-----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, G29Wo2BRxQCAOrCiZtIIGHDoZLeEdxjgXfsUpvkYTzqjBhWjwJiGkubG1+8uyw1w jI1UUvVVVEm9DRr7E9gNQQ== 0001019687-01-500102.txt : 20010503 0001019687-01-500102.hdr.sgml : 20010503 ACCESSION NUMBER: 0001019687-01-500102 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20010203 FILED AS OF DATE: 20010502 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HOT TOPIC INC /CA/ CENTRAL INDEX KEY: 0001017712 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-APPAREL & ACCESSORY STORES [5600] 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: 1619959 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 hottopic_10k-020301.txt 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 FEBRUARY 3, 2001 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 20,495,590 as of April 20, 2001. The aggregate market value of Common Stock held by non-affiliates of the registrant as of April 20, 2001 was approximately $622,088,000, based on the closing price on that date of Common Stock on the Nasdaq National Stock Market.* DOCUMENTS INCORPORATED BY REFERENCE Certain portions of the registrant's Definitive Proxy Statement for the Annual Meeting of Shareholders to be held on June 7, 2001, to be filed with the Securities and Exchange Commission (the "SEC") no later than 120 days after February 3, 2001, are incorporated by reference into Part III of this Form 10-K (Items 10 through 13). - ------------ *Excludes 544,089 shares of Common Stock held by directors and officers and shareholders whose beneficial ownership exceeds 10% of the shares outstanding on April 20, 2001. Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the Registrant, or that such person is controlled by or under common control with the Registrant. THE STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K THAT ARE NOT HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"), INCLUDING STATEMENTS REGARDING THE COMPANY'S EXPECTATIONS, BELIEFS, INTENTIONS OR STRATEGIES REGARDING THE FUTURE. FORWARD-LOOKING STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS REGARDING THE EXTENT AND TIMING OF FUTURE REVENUES AND EXPENSES AND CUSTOMER DEMAND, STATEMENTS REGARDING EXPECTED FINANCIAL RESULTS, THE PROFITABILITY OF FUTURE SALES OF THE COMPANY'S PRODUCTS, NEW STORE OPENINGS AND NEW STORE CONCEPTS. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ARE BASED ON INFORMATION AVAILABLE TO US AS OF THE DATE HEREOF AND WE ASSUME NO OBLIGATION TO UPDATE ANY FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS INVOLVE KNOWN OR UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH MAY CAUSE OUR ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS, OR INDUSTRY RESULTS TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE BUT ARE NOT LIMITED TO: RELATIONSHIPS WITH MALL DEVELOPERS AND OPERATORS, THE AVAILABILITY OF CASH AND/OR MALL SPACE FOR PLANNED EXPANSION, FLUCTUATIONS IN SALES AND STORE SALE RESULTS, UNCERTAINTIES RELATED TO NEW STORE OPENINGS, NEW STORE CONCEPTS, MUSIC AND FASHION TRENDS, COMPETITION FROM OTHER RETAILERS, SUCCESS OF JOINT VENTURES AND RELATIONSHIPS WITH AND RELIANCE UPON THIRD PARTIES, UNCERTAINTIES GENERALLY ASSOCIATED WITH SPECIALTY RETAILING, AND THE OTHER FACTORS REFERRED TO HEREIN INCLUDING, BUT NOT LIMITED TO, THE ITEMS DISCUSSED IN PART I, ITEM 1 UNDER THE CAPTION "CERTAIN RISK FACTORS RELATED TO THE COMPANY'S BUSINESS" AND IN PART II, ITEM 7 UNDER THE CAPTION "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS." PART I ITEM 1. BUSINESS GENERAL Hot Topic, Inc. ("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 and television programs. The Company opened its first store in 1989, and operated 274 stores as of February 3, 2001 in 45 states across the United States. The Company opened 26, 40, 50, 54 and 62 additional stores during fiscal 1996, 1997, 1998, 1999 and 2000 respectively. The Company also occasionally relocates or expands smaller existing stores. During fiscal 2000 the Company expanded or relocated four stores, three of which were near the end of the lease term. The Company plans to open approximately 65 new Hot Topic stores in the fiscal year ending February 2, 2002 ("fiscal 2001"), 18 of which were open as of April 20, 2001. In addition, the Company plans to test a second retail concept in fiscal 2001 with the trade name Torrid(TM). Torrid will offer a selection of apparel, lingerie, shoes and accessories centered around various lifestyles for plus-size women between the ages of 15 and 30. The Company plans to open six of the Torrid stores in fiscal 2001, one of which was opened on April 18, 2001. The Company also maintains a website, www.hottopic.com, through which it markets its Hot Topic stores, store concept and sells certain of its merchandise. The Company's net sales via the Internet continued to increase in fiscal 2000 to almost two percent of total sales. In addition, on April 18, 2001 the Company also launched a website related to its test concept Torrid at www.torrid.com. 2. 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 music network, which enables fans not only to listen to the latest music and artists 24 hours a day, but also to experience a full sight and sound package of appearance and attitude. According to industry estimates, in 1999 MTV music network programming could be seen in more than 74 million households in the United States and in over 340 million households worldwide. As a result, popular artists and fashions 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, 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. 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 1999 and is expected to grow to approximately 40 million by 2008, representing a projected growth rate close to twice the rate of the overall population. By 2010, there will be likely 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 $153 billion in 1999. 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 10,000 Stock Keeping Units ("SKUs") in approximately 20 different product categories. The Company believes its selection of music-licensed merchandise is the most extensive assortment available in a single mall store. The Company complements its licensed merchandise with a unique and eclectic assortment of music-influenced 3. 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 enables 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 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 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. The Company has always focused on the lifestyle and values of the youth generation. Hot Topic stores are designed with an industrial theme that incorporates dense merchandising and utilizes a professional sound system playing alternative music releases to create a fun, high-energy store that teens will consider "their place" to shop with friends. The Company believes that this atmosphere enhances the Company's image as a source for music-inspired fashion while encouraging customers to shop in its stores for longer periods of time. Late in fiscal 2000, the Company tested a new store design in two locations in California. Continuing to focus on the world of music and musicians as inspiration, the objective of the new design is to provide a more kinetic and industrial-club feel, while portraying a less gothic appearance than the Company's previous store design. This new look was inspired by the markets, clubs and old warehouse districts in London where the Company's designers toured and created this new "industrial club" theme. The majority of the 65 new Hot Topic stores opening in fiscal 2001 will be built in this new design. 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 4. 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), Morbid Metals (body jewelry), and Hot Topic label shoes. 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. The Company's Torrid stores also have a line of private label under the trade name Torrid(TM). o TEST NEW RETAIL CONCEPT CALLED TORRID The Company is starting a second retail concept in fiscal 2001 with the trade name Torrid(TM). Torrid will offer a selection of apparel, lingerie, shoes and accessories centered around various lifestyles for plus-size women between the ages of 15 and 30. The selection will include clubwear, streetwear, rockabilly and renaissance, the majority of which will be exclusive to the store. The Company plans to open six of the Torrid stores in fiscal 2001, one of which was opened on April 18, 2001. In addition, in fiscal 2001, a selected assortment of Torrid products will be available for purchase on-line at www.torrid.com. STORE LOCATIONS As of February 3, 2001, the Company operated 274 stores in both metropolitan and middle markets in 45 states across the United States. The following chart sets forth, as of April 20, 2001, the number of stores that Hot Topic operates in each state and the cities in which those stores are located.1 5.
HOT TOPIC, INC. STORES BY STATE AS OF APRIL 20, 2001 ARIZONA - 3 CONNECTICUT - 6 INDIANA - 6 MISSOURI - 4 NORTH DAKOTA - 1 TEXAS - 22 Phoenix Danbury Evansville Columbia Grand Forks Austin (2) Tucson (2) Manchester Fort Wayne St .Louis (2) Beaumont Milford Lafayette St. Peters OHIO - 7 Brownsville CALIFORNIA - 46 Trumbull Mishawaka Cincinnati College Station Arcadia Waterbury Muncie MONTANA - 1 Dayton Corpus Christi Bakersfield Waterford Terre Haute Billings Elyria Dallas Berkeley Mentor El Paso* Brea (2) * DELAWARE - 1 KANSAS - 4 NEBRASKA - 2 North Olmstead Fort Worth Capitola Wilmington Olathe Lincoln Niles Frisco Carlsbad Topeka Omaha Parma Houston* Cerritos FLORIDA - 13 Wichita (2) Humble Chula Vista* Altamonte Springs NEVADA - 5 OKLAHOMA - 3 Irving Citrus Heights Boynton Beach KENTUCKY - 3 Henderson Norman Katy Concord Coral Springs Bowling Green Las Vegas (2) Oklahoma City (2) Laredo Cupertino Jacksonville (2) Louisville Reno (2) Lewisville Daly City Miami (2)* Paducah OREGON - 2 Lubbock El Cajon Ocoee NEW HAMPSHIRE - 4 Portland (2) Mesquite Escondido Orange Park* LOUISIANA - 3 Concord Plano Fairfield Orlando Baton Rouge Manchester PENNSYLVANIA - 18 San Antonio (2) Fresno St. Petersburg Metarie Nashua Altoona Woodlands Glendale Tallahassee Monroe Salem Bensalem Irvine* Tampa Camp Hill UTAH - 3 Laguna Hills MAINE - 1 NEW JERSEY - 10 Erie Orem Lakewood GEORGIA - 5 Bangor Deptford Exton Salt Lake City Milpitas Buford Eatontown Greensburg Sandy Modesto Douglasville MARYLAND - 7 Elizabeth Harrisburg Montclair Duluth Baltimore (2) Freehold King of Prussia VERMONT - 1 Montebello Kennesaw Columbia Mays Landing Lancaster Burlington National City Macon Frederick Paramus Langhorne Northridge Glen Burnie* Rockaway Media VIRGINIA - 3 Ontario HAWAII - 3 Hagerstown Toms River North Wales Dulles Palm Desert Alea Towson Wayne Scranton Newport News Palmdale Honolulu Woodbridge State College Springfield Pleasanton Kahului MASSACHUSETTS - 6 W. Mifflin Riverside Holyoke NEW MEXICO - 2 Wilkes-Barre WASHINGTON - 13 Sacramento IDAHO - 1 Marlborough Albuquerque (2) Williamsport Bellingham San Diego (2)* Boise Natick York Burlington* San Jose (2)* North Attleboro NEW YORK - 16 Everett San Leandro IOWA - 4 Saugus Albany RHODE ISLAND - 1 Kennewick Santa Ana Cedar Rapids Taunton Bay Shore Providence Lynnwood Santa Monica Coralville Buffalo Olympia Santa Rosa Des Moines MICHIGAN - 9 Clay SOUTH CAROLINA - 3 Puyallup Thousand Oaks Sioux City Ann Arbor Johnson City Columbia* Seattle Universal City Auburn Hills Lake Grove Greenville Silverdale Valencia ILLINOIS - 10 Flint Massapequa North Charleston Spokane (2) Ventura Aurora Grandville Middletown Tacoma West Covina Bloomingdale Lansing New Hartford SOUTH DAKOTA - 2 Tukwila Carbondale* Port Huron* Poughkeepsie Rapid City COLORADO - 8 Champaign Portage Rochester Sioux Falls WEST VIRGINIA - 2 Broomfield Chicago Ridge Traverse City Staten Island Barboursville* Colorado Springs (2) Joliet Troy Syracuse TENNESSEE - 6 Charleston Denver Orland Park Victor Antioch Fort Collins Rockford MINNESOTA - 7 West Nyack Clarksville WISCONSIN - 7 Littleton (2) Schaumburg* Bloomington White Plains Franklin Appleton Westminister West Dundee Burnsville Goodlettsville Brookfield Duluth NORTH CAROLINA - 7 Memphis Eau Claire Mankato Cary Nashville Greendale Minnetonka Concord Madison (2) St. Cloud Fayetteville Wausau* St. Paul Hickory Pineville Wilmington* Winston
1. An asterisk next to the city indicates that a store has been opened in such city during fiscal 2001. As of April 20, 2001, the Company had opened 17 new Hot Topic stores and one new Torrid store in fiscal 2001. The Company closed one Hot Topic store at the end of its lease term during fiscal 2001 (Victorville, California), with plans to reopen the store in February 2002. 6. EXPANSION STRATEGY The following table provides a history of the Company's store expansion over the last five fiscal years: FISCAL YEAR --------------------------------------------------- 1996 1997 1998 1999 2000 --------------------------------------------------- (Number of stores) Stores at beginning of year 42 68 108 158 212 New stores opened 26 40 50 54 62 --------------------------------------------------- Stores at end of year 68 108 158 212 274 --------------------------------------------------- All but two of the Company's stores are located in shopping malls. The two non-mall stores are located in "street locations", one each in Denver, Colorado and in Berkeley, California. The Company's expansion strategy is to open stores in shopping malls and entertainment centers in both new and existing markets throughout the United States. The Company believes it has developed a store concept that is successful in both metropolitan and middle markets. Further, as a result of the nationwide influence of MTV, music distribution, movies, television programs, the Company believes that its 12 to 22 year-old target customers have similar fashion preferences throughout the United States. The Company opened 62 new stores in fiscal 2000 and expanded or relocated four existing stores. During fiscal 2001, the Company plans to open approximately 65 new Hot Topic stores and six new Torrid stores, in addition to expanding or relocating seven existing smaller Hot Topic stores. The Company selects and evaluates potential store locations based on a variety of criteria including the sales and square footage of the mall, sales of anchor stores, sales of teenage-oriented stores, foot traffic, number of teenagers in the trade area, median family income and other factors relevant to the Company's unique merchandising strategy. 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, consisting of its Chief Executive Officer and Chief Operating Officer. The Company generally seeks potential store sites between 1,200 and 2,400 square feet. The average size of the Company's fiscal 2000 openings was 1,758 square feet. The Company's stores currently average approximately 1,559 square feet. STORE-LEVEL ECONOMICS During fiscal 2000, the Company achieved average store net sales of approximately $1,020,000 and average store net sales per square foot of approximately $669. Store-level operating cash flow (defined as store operating income before depreciation and excluding changes in working capital) for stores open the entire year in fiscal 2000 were approximately $319,000, or 31% of average net sales. Capital expenditures, including leasehold improvements, furniture and fixtures and net of landlord construction allowances for the 62 stores opened in fiscal 2000 averaged approximately $179,000, initial gross inventory requirements (which were partially financed by trade credit) averaged $101,000, and pre-opening costs (which were expensed when incurred) averaged $21,000. Inventory requirements vary at new stores depending on the season and on current merchandise trends. In fiscal 2000, 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. 7. 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. Approximately half of the Company's products are music-licensed products, and the other half are music-influenced products. A key strategy of the Company is to offer over 10,000 SKUs in 20 different product categories or "departments." On average, over 100 different licensed band t-shirts are carried in each store from current artists such as Korn, Blink 182, Limp Bizkit, Deftones, Linkin Park, and Slip Knot as well as rock and classic rock artists such as Pink Floyd, Nirvana, Pantera, Metallica, Jimi Hendrix, The Doors, Beatles and Led Zeppelin. New items and categories are regularly tested as customer demand and product trends evolve. The Company 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 2000, 1999 and 1998: PERCENTAGE OF NET SALES --------------------------------------- 2000 1999 1998 --------------------------------------- Apparel, T-Shirts and Outerwear 51% 50% 50% Gifts 15 16 19 Accessories 27 27 26 Intimate Apparel and Shoes 7 7 5 --------------------------------------- 100% 100% 100% The Company has five lines of private label merchandise to complement and supplement current product offerings. The Company believes that Hot Topic brands play an important part in differentiating its stores from those of its competitors and provide the Company with higher margin opportunities as compared to other merchandise. Management estimates that in both fiscal 2000 and fiscal 1999 Hot Topic brands accounted for approximately 25% of the Company's sales. The Company's proprietary brands include Morbid Makeup (cosmetics), Morbid Metals (body jewelry), Morbid Threads (men's and women's apparel and hosiery) and MT:2 (men's and women's apparel). Shoes are also sold under the Hot Topic label. PURCHASING The Company's purchasing staff consists of a Vice President, General Merchandise Manager, two Divisional Merchandise Managers, nine Buyers and ten 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 solicits input from its store employees, in order to draw from many different experiences and perspectives. 8. 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 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 2000, the Company had approximately 800 vendors, certain of which have limited financial resources and production capabilities. No single vendor accounted for more than 5% of the Company's merchandise purchases. The Company believes that its relationships with its vendors are good. 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. 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. Prior to the implementation of the Arthur Allocation system, the Company used proprietary software developed by Hot Topic to allocate merchandise to each store. The Company's Vice President of Planning and Allocation along with two directors of Planning and Allocation and 16 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, are 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. 9. In March 2001, the Company entered into a lease for additional space for future expansion of its headquarters and distribution facility in the City of Industry, California. The additional 125,000 square feet is in the same building as is its current headquarters and distribution center. The original lease terms of the Company's headquarters and distribution facility granted the Company the right of first refusal on the remaining 125,000 square feet of space in the building at 90% of the fair market lease rates for such space. In February 2001, the Company was notified that the space would become available in 2001 and was provided with comparable market lease rates. The Company considered the terms and timing of leasing the additional space against other possible alternatives and determined that it was in the Company's best interest to lease the additional space under the negotiated terms. The Company may sublease part of the additional space during part of fiscal 2001 but believes it will begin utilizing all of the space in fiscal 2002. The Company also believes that leasing the adjacent space is more efficient and cost effective than its alternatives for expansion such as moving the entire facility or acquiring additional separate space. The Company estimates that the operating capacity gained from this additional space will allow for growth to up to 750 stores. STORE OPERATIONS Hot Topic's store operations are currently managed by six regional managers and 46 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 frequenting clubs, and are encouraged to communicate customer requests and their own merchandise ideas to the buyers and management. Hot Topic encourages its sales associates to dress and accessorize themselves with the same fashionable merchandise that is sold in its stores. 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. 10. 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, a significant number of its store managers have been promoted from within the Company. STORE ENVIRONMENT Hot Topic stores are designed with an industrial theme that incorporates dense merchandising. The latest music releases are played on a professional sound system to create a high-energy and fun shopping environment. The Company has always focused on the lifestyle and values of the youth generation. 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. Late in fiscal 2000, the Company tested a new store design in two locations in California. Continuing a focus on the world of music and musicians as inspiration, the objective of the new design is to provide a more kinetic and "industrial club" feel, while portraying a less gothic appearance than the Company's previous store design. This new look was inspired by the markets, clubs and old warehouse districts in London where the Company's designers toured and created this new "industrial club" theme. The majority of the 65 new Hot Topic stores to open in fiscal 2001 will be built with this new design. 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 within areas of high teenage population and relies on existing customers, sales associates, store design and exciting music to attract new customers to its stores. During fiscal 2000 the Company sponsored a major touring rock festival called "Ozzfest." As a co-sponsor and major participant, the Company's name was associated with all promotional activities at each venue. The Company appreciated the opportunity to sponsor a national music tour, which reached many of its target customers. The Company is planning to enter into a similar sponsorship at Ozzfest in fiscal 2001. As a part of the Company's marketing strategy, the Company maintains a website, www.hottopic.com., through which it markets its stores and merchandise. During fiscal 1999, the site was re-launched with a focus on e-commerce. The site also includes posting boards, customer surveys, a gift registry and content features including artist news and tour schedules. The Company's net sales via the Internet continued to increase in fiscal 2000 comprising almost two percent of the Company's total sales. In addition, in fiscal 2001, a selected assortment of Torrid products will be available for purchase on-line at www.torrid.com. 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, 11. accounts payable and integrated financials. These systems operate on software licensed from GERS Retail Systems ("GERS") running on an Oracle database platform. Sales are updated daily in the merchandising reporting systems by polling sales information from each store's point-of-sale ("POS") terminals. The Company's POS system consists of registers providing price look-up, time and attendance, e-mail and credit card 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 system. 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 the new GERS hardware and software for its stores, office and distribution center. The Company implemented the host hardware and software systems at its office and distribution center during the second half of fiscal 2000 and plans to install certain POS upgrades at its stores in fiscal 2001. The Company estimates the hardware, software, modifications, training and implementation will cost approximately $5 to $6 million. Of that total amount, approximately $.5 million was spent in fiscal 1999, $2.1 million was spent in fiscal 2000 and approximately $2.5 to $3.0 million will be spent to implement the point of sale upgrades to existing stores in fiscal 2001. TRADEMARKS The Company has registered on the Principal Register of the United States Patent and Trademark Office its retail store service mark Hot Topic(R) and various trademarks for merchandise including Hot Topic(R), Morbid Make-Up(R), Morbid Scents(R), Morbid Metals(R), Morbid Adornments(R), Tragedy(R), Misery(R), MT: 2(R) and Morbid Threads(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), Torrid(TM), Torrid & Design(TM) and Torrid Flaming Heart Design(TM) in the United States. The Company is not aware of any claims of infringement or other challenges to the Company's right to use its marks in the United States. The Company also has additional registrations and pending applications in foreign jurisdictions. All other trademarks, tradenames and servicemarks referenced herein are the property of their respective owners. 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, 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, Claire's Stores, Inc., Charlotte Russe, Delias Inc., d.e.m.o., Gadzooks, Inc., Millers Outpost, Inc., Pacific Sunwear of California, Inc., Spencer Gifts, Inc., Urban Outfitters, Inc., The Wet Seal, Inc., and, to a lesser extent, with music stores. 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 1,009 full-time and 2,367 part-time employees as of April 20, 2001. Of the Company's 3,376 employees, 298 were corporate headquarters and distribution center personnel and 3,078 were store 12. employees. The number of part-time employees fluctuates with seasonal needs. None of the Company's employees are covered by collective bargaining agreements. 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 20, 2001 are as follows: NAME AGE POSITION - ------------------------- --- ----------------------------------------------- Elizabeth M. McLaughlin 40 Chief Executive Officer, President and Director Jerry Cook 48 Chief Operating Officer Jim McGinty 38 Chief Financial Officer Jay A. Johnson 55 Senior Vice President of Strategic Analysis and Investor Relations Cindy Levitt 40 Vice President, General Merchandise Manager Marc R. Bertone 44 Vice President, Real Estate and Construction Alain Krakirian 35 Vice President, Planning and Allocation Darrell Kinsley 38 Vice President, Store Operations Patricia A. Bodner 38 Vice President, hottopic.com Sue McPherson 33 Vice President, Distribution Center Karen Talley 43 Divisional Vice President and Divisional Merchandise Manager ELIZABETH M. MCLAUGHLIN has served as Chief Executive Officer of the Company since August 2000 and President since February 2000, and has served on the Board since May 2000. From June 1996 through February 2000, Ms. McLaughlin served as Senior Vice President and General Merchandise Manager of the Company. From May 1993 through May 1996, Ms. McLaughlin was the Company's Vice President, Operations. Prior to joining the Company, Ms. McLaughlin held various positions with Millers Outpost, a privately-held teen retailer, where she served as Divisional Merchandise Manager, Director of Store Operations, and Director of Financial Planning and Budgeting. Prior to joining Millers Outpost, Ms. McLaughlin held various financial analyst and store positions with The Broadway. Ms. McLaughlin holds a B.A. degree in Economics from the University of California at Irvine. JERRY COOK has been Chief Operating Officer since February 2001. Mr. Cook has 25 years of experience in retail. From February 1999 until joining the Company, he was the President and Chief Operating Officer of Travel 2000, Inc. >From 1995 to April 1998, Mr. Cook was Senior Vice President, Operations for The Bombay Company, Inc. and from 1989 to 1995, Mr. Cook was the Vice President, Stores and the Vice President, General Merchandising Manager of Woman's World Stores. Prior to 1989, he held management positions with Barnes & Noble/B Dalton, The Gap Stores and the Limited, Inc. 13. JIM MCGINTY joined Hot Topic in August 2000 as its Vice President, Finance and was promoted to Chief Financial Officer in February 2001. >From July 1996 to July 2000, Mr. McGinty was Vice President-Controller at Victoria's Secret Stores, the leading brand and largest specialty retailer in the Limited, Inc. From 1984 to 1996, he held various financial and accounting positions within the Structure and Express divisions of the Limited, Inc. Mr. McGinty holds a B.S. degree in accounting from Miami University in Oxford, Ohio. JAY A. JOHNSON has served as the Senior Vice President, Strategic Analysis and Investor Relations since February 2001. He also is the Company's Assistant Secretary. From May 1995 to February 2001, he was the Chief Financial Officer and Assistant Secretary of the Company. From January 1993 to May 1995, he was Vice President/Chief Financial Officer of Frame-n-Lens Optical, Inc., a national optical retailer 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. CINDY LEVITT has been Vice President, General Merchandise Manager since February 2000. Since 1989, Ms. Levitt has held senior buying positions at Hot Topic. From June 1996 to February 2000, she served as the Divisional Merchandise Manager, Apparel and Music. MARC R. BERTONE has served as Vice President, Real Estate and Construction, since August 1994. Mr. Bertone has 16 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 and is currently an inactive member. 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. Mr. Krakirian holds a B.S. degree in finance from the University of LaVerne and an M.B.A. degree from Pepperdine University. 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. From February 1997 through June 1998, he was Regional Director for the eastern United States. Mr. Kinsley joined the Company in February 1995 as the District Manager for the eastern United States. PATRICIA A. BODNER has been Vice President, hottopic.com since June 2000. Previously, Ms. Bodner was Chief Marketing Officer at allpets.com from August 1999 through June 2000. Prior to allpets.com, Ms. Bodner held marketing positions at Digital Lava Inc., a communications application services provider for streaming media technology from May 1997 through July 1999. Between September 1995 and January 1997, Ms. Bodner worked at Inscape, a multimedia developer and publisher of CD-ROM games where she held various marketing positions. Between June 1986 and September 1995, Ms. Bodner held various marketing positions at companies including Bertelsmann Music Group, New Line Cinema, and Warner Bros. Ms. Bodner holds a B.A. degree in French Studies from the University of Wisconsin-Madison. SUE MCPHERSON was promoted to Vice President, Distribution Center, in February 2001 and was the Divisional Vice President, Distribution Center from February 2000 to February 2001. Ms. McPherson joined the Company in 1989 as a store employee in its first store while attending the University of Southern California. From March 1995 to February 2000, she was the Director of the Distribution Center. Ms. McPherson holds a B.S. degree in Business from the University of Southern California. 14. KAREN TALLEY has served as Divisional Vice President and Divisional Merchandise Manager, Accessories since February 2000. Ms. Talley joined the Company in 1993 as the Senior Accessory Buyer. She was the Company's Divisional Merchandise Manager of Accessories from April 1996 to February 2000. Prior to joining Hot Topic, Ms. Talley held buying positions at Jay Jacobs and Nordstrom. 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. Sixty-two of the Company's 274 stores opened as of February 3, 2001 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 71 stores, including six Torrid stores, during fiscal 2001, 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 2000, the Company entered three 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 and among others, the Company's ability to identify and enter new markets, locate suitable store sites, negotiate acceptable lease terms, hire and train store managers and sales associates and obtain adequate capital resources on acceptable terms. Early in its history, the Company encountered difficulties in leasing certain store sites. The Company believes these difficulties were in part due to the Company's level of capitalization, its limited operating history at such time, its then unproven store concept, and apprehension on the part of mall operators concerning the Company's teenage customers. In fiscal 1999, a major mall developer asserted that the Company had violated a "use clause" applicable to certain or all of the Company's leases with that developer. As a result, the developer ceased ongoing discussions relating to potential new Hot Topic stores and told the Company that no new leases would be entered into. Upon notice of the alleged violation, the Company adjusted its merchandise mix in stores leased from that developer (and to a somewhat lesser extent, in all other stores) and took certain other actions to ensure ongoing "use clause" compliance. These actions and continuing discussions with the developer resulted in an amended "use clause" for all leases with the developer. In early 2000, the Company satisfied the concerns of 15. 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 that opened 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 certain revenue levels and other targets, and may suffer a decline in stock price. Any restrictions on the Company's ability to expand to new store sites or to offer a broad assortment of merchandise could have a material adverse effect on the Company's business, results of operations and financial condition. FLUCTUATIONS IN COMPARABLE STORE SALES RESULTS A variety of factors affect the Company's comparable store sales including, among others, the timing of releases of new music-related products, music and fashion trends, the general retail sales environment, the Company's ability to efficiently source and distribute products, changes in the Company's merchandise mix and the Company's ability to execute its business strategy efficiently. The Company's comparable store sales results have fluctuated significantly in the past and the Company believes that such fluctuations may continue. The Company's comparable store sales results for fiscal 1996, 1997, 1998, 1999 and 2000 were 8.9%, 2.2%, 0.4%, 22.8% and 16.7% respectively. The Company's comparable store sales results were 24.1%, 21.8%, 15.3% and 11.2% for the first, second, third and fourth quarters, respectively, of fiscal 2000 and 15.3%, 16.9%, 26.1% and 27.1% for the first, second, third and fourth quarters of fiscal 1999. Past comparable store sales results are not an indicator of future results, and there can be no assurance that the Company's comparable store sales results will not decrease in the future. The Company's comparable store sales results could cause the price of the Common Stock to fluctuate substantially. DEPENDENCE ON AND CHANGES IN MUSIC AND FASHION TRENDS The Company's profitability is largely dependent upon (i) the continued popularity of alternative and rock music, music videos, and MTV among teenagers and college age adults, (ii) the emergence of new artists and the success of music releases and music-related products, (iii) the continuance of a significant level of teenage spending on music-licensed and music-influenced products, and (iv) the Company's ability to anticipate and keep pace with the music, fashion and merchandise preferences of its customers. The popularity of particular types of music, artists, styles and brands is subject to change. The Company's failure to anticipate, identify and react appropriately to changing trends, could lead to, among other things, excess inventories and higher markdowns, and poor customer acceptance of its new store design, which could have a material adverse effect on the Company's business results of operations and financial condition, and on its image with its customers. There can be no assurance that the Company's new products and new store design will be met with the same level of acceptance as in the past or that the failure of the new products and/or new store design will not have an adverse material effect on the Company business, results of operations and financial condition. IMPACT OF ECONOMIC CONDITIONS; MINIMUM WAGE RATES Certain economic conditions affect the level of consumer spending on merchandise offered by the Company, including, among others, business conditions, interest rates, taxation and consumer confidence in future economic conditions. The Company is also dependent upon the continued popularity of malls as a shopping destination and the ability of mall anchor tenants and other attractions to generate customer traffic for its stores. A decrease in mall traffic would adversely affect the Company's growth, 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, deterioration in economic conditions in that region could particularly affect the Company's business, results of operations and financial condition. 16. 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 increases took effect on January 1, 2001 in California, Connecticut, Massachusetts and Washington. The Company operated a total of 70 stores in those states as of April 20, 2001. Statutory increases in Federal and state minimum wages could adversely affect the Company's profitability. The recent state increases in minimum wage and any other such increases will raise minimum wages above current wage rates of certain of the Company's 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, back-to-school and Halloween seasons, 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) and the Halloween holiday. 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 first fiscal quarter net sales. 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, 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. Its largest vendor, Changes Manufacturing, supplied just under 5% of the Company's merchandise purchases in fiscal 2000. Substantially all of the Company's music-licensed products are available only from vendors that have exclusive license rights. In addition, many of the Company's music-influenced products are supplied by small, specialized vendors that create unique products primarily for the Company. The Company's smaller vendors generally have limited resources, production capacities and operating histories, and some of the Company's vendors have limited the distribution of their merchandise in the past. The Company has no long-term purchase contracts or other contractual assurances of continued supply, pricing or access to new products. There can be no assurance that the Company will be able to acquire desired merchandise in sufficient quantities on terms acceptable to the Company in the future or that any inability to acquire suitable merchandise, or the loss of one or more key vendors, will not have a material adverse effect on the Company's business, results of operations and financial condition. 17. NEW TORRID STORES AND ASSOCIATED RISKS The Company's ability to expand into new concepts has not been tested. Accordingly, the operation of its Torrid stores and the sale of Torrid merchandise on line at www.torrid.com, are subject to numerous risks, including unanticipated operating problems, lack of experience, lack of customer acceptance, new vendor relationships and competition from existing and new retailers. For example, it may be that the Company will not be able to generate sufficient customer interest in Torrid stores and Torrid products, or that this concept may not be able to support the store format. There can be no assurance that the Company's Torrid stores or Torrid website will achieve sales and profitability levels that justify the Company's investment in this new retail format. Establishing and increasing the number of Torrid stores also involve other risks that could have a material adverse effect on the Company, including (i) the risk of diversion of management's attention from the Company's core business and products, (ii) difficulties with the hiring, retention and training of management and personnel for the Torrid stores, (iii) risks associated with new vendors and (iv) difficulties with locating and obtaining favorable store sites and acceptable lease terms. Risks inherent in any new concept are particularly acute in the Company's case with respect to Torrid, because this is the first significant new venture by the Company. The Company has traditionally concentrated its expansion efforts on increasing the number of and sales in Hot Topic stores. UNCERTAINTIES REGARDING IMPLEMENTATION OF NEW MANAGEMENT INFORMATION SYSTEM During fiscal 1999, after completing an evaluation of its long-term management information system needs, the Company selected new hardware and software for its stores, office and distribution center. The Company implemented the host hardware and software systems at its office and distribution center during the second half of fiscal 2000 and plans to install certain point-of-sale upgrades at its stores in fiscal 2001. If the new information systems and software do not work effectively, the Company may experience delays or failures in its operations. These delays or failures could adversely impact the promptness and accuracy of the Company's transaction processing, financial accounting and reporting and ability to properly forecast earnings and cash requirements. The Company's current and planned systems, transaction processing, procedures and controls may not be adequate to support future operations. To manage growth of its operations and personnel, the Company may need to continue to improve its operational and financial systems, transaction processing, procedures and controls. DEPENDENCE ON KEY PERSONNEL The Company's performance depends largely on the efforts and abilities of senior management, especially Elizabeth McLaughlin, the Company's Chief Executive Officer and President, who has been with the Company since 1993. Due to the retirement of the Company's founder, Orval Madden, and his resignation from the Board in April 2001, the Company remains reliant on Elizabeth McLaughlin and her senior management team. The Company has a $2,000,000, key-person life insurance policy on Ms. McLaughlin. However, the sudden loss of Ms. McLaughlin's services or the services of other members of the management team could have a material adverse effect on the Company's business, results of operations and financial condition. Furthermore, there can be no assurance that Ms. McLaughlin and the Company's existing management team will be able to manage the Company or its growth or that the Company will be able to attract and retain additional qualified personnel as needed in the future. UNCERTAINTIES REGARDING DISTRIBUTION OF MERCHANDISE The Company relies upon the United Parcel Service for its product shipments, including shipments to and from all of its stores, and, accordingly, is subject to the risks, including employee strikes and inclement weather, associated with United Parcel Service's ability to provide delivery services to meet the Company's shipping needs. The Company is also dependent upon temporary employees to adequately staff its distribution facility, particularly during busy periods, such as during the Christmas season and while multiple stores are 18. 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, Charlotte Russe, Claire's Stores, Inc., Delias Inc., d.e.m.o., Gadzooks, Inc., Millers Outpost, Inc., Pacific Sunwear of California, Inc., Spencer Gifts, Inc., Urban Outfitters, Inc., The Wet Seal, Inc., and, to a lesser extent, with music stores and mail order catalogs and websites. Many of the Company's competitors are larger and have substantially greater financial, marketing and other resources than the Company. Direct competition with these and other retailers may increase significantly in the future, which could require the Company, among other things, to lower its prices and/or take other measures. Increased competition could have a material adverse effect on the Company's business, results of operations and financial condition. PRICE VOLATILITY The Company's Common Stock is quoted on the Nasdaq National Market, which has experienced and is likely to experience in the future significant price and volume fluctuations, which could adversely affect the market price of the Common Stock without regard to the operating performance of the Company. In addition, the Company believes that factors such as quarterly fluctuations in the financial results of the Company, fluctuations in the Company's comparable store sales, announcements by other apparel, accessory and gift item retailers, the trading volume of the Company's Common Stock in the public market, the condition of the overall economy and the condition of the financial markets could cause the price of the Common Stock to fluctuate substantially. ANTI-TAKEOVER MATTERS The Company's Amended and Restated Articles of Incorporation and Amended and Restated Bylaws contain provisions that may have the effect of delaying, deterring or preventing a takeover of the Company that shareholders may consider being in their best interests. For instance, the Company's Amended and Restated Articles of Incorporation and Amended and Restated Bylaws prohibit shareholder action by written consent and include certain "fair price provisions." Additionally, the Board of Directors has the authority to issue up to 10,000,000 shares of "blank check" preferred stock having such rights, preferences and privileges as designated by the Board of Directors without shareholder approval. 19. ITEM 2. PROPERTIES The Company leases all of the Company's existing store locations, with lease terms expiring between 2001 and 2010. The leases for most of the existing stores are for ten-year years and provide for contingent rent based upon a percent of sales in excess of specified minimums. Leases for future stores will likely include similar contingent rent provisions. 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 annual base rent for the initial five-year term is approximately $525,000. This lease will terminate on August 1, 2001. Beginning August 1, 2001, the Company will double the size of its leased office and distribution center space, and has entered into an amended lease with its existing landlord. The amended lease is for a five-year term (from the beginning of the original lease) with two options to extend the lease, each for a three-year period. The initial five-year term will expire in April 2004. The annual base rent for the initial five-year term is approximately $1,131,900 including the additional space. The original lease terms of the Company's headquarters and distribution facility granted the Company the right of first refusal on the remaining 125,000 square feet of space in the building at 90% of the fair market lease rates for such space. In February 2001, the Company was notified that the space would become available in 2001 and was provided with comparable market lease rates. The Company considered the terms and timing of leasing the additional space against other possible alternatives and determined that it was in the Company's best interest to lease the additional space under the negotiated terms. The Company may sublease part of the additional space during part of fiscal 2001 but believes it will begin utilizing all of the space in fiscal 2002. The Company also believes that leasing the adjacent space is more efficient and cost effective than its alternatives for expansion such as moving the entire facility or acquiring additional separate space. The Company believes the property covered by the amended lease will allow for growth of to up to 750 stores. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material pending legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 20. 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 27, 2000. The stock split was affected by way of a stock dividend. The dividend was distributed to shareholders of record as of December 14, 2000. This was the second two for one split for the Company, the first split having occurred in December 1999. All share and per share amounts have been restated to reflect the splits. 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. 2000 FISCAL YEAR QUARTERS HIGH LOW ------------------------------------ First Quarter $ 17 15/16 $ 7 15/16 Second Quarter $ 17 27/32 $ 11 25/64 Third Quarter $ 19 3/4 $ 13 3/4 Fourth Quarter $ 26 11/16 $ 14 9/16 1999 FISCAL YEAR QUARTERS HIGH LOW ------------------------------------ First Quarter $ 4 3/4 $ 3 3/16 Second Quarter $ 7 25/32 $ 4 1/4 Third Quarter $ 9 3/8 $ 5 61/64 Fourth Quarter $ 13 11/32 $ 8 19/32 On April 20, 2001, the last sales price of the Common Stock as reported on the NASDAQ National Market was $31.18 per share. As of April 20, 2001, there were approximately 194 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 8,000 holders. The Company has not paid any cash dividends since inception and does not anticipate paying any cash dividends in the foreseeable future. ITEM 6. SELECTED FINANCIAL DATA The following selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report on Form 10-K. 21. HOT TOPIC, INC. AND SUBSIDIARIES SELECTED FINANCIAL DATA:
FISCAL YEAR --------------------------------------------------------- 2000 1999 1998 1997 1996 --------- --------- --------- --------- --------- (In thousands, except per share data, number of stores, comparable store sales and sales per square foot) STATEMENT OF OPERATIONS DATA: Net sales $257,187 $168,949 $103,371 $ 70,532 $ 43,618 Cost of goods sold, including buying, distribution and occupancy costs 154,298 103,998 65,855 44,417 27,049 --------- --------- --------- --------- --------- Gross Margin 102,889 64,951 37,516 26,115 16,569 Selling, general and administrative expenses 67,917 44,749 29,077 19,862 12,846 --------- --------- --------- --------- --------- Operating income 34,972 20,202 8,439 6,253 3,723 Interest income, net 1,925 933 931 901 382 --------- --------- --------- --------- --------- Income before income taxes 36,897 21,135 9,370 7,154 4,105 Income taxes 13,652 7,634 3,367 2,611 1,535 --------- --------- --------- --------- --------- Net income 23,245 $ 13,501 $ 6,003 $ 4,543 $ 2,570 Net income per share: Basic $ 1.18 $ 0.73 $ 0.31 $ 0.24 $ 0.18 Diluted $ 1.09 $ 0.69 $ 0.30 $ 0.23 $ 0.16 Weighted average shares outstanding Basic 19,779 18,534 19,268 18,762 14,512 Diluted 21,379 19,594 19,824 19,760 15,596 SELECTED OPERATING DATA: Number of stores at year end 274 212 158 108 68 Comparable stores sales increase (decrease) 16.7% 22.8% 0.4% 2.2% 8.9% Average sales per square foot $ 669 $ 623 $ 542 $ 565 $ 578 Average sales per store (000s) $ 1,020 $ 909 $ 772 $ 769 $ 748 BALANCE SHEET DATA: Working capital $ 61,253 $ 37,564 $ 28,432 $ 29,230 $ 29,247 Total assets 118,646 89,022 58,764 51,953 44,033 Long-term obligations including current portion 123 231 120 161 48 Shareholders' equity $ 99,291 $ 67,278 $ 48,749 $ 44,736 $ 39,069
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 274 stores in 45 states across the United States as of February 3, 2001. The Company opened 26 stores during fiscal 1996, most of which were 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; 54 stores during fiscal 1999, both in existing markets and in 4 additional states; and; 62 stores during fiscal 2000, both in existing markets and 3 additional states. 22. The Company operates on a 52 or 53-week fiscal year, which ends on the Saturday nearest to January 31. Fiscal 2000 was a 53-week year. Fiscal 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 --------------------------------- 2000 1999 1998 --------------------------------- Net sales 100.0% 100.0% 100.0% Cost of goods sold, including buying, distribution & occupancy costs 60.0% 61.6% 63.7% Gross margin 40.0% 38.4% 36.3% Selling, general and administrative expenses 26.4% 26.4% 28.1% Operating income 13.6% 12.0% 8.2% Interest income, net 0.7% 0.6% 0.9% Income before income tax 14.3% 12.6% 9.1% Provision for income taxes 5.3% 4.6% 3.3% Net income 9.0% 8.0% 5.8% Number of stores at year end 274 212 158 Comparable store sales increase 16.7% 22.8% 0.4% 23. FISCAL 2000 COMPARED TO FISCAL 1999 Net sales increased approximately $88.3 million, or 52%, to $257.2 million in fiscal 2000 from $168.9 million in fiscal 1999. Net sales for the 62 stores opened during fiscal 2000 and for those stores not yet qualifying as comparable stores contributed $62.8 million of the net sales increase. Comparable store sales increased 16.7% in fiscal 2000 and contributed $25.5 million of the increase in net sales. The average store volume increased to $1,020,000 from $909,000 in fiscal 1999. The sales mix in fiscal 2000 saw a slight shift toward apparel and T-shirts, with this category contributing approximately 51% of net sales in 2000 as compared to approximately 50% in 1999. Gross margin increased approximately $38.0 million to $102.9 million in fiscal 2000 from $64.9 million in fiscal 1999. As a percentage of net sales, gross margin increased to 40.0% in fiscal 2000 from 38.4% in fiscal 1999. The increase, as a percentage of sales, reflected the leveraging of occupancy expense achieved from the significant increase in the average store sales volume and an increase in merchandise margin. Merchandise margin increased approximately 1.0%, as a percentage of sales compared to the prior year, principally from an average higher initial markup and lower markdowns, shrinkage and freight, all as a percentage of sales. Selling, general and administrative expenses increased approximately $23.2 million to $67.9 million during fiscal 2000 from $44.7 million during fiscal 1999. As a percentage of net sales, selling, general and administrative expense was 26.4% for fiscal 2000, the same percentage as in fiscal 1999. Many of the fiscal 2000 selling, general and administrative expenses decreased as a percent of net sales due to the operating leverage achieved through the Company's larger store base and higher average store sales volume. This leverage was off-set by higher performance based bonuses, development costs for the new Torrid concept, higher store management payroll, increased benefit coverage and continued investment in management infrastructure. Operating income increased approximately $14.8 million to $35.0 million during fiscal 2000 from $20.2 million during fiscal 1999. As a percentage of net sales, operating income increased significantly to 13.6% in fiscal 2000 from 12.0% in fiscal 1999, principally from the larger store base, higher average store sales and higher margins. Operating income on an average per store basis was approximately $142,000 in fiscal 2000, up 30% from last year's $109,000. Net interest income increased by $1.0 million to $1.9 million or 0.7% of sales during fiscal 2000, from $0.9 million or 0.6% of sales during fiscal 1999, principally a result of higher average cash balances. The Company's effective tax rate was 37.0% in fiscal 2000 and 36.1% in fiscal 1999. The variance from an expected rate of approximately 40% in both fiscal 2000 and 1999 is a result of a significant portion of each fiscal year's interest income being non-taxable. 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 50% of net sales in each fiscal year. 24. 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 markup 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. 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, back-to-school, Halloween seasons, 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) and the Halloween holiday, (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 first fiscal quarter net sales. 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 25. 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. 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 2000 FISCAL YEAR 1999 ----------------------------------------- ----------------------------------------- (In thousands, except selected FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH operating and per share data) -------- -------- -------- -------- -------- -------- -------- -------- STATEMENT OF OPERATIONS DATA: Net sales $44,839 $51,718 $72,203 $88,427 $28,286 $32,779 $47,964 $59,920 Gross Margin 16,769 19,287 29,210 37,623 9,746 11,413 19,019 24,773 Operating income 3,456 4,578 11,165 15,772 781 1,638 6,576 11,207 Net income $ 2,443 $ 3,121 $ 7,317 $10,364 $ 635 $ 1,152 $ 4,306 $ 7,408 Net income per share: Basic $ 0.13 $ 0.16 $ 0.37 $ 0.51 $ 0.03 $ 0.06 $ 0.23 $ 0.40 Diluted $ 0.12 $ 0.15 $ 0.34 $ 0.48 $ 0.03 $ 0.06 $ 0.22 $ 0.36 Weighted average shares outstanding: Basic 19,441 19,732 19,795 20,147 18,484 18,478 18,572 18,602 Diluted 21,016 21,294 21,426 21,784 18,848 19,264 19,678 20,588 SELECTED OPERATING DATA: Comparable store sales increase 24.1% 21.8% 15.3% 11.2% 15.3% 16.9% 26.1% 27.1% Stores open at end of period 224 247 267 274 168 184 198 212
LIQUIDITY AND CAPITAL RESOURCES During the last three fiscal years, the Company's primary uses of cash have been to finance store openings, purchase merchandise inventories, and in fiscal 1999, to expand the headquarters and distribution facility. In fiscal 2000, an additional significant use of capital was used to secure the hardware and software related to the host computer systems implemented during the third quarter. The Company has satisfied its cash requirements exclusively from cash flows from operations. Cash flows provided by operating activities were $19.7 million, $25.8 million, and $9.3 million in fiscal 2000, 1999 and 1998, respectively. The decrease in cash flows from operating activities in fiscal 2000 was primarily attributable to the timing of the payment of estimated 2000 income tax liabilities and the payment of February 2001 rents (payment required prior to the fiscal 2000 year end of February 3, 2001). Cash flows used in investing activities were $16.7 million, $15.8 million and $9.3 million in fiscal 2000, 1999 and 1998, respectively. Cash flows used in investing activities relate primarily to store openings and, in 2000, approximately $2.6 million was used for the hardware and software related to the 26. new system implementation, and in 1999, $4.2 million was used for equipment and leasehold improvements for the Company's new headquarters office and distribution facility. The Company opened 62, 54 and 50 stores in fiscal 2000, 1999 and 1998, respectively. Cash flows provided by (used in) financing activities were $8.7 million, $5.0 million and ($2.1) million in fiscal 2000, 1999 and 1998, respectively. Cash flows related to the exercise of stock options represented $8.8 million of the fiscal year 2000 financing activities. The Company anticipates that it will spend approximately $20 million on capital expenditures in fiscal 2001. Of that amount, approximately $13 to $15 million is needed for the construction of the planned 65 Hot Topic stores and 6 Torrid stores in fiscal 2001. During fiscal 2000, the Company's average capital expenditures to open a store, including leasehold improvements and furniture and fixtures, totaled approximately $179,000. The average initial gross inventory for the new 2000 stores was approximately $101,000 (which was partially financed by trade credit) and pre-opening costs averaged approximately $21,000 for these stores. The Company expects the average total costs associated with opening a store to increase moderately to approximately $200,000 in fiscal 2001 as a result of the implementation of a new store design that was tested in two new stores in the fourth quarter of 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, and 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. During fiscal 1999, after completing an evaluation of its long-term management information system needs, the Company selected new hardware and software for its stores, office and distribution center. The Company implemented the host hardware and software systems at its office and distribution center during the third quarter of fiscal 2000 and plans to install certain point of sale upgrades at its stores in fiscal 2001. During fiscal 2000, the Company spent approximately $2.1 million for the hardware, software, modifications, training and implementation of the host system. The Company presently estimates the point of sale upgrades and currently planned enhancements and modifications to the host system will cost approximately $2.5 to $3.0 million, substantially all of which will be spent in fiscal 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 at least 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. 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. 27. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT See the section entitled "Executive Officers and Key Employees" in Part I, Item 1 hereof for information regarding the Company's executive officers. The information required by this item with respect to directors is incorporated by reference to the information appearing under the caption "Election of Directors," contained in the Company's Definitive Proxy Statement which will be filed with the SEC within 120 days of fiscal year-end pursuant to Regulation 14A in connection with the solicitation of proxies for the Company's Annual Meeting of Shareholders to be held on June 7, 2001 (the "2001 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 2001 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 2001 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 2001 Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K (a)(1) CONSOLIDATED FINANCIAL STATEMENTS The following consolidated financial statements required by this item are submitted in a separate section beginning on page F-1 of this Annual Report on Form 10-K:
PAGE Report of Ernst & Young LLP, Independent Auditors............................. F-1 --- Consolidated Balance Sheets as of February 3, 2001 and January 29, 2000....... F-2 --- Consolidated Statements of Operations for the years ended February 3, 2001, January 29, 2000 and January 30, 1999................................ F-3 --- Consolidated Statements of Shareholders' Equity for the years ended February 3, 2001, January 29, 2000 and January 30, 1999.............. F-4 --- Consolidated Statements of Cash Flows for the years ended February 3, 2001, January 29, 2000 and January 30, 1999.......................... F-5 --- Notes to Consolidated Financial Statements.................................... F-6 ---
28. (a)(2) FINANCIAL STATEMENT SCHEDULES All financial statement schedules are omitted because they are not required, are not applicable, or the information is included in the consolidated financial statements or notes thereto. (a)(3) EXHIBITS The exhibits listed under Item 14(c) hereof are filed with, or incorporated by reference into, this Annual Report on Form 10-K. (b) REPORTS ON FORM 8-K During the quarter ended February 3, 2001, the Company filed one report on Form 8-K. On December 1, 2000, the Company filed a report on Form 8-K reporting, under Item 5, the announcement that its Board of Directors approved a two-for-one stock split to be implemented as a 100% stock dividend to each of the Company's shareholders of record as of December 14, 2000. (c) EXHIBITS EXHIBIT NUMBER DESCRIPTION OF DOCUMENT ------ ----------------------- 3.1 Amended and Restated Articles of Incorporation. (1) 3.2 Amended and Restated Bylaws. 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) 10.7 401(k) Defined Contribution Plan of Registrant, effective as of August 1, 1995. (1) 10.8 Industrial Real Estate Lease (Multi-Tenant Facility), dated December 10, 1998, entered into between Registrant's wholly owned subsidiary, Hot Topic Administration, Inc. and Majestic Realty Co. and Patrician Associates, Inc. (2) 10.9 Guaranty of Lease, dated December 10, 1998, entered into between the Registrant and Majestic Realty Co. and Patrician Associates, Inc. (2) 10.10 First Amendment to Industrial Real Estate Lease, dated March 19, 2001, by and between Majestic - Fullerton Road, LLC, PFG Fullerton Limited Partnership, and Hot Topic Administration, Inc. 29. EXHIBIT NUMBER DESCRIPTION OF DOCUMENT ------ ----------------------- 10.11 Employment Agreement dated January 22, 2001, between the Registrant and Elizabeth McLaughlin. 10.12 Employment Offer Letter dated January 12, 2001, between the Registrant and Jerry Cook. 23.1 Consent of Ernst & Young LLP, Independent Auditors. 24.1 Power of Attorney is contained on the signature page. - ------------ (1) Filed as an exhibit to Registrant's Registration Statement on Form SB-2 (No. 333-5054-LA) and incorporated herein by reference. (2) Filed as an exhibit to Registrant's Annual Report on Form 10-K for the year ended January 30, 1999 and incorporated herein by reference (10.8 and 10.9). (d) FINANCIAL STATEMENT SCHEDULES Reference is made to Item 14(a)(2). 30. 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 27th day of April 2001. HOT TOPIC, INC. By: /s/ Elizabeth M. McLaughlin --------------------------- Elizabeth M. McLaughlin Chief Executive Officer, President and Director POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Elizabeth M. McLaughlin and Jim McGinty, or either of them, his attorney-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
NAME POSITION DATE - ----------------------------------- --------------------------------- -------------- /s/ ELIZABETH M. MCLAUGHLIN Chief Executive Officer, President April 27, 2001 - ----------------------------------- and Director (PRINCIPAL EXECUTIVE Elizabeth M. McLaughlin OFFICER) /s/ JIM MCGINTY Chief Financial Officer (PRINCIPAL April 27, 2001 - ----------------------------------- FINANCIAL AND ACCOUNTING OFFICER) Jim McGinty /s/ ROBERT M. JAFFE Chairman of the Board April 27, 2001 - ----------------------------------- Robert M. Jaffe /s/ EDGAR F. BERNER Director April 27, 2001 - ----------------------------------- Edgar F. Berner /s/ CORRADO FEDERICO Director April 27, 2001 - ----------------------------------- Corrado Federico /s/ ANDREW SCHUON Director April 27, 2001 - ----------------------------------- Andrew Schuon /s/BRUCE A. QUINNELL Director April 27, 2001 - ----------------------------------- Bruce A. Quinnell
31. REPORT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders Hot Topic, Inc. We have audited the accompanying consolidated balance sheets of Hot Topic, Inc. and subsidiaries as of February 3, 2001 and January 29, 2000, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended February 3, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hot Topic, Inc. and subsidiaries at February 3, 2001 and January 29, 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended February 3, 2001 in conformity with accounting principles generally accepted in the United States. /S/ Ernst & Young LLP ---------------------- Ernst & Young Los Angeles, California March 9, 2001 Hot Topic, Inc. and Subsidiaries Consolidated Balance Sheets
February 3, 2001 January 29, 2000 Assets Current assets: Cash and cash equivalents $ 51,287,698 $ 39,549,654 Inventory 21,335,515 15,366,745 Prepaid expenses and other 5,552,600 1,580,433 Deferred tax asset 943,742 721,161 ------------- ------------- Total current assets 79,119,555 57,217,993 Leaseholds, fixtures and equipment, net 39,165,998 31,721,478 Deposits and other 100,662 82,986 Deferred tax asset 259,845 - ------------- ------------- Total assets $118,646,060 $ 89,022,457 ============= ============= Liabilities and shareholders' equity Current liabilities: Accounts payable $ 6,632,140 $ 6,215,011 Accrued payroll and related expenses 10,093,360 8,452,469 Accrued sales and other taxes payable 1,103,150 637,623 Federal and state income taxes payable - 4,288,815 Current portion of obligations under capital leases 37,691 59,736 ------------- ------------- Total current liabilities 17,866,341 19,653,654 Deferred rent 1,403,576 1,104,709 Capital lease obligations, less current portion 84,869 170,767 Deferred tax liability - 815,796 Shareholders' equity: Common shares, no par value; 50,000,000 shares authorized; 20,293,855 and 19,321,688 shares issued and outstanding at February 3, 2001 and January 29, 2000, respectively 49,429,508 40,667,571 Deferred compensation - (6,727) Retained earnings 49,861,766 26,616,687 Total shareholders' equity 99,291,274 67,277,531 ------------- ------------- Total liabilities and shareholders' equity $118,646,060 $ 89,022,457 ============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-2 Hot Topic, Inc. and Subsidiaries Consolidated Statements of Income
Years ended ----------- February 3, January 29, January 30, 2001 2000 1999 -------------- -------------- -------------- Net sales $ 257,187,317 $ 168,948,553 $ 103,370,683 Cost of goods sold, including buying, distribution and occupancy costs 154,298,004 103,998,031 65,854,559 -------------- -------------- -------------- Gross margin 102,889,313 64,950,522 37,516,124 Selling, general and administrative expenses 67,917,723 44,748,988 29,077,124 -------------- -------------- -------------- Operating income 34,971,590 20,201,534 8,439,000 Interest income (1,955,414) (964,826) (951,119) Interest expense 30,025 32,086 20,296 -------------- -------------- -------------- Income before income taxes 36,896,979 21,134,274 9,369,823 Provision for income taxes (Note 6) 13,651,900 7,633,600 3,366,900 -------------- -------------- -------------- Net income $ 23,245,079 $ 13,500,674 $ 6,002,923 ============== ============== ============== Net income per share: Basic $ 1.18 $ 0.73 $ 0.31 ============== ============== ============== Diluted $ 1.09 $ 0.69 $ 0.30 ============== ============== ============== Shares used in computing net income per share: Basic 19,778,706 18,533,704 19,268,096 Diluted 21,379,418 19,594,724 19,823,188
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-3 Hot Topic, Inc. and Subsidiaries Consolidated Statements of Shareholders' Equity
Common Shares Total ----------------------------- Deferred Retained Shareholders' Shares Amount Compensation Earnings Equity ------------- ------------- ------------- ------------- ------------- Balance at January 31, 1998 19,038,424 $ 37,700,992 ($ 78,511) $ 7,113,090 $ 44,735,571 Exercise of stock options 444,308 388,728 - - 388,728 Employee stock purchase plan 14,992 49,500 - - 49,500 Repurchase common stock (880,000) (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 18,617,724 35,675,752 (42,619) 13,116,013 48,749,146 Exercise of stock options 964,192 4,187,278 - - 4,187,278 Employee stock purchase plan 15,772 60,469 - - 60,469 Repurchase common stock (276,000) (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 19,321,688 40,667,571 (6,727) 26,616,687 67,277,531 Exercise of stock options 959,910 4,767,049 - - 4,767,049 Employee stock purchase plan 12,257 143,170 - - 143,170 Amortization of deferred compensation - - 6,727 - 6,727 Tax benefit from exercise of options - 3,851,718 - - 3,851,718 Net income - - - 23,245,079 23,245,079 ------------- ------------- ------------- ------------- ------------- Balance at February 3, 2001 20,293,855 $ 49,429,508 - $ 49,861,766 $ 99,291,274 ============= ============= ============= ============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-4 Hot Topic, Inc. and Subsidiaries Consolidated Statements of Cash Flows
Years ended -------------------------------------------- February 3, January 29, January 30, 2001 2000 1999 ------------- ------------- ------------- OPERATING ACTIVITIES Net income $ 23,245,079 $ 13,500,674 $ 6,002,923 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 8,645,306 5,890,519 4,069,200 Deferred rent 298,867 360,998 234,889 Deferred compensation 6,727 35,892 35,892 Deferred taxes (1,298,222) (422,800) 124,198 Loss on disposal of fixed assets 501,427 10,072 - Changes in operating assets and liabilities: Inventory (5,968,770) (4,920,119) (2,810,030) Prepaid expenses and other current assets (3,972,167) (140,147) (782,537) Deposits and other assets (17,676) 3,936 (46,397) Accounts payable 417,129 4,028,549 480,803 Accrued payroll and related expenses 1,712,434 4,601,036 1,409,150 Accrued sales and other taxes payable 465,527 254,881 118,883 Income taxes payable (4,288,815) 2,580,813 488,804 ------------- ------------- ------------- Net cash provided by operating activities 19,746,846 25,784,304 9,325,778 INVESTING ACTIVITIES Purchases of property and equipment (16,662,796) (15,763,802) (9,274,002) ------------- ------------- ------------- Net cash used in investing activities (16,662,796) (15,763,802) (9,274,002) FINANCING ACTIVITIES Payments on capital lease obligations (107,943) (36,541) (31,689) Repurchase common shares - (1,064,863) (2,968,565) Proceeds from employee stock purchases and exercise of stock options, including related tax benefit 8,761,937 6,056,682 943,325 ------------- ------------- ------------- Net cash provided by (used in) financing activities 8,653,994 4,955,278 (2,056,929) ------------- ------------- ------------- Increase (decrease) in cash and cash equivalents 11,738,044 14,975,780 (2,005,153) Cash and cash equivalents at beginning of year 39,549,654 24,573,874 26,579,027 ------------- ------------- ------------- Cash and cash equivalents at end of year $ 51,287,698 $ 39,549,654 $ 24,573,874 ============= ============= ============= SUPPLEMENTAL INFORMATION Cash paid during the year for interest $ 30,245 $ 32,086 $ 20,296 ============= ============= ============= Cash paid during the year for income taxes $ 17,399,328 $ 3,674,209 $ 2,245,212 ============= ============= ============= Capital lease obligations entered into for equipment $ - $ 171,885 $ - ============= ============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-5 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements February 3, 2001 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 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 year ended February 3, 2001 is a 53-week year. The years ended January 29, 2000 and January 30, 1999 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 27, 2000. 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, the investment of cash equivalents is 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 that indicate that their carrying value may not be recoverable. At February 3, 2001, 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". NEW ACCOUNTING PRONOUNCEMENT Effective in 2001, accounting for gains or losses resulting from changes in the value of derivatives would be changed depending on the use of the derivative and whether they qualify for hedge accounting. The adoption of this new requirement is not expected to have a material impact on the financial position or results of operations of the Company. 2. LEASEHOLDS, FIXTURES AND EQUIPMENT Leaseholds, fixtures and equipment are summarized as follows: February 3, January 29, 2001 2000 ------------- ------------- Furniture, fixtures and equipment $ 31,299,751 $ 25,396,222 Leasehold improvements 29,135,468 21,419,124 ------------- ------------- 60,435,219 46,815,346 Less accumulated depreciation and amortization (21,269,221) (15,093,868) ------------- ------------- $ 39,165,998 $ 31,721,478 ============= ============= 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. The retail space leases provide for rents based upon the greater of the minimum annual rental amounts or 5% to 8% of annual sales volume. Certain of the leases provide for increasing minimum annual rental amounts. Rent expense is recorded 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 February 3, 2001, January 29, 2000 and January 30, 1999 was $16,093,011, $10,364,345 and $7,505,514, respectively, including contingent rentals of $2,694,146, $1,221,200 and $293,759, 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 $159,560 and $53,282, respectively, at February 3, 2001, $291,151 and $49,440, respectively, at January 29, 2000 and $168,930 and $49,137, respectively, at January 30, 1999. Annual future minimum lease payments under operating and capital leases as of February 3, 2001 are as follows: Operating Capital Fiscal year Leases Leases - ------------ ------------- ------------- 2002 $ 15,402,097 $ 45,211 2003 15,397,604 86,123 2004 15,276,081 - 2005 14,819,341 - 2006 14,593,500 - Thereafter 45,952,654 - ------------- ------------- Total minimum lease payments $121,441,277 $ 131,334 ============= ============= Less amounts representing interest - 8,774 ------------- ------------- Present value of future minimum capital lease payments - 122,560 Less amounts due in one year - 37,691 ------------- ------------- Long-term portion of obligations under capital leases - $ 84,869 ============= ============= 4. SHAREHOLDERS' EQUITY 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 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 F-9 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. SHAREHOLDERS' EQUITY (CONTINUED) generally expire ten years from the date of grant. An aggregate of 7,220,000 shares of common stock may be issued pursuant to the plans. During fiscal 2000, the Plan was amended to increase the aggregate number of shares of common stock authorized for issuance by 1,900,000 shares. As of February 3, 2001, 1,725,320 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 600,000 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 2000, 1999 and 1998: 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 0.84 for 2000, 0.80 for 1999 and 0.79 for 1998; and a weighted average expected life of the option of 5 years. The weighted average fair value of options granted during the year are $11.23, $5.01 and $3.67 per share for fiscal 2000, 1999 and 1998, respectively. F-10 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. SHAREHOLDERS' EQUITY (CONTINUED) For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting periods. The Company's pro forma information follows: Years Ended ---------------------------------------------- February 3, January 29, January 30, 2001 2000 1999 -------------- -------------- -------------- Pro forma net income $ 20,671,693 $ 11,303,530 $ 4,495,809 Pro forma earnings per share Basic $ 1.05 $ 0.61 $ 0.24 Diluted $ 0.97 $ 0.60 $ 0.23 A summary of the Company's stock option activity and related information follows:
February 3, 2001 January 29, 2000 January 30, 1999 -------------------------- -------------------------- -------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price ------------ ------------ ------------ ------------ ------------ ------------ Outstanding at beginning of year 2,653,124 $ 4.84 2,796,604 $ 5.12 2,249,240 $ 4.11 Granted 1,060,100 $ 11.23 1,024,400 $ 3.69 1,146,352 $ 5.41 Exercised (959,910) $ 4.97 (964,192) $ 4.35 (444,308) $ 0.88 Canceled (253,572) $ 4.46 (203,688) $ 5.22 (154,680) $ 4.81 ------------ ------------ ------------ ------------ ------------ ------------ Outstanding at end of year 2,499,742 $ 7.53 2,653,124 $ 4.84 2,796,604 $ 5.12 ============ ============ ============ ============ ============ ============ Exercisable at end of year 512,013 $ 5.23 546,284 $ 5.44 785,140 $ 4.28
Exercise prices for options outstanding as of February 3, 2001 ranged from $1.25 to $15.78. Of the 2,499,742 options outstanding at February 3, 2001, 705,775 have exercise prices ranging from $1.25 to $5.00, 738,367 have exercise prices ranging from $5.25 to $6.97, 885,600 have exercise prices ranging from $8.38 to $13.44 and 170,000 have exercise prices ranging from $14.63 to $15.78. 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: February 3, January 29, January 30, 2001 2000 1999 ------------ ------------ ------------ Basic EPS Computation: Numerator $23,245,079 $13,500,674 $ 6,002,923 Denominator: Weighted average common shares outstanding 19,778,706 18,533,704 19,268,096 ------------ ------------ ------------ Total shares 19,778,706 18,533,704 19,268,096 ------------ ------------ ------------ Basic EPS $ 1.18 $ 0.73 $ 0.31 ============ ============ ============ Diluted EPS Computation: Numerator $23,245,079 $13,500,674 $ 6,002,923 Denominator: Weighted average common shares outstanding 19,778,706 18,533,704 19,268,096 Incremental shares from assumed conversion of options 1,600,712 1,061,020 555,092 ------------ ------------ ------------ Total shares 21,379,418 19,594,724 19,823,188 ------------ ------------ ------------ Diluted EPS $ 1.09 $ 0.69 $ 0.30 ============ ============ ============ 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: February 3, January 29, January 30, 2001 2000 1999 ------------- ------------- ------------- Current: Federal $ 13,092,892 $ 6,873,075 $ 2,770,434 State 1,847,868 1,183,325 472,268 ------------- ------------- ------------- 14,940,760 8,056,400 3,242,702 Deferred: Federal (1,069,096) (393,151) 127,057 State (219,764) (29,649) (2,859) ------------- ------------- ------------- (1,288,860) (422,800) 124,198 ------------- ------------- ------------- Total income tax expense $ 13,651,900 $ 7,633,600 $ 3,366,900 ============= ============= ============= Significant components of the Company's deferred tax assets and liabilities: February 3, January 29, 2001 2000 ------------ ------------ Current deferred tax assets: Accrued vacation and other $ 345,876 $ 227,759 Inventory 650,928 445,380 State taxes 98,903 258,895 Other liabilities (151,965) (196,373) ------------ ------------ Total deferred tax assets 943,742 735,661 Valuation allowance for deferred tax assets - (14,500) ------------ ------------ Net current deferred tax assets 943,742 721,161 Noncurrent deferred tax assets (liabilities): Depreciation (76,357) (1,176,467) Deferred rent 336,202 360,671 ------------ ------------ Total noncurrent deferred tax assets (liabilities) 259,845 (815,796) ------------ ------------ Net deferred tax (liability) asset $ 1,203,587 ($ 94,635) ============ ============ 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: February 3, January 29, January 30, 2001 2000 1999 ---------- ---------- ---------- Statutory federal rate 35.0% 35.0% 34.0% Permanent differences (1.3) (1.3) (2.9) State and local taxes, net of federal benefit 2.7 2.8 3.3 Change in valuation allowance and other items 0.6 (0.4) 1.5 ---------- ---------- ---------- Effective income tax rate 37.0% 36.1% 35.9% ========== ========== ========== 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, maintained a minimum of 1,000 hours worked during the year and are at least 21 years of age are eligible to participate. Employees may contribute to the 401(k) Plan up to 25% of their current compensation, subject to a statutorily prescribed annual limit. The Company may in its discretion contribute certain amounts to eligible employees' accounts. The Company has not made any contributions to the 401(k) Plan. F-14 EX-3.2 2 hottopic_bylaws.txt AMENDED AND RESTATED BYLAWS ================================================================================ AMENDED AND RESTATED BYLAWS OF HOT TOPIC, INC. DATED SEPTEMBER 23, 1996 ================================================================================
ARTICLE I OFFICES......................................................................1 Section 1. Principal Office...............................................1 Section 2. Other Offices..................................................1 ARTICLE II MEETINGS OF SHAREHOLDERS.....................................................1 Section 1. Place of Meeting...............................................1 Section 2. Annual Meeting.................................................1 Section 3. Special Meeting................................................3 Section 4. Notice of Shareholders' Meetings...............................3 Section 5. Manner of Giving Notice; Affidavit of Notice...................4 Section 6. Quorum.........................................................4 Section 7. Adjourned Meeting; Notice......................................4 Section 8. Voting.........................................................5 Section 9. Waiver of Notice or Consent by Absent Shareholders.............5 Section 10. Shareholder Action by Written Consent Without a Meeting........6 Section 11. Proxies........................................................6 Section 12. Inspectors of Election.........................................6 ARTICLE III DIRECTORS....................................................................7 Section 1. Powers.........................................................7 Section 2. Number and Qualification of Directors..........................7 Section 3. Election and Term of Office of Directors.......................8 Section 4. Vacancies......................................................8 Section 5. Place of Meetings and Meetings by Telephone....................8 Section 6. Annual Meeting.................................................9 Section 7. Other Regular Meetings.........................................9 Section 8. Special Meetings...............................................9 Section 9. Quorum.........................................................9 Section 10. Waiver of Notice...............................................9 Section 11. Adjournment...................................................10 Section 12. Notice of Adjournment.........................................10 Section 13. Action Without Meeting........................................10 Section 14. Fees and Compensation of Director.............................10 Section 15. Removal Without Cause.........................................10 ARTICLE IV COMMITTEES...................................................................10 Section 1. Committees of Directors.......................................10 Section 2. Meetings and Action of Committees.............................11 ARTICLE V OFFICERS.....................................................................11 Section 1. Officers......................................................11 Section 2. Election of Officers..........................................11 Section 3. Subordinate Officers..........................................11 Section 4. Removal and Resignation of Officers...........................11 Section 5. Vacancies in Offices..........................................12 Section 6. Chairman of the Board.........................................12 Section 7. President.....................................................12 Section 8. Vice President................................................12 Section 9. Secretary.....................................................12 Section 10. Chief Financial Officer.......................................13 Section 11. Excessive Compensation........................................13 ARTICLE VI RECORDS AND REPORTS..........................................................13 Section 1. Maintenance and Inspection of Share Register..................13 Section 2. Maintenance and Inspection of Bylaws..........................14 Section 3. Maintenance and Inspection of Other Corporate Records.........14 Section 4. Inspection by Directors.......................................14 Section 5. Annual Report to Shareholders.................................14 Section 6. Financial Statements..........................................15 Section 7. Annual Statement of General Information.......................15 ARTICLE VII GENERAL CORPORATE MATTERS...................................................15 Section 1. Record Date for Purposes Other than Notice and Voting.........15 Section 2. Checks, Drafts, Evidences of Indebtedness.....................16 Section 3. Corporate Contracts and Instruments; How Executed.............16 Section 4. Certificate for Shares........................................16 Section 5. Lost Certificates.............................................17 Section 6. Representation of Shares of Other Corporations................17 Section 7. Construction and Definitions..................................17 ARTICLE VIII AMENDMENTS.................................................................17 Section 1. Amendment by Shareholders.....................................17 Section 2. Amendment by Directors........................................17 ARTICLE IX INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND AGENTS.................18 Section 1. Director......................................................18 Section 2. Officers, Employees and Other Agents..........................18 Section 3. Determination by the Corporation..............................18 Section 4. Good Faith....................................................18 Section 5. Expenses......................................................19 Section 6. Enforcement...................................................19 Section 7. Non-Exclusivity of Rights.....................................20 Section 8. Survival of Rights............................................20 Section 9. Insurance.....................................................20 Section 10. Amendments....................................................20 Section 11. Employee Benefit Plans........................................20 Section 12. Saving Clause.................................................20 Section 13. Certain Definitions...........................................20
AMENDED AND RESTATED BYLAWS OF HOT TOPIC, INC. ARTICLE I OFFICES SECTION 1. PRINCIPAL OFFICE. The board of directors shall fix the location of the principal executive office of the corporation at any place within or outside the State of California. If the principal executive office is located outside this state, and the corporation has one or more business offices in this state, the board of directors shall fix and designate a principal business office in the State of California. SECTION 2. OTHER OFFICES. The board of directors may at any time establish branch or subordinate offices at any place or places where the corporation is qualified to do business. ARTICLE II MEETINGS OF SHAREHOLDERS SECTION 1. PLACE OF MEETING. Meetings of shareholders shall be held at any place within or outside the State of California designated by the board of directors. In the absence of any such designation, shareholders' meetings shall be held at the principal executive office of the corporation. SECTION 2. ANNUAL MEETING. The annual meeting of the shareholders shall be held each year on a date and at a time designated by the board of directors. If this day shall be a legal holiday, then the meeting shall be held on the next succeeding business day, at the same hour. At each annual meeting, directors shall be elected and other proper business may be transacted. At an annual meeting of the shareholders, only such business shall be conducted as shall have been properly brought before the meeting. To be properly brought before an annual meeting, business must be: (i) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the board of directors, (ii) otherwise properly brought before the meeting by or at the direction of the board of directors, or (iii) otherwise properly brought before the meeting by a shareholder. For business to be properly brought before an annual meeting by a shareholder, the shareholder must have given timely notice thereof in writing to the secretary of the corporation. To be timely, a shareholder's notice must be delivered to or mailed and received at the principal executive offices of the corporation not less than one hundred twenty (120) calendar days in advance of the date specified in the corporation's proxy statement released to shareholders in connection with the previous year's annual meeting of shareholders; provided, however, that in the event that no annual 1. meeting was held in the previous year or the date of the annual meeting has been changed by more than thirty (30) days from the date contemplated at the time of the previous year's proxy statement, notice by the shareholder to be timely must be so received a reasonable time before the solicitation is made. A shareholder's notice to the secretary shall set forth as to each matter the shareholder proposes to bring before the annual meeting (i) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (ii) the name and address, as they appear on the corporation's books, of the shareholder proposing such business, (iii) the class and number of shares of the corporation which are beneficially owned by the shareholder, (iv) any material interest of the shareholder in such business and (v) any other information that is required to be provided by the shareholder pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the "1934 Act"), in his capacity as a proponent of a shareholder proposal. Notwithstanding the foregoing, in order to include information with respect to a shareholder proposal in the proxy statement and form of proxy for a shareholders' meeting, shareholders must provide notice as required by the regulations promulgated under the 1934 Act. Notwithstanding anything in these bylaws to the contrary, no business shall be conducted at any annual meeting except in accordance with the procedures set forth in this paragraph. The chairman of the annual meeting shall, if the facts warrant, determine and declare at the meeting that business was not properly brought before the meeting and in accordance with the provisions of this paragraph, and, if he should so determine, he shall so declare at the meeting that any such business not properly brought before the meeting shall not be transacted. Only persons who are nominated in accordance with the procedures set forth in this paragraph shall be eligible for election as directors. Nominations of persons for election to the board of directors of the corporation may be made at a meeting of shareholders by or at the direction of the board of directors or by any shareholder of the corporation entitled to vote in the election of directors at the meeting who complies with the notice procedures set forth in this paragraph. Such nominations, other than those made by or at the direction of the board of directors, shall be made pursuant to timely notice in writing to the secretary of the corporation in accordance with the provisions of the preceding paragraph. Such shareholder's notice shall set forth (i) as to each person, if any, whom the shareholder proposes to nominate for election or re election as a director: (A) the name, age, business address and residence address of such person, (B) the principal occupation or employment of such person, (C) the class and number of shares of the corporation which are beneficially owned by such person, (D) a description of all arrangements or understandings between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nominations are to be made by the shareholder, and (E) any other information relating to such person that is required to be disclosed in solicitations of proxies for election of directors, or is otherwise required, in each case pursuant to Regulation 14A under the 1934 Act (including without limitation such person's written consent to being named in the proxy statement, if any, as a nominee and to serving as a director if elected); and (ii) as to such shareholder giving notice, the information required to be provided pursuant to the preceding paragraph. At the request of the board of directors, any person nominated by a shareholder for election as a director shall furnish to the secretary of the corporation that information required to be set forth in the shareholder's notice of nomination which pertains to the nominee. No person shall be eligible for election as a director of the corporation unless nominated in accordance with the procedures 2. set forth in this paragraph. The chairman of the meeting shall, if the facts warrant, determine and declare at the meeting that a nomination was not made in accordance with the provisions of this paragraph, and if he should so determine, he shall so declare at the meeting, and the defective nomination shall be disregarded. SECTION 3. SPECIAL MEETING. Special meetings of the shareholders may be called at any time by the board of directors, the chairman of the board, the president, a vice president, the secretary or by one or more shareholders holding not less than one-tenth (1/10th) of the voting power of the corporation. Except as next provided, notice shall be given as for the annual meeting. Upon receipt of a written request addressed to the chairman, president, vice president or secretary, mailed or delivered personally to such office by any person (other than the board) entitled to call a special meeting of shareholders, such officer shall cause notice to be given, to the shareholders entitled to vote, that a meeting will be held at a time requested by the person or persons calling the meeting, not less than thirty-five (35) nor more than sixty (60) days after the receipt of such request. If such notice is not given within twenty (20) days after receipt of such request, the persons calling the meeting may give notice thereof in the manner provided by these bylaws or apply to the Superior Court as provided in Section 305(c) of the Corporations Code of California. Such person's notice delivered to such office shall set forth as to each matter such person proposes to bring before the special meeting (i) a brief description of the business desired to be brought before the special meeting and the reasons for conducting such business at the special meeting, (ii) the name and address, as they appear on the corporation's books, of the person proposing such business, if applicable, (iii) the class and number of shares of the corporation which are beneficially owned by the person, if applicable, (iv) any material interest of the person in such business and (v) any other information that is required to be provided by the shareholder pursuant to Regulation 14A under the 1934 Act. SECTION 4. NOTICE OF SHAREHOLDERS' MEETINGS. All notices of meetings shall be sent or otherwise given in accordance with Section 5 of this Article II not less than ten (10) nor more than sixty (60) days before the date of the meeting. The notice shall specify the place, date and hour of the meeting and (i) in the case of a special meeting, the general nature of the business to be transacted, or (ii) in the case of the annual meeting, those matters which the board of directors, at the time of giving the notice, intends to present for action by the shareholders. The notice of any meeting at which directors are to be elected shall include the name of any nominee or nominees whom, at the time of the notice, management intends to present for election. If action is proposed to be taken at any meeting for approval of (i) a contract or transaction in which a director has a direct or indirect financial interest, pursuant to Section 310 of the Corporations Code of California, (ii) an amendment of the articles of incorporation, pursuant to Section 902 of that Code, (iii) a reorganization of the corporation, pursuant Section 1201 of that Code, (iv) a voluntary dissolution of the corporation, pursuant to Section 1900 of that Code, or (v) a distribution in dissolution other than in accordance with the rights of outstanding preferred shares, pursuant to Section 2007 of that Code, the notice shall also state the general nature of that proposal. 3. SECTION 5. MANNER OF GIVING NOTICE; AFFIDAVIT OF NOTICE. Notice of any meeting of shareholders shall be given either personally or by first-class mail or telegraphic or other written communication, charges prepaid, addressed to the shareholder at the address of that shareholder appearing on the books of the corporation or given by the shareholder to the corporation for the purpose of notice. If no such address appears on the corporation's books or is given, notice shall be deemed to have been given if sent to that shareholder by first-class mail or telegraphic or other written communication to the corporation's principal executive office, or if published at least once in a newspaper of general circulation in the county where that office is located. Notice shall be deemed to have been given at the time when delivered personally or deposited in the mail or sent by telegram or other means of written communication. If any notice addressed to a shareholder at the address of that shareholder appearing on the books of the corporation is returned to the corporation by the United States Postal Service marked to indicate that the United States Postal Service is unable to deliver the notice to the shareholder at that address, all future notices or reports shall be deemed to have been duly given without further mailing if these shall be available to the shareholder on written demand of the shareholder at the principal executive office of the corporation for a period of one year from the date of giving of the notice. An affidavit of the mailing or other means of giving any notice of any shareholders' meeting shall be executed by the secretary, assistant secretary or any transfer agent of the corporation giving the notice, and shall be filed and maintained in the minute book of the corporation. SECTION 6. QUORUM. The presence in person or by proxy of the holders of a majority of the shares entitled to vote at any meeting of shareholders shall constitute a quorum for the transaction of business. The shareholders present at a duly called or held meeting at which a quorum is present may continue to do business until adjournment, notwithstanding the withdrawal of enough shareholders to leave less than a quorum, if any action taken (other than adjournment) is approved by at least a majority of the shares required to constitute a quorum. SECTION 7. ADJOURNED MEETING; NOTICE. Any shareholders' meeting, annual or special, whether or not a quorum is present, may be adjourned from time to time by the vote of the majority of the shares represented at that meeting, either in person or by proxy, but in the absence of a quorum, no other business may be transacted at that meeting, except as provided in Section 6 of this Article II. When any meeting of shareholders, either annual or special, is adjourned to another time or place, notice need not be given of the adjourned meeting if the time and place are announced at a meeting at which the adjournment is taken, unless a new record date for the adjourned meeting is fixed, or unless the adjournment is for more than forty-five (45) days from the date set for the original meeting, in which case the board of directors shall set a new record date. Notice of any such adjourned meeting shall be given to each shareholder of record entitled to vote at the adjourned meeting in accordance with the provisions of sections 4 and 5 of this Article II. At any adjourned meeting, the corporation may transact any business which might have been transacted at the original meeting. 4. SECTION 8. VOTING. The shareholders entitled to vote at any meeting of shareholders shall be determined in accordance with the provisions of Section 11 of this Article II, subject to the provisions of Sections 702 to 704, inclusive, of the Corporations Code of California (relating to voting shares held by a fiduciary, in the name of a corporation or in joint ownership). The shareholders' vote may be by voice vote or by ballot; provided, however, that any election for directors must be by ballot if demanded by any shareholder before the voting has begun. On any matter other than elections of directors, any shareholder may vote part of the shares in favor of the proposal and refrain from voting the remaining shares or vote them against the proposal, but, if the shareholder fails to specify the number of shares which the shareholder is voting affirmatively, it will be conclusively presumed that the shareholder's approving vote is with respect to all shares that the shareholder is entitled to vote. If a quorum is present, the affirmative vote of the majority of the shares represented at the meeting and entitled to vote on any matter (other than the election of directors) shall be the act of the shareholders, unless the vote of a greater number or voting by classes is required by the Corporations Code of California or by the articles of incorporation. At a shareholders' meeting at which directors are to be elected, no shareholder shall be entitled to cumulate votes (i.e., cast for any one or more candidates a number of votes greater than the number of the shareholder's shares) unless the candidates' names have been placed in nomination prior to commencement of the voting and a shareholder has given notice prior to commencement of the voting of the shareholder's intention to cumulate votes. If any shareholder has given such a notice, then every shareholder entitled to vote may cumulate votes for candidates in nomination and give one candidate a number of votes equal to the number of directors to be elected multiplied by the number of votes to which that shareholder's shares are entitled, or distribute the shareholder's votes on the same principle among any or all of the candidates, as the shareholder thinks fit. The candidates receiving the highest number of votes, up to the number of directors to be elected, shall be elected. So long as the corporation has equity securities qualified for trading on the Nasdaq National Market: (A) cumulative voting shall no longer be available to the shareholders, (B) the immediately preceding paragraph shall no longer be applicable, (C) the third sentence of the first paragraph of this Section 8 shall read, "Any shareholder may vote part of the shares in favor of the proposal and refrain from voting the remaining shares or vote them against the proposal, but, if the shareholder fails to specify the number of shares which the shareholder is voting affirmatively, it will be conclusively presumed that the shareholder's approving vote is with respect to all shares that the shareholder is entitled to vote", and (D) the parenthetical reference in the first paragraph of this Section 8, "(other than the election of directors)," shall no longer be applicable. SECTION 9. WAIVER OF NOTICE OR CONSENT BY ABSENT SHAREHOLDERS. The transactions at any meeting of shareholders, either annual or special, however called and noticed, and wherever held, shall be as valid as though had at a meeting duly held after regular call and notice, if a quorum be present either in person or by proxy, and if, either before or after the meeting, each person entitled to vote, who was not present in person or by proxy, signs a written waiver of notice, a consent to holding of the meeting or an approval of the minutes. The waiver of notice or consent need not specify either the business to be transacted or the purpose of any annual or special meeting of shareholders, 5. except that if action is taken or proposed to be taken for approval of any of those matters specified in the second paragraph of Section 4 of this Article II, the waiver of notice or consent shall state the general nature of the proposal. All such waivers, consents or approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Attendance by a person at a meeting shall also constitute a waiver of notice of that meeting, except when the person objects, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened, and except that attendance at a meeting is not a waiver of any right to object to the consideration of matters not included in the notice of the meeting if that objection is expressly made at the meeting. SECTION 10. SHAREHOLDER ACTION BY WRITTEN CONSENT WITHOUT A MEETING. No action shall be taken by the shareholders of the corporation, except at an annual or special meeting of the shareholders called in accordance with these bylaws. (a) RECORD DATE FOR SHAREHOLDER NOTICE, VOTING AND GIVING CONSENTS. For purposes of determining the shareholders entitled to notice of or to vote at any meeting, the board of directors may fix, in advance, a record date, which shall not be more than sixty (60) days nor less than ten (10) days before the date of any such meeting, and in this event only shareholders of record on the date so fixed are entitled to notice or to vote, as the case may be, notwithstanding any transfer of any shares on the books of the corporation after the record date, except as otherwise provided in the Corporations Code of California. If the board of directors does not so fix a record date, the record date for determining shareholders entitled to notice of or to vote at a meeting of shareholders shall be at the close of business on the business day next preceding the day an which notice is given or, if notice is waived, at the close of business on the business day next preceding the day on which the meeting is held. SECTION 11. PROXIES. Every person entitled to vote for directors or on any other matter shall have the right to do so either in person or by one or more agents authorized by a written proxy signed by the person and filed with the secretary of the corporation. A proxy shall be deemed signed if the shareholder's name is placed on the proxy (whether by manual signature, typewriting, telegraphic transmission or otherwise) by the shareholder or the shareholder's attorney in fact. A validly executed proxy which does not state that it is irrevocable shall continue in full force and effect unless (i) revoked by the person executing it, before the vote pursuant to that proxy, by a writing delivered to the corporation stating that the proxy is revoked, or by a subsequent proxy executed by, or attendance at the meeting and voting in person by, the person executing the proxy; or (ii) written notice of the death or incapacity of the maker of that proxy is received by the corporation before the vote pursuant to that proxy is counted; provided, however, that no proxy shall be valid after the expiration of eleven (11) months from the date of the proxy, unless otherwise provided in the proxy. The revocability of a proxy that states on its face that it is irrevocable shall be governed by the provisions of Sections 705(e) and 705(f) of the Corporations Code of California. SECTION 12. INSPECTORS OF ELECTION. Before any meeting of shareholders, the board of directors may appoint any persons other than nominees for office to act as inspectors of election at the meeting or its adjournment. If no 6. inspectors of election are so appointed, the chairman of the meeting may, and on the request of any shareholder or a shareholder's proxy shall, appoint inspectors of election at the meeting. The number of inspectors shall be either one (1) or three (3). If inspectors are appointed at a meeting on the request of one or more shareholders or proxies, the holders of a majority of shares or their proxies present at the meeting shall determine whether one (1) or three (3) inspectors are to be appointed. If any person appointed as inspector fails to appear or fails or refuses to act, the chairman of the meeting may, and upon the request of any shareholder or a shareholder's proxy shall, appoint a person to fill that vacancy. These inspectors shall: (a) Determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum and the authenticity, validity and effect of proxies; (b) Receive votes, ballots or consents; (c) Hear and determine all challenges and questions in any way arising in connection with the right to vote; (d) Count and tabulate all votes or consents; (e) Determine when the polls shall close; (f) Determine the result; and (g) Do any other acts that may be proper to conduct the election or vote with fairness to all shareholders. ARTICLE III DIRECTORS SECTION 1. POWERS. Subject to the provisions of the Corporations Code of California and any limitations in the articles of incorporation and these bylaws relating to action required to be approved by the shareholders or by the outstanding shares, the business and affairs of the corporation shall be managed and all corporate powers shall be exercised by or under the direction of the board of directors. SECTION 2. NUMBER AND QUALIFICATION OF DIRECTORS. (a) The number of directors of the corporation shall be not less than six (6) nor more than eleven (11) and the exact number of directors shall be fixed within these limits from time to time by approval of the board of directors. The indefinite number of directors may be changed, or a definite number fixed without provision for an indefinite number, by a duly adopted amendment to the articles of incorporation or by an amendment to this bylaw duly adopted by the vote of holders of sixty-six and two-thirds percent (66-2/3%) of 7. the outstanding shares entitled to vote. No amendment may change the stated maximum number of authorized directors to a number greater than two (2) times the stated minimum number of directors minus one (1). SECTION 3. ELECTION AND TERM OF OFFICE OF DIRECTORS. Directors shall be elected at each annual meeting by the shareholders to hold office until the next annual meeting. Each director, including a director elected to fill a vacancy, shall hold office until the expiration of the term for which elected and until a successor has been elected and qualified. SECTION 4. VACANCIES. Vacancies in the board of directors may be filled by a majority of the remaining directors, though less than a quorum, or by a sole remaining director. Each director so elected shall hold office until the next annual meeting of the shareholders and until a successor has been elected and qualified. A vacancy or vacancies in the board of directors shall be deemed to exist in the event of the death, resignation, or removal of any director, or if the board of directors by resolution declares vacant the office of a director who has been declared of unsound mind by an order of court or convicted of a felony, or if the authorized number of directors is increased, or if the shareholders fail, at any meeting of shareholders at which any director or directors are elected, to elect the number of directors to be voted for at that meeting. The shareholders may elect a director or directors at any time to fill any vacancy or vacancies not filled by the directors. Any director may resign effective on giving written notice to the chairman of the board, the president, the secretary or the board of directors, unless the notice specifies a later time for that resignation to become effective. If the resignation of a director is effective at a future time, the board of directors may elect a successor to take office when the resignation becomes effective. No reduction of the authorized number of directors shall have the effect of removing any director before that director's term of office expires. SECTION 5. PLACE OF MEETINGS AND MEETINGS BY TELEPHONE. Regular meetings of the board of directors may be held at any place within or outside the State of California that has been designated from time to time by resolution of the board. In the absence of such a designation, regular meetings shall be held at the principal executive office of the corporation. Special meetings of the board shall be held at any place within or outside the State of California that has been designated in the notice of the meeting or, if not stated in the notice or there is no notice, at the principal executive office of the corporation. Any meeting, regular or special, may be held by conference telephone or similar communication equipment, so long as all directors participating in the meeting can hear one another, and all such directors shall be deemed to be present in person at the meeting. SECTION 6. ANNUAL MEETING. Immediately following each annual meeting of shareholders, the board of directors shall hold a regular meeting for the purpose of organization, any desired election of officers and the transaction of other business. Notice of this meeting shall not be required. 8. SECTION 7. OTHER REGULAR MEETINGS. Other regular meetings of the board of directors shall be held without call at such time as shall from time to time be fixed by the board of directors. Such regular meetings may be held without notice. SECTION 8. SPECIAL MEETINGS. Special meetings of the board of directors for any purpose or purposes may be called at any time by the chairman of the board, the president, any vice president, the secretary or any two directors. Notice of the time and place of special meetings shall be delivered personally or by telephone to each director or sent by first-class mail or telegram, charges prepaid, addressed to each director at that director's address as it is shown on the records of the corporation. In the event that the notice is mailed, it shall be deposited in the United States mail at least four (4) days before the time of the holding of the meeting. In the event that the notice is delivered personally or by telephone or telegram, it shall be delivered personally or by telephone or to the telegraph company at least forty-eight (48) hours before the time of the holding of the meeting. Any oral notice given personally or by telephone may be communicated either to the director or to a person at the office of the director who the person giving the notice has reason to believe will promptly communicate it to the director. The notice need not specify the purpose of the meeting, or the place of the meeting if the meeting is to be held at the principal executive office of the corporation. SECTION 9. QUORUM. A majority of the authorized number of directors shall constitute a quorum for the transaction of business, except to adjourn as provided in Section 11 of this Article III. Every act or decision done or made by a majority of the directors present at a meeting duly held at which a quorum is present shall be regarded as the act of the board of directors, subject to the provisions of Section 310 of the Corporations Code of California (as to approval of contracts or transactions in which a director has a direct or indirect material financial interest), Section 311 of that Code (as to appointment of committees) and Section 317(e) of that Code (as to indemnification of directors). A meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of directors, if any action taken is approved by at least a majority of the required quorum for that meeting. SECTION 10. WAIVER OF NOTICE. The transaction of any meeting of the board of directors, however called and noticed or wherever held, shall be as valid as though had at a meeting duly held after regular call and notice if a quorum is present and if, either before or after the meeting, each of the directors not present signs a written waiver of notice, a consent to holding the meeting or an approval of the minutes. The waiver of notice or consent need not specify the purpose of the meeting. All such waivers, consents and approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Notice of a meeting shall also be deemed given to any director who attends the meeting without protesting, before or at its commencement, the lack of notice to that director. SECTION 11. ADJOURNMENT. A majority of the directors present, whether or not constituting a quorum, may adjourn any meeting to another time and place. 9. SECTION 12. NOTICE OF ADJOURNMENT. Notice of the time and place of holding an adjourned meeting need not be given, unless the meeting is adjourned for more than twenty-four (24) hours, in which case notice of the time and place shall be given before the time of the adjourned meeting, in the manner specified in Section 8 of this Article III, to the directors who were not present at the time of the adjournment. SECTION 13. ACTION WITHOUT MEETING. Any action required or permitted to be taken by the board of directors may be taken without a meeting, if all members of the board shall individually or collectively consent in writing to that action. Such action by written consent shall have the same force and effect as a unanimous vote of the board of directors. Such written consent or consents shall be filed with the minutes of the proceedings of the board. SECTION 14. FEES AND COMPENSATION OF DIRECTOR. Directors and members of committees may receive such compensation, if any, for their services, and such reimbursement of expenses, as may be fixed or determined by resolution of the board of directors. This Section 14 shall not be construed to preclude any director from serving the corporation in any other capacity as an officer, agent, employee or otherwise, and receiving compensation for those services. SECTION 15. REMOVAL WITHOUT CAUSE. Any or all of the directors may be removed without cause if the removal is approved by the outstanding shares entitled to vote. ARTICLE IV COMMITTEES SECTION 1. COMMITTEES OF DIRECTORS. The board of directors may, by resolution adopted by a majority of the authorized number of directors, designate one or more committees, each consisting of two (2) or more directors, to serve at the pleasure of the board. The board may designate one or more directors as alternate members of any committee, who may replace any absent member at any meeting of the committee. Any committee, to the extent provided in the resolution of the board, shall have all the authority of the board, except with respect to: (a) the approval of any action which, under the Corporations Code of California, also requires shareholders' approval or approval of the outstanding shares; (b) the filling of vacancies on the board of directors or any committee; (c) the fixing of compensation of the directors for serving on the board or any committee; (d) the amendment or repeal of bylaws or the adoption of new bylaws; (e) the amendment or repeal of any resolution of the board of directors which by its express terms is not so amendable or repealable; 10. (f) a distribution to the shareholders of the corporation, except at a rate or in a periodic amount or within a price range determined by the board of directors; (g) the appointment of any other committees of the board of directors or the members of these committees. SECTION 2. MEETINGS AND ACTION OF COMMITTEES. Meetings and action of committees shall be governed by, and held and taken in accordance with, the provisions of Article III of these bylaws, Section 5 (place of meetings), Section 7 (regular meetings), Section 8 (special meetings and notice), Section 9 (quorum), Section 10 (waiver of notice), Section 11 (adjournment), Section 12 (notice of adjournment) and Section 13 (action without meeting), with such changes in the context of those bylaws as are necessary to substitute the committee and its members for the board of directors and its members, except that the time of regular meetings of committees may be determined either by resolution of the board of directors or by resolution of the committee; special meetings of committees may also be called by resolution of the board of directors; and notice of special meetings of committees shall also be given to all alternate members, who shall have the right to attend all meetings of the committee. The board of directors may adopt rules for the government of any committee not inconsistent with the provisions of these bylaws. ARTICLE V OFFICERS SECTION 1. OFFICERS. The officers of the corporation shall be a president, a secretary and a chief financial officer. The corporation may also have, at the discretion of the board of directors, a chairman of the board, one or more vice presidents, one or more assistant secretaries, one or more assistant treasurers and such other officers as may be appointed in accordance with the provisions of Section 3 of this Article V. Any number of offices may be held by the same person. SECTION 2. ELECTION OF OFFICERS. The officers of the corporation, except such officers as may be appointed in accordance with the provisions of Section 3 or Section 5 of this Article V, shall be chosen by the board of directors, and each shall serve at the pleasure of the board, subject to the rights, if any, of an officer under any contract of employment. SECTION 3. SUBORDINATE OFFICERS. The board of directors may appoint, and may empower the president to appoint, such other officers as the business of the corporation may require, each of whom shall hold office for such period, have such authority and perform such duties as are provided in the bylaws or as the board of directors may from time to time determine. SECTION 4. REMOVAL AND RESIGNATION OF OFFICERS. Subject to the rights, if any, of an officer under any contract of employment, any officer may be removed, either with or without cause, by the board of directors, at any regular or special meeting of the board, or, except in case of an officer chosen by the board of directors, by any officer upon whom such power of removal may be conferred by the board of directors. 11. Any officer may resign at any time by giving written notice to the corporation. Any resignation shall take effect at the date of the receipt of that notice or at any later time specified in that notice; and, unless otherwise specified in that notice, the acceptance of the resignation shall not be necessary to make it effective. Any resignation is without prejudice to the rights, if any, of the corporation under any contract to which the officer is a party. SECTION 5. VACANCIES IN OFFICES. A vacancy in any office because of death, resignation, removal, disqualification or any other cause shall be filled in the manner prescribed in these bylaws for regular appointments to that office. SECTION 6. CHAIRMAN OF THE BOARD. The chairman of the board, if such an officer be elected, shall, if present, preside at meetings of the board of directors and exercise and perform such other powers and duties as may be from time to time assigned to him by the board of directors or prescribed by the bylaws. If there is no president, the chairman of the board shall in addition be the chief executive officer of the corporation and shall have the powers and duties prescribed in Section 7 of this Article V. SECTION 7. PRESIDENT. Subject to such supervisory powers, if any, as may be given by the board of directors to the chairman of the board, if there be such an officer, the president shall be the chief executive officer of the corporation and shall, subject to the control of the board of directors, have general supervision, direction and control of the business and the officers of the corporation. He shall preside at all meetings of the shareholders and, in the absence of the chairman of the board, or if there be none, at all meetings of the board of directors. He shall have the general powers and duties of management usually vested in the office of president of a corporation, and shall have such other powers and duties as may be prescribed by the board of directors or these bylaws. SECTION 8. VICE PRESIDENT. In the absence or disability of the president, the vice presidents, if any, in order of their rank as fixed by the board of directors or, if not ranked, a vice president designated by the board of directors, shall perform all the duties of the president, and when so acting shall have all the powers of, and be subject to all the restrictions upon, the president. The vice presidents shall have such other powers and perform such other duties as from time to time may be prescribed for each of them, respectively, by the board of directors or the bylaws, and the president or the chairman of the board. SECTION 9. SECRETARY. The secretary shall keep or cause to be kept, at the principal executive office or such other place as the board of directors may direct, a book of minutes of all meetings and actions of directors, committees of directors and shareholders, with the time and place of holding, whether regular or special, and, if special, how authorized, the notice given, the names of those present at directors' meetings or committee meetings, the number of shares present or represented at shareholders' meetings, and the proceedings. The secretary shall keep, or cause to be kept, at the principal executive office or at the office of the corporation's transfer agent or registrar, as determined by resolution of the board of directors, a share register, or a duplicate share register, showing the names of all shareholders and their addresses, the number and classes of shares held by each, the number 12. and date of certificates issued for the same, and the number and date of cancellation of every certificate surrendered for cancellation. The secretary shall give, or cause to be given, notice of all meetings of the shareholders and of the board of directors required by these bylaws or by law to be given, and shall keep the seal of the corporation, if one be adopted, in safe custody, and shall have such other powers and perform such other duties as may be prescribed by the board of directors or by these bylaws. SECTION 10. CHIEF FINANCIAL OFFICER. The chief financial officer shall keep and maintain, or cause to be kept and maintained, adequate and correct books and records of accounts of the properties and business transactions of the corporation, including accounts of its assets, liabilities, receipts, disbursements, gains, losses, capital, retained earnings and shares. The books of account shall at all reasonable times be open to inspection by any directors. The chief financial officer shall deposit all moneys and other valuables in the name and to the credit of the corporation with such depositories as may be designated by the board of directors. He shall disburse the funds of the corporation as may be ordered by the board of directors, shall render to the president and directors, whenever they request it, an account of all of his transactions as chief financial officer and of the financial condition of the corporation, and shall have the powers and perform such other duties as may be prescribed by the board of directors or these bylaws. SECTION 11. EXCESSIVE COMPENSATION. If the Internal Revenue Service disallows as a business deduction to the corporation any part of the salary or other compensation paid by it to any officer, director or employee as being excessive compensation, that part disallowed shall be repaid to the corporation by the officer, director or employee, unless the board of directors declares otherwise. ARTICLE VI RECORDS AND REPORTS SECTION 1. MAINTENANCE AND INSPECTION OF SHARE REGISTER. The corporation shall keep at its principal executive office, or at the office of its transfer agent or registrar, if either be appointed and as determined by resolution of the board of directors, a record of its shareholders, giving the names and addresses of all shareholders and the number and classes of shares held by each shareholder. A shareholder or shareholders of the corporation holding at least five percent (5%) in the aggregate of the outstanding voting shares of the corporation may (i) inspect and copy the records of shareholders' names and addresses and shareholdings during usual business hours on five (5) days' prior written demand on the corporation, and (ii) obtain from the transfer agent of the corporation, on written demand and on the tender of such shareholders' names and addresses, a list of who are entitled to vote for the election of directors, and their shareholdings, as of the most recent record date for which that list has been compiled or as of a date specified by the shareholder after the date of demand. This list shall be made available to any such shareholder by the 13. transfer agent on or before the later of five (5) days after the demand is received or the date specified in the demand as the date as of which the list is to be compiled. The record of shareholders shall also be open to inspection on the written demand of any shareholder or holder of a voting trust certificate, at any time during usual business hours, for a purpose reasonably related to the holder's interests as a shareholder or as the holder of a voting trust certificate. Any inspection and copying under this Section 1 may be made in person or by an agent or attorney for the shareholder or holder of a voting trust certificate making the demand. SECTION 2. MAINTENANCE AND INSPECTION OF BYLAWS. The corporation shall keep at its principal executive office, or if its principal executive office is not in the State of California, at its principal business office in this state, the original or a copy of the bylaws as amended to date, which shall be open to inspection by the shareholders at all reasonable times during office hours. If the principal executive office of the corporation is outside the State of California and the corporation has no principal business office in this state, the Secretary shall, upon the written request of any shareholder, furnish to that shareholder a copy of the bylaws as amended to date. SECTION 3. MAINTENANCE AND INSPECTION OF OTHER CORPORATE RECORDS. The accounting books and records and minutes of proceedings of the shareholders and the board of directors and any committee or committees of the board of directors shall be kept at such place or places designated by the board of directors or, in the absence of such designation, at the principal executive office of the corporation. The minutes shall be kept in written form and the accounting books and records shall be kept either in written form in any other form capable of being converted into written form. The minutes and accounting books and records shall be open to inspection upon the written demand of any shareholder or holder of a voting trust certificate, at any reasonable time during usual business hours, for a purpose reasonably related to the holder's interests as a shareholder or as the holder of a voting trust certificate. The inspection may be made in person or by an agent or attorney, and shall include he right to copy and make extracts. These rights of inspection shall extend to the records of each subsidiary corporation of the corporation. SECTION 4. INSPECTION BY DIRECTORS. Every director shall have the absolute right at any reasonable time to inspect all books, records and documents of every kind and the physical properties of the corporation and each of its subsidiary corporations. This inspection by a director may be made in person or by an agent or attorney and the right of inspection includes the right to copy and make extracts of documents. SECTION 5. ANNUAL REPORT TO SHAREHOLDERS. The annual report to shareholders referred to in Section 1501 of the Corporations Code of California is expressly dispensed with, but nothing herein shall be interpreted as prohibiting the board of directors from issuing annual or other periodic reports to the shareholders of the corporation as they consider appropriate. SECTION 6. FINANCIAL STATEMENTS. A copy of any annual financial statement and any income statement of the corporation for each quarterly period of each fiscal year, and any accompanying balance sheet of the corporation as of the end of each such period, that has been prepared by the corporation shall be kept on file in the principal executive office of the corporation for twelve (12) months and each such statement shall be exhibited at all reasonable times 14. to any shareholder demanding an examination of any such statement or a copy shall be mailed to any such shareholder. If a shareholder or shareholders holding at least five percent (5%) of the outstanding shares of any class of stock of the corporation makes a written request to the corporation for an income statement of the corporation for the three-month, six-month or nine-month period of the then current fiscal year ended more than thirty (30) days before the date of the request, and a balance sheet of the corporation as of the end of that period, the chief financial officer shall cause that statement to be prepared, if not already prepared, and shall deliver personally or mail that statement or statements to the person making the request within thirty (30) days after the receipt of the request. If the corporation has not sent to the shareholder an annual report which is available for the last fiscal year, this report shall likewise be delivered or mailed to the shareholder within thirty (30) days after the request. The corporation shall also, on the written request of any shareholder, mail to the shareholder a copy of the last annual, semi-annual or quarterly income statement which it has prepared, and a balance sheet as of the end of that period. The quarterly income statements and balance sheets referred to in this section shall be accompanied by the report, if any, of any independent accountants engaged by the corporation or the certificate of an authorized officer of the corporation that the financial statements were prepared without audit from the books and records of the corporation. SECTION 7. ANNUAL STATEMENT OF GENERAL INFORMATION. The corporation shall, by the end of the calendar month of the anniversary date of its incorporation each year, file with the Secretary of State of the State of California, on the prescribed form, a statement setting forth the authorized number of directors, the number of any vacancies on the board, the names and complete business or residence addresses of all incumbent directors, the names and complete business or residence addresses of the chief executive officer, secretary and chief financial officer, the street address of its principal executive office, if the principal executive office is not in this state, the principal business office in this state, and the general type of business constituting the principal business activity of the corporation, together with a designation of the agent of the corporation for the purpose of service of process, all in compliance with Section 1502 of the Corporations Code of California. ARTICLE VII GENERAL CORPORATE MATTERS SECTION 1. RECORD DATE FOR PURPOSES OTHER THAN NOTICE AND VOTING. For purposes of determining the shareholders entitled to receive payment of any dividend or other distribution or allotment of any rights or entitled to exercise any rights in respect of any other lawful action, the board of directors may fix, in advance, a record date, which shall not be more than sixty (60) days before any such action, and in that case only shareholders of record on the date so fixed are entitled to receive the dividend, distribution, 15. allotment, rights or to exercise the rights, as the case may be, notwithstanding any transfer of any shares on the books of the corporation after the record date so fixed, except as otherwise provided in the Corporations Code of California. If the board of directors does not so fix a record date, the record date for determining shareholders for any such purpose shall be at the close of business on the day on which the board adopts the applicable resolution or the sixtieth (60th) day before the date of that action, whichever is later. SECTION 2. CHECKS, DRAFTS, EVIDENCES OF INDEBTEDNESS. All checks, drafts or other orders for payment of money, notes or other evidences of indebtedness, issued in the name of or payable to the corporation, shall be signed or endorsed by such person or persons and in such manner as from time to time determined by resolution of the board of directors. SECTION 3. CORPORATE CONTRACTS AND INSTRUMENTS; HOW EXECUTED. The board of directors, except as otherwise provided in these bylaws, may authorize any officer or officers, agent or agents, to enter into any contract or execute any instrument in the name of and on behalf of the corporation, and this authority may be general or confined to specific instances; and, unless so authorized or ratified by the board of directors or within the agency power of an officer, no officer, agent or employee shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or for any amount. SECTION 4. CERTIFICATE FOR SHARES. A certificate or certificates for shares of the capital stock of the corporation may be issued to each shareholder when any of these shares are fully paid, and the board of directors may authorize the issuance of certificates or shares as partly paid provided that these certificates shall state the amount of consideration to be paid for them and the amount paid. All certificates shall be signed in the name of the corporation by the chairman of the board or vice chairman of the board or the president or vice president and by the chief financial officer or an assistant treasurer or the secretary or any assistant secretary, certifying the number of shares and the class or series of shares owned by the shareholder. Any or all of the signatures on the certificate may be facsimile. In the event that any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed on a certificate shall have ceased to be that officer, transfer agent or registrar before that certificate is issued, it may be issued by the corporation with the same effect as if that person were an officer, transfer agent or registrar at the date of issue. Notwithstanding any provision in these bylaws to the contrary, the board of directors of the corporation may issue, record and transfer its shares of capital stock by electronic or other means not involving any issuance of certificates, including provisions for notice to purchasers in substitution for the required statements on certificates required by the Corporations Code of California, and as may be required by the California Commissioner of Corporation in administering the California Corporate Securities Law of 1968, which has been (1) approved by the United States Securities and Exchange Commission, (2) is authorized in any statute of the United States or (3) is in accordance with Division 8 (commencing with Section 801) of the California Commercial Code. If 16. the board of directors implements the provisions of this paragraph, the provisions shall not become effective as to previously issued and outstanding certificated shares until the certificates therefor have been surrendered to the corporation. SECTION 5. LOST CERTIFICATES. Except as provided in this Section 5, no new certificate for shares shall be issued to replace an old certificate unless the latter is surrendered to the corporation and canceled at the same time. The board of directors may, in case any share certificate or certificate for any other security is lost, stolen or destroyed, authorize the issuance of a replacement certificate on such terms and conditions as the board may require, including provision for indemnification of the corporation secured by a bond or other adequate security sufficient to protect the corporation against any claim that may be made against it, including any expense or liability on account of the alleged loss, theft or destruction of the certificate or the issuance of the replacement certificate. SECTION 6. REPRESENTATION OF SHARES OF OTHER CORPORATIONS. The chairman of the board, the president, any vice president or any other person authorized by resolution of the board of directors or by any of the foregoing designated officers, is authorized to vote on behalf of the corporation any and all shares of any other corporation or corporations, foreign or domestic, standing in the name of the corporation. The authority granted to these officers to vote or represent on behalf of the corporation any and all shares held by the corporation in any other corporation or corporations may be exercised by any of these officers in person or by any person authorized to do so by a proxy duly executed by these officers. SECTION 7. CONSTRUCTION AND DEFINITIONS. Unless the context requires otherwise, the general provisions, rules of construction and definitions in the Corporations Code of California shall govern the construction of these bylaws. Without limiting the generality of this provision, the singular number includes the plural, the plural number includes the singular and the term "person" includes both a corporation and a natural person. ARTICLE VIII AMENDMENTS SECTION 1. AMENDMENT BY SHAREHOLDERS. New bylaws may be adopted or these bylaws may be amended or repealed by the vote of a majority of the outstanding shares entitled to vote; provided, however, that (i) if the articles of incorporation of the corporation set forth the number of authorized directors of the corporation, the authorized number of directors may be changed only by an amendment of the articles of incorporation, and (ii) Article II, Sections 2, 3, 8 and 10, Article III, Sections 2 and 4 and this Article VIII, Section 1 of these bylaws may be altered, amended or repealed by the affirmative vote of at least sixty-six and two-thirds percent (66-2/3%) of the outstanding shares of the outstanding shares entitled to vote. SECTION 2. AMENDMENT BY DIRECTORS. Subject to the rights of the shareholders as provided in Section 1 of this Article VIII, bylaws other than a bylaw or an amendment of a bylaw changing the authorized number of directors may be adopted, amended or repealed by the board of directors. 17. ARTICLE IX INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND AGENTS SECTION 1. DIRECTOR. The corporation shall indemnify its directors to the fullest extent not prohibited by the Corporations Code of California; provided, however, that the corporation may limit the extent of such indemnification by individual contracts with its directors; and, provided, further, that the corporation shall not be required to indemnify any director in connection with any proceeding (or part thereof) initiated by such person or any proceeding by such person against the corporation or its directors, officers, employees or other agents unless (i) such indemnification is expressly required to be made by law, (ii) the proceeding was authorized by the board of directors of the corporation or (iii) such indemnification is provided by the corporation, in its sole discretion, pursuant to the powers vested in the corporation under the Corporations Code of California. SECTION 2. OFFICERS, EMPLOYEES AND OTHER AGENTS. The corporation shall have power to indemnify its officers, employees and other agents as set forth in the Corporations Code of California. SECTION 3. DETERMINATION BY THE CORPORATION. Promptly after receipt of a request for indemnification hereunder (and in any event within 90 days thereof), a reasonable, good faith determination as to whether indemnification of the director is proper under the circumstances because such director has met the applicable standard of care shall be made by: (a) a majority vote of a quorum consisting of directors who are not parties to such proceeding; (b) if such quorum is not obtainable, by independent legal counsel in a written opinion; or (c) approval or ratification by the affirmative vote of a majority of the shares of this corporation represented and voting at a duly held meeting at which a quorum is present (which shares voting affirmatively also constitute at least a majority of the required quorum) where the shares owned by the person to be indemnified shall not be considered entitled to vote thereon. SECTION 4. GOOD FAITH. (a) For purposes of any determination under this bylaw, a director shall be deemed to have acted in good faith and in a manner he reasonably believed to be in the best interests of the corporation and its shareholders, and, with respect to any criminal action or proceeding, to have had no reasonable cause to believe that his conduct was unlawful, if his action is based on information, opinions, reports and statements, including financial statements and other financial data, in each case prepared or presented by: 18. (1) one or more officers or employees of the corporation whom the director believed to be reliable and competent in the matters presented; (2) counsel, independent accountants or other persons as to matters which the director believed to be within such person's professional competence; and (3) a committee of the Board upon which such director does not serve, as to matters within such committee's designated authority, which committee the director believes to merit confidence; so long as, in each case, the director acts without knowledge that would cause such reliance to be unwarranted. (b) The termination of any proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in the best interests of the corporation and its shareholders or that he had reasonable cause to believe that his conduct was unlawful. (c) The provisions of this Section 4 shall not be deemed to be exclusive or to limit in any way the circumstances in which a person may be deemed to have met the applicable standard of conduct set forth by the Corporations Code of California. SECTION 5. EXPENSES. The corporation shall advance, prior to the final disposition of any proceeding, promptly following request therefor, all expenses incurred by any director in connection with such proceeding upon receipt of an undertaking by or on behalf of such person to repay said amounts if it shall be determined ultimately that such person is not entitled to be indemnified under this bylaw or otherwise. SECTION 6. ENFORCEMENT. Without the necessity of entering into an express contract, all rights to indemnification and advances to directors under this bylaw shall be deemed to be contractual rights and be effective to the same extent and as if provided for in a contract between the corporation and the director. Any right to indemnification or advances granted by this bylaw to a director shall be enforceable by or on behalf of the person holding such right in the forum in which the proceeding is or was pending or, if such forum is not available or a determination is made that such forum is not convenient, in any court of competent jurisdiction if (i) the claim for indemnification or advances is denied, in whole or in part, or (ii) no disposition of such claim is made within ninety (90) days of request therefor. The claimant in such enforcement action, if successful in whole or in part, shall be entitled to be paid also the expense of prosecuting his claim. The corporation shall be entitled to raise as a defense to any such action (other than an action brought to enforce a claim for expenses incurred in connection with any proceeding in advance of its final disposition when the required undertaking has been tendered to the corporation) that the claimant has not met the standards of conduct that make it permissible under the Corporations Code of California for the corporation to indemnify the claimant for the amount claimed. Neither the failure of the corporation (including its board of directors, independent legal counsel or its shareholders) to have made a determination prior to the commencement of such action that indemnification of the claimant is proper in the circumstances because he has met the applicable standard of conduct set forth in the Corporations Code of California, nor an actual determination by the corporation 19. (including its board of directors, independent legal counsel or its shareholders) that the claimant has not met such applicable standard of conduct, shall be a defense to the action or create a presumption that claimant has not met the applicable standard of conduct. SECTION 7. NON-EXCLUSIVITY OF RIGHTS. To the fullest extent permitted by the corporation's articles of incorporation and the Corporations Code of California, the rights conferred on any person by this bylaw shall not be exclusive of any other right which such person may have or hereafter acquire under any statute, provision of the articles of incorporation, bylaws, agreement, vote of shareholders or disinterested directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding office. The corporation is specifically authorized to enter into individual contracts with any or all of its directors, officers, employees or agents respecting indemnification and advances, to the fullest extent permitted by the Corporations Code of California and the corporation's articles of incorporation. SECTION 8. SURVIVAL OF RIGHTS. The rights conferred on any person by this bylaw shall continue as to a person who has ceased to be a director and shall inure to the benefit of the heirs, executors and administrators of such a person. SECTION 9. INSURANCE. The corporation, upon approval by the board of directors, may purchase insurance on behalf of any person required or permitted to be indemnified pursuant to this bylaw. SECTION 10. AMENDMENTS. Any repeal or modification of this bylaw shall only be prospective and shall not affect the rights under this bylaw in effect at the time of the alleged occurrence of any action or omission to act that is the cause of any proceeding against any agent of the corporation. SECTION 11. EMPLOYEE BENEFIT PLANS. The corporation shall indemnify the directors and officers of the corporation who serve at the request of the corporation as trustees, investment managers or other fiduciaries of employee benefit plans to the fullest extent permitted by the Corporations Code of California, and any other applicable laws. SECTION 12. SAVING CLAUSE. If this bylaw or any portion hereof shall be invalidated on any ground by any court of competent jurisdiction, then the corporation shall nevertheless indemnify each director to the fullest extent permitted by any applicable portion of this bylaw that shall not have been invalidated, or by any other applicable law. SECTION 13. CERTAIN DEFINITIONS. For the purposes of this bylaw, the following definitions shall apply: (a) The term "proceeding" shall be broadly construed and shall include, without limitation, the investigation, preparation, prosecution, defense, settlement and appeal of any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative, arbitrative or investigative. 20. (b) The term "expenses" shall be broadly construed and shall include, without limitation, court costs, attorneys' fees, witness fees, fines, amounts paid in settlement or judgment and any other costs and expenses of any nature or kind incurred in connection with any proceeding, including expenses of establishing a right to indemnification under this bylaw or any applicable law. (c) The term the "corporation" shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, and employees or agents, so that any person who is or was a director, officer, employee or agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under the provisions of this bylaw with respect to the resulting or surviving corporation as he would have with respect to such constituent corporation if its separate existence had continued. (d) References to a "director," "officer," "employee" or "agent" of the corporation shall include, without limitation, situations where such person is serving corporation as a director, officer, employee, trustee or agent of another corporation, partnership, joint venture, trust or other enterprise. 21. EX-10.10 3 ex10-10.txt EXHIBIT 10.10 FIRST AMENDMENT TO INDUSTRIAL REAL ESTATE LEASE This FIRST AMENDMENT TO INDUSTRIAL REAL ESTATE LEASE ("FIRST AMENDMENT"), is made and entered into as of March 19, 2001 (the FIRST AMENDMENT DATE"), by and between MAJESTIC-FULLERTON ROAD, LLC, a California limited liability company and PFG FULLERTON LIMITED PARTNERSHIP, an Iowa limited partnership (collectively, as "LANDLORD"), and HOT TOPIC ADMINISTRATION, INC., a California Corporation (as "TENANT'). RECITALS: A. Tenant and Majesty Realty Co., a California Corporation and Patrician Associates, Inc., a California corporation predecessor-in-interest to Landlord entered into that certain Industrial Real Estate Lease (the "LEASE"), dated December 10, 1998, whereby Landlord leased to Tenant and Tenant leased from Landlord approximately 125,000 square feet of space (the "EXISTING PROPERTY") in the building commonly known as 18305 East San Jose Avenue, City of Industry, California. B. Tenant desires to expand the Existing Property to include that certain adjacent space which is in the Project, consisting of approximately 125,000 square feet ("EXPANSION SPACE") in the building commonly known as 18305 East San Jose Avenue, City of Industry, California, as delineated on Exhibit "A" attached hereto and made a part hereof. C. The parties desire to amend the Lease on the terms and conditions set forth in this First Amendment. AGREEMENT: NOW, THEREFOR, in consideration of the foregoing recitals and the mutual covenants contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: 1. TERMS. All undefined terms when used herein shall have the same respective meanings as are given such terms in the Lease unless expressly provided otherwise in this First Amendment. 2. PROPERTY. 2.1 TENANT'S ACCEPTANCE OF THE PROPERTY. Effective as of August 1, 2001 ("EXPANSION SPACE COMMENCEMENT Date"), the "Property" shall contain approximately 250,000 square feet of space in the Project and shall consist of the Existing Property and the Expansion Space. Tenant shall accept the Property in its presently existing, "as is" condition and Landlord has made no representation or warranty with regard to the condition of the Property of the Property or the suitability thereof for Tenant's business, nor shall Landlord be obligated to provide or pay for any improvement work or services related to the improvement of the Property; provided, however, Landlord, at its sole cost and expense, shall, at such time as is mutually agreeable to Landlord and Tenant, remove the presently existing demising wall as set forth on Exhibit "A" attached hereto ("LANDLORDS WORK"). Landlord shall use Landlord's standard building materials and finishes in the construction of Landlords Work. Since Tenant may be occupying a portion of the Property pursuant to the Lease; as amended by this First Amendment, while Landlord is performing Landlord's Work, Landlord agrees that it shall use commercially reasonable efforts to perform Landlord's Work in a manner so as to minimize interference with Tenant's business. Tenant hereby acknowledges that, notwithstanding Tenant's occupancy of a portion of the Property during the performance of Landlord's Work, Landlord shall be permitted to perform Landlord's Work during normal business hours, and Tenant shall provide a clear working area for Landlord's Work (including, but not limited to, the moving of furniture, fixtures and Tenant's property away from the area Landlord is conducting Landlord's Work). Tenant hereby agrees that the performance of Landlord's Work shall in no way constitute a constructive eviction of Tenant not entitle Tenant to, if any, abatement of rent. Landlord shall have no responsibility or for any reason be liable to Tenant for any direct or indirect injury to or interference with Tenant's business arising from Landlords Work, nor shall Tenant be entitled to any compensation or damages from Landlord for loss of the use of whole or any part of the Property, for loss of or damage to Tenant's personal property, merchandise, fixtures or improvements, or for any inconvenience or annoyance resulting form Landlord's Work or for Landlord's actions in connection with Landlord's Work. 2.2 RESTORATION OF THE DEMISING WALL. Prior to the termination of this Lease, Tenant, at Tenant's sole cost and expense, shall restore the above referenced demising wall. 3. RENT. 3.1 BASE RENT. Effective as of the Expansion Space Commencement Date, the monthly Base Rent for the Property shall be NINETY-FOUR THOUSAND THREE HUNDRED TWENTY-FIVE AND NO/100 DOLLARS ($94,325.00). 3.2 PREPAID RENT. Concurrent with Tenant's execution and delivery of this First Amendment, Tenant shall deliver to Landlord a check payable to Landlord in the amount of FIFTY THOUSAND FIVE HUNDRED SEVENTY-FIVE AND NO/100 DOLLARS ($50,757.00), which amount represents the first month's rent due for the Expansion Space. 3.3 TENANT'S SHARE. Effective as of the Expansion Space Commencement Date, Section 1.12(b)(iv) is deleted in its entirely and the following is substituted in place thereof: "Tenant's Initial Pro Rata Share of Common Area Expenses is 100%." 3.4 LANDSCAPE FEE. Effective as of the Expansion Space Commencement Date, the Landscape Fee shall commence at an amount equal to ONE THOUSAND TWO HUNDRED FIFTY AND NO/100 DOLLARS ($1,250.00); provided however Landlord and Tenant acknowledge that such amount may be adjusted in accordance to the terms of Article 16 of the Lease, as amended by this First Amendment. 4. SECURITY DEPOSIT. Concurrently with Tenant's execution and delivery of this First Amendment, Tenant shall deposit with Landlord an additional Security Deposit in an amount equal to FIFTY THOUSAND FIVE HUNDRED SEVENTY-FIVE AND NO/100 DOLLARS ($50,575.00) as additional security for the performance by Tenant of its obligation under the Lease, as amended by this First Amendment. 5. DELETIONS. Effective as of the Expansion Space Commencement Date, Article 17 of the Lease are hereby deleted and shall be of no further force or effect. 6. BROKERS. The parties recognize that the only brokers involved in the negotiation of this First Amendment are Majestic Realty Co. and The Staubach Company and agree that Landlord shall be solely responsible for the payment of any "Brokerage Commission" to such broker. Each party represents and warrants to the other that they have not dealt with any other broker in connection with the negotiation and consummation of this First Amendment and they each know of no other real estate broker, agent or finder who is, or might be, entitled to a commission or compensation in connection with this First Amendment. Each party agrees to indemnify and defend the other party against, and hold the other party harmless from, any and all claims, demands, losses, liabilities, damages, lawsuits, judgments, and costs and expenses (including, without limitation, reasonable attorneys' fees and costs) with respect to any leasing commission or equivalent compensation alleged to be owing on account of the indemnifying party's dealings with any other real estate broker or agent. 7. NO OTHER MODIFICATIONS. Except as otherwise provided herein, all other terms and provisions of the Lease shall remain in full force and effect, unmodified by this First Amendment. 8. BINDING EFFECT. The provisions of this First Amendment shall be binding upon and inure to the benefit of the heirs, representatives, successors and permitted assigns of the parties hereto. 9. AUTHORITY. The parties represent and warrant that they have the requisite authority to bind the entity on whose behalf they are signing. 10. COUNTERPARTS. This First Amendment may be executed in any number of original counterparts. Any such counterpart, when executed, shall constitute an original of this First Amendment, and all such counterparts together shall constitute one and the same First Amendment. IN WITNESS WHEREOF, the parties have entered into this First Amendment as of the date first set forth above. "LANDLORD" "TENANT" MAJESTIC-FULLERTON ROAD, LLC, HOT TOPIC ADMINISTRATION, INC. a California limited liability company a California corporation By: MAJESTIC REALTY CO., By: /s/ Betsy McLaughlin a California corporation, its sole member Its: BETSY MCLAUGHLIN, PRESIDENT By: By: /s/ Marc Bertone --------------------------------- ----------------------------- Its: Its: MARC BERTONE, VICE PRESIDENT --------------------------- ------------------------ PFG FULLERTON LIMITED PARTNERSHIP, an Iowa limited partnership By: PATRICIAN ASSOCIATES, INC., a California corporation, its general partner By: ------------------------------- Its: -------------------------- By: ------------------------------- Its: ------------------------- GUARANTOR HEREBY ACKNOWLEDGES AND AGREES TO THE TERMS OF THIS FIRST AMENDMENT TO INDUSTRUAL REAL ESTATE LEASE AS OF THE DATE FIRST SET FORTH ABOVE. HOT TOPIC, INC. a California corporation By: /s/ Betsy McLaughlin -------------------------------- Its: BETSY MCLAUGHLIN, PRESIDENT By: /s/ Marc Bertone -------------------------------- Its: MARC BERTONE, VICE PRESIDENT ------------------------- EX-10.11 4 hottopic_empagmt.txt EMPLOYMENT AGREEMENT - ELIZABETH MCLAUGHLIN EMPLOYMENT AGREEMENT -------------------- This EMPLOYMENT AGREEMENT (this "AGREEMENT") is made and entered into effective as of January 22, 2001 (the "Effective Date"), by and between Hot Topic, Inc., a California corporation (the "COMPANY"), and Elizabeth McLaughlin ("EXECUTIVE"), with reference to the following facts. The Company and the Executive are hereinafter collectively referred to as the "PARTIES," and individually referred to as a "PARTY." A. The Company desires assurance of the continued association and services of Executive in order to retain Executive's experience, skills, abilities, background and knowledge, and is willing to engage Executive's services on the terms and conditions set forth in this Agreement. B. Executive desires to be in the employ of the Company, and is willing to accept such employment upon the terms and conditions herein set forth. NOW, THEREFORE, in consideration of the foregoing premises and the mutual covenants herein contained, the Parties agree as follows: 1. EMPLOYMENT. 1.1 The Company hereby employs Executive, and Executive hereby accepts employment by the Company, upon the terms and conditions set forth in this Agreement, for the period commencing the Effective Date and ending January 30, 2003 (the "TERM"). On January 30, 2003, and on January 30 of each year thereafter, the Term shall automatically be extended by one (1) year unless written notice has been provided by either Party pursuant to Section 4.1(d) below no fewer than ninety (90) days prior to the date of such automatic renewal (a "NON-RENEWAL NOTICE"). Notwithstanding anything herein to the contrary: (a) either Party may terminate Executive's employment under this Agreement at any time, with or without cause, subject to the terms and conditions of Section 4 below and (b) the Parties may mutually agree to extend the Term of this Agreement beyond that which is provided for herein at any time so long as it is in writing and executed by Executive and an authorized representative of the Board of Directors of the Company (the "BOARD"). 1.2 Executive shall have the title of Chief Executive Officer and President and shall serve in such other capacity or capacities as the Board may from time to time prescribe. Executive shall report to the Board. Executive shall relinquish the title of President if and when the Board and Executive determine that it is necessary to appoint another individual as President in order to attract or retain such individual as a senior officer of the Company and such relinquishment of the title of President shall not constitute "good reason" under Paragraph 5.4(b) hereof. 1.3 Executive shall do and perform all services, acts or things necessary or advisable to manage and conduct the business of the Company and which are normally associated with the position of Chief Executive Officer, consistent with the bylaws of the Company and as required by the Board. 1.4 The employment relationship between the Parties shall be governed by the policies and practices established by the Board, except that when the terms of this Agreement differ from or are in conflict with the Company's policies or practices, this Agreement shall control. 1.5 Unless the Parties otherwise agree in writing, during the Term of this Agreement, Executive shall perform the services Executive is required to perform pursuant to this Agreement at the Company's headquarters offices located in California; provided, however, that the Company may from time to time require Executive to travel temporarily to other locations in connection with the Company's business. 2. LOYAL AND CONSCIENTIOUS PERFORMANCE; NONCOMPETITION. Executive's entire business time, attention, energies, skills, learning and best efforts shall be devoted to the performance of Executive's duties; provided, however, that this Section 2 shall not be construed as preventing Executive from participating in social, civic or professional associations or engaging in passive outside investment activities which may require a limited portion of time and effort to manage, consistent with any Company, Board of Director or employment policies, so long as such activities do not interfere materially with Executive's performance of her duties nor compete, in any way, with the products or services offered (or intended for offer) by or through the Company; and provided, Farther, that in the event the Board, in good faith, shall ever determine that such activities so compete (or are likely to so compete), then Executive agrees to terminate such activities within a reasonable time promptly upon the request of the Board. 3. COMPENSATION OF EXECUTIVE. 3.1 For all services rendered by Executive to the Company, the Company shall pay/provide to Executive the following (collectively, the "COMPENSATION PACKAGE"): (a) base compensation in the amount of $400,000 per annum (the "BASE SALARY"); (b) such periodic bonuses as may be earned in accordance with the bonus parameters established by the Board (or any committee of the Board which is appointed to consider matters relating to compensation) and communicated to Executive in writing, with the bonus parameters for the year ended January 30, 2002 to be as set forth in Exhibit A attached hereto (the "BONUS PLAN") and the bonus parameters (but not necessarily the resulting bonus) for subsequent years during the Term being no less favorable to Executive than those set forth in Exhibit A; (c) such grants of equity-based compensation ~ option grants to purchase common stock of the Company), if any, as may be earned in accordance with the equity award parameters established by the Board (or any committee of the Board which is appointed to consider matters relative to equity-based compensation) and communicated to Executive in writing, with the equity award parameters for the year ended January 30, 2002 to be as set forth in Exhibit B attached hereto (the "OPTION PLAN") and the equity-based compensation parameters 2 (but not necessarily the resulting equity-based compensation) for subsequent years during the Term being no less favorable to Executive than those set forth in Exhibit B; (d) such medical and life insurance and participation in other benefit plans (the "BENEFITS PACKAGE"), to be set forth on Exhibit C; and (e) an annual amount of vacation days consistent with amounts available for other executive employees of the Company. 3.2 The Base Salary may be adjusted upward from time to time in the sole discretion of the Board (or any committee of the Board which is appointed to consider matters relating to compensation). Compensation under the Compensation Package shall be paid to Executive less required deductions for Social Security, withholding taxes and other authorized deductions and at times when employees of the Company normally receive their compensation. 4. TERMINATION. 4.1 TERMINATION BY THE COMPANY. Executive's employment with the Company may be terminated under the following conditions: (a) DEATH OR DISABILITY. Executive's employment with the Company shall terminate effective upon the date of Executive's death or Complete Disability (as defined in Section 5.4(a) below). (b) FOR CAUSE. The Company may terminate Executive's employment under this Agreement for "Cause" (as defined in Section 5.4(c) below) by delivery or written notice to Executive specifying the cause or causes relied upon for such termination. Any notice of termination given pursuant to this Section 4.1(b) shall effect termination as of the date specified in such notice or, in the event no date is specified, on the last day of the month in which such notice is delivered or deemed delivered as provided in Section 11 below. (c) WITHOUT CAUSE. The Company may terminate Executive's employment under this Agreement at any time and for any reason by delivery of no fewer than 90 days' written notice of such termination to the Executive. Any notice of termination given pursuant to this Section 4.1(c) shall effect termination as of the date specified in such notice or, in the event no date is specified, on the last day of the third month following the month in which such notice is delivered or deemed delivered as provided in Section 11 below. (d) NON-RENEWAL NOTICE. The Company may terminate this Agreement by providing Executive with a Non-Renewal Notice no fewer than 90 days prior to the date of automatic renewal, as provided in Section 1.1 above. 4.2 TERMINATION BY EXECUTIVE. Executive may terminate her employment with the Company (a) for "Good Reason" (as defined in Section 5.4(b) below) by delivery of no fewer than 45 days' written notice to the Company specifying the "Good Reason" relied upon by Executive for such termination, provided that such notice is delivered within sixty (60) days following the occurrence of any event or events constituting Good Reason or (b) by submitting a 3 written resignation effective 90 days thereafter at any time during the Term without Good Reason. 4.3 TERMINATION BY MUTUAL AGREEMENT OF THE PARTIES. Executive's employment pursuant to this Agreement may be terminated, at any time upon a mutual agreement in writing of the Parties. Any such termination of employment shall have the consequences specified in such agreement. 5. COMPENSATION UPON TERMINATION. 5.1 DEATH OR COMPLETE DISABILITY. If Executive's employment shall be terminated by death or Complete Disability as provided in Section 4.1(a), the Parties shall have no obligation to one another under this Agreement other than the Company shall pay Executive her accrued Base Salary and accrued and unused vacation benefits earned through the date of termination at the rate in effect at the time Executive's employment is deemed terminated. 5.2 FOR CAUSE OR WITHOUT GOOD REASON. If the Company terminates Executive's employment for Cause or Executive terminates her employment hereunder without Good Reason, the Parties shall have no obligation to one another under this Agreement other than the Company shall pay Executive her accrued Base Salary and accrued and unused vacation benefits earned through the date of termination at the rate in effect at the time Executive's employment is deemed terminated. 5.3 WITHOUT CAUSE, FOR GOOD REASON OR PURSUANT TO NON-RENEWAL NOTICE. If Executive shall terminate Executive's employment with the Company for Good Reason or the Company shall terminate Executive's employment without Cause or the Company provides Executive with a Non-Renewal Notice prior to the date of automatic renewal as provided in Section 1.1, then Executive shall immediately upon such termination of employment become a consultant to the Company and shall be entitled to the following: (a) Executive's accrued but unpaid Base Salary and accrued and unused vacation earned through the date of termination of employment, with all such payments subject to standard deductions and withholdings; (b) an amount equal to Executive's Base Salary in effect at the time of termination, payable over twelve (12) months in accordance with the Company's standard payroll policies in effect at the time of termination, less any amounts that Executive at any time actually receives directly or indirectly from employment or consulting services performed during the Consulting Period and (c) continuation of the Benefits Package and continued vesting of all unvested stock options for the twelve (12) month period of payment provided in subparagraph (b). Executive shall remain a consultant to the Company for a period of twelve (12) months immediately following such employment termination (the "CONSULTING PERIOD"). As a consultant, Executive's duties shall include those matters reasonably requested by the Board, but which shall not interfere (as to time required) with the opportunity to maintain other employment consistent with this Section 5.3, and which shall not require in excess of ten (10) hours per month of Executive's time. Payment of the amounts and provision of the benefits described in this Section 5.3 shall be conditioned upon Executive executing and delivering to the Company a form of release in form attached as Exhibit ID hereto(the "RELEASE") and, if Executive is then serving as a member of the Board of Directors of the Company, Executive's resignation as a Director. During the Consulting Period under this section 5.3, Executive agrees that Executive shall not: 4 (a) Induce or attempt to include any person who is an employee, agent or consultant of the Company to leave the employ of the Company; or (b) Take any other action materially inimical to the interests of the Company. 5.4 DEFINITIONS. For purposes of this Agreement, the following terms shall have the following meanings: (a) "COMPLETE DISABILITY" shall mean the inability of Executive to perform Executive's duties under this Agreement because Executive has become permanently disabled within the meaning of any policy of disability income insurance covering employees of the Company then in force. In the event the Company has no policy of disability income insurance covering employees of the Company in force when Executive becomes disabled, the term "COMPLETE DISABILITY" shall mean the inability of Executive to perform Executive's duties under this Agreement by reason of any incapacity, physical or mental, which the Board, based upon medical advice or an opinion provided by a licensed physician acceptable to the Board, determines to have incapacitated Executive from satisfactorily performing all of Executive's usual services for the Company for a period of at least one hundred twenty (120) days during any twelve (12) month period (whether or not consecutive). Based upon such medical advice or opinion, the determination of the Board shall be final and binding and the date such determination is made shall be the date of such Complete Disability for purposes of this Agreement. (b) "GOOD REASON" for Executive to terminate Executive's employment hereunder shall mean the occurrence of any of the following events without Executive's consent: (i) The regular assignment to Executive of duties materially inconsistent with the position and status of Executive as set forth in this Agreement; (ii) A substantial alteration in the nature, status or prestige of. Executive's responsibilities as set forth in this Agreement or a change in Executive's title or reporting level from that set forth in this Agreement; (iii) The relocation of the Company's executive offices or principal business location to a point more than fifty (50) miles from its location within the state of California as of the Effective Date; (iv) A failure by the Company to obtain from any successor, before the succession takes place, an agreement to assume and perform all of the terms and conditions of this Agreement; (v) A reduction by the Company of Executive's Base Salary as initially set forth herein or as the same may be increased from time to time, except for across-the-board salary reductions approved by sixty-six and two-thirds percent (66 2/3 %) of the Board similarly affecting all management personnel of the Company; 5 (vi) Any action by the Company (including the elimination of benefit plans without providing substitutes thereof or the reduction of Executive's benefits thereunder) that would substantially diminish the aggregate value of Executive's Benefits Package as they exist at such time; or (vii) The creation by the Board of a work environment that is openly hostile or designed to elicit or encourage Executive's resignation. (c) "FOR CAUSE" shall mean occurrence of the following during the Term hereof: (i) Executive's (1) willful or reckless and (2) repeated failure satisfactorily to perform Executive's job duties under this Agreement after written notice to Executive and no less than a 90 day period within which prospectively to cure such failure to perform provided such failure to perform is subject to cure with the passage of time; (ii) Failure by the Executive to comply with all material applicable laws in performing Executive's job duties or in directing the conduct of the Company's business; (iii) Failure by the Executive to comply with reasonable policies of the Company or of instructions given in writing to the Executive by the Board; (iv) Commission by the Executive of any felony or intentionally fraudulent act against the Company, or its employees, agents or customers, that demonstrates Executive's untrustworthiness or lack of integrity or intentional appropriation for Executive's personal use or benefit of any material funds or properties of the Company not authorized by the Board to be so used or appropriated; or (v) Commission by the Executive of any material securities law violation or breach of the company's insider trading policies; (vi) Commission by Executive of any crime involving moral turpitude. 6. CHANGE OF CONTROL. 6.1 In the event of a Change of Control of the Company, as defined, all of Executive's unvested options that are not fully vested shall become fully vested immediately prior to effectiveness of such Change of Control whether or not Executive's employment terminates as a result of such Change of Control. For purposes of this Section 6, a Change of Control shall mean: (a) The acquisition by any individual, entity, or group (within the meaning of Section 13 (d) (3) or 14 (d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule l3d-3 promulgated under the Exchange Act) of thirty percent (30%) or more of either (A) the then outstanding shares of common stock of the Company (the "Outstanding Company Common Stock") or (B) the combined voting power of the then outstanding voting securities of the 6 Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); or (b) Individuals who, as of the date hereof, constitute the Board of Directors (the "Incumbent Board') cease for any reason to constitute at least two thirds of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by Company stockholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board of Directors; or (c) Consummation of a reorganization, merger or consolidation, or sale or other disposition of all or substantially all of the assets of the Company (a "Business Combination") unless, following such Business Combination, (A) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than sixty percent (60%) of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all substantially all of The Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as theft ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be (with respect to this subsection (A), such calculation shall be made with respect to all considerations received in exchange for, or as a consequence of, a Business Combination); or (B) no Person (excluding any corporation resulting from such Business Combination or any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, thirty percent (30%) or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination; and (C) at least two-thirds of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; (d) Approval by the stockholders of the Company of a complete liquidation or dissolution of the Company; or (e) Occurrence of any of the events listed in 6(a) through 6(d) above in respect of any subsidiary (meaning any entity over which the Company has voting control) of the Company that, immediately prior to the relevant event, constituted at least fifty percent (50%) of 7 The Company's consolidated assets or, for the fiscal year prior to the event, contributed at least fifty percent (50%) or more of the Company's consolidated revenues. 7. PAYMENT LIMITATIONS. All payments to Executive hereunder shall be reduced by applicable local, state and federal withholding requirements. Should any payments hereunder be determined by the Company's independent public accounting firm to be in excess of federal or state Golden Parachute limitations (currently Internal Revenue Code Section 2800) after having taken all steps reasonably that may be taken by the Company to avoid such characterization, then Executive and the Company hereby agree that such payments shall be modified so as to be one dollar less than such Golden Parachute limitations. If the determination is made after the payment(s) have been made by the Company, then Executive shall promptly refund the overpayment to Employer. 8. CONFIDENTIALITY AND INVENTIONS. Executive recognizes that the Company has and shall continue to have and develop information, knowledge and rights regarding inventions, confidential information, products, services, future plans, business affairs, processes, trade secrets, technical matters, customer lists, experimental designs and items of intellectual property. Executive agrees to execute and deliver the Proprietary Information and Inventions Agreement in use at the date hereof (which is incorporated herein by reference). 9. RESOLUTION OF DISPUTES. Any controversy, claim, action or dispute arising out of relating to this Agreement, shall be heard by a referee pursuant to the provisions of California Code of Civil Procedure ss.ss.638 through 645.1, inclusive, according to the following procedures: (a) The parties shall agree upon a single referee who shall then try all issues, whether of fact or law, and report a finding and judgment thereon, If the parties are unable to agree upon a referee within ten (10) days of a written request to do so by any party, then any party may thereafter seek to have a referee appointed pursuant to California Code of Civil Procedure ss.ss.638 and 640; (b) The parties agree that the referee shall have the power to decide all issues of fact and law and report his/her decision thereon, and to issue all legal and equitable relief appropriate under the circumstances of the controversy before him/her; provided, however, that to the extent the referee is unable to issue and/or enforce any such legal and equitable relief, either party may petition the court to issue and/or enforce such relief on the basis of the referee`s decision; (c) The California Evidence Code rules of evidence and procedure relating to the conduct of the hearing examination of witnesses and presentation of evidence shall apply; 8 (d) Any party desiring a stenographic record of the hearing may secure a court reporter to attend the hearing; provided, the requesting party notifies the other parties of the request and pays for the costs incurred for the court reporter; (e) The referee shall issue a written statement of decision which shall be reported to the court in accordance with California Code of Civil Proceduress.643 and mailed promptly to the parties; (f) Judgment may be entered on the decision of the referee in accordance with California Code of Civil Proceduress.644, and the decision may be excepted to, challenged and appealed according to law; (g) The parties shall promptly and diligently cooperate with one another and the referee, and shall perform such acts as may be necessary to obtain a prompt and expeditious resolution of the dispute or controversy in accordance with the terms hereof; and (h) The cost of such proceeding, including but not limited to the referee's fees, shall initially be borne equally by the parties to the dispute or controversy. However, the prevailing party in such proceeding shall be entitled, in addition to all other costs, to recover its contribution for the cost of the reference and its reasonable attorneys' fees as items of recoverable costs. 10. SECTION HEADINGS. The section headings or captions in this Agreement are for convenience of reference only and do not form a part hereof, and do not in any way modify, interpret or construe the intent of the Parties or affect any of the provisions of this Agreement. 11. SURVIVAL. The obligations and rights imposed upon the Parties by the provisions of this Agreement which relate to acts or events subsequent to the termination of this Agreement shall survive the termination of this Agreement and shall remain fully effective thereafter. 12. SEVERABILITY. Should any one or more of the provisions of this Agreement or of any agreement entered into pursuant to this Agreement be determined to be illegal or unenforceable in any relevant jurisdiction, then such illegal or unenforceable provision shall be modified by the proper court, if possible, but only to the extent necessary to make such provision enforceable, and such modified provision and all other provisions of this Agreement and of each other agreement entered into pursuant to this Agreement shall be given effect separately from the provision or portion thereof determined to be illegal or unenforceable and shall not be affected thereby; provided, however, that any such modification shall apply only with respect to the operation of this Agreement in the particular jurisdiction in which such determination of illegality or unenforceability is made. 9 13. NOTICES. All notices or demands of any kind required or permitted to be given by the Company or Executive under this Agreement shall be given in writing and shall be personally delivered (and receipted for) or mailed by certified mail, return receipt requested, postage prepaid, addressed as follows: 13.1 If to the Company: Chairman of the Board Hot Topic, Inc. 18305 East San Jose Avenue City of Industry, California 91784 13.2 If to Executive: At the address set forth on the Company's payroll records. Any such written notice shall be deemed received when personally delivered or three (3) days after its deposit in the United States mail as specified above. Either Party may change its address for notices by giving notice to the other Party in the manner specified in this Section 11. 14. WAIVER. The failure of either Party to enforce any provision of this Agreement shall not be construed as a waiver of any such provision, nor prevent such Party thereafter from enforcing such provision or any other provision of this Agreement. The rights granted to the Parties herein are cumulative and the election of one shall not constitute a waiver of such Party's right to assert all other legal remedies available under the circumstances. 15. PARTIES IN INTEREST. Nothing in this Agreement, whether express or implied, is intended to confer any rights or remedies under or by reason of this Agreement on any persons other than the Parties and the successors, assigns and affiliates of the Company, nor is anything in this Agreement intended to relieve or discharge the obligation or liability of any third person to any Party, nor shall any provision give any third person any right of subrogation or action over or against any Party. 16. ASSIGNMENT. This Agreement shall be binding upon and inure to the benefit of Executive and Executive's heirs, executors, personal and legal representatives, successors and assigns. Because of the unique and personal nature of Executive's duties under this Agreement, Executive may not assign this Agreement or delegate Executive's responsibilities hereunder. This Assignment shall be binding upon and inure to the benefit of the Company and its successors, assigns and legal representatives. 10 17. CHOICE OF LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of California, without regard to the conflicts of law principles thereof 18. ENTIRE AGREEMENT. Except for the Proprietary Information and Inventions Agreement, this Agreement contains the entire agreement of the Parties and no representation, inducement, promise or agreement, oral or otherwise, between the Parties not embodied herein shall be of any force or effect. No modification, termination or attempted waiver shall be valid unless in writing and signed by the Party against whom or which such modification, termination or waiver is sought to be enforced. 19. COUNTERPARTS. This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the Parties have executed this Agreement as of the Effective Date. THE COMPANY Hot Topic, Inc. By: /s/ Robert M. Jaffe ------------------------ Its: Chairman ---------------------- EXECUTIVE: /s/ Elizabeth McLaughlin --------------------------- Elizabeth McLaughlin 11 EX-10.12 5 ex10-12.txt EXHIBIT 10.12 HOT TOPIC 18305 E. San Jose Ave. EVERYTHING ABOUT THE MUSIC City of Industry, CA 91748 Office: 626-839-4681 Fax: 626-839-4686 Email: hottopic.com - -------------------------------------------------------------------------------- January 12, 2001 Jerry Cook 1900 Belwood Okemos, Michigan 48864 RE: EMPLOYMENT TERMS Dear Jerry: Hot Topic, Inc. (the "Company") is pleased to offer you the position of Chief Operating Officer, pursuant to the terms of this letter agreement ("Agreement"). 1. DUTIES You will be expected to perform various duties consistent with your position. You will report to the Company's Chief Executive Officer ("CEO"), unless otherwise assigned by the Company. You will work at our facility located in the City of Industry. 2. BASE SALARY Your base salary will be $300,000 per year, less payroll deductions and all required withholdings, which will be subject to annual review. You will be paid semi-monthly and you will be eligible for the following standard Company benefits: medical insurance, vacation, sick leave, holidays, 401k plan and Employee Stock Purchase Plan. Details about these benefit plans are available for your review. In addition, the Company plans to obtain a long-term disability policy subject to the satisfaction of the certain underwriting criteria. The Company may modify benefits from time to time, as it deems necessary. 3. BONUS In addition to your base salary, you will be eligible to earn an annual performance bonus ("Bonus") pursuant to the Company's EBIT Plan, as approved by the Board of Directors. Your target Bonus under the Plan will be fifty percent of your base salary based upon achievement of the goals set forth in the Plan. Assuming continuous employment, the Bonus will be awarded in the first quarter of the Company's fiscal year. You must be employed on the date the Bonus is awarded to be eligible for the Bonus. The Bonus will not be pro-rated in the event your employment is terminated with or without Cause (as defined below) prior to the date on which the Bonus is awarded. 4. AUTOMOBILE ALLOWANCE The Company will pay for you to have a Company leased automobile of your choice, provided that the value of the automobile does not exceed $60,000. The Company will also reimburse you for expenses including gas, insurance and maintenance for the automobile. 5. STOCK OPTIONS Upon commencement of employment and subject to approval of the Company's Board of Directors, you will be granted an Incentive Stock Option under the Company's 1996 Equity Incentive Plan to purchase 50,000 shares of the Company's Common Stock (the "Stock Option"). The Stock Option will be governed by and granted pursuant to a separate Stock Option Agreement. The exercise price per share of the Stock Option will be equal to the fair market value of the Common Stock established on the date of grant, subject to approval by the Board of Directors. The Stock Option will be subject to vesting over four (4) years so long as you continue to be employed with the Company, according to the following schedule: twenty-five percent (25%) of the shares subject to the Stock Option will vest on the last day of the twelfth full calendar month of your employment after the date of grant and the remaining shares subject to the Stock Option will vest in equal installments at the end of each monthly period thereafter for three (3) years. If you have questions regarding the tax implications of the Stock Option or any part of your compensation package, please consult with your own tax advisor. 6. TERMINATION The Company may terminate your employment at any time and for any or no reason, with or without Cause (as defined herein) or advance notice, by giving written notice of such termination. Similarly, you may terminate your employment with the Company at any time at your election, in your sole discretion, for any or no reason upon two weeks notice to the Company during which time you shall provide reasonable transition assistance to the Company. The Company reserves the right to ask you to expedite your resignation date and to leave prior to the end of the two weeks notice period. The at-will nature of your employment relationship may not be modified except by a written agreement with the CEO of the Company. If the Company terminates your employment without Cause (as defined herein), then upon your furnishing to the Company an executed release and waiver of claims (a form of which is attached hereto as Exhibit A), you shall be entitled to receive severance payments in the form of continuation of your base salary and medical insurance benefits that are in effect at the time of your termination, subject to standard payroll deductions and withholdings, for six (6) months (the "Severance Period"). If you voluntarily resign or your employment is terminated for Cause (as defined herein), all compensation and benefits will cease immediately and you will receive no additional payments from the Company other than your accrued base salary and accrued and unused vacation benefits earned through the date of your termination. For purposes of this Agreement, "Cause" shall mean (i) willful misconduct by you, including, but not limited to, dishonesty which materially and adversely reflects upon your ability to perform your duties for the Company, (ii) your conviction of, or the entry of a pleading of guilty or nolo contendere by you to, any crime involving moral turpitude or any felony, (iii) fraud, embezzlement or theft against the Company, (iv) a material breach by you of any material provision of any employment contract, assignment of inventions, confidentiality and/or nondisclosure agreement between you and the Company, or (v) your willful and habitual failure to attend to your duties as assigned by the CEO of the Company, after written notice to Executive and no less than a 90 day period to cure such failure provided such failure to perform is subject to cure with the passage of time 7. CHANGE OF CONTROL Following a Change in Control (as defined herein) the vesting of your Stock Options will be immediately accelerated such that one hundred percent (100%) of the Stock Options shall be vested and exercisable. For purposes of this Agreement, Change of Control is defined as follows: (i) a sale of all or substantially all of the assets of the Company; (ii) a merger or consolidation in which the Company is not the surviving corporation and in which beneficial ownership of securities of the Company representing at least fifty percent (50%) of the combined voting power entitled to vote in the election of Directors has changed; (iii) an acquisition by any person, entity or group within the meaning of Section 13(d) or 14(d) of the Exchange Act, or any comparable successor provisions (excluding any employee benefit plan, or related trust, sponsored or maintained by the Company or subsidiary of the Company or other entity controlled by the Company) of the beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act, or comparable successor rule) of securities of the Company representing at least fifty percent (50%) of the combined voting power entitled to vote in the election of Directors. 8. COMPANY POLICY As a Company employee, you will be expected to abide by Company rules and regulations and acknowledge in writing that you have read the Company's Employee Handbook which will govern the terms and conditions of your employment. The Company's Employee Handbook may be modified from time to time at the sole discretion of the Company. 9. PROPRIETARY INFORMATION AGREEMENT As a condition of employment, you will be required to sign and comply with the attached Proprietary Information Agreement attached hereto as Exhibit B, which prohibits unauthorized use or disclosure of the Company's proprietary information, among other things. In your work for the Company, you will be expected not to use or disclose any confidential information, including trade secrets, of any former employer or other person to whom you have an obligation of confidentiality. Rather, you will be expected to use only that information which is generally known and used by persons with training and experience comparable to your own, which is common knowledge in the industry or otherwise legally in the public domain, or which is otherwise provided or developed by the Company. During our discussions about your proposed job duties, you assured us that you would be able to perform those duties within the guidelines just described. You agree that you will not bring onto Company premises any unpublished documents or property belonging to any former employer or other person to whom you have an obligation of confidentiality. 10. ENTIRE AGREEMENT This Agreement, together with Exhibits attached hereto and the stock option documents referred to herein, forms the complete and exclusive statement of the terms of your employment with the Company. The employment terms in this Agreement supersede any other agreements or promises made to you by anyone, whether oral or written. 11. GOVERNING LAW This Agreement will be governed by and construed according to the laws of the State of California. You hereby expressly consent to the personal jurisdiction of the state and federal courts located in Los Angeles, California for any lawsuit filed there against you by the Company arising from or related to this Agreement. In the event of any litigation arising out of or relating to this Agreement, its breach or enforcement, including an action for declaratory relief, the prevailing party in such action or proceeding shall be entitled to receive his or its damages, court costs, and all out-of-pocket expenses, including attorneys fees. Such recovery shall include court costs, out-of-pocket expenses, and attorneys fees on appeal, if any. 12. SUCCESSORS AND ASSIGNS. This Agreement will be binding upon your heirs, executors, administrators and other legal representatives and will be for the benefit of the Company, its successors, and its assigns. As required by law, this offer is subject to satisfactory proof of your right to work in the United States. Sincerely, /s/ Betsy McLaughlin - ----------------------------- Betsy McLaughlin Chief Executive Officer Accepted: /s/ Jerry Cook - ----------------------------- Jerry Cook - ----------------------------- Date Attachment: Exhibit A: Waiver and Release EXHIBIT A RELEASE AND WAIVER OF CLAIMS In consideration of the payments and other benefits set forth in Section 5 of the Agreement dated ___________, to which this form is attached, I, JERRY COOK, hereby furnish Hot Topic, Inc. (the "Company"), with the following release and waiver ("Release and Waiver"). I hereby release, and forever discharge the Company, its officers, directors, agents, employees, stockholders, successors, assigns affiliates and Benefit Plans, of and from any and all claims, liabilities, demands, causes of action, costs, expenses, attorneys' fees, damages, indemnities and obligations of every kind and nature, in law, equity, or otherwise, known and unknown, suspected and unsuspected, disclosed and undisclosed, arising at any time prior to and including my employment termination date with respect to any and all claims including, but not limited to, claims relating to my employment and the termination of my employment, claims pursuant to any federal, state or local law relating to employment, including, but not limited to, discrimination claims, claims under the California Fair Employment and Housing Act, and the Federal Age Discrimination in Employment Act of 1967, as amended ("ADEA"), or claims for wrongful termination, breach of the covenant of good faith, contract claims, tort claims, and wage or benefit claims, including but not limited to, claims for salary, bonuses, commissions, stock, stock options, vacation pay, fringe benefits, severance pay or any form of compensation. I also acknowledge that I have read and understand Section 1542 of the California Civil Code which reads as follows: "A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH THE DEBTOR." I hereby expressly waive and relinquish all rights and benefits under that section and any law of any jurisdiction of similar effect with respect to any claims I may have against the Company. I acknowledge that, among other rights, I am waiving and releasing any rights I may have under the ADEA, that this Release and Waiver is knowing and voluntary, and that the consideration given for this Release and Waiver is in addition to anything of value to which I was already entitled as an executive of the Company. I further acknowledge that I have been advised, as required by the Older Workers Benefit Protection Act, that: (a) the Release and Waiver granted herein does not relate to claims which may arise after this Release and Waiver is executed; (b) I have the right to consult with an attorney prior to executing this Release and Waiver (although I may choose voluntarily not to do so); and if I am over 40 years of age upon execution of this Release and Waiver: (c) I have twenty-one (21) days from the date of termination of my employment with the Company in which to consider this Release and Waiver (although I may choose voluntarily to execute this Release and Waiver earlier); (d) I have seven (7) days following the execution of this Release and Waiver to revoke my consent to this Release and Waiver; and (e) this Release and Waiver shall not be effective until the seven (7) day revocation period has expired. Date: By: /s/ Jerry Cook ----------------------- ------------------------------- JERRY COOK EXHIBIT B HOT TOPIC, INC. EMPLOYEE PROPRIETARY INFORMATION AGREEMENT EX-23.1 6 hottopic_exh23-1.txt CONSENT OF INDEPENDENT AUDITORS Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statements (Form S-8 No. 333-13875, No. 333-58173, No. 333-43992), 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 9, 2001 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 February 3, 2001. /s/ Ernst & Young LLP ---------------------- Los Angeles, California April 27, 2001 -----END PRIVACY-ENHANCED MESSAGE-----