-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UpX2I647kAsXoeneC30V6XmW/mrj1smcNKavySRR15RJyM158pgDdInM87BgVH5y 0O4f2WR6usU/SN1rnw7H3w== 0001019687-00-000513.txt : 20000427 0001019687-00-000513.hdr.sgml : 20000427 ACCESSION NUMBER: 0001019687-00-000513 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20000129 FILED AS OF DATE: 20000426 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HOT TOPIC INC /CA/ CENTRAL INDEX KEY: 0001017712 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-RETAIL STORES, NEC [5990] IRS NUMBER: 770198182 STATE OF INCORPORATION: CA FISCAL YEAR END: 0130 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-28784 FILM NUMBER: 609229 BUSINESS ADDRESS: STREET 1: 18305 EAST SAN JOSE AVENUE CITY: CITY OF INDUSTRY STATE: CA ZIP: 91748 BUSINESS PHONE: 6268394681 MAIL ADDRESS: STREET 1: 18305 EAST SAN JOSE AVENUE CITY: CITY OF INDUSTRY STATE: CA ZIP: 91768 10-K 1 HOT TOPIC, INC. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JANUARY 29, 2000 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. 91748 CITY OF INDUSTRY, CALIFORNIA (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (626) 839-4681 Securities registered pursuant to Section 12(b) of the Act: none Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, NO PAR VALUE (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ---- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K ___. The number of shares outstanding of the Registrant's Common Stock was 9,829,724 as of April 21, 2000. The aggregate market value of Common Stock held by non-affiliates of the registrant as of April 21, 2000 was approximately $265,909,000, 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 Company's Definitive Proxy Statement for the annual meeting of stockholders to be held on June 28, 2000 to be filed with the Securities and Exchange Commission (the "Commission") no later than 120 days after January 29, 2000, are incorporated by reference into Part III of this Form 10-K (Items 10 through 13). Certain Exhibits filed with the Registrant's Registration Statement on Form SB-2 (Registration No. 333-5054-LA), as amended, are incorporated by reference into Part IV of this Form 10-K (Item 14). - ------------ *Excludes 966,087 shares of Common Stock held by directors and officers and shareholders whose beneficial ownership exceeds 10% of the shares outstanding on April 21, 2000. 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. THIS ANNUAL REPORT ON FORM 10-K CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL FUTURE RESULTS COULD DIFFER MATERIALLY FROM THOSE STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE FOUND IN THIS ANNUAL REPORT ON FORM 10-K IN PART I, ITEM 1 UNDER THE CAPTION "CERTAIN RISK FACTORS RELATED TO THE COMPANY'S BUSINESS," IN PART II, ITEM 7 UNDER THE CAPTION "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND ADDITIONAL FACTORS DISCUSSED ELSEWHERE IN THIS ANNUAL REPORT. PART I ITEM 1. BUSINESS GENERAL Hot Topic, Inc. ("Hot Topic" or the "Company") is a rapidly growing, 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. 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, television programs and fashion magazines. The Company opened its first store in 1989, and operated 212 stores as of January 29, 2000 in 42 states across the United States. During fiscal 1995, the Company significantly accelerated its store expansion program and opened 18 stores, including its first stores in the Northeast and Midwest. The Company opened 26, 40, 50 and 54 additional stores during fiscal 1996, 1997, 1998 and 1999, respectively, and in fiscal 1996 relocated two existing stores. In fiscal 1998, the Company opened its first "street stores," which are stores on street fronts rather than in enclosed shopping malls. The Company plans to open approximately 60 new stores in fiscal 2000, 11 of which were opened as of April 21, 2000. The Company also maintains a website, www.hottopic.com through which it markets its stores and store concept and sells certain of its merchandise. During fiscal 1999, the site was relaunched with a focus on e-commerce together with posting boards, customer surveys, a gift registry and content features including artist news and concert tour schedules. The Company's net sales via the Internet continue to increase significantly, although the total sales are still modest. THE MARKET The music-licensed apparel industry began in the 1960s with bootleggers selling T-shirts at concert venues. Over the ensuing two decades, artists began to realize the commercial potential of licensing their likenesses and logos to T-shirt manufacturers and others who produced assorted merchandise. Management believes that the single largest impact on the music industry during recent years has been the success of MTV, which enables fans not only to listen to the latest music and artists 24 hours a day, but also to see a full sight and sound package of appearance and attitude. According to industry estimates, in 1996 MTV programming could be seen in more than 60 million households in the United States and in over 260 million households worldwide. It is also estimated that viewers in over 23 million homes watch MTV every week. As a result, popular artists and the fashions they wear are much more visible today than 30 years ago. Management believes that this increased visibility has contributed to the increase in demand for music-licensed and music-influenced apparel and accessories. 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 and 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. 2 Teenagers represent both a growing part of the United States population and an increasing source of purchasing power. According to the U.S. Department of Commerce Bureau of the Census, the teenage population in the United States reached approximately 31 million in 1998 and is expected to grow to approximately 35 million by 2008, representing a projected growth rate close to twice the rate of the overall population. By 2010, there likely will be more teenagers in the United States than at any other time in history. The Company also believes, based upon statistics released by an independent research firm, that teenage spending has also been increasing annually, growing to an estimated $111 billion in 1997. 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. Management believes that fashions and products associated with popular music artists have a significant influence on teenagers today, who often want to emulate their favorite artists. The Company has developed a unique strategy focused exclusively on offering music-licensed and music-influenced merchandise in the mall environment. The Company believes most of the merchandise it offers is not available elsewhere in the mall and is often hard to find other than at alternative shopping venues in major metropolitan areas. 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 currently consists of over 12,000 SKUs in 26 different product categories. The Company believes its selection of music-licensed merchandise is the most extensive assortment available in one 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 employees 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 ACTIVELY MANAGE MERCHANDISE MIX. 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 proactive inventory management program around this strategy. The Company often tests new merchandise in a small number of stores 3 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. In cases where it does not have return privileges with its vendors, 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 to consistent markdown rates which the Company believes are lower than industry averages. O CREATE AN ENTERTAINING STORE ENVIRONMENT. The Company seeks to create a compelling shopping environment that brings into the mall elements of the alternative urban shopping experience sought by teenagers. Hot Topic stores are designed with an industrial warehouse 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. O EMPHASIZE CUSTOMER SERVICE. Hot Topic trains its store associates to provide value-added, non-intrusive customer service. Sales associates are taught 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 DEVELOP PRIVATE LABEL PRODUCTS FOR MUSIC-ORIENTED LIFESTYLES. The Company has developed private label product lines to complement and supplement its other product offerings. The Company's private label product lines include, among others, Morbid Threads (apparel and hosiery), MT2 (apparel) and Morbid Metals (body jewelry). The Company believes that these private label products differentiate it from its competition and enhance customer loyalty through the development of a unique brand image. STORE LOCATIONS As of January 29, 2000, the Company operated 212 stores in both metropolitan and middle markets in 42 states across the United States. The following chart sets forth, as of April 21, 2000, the number of stores that Hot Topic operates in each state and the cities in which those stores are located. (1) - -------------------- (1). An asterisk next to a city indicates that a store has been opened in such city during fiscal 2000. 4
ARIZONA - 3 Connecticut - 5 Kansas - 4 Missouri - 4 North Carolina - 4 Texas - 15 Phoenix Danbury Olathe Columbia Concord Austin (2) Tucson (2) Manchester Topeka St .Louis (2) Hickory* Beaumont Milford Wichita St. Peters Pineville College Station CALIFORNIA - 37 Waterbury Wichita* Winston Corpus Christi Arcadia* Waterford NEBRASKA - 2 Dallas Bakersfield KENTUCKY - 3 Lincoln NORTH DAKOTA - 1 Ft. Worth Berkeley DELAWARE - 1 Bowling Green Omaha Grand Forks* Humble Brea Wilmington Louisville Katy Capitola Paducah NEVADA - 5 Ohio - 7 Lewisville Carlsbad FLORIDA - 6 Henderson Cincinnati Lubbock Cerritos Altamonte Springs LOUISIANA - 3 Las Vegas (2) Dayton Mesquite Citrus Heights Coral Springs Baton Rouge Reno (2) Elyria Plano* Concord Jacksonville Metarie Mentor San Antonio Cupertino St. Petersburg Monroe NEW HAMPSHIRE - 3 North Olmstead Woodlands Daly City Tallahassee Manchester Niles El Cajon Tampa MAIN - 1 Nashua Parma UTAH - 3 Escondido Bangor Salem Orem Fairfield GEORGIA - 5 OKLAHOMA - 2 Salt Lake City Fresno Buford MARYLAND - 3 New Jersey - 9 Oklahoma City (2) Sandy Lakewood Douglasville Baltimore Deptford Modesto Duluth Columbia Eatontown OREGON - 2 Virginia - 2 Montclair Kennesaw Towson Freehold Portland (2) Dulles Montebello Macon Mays Landing Springfield National City MASSACHUSETTS - 6 Paramus PENNSYLVANIA - 12 Northridge HAWAII - 1 Holyoke Rockaway Altoona WASHINGTON - 12 Ontario Honolulu Marlborough Toms River Camp Hill Bellingham Palm Desert Natick Wayne King of Prussia Everett Palmdale IDAHO - 1 North Attleboro Woodbridge Lancaster Kennewick Pleasanton Boise Saugus Langhorne Lynnwood Riverside Taunton NEW MEXICO - 2 Media Olympia Sacramento IOWA - 2 Albuquerque (2) North Wales Puyallup San Diego Coralville MICHIGAN - 6 Scranton Seattle San Jose Sioux City* Auburn Hills NEW YORK - 16 W. Mifflin Silverdale San Leandro Flint Albany Wilkes-Barre Spokane (2) Santa Ana ILLINOIS - 6 Grandville Bay Shore Williamsport* Tacoma Santa Monica Aurora Lansing Buffalo York Tukwila Thousand Oaks Bloomingdale Traverse City Clay Valencia Champaign Troy Johnson City RHODE ISLAND - 1 West Virginia - 1 Ventura Joliet Lake Grove Providence Charleston Victor Valley Orland Park MINNESOTA - 6 Massapequa West Covina* West Dundee Bloomington Middletown SOUTH CAROLINA - 2 Wisconsin - 5 Burnsville New Hartford Greenville Appleton COLORADO - 6 Indiana - 5 Duluth Poughkeepsie* North Charleston Brookfield Colorado Springs (2) Evansville Mankato Rochester Eau Claire Denver Fort Wayne St. Cloud Staten Island SOUTH DAKOTA - 1 Greendale* Littleton (2) Lafayette St. Paul Syracuse Sioux Falls Madison Westminster Mishawaka Victor Terre Haute West Nyack TENNESSEE - 2 White Plains Antioch Goodlettsville*
5 EXPANSION STRATEGY The following table provides a history of the Company's store expansion over the last five fiscal years:
FISCAL YEAR --------------------------------------------------------------- 1995 1996 1997 1998 1999 --------------------------------------------------------------- (number of stores) Stores at beginning of year 24 42 68 108 158 New Stores opened 18 26 40 50 54 --------------------------------------------------------------- Stores at end of year 42 68 108 158 212 ---------------------------------------------------------------
All but two of the Company's stores are currently in shopping malls. During fiscal 1998, the Company opened two "street location" stores, one each in Denver, Colorado and in Berkeley, California. The Company's expansion strategy is to open stores in shopping malls in both new and existing markets throughout the United States. The Company may open additional "street stores" in markets that the Company believes can sustain a Hot Topic store outside the mall environment, although the Company may elect not to aggressively expand its "street store" concept. 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, television programs and fashion magazines, the Company believes that its 12 to 22 year old target customers have similar fashion preferences throughout the United States. The Company opened 54 new stores in fiscal 1999 and plans to open approximately 60 new stores during fiscal 2000. 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 trade area, median family income and other factors relevant to the Company's unique merchandising strategy. The Company looks at similar criteria for "street store" locations. Model statements of operations are developed for each potential location and are measured against target financial criteria. Hot Topic has a real estate committee, including its Chief Executive Officer and two outside directors, which reviews and approves all new store locations. The Company generally seeks potential store sites between 1,200 and 2,400 square feet and its stores currently average approximately 1,480 square feet. STORE-LEVEL ECONOMICS During fiscal 1999, the Company's 158 stores that were in operation for all of the fiscal year generated average net sales of approximately $905,000 and average net sales per square foot of approximately $635. These stores also generated average store-level operating cash flow (defined as store operating income before depreciation and excluding changes in working capital) of approximately $270,000, or 29% of average net sales. Capital expenditures, including leasehold improvements, furniture and fixtures and net of landlord construction allowances for the 54 stores opened in fiscal 1999 averaged approximately $175,000, initial gross inventory requirements (which were partially financed by trade credit) averaged $75,000, and pre-opening costs (which were expensed in the periods the stores opened) averaged $22,000. Inventory requirements vary at new stores depending on the season and on current merchandise trends. In fiscal 1999, all of the Company's 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. 6 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, CDs, videos and other items. Music-influenced merchandise includes woven and knit tops, skirts, pants, shorts, jackets, shoes, costume jewelry, body jewelry, sunglasses, cosmetics and gift items. The Company estimates that approximately half of the Company's products are music-licensed products, and half are music-influenced products. A key strategy of the Company is to offer over 12,000 SKUs in 26 different product categories or "departments." Within each category, the Company seeks to offer a broader assortment of merchandise than is available at any other mall location. For example, on average, over 100 different licensed band T-shirts are carried in each store from alternative artists such as Korn, Blink 182, Limp Bizkit, Deftones, Rage Against the Machine, Slip Knot, and others; and rock artists such as the Pink Floyd, Static X, Pantera, Metallica, Jimi Hendrix, The Doors, the Beatles, Led Zeppelin, and others. New items and categories are tested regularly as customer demand and product trends evolve. The Company does not dictate leading edge fashion, but quickly reacts to changes in trends and demand to keep Hot Topic stores fresh and exciting. Further, the Company strives to identify music artists and releases that will have strong appeal, and to quickly acquire related music-licensed products and music-influenced merchandise, featured on music videos or otherwise, associated with such artists and releases. The following table sets forth the Company's four major merchandise groups as an approximate percentage of net sales for fiscal years 1999, 1998 and 1997: PERCENTAGE OF NET SALES ------------------------------------ 1999 1998 1997 ------------------------------------ Apparel and T-Shirts 48% 48% 47% Gifts 18 19 20 Accessories 27 26 25 Hosiery, Shoes, and Outerwear 7 7 8 ------------------------------------ 100% 100% 100% The Company has five lines of private label merchandise to complement and supplement its 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. Management estimates that Hot Topic brands accounted for approximately 20% of the Company's sales in both fiscal 1999 and 1998. The Company's proprietary brands include Morbid Makeup (cosmetics), Morbid Metals (body jewelry), Morbid Scents (incense and oils), Morbid Threads (men's and women's apparel and hosiery) and MT:2 (men's and women's apparel). PURCHASING The Company's purchasing staff consists of a Vice President, General Merchandise Manager, a Divisional Vice President, Merchandise Managers, nine buyers and seven assistant buyers. The purchasing staff reflects the Company's culture in that its decisions and actions are influenced by a passion for music. In determining which merchandise to buy, the purchasing staff spends considerable time viewing music videos, reviewing industry album 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 staff regularly visits nightclubs, and attends concerts and other events that attract young people. The Company also conducts periodic customer focus groups and intercept surveys, and consults with and solicits input from its store employees, in order to draw from many different experiences and perspectives. 7 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 sometimes receives accommodations such as pre-ticketing of orders, early shipments of new releases, exclusive merchandise and vendors' acceptance of returns. 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. Most of the products purchased from the Company's vendors are sold under the labels of the manufacturers, and some are sold under Hot Topic's private labels. 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 small purchases for testing 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 1999, the Company had approximately 800 vendors, certain of which have limited financial resources and production capabilities. No single vendor accounted for more than 6% of the Company's merchandise purchases. The Company believes that its relationships with its vendors are good. 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 inventory plans and SKU performance by using the Arthur Allocation software system implemented during fiscal 1999. Prior to the implementation of the Arthur Allocation system, the Company used proprietary software developed by Hot Topic to allocate merchandise to each store. 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 and 12 inventory analysts work closely with the merchandise buyers and store personnel to meet the requirements of individual stores for appropriate merchandise in sufficient quantities. Hot Topic's headquarters and distribution facility, consisting of approximately 125,000 square feet, is located in City of Industry, California. All merchandise is delivered by vendors to this facility, where it is inspected, price marked, entered into the Company's allocation software system, 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 reordered and new merchandise. Minimal back stock is maintained in the Company's distribution facility and at its stores, so that at all times almost all of the Company's merchandise is available for sale on the floors of its stores. 8 STORE OPERATIONS Hot Topic's store operations are currently managed by four regional managers and 37 district or area managers who each supervise approximately 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 employees are 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 employees, which helps streamline the Company's interview and hiring processes at the store level. 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 clubs, and are encouraged to communicate customer requests and their own merchandise ideas to management. Hot Topic encourages its sales associates to dress and accessorize themselves with the same fashionable merchandise that is sold in its stores. 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 weekly category sales 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 and area managers may also qualify to receive periodic stock option grants, and certain employees 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 employees. 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, the majority of its store managers have been promoted from within the Company. 9 STORE ENVIRONMENT Hot Topic stores are designed with an industrial warehouse theme that incorporates dense merchandising, and the latest music releases are played on a professional sound system to create a high-energy and fun shopping environment. The Company believes 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. Stores are constructed and fixtured to maximize merchandising flexibility, which enables the Company to highlight new product offerings and create a compelling shopping environment. Bi-monthly planograms are developed to assist store managers in displaying merchandise in an exciting and dynamic manner. In addition, sales associates are encouraged to wear the Company's products, which the Company believes contributes to the overall atmosphere of its stores. MARKETING, PROMOTION AND INTERNET The Company generally locates its stores in high traffic malls located 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. Special artist events are run in conjunction with record companies and licensed merchandise companies to promote new bands, music and movie releases. Hot Topic has found these methods to be more effective than traditional media advertising. As a part of the Company's marketing strategy, the Company maintains a website www.hottopic.com through which it markets its stores and store concept and sells certain of its merchandise. During fiscal 1999, the site was re-launched with a focus on e-commerce together with posting boards, customer surveys, a gift registry and content features including artist news and tour schedules. The Company's net sales via the Internet continue to increase significantly, although the total sales are still modest. MANAGEMENT INFORMATION SYSTEMS Hot Topic's information systems provide integration of store, merchandising, distribution and financial systems. 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, fixed asset management, payroll and integrated financials. These systems operate on a Unix platform with a central IBM minicomputer and a PC NT server network. 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 and 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 and system maintenance are downloaded through the POS devices. The Company evaluates information obtained through daily polling to implement merchandising decisions regarding reorders, markdowns and allocation of merchandise. 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 is planning to implement the host hardware and software systems at its office and distribution center during the second half of fiscal 2000 and install certain point of sale upgrades at its stores in fiscal 2001. The Company presently estimates the hardware, software, modifications, training and implementation will cost approximately $4 to $5 million. Of that amount, approximately $1.5 million was spent in fiscal 1999. The Company presently estimates the balance will be spent in fiscal 2000 and 2001. 10 YEAR 2000 In prior years, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed remediation and testing of its technology systems. As a result of those planning and implementation efforts, the Company has experienced no significant disruptions in mission critical information technology and non-information technology systems as of April 21, 2000 and believes those systems successfully responded to the Year 2000 date change. The Company expensed less than $100,000 during 1999 in connection with remediating its systems. The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly. 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) and Misery(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 Everything About the Music(TM), Morbid Threads(TM) and MT:2(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. 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 and for teenage and college age customers, suitable retail locations and qualified employees and management personnel. 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, Millers Outpost, Inc., Pacific Sunwear of California, Inc., Spencer Gifts, Inc., Urban Outfitters, Inc., The Wet Seal, Inc., Gadzooks, Inc. and, to a lesser extent, with music stores. Competition from mail order catalogs of apparel and accessories targeting the teen customer has increased in recent years. 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. EMPLOYEES The Company employed approximately 685 full-time and 1,596 part-time employees at April 8, 2000. Of the Company's 2,281 employees, 209 were corporate and distribution center personnel and 2,072 were store employees. The number of part-time employees fluctuates with seasonal needs. None of the Company's employees is covered by a collective bargaining agreement. The Company considers its employee relations to be good. EXECUTIVE OFFICERS AND KEY EMPLOYEES The executive officers and key employees of the Company and their ages at April 21, 2000 are as follows: 11
NAME AGE POSITION - ------------------------------ ----- ----------------------------------------------- Orval D. Madden............... 51 Chief Executive Officer and Director Elizabeth M. McLaughlin 39 President Jay A. Johnson................ 54 Chief Financial Officer and Assistant Secretary Marc R. Bertone............... 43 Vice President, Real Estate and Construction Cindy Levitt.................. 39 Vice President, General Merchandise Manager Alain Krakirian............... 34 Vice President, Planning and Allocation Darrell Kinsley............... 37 Vice President, Store Operations M. Reid Killen................ 42 Vice President, Information Technology
ORVAL D. MADDEN founded Hot Topic in 1988, and has been the Company's Chief Executive Officer and a Director since its inception and was also its President until February 2000. Prior to founding Hot Topic, Mr. Madden was a Senior Vice President of Federal Department Stores' Children's Place and Accessory Place divisions, and was a Divisional Vice President for Carter-Hawley-Hale Stores' Broadway and Weinstock's Department Store divisions. In 1993, Mr. Madden was recognized as regional California retailing "Entrepreneur Of The Year" in a competition sponsored by Ernst & Young, Merrill Lynch, and Inc. Magazine. ELIZABETH M. MCLAUGHLIN was promoted to President in February 2000. >From June 1998 through February 2000, Ms. McLaughlin was the Company's Senior Vice President, General Merchandise Manager and from June 1996 through May 1998, Ms. McLaughlin was the Company's Vice President, General Merchandise Manager. Ms. McLaughlin was the Company's Vice President, Operations from May 1993 through May 1996. From 1985 to May 1993, she held various positions with Millers Outpost including, Director of Stores, Director of Planning and Divisional Merchandise Manager. From 1978 to 1985, she held various positions with The Broadway. JAY A. JOHNSON has been Chief Financial Officer and Assistant Secretary of the Company since May 1995. From January 1993 to May 1995, he was Vice President/Chief Financial Officer of Frame-n-Lens Optical, Inc., a national optical retailer with approximately 300 stores. From July 1978 to July 1992, Mr. Johnson held senior financial management positions at one manufacturing and two retail companies. Mr. Johnson is a certified public accountant. MARC R. BERTONE has been Vice President, Real Estate and Construction, of the Company since August 1994. Mr. Bertone has 18 years of leasing and legal experience, and from November 1988 to August 1994, served as Vice President and General Counsel for The Wet Seal, Inc., a specialty retailer. Mr. Bertone was admitted to the California Bar in June 1982. CINDY LEVITT has been Vice President, General merchandise Manager since February 2000. Ms. Levitt joined Hot Topic in 1989. Since 1989, Ms. Levitt has held senior buying positions at Hot Topic, most recently from June 1996 to February 2000 as the Divisional Merchandise Manager, Apparel and Music. ALAIN KRAKIRIAN has been 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. 12 DARRELL KINSLEY has been Vice President, Store Operations since February 2000. From June 1998 through February 2000, Mr. Kinsley was Regional Director for the Western United States. Mr. Kinsley joined Hot Topic in February 1995 as the District Manager for the Eastern United States. M. REID KILLEN has been Vice President, Information Technology of the Company since July 1998. From June 1994 to July 1998, Mr. Killen was Director of Applications Development at The Gymboree Corporation. From September 1990 to May 1994, Mr. Killen was a Senior Business Analyst at The Gap, Inc. CERTAIN RISK FACTORS RELATED TO THE COMPANY'S BUSINESS In addition to risks identified elsewhere in this Annual Report, the Company is subject to other risks, including the following: 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. Fifty-four of the Company's 212 stores opened as of January 29, 2000 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 60 stores during fiscal 2000, which will result in a significant increase in the number of stores operated by the Company. Through fiscal 1994, all of the Company's stores were located in the Western United States. In fiscal 1995, the Company expanded into new markets by opening stores in the Northeastern and Midwestern regions of the United States. The Company plans to continue to enter new markets in various regions of the United States, and approximately one-half of its stores opened in fiscal years 1996, 1997 and 1998 were in new markets. In fiscal 1999, the Company entered four new states. 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, 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 13 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. During the first quarter of fiscal 2000, the first such lease was executed with the developer for a new store to open in fiscal 2000. 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 revenue 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 1994, 1995, 1996, 1997, 1998 and 1999 were 20.3%, (0.9%), 8.9%, 2.2%, 0.4% and 22.8% respectively. The Company's comparable store sales results were (0.6%), 2.0%, 9.5% and (5.9%) for the first, second, third and fourth quarters, respectively, of fiscal 1998 and 15.3%, 16.9%, 26.1% and 27.1% for the first, second, third and fourth quarters, respectively, of fiscal 1999. Past comparable store sales results are no indication 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, which could have a material adverse effect on the Company's business, results of operations and financial condition, and on its image with its customers. 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 14 traffic would adversely affect the Company's growth, net sales, comparable store sales results and profitability. In addition, a significant number of the Company's stores are concentrated in the Western United States, and as a result a deterioration in economic conditions in that region could particularly affect the Company's business, results of operations and financial condition. Changes to federal minimum wage laws in each of 1996 and 1997 raised the mandatory minimum wage. California, Washington, Massachusetts and other states have also enacted increases in State required minimum wages that are higher than the Federal requirements. The most recent such increases were effective January 1, 2000 in Washington and Massachusetts where the Company operated a total of 18 stores as of April 21, 2000. Statutory increases in federal and state minimum wages could adversely affect the Company's profitability. The recent state increases and any other such increases will raise minimum wages above current wage rates of certain of the Company's employees, and competitive factors could require corresponding increases in higher employee 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 have and are expected to continue to 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 Christmas holiday, the back-to-school season and other periods when school is not in session. As is the case with many retailers of apparel, accessories and related merchandise, the Company typically experiences lower net sales during the first fiscal quarter. The Company has experienced quarterly losses in the past and may experience such losses in the future. Because of these fluctuations in net sales and net income (loss), the results of operations of any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year or any future quarter. 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, with the largest vendor, Giant Manufacturing, a Division of the Warner Music Group, supplying 6% of the Company's merchandise purchases in fiscal 1999. 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 acquired from 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. 15 DEPENDENCE ON KEY PERSONNEL The Company's performance depends largely on the efforts and abilities of senior management, particularly Orval Madden, the Company's Chief Executive Officer and founder and Elizabeth McLaughlin, the Company's President who has been with the company since 1993. The sudden loss of Mr. Madden's or 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. The Company has a $500,000 key-man life insurance policy on Mr. Madden. There can be no assurance that Mr. Madden, 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 employees 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 employees, or that there will continue to be sufficient sources of temporary employees. FAILURE TO AUTHENTICATE LICENSING RIGHTS The Company purchases licensed merchandise from a number of suppliers who hold manufacturing and distribution rights under the terms of certain licenses. The Company generally relies upon vendors' representations concerning manufacturing and distribution rights and does not independently verify whether these vendors legally hold adequate rights to licensed properties they are manufacturing or distributing. If the Company acquires unlicensed merchandise, it could be obligated to remove such merchandise from its stores, incur costs associated with destruction of merchandise if the distributor is unwilling or unable to reimburse the Company, and be subject to liability under various civil and criminal causes of action, including actions to recover unpaid royalties and other damages. Any of these results could have a material adverse effect on the Company's business, results of operations and financial condition. COMPETITION The retail apparel and accessory industry is highly competitive. The Company competes with other retailers for vendors and for teenage and college age customers, suitable retail locations and qualified employees 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, Millers Outpost, Inc., Pacific Sunwear of California, Inc., Spencer Gifts, Inc., Urban Outfitters, Inc., The Wet Seal, Inc., Gadzooks, Inc., and, to a lesser extent, with music stores and mail order catalogs and Websites. 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 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. 16 ANTI-TAKEOVER MATTERS The Company's Amended and Restated Articles of Incorporation and Bylaws contain provisions that may have the effect of delaying, deterring or preventing a takeover of the Company that shareholders may consider to be in their best interests. For instance, the Company's Amended and Restated Articles of Incorporation and 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 All of the Company's existing store locations are leased by the Company, with lease terms expiring between 2001 and 2010. The leases for most of the existing stores are for terms of 10 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. The Company's headquarters office and distribution center are located in City of Industry, California, and are occupied under the terms of a lease covering approximately 125,000 square feet. The lease is for a five year term, with two options to extend the lease, each for a three year period. The initial five year term expires in April 2004. The annual base rent for the initial five year term is approximately $525,000. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material 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 two-for-one stock split of the Company's Common Stock became effective December 28, 1999. The stock split was effected by way of a stock dividend. The dividend was distributed to shareholders of record as of December 10, 1999. All share and per share amounts have been restated to reflect the split. The Company consummated its initial public offering in September 1996 at a price of $9.00 per share. The following table sets forth, for the periods indicated, the high and low "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. 1999 HIGH LOW ------------ ------------- First Quarter $9 1/2 $6 3/8 Second Quarter $15 9/16 $8 1/2 Third Quarter $18 3/4 $11 29/32 Fourth Quarter $26 11/16 $17 3/16 17 1998 HIGH LOW ------------ ------------- First Quarter $14 7/8 $11 3/8 Second Quarter $14 7/16 $10 Third Quarter $11 1/2 $6 Fourth Quarter $12 5/8 $5 5/8 On April 21, 2000, the last sales price of the Common Stock as reported on the Nasdaq National Market was $30.00 per share. As of April 21, 2000, there were approximately 250 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 1,000 holders. The Company has not paid any cash dividends since inception and does not anticipate paying any cash dividends in the foreseeable future. 18 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 ------------------------------------------------------------------------ 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (In thousands, except per share data, number of stores, comparable store sales and sales per square foot) STATEMENT OF OPERATIONS DATA: Net sales $168,949 $103,371 $70,532 $43,618 $23,632 Cost of goods sold, including buying, distribution and occupancy costs 103,998 65,855 44,417 27,049 15,067 --------- --------- --------- --------- --------- Gross Margin 64,951 37,516 26,115 16,569 8,565 Selling, general and administrative expenses 44,749 29,077 19,862 12,846 7,981 --------- --------- --------- --------- --------- Operating income 20,202 8,439 6,253 3,723 584 Interest income, net 933 931 901 382 143 --------- --------- --------- --------- --------- Income before income taxes 21,135 9,370 7,154 4,105 727 Income taxes 7,634 3,367 2,611 1,535 291 --------- --------- --------- --------- --------- Net income $13,501 $6,003 $4,543 $2,570 $436 Net income per share: Basic $1.46 $0.62 $0.48 $0.35 $0.07 Diluted $1.38 $0.61 $0.46 $0.33 $0.07 Weighted average shares outstanding Basic 9,267 9,634 9,381 7,256 6,164 Diluted 9,797 9,912 9,880 7,798 6,270 SELECTED OPERATING DATA: Number of stores at year end 212 158 108 68 42 Comparable stores sales increase (decrease) 22.8% 0.4% 2.2% 8.9% (0.9%) Average sales per square foot $623 $542 $565 $578 $572 Average sales per store (000s) $909 $772 $769 $748 $705 BALANCE SHEET DATA: Working capital $37,564 $28,432 $29,230 $29,247 $5,857 Total assets 89,022 58,764 51,953 44,033 14,959 Long-term obligations, including current portion 231 120 161 48 34 Redeemable preferred stock - - - - 11,245 Shareholders' equity $67,278 $48,749 $44,736 $39,069 $785
19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Hot Topic 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. The Company opened its first store in 1989, and operated 212 stores in 42 states across the United States as of January 29, 2000. The Company opened 18 stores during fiscal 1995, including its first 12 stores in the Midwest and Northeast; 26 stores during fiscal 1996, most of which are in new markets in the Midwest and Northeast adjacent to markets entered in fiscal 1995; 40 stores during fiscal 1997, both in existing markets and in 12 additional states, 50 stores during fiscal 1998, both in existing markets and in 6 additional states; and, 54 stores during fiscal 1999, both in existing markets and in 4 additional states. The Company operates on a 52 or 53 week fiscal year which ends on the Saturday nearest to January 31. Fiscal 1997, 1998 and 1999 were 52-week years. 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 ------------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Net sales 100.0% 100.0% 100.0% Cost of goods sold, including buying, distribution & occupancy costs 61.6% 63.7% 63.0% ------------ ------------ ------------ Gross margin 38.4% 36.3% 37.0% Selling, general and administrative expenses 26.4% 28.1% 28.2% ------------ ------------ ------------ Operating income 12.0% 8.2% 8.8% Interest income, net 0.6% 0.9% 1.3% ------------ ------------ ------------ Income before income tax 12.6% 9.1% 10.1% Provision for income taxes 4.6% 3.3% 3.7% ------------ ------------ ------------ Net income 8.0% 5.8% 6.4% ============ ============ ============ Number of stores at year end 212 158 108 ============ ============ ============ Comparable store sales increase 22.8% 0.4% 2.2% ============ ============ ============
FISCAL 1999 COMPARED TO FISCAL 1998 Net sales increased approximately $65.5 million, or 63%, to $168.9 million in fiscal 1999 from $103.4 million in fiscal 1998. Net sales for the 54 stores opened during fiscal 1999 and for those stores not yet qualifying as comparable stores contributed $44.7 million of the net sales increase. Comparable store sales increased 22.8% in fiscal 1999 and contributed $20.8 million of the increase in net sales. The average store volume increased to $909,000 from $772,000 in fiscal 1998. The sales mix in fiscal 1999 was approximately the same as the mix in fiscal 1998, with apparel and T-shirts contributing approximately 48% of net sales in each fiscal year. 20 Gross margin increased approximately $27.4 million to $64.9 million in fiscal 1999 from $37.5 million in fiscal 1998. As a percentage of net sales, gross margin increased to 38.4% in fiscal 1999 from 36.3% in fiscal 1998. The increase, as a percentage of sales, reflected the leveraging of occupancy expense achieved from the significant increase in the average store sales volume and an increase in merchandise margin. Merchandise margin increased approximately 0.4% compared to the prior year, principally from an average higher initial mark-on and lower merchandise markdowns, as a percentage of sales. Selling, general and administrative expenses increased approximately $15.6 million to $44.7 million during fiscal 1999 from $29.1 million during fiscal 1998, but decreased as a percentage of net sales to 26.4% in fiscal 1999 from 28.1% in fiscal 1998. The decrease as a percentage of net sales was primarily due to a reduction of corporate overhead expense as a percentage of net sales due to the operating leverage achieved through the Company's larger store base and to a reduction in the store payroll and operating expenses as a percentage of sales due to the operating leverage achieved from the higher average store sales. Operating income increased approximately $11.8 million to $20.2 million during fiscal 1999 from $8.4 million during fiscal 1998. As a percentage of net sales, operating income increased significantly to 12.0% in fiscal 1999 from 8.2% in fiscal 1998, principally from the larger store base, higher average store sales and higher margins. Interest income, net, of $933,000 during fiscal 1999 was approximately the same as the $931,000 during fiscal 1998. The Company's effective tax rate was 36.1% in fiscal 1999 and 35.9% in fiscal 1998. The variance from an expected rate of approximately 40% in both fiscal 1999 and 1998 is a result of a significant portion of each fiscal year's interest income being non-taxable. FISCAL 1998 COMPARED TO FISCAL 1997 Net sales increased approximately $32.9 million, or 46.6%, to $103.4 million in fiscal 1998 from $70.5 million in fiscal 1997. Net sales for the 50 stores opened during fiscal 1998 and for those stores not yet qualifying as comparable stores contributed $32.7 million of the net sales increase. Comparable store sales increased 0.4% in fiscal 1998 and contributed $200,000 of the increase in net sales. Apparel and T-shirts increased to 48% of net sales in fiscal 1998 from 47% of net sales in fiscal 1997. Gross margin increased approximately $11.4 million to $37.5 million in fiscal 1998 from $26.1 million in fiscal 1997. As a percentage of net sales, gross margin decreased to 36.3% in fiscal 1998 from 37.0% in fiscal 1997, principally due to higher occupancy and distribution expenses, as a percentage of sales. Selling, general and administrative expenses increased approximately $9.2 million to $29.1 million during fiscal 1998 from $19.9 million during fiscal 1997, but decreased slightly as a percentage of net sales to 28.1% in fiscal 1998 from 28.2% in fiscal 1997. The decrease as a percentage of net sales was primarily due to a reduction of corporate overhead expense as a percentage of net sales due to the operating leverage achieved through the Company's larger store base offset in part by an increase in store payroll expense and store operating expenses. Operating income increased approximately $2.2 million to $8.4 million during fiscal 1998 from $6.2 million during fiscal 1997. As a percentage of net sales, operating income decreased to 8.2% in fiscal 1998 from 8.8% in fiscal 1997, principally from the lower gross margin. 21 Interest income, net, increased slightly to $931,000 during fiscal 1998 from $901,000 during fiscal 1997. The Company's effective tax rate was 35.9% in fiscal 1998 and 36.5% in fiscal 1997. The variance from an expected rate of approximately 40% in both fiscal 1998 and 1997 is a result of a significant portion of each fiscal 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 Christmas holiday, back-to-school season, and other periods when schools are not in session. The Christmas 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), reduces somewhat the Company's dependence on the Christmas holiday selling season. Furthermore, summer vacation, spring break and the back-to-school season take place at somewhat different times in different parts of the country, spreading the impact of these events on the Company's sales over a longer period. As is the case with many retailers of apparel, accessories and related merchandise, the Company typically experiences lower net sales and operating losses during the first fiscal quarter. The Company has experienced quarterly losses in the past and may experience such losses in the future. 22 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.
FISCAL YEAR 1998 FISCAL YEAR 1999 ---------------------------------------------- ---------------------------------------------- FIRST Second Third Fourth First Second Third Fourth ----- ------ ----- ------ ----- ------ ----- ------ (In thousands, except selected operating and per share data) STATEMENT OF OPERATIONS DATA: Net sales $17,314 $20,787 $28,708 $36,561 $28,286 $32,779 $47,964 $59,920 Gross Margin 5,722 6,776 10,642 14,376 9,746 11,413 19,019 24,773 Operating income (loss) (179) 318 2,587 5,713 781 1,638 6,576 11,207 Net income $45 $334 $1,758 $3,866 $635 $1,152 $4,306 $7,408 Net income per share: Basic $0.01 $0.04 $0.18 $0.40 $0.07 $0.13 $0.47 $0.80 Diluted $0.01 $0.04 $0.18 $0.39 $0.07 $0.12 $0.44 $0.72 Weighted average shares outstanding: Basic 9,556 9,622 9,662 9,696 9,242 9,239 9,286 9,301 Diluted 9,958 9,968 9,888 9,832 9,424 9,632 9,839 10,294 SELECTED OPERATING DATA: Comparable store sales increase (0.6%) 2.0% 9.5% (5.9%) 15.3% 16.9% 26.1% 27.1% Stores open at end of period 123 133 145 158 168 184 198 212
LIQUIDITY AND CAPITAL RESOURCES During the last three fiscal years, the Company's primary uses of cash have been to finance store openings and purchase merchandise inventories. In fiscal 1999, an additional significant use was the equipment and leasehold improvements for a new headquarters office and distribution facility. The Company has satisfied its cash requirements principally from cash flows from operations. Cash flows provided by operating activities were $25.8 million, $9.3 million, and $7.2 million in fiscal 1999, 1998 and 1997, respectively. The increases in cash flows from operating activities in fiscal 1999 was primarily attributable to the increase in net income and increases in accounts payable, accrued expenses and income taxes payable, partially off-set by an increase in inventory. The increases in cash flows from operating activities in the 1997 and 1998 fiscal years was primarily attributable to increases in the company's net income. Cash flows used in investing activities were $15.8 million, $9.3 million and $8.9 million in fiscal 1999, 1998 and 1997, respectively. Cash flows used in investing activities relate primarily to store openings and, in 1999, approximately $4.2 million was used for equipment and leasehold improvements for the Company's new headquarters office and distribution facility and, in 1997, approximately $750,000 was used to expand the capacity and increase the efficiency of the Company's distribution facility. The Company opened 54, 50 and 40 stores in fiscal 1999, 1998 and 1997, respectively. 23 Cash flows provided by financing activities were $5.0 million, ($2.1) million and $1.1 million in fiscal 1999, 1998 and 1997, respectively. In February and March 1999, the company used $1.1 million to repurchase 138,000 shares of its Common Stock and in January 1999, used $3.0 million to repurchase 440,000 shares of its Common Stock. The Company anticipates that it will spend approximately $11.5 to $12.5 million to open approximately 60 stores in fiscal 2000. During fiscal 1999, the Company's average capital expenditures to open a store, including leasehold improvements and furniture and fixtures, totaled approximately $175,000. The average initial gross inventory for the new 1999 stores was approximately $75,000 (which was partially financed by trade credit) and pre-opening costs averaged approximately $22,000 for these stores. The Company expects the average total costs associated with opening a store to be approximately the same in fiscal 2000. Pre-opening costs are expensed as incurred. 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, the size of the stores and the extent of the build-out required at the selected sites. Initial inventory requirements vary at new stores depending on the season and current merchandise trends. To accommodate its needs in fiscal 1999 and its planned expansion, the Company moved its headquarters office and merchandise distribution facility to a larger leased facility during May and June 1999. The construction of the offices and installation of the distribution equipment commenced in February 1999 and the cost of construction, equipment, fixtures and furniture was approximately $4.2 million. The new facility has a projected capacity of approximately 500 stores. 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 is planning to implement the host hardware and software systems at its office and distribution center during the second half of fiscal 2000 and install certain point of sale upgrades at its stores in fiscal 2001. The Company presently estimates the hardware, software, modifications, training and implementation will cost approximately $4 to $5 million. Of that amount, approximately $1.5 million was spent in fiscal 1999. The Company presently estimates the balance will be spent in fiscal 2000 and 2001. The Company believes that its existing cash balances and cash generated from operations will be sufficient to fund its operations and planned expansion through the next 12 months. 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. YEAR 2000 COMPLIANCE In prior years, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed remediation and testing of its technology systems. As a result of those planning and implementation efforts, the Company has experienced no significant disruptions in mission critical information technology and non-information technology systems as of April 7, 2000 and believes those systems successfully responded to the Year 2000 date change. The Company expensed less than $100,000 during 1999 in connection with remediating its systems. The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly. 24 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. 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" in Part I, Item 1 hereof for information regarding executive officers. The information required by this item with respect to directors is incorporated by reference from the information under the caption "Election of Directors," contained in the Company's Definitive Proxy Statement which will be filed within 120 days of fiscal year-end with the Securities and Exchange Commission pursuant to Regulation 14A in connection with the solicitation of proxies for the Company's Annual Meeting of Shareholders to be held on June 28, 2000 (the "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 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 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 Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K (a)(1) INDEX TO CONSOLIDATED FINANCIAL STATEMENTS The 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. 25 Page Report of Ernst & Young LLP, Independent Auditors......................... F-1 Consolidated Balance Sheets as of January 29, 2000 and January 30, 1999... F-2 Consolidated Statements of Operations for the years ended January 29, 2000, January 30, 1999 and January 31, 1998................................. F-3 Consolidated Statements of Shareholders' Equity for the years ended January 29, 2000, January 30, 1999 and January 31, 1998....................... F-4 Consolidated Statements of Cash Flows for the years ended January 29, 2000, January 30, 1999 and January 31, 1998................................. F-5 Notes to Consolidated Financial Statements................................ F-6 (a)(2) INDEX TO FINANCIAL STATEMENT SCHEDULES All schedules are omitted because they are not required, are not applicable, or the information is included in the Financial Statements or notes thereto. (a)(3) INDEX TO EXHIBITS See Index to Exhibits beginning on page 28. The following management compensatory plans and arrangements are required to be filed as exhibits to this Report on Form 10-K pursuant to Item 14(c): EXHIBIT NUMBER DESCRIPTION OF DOCUMENT ------ ----------------------- 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) 10.5 Non-Employee Directors' Stock Option Plan. (1) 10.6 Employee Stock Purchase Plan. (1) 10.11 Letter Agreement regarding Employment Terms, dated August 9, 1994, entered into between Registrant and Elizabeth M. McLaughlin. (1) 10.15 401(k) Defined Contribution Plan of Registrant, effective as of August 1, 1995. (1) - ------------ (1) Filed as an exhibit to Registrant's Registration Statement on Form SB-2 (No. 333-5054-LA) and incorporated herein by reference. (b) REPORTS ON FORM 8-K During the quarter ended January 29, 2000, the Registrant filed one current report on Form 8-K. On December 2, 1999, the Registrant filed a Current Report on Form 8-K regarding the Registrant's announcement that it's Board of Directors approved a two-for-one stock split to be implemented as a 100% stock dividend to each of the Registrant's shareholder of record as of December 13, 1999. (c) EXHIBITS The exhibits required by this Item are listed under Item 14(a)(3). (d) FINANCIAL STATEMENT SCHEDULES The financial statement schedules required by this Item are listed under Item 14(a)(2). 26 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 25th day of April, 2000. HOT TOPIC, INC. By: /s/ Orval D. Madden ------------------------------------ Orval D. Madden Chief Executive Officer and Director POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Orval D. Madden and Jay A. Johnson, 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/ ROBERT M. JAFFE Chairman of the Board April 25, 2000 - ----------------------------------------------- Robert M. Jaffe /s/ ORVAL D. MADDEN Chief Executive Officer and Director April 25, 2000 - ----------------------------------------------- (PRINCIPAL EXECUTIVE OFFICER) Orval D. Madden /s/ JAY A. JOHNSON Chief Financial Officer and Assistant April 25, 2000 - ----------------------------------------------- Secretary Jay A. Johnson (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER) /s/ EDGAR F. BERNER Director April 25, 2000 - ----------------------------------------------- Edgar F. Berner /s/ STANLEY E. FOSTER Director April 25, 2000 - ----------------------------------------------- Stanley E. Foster /s/ CORRADO FEDERICO Director April 25, 2000 - ----------------------------------------------- Corrado Federico /s/ ANDREW SCHUON Director April 25, 2000 - ----------------------------------------------- Andrew Schuon /s/ BRUCE A. QUINNELL Director April 25, 2000 - ----------------------------------------------- Bruce A. Quinnell
27 EXHIBIT INDEX 3.1 Form of Amended and Restated Articles of Incorporation of Registrant. (1) 3.2 Form of amended and restated Bylaws, Registrant. (1) 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) 10.5 Non-Employee Directors' Stock Option Plan. (1) 10.6 Employee Stock Purchase Plan. (1) 10.7 Letter Agreement regarding Employment Terms, dated August 9, 1994, entered into between Registrant and Elizabeth M. McLaughlin. (1) 10.8 401(k) Defined Contribution Plan of Registrant, effective as of August 1, 1995. (1) 10.9 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) 10.10 Guaranty of Lease, dated December 10, 1998, entered into between the Registrant and Majestic Realty Co. and Patrician Associates, Inc. (2) 23.1 Consent of Ernst & Young LLP, Independent Auditors. 24.1 Power of Attorney. Reference is made to page 27. 27.1 Financial Data Schedule. - ------------ (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 10K for the year ended January 30, 1999 and incorporated herein by reference. 28 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. as of January 29, 2000 and January 30, 1999, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended January 29, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits 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 consolidated 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 subsidiaries at January 29, 2000 and January 30, 1999, and the results of its consolidated operations and its consolidated cash flows for each of the three years in the period ended January 29, 2000 in conformity with generally accepted accounting principles. /S/ Ernst & Young LLP March 9, 2000 F-1 Hot Topic, Inc. and Subsidiaries Consolidated Balance Sheets
JANUARY 29, JANUARY 30, 2000 1999 --------------------------------- ASSETS Current assets: Cash and cash equivalents $ 39,549,654 $ 24,573,874 Inventory 15,366,745 10,446,626 Prepaid expenses and other 1,580,433 1,440,286 Deferred tax asset (NOTE 6) 721,161 321,825 --------------------------------- Total current assets 57,217,993 36,782,611 Leaseholds, fixtures and equipment, net (NOTE 2) 31,721,478 21,895,132 Deposits and other 82,986 86,922 --------------------------------- Total assets $ 89,022,457 $ 58,764,665 ================================= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 6,215,011 $ 2,186,462 Accrued payroll and related expenses 8,452,469 4,035,805 Accrued sales and other taxes payable 637,623 382,742 Federal and state income taxes payable 4,288,815 1,715,559 Current portion of obligations under capital leases 59,736 29,629 --------------------------------- Total current liabilities 19,654,654 8,350,197 Deferred rent (NOTE 3) 1,104,709 743,711 Capital lease obligations, less current portion (NOTE 3) 170,767 89,908 Deferred tax liability (NOTE 6) 815,796 831,703 Shareholders' equity (NOTE 4): Common shares, no par value; 50,000,000 shares authorized; 9,660,844 and 9,308,862 shares issued and outstanding at January 29, 2000 and January 30, 1999, respectively 40,667,571 35,675,752 Deferred compensation (6,727) (42,619) Retained earnings 26,616,687 13,116,013 --------------------------------- Total shareholders' equity 67,277,531 48,749,146 --------------------------------- Total liabilities and shareholders' equity $ 89,022,457 $ 58,764,665 =================================
SEE ACCOMPANYING NOTES. F-2 Hot Topic, Inc. and Subsidiaries Consolidated Statements of Income
YEARS ENDED JANUARY 29, JANUARY 30, JANUARY 31, 2000 1999 1998 ---------------------------------------------------------- Net sales $ 168,948,553 $ 103,370,683 $ 70,531,592 Cost of goods sold, including buying, distribution and occupancy costs 103,998,031 65,854,559 44,416,873 --------------------------------------------------------- Gross margin 64,950,522 37,516,124 26,114,719 Selling, general and administrative expenses 44,748,988 29,077,124 19,861,808 --------------------------------------------------------- Operating income 20,201,534 8,439,000 6,252,911 Interest income (964,826) (951,119) (917,348) Interest expense 32,086 20,296 16,787 ---------------------------------------------------------- Income before income taxes 21,134,274 9,369,823 7,153,472 Provision for income taxes (NOTE 6) 7,633,600 3,366,900 2,610,800 ---------------------------------------------------------- Net income $ 13,500,674 $ 6,002,923 $ 4,542,672 ========================================================= Net income per share: Basic $ 1.46 $ 0.62 $ 0.48 ========================================================= Diluted $ 1.38 $ 0.61 $ 0.46 ========================================================= Shares used in computing net income per share: Basic 9,266,852 9,634,048 9,380,980 Diluted 9,797,362 9,911,594 9,879,894 SEE ACCOMPANYING NOTES.
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 February 1, 1997 9,198,506 $ 36,613,148 $ (114,403) $ 2,570,418 $ 39,069,163 Exercise of stock options 316,644 446,528 - - 446,528 Employee stock purchase plan 4,062 37,692 - - 37,692 Amortization of deferred compensation - - 35,892 - 35,892 Tax benefit from exercise of options - 603,624 - - 603,624 Net income - - - 4,542,672 4,542,672 --------------------------------------------------------------------------- Balance at January 31, 1998 9,519,212 37,700,992 (78,511) 7,113,090 44,735,571 Exercise of stock options 222,154 388,728 - - 388,728 Employee stock purchase plan 7,496 49,500 - - 49,500 Repurchase common stock (440,000) (2,968,565) (2,968,565) Amortization of deferred compensation - - 35,892 - 35,892 Tax benefit from exercise of options - 505,097 - - 505,097 Net income - - - 6,002,923 6,002,923 --------------------------------------------------------------------------- Balance at January 30, 1999 9,308,862 35,675,752 (42,619) 13,116,013 48,749,146 --------------------------------------------------------------------------- Exercise of stock options 482,096 4,187,278 - - 4,187,278 Employee stock purchase plan 7,886 60,469 - - 60,469 Repurchase common stock (138,000) (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 9,660,844 $ 40,667,571 $ (6,727) $ 26,616,687 $ 67,277,531 ===========================================================================
SEE ACCOMPANYING NOTES. F-4 Hot Topic, Inc. and Subsidiaries Consolidated Statements of Cash Flows
YEARS ENDED JANUARY 29, JANUARY 30, JANUARY 31, 2000 1999 1998 ----------------------------------------------------- OPERATING ACTIVITIES Net income $ 13,500,674 $ 6,002,923 $ 4,542,672 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 5,890,519 4,069,200 2,872,483 Deferred rent 360,998 234,889 189,816 Deferred compensation 35,892 35,892 35,892 Deferred taxes (415,243) 124,198 104,238 Loss on disposal of fixed assets 10,072 - 46,071 Changes in operating assets and liabilities: Inventory (4,920,119) (2,810,030) (2,699,378) Prepaid expenses and other current assets (140,147) (782,537) 335,485 Deposits and other assets 3,936 (46,397) (4,982) Accounts payable 4,028,549 480,803 478,556 Accrued payroll and related expenses 4,601,036 1,409,150 792,152 Accrued sales and other taxes payable 254,881 118,883 54,077 Income taxes payable 2,5736256 488,804 492,687 ----------------------------------------------------- Net cash provided by operating activities 25,784,304 9,325,778 7,239,769 INVESTING ACTIVITIES Purchases of property and equipment (15,763,802) (9,274,002) (8,869,800) ----------------------------------------------------- Net cash used in investing activities (15,763,802) (9,274,002) (8,869,800) FINANCING ACTIVITIES Payments on capital lease obligations (36,541) (31,689) (30,031) Repurchase common shares (1,064,863) (2,968,565) - Proceeds from employee stock purchases and exercise of stock options, including related tax benefit 6,056,682 943,325 1,087,844 ----------------------------------------------------- Net cash provided by (used in) financing activities 4,955,278 (2,056,929) 1,057,813 ----------------------------------------------------- Increase (Decrease) in cash and cash equivalents 14,975,780 (2,005,153) (572,218) Cash and cash equivalents at beginning of year 24,573,874 26,579,027 27,151,245 ----------------------------------------------------- Cash and cash equivalents at end of year $ 39,549,654 $ 24,573,874 $ 26,579,027 ===================================================== SUPPLEMENTAL INFORMATION Cash paid during the year for interest $ 32,086 $ 20,296 $ 16,787 ===================================================== Cash paid during the year for income taxes $ 8,574,900 $ 2,245,212 $ 1,415,012 ===================================================== Capital lease obligations entered into for equipment $ 112,400 $ - $ 142,990 =====================================================
SEE ACCOMPANYING NOTES. F-5 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements January 29, 2000 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND BUSINESS ACTIVITY Hot Topic, Inc. (the Company) was incorporated in California in September 1988. The Company sells music licensed and music influenced apparel, accessories and gift items for young men and women through its retail stores. The Company operates mall based retail stores throughout the western, mid-western, southeastern and northeastern regions of the United States. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts have been eliminated in consolidation. FISCAL YEAR The Company's fiscal year is on a 52-53 week basis and ends on the Saturday nearest to January 31. The fiscal years ended January 29, 2000, January 30, 1999 and January 31, 1998 were 52 week years. REVENUE RECOGNITION Retail merchandise sales are recognized at the point of sale less estimated sales returns. 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 5). A two-for-one stock split became effective December 28, 1999. All share and per share amounts have been restated to reflect the split. F-6 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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 of the investment of cash equivalents at two financial institutions. INVENTORY Inventories and related cost of sales are accounted for by the retail method. The cost of inventory is determined at the lower of the first-in, first-out (FIFO) method or market. STORE PRE-OPENING COSTS Costs incurred in connection with the opening of a new store are expensed as incurred. 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. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles 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 which indicate that their carrying value may not be recoverable. At January 29, 2000, the Company believes there has been no impairment of the value of such assets. F-7 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) STOCK-BASED COMPENSATION The Company accounts for stock-based awards to employees using the intrinsic value method as prescribed by Accounting Principle Board Opinion No. 25, "Accounting for stock issued to Employees". 2. LEASEHOLDS, FIXTURES AND EQUIPMENT Leaseholds, fixtures and equipment are summarized as follows:
JANUARY 29, JANUARY 30, 2000 1999 -------------------------------------- Furniture, fixtures and equipment $ 25,396,222 $ 17,709,670 Leasehold improvements 21,419,124 14,725,529 -------------------------------------- 46,815,346 32,435,199 Less accumulated depreciation and amortization (15,093,868) (10,540,067) -------------------------------------- $ 31,721,478 $ 21,895,132 ======================================
3. COMMITMENTS 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. In December 1998, a wholly-owned subsidiary of the Company entered into a lease for a building for a new office and distribution facility. The lease provides for a five year term and two three year lease extensions. The retail space leases provide for rents based upon the greater of the minimum annual rental amounts or 6% to 8% of annual sales volume. Certain of the leases provide for increasing minimum annual rental amounts. Rent expense is recorded evenly 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 agreement. Total rent expense for the years ended January 29, 2000, January 30, 1999 and January 31, 1998 was $10,364,345, $7,505,514 and $5,138,226, respectively, including contingent rentals of $1,221,200, $293,759 and $272,900, respectively. F-8 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. COMMITMENTS (CONTINUED) LEASES (CONTINUED) The Company leases certain equipment under capital lease obligations. Cost and accumulated depreciation of equipment under capital leases were $291,151 and $49,440, respectively, at January 29, 2000, $168,930 and $49,137, respectively, at January 30, 1999 and $186,489 and $41,243, respectively, at January 31, 1998. Annual future minimum lease payments under operating and capital leases as of January 29, 2000 are as follows:
OPERATING CAPITAL Fiscal year LEASES LEASES - ------------ ------------------------------------ 2001 $ 11,647,694 $ 81,429 2002 11,589,796 56,413 2003 11,500,756 98,743 2004 11,305,950 29,116 2005 10,820,425 Thereafter 35,836,889 ------------------------------------ Total minimum lease payments $ 92,701,510 265,701 =================== Less amounts representing interest 35,198 ---------------- Present value of future minimum capital lease payments 230,503 Less amounts due in one year 59,736 ---------------- Long-term portion of obligations under capital leases $ 170,767 ================
4. SHAREHOLDERS' EQUITY STOCK OPTIONS Under the Company's long-term incentive plans (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 Plan 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 F-9 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. SHAREHOLDERS' EQUITY (CONTINUED) STOCK OPTIONS (CONTINUED) 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 2,660,000 shares of common stock may be issued pursuant to the plans. As of January 29, 2000, 308,688 shares were available for future grants. 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 300,000 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. Pro forma information regarding net income and earnings per share is required by Statement 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 1999, 1998 and 1997: weighted-average risk-free interest rates of 6%; dividend yields of 0%; weighted-average volatility factors of the expected market price of the Company's common stock of 0.80 for 1999, 0.79 for 1998 and 0.53 for 1997; and a weighted average expected life of the option of 5 years. The weighted average fair value of options granted during the year is $10.02, $7.33 and $6.44 per share for fiscal 1999, 1998 and 1997, respectively. F-10 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. SHAREHOLDERS' EQUITY (CONTINUED) STOCK OPTIONS (CONTINUED) For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows:
1999 1998 1997 --------------------------------------------------- Pro forma net income $ 11,303,530 $ 4,495,809 $ 3,888,986 Pro forma earnings per share Basic $1.22 $0.47 $0.42 Diluted $1.20 $0.46 $0.41
A summary of the Company's stock option activity and related information follows:
JANUARY 29, 2000 JANUARY 30, 1999 JANUARY 31, 1998 ------------------------------------------------------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE ------------------------------------------------------------------------- Outstanding at beginning of year 1,398,302 $10.23 1,124,620 $8.22 798,244 $2.11 Granted 512,200 $7.37 573,176 $10.81 672,704 $12.19 Exercised (482,096) $8.69 (222,154) $1.75 (316,644) $1.42 Canceled (101,844) $10.43 (77,340) $9.61 (29,684) $6.52 ------------------------------------------------------------------------- Outstanding at end of year 1,326,562 $9.67 1,398,302 $10.23 1,124,620 $8.22 ========================================================================= Exercisable at end of year 273,142 $10.88 392,570 $8.55 242,300 $2.04
Exercise prices for options outstanding as of January 29, 2000 ranged from $1.25 to $13.94. Of the 1,326,562 options outstanding at January 29, 2000, 44,638 have exercise prices ranging from $1.25 to $2.50, 592,812 have exercise prices ranging from $6.82 to $9.63 and 689,112 have exercise prices ranging from $10.00 to $13.94. The weighted average remaining contractual life of those options is 8 years. F-11 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 5. 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. A reconciliation of the numerator and denominator of basic earnings per share and diluted earnings per share for the year ended, is as follows:
JANUARY 29, JANUARY 30, JANUARY 31, 2000 1999 1998 ------------------------------------------------------ Basic EPS Computation: Numerator $ 13,500,674 $ 6,002,923 $ 4,542,672 Denominator: Weighted average common shares outstanding 9,266,852 9,634,048 9,380,980 ------------------------------------------------------ Total shares 9,266,852 9,634,048 9,380,980 ------------------------------------------------------ Basic EPS $ 1.46 $ 0.62 $ 0.49 ====================================================== Diluted EPS Computation: Numerator $ 13,500,674 $ 6,002,923 $ 4,542,672 Denominator: Weighted average common shares outstanding 9,266,852 9,634,048 9,380,980 Incremental shares from assumed conversion of options 530,510 277,546 498,914 ------------------------------------------------------ Total shares 9,797,362 9,911,594 9,879,894 ------------------------------------------------------ Diluted EPS $ 1.38 $ 0.61 $ 0.46 ======================================================
F-12 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 6. INCOME TAXES Following is the composition of the provision for income taxes for the years ended:
JANUARY 29, JANUARY 30, JANUARY 31, 2000 1999 1998 ----------------------------------------------------- Current: Federal $ 6,873,075 $ 2,770,434 $ 2,042,664 State 1,183,325 472,268 463,898 ----------------------------------------------------- 8,056,400 3,242,702 2,506,562 Deferred: Federal (393,151) 127,057 89,336 State (29,649) (2,859) 14,902 ----------------------------------------------------- (422,800) 124,198 104,238 ----------------------------------------------------- Total income tax expense $ 7,633,600 $ 3,366,900 $ 2,610,800 =====================================================
Significant components of the Company's deferred tax assets and liabilities:
JANUARY 29, JANUARY 30, 2000 1999 ------------------------------------ Current deferred tax assets: Accrued vacation and other $ 227,759 $ 230,496 Inventory 445,380 291,499 State taxes 258,895 78,833 Other liabilities (196,373) (264,503) ------------------------------------ Total deferred tax assets 735,661 336,325 Valuation allowance for deferred tax assets (14,500) (14,500) ------------------------------------ Net current deferred tax assets 721,161 321,825 Noncurrent deferred tax liabilities: Depreciation (1,176,467) (1,033,235) Deferred rent 360,671 201,532 ------------------------------------ Total noncurrent deferred tax liabilities (815,796) (831,703) ------------------------------------ Net deferred tax (liability) asset $ (94,635) $ (509,878) ====================================
F-13 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 6. INCOME TAXES (CONTINUED) Reconciliation of provision for taxes to statutory tax rate for the years ended:
JANUARY 29, JANUARY 30, JANUARY 31, 2000 1999 1998 --------------------------------------------------- Statutory federal rate 35.0% 34.0% 34.0% Permanent differences (1.3) (2.9) (3.9) State and local taxes, net of federal benefit 2.8 3.3 4.4 Change in valuation allowance and other items (0.5) 1.5 2.0 --------------------------------------------------- Effective income tax rate 36.1% 35.9% 36.5% ===================================================
7. 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 (provided that such service represents 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 20% 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 EX-23.1 2 CONSENT OF ERNST & YOUNG LLP Exhibit 23.1 Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-13875), pertaining to the Non-Plan Options, the 1996 Equity Incentive Plan, as amended, and the Non-Employee Directors' Stock Option Plan, as amended, of our report dated March 10, 2000 with respect to the consolidated financials statements of Hot Topic, Inc. included in the Annual Report on Form 10-K for the fiscal year ended January 29, 2000 filed with the Securities and Exchange Commission. /s/ Ernst & Young LLP Los Angeles, California April 24, 2000 EX-27 3 FINANCIAL DATA SCHEDULE
5 1 US DOLLARS YEAR JAN-29-2000 JAN-31-1999 JAN-29-2000 1 39,549,654 0 0 0 15,366,745 57,217,993 46,815,346 15,093,868 89,022,457 19,654,654 0 0 0 40,667,571 26,609,960 89,022,457 168,948,553 168,948,553 103,998,031 103,998,031 44,748,988 0 32,086 21,134,274 7,633,600 13,500,674 0 0 0 13,500,674 1.46 1.38
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