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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED FEBRUARY 2, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM
_____________________________ TO ____________________________________
COMMISSION FILE NO. 0-28784
HOT TOPIC, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 77-0198182
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
18305 E. SAN JOSE AVE.
CITY OF INDUSTRY, CALIFORNIA 91748
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (626) 839-4681
Securities registered pursuant to Section 12(b) of the Act: none
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of Registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K ___.
The number of shares outstanding of the registrant's Common Stock was
31,525,436 as of April 10, 2002.
The aggregate market value of Common Stock held by non-affiliates of
the registrant as of April 10, 2002 was approximately $722,687,000, based on the
closing price on that date of Common Stock on the Nasdaq National Stock Market.*
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's Definitive proxy Statement for the
Annual Meeting of Shareholders to be held on June 13, 2002, to be filed with the
Securities and Exchange Commission (the "SEC") no later than 120 days after
February 2, 2002, are incorporated by reference into Part III of this Form 10-K
(Items 10 through 13).
*Excludes 428,728 shares of Common Stock held by directors and officers on April
10, 2002. Exclusion of shares held by any person should not be construed to
indicate that such person possesses the power, direct or indirect, to direct or
cause the direction of the management or policies of the Registrant, or that
such person is controlled by or under common control with the Registrant.
THE STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K THAT ARE
NOT HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A
OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND SECTION
21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"),
INCLUDING STATEMENTS REGARDING THE COMPANY'S EXPECTATIONS, BELIEFS, INTENTIONS
OR STRATEGIES REGARDING THE FUTURE. FORWARD-LOOKING STATEMENTS INCLUDE, WITHOUT
LIMITATION, STATEMENTS REGARDING THE EXTENT AND TIMING OF FUTURE REVENUES AND
EXPENSES AND CUSTOMER DEMAND, STATEMENTS REGARDING EXPECTED FINANCIAL RESULTS,
THE PROFITABILITY OF FUTURE SALES OF THE COMPANY'S PRODUCTS, NEW STORE OPENINGS
AND NEW STORE CONCEPTS. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT
ARE BASED ON INFORMATION AVAILABLE TO US AS OF THE DATE HEREOF AND WE ASSUME NO
OBLIGATION TO UPDATE ANY FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS
INVOLVE KNOWN OR UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH MAY CAUSE
OUR ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS, OR INDUSTRY RESULTS TO BE
MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS
EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD
CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE BUT ARE NOT LIMITED TO:
RELATIONSHIPS WITH MALL DEVELOPERS AND OPERATORS, THE AVAILABILITY OF CASH
AND/OR MALL SPACE FOR PLANNED EXPANSION, FLUCTUATIONS IN SALES AND STORE SALE
RESULTS, UNCERTAINTIES RELATED TO NEW STORE OPENINGS, NEW STORE CONCEPTS, MUSIC
AND FASHION TRENDS, COMPETITION FROM OTHER RETAILERS, SUCCESS OF JOINT VENTURES
AND RELATIONSHIPS WITH AND RELIANCE UPON THIRD PARTIES, UNCERTAINTIES GENERALLY
ASSOCIATED WITH SPECIALTY RETAILING, POLITICAL AND OR SOCIAL CHANGES OR EVENTS
THAT COULD NEGATIVELY IMPACT SHOPPING PATTERNS AND/OR MALL TRAFFIC AND THE OTHER
FACTORS REFERRED TO HEREIN INCLUDING, BUT NOT LIMITED TO, THE ITEMS DISCUSSED IN
PART I, ITEM 1 UNDER THE CAPTION "CERTAIN RISK FACTORS RELATED TO THE COMPANY'S
BUSINESS" AND IN PART II, ITEM 7 UNDER THE CAPTION "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
PART I
ITEM 1. BUSINESS
GENERAL
Hot Topic, Inc. (together with its subsidiaries, "Hot Topic" or the
"Company") operates Hot Topic stores, a mall-based specialty retailer of
music-licensed and music-influenced apparel, accessories and gift items for
young men and women principally between the ages of 12 and 22. In the first half
of fiscal 2001 (the fiscal year ended February 2, 2002) the Company launched a
second retail concept with the opening of six stores under the trade name
Torrid(TM). Torrid offers a selection of music influenced apparel, lingerie,
shoes and accessories centered around various lifestyles for plus-size young
women between the ages of 15 and 29. The Company opened its first Hot Topic
store in 1989 and at the end of fiscal 2001, the Company operated 346 Hot Topic
stores and six Torrid stores in 48 states. The Company also maintains two
distinct websites, www.hottopic.com and www.torrid.com which reflect the Hot
Topic and Torrid store concepts and sell certain items of merchandise. The
Company believes teenagers throughout the United States have similar fashion
preferences, largely as a result of the nationwide influence of MTV, music
distribution, movies and television programs.
The Company opened 73 Hot Topic and six Torrid stores during fiscal
2001. The Company also occasionally relocates or expands existing stores. During
fiscal 2001, the Company expanded or relocated seven stores. The Company plans
to open approximately 70 new Hot Topic stores and 15 Torrid stores in the fiscal
year ending February 1, 2003 ("fiscal 2002"); and 17 of these new Hot Topic
stores and none of the Torrid stores were open as of April 10, 2002.
THE MARKET
The music-licensed apparel industry began in the 1960s with bootleggers
selling T-shirts at concert venues. Over the ensuing two decades, artists began
to realize the commercial potential of licensing their likenesses and logos to
T-shirt manufacturers and others who produced assorted merchandise. Management
2
believes that the single largest impact on the music industry during recent
years has been the success of the MTV music network, which enables fans not only
to listen to the latest music and artists 24 hours a day, but also to experience
a full sight and sound package of appearance and attitude. According to the
Neilson Media Research Report, in 2001 MTV music network programming could be
seen in more than 83 million households in the United States and in over 384
million households worldwide. As a result, popular artists and fashions are much
more visible today than 30 years ago. Hot Topic's management believes that this
increased visibility has contributed to the increase in demand for
music-licensed and music-influenced apparel and accessories.
MTV Networks has also achieved great success with specialized
programming. For instance, "The Osbournes" drew more than 4 million viewers to
its regular time slot on March 26, 2002. Through the Company's continued
sponsorship of the largest summer rock tour, Ozzfest, Hot Topic expects to
benefit from this broader audience.
Hot Topic's target customers are young men and women between the ages
of 12 to 22 years old, who are passionate about music, music videos,
music-inspired fashion, and are avid MTV viewers. The Company believes its
music-oriented merchandise appeals to teenagers from diverse socio-economic
backgrounds, and that its customers are broadly representative of the teenage
population in the United States.
Torrid targets customers that are plus-size females ages 15 to 29 years
old and influenced by music and pop-culture. Hot Topic actively listens to
customer feedback, and based on requests from plus-size customers, the Company
launched Torrid, its new junior plus-size store. Hot Topic believes young women
wearing sizes 14 to 26 can now match the style, excitement and selection
available at other junior retailers with the assortment found in Torrid. Torrid
is a new specialty retail concept largely inspired by requests from young,
female shoppers at Hot Topic stores and www.hottopic.com. After analyzing
customer feedback and researching the market demographics, the Torrid concept
was born. Torrid was launched in the first half of fiscal 2001, with the opening
of six locations across the country and a website, www.torrid.com. The
performance of these first six stores prompted the planned expansion of 15
additional stores starting in the second quarter of fiscal 2002.
Teenagers represent both a growing part of the United States population
and an increasing source of purchasing power. According to Teenage Research
Unlimited, it is estimated that the teenage population in the United States
reached approximately 32 million in 2000 and is expected to grow to
approximately 34 million by 2005, representing a projected growth rate close to
twice the rate of the overall population. By 2010, there are likely to be more
teenagers in the United States than at any other time in history. Teenage
spending has also increased annually. The average American teen spent more than
$104 a week in 2001 according to the marketing research firm Teen Research
Unlimited, an increase of $26 from $78 in 1998. In the past five years, teenage
spending has grown from an estimated $122 billion a year to $172 billion a year.
3
HOT TOPIC BUSINESS STRATEGY
The Company's goal is to become the leading retailer of music-licensed
and music-influenced apparel and accessories for young men and women. The
principal elements of the Company's business strategy are as follows:
O FOCUS ON UNIQUE MUSIC-ORIENTED MERCHANDISE
Hot Topic's management believes that fashions and products associated
with popular music artists have a significant influence on teenagers. The
Company has developed a unique strategy focused exclusively on offering
music-licensed and music-influenced merchandise in the mall environment.
Accordingly, the Company believes it is well positioned to capitalize on the
growing teenage population and demand for music-related merchandise.
O OFFER "EVERYTHING ABOUT THE MUSIC"
The Company's stores are designed to serve as a headquarters for
music-licensed and music-influenced apparel, accessories and gift items. The
Company's slogan, "Everything About The Music," reflects the Company's broad
assortment of products, which include over 10,000 Stock Keeping Units ("SKUs")
in approximately 20 different product categories. The Company believes its
selection of music-licensed merchandise is the most extensive assortment
available in a single mall store. The Company complements its licensed
merchandise with a unique and eclectic assortment of music-influenced apparel
and accessories, and frequently introduces new items and categories in response
to changes in trends and demand. The Company believes it has a history of being
the first to offer the latest music fashions, which, together with its
assortment of merchandise, has made it a destination store for teenagers seeking
music-related products.
O PROMOTE MUSIC-INSPIRED CULTURE
Hot Topic is committed to addressing the music-oriented lifestyles of
its customers by building a culture throughout the organization that reflects a
passion for music. Management diligently tracks alternative and rock music
trends by regularly monitoring new music, music video releases, and radio
station air play, visiting nightclubs around the country and attending concerts.
The Company also actively solicits feedback from its associates and customers.
The Company believes these activities enable it to react quickly to emerging
trends, and provide it with a competitive advantage over retailers who do not
devote the time and resources necessary to anticipate these trends.
O LISTENING TO THE CUSTOMER
Hot Topic does not dictate fashion trends, but rather seeks to identify
music artists and releases that will have strong appeal and related products
that will generate strong demand. The Company has developed a disciplined
approach to buying and a dynamic inventory management process to support the
merchandise strategy. The Company regularly tests new merchandise in select
stores before chain-wide distribution, and orders a majority of its merchandise
not more than 60 days before delivery, enabling it to respond quickly to
emerging trends. Hot Topic is aggressive in taking prompt markdowns to maintain
a fresh merchandise mix. By actively managing the mix of categories and products
in its stores, the Company believes it is able to capitalize on emerging trends
and minimize its dependence on any particular category. The Company believes
that this approach to managing its merchandise mix has contributed to its strong
merchandise margins and consistent markdown rates. The Company believes this
markdown rate is lower than industry averages.
4
O EMPHASIZE CUSTOMER SERVICE
Hot Topic trains its store associates to provide value-added,
non-intrusive customer service. Sales associates are trained to greet each
customer, provide information about new music and fashion trends and suggest
merchandise that matches the customer's lifestyle and music preferences. The
Company strives to give its teenage customers the same level of respect and
attention that is generally given to adult customers at other retail stores and
to provide friendly and informed customer service for parents. The Company
believes that a high level of product knowledge and a commitment to music
fashion create high credibility and differentiate the Company from other
teenage-focused retailers.
O CREATE AN ENTERTAINING STORE ENVIRONMENT
The Company seeks to create a compelling shopping environment that
brings to the mall the elements of the alternative urban shopping experience
sought by teenagers. The Company has always focused on the lifestyles of the
youth generation. Hot Topic stores are designed with an industrial theme that
incorporates dense merchandising and utilizes a professional sound system
playing alternative music releases to create a fun, high-energy store that teens
will consider "their place" to shop with friends. The Company believes that this
atmosphere enhances the Company's image as a source for music-inspired fashion
while encouraging customers to shop in its stores for longer periods of time.
Late in fiscal 2000, the Company tested a new store design in two locations in
California. Continuing to focus on the world of music and musicians as
inspiration, the objective of the new design is to provide a more kinetic and
industrial-club feel, while portraying a less gothic appearance than the
Company's previous store design. This new look was inspired by the markets,
clubs and old warehouse districts in London where the Company's designers toured
and created this new "industrial club" theme. Virtually all of the 73 new Hot
Topic stores opened in fiscal 2001 were built with this new design. The Company
plans to continue with this design for the 70 Hot Topic stores it expects to
open in fiscal 2002.
TORRID BUSINESS STRATEGY
The Company's goal for the Torrid division is to become the leading
specialty retailer of fashion forward plus-size junior apparel. The principal
elements of the Company's business strategy for Torrid are as follows:
O FOCUS ON FASHION FORWARD PLUS-SIZE APPAREL AND ACCESSORIES
THAT ARE MUSIC-INSPIRED
Torrid's merchandising team is focused on providing a fashion forward
merchandise assortment that reflects the influence of music and provides the
plus-size customer with fun, hip, trendy apparel and accessories. The Company
believes that it is the first mall concept to offer a complete store assortment
of fashion junior plus-size apparel.
O LISTENING TO THE CUSTOMER
Torrid does not dictate fashion trends, but rather listens to customers
and watches music pop culture influences to determine emerging trends in order
to provide merchandise that will have strong customer appeal. Torrid, like Hot
Topic, receives direct feedback from Torrid store associates and customers. This
feedback has a direct influence on future purchases of Torrid merchandise.
5
O EMPHASIZE CUSTOMER SERVICE AND CREATING A FUN, EXCITING
ENVIRONMENT
Torrid trains its store associates to provide one-on-one service to
customers. Since the plus-size customer has been previously unable to find the
same fashion forward merchandise available to their smaller friends, Torrid's
customer service approach focuses on suggesting outfits and ensuring the correct
fit.
Through a focus on customer service and an edgy fashion-forward
merchandise offering, the Company seeks to create a compelling shopping
environment that will be sought after by the plus-size female customer. The warm
reception, great selection, and honest customer service by associates help to
create a comfortable and exciting environment that will be attractive and
welcoming to the Torrid customer.
STORE LOCATIONS
As of February 2, 2002, the Company operated 346 Hot Topic stores in
both metropolitan and middle markets in 48 states across the United States and
six Torrid stores in five states (California, Maryland, Nebraska, Maryland and
Colorado). Between February 2, 2002 and April 10, 2002, the Company opened an
additional 17 Hot Topic stores. The following chart sets forth, as of April 10,
2002, the number of Hot Topic and Torrid stores the Company operates in each
state in which those stores are located:
6
HOT TOPIC, INC.
STORES BY STATE
----------------------------------------------------------------------------------
HOT TOPIC STORES TORRID STORES TOTAL CO.
----------------------------------------------------------------------------------
OPEN NEW HT HT OPEN NEW
AT FY02 AT OPEN AT TORRID OPEN AT OPEN AT
2/2/2002 TO DATE 4/10/2002 2/2/2002 FY02 TO DATE 4/10/2002 4/10/2002
Alabama 1 1 0 0 1
Arizona 6 6 0 0 6
Arkansas 2 2 0 0 2
California 51 4 55 2 2 57
Colorado 8 2 10 1 1 11
Connecticut 6 6 0 0 6
Delaware 2 2 0 0 2
Florida 18 18 0 0 18
Georgia 7 1 8 0 0 8
Hawaii 3 3 0 0 3
Idaho 1 1 0 0 1
Illinois 14 14 0 0 14
Indiana 8 8 0 0 8
Iowa 5 5 0 0 5
Kansas 4 4 0 0 4
Kentucky 4 4 0 0 4
Louisiana 3 3 0 0 3
Maine 1 1 0 0 1
Maryland 9 9 1 1 10
Massachusetts 7 7 1 1 8
Michigan 11 1 12 0 0 12
Minnesota 9 1 10 0 0 10
Mississippi 1 1 0 0 1
Missouri 7 7 0 0 7
Montana 1 1 2 0 0 2
Nebraska 2 2 1 1 3
Nevada 5 5 0 0 5
New Hampshire 4 4 0 0 4
New Jersey 12 2 14 0 0 14
New Mexico 3 3 0 0 3
New York 16 16 0 0 16
North Carolina 6 1 7 0 0 7
North Dakota 1 1 0 0 1
Ohio 10 10 0 0 10
Oklahoma 4 4 0 0 4
Oregon 3 3 0 0 3
Pennsylvania 19 19 0 0 19
Rhode Island 1 1 0 0 1
South Carolina 4 4 0 0 4
South Dakota 2 2 0 0 2
Tennessee 8 1 9 0 0 9
Texas 26 2 28 0 0 28
Utah 3 3 0 0 3
Vermont 1 1 0 0 1
Virginia 4 1 5 0 0 5
Washington 14 14 0 0 14
West Virginia 2 2 0 0 2
Wisconsin 7 7 0 0 7
TOTAL 346 17 363 6 0 6 369
# OF STATES 48 11 48 5 0 5 48
7
EXPANSION STRATEGY
The following table provides a history of the Company's store expansion
over the last five fiscal years:
FISCAL YEAR
----------------------------------------------------------
2002
THROUGH
1997 1998 1999 2000 2001 4-10-02
----------------------------------------------------------
(Number of stores)
Stores at beginning of year 68 108 158 212 274 352
Hot Topic store closing/reopening* (1) 1
New stores opened - Hot Topic 40 50 54 62 73 16
New stores opened - Torrid 6
----------------------------------------------------------
Stores at end of year 108 158 212 274 352 369
----------------------------------------------------------
* Victorville, CA store re-opened in first quarter of fiscal 2002.
The Company's expansion strategy is to open stores primarily in
shopping malls and selected entertainment centers in both new and existing
markets throughout the United States. The Company believes it has developed a
store concept that is successful in both metropolitan and middle markets.
Further, as a result of the nationwide influence of MTV, music distribution,
movies and television programs, the Company believes that its 12 to 22 year-old
target customers have similar fashion preferences throughout the United States.
The Company opened 73 new Hot Topic stores and six Torrid stores in
fiscal 2001 as well as expanded or relocated seven existing Hot Topic stores.
The Company closed one store in fiscal 2001 that was at the end of its lease.
During fiscal 2002, the Company plans to open approximately 70 new Hot Topic
stores (16 stores of which the Company has opened in the first quarter of fiscal
2002 and one re-opening of the store closed in fiscal 2001) and 15 new Torrid
stores, in addition to expanding or relocating 10 existing Hot Topic stores. The
Company selects and evaluates potential store locations based on a variety of
criteria including the sales and square footage of the mall, sales of anchor
stores, sales of teenage-oriented stores, foot traffic, number of teenagers in
the trade area, median family income and other factors relevant to the Company's
unique merchandising strategy. Hot Topic has a real estate committee, consisting
of its Chief Executive Officer, Chief Operating Officer, Chief Financial
Officer, Vice President of Store Operations, Vice President of Real Estate and
the Torrid General Manager. The Company generally seeks potential store sites
between 1,600 square feet and 2,200 square feet for Hot Topic stores between
2,200 square feet and 2,800 square feet for Torrid stores. The average size of
the Company's fiscal 2001 Hot Topic openings was 1,877 square feet and 2,452
square feet for the Company's Torrid openings.
The Company's Hot Topic stores currently average approximately 1,617
square feet and 2,452 square feet for Torrid stores.
STORE-LEVEL ECONOMICS
During fiscal 2001, the Company achieved average Hot Topic store net
sales of approximately $1,038,000 and average Hot Topic store net sales per
square foot of approximately $642. Store-level operating cash flow (defined as
store operating income before depreciation and excluding changes in working
capital) for Hot Topic stores open the entire year in fiscal 2001 was
approximately $311,000, or 30% of average net sales. In fiscal 2001, all of the
8
Company's Hot Topic stores generated positive store-level operating income, but
there can be no assurance this trend will continue. There also can be no
assurance that in the future the average store-level sales and operating cash
flow will not vary from historical results or that the total estimated capital
expenditures for new stores will not increase.
HOT TOPIC MERCHANDISING
The Company's stores are designed to serve as a headquarters for
music-licensed and music-influenced apparel, accessories and gift items.
Music-licensed merchandise includes T-shirts, hats, posters, stickers, patches,
postcards, books, shoes, intimate apparel, novelty accessories, compact discs
and albums. Music-influenced merchandise includes woven and knit tops, skirts,
pants, shorts, jackets, shoes, costume jewelry, body jewelry, sunglasses,
cosmetics, leather accessories and gift items. Additional licensed apparel and
accessories are influenced by television shows, cartoons and major motion
pictures. Approximately half of the Company's products are licensed, and the
other half are music-influenced products. A key strategy of the Company is to
offer over 10,000 SKUs in 20 different product categories or "departments." On
average, over 100 different licensed band T-shirts are carried in each store
from current artists such as SlipKnot, System of a Down, Linkin Park, Tool and
the Strokes as well as classic rock artists such as Pink Floyd, Nirvana,
Metallica, Jimi Hendrix, The Doors, Beatles and Led Zeppelin. New items and
categories are regularly tested as customer demand and product trends evolve.
The Company's merchandising staff consists of a Vice President, General
Merchandise Manager, two divisional merchandise managers, nine buyers, three
associate buyers and ten assistant buyers. The merchandising staff reflects the
Company's culture in that its decisions and actions are influenced by music. In
determining which merchandise to buy, the staff spends considerable time viewing
music videos, reviewing industry music sales, monitoring alternative radio
station air play, consulting with sales associates, reviewing customer requests,
attending trade shows and reading music and fashion industry periodicals. In
addition, the merchandising staff regularly visits nightclubs and attends
concerts and other events that attract young people. The Company also solicits
input from its store associates, in order to draw from many different
experiences and perspectives.
The following table sets forth the Company's four major merchandise
groups as an approximate percentage of net sales for fiscal years 2001, 2000 and
1999:
PERCENTAGE OF NET SALES
---------------------------------------
2001 2000 1999
---------------------------------------
Apparel and T-Shirts 53% 51% 50%
Gifts 15 15 16
Accessories 26 27 27
Intimate Apparel and Shoes 6 7 7
---------------------------------------
100% 100% 100%
=======================================
Approximately half of the Company's products are licensed products.
Artists typically license their likeness to a "master licensor." The master
licensor often retains the rights to market T-shirts and then may choose to
sub-license to manufacturers, other categories of merchandise such as posters,
stickers and patches. Some artists also retain their licensing rights and
negotiate directly with licensees. Hot Topic buys its licensed merchandise from
master licensors, licensees and directly from artists. The Company currently
purchases licensed T-shirts from over 30 companies and other licensed products
from over 100 companies. Because of the Company's knowledge of teenage
consumers' music preferences and music-influenced fashion, licensors often seek
the Company's advice prior to licensing new artists or product designs. As a
result, the Company often receives accommodations such as early shipments of new
releases, exclusive merchandise, advanced lead times, exclusive designs and
vendors' acceptance of returns.
9
The Company buys its unlicensed, music-influenced merchandise from a
variety of manufacturers. The Company actively searches for new vendors that
offer unique and timely music-influenced products. As a result, the Company at
any given time has many different vendors of different sizes, including some
from which it has not previously purchased.
The Company has five lines of private label merchandise to complement
and supplement current product offerings. The Company believes that Hot Topic
brands play an important part in differentiating its stores from those of its
competitors and provide the Company with higher margin opportunities as compared
to other merchandise. The Company's management estimates that in fiscal 2001 Hot
Topic brands accounted for approximately 25% of the Company's sales, the same
percentage as in fiscal 2000. The Company's proprietary brands include Morbid
Makeup (cosmetics), Morbid Metals (body jewelry), Morbid Threads (men's and
women's apparel and hosiery) and MT:2 (men's and women's apparel). Shoes are
also sold under the Hot Topic label.
In order to reduce fashion risk and maintain the ability to respond
quickly to emerging trends, Hot Topic buys a majority of its merchandise not
more than 60 days in advance of delivery, and will often begin with smaller test
purchases prior to chain-wide distribution. The Company regularly monitors store
sales by merchandise classification, SKU, color and size to determine types and
amounts of products to purchase, to detect products and trends that are emerging
or declining, and to manage the product mix in its stores to respond to the
spending patterns of its customers. The Company also works with its vendors to
ensure that sources for new and private label products are maintained and
expanded.
During fiscal 2001, the Company had approximately 944 vendors, certain
of which have limited financial resources and production capabilities. No single
vendor accounted for more than 5% of the Company's merchandise purchases. The
Company believes that its relationships with its vendors are good.
TORRID MERCHANDISING
The Company's Torrid stores are designed to serve as the destination
for fashion forward apparel and accessories for the plus-size junior woman. The
Company believes that the Torrid customer wants to wear the same merchandise as
her smaller-sized peers. Torrid's merchandise includes novelty t-shirts, fashion
tops, pants, shorts, skirts, dresses, jackets, intimate apparel, shoes, hosiery,
accessories, gifts, and beauty products. Torrid apparel is sized 14 to 26.
Approximately 30% of the products come from established branded vendors,
including Paris Blues, Z Cavaricchi, Necessary Objects, Kikwear, Macgirl,
Dollhouse, Fine and Hot Kiss and more fashion-forward vendors such as Serious,
Lip Service, and Tripp. The Company worked with these and other vendors, to
develop plus-size junior apparel fit specifications. The Company believes its
selection of fashion items from these and similar vendors gives the Torrid
customer an opportunity to buy the same or similar branded items that have
historically been available to other young women of the same age who are not
plus-size. Working together with vendors, fashion trends and customer requests
are researched, designed and manufactured for Torrid. Torrid, through its own
fit specialist, works with the manufacturers' design teams to help ensure that
quality standards are achieved and maintained.
During fiscal 2001, approximately 75% of Torrid's net sales were
generated in apparel merchandise categories and 25% of Torrid's sales were
produced in accessories, including intimate apparel and shoes.
10
The Torrid merchandising staff consists of a divisional merchandise
manager, two buyers, one associate buyer and one assistant buyer. The Company's
culture of soliciting and listening to customers and store associates is
evidenced by the Torrid merchandising staff's decisions and actions.
Furthermore, the Company believes that Torrid's merchandising direction is
influenced by music and music related activities. The range of music and music
artists that influence Torrid fashion is much broader than those influencing
fashion at Hot Topic stores, consistent with the broader target customer base of
females ages 15 to 29.
Merchandising decisions for Torrid are also influenced by emerging
fashions in the junior market. The decisions of the Torrid merchandising group
are heavily influenced by feedback from customers and associates, in order to
draw from many different experiences and perspectives. The staff also spends
considerable time visiting nightclubs, attending concerts, attending trade shows
and other events that attract young people. Approximately 30% of Torrid
merchandise is purchased from established branded vendors. The remaining 70% is
Torrid private label merchandise that provides the customer with unique,
fashion-forward merchandise, often at more competitive price points than branded
merchandise. Private label merchandise also often provides the Company with
higher margin opportunities as compared to other merchandise. In order to reduce
fashion risk and maintain the ability to respond quickly to emerging trends,
Torrid buys a majority of its merchandise not more than 90 days, and many times
less than 60 days, in advance of delivery, and will often begin with small
purchases for testing.
ALLOCATION AND DISTRIBUTION OF MERCHANDISE
Allocation and distribution of the Company's inventory is addressed at
the store, merchandise classification and SKU levels using integrated third
party software. Most merchandise is ordered in bulk and then allocated to each
store based on store inventory plans and SKU performance by using Arthur
Allocation software. Buyers determine SKU reorder quantities by using a
proprietary automated software program which considers sales history, projected
sales, planned inventories by store, store demographics, geographic preferences,
store openings and planned markdown dates.
The Company's Vice President of Planning and Allocation, two directors
of Planning and Allocation and 20 inventory analysts work closely with the
merchandise buyers and store associates to meet the appropriate inventory
requirements of each store. Hot Topic's headquarters and distribution facility
consists of approximately 250,000 square feet located in City of Industry,
California. All merchandise is delivered by vendors to this facility, where it
is inspected, priced, allocated, picked and boxed for shipment to the Company's
stores. Merchandise is shipped to stores each weekday, providing Hot Topic
stores with a steady flow of new and reordered merchandise. Minimal back stock
is maintained in the Company's distribution facility and at its stores; so that
most of the Company's merchandise is available for sale on the selling floors of
its stores.
In March 2001, the Company entered into a lease for an additional
125,000 square feet in the same building as is its current headquarters and
distribution facility in the City of Industry, California bringing the total
square feet to approximately 250,000. Late in the fourth quarter of fiscal 2001,
the Company began construction to expand its office and distribution center into
the additional space. The expansion is planned to be completed during the second
quarter of fiscal 2002 at an estimated cost of approximately $4.2 million. The
Company estimates that the operating capacity gained from this additional space
and the related offices and equipment will allow for growth to approximately 700
stores.
HOT TOPIC STORE OPERATIONS
Hot Topic's store operations are currently managed by six regional
managers and 57 district or area managers who each supervise approximately four
to eight stores. Individual stores are managed by a store manager and two or
three assistant managers. In addition to managers and assistant managers, a
typical store has approximately six to ten part-time sales associates, depending
on the season. The hiring and training of new associates is the responsibility
of the store manager and district manager and the Company has established
training and operations procedures to assist them. Additionally, Hot Topic uses
a customized, automated telephone screening system licensed from a third party
to help evaluate potential new associates, which helps streamline the Company's
interview and hiring processes at the store level.
11
The Company strives to create a store environment that teenagers will
consider "their place" to shop with friends. Hot Topic seeks to hire sales
associates who fit the profile of its target customer -- energetic people who
are knowledgeable and passionate about music and music-inspired fashion. To
assist management in properly considering the preferences and opinions of its
target customers, selected sales associates accompany Hot Topic's buyers on
buying trips. Further, in return for feedback on fashion and other trends, sales
associates are reimbursed for the cost of attending concerts and frequenting
clubs, and are encouraged to communicate customer requests and their own
merchandise ideas to the buyers and management. Hot Topic encourages its sales
associates to dress and accessorize themselves with the same fashionable
merchandise that is sold in its stores. To further encourage its associates to
dress and accessorize themselves with Hot Topic merchandise, the Company offers
a 40% employee discount on merchandise. Management believes its music-based
culture and its interaction with and respect for sales associates has led to
associate turnover rates that the Company believes are lower than the industry
average.
The primary objective of sales associates is to provide superior,
informed customer service in order to maximize sales and minimize inventory
shrinkage. Store management is provided with daily store sales and category
results so that performance can be measured against set goals. Postage-paid
"report cards" are provided in all stores for customers to grade performance and
make recommendations to Company management. The Company strives to give its
teenage customers the same level of respect and attention that is generally
given to adult customers at other retail stores. Associates are trained to greet
each customer, to inform the customer about new music fashion trends and to
suggest merchandise that matches the customer's lifestyle and music preferences.
Hot Topic also strives to provide friendly and informed customer service for
parents. The Company provides a listing of music artists' national tour dates at
each of its stores. The Company believes that its high level of product
knowledge and service differentiates Hot Topic from other teenage-focused
retailers.
Store, district and area managers are compensated with a base salary
and may qualify to receive a quarterly bonus based on sales and inventory
shrinkage. Additionally, district, area and store managers may also qualify to
receive periodic stock option grants, and certain associates are eligible to
participate in the Company's Employee Stock Purchase Plan. The Company believes
that its continued success is dependent in part on its ability to attract,
retain and motivate qualified associates. In particular, the success of the
Company's expansion program will be dependent on its ability to promote and/or
recruit qualified district and store managers. To date, a significant number of
its store managers have been promoted from within the Company.
TORRID STORE OPERATIONS
Torrid store operations are currently supervised by one district
manager and one area manager. Individual stores are managed by one store manager
and two or three assistant managers. In addition, each store has six to ten
part-time associates, depending on the season. The store and district managers
are responsible for associate training, and the Torrid division has established
training programs and operating procedures.
Similar to Hot Topic stores, Torrid district, area and store managers
are compensated with a base salary and may qualify for quarterly bonuses based
on sales and inventory shrinkage results. District, area and store managers may
also qualify to receive periodic stock option grants, and certain associates are
eligible to participate in the Company's Employee Stock Purchase Plan. The
division believes that its continued success is dependent in part on its ability
to attract, retain and motivate qualified associates. In particular, the success
of the Torrid division's expansion program will be dependent on its ability to
promote and/or recruit qualified district and store managers.
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MARKETING, PROMOTION AND INTERNET
The Company generally locates its stores in high traffic malls within
areas of high teenage population and relies on existing customers, sales
associates, store design and exciting music to attract new customers to its
stores. During fiscal 2000 and fiscal 2001 the Company co-sponsored a major
summer rock tour, Ozzfest. As sponsor, the Company's name was associated with
all promotional activities at each venue. The Company has entered into a similar
sponsorship of Ozzfest in fiscal 2002.
The Company continued to operate its core website, www.hottopic.com,
which offers merchandise, tour dates, contests, job postings, store locations
and community features such as band reviews. An additional website was also
launched to support the Torrid concept: www.torrid.com. The Torrid website also
markets merchandise and announces new store locations. The Company's net sales
from Internet operations (with www.torrid.com) rose by 47% and contributed
approximately 1.5% of total sales in fiscal 2001. The Company intends to
relaunch each of the websites in fiscal 2002 with improved functionality to
better drive sales and support customer needs.
INFORMATION TECHNOLOGY
Hot Topic's information systems provide integration of store,
merchandising, distribution, financial, and human resources. These systems
include SKU and classification inventory tracking, purchase order management,
open-to-buy, merchandise distribution, automated ticket making, general ledger,
sales audit, accounts payable, integrated financials and human
resources/payroll. Most of these systems operate on software licensed from GERS
Retail Systems ("GERS") running on an Oracle database platform. Sales are
updated daily in the merchandising reporting systems by polling sales
information from each store's point-of-sale ("POS") terminals. The Company's POS
system consists of registers providing price look-up, time and attendance,
e-mail and credit card/check authorization. Through automated nightly two-way
electronic communication with each store, sales information, payroll hours and
e-mail messages are uploaded to the host system and receiving, price changes,
system maintenance and e-mail are downloaded through the POS system. The Company
evaluates information obtained through nightly polling to implement
merchandising decisions, including product purchasing/reorders, markdowns and
allocation of merchandise on a daily basis.
During fiscal 2001, the Company had two main areas of focus in
information technology. The Company's POS system upgrade was completed in all
existing stores, at a cost of approximately $3.0 million. Advanced features of
the GERS Retail Systems ("GERS") were implemented, along with informational
report development.
In addition, in fiscal 2002 the Company plans to invest approximately
$1.4 million in a new Wide Area Network to connect all Company stores. The
Company expects this new technology to improve efficiency and assist in
communicating more effectively with all store locations nationwide.
TRADEMARKS
The Company has registered on the Principal Register of the United
States Patent and Trademark Office its retail store service mark Hot Topic(R)
and various trademarks for merchandise including Hot Topic(R), Morbid
Make-Up(R), Morbid Scents(R), Morbid Metals(R), Morbid Adornments(R),
Tragedy(R), Misery(R), MT:2(R), Morbid Threads(R) and Everything About the
Music(R). Each federal registration is renewable indefinitely if the mark is in
use at the time of the renewal. Applications have been made to register
Naturally Morbid(TM), Torrid(TM), Torrid & Design(TM) and Torrid Flaming Heart
Design(TM) in the United States. The Company is not aware of any claims of
infringement or other challenges to the Company's right to use its marks in the
United States. The Company also has additional registrations and pending
applications in foreign jurisdictions. All other trademarks, tradenames and
servicemarks referenced herein are the property of their respective owners.
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HOT TOPIC COMPETITION
The teenage retail apparel and accessory industry is highly competitive
and the Company expects competition in its niche to increase. The Company
competes with other retailers for vendors, customers, suitable retail locations
and qualified associates. Hot Topic currently competes with street alternative
and vintage clothing stores located primarily in metropolitan areas and with
other mall-based teenage-focused retailers such as The Buckle, Claire's Stores,
Inc., Charlotte Russe Inc., Delias Inc., d.e.m.o. (a divison of Pacific Sunwear,
Inc.), Gadzooks, Inc., Millers Outpost, Inc., Pacific Sunwear of California,
Inc., Spencer Gifts, Inc., Urban Outfitters, Inc., The Wet Seal, Inc., and, to a
lesser extent, with music stores. Many of the Company's competitors are larger
and have substantially greater financial, marketing and other resources than the
Company. The principal factors of competition in the Company's business are
merchandise selection, customer service, store location and price.
TORRID COMPETITION
Based on direct customer research conducted by the Company, Hot Topic
believes that teen plus-size females have historically shopped for apparel at
department stores and specialty stores such as Lane Bryant. The Company believes
such stores generally target an older customer than does Torrid. While the
Company is not aware of other mall-based chains that are specifically targeting
junior, plus-size fashion-forward customers, Torrid competes with traditional
department stores, local specialty stores and junior teen retailers that offer
some larger-sized merchandise, such as Deb Shops, and certain traditional and
web-based catalogs. Many companies compete for the junior customers and
additional competitors may enter into the plus-size female market.
EMPLOYEES
The Company employed approximately 1,200 full-time and 2,800 part-time
associates as of April 20, 2002. Of the Company's 4,000 associates,
approximately 290 were corporate headquarters and distribution center personnel,
60 regional and district managers and approximately 3,650 were store associates.
The number of part-time associates fluctuates with seasonal needs. None of the
Company's associates are covered by collective bargaining agreements. The
Company considers its associate relations to be good.
EXECUTIVE OFFICERS AND KEY EMPLOYEES
The executive officers and key employees of the Company and their ages
at April 20, 2001 are as follows:
NAME AGE POSITION
---- --- --------
Elizabeth M. McLaughlin 41 President and Chief Executive Officer and Director
Gerald A. Cook 49 Chief Operating Officer
James J. McGinty 39 Chief Financial Officer
Jay A. Johnson 56 Senior Vice President of Strategic Analysis and Investor
Relations
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Thomas A. Rail 51 Senior Vice President and General Manager, Torrid
Jane Cruz 42 Senior Vice President, Human Resources
Cindy Levitt 41 Vice President, General Merchandise Manager
Darrell Kinsley 39 Vice President, Store Operations
John Neppl 45 Vice President, Real Estate and Construction
Alain Krakirian 36 Vice President, Planning and Allocation
Sue McPherson-Spissu 34 Vice President, Distribution Center and Internet
John Horwath 42 Vice President, Information Technology
George Wehlitz, Jr. 41 Vice President, Controller
Karen Talley 44 Divisional Vice President and Divisional Merchandise Manager,
Accessories
ELIZABETH M. MCLAUGHLIN has served as Chief Executive Officer of the
Company since August 2000 and President since February 2000, and has served on
the Board since May 2000. From June 1996 through February 2000, Ms. McLaughlin
served as Senior Vice President and General Merchandise Manager of the Company.
From May 1993 through May 1996, Ms. McLaughlin was the Company's Vice President,
Operations. Prior to joining the Company, Ms. McLaughlin held various positions
with Millers Outpost, a privately-held teen retailer, where she served as
Divisional Merchandise Manager, Director of Store Operations, and Director of
Financial Planning and Budgeting. Prior to joining Millers Outpost, Ms.
McLaughlin held various financial analyst and store positions with The Broadway.
Ms. McLaughlin holds a B.A. degree in Economics from the University of
California at Irvine.
GERALD A. COOK has been Chief Operating Officer of the Company since
February 2001. From February 1999 until joining the Company, he was the
President and Chief Operating Officer of Travel 2000, Inc. Subsequent to his
leaving Travel 2000, Inc., the 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.
JAMES J. MCGINTY has served as Chief Financial Officer of the Company
since February 2001. Mr. McGinty joined Hot Topic in August 2000 as its Vice
President, Finance and was promoted to Chief Financial Officer in February 2001.
From July 1996 to July 2000, Mr. McGinty was Vice President-Controller at
Victoria's Secret Stores, the leading brand and largest specialty retailer in
the Limited, Inc. From 1984 to 1996, he held various financial and accounting
positions within the Structure and Express divisions of the Limited, Inc. Mr.
McGinty holds a B.S. degree in Accounting from Miami University in Oxford, Ohio.
JAY A. JOHNSON has served as the Senior Vice President, Strategic
Analysis and Investor Relations of the Company since February 2001. Since May
1995 he also has served as the Company's Assistant Secretary. From May 1995 to
February 2001, he was the Chief Financial Officer of the Company. From January
1993 to May 1995, he was Vice President/Chief Financial Officer of Frame-n-Lens
Optical, Inc., a national optical retailer then with approximately 300 stores.
15
From July 1978 to July 1992, Mr. Johnson held senior financial management
positions at one manufacturing and two retail companies. Mr. Johnson is a
certified public accountant. Mr. Johnson holds a B.S. degree in Accounting from
the California State University, Northridge.
THOMAS A. RAIL has been Senior Vice President and General Manager of
Torrid since May 2001. From January 1999 to April 2001, Mr. Rail was President
of Retail for Aris Industries where he was responsible for the XOXO boutique and
outlet stores, an XOXO Internet site, and the coordination of retail licensees.
From August 1995 to December 1998, he was President of Retail for Designer
Holdings where he was responsible for developing 37 Calvin Klein Outlet stores
and, upon its acquisition by Warnaco in the Fall of 1997, assumed the additional
responsibilities for approximately 85 Olga Warner stores. Mr. Rail spent June
1985 through August of 1996 in various management positions with Millers
Outpost, including six years as the General Manager of Levi's Outlet by MOST (a
start-up division for Millers). Mr. Rail has a B.S. in Business Management from
Brigham Young University.
JANE CRUZ joined the Company in August 2001 as Senior Vice President,
Human Resources. Ms. Cruz has over 18 years of human resource experience. From
July 1996 to July 2001, Ms. Cruz held human resource management positions with
Universal Studios' Television and Networks Group, including most recently,
Senior Vice President, Human Resources. At Universal Studios her
responsibilities included both domestic and international operations. From
November 1994 to July 1996, Ms. Cruz was Director, Human Resources of EQE
International, an engineering consulting firm. She spent March 1983 through
November of 1994 in various Human Resource positions with Viacom - Cable
Division, including Regional Director, Human Resources. Ms. Cruz has a B.S. in
Economics from the University of San Francisco and an M.B.A. from the University
of California, Berkeley.
CINDY LEVITT has been Vice President, General Merchandise Manager of
the Company since February 2000. From June 1996 to February 2000, she served as
the Company's Divisional Merchandise Manager, Apparel and Music. Since 1989, Ms.
Levitt has held senior buying positions at the Company. Prior to her career at
Hot Topic, Ms. Levitt held buying positions at May Department Stores.
DARRELL KINSLEY has been Vice President, Stores of the Company since
February 2000. From June 1998 through February 2000, Mr. Kinsley was the
Company's Regional Director for the western United States. From February 1997
through June 1998, he was the Company's Regional Director for the eastern United
States. Mr. Kinsley joined the Company in February 1995 as the District Manager
for the eastern United States. Mr. Kinsley holds a business management
leadership certificate from the Anderson School of Business at the University of
California, Los Angeles.
JOHN NEPPL joined the Company in October 2001 as Vice-President of Real
Estate and Contruction. 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 out of New Hampshire. Mr. Neppl served as
Director of Real Estate at Miller's Outpost/Anchor Blue from October 1987 to
December 1994. Mr. Neppl held various financial positions with Mervyn's
department stores, a division of Target Corporation, from October 1978 to
September 1987. Mr. Neppl received a B.S. in Accounting from Villanova
University in 1978.
ALAIN KRAKIRIAN has been the Company's Vice President, Planning and
Allocation since February 2000. From July 1997 through February 2000, Mr.
Krakirian was the Company's Director of Planning and Allocation. Mr. Krakirian
was the Planning Manager at Disney Stores from December 1996 to July 1997 and
the Director of Merchandise Planning and Allocation at Kids Mart from February
1996 to December 1996. From September 1991 to January 1996, Mr. Krakirian held
various merchandise control and planning positions at Clothestime Stores,
including Director of Merchandise Control and Information Office from October
1994 to January 1996. Mr. Krakirian holds a B.S. degree in Finance from the
University of LaVerne and an M.B.A. degree from Pepperdine University.
16
SUE MCPHERSON-SPISSU was promoted to the Company's Vice President of
Distribution Center and Internet in October 2001. Ms. McPherson-Spissu was the
Company's Vice-President, Distribution Center from February 2001 to October 2001
and was the Company's Divisional Vice President of Distribution Center from
February 2000 to February 2001. From March 1995 to February 2000, she was the
Company's Director of the Distribution Center. Ms. McPherson-Spissu joined the
Company in 1989 as a store associate in its first store while attending the
University of Southern California. Ms. McPherson-Spissu holds a B.S. degree in
Business from the University of Southern California.
JOHN HORWATH has been the Company's Vice President, Information
Technology since June 2001. Mr. Horwath has over 24 years of Information
Technology experience. From May 2000 until joining the Company, he was Director
of Information Technology at World Wide Restaurants, Inc. From August 1998 until
May 2000, Mr. Horwath was the Vice President and Chief Information Officer for
Wherehouse Entertainment, Inc. From February 1992 to July 1998, he was Regional
Vice President of Information Technology for PolyGram Holding, Inc. Prior to
1992, he held management positions with LA Gear, Inc., Pic`N'Save, Inc.,
Tutor/Saliba, Inc., and Kasler Corporation.
GEORGE WEHLITZ, JR. joined Hot Topic in February 2002 as its Vice
President, Controller. From August 2000 to February 2002, Mr. Wehlitz was Chief
Financial Officer at The Popcorn Factory, Inc., a catalog company for gourmet
popcorn gifts. From 1987 to 2000 Mr. Wehlitz held various financial related
positions, at the divisional and corporate level, for The Bombay Company, Inc.
Mr. Wehlitz holds a B.A. degree in Accounting from Texas Christian University
and is a Certified Public Accountant.
KAREN TALLEY has served as Divisional Vice President and Divisional
Merchandise Manager, Accessories of the Company since February 2000. Ms. Talley
joined the Company in 1993 as the Senior Accessory Buyer. She was the Company's
Divisional Merchandise Manager of Accessories from April 1996 to February 2000.
Prior to joining the Company, Ms. Talley held buying positions at Jay Jacobs and
Nordstrom.
17
CERTAIN RISK FACTORS RELATED TO THE COMPANY'S BUSINESS
Certain sections of this Annual Report on Form 10-K, including the
preceding "Management's Discussion and Analysis of Financial Condition and
Results of Operations," contain various forward looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, which represent the
Company's expectations or beliefs concerning future events. These forward
looking statements involve risks and uncertainties, and the Company cautions
that these statements are further qualified by important factors that could
cause actual results to differ materially from those in the forward looking
statements, including, without limitation, the sufficiency of the Company's
working capital and cash flows from operating activities, the effect of economic
conditions, the effect of severe weather or natural disasters, political and/or
social changes or events that could negatively impact shopping patterns and/or
mall traffic and the effect of competitive pressures from other retailers as
well as other risks detailed below:
IMPLEMENTATION AND MANAGEMENT OF AGGRESSIVE GROWTH STRATEGY
The Company's net sales and net income have grown significantly during
the past several years, primarily as a result of the opening of stores and, to a
lesser extent, the introduction of new products and categories. Seventy-nine of
the Company's 352 stores opened as of February 2, 2002 had been open for less
than one full year. The Company intends to continue to pursue an aggressive
growth strategy for the foreseeable future, and its future operating results
will depend largely upon its ability to open and operate stores successfully and
to manage a larger business profitably. The Company anticipates opening
approximately 85 stores, consisting of 70 Hot Topic and 15 Torrid stores, during
fiscal 2002, which will result in a significant increase in the number of stores
operated by the Company. Operation of a greater number of new stores and
expansion into new markets may present competitive and merchandising challenges
that are different from those currently encountered by the Company in its
existing stores and markets. In addition, there can be no assurance that the
Company's expansion within its existing markets will not adversely affect the
individual financial performance of the Company's existing stores or its overall
results of operations, or that new stores will achieve sales and profitability
levels consistent with existing stores. The Company will need to continually
evaluate the adequacy of its store management and management information and
distribution systems to manage its planned expansion. There can be no assurance
that the Company will anticipate all of the changing demands that its expanding
operations will impose on such systems, and the failure to adapt its systems and
procedures to such changing demands could have a material adverse effect on the
Company's business, results of operations and financial condition. There can be
no assurance that the Company will successfully achieve its expansion targets
or, if achieved, that planned expansion will result in profitable operations.
The Company's ability to open stores and the performance of such stores
will depend upon many factors, including and among others, the Company's ability
to identify and enter new markets, locate suitable store sites, negotiate
acceptable lease terms, hire and train store managers and sales associates and
obtain adequate capital resources on acceptable terms. Early in its history, the
Company encountered difficulties in leasing certain store sites. The Company
believes these difficulties were in part due to the Company's level of
capitalization, its limited operating history at such time, its then unproven
store concept, and apprehension on the part of mall operators concerning the
Company's teenage customers. In fiscal 1999, a major mall developer asserted
that the Company had violated a "use clause" applicable to certain or all of the
Company's leases with that developer. As a result, the developer ceased ongoing
discussions relating to potential new Hot Topic stores and told the Company that
no new leases would be entered into. Upon notice of the alleged violation, the
Company adjusted its merchandise mix in stores leased from that developer (and
to a somewhat lesser extent, in all other stores) and took certain other actions
to ensure ongoing "use clause" compliance. These actions and continuing
discussions with the developer resulted in an amended "use clause" for all
leases with the developer. In early 2000, the Company satisfied the concerns of
the developer and resumed discussions with the developer concerning potential
new stores for fiscal 2000 and beyond.
18
There can be no assurance that the Company will not face similar resistance from
mall operators or others in the future. If the Company's relations with mall
operators or developers are ever again strained, the Company may not grow as
planned, may not reach certain revenue levels and other targets, and may suffer
a decline in stock price. Any restrictions on the Company's ability to expand to
new store sites or to offer a broad assortment of merchandise could have a
material adverse effect on the Company's business, results of operations and
financial condition.
FLUCTUATIONS IN COMPARABLE STORE SALES RESULTS
A variety of factors affect the Company's comparable store sales
including, among others, the timing of releases of new music-related products,
music and fashion trends, the general retail sales environment, the Company's
ability to efficiently source and distribute products, changes in the Company's
merchandise mix and the Company's ability to execute its business strategy
efficiently. The Company's comparable store sales results have fluctuated
significantly in the past and the Company believes that such fluctuations may
continue. The Company's comparable store sales results for fiscal 1997, 1998,
1999, 2000 and 2001 were 2.2%, 0.4%, 22.8%, 16.7% and 3.9% respectively. The
Company's comparable store sales results were 8.0%, 2.4%, 2.2% and 3.8% for the
first, second, third and fourth quarters, respectively, of fiscal 2001 and
24.1%, 21.8%, 15.3% and 11.2% for the first, second, third and fourth quarters,
respectively, of fiscal 2000. Past comparable store sales results are not an
indicator of future results, and there can be no assurance that the Company's
comparable store sales results will not decrease in the future. The Company's
comparable store sales results could cause the price of the Common Stock to
fluctuate substantially.
DEPENDENCE ON AND CHANGES IN MUSIC AND FASHION TRENDS
The Company's profitability is largely dependent upon (i) the continued
popularity of alternative and rock music, music videos, and MTV among teenagers
and college age adults, (ii) the emergence of new artists and the success of
music releases and music-related products, (iii) the continuance of a
significant level of teenage spending on music-licensed and music-influenced
products, and (iv) the Company's ability to anticipate and keep pace with the
music, fashion and merchandise preferences of its customers. The popularity of
particular types of music, artists, styles and brands is subject to change. The
Company's failure to anticipate, identify and react appropriately to changing
trends, could lead to, among other things, excess inventories and higher
markdowns, and poor customer acceptance of its new store design, which could
have a material adverse effect on the Company's results of operations and
financial condition, and on its image with customers. There can be no assurance
that the Company's new products and new store design will be met with the same
level of acceptance as in the past or that the failure of the new products
and/or new store design will not have an adverse material effect on the Company
business, results of operations and financial condition.
IMPACT OF ECONOMIC CONDITIONS; MINIMUM WAGE RATES
Certain economic conditions affect the level of consumer spending on
merchandise offered by the Company, including, among others, business
conditions, interest rates, taxation and consumer confidence in future economic
conditions. The Company is also dependent upon the continued popularity of malls
as a shopping destination and the ability of mall anchor tenants and other
attractions to generate customer traffic for its stores. A decrease in mall
traffic would adversely affect the Company's growth, sales results and
profitability.
Changes to Federal minimum wage laws in each of 1996 and 1997 raised
the mandatory minimum wage. California, Connecticut, Washington, Massachusetts
and other states have also enacted increases in state-required minimum wages
that are higher than the Federal requirements. The most recent increases in
states where the Company currently operates took effect on January 1, 2002 in
California, Connecticut, Delaware, Hawaii, Maine, Massachusetts, Oregon, Rhode
Island, Vermont and Washington. The Company operated a total of 96 stores in
19
those states as of April 10, 2002. Statutory increases in Federal and state
minimum wages could adversely affect the Company's profitability. The recent
state increases in minimum wage and any other such increases will raise minimum
wages above current wage rates of certain of the Company's associates, and
competitive factors could require corresponding increases in higher associate
wage rates, any of which would increase the Company's expenses and adversely
affect results of operations.
QUARTERLY RESULTS AND SEASONALITY
The Company's quarterly results of operations may fluctuate materially
depending on, among other things, the timing of store openings and related
pre-opening and other startup expenses, net sales contributed by new stores,
increases or decreases in comparable store sales, releases of new music and
music-related products, shifts in timing of certain holidays, changes in the
Company's merchandise mix and overall economic and political conditions.
The Company's business is also subject to seasonal influences, with
heavier concentrations of sales during the back-to-school, Halloween and Holiday
seasons (defined as the week of Thanksgiving through the first few days of
January), and other periods when schools are not in session. The Holiday season
remains the Company's single most important selling season. The Company
believes, however, that the importance of the summer vacation and back-to-school
seasons (which affect operating results in the second and third quarters,
respectively) and to a lesser extent, the spring break season (which affects
operating results in the first quarter) as well as Halloween (which affects
operating results in the third quarter), all reduce the Company's dependence on
the Holiday selling season. As is the case with many retailers of apparel,
accessories and related merchandise, the Company typically experiences lower
first fiscal quarter net sales relative to other quarters.
DEPENDENCE ON KEY VENDORS
The Company's performance depends on its ability to purchase current
music-related merchandise in sufficient quantities at competitive prices. The
Company has many sources of merchandise. Its largest vendor, Changes
Manufacturing, supplied just under 5% of the Company's merchandise purchases in
fiscal 2001. Substantially all of the Company's music-licensed products are
available only from vendors that have exclusive license rights. In addition,
many of the Company's music-influenced products are supplied by small,
specialized vendors that create unique products primarily for the Company. The
Company's smaller vendors generally have limited resources, production
capacities and operating histories, and some of the Company's vendors have
limited the distribution of their merchandise in the past. The Company has no
long-term purchase contracts or other contractual assurances of continued
supply, pricing or access to new products. There can be no assurance that the
Company will be able to acquire desired merchandise in sufficient quantities on
terms acceptable to the Company in the future or that any inability to acquire
suitable merchandise, or the loss of one or more key vendors, will not have a
material adverse effect on the Company's business, results of operations and
financial condition.
NEW TORRID STORES AND ASSOCIATED RISKS
The Company's ability to expand into new concepts has not been fully
tested. Accordingly, the operation of its Torrid stores and the sale of Torrid
merchandise over the Internet at www.torrid.com, are subject to numerous risks,
including unanticipated operating problems, lack of experience, lack of customer
acceptance, new vendor relationships and competition from existing and new
retailers. For example, it may be that the Company will not be able to generate
continued customer interest in Torrid stores and Torrid products, or that this
concept may not be able to support the store format. There can be no assurance
that the Company's Torrid stores or Torrid website will achieve sales and
20
profitability levels that justify the Company's investment in this new retail
format. Establishing and increasing the number of Torrid stores also involves
other risks that could have a material adverse effect on the Company, including
(i) the risk of diversion of management's attention from the Company's core
business and products, (ii) difficulties with the hiring, retention and training
of management and personnel for the Torrid stores, (iii) risks associated with
new vendors and (iv) difficulties with locating and obtaining favorable store
sites and acceptable lease terms. Risks inherent in any new concept are
particularly acute in the Company's case with respect to Torrid, because this is
the first significant new venture by the Company. The Company has traditionally
concentrated its expansion efforts on increasing the number of and sales in Hot
Topic stores.
UNCERTAINTIES REGARDING IMPLEMENTATION OF NEW MANAGEMENT INFORMATION
SYSTEM
During fiscal 1999, after completing an evaluation of its long-term
management information system needs, the Company selected new hardware and
software for its stores, office and distribution center. The Company implemented
the host hardware and software systems at its office and distribution center
during the second half of fiscal 2000 and installed certain point-of-sale
upgrades at its stores in fiscal 2001. In addition, in fiscal 2002 the Company
plans to install a new Wide Area Network at its stores. If the information
systems and software do not work effectively, the Company may experience delays
or failures in its operations. These delays or failures could adversely impact
the promptness and accuracy of the Company's transaction processing, financial
accounting and reporting and ability to properly forecast earnings and cash
requirements. The Company's current and planned systems, transaction processing,
procedures and controls may not be adequate to support future operations. To
manage growth of its operations and personnel, the Company may need to continue
to improve its operational and financial systems, transaction processing,
procedures and controls.
DEPENDENCE ON KEY PERSONNEL
The Company's performance depends largely on the efforts and abilities
of senior management, especially Elizabeth McLaughlin, the Company's Chief
Executive Officer and President, who has been with the Company since 1993. The
Company has a $2,000,000, key-person life insurance policy on Ms. McLaughlin.
However, the sudden loss of Ms. McLaughlin's services or the services of other
members of the management team could have a material adverse effect on the
Company's business, results of operations and financial condition. Furthermore,
there can be no assurance that Ms. McLaughlin and the Company's existing
management team will be able to manage the Company or its growth or that the
Company will be able to attract and retain additional qualified personnel as
needed in the future.
UNCERTAINTIES REGARDING DISTRIBUTION OF MERCHANDISE
The Company relies upon the United Parcel Service for its product
shipments, including shipments to and from all of its stores, and, accordingly,
is subject to the risks, including employee strikes and inclement weather,
associated with United Parcel Service's ability to provide delivery services to
meet the Company's shipping needs. The Company is also dependent upon temporary
associates to adequately staff its distribution facility, particularly during
busy periods, such as during the Christmas season and while multiple stores are
opening. There can be no assurance that the Company will continue to receive
adequate assistance from its temporary associates, or that there will continue
to be sufficient sources of temporary associates.
FAILURE TO AUTHENTICATE LICENSING RIGHTS
The Company purchases licensed merchandise from a number of suppliers
who hold manufacturing and distribution rights under the terms of certain
licenses. The Company generally relies upon vendors' representations concerning
manufacturing and distribution rights and does not independently verify whether
these vendors legally hold adequate rights to licensed properties they are
manufacturing or distributing. If the Company acquires unlicensed merchandise,
it could be obligated to remove such merchandise from its stores, incur costs
21
associated with destruction of merchandise if the distributor is unwilling or
unable to reimburse the Company, and be subject to liability under various civil
and criminal causes of action, including actions to recover unpaid royalties and
other damages. Any of these results could have a material adverse effect on the
Company's business, results of operations and financial condition.
COMPETITION
The retail apparel and accessory industry is highly competitive. The
Company competes with other retailers for vendors, teenage and college age
customers, suitable retail locations and qualified associates and management
personnel. Hot Topic currently competes with street alternative stores located
primarily in metropolitan areas and with other mall-based teenage-focused
retailers such as The Buckle, Charlotte Russe, Claire's Stores, Inc., Delias
Inc., d.e.m.o. (a division of Pacific Sunwear, Inc.), Gadzooks, Inc., Millers
Outpost, Inc., Pacific Sunwear of California, Inc., Spencer Gifts, Inc., Urban
Outfitters, Inc., The Wet Seal, Inc., and, to a lesser extent, with music stores
and mail order catalogs and websites. Torrid has other competitors, such as Lane
Bryant, Deb Shops and plus size departments at traditional department stores as
well as numerous potential competitors who may begin or increase efforts to
market and sell products competitive with Torrid. Many of the Company's
competitors are larger and have substantially greater financial, marketing and
other resources than the Company. Direct competition with these and other
retailers may increase significantly in the future, which could require the
Company, among other things, to lower its prices and/or take other measures.
Increased competition could have a material adverse effect on the Company's
business, results of operations and financial condition.
PRICE VOLATILITY
The Company's Common Stock is quoted on the Nasdaq National Market,
which has experienced and is likely to experience in the future significant
price and volume fluctuations, which could adversely affect the market price of
the Common Stock without regard to the operating performance of the Company. In
addition, the Company believes that factors such as quarterly fluctuations in
the financial results of the Company, fluctuations in the Company's comparable
store sales, announcements by other apparel, accessory and gift item retailers,
the trading volume of the Company's Common Stock in the public market, the
condition of the overall economy and the condition of the financial markets
could cause the price of the Common Stock to fluctuate substantially.
ANTI-TAKEOVER MATTERS
The Company's Amended and Restated Articles of Incorporation and
Amended and Restated Bylaws contain provisions that may have the effect of
delaying, deterring or preventing a takeover of the Company that shareholders
may not consider being in their best interests. For instance, the Company's
Amended and Restated Articles of Incorporation and Amended and Restated Bylaws
prohibit shareholder action by written consent and include certain "fair price
provisions." Additionally, the Board of Directors has the authority to issue up
to 10,000,000 shares of "blank check" Preferred Stock having such rights,
preferences and privileges as designated by the Board of Directors without
shareholder approval.
ITEM 2 PROPERTIES
The Company leases all of the Company's existing store locations, with
lease terms expiring between 2002 and 2012. The leases for most of the existing
stores are for ten-year years and provide for contingent rent based upon a
percent of sales in excess of specified minimums. Leases for future stores will
likely include similar contingent rent provisions.
Beginning August 1, 2001, the Company doubled the size of its leased
office and distribution center space, located in City of Industry, California,
and has entered into an amended lease with its existing landlord. The additional
space will be fully utilized by the middle of fiscal 2002. The amended lease is
22
for a five-year term (from the beginning of the original lease) with two options
to extend the lease, each for a three-year period. The initial five-year term
will expire in April 2004. The annual base rent for the initial five-year term
is approximately $1,131,900 including the additional space.
The original lease terms of the Company's headquarters and distribution
facility granted the Company the right of first refusal on the remaining 125,000
square feet of space in the building at 90% of the fair market lease rates for
such space. In February 2001, the Company was notified that the space would
become available in 2001 and was provided with comparable market lease rates.
The Company believes the property covered by the amended lease will allow for
growth of to up to 700 stores.
ITEM 3 LEGAL PROCEEDINGS
The Company is not a party to any material pending legal proceedings.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
The Common Stock of the Company is traded on the Nasdaq National Market
under the symbol "HOTT". A three-for-two stock split of the Company's Common
Stock became effective February 6, 2002. The stock split was affected by way of
a stock dividend. The dividend was distributed to shareholders of record as of
January 23, 2002. This was the first three-for-two stock split for the Company.
The Company also effected two-for-one stock splits of the Company's Common Stock
in December 1999 and December 2000. All share and per share amounts have been
restated to reflect each of these three splits. The following table sets forth,
for the periods indicated, the high and low end of day closing sales prices of
the shares of Common Stock of the Company, as reported on the Nasdaq National
Market. Such quotations represent inter-dealer prices without retail markup,
markdown or commission and may not necessarily represent actual transactions.
2001 FISCAL YEAR QUARTERS HIGH LOW
----------------------
First Quarter $23.33 $15.46
Second Quarter $24.86 $17.01
Third Quarter $22.75 $15.00
Fourth Quarter $22.97 $16.17
2000 FISCAL YEAR QUARTERS HIGH LOW
----------------------
First Quarter $11.96 $5.29
Second Quarter $11.90 $7.59
Third Quarter $13.17 $9.17
Fourth Quarter $17.79 $9.71
On April 15, 2002, the last sales price of the Common Stock as reported
on the Nasdaq National Market was $23.51 per share. As of April 15, 2002, there
were approximately 213 holders of record of the Company's Common Stock. This
number does not reflect the actual number of beneficial holders of the Company's
Common Stock, which the Company believes to be in excess of 9,000 holders.
23
The Company has not paid any cash dividends since inception and does
not anticipate paying any cash dividends in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and Notes thereto included
elsewhere in this Annual Report on Form 10-K.
HOT TOPIC, INC. and SUBSIDIARIES
Selected financial data:
Fiscal Year
---------------------------------------------------------------------
2001 2000 1999 1998 1997
--------- --------- --------- --------- ---------
(In thousands, except per share data, number of
stores, comparable store sales and sales per square
foot)
Statement of Operations Data:
Net sales $336,094 $257,187 $168,949 $103,371 $ 70,532
Cost of goods sold, including buying, distribution
and occupancy costs 204,993 154,298 103,998 65,855 44,417
--------- --------- --------- --------- ---------
Gross margin 131,101 102,889 64,951 37,516 26,115
Selling, general and administrative expenses 86,950 67,917 44,749 29,077 19,862
--------- --------- --------- --------- ---------
Operating income 44,151 34,972 20,202 8,439 6,253
Interest income, net 1,884 1,925 933 931 901
--------- --------- --------- --------- ---------
Income before income taxes 46,035 36,897 21,135 9,370 7,154
Income taxes 17,435 13,652 7,634 3,367 2,611
--------- --------- --------- --------- ---------
Net income $ 28,600 $ 23,245 $ 13,501 $ 6,003 $ 4,543
Net income per share:
Basic $ 0.92 $ 0.78 $ 0.49 $ 0.21 $ 0.16
Diluted $ 0.86 $ 0.72 $ 0.46 $ 0.20 $ 0.15
Weighted average shares outstanding:
Basic 30,978 29,668 27,801 28,902 28,143
Diluted 33,219 32,069 29,392 29,736 29,640
Selected Operating Data:
Number of stores at year end 352 274 212 158 108
Comparable stores sales increase 3.9% 16.7% 22.8% 0.4% 2.2%
Average sales per square foot $ 636 $ 669 $ 623 $ 542 $ 565
Average sales per store (000s) $ 1,036 $ 1,020 $ 909 $ 772 $ 769
Balance sheet data:
Cash and short-term investments $ 71,310 $ 51,288 $ 39,550 $ 26,579 $ 27,151
Working capital 82,369 61,253 37,564 28,432 29,230
Total assets 162,662 118,646 89,022 58,764 51,953
Long-term obligations including current portion 218 123 231 120 161
Shareholders' equity $135,368 $ 99,291 $ 67,278 $ 48,749 $ 44,736
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS GENERAL
Hot Topic Inc. (the "Company") operates Hot Topic stores, a mall-based
specialty retailer of music-licensed and music-influenced apparel, accessories
and gift items for young men and women principally between the ages of 12 and
22. In the first half of fiscal 2001 (the fiscal year ended February 2, 2002)
the Company launched a second retail concept with the opening of six stores
under the trade name Torrid(TM). Torrid offers a selection of apparel, lingerie,
shoes and accessories centered around various lifestyles for plus-size young
women between the ages of 15 and 29. At the end of fiscal 2001, the Company
operated 346 Hot Topic stores and six Torrid stores in 48 states and websites
hottopic.com and torrid.com.
The Company considers a store comparable after it has been open for 15
full months. If a store is relocated or expanded by more than 15% in total
square footage, it is removed from the comparable store base and, similar to new
stores, becomes comparable after 15 full months. At the end of fiscal 2001, 255
of the Company's 346 Hot Topic stores were included in the comparable store
base, compared to 189 of the 274 stores open at the end of fiscal 2000.
The Company operates on a 52 or 53-week fiscal year, which ends on the
Saturday nearest to January 31. Fiscal 2001 and fiscal 1999 were 52-week years.
Fiscal 2000 was a 53-week year.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
selected statement of operations data expressed as a percentage of net sales and
certain store data:
FISCAL YEAR
-------------------------------
2001 2000 1999
------ ------ ------
Net sales 100.0% 100.0% 100.0%
Cost of goods sold, including
buying, distribution & occupancy costs 61.0% 60.0% 61.6%
----- ----- -----
Gross margin 39.0% 40.0% 38.4%
Selling, general and administrative expenses 25.9% 26.4% 26.4%
----- ----- -----
Operating income 13.1% 13.6% 12.0%
Interest income, net 0.6% 0.7% 0.6%
----- ----- -----
Income before income tax 13.7% 14.3% 12.6%
Provision for income taxes 5.2% 5.3% 4.6%
----- ----- -----
Net income 8.5% 9.0% 8.0%
===== ===== =====
Number of stores at year end 352 274 212
Comparable store sales increase 3.9% 16.7% 22.8%
FISCAL 2001 COMPARED TO FISCAL 2000
Net sales increased approximately $78.9 million, or 31%, to $336.1
million in fiscal 2001 from $257.2 million in fiscal 2000. Net sales for the 73
Hot Topic stores opened during fiscal 2001 and for the other Hot Topic stores
not yet qualifying as comparable stores contributed $65.8 million of the net
sales increase. Comparable store sales increased 3.9% in fiscal 2001 and
contributed $8.6 million of the increase in net sales. The six Torrid stores and
torrid.com contributed to approximately $4.5 million of the increase.
Hottopic.com sales were approximately one percent of total Company sales.
25
The annual average Hot Topic store volume increased to $1,038,000 in
fiscal 2001 from $1,020,000 in fiscal 2000. The sales mix in Hot Topic stores in
fiscal 2001 saw a slight shift toward apparel and T-shirts, with this category
contributing approximately 53% of net sales in 2001 as compared to approximately
51% in 2000.
The Company experienced lower sales increases during the September 2001
(0.6% comp increase) and October 2001 (4.4% comp decrease) periods. The Company
attributes this to reduced mall traffic primarily due to the events of September
11, 2001 relative to the balance of fiscal 2001.
Gross margin increased approximately $28.2 million to $131.1 million in
fiscal 2001 from $102.9 million in fiscal 2000. As a percentage of net sales,
gross margin decreased to 39.0% in fiscal 2001 from 40.0% in fiscal 2000. This
1.0% reduction in gross margin was due to a 0.5% increase in store occupancy
expenses, a 0.4% reduction in merchandise margin and a 0.1% increase in buying
expenses all as a percentage of net sales. Occupancy expenses were 0.5% higher
primarily due to higher common area charges. The 0.4% reduction in merchandise
margin was a result of three major factors: merchandise mix changes at Hot Topic
from accessories toward increased apparel, with apparel achieving lower overall
merchandise margins compared to accessories; the leveraging of markdowns in
fiscal 2000 relative to the extra week of sales volume in 2000 compared to 2001
and higher Torrid markdowns. The higher Torrid markdowns were related to minimum
purchases of merchandise required in excess of what was needed for the small
store base. The remaining 0.1% increase was due to a rise in buying expense as a
percent of sales primarily due to the addition of the Torrid merchandising
staffing in fiscal 2001.
Selling, general and administrative expenses increased approximately
$19.0 million to $86.9 million during fiscal 2001 from $67.9 million during
fiscal 2000. As a percentage of net sales, selling, general and administrative
expense was 25.9% for fiscal 2001 compared to 26.4% in fiscal 2000. The total
dollar increase in selling, general and administrative expenses was primarily
attributable to an increase in the number of retail stores from 274 at the end
of fiscal 2000 to 352 at the end of fiscal 2001 and the corresponding additional
payroll and other expenses required to support these additional stores. The
decrease as a percentage of net sales was primarily attributable to leveraging
administrative expenses over the greater sales base in fiscal 2001 and lower
store operating expenses resulting from management's efforts to control such
expenses. This leverage was partially offset by higher selling payroll expense
as a percentage of sales, due to slightly higher pay rates and increased benefit
coverage.
Operating income increased approximately $9.2 million to $44.2 million
during fiscal 2001 from $35.0 million during fiscal 2000. As a percentage of net
sales, operating income was 13.1% in fiscal 2001 compared to 13.6% in fiscal
2000. Operating income on an average store basis was approximately $137,000 in
fiscal 2001.
Net interest income was $1.9 million in both fiscal 2001 and fiscal
2000, but it was a lower percentage of sales in fiscal 2001. Average cash
balances were higher in fiscal 2001 but interest rates were significantly lower.
The Company's effective tax rate was 37.9% in fiscal 2001 and 37.0% in
fiscal 2000. The higher rate for fiscal 2001 is principally attributable to the
tax-exempt interest income that is a smaller percentage of pre-tax income in
2001 as compared to 2000 and higher effective state income tax rates in fiscal
2001.
26
FISCAL 2000 COMPARED TO FISCAL 1999
Net sales increased approximately $88.3 million, or 52%, to $257.2
million in fiscal 2000 from $168.9 million in fiscal 1999. Net sales for the 62
stores opened during fiscal 2000 and for the other stores not yet qualifying as
comparable stores contributed $62.8 million of the net sales increase.
Comparable store sales increased 16.7% in fiscal 2000 and contributed $25.5
million of the increase in net sales. The average store volume increased to
$1,020,000 from $909,000 in fiscal 1999. The sales mix in fiscal 2000 saw a
slight shift toward apparel and T-shirts, with this category contributing
approximately 51% of net sales in 2000 as compared to approximately 50% in 1999.
Gross margin increased approximately $38.0 million to $102.9 million in
fiscal 2000 from $64.9 million in fiscal 1999. As a percentage of net sales,
gross margin increased to 40.0% in fiscal 2000 from 38.4% in fiscal 1999. The
increase, as a percentage of sales, reflected the leveraging of store occupancy
expense achieved from the significant increase in the average store sales volume
and an increase in merchandise margin. Merchandise margin increased
approximately 1.0%, as a percentage of sales compared to the prior year,
principally from an average higher initial markup and lower markdowns, shrinkage
and freight, all as a percentage of sales.
Selling, general and administrative expenses increased approximately
$23.2 million to $67.9 million during fiscal 2000 from $44.7 million during
fiscal 1999. The total dollar increase in selling, general and administrative
expenses was primarily attributable to an increase in the number of retail
stores from 212 at the end of fiscal 1999 to 274 at the end of fiscal 2000 and
the corresponding additional payroll and other expenses required to support
these additional stores. As a percentage of net sales, selling, general and
administrative expense was 26.4% for fiscal 2000, the same percentage as in
fiscal 1999. Many of the fiscal 2000 selling, general and administrative
expenses decreased as a percent of net sales due to the operating leverage
achieved through the Company's larger store base and higher average store sales
volume. This leverage was off-set by higher performance based bonuses,
development costs for the new Torrid concept, higher store management payroll,
increased benefit coverage and continued investment in management
infrastructure.
Operating income increased approximately $14.8 million to $35.0 million
during fiscal 2000 from $20.2 million during fiscal 1999. As a percentage of net
sales, operating income increased significantly to 13.6% in fiscal 2000 from
12.0% in fiscal 1999, principally from the larger store base, higher average
store sales and higher margins. Operating income on an average per store basis
was approximately $142,000 in fiscal 2000, up 30% from last year's $109,000.
Net interest income increased by $1.0 million to $1.9 million or 0.7%
of sales during fiscal 2000, from $0.9 million or 0.6% of sales during fiscal
1999, principally a result of higher average cash balances.
The Company's effective tax rate was 37.0% in fiscal 2000 and 36.1% in
fiscal 1999. The variance from an expected rate of approximately 40% in both
fiscal 2000 and fiscal 1999 was a result of a significant portion of each year's
interest income being non-taxable.
QUARTERLY RESULTS AND SEASONALITY
The Company's quarterly results of operations may fluctuate materially
depending on, among other things, the timing of store openings and related
pre-opening and other startup expenses, net sales contributed by new stores,
increases or decreases in comparable store sales, releases of new music and
music-related products, shifts in timing of certain holidays, changes in the
Company's merchandise mix and overall economic conditions.
The Company's business is also subject to seasonal influences, with
heavier concentrations of sales during the back-to-school, Halloween and Holiday
seasons (defined as the week of Thanksgiving through the first few days of
January), and other periods when schools are not in session. The Holiday season
remains the Company's single most important selling season. The Company
believes, however, that the importance of the summer vacation and back-to-school
27
seasons (which affect operating results in the second and third quarters,
respectively) and to a lesser extent, the spring break season (which affects
operating results in the first quarter) as well as Halloween (which affects
operating results in the third quarter), all reduce the Company's dependence on
the Holiday selling season. As is the case with many retailers of apparel,
accessories and related merchandise, the Company typically experiences lower
first fiscal quarter net sales relative to other quarters.
The following table sets forth certain statement of operations and
operating data for each of the Company's last eight fiscal quarters. The
quarterly statement of operations data and selected operating data set forth
below were derived from unaudited financial statements of the Company, which in
the opinion of management of the Company contain all adjustments (consisting
only of normal recurring adjustments) necessary for fair presentation thereof.
Results in any quarter are not necessarily indicative of results that may be
achieved for a full year.
(In thousands, except selected
operating and per share data) FISCAL YEAR 2001 FISCAL YEAR 2000
----------------------------------------- ----------------------------------------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
----- ------ ----- ------ ----- ------ ----- ------
STATEMENT OF OPERATIONS DATA:
Net sales $ 62,927 $ 71,944 $ 92,080 $109,143 $ 44,839 $ 51,718 $ 72,203 $ 88,427
Gross margin 23,478 26,160 35,930 45,533 16,769 19,287 29,210 37,623
Operating income 4,743 6,342 13,236 19,830 3,457 4,578 11,165 15,772
Net income $ 3,347 $ 4,279 $ 8,507 $ 12,467 $ 2,443 $ 3,121 $ 7,317 $ 10,364
Net income per share:
Basic $ 0.11 $ 0.14 $ 0.27 $ 0.40 $ 0.08 $ 0.11 $ 0.25 $ 0.34
Diluted $ 0.10 $ 0.13 $ 0.26 $ 0.38 $ 0.08 $ 0.10 $ 0.23 $ 0.32
Weighted average shares outstanding:
Basic 30,611 30,900 31,104 31,295 29,162 29,598 29,692 30,220
Diluted 33,369 33,294 33,120 33,225 31,524 31,941 32,139 32,676
SELECTED OPERATING DATA:
Comparable store sales increase 8.0% 2.4% 2.2% 3.8% 24.1% 21.8% 15.3% 11.2%
Stores open at end of period 296 322 347 352 224 247 267 274
LIQUIDITY AND CAPITAL RESOURCES
During the last three fiscal years, the Company's primary uses of cash
have been to finance store openings, purchase merchandise inventories, upgrade
of information systems, and in fiscal 1999, expand the headquarters office and
distribution facility. The Company has satisfied its cash requirements
exclusively from cash flows from operations. The Company has no debt, other than
certain capital lease obligations during fiscal 2001. At the end of fiscal 2001
the Company had $71.3 million in cash and short-term investments, an increase of
$20.0 million, or 39% compared to the $51.3 million cash and short-term
investment balance at the end of fiscal 2000. Working capital was $82.4 million,
$61.3 million and $37.6 million for fiscal 2001, 2000 and 1999, respectively.
The increase in working capital each of these fiscal years was primarily
attributable to cash provided by net income.
Net cash flows provided by operating activities were $38.7 million,
$19.7 million, and $25.8 million in fiscal 2001, 2000 and 1999, respectively.
The increase in cash flows from operating activities in fiscal 2001 as compared
to fiscal 2000 was primarily attributable to the increases in net income,
depreciation and amortization, accounts payable, and income taxes payable. These
increases in cash flows were offset in part by higher inventory balances
required for the increase in the number of stores from 274 at the end of fiscal
2000 to 352 at the end of fiscal 2001.
28
Net cash flows used in investing activities were $40.9 million, $17.4
million and $17.6 million in fiscal 2001, 2000 and 1999, respectively. Cash
flows used in investing activities related to property and equipment for store
openings and the purchase of computer hardware and software. In fiscal 2001,
approximately $22 million was used for the construction of 73 Hot Topic stores,
six Torrid stores, the expansion of seven Hot Topic stores and progress payments
for construction of Hot Topic stores opening in early fiscal 2002. The Company
also used approximately $4.0 million for computer hardware and software at the
Company's headquarters and for certain point-of-sale hardware and software
upgrades at its stores during fiscal 2001. The change in capital expenditures
for fiscal 2001 compared to fiscal 2000 relate primarily to opening 17 more new
stores (including the six new Torrid stores), the higher cost of new Hot Topic
stores in fiscal 2001 resulting from a slightly higher average store size and
the new industrial club design, as well as higher costs for the six Torrid
stores. The Company opened 79 (including six Torrid stores), 62, and 54 stores
in fiscal 2001, 2000 and 1999, respectively. Cash flows used in investing
activities also increased in fiscal 2001 by $14.7 million due to additional
funds placed into low-risk, short-term investments.
Net cash flows provided by financing activities were $7.4 million, $8.7
million and $5.0 million in fiscal 2001, 2000 and 1999, respectively. Most of
the cash provided by financing activities relate to proceeds received from the
exercise of stock options for common stock shares, including the related tax
benefit.
The Company anticipates that it will spend approximately $32 million on
capital expenditures in fiscal 2002, including approximately $23 million for
stores, $5 million for computer hardware and software and $4 million to expand
its headquarters and distribution center. The approximately $23 million for
stores is to be used for the construction of the planned 70 Hot Topic stores and
15 Torrid stores, the expansion of approximately 10 existing Hot Topic stores
and progress payments for early fiscal 2003 new store openings. During fiscal
2001, the Company's average capital expenditures to open a Hot Topic store,
including leasehold improvements and furniture and fixtures, totaled
approximately $211,000, net of landlord allowances. The average initial gross
inventory for the new Hot Topic 2001 stores was approximately $107,000 (which
was partially financed by trade credit) and the average pre-opening costs for a
new Hot Topic store was approximately $20,000. Initial inventory requirements
vary at new stores depending on the season and current merchandise trends. The
Company expects the average total costs associated with opening a Hot Topic
store to be approximately the same in fiscal 2002 as those in fiscal 2001. The
Company expects that the average costs to open a Torrid store in fiscal 2002
will be approximately the same on a square footage basis as a Hot Topic store.
Torrid stores are planned to be approximately 2,500 square feet compared to Hot
Topic stores planned to be approximately 1,800 square feet. The actual costs
that the Company will incur in connection with opening future stores cannot be
predicted with precision because such costs will vary based upon, among other
things, geographic location, and the size of the stores and the extent of the
build-out required at the selected sites.
As of February 2, 2002, the aggregate capital and operating lease
obligations through 2012 are approximately $169 million, which includes
approximately $22 million for fiscal 2002, $21 million for fiscal 2003, $21
million for fiscal 2004, $21 million for fiscal 2005 and $84 million thereafter.
See Note 4 to the Company's Consolidated Financial Statements for additional
disclosure related to capital and operating lease obligations.
In addition, in the past the Company has repurchased a portion of its
shares from time to time on the open market. The Company may determine it in the
best interest of the Company and its shareholders to make additional
repurchases.
The Company believes that its existing cash balances and cash generated
from operations will be sufficient to fund its operations and planned expansion
through at least the next 12 months.
29
CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of the Company's financial
condition and results of operations are based upon the Company's consolidated
financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States of America. The preparation
of these financial statements requires the Company to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosures of contingent assets and liabilities. On an
ongoing basis, the Company evaluates estimates, including those related
primarily to inventories, long-lived assets and contingencies. The Company bases
its estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
The Company believes the following critical accounting policies affect
the more significant judgments and estimates used in the preparation of our
consolidated financial statements. For a further discussion on 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 to 50% of the original retail. In cases where the
merchandise does not sell after the first markdown, an additional markdown is
made in a subsequent month. Any marked down merchandise that does not sell is
marked down to a zero value and removed from the store, approximately three
months after the original markdown. In determining the lower of average cost or
market value of period ending inventories, consistently applied valuation
criteria is used. Consideration is given to a number of quantitative factors,
including anticipated subsequent permanent markdowns and aging of inventories.
VALUATION OF LONG-LIVED ASSETS: The Company assesses the impairment of
long-lived assets whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors considered important that could
trigger an impairment review include a significant underperformance relative to
expected historical or projected future operating results, a significant change
in the manner of the use of the asset or a significant negative industry or
economic trend. When the Company determines that the carrying value of
long-lived assets may not be recoverable based upon the existence of one or more
of the above indicators of impairment, the Company will measure any impairment
based on a projected discounted cash flow method using a discount rate
determined by our management. The Company has not historically had an impairment
of a long-lived asset.
INFLATION
The Company does not believe that inflation has had a material adverse
effect on net sales or results of operations. The Company has generally been
able to pass on increased costs related to inflation through increases in
selling prices.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's market risks relevant to disclosure pursuant to Item 7A
are not material and are therefore not required.
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The financial statements of the Company listed in Item 14(a) are
included herein on pages F-1 through F-14 and are incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
See the section entitled "Executive Officers and Key Employees" in Part
I, Item 1 hereof for information regarding the Company's executive officers.
The information required by this item with respect to directors is
incorporated by reference to the information appearing under the caption
"Election of Directors," contained in the Company's Definitive Proxy Statement
which will be filed with the SEC within 120 days of fiscal year-end pursuant to
Regulation 14A in connection with the solicitation of proxies for the Company's
Annual Meeting of Shareholders to be held on June 13, 2002 (the "2002 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 2002
Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to
the information appearing under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the 2002 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 2002
Proxy Statement.
31
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
(a)(1) CONSOLIDATED FINANCIAL STATEMENTS
The following consolidated financial statements required by
this item are submitted in a separate section beginning on page F-1 of this
Annual Report on Form 10-K:
PAGE
Report of Ernst & Young LLP, Independent Auditors...................................... F-1
Consolidated Balance Sheets as of February 2, 2002 and February 3, 2001................ F-2
Consolidated Statements of Income for the years ended February 2, 2002, February 3, 2001
and January 29, 2000.......................................................... F-3
Consolidated Statements of Shareholders' Equity for the years ended
February 2, 2002, February 3, 2001 and January 29, 2000................... F-4
Consolidated Statements of Cash Flows for the years ended February 2, 2002, February 3,
2001 and January 29, 2000..................................................... F-5
Notes to Consolidated Financial Statements............................................. F-6
(a)(2) FINANCIAL STATEMENT SCHEDULES
All financial statement schedules are omitted because they are
not required, are not applicable, or the information is included in the
consolidated financial statements or notes thereto.
(a)(3) EXHIBITS
The exhibits listed under Item 14(c) hereof are filed with, or
incorporated by reference into, this Annual Report on Form 10-K.
(b) REPORTS ON FORM 8-K
During the quarter ended February 2, 2002, the Company filed
one report on Form 8-K. On January 9, 2002, the Company filed a report on Form
8-K reporting, under Item 5, the announcement that its Board of Directors
approved a three-for-two stock split to be implemented on February 6, 2002 as a
50% stock dividend to each of the Company's shareholders of record as of January
23, 2002.
(c) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------ -----------------------
3.1 Amended and Restated Articles of Incorporation. (1)
3.2 Amended and Restated Bylaws. (3)
4.1 Reference is made to Exhibits 3.1 and 3.2.
4.2 Specimen stock certificate. (1)
10.1 Form of Indemnity Agreement to be entered into between Registrant and
its directors and officers. (1)
10.2 1996 Equity Incentive Plan (the "1996 Plan"). (1)
10.3 Form of Nonstatutory Stock Option Agreement of Registrant pursuant to
the 1996 Plan. (1)
10.4 Form of Incentive Stock Option Agreement of Registrant pursuant to the
1996 Plan. (1)
32
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------ -----------------------
10.5 Non-Employee Directors' Stock Option Plan. (1)
10.6 Employee Stock Purchase Plan. (1)
10.7 401(k) Defined Contribution Plan of Registrant, effective as of August
1, 1995. (1)
10.8 Industrial Real Estate Lease (Multi-Tenant Facility), dated December
10, 1998, entered into between Registrant's wholly owned subsidiary,
Hot Topic Administration, Inc. and Majestic Realty Co. and Patrician
Associates, Inc. (2)
10.9 Guaranty of Lease, dated December 10, 1998, entered into between the
Registrant and Majestic Realty Co. and Patrician Associates, Inc. (2)
10.10 First Amendment to Industrial Real Estate Lease, dated March 19, 2001,
by and between Majestic - Fullerton Road, LLC, PFG Fullerton Limited
Partnership, and Hot Topic Administration, Inc. (3)
10.11 Employment Agreement dated January 22, 2001, between the Registrant and
Elizabeth McLaughlin. (3)
10.12 Employment Offer Letter dated January 12, 2001, between the Registrant
and Jerry Cook. (3)
10.13 Form of Restricted Stock Bonus Agreement between the Registrant and
each of its non-employee directors as of March 7, 2001 (with Robert
Jaffe for 1,270 shares, and with each of Bruce Quinnell, Edgar Berner,
Andrew Schuon and Corrado Federico for 1,058 shares) and as of
September 24, 2001 (with Cynthia Cohen for 785 shares and vesting from
September 24, 2001) and as of January 28, 2002 (with W. Scott Hedrick
for 412 shares and vesting from January 28, 2002). (4)
10.14 Employment Offer Letter dated April 12, 2001, between the Registrant
and Thomas A. Rail.
10.15 Employment Offer Letter dated June 11, 2001, between the Registrant and
Jane Cruz.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney is contained on the signature page.
- ------------
(1) Filed as an exhibit to Registrant's Registration Statement on Form SB-2
(No. 333-5054-LA) and incorporated herein by reference.
(2) Filed as an exhibit to Registrant's Annual Report on Form 10-K for the
year ended January 30, 1999 and incorporated herein by reference.
(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.
(d) FINANCIAL STATEMENT SCHEDULES
Reference is made to Item 14(a)(2).
33
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Industry,
County of Los Angeles, State of California, on the 2nd day of May 2002.
HOT TOPIC, INC.
By: /s/ Elizabeth M. McLaughlin
------------------------------
Elizabeth M. McLaughlin
Chief Executive Officer,
President and Director
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Elizabeth M. McLaughlin and Jim McGinty,
or either of them, his attorney-in-fact, each with the power of substitution,
for him in any and all capacities, to sign any amendments to this Report, and to
file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that each of said attorneys-in-fact, or his substitute or
substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
NAME POSITION DATE
---- -------- ----
/s/ ELIZABETH M. MCLAUGHLIN Chief Executive Officer, President May 2, 2002
- ----------------------------- and Director (PRINCIPAL EXECUTIVE
Elizabeth M. McLaughlin OFFICER)
/s/ JAMES J. MCGINTY Chief Financial Officer (PRINCIPAL May 2, 2002
- ----------------------------- FINANCIAL AND ACCOUNTING OFFICER)
James J. McGinty
/s/ ROBERT M. JAFFE Chairman of the Board May 2, 2002
- -----------------------------
Robert M. Jaffe
/s/ EDGAR F. BERNER Director May 2, 2002
- -----------------------------
Edgar F. Berner
/s/ CORRADO FEDERICO Director May 2, 2002
- -----------------------------
Corrado Federico
/s/ ANDREW SCHUON Director May 2, 2002
- ----------------------------
Andrew Schuon
/s/ CYNTHIA COHEN Director May 2, 2002
- -----------------------------
Cynthia Cohen
/s/ W. SCOTT HEDRICK Director May 2, 2002
- -----------------------------
W. Scott Hedrick
34
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Hot Topic, Inc.
We have audited the accompanying consolidated balance sheets of Hot Topic, Inc.
and its subsidiaries as of February 2, 2002 and February 3, 2001, and the
related consolidated statements of income, shareholders' equity, and cash flows
for each of the three years in the period ended February 2, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Hot
Topic, Inc. and its subsidiaries at February 2, 2002 and February 3, 2001, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended February 2, 2002 in conformity with
accounting principles generally accepted in the United States.
/S/ Ernst & Young LLP
Los Angeles, California
March 1, 2002
F-1
Hot Topic, Inc. and Subsidiaries
Consolidated Balance Sheets
FEBRUARY 2, 2002 FEBRUARY 3, 2001
Assets
Current assets:
Cash and cash equivalents $ 34,071,642 $ 28,785,985
Short-term investments 37,238,076 22,501,713
Inventory 29,552,751 21,335,515
Prepaid expenses and other 5,434,328 5,552,600
Deferred tax asset 1,417,229 943,742
------------- -------------
Total current assets 107,714,026 79,119,555
Leaseholds, fixtures and equipment, net 53,926,304 39,165,998
Deposits and other 174,150 100,662
Deferred tax asset 847,332 259,845
------------- -------------
Total assets $162,661,812 $118,646,060
============= =============
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 11,252,620 $ 6,632,140
Accrued liabilities 10,952,614 10,093,360
Sales and other taxes payable 1,012,820 1,103,150
Income taxes payable 2,096,037 -
Current portion of obligations under capital leases 30,372 37,691
------------- -------------
Total current liabilities 25,344,463 17,866,341
Deferred rent 1,761,246 1,403,576
Capital lease obligations, less current portion 187,889 84,869
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; 50,000,000 shares authorized;
31,375,064 and 30,440,783 shares issued and outstanding at
February 2, 2002 and February 3, 2001, respectively 56,906,195 49,429,508
Retained earnings 78,462,019 49,861,766
------------- -------------
Total shareholders' equity 135,368,214 99,291,274
------------- -------------
Total liabilities and shareholders' equity $162,661,812 $118,646,060
============= =============
See notes to consolidated financial statements.
F-2
Hot Topic, Inc. and Subsidiaries
Consolidated Statements of Income
Years ended
--------------------------------------------------------
February 2, February 3, January 29,
2002 2001 2000
--------------------------------------------------------
Net sales $ 336,093,512 $ 257,187,317 $ 168,948,553
Cost of goods sold, including buying,
distribution and occupancy costs 204,992,766 154,298,004 103,998,031
--------------------------------------------------------
Gross margin 131,100,746 102,889,313 64,950,522
Selling, general and administrative expenses 86,949,911 67,917,723 44,748,988
--------------------------------------------------------
Operating income 44,150,835 34,971,590 20,201,534
Interest income (1,911,784) (1,955,414) (964,826)
Interest expense 27,596 30,025 32,086
--------------------------------------------------------
Income before income taxes 46,035,023 36,896,979 21,134,274
Provision for income taxes 17,434,770 13,651,900 7,633,600
--------------------------------------------------------
Net income $ 28,600,253 $ 23,245,079 $ 13,500,674
========================================================
Net income per share:
Basic $ 0.92 $ 0.78 $ 0.49
========================================================
Diluted $ 0.86 $ 0.72 $ 0.46
========================================================
Shares used in computing net income per share:
Basic 30,977,578 29,668,059 27,800,556
Diluted 33,218,739 32,069,127 29,392,086
See notes to consolidated financial statements.
F-3
Hot Topic, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity
Common Shares Total
--------------------------------- Deferred Retained Shareholders'
Shares Amount Compensation Earnings Equity
------------------------------------------------------------------------------------
BALANCE AT JANUARY 30, 1999 27,926,586 $ 35,675,752 $ (42,619) $ 13,116,013 $ 48,749,146
Exercise of stock options 1,446,288 4,187,278 - - 4,187,278
Employee stock purchase plan 23,658 60,469 - - 60,469
Repurchase common stock (414,000) (1,064,863) - - (1,064,863)
Amortization of deferred compensation - - 35,892 - 35,892
Tax benefit from exercise of options - 1,808,935 - - 1,808,935
Net income - - - 13,500,674 13,500,674
------------------------------------------------------------------------------------
BALANCE AT JANUARY 29, 2000 28,982,532 40,667,571 (6,727) 26,616,687 67,277,531
Exercise of stock options 1,439,865 4,767,049 - - 4,767,049
Employee stock purchase plan 18,386 143,170 - - 143,170
Amortization of deferred compensation - - 6,727 - 6,727
Tax benefit from exercise of options - 3,851,718 - - 3,851,718
Net income - - - 23,245,079 23,245,079
------------------------------------------------------------------------------------
BALANCE AT FEBRUARY 3, 2001 30,440,783 49,429,508 - 49,861,766 99,291,274
Exercise of stock options 917,163 3,679,826 - - 3,679,826
Employee stock purchase plan 17,381 204,594 - - 204,594
Fractional shares purchased in 3-for-2
stock split (263) (6,265) - - (6,265)
Tax benefit from exercise of options - 3,598,532 - - 3,598,532
Net income - - - 28,600,253 28,600,253
------------------------------------------------------------------------------------
BALANCE AT FEBRUARY 2, 2002 31,375,064 $ 56,906,195 - $ 78,462,019 $ 135,368,214
====================================================================================
See notes to consolidated financial statements.
F-4
Hot Topic, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years ended
-------------------------------------------------
February 2, February 3, January 29,
2002 2001 2000
-------------------------------------------------
OPERATING ACTIVITIES
Net income $ 28,600,253 $ 23,245,079 $ 13,500,674
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 11,082,192 8,645,306 5,890,519
Deferred rent 357,670 298,867 360,998
Deferred compensation - 6,727 35,892
Deferred taxes (1,060,974) (1,298,222) (422,800)
Loss on disposal of fixed assets 400,957 501,427 10,072
Changes in operating assets and liabilities:
Inventory (8,217,236) (5,968,770) (4,920,119)
Prepaid expenses and other current assets 118,272 (3,972,167) (140,147)
Deposits and other assets (73,488) (17,676) 3,936
Accounts payable 4,620,480 417,129 4,028,549
Accrued liabilities 859,254 1,712,434 4,601,036
Sales and other taxes payable (90,330) 465,527 254,881
Income taxes payable 2,096,037 (4,288,815) 2,580,813
-------------------------------------------------
Net cash provided by operating activities 38,693,087 19,746,846 25,784,304
INVESTING ACTIVITIES
Purchases of property and equipment (26,119,339) (16,662,796) (15,763,802)
Purchases of short-term investments (31,213,275) (23,769,601) (22,226,409)
Proceeds from sale of short-term investments 16,476,912 23,059,261 20,391,778
-------------------------------------------------
Net cash used in investing activities (40,855,702) (17,373,136) (17,598,433)
FINANCING ACTIVIITIES
Payments on capital lease obligations (28,415) (107,943) (36,541)
Repurchase common shares (6,265) - (1,064,863)
Proceeds from employee stock purchases and exercise of
stock options, including related tax benefit 7,482,952 8,761,937 6,056,682
-------------------------------------------------
Net cash provided by financing activities 7,448,272 8,653,994 4,955,278
-------------------------------------------------
Increase in cash and cash equivalents 5,285,657 11,027,704 13,141,149
Cash and cash equivalents at beginning of year 28,785,985 17,758,281 4,617,132
-------------------------------------------------
Cash and cash equivalents at end of year $ 34,071,642 $ 28,785,985 $ 17,758,281
=================================================
SUPPLEMENTAL INFORMATION
Cash paid during the year for interest $ 27,596 $ 30,245 $ 32,086
=================================================
Cash paid during the year for income taxes $ 10,798,850 $ 17,399,328 $ 3,674,209
=================================================
Capital lease obligations entered into for equipment $ 147,132 $ - $ 171,885
=================================================
See notes to consolidated financial statements.
F-5
Hot Topic, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
February 2, 2002
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS ACTIVITY
Hot Topic, Inc. (together with its subsidiaries, the "Company") is a mall-based
specialty retailer of music-licensed and music-influenced apparel, accessories
and gift items for young men and women principally between the ages of 12 and
22. In the first half of fiscal 2001 (fiscal year ended February 2, 2002), the
Company launched a new retail concept with the opening of six stores under the
trade name Torrid. Torrid offers a selection of apparel, lingerie, shoes and
accessories centered around various lifestyles for plus-size young women between
the ages of 15 and 29. At the end of fiscal 2001, the Company operated 346 Hot
Topic stores in 48 states throughout the United States, six Torrid stores and
websites hottopic.com and torrid.com. The Company has one reportable segment
given the similarities of the economic characteristics among the store formats.
PRINCIPALS OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany transactions and
balances have been eliminated in consolidation.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year amounts to conform to
current year presentation.
FISCAL YEAR
The Company's fiscal year is on a 52-53 week basis and ends on the Saturday
nearest to January 31. The fiscal years ended February 2, 2002, February 3, 2001
and January 29, 2000 were 52 weeks, 53 weeks and 52 weeks, respectively.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of less than
three months when purchased to be cash equivalents. The Company is potentially
exposed to a concentration of credit risk when cash deposits in banks are in
excess of federally insured limits, and as a result, the investment of cash
equivalents is at two financial institutions.
SHORT-TERM INVESTEMENTS
Short-term investments with maturities in excess of three months, consist
primarily of interest bearing tax exempt bonds that are highly liquid, low risk
with minimum credit quality rating of A-1 (Standard and Poor's); SP-1 (Moody's
Investor Service) or equivalent and are available for sale.
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.
F-6
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost or in the case of capitalized
leases, at the present value of future minimum lease payments. Depreciation is
provided using the straight-line method over the estimated useful lives of the
assets (3-10 years). Leasehold improvements are amortized using the
straight-line method over the shorter of the lease term or ten years.
Expenditures for repairs that do not significantly extend the life of the asset
are expensed as incurred.
REVENUE RECOGNITION
Sales are recognized upon the purchase by customers at the Company's retail
store locations and websites, less merchandise returned by customers.
STORE PRE-OPENING COSTS
Costs incurred in connection with the opening of a new store are expensed as
incurred.
ADVERTISING COSTS
Advertising costs are expensed the first time the event occurs or as incurred.
Advertising expenses were $334,319, $322,897 and $46,182 for the years ended
February 2, 2002, February 3, 2001 and January 29, 2000, respectively.
INCOME TAXES
The Company utilizes Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes", which prescribes the use of the liability method
to compute the difference between the tax basis of assets and liabilities and
the related financial reporting amounts using currently enacted tax laws and
rates.
NET INCOME PER SHARE
Net income per share has been computed in accordance with Financial Accounting
Standards Board (FASB) Statement No. 128, "Earnings per Share" (see Note 6). A
three-for-two stock split became effective February 6, 2002. All share and per
share amounts have been restated to reflect the split and all previous stock
splits.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
LONG-LIVED ASSETS
The Company accounts for the impairment and disposition of long-lived assets in
accordance with Statement of Financial Accounting Standards (SFAS) No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of" (SFAS No. 121). In accordance with SFAS No. 121, long-lived
assets to be held are reviewed for events or changes in circumstances that
indicate that their carrying value may not be recoverable. The review is based
on comparing the expected undiscounted cash flows to the net book value of the
assets. At February 2, 2002, the Company believes there has been no impairment
of the value of such assets to date.
F-7
STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees and directors using the
intrinsic value method as prescribed by Accounting Principle Board Opinion No.
25, "Accounting for Stock Issued to Employees" and provides the pro forma
disclosure provisions of SFAS No. 123 "Accounting for Stock-Based Compensation."
As such, compensation expense for stock options issued to employees is recorded
on the date of the grant only if the current market price of the underlying
stock exceeded the exercise price.
NEW ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board issued SFAS No. 144,
"Accounting for the Impairment of Long-Lived Assets", which establishes
accounting and reporting standards for impairment and disposition of long-lived
assets, including discontinued operations. SFAS No. 144 becomes effective for
all financial statements issued for fiscal years beginning after December 15,
2001 and, generally, its provisions are to be applied prospectively. The Company
does not believe the adoption of SFAS No. 144 will have any immediate impact on
the Company's financial position, results of operations or cash flows.
In June 2001, the Financial Accounting Standards Board issued SFAS No. 143,
"Accounting for Asset Retirement Obligations." This Statement addresses
financial accounting and reporting obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. This
standard is effective for financial statements issued for fiscal years beginning
after June 15, 2002. The Company does not believe the adoption of SFAS No. 143
will have a significant impact on the financial position, results of operations
or cash flows of the Company.
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets.
SFAS No. 141 addresses the initial recognition and measurement of goodwill and
other intangible assets acquired in a business combination. SFAS No. 142
addresses the initial recognition and measurement of intangible assets acquired
outside of a business combination, whether acquired individually or with a group
of other assets, and the accounting and reporting for goodwill and other
intangibles subsequent to their acquisition. These standards require all future
business combinations to be accounted for using the purchase method of
accounting. Goodwill will no longer be amortized, but instead will be subject to
an impairment test each reporting period. The Company is required to adopt FAS
141 and FAS 142 on a prospective basis as of February 2, 2002. The Company does
not believe the adoption of SFAS No. 141 and 142 will have an impact on the
financial position, results of operations or cash flows of the Company. The
Company does not have any amortization expense related to goodwill in its
results of operations.
In March 2000, the Financial Accounting Standards Board issued Interpretation
("FIN") No. 44, "Accounting for Certain Transactions Involving Stock
Compensation." FIN No. 44 is an interpretation of Accounting Principal Board's
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." Among other
matters, FIN No. 44 clarifies the application of APB Opinion No. 25 regarding
the definition of employee for purposes of applying APB Opinion No. 25, the
criteria for determining whether a plan qualifies as non compensatory and the
accounting consequences of modifications to the terms of previously issued stock
options or similar awards. The Company adopted the provisions of FIN No. 44 in
fiscal 2000. The adoption of FIN No. 44 did not have a material impact on the
Company's consolidated results of operations or financial condition.
Pursuant to Emerging Issues Task Force Issue 00-10 "Accounting for
Shipping and Handling Fees and Costs", cost of sales includes the cost of
merchandise, inventory markdowns, inventory shrinkage, inbound freight,
distribution and warehousing, in addition to payroll for buying personnel and
retail store occupancy costs.
F-8
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." SAB No.
101 summarizes the staff's views in applying accounting principles generally
accepted in the United States of America to revenue recognition in financial
statements. The Company adopted SAB No. 101 in fiscal year 2000. The adoption of
SAB No. 101 did not have an impact on the Company's consolidated results of
operations or financial condition.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
establishes accounting and reporting standards for derivative instruments and
for hedging activities. The Company adopted SFAS No. 133 in fiscal 2001 and the
adoption did not have an impact on the Company's consolidated results of
operations or financial condition.
2. LEASEHOLDS, FIXTURES AND EQUIPMENT
Leaseholds, fixtures and equipment are summarized as follows:
February 2, February 3,
2002 2001
------------- -------------
Furniture, fixtures and equipment $ 43,481,768 $ 31,299,751
Leasehold improvements 41,412,327 29,135,468
------------- -------------
84,894,095 60,435,219
Less accumulated depreciation and amortization (30,967,791) (21,269,221)
------------- -------------
$ 53,926,304 $ 39,165,998
============= =============
3. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
February 2, February 3,
2002 2001
------------- -------------
Accrued payroll and related expenses $ 5,323,743 $ 5,996,249
Gift certificates and store merchandise credits 1,626,828 981,227
Other 4,002,043 3,115,884
------------- -------------
$ 10,952,614 $ 10,093,360
============= =============
4. COMMITMENTS AND CONTINGENTCIES
LEASES
The Company has entered into lease agreements for retail and office space under
primarily noncancelable leases with terms ranging from three to approximately
ten years. The retail space leases provide for rents based upon the greater of
the minimum annual rental amounts or 5% to 8% of annual sales volume. Certain of
the leases provide for increasing minimum annual rental amounts. Rent expense is
recorded on a straight-line basis over the term of the lease. Accordingly,
deferred rent, as reflected in the accompanying balance sheets, represents the
difference between rent expense accrued and amounts paid under the terms of the
lease agreements. Total rent expense for the years ended February 2, 2002,
February 3, 2001 and January 29, 2000 was $21,783,895, $16,093,011 and
$10,364,345, respectively, including contingent rentals of $3,163,983,
$2,694,146 and $1,221,200, respectively.
F-9
The Company leases certain equipment under capital lease obligations. Cost and
accumulated depreciation of equipment under capital leases were $263,938 and
$33,492, respectively, at February 2, 2002, $159,560 and $53,282, respectively,
at February 3, 2001 and $291,151 and $49,440, respectively, at January 29, 2000.
Annual future minimum lease payments under operating and capital leases as of
February 2, 2002 are as follows:
Operating Capital
Fiscal year Leases Leases
- ------------ ------------- -------------
2002 $ 21,999,512 $ 43,054
2003 21,022,791 136,198
2004 20,762,368 55,909
2005 20,780,877 -
2006 20,006,999 -
Thereafter 64,314,296 -
------------- -------------
Total minimum lease payments $168,886,843 $ 235,161
=============
Less amounts representing interest 16,900
-------------
Present value of future minimum capital lease payments 218,261
Less amounts due in one year 30,372
-------------
Long-term portion of obligations under capital leases $ 187,889
=============
LITIGATION
The Company is involved in various matters of litigation during the ordinary
course of business. Management does not believe any such matters will have a
material affect on the financial position or results of operations of the
Company.
5. SHAREHOLDERS' EQUITY
Under the Company's 1996 Equity Incentive Plan and 1996 Non-Employee Directors'
Stock Option Plan (the "Plans"), the Company may grant stock options to
employees, directors or consultants of the Company as deemed appropriate by the
Board of Directors. The exercise price of options granted under the Plans shall
be determined by the Board of Directors at the date of grant and shall not be
lower than (i) 100% of the fair market value of the Company's common stock on
the date of grant for incentive stock options, (ii) 85% of the fair market value
of the Company's common stock on the date of grant for non-statutory stock
options, and (iii) 110% of the fair market value of the Company's common stock
on the date of grant for persons possessing 10% or more of the total combined
voting power of all classes of stock of the Company. Unless the Board of
Directors declares otherwise, options vest over four years and generally expire
ten years from the date of grant. An aggregate of 10,830,000 shares of common
stock may be issued pursuant to the Plans. During fiscal 2000, the Plans were
amended to increase the aggregate number of shares of common stock authorized
for issuance by 2,850,000 shares. As of February 2, 2002, 2,204,009 shares were
available for future grants. No options, under the Plans, have been granted to
consultants.
F-10
In June 1996, the Board of Directors adopted the Employee Stock Purchase Plan
(the "Stock Purchase Plan"). The Stock Purchase Plan provides for the issuance
of up to 900,000 shares of common stock to employees of the Company. Under the
Stock Purchase Plan, all eligible employees are granted identical rights to
purchase common stock for each Board authorized offering under the Stock
Purchase Plan. Rights granted pursuant to any offering under the Stock Purchase
Plan terminate immediately upon cessation of an employee's employment for any
reason. In general, an employee may withdraw from participation in an offering
at any time during the purchase period for such offering. Rights granted under
the Stock Purchase Plan are not transferable and may be exercised only by the
person to whom such rights are granted. The initial offering under the Stock
Purchase Plan commenced October 24, 1996 and terminated December 31, 1996.
Subsequent offerings occur every six months commencing January 1, 1997.
During the year ended February 2, 2002, the Company granted restricted common
stock shares, totaling 9,844 shares, to non-employee directors under the 1996
Equity Incentive Plan. The restricted shares will vest in the year ending
February 1, 2003 and the shares will remain restricted until such time the
recipient is no longer a member of the Company's Board of Directors. The value
of these grants is expensed over the vesting period, $129,583 was expensed in
the year ended February 2, 2002.
Pro forma information regarding net income and earnings per share is required by
SFAS No. 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that Statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted average assumptions for fiscal
2001, 2000 and 1999: weighted average risk-free interest rate of 5% for fiscal
2001 and 6% for fiscal 2000 and 1999; dividend yields of 0%; weighted-average
volatility factors of the expected market price of the Company's common stock of
0.61 for fiscal 2001, 0.84 for fiscal 2000 and 0.80 for fiscal 1999; and a
weighted average expected life of the options of 5 years. The weighted average
fair value of options granted during the year are $9.21, $7.49 and $3.34 per
share for fiscal 2001, 2000 and 1999, respectively.
For purposes of pro forma disclosures, the estimated fair value of the options,
based on the Black-Scholes option pricing model, is amortized to expense over
the options' vesting periods. The Company's pro forma information follows:
Years Ended
-----------------------------------------------------------
February 2, 2002 February 3, 2001 January 29, 2000
-----------------------------------------------------------
Net Earnings
As reported $ 28,600,253 $ 23,245,079 $ 13,500,674
Pro forma $ 25,560,809 $ 20,671,693 $ 11,303,530
Basic earnings per share
As reported $ 0.92 $ 0.78 $ 0.49
Pro forma $ 0.83 $ 0.70 $ 0.41
Diluted earnings per share
As reported $ 0.86 $ 0.72 $ 0.46
Pro forma $ 0.77 $ 0.64 $ 0.38
F-11
A summary of the Company's stock option activity and related information
follows:
February 2, 2002 February 3, 2001 January 29, 2000
------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------------------------------------------------------------------------------------
Outstanding at beginning of year 3,749,613 $ 5.02 3,979,686 $ 3.23 4,194,906 $ 3.41
Granted 1,014,675 $ 16.35 1,590,150 $ 7.49 1,536,600 $ 2.46
Exercised (917,159) $ 4.01 (1,439,865) $ 3.31 (1,446,288) $ 2.90
Canceled (586,284) $ 5.36 (380,358) $ 2.97 (305,532) $ 3.48
------------------------------------------------------------------------------------
Outstanding at end of year 3,260,845 $ 8.77 3,749,613 $ 5.02 3,979,686 $ 3.23
====================================================================================
Exercisable at end of year 1,139,881 $ 4.96 768,020 $ 3.49 819,426 $ 3.63
====================================================================================
Exercise prices for the 3,260,845 options outstanding as of February 2, 2002
ranged from $0.83 to $22.00. The weighted average contractual life of those
options is 7.9 years. The following table summarizes information about stock
options outstanding as of February 2, 2002:
Outstanding Options
-------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Number Exercise Contractual Number Exercise
Range of Exercise Prices Outstanding Price Life Exercisable Price
- -------------------------- ------------------------------------------------------------- ---------------------------------------
$0.83 - $3.97 854,925 $ 2.99 6.6 518,679 $ 3.13
$4.04 - $5.59 800,883 $ 5.32 7.4 424,318 $ 5.09
$8.75 - $15.00 671,737 $ 9.61 8.5 196,884 $ 9.50
$15.46 - $22.00 933,300 $16.42 9.2 - N/A
------------------------------------------------------------- ---------------------------------------
$0.83 - $22.00 3,260,845 $ 8.77 7.9 1,139,881 $ 4.96
============================================================= =======================================
The Company recorded tax benefits associated with the exercise of non-qualified
stock options. The tax benefits increased additional paid-in capital and
decreased income taxes payable in the amounts of $3,598,532, $3,851,718 and
$1,808,935 for the years ended February 2, 2002, February 3, 2001 and
January 29, 2000, respectively.
6. NET INCOME PER SHARE
The Company computes net income per share pursuant to Statement of Financial
Accounting Standards No. 128, "Earnings Per Share" (SFAS 128). Basic net income
per share is computed based on the weighted average number of common shares
outstanding for the period. Diluted net income per share is computed based on
the weighted average number of common and potentially dilutive common stock
equivalents outstanding for the period.
F-12
A reconciliation of the numerator and denominator of basic earnings per share
and diluted earnings per share for the years ended, is as follows:
February 2, February 3, January 29,
2002 2001 2000
------------ ------------ ------------
Basic EPS Computation:
Numerator $28,600,253 $23,245,079 $13,500,674
Denominator:
Weighted average common
shares outstanding 30,977,578 29,668,059 27,800,556
------------ ------------ ------------
Total shares 30,977,578 29,668,059 27,800,556
============ ============ ============
Basic EPS $ 0.92 $ 0.78 $ 0.49
============ ============ ============
Diluted EPS Computation:
Numerator $28,600,253 $23,245,079 $13,500,674
Denominator:
Weighted average common
shares outstanding 30,977,578 29,668,059 27,800,556
Incremental shares from assumed
conversion of options 2,241,161 2,401,068 1,591,530
------------ ------------ ------------
Total shares 33,218,739 32,069,127 29,392,086
============ ============ ============
Diluted EPS $ 0.86 $ 0.72 $ 0.46
============ ============ ============
7. INCOME TAXES
Following is the composition of the provision for income taxes for the years
ended:
February 2, February 3, January 29,
2002 2001 2000
------------- ------------- -------------
Current:
Federal $ 15,726,960 $ 13,092,892 $ 6,873,075
State 2,768,784 1,847,868 1,183,325
------------- ------------- -------------
18,495,744 14,940,760 8,056,400
Deferred:
Federal (858,535) (1,069,096) (393,151)
State (202,439) (219,764) (29,649)
------------- ------------- -------------
(1,060,974) (1,288,860) (422,800)
------------- ------------- -------------
Total income tax expense $ 17,434,770 $ 13,651,900 $ 7,633,600
============= ============= =============
F-13
Significant components of the Company's deferred tax assets and liabilities:
February 2, February 3,
2002 2001
------------ ------------
Current deferred tax assets (liabilities):
Accrued vacation and other $ 459,285 $ 345,876
Inventory 648,829 650,928
State taxes 738,903 98,903
Other liabilities (429,788) (151,965)
------------ ------------
Net current deferred tax assets 1,417,229 943,742
Noncurrent deferred tax assets (liabilities):
Depreciation 201,816 (76,357)
Deferred rent 645,516 336,202
------------ ------------
Total noncurrent deferred tax assets 847,332 259,845
------------ ------------
Net deferred tax assets $ 2,264,561 $ 1,203,587
============ ============
Reconciliation of provision for taxes to statutory tax rate for the years ended:
February 2, February 3, January 29,
2002 2001 2000
---------- ---------- ----------
Statutory federal rate 35.0% 35.0% 35.0%
Permanent differences (1.0) (1.3) (1.3)
State and local taxes, net of federal
benefit 3.4 2.7 2.8
Change in valuation allowance and
other items 0.5 0.6 (0.4)
---------- ---------- ----------
Effective income tax rate 37.9% 37.0% 36.1%
========== ========== ==========
8. EMPLOYEE BENEFIT PLAN
Effective January 1, 1995, the Company adopted the Hot Topic 401(k) Retirement
Savings Plan (the "401(k) Plan"). All employees who have been employed by the
Company for at least one year of service, maintained a minimum of 1,000 hours
worked during the year and are at least 21 years of age are eligible to
participate. Employees may contribute to the 401(k) Plan up to 25% of their
current compensation, subject to a statutorily prescribed annual limit. The
Company may in its discretion contribute certain amounts to eligible employees'
accounts. The Company has not made any contributions to the 401(k) Plan.
F-14