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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 29, 2005
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 July 30, 2004 was approximately $739,697,726 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
44,814,650 as of April 2, 2005.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Registrant's Definitive Proxy Statement for the
Annual Meeting of Shareholders to be held on June 15, 2005 to be filed with the
Securities and Exchange Commission (the "SEC") no later than 120 days after
January 29, 2005, are incorporated by reference into Part III of this Form 10-K
(Items 10 through 13).
HOT TOPIC, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE
YEAR ENDED JANUARY 29, 2005
TABLE OF CONTENTS
PART I PAGE
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Item 1. Business 3
Item 2. Properties 23
Item 3. Legal Proceedings 23
Item 4. Submission of Matters to a Vote of Security Holders 24
PART II
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Item 5. Market for Registrant's Common Equity, Related Shareholder
Matters and Issuer Purchases of Equity Securities 25
Item 6. Selected Financial Data 26
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 28
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 36
Item 8. Financial Statements and Supplemental Data 36
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 37
Item 9A. Controls and Procedures 37
Item 9B. Other Information 40
PART III
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Item 10. Directors and Executive Officers of the Registrant 40
Item 11. Executive Compensation 40
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Shareholder Matters 40
Item 13. Certain Relationships and Related Transactions 40
Item 14. Principal Accountant Fees and Services 40
PART IV
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Item 15. Exhibits and Financial Statement Schedules 40
2.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING DISCLOSURE
THIS REPORT 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"). THESE STATEMENTS INCLUDE, FOR EXAMPLE, STATEMENTS REGARDING OUR
EXPECTATIONS, BELIEFS, INTENTIONS OR STRATEGIES REGARDING THE FUTURE, SUCH AS
THE EXTENT AND TIMING OF FUTURE REVENUES AND EXPENSES AND CUSTOMER DEMAND, OTHER
EXPECTED FINANCIAL RESULTS AND INFORMATION, NEW STORE OPENINGS AND NEW STORE
CONCEPTS. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ARE BASED ON
INFORMATION AVAILABLE TO US AS OF THE DATE OF THIS REPORT. WE WILL NOT
NECESSARILY UPDATE ANY FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS
INVOLVE KNOWN OR UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH MAY CAUSE
OUR ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS, OR INDUSTRY RESULTS TO BE
DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR
IMPLIED. RISKS, UNCERTAINTIES AND OTHER FACTORS RELATED TO US ARE LOCATED, AMONG
OTHER PLACES, 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
We are a mall-based specialty retailer operating the Hot Topic and Torrid
store concepts. Hot Topic stores sell 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. Torrid stores sell
apparel, lingerie, shoes and accessories designed for various lifestyles for
plus-size females between the ages of 15 and 29. We opened our first Hot Topic
store in 1989 and our first Torrid store in 2001. At the end of fiscal 2004 (the
fiscal year ended January 29, 2005), we operated 592 Hot Topic stores throughout
the United States and Puerto Rico, and 76 Torrid stores. We also sell
merchandise on two websites, www.hottopic.com ("hottopic.com") and
www.torrid.com ("torrid.com"), which reflect the Hot Topic and Torrid store
concepts and carry merchandise similar to that sold in the respective stores.
Throughout this report, the terms "our", "we" and "us" refer to Hot Topic, Inc.
and its subsidiaries.
We opened 91 Hot Topic and 24 Torrid stores during fiscal 2004. We also
occasionally relocate, expand, or close existing stores. During fiscal 2004, we
expanded or relocated ten stores. We plan to open approximately 65 new Hot Topic
stores and 45 Torrid stores in the fiscal year ending January 28, 2006 ("fiscal
2005"). As of March 9, 2005, five of these new Hot Topic stores and one of these
new Torrid stores were open.
THE MARKET
The music-licensed apparel industry essentially began in the 1960s with
bootleggers selling tee shirts at concert venues. Over the next 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. We believe that during recent years, the music industry has been
significantly impacted by the availability and accessibility of Internet and
digital technology and the continuing success of MTV and other music television
networks. These media 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. This is in stark contrast to past decades when the
vinyl record cover and a few magazines of modest circulation were the primary
source of young people's information about their music and favorite bands. The
growing importance of the Internet is illustrated in a recent 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 86 million households in the United States
in December 2003, according to Viacom International, Inc., MTV's parent company.
3.
As a result, both emerging and well-known artists, and the fashions they
inspire, are much more visible today than ever before. We believe that this
increased visibility has contributed to a rise in demand for music/pop
culture-licensed and music/pop culture-influenced apparel and accessories. We
believe 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 (including through the rapidly
growing avenue provided by digital music and "downloads"), 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. We believe our music/pop culture-influenced merchandise
appeals to teenagers from diverse socio-economic backgrounds and that our
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 2004, and 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 $91 a week in
2004 according to Teen Research Unlimited. In the past seven years, teenage
spending has grown an average of 5% per year, to $169 billion in 2004.
We developed the Torrid concept after analyzing customer feedback and
researching the market demographics. We concluded there was a significant
portion of young women consumers who were plus-size and unable to find and buy a
broad enough selection of "cool" fashion forward clothes in comparison to their
smaller sized friends. We launched Torrid 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 primarily
influenced by fashion trends, and also by pop culture. We believe the Torrid
assortment allows young 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
Our goal for 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. Elements of Hot Topic's business strategy
include:
o FOCUS ON UNIQUE MUSIC/POP CULTURE-ORIENTED MERCHANDISE
We believe that fashions and products associated with popular music artists
and pop culture trends have a significant influence on teenagers. We have
developed a unique strategy focused exclusively on offering music/pop
culture-licensed and music/pop culture-influenced merchandise in the mall
environment. Accordingly, we believe we are 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 relevant pop culture trends are reflected in its broad
assortment of products. We believe 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. We believe 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.
4.
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. We diligently track 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. We also actively
solicit feedback from our associates and customers. We believe these activities
allow us to react quickly to emerging trends, and provide 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 at their early stages and react
accordingly to keep its in-store product assortment current with those trends.
We have developed a disciplined approach to buying and a dynamic inventory
planning and allocation process to support our merchandise strategy. We
regularly test new merchandise in select Hot Topic stores before chain-wide
distribution. We also order a majority of our merchandise not more than 60 to 90
days before delivery, allowing us to respond quickly to emerging trends. We are
also aggressive in taking prompt markdowns to maintain a fresh merchandise mix.
By actively managing the mix of categories and products in Hot Topic stores, we
believe we are able to capitalize on emerging trends and minimize our dependence
on any one particular merchandise category. We believe this approach to managing
Hot Topic's merchandise mix has contributed to strong merchandise margins and
markdown rates that are lower than industry average.
o EMPHASIZE CUSTOMER SERVICE AND THE IN-STORE EXPERIENCE
Hot Topic store associates are trained to provide a value-added,
non-intrusive customer experience. Sales associates are encouraged 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. We believe 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.
We also seek to create an exciting and compelling shopping environment
focusing on the lifestyles of our core customer. Hot Topic stores are designed
with an industrial theme that incorporates dense merchandising and utilizes a
professional sound system playing alternative music to create a fun, high-energy
store that teens will consider "their place" to shop with friends. We believe
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
Our goal for Torrid stores is to become a leading specialty retailer of
fashion forward plus-size young women's apparel and accessories. Elements of
Torrid's business strategy include:
o FOCUS ON CURRENT FASHION TRENDS IN APPAREL AND ACCESSORIES THAT ALLOW
THE PLUS-SIZE CUSTOMER TO FEEL FEMININE, BEAUTIFUL, AND SEXY
5.
Our Torrid merchandising team focuses on providing a fashion forward
merchandise assortment that reflects the influence of cutting edge fashion
trends and pop culture. These influences provide the inspiration for hip, trendy
apparel and accessories that our plus-size customer relates to. We believe that
Torrid is the first mall concept to offer a complete store assortment of fashion
forward apparel for plus-size young women.
o LISTEN TO THE CUSTOMER
Torrid does not dictate fashion trends, but rather listens to customers and
emphasizes current fashion direction, as well as pop culture influences, to
identify and keep current with emerging trends. These trends dictate a fashion
forward merchandise selection with strong customer appeal. Torrid, like Hot
Topic, seeks direct feedback at the grass-roots level 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
We train Torrid store associates to provide one-on-one service to
customers. Because we believe that the plus-size customer has been previously
unable to find sufficient quantities and selections of fashionable apparel in
line with current trends like her friends buy and wear, Torrid's customer
service approach focuses on suggesting outfits and ensuring the correct fit.
Through a focus on customer service and a trendy fashion merchandise
offering, Torrid seeks to create a compelling shopping environment that the
younger plus-size female customer is looking for. We believe that the warm
reception, trendy fashion offerings, and helpful customer service by Torrid
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 29, 2005, we operated 592 Hot Topic stores throughout the
United States and Puerto Rico and 76 Torrid stores in 25 states in both
metropolitan and middle markets. Between January 30, 2005 and March 9, 2005, we
opened an additional five Hot Topic stores and one Torrid store. The following
chart shows, as of March 9, 2005, the number of Hot Topic and Torrid stores we
operate in each state in which those stores are located:
6.
HOT TOPIC, INC.
STORES BY STATE
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HOT TOPIC STORES TORRID STORES TOTAL COMPANY
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OPEN AT NEW HT OPEN AT OPEN AT NEW TORRID OPEN AT OPEN AT
1/29/2005 FY05 TO DATE 3/9/2005 1/29/2005 FY05 TO DATE 3/9/2005 3/9/2005
Alabama 6 6 6
Alaska 3 3 3
Arizona 14 14 4 4 18
Arkansas 2 2 2
California 66 2 68 29 29 97
Colorado 11 11 1 1 12
Connecticut 7 7 7
Delaware 2 2 2
Florida 37 37 2 2 39
Georgia 12 12 1 1 13
Hawaii 4 4 4
Idaho 3 3 3
Illinois 17 17 2 2 19
Indiana 12 12 1 1 13
Iowa 9 9 9
Kansas 5 5 5
Kentucky 7 7 7
Louisiana 8 8 8
Maine 2 2 2
Maryland 14 14 2 2 16
Massachusetts 15 15 3 3 18
Michigan 23 23 2 2 25
Minnesota 12 12 1 1 13
Mississippi 2 2 2
Missouri 13 13 2 2 15
Montana 3 3 3
Nebraska 4 4 1 1 5
Nevada 5 5 2 2 7
New Hampshire 4 4 1 1 5
New Jersey 16 16 3 1 4 20
New Mexico 7 7 1 1 8
New York 28 28 5 5 33
North Carolina 12 1 13 13
North Dakota 3 3 3
Ohio 26 26 1 1 27
Oklahoma 7 7 7
Oregon 7 7 2 2 9
Pennsylvania 28 1 29 1 1 30
Rhode Island 1 1 1
South Carolina 6 6 6
South Dakota 2 2 2
Tennessee 15 15 2 2 17
Texas 49 49 5 5 54
Utah 8 8 8
Vermont 2 2 2
Virginia 14 14 14
Washington 18 18 1 1 19
West Virginia 4 4 4
Wisconsin 11 11 1 1 12
Wyoming 1 1 1
Puerto Rico 5 1 6 6
TOTAL 592 5 597 76 1 77 674
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7.
EXPANSION STRATEGY
The following table provides a history of our store expansion:
FISCAL YEAR
------------------------------------------------
2000 2001 2002 2003 2004 2005
THROUGH
3-9-05
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(Number of stores)
Stores at beginning of year 212 274 352 445 554 668
Hot Topic stores opened 62 73 74 84 91 5
Hot Topic stores closed* (1) (2) (1)
Torrid stores opened 6 21 25 24 1
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Stores at end of year 274 352 445 554 668 674
------------------------------------------------
Hot Topic and Torrid stores
expanded or relocated 5 7 8 4 10 1
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* Victorville, CA store closed in fiscal 2001 and re-opened in the first
quarter of fiscal 2002, and is included in our current store count.
Parklane, NV and Bayfair, CA store leases expired in the fourth
quarter of fiscal 2002 and were not renewed. Cupertino, CA store lease
expired in the first quarter of fiscal 2004 and was not renewed.
Our expansion strategy is to open stores primarily in shopping malls and
selected entertainment centers in both new and existing markets throughout the
United States. We opened 91 new Hot Topic stores and 24 Torrid stores in fiscal
2004, and we also expanded or relocated ten existing stores. During fiscal 2005,
we plan to open approximately 65 new Hot Topic stores and 45 new Torrid stores.
Additionally, we plan to expand or relocate approximately 20 existing stores. We
have identified regional malls nationwide and in Puerto Rico for potential new
locations.
We evaluate potential store locations based on a variety of criteria
relevant to our merchandising strategy, including: the sales of the mall and
anchor stores, sales of teenage-oriented and plus-size stores, age demographics
in the trade area, median family income and other economic factors. We have a
real estate committee that meets regularly to evaluate and select store
locations. We generally seek potential store sites between 1,500 square feet and
2,000 square feet for Hot Topic stores, and between 2,200 square feet and 2,600
square feet for Torrid stores. Our Hot Topic stores currently average
approximately 1,700 square feet and our Torrid stores currently average
approximately 2,500 square feet.
STORE-LEVEL ECONOMICS
During fiscal 2004, we achieved average Hot Topic store net sales of
approximately $1,048,000 and average Hot Topic store net sales per square foot
of approximately $602. We cannot guarantee that these results will continue or
that future average store-level sales will not vary from historical results.
HOT TOPIC MERCHANDISING
Our Hot Topic stores 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 Hot Topic's
products are music/pop culture-licensed and the other half are music/pop
culture-influenced products. A key strategy of our Hot Topic stores is to offer
a diverse product assortment. We have more than 20 distinct merchandise
categories or "departments." On average, over 120 different licensed band tee
8.
shirts are carried in each store, from current artists such as Green Day, AFI,
Slipknot, Good Charlotte, ICP and Linkin Park to classic rock artists such as
The Ramones, Nirvana, Bob Marley, The Rolling Stones, Metallica and Led
Zeppelin. New items and categories are regularly tested to stay current with
customer demand and new product trends.
During fiscal 2004, 53% of Hot Topic's net sales were generated in apparel
categories and 47% of Hot Topic's net sales were produced in non-apparel
categories (including accessories, gifts, intimate apparel and shoes).
Our Hot Topic merchandising staff consists of a General Merchandise
Manager, Divisional Merchandise Managers, and a staff of buyers and assistant
buyers who manage the various product categories. The merchandising staff
reflects our 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 several lines of private label merchandise to complement and
supplement current product offerings. We believe that Hot Topic brands play an
important part in differentiating its stores from those of its competitors and
provide us with higher margin opportunities as compared to other merchandise. We
estimate that in fiscal 2004 our Hot Topic brands accounted for approximately
25% of our sales, the same percentage as in fiscal 2003. Our proprietary brands
include Ugly Shirt, 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. We also often begin with smaller test
purchases prior to chain-wide distribution. We regularly monitor 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 our
stores by responding to the spending patterns of our customers. We also develop
good relationships with our vendors because we understand their importance of
facilitating a quick response.
TORRID MERCHANDISING
Our Torrid stores serve a premier destination for current trends in fashion
apparel and accessories for plus-size young women. We believe 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, swimwear, intimate apparel, shoes, hosiery,
accessories, gifts, and beauty products. Torrid apparel is sized 12 to 26. A
broad selection of merchandise comes from established branded vendors, including
Dickies, Paris Blues, Z Cavaricchi, LEI, Fine and Hot Kiss and more fashion
forward vendors, such as Tripp. Torrid works with these and other vendors to
monitor and maintain its own plus-size apparel fit specifications for young
women. We believe Torrid's 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 been available to other young women of the same age who
are not plus-size. We research current fashion trends and customer requests and
then work with vendors to design and manufacture them for Torrid. The Torrid fit
specialist team works with the manufacturers' design teams to help ensure that
fit and quality standards are achieved and maintained.
During fiscal 2004, approximately 75% of Torrid's net sales were generated
in apparel categories and approximately 25% of Torrid's net sales were produced
in non-apparel categories (including accessories, gifts, intimate apparel and
shoes).
9.
Our Torrid merchandising staff consists of a General Merchandise Manager, a
Divisional Merchandise Manager, a fit specialist team, and a staff of buyers and
assistant buyers who manage all product categories. The Torrid merchandising
staff's decisions and actions are influenced by customer and store associate
feedback. The merchandising staff spends considerable time visiting trendy young
fashion shopping areas and nightclubs, researching international fashion trends,
and attending trade shows and other events that attract young people. We also
believe that emerging fashion trends in the junior market and pop culture
influence Torrid's merchandising direction. The range of pop culture and music
artists that influence Torrid fashion is much broader than at Hot Topic,
consistent with the broader target customer base of females ages 15 to 29.
Approximately 40% of Torrid merchandise is purchased from established
branded vendors. The remaining 60% is Torrid's private label merchandise that
provides the customer with unique, fashion forward merchandise, often at more
competitive prices than branded merchandise. Private label merchandise also
often provides Torrid 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 120 days, and many times less than 75 days, in advance of delivery. We
often begin with small purchases for testing.
PLANNING AND ALLOCATION OF MERCHANDISE
Planning and allocation of our inventory is done 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.
Our headquarters and distribution facility located in the City of Industry,
California is approximately 250,000 square feet. Vendors deliver all merchandise
to this facility, where it is inspected, allocated, picked, prepared and boxed
for shipment to our stores and internet customers. We ship merchandise to stores
each weekday, providing our Hot Topic and Torrid stores with a steady flow of
new and reordered merchandise. Minimal back stock is maintained in our
distribution facility and at our stores, so that most of our merchandise is
available for sale on the selling floors of our stores. No single vendor
accounted for more than 7% of our merchandise purchases during fiscal 2004.
We have entered into a lease (with a purchase option) for an additional
distribution center facility in Tennessee, which we expect to be operational by
the end of the second quarter of fiscal 2005. We believe this second
distribution center will allow for us to accommodate our growth for many years.
We also expect improved delivery times to many of our stores, especially east
coast locations. The Tennessee distribution center will receive merchandise for
and ship merchandise primarily to stores in the eastern half of the country.
HOT TOPIC AND TORRID STORE OPERATIONS
Hot Topic and Torrid store operations are managed by separate teams of a
Vice President of Store Operations, regional directors and district managers. On
average, each district manager supervises approximately six 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 store
manager and district manager are responsible for the hiring and training of new
associates. We have established training and operating procedures to assist
field management in the supervision and training of all associates. We have also
designed a store manager training program, which is used to train externally
hired managers.
We strive to create a store environment that customers will consider "their
place" to shop with friends. We seek to hire sales associates who are like our
customers - energetic people who are knowledgeable and passionate about music
and pop culture-inspired fashion, as well as trendy fashion inspiration. We
10.
understand the importance of focusing on the preferences and opinions of our
target customers. So store associates, who have the closest and most frequent
contacts and interactions with our customers, from time to time accompany buyers
on buying trips. Additionally, in return for feedback on fashion and other
trends, we reimburse store associates for the cost of attending concerts. They
are also encouraged to directly communicate customer feedback as well as their
own merchandise and product ideas to the buyers and management. Our culture and
our direct interaction with and respect for sales associates are significant
factors in producing associate retention rates that we believe are higher than
the industry average.
The primary goal of the sales associate position is to provide superior,
informed customer service in order to maximize sales and minimize inventory
shrinkage. Store management receives 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 us. We train associates 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 and/or trends.
We believe that our associates' high level of product knowledge and customer
service differentiates us from other specialty retailers.
District managers, along with all members of the store teams, have a base
pay rate and may qualify to receive certain bonus payouts. District managers may
also qualify to receive stock option grants. All of our employees who meet
certain eligibility criteria are eligible to participate in our Employee Stock
Purchase Plan. We believe that our continued success is dependent in part on our
ability to attract, retain and motivate qualified associates. In particular, the
success of our growth will be dependent on our ability to promote and/or recruit
talented district and store managers. In order to ensure new stores have a
capable pool of candidates, we have assigned dedicated field recruiters to work
with each region's management team.
MARKETING, PROMOTION AND INTERNET
We generally open stores in high traffic malls in areas of high teenage and
young adult population, and we rely on existing customers, associates, store
design and exciting music to attract new customers to our stores. To further
promote Hot Topic stores, we sponsor various music events and conduct periodic
contests. For example, since 2000, we have co-sponsored a major summer rock
tour, Ozzfest (headlined by Ozzy Osbourne). As an Ozzfest sponsor, our name has
been associated with promotional activities at each venue. Torrid enhances its
image through visual advertising and promotion, with an emphasis on lifestyle
photography illustrating a young plus-size woman in various lifestyle activities
and fashions representative of the feminine, beautiful and/or sexy essence of
the brand. In the fourth quarter of fiscal 2004, Torrid began testing in a small
number of stores a customer loyalty program called Divastyle. In addition to our
broad selection of merchandise for sale, including some Internet-only items, our
websites offer merchandise, tour dates, contests, job postings, store locations
and community features such as band reviews and advice columns. Our net sales
from Internet operations rose by 25% in fiscal 2004 compared to fiscal 2003 and
contributed approximately 2.8% of total sales in fiscal 2004.
In fiscal 2004, we established the Hot Topic Foundation. The Foundation's
objective is to support programs and organizations that specifically focus on
encouraging and educating youth in music, creative writing, painting,
photography, and filmmaking. The Foundation has been funded through donations
from our employees, our company, and our customers. As of January 29, 2005,
$339,000 has been raised for the benefit of the Foundation. We are pleased with
the meaningful contributions the Foundation has made to school music programs
and other initiatives, and we believe these activities have a positive influence
on young people.
INFORMATION TECHNOLOGY
Our 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. Our financial systems are licensed from Lawson Software and are
used for general ledger, accounts payable, and asset management as integrated
11.
financials. Sales are updated daily in the merchandising reporting systems by
polling sales information from each store's point-of-sale, or POS, terminals.
Our POS system consists of registers providing price look-up, time and
attendance, e-mail and credit card/check/gift card 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. We evaluate information obtained through nightly polling
to implement merchandising decisions, including product purchasing/reorders,
markdowns and allocation of merchandise on a daily basis. In June 2004, we
implemented our new warehouse management system in our California distribution
center, which is licensed from Manhattan Associates.
Our Wide Area Network ("WAN") is used to connect all locations with
real-time e-mail and several Intranet applications. In addition, this technology
has improved operating efficiency in such areas as credit card and gift card
authorization, store-to-store transfer, product lookup, product location and
several other applications to eliminate paper distribution and paperwork.
In 2005, we plan to open a new distribution center in Tennessee and
implement a new Internet order management software system and a customer loyalty
software system. We believe our enhancements to existing systems and additions
of new systems will help support our growth.
TRADEMARKS
We have registered on the Principal Register of the United States Patent
and Trademark Office our retail store service marks Hot Topic(R) and Torrid(R)
in various forms. We have also registered various other trademarks for
merchandise such as Morbid Make-Up(R), Morbid Scents(R), Morbid Metals(R),
Morbid Threads(R), Tragedy(R), Misery(R), and MT:2(R); and general marks such as
our slogan "Everything About the Music". Each federal registration is renewable
indefinitely if the mark is in use at the time of the renewal. We have several
trademark applications on file with the USPTO, for which we hope to obtain
registration in the future. In addition, we have common law trademark rights to
certain trademarks, service marks and trade names used in our business from time
to time. We are not aware of our use of any of our marks raising any claims of
infringement or other challenges to our right to use our marks in the United
States. We also have additional registrations and pending applications in
foreign jurisdictions. All other trademarks, trade names and service marks
referenced in this report and in our stores are the property of their respective
owners.
HOT TOPIC COMPETITION
We compete 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, Wet
Seal, Inc., and Urban Outfitters, Inc.; and, to a lesser extent, with music
stores. Some of our competitors are larger and have substantially greater
financial, marketing and other resources than us. The principal factors of
competition are merchandise selection, connection to the music industry,
customer service, store location and price.
TORRID COMPETITION
Based on direct customer research we have conducted, we believe 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. Though a source of competition, we believe such stores generally
target more mature customers, which is also reflected in their store
environments. We are 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-sizes. Many companies compete for the junior customers and additional
competitors may enter into the plus-size female market.
12.
EMPLOYEES
We employed approximately 2,030 full-time and 5,940 part-time employees,
which we refer to as associates, as of March 9, 2005. Of our 7,970 associates,
approximately 600 were headquarters and distribution center personnel and the
remainder were field management and store associates. The number of part-time
associates changes with seasonal needs. None of our associates are covered by
collective bargaining agreements. We believe that our relationships with our
associates are good.
EXECUTIVE OFFICERS AND KEY EMPLOYEES
Our executive officers and key employees and their ages at March 9, 2005
are as follows:
NAME AGE POSITION
- ----------------------- ----- ------------------------------------------------------
Elizabeth McLaughlin 44 Chief Executive Officer and Director
Gerald Cook 52 President, Hot Topic
Patricia Van Cleave 57 President, Torrid
James McGinty 42 Chief Financial Officer
Tom Beauchamp 52 Senior Vice President and Chief Information Officer
Christopher Kearns 38 Senior Vice President, General Counsel and Secretary
Cindy Boden 50 Vice President, Torrid Store Operations
Christopher Daniel 47 Vice President, Torrid General Merchandise Manager
Ed Gusman 46 Vice President, Hot Topic Store Operations
Tricia Higgins 37 Vice President, Distribution
Darrell Kinsley 42 Vice President, Store Design and Visual Merchandising
Alain Krakirian 39 Vice President, Hot Topic Planning and Allocation
Cindy Levitt 44 Vice President, Hot Topic General Merchandise Manager
Sue McPherson-Spissu 37 Vice President, Logistics
John Neppl 48 Vice President, Real Estate and Construction
George Wehlitz, Jr. 44 Vice President, Finance
ELIZABETH MCLAUGHLIN has served as Chief Executive Officer and on the Board
of Directors since 2000. From 1996 through 2000, Ms. McLaughlin served as Senior
Vice President and General Merchandise Manager. From 1993 through 1996, Ms.
McLaughlin was our Vice President, Operations. Prior to joining us, 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 Director of Noodles & Company, a privately held
quick casual restaurant concept. She is also a member of the Board of Visitors
for the Anderson School at UCLA.
13.
GERALD COOK has been President, Hot Topic since September 2003. From
February 2001 to September 2003, he was Chief Operating Officer. From February
1999 until joining us, 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. From
September 2002 to September 2003, she was Chief Merchandising Officer. 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 since February 2001.
Mr. McGinty joined us in August 2000 as 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.
TOM BEAUCHAMP has been Senior Vice President and Chief Information Officer
since June 2004. Mr Beauchamp has over 30 years of Information technology
experience. From October 2001 until joining us, he was Chief Information Officer
for CMI Marketing, a provider of loyalty marketing programs. From January 2000
until June of 2001, Mr. Beauchamp was Chief Information Officer of Columbia
House. From June 1999 through January 2001, he was Senior Vice President, Chief
Information Officer for Oxford Health Plans. From March 1996 through June 1999,
he was Senior Vice President, Chief Information Officer for Woolworth
Corporation. Prior to 1996, Mr. Beauchamp held management positions with
Montgomery Ward, Limited, Inc., Millers Outpost, and The Broadway.
CHRISTOPHER KEARNS has served as Senior Vice President, General Counsel and
Secretary since April 2004. Prior to that, Mr. Kearns spent a decade as an
attorney in private practice, most recently as a Partner with the law firm
Cooley Godward LLP, which he joined in 1996. Mr. Kearns holds a B.A. degree in
History and a specialization in Business Administration from UCLA, and a J.D.
with honors from the University of California, Hastings College of the Law.
CINDY BODEN has been Vice President, Torrid Store Operations since October
2003. Prior to that, Ms. Boden held Regional Director positions with Hot Topic
both in the Northeast and the Midwest regions, beginning in 2000. 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.
CHRISTOPHER DANIEL has served as Vice President, General Merchandise
Manager for Torrid since October 2004. From September 1996 until September 2004,
he was the Vice President of Design and Product Development for Mervyn's, a
division of Target Corporation. Prior to that, Mr. Daniel held management
positions in merchandising and product development with Structure, a division of
Limited, Inc., Charming Shoppes, a national women's specialty retailer, and
14.
Dayton-Hudson, the department store division of Target Corporation. Prior to
that, he held merchandising positions with Bullock's, a Los Angeles based
division of Federated Stores and Miller and Rhoads, a division of Allied stores
based in Richmond, Virginia. Mr. Daniel holds a B.A. degree in English
literature from the University of Richmond in Richmond, Virginia.
ED GUSMAN has served as Vice President, Hot Topic Store Operations since
January 2005. From January 2004 to January 2005, Mr. Gusman was the Senior
Regional Director for the Eastern United States. From March 2001 to December
2003, Mr. Gusman was the Regional Director for the Southeast. From September
1999 to February 2001, he was the district manager for Urban Outfitters for the
Mid Atlantic, Southeast. From May 1994 to August 1999, Mr. Gusman was a regional
director for Zany Brainy, heading up their expansion on the West Coast. From
1990 to 1994, he was regional director for Brentano's, Waldenbooks Super Store.
Prior to that, he held various management positions with Waldenbooks.
TRICIA HIGGINS has been Vice President, Distribution since October 2004 and
is responsible for the Distribution Center in the City of Industry. From
February 2004 to October 2004, she was Vice President, Internet. Before her
promotion to Vice President, Internet, she held the position of Director,
Internet, beginning in June 2002. Prior to joining us, 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.
DARRELL KINSLEY was promoted to Vice President, Store Design and Visual
Merchandising, in January 2005. From February 2000 through December 2004, Mr.
Kinsley was Vice President, Hot Topic Store Operations. From June 1998 through
February 2000, Mr. Kinsley was Regional Director for the western United States.
From February 1997 through June 1998, he was Regional Director for the eastern
United States. Mr. Kinsley joined us 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 Vice President, Hot Topic Planning and Allocation
since February 2000. From July 1997 through February 2000, Mr. Krakirian was
Director of Planning and Allocation. Mr. Krakirian was a 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 Divisional
Merchandise Manager, Apparel and Music. Ms. Levitt has held senior buying
positions since 1989. 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 has been Vice President, Logistics since October 2004.
From October 2001 to October 2004, she was Vice President, Distribution Center
and E-Commerce. Ms. McPherson-Spissu was Vice-President, Distribution Center
from February 2001 to October 2001 and was Divisional Vice President of
Distribution Center from February 2000 to February 2001. From March 1995 to
February 2000, she was Director of the Distribution Center. Ms. McPherson-Spissu
joined us in 1989 as a store associate in our 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.
15.
JOHN NEPPL joined us 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 Vice President, Finance since August 2003. He
joined us in February 2002 as 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 our present knowledge, compliance with federal, state and local
provisions enacted or adopted for protection of the environment has had no
material effect upon our operations.
INTERNET WEBSITE
We make available free of charge through our investor relations website at
www.corporatewindow.com/fl/hott/frame.html our 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. We also make available our
Standards of Business Ethics at www.corporatewindow.com/fl/hott/frame.html.
CERTAIN RISKS RELATED TO THE COMPANY'S BUSINESS
Before deciding to invest in Hot Topic, Inc. or to maintain or increase an
investment in Hot Topic, Inc., 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 other filings with the SEC, including our Quarterly
Reports on Form 10-Q and Current Reports on Form 8-K. The risks described below
are not the only risks we face. Additional risks that are not presently known to
us or that we currently deem immaterial may also affect our business. If any of
these known or unknown risks actually occur, our business, financial condition
and results of operations could be seriously harmed, and our stock price could
decline.
OUR AGGRESSIVE GROWTH STRATEGY ANTICIPATES A SIGNIFICANT NUMBER OF NEW
STORE OPENINGS, WHICH COULD CREATE CHALLENGES WE MAY NOT BE ABLE TO ADEQUATELY
MEET.
Our net sales 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 our 668 stores opened as of January 29, 2005,
115 had been open for less than one full year. We intend to continue to pursue
an aggressive growth strategy for the foreseeable future, and our future
operating results will depend largely upon our ability to open and operate
stores successfully and to profitably manage a larger business. We currently
anticipate opening approximately 110 stores, consisting of 65 Hot Topic and 45
Torrid stores, during fiscal 2005, which will result in a significant increase
in the number of stores we operate. Five of these Hot Topic stores and one of
these Torrid stores were opened as of March 9, 2005. 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
us in our existing stores and markets. In addition, as the number of stores
increases, we may face risks associated with market saturation of our products
and concepts. There can be no assurance that our expansion will not adversely
affect the individual financial performance of our existing stores or our
overall results of operations, or that new stores will achieve sales and
profitability levels consistent with existing stores. Further, there can be no
assurance that we will successfully achieve our expansion targets or, if
achieved, that planned expansion will result in profitable operations.
16.
THIS GROWTH STRATEGY REQUIRES EFFECTIVE UPSCALING OF OUR OPERATIONS, AND WE
MAY NOT BE ABLE TO DO THIS SUFFICIENTLY TO EFFECTIVELY PREVENT NEGATIVE IMPACT
ON OUR OPERATIONS AND FINANCIAL RESULTS.
In order to manage our planned expansion, among other things, we 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 our existing operations; and maintain adequate distribution center
space and information technology and other operations systems.
We have entered into a lease (with a purchase option) for an additional
distribution center facility located in Tennessee, which we expect to be
operational in the second quarter of fiscal 2005, and we face challenges and
risks associated with establishing operations in this facility. In particular,
there are staffing and logistical concerns, as well as financial risks and other
risks associated with opening a significant facility in a site approximately
2,000 miles from our headquarters and current distribution center.
We also need to continually evaluate the adequacy of our management
information and distribution systems. Implementing new systems and changes made
to existing systems could present challenges we do not anticipate and could
impact our business (for example, we experienced some delay in product
distribution during our second quarter of fiscal 2004 upon implementing our new
warehouse management system). We cannot anticipate all of the changing demands
that our expanding operations will impose on our business, systems and
procedures, and our failure to adapt to such changing demands could have a
material adverse effect on our results of operations and financial condition.
Our failure to timely implement initiatives necessary to support our expanding
operations could also materially impact our business.
EXPANDING OUR OPERATIONS TO INCLUDE AN INCREASING NUMBER OF TORRID STORES
AND ANY OTHER NEW CONCEPTS PRESENTS RISKS WE HAVE FACED WITH THE HOT TOPIC
CONCEPT BUT ALSO NEW RISKS DUE TO DIFFERENCES IN CONCEPT OBJECTIVES AND
STRATEGIES.
Our ability to expand into new concepts, and in particular our Torrid
concept, has not been fully tested. Accordingly, the operation of Torrid stores
and the sale of Torrid merchandise over the Internet are subject to numerous
risks, including unanticipated operational 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 Hot Topic concept.
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 concept that concentrates on apparel and fashion,
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. We may not be able to generate continued customer interest in Torrid
stores and products, and the Torrid concept may not be able to support the store
or Internet sales formats. Risks inherent in any new concept are particularly
acute with respect to Torrid, because this is our first significant new venture,
and the nature of the Torrid business differs in certain respects from that of
the Hot Topic business. There can be no assurance that the Torrid stores or
website will achieve sales and profitability levels that justify our investment.
THE SUCCESS OF OUR BUSINESS DEPENDS ON ESTABLISHING AND MAINTAINING GOOD
RELATIONSHIPS WITH MALL OPERATORS AND DEVELOPERS, AND PROBLEMS WITH THOSE
RELATIONSHIPS COULD MAKE IT MORE DIFFICULT FOR US TO EXPAND TO CERTAIN SITES OR
OFFER CERTAIN PRODUCTS.
Any restrictions on our ability to expand to new store sites or to offer a
broad assortment of merchandise could have a material adverse effect on our
business, results of operations and financial condition. If our relations with
mall operators or developers become strained, or we otherwise encounter
difficulties in leasing store sites, we may not grow as planned and may not
reach certain revenue levels and other operating targets. Risks associated with
these relationships are more acute given recent consolidation in that industry,
and we have seen certain increases in expenses as a result of such consolidation
that could continue.
17.
OUR COMPARABLE STORE SALES ARE SUBJECT TO FLUCTUATION RESULTING FROM
FACTORS WITHIN AND OUTSIDE OUR CONTROL, AND LOWER THAN EXPECTED COMPARABLE STORE
SALES COULD IMPACT OUR BUSINESS AND OUR STOCK PRICE.
A variety of factors affects our 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; our ability to efficiently source and
distribute products; changes in our merchandise mix; and our ability to execute
our business strategy efficiently. Our comparable store sales results have
fluctuated significantly in the past and we believe that such fluctuations will
continue. The following table shows our comparable store sales results for
recent periods:
Fiscal Year 2004 2003 2002 2001
----------------------------------------------------------
(2.9)% 7.4% 5.0% 3.9%
FY 2004 FY 2003
-----------------------------------------------
1st Quarter 4.0% 2.6%
2nd Quarter (2.1)% 5.2%
3rd Quarter (4.2)% 10.8%
4th Quarter (6.0)% 8.5%
Past comparable store sales results are not an indicator of future results,
and there can be no assurance that our comparable store sales results will not
decrease in the future. Changes in our comparable store sales results could
cause our stock price to fluctuate substantially.
OUR SUCCESS RELIES ON POPULARITY WITH YOUNG PEOPLE OF MUSIC, POP CULTURE,
AND FASHION TRENDS, AND WE MAY NOT BE ABLE TO REACT TO TRENDS IN A WAY TO
PREVENT DECLINING POPULARITY AND SALES OF OUR PRODUCTS.
Our financial performance is largely dependent upon the continued
popularity of alternative and rock music, the Internet and digital music, 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 our ability to anticipate and keep pace with the music, fashion
and merchandise preferences of our customers. The popularity of particular types
of music, artists, styles, trends and brands is subject to change. Our 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 our results of operations and financial
condition, and on our image with customers. There can be no assurance that our
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
our business, results of operations and financial condition.
ECONOMIC CONDITIONS COULD CHANGE IN WAYS THAT REDUCE OUR SALES OR INCREASE
OUR EXPENSES.
Certain economic conditions affect the level of consumer spending on
merchandise we offer, including, among others, employment levels; salary and
wage levels; interest rates; taxation; and consumer confidence in future
economic conditions. We are 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 or 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 our growth, sales results and
financial performance.
CHANGES IN LAWS, INCLUDING EMPLOYMENT LAWS AND LAWS RELATED TO OUR
MERCHANDISE, COULD MAKE CONDUCTING OUR BUSINESS MORE EXPENSIVE OR CHANGE THE WAY
WE DO BUSINESS.
18.
In addition to increased regulatory compliance requirements, changes in
laws could make ordinary conduct of our business more expensive or require us to
change the way we do business. For example, changes in federal and state minimum
wage laws could raise the wage requirements for certain of our associates, which
would likely cause us to reexamine our entire wage structure for stores. Other
laws related to employee benefits and treatment of employees could also
negatively impact us such as by increasing benefits costs such as medical
expenses. Moreover, changes in product safety or other consumer protection laws
could lead to increased costs to us for certain merchandise, or additional labor
costs associated with readying merchandise for sale. It is often difficult for
us to plan and prepare for potential changes to applicable laws.
TIMING AND SEASONAL ISSUES COULD NEGATIVELY IMPACT OUR FINANCIAL
PERFORMANCE FOR GIVEN PERIODS.
Our 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 our
merchandise mix and overall economic and political conditions.
Our 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 our single most important selling season. We believe 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 our dependence on the Holiday selling season, but
this may not always be the case to the same degree. As is the case with many
retailers of apparel, accessories and related merchandise, we typically
experience lower net sales in the first fiscal quarter relative to other
quarters.
WE HAVE MANY IMPORTANT VENDOR RELATIONSHIPS, AND OUR ABILITY TO GET
MERCHANDISE COULD BE HURT BY CHANGES IN THOSE RELATIONSHIPS AND EVENTS HARMFUL
TO OUR VENDORS COULD IMPACT OUR RESULTS OF OPERATION.
Our financial performance depends on our ability to purchase desired
merchandise in sufficient quantities at competitive prices. Although we may have
many sources of merchandise, substantially all of our music/pop culture-licensed
products are available only from vendors that have exclusive license rights. In
addition, certain of our products are supplied by small, specialized vendors,
some of which create unique products primarily for us. Our smaller vendors
generally have limited resources, production capacities and operating histories,
and some of our vendors have restricted the distribution of their merchandise in
the past. We generally have no long-term purchase contracts or other contractual
assurances of continued supply, pricing or access to new products. There can be
no assurance that we will be able to acquire desired merchandise in sufficient
quantities on acceptable terms 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 our business, results of operations and financial condition.
TECHNOLOGY AND OTHER RISKS ASSOCIATED WITH OUR INTERNET SALES COULD HINDER
OUR OVERALL FINANCIAL PERFORMANCE.
We sell merchandise over the Internet through the websites hottopic.com and
torrid.com. Our Internet operations are subject to numerous risks and pose risks
to our overall business, including, among other things: hiring; retention and
training of personnel to conduct the Internet operations; diversion of sales
from our stores; rapid technological change and the need to invest in additional
computer hardware and software to support sales, customer service and order
fulfillment; 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 our Internet operations will achieve
sales and profitability levels that justify our investment in them.
19.
WE HAVE MADE AND PLAN TO CONTINUE TO MAKE SIGNIFICANT CHANGES TO
INFORMATION SYSTEMS AND SOFTWARE USED IN OPERATION OF OUR BUSINESS, AND WE MAY
NOT BE ABLE TO EFFECTIVELY ADOPT CHANGES IN A WAY TO PREVENT FAILURES IN OUR
OPERATIONS OR NEGATIVE IMPACT ON OUR FINANCIAL PERFORMANCE AND REPORTING.
Over the past several years, we have made improvements to existing hardware
and software systems, as well as implemented new systems. For example, we have
invested approximately $6 million to enhance the functionality of our current
GERS Retail Systems software and to implement new financial system software from
Lawson. In addition, we are investing approximately $10 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. We
expect to significantly increase our reliance on these systems in fiscal 2005.
If these information systems and software do not work effectively, we may
experience delays or failures in our operations. These delays or failures could
adversely impact the promptness and accuracy of our merchandise distribution,
transaction processing, financial accounting and reporting and ability to
properly forecast earnings and cash requirements. For example, in the second
quarter of 2004, we experienced some delay in product distribution upon
implementation of our new warehouse management system. To manage growth of our
operations and personnel, we may need to continue to improve our operational and
financial systems, transaction processing, and procedures and controls, and in
doing so, we could incur substantial additional expenses.
LOSS OF KEY PEOPLE OR AN INABILITY TO HIRE NECESSARY AND SIGNIFICANT
PERSONNEL COULD HURT OUR BUSINESS.
Our financial performance depends largely on the efforts and abilities of
senior management, especially Elizabeth McLaughlin, our Chief Executive Officer,
who has been with us since 1993. We have 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 our management team could have a material
adverse effect on our business, results of operations and financial condition.
Furthermore, there can be no assurance that Ms. McLaughlin and our existing
management team will be able to manage Hot Topic, Inc. or our growth or that we
will be able to attract and retain additional qualified personnel as needed in
the future.
OUR RELIANCE ON UNITED PARCEL SERVICE, TEMPORARY EMPLOYEES AND OTHER
MECHANICS OF SHIPPING OF OUR MERCHANDISE CREATES DISTRIBUTION RISKS AND
UNCERTAINTIES THAT COULD HURT OUR SALES AND BUSINESS.
We rely upon United Parcel Service for our product shipments, including
shipments to and from a significant number of our stores. Our reliance on this
source for shipments is subject to risks, including employee strikes and
inclement weather, associated with United Parcel Service's ability to provide
delivery services that adequately meet our shipping needs. We are also dependent
upon temporary associates to adequately staff our distribution facility,
particularly during busy periods such as the Holiday season and while multiple
stores are opening. There can be no assurance that we will continue to receive
adequate assistance from our temporary associates, or that there will continue
to be sufficient sources of temporary associates. Additionally, certain products
are imported and subject to delivery delays based on availability and ports
capacity.
THERE IS A RISK WE COULD ACQUIRE MERCHANDISE WITHOUT FULL RIGHTS TO SELL
IT, WHICH COULD LEAD TO DISPUTES OR LITIGATION AND HURT OUR FINANCIAL
PERFORMANCE AND STOCK PRICE.
We purchase licensed merchandise from a number of suppliers who hold
manufacturing and distribution rights under the terms of certain licenses. We
generally rely upon vendors' representations concerning manufacturing and
distribution rights and do not independently verify whether these vendors
legally hold adequate rights to licensed properties they are manufacturing or
distributing. If we acquire unlicensed merchandise, we could be obligated to
remove such merchandise from our stores, incur costs associated with destruction
of merchandise if the distributor is unwilling or unable to reimburse us, 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 our business, results of
operations and financial condition.
20.
WE FACE INTENSE COMPETITION, AND AN INABILITY TO ADEQUATELY ADDRESS IT, OR
THE SUCCESS OF OUR COMPETITORS, COULD LIMIT OR PREVENT OUR BUSINESS GROWTH AND
SUCCESS.
The retail apparel and accessory industry is highly competitive. We compete
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,
Charlotte Russe Inc., Claire's Stores, Inc., Forever 21, Pacific Sunwear of
California, Inc., Spencer Gifts, Inc., H&M, The Buckle, Wet Seal, Inc., and
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., Old Navy (a division of Gap Inc.), 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 our competitors are
larger and may have greater financial, marketing and other resources. Direct
competition with these and other retailers may increase significantly in the
future, which could require us, among other things, to lower our prices.
Increased competition could have a material adverse effect on our business,
results of operations and financial condition.
WAR, TERRORISM AND OTHER CATASTROPHES COULD NEGATIVELY IMPACT OUR
CUSTOMERS, PLACES WHERE WE DO BUSINESS, AND OUR EXPENSES, ALL OF WHICH COULD
HURT OUR BUSINESS.
The effects of war or acts of terrorism could have a material adverse
effect on our 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. 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, our 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. Our principal executive offices, distribution center and a
significant number of our stores are located in California. If we experience a
sustained disruption in energy supplies, or if electricity and gas costs in
California fluctuate dramatically, our 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 our facilities could have a material adverse impact on our
business, financial condition and operating results.
THERE ARE NUMEROUS RISKS THAT COULD CAUSE OUR STOCK PRICE TO FLUCTUATE
SUBSTANTIALLY.
Our 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 our stock price without regard
to our financial performance. In addition, we believe that factors such as
quarterly fluctuations in our financial results and comparable store sales;
announcements by other apparel, accessory and gift item retailers; the trading
volume of our stock; changes in estimates of our performance by securities
analysts; overall economic and political conditions; the condition of the
financial markets; and other events or factors outside of our control could
cause our stock price to fluctuate substantially.
21.
OUR CHARTER DOCUMENTS AND OTHER CIRCUMSTANCES COULD PREVENT A TAKEOVER OR
CAUSE DILUTION OF OUR EXISTING SHAREHOLDERS, WHICH COULD BE DETRIMENTAL TO
EXISTING SHAREHOLDERS AND HINDER BUSINESS SUCCESS.
Our Articles of Incorporation and Bylaws contain provisions that may have
the effect of delaying, deterring or preventing a takeover of Hot Topic, Inc.
For instance, our 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 our Bylaws prohibit shareholder action by written consent.
Additionally, our 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 certain
shareholders, and potentially prohibit a takeover of Hot Topic, Inc. by
requiring the preferred shareholders to approve such a transaction.
We also have a significant number of authorized and unissued shares of our
common stock available under our Articles of Incorporation. These shares provide
us with the flexibility to issue our 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 could result in dilution to our shareholders.
WE INCUR COSTS ASSOCIATED WITH REGULATORY COMPLIANCE, AND THIS COST COULD
BE SIGNIFICANT.
All companies are subject to laws and regulations, some of which require
certain actions to be taken (or not taken) and costs to be incurred relating to
business processes and risk management. There are additional requirements for
public companies, including the provisions of the Sarbanes-Oxley Act of 2002.
With regard to the Sarbanes-Oxley Act, we have and will continue to incur
significant expense as we continue to address the implications of applicable
rules and our operations relative thereto, and as we work to respond to and
comply with applicable requirements. Among other things, we have incurred and
will incur additional expenses as we implement Section 404 of the Sarbanes-Oxley
Act. Section 404 requires management to report on, and our independent auditors
to attest to, our internal controls. Compliance with these rules could also
result in continued diversion of management's time and attention, which could be
disruptive to normal business operations.
If we do not satisfactorily or timely comply with these requirements,
possible consequences could include sanction or investigation by regulatory
authorities such as the Securities and Exchange Commission or the Nasdaq
National Market, incomplete or late filing of our annual report on Form 10-K, or
civil or criminal liability. Our stock price and business could also be
adversely affected.
THERE ARE LITIGATION AND OTHER CLAIMS AGAINST US FROM TIME TO TIME, WHICH
COULD DISTRACT MANAGEMENT FROM OUR BUSINESS ACTIVITIES, AND COULD LEAD TO
ADVERSE CONSEQUENCES TO OUR BUSINESS AND FINANCIAL CONDITION.
As a growing company with expanding operations, we are increasingly
involved from time to time with litigation and other claims against us. These
arise primarily in the ordinary course of our business, and include employee
claims, commercial disputes, intellectual property issues and product-oriented
allegations. Often these cases raise complex factual and legal issues, which are
subject to risks and uncertainties and which could require significant
management time. Although we do not currently believe that the outcome of any
current litigation and claims against us will have a material adverse effect on
us, adverse settlements or resolutions may occur and negatively impact earnings,
injunctions against us could have an adverse effect on our business by requiring
us to do or prohibiting us from doing certain things, and other unexpected
events could have a negative impact on us.
22.
RECENT ACCOUNTING REGULATION CHANGES WILL REQUIRE THE EXPENSING OF STOCK
OPTIONS.
Recently effective accounting regulation changes require that all publicly
traded companies begin recording compensation expense related to all unvested
and newly granted stock options prospectively for interim or annual periods
beginning after June 15, 2005. Currently, we include such expenses on a pro
forma basis in the notes to our quarterly and annual financial statements in
accordance with accounting principles generally accepted in the United States of
America and do not include compensation expense related to stock options in our
reported earnings in the financial statements. When we begin expensing stock
options as provided above, our reported earnings will be negatively impacted and
our stock price could decline.
ITEM 2. PROPERTIES
We lease all of our existing store locations, with lease terms expiring
between 2005 and 2015. At January 29, 2005, we had a total of 1,214,424 leased
store square feet (Hot Topic and Torrid stores) with an average store size of
1,810 square feet (Hot Topic and Torrid stores). The leases for most of the
existing stores are for approximately 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.
We lease our headquarters and distribution center facility, located in City
of Industry, California, which is approximately 250,000 square feet. Our lease
expires April 2014, and the annual base rent is approximately $1,110,000. We
have entered into a lease (with a purchase option) for an additional
distribution center facility in Tennessee, which is approximately 300,000 square
feet, which we expect to be operational by the end of the second quarter of
fiscal 2005.
ITEM 3. LEGAL PROCEEDINGS
On June 23, 2004, a non-profit corporation named Center for Environmental
Health filed a lawsuit in Federal district court in Alameda, California against
over two dozen retailers, large and small, including Hot Topic, Inc. Other
defendants include teen retailers like Claire's and Wet Seal, department stores
like Sears, Nordstrom, Macy's and J.C. Penney, and large retailers like Wal-Mart
and Target. Certain of the defendants, but not Hot Topic, were also named
defendants in a substantially similar lawsuit filed by the State of California.
The complaint in each case alleges, in general, that the defendant retailers
have violated certain California statutes by not providing sufficient warning
about an alleged potential for lead exposure relating to costume jewelry sold in
stores. The complaints do not contain allegations of personal injury. In August
2004, we were served another complaint, filed in the Circuit Court of Shelby
County, Tennessee, claiming we are liable due to alleged lead content in our
costume jewelry we allegedly target to children. This complaint is an alleged
class action, again excluding any personal injury claim, with counts of
negligence and breach of implied warranty. Similar claims had been made, prior
to service upon us, against other retailers in the same jurisdiction by
plaintiffs represented by the same law firm. Currently, a motion to dismiss is
under consideration by the court in a separate case against another retailer,
and the Tennessee case against us has been delayed pending the court's ruling on
that motion. We expect to file a similar motion to dismiss for our case. The
plaintiffs in the above California cases seek unspecified fines and penalties,
attorneys' fees and costs, and injunctive and other equitable relief; and the
plaintiff in the Tennessee case seeks unspecified money damages, punitive
damages, attorneys' fees and injunctive relief on behalf of the alleged class.
We continue to evaluate appropriate action in each of these cases with our
counsel. In each case, we believe we have meritorious defenses to the
plaintiff's claims and intend to defend against such claims; though it is
impossible to predict the outcome of the proceeding, and it is possible the
plaintiff will be awarded requested remedies or that we may determine it
appropriate to settle the lawsuit which could require us to take or not take
certain actions.
On September 17, 2004, a former Torrid employee filed a lawsuit against us
in Superior Court of Los Angeles County, on behalf of a purported class. The
lawsuit asserts claims for failure to provide adequate meal or rest breaks,
improper payment of overtime wages, failure to timely pay wages at end of
employment and unfair business practices. The lawsuit seeks compensatory
damages, statutory penalties, punitive damages, attorneys' fees and injunctive
relief. On October 21, 2004, we filed an answer denying the material allegations
of the complaint, and we intend to vigorously defend ourselves against the
various claims. Discovery has begun in connection with this matter but at the
present time we are unable to predict the outcome of this matter.
23.
On November 18, 2004, a former Torrid employee filed a lawsuit against us
in Superior Court of Los Angeles County, on behalf of a purported class. The
lawsuit asserts claims for, among other things, failure to pay overtime wages
and unfair business practices. The lawsuit seeks compensatory damages, statutory
penalties, restitution, interest and other costs, and attorneys' fees. We intend
to vigorously defend ourselves against the various claims, though at the present
time we are unable to predict the outcome of this matter.
Though significant litigation or awards against us could seriously harm our
business and financial results, we do not at this time expect any of the
above-described litigation to have a material adverse effect on us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
24.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Our Common Stock is traded on the Nasdaq National Market under the symbol
"HOTT." The following table shows, for the periods indicated, the high and low
end-of-day closing sales prices of our shares of Common Stock, 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.
2004 FISCAL YEAR QUARTERS HIGH LOW
------------------------------------------------------
First Quarter $30.79 $21.78
Second Quarter $22.91 $14.87
Third Quarter $20.56 $14.49
Fourth Quarter $20.95 $15.46
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
On August 12, 2003, we announced that our Board of Directors approved a
three-for-two stock split (in the form of a dividend) of our 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 9, 2005, the last sales price of our common stock as reported on
the Nasdaq National Market was $23.05 per share. As of March 9, 2005, there were
approximately 208 holders of record of our common stock. This number does not
reflect the actual number of beneficial holders of our common stock, which we
believe to be in excess of 25,000 holders.
On March 19, 2004, we announced that our Board of Directors approved the
repurchase of up to an aggregate of 2,000,000 shares of our common stock during
the period ending January 29, 2005. As of July 31, 2004 we had completed the
repurchase of 2,000,000 shares of our common stock at a cost of $46.8 million at
an average price of $23.41.
On August 18, 2004, we announced that our Board of Directors approved an
additional repurchase of up to an aggregate of 2,000,000 shares of our common
stock during the period ending January 29, 2005. As of January 29, 2005 we had
completed the repurchase of 2,000,000 shares of our common stock at a cost of
$32.8 million at an average price of $16.42. The following table summarizes
activity in the quarter ended January 29, 2005.
25.
ISSUER PURCHASES OF EQUITY SECURITIES
- -------------------------------------------------------------------------------------------------------------------------
TOTAL NUMBER OF
SHARES PURCHASED AS MAXIMUM NUMBER OF
PART OF PUBLICLY SHARES THAT MAY YET BE
TOTAL NUMBER OF AVERAGE PRICE PAID ANNOUNCED PLANS OR PURCHASED UNDER THE
FISCAL PERIOD SHARES PURCHASED PER SHARE PROGRAMS PLANS OR PROGRAMS
- ------------------------ ---------------- ------------------ ------------------- ----------------------
November 28, 2004 -
January 1, 2005 1,000,000 $15.98 2,000,000 -
---------------- ------------------ ------------------- ----------------------
Total 1,000,000 $15.98 2,000,000 -
================ ================== =================== ======================
We have not paid any cash dividends since inception and do not anticipate
paying any cash dividends in the foreseeable future.
Please see Item 12 for information about our equity compensation plans.
ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes selected financial data for each of the five
fiscal years in the period ended January 29, 2005 and have been restated to
reflect adjustments that are discussed further in Note 2. "Restatement of
Financial Statements" in the Notes to Consolidated Financial Statements included
in Item 8. "Financial Statements and Supplementary Data" in this Form 10-K. 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 included elsewhere in this Annual Report on Form 10-K.
26.
Fiscal Year (as restated)
--------------------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- --------- --------- ---------
(In thousands, except per share data, number of stores, comparable store
sales and sales per square foot)
Statement of Operations Data:
Net sales $ 656,468 $ 572,039 $ 443,250 $ 336,094 $ 257,187
Cost of goods sold, including buying, distribution
and occupancy costs 422,712 352,277 274,008 205,756 154,765
--------- --------- --------- --------- ---------
Gross margin 233,756 219,762 169,242 130,338 102,422
Selling, general and administrative expenses 170,384 143,952 115,634 86,950 67,917
--------- --------- --------- --------- ---------
Operating income 63,372 75,810 53,608 43,388 34,505
Interest income, net 919 1,318 1,371 1,884 1,925
--------- --------- --------- --------- ---------
Income before income taxes 64,291 77,128 54,979 45,272 36,430
Provision for income taxes 24,618 29,539 20,892 17,146 13,479
--------- --------- --------- --------- ---------
Net income $ 39,673 $ 47,589 $ 34,087 $ 28,126 $ 22,951
========= ========= ========= ========= =========
Net income per share:
Basic $ 0.86 $ 1.00 $ 0.72 $ 0.61 $ 0.52
Diluted $ 0.83 $ 0.96 $ 0.69 $ 0.56 $ 0.48
Weighted average shares outstanding:
Basic 46,379 47,479 47,027 46,467 44,502
Diluted 47,875 49,588 49,276 49,829 48,104
Selected Operating Data:
Number of stores at year end 668 554 445 352 274
Comparable stores sales (2.9)% 7.4% 5.0% 3.9% 16.7%
Average sales per square foot $ 571 $ 619 $ 619 $ 636 $ 669
Average sales per store $ 1,034 $ 1,106 $ 1,064 $ 1,036 $ 1,020
Balance Sheet Data:
Cash and short-term investments $ 66,339 $ 128,205 $ 83,418 $ 71,310 $ 51,288
Working capital 87,221 141,803 90,261 82,370 61,253
Total assets 278,395 296,082 215,854 169,904 123,317
Shareholders' equity $ 187,562 $ 221,279 $ 158,756 $ 133,738 $ 98,135
27.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of our results of operations, financial condition
and liquidity, and other matters should be read in conjunction with our
Consolidated Financial Statements and Notes related 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 our 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
We are a mall-based specialty retailer operating the Hot Topic and Torrid
store concepts. Hot Topic stores sell 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. Torrid stores sell
apparel, lingerie, shoes and accessories designed for various lifestyles for
plus-size females between the ages of 15 and 29. We opened our first Hot Topic
store in 1989 and our first Torrid store in 2001. At the end of fiscal 2004 (the
fiscal year ended January 29, 2005), we operated 592 Hot Topic stores throughout
the United States and Puerto Rico, and 76 Torrid stores. We also sell
merchandise on two websites, www.hottopic.com ("hottopic.com") and
www.torrid.com ("torrid.com"), which reflect the Hot Topic and Torrid store
concepts and carry merchandise similar to that sold in the respective stores.
We consider 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 2004, 471 of the 592 Hot
Topic stores were included in the comparable store base, compared to 401 of the
502 stores open at the end of fiscal 2003. At the end of fiscal 2004, 46 of the
76 Torrid stores were included in the comparable store base, compared to 22 of
the 52 stores open at the end of fiscal 2003.
We operate on a 52 or 53-week fiscal year, which ends on the Saturday
nearest to January 31. Fiscal 2004, 2003 and 2002 were 52-week fiscal years.
See Note 2 to the Consolidated Financial Statements included in this report
for a summary of changes related to accounting of leases on our consolidated
balance sheet as of January 31, 2004, as well as our consolidated statements of
income and cash flows for the fiscal years ended January 31, 2004 and February
1, 2003. This Management's Discussion and Analysis gives effect to those
corrections.
28.
RESULTS OF OPERATIONS
The following table shows, for the periods indicated, certain selected
statement of operations data expressed as a percentage of net sales and certain
store data:
FISCAL YEAR
-------------------------------
2004 2003 2002
---- ---- ----
Net sales 100.0% 100.0% 100.0%
Cost of goods sold, including
buying, distribution & occupancy
costs 64.4% 61.6% 61.8%
----- ----- -----
Gross margin 35.6% 38.4% 38.2%
Selling, general and administrative expenses 25.9% 25.1% 26.1%
----- ----- -----
Operating income 9.7% 13.3% 12.1%
Interest income, net 0.1% 0.2% 0.3%
---- ---- ----
Income before income tax 9.8% 13.5% 12.4%
Provision for income taxes 3.8% 5.2% 4.7%
---- ---- ----
Net income 6.0% 8.3% 7.7%
==== ==== ====
Number of stores at year end 668 554 445
Comparable store sales (2.9)% 7.4% 5.0%
FISCAL 2004 COMPARED TO FISCAL 2003
Net sales increased approximately $84.4 million, or 14.8%, to $656.5
million in fiscal 2004 from $572.0 million in fiscal 2003. The components of
this $84.4 million increase in net sales are as follows:
AMOUNT
($ MILLIONS) DESCRIPTION
------------ -----------------------------------------------------------
$75.6 Net sales from new Hot Topic stores opened during fiscal
2004 and Hot Topic stores not yet qualifying as comparable
stores
19.2 Net sales from new Torrid stores opened during fiscal 2004
and Torrid stores not yet qualifying as comparable stores
(14.4) 2.9% decrease in comparable store net sales in fiscal 2004
compared to fiscal 2003
4.0 Increase in Internet sales (hottopic.com and torrid.com)
-----------
$84.4 TOTAL
===========
The annual average Hot Topic store volume decreased to $1.05 million in
fiscal 2004 from $1.13 million in fiscal 2003. Hot Topic sales of apparel
category merchandise, as a percentage of total net sales, were 53% in fiscal
2004 compared to 52% in fiscal 2003. The increase in apparel was primarily due
to increases in men's music-related tee shirts partially offset by decreases in
women's bottoms, men's fashion tops and men's bottoms.
29.
Gross margin increased approximately $14.0 million to $233.8 million in
fiscal 2004 from $219.8 million in fiscal 2003. As a percentage of net sales,
gross margin decreased to 35.6% in fiscal 2004 from 38.4% in fiscal 2003. The
significant components of this 2.8% decrease in gross margin, as a percentage of
net sales, are as follows:
% DESCRIPTION
------------ -----------------------------------------------------------
(2.1)% Decrease in merchandise margin, principally due to higher
markdown activity driven by lower comparable store sales
(0.5) Increase in occupancy and store depreciation expenses,
primarily due to deleveraging over lower comparable store
sales
(0.2) Increase in distribution expenses and buying costs,
primarily due to higher freight costs and deleveraging
payroll costs over lower comparable store sales
-----------
(2.8)% TOTAL
===========
Selling, general and administrative expenses increased approximately $26.4
million to $170.4 million during fiscal 2004 from $144.0 million during fiscal
2003. As a percentage of net sales, selling, general and administrative expenses
were 25.9% for fiscal 2004 compared to 25.1% in fiscal 2003. The total dollar
increase in selling, general and administrative expenses was primarily
attributable to an increase in the number of retail stores from 554 at the end
of fiscal 2003 to 668 at the end of fiscal 2004 and the corresponding additional
payroll and other expenses required to support these additional stores. The
significant components of this 0.8% increase in selling, general and
administrative expenses as a percentage of net sales are as follows:
% DESCRIPTION
------------ -----------------------------------------------------------
0.5% Increase in store payroll due to deleveraging of payroll
costs over lower comparable store sales, and increase in
payroll-related benefits costs, partially offset by lower
store bonus payouts
0.5% Increase in other store expenses as a result of
deleveraging expenses over lower comparable store sales
along with increases in store supply costs and expenses
related to our wide area network
0.1% Increase in depreciation and amortization as a result of
our new warehouse management software implemented during
2004 and higher marketing expenses to support new
advertising programs.
(0.3)% Decrease in other general and administrative expenses
primarily due to a decrease in performance based
compensation, partially offset by an increase in payroll
related benefits costs and an increase in professional
fees related to implementing Section 404 of the
Sarbanes-Oxley Act
------------
0.8% TOTAL
============
Operating income decreased approximately $12.4 million to $63.4 million
during fiscal 2004 from $75.8 million during fiscal 2003. As a percentage of net
sales, operating income was 9.7% in fiscal 2004 compared to 13.3% in fiscal
2003. Operating income on an average store basis was approximately $103,000 in
fiscal 2004 as compared to $151,000 in fiscal 2003.
30.
Net interest income decreased to $0.9 million in fiscal 2004 from $1.3
million in fiscal 2003, principally due to lower average cash balances, which
was primarily a result of cash used for purposes of common stock repurchases.
Our effective tax rate was 38.3% in both fiscal 2004 and 2003.
FISCAL 2003 COMPARED TO FISCAL 2002
Net sales increased approximately $128.8 million, or 29.1%, to $572.0
million in fiscal 2003 from $443.2 million in fiscal 2002. The components of
this $128.8 million increase in net sales are as follows:
AMOUNT
($ MILLIONS) DESCRIPTION
------------ -----------------------------------------------------------
$71.5 Net sales from new Hot Topic stores opened during fiscal
2003 and Hot Topic stores not yet qualifying as comparable
stores
20.3 Net sales from new Torrid stores opened during fiscal 2003
and Torrid stores not yet qualifying as comparable stores
29.1 7.4% increase in comparable store net sales in fiscal 2003
compared to fiscal 2002
7.9 Increase in Internet sales (hottopic.com and torrid.com)
------------
$128.8 TOTAL
============
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 $50.6 million to $219.8 million in
fiscal 2003 from $169.2 million in fiscal 2002. As a percentage of net sales,
gross margin increased to 38.4% in fiscal 2003 from 38.2% in fiscal 2002. The
significant components of this 0.2% improvement in gross margin, as a percentage
of net sales, are as follows:
% DESCRIPTION
------------ -----------------------------------------------------------
0.4% Decrease in distribution expenses, primarily due to
significant savings in freight costs, due to change in
shipping method to stores, and labor costs, due to
productivity improvements
0.2 Decrease in store depreciation as a result of leverage
gained from higher comparable store sales, partially offset
by an increase in store occupancy resulting from higher rent
expenses and common area charges
(0.4) Decrease in merchandise margin, principally due to lower
initial markup and higher shrinkage, partially offset by
lower markdowns.
------------
0.2% TOTAL
============
31.
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
significant components of this 1.0% decrease in selling, general and
administrative expenses as a percentage of net sales are as follows:
% DESCRIPTION
------------ -----------------------------------------------------------
(1.2)% Decrease in store payroll and administrative salary expense
resulting from leverage gained from higher comparable store
sales and controlling payroll costs
(0.1) Decrease in pre-opening expenses
0.3 Increase in administrative performance based payroll
expenses, partially offset by headquarters expenses which
benefited from leverage gained from higher comparable store
sales
-----------
(1.0)% TOTAL
===========
Operating income increased approximately $22.2 million to $75.8 million
during fiscal 2003 from $53.6 million during fiscal 2002. As a percentage of net
sales, operating income was 13.3% in fiscal 2003 compared to 12.1% in fiscal
2002. Operating income on an average store basis was approximately $151,000 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.
Our 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.
QUARTERLY RESULTS AND SEASONALITY
Our 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 our
merchandise mix and overall economic and political conditions.
Our 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 our
single most important selling season. We believe, 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 our 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 our sales over a longer period. As is the case with many retailers of
apparel, accessories and related merchandise, we typically experience lower
first fiscal quarter net sales relative to other quarters.
32.
The following table shows certain statement of operations and selected
operating data for each of our last eight fiscal quarters (13 week periods). See
Note 2 to the Consolidated Financial Statements for changes related to
accounting for leases, which are reflected in the amounts below. The quarterly
statement of operations data and selected operating data shown below were
derived from our unaudited financial statements, which in the opinion of
management contain all adjustments (consisting only of normal recurring
adjustments) necessary for fair presentation. Results in any quarter are not
necessarily indicative of results that may be achieved for a full year.
FISCAL YEAR 2004 (AS RESTATED) FISCAL YEAR 2003 (AS RESTATED)
------------------------------------------- ------------------------------------------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
----- ------ ----- ------ ----- ------ ----- ------
(In thousands, except selected operating and per share data)
STATEMENT OF OPERATIONS DATA:
Net sales $128,143 $136,263 $180,808 $211,254 $100,657 $115,728 $161,546 $194,108
Gross margin 44,185 46,650 64,540 78,381 35,350 41,397 62,754 80,261
Operating income 8,200 7,135 19,987 28,050 6,501 9,090 24,128 36,091
Net income $5,277 $4,528 $12,448 $17,420 $4,254 $5,740 $15,093 $22,502
Net income per share:
Basic $0.11 $0.10 $0.27 $0.39 $0.09 $0.12 $0.32 $0.47
Diluted $0.11 $0.09 $0.26 $0.38 $0.09 $0.12 $0.30 $0.45
Weighted average shares outstanding:
Basic 48,019 46,565 46,086 44,944 46,968 47,360 47,656 47,932
Diluted 50,131 48,023 47,202 46,127 48,567 49,127 49,917 50,342
SELECTED OPERATING DATA:
Comparable stores sales 4.0% (2.1)% (4.2)% (6.0)% 2.6% (5.2)% 10.8% 8.5%
Stores open at end of period 581 613 649 668 468 497 540 554
LIQUIDITY AND CAPITAL RESOURCES
In recent years, we have satisfied our cash requirements principally from
cash flows from operations and to a lesser extent proceeds from the exercise of
stock options. During the last three fiscal years, our primary uses of cash have
been to finance store openings and purchase merchandise inventories, as well as
periodic repurchases of our common stock. In August 2004, we announced the
approval by our Board of Directors of the repurchase of up to 2,000,000 shares
of our common stock. As of January 29, 2005 we had completed the repurchase of
2,000,000 shares of our common stock at an average price of $16.42. In addition,
pursuant to authorization by our Board of Directors in March 2004, we
repurchased 2,000,000 shares of our common stock at an average price of $23.41
during the six months ended July 31, 2004. We also maintain a $5.0 million
unsecured credit agreement for the purpose of issuing letters of credit,
primarily for inventory purchases. At January 29, 2005, we had $0.1 million of
outstanding letters of credit under the credit agreement. At the end of fiscal
33.
2004, we had $66.3 million in cash, cash equivalents and short-term investments,
a decrease of $61.9 million, or 48%, compared to the $128.2 million at the end
of fiscal 2003. Working capital was $87.2 million, $141.8 million, and $90.3
million for fiscal 2004, 2003 and 2002, respectively. The decrease in working
capital from 2003 to 2004 is primarily attributable to cash used for the
repurchase of our common stock.
Net cash flows provided by operating activities were $71.1 million, $78.6
million and $64.8 million in fiscal 2004, 2003, and 2002, respectively. The $7.5
million decrease in cash flows from operating activities in fiscal 2004 as
compared to fiscal 2003 was primarily attributable to decreases in net income,
accrued liabilities and tax benefits from exercise of stock options, partially
offset by increases in deferred rent, deferred taxes, and depreciation and
amortization, and decrease in the change of inventory compared to fiscal 2003.
The significant changes in net cash provided by operating activities were due
primarily to the increase in store growth to 668 stores at the end of fiscal
2004 compared to 554 stores at the end of fiscal 2003.
Net cash flows used in investing activities were $2.6 million, $88.2
million and $41.6 million in fiscal 2004, 2003 and 2002, respectively. In fiscal
2004, approximately $39 million was used for the construction of 91 Hot Topic
stores, 24 Torrid stores, expansion and refurbishment of ten Hot Topic and
Torrid stores and progress payments for construction of stores opening in early
fiscal 2005. We used approximately $14 million on computer hardware and software
and $5 million on our headquarters and distribution center infrastructure. We
opened 115, 109, and 95 stores in fiscal 2004, 2003 and 2002, respectively. Net
cash used in investing activities was reduced by the net proceeds ($55 million)
of short-term investments sold.
Net cash flows used in financing activities were $75.1 million in fiscal
2004 compared to net cash flows provided by financing activities of $8.3 million
and net cash flows used in financing activities of $14.3 million in fiscal 2003
and 2002, respectively. The $83.5 million decrease in fiscal 2004 compared to
fiscal 2003 was principally a result of $79.6 million of cash used to repurchase
our common stock in fiscal 2004 and $3.9 million related to a decrease in
proceeds from exercise of stock options.
We anticipate that we will spend approximately $56 million on capital
expenditures in fiscal 2005, including approximately $38 million for stores, $10
million for the second distribution center located in Tennessee, and $8 million
for computer hardware and software. The $38 million for stores is to be
primarily used for the construction of 65 Hot Topic stores and 45 Torrid stores,
and expansion of approximately 20 existing stores.
During fiscal 2004, our average gross capital expenditures for a new Hot
Topic store, including leasehold improvements and furniture and fixtures,
totaled approximately $235,000. The average initial gross inventory for the new
Hot Topic stores opened in 2004 was approximately $110,000 and the average
pre-opening costs for a new Hot Topic store were approximately $21,000. Initial
inventory requirements vary at new stores depending on the season and current
merchandise trends. We expect the average total cost per square foot associated
with opening a Hot Topic store to be approximately the same in fiscal 2005 as
those in fiscal 2004. Hot Topic stores are planned to be approximately 1,700
square feet compared to Torrid stores which are planned to be approximately
2,500 square feet. The costs associated with opening a new Torrid store will be
higher than a Hot Topic store primarily due to the larger size of the Torrid
stores. The actual costs that we will incur in connection with opening future
stores cannot be predicted with precision because such costs will vary based
upon, among other things, geographic location, store size, and the extent of the
build-out required at the selected sites.
The following table summarizes our contractual obligations as of January
29, 2005, and the timing and effect that such commitments are expected to have
on our liquidity and capital requirements in future periods:
34.
PAYMENTS DUE BY PERIOD ($ IN THOUSANDS)
-----------------------------------------------------------------------
MORE THAN
CONTRACTUAL OBLIGATIONS TOTAL WITHIN 1 YEAR 2-3 YEARS 4-5 YEARS 5 YEARS
----- ------------- --------- --------- -----------
OPERATING LEASES $339,423 $45,969 $90,538 $82,495 $120,421
PURCHASE OBLIGATIONS 55,624 55,624 - - -
LETTERS OF CREDIT AND OTHER OBLIGATIONS 3,283 3,021 262 - -
-----------------------------------------------------------------------
TOTAL CONTRACTUAL OBLIGATIONS $398,330 $104,614 $90,800 $82,495 $120,421
=======================================================================
See Note 6 to our consolidated financial statements for additional
disclosure related to operating lease obligations.
On March 19, 2004, we announced that our Board of Directors approved the
repurchase of up to an aggregate of 2,000,000 shares of our common stock during
the period ending January 29, 2005. As of July 31, 2004 we had completed the
repurchase of 2,000,000 shares of our common stock at a cost of $46.8 million at
an average price of $23.41.
On August 18, 2004, we announced that our Board of Directors approved an
additional repurchase of up to an aggregate of 2,000,000 shares of our common
stock during the period ending January 29, 2005. As of January 29, 2005 we had
completed the repurchase of 2,000,000 shares of our common stock at a cost of
$32.8 million at an average price of $16.42.
We believe that our existing cash balances and cash generated from
operations will be sufficient to fund our operations, planned expansion and
repurchase of our common stock through at least the next 12 months.
CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of Hot Topic, Inc.'s financial
condition and results of operations are based upon our 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 us 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, we
evaluate estimates, including those related primarily to inventories, long-lived
assets and contingencies. We base our estimates on historical experience and on
various other assumptions that we believe 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.
We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements. For a further discussion about the application of these
and other accounting policies, see Note 1 to our 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 25% to 50% of the original retail price. Typically, 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 our estimated markdowns at
year-end prove to be insufficient, additional future markdowns will need to be
recorded.
35.
VALUATION OF LONG-LIVED ASSETS: We assess 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. If we were to determine 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, we would measure any impairment based on a projected
discounted cash flow method using a discount rate determined by management. To
date, we have not recorded any significant 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 we believe 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
our retail store locations and websites, less merchandise returned by customers.
We provide 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. Shipping and handling revenues from our websites are
included as a component of net sales.
RENT EXPENSE: Rent expense under our operating leases typically provide for
fixed non-contingent rent escalations. We recognize rent expense on a
straight-line over the non-cancelable term of each lease, commencing when we
take possession of the property. Construction allowances are recorded as a
deferred rent liability, which we amortize as a reduction of rent expense over
the non-cancelable term of each lease.
SELF-INSURANCE: We are self-insured for medical insurance coverage and
workers compensation insurance coverage, up to maximum exposure limits, above
which we are covered by insurance policies. We maintain a liability for
estimated claims based on historical claims experience and other actuarial
assumptions.
INCOME TAXES: Current income tax expense is the amount of income taxes
expected to be payable for the current year. The combined federal, state and
local income tax expense is calculated using estimated effective annual tax
rates. A deferred income tax asset or liability is established for the expected
future consequences of temporary differences in the financial reporting and tax
bases of assets and liabilities. We consider future taxable income and ongoing
prudent and feasible tax planning in assessing the value of our deferred tax
assets. Evaluating the value of these assets is necessarily based on our
judgment. If we were to determine that it is more likely than not that these
assets will not be realized, we would reduce the value of these assets to their
expected realizable value through a valuation allowance, thereby decreasing net
income. If we subsequently were to determine that the deferred tax assets, which
had been written down, would be realized in the future, the value of the
deferred tax assets would be increased, thereby increasing net income in the
period when that determination was made. We have recorded tax contingencies
based on our estimates of current tax exposures and adjust our estimates as
circumstances or regulations change.
INFLATION
We do not believe that inflation has had a material adverse effect on our
net sales or results of operations. We have generally been able to pass along
increased costs related to inflation through increases in selling prices.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are not a party to any derivative financial instruments. Our exposure to
market risk primarily relates to changes in interest rates on our investments
with maturities of less than three months (which are considered to be cash and
cash equivalents) and 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
Our consolidated financial statements and notes listed in Item 15(a) are
incorporated herein by reference.
36.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
a) CONCLUSION REGARDING THE EFFECTIVENESS OF DISCLOSURE CONTROLS AND PROCEDURES
The management of the company maintains disclosure controls and procedures
that are designed to ensure that the information required to be disclosed in our
reports under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), is recorded, processed, summarized and reported within the time periods
specified in the Security and Exchange Commissions's (the "SEC") rules and
forms, and that such information is accumulated and communicated to management,
including the Chief Executive Officer ("CEO") and Chief Financial Officer
("CFO"), as appropriate, to allow timely decisions regarding required
disclosure.
A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. Because of inherent limitations, our disclosure controls and
procedures may not prevent or detect misstatements. In addition, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, have been detected.
We conducted an evaluation of the effectiveness of the design and operation
of our disclosure controls and procedures in connection with the preparation of
this annual report, under the supervision of and with the participation of our
management, including the CEO and CFO.
In making our assessment, we used the criteria set forth by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control--Integrated Framework. Based on that evaluation, our CEO and CFO
concluded that our disclosure controls and procedures were not effective as of
January 29, 2005, for the following reason: On March 2, 2005, we announced that
our financial statements were to be restated, relating to certain lease
accounting and leasehold depreciation accounting practices, consistent with
similar adjustments made by many other retailers and other publicly traded
companies concerning these practices. This restatement is described elsewhere in
this annual report. Although prior to the end of fiscal 2004, management
surfaced certain lease accounting issues based upon the internal control
practice of reviewing industry publications and financial statement filings and
brought this to the attention of our independent registered public accounting
firm, the decision to modify our lease accounting policy and practices was not
made prior to the end of the fiscal year. Our conclusion to change our
accounting policy and restate was made, among other things, in consideration of
the views of the Office of the Chief Accountant of the SEC expressed in its
letter related to these matters dated February 7, 2005. Accordingly, we
concluded that our controls over the selection of appropriate assumptions and
factors affecting lease accounting practices were not effective as of January
29, 2005.
REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
We are responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f). Our internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. Internal control over financial
reporting includes those policies and procedures that (1) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect
the transactions and dispositions of our assets; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting
principles, and that our receipts and expenditures are being made only in
accordance with authorizations of our management and directors; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of our assets that could have a material effect
on the financial statements.
37.
All internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies and procedures may deteriorate.
Our management has assessed the effectiveness of our internal control over
financial reporting as of January 29, 2005. In making our assessment, management
used the criteria set forth by the COSO in Internal Control--Integrated
Framework. In particular, our management evaluated the impact of the lease
accounting corrections described above on such assessment and concluded that the
control deficiency that resulted in the restatement of previously issued
financial statements for understatement of rent expense and deferred rent
represented a material weakness. As a result, management concluded that, as of
January 29, 2005, our internal control over financial reporting was not
effective based on the criteria set forth by COSO in Internal
Control--Integrated Framework.
A material weakness in internal control over financial reporting is a
control deficiency (within the meaning of the Public Company Accounting
Oversight Board ("PCAOB") Auditing Standard No. 2), or combination of control
deficiencies, that results in there being more than a remote likelihood that a
material misstatement of the annual or interim financial statements will not be
prevented or detected. PCAOB Auditing Standard No. 2 identifies a number of
circumstances that, because of their likely significant negative effect on
internal control over financial reporting, are to be regarded as at least
significant deficiencies as well as strong indicators that a material weakness
exists, including the restatement of previously issued financial statements to
reflect the correction of a misstatement.
Our independent registered public accounting firm, Ernst & Young LLP, has
issued an attestation report on management's assessment of our internal control
over financial reporting. This report appears below.
REMEDIATION STEPS
We have remediated the material weakness in internal control by correcting
our application of lease accounting principles for free rent periods. We have
implemented controls to ensure all future leases will be reviewed and accounted
for in accordance with SFAS No. 13, FTB No. 85-3 and FTB No. 88-1. We believe
these steps will help ensure continued compliance with, among other things, the
views of the Office of the Chief Accountant of the SEC expressed as of February
7, 2005 and described above.
b) CHANGE IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During our last fiscal quarter, ended January 29, 2005, as part of our
review of lease accounting policies discussed above, we remediated our controls
associated with our accounting for tenant improvement allowances and the related
deferred rent credit and depreciation expense. These changes in internal control
identified the need to restate previously issued financial statements to record
tenant improvement allowances as a deferred rent credit, to record the related
fixed assets at their gross amount, and to record adjustments to depreciation
and rent expense.
c) REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
We have audited management's assessment, included in the accompanying
Report of Management on Internal Control over Financial Reporting, that Hot
Topic, Inc. did not maintain effective internal control over financial reporting
as of January 29, 2005, because of the effect of the Company's insufficient
controls over the selection and monitoring of appropriate assumptions and
factors affecting lease accounting, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). Hot Topic, Inc.'s
management is responsible for maintaining effective internal
38.
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an
opinion on management's assessment and an opinion on the effectiveness of the
company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. The following material weakness has been identified and included in
management's assessment: In its assessment as of January 29, 2005, management
identified as a material weakness the Company's insufficient controls over the
selection and monitoring of appropriate assumptions and factors affecting lease
accounting. As a result of this material weakness in internal control, Hot
Topic, Inc. concluded the Company's previously reported rent expense and
deferred rent liabilities had been understated and that previously issued
financial statements should be restated. This material weakness was considered
in determining the nature, timing, and extent of audit tests applied in our
audit of the 2004 financial statements, and this report does not affect our
report dated March 11, 2005 on those financial statements.
In our opinion, management's assessment that Hot Topic, Inc. did not
maintain effective internal control over financial reporting as of January 29,
2005 is fairly stated, in all material respects, based on the COSO control
criteria. Also, in our opinion, because of the effect of the material weakness
described above on the achievement of the objectives of the control criteria,
Hot Topic, Inc. has not maintained effective internal control over financial
reporting as of January 29, 2005, based on the COSO control criteria.
/s/ Ernst & Young LLP
Los Angeles, California
March 11, 2005
39.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
See the section entitled "Executive Officers and Key Employees" in Part I,
Item 1 hereof for information regarding our 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 our Definitive Proxy Statement which will
be filed with the SEC within 120 days of January 29, 2005 pursuant to Regulation
14A in connection with the solicitation of proxies for our Annual Meeting of
Shareholders to be held on June 15, 2005 (the "2005 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 2005 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 2005
Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED SHAREHOLDER 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 2005 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 2005 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 2005 Proxy Statement.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(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:
40.
PAGE
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm...... F-1
Consolidated Balance Sheets as of January 29, 2005 and January 31, 2004......... F-2
Consolidated Statements of Income for the years ended January 29, 2005,
January 31, 2004, and February 1, 2003 ................................... F-3
Consolidated Statements of Shareholders' Equity for the years ended
January 29, 2005, January 31, 2004, and February 1, 2003.................. F-4
Consolidated Statements of Cash Flows for the years ended January 29, 2005,
January 31, 2004, and February 1, 2003.................................... F-5
Notes to Consolidated Financial Statements...................................... F-6
(a)(2) FINANCIAL STATEMENT SCHEDULES
Schedule II - Valuation and Qualifying Accounts
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission other than the ones listed
above are not required under the related instructions or are not applicable, and
therefore, have been omitted.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
FOR THE FISCAL YEARS ENDED JANUARY 29, 2005,
JANUARY 31, 2004, AND FEBRUARY 1, 2003
Provision
Balance at Charged to Balance
Beginning Costs and at End
of Year Expenses Deductions of Year
--------- --------- --------- ---------
FISCAL 2004
- -----------
Allowance for sales returns $ 512 $ 65 $ - $ 577
Allowance for aged inventory 1,057 453 - 1,510
--------- --------- --------- ---------
$ 1,569 $ 518 $ - $ 2,087
========= ========= ========= =========
FISCAL 2003
- -----------
Allowance for sales returns $ 350 $ 162 $ - $ 512
Allowance for aged inventory 866 191 - 1,057
--------- --------- --------- ---------
$ 1,216 $ 353 $ - $ 1,569
========= ========= ========= =========
FISCAL 2002
- -----------
Allowance for sales returns $ - $ 350 $ - $ 350
Allowance for aged inventory 490 376 - 866
--------- --------- --------- ---------
$ 490 $ 726 $ - $ 1,216
========= ========= ========= =========
41.
(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.
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
3.1 Amended and Restated Articles of Incorporation. (1)
3.2 Certificate of Amendment of Amended and Restated Articles of
Incorporation
3.3 Amended and Restated Bylaws, as amended.
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"), as amended.
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, as amended.
10.6a Employee Stock Purchase Plan, as amended.
10.7a 401(k) Defined Contribution Plan of Registrant, effective as
of August 1, 1995, as amended.
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 August 14, 2002, between the
Registrant and Patricia Van Cleave. (6)
10.14a Employment Letter dated January 23, 2003, between the
Registrant and James McGinty. (6)
10.15 Third Amendment to Industrial Real Estate Lease, dated
February 25, 2004, by and among Majestic-Fullerton Road,
LLC, PFG Fullerton Limited Partnership, and Hot Topic
Administration, Inc. (7)
42.
10.16 Employment Offer Letter dated March 15, 2004, between the
Registrant and Christopher J. Kearns. (7)
10.17 Centre Pointe Distribution Park Lease, dated June 1, 2004,
by and among Crescent Resources, LLC and Hot Topic, Inc. (8)
10.18 Employment Offer Letter dated May 13, 2004, between the
Registrant and Thomas Beauchamp. (8)
21 Hot Topic, Inc. List of Subsidiaries
23.1 Consent of Ernst & Young LLP, Independent Registered Public
Accounting Firm.
24.1 Power of Attorney is contained on the signature page.
31.1 Certification, dated April 13, 2005, of Registrant's Chief
Executive Officer required by Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification, dated April 13, 2005, of Registrant's Chief
Financial Officer required by Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certifications, dated April 13, 2005, 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.
(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.
(7) Filed as an exhibit to Registrant's Quarterly Report on Form 10-Q for the
quarter ended May 1, 2004 and incorporated herein by reference.
(8) Filed as an exhibit to Registrant's Quarterly Report on Form 10-Q for the
quarter ended July 31, 2004 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).
43.
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 13, 2005
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 April 13, 2005
- ---------------------------- Director (PRINCIPAL EXECUTIVE
Elizabeth McLaughlin OFFICER)
/s/ JAMES MCGINTY Chief Financial Officer April 13, 2005
- ---------------------------- (PRINCIPAL FINANCIAL OFFICER)
James McGinty
/s/ GEORGE WEHLITZ, JR. Vice President, Finance April 13, 2005
- ---------------------------- (PRINCIPAL ACCOUNTING
George Wehlitz, Jr. OFFICER)
/s/ BRUCE QUINNELL Chairman of the Board April 8, 2005
- ----------------------------
Bruce Quinnell
/s/ KATHLEEN MASON Director April 7, 2005
- ----------------------------
Kathleen Mason
/s/ CORRADO FEDERICO Director April 7, 2005
- ----------------------------
Corrado Federico
/s/ ANDREW SCHUON Director April 11, 2005
- ----------------------------
Andrew Schuon
/s/ CYNTHIA COHEN Director April 8, 2005
- ----------------------------
Cynthia Cohen
/s/ W. SCOTT HEDRICK Director April 10, 2005
- ----------------------------
W. Scott Hedrick
44.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of Hot Topic, Inc.
We have audited the accompanying consolidated balance sheets of Hot Topic,
Inc. and subsidiaries as of January 29, 2005 and January 31, 2004 (restated) and
the related consolidated statements of income, shareholders' equity and cash
flows for each of the three years in the period ended January 29, 2005. Our
audit also included the financial statement schedule listed in the Index at Item
15(a). These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Hot Topic, Inc.
and its subsidiaries at January 29, 2005 and January 31, 2004, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended January 29, 2005, in conformity with U.S.
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, present fairly in all material respects the
information set forth herein.
As described in Note 2, Restatement of the Financial Statements, the
Company has corrected its accounting for leases and restated previously issued
financial statements.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of Hot
Topic, Inc. and subsidiaries internal control over financial reporting as of
January 29, 2005, based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated March 11, 2005 expressed an unqualified opinion
on management's assessment of the effectiveness of internal control over
financial reporting and an adverse opinion on the effectiveness of internal
control over financial reporting.
/s/ ERNST & YOUNG LLP
Los Angeles, California
March 11, 2005
F-1
HOT TOPIC, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
January 29, January 31,
2005 2004
(As Restated)
----------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 5,248 $ 11,886
Short-term investments 61,091 116,319
Inventory 60,481 51,937
Prepaid expenses and other 12,390 10,654
Deferred tax assets 2,541 2,259
----------------------------
Total current assets 141,751 193,055
Leaseholds, fixtures and equipment, net 136,401 102,838
Deposits and other 243 189
----------------------------
Total assets $ 278,395 $ 296,082
============================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 17,874 $ 15,841
Accrued liabilities 27,769 28,133
Income taxes payable 8,887 7,278
----------------------------
Total current liabilities 54,530 51,252
Deferred rent 30,227 21,843
Deferred tax liability 6,076 1,708
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;
44,592,836 and 48,120,989 shares issued and outstanding at
January 29, 2005 and January 31, 2004, respectively 90,921 86,238
Retained earnings 96,847 135,242
Accumulated other comprehensive loss (206) (201)
----------------------------
Total shareholders' equity 187,562 221,279
----------------------------
Total liabilities and shareholders' equity $ 278,395 $ 296,082
============================
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 29, January 31, February 1,
2005 2004 2003
(As Restated) (As Restated)
------------------------------------------
Net sales $ 656,468 $ 572,039 $ 443,250
Cost of goods sold, including buying,
distribution and occupancy costs 422,712 352,277 274,008
------------------------------------------
Gross margin 233,756 219,762 169,242
Selling, general and administrative expenses 170,384 143,952 115,634
------------------------------------------
Operating income 63,372 75,810 53,608
Interest income, net 919 1,318 1,371
------------------------------------------
Income before income taxes 64,291 77,128 54,979
Provision for income taxes 24,618 29,539 20,892
------------------------------------------
Net income $ 39,673 $ 47,589 $ 34,087
==========================================
Net income per share:
Basic $ 0.86 $ 1.00 $ 0.72
==========================================
Diluted $ 0.83 $ 0.96 $ 0.69
==========================================
Shares used in computing net income per share:
Basic 46,379 47,479 47,027
Diluted 47,875 49,588 49,276
See notes to consolidated financial statements.
F-3
Hot Topic, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity
(In thousands)
Common Shares Accumulated Other Total
----------------------------- Retained Comprehensive Shareholders'
Shares Amount Earnings Loss Equity
----------------------------------------------------------------------------
BALANCE AT FEBRUARY 2, 2002 (As restated) 47,063 $ 60,643 $ 73,095 $ - $ 133,738
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) (171) (19,529) - (19,700)
Tax benefit from exercise of stock options - 5,118 - - 5,118
Net income (As restated) - - 34,087 - 34,087
----------------------------------------------------------------------------
BALANCE AT FEBRUARY 1, 2003 (As restated) 46,806 71,103 87,653 - 158,756
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 (As restated) - - 47,589 - 47,589
Unrealized loss on marketable securities, net - - - (201) (201)
------------
Total comprehensive income 47,388
----------------------------------------------------------------------------
BALANCE AT JANUARY 31, 2004 (As restated) 48,121 86,238 135,242 (201) 221,279
Exercise of stock options 409 3,662 - - 3,662
Employee stock purchase plan 54 862 - - 862
Restricted stock awards 9 155 - - 155
Repurchase of common stock (4,000) (1,581) (78,068) (79,649)
Tax benefit from exercise of stock options - 1,585 - - 1,585
Comprehensive Income:
Net income - - 39,673 - 39,673
Unrealized loss on marketable securities, net - - - (5) (5)
------------
Total comprehensive income 39,668
----------------------------------------------------------------------------
BALANCE AT January 29, 2005 44,593 $ 90,921 $ 96,847 $ (206) $ 187,562
============================================================================
F-4
HOT TOPIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Years Ended
--------------------------------------------
January 29, January 31, February 1,
2005 2004 2003
(As Restated) (As Restated)
--------------------------------------------
OPERATING ACTIVITIES
Net income $ 39,673 $ 47,589 $ 34,087
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 24,635 20,360 16,364
Tax benefit from exercise of stock options 1,585 6,616 5,118
Stock-based compensation 155 155 142
Loss on disposal of fixed assets 751 656 278
Changes in operating assets and liabilities:
Inventory (8,544) (13,528) (8,856)
Prepaid expenses and other current assets (1,736) (2,787) (2,431)
Deposits and other assets (53) (18) 3
Accounts payable 2,033 434 4,155
Accrued liabilities (1,459) 8,519 7,528
Deferred rent 8,383 6,270 4,940
Deferred taxes 4,086 3,793 (655)
Income taxes payable 1,609 548 4,166
--------------------------------------------
Net cash provided by operating activities 71,118 78,607 64,839
INVESTING ACTIVITIES
Purchases of leasehold, fixtures and equipment (57,853) (41,959) (38,401)
Proceeds from sale of short-term investments 162,931 52,906 46,105
Purchases of short-term investments (107,709) (99,146) (49,296)
--------------------------------------------
Net cash used in investing activities (2,631) (88,199) (41,592)
FINANCING ACTIVITIES
Repurchase of common stock (79,649) (23) (19,700)
Proceeds from employee stock purchases and exercise
of stock options 4,524 8,362 5,370
--------------------------------------------
Net cash (used in) provided by financing activities (75,125) 8,339 (14,330)
--------------------------------------------
(Decrease) increase in cash and cash equivalents (6,638) (1,253) 8,917
Cash and cash equivalents at beginning of year 11,886 13,139 4,222
--------------------------------------------
Cash and cash equivalents at end of year $ 5,248 $ 11,886 $ 13,139
============================================
SUPPLEMENTAL INFORMATION
Cash paid during the year for interest $ 8 $ 40 $ 19
============================================
Cash paid during the year for income taxes $ 17,400 $ 18,614 $ 12,317
============================================
See notes to consolidated financial statements.
F-5
HOT TOPIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 29, 2005
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS ACTIVITIES
Hot Topic, Inc. is a mall-based specialty retailer operating the Hot Topic and
Torrid store concepts. Hot Topic sells 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
fiscal year ended February 2, 2002), we launched a second retail concept under
the trade name Torrid. Torrid sells apparel, lingerie, shoes and accessories
designed for various lifestyles for plus-size females between the ages of 15 and
29. At the end of the fiscal year ending January 29, 2005, we operated 592 Hot
Topic stores in 50 states and Puerto Rico, and 76 Torrid stores. We also
maintain 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. We
have one reportable segment given the similarities of the economic
characteristics among the store formats.
Throughout this report, the terms "our", "we" and "us" refer to Hot Topic, Inc.
and its subsidiaries.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Hot Topic, Inc.
and our 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. The common stock and retained earnings balances at
January 31, 2004 and February 1, 2003 have been reclassified to reflect the
excess of the repurchase cost of common stock over its issuance price (as
determined on a first-in, first-out basis) as a reduction of retained earnings.
Previously, all common stock repurchases had been charged against common stock.
FISCAL YEAR
Our fiscal year is on a 52-53 week basis and ends on the Saturday nearest to
January 31. The fiscal years ended January 29, 2005, January 31, 2004 and
February 1, 2003 were 52-week years.
CASH AND CASH EQUIVALENTS
We consider all highly liquid investments with maturities of less than three
months when purchased to be cash equivalents. We are potentially exposed to a
concentration of credit risk when cash deposits in banks are in excess of
federally insured limits.
F-6
FAIR VALUE OF FINANCIAL INSTRUMENTS
We consider 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.
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. At January 29, 2005
and January 31, 2004, short-term investments consisted of municipal bonds of
$37.7 million and $96.0 million, government obligations of $15.3 million and
$12.7 million, and corporate bonds of $8.0 million and $7.6 million,
respectively. Short-term investments are recorded at fair market value, based on
established market prices as of the end of the period for which the values are
determined.
Unrealized gains and losses, net, from short-term investments comprise
accumulated other comprehensive loss, reflected in the Shareholders' Equity
section of the Consolidated Balance Sheets, which for the fiscal years ended
January 29, 2005 and January 31, 2004 were $5,000 and $201,000, respectively. As
a result, for the years ended January 29, 2005 and January 31, 2004, the
Company's other comprehensive income was lower than its net income.
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.
LEASEHOLD, FIXTURES AND EQUIPMENT
Leasehold, fixtures 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 ten years or the life of the
lease. 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 our retail store
locations and websites, less merchandise returned by customers. We provide 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.
F-7
COST OF GOODS SOLD, INCLUDING BUYING, DISTRIBUTION AND OCCUPANCY COSTS
Cost of goods sold, including buying, distribution and occupancy costs includes:
merchandise costs, freight, inventory shrink, payroll expenses associated with
the merchandising and distribution departments, distribution center expenses
including rent, common area maintenance charges, real estate taxes,
depreciation, utilities, supplies and maintenance; and store expenses including
rents, common area maintenance charges, real estate taxes, and depreciation.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses include: payroll expenses
associated with stores, store operating expenses, store pre-opening costs,
marketing expenses; and payroll and other expenses associated with headquarters
and administrative functions.
STORE PRE-OPENING COSTS
Costs incurred in connection with the opening of a new store are expensed as
incurred.
SHIPPING AND HANDLING COSTS
We classify shipping and handling costs in costs of goods sold, including
buying, distribution and occupancy costs in the accompanying statements of
income.
LEASES
Rent expense under non-cancelable operating leases with scheduled rent increases
or free rent periods is accounted for on a straight-line basis over the lease
term, beginning on the date of initial possession, which is generally when we
enter the space and begin construction build-out. The amount of the excess of
straight-line rent expense over scheduled payments is recorded as a deferred
rent liability. Construction allowances and other such lease incentives are
recorded as deferred credits, and are amortized on a straight-line basis as a
reduction of rent expense.
ADVERTISING COSTS
Advertising costs are expensed the first time the event occurs or as incurred.
Advertising expenses were $1,152,000, $1,065,000, and $521,000 for the years
ended January 29, 2005, January 31, 2004, and February 1, 2003, respectively. At
January 29, 2005 and January 31, 2004, the amount of advertising costs reported
as prepaid advertising was $49,000 and $42,000, respectively.
INCOME TAXES
We utilize Statement of Financial Accounting Standards ("SFAS") No. 109,
"Accounting for Income Taxes", which prescribes the use of the liability method
to compute the difference between the tax basis of assets and liabilities and
the related financial reporting amounts using currently enacted tax laws and
rates.
NET INCOME PER SHARE
Net income per share has been computed in accordance with Financial Accounting
Standards Board ("FASB") Statement No. 128, "Earnings per Share" (see Note 8). A
three-for-two stock split became effective September 2, 2003. All share and per
share amounts prior to that date have been restated to reflect the stock split
and all previous stock splits.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
F-8
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, we will recognize an impairment loss, measured by the future
discounted cash flow method. At January 29, 2005, we believe 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
our results of operations or financial condition.
STOCK-BASED COMPENSATION
SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and
Disclosure an Amendment of SFAS No. 123", amends the disclosure requirements of
SFAS No. 123, "Accounting for Stock-Based Compensation", 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.
We account for stock-based awards to employees and directors using the intrinsic
value method of accounting in accordance with Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." We follow
the disclosure provisions of SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS No. 148 requires disclosures of
the effects of an entity's accounting policy with respect to stock-based
employee compensation on reported net income (loss) and earnings (loss) per
share in annual and interim financial statements. We are required to follow the
prescribed disclosure format and have provided the additional disclosures
required by SFAS No. 148 for the fiscal years ended January 29, 2005, January
31, 2004 and February 1, 2003.
Pro forma information regarding net income and earnings per share is required by
SFAS No. 123, and has been determined as if we accounted for our employee stock
incentives 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 2004,
2003, and 2002: weighted average risk-free interest rates of 5%; dividend yields
of 0%; weighted average volatility factors of the expected market price of our
common stock of 0.48 for fiscal 2004, 0.40 for fiscal 2003, and 0.61 for fiscal
2002; and a weighted average expected life of the options of 3.6 years for
fiscal 2004, 5 years for fiscal 2003 and 2002. The weighted average fair value
of options granted during the year are $8.57, $6.70, and $8.53 per share for
fiscal 2004, 2003, and 2002, respectively.
F-9
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 using
the fair value method under SFAS No. 123, as amended by SFAS No. 148 (in
thousands, except per share amounts):
Years Ended
--------------------------------------------
January 31, February 1,
January 29, 2004 2003
2005 (As Restated) (As Restated)
------------ ------------ ------------
Net income
As reported $39,673 $47,589 $34,087
Add: Stock-based compensation expense
included in reported net income, net of
related tax effects 96 96 88
Deduct: Total stock-based compensation
expense determined under fair value
method for all awards, net of related
tax effects (11,804) (5,166) (4,189)
------------ ------------ ------------
Pro forma $27,965 $42,519 $29,986
============ ============ ============
Basic earnings per share:
As reported $0.86 $1.00 $0.72
Pro forma $0.60 $0.90 $0.64
Diluted earnings per share:
As reported $0.83 $0.96 $0.69
Pro forma $0.59 $0.87 $0.61
ACCELERATED OPTIONS
We accelerated the vesting of certain stock options awarded to employees,
officers and directors under various stock option plans, which had exercise
prices that were below market closing price on January 4, 2005. Options to
purchase approximately 1.38 million shares became exercisable immediately as a
result of the vesting acceleration. Our Board approved the vesting acceleration
as a result of SFAS No. 123 requiring the expensing of stock options effective
later in 2005 which with respect to such accelerated options would have
negatively impacted our results from operations.
COMPREHENSIVE INCOME
We report comprehensive income in accordance with the provisions of SFAS 130,
"Reporting Comprehensive Income." SFAS 130 established standards for the
reporting and display of comprehensive income. Components of comprehensive
income include net earnings (loss), foreign currency translation adjustments and
gains/losses associated with investments available for sale. Comprehensive
income for the fiscal years ended January 29, 2005 and January 31, 2004 were
$39.7 million and $47.4 million, respectively.
F-10
NEW ACCOUNTING PRONOUNCEMENTS
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. FIN 46(R) clarifies the application of ARB No. 51, "Consolidated
Financial Statements," to certain entities in which equity 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
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 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. FIN 46(R) applies immediately to variable interest entities created
after December 31, 2003, and to variable interest entities in which an
enterprise obtains an interest after that date. It applies no later than the
first reporting period ending after March 15, 2004, to variable interest
entities in which an enterprise holds a variable interest (other than special
purpose) that it acquired before January 1, 2004. FIN 46(R) applies to public
enterprises as of the beginning of the applicable interim or annual period. We
do not currently have any variable interest entities and the adoption of the
provisions of FIN 46 and FIN 46(R) did not have a material impact on our results
of operations or financial condition.
In November 2003, consensus was reached on Emerging Issues Task Force ("EITF")
Issue No. 03-10, "Application of EITF Issue No. 02-16, `Accounting by a Customer
(Including a Reseller) for Certain Consideration Received from a Vendor,' by
Resellers to Sales Incentives Offered to Consumers by Manufacturers." Under
Issue 02-16, cash consideration received by a customer from a vendor is presumed
to be a price reduction of the vendor's products or services and should
therefore be characterized as a reduction of cost of sales when recognized in
the income statement of the customer. Issue No. 03-10 is effective for fiscal
periods beginning after November 25, 2003. The adoption of Issue No. 03-10 did
not have a material impact on our operating results or financial condition.
In March 2004, the EITF reached a consensus on EITF Issue No. 03-1 ("EITF
03-1"), "The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments," for which the measurement and recognition provisions were
to be effective for reporting periods beginning after June 15, 2004. However, in
September 2004, the EITF issued FASB Staff Position EITF Issue No. 03-1-1,
"Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, `The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments,'"
which postponed the measurement and recognition provisions of EITF 03-1, but
maintained the disclosure requirements for all investments within the scope of
the guidance to be effective in annual financial statements for fiscal years
ending after June 15, 2004. EITF 03-1 provides a three-step process for
determining whether investments, including debt securities, are other than
temporarily impaired and requires additional disclosures in annual financial
statements. An investment is impaired if the fair value of the investment is
less than its cost. EITF 03-1 outlines that an impairment would be considered
other-than-temporary unless: a) the investor has the ability and intent to hold
an investment for a reasonable period of time sufficient for the recovery of the
fair value up to (or beyond) the cost of the investment, and b) evidence
F-11
indicating that the cost of the investment is recoverable within a reasonable
period of time outweighs evidence to the contrary. Although not presumptive, a
pattern of selling investments prior to the forecasted recovery of fair value
may call into question the investor's intent. In addition, the severity and
duration of the impairment should also be considered in determining whether the
impairment is other-than-temporary. We do not expect the adoption of EITF 03-1
to have a material impact on our results of operations or financial condition
because our investments are short-term in nature and consist primarily of
interest bearing bonds that are highly liquid and low risk with a minimum credit
quality rating of A-1 (Standard and Poor's), SP-1 (Moody's Investor Service) or
equivalent
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - an Amendment
of ARB No. 43, Chapter 4". SFAS No. 151 clarifies that abnormal amounts of idle
facility expense, freight, handling costs, and wasted materials (spoilage)
should be recognized as current-period charges. In addition, SFAS No. 151
requires the allocation of fixed production overheads to the cost of conversion
be based on the normal capacity of the production facilities. SFAS No. 151 is
effective for fiscal years beginning after June 15, 2005. We do not expect the
adoption of SFAS No. 151 to have a material impact on our operating results or
financial condition.
In December 2004, the FASB issued SFAS No. 153, "Exchange of Nonmentary Assets,
an amendment of APB Opinion No. 29". SFAS No. 153 eliminates the exception for
nonmonetary exchanges of similar productive assets, which were previously
required to be recorded on a carryover basis rather than a fair value basis.
Instead, this statement provides that exchanges of nonmonetary assets that do
not have commercial substance be reported at carryover basis rather than a fair
value basis. A nonmonetary exchange is considered to have commercial substance
if the future cash flows of the entity are expected to change significantly as a
result of the exchange. The provisions of this statement are effective for
nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,
2005. We do not expect the adoption of SFAS No. 153 to have a material impact on
our operating results or financial condition.
In December 2004, the FASB issued Statement No. 123 (revised 2004), "Share-Based
Payment" ("SFAS No. 123R"), which is a revision of SFAS No. 123. SFAS No. 123R
supersedes APB No. 25 and amends Statement No. 95, "Statement of Cash Flows."
Under SFAS No. 123, companies must calculate and record in the income statement
the cost of equity instruments, such as stock options, awarded to employees for
services received and pro forma disclosure is no longer permitted. The cost of
the equity instruments will be measured based on fair value of the instruments
on the date they are granted (with certain exceptions) and will be required to
be recognized over the period during which the employees are required to provide
services in exchange for the equity instruments. The statement is effective in
the first interim or annual reporting period beginning after June 15, 2005.
SFAS No. 123R provides two alternatives for adoption: (1) a "modified
prospective" method in which compensation cost is recognized for all awards
granted subsequent to the effective date of this statement as well as for the
unvested portion of awards outstanding as of the effective date; or (2) a
"modified retrospective" method which follows the approach in the "modified
prospective" method, but also permits entities to restate prior periods to
record compensations cost calculated under SFAS No. 123 for the pro forma
disclosure. We are currently evaluating our share-based payment programs on our
results of operations, and do not expect the adoption of SFAS No. 123 to have a
material impact on our overall financial position but could significantly impact
results of operations.
The impact of adopting SFAS No. 123R cannot be accurately estimated at this time
because it will depend on levels of share-based awards granted in the future.
However, had we adopted SFAS No. 123R in prior periods, the impact of that
standard would have approximated the impact of SFAS No. 123 as described in the
F-12
disclosure of pro forma net income and earnings per share in Note 1 to our
consolidated financial statements. SFAS No 123R also requires the benefits of
tax deductions in excess of recognized compensation cost to be reported as a
financing cash flow. This change will reduce net operating cash flows and
increase net financing cash flows in periods after adoption. While the amount of
this change cannot be estimated at this time, the amount of operating cash flows
recognized in prior periods for such excess tax deductions were $1.6 million,
$6.6 million, and $5.1 million in fiscal 2004, 2003 and 2002, respectively.
NOTE 2. RESTATEMENT OF FINANCIAL STATEMENTS
In accordance with SFAS No. 13, "Accounting for Leases" and Financial Accounting
Standards Board Technical Bulletin No. 88-1, "Issues Relating to Accounting for
Leases" ("FTB 88-1"), we account for rental expense for step provisions and
escalation clauses on a straight-line basis over the minimum lease term, with
such amounts being included along with other related rent expense as part of
"Cost of goods sold, including buying, distribution and occupancy costs."
Construction allowances and other lease concessions received from landlords are
amortized over the minimum lease term on a straight-line basis as part of "Cost
of goods sold, including buying, distribution and occupancy costs." However, in
our detailed accounts, we had previously recorded this amortization as a
reduction of depreciation expense, rather than rent expense. Both depreciation
and rent expense are reflected within "Cost of goods sold, including buying,
distribution and occupancy costs" on the statements of income.
Historically, our balance sheets have reflected the unamortized portion of
construction allowances and other lease concessions as a reduction of
"Leaseholds, fixtures and equipment, net," instead of as a component of deferred
rent liability. Further, our historical statements of cash flows have reflected
construction allowances and other lease concessions received as a reduction of
"Leaseholds, fixtures and equipment, net" (within "investing" cash flows),
rather than as an operating lease activity (within "operating" cash flows).
We had historically recognized rent expense on a straight-line basis over the
lease term. Our leases typically have a rent commencement date to coincide with
the initial occupancy date, or store opening date. The store opening date
coincided with the commencement of business operations, which is the intended
use of the property. Management re-evaluated FASB Technical Bulletin No. 85-3,
"Accounting for Operating Leases with Scheduled Rent Increases" and determined
that the lease term for amortization purposes should commence on the date we
take possession of the leased space for construction purposes, which is
generally two months prior to a store opening date. Excluding tax impacts, the
correction of this accounting requires us to record additional rent credits in
"Deferred rent" and to adjust "Retained earnings" on the consolidated balance
sheets, as well as to record additional rent expense in the form of deferred
rent amortization in "Costs of goods sold, including, buying, distribution and
occupancy costs" on the consolidated statements of income for the years ended
January 31, 2004 and February 1, 2003. The cumulative effect of these changes is
a reduction to retained earnings of $1.6 million as of the beginning of fiscal
2002 and incremental decreases to retained earnings of $543,000 and $453,000,
for the fiscal years ended 2002 and 2003, respectively. The impact of these
adjustments reduced net income recorded in the first, second and third quarters
of fiscal 2004 by $82,000, $119,000, and $132,000, respectively and changed net
income recorded in the first, second, third and fourth quarters of fiscal 2003
by ($156,000), ($150,000), ($178,000) and $31,000, respectively.
F-13
The following is a summary of the effects of these changes on our consolidated
balance sheets as of January 31, 2004 and February 1, 2003, as well as the
effects of these changes on our consolidated statements of income and cash flows
for fiscal years 2003 and 2002 (in thousands, except share data):
Consolidated Statements of Income
--------------------------------------------
As
Previously
Fiscal Year Ended January 31, 2004 Reported Adjustments As Restated
- ---------------------------------------------------------------------- ------------ ------------ ------------
Cost of goods sold, including buying, distribution and occupancy costs $ 351,542 $ 735 $ 352,277
Operating income 76,545 (735) 75,810
Income before income taxes 77,863 (735) 77,128
Provision for income taxes 29,821 (282) 29,539
Net income 48,042 (453) 47,589
Net income per share - basic 1.01 (0.01) 1.00
Net income per share - diluted 0.97 (0.01) 0.96
Fiscal Year Ended February 1, 2003
- ----------------------------------------------------------------------
Cost of goods sold, including buying, distribution and occupancy costs $ 273,132 $ 876 $ 274,008
Operating income 54,484 (876) 53,608
Income before income taxes 55,855 (876) 54,979
Provision for income taxes 21,225 (333) 20,892
Net income 34,630 (543) 34,087
Net income per share - basic 0.74 (0.01) 0.72
Net income per share - diluted 0.70 (0.01) 0.69
Consolidated Balance Sheets
--------------------------------------------
As
Previously
January 31, 2004 Reported Adjustments As Restated
- ---------------------------------------------------------------------- ------------ ------------ ------------
Leasehold, fixtures and equipment, net $ 88,348 $ 14,490 $ 102,838
Total assets 281,592 14,490 296,082
Income taxes payable 7,242 36 7,278
Deferred rent 3,155 18,688 21,843
Deferred taxes, net 3,316 (1,608) 1,708
Retained earnings 137,868 (2,626) 135,242
Total shareholders' equity 223,905 (2,626) 221,279
Total liabilities and shareholders' equity 281,592 14,490 296,082
F-14
Consolidated Statements of Cash Flows
--------------------------------------------
As
Previously
Fiscal Year Ended January 31, 2004 Reported Adjustments As Restated
- ---------------------------------------------------------------------- ------------ ------------ ------------
Net cash provided by operating activities $ 72,302 $ 6,305 $ 78,607
Net cash provided by investing activities (81,894) (6,305) (88,199)
Fiscal Year Ended February 1, 2003
- ----------------------------------------------------------------------
Net cash provided by operating activities $ 60,317 $ 4,522 $ 64,839
Net cash provided by investing activities (37,070) (4,522) (41,592)
Consolidated Statements of Shareholders' Equity
-----------------------------------------------
As
Previously
February 2, 2002 Reported Adjustments As Restated
- ---------------------------------------------------------------------- ------------ ------------ ------------
Retained earnings $ 74,725 $ (1,630) $ 73,095
NOTE 3. LEASEHOLDS, FIXTURES AND EQUIPMENT
Leaseholds, fixtures and equipment are summarized as follows (in thousands):
January 31,
January 29, 2004
2005 (As Restated)
----------- -----------
Furniture, fixtures and equipment $ 110,503 $ 78,476
Leasehold improvements 115,579 91,175
----------- -----------
226,082 169,651
Less: accumulated depreciation and amortization (89,681) (66,813)
----------- -----------
$ 136,401 $ 102,838
=========== ===========
F-15
NOTE 4. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
January 31,
January 29, 2004
2005 (As Restated)
----------- -----------
Accrued payroll and related expenses $ 4,194 $ 9,833
Gift cards, gift certificates and
store merchandise credits 7,943 5,713
Accrued percentage rents 1,858 4,012
Other 13,774 8,575
----------- -----------
$ 27,769 $ 28,133
=========== ===========
NOTE 5. BANK CREDIT AGREEMENT
We maintain an unsecured bank credit agreement of $5.0 million. The credit
agreement will expire in August 2005 and we expect to renew the credit agreement
under similar terms. Letters of credit are issued under the credit agreement,
which are primarily used for inventory purchases. At January 29, 2005, we had
$130,000 of outstanding letters of credit issued under the credit agreement.
NOTE 6. COMMITMENTS AND CONTINGENCIES
LEASES
We have entered into lease agreements for retail, distribution and office space,
vehicles, and equipment under primarily noncancelable leases with terms ranging
from approximately two 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 leases provide for increasing minimum annual rental
amounts. Rent expense is recorded on a straight-line basis over the term of the
lease based on us taking possession of premises. 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 29, 2005, January 31, 2004, and
February 1, 2003 was $44,341,000, $38,572,000, and $30,787,000, respectively,
including contingent rentals of $4,259,000, $4,866,000, and $3,670,000,
respectively.
F-16
Annual future minimum lease payments under operating leases as of January 29,
2005 are as follows (in thousands):
Fiscal Year Operating Leases
- ----------- ----------------
2005 $ 45,969
2006 45,875
2007 44,663
2008 42,504
2009 39,991
Thereafter 120,420
----------
Total minimum operating lease payments $ 339,422
==========
LITIGATION
We are involved in various matters of litigation during the ordinary course of
business. Management does not currently believe any such matters will have a
material adverse effect on our financial condition or results of operations.
INDEMNITIES, COMMITMENTS AND GUARANTEES
During the ordinary course of business, we have made certain indemnities,
commitments and guarantees under which we may be required to make payments in
relation to certain transactions. These indemnities include those given to
various lessors in connection with facility leases for certain claims arising
from such facility or lease and indemnities to our directors and officers to the
maximum extent permitted under the laws of the State of California. We have
issued guarantees in the form of letters of credit as security for some
merchandise shipments from overseas. There were $130,000 of these letters of
credit outstanding at January 29, 2005. The durations of these indemnities,
commitments and guarantees vary. Some of these indemnities, commitments and
guarantees do not provide for any limitation of the maximum potential future
payments we could be obligated to make. We have not recorded any liability for
these indemnities, commitments and guarantees in the accompanying consolidated
financial statements.
NOTE 7. SHAREHOLDERS' EQUITY
STOCK SPLIT
On August 12, 2003, we announced that our Board of Directors approved a
three-for-two stock split (in the form of a dividend) of our 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 us.
F-17
STOCK REPURCHASE
On May 8, 2002, we announced that our Board of Directors approved the repurchase
of up to an aggregate of 1,500,000 shares of our common stock during the period
ending January 31, 2003. As of January 31, 2003, we completed the repurchase of
1,500,000 shares of our common stock at a cost of $19.7 million, at an average
price of $13.13 per common share.
On March 19, 2004, we announced that our Board of Directors approved the
repurchase of up to an aggregate of 2,000,000 shares of our common stock during
the period ending January 29, 2005. As of July 31, 2004 we completed the
repurchase of 2,000,000 shares of our common stock at a cost of $46.8 million at
an average price of $23.41.
On August 18, 2004, we announced that our Board of Directors approved an
additional repurchase of up to an aggregate of 2,000,000 shares of our common
stock during the period ending January 29, 2005. As of January 29, 2005, we
completed the repurchase of 2,000,000 shares of our common stock at a cost of
$32.8 million at an average price of $16.42.
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 our employees. 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 our 1996 Equity Incentive Plan, we may grant stock options, stock
bonuses, restricted stock purchase rights and stock appreciation rights to
employees, our directors or consultants, as deemed appropriate by the Board of
Directors. Under our 1996 Non-Employee Directors' Stock Option Plan and together
with the 1996 Equity Incentive Plan (the "Plans"), we may grant stock options to
non-employee directors. 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 our common stock on the date
of grant for incentive stock options, (ii) 85% of the fair market value our
common stock on the date of grant for non-statutory stock options, and (iii)
110% of the fair market value of our common stock on the date of grant for
persons possessing 10% or more of the total combined voting power of all classes
of stock. 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 29,
2005, 2,388,671 shares were available for future grants. No options, under the
Plans, have been granted to consultants.
F-18
We granted 7,737; 8,855; and 8,424 shares of restricted common stock in the year
ended January 29, 2005, January 31, 2004, and February 1, 2003, respectively, to
non-employee directors under the 1996 Equity Incentive Plan. The 7,737
restricted shares issued in fiscal 2004 will vest in the year ending January 28,
2006, the 8,855 restricted shares issued in fiscal 2003 vested in the year ended
January 29, 2005, the 8,424 restricted shares issued in fiscal 2002 vested in
the year ended January 31, 2004. All awarded common shares will remain
restricted until such time the recipient is no longer a member of our Board of
Directors. The value of these grants is expensed over the vesting period and
$155,000, $155,000, and $142,000 was expensed in the years ended January 29,
2005, January 31, 2004, and February 1, 2003, respectively.
A summary of our stock option activity and related information follows:
January 29, 2005 January 31, 2004 February 1, 2003
---------------------- ---------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
---------------------- ---------------------- ----------------------
Outstanding at beginning of year 4,813,795 $ 11.28 4,876,941 $ 8.70 4,891,268 $ 5.85
Granted 1,447,750 $ 24.75 1,396,931 $ 15.78 1,394,475 $ 15.14
Exercised (409,446) $ 8.94 (1,260,630) $ 6.11 (1,195,529) $ 4.13
Forfeited (159,254) $ 19.51 (199,447) $ 12.37 (213,273) $ 10.88
---------------------- ---------------------- ----------------------
Outstanding at end of year 5,692,845 $ 14.67 4,813,795 $ 11.28 4,876,941 $ 8.70
====================== ====================== ======================
---------------------- ---------------------- ----------------------
Exercisable at end of year 4,417,071 $ 14.48 2,146,586 $ 7.80 2,000,054 $ 5.06
====================== ====================== ======================
F-19
Exercise prices for the 5,692,845 options outstanding as of January 29, 2005
ranged from $1.51 to $27.60. The weighted average contractual life of those
options is 7.2 years. The following table summarizes information about stock
options outstanding as of January 29, 2005:
Outstanding Options
-------------------------------------------------------------------------
Range of Exercise Prices Weighted Weighted Weighted
Average Average Average
Number Exercise Contractual Number Exercise
Outstanding Price Life Exercisable Price
- ------------------------------------------------------------------------------------------------------
$1.51 - $3.73 780,942 $ 2.88 4.4 780,942 $ 2.88
$5.97 - $11.00 1,112,878 $ 8.90 5.9 1,040,596 $ 8.80
$11.23 - $15.33 1,139,378 $ 14.77 7.1 739,432 $ 14.77
$15.61 - $25.06 1,491,697 $ 16.56 8.3 691,589 $ 17.25
$25.51 - $27.60 1,167,950 $ 25.52 9.1 1,164,512 $ 25.52
-------------------------------------------------------------------------
$1.51 - $27.60 5,692,845 $ 14.67 7.2 4,417,071 $ 14.48
=========================================================================
We recorded tax benefits associated with the exercise of non-qualified stock
options and non-qualifying dispositions of incentive stock options. The tax
benefits increased shareholders' equity and decreased income taxes payable in
the amounts of $1,585,000, $6,616,000, and $5,118,000 for the years ended
January 29, 2005, January 31, 2004, and February 1, 2003, respectively.
NOTE 8. NET INCOME PER SHARE
We compute net income per share pursuant to Statement of Financial Accounting
Standards 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 outstanding for the period and potentially dilutive
common stock equivalents outstanding for the period.
A reconciliation of the numerator and denominator of basic earnings per share
and diluted earnings per share is as follows (all amounts in thousands except
per share amounts):
January 29, January 31, February 1,
2005 2004 2003
(As Restated) (As Restated)
----------- ----------- -----------
Basic Earnings Per Share Computation:
Numerator $ 39,673 $ 47,589 $ 34,087
Denominator:
Weighted average common shares outstanding 46,379 47,479 47,027
----------- ----------- -----------
Total shares 46,379 47,479 47,027
=========== =========== ===========
Basic earnings per share $ 0.86 $ 1.00 $ 0.72
=========== =========== ===========
Diluted Earnings Per Share Computation:
Numerator $ 39,673 $ 47,589 $ 34,087
Denominator:
Weighted average common shares outstanding 46,379 47,479 47,027
Incremental shares from assumed
conversion of options 1,496 2,109 2,249
----------- ----------- -----------
Total shares 47,875 49,588 49,276
=========== =========== ===========
Diluted earnings per share $ 0.83 $ 0.96 $ 0.69
=========== =========== ===========
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NOTE 9. INCOME TAXES
Composition of the provision for income taxes for the years ended (in
thousands):
January 29, January 31, February 1,
2005 2004 2003
(As Restated) (As Restated)
----------- ----------- -----------
Current:
Federal $ 17,141 $ 21,169 $ 18,570
State 3,574 4,577 2,963
----------- ----------- -----------
20,715 25,746 21,533
----------- ----------- -----------
Deferred:
Federal 3,949 4,155 (415)
State (46) (362) (226)
----------- ----------- -----------
3,903 3,793 (641)
----------- ----------- -----------
Total income tax expense $ 24,618 $ 29,539 $ 20,892
=========== =========== ===========
Significant components of our deferred tax assets and liabilities as of (in
thousands):
January 29, January 31,
2005 2004
(As Restated)
----------- -----------
Current deferred tax assets:
Inventory $ 940 $ 701
Accrued vacation and other 779 727
State taxes 566 597
Other assets 256 234
----------- -----------
Net current deferred tax assets 2,541 2,259
----------- -----------
Noncurrent deferred tax assets (liabilities):
Depreciation (6,600) (2,447)
Deferred rent 524 739
----------- -----------
Total noncurrent deferred tax liabilities (6,076) (1,708)
----------- -----------
Net deferred tax liabilities $ (3,535) $ (551)
=========== ===========
F-21
Reconciliation of the provision for income taxes to the statutory tax rate for
the years ended:
January 29, January 31, February 1,
2005 2004 2003
----------- ----------- -----------
Statutory federal rate 35.0% 35.0% 35.0%
Permanent differences (0.2) (0.4) (0.5)
State and local taxes, net of federal benefit 3.6 3.6 3.7
Other items (0.1) 0.1 (0.2)
----------- ----------- -----------
Effective income tax rate 38.3% 38.3% 38.0%
=========== =========== ===========
We operate in numerous tax jurisdictions and are subject to routine tax
examinations. Any such examinations could involve difficult issues and multiple
years. Although we cannot predict the outcome of future examinations, amounts
that could be owed in excess of amounts accrued will impact future tax expense
but will not impact our financial condition.
NOTE 10. EMPLOYEE BENEFIT PLAN
Effective January 1, 1995, we adopted the Hot Topic 401(k) Retirement Savings
Plan (the "401(k) Plan"). All employees who have been employed by us 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. We may at our discretion contribute
certain amounts to eligible employees' accounts. We have not made any
contributions to the 401(k) Plan.
F-22