounts have been
restated to reflect this stock split and all previous stock splits effectuated
by the Company.
Stock Repurchase
On May 8, 2002, the Company announced that its Board of Directors approved the
repurchase of up to an aggregate of 1,500,000 shares of its common stock during
the period ending January 31, 2003. As of January 31, 2003, the Company had
completed the repurchase of 1,500,000 shares of its common stock at a cost of
$19.7 million, at an average price of $13.13 per common share.
F-11
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 1,350,000 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 19,020,000 shares of common stock may be issued
pursuant to the Plans. During fiscal 2003, the Plans were amended to increase
the aggregate number of shares of common stock authorized for issuance by
2,775,000 shares. As of January 31, 2004, 3,684,904 shares were available for
future grants. No options, under the Plans, have been granted to consultants.
The Company granted 8,855, 8,424, and 14,766 shares of restricted common stock
in the year ended January 31, 2004, February 1, 2003, and February 2, 2002,
respectively, to non-employee directors under the 1996 Equity Incentive Plan.
The 8,855 restricted shares issued in fiscal 2003 will vest in the year ending
January 29, 2005, the 8,424 restricted shares issued in fiscal 2002 vested in
the year ended January 31, 2004, and the 14,766 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 $155,000, $142,000, and $130,000 was expensed in the years
ended January 31, 2004, February 1, 2003, and February 2, 2002 respectively.
F-12
A summary of the Company's stock option activity and related information
follows:
January 31, 2004 February 1, 2003 February 2, 2002
--------------------- ---------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
----------- ------- ----------- -------- ----------- --------
Outstanding at beginning of year 4,876,941 $ 8.70 4,891,268 $ 5.85 5,624,420 $ 3.35
Granted 1,396,931 $15.78 1,394,475 $ 15.14 1,522,013 $ 10.90
Exercised (1,260,630) $ 6.11 (1,195,529) $ 4.13 (1,375,739) $ 2.67
Forfeited (199,447) $12.37 (213,273) $ 10.88 (879,426) $ 3.57
----------- ------- ----------- -------- ----------- --------
Outstanding at end of year 4,813,795 $11.28 4,876,941 $ 8.70 4,891,268 $ 5.85
=========== ======= =========== ======== =========== ========
Exercisable at end of year 2,146,586 $ 7.80 2,000,054 $ 5.06 1,709,822 $ 3.31
=========== ======= =========== ======== =========== ========
Exercise prices for the 4,813,795 options outstanding as of January 31, 2004
ranged from $1.51 to $23.02. The weighted average contractual life of those
options is 7.5 years. The following table summarizes information about stock
options outstanding as of January 31, 2004:
Outstanding Options
------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Number Exercise Contractual Number Exercise
Range of Exercise Prices Outstanding Price Life Exercisable Price
- ------------------------ ----------------------------------- ------------------------
$1.51 - $5.83 859,579 $ 2.93 5.4 798,688 $ 2.85
$5.97 - $10.64 1,299,677 $ 8.67 6.8 859,340 $ 8.44
$11.00 - $15.33 1,271,783 $ 14.65 8.1 473,100 $ 14.67
$15.61 - $23.02 1,382,756 $ 15.83 9.1 15,458 $ 17.66
----------------------------------- ------------------------
$1.51 - $23.02 4,813,795 $ 11.28 7.5 2,146,586 $ 7.80
=================================== ========================
The Company recorded tax benefits associated with the exercise of non-qualified
stock options. The tax benefits increased shareholders' equity and decreased
income taxes payable in the amounts of $6,616,000, $5,118,000, and $3,598,000
for the years ended January 31, 2004, February 1, 2003 and February 2, 2002,
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. A
three-for-two stock split of the Company's common stock became effective
September 2, 2003. All share and per share amounts have been restated to reflect
this stock split and all previous stock splits effectuated by the Company.
F-13
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):
January 31, February 1, February 2,
2004 2003 2002
---------- ---------- ----------
Basic Earnings Per Share Computation:
Numerator $ 48,042 $ 34,630 $ 28,600
Denominator:
Weighted average common
shares outstanding 47,479 47,027 46,467
---------- ---------- ----------
Total shares 47,479 47,027 46,467
========== ========== ==========
Basic earnings per share $ 1.01 $ 0.74 $ 0.62
========== ========== ==========
Diluted Earnings Per Share Computation:
Numerator $ 48,042 $ 34,630 $ 28,600
Denominator:
Weighted average common
shares outstanding 47,479 47,027 46,467
Incremental shares from assumed
conversion of options 2,109 2,249 3,362
---------- ---------- ----------
Total shares 49,588 49,276 49,829
========== ========== ==========
Diluted earnings per share $ 0.97 $ 0.70 $ 0.57
========== ========== ==========
8. INCOME TAXES
Composition of the provision for income taxes for the years ended (in
thousands):
January 31, February 1, February 2,
2004 2003 2002
----------- ----------- -----------
Current:
Federal $ 21,169 $ 18,584 $ 15,727
State 4,577 2,963 2,769
----------- ----------- -----------
25,746 21,547 18,496
----------- ----------- -----------
Deferred:
Federal 4,397 (125) (859)
State (322) (197) (202)
----------- ----------- -----------
4,075 (322) (1,061)
----------- ----------- -----------
Total income tax expense $ 29,821 $ 21,225 $ 17,435
=========== =========== ===========
F-14
Significant components of the Company's deferred tax assets and liabilities as
of (in thousands):
January 31, February 1,
2004 2003
----------- -----------
Current deferred tax assets (liabilities):
Accrued vacation and other $ 727 $ 835
Inventory 701 496
State taxes 597 1,004
Other assets (liabilities) 234 (242)
----------- -----------
Net current deferred tax assets 2,259 2,093
----------- -----------
Noncurrent deferred tax assets (liabilities):
Depreciation (4,048) 419
Deferred rent 732 264
----------- -----------
Total noncurrent deferred tax assets (liabilities) (3,316) 683
----------- -----------
Net deferred tax assets (liabilities) $ (1,057) $ 2,776
=========== ===========
Reconciliation of the provision for income taxes to the statutory tax rate for
the years ended:
January 31, February 1, February 2,
2004 2003 2002
----------- ----------- -----------
Statutory federal rate 35.0% 35.0% 35.0%
Permanent differences (0.4) (0.5) (1.0)
State and local taxes, net of federal
benefit 3.6 3.7 3.4
Other items 0.1 (0.2) 0.5
----------- ----------- -----------
Effective income tax rate 38.3% 38.0% 37.9%
=========== =========== ===========
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-15