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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR l5(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
COMMISSION FILE NUMBER: 0-28784
HOT TOPIC, INC.
---------------
(Exact name of registrant as specified in its charter)
CALIFORNIA 77-0198182
- ---------- ----------
(State of incorporation) (IRS Employer Identification No.)
18305 EAST SAN JOSE AVE., CITY OF INDUSTRY, CA 91748
- ---------------------------------------------- ---------
(Address of principal executive offices) (Zip Code)
(626) 839-4681
(Registrant's telephone number, including area code)
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 whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding
of each of the issuer's classes of common stock, as of the latest practicable
date: August 23, 2004 - 46,466,368 shares of common stock, no par value.
HOT TOPIC, INC.
INDEX TO FORM 10-Q
Page No.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED):
Consolidated Balance Sheets - July 31, 2004 and January 31,
2004 3
Consolidated Statements of Income for the three months and
six months ended July 31, 2004 and August 2, 2003 4
Consolidated Statements of Cash Flows for the six months
ended July 31, 2004 and August 2, 2003 5
Notes to Consolidated Financial Statements 6-9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 10-24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 25
ITEM 4. CONTROLS AND PROCEDURES 25
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 25
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF
EQUITY SECURITIES 26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 27
SIGNATURES 28
2
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Hot Topic, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share amounts)
July 31, January 31,
2004 2004
---------- ----------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 20,903 $ 11,886
Short-term investments 50,732 116,319
Inventory 80,906 51,937
Prepaid expenses and other 11,704 10,654
Deferred tax assets 2,259 2,259
---------- ----------
Total current assets 166,504 193,055
Leaseholds, fixtures and equipment, net 103,044 88,348
Deposits and other 204 189
---------- ----------
Total assets $ 269,752 $ 281,592
========== ==========
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 47,060 $ 15,841
Accrued liabilities 22,966 28,133
Income taxes payable 1,094 7,242
---------- ----------
Total current liabilities 71,120 51,216
Deferred rent 3,597 3,155
Deferred tax liability 3,316 3,316
Commitments and contingencies -- --
Shareholders' equity:
Preferred shares, no par value; 10,000,000 shares
authorized; no shares issued and outstanding -- --
Common shares, no par value; 150,000,000
shares authorized; 46,463,425 and 48,120,989
shares issued and outstanding at
July 31, 2004 and January 31, 2004, respectively 20,786 62,972
Retained earnings 171,139 161,134
Accumulated other comprehensive loss (206) (201)
---------- ----------
Total shareholders' equity 191,719 223,905
---------- ----------
Total liabilities and shareholders' equity $ 269,752 $ 281,592
========== ==========
See notes to consolidated financial statements.
3
HOT TOPIC, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(Unaudited)
(In thousands, except per share amounts)
Three Months Ended Six Months Ended
-------------------- --------------------
July 31, August 2, July 31, August 2,
2004 2003 2004 2003
--------- --------- --------- ---------
Net sales $136,263 $115,728 $264,406 $216,386
Cost of goods sold, including buying,
distribution and occupancy costs 89,420 74,087 173,246 139,132
--------- --------- --------- ---------
Gross margin 46,843 41,641 91,160 77,254
Selling, general and administrative
expenses 39,515 32,307 75,500 61,165
--------- --------- --------- ---------
Operating income 7,328 9,334 15,660 16,089
Interest income, net 204 247 556 606
--------- --------- --------- ---------
Income before income taxes 7,532 9,581 16,216 16,695
Provision for income taxes 2,885 3,691 6,211 6,394
--------- --------- --------- ---------
Net income $ 4,647 $ 5,890 $ 10,005 $ 10,301
========= ========= ========= =========
Net income per share:
Basic $ 0.10 $ 0.12 $ 0.21 $ 0.22
========= ========= ========= =========
Diluted $ 0.10 $ 0.12 $ 0.20 $ 0.21
========= ========= ========= =========
Shares used in computing net income per share:
Basic 46,565 47,360 47,242 47,164
Diluted 48,023 49,127 49,055 48,833
See notes to consolidated financial statements.
4
HOT TOPIC, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
Six Months Ended
-------------------------
July 31, August 2,
2004 2003
---------- ----------
OPERATING ACTIVITIES
Net income $ 10,005 $ 10,301
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 10,440 8,946
Tax benefit from exercise of stock options 1,390 2,759
Stock-based compensation 77 90
Deferred rent 442 350
Loss on disposal of fixed assets 146 194
Changes in operating assets and liabilities:
Inventory (28,969) (25,576)
Prepaid expenses and other current assets (1,050) (1,771)
Deposits and other assets (15) (11)
Accounts payable 31,219 13,140
Accrued liabilities (5,031) (1,161)
Income taxes payable (6,149) (6,453)
---------- ----------
Net cash provided by operating activities 12,505 808
INVESTING ACTIVITIES
Purchases of property and equipment (25,338) (17,943)
Proceeds from sale of short-term investments 116,764 70,391
Purchases of short-term investments (51,183) (63,117)
---------- ----------
Net cash provided by (used in)
investing activities 40,243 (10,669)
FINANCING ACTIVITIES
Repurchase of common stock (46,812) --
Proceeds from employee stock purchases
and exercise of stock options 3,081 3,973
---------- ----------
Net cash provided by (used in) financing activities (43,731) 3,973
---------- ----------
Increase (decrease) in cash and cash equivalents 9,017 (5,888)
Cash and cash equivalents at beginning of period 11,886 13,139
---------- ----------
Cash and cash equivalents at end of period $ 20,903 $ 7,251
========== ==========
SUPPLEMENTAL INFORMATION
Cash paid during the period for interest $ 3 $ 27
========== ==========
Cash paid during the period for income taxes $ 9,601 $ 10,883
========== ==========
See notes to consolidated financial statements.
5
HOT TOPIC, INC. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION
Hot Topic, Inc. is a mall-based specialty retailer operating the Hot Topic and
Torrid store concepts. Hot Topic sells a selection of music/pop culture-licensed
and music/pop culture-influenced apparel, accessories and gift items for young
men and women principally between the ages of 12 and 22. In fiscal 2001 (the
fiscal year ended February 2, 2002), we launched a second retail concept with
the opening of six stores under the trade name Torrid. Torrid sells apparel,
lingerie, shoes and accessories designed for various lifestyles for plus-size
females between the ages of 15 and 29. At the end of the second quarter (July
31, 2004) of fiscal 2004 (the fiscal year ending January 29, 2005), we operated
554 Hot Topic stores in 50 states and Puerto Rico, and 59 Torrid stores. We also
maintain two distinct websites, www.hottopic.com ("hottopic.com") and
www.torrid.com ("torrid.com"), which reflect the Hot Topic and Torrid store
concepts and sell merchandise similar to that sold in the respective stores.
Throughout this report, the terms "our", "we" and "us" refer to Hot Topic, Inc.
and its subsidiaries.
The information set forth in these financial statements is unaudited except for
the January 31, 2004 Consolidated Balance Sheet. These statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information, the instructions to Form 10-Q,
and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements.
In the opinion of management, all adjustments, consisting only of normal
recurring accruals, necessary for a fair presentation have been included. The
results of operations for the six months ended July 31, 2004 are not necessarily
indicative of the results that may be expected for the year ending January 29,
2005.
Certain reclassifications have been made to prior year periods to conform to
current period presentation. For further information, refer to the consolidated
financial statements and notes thereto included in our Annual Report on Form
10-K for the year ended January 31, 2004.
NOTE 2. NET INCOME PER SHARE
We compute net income per share pursuant to Statement of Financial Accounting
Standards ("SFAS") No. 128 "Earnings Per Share." Basic net income per share is
computed based on the weighted average number of common shares outstanding for
the period. Diluted net income per share is computed based on the weighted
average number of common shares outstanding for the period and potentially
dilutive common stock equivalents outstanding for the period. A three-for-two
stock split of our common stock became effective September 2, 2003. All share
and per share amounts have been restated to reflect this stock split and all
previous stock splits we effectuated.
6
A reconciliation of the numerator and denominator of basic earnings per share
and diluted earnings per share is as follows (all amounts in thousands except
per share amounts):
Three Months Ended Six Months Ended
--------------------- ----------------------
July 31, August 2, July 31, August 2,
2004 2003 2004 2003
--------- --------- --------- ---------
Basic EPS Computation:
Numerator $ 4,647 $ 5,890 $10,005 $10,301
Denominator:
Weighted average common shares outstanding 46,565 47,360 47,242 47,164
-------- -------- -------- --------
Total shares 46,565 47,360 47,242 47,164
======== ======== ======== ========
Basic EPS $ 0.10 $ 0.12 $ 0.21 $ 0.22
======== ======== ======== ========
Diluted EPS Computation:
Numerator $ 4,647 $ 5,890 $10,005 $10,301
Denominator:
Weighted average common shares outstanding 46,565 47,360 47,242 47,164
Incremental shares from assumed
conversion of options 1,458 1,767 1,813 1,669
-------- -------- -------- --------
Total shares 48,023 49,127 49,055 48,833
======== ======== ======== ========
Diluted EPS $ 0.10 $ 0.12 $ 0.20 $ 0.21
======== ======== ======== ========
NOTE 3. COMPREHENSIVE INCOME
Comprehensive Income for the three months and six months ended July 31, 2004 and
August 2, 2003 is as follows (in thousands):
Three Months Ended Six Months Ended
------------------------------ ------------------------------
July 31, 2004 August 2, 2003 July 31, 2004 August 2, 2003
------------- -------------- ------------- --------------
Comprehensive Income
Net income $ 4,647 $ 5,890 $ 10,005 $ 10,301
Unrealized gain (loss) on marketable
securities, net 122 -- (5) --
--------- --------- --------- ---------
Total comprehensive income $ 4,769 $ 5,890 $ 10,000 $ 10,301
========= ========= ========= =========
NOTE 4. SHAREHOLDERS' EQUITY
On March 19, 2004, we announced that our Board of Directors approved the
repurchase of up to an aggregate of 2,000,000 shares of our common stock during
the period ending January 29, 2005. For the quarter ended July 31, 2004, we
7
purchased 720,000 shares of our common stock and as of July 31, 2004, we had
completed the repurchase of 2,000,000 shares of our common stock at a cost of
$46.8 million.
On August 18, 2004, we announced that our Board of Directors approved an
additional repurchase of up to an aggregate of 2,000,000 shares of our common
stock during the period ending January 29, 2005.
NOTE 5. BANK CREDIT AGREEMENT
We maintain an unsecured bank credit agreement of $5.0 million. The credit
agreement will expire in August 2005 and we expect to renew the credit agreement
under similar terms. Letters of credit are issued under the credit agreement,
which are primarily used for inventory purchases. At July 31, 2004, we had $1.0
million of outstanding letters of credit issued under the credit agreement.
NOTE 6. STOCK-BASED COMPENSATION
Pro forma information regarding net income and earnings per share is required by
SFAS No. 123, and has been determined as if we accounted for our employee stock
incentives under the fair value method of that Statement. For purposes of pro
forma disclosures, the estimated fair value of the options, based on the
Black-Scholes option pricing model, is amortized to expense over the options'
vesting periods. The following is the pro forma information using the fair value
method under SFAS No. 123, as amended by SFAS No. 148 (in thousands, except per
share amounts):
Three Months Ended Six Months Ended
----------------------- -----------------------
July 31, August 2, July 31, August 2,
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net income
As reported $ 4,647 $ 5,890 $ 10,005 $ 10,301
Add: Stock-based
compensation expense
included in reported net
income, net of
related tax effects 24 34 48 58
Deduct: Total stock-based
compensation
expense determined under
fair value method for
all awards, net of related
tax effects (1,759) (1,495) (3,308) (2,699)
---------- ---------- ---------- ----------
Pro forma $ 2,912 $ 4,429 $ 6,745 $ 7,660
========== ========== ========== ==========
Basic earnings per share:
As reported $ 0.10 $ 0.12 $ 0.21 $ 0.22
Pro forma $ 0.06 $ 0.09 $ 0.14 $ 0.16
Diluted earnings per share:
As reported $ 0.10 $ 0.12 $ 0.20 $ 0.21
Pro forma $ 0.06 $ 0.09 $ 0.14 $ 0.16
8
NOTE 7. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2003, consensus was reached on Emerging Issues Task Force ("EITF")
Issue No. 03-10, "Application of EITF Issue No. 02-16, `Accounting by a Customer
(Including a Reseller) for Certain Consideration Received from a Vendor,' by
Resellers to Sales Incentives Offered to Consumers by Manufacturers." Under
Issue 02-16, cash consideration received by a customer from a vendor is presumed
to be a price reduction of the vendor's products or services and should
therefore be characterized as a reduction of cost of sales when recognized in
the income statement of the customer. Issue No. 03-10 is effective for fiscal
periods beginning after November 25, 2003. The adoption of Issue No. 03-10 did
not have a material impact on our operating results or financial condition.
During April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 ("SFAS 149"), "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities." SFAS 149 amends and clarifies accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under Statement 133. SFAS 149 is effective
for contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The guidance should be applied
prospectively. The adoption of SFAS 149 did not have a material impact on our
operating results or financial condition as we do not have any derivative
instruments that are affected by SFAS 149.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." In general, a variable interest
entity is a corporation, partnership, trust, or any other legal structure used
for business purposes that either (a) does not have equity investors with voting
rights or (b) has equity investors that do not provide sufficient financial
resources for the entity to support its activities. FIN 46 requires certain
variable interest entities to be consolidated by the primary beneficiary of the
entity if the investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. The consolidation requirements of FIN 46 apply immediately to
variable interest entities created after January 31, 2003. The consolidation
requirements apply to older entities in the first fiscal year or interim period
beginning after June 15, 2003. Certain of the disclosure requirements apply in
all financial statements issued after January 31, 2003, regardless of when the
variable interest entity was established. We do not currently have any variable
interest entities and the adoption of the provisions of FIN 46 did not have a
material impact on our results of operations or financial condition.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of our results of operations, financial condition and
liquidity, and other matters should be read in conjunction with our Consolidated
Financial Statements and the Notes related thereto.
Our fiscal year is on a 52-53 week basis and ends on the Saturday nearest to
January 31. The fiscal years ended January 31, 2004, February 1, 2003 and
February 2, 2002 were 52-week years.
The discussion below includes references to "comparable stores." We consider a
store comparable after it has been open for 15 full months. If a store is
relocated or expanded by more than 15% in total square footage, it is removed
from the comparable store base and, similar to new stores, becomes comparable
after 15 full subsequent months.
RESULTS OF OPERATIONS
Three Months Ended July 31, 2004 Compared to Three Months Ended August 2, 2003
The following table sets forth selected data from our income statement expressed
as a percentage of net sales for the periods indicated. The discussion that
follows should be read in conjunction with this table:
JULY 31, AUGUST 2,
FOR THE SECOND QUARTER ENDED: 2004 2003
------------------------------------------------------------------------
Net sales 100.0% 100.0%
Cost of goods sold (including buying,
distribution and occupancy costs) 65.6 64.0
------- -------
Gross margin 34.4 36.0
Selling, general and administrative expenses 29.0 27.9
------- -------
Operating income 5.4 8.1
Interest income, net 0.1 0.2
------- -------
Income before income tax expense 5.5 8.3
Income tax expense 2.1 3.2
------- -------
Net income 3.4% 5.1%
======= =======
Net sales increased $20.6 million, or 17.7%, to $136.3 million during the second
quarter of fiscal 2004 from $115.7 million during the second quarter of fiscal
2003. The components of this $20.6 million increase in net sales are as follows:
AMOUNT
($ MILLION) DESCRIPTION
--------------------------------------------------------------------------
$17.3 Net sales from new Hot Topic stores opened during the second
quarter of fiscal 2004 and Hot Topic stores not yet qualifying
as comparable stores
4.5 Net sales from new Torrid stores opened during the second
quarter of fiscal 2004 and Torrid stores not yet qualifying as
comparable stores
1.1 Internet sales (hottopic.com and torrid.com)
0.1 Net sales from 11 expanded or relocated Hot Topic and Torrid
stores
(2.4) 2.1% decrease in comparable store net sales in the second
quarter of fiscal 2004 compared to the second quarter of
fiscal 2003
----------
$20.6 TOTAL
==========
10
At the end of the second quarter of fiscal 2004, 445 of our 613 stores (Hot
Topic and Torrid) were included in the comparable store base, compared to 356 of
our 497 stores (Hot Topic and Torrid) open at the end of the second quarter of
fiscal 2003. Sales of Hot Topic's apparel and tee-shirts, as a percentage of
total net sales, were 54% in the second quarter of fiscal 2004 compared to 52%
in the second quarter of fiscal 2003. The increase in apparel and tee-shirt
sales as a percentage of net sales was due primarily to increased sales of men's
novelty tee-shirts and men's music-related tee-shirts, partially offset by
decreases in women's apparel sales.
We believe our net sales for the second quarter were negatively impacted as we
experienced difficulty translating the current "clean and preppy" fashion trends
to styles that appeal to our customer base. We also believe sales were
negatively impacted by some delays we experienced in product distribution to our
stores in the second quarter, which was attributable to our implementing a new
warehouse management system in June 2004. We believe we have made necessary
adjustments to prevent future product distribution delays.
Gross margin increased $5.2 million to $46.8 million during the second quarter
of fiscal 2004 from $41.6 million during the second quarter of fiscal 2003. As a
percentage of net sales, gross margin decreased to 34.4% during the second
quarter of fiscal 2004 from 36.0% in the second quarter of fiscal 2003. The
significant components of this 1.6% decrease in gross margin as a percentage of
net sales are as follows:
% DESCRIPTION
--------------------------------------------------------------------------
(1.0)% Decrease in merchandise margin, principally due to higher
markdown activity
(0.4) Increase in occupancy expenses, primarily due to deleveraging
store expenses over lower comparable store sales
(0.2) Increase in distribution expenses, primarily due to higher
freight costs as a result of expediting product to selected
stores impacted by processing delays from new warehouse
management system implementation
----------
(1.6)% TOTAL
==========
Selling, general and administrative expenses increased $7.2 million, or 22.3%,
to $39.5 million during the second quarter of fiscal 2004 compared to $32.3
million during the second quarter of fiscal 2003. As a percentage of net sales,
selling, general and administrative expenses increased to 29.0% in the second
quarter of fiscal 2004 compared to 27.9% in the second quarter of fiscal 2003.
The total dollar increase in selling, general and administrative expenses is
primarily attributable to an increase in the number of retail stores from 497 at
the end of the second quarter of fiscal 2003 to 613 at the end of the second
quarter of fiscal 2004 and the corresponding additional payroll and other
expenses required to support these additional stores. The significant components
of this 1.1% increase in selling, general and administrative expenses as a
percentage of net sales are as follows:
11
% DESCRIPTION
--------------------------------------------------------------------------
0.7% Increase in store payroll due to deleveraging of payroll costs
over lower comparable store sales, partially offset by lower
bonus accruals
0.7 Increase in other store expenses (supplies and wide area
network costs)
(0.2) Decrease in other general and administrative expenses
(primarily a decrease in performance based compensation,
partially offset by an increase in professional fees related
to implementing Section 404 of the Sarbanes-Oxley Act)
(0.1) Decrease in store pre-opening costs due to fewer store
openings as a percent of total store base
----------
1.1% TOTAL
==========
Operating income decreased $2.0 million to $7.3 million during the second
quarter of fiscal 2004 from $9.3 million during the second quarter of fiscal
2003. As a percentage of net sales, operating income was 5.4% in the second
quarter of fiscal 2004 compared to 8.1% in the second quarter of fiscal 2003.
Six Months Ended July 31, 2004 Compared to Six Months Ended August 2, 2003
The following table sets forth selected data from our income statement expressed
as a percentage of net sales for the periods indicated. The discussion that
follows should be read in conjunction with this table:
JULY 31, AUGUST 2,
FOR THE SIX MONTHS ENDED: 2004 2003
-------------------------------------------------------------------------
Net sales 100.0% 100.0%
Cost of goods sold (including buying,
distribution and occupancy costs) 65.5 64.3
------- ------
Gross margin 34.5 35.7
Selling, general and administrative expenses 28.6 28.3
------- ------
Operating income 5.9 7.4
Interest income, net 0.2 0.3
------- ------
Income before income tax expense 6.1 7.7
Income tax expense 2.3 2.9
------- ------
Net income 3.8% 4.8%
======= ======
12
Net sales increased $48.0 million, or 22.2%, to $264.4 million during the first
six months of fiscal 2004 from $216.4 million during the first six months of
fiscal 2003. The components of this $48.0 million increase in net sales are as
follows:
AMOUNT
($ MILLION) DESCRIPTION
--------------------------------------------------------------------------
$34.7 Net sales from new Hot Topic stores opened during the first
six months of fiscal 2004 and Hot Topic stores not yet
qualifying as comparable stores
9.4 Net sales from new Torrid stores opened during the first six
months of fiscal 2004 and Torrid stores not yet qualifying as
comparable stores
2.2 Internet sales (hottopic.com and torrid.com)
1.3 0.8 % increase in comparable store net sales in the first six
months of fiscal 2004 compared to the first six months of
fiscal 2003
0.4 Net sales from 11 expanded or relocated Hot Topic and Torrid
stores
-----------
$48.0 TOTAL
===========
Sales of Hot Topic's apparel and tee-shirts, as a percentage of total net sales,
were 53% in the first six months of fiscal 2004 compared to 51% in the first six
months of fiscal 2003. The increase in apparel and tee-shirt sales as a
percentage of net sales was due primarily to increased sales of men's novelty
tee-shirts and men's music-related tee-shirts, partially offset by decreases in
sales of women's apparel and men's fashion tops and bottoms.
We also believe our net sales for the six-month period were negatively impacted
as we experienced difficulty translating the current "clean and preppy" fashion
trends to styles that appeal to our customer base. We also believe sales were
negatively impacted by some delays we experienced in product distribution to our
stores in the second quarter which was attributable to our implementing a new
warehouse management system in June 2004. We believe we have made necessary
adjustments to prevent future product distribution delays.
Gross margin increased approximately $13.9 million to $91.2 million during the
first six months of fiscal 2004 from $77.3 million during the first six months
of fiscal 2003. As a percentage of net sales, gross margin decreased to 34.5%
during the first six months of fiscal 2004 from 35.7% in the first six months of
fiscal 2003. The significant components of this 1.2% decrease in gross margin as
a percentage of net sales are as follows:
% DESCRIPTION
--------------------------------------------------------------------------
(1.0)% Decrease in merchandise margin, principally due to higher
markdown activity
(0.1) Increase in occupancy expenses, primarily due to deleveraging
store expenses over comparable store sales
(0.1) Increase in distribution expenses, primarily due to higher
freight costs as a result of expediting product to selected
stores impacted by processing delays from new warehouse
management system implementation
-----------
(1.2)% TOTAL
===========
13
Selling, general and administrative expenses increased $14.3 million, or 23.4%,
to $75.5 million during the first six months of fiscal 2004 compared to $61.2
million during the first six months of fiscal 2003. As a percentage of net
sales, selling, general and administrative expenses increased to 28.6% in the
first six months of fiscal 2004 compared to 28.3% in the first six months of
fiscal 2003. The total dollar increase in selling, general and administrative
expenses is primarily attributable to an increase in the number of retail stores
from 497 at the end of the first six months of fiscal 2003 to 613 at the end of
the first six months of fiscal 2004 and the corresponding additional payroll and
other expenses required to support these additional stores. The significant
components of this 0.3% increase in selling, general and administrative expenses
as a percentage of net sales are as follows:
% DESCRIPTION
--------------------------------------------------------------------------
0.3% Increase in store payroll due to deleveraging of payroll costs
over lower comparable store sales, partially offset by lower
bonuses
0.4 Increase in other store expenses (supplies and wide area
network costs)
(0.3) Decrease in other general and administrative expenses
(primarily a decrease in performance based compensation,
partially offset by increase in professional fees related to
implementing Section 404 of the Sarbanes-Oxley Act)
(0.1) Decrease in store pre-opening costs due to fewer store
openings as a percent of total store base
-----------
0.3% TOTAL
===========
Operating income decreased $0.4 million to $15.7 million during the first six
months of fiscal 2004 from $16.1 million during the first six months of fiscal
2003. As a percentage of net sales, operating income was 5.9% in the first six
months of fiscal 2004 compared to 7.4% in the first six months of fiscal 2003.
LIQUIDITY AND CAPITAL RESOURCES
Historically, as well as during the first six months of fiscal 2004, our primary
uses of cash have been to finance store openings and purchase merchandise
inventories as well as make periodic repurchases of our common shares. In August
2004, we announced the approval by our Board of Directors of the additional
repurchase of up to two million shares of our common stock. In recent years, we
have satisfied our cash requirements principally from cash flows from operations
and to a lesser extent proceeds from the exercise of stock options. We also
maintain a $5.0 million unsecured credit agreement for the purpose of issuing
letters of credit, primarily for inventory purchases. At July 31, 2004, we had
$1.0 million of outstanding letters of credit under the credit agreement.
Cash flows provided by operating activities were $12.5 million in the first six
months of fiscal 2004 compared to $0.8 million provided by operating activities
in the first six months of fiscal 2003. The increase of $11.7 million in cash
flows from operating activities in the first six months of 2004 compared to the
first six months of 2003 resulted primarily from an increase in accounts payable
($18.1 million) and changes in prepaid expenses and income taxes payable ($1.0
million), partially offset by a decrease in accrued liabilities ($3.9 million)
and an increase in inventory ($3.4 million).
14
Cash flows provided by investing activities were $40.2 million in the first six
months of fiscal 2004 compared to $10.7 million used in the first six months of
fiscal 2003. The $50.9 million increase in net cash provided by investing
activities is due to an increase ($58.3 million) in the proceeds from the sale
of short-term investments (net of purchases) partially offset by an increase
($7.4 million) in purchases of property and equipment primarily to support store
openings, and for hardware and software systems.
Cash flows used in financing activities were $43.7 million in the first six
months of fiscal 2004 compared to cash flows provided by financing activities of
$4.0 million in the first six months of fiscal 2003. The $47.7 million decrease
in cash flows from financing activities is principally the result of
repurchasing 2,000,000 shares of our common stock for $46.8 million in the first
six months of 2004.
We believe our current cash balances and cash generated from operations will be
sufficient to fund our operations, planned expansion through at least the next
12 months and any shares to be repurchased as part of the approved stock
repurchase described above.
In the second quarter of fiscal 2004, we entered into a lease (with a purchase
option) for a build-to-suit facility in Tennessee, which we expect to use as our
second distribution center beginning in second quarter of fiscal 2005. The
following table summarizes our contractual obligations as of July 31, 2004, and
the timing and effect that such commitments are expected to have on our
liquidity and capital requirements in future periods:
PAYMENTS DUE BY PERIOD ($ IN THOUSANDS)
-------------------------------------------------------------
WITHIN 1 MORE THAN
CONTRACTUAL OBLIGATIONS TOTAL YEAR 2-3 YEARS 4-5 YEARS 5 YEARS
- ----------------------- --------- --------- --------- --------- ---------
OPERATING LEASES $311,190 $ 40,931 $ 81,499 $ 75,275 $113,485
PURCHASE OBLIGATIONS 84,200 84,200 -- -- --
LETTERS OF CREDIT AND OTHER 1,903 1,903 -- -- --
OBLIGATIONS
--------- --------- --------- --------- ---------
TOTAL CONTRACTUAL OBLIGATIONS $397,293 $127,034 $ 81,499 $ 75,275 $113,485
========= ========= ========= ========= =========
CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of Hot Topic, Inc.'s financial condition
and results of operations are based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosures
of contingent assets and liabilities. On an ongoing basis, we evaluate
estimates, including those related primarily to inventories, long-lived assets
and contingencies. We base our estimates on historical experience and on various
other assumptions that we believe to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
15
We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements. For a further discussion about the application of these
and other accounting policies, refer to the notes included in our Annual Report
on Form 10-K for the year ended January 31, 2004.
INVENTORIES: Inventories and related costs 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 basis, utilizing the retail method.
Each month, slow moving or seasonally obsolete merchandise is marked down. The
first markdown is typically 25% to 50% of the original retail price. In cases
where the merchandise does not sell after the first markdown, an additional
markdown is made in a subsequent month. Any marked down merchandise that does
not sell is typically marked down to a zero value and removed from the store,
approximately three months after the original markdown. In determining the lower
of average cost or market value of period-ending inventories, consistently
applied valuation criteria are used. Consideration is given to a number of
quantitative factors, including anticipated subsequent permanent markdowns and
aging of inventories. To the extent our estimated markdowns at period-end prove
to be insufficient, additional future markdowns will need to be recorded.
VALUATION OF LONG-LIVED ASSETS: We assess the impairment of long-lived
assets whenever events or changes in circumstances indicate that the carrying
value may not be recoverable. Factors considered important that could trigger an
impairment review include a significant underperformance relative to expected
historical or projected future operating results, a significant change in the
manner of the use of the asset or a significant negative industry or economic
trend. When we determine that the carrying value of long-lived assets may not be
recoverable based upon the existence of one or more of the above indicators of
impairment, we will measure any impairment based on a projected discounted cash
flow method using a discount rate determined by management. To date, we have not
recorded any significant impairment of a long-lived asset. In the event future
store performance is lower than forecasted results, future cash flows may be
lower than expected, which could result in future impairment charges. While we
believe recently opened stores will provide sufficient cash flow, material
changes in results could result in future impairment charges.
REVENUE RECOGNITION: Sales are recognized upon the purchase by
customers at our retail store locations and websites, less merchandise returned
by customers. We provide a reserve for projected merchandise returns based on
historical experience. As the reserve for merchandise returns is based on
estimates the actual returns could differ from the reserve, which could impact
sales. Revenue from gift cards, gift certificates and store merchandise credits
is recognized at the time of redemption. Shipping and handling revenues from our
websites are included as a component of net sales.
SELF-INSURANCE: We are self-insured for medical insurance coverage and
workers compensation insurance coverage, up to maximum exposure limits, above
which we are covered by insurance policies. We maintain a liability for
estimated claims based on historical claims experience and other actuarial
assumptions.
INFLATION
We do not believe that inflation has had a material adverse effect on our net
sales or results of operations. We have generally been able to pass along
increased costs related to inflation through increases in selling prices.
16
STATEMENT REGARDING FORWARD LOOKING DISCLOSURE
This Quarterly Report on Form 10-Q contains 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 are
subject to the "safe harbor" created by these sections, including statements
regarding our 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, expected financial results, the profitability of future sales of our
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. Such risks, uncertainties and other factors include
but are not limited to the items discussed under the captions "Certain Risks
Related to the Our Business" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in this Item 2.
CERTAIN RISKS RELATED TO OUR BUSINESS
Before deciding to invest in Hot Topic, Inc. or to maintain or increase an
investment in Hot Topic, Inc., readers should carefully consider the risks
described below, in addition to the other information contained in our Annual
Report on Form 10-K and in other filings with the SEC, including our Quarterly
Reports on Form 10-Q and Current Reports on Form 8-K. The risks described below
are not the only risks we face. Additional risks that are not presently known to
us or that we currently deem immaterial may also affect our business. If any of
these known or unknown risks actually occur, our business, financial condition
and results of operations could be seriously harmed, and our stock price could
decline.
OUR AGGRESSIVE GROWTH STRATEGY ANTICIPATES A SIGNIFICANT NUMBER OF NEW STORE
OPENINGS WHICH COULD CREATE CHALLENGES WE MAY NOT BE ABLE TO ADEQUATELY MEET.
Our net sales and net income have grown significantly during the past several
years, primarily as a result of the opening of new stores and, to a lesser
extent, the introduction of new products. We intend to continue to pursue an
aggressive growth strategy for the foreseeable future, and our future operating
results will depend largely upon our ability to open and operate stores
successfully and to profitably manage a larger business. We currently anticipate
opening approximately 115 stores, consisting of 90 Hot Topic and 25 Torrid
stores, during fiscal 2004, which will result in a significant increase in the
number of stores we operate. Operation of a greater number of new stores and
expansion into new markets may present competitive and merchandising challenges
that are different from those currently encountered by us in our existing stores
and markets. In addition, as the number of stores increases, we may face risks
associated with market saturation of our products and concepts. There can be no
assurance that our expansion will not adversely affect the individual financial
performance of our existing stores or our overall results of operations, or that
new stores will achieve sales and profitability levels consistent with existing
stores. Further, there can be no assurance that we will successfully achieve our
expansion targets or, if achieved, that planned expansion will result in
profitable operations.
THIS GROWTH STRATEGY REQUIRES EFFECTIVE UPSCALING OF OUR OPERATIONS, AND WE MAY
NOT BE ABLE TO DO THIS SUFFICIENTLY TO EFFECTIVELY PREVENT NEGATIVE IMPACT ON
OUR OPERATIONS AND FINANCIAL RESULTS.
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In order to manage our planned expansion, among other things, we will need to
locate suitable store sites; negotiate acceptable lease terms; obtain or
maintain adequate capital resources on acceptable terms; source sufficient
levels of inventory; hire and train store managers and sales associates;
integrate new stores into our existing operations; and maintain adequate
distribution center space and information technology and other operations
systems.
We have entered into a lease (with a purchase option) for an additional
distribution center facility, which we expect to be operational in the second
quarter of fiscal 2005, and we face challenges and risks associated with
establishing operations in that facility. We also need to continually evaluate
the adequacy of our management information and distribution systems.
Implementing new systems and changes made to existing systems could present
challenges we do not anticipate and could impact our business (for example, we
experienced some delay in product distribution during our second quarter of
fiscal 2004 upon implementing our new warehouse management system). There can be
no assurance that we will anticipate all of the changing demands that our
expanding operations will impose on our business, systems and procedures, and
our failure to adapt to such changing demands could have a material adverse
effect on our results of operations and financial condition. Our failure to
timely implement initiatives necessary to support our expanding operations could
also materially impact our business.
EXPANDING OUR OPERATIONS TO INCLUDE AN INCREASING NUMBER OF TORRID STORES AND
ANY OTHER NEW CONCEPTS PRESENTS RISKS WE HAVE FACED WITH THE HOT TOPIC CONCEPT
BUT ALSO NEW RISKS DUE TO DIFFERENCES IN CONCEPT OBJECTIVES AND STRATEGIES.
Our ability to expand into new concepts, and in particular our Torrid concept,
has not been fully tested. Accordingly, the operation of Torrid stores and the
sale of Torrid merchandise over the Internet are subject to numerous risks,
including unanticipated operational problems; lack of experience; lack of
customer acceptance; new vendor relationships; competition from existing and new
retailers; and diversion of management's attention from the Hot Topic concept.
The Torrid concept involves implementation of a retail apparel concept which is
subject to most of the same risks as the Hot Topic concept, as well as
additional risks inherent in a concept that concentrates on apparel and fashion,
including risks of difficulty in merchandising, uncertainty of customer
acceptance, fluctuations in fashion trends and customer tastes, extreme
competition with a less differentiated product offering, and attendant mark-down
risks. We may not be able to generate continued customer interest in Torrid
stores and products, and the Torrid concept may not be able to support the store
or Internet sales formats. Risks inherent in any new concept are particularly
acute with respect to Torrid, because this is our first significant new venture,
and the nature of the Torrid business differs in certain respects from that of
the Hot Topic business. There can be no assurance that the Torrid stores or
website will achieve sales and profitability levels that justify our investment.
THE SUCCESS OF OUR BUSINESS DEPENDS ON ESTABLISHING AND MAINTAINING GOOD
RELATIONSHIPS WITH MALL OPERATORS AND DEVELOPERS, AND PROBLEMS WITH THOSE
RELATIONSHIPS COULD MAKE IT MORE DIFFICULT FOR US TO EXPAND TO CERTAIN SITES OR
OFFER CERTAIN PRODUCTS.
Any restrictions on our ability to expand to new store sites or to offer a broad
assortment of merchandise could have a material adverse effect on our business,
results of operations and financial condition. If our relations with mall
operators or developers become strained, or we otherwise encounter difficulties
in leasing store sites, we may not grow as planned and may not reach certain
revenue levels and other operating targets.
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OUR COMPARABLE STORE SALES ARE SUBJECT TO FLUCTUATION RESULTING FROM FACTORS
WITHIN AND OUTSIDE OUR CONTROL, AND LOWER THAN EXPECTED COMPARABLE STORE SALES
COULD IMPACT OUR BUSINESS AND OUR STOCK PRICE.
A variety of factors affects our comparable store sales including, among others,
the timing of new music releases and music/pop culture-related products; music
and fashion trends; the general retail sales environment and the effect of the
overall economic environment; our ability to efficiently source and distribute
products; changes in our merchandise mix; and our ability to execute our
business strategy efficiently. Our comparable store sales results have
fluctuated significantly in the past and we believe that such fluctuations will
continue. Our comparable store sales results for fiscal 2000, 2001, 2002 and
2003 were 16.7%, 3.9%, 5.0% and 7.4%, respectively. Our comparable store sales
results were 4.0% and (2.1%) for the first and second quarters, respectively, of
fiscal 2004; 2.6%, 5.2%, 10.8%, and 8.5% for the first, second, third and fourth
quarters, respectively, of fiscal 2003 and (0.5%), 0.6%, 6.3% and 9.7% for the
first, second, third and fourth quarters, respectively, of fiscal 2002. Past
comparable store sales results are not an indicator of future results, and there
can be no assurance that our comparable store sales results will not decrease in
the future. Changes in our comparable store sales results could cause our stock
price to fluctuate substantially.
OUR SUCCESS RELIES ON POPULARITY WITH YOUNG PEOPLE OF MUSIC, POP CULTURE, AND
FASHION TRENDS, AND WE MAY NOT BE ABLE TO REACT TO TRENDS IN A WAY TO PREVENT
DECLINING POPULARITY AND SALES OF OUR PRODUCTS.
Our financial performance is largely dependent upon the continued popularity of
alternative and rock music, the Internet, music videos, and MTV and other music
television networks among teenagers and college age adults; the emergence of new
artists and the success of music releases and music/pop culture-related
products; the continuance of a significant level of teenage spending on
music/pop culture-licensed and music/pop culture-influenced products; and our
ability to anticipate and keep pace with the music, fashion and merchandise
preferences of our customers. The popularity of particular types of music,
artists, styles, trends and brands is subject to change. Our failure to
anticipate, identify and react appropriately to changing trends could lead to,
among other things, excess inventories and higher markdowns, which could have a
material adverse effect on our results of operations and financial condition,
and on our image with customers. There can be no assurance that our new products
will be met with the same level of acceptance as in the past or that the failure
of any new products will not have an adverse material effect on our business,
results of operations and financial condition.
ECONOMIC CONDITIONS, INCLUDING MINIMUM WAGES AND OTHER WAGE-RELATED ISSUES,
COULD CHANGE IN WAYS THAT REDUCE OUR SALES OR INCREASE OUR EXPENSES.
Certain economic conditions affect the level of consumer spending on merchandise
we offer, including, among others, employment levels; salary and wage levels;
interest rates; taxation; and consumer confidence in future economic conditions.
We are also dependent upon the continued popularity of malls as a shopping
destination, the ability of mall anchor tenants and other attractions to
generate customer traffic, and the development of new malls. A slowdown in the
United States economy as well as an uncertain economic outlook could lower
consumer spending levels and cause a decrease in mall traffic or new mall
development, each of which would adversely affect our growth, sales results and
financial performance.
Changes in federal and state minimum wage laws or statutory employment
regulations could raise wages above current wage rates or change the wage
structure of certain of our associates, and competitive factors could require
corresponding increases in higher associate wage rates. These factors, as well
as significant increased benefits costs such as medical expenses, would increase
our expenses and adversely affect our results of operations.
19
TIMING AND SEASONAL ISSUES COULD NEGATIVELY IMPACT OUR FINANCIAL PERFORMANCE FOR
GIVEN PERIODS.
Our quarterly results of operations may fluctuate materially depending on, among
other things, the timing of store openings and related pre-opening and other
startup expenses, net sales contributed by new stores, increases or decreases in
comparable store sales, releases of new music and music/pop culture-related
products, shifts in timing of certain holidays, changes in our merchandise mix
and overall economic and political conditions.
Our business is also subject to seasonal influences, with heavier concentrations
of sales during the back-to-school, Halloween and Holiday (defined as the week
of Thanksgiving through the first few days of January) seasons, and other
periods when schools are not in session. The Holiday season has historically
been our single most important selling season. We believe that the importance of
the summer vacation and back-to-school seasons (which affect operating results
in the second and third quarters, respectively) and to a lesser extent, the
spring break season (which affects operating results in the first quarter) as
well as Halloween (which affects operating results in the third quarter), all
reduce our dependence on the Holiday selling season, but this may not always be
the case to the same degree. As is the case with many retailers of apparel,
accessories and related merchandise, we typically experience lower net sales in
the first fiscal quarter relative to other quarters.
WE HAVE MANY IMPORTANT VENDOR RELATIONSHIPS, AND OUR ABILITY TO GET MERCHANDISE
COULD BE HURT BY CHANGES IN THOSE RELATIONSHIPS AND EVENTS HARMFUL TO OUR
VENDORS COULD IMPACT OUR RESULTS OF OPERATION.
Our financial performance depends on our ability to purchase desired merchandise
in sufficient quantities at competitive prices. Although we have many sources of
merchandise, substantially all of our music/pop culture-licensed products are
available only from vendors that have exclusive license rights. In addition,
certain of our products are supplied by small, specialized vendors, some of
which create unique products primarily for us. Our smaller vendors generally
have limited resources, production capacities and operating histories, and some
of our vendors have restricted the distribution of their merchandise in the
past. We generally have no long-term purchase contracts or other contractual
assurances of continued supply, pricing or access to new products. There can be
no assurance that we will be able to acquire desired merchandise in sufficient
quantities on acceptable terms in the future. Any inability to acquire suitable
merchandise, or the loss of one or more key vendors, may have a material adverse
effect on our business, results of operations and financial condition.
TECHNOLOGY AND OTHER RISKS ASSOCIATED WITH OUR INTERNET SALES COULD HINDER OUR
OVERALL FINANCIAL PERFORMANCE.
We sell merchandise over the Internet through the websites hottopic.com and
torrid.com. Our Internet operations are subject to numerous risks and pose risks
to our overall business, including, among other things, hiring, retention and
training of personnel to conduct the Internet operations; diversion of sales
from our stores; rapid technological change and the need to invest in additional
computer hardware and software; liability for online content; failure of
computer hardware and software, including computer viruses, telecommunication
failures, online security breaches and similar disruptions; governmental
regulation; and credit card fraud. There can be no assurance that our Internet
operations will achieve sales and profitability levels that justify our
investment in them.
20
WE HAVE MADE AND PLAN TO CONTINUE TO MAKE SIGNIFICANT CHANGES TO INFORMATION
SYSTEMS AND SOFTWARE USED IN OPERATION OF OUR BUSINESS, AND WE MAY NOT BE ABLE
TO EFFECTIVELY ADOPT CHANGES IN A WAY TO PREVENT FAILURES IN OUR OPERATIONS OR
NEGATIVE IMPACT ON OUR FINANCIAL PERFORMANCE AND REPORTING.
Over the past several years, we have made improvements to existing hardware and
software systems, as well as implemented new systems. For example, we have
invested approximately $5 million to enhance the functionality of our current
GERS Retail Systems software and to implement new financial system software from
Lawson. In addition, we are investing approximately $9 million in the
implementation of a new warehouse management software system, a new Internet
order management software system, and a new customer loyalty software system. We
expect to begin relying heavily on these systems in fiscal 2004 and 2005. If
these information systems and software do not work effectively, we may
experience delays or failures in our operations. These delays or failures could
adversely impact the promptness and accuracy of our merchandise distribution,
transaction processing, financial accounting and reporting and ability to
properly forecast earnings and cash requirements. For example, in the second
quarter of 2004, we experienced some delay in product distribution upon
implementation of our new warehouse management system. To manage growth of our
operations and personnel, we may need to continue to improve our operational and
financial systems, transaction processing, and procedures and controls, and in
doing so, we could incur substantial additional expenses.
LOSS OF KEY PEOPLE OR AN INABILITY TO HIRE NECESSARY AND SIGNIFICANT PERSONNEL
COULD HURT OUR BUSINESS.
Our financial performance depends largely on the efforts and abilities of senior
management, especially Elizabeth McLaughlin, our Chief Executive Officer, who
has been with us since 1993. We have a $2,000,000 key-person life insurance
policy on Ms. McLaughlin. However, the sudden loss of Ms. McLaughlin's services
or the services of other members of our management team could have a material
adverse effect on our business, results of operations and financial condition.
Furthermore, there can be no assurance that Ms. McLaughlin and our existing
management team will be able to manage Hot Topic, Inc. or our growth or that we
will be able to attract and retain additional qualified personnel as needed in
the future.
OUR RELIANCE ON UNITED PARCEL SERVICE, TEMPORARY EMPLOYEES AND OTHER MECHANICS
OF DISTRIBUTION OF OUR MERCHANDISE CREATES DISTRIBUTION RISKS AND UNCERTAINTIES
THAT COULD HURT OUR SALES AND BUSINESS.
We rely upon United Parcel Service for our product shipments, including
shipments to and from a significant number of our stores. Our reliance on this
source for shipments is subject to risks, including employee strikes and
inclement weather, associated with United Parcel Service's ability to provide
delivery services that adequately meet our shipping needs. We are also dependent
upon temporary associates to adequately staff our distribution facility,
particularly during busy periods such as the Holiday season and while multiple
stores are opening. There can be no assurance that we will continue to receive
adequate assistance from our temporary associates, or that there will continue
to be sufficient sources of temporary associates.
THERE IS A RISK WE COULD ACQUIRE MERCHANDISE WITHOUT FULL RIGHTS TO SELL IT,
WHICH COULD LEAD TO DISPUTES OR LITIGATION AND HURT OUR FINANCIAL PERFORMANCE
AND STOCK PRICE.
We purchase licensed merchandise from a number of suppliers who hold
manufacturing and distribution rights under the terms of certain licenses. We
generally rely upon vendors' representations concerning manufacturing and
distribution rights and do not independently verify whether these vendors
legally hold adequate rights to licensed properties they are manufacturing or
distributing. If we acquire unlicensed merchandise, we could be obligated to
21
remove such merchandise from our stores, incur costs associated with destruction
of merchandise if the distributor is unwilling or unable to reimburse us, and be
subject to liability under various civil and criminal causes of action,
including actions to recover unpaid royalties and other damages. Any of these
results could have a material adverse effect on our business, results of
operations and financial condition.
WE FACE INTENSE COMPETITION, AND AN INABILITY TO ADEQUATELY ADDRESS IT, OR THE
SUCCESS OF OUR COMPETITORS, COULD LIMIT OR PREVENT OUR BUSINESS GROWTH AND
SUCCESS.
The retail apparel and accessory industry is highly competitive. We compete with
other retailers for vendors, teenage and young adult customers, suitable store
locations and qualified associates and management personnel. Hot Topic currently
competes with street alternative stores located primarily in metropolitan areas;
with other mall-based teenage-focused retailers such as Abercrombie & Fitch,
Aeropostale, American Eagle Outfitters, Anchor Blue, Charlotte Russe Inc.,
Claire's Stores, Inc., Forever 21, Pacific Sunwear of California, Inc., Spencer
Gifts, Inc., H&M, The Buckle, The Wet Seal, Inc., and Urban Outfitters, Inc.;
and, to a lesser extent, with music stores and mail order catalogs and websites.
Torrid has additional competitors, such as Alloy, Inc., Deb Shops, Delia's
Corp., Old Navy (a division of Gap Inc.), Lane Bryant, and plus-size departments
in department stores and discount stores as well as numerous potential
competitors who may begin or increase efforts to market and sell products
competitive with Torrid's products. Some of our competitors are larger and may
have greater financial, marketing and other resources. Direct competition with
these and other retailers may increase significantly in the future, which could
require us, among other things, to lower our prices. Increased competition could
have a material adverse effect on our business, results of operations and
financial condition.
WAR, TERRORISM AND OTHER CATASTROPHES COULD NEGATIVELY IMPACT OUR CUSTOMERS,
PLACES WHERE WE DO BUSINESS, AND OUR EXPENSES, ALL OF WHICH COULD HURT OUR
BUSINESS.
The effects of war or acts of terrorism could have a material adverse effect on
our business, operating results and financial condition. The terrorist attacks
in New York and Washington, D.C. on September 11, 2001 disrupted commerce and
intensified the uncertainty of the U.S. economy, a condition which has persisted
due to recent military actions in Afghanistan and Iraq. The continued threat of
terrorism and heightened security and military action in response to this
threat, or any future acts of terrorism, may cause further disruptions and
create further uncertainties. To the extent that such disruptions or
uncertainties negatively impact shopping patterns and/or mall traffic, or
adversely affect consumer confidence or the economy in general, our business,
operating results and financial condition could be materially and adversely
affected.
In addition, a few years ago, California experienced substantially increased
costs of electricity and gas caused by, among other things, disruption in energy
supplies. Our principal executive offices, distribution center and a significant
number of our stores are located in California. If we experience a sustained
disruption in energy supplies, or if electricity and gas costs in California
fluctuate dramatically, our results of operations could be materially and
adversely affected. California is also subject to natural disasters such as
earthquakes and floods. A significant natural disaster or other catastrophic
event affecting our facilities could have a material adverse impact on our
business, financial condition and operating results.
THERE ARE NUMEROUS RISKS THAT COULD CAUSE OUR STOCK PRICE TO FLUCTUATE
SUBSTANTIALLY.
Our common stock is quoted on the Nasdaq National Market, which has experienced
and is likely to experience in the future significant price and volume
fluctuations, which could adversely affect our stock price without regard to our
22
financial performance. In addition, we believe that factors such as quarterly
fluctuations in our financial results and comparable store sales; announcements
by other apparel, accessory and gift item retailers; the trading volume of our
stock; changes in estimates of our performance by securities analysts; overall
economic and political conditions; the condition of the financial markets; and
other events or factors outside of our control could cause our stock price to
fluctuate substantially.
OUR CHARTER DOCUMENTS AND OTHER CIRCUMSTANCES COULD PREVENT A TAKEOVER OR CAUSE
DILUTION OF OUR EXISTING SHAREHOLDERS, WHICH COULD BE DETRIMENTAL TO EXISTING
SHAREHOLDERS AND HINDER BUSINESS SUCCESS.
Our Articles of Incorporation and Bylaws contain provisions that may have the
effect of delaying, deterring or preventing a takeover of Hot Topic, Inc. For
instance, our Articles of Incorporation include certain "fair price provisions"
generally prohibiting business combinations with controlling or significant
shareholders unless certain minimum price or procedural requirements are
satisfied, and our Bylaws prohibit shareholder action by written consent.
Additionally, our Board of Directors has the authority to issue, without
shareholder approval, up to 10,000,000 shares of "blank check" preferred stock
having such rights, preferences and privileges as designated by the Board of
Directors. The issuance of these shares could have a dilutive effect on certain
shareholders, and potentially prohibit a takeover of Hot Topic, Inc. by
requiring the preferred shareholders to approve such a transaction.
We also have a significant number of authorized and unissued shares of our
common stock available under our Articles of Incorporation. These shares provide
us with the flexibility to issue our common stock for future business and
financial purposes including stock splits, raising capital and providing equity
incentives to employees, officers and directors. However, the issuance of these
shares could result in dilution to our shareholders.
WE INCUR COSTS ASSOCIATED WITH REGULATORY COMPLIANCE, AND THIS COST COULD BE
SIGNIFICANT.
All companies are subject to laws and regulations, some of which require certain
actions to be taken (or not taken) and costs to be incurred relating to business
processes and risk management. There are additional requirements for public
companies, including the provisions of the Sarbanes-Oxley Act of 2002. With
regard to the Sarbanes-Oxley Act, we have and will continue to incur significant
expense as we evaluate the implications of new rules and our operations relative
thereto, and as we work to respond to and comply with new requirements. Among
other things, we have incurred and will incur additional expenses as we
implement Section 404 of the Sarbanes Oxley Act. Section 404 requires management
to report on, and our independent auditors to attest to, our internal controls.
Compliance with these new rules could also result in continued diversion of
management's time and attention, which could be disruptive to normal business
operations.
We are currently conducting evaluations and taking actions required to ensure
compliance with the management certification and auditor attestation
requirements under Section 404. We have retained expert consultants to help us
in this process, and are working with our auditors as appropriate. We cannot be
certain as to the timing of completion of our evaluation and related actions, or
the impact of any of them on our operations. If we do not satisfactorily or
timely complete these steps, possible consequences could include sanction or
investigation by regulatory authorities such as the Securities and Exchange
Commission or The Nasdaq National Market, incomplete or late filing of our
annual report on Form 10-K, civil or criminal liability, and our stock price and
business could also be adversely affected.
23
THERE ARE LITIGATION AND OTHER CLAIMS AGAINST US FROM TIME TO TIME, WHICH COULD
DISTRACT MANAGEMENT FROM OUR BUSINESS ACTIVITIES, AND COULD LEAD TO ADVERSE
CONSEQUENCES TO OUR BUSINESS AND FINANCIAL CONDITION.
As a growing company with expanding operations, we are increasingly involved
from time to time with litigation and other claims against us. These arise
primarily in the ordinary course of our business, and include employment claims,
commercial disputes, intellectual property issues and product-oriented
allegations. Often these cases raise complex factual and legal issues, which are
subject to risks and uncertainties and which could require significant
management time. Although we believe that the outcome of current litigation and
claims against us will not have a material adverse effect on us, adverse
settlements or resolutions may occur and negatively impact earnings, injunctions
against us could have an adverse effect on our business by requiring us to do or
prohibiting us from doing certain things, and other unexpected events could have
a negative impact on us.
24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are not a party to any derivative financial instruments. Our exposure to
market risk primarily relates to changes in interest rates on our investments
with maturities of less than three months (which are considered to be cash and
cash equivalents) and short-term investments with maturities in excess of three
months. Changes in interest rates affect the investment income earned on those
investments.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Based on our evaluation of our disclosure controls and
procedures conducted prior to the date of filing this report
on Form 10-Q, our Chief Executive Officer and Chief Financial
Officer have concluded that our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e)
promulgated under the Securities Exchange Act of 1934) are
effective as of the end of the period covered by this report.
(b) Changes in Internal Controls
There were no changes in our internal controls over financial
reporting that occurred during the period covered by this
report, that have materially affected, or are reasonably
likely to materially affect, our internal controls over
financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On June 23, 2004, a non-profit corporation named Center for Environmental Health
filed a lawsuit in Federal district court in Alameda, California against over
two dozen retailers, large and small, including Hot Topic, Inc. Other defendants
include teen retailers like Claire's and Wet Seal, department stores like Sears,
Nordstrom, Macy's and J.C. Penney, and large retailers like Wal-Mart and Target.
Certain of the defendants, but not Hot Topic, were also named defendants in a
substantially similar lawsuit filed by the State of California. The complaint in
each case alleges, in general, that the defendant retailers have violated
certain California statutes by not providing sufficient warning about an alleged
potential for lead exposure relating to costume jewelry sold in stores. The
complaints do not contain allegations of personal injury. The plaintiff in each
case seeks unspecified fines and penalties, injunctive and other equitable
relief, and attorneys' fees and costs.
We currently expect to file an answer to the complaint in September 2004, and
are in the process of investigating other appropriate action with our counsel.
We believe we have meritorious defenses to the plaintiff's claims and intend to
defend against such claims, though it is possible the plaintiff will be awarded
requested remedies or that we may determine it appropriate to settle the lawsuit
and pay money or agree to take or not take certain actions. Though significant
litigation or awards against us could seriously harm our business and financial
results, we do not at this time expect this lawsuit to have a material adverse
effect on us.
25
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Issuer Purchases of Equity Securities
- -----------------------------------------------------------------------------------------------------
TOTAL AVERAGE TOTAL NUMBER OF SHARES MAXIMUM NUMBER OF
NUMBER PRICE PURCHASED AS PART OF SHARES THAT MAY YET BE
OF SHARES PAID PER PUBLICLY ANNOUNCED PURCHASED UNDER THE
FISCAL PERIOD PURCHASED SHARE PLANS OR PROGRAMS (1) PLANS OR PROGRAMS
---------- --------- -------------------- ----------------------
May 2, 2004 -
May 29, 2004 720,000 $21.56 2,000,000 --
---------- --------- -------------------- ----------------------
Total 720,000 $21.56 2,000,000 --
========== ========= ==================== ======================
(1) On March 19, 2004, we announced that our Board of Directors
approved a stock repurchase program, authorizing repurchase of up to 2,000,000
shares of our common stock. We were authorized to make repurchases from time to
time in the open market pursuant to existing rules and regulations and other
parameters set by the Board. In the first quarter of fiscal 2004 (ended May 1,
2004) we repurchased 1,280,000 shares pursuant to this program. With the
purchases disclosed in the table above, the above-described repurchase program
was completed in the quarter ended July 31, 2004.
ITEMS 3 & 5 ARE NOT APPLICABLE.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of shareholders of the Company (the "Annual Meeting") was
held on June 17, 2004 in the City of Industry, California. The Company had
48,272,012 shares of common stock outstanding as of the close of business on
April 21, 2004, the record date for the Annual Meeting.
Proposal 1 - Each of the candidates listed below was duly elected to the Board
of Directors at the Annual Meeting by the tally indicated.
Candidate Votes in Favor Votes Withheld
- --------------------- ---------------- --------------
Cynthia Cohen 44,827,574 184,073
Corrado Federico 43,375,463 1,636,184
W. Scott Hedrick 43,376,018 1,635,629
Elizabeth McLaughlin 44,829,474 182,173
Bruce Quinnell 44,831,170 180,477
Andrew Schuon 43,374,992 1,636,655
Proposal 2 - The selection of Ernst & Young LLP as Independent Registered Public
Accounting Firm of the Company for its fiscal year ending January 29, 2005 was
ratified by the tally indicated.
Votes in Favor Votes Against Votes Abstained
- -------------- ------------- ---------------
44,505,158 478,178 28,311
26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
Exhibit
Number Description of Document
------ -----------------------
3.1 Amended and Restated Articles of Incorporation. (1)
3.2 Amended and Restated Bylaws. (2)
4.1 Reference is made to Exhibits 3.1 and 3.2.
4.2 Specimen stock certificate. (1)
10.1 Centre Pointe Distribution Park Lease, dated June 1, 2004, by
and among Crescent Resources, LLC and Hot Topic, Inc.
10.2a Employment Offer Letter dated May 13, 2004, between the
Registrant and Thomas Beauchamp.
31.1 Certification, dated September 2, 2004, of Registrant's Chief
Executive Officer required by Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification, dated September 2, 2004, of Registrant's Chief
Financial Officer required by Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certifications, dated September 2, 2004, of Registrant's Chief
Executive Officer and Chief Financial Officer required by
Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C ss.
1350, as adopted).
-------------
(1) Filed as an exhibit to Registrant's Registration Statement on
Form SB - 2 (No. 333-5054-LA) and incorporated herein by
reference.
(2) Filed as an exhibit to Registrant's Annual Report on Form 10-K
for the year ended February 3, 2001 and incorporated herein by
reference.
a. Denotes management contract or compensatory plan or
arrangement.
(b) Reports on Form 8-K
On May 5, 2004, we filed a report on Form 8-K furnishing, under Item
12, information related to our sales for the first quarter of fiscal 2004
(quarter ended May 1, 2004). On May 19, 2004, we filed a report on Form 8-K
furnishing, under Item 12, information related to our overall financial results
for the first quarter of fiscal 2004.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOT TOPIC, INC.
(Registrant)
Date: September 2, 2004 /s/ Elizabeth McLaughlin
-----------------------------
Elizabeth McLaughlin
Chief Executive Officer
(Principal Executive Officer)
Date: September 2, 2004 /s/ James McGinty
-----------------------------
James McGinty
Chief Financial Officer
(Principal Financial Officer)
28
EXHIBIT INDEX
Exhibit No. Document
- --------------------------------------------------------------------------------
10.1 Centre Pointe Distribution Park Lease, dated June 1, 2004, by
and among Crescent Resources, LLC and Hot Topic, Inc.
10.2 Employment Offer Letter dated May 13, 2004, between the
Registrant and Thomas Beauchamp.
31.1 Certification, dated September 2, 2004, of Registrant's Chief
Executive Officer required by Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification, dated September 2, 2004, of Registrant's Chief
Financial Officer required by Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certifications, dated September 2, 2004, of Registrant's Chief
Executive Officer and Chief Financial Officer required by
Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C ss.
1350, as adopted).
29