-----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, Cfhh8oKQgH6sopQ+uRzUIci2qsTrNvnJvqq/d3b/uLHjyJYaMFPq1mvA4+yBFfrf uM4065nwhFnz+etZYaHSBQ== 0001019687-05-001017.txt : 20050414 0001019687-05-001017.hdr.sgml : 20050414 20050413194102 ACCESSION NUMBER: 0001019687-05-001017 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 20050129 FILED AS OF DATE: 20050414 DATE AS OF CHANGE: 20050413 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: 1934 Act SEC FILE NUMBER: 000-28784 FILM NUMBER: 05749266 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-012905.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JANUARY 29, 2005 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____________________________ TO ____________________________________ COMMISSION FILE NO. 0-28784 HOT TOPIC, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 77-0198182 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 18305 E. SAN JOSE AVE. 91748 CITY OF INDUSTRY, CALIFORNIA (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (626) 839-4681 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, NO PAR VALUE (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [X] No [ ] The aggregate market value of Common Stock held by non-affiliates of the Registrant as of July 30, 2004 was approximately $739,697,726 based on the closing price on that date of the Registrant's Common Stock on the Nasdaq National Stock Market. All outstanding shares of voting stock, except for shares held by executive officers and members of the Board of Directors and their affiliates are deemed to be held by non-affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of shares outstanding of the Registrant's Common Stock was 44,814,650 as of April 2, 2005. DOCUMENTS INCORPORATED BY REFERENCE Certain portions of the Registrant's Definitive Proxy Statement for the Annual Meeting of Shareholders to be held on June 15, 2005 to be filed with the Securities and Exchange Commission (the "SEC") no later than 120 days after January 29, 2005, are incorporated by reference into Part III of this Form 10-K (Items 10 through 13). HOT TOPIC, INC. ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED JANUARY 29, 2005 TABLE OF CONTENTS PART I PAGE ------ Item 1. Business 3 Item 2. Properties 23 Item 3. Legal Proceedings 23 Item 4. Submission of Matters to a Vote of Security Holders 24 PART II ------- Item 5. Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities 25 Item 6. Selected Financial Data 26 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 28 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 36 Item 8. Financial Statements and Supplemental Data 36 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 37 Item 9A. Controls and Procedures 37 Item 9B. Other Information 40 PART III -------- Item 10. Directors and Executive Officers of the Registrant 40 Item 11. Executive Compensation 40 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters 40 Item 13. Certain Relationships and Related Transactions 40 Item 14. Principal Accountant Fees and Services 40 PART IV ------- Item 15. Exhibits and Financial Statement Schedules 40 2. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING DISCLOSURE THIS REPORT CONTAINS VARIOUS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). THESE STATEMENTS INCLUDE, FOR EXAMPLE, STATEMENTS REGARDING OUR EXPECTATIONS, BELIEFS, INTENTIONS OR STRATEGIES REGARDING THE FUTURE, SUCH AS THE EXTENT AND TIMING OF FUTURE REVENUES AND EXPENSES AND CUSTOMER DEMAND, OTHER EXPECTED FINANCIAL RESULTS AND INFORMATION, NEW STORE OPENINGS AND NEW STORE CONCEPTS. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ARE BASED ON INFORMATION AVAILABLE TO US AS OF THE DATE OF THIS REPORT. WE WILL NOT NECESSARILY UPDATE ANY FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS INVOLVE KNOWN OR UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH MAY CAUSE OUR ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS, OR INDUSTRY RESULTS TO BE DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED. RISKS, UNCERTAINTIES AND OTHER FACTORS RELATED TO US ARE LOCATED, AMONG OTHER PLACES, IN PART I, ITEM 1 UNDER THE CAPTION "CERTAIN RISKS RELATED TO THE COMPANY'S BUSINESS" AND IN PART II, ITEM 7 UNDER THE CAPTION "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS." PART I ITEM 1. BUSINESS GENERAL We are a mall-based specialty retailer operating the Hot Topic and Torrid store concepts. Hot Topic stores sell a selection of music/pop culture-licensed and music/pop culture-influenced apparel, accessories and gift items for young men and women principally between the ages of 12 and 22. Torrid stores sell apparel, lingerie, shoes and accessories designed for various lifestyles for plus-size females between the ages of 15 and 29. We opened our first Hot Topic store in 1989 and our first Torrid store in 2001. At the end of fiscal 2004 (the fiscal year ended January 29, 2005), we operated 592 Hot Topic stores throughout the United States and Puerto Rico, and 76 Torrid stores. We also sell merchandise on two websites, www.hottopic.com ("hottopic.com") and www.torrid.com ("torrid.com"), which reflect the Hot Topic and Torrid store concepts and carry merchandise similar to that sold in the respective stores. Throughout this report, the terms "our", "we" and "us" refer to Hot Topic, Inc. and its subsidiaries. We opened 91 Hot Topic and 24 Torrid stores during fiscal 2004. We also occasionally relocate, expand, or close existing stores. During fiscal 2004, we expanded or relocated ten stores. We plan to open approximately 65 new Hot Topic stores and 45 Torrid stores in the fiscal year ending January 28, 2006 ("fiscal 2005"). As of March 9, 2005, five of these new Hot Topic stores and one of these new Torrid stores were open. THE MARKET The music-licensed apparel industry essentially began in the 1960s with bootleggers selling tee shirts at concert venues. Over the next two decades, artists began to realize the commercial potential of licensing their likenesses and logos to tee shirt manufacturers and others who produced assorted merchandise. We believe that during recent years, the music industry has been significantly impacted by the availability and accessibility of Internet and digital technology and the continuing success of MTV and other music television networks. These media enable fans not only to listen to the latest music and artists 24 hours a day, but also to experience a full sight and sound package of appearance and attitude. This is in stark contrast to past decades when the vinyl record cover and a few magazines of modest circulation were the primary source of young people's information about their music and favorite bands. The growing importance of the Internet is illustrated in a recent U.S. Census Bureau report, stating that 80% of America's school-age children have Internet access either at home or at school, regardless of their ethnic group or household income. MTV music television reached 86 million households in the United States in December 2003, according to Viacom International, Inc., MTV's parent company. 3. As a result, both emerging and well-known artists, and the fashions they inspire, are much more visible today than ever before. We believe that this increased visibility has contributed to a rise in demand for music/pop culture-licensed and music/pop culture-influenced apparel and accessories. We believe teenagers throughout the United States have similar fashion preferences, largely as a result of the nationwide influence of the Internet, MTV and other music television networks, music distribution (including through the rapidly growing avenue provided by digital music and "downloads"), movies and television programs. Hot Topic's target customers are young men and women between the ages of 12 and 22, who are passionate about music, music videos, pop culture trends and music-inspired fashion. We believe our music/pop culture-influenced merchandise appeals to teenagers from diverse socio-economic backgrounds and that our customers are broadly representative of the teenage population in the United States. Teenagers represent both a growing part of the United States population and an increasing source of purchasing power. The U.S. Census Bureau estimates that the teenage population (ages 12-19) in the United States reached approximately 33 million in 2004, and by 2008, there are likely to be more teenagers in the United States than at any other time in history. Teenage spending has also increased annually. The average American teen spent approximately $91 a week in 2004 according to Teen Research Unlimited. In the past seven years, teenage spending has grown an average of 5% per year, to $169 billion in 2004. We developed the Torrid concept after analyzing customer feedback and researching the market demographics. We concluded there was a significant portion of young women consumers who were plus-size and unable to find and buy a broad enough selection of "cool" fashion forward clothes in comparison to their smaller sized friends. We launched Torrid in the first half of fiscal 2001, with the opening of six locations across the country and a website, torrid.com. Torrid's target customers are plus-size females ages 15 to 29, who are primarily influenced by fashion trends, and also by pop culture. We believe the Torrid assortment allows young customers wearing sizes 12 to 26 to match the style, excitement and selection available at other non-plus-size junior retailers. HOT TOPIC BUSINESS STRATEGY Our goal for Hot Topic stores is to be a leading retailer of music/pop culture-licensed and music/pop culture-influenced apparel, accessories and gift items for young men and women. Elements of Hot Topic's business strategy include: o FOCUS ON UNIQUE MUSIC/POP CULTURE-ORIENTED MERCHANDISE We believe that fashions and products associated with popular music artists and pop culture trends have a significant influence on teenagers. We have developed a unique strategy focused exclusively on offering music/pop culture-licensed and music/pop culture-influenced merchandise in the mall environment. Accordingly, we believe we are well positioned to capitalize on the growing teenage population and demand for music/pop culture-influenced merchandise. o OFFER "EVERYTHING ABOUT THE MUSIC" AND POP CULTURE Hot Topic stores are designed to serve as a headquarters for music/pop culture-licensed and music/pop culture-influenced apparel, accessories and gift items. Hot Topic's slogan, "Everything About The Music" and its ability to relate and understand relevant pop culture trends are reflected in its broad assortment of products. We believe Hot Topic's selection of music/pop culture-licensed merchandise is the most extensive assortment available in a single mall store. Hot Topic complements its licensed merchandise with a unique and eclectic assortment of music/pop culture-influenced apparel and accessories, and frequently responds to changes in trends and demand by introducing new items and categories. We believe Hot Topic has a history of being the first to offer the latest music/pop culture fashions, which has made Hot Topic a destination store for teenagers. 4. o PROMOTE MUSIC-INSPIRED CULTURE Hot Topic is committed to addressing the music-inspired lifestyles of its customers by building a culture throughout the organization that reflects a passion for music. We diligently track alternative and rock music trends by regularly monitoring new music, music video releases and radio station air play, visiting nightclubs around the country, and attending concerts. We also actively solicit feedback from our associates and customers. We believe these activities allow us to react quickly to emerging trends, and provide a competitive advantage over retailers who do not devote the time and resources necessary to anticipate these trends. o LISTEN TO THE CUSTOMER Hot Topic does not dictate fashion trends, but rather seeks to identify music artists, music and pop culture trends at their early stages and react accordingly to keep its in-store product assortment current with those trends. We have developed a disciplined approach to buying and a dynamic inventory planning and allocation process to support our merchandise strategy. We regularly test new merchandise in select Hot Topic stores before chain-wide distribution. We also order a majority of our merchandise not more than 60 to 90 days before delivery, allowing us to respond quickly to emerging trends. We are also aggressive in taking prompt markdowns to maintain a fresh merchandise mix. By actively managing the mix of categories and products in Hot Topic stores, we believe we are able to capitalize on emerging trends and minimize our dependence on any one particular merchandise category. We believe this approach to managing Hot Topic's merchandise mix has contributed to strong merchandise margins and markdown rates that are lower than industry average. o EMPHASIZE CUSTOMER SERVICE AND THE IN-STORE EXPERIENCE Hot Topic store associates are trained to provide a value-added, non-intrusive customer experience. Sales associates are encouraged to greet customers, provide information about new music/fashion trends and suggest merchandise that meets the customer's lifestyle and music preferences. Hot Topic provides its teenage customers the same level of respect and attention that is afforded to adult customers at other retail stores, while also providing friendly and informed customer service for parents. We believe that a high level of employee product knowledge and a commitment to music/fashion create credibility and differentiate Hot Topic from other teenage-focused retailers. We also seek to create an exciting and compelling shopping environment focusing on the lifestyles of our core customer. Hot Topic stores are designed with an industrial theme that incorporates dense merchandising and utilizes a professional sound system playing alternative music to create a fun, high-energy store that teens will consider "their place" to shop with friends. We believe this atmosphere enhances Hot Topic's image as a source for music/pop culture-inspired fashion while encouraging customers to shop in its stores for longer periods of time. TORRID BUSINESS STRATEGY Our goal for Torrid stores is to become a leading specialty retailer of fashion forward plus-size young women's apparel and accessories. Elements of Torrid's business strategy include: o FOCUS ON CURRENT FASHION TRENDS IN APPAREL AND ACCESSORIES THAT ALLOW THE PLUS-SIZE CUSTOMER TO FEEL FEMININE, BEAUTIFUL, AND SEXY 5. Our Torrid merchandising team focuses on providing a fashion forward merchandise assortment that reflects the influence of cutting edge fashion trends and pop culture. These influences provide the inspiration for hip, trendy apparel and accessories that our plus-size customer relates to. We believe that Torrid is the first mall concept to offer a complete store assortment of fashion forward apparel for plus-size young women. o LISTEN TO THE CUSTOMER Torrid does not dictate fashion trends, but rather listens to customers and emphasizes current fashion direction, as well as pop culture influences, to identify and keep current with emerging trends. These trends dictate a fashion forward merchandise selection with strong customer appeal. Torrid, like Hot Topic, seeks direct feedback at the grass-roots level from Torrid store associates and customers. This feedback has a direct influence on future purchases of Torrid merchandise. o EMPHASIZE CUSTOMER SERVICE AND THE IN-STORE EXPERIENCE We train Torrid store associates to provide one-on-one service to customers. Because we believe that the plus-size customer has been previously unable to find sufficient quantities and selections of fashionable apparel in line with current trends like her friends buy and wear, Torrid's customer service approach focuses on suggesting outfits and ensuring the correct fit. Through a focus on customer service and a trendy fashion merchandise offering, Torrid seeks to create a compelling shopping environment that the younger plus-size female customer is looking for. We believe that the warm reception, trendy fashion offerings, and helpful customer service by Torrid associates help to create a welcoming and exciting environment that will be attractive to, and preferred by, the Torrid customer. STORE LOCATIONS As of January 29, 2005, we operated 592 Hot Topic stores throughout the United States and Puerto Rico and 76 Torrid stores in 25 states in both metropolitan and middle markets. Between January 30, 2005 and March 9, 2005, we opened an additional five Hot Topic stores and one Torrid store. The following chart shows, as of March 9, 2005, the number of Hot Topic and Torrid stores we operate in each state in which those stores are located: 6. HOT TOPIC, INC. STORES BY STATE -------------------------------------------------------------------------------------------------------- HOT TOPIC STORES TORRID STORES TOTAL COMPANY -------------------------------------------------------------------------------------------------------- OPEN AT NEW HT OPEN AT OPEN AT NEW TORRID OPEN AT OPEN AT 1/29/2005 FY05 TO DATE 3/9/2005 1/29/2005 FY05 TO DATE 3/9/2005 3/9/2005 Alabama 6 6 6 Alaska 3 3 3 Arizona 14 14 4 4 18 Arkansas 2 2 2 California 66 2 68 29 29 97 Colorado 11 11 1 1 12 Connecticut 7 7 7 Delaware 2 2 2 Florida 37 37 2 2 39 Georgia 12 12 1 1 13 Hawaii 4 4 4 Idaho 3 3 3 Illinois 17 17 2 2 19 Indiana 12 12 1 1 13 Iowa 9 9 9 Kansas 5 5 5 Kentucky 7 7 7 Louisiana 8 8 8 Maine 2 2 2 Maryland 14 14 2 2 16 Massachusetts 15 15 3 3 18 Michigan 23 23 2 2 25 Minnesota 12 12 1 1 13 Mississippi 2 2 2 Missouri 13 13 2 2 15 Montana 3 3 3 Nebraska 4 4 1 1 5 Nevada 5 5 2 2 7 New Hampshire 4 4 1 1 5 New Jersey 16 16 3 1 4 20 New Mexico 7 7 1 1 8 New York 28 28 5 5 33 North Carolina 12 1 13 13 North Dakota 3 3 3 Ohio 26 26 1 1 27 Oklahoma 7 7 7 Oregon 7 7 2 2 9 Pennsylvania 28 1 29 1 1 30 Rhode Island 1 1 1 South Carolina 6 6 6 South Dakota 2 2 2 Tennessee 15 15 2 2 17 Texas 49 49 5 5 54 Utah 8 8 8 Vermont 2 2 2 Virginia 14 14 14 Washington 18 18 1 1 19 West Virginia 4 4 4 Wisconsin 11 11 1 1 12 Wyoming 1 1 1 Puerto Rico 5 1 6 6 TOTAL 592 5 597 76 1 77 674 - -------------------------------------------------------------------------------------------------------------------------------- 7.
EXPANSION STRATEGY The following table provides a history of our store expansion: FISCAL YEAR ------------------------------------------------ 2000 2001 2002 2003 2004 2005 THROUGH 3-9-05 ------------------------------------------------ (Number of stores) Stores at beginning of year 212 274 352 445 554 668 Hot Topic stores opened 62 73 74 84 91 5 Hot Topic stores closed* (1) (2) (1) Torrid stores opened 6 21 25 24 1 ------------------------------------------------ Stores at end of year 274 352 445 554 668 674 ------------------------------------------------ Hot Topic and Torrid stores expanded or relocated 5 7 8 4 10 1 ------------------------------------------------ * Victorville, CA store closed in fiscal 2001 and re-opened in the first quarter of fiscal 2002, and is included in our current store count. Parklane, NV and Bayfair, CA store leases expired in the fourth quarter of fiscal 2002 and were not renewed. Cupertino, CA store lease expired in the first quarter of fiscal 2004 and was not renewed. Our expansion strategy is to open stores primarily in shopping malls and selected entertainment centers in both new and existing markets throughout the United States. We opened 91 new Hot Topic stores and 24 Torrid stores in fiscal 2004, and we also expanded or relocated ten existing stores. During fiscal 2005, we plan to open approximately 65 new Hot Topic stores and 45 new Torrid stores. Additionally, we plan to expand or relocate approximately 20 existing stores. We have identified regional malls nationwide and in Puerto Rico for potential new locations. We evaluate potential store locations based on a variety of criteria relevant to our merchandising strategy, including: the sales of the mall and anchor stores, sales of teenage-oriented and plus-size stores, age demographics in the trade area, median family income and other economic factors. We have a real estate committee that meets regularly to evaluate and select store locations. We generally seek potential store sites between 1,500 square feet and 2,000 square feet for Hot Topic stores, and between 2,200 square feet and 2,600 square feet for Torrid stores. Our Hot Topic stores currently average approximately 1,700 square feet and our Torrid stores currently average approximately 2,500 square feet. STORE-LEVEL ECONOMICS During fiscal 2004, we achieved average Hot Topic store net sales of approximately $1,048,000 and average Hot Topic store net sales per square foot of approximately $602. We cannot guarantee that these results will continue or that future average store-level sales will not vary from historical results. HOT TOPIC MERCHANDISING Our Hot Topic stores serve as a headquarters for music/pop culture-licensed and music/pop culture-influenced apparel, accessories and gift items. Music/pop culture-licensed merchandise includes tee shirts, hats, posters, stickers, patches, postcards, books, novelty accessories, compact discs and albums. Music/pop culture-influenced merchandise includes woven and knit tops, skirts, pants, shorts, jackets, shoes, costume jewelry, body jewelry, sunglasses, cosmetics, leather accessories and gift items. Approximately half of Hot Topic's products are music/pop culture-licensed and the other half are music/pop culture-influenced products. A key strategy of our Hot Topic stores is to offer a diverse product assortment. We have more than 20 distinct merchandise categories or "departments." On average, over 120 different licensed band tee 8. shirts are carried in each store, from current artists such as Green Day, AFI, Slipknot, Good Charlotte, ICP and Linkin Park to classic rock artists such as The Ramones, Nirvana, Bob Marley, The Rolling Stones, Metallica and Led Zeppelin. New items and categories are regularly tested to stay current with customer demand and new product trends. During fiscal 2004, 53% of Hot Topic's net sales were generated in apparel categories and 47% of Hot Topic's net sales were produced in non-apparel categories (including accessories, gifts, intimate apparel and shoes). Our Hot Topic merchandising staff consists of a General Merchandise Manager, Divisional Merchandise Managers, and a staff of buyers and assistant buyers who manage the various product categories. The merchandising staff reflects our culture in that its decisions and actions are influenced by music and pop culture. In determining which merchandise to buy, the staff spends considerable time viewing music videos, reviewing industry music sales, monitoring alternative radio station air play, consulting with sales associates (to draw from their different experiences and perspectives), reviewing customer requests, attending trade shows and reading music and fashion industry periodicals. In addition, the merchandising staff regularly visits nightclubs and attends concerts and other events that attract young people. Hot Topic has several lines of private label merchandise to complement and supplement current product offerings. We believe that Hot Topic brands play an important part in differentiating its stores from those of its competitors and provide us with higher margin opportunities as compared to other merchandise. We estimate that in fiscal 2004 our Hot Topic brands accounted for approximately 25% of our sales, the same percentage as in fiscal 2003. Our proprietary brands include Ugly Shirt, Morbid Metals (body jewelry), Morbid Threads (men's and women's apparel and hosiery) and MT:2 (men's and women's apparel). Some shoes are also sold under the Hot Topic label. In order to reduce fashion risk and maintain the ability to respond quickly to emerging trends, Hot Topic buys a majority of its merchandise not more than 60 to 90 days in advance of delivery. We also often begin with smaller test purchases prior to chain-wide distribution. We regularly monitor store sales by merchandise theme and classification, Stock Keeping Units (SKUs), color and size to determine types and amounts of products to purchase, to detect products and trends that are emerging or declining, and to manage the product mix in our stores by responding to the spending patterns of our customers. We also develop good relationships with our vendors because we understand their importance of facilitating a quick response. TORRID MERCHANDISING Our Torrid stores serve a premier destination for current trends in fashion apparel and accessories for plus-size young women. We believe that the Torrid customer wants to wear the same types of merchandise as her smaller-sized peers. Torrid's merchandise includes novelty tee shirts, fashion tops, pants, shorts, skirts, dresses, jackets, swimwear, intimate apparel, shoes, hosiery, accessories, gifts, and beauty products. Torrid apparel is sized 12 to 26. A broad selection of merchandise comes from established branded vendors, including Dickies, Paris Blues, Z Cavaricchi, LEI, Fine and Hot Kiss and more fashion forward vendors, such as Tripp. Torrid works with these and other vendors to monitor and maintain its own plus-size apparel fit specifications for young women. We believe Torrid's selection of fashion items from these and similar vendors gives the Torrid customer an opportunity to buy the same or similar branded items that have been available to other young women of the same age who are not plus-size. We research current fashion trends and customer requests and then work with vendors to design and manufacture them for Torrid. The Torrid fit specialist team works with the manufacturers' design teams to help ensure that fit and quality standards are achieved and maintained. During fiscal 2004, approximately 75% of Torrid's net sales were generated in apparel categories and approximately 25% of Torrid's net sales were produced in non-apparel categories (including accessories, gifts, intimate apparel and shoes). 9. Our Torrid merchandising staff consists of a General Merchandise Manager, a Divisional Merchandise Manager, a fit specialist team, and a staff of buyers and assistant buyers who manage all product categories. The Torrid merchandising staff's decisions and actions are influenced by customer and store associate feedback. The merchandising staff spends considerable time visiting trendy young fashion shopping areas and nightclubs, researching international fashion trends, and attending trade shows and other events that attract young people. We also believe that emerging fashion trends in the junior market and pop culture influence Torrid's merchandising direction. The range of pop culture and music artists that influence Torrid fashion is much broader than at Hot Topic, consistent with the broader target customer base of females ages 15 to 29. Approximately 40% of Torrid merchandise is purchased from established branded vendors. The remaining 60% is Torrid's private label merchandise that provides the customer with unique, fashion forward merchandise, often at more competitive prices than branded merchandise. Private label merchandise also often provides Torrid with higher margin opportunities as compared to other merchandise. In order to reduce fashion risk and maintain the ability to respond quickly to emerging trends, Torrid buys a majority of its merchandise not more than 120 days, and many times less than 75 days, in advance of delivery. We often begin with small purchases for testing. PLANNING AND ALLOCATION OF MERCHANDISE Planning and allocation of our inventory is done at the store, merchandise classification and SKU levels, using integrated third-party software. Most merchandise is ordered in bulk and then allocated to each store based on store inventory plans and SKU performance using JDA's Advanced Allocation software. Buyers and inventory analysts determine SKU reorder quantities by using a proprietary automated software program which considers sales history, projected sales, planned inventories by store, store demographics, geographic preferences, store openings and planned markdown dates. Our headquarters and distribution facility located in the City of Industry, California is approximately 250,000 square feet. Vendors deliver all merchandise to this facility, where it is inspected, allocated, picked, prepared and boxed for shipment to our stores and internet customers. We ship merchandise to stores each weekday, providing our Hot Topic and Torrid stores with a steady flow of new and reordered merchandise. Minimal back stock is maintained in our distribution facility and at our stores, so that most of our merchandise is available for sale on the selling floors of our stores. No single vendor accounted for more than 7% of our merchandise purchases during fiscal 2004. We have entered into a lease (with a purchase option) for an additional distribution center facility in Tennessee, which we expect to be operational by the end of the second quarter of fiscal 2005. We believe this second distribution center will allow for us to accommodate our growth for many years. We also expect improved delivery times to many of our stores, especially east coast locations. The Tennessee distribution center will receive merchandise for and ship merchandise primarily to stores in the eastern half of the country. HOT TOPIC AND TORRID STORE OPERATIONS Hot Topic and Torrid store operations are managed by separate teams of a Vice President of Store Operations, regional directors and district managers. On average, each district manager supervises approximately six to eight stores. A store manager and two or three assistant managers manage individual stores. In addition to managers and assistant managers, a typical store has approximately six to ten part-time sales associates, depending on the season. The store manager and district manager are responsible for the hiring and training of new associates. We have established training and operating procedures to assist field management in the supervision and training of all associates. We have also designed a store manager training program, which is used to train externally hired managers. We strive to create a store environment that customers will consider "their place" to shop with friends. We seek to hire sales associates who are like our customers - energetic people who are knowledgeable and passionate about music and pop culture-inspired fashion, as well as trendy fashion inspiration. We 10. understand the importance of focusing on the preferences and opinions of our target customers. So store associates, who have the closest and most frequent contacts and interactions with our customers, from time to time accompany buyers on buying trips. Additionally, in return for feedback on fashion and other trends, we reimburse store associates for the cost of attending concerts. They are also encouraged to directly communicate customer feedback as well as their own merchandise and product ideas to the buyers and management. Our culture and our direct interaction with and respect for sales associates are significant factors in producing associate retention rates that we believe are higher than the industry average. The primary goal of the sales associate position is to provide superior, informed customer service in order to maximize sales and minimize inventory shrinkage. Store management receives daily store sales and category results so that performance can be measured against set goals. Postage-paid "report cards" are provided in all stores for customers to grade performance and make recommendations to us. We train associates to greet each customer, to inform the customer about new music and fashion trends and to suggest merchandise that matches the customer's lifestyle, music and fashion preferences and/or trends. We believe that our associates' high level of product knowledge and customer service differentiates us from other specialty retailers. District managers, along with all members of the store teams, have a base pay rate and may qualify to receive certain bonus payouts. District managers may also qualify to receive stock option grants. All of our employees who meet certain eligibility criteria are eligible to participate in our Employee Stock Purchase Plan. We believe that our continued success is dependent in part on our ability to attract, retain and motivate qualified associates. In particular, the success of our growth will be dependent on our ability to promote and/or recruit talented district and store managers. In order to ensure new stores have a capable pool of candidates, we have assigned dedicated field recruiters to work with each region's management team. MARKETING, PROMOTION AND INTERNET We generally open stores in high traffic malls in areas of high teenage and young adult population, and we rely on existing customers, associates, store design and exciting music to attract new customers to our stores. To further promote Hot Topic stores, we sponsor various music events and conduct periodic contests. For example, since 2000, we have co-sponsored a major summer rock tour, Ozzfest (headlined by Ozzy Osbourne). As an Ozzfest sponsor, our name has been associated with promotional activities at each venue. Torrid enhances its image through visual advertising and promotion, with an emphasis on lifestyle photography illustrating a young plus-size woman in various lifestyle activities and fashions representative of the feminine, beautiful and/or sexy essence of the brand. In the fourth quarter of fiscal 2004, Torrid began testing in a small number of stores a customer loyalty program called Divastyle. In addition to our broad selection of merchandise for sale, including some Internet-only items, our websites offer merchandise, tour dates, contests, job postings, store locations and community features such as band reviews and advice columns. Our net sales from Internet operations rose by 25% in fiscal 2004 compared to fiscal 2003 and contributed approximately 2.8% of total sales in fiscal 2004. In fiscal 2004, we established the Hot Topic Foundation. The Foundation's objective is to support programs and organizations that specifically focus on encouraging and educating youth in music, creative writing, painting, photography, and filmmaking. The Foundation has been funded through donations from our employees, our company, and our customers. As of January 29, 2005, $339,000 has been raised for the benefit of the Foundation. We are pleased with the meaningful contributions the Foundation has made to school music programs and other initiatives, and we believe these activities have a positive influence on young people. INFORMATION TECHNOLOGY Our information systems provide integration of store, merchandising, distribution, financial, and human resources. Software licensed from GERS Retail Systems is used for SKU and classification inventory tracking, purchase order management, open-to-buy, merchandise distribution, automated ticket making, and sales audit. Our financial systems are licensed from Lawson Software and are used for general ledger, accounts payable, and asset management as integrated 11. financials. Sales are updated daily in the merchandising reporting systems by polling sales information from each store's point-of-sale, or POS, terminals. Our POS system consists of registers providing price look-up, time and attendance, e-mail and credit card/check/gift card authorization. Through automated nightly two-way electronic communication with each store, sales information and payroll hours are uploaded to the host system. The host system downloads price changes, performs system maintenance and provides software updates to the stores. We evaluate information obtained through nightly polling to implement merchandising decisions, including product purchasing/reorders, markdowns and allocation of merchandise on a daily basis. In June 2004, we implemented our new warehouse management system in our California distribution center, which is licensed from Manhattan Associates. Our Wide Area Network ("WAN") is used to connect all locations with real-time e-mail and several Intranet applications. In addition, this technology has improved operating efficiency in such areas as credit card and gift card authorization, store-to-store transfer, product lookup, product location and several other applications to eliminate paper distribution and paperwork. In 2005, we plan to open a new distribution center in Tennessee and implement a new Internet order management software system and a customer loyalty software system. We believe our enhancements to existing systems and additions of new systems will help support our growth. TRADEMARKS We have registered on the Principal Register of the United States Patent and Trademark Office our retail store service marks Hot Topic(R) and Torrid(R) in various forms. We have also registered various other trademarks for merchandise such as Morbid Make-Up(R), Morbid Scents(R), Morbid Metals(R), Morbid Threads(R), Tragedy(R), Misery(R), and MT:2(R); and general marks such as our slogan "Everything About the Music". Each federal registration is renewable indefinitely if the mark is in use at the time of the renewal. We have several trademark applications on file with the USPTO, for which we hope to obtain registration in the future. In addition, we have common law trademark rights to certain trademarks, service marks and trade names used in our business from time to time. We are not aware of our use of any of our marks raising any claims of infringement or other challenges to our right to use our marks in the United States. We also have additional registrations and pending applications in foreign jurisdictions. All other trademarks, trade names and service marks referenced in this report and in our stores are the property of their respective owners. HOT TOPIC COMPETITION We compete with other retailers for vendors, customers, suitable retail locations and qualified associates. Hot Topic currently competes with street alternative and vintage clothing stores located primarily in metropolitan areas and with other mall-based teenage-focused retailers such as Abercrombie & Fitch, Aeropostale, American Eagle Outfitters, Anchor Blue (Millers Outpost), Charlotte Russe Inc., Claire's Stores, Inc., Forever 21, Old Navy (a division of Gap Inc.), Pacific Sunwear of California, Inc., Spencer Gifts, Inc., The Buckle, Wet Seal, Inc., and Urban Outfitters, Inc.; and, to a lesser extent, with music stores. Some of our competitors are larger and have substantially greater financial, marketing and other resources than us. The principal factors of competition are merchandise selection, connection to the music industry, customer service, store location and price. TORRID COMPETITION Based on direct customer research we have conducted, we believe that plus-size female teens and young women have historically shopped for apparel at department stores, discount stores such as Target and specialty stores such as Lane Bryant. Though a source of competition, we believe such stores generally target more mature customers, which is also reflected in their store environments. We are not aware of other exclusively mall-based chains that are specifically targeting younger plus-size fashion forward customers. Torrid competes with traditional department stores, local specialty stores and junior teen retailers that offer a combination of junior and plus-sizes, such as Deb Shops. Torrid also competes with traditional plus-size catalogs and web sites, as well as Delia's Corp. and Alloy, Inc. which carry both junior and junior plus-sizes. Many companies compete for the junior customers and additional competitors may enter into the plus-size female market. 12. EMPLOYEES We employed approximately 2,030 full-time and 5,940 part-time employees, which we refer to as associates, as of March 9, 2005. Of our 7,970 associates, approximately 600 were headquarters and distribution center personnel and the remainder were field management and store associates. The number of part-time associates changes with seasonal needs. None of our associates are covered by collective bargaining agreements. We believe that our relationships with our associates are good. EXECUTIVE OFFICERS AND KEY EMPLOYEES Our executive officers and key employees and their ages at March 9, 2005 are as follows: NAME AGE POSITION - ----------------------- ----- ------------------------------------------------------ Elizabeth McLaughlin 44 Chief Executive Officer and Director Gerald Cook 52 President, Hot Topic Patricia Van Cleave 57 President, Torrid James McGinty 42 Chief Financial Officer Tom Beauchamp 52 Senior Vice President and Chief Information Officer Christopher Kearns 38 Senior Vice President, General Counsel and Secretary Cindy Boden 50 Vice President, Torrid Store Operations Christopher Daniel 47 Vice President, Torrid General Merchandise Manager Ed Gusman 46 Vice President, Hot Topic Store Operations Tricia Higgins 37 Vice President, Distribution Darrell Kinsley 42 Vice President, Store Design and Visual Merchandising Alain Krakirian 39 Vice President, Hot Topic Planning and Allocation Cindy Levitt 44 Vice President, Hot Topic General Merchandise Manager Sue McPherson-Spissu 37 Vice President, Logistics John Neppl 48 Vice President, Real Estate and Construction George Wehlitz, Jr. 44 Vice President, Finance
ELIZABETH MCLAUGHLIN has served as Chief Executive Officer and on the Board of Directors since 2000. From 1996 through 2000, Ms. McLaughlin served as Senior Vice President and General Merchandise Manager. From 1993 through 1996, Ms. McLaughlin was our Vice President, Operations. Prior to joining us, Ms. McLaughlin held various positions with Millers Outpost and The Broadway. Ms. McLaughlin holds a B.A. degree in Economics from the University of California at Irvine. Ms. McLaughlin is a Director of Noodles & Company, a privately held quick casual restaurant concept. She is also a member of the Board of Visitors for the Anderson School at UCLA. 13. GERALD COOK has been President, Hot Topic since September 2003. From February 2001 to September 2003, he was Chief Operating Officer. From February 1999 until joining us, he was the President and Chief Operating Officer of Travel 2000, Inc. Subsequent to his departing Travel 2000, Inc., that company filed for chapter 11 bankruptcy in March 2001. From 1995 to April 1998, Mr. Cook was Senior Vice President, Operations for The Bombay Company, Inc. and from 1989 to 1995, Mr. Cook was the Vice President, Stores and the Vice President, General Merchandising Manager of Woman's World Stores. Prior to 1989, he held management positions with Barnes & Noble/B Dalton, The Gap Stores and the Limited, Inc. Mr. Cook holds a B.S. degree in Business Administration from the University of Minnesota. PATRICIA VAN CLEAVE has been President, Torrid since September 2003. From September 2002 to September 2003, she was Chief Merchandising Officer. From July 1998 to June 2001, she was the President and CEO of Sundance Catalog Company. From May 1995 until joining Sundance, she was the President of Cherokee. Prior to joining Cherokee, she was Executive Vice President of Merchandising for apparel, fashion accessories and intimate apparel for The Broadway. She came to The Broadway from The Bon Marche, a Seattle-based division of Federated Department Stores where she was Senior Vice President, General Merchandise Manager of Apparel. Prior to that she held management positions for The Broadway Southwest, John Wanamaker, The May Company and Daytons. Ms. Van Cleave holds a B.S. degree in Business and Textiles from the University of Minnesota. JAMES MCGINTY has served as Chief Financial Officer since February 2001. Mr. McGinty joined us in August 2000 as Vice President, Finance and was promoted to Chief Financial Officer in February 2001. From July 1996 to July 2000, Mr. McGinty was Vice President-Controller at Victoria's Secret Stores, the leading brand and largest specialty retailer division of the Limited, Inc. From 1984 to 1996, he held various financial and accounting positions within the Structure and Express divisions of the Limited, Inc. Mr. McGinty holds a B.S. degree in Accounting from Miami University in Oxford, Ohio. TOM BEAUCHAMP has been Senior Vice President and Chief Information Officer since June 2004. Mr Beauchamp has over 30 years of Information technology experience. From October 2001 until joining us, he was Chief Information Officer for CMI Marketing, a provider of loyalty marketing programs. From January 2000 until June of 2001, Mr. Beauchamp was Chief Information Officer of Columbia House. From June 1999 through January 2001, he was Senior Vice President, Chief Information Officer for Oxford Health Plans. From March 1996 through June 1999, he was Senior Vice President, Chief Information Officer for Woolworth Corporation. Prior to 1996, Mr. Beauchamp held management positions with Montgomery Ward, Limited, Inc., Millers Outpost, and The Broadway. CHRISTOPHER KEARNS has served as Senior Vice President, General Counsel and Secretary since April 2004. Prior to that, Mr. Kearns spent a decade as an attorney in private practice, most recently as a Partner with the law firm Cooley Godward LLP, which he joined in 1996. Mr. Kearns holds a B.A. degree in History and a specialization in Business Administration from UCLA, and a J.D. with honors from the University of California, Hastings College of the Law. CINDY BODEN has been Vice President, Torrid Store Operations since October 2003. Prior to that, Ms. Boden held Regional Director positions with Hot Topic both in the Northeast and the Midwest regions, beginning in 2000. From 1993 to 1997, Ms. Boden was a Regional Manager for County Seat stores. From 1990 to 1992, she held the position of Regional Manager for Millers Outpost stores. Prior to Millers Outpost, she was a District Manager for Brookstone for five years. Ms. Boden holds a B.S. degree in Textiles and Clothing with a minor in Business Administration from the University of Minnesota at Mankato. CHRISTOPHER DANIEL has served as Vice President, General Merchandise Manager for Torrid since October 2004. From September 1996 until September 2004, he was the Vice President of Design and Product Development for Mervyn's, a division of Target Corporation. Prior to that, Mr. Daniel held management positions in merchandising and product development with Structure, a division of Limited, Inc., Charming Shoppes, a national women's specialty retailer, and 14. Dayton-Hudson, the department store division of Target Corporation. Prior to that, he held merchandising positions with Bullock's, a Los Angeles based division of Federated Stores and Miller and Rhoads, a division of Allied stores based in Richmond, Virginia. Mr. Daniel holds a B.A. degree in English literature from the University of Richmond in Richmond, Virginia. ED GUSMAN has served as Vice President, Hot Topic Store Operations since January 2005. From January 2004 to January 2005, Mr. Gusman was the Senior Regional Director for the Eastern United States. From March 2001 to December 2003, Mr. Gusman was the Regional Director for the Southeast. From September 1999 to February 2001, he was the district manager for Urban Outfitters for the Mid Atlantic, Southeast. From May 1994 to August 1999, Mr. Gusman was a regional director for Zany Brainy, heading up their expansion on the West Coast. From 1990 to 1994, he was regional director for Brentano's, Waldenbooks Super Store. Prior to that, he held various management positions with Waldenbooks. TRICIA HIGGINS has been Vice President, Distribution since October 2004 and is responsible for the Distribution Center in the City of Industry. From February 2004 to October 2004, she was Vice President, Internet. Before her promotion to Vice President, Internet, she held the position of Director, Internet, beginning in June 2002. Prior to joining us, she was Director, Contact Center Operations for Cooking.com. From 1997 to August 2000, Ms. Higgins was Director, Retail Operations for the Williams-Sonoma, Pottery Barn and Hold Everything divisions of Williams-Sonoma, Inc. From 1994 to July 1997, she held various positions with The Disney Stores, Inc. in Retail Operations and New Business Development. Ms. Higgins holds a B.A. degree in Psychology from Indiana University. DARRELL KINSLEY was promoted to Vice President, Store Design and Visual Merchandising, in January 2005. From February 2000 through December 2004, Mr. Kinsley was Vice President, Hot Topic Store Operations. From June 1998 through February 2000, Mr. Kinsley was Regional Director for the western United States. From February 1997 through June 1998, he was Regional Director for the eastern United States. Mr. Kinsley joined us in February 1995 as the District Manager for the eastern United States and was responsible for the expansion into the East Coast. Mr. Kinsley holds a business management leadership certificate from the Anderson School of Business at the University of California, Los Angeles. ALAIN KRAKIRIAN has been Vice President, Hot Topic Planning and Allocation since February 2000. From July 1997 through February 2000, Mr. Krakirian was Director of Planning and Allocation. Mr. Krakirian was a Planning Manager at Disney Stores from December 1996 to July 1997 and the Director of Merchandise Planning and Allocation at Kids Mart from February 1996 to December 1996. From September 1991 to January 1996, Mr. Krakirian held various merchandise control and planning positions at Clothestime Stores, including Director of Merchandise Control and Information Office from October 1994 to January 1996. Mr. Krakirian holds a B.S. degree in Finance from the University of LaVerne and an M.B.A. degree from Pepperdine University. CINDY LEVITT has been Vice President, Hot Topic General Merchandise Manager since February 2000. From June 1996 to February 2000, she served as Divisional Merchandise Manager, Apparel and Music. Ms. Levitt has held senior buying positions since 1989. Prior to her career at Hot Topic, Ms. Levitt held buying positions at The May Company. Ms. Levitt holds a degree in Fashion Merchandising from Orange Coast College. SUE MCPHERSON-SPISSU has been Vice President, Logistics since October 2004. From October 2001 to October 2004, she was Vice President, Distribution Center and E-Commerce. Ms. McPherson-Spissu was Vice-President, Distribution Center from February 2001 to October 2001 and was Divisional Vice President of Distribution Center from February 2000 to February 2001. From March 1995 to February 2000, she was Director of the Distribution Center. Ms. McPherson-Spissu joined us in 1989 as a store associate in our first store while attending the University of Southern California. Ms. McPherson-Spissu holds a B.S. degree in Business from the University of Southern California. 15. JOHN NEPPL joined us in October 2001 as Vice President, Real Estate and Construction. From January 1995 to September 2001, Mr. Neppl served as Vice-President of Real Estate and Construction for Eastern Mountain Sports, Inc., a specialty retailer based in New Hampshire. Mr. Neppl served as Director of Real Estate at Miller's Outpost/Anchor Blue from October 1987 to December 1994. Mr. Neppl held various financial positions with Mervyn's department stores, a division of Target Corporation, from October 1978 to September 1987. Mr. Neppl received a B.S. degree in Accounting from Villanova University. GEORGE WEHLITZ, JR. has been Vice President, Finance since August 2003. He joined us in February 2002 as Vice President, Controller. From August 2000 to February 2002, Mr. Wehlitz was Chief Financial Officer at The Popcorn Factory, Inc., a catalog company for gourmet popcorn gifts. From 1987 to 2000 Mr. Wehlitz held various financial-related positions, at the divisional and corporate level, for The Bombay Company, Inc. Mr. Wehlitz holds a B.A. degree in Accounting from Texas Christian University and is a Certified Public Accountant. COMPLIANCE WITH ENVIRONMENTAL REGULATIONS To our present knowledge, compliance with federal, state and local provisions enacted or adopted for protection of the environment has had no material effect upon our operations. INTERNET WEBSITE We make available free of charge through our investor relations website at www.corporatewindow.com/fl/hott/frame.html our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. We also make available our Standards of Business Ethics at www.corporatewindow.com/fl/hott/frame.html. CERTAIN RISKS RELATED TO THE COMPANY'S BUSINESS Before deciding to invest in Hot Topic, Inc. or to maintain or increase an investment in Hot Topic, Inc., readers should carefully consider the risks described below, in addition to the other information contained in this Annual Report on Form 10-K and in other filings with the SEC, including our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. The risks described below are not the only risks we face. Additional risks that are not presently known to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks actually occur, our business, financial condition and results of operations could be seriously harmed, and our stock price could decline. OUR AGGRESSIVE GROWTH STRATEGY ANTICIPATES A SIGNIFICANT NUMBER OF NEW STORE OPENINGS, WHICH COULD CREATE CHALLENGES WE MAY NOT BE ABLE TO ADEQUATELY MEET. Our net sales have grown significantly during the past several years, primarily as a result of the opening of new stores and, to a lesser extent, the introduction of new products. Of our 668 stores opened as of January 29, 2005, 115 had been open for less than one full year. We intend to continue to pursue an aggressive growth strategy for the foreseeable future, and our future operating results will depend largely upon our ability to open and operate stores successfully and to profitably manage a larger business. We currently anticipate opening approximately 110 stores, consisting of 65 Hot Topic and 45 Torrid stores, during fiscal 2005, which will result in a significant increase in the number of stores we operate. Five of these Hot Topic stores and one of these Torrid stores were opened as of March 9, 2005. Operation of a greater number of new stores and expansion into new markets may present competitive and merchandising challenges that are different from those currently encountered by us in our existing stores and markets. In addition, as the number of stores increases, we may face risks associated with market saturation of our products and concepts. There can be no assurance that our expansion will not adversely affect the individual financial performance of our existing stores or our overall results of operations, or that new stores will achieve sales and profitability levels consistent with existing stores. Further, there can be no assurance that we will successfully achieve our expansion targets or, if achieved, that planned expansion will result in profitable operations. 16. THIS GROWTH STRATEGY REQUIRES EFFECTIVE UPSCALING OF OUR OPERATIONS, AND WE MAY NOT BE ABLE TO DO THIS SUFFICIENTLY TO EFFECTIVELY PREVENT NEGATIVE IMPACT ON OUR OPERATIONS AND FINANCIAL RESULTS. In order to manage our planned expansion, among other things, we will need to locate suitable store sites; negotiate acceptable lease terms; obtain adequate capital resources on acceptable terms; source sufficient levels of inventory; hire and train store managers and sales associates; integrate new stores into our existing operations; and maintain adequate distribution center space and information technology and other operations systems. We have entered into a lease (with a purchase option) for an additional distribution center facility located in Tennessee, which we expect to be operational in the second quarter of fiscal 2005, and we face challenges and risks associated with establishing operations in this facility. In particular, there are staffing and logistical concerns, as well as financial risks and other risks associated with opening a significant facility in a site approximately 2,000 miles from our headquarters and current distribution center. We also need to continually evaluate the adequacy of our management information and distribution systems. Implementing new systems and changes made to existing systems could present challenges we do not anticipate and could impact our business (for example, we experienced some delay in product distribution during our second quarter of fiscal 2004 upon implementing our new warehouse management system). We cannot anticipate all of the changing demands that our expanding operations will impose on our business, systems and procedures, and our failure to adapt to such changing demands could have a material adverse effect on our results of operations and financial condition. Our failure to timely implement initiatives necessary to support our expanding operations could also materially impact our business. EXPANDING OUR OPERATIONS TO INCLUDE AN INCREASING NUMBER OF TORRID STORES AND ANY OTHER NEW CONCEPTS PRESENTS RISKS WE HAVE FACED WITH THE HOT TOPIC CONCEPT BUT ALSO NEW RISKS DUE TO DIFFERENCES IN CONCEPT OBJECTIVES AND STRATEGIES. Our ability to expand into new concepts, and in particular our Torrid concept, has not been fully tested. Accordingly, the operation of Torrid stores and the sale of Torrid merchandise over the Internet are subject to numerous risks, including unanticipated operational problems; lack of experience; lack of customer acceptance; new vendor relationships; competition from existing and new retailers; and diversion of management's attention from the Hot Topic concept. The Torrid concept involves implementation of a retail apparel concept which is subject to most of the same risks as the Hot Topic concept, as well as additional risks inherent in a concept that concentrates on apparel and fashion, including risks of difficulty in merchandising, uncertainty of customer acceptance, fluctuations in fashion trends and customer tastes, extreme competition with a less differentiated product offering and attendant mark-down risks. We may not be able to generate continued customer interest in Torrid stores and products, and the Torrid concept may not be able to support the store or Internet sales formats. Risks inherent in any new concept are particularly acute with respect to Torrid, because this is our first significant new venture, and the nature of the Torrid business differs in certain respects from that of the Hot Topic business. There can be no assurance that the Torrid stores or website will achieve sales and profitability levels that justify our investment. THE SUCCESS OF OUR BUSINESS DEPENDS ON ESTABLISHING AND MAINTAINING GOOD RELATIONSHIPS WITH MALL OPERATORS AND DEVELOPERS, AND PROBLEMS WITH THOSE RELATIONSHIPS COULD MAKE IT MORE DIFFICULT FOR US TO EXPAND TO CERTAIN SITES OR OFFER CERTAIN PRODUCTS. Any restrictions on our ability to expand to new store sites or to offer a broad assortment of merchandise could have a material adverse effect on our business, results of operations and financial condition. If our relations with mall operators or developers become strained, or we otherwise encounter difficulties in leasing store sites, we may not grow as planned and may not reach certain revenue levels and other operating targets. Risks associated with these relationships are more acute given recent consolidation in that industry, and we have seen certain increases in expenses as a result of such consolidation that could continue. 17. OUR COMPARABLE STORE SALES ARE SUBJECT TO FLUCTUATION RESULTING FROM FACTORS WITHIN AND OUTSIDE OUR CONTROL, AND LOWER THAN EXPECTED COMPARABLE STORE SALES COULD IMPACT OUR BUSINESS AND OUR STOCK PRICE. A variety of factors affects our comparable store sales including, among others, the timing of new music releases and music/pop culture-related products; music and fashion trends; the general retail sales environment and the effect of the overall economic environment; our ability to efficiently source and distribute products; changes in our merchandise mix; and our ability to execute our business strategy efficiently. Our comparable store sales results have fluctuated significantly in the past and we believe that such fluctuations will continue. The following table shows our comparable store sales results for recent periods: Fiscal Year 2004 2003 2002 2001 ---------------------------------------------------------- (2.9)% 7.4% 5.0% 3.9% FY 2004 FY 2003 ----------------------------------------------- 1st Quarter 4.0% 2.6% 2nd Quarter (2.1)% 5.2% 3rd Quarter (4.2)% 10.8% 4th Quarter (6.0)% 8.5% Past comparable store sales results are not an indicator of future results, and there can be no assurance that our comparable store sales results will not decrease in the future. Changes in our comparable store sales results could cause our stock price to fluctuate substantially. OUR SUCCESS RELIES ON POPULARITY WITH YOUNG PEOPLE OF MUSIC, POP CULTURE, AND FASHION TRENDS, AND WE MAY NOT BE ABLE TO REACT TO TRENDS IN A WAY TO PREVENT DECLINING POPULARITY AND SALES OF OUR PRODUCTS. Our financial performance is largely dependent upon the continued popularity of alternative and rock music, the Internet and digital music, music videos, and MTV and other music television networks among teenagers and college age adults; the emergence of new artists and the success of music releases and music/pop culture-related products; the continuance of a significant level of teenage spending on music/pop culture-licensed and music/pop culture-influenced products; and our ability to anticipate and keep pace with the music, fashion and merchandise preferences of our customers. The popularity of particular types of music, artists, styles, trends and brands is subject to change. Our failure to anticipate, identify and react appropriately to changing trends could lead to, among other things, excess inventories and higher markdowns, which could have a material adverse effect on our results of operations and financial condition, and on our image with customers. There can be no assurance that our new products will be met with the same level of acceptance as in the past or that the failure of any new products will not have an adverse material effect on our business, results of operations and financial condition. ECONOMIC CONDITIONS COULD CHANGE IN WAYS THAT REDUCE OUR SALES OR INCREASE OUR EXPENSES. Certain economic conditions affect the level of consumer spending on merchandise we offer, including, among others, employment levels; salary and wage levels; interest rates; taxation; and consumer confidence in future economic conditions. We are also dependent upon the continued popularity of malls as a shopping destination, the ability of mall anchor tenants and other attractions to generate customer traffic, and the development of new malls. A slowdown in the United States economy or an uncertain economic outlook could lower consumer spending levels and cause a decrease in mall traffic or new mall development, each of which would adversely affect our growth, sales results and financial performance. CHANGES IN LAWS, INCLUDING EMPLOYMENT LAWS AND LAWS RELATED TO OUR MERCHANDISE, COULD MAKE CONDUCTING OUR BUSINESS MORE EXPENSIVE OR CHANGE THE WAY WE DO BUSINESS. 18. In addition to increased regulatory compliance requirements, changes in laws could make ordinary conduct of our business more expensive or require us to change the way we do business. For example, changes in federal and state minimum wage laws could raise the wage requirements for certain of our associates, which would likely cause us to reexamine our entire wage structure for stores. Other laws related to employee benefits and treatment of employees could also negatively impact us such as by increasing benefits costs such as medical expenses. Moreover, changes in product safety or other consumer protection laws could lead to increased costs to us for certain merchandise, or additional labor costs associated with readying merchandise for sale. It is often difficult for us to plan and prepare for potential changes to applicable laws. TIMING AND SEASONAL ISSUES COULD NEGATIVELY IMPACT OUR FINANCIAL PERFORMANCE FOR GIVEN PERIODS. Our quarterly results of operations may fluctuate materially depending on, among other things, the timing of store openings and related pre-opening and other startup expenses, net sales contributed by new stores, increases or decreases in comparable store sales, releases of new music and music/pop culture-related products, shifts in timing of certain holidays, changes in our merchandise mix and overall economic and political conditions. Our business is also subject to seasonal influences, with heavier concentrations of sales during the back-to-school, Halloween and Holiday (defined as the week of Thanksgiving through the first few days of January) seasons, and other periods when schools are not in session. The Holiday season has historically been our single most important selling season. We believe that the importance of the summer vacation and back-to-school seasons (which affect operating results in the second and third quarters, respectively) and to a lesser extent, the spring break season (which affects operating results in the first quarter) as well as Halloween (which affects operating results in the third quarter), all reduce our dependence on the Holiday selling season, but this may not always be the case to the same degree. As is the case with many retailers of apparel, accessories and related merchandise, we typically experience lower net sales in the first fiscal quarter relative to other quarters. WE HAVE MANY IMPORTANT VENDOR RELATIONSHIPS, AND OUR ABILITY TO GET MERCHANDISE COULD BE HURT BY CHANGES IN THOSE RELATIONSHIPS AND EVENTS HARMFUL TO OUR VENDORS COULD IMPACT OUR RESULTS OF OPERATION. Our financial performance depends on our ability to purchase desired merchandise in sufficient quantities at competitive prices. Although we may have many sources of merchandise, substantially all of our music/pop culture-licensed products are available only from vendors that have exclusive license rights. In addition, certain of our products are supplied by small, specialized vendors, some of which create unique products primarily for us. Our smaller vendors generally have limited resources, production capacities and operating histories, and some of our vendors have restricted the distribution of their merchandise in the past. We generally have no long-term purchase contracts or other contractual assurances of continued supply, pricing or access to new products. There can be no assurance that we will be able to acquire desired merchandise in sufficient quantities on acceptable terms in the future. Any inability to acquire suitable merchandise, or the loss of one or more key vendors, may have a material adverse effect on our business, results of operations and financial condition. TECHNOLOGY AND OTHER RISKS ASSOCIATED WITH OUR INTERNET SALES COULD HINDER OUR OVERALL FINANCIAL PERFORMANCE. We sell merchandise over the Internet through the websites hottopic.com and torrid.com. Our Internet operations are subject to numerous risks and pose risks to our overall business, including, among other things: hiring; retention and training of personnel to conduct the Internet operations; diversion of sales from our stores; rapid technological change and the need to invest in additional computer hardware and software to support sales, customer service and order fulfillment; liability for online content; failure of computer hardware and software, including computer viruses, telecommunication failures, online security breaches and similar disruptions; governmental regulation; and credit card fraud. There can be no assurance that our Internet operations will achieve sales and profitability levels that justify our investment in them. 19. WE HAVE MADE AND PLAN TO CONTINUE TO MAKE SIGNIFICANT CHANGES TO INFORMATION SYSTEMS AND SOFTWARE USED IN OPERATION OF OUR BUSINESS, AND WE MAY NOT BE ABLE TO EFFECTIVELY ADOPT CHANGES IN A WAY TO PREVENT FAILURES IN OUR OPERATIONS OR NEGATIVE IMPACT ON OUR FINANCIAL PERFORMANCE AND REPORTING. Over the past several years, we have made improvements to existing hardware and software systems, as well as implemented new systems. For example, we have invested approximately $6 million to enhance the functionality of our current GERS Retail Systems software and to implement new financial system software from Lawson. In addition, we are investing approximately $10 million in the implementation of a new warehouse management software system, a new Internet order management software system, and a new customer loyalty software system. We expect to significantly increase our reliance on these systems in fiscal 2005. If these information systems and software do not work effectively, we may experience delays or failures in our operations. These delays or failures could adversely impact the promptness and accuracy of our merchandise distribution, transaction processing, financial accounting and reporting and ability to properly forecast earnings and cash requirements. For example, in the second quarter of 2004, we experienced some delay in product distribution upon implementation of our new warehouse management system. To manage growth of our operations and personnel, we may need to continue to improve our operational and financial systems, transaction processing, and procedures and controls, and in doing so, we could incur substantial additional expenses. LOSS OF KEY PEOPLE OR AN INABILITY TO HIRE NECESSARY AND SIGNIFICANT PERSONNEL COULD HURT OUR BUSINESS. Our financial performance depends largely on the efforts and abilities of senior management, especially Elizabeth McLaughlin, our Chief Executive Officer, who has been with us since 1993. We have a $2,000,000 key-person life insurance policy on Ms. McLaughlin. However, the sudden loss of Ms. McLaughlin's services or the services of other members of our management team could have a material adverse effect on our business, results of operations and financial condition. Furthermore, there can be no assurance that Ms. McLaughlin and our existing management team will be able to manage Hot Topic, Inc. or our growth or that we will be able to attract and retain additional qualified personnel as needed in the future. OUR RELIANCE ON UNITED PARCEL SERVICE, TEMPORARY EMPLOYEES AND OTHER MECHANICS OF SHIPPING OF OUR MERCHANDISE CREATES DISTRIBUTION RISKS AND UNCERTAINTIES THAT COULD HURT OUR SALES AND BUSINESS. We rely upon United Parcel Service for our product shipments, including shipments to and from a significant number of our stores. Our reliance on this source for shipments is subject to risks, including employee strikes and inclement weather, associated with United Parcel Service's ability to provide delivery services that adequately meet our shipping needs. We are also dependent upon temporary associates to adequately staff our distribution facility, particularly during busy periods such as the Holiday season and while multiple stores are opening. There can be no assurance that we will continue to receive adequate assistance from our temporary associates, or that there will continue to be sufficient sources of temporary associates. Additionally, certain products are imported and subject to delivery delays based on availability and ports capacity. THERE IS A RISK WE COULD ACQUIRE MERCHANDISE WITHOUT FULL RIGHTS TO SELL IT, WHICH COULD LEAD TO DISPUTES OR LITIGATION AND HURT OUR FINANCIAL PERFORMANCE AND STOCK PRICE. We purchase licensed merchandise from a number of suppliers who hold manufacturing and distribution rights under the terms of certain licenses. We generally rely upon vendors' representations concerning manufacturing and distribution rights and do not independently verify whether these vendors legally hold adequate rights to licensed properties they are manufacturing or distributing. If we acquire unlicensed merchandise, we could be obligated to remove such merchandise from our stores, incur costs associated with destruction of merchandise if the distributor is unwilling or unable to reimburse us, and be subject to liability under various civil and criminal causes of action, including actions to recover unpaid royalties and other damages. Any of these results could have a material adverse effect on our business, results of operations and financial condition. 20. WE FACE INTENSE COMPETITION, AND AN INABILITY TO ADEQUATELY ADDRESS IT, OR THE SUCCESS OF OUR COMPETITORS, COULD LIMIT OR PREVENT OUR BUSINESS GROWTH AND SUCCESS. The retail apparel and accessory industry is highly competitive. We compete with other retailers for vendors, teenage and young adult customers, suitable store locations and qualified associates and management personnel. Hot Topic currently competes with street alternative stores located primarily in metropolitan areas; with other mall-based teenage-focused retailers such as Abercrombie & Fitch, Aeropostale, American Eagle Outfitters, Anchor Blue, Charlotte Russe Inc., Claire's Stores, Inc., Forever 21, Pacific Sunwear of California, Inc., Spencer Gifts, Inc., H&M, The Buckle, Wet Seal, Inc., and Urban Outfitters, Inc.; and, to a lesser extent, with music stores and mail order catalogs and websites. Torrid has additional competitors, such as Alloy, Inc., Deb Shops, Delia's Corp., Old Navy (a division of Gap Inc.), Lane Bryant, and plus-size departments in department stores and discount stores as well as numerous potential competitors who may begin or increase efforts to market and sell products competitive with Torrid's products. Some of our competitors are larger and may have greater financial, marketing and other resources. Direct competition with these and other retailers may increase significantly in the future, which could require us, among other things, to lower our prices. Increased competition could have a material adverse effect on our business, results of operations and financial condition. WAR, TERRORISM AND OTHER CATASTROPHES COULD NEGATIVELY IMPACT OUR CUSTOMERS, PLACES WHERE WE DO BUSINESS, AND OUR EXPENSES, ALL OF WHICH COULD HURT OUR BUSINESS. The effects of war or acts of terrorism could have a material adverse effect on our business, operating results and financial condition. The terrorist attacks in New York and Washington, D.C. on September 11, 2001 disrupted commerce and intensified the uncertainty of the U.S. economy, a condition which has persisted due to recent military actions. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions and create further uncertainties. To the extent that such disruptions or uncertainties negatively impact shopping patterns and/or mall traffic, or adversely affect consumer confidence or the economy in general, our business, operating results and financial condition could be materially and adversely affected. In addition, a few years ago, California experienced substantially increased costs of electricity and gas caused by, among other things, disruption in energy supplies. Our principal executive offices, distribution center and a significant number of our stores are located in California. If we experience a sustained disruption in energy supplies, or if electricity and gas costs in California fluctuate dramatically, our results of operations could be materially and adversely affected. California is also subject to natural disasters such as earthquakes and floods. A significant natural disaster or other catastrophic event affecting our facilities could have a material adverse impact on our business, financial condition and operating results. THERE ARE NUMEROUS RISKS THAT COULD CAUSE OUR STOCK PRICE TO FLUCTUATE SUBSTANTIALLY. Our common stock is quoted on the Nasdaq National Market, which has experienced and is likely to experience in the future significant price and volume fluctuations, which could adversely affect our stock price without regard to our financial performance. In addition, we believe that factors such as quarterly fluctuations in our financial results and comparable store sales; announcements by other apparel, accessory and gift item retailers; the trading volume of our stock; changes in estimates of our performance by securities analysts; overall economic and political conditions; the condition of the financial markets; and other events or factors outside of our control could cause our stock price to fluctuate substantially. 21. OUR CHARTER DOCUMENTS AND OTHER CIRCUMSTANCES COULD PREVENT A TAKEOVER OR CAUSE DILUTION OF OUR EXISTING SHAREHOLDERS, WHICH COULD BE DETRIMENTAL TO EXISTING SHAREHOLDERS AND HINDER BUSINESS SUCCESS. Our Articles of Incorporation and Bylaws contain provisions that may have the effect of delaying, deterring or preventing a takeover of Hot Topic, Inc. For instance, our Articles of Incorporation include certain "fair price provisions" generally prohibiting business combinations with controlling or significant shareholders unless certain minimum price or procedural requirements are satisfied, and our Bylaws prohibit shareholder action by written consent. Additionally, our Board of Directors has the authority to issue, without shareholder approval, up to 10,000,000 shares of "blank check" preferred stock having such rights, preferences and privileges as designated by the Board of Directors. The issuance of these shares could have a dilutive effect on certain shareholders, and potentially prohibit a takeover of Hot Topic, Inc. by requiring the preferred shareholders to approve such a transaction. We also have a significant number of authorized and unissued shares of our common stock available under our Articles of Incorporation. These shares provide us with the flexibility to issue our common stock for future business and financial purposes including stock splits, raising capital and providing equity incentives to employees, officers and directors. However, the issuance of these shares could result in dilution to our shareholders. WE INCUR COSTS ASSOCIATED WITH REGULATORY COMPLIANCE, AND THIS COST COULD BE SIGNIFICANT. All companies are subject to laws and regulations, some of which require certain actions to be taken (or not taken) and costs to be incurred relating to business processes and risk management. There are additional requirements for public companies, including the provisions of the Sarbanes-Oxley Act of 2002. With regard to the Sarbanes-Oxley Act, we have and will continue to incur significant expense as we continue to address the implications of applicable rules and our operations relative thereto, and as we work to respond to and comply with applicable requirements. Among other things, we have incurred and will incur additional expenses as we implement Section 404 of the Sarbanes-Oxley Act. Section 404 requires management to report on, and our independent auditors to attest to, our internal controls. Compliance with these rules could also result in continued diversion of management's time and attention, which could be disruptive to normal business operations. If we do not satisfactorily or timely comply with these requirements, possible consequences could include sanction or investigation by regulatory authorities such as the Securities and Exchange Commission or the Nasdaq National Market, incomplete or late filing of our annual report on Form 10-K, or civil or criminal liability. Our stock price and business could also be adversely affected. THERE ARE LITIGATION AND OTHER CLAIMS AGAINST US FROM TIME TO TIME, WHICH COULD DISTRACT MANAGEMENT FROM OUR BUSINESS ACTIVITIES, AND COULD LEAD TO ADVERSE CONSEQUENCES TO OUR BUSINESS AND FINANCIAL CONDITION. As a growing company with expanding operations, we are increasingly involved from time to time with litigation and other claims against us. These arise primarily in the ordinary course of our business, and include employee claims, commercial disputes, intellectual property issues and product-oriented allegations. Often these cases raise complex factual and legal issues, which are subject to risks and uncertainties and which could require significant management time. Although we do not currently believe that the outcome of any current litigation and claims against us will have a material adverse effect on us, adverse settlements or resolutions may occur and negatively impact earnings, injunctions against us could have an adverse effect on our business by requiring us to do or prohibiting us from doing certain things, and other unexpected events could have a negative impact on us. 22. RECENT ACCOUNTING REGULATION CHANGES WILL REQUIRE THE EXPENSING OF STOCK OPTIONS. Recently effective accounting regulation changes require that all publicly traded companies begin recording compensation expense related to all unvested and newly granted stock options prospectively for interim or annual periods beginning after June 15, 2005. Currently, we include such expenses on a pro forma basis in the notes to our quarterly and annual financial statements in accordance with accounting principles generally accepted in the United States of America and do not include compensation expense related to stock options in our reported earnings in the financial statements. When we begin expensing stock options as provided above, our reported earnings will be negatively impacted and our stock price could decline. ITEM 2. PROPERTIES We lease all of our existing store locations, with lease terms expiring between 2005 and 2015. At January 29, 2005, we had a total of 1,214,424 leased store square feet (Hot Topic and Torrid stores) with an average store size of 1,810 square feet (Hot Topic and Torrid stores). The leases for most of the existing stores are for approximately ten-year terms and provide for contingent rent based upon a percent of sales in excess of specified minimums. Leases for future stores will likely include similar contingent rent provisions. We lease our headquarters and distribution center facility, located in City of Industry, California, which is approximately 250,000 square feet. Our lease expires April 2014, and the annual base rent is approximately $1,110,000. We have entered into a lease (with a purchase option) for an additional distribution center facility in Tennessee, which is approximately 300,000 square feet, which we expect to be operational by the end of the second quarter of fiscal 2005. ITEM 3. LEGAL PROCEEDINGS On June 23, 2004, a non-profit corporation named Center for Environmental Health filed a lawsuit in Federal district court in Alameda, California against over two dozen retailers, large and small, including Hot Topic, Inc. Other defendants include teen retailers like Claire's and Wet Seal, department stores like Sears, Nordstrom, Macy's and J.C. Penney, and large retailers like Wal-Mart and Target. Certain of the defendants, but not Hot Topic, were also named defendants in a substantially similar lawsuit filed by the State of California. The complaint in each case alleges, in general, that the defendant retailers have violated certain California statutes by not providing sufficient warning about an alleged potential for lead exposure relating to costume jewelry sold in stores. The complaints do not contain allegations of personal injury. In August 2004, we were served another complaint, filed in the Circuit Court of Shelby County, Tennessee, claiming we are liable due to alleged lead content in our costume jewelry we allegedly target to children. This complaint is an alleged class action, again excluding any personal injury claim, with counts of negligence and breach of implied warranty. Similar claims had been made, prior to service upon us, against other retailers in the same jurisdiction by plaintiffs represented by the same law firm. Currently, a motion to dismiss is under consideration by the court in a separate case against another retailer, and the Tennessee case against us has been delayed pending the court's ruling on that motion. We expect to file a similar motion to dismiss for our case. The plaintiffs in the above California cases seek unspecified fines and penalties, attorneys' fees and costs, and injunctive and other equitable relief; and the plaintiff in the Tennessee case seeks unspecified money damages, punitive damages, attorneys' fees and injunctive relief on behalf of the alleged class. We continue to evaluate appropriate action in each of these cases with our counsel. In each case, we believe we have meritorious defenses to the plaintiff's claims and intend to defend against such claims; though it is impossible to predict the outcome of the proceeding, and it is possible the plaintiff will be awarded requested remedies or that we may determine it appropriate to settle the lawsuit which could require us to take or not take certain actions. On September 17, 2004, a former Torrid employee filed a lawsuit against us in Superior Court of Los Angeles County, on behalf of a purported class. The lawsuit asserts claims for failure to provide adequate meal or rest breaks, improper payment of overtime wages, failure to timely pay wages at end of employment and unfair business practices. The lawsuit seeks compensatory damages, statutory penalties, punitive damages, attorneys' fees and injunctive relief. On October 21, 2004, we filed an answer denying the material allegations of the complaint, and we intend to vigorously defend ourselves against the various claims. Discovery has begun in connection with this matter but at the present time we are unable to predict the outcome of this matter. 23. On November 18, 2004, a former Torrid employee filed a lawsuit against us in Superior Court of Los Angeles County, on behalf of a purported class. The lawsuit asserts claims for, among other things, failure to pay overtime wages and unfair business practices. The lawsuit seeks compensatory damages, statutory penalties, restitution, interest and other costs, and attorneys' fees. We intend to vigorously defend ourselves against the various claims, though at the present time we are unable to predict the outcome of this matter. Though significant litigation or awards against us could seriously harm our business and financial results, we do not at this time expect any of the above-described litigation to have a material adverse effect on us. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 24. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Our Common Stock is traded on the Nasdaq National Market under the symbol "HOTT." The following table shows, for the periods indicated, the high and low end-of-day closing sales prices of our shares of Common Stock, as reported on the Nasdaq National Market. Such quotations represent inter-dealer prices without retail markup, markdown or commission and may not necessarily represent actual transactions. 2004 FISCAL YEAR QUARTERS HIGH LOW ------------------------------------------------------ First Quarter $30.79 $21.78 Second Quarter $22.91 $14.87 Third Quarter $20.56 $14.49 Fourth Quarter $20.95 $15.46 2003 FISCAL YEAR QUARTERS HIGH LOW ------------------------------------------------------ First Quarter $16.35 $14.01 Second Quarter $19.67 $15.69 Third Quarter $29.25 $18.33 Fourth Quarter $31.85 $26.60 On August 12, 2003, we announced that our Board of Directors approved a three-for-two stock split (in the form of a dividend) of our common stock. On the effective date of September 2, 2003, shareholders received a dividend of one additional share for every two shares they owned at the close of business on the record date of August 21, 2003. The prices listed in the above table have been adjusted for the split. On March 9, 2005, the last sales price of our common stock as reported on the Nasdaq National Market was $23.05 per share. As of March 9, 2005, there were approximately 208 holders of record of our common stock. This number does not reflect the actual number of beneficial holders of our common stock, which we believe to be in excess of 25,000 holders. On March 19, 2004, we announced that our Board of Directors approved the repurchase of up to an aggregate of 2,000,000 shares of our common stock during the period ending January 29, 2005. As of July 31, 2004 we had completed the repurchase of 2,000,000 shares of our common stock at a cost of $46.8 million at an average price of $23.41. On August 18, 2004, we announced that our Board of Directors approved an additional repurchase of up to an aggregate of 2,000,000 shares of our common stock during the period ending January 29, 2005. As of January 29, 2005 we had completed the repurchase of 2,000,000 shares of our common stock at a cost of $32.8 million at an average price of $16.42. The following table summarizes activity in the quarter ended January 29, 2005. 25. ISSUER PURCHASES OF EQUITY SECURITIES - ------------------------------------------------------------------------------------------------------------------------- TOTAL NUMBER OF SHARES PURCHASED AS MAXIMUM NUMBER OF PART OF PUBLICLY SHARES THAT MAY YET BE TOTAL NUMBER OF AVERAGE PRICE PAID ANNOUNCED PLANS OR PURCHASED UNDER THE FISCAL PERIOD SHARES PURCHASED PER SHARE PROGRAMS PLANS OR PROGRAMS - ------------------------ ---------------- ------------------ ------------------- ---------------------- November 28, 2004 - January 1, 2005 1,000,000 $15.98 2,000,000 - ---------------- ------------------ ------------------- ---------------------- Total 1,000,000 $15.98 2,000,000 - ================ ================== =================== ======================
We have not paid any cash dividends since inception and do not anticipate paying any cash dividends in the foreseeable future. Please see Item 12 for information about our equity compensation plans. ITEM 6. SELECTED FINANCIAL DATA The following table summarizes selected financial data for each of the five fiscal years in the period ended January 29, 2005 and have been restated to reflect adjustments that are discussed further in Note 2. "Restatement of Financial Statements" in the Notes to Consolidated Financial Statements included in Item 8. "Financial Statements and Supplementary Data" in this Form 10-K. This data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and Notes included elsewhere in this Annual Report on Form 10-K. 26. Fiscal Year (as restated) -------------------------------------------------------------- 2004 2003 2002 2001 2000 --------- --------- --------- --------- --------- (In thousands, except per share data, number of stores, comparable store sales and sales per square foot) Statement of Operations Data: Net sales $ 656,468 $ 572,039 $ 443,250 $ 336,094 $ 257,187 Cost of goods sold, including buying, distribution and occupancy costs 422,712 352,277 274,008 205,756 154,765 --------- --------- --------- --------- --------- Gross margin 233,756 219,762 169,242 130,338 102,422 Selling, general and administrative expenses 170,384 143,952 115,634 86,950 67,917 --------- --------- --------- --------- --------- Operating income 63,372 75,810 53,608 43,388 34,505 Interest income, net 919 1,318 1,371 1,884 1,925 --------- --------- --------- --------- --------- Income before income taxes 64,291 77,128 54,979 45,272 36,430 Provision for income taxes 24,618 29,539 20,892 17,146 13,479 --------- --------- --------- --------- --------- Net income $ 39,673 $ 47,589 $ 34,087 $ 28,126 $ 22,951 ========= ========= ========= ========= ========= Net income per share: Basic $ 0.86 $ 1.00 $ 0.72 $ 0.61 $ 0.52 Diluted $ 0.83 $ 0.96 $ 0.69 $ 0.56 $ 0.48 Weighted average shares outstanding: Basic 46,379 47,479 47,027 46,467 44,502 Diluted 47,875 49,588 49,276 49,829 48,104 Selected Operating Data: Number of stores at year end 668 554 445 352 274 Comparable stores sales (2.9)% 7.4% 5.0% 3.9% 16.7% Average sales per square foot $ 571 $ 619 $ 619 $ 636 $ 669 Average sales per store $ 1,034 $ 1,106 $ 1,064 $ 1,036 $ 1,020 Balance Sheet Data: Cash and short-term investments $ 66,339 $ 128,205 $ 83,418 $ 71,310 $ 51,288 Working capital 87,221 141,803 90,261 82,370 61,253 Total assets 278,395 296,082 215,854 169,904 123,317 Shareholders' equity $ 187,562 $ 221,279 $ 158,756 $ 133,738 $ 98,135 27.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of our results of operations, financial condition and liquidity, and other matters should be read in conjunction with our Consolidated Financial Statements and Notes related thereto included in Item 8. "Financial Statements and Supplementary Data" in this Form 10-K. These statements have been prepared in conformity with accounting principles generally accepted in the United States and require our management to make estimates and assumptions that affect amounts reported and disclosed in the financial statements and related notes. Actual results could differ from these estimates. GENERAL We are a mall-based specialty retailer operating the Hot Topic and Torrid store concepts. Hot Topic stores sell a selection of music/pop culture-licensed and music/pop culture-influenced apparel, accessories and gift items for young men and women principally between the ages of 12 and 22. Torrid stores sell apparel, lingerie, shoes and accessories designed for various lifestyles for plus-size females between the ages of 15 and 29. We opened our first Hot Topic store in 1989 and our first Torrid store in 2001. At the end of fiscal 2004 (the fiscal year ended January 29, 2005), we operated 592 Hot Topic stores throughout the United States and Puerto Rico, and 76 Torrid stores. We also sell merchandise on two websites, www.hottopic.com ("hottopic.com") and www.torrid.com ("torrid.com"), which reflect the Hot Topic and Torrid store concepts and carry merchandise similar to that sold in the respective stores. We consider a store comparable after it has been open for 15 full months. If a store is relocated or expanded by more than 15% in total square footage, it is removed from the comparable store base and, similar to new stores, becomes comparable after 15 full months. At the end of fiscal 2004, 471 of the 592 Hot Topic stores were included in the comparable store base, compared to 401 of the 502 stores open at the end of fiscal 2003. At the end of fiscal 2004, 46 of the 76 Torrid stores were included in the comparable store base, compared to 22 of the 52 stores open at the end of fiscal 2003. We operate on a 52 or 53-week fiscal year, which ends on the Saturday nearest to January 31. Fiscal 2004, 2003 and 2002 were 52-week fiscal years. See Note 2 to the Consolidated Financial Statements included in this report for a summary of changes related to accounting of leases on our consolidated balance sheet as of January 31, 2004, as well as our consolidated statements of income and cash flows for the fiscal years ended January 31, 2004 and February 1, 2003. This Management's Discussion and Analysis gives effect to those corrections. 28. RESULTS OF OPERATIONS The following table shows, for the periods indicated, certain selected statement of operations data expressed as a percentage of net sales and certain store data: FISCAL YEAR ------------------------------- 2004 2003 2002 ---- ---- ---- Net sales 100.0% 100.0% 100.0% Cost of goods sold, including buying, distribution & occupancy costs 64.4% 61.6% 61.8% ----- ----- ----- Gross margin 35.6% 38.4% 38.2% Selling, general and administrative expenses 25.9% 25.1% 26.1% ----- ----- ----- Operating income 9.7% 13.3% 12.1% Interest income, net 0.1% 0.2% 0.3% ---- ---- ---- Income before income tax 9.8% 13.5% 12.4% Provision for income taxes 3.8% 5.2% 4.7% ---- ---- ---- Net income 6.0% 8.3% 7.7% ==== ==== ==== Number of stores at year end 668 554 445 Comparable store sales (2.9)% 7.4% 5.0% FISCAL 2004 COMPARED TO FISCAL 2003 Net sales increased approximately $84.4 million, or 14.8%, to $656.5 million in fiscal 2004 from $572.0 million in fiscal 2003. The components of this $84.4 million increase in net sales are as follows: AMOUNT ($ MILLIONS) DESCRIPTION ------------ ----------------------------------------------------------- $75.6 Net sales from new Hot Topic stores opened during fiscal 2004 and Hot Topic stores not yet qualifying as comparable stores 19.2 Net sales from new Torrid stores opened during fiscal 2004 and Torrid stores not yet qualifying as comparable stores (14.4) 2.9% decrease in comparable store net sales in fiscal 2004 compared to fiscal 2003 4.0 Increase in Internet sales (hottopic.com and torrid.com) ----------- $84.4 TOTAL =========== The annual average Hot Topic store volume decreased to $1.05 million in fiscal 2004 from $1.13 million in fiscal 2003. Hot Topic sales of apparel category merchandise, as a percentage of total net sales, were 53% in fiscal 2004 compared to 52% in fiscal 2003. The increase in apparel was primarily due to increases in men's music-related tee shirts partially offset by decreases in women's bottoms, men's fashion tops and men's bottoms. 29. Gross margin increased approximately $14.0 million to $233.8 million in fiscal 2004 from $219.8 million in fiscal 2003. As a percentage of net sales, gross margin decreased to 35.6% in fiscal 2004 from 38.4% in fiscal 2003. The significant components of this 2.8% decrease in gross margin, as a percentage of net sales, are as follows: % DESCRIPTION ------------ ----------------------------------------------------------- (2.1)% Decrease in merchandise margin, principally due to higher markdown activity driven by lower comparable store sales (0.5) Increase in occupancy and store depreciation expenses, primarily due to deleveraging over lower comparable store sales (0.2) Increase in distribution expenses and buying costs, primarily due to higher freight costs and deleveraging payroll costs over lower comparable store sales ----------- (2.8)% TOTAL =========== Selling, general and administrative expenses increased approximately $26.4 million to $170.4 million during fiscal 2004 from $144.0 million during fiscal 2003. As a percentage of net sales, selling, general and administrative expenses were 25.9% for fiscal 2004 compared to 25.1% in fiscal 2003. The total dollar increase in selling, general and administrative expenses was primarily attributable to an increase in the number of retail stores from 554 at the end of fiscal 2003 to 668 at the end of fiscal 2004 and the corresponding additional payroll and other expenses required to support these additional stores. The significant components of this 0.8% increase in selling, general and administrative expenses as a percentage of net sales are as follows: % DESCRIPTION ------------ ----------------------------------------------------------- 0.5% Increase in store payroll due to deleveraging of payroll costs over lower comparable store sales, and increase in payroll-related benefits costs, partially offset by lower store bonus payouts 0.5% Increase in other store expenses as a result of deleveraging expenses over lower comparable store sales along with increases in store supply costs and expenses related to our wide area network 0.1% Increase in depreciation and amortization as a result of our new warehouse management software implemented during 2004 and higher marketing expenses to support new advertising programs. (0.3)% Decrease in other general and administrative expenses primarily due to a decrease in performance based compensation, partially offset by an increase in payroll related benefits costs and an increase in professional fees related to implementing Section 404 of the Sarbanes-Oxley Act ------------ 0.8% TOTAL ============ Operating income decreased approximately $12.4 million to $63.4 million during fiscal 2004 from $75.8 million during fiscal 2003. As a percentage of net sales, operating income was 9.7% in fiscal 2004 compared to 13.3% in fiscal 2003. Operating income on an average store basis was approximately $103,000 in fiscal 2004 as compared to $151,000 in fiscal 2003. 30. Net interest income decreased to $0.9 million in fiscal 2004 from $1.3 million in fiscal 2003, principally due to lower average cash balances, which was primarily a result of cash used for purposes of common stock repurchases. Our effective tax rate was 38.3% in both fiscal 2004 and 2003. FISCAL 2003 COMPARED TO FISCAL 2002 Net sales increased approximately $128.8 million, or 29.1%, to $572.0 million in fiscal 2003 from $443.2 million in fiscal 2002. The components of this $128.8 million increase in net sales are as follows: AMOUNT ($ MILLIONS) DESCRIPTION ------------ ----------------------------------------------------------- $71.5 Net sales from new Hot Topic stores opened during fiscal 2003 and Hot Topic stores not yet qualifying as comparable stores 20.3 Net sales from new Torrid stores opened during fiscal 2003 and Torrid stores not yet qualifying as comparable stores 29.1 7.4% increase in comparable store net sales in fiscal 2003 compared to fiscal 2002 7.9 Increase in Internet sales (hottopic.com and torrid.com) ------------ $128.8 TOTAL ============ The annual average Hot Topic store volume increased to $1.13 million in fiscal 2003 from $1.07 million in fiscal 2002. Hot Topic sales of apparel category merchandise, as a percentage of total net sales, were 52% in fiscal 2003 compared to 51% in fiscal 2002. The increase in apparel was primarily due to increases in men's novelty tee shirts and men's music-related tee shirts partially offset by decreases in women's apparel (women's bottoms and novelty tees), men's fashion tops and men's bottoms. The sales mix for Hot Topic in fiscal 2003 saw a decrease in sales of non-apparel merchandise (including accessories, gifts, intimate apparel and shoes) to 48% from 49% in fiscal 2002. Gross margin increased approximately $50.6 million to $219.8 million in fiscal 2003 from $169.2 million in fiscal 2002. As a percentage of net sales, gross margin increased to 38.4% in fiscal 2003 from 38.2% in fiscal 2002. The significant components of this 0.2% improvement in gross margin, as a percentage of net sales, are as follows: % DESCRIPTION ------------ ----------------------------------------------------------- 0.4% Decrease in distribution expenses, primarily due to significant savings in freight costs, due to change in shipping method to stores, and labor costs, due to productivity improvements 0.2 Decrease in store depreciation as a result of leverage gained from higher comparable store sales, partially offset by an increase in store occupancy resulting from higher rent expenses and common area charges (0.4) Decrease in merchandise margin, principally due to lower initial markup and higher shrinkage, partially offset by lower markdowns. ------------ 0.2% TOTAL ============ 31. Selling, general and administrative expenses increased approximately $28.4 million to $144.0 million during fiscal 2003 from $115.6 million during fiscal 2002. As a percentage of net sales, selling, general and administrative expenses were 25.1% for fiscal 2003 compared to 26.1% in fiscal 2002. The total dollar increase in selling, general and administrative expenses was primarily attributable to an increase in the number of retail stores from 445 at the end of fiscal 2002 to 554 at the end of fiscal 2003 and the corresponding additional payroll and other expenses required to support these additional stores. The significant components of this 1.0% decrease in selling, general and administrative expenses as a percentage of net sales are as follows: % DESCRIPTION ------------ ----------------------------------------------------------- (1.2)% Decrease in store payroll and administrative salary expense resulting from leverage gained from higher comparable store sales and controlling payroll costs (0.1) Decrease in pre-opening expenses 0.3 Increase in administrative performance based payroll expenses, partially offset by headquarters expenses which benefited from leverage gained from higher comparable store sales ----------- (1.0)% TOTAL =========== Operating income increased approximately $22.2 million to $75.8 million during fiscal 2003 from $53.6 million during fiscal 2002. As a percentage of net sales, operating income was 13.3% in fiscal 2003 compared to 12.1% in fiscal 2002. Operating income on an average store basis was approximately $151,000 in fiscal 2003 as compared to $133,000 in fiscal 2002. Net interest income decreased to $1.3 million in fiscal 2003 from $1.4 million in fiscal 2002, principally due to lower interest rates offset in part by the additional interest earned from higher average cash balances. Our effective tax rate was 38.3% in fiscal 2003 and 38.0% in fiscal 2002. The higher rate for fiscal 2003 is principally attributable to lower tax-exempt interest income as a percentage of pre-tax income in fiscal 2003 as compared to fiscal 2002. QUARTERLY RESULTS AND SEASONALITY Our quarterly results of operations may fluctuate materially depending on, among other things, the timing of store openings and related pre-opening and other startup expenses, net sales contributed by new stores, increases or decreases in comparable store sales, releases of new music and music/pop culture-related products, shifts in timing of certain holidays, changes in our merchandise mix and overall economic and political conditions. Our business is also subject to seasonal influences, with heavier concentrations of sales during the back-to-school, Halloween and Holiday seasons (defined as the week of Thanksgiving through the first few days of January), and other periods when schools are not in session. The Holiday season remains our single most important selling season. We believe, however, that the importance of the summer vacation and back-to-school seasons (which affect operating results in the second and third quarters, respectively) and to a lesser extent, the spring break season (which affects operating results in the first quarter) as well as Halloween (which affects operating results in the third quarter), all reduce our dependence on the Holiday selling season. Furthermore, summer vacation, back-to-school season and spring break season take place at somewhat different times in different parts of the country, spreading the impact of these events on our sales over a longer period. As is the case with many retailers of apparel, accessories and related merchandise, we typically experience lower first fiscal quarter net sales relative to other quarters. 32. The following table shows certain statement of operations and selected operating data for each of our last eight fiscal quarters (13 week periods). See Note 2 to the Consolidated Financial Statements for changes related to accounting for leases, which are reflected in the amounts below. The quarterly statement of operations data and selected operating data shown below were derived from our unaudited financial statements, which in the opinion of management contain all adjustments (consisting only of normal recurring adjustments) necessary for fair presentation. Results in any quarter are not necessarily indicative of results that may be achieved for a full year. FISCAL YEAR 2004 (AS RESTATED) FISCAL YEAR 2003 (AS RESTATED) ------------------------------------------- ------------------------------------------ FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH ----- ------ ----- ------ ----- ------ ----- ------ (In thousands, except selected operating and per share data) STATEMENT OF OPERATIONS DATA: Net sales $128,143 $136,263 $180,808 $211,254 $100,657 $115,728 $161,546 $194,108 Gross margin 44,185 46,650 64,540 78,381 35,350 41,397 62,754 80,261 Operating income 8,200 7,135 19,987 28,050 6,501 9,090 24,128 36,091 Net income $5,277 $4,528 $12,448 $17,420 $4,254 $5,740 $15,093 $22,502 Net income per share: Basic $0.11 $0.10 $0.27 $0.39 $0.09 $0.12 $0.32 $0.47 Diluted $0.11 $0.09 $0.26 $0.38 $0.09 $0.12 $0.30 $0.45 Weighted average shares outstanding: Basic 48,019 46,565 46,086 44,944 46,968 47,360 47,656 47,932 Diluted 50,131 48,023 47,202 46,127 48,567 49,127 49,917 50,342 SELECTED OPERATING DATA: Comparable stores sales 4.0% (2.1)% (4.2)% (6.0)% 2.6% (5.2)% 10.8% 8.5% Stores open at end of period 581 613 649 668 468 497 540 554
LIQUIDITY AND CAPITAL RESOURCES In recent years, we have satisfied our cash requirements principally from cash flows from operations and to a lesser extent proceeds from the exercise of stock options. During the last three fiscal years, our primary uses of cash have been to finance store openings and purchase merchandise inventories, as well as periodic repurchases of our common stock. In August 2004, we announced the approval by our Board of Directors of the repurchase of up to 2,000,000 shares of our common stock. As of January 29, 2005 we had completed the repurchase of 2,000,000 shares of our common stock at an average price of $16.42. In addition, pursuant to authorization by our Board of Directors in March 2004, we repurchased 2,000,000 shares of our common stock at an average price of $23.41 during the six months ended July 31, 2004. We also maintain a $5.0 million unsecured credit agreement for the purpose of issuing letters of credit, primarily for inventory purchases. At January 29, 2005, we had $0.1 million of outstanding letters of credit under the credit agreement. At the end of fiscal 33. 2004, we had $66.3 million in cash, cash equivalents and short-term investments, a decrease of $61.9 million, or 48%, compared to the $128.2 million at the end of fiscal 2003. Working capital was $87.2 million, $141.8 million, and $90.3 million for fiscal 2004, 2003 and 2002, respectively. The decrease in working capital from 2003 to 2004 is primarily attributable to cash used for the repurchase of our common stock. Net cash flows provided by operating activities were $71.1 million, $78.6 million and $64.8 million in fiscal 2004, 2003, and 2002, respectively. The $7.5 million decrease in cash flows from operating activities in fiscal 2004 as compared to fiscal 2003 was primarily attributable to decreases in net income, accrued liabilities and tax benefits from exercise of stock options, partially offset by increases in deferred rent, deferred taxes, and depreciation and amortization, and decrease in the change of inventory compared to fiscal 2003. The significant changes in net cash provided by operating activities were due primarily to the increase in store growth to 668 stores at the end of fiscal 2004 compared to 554 stores at the end of fiscal 2003. Net cash flows used in investing activities were $2.6 million, $88.2 million and $41.6 million in fiscal 2004, 2003 and 2002, respectively. In fiscal 2004, approximately $39 million was used for the construction of 91 Hot Topic stores, 24 Torrid stores, expansion and refurbishment of ten Hot Topic and Torrid stores and progress payments for construction of stores opening in early fiscal 2005. We used approximately $14 million on computer hardware and software and $5 million on our headquarters and distribution center infrastructure. We opened 115, 109, and 95 stores in fiscal 2004, 2003 and 2002, respectively. Net cash used in investing activities was reduced by the net proceeds ($55 million) of short-term investments sold. Net cash flows used in financing activities were $75.1 million in fiscal 2004 compared to net cash flows provided by financing activities of $8.3 million and net cash flows used in financing activities of $14.3 million in fiscal 2003 and 2002, respectively. The $83.5 million decrease in fiscal 2004 compared to fiscal 2003 was principally a result of $79.6 million of cash used to repurchase our common stock in fiscal 2004 and $3.9 million related to a decrease in proceeds from exercise of stock options. We anticipate that we will spend approximately $56 million on capital expenditures in fiscal 2005, including approximately $38 million for stores, $10 million for the second distribution center located in Tennessee, and $8 million for computer hardware and software. The $38 million for stores is to be primarily used for the construction of 65 Hot Topic stores and 45 Torrid stores, and expansion of approximately 20 existing stores. During fiscal 2004, our average gross capital expenditures for a new Hot Topic store, including leasehold improvements and furniture and fixtures, totaled approximately $235,000. The average initial gross inventory for the new Hot Topic stores opened in 2004 was approximately $110,000 and the average pre-opening costs for a new Hot Topic store were approximately $21,000. Initial inventory requirements vary at new stores depending on the season and current merchandise trends. We expect the average total cost per square foot associated with opening a Hot Topic store to be approximately the same in fiscal 2005 as those in fiscal 2004. Hot Topic stores are planned to be approximately 1,700 square feet compared to Torrid stores which are planned to be approximately 2,500 square feet. The costs associated with opening a new Torrid store will be higher than a Hot Topic store primarily due to the larger size of the Torrid stores. The actual costs that we will incur in connection with opening future stores cannot be predicted with precision because such costs will vary based upon, among other things, geographic location, store size, and the extent of the build-out required at the selected sites. The following table summarizes our contractual obligations as of January 29, 2005, and the timing and effect that such commitments are expected to have on our liquidity and capital requirements in future periods: 34. PAYMENTS DUE BY PERIOD ($ IN THOUSANDS) ----------------------------------------------------------------------- MORE THAN CONTRACTUAL OBLIGATIONS TOTAL WITHIN 1 YEAR 2-3 YEARS 4-5 YEARS 5 YEARS ----- ------------- --------- --------- ----------- OPERATING LEASES $339,423 $45,969 $90,538 $82,495 $120,421 PURCHASE OBLIGATIONS 55,624 55,624 - - - LETTERS OF CREDIT AND OTHER OBLIGATIONS 3,283 3,021 262 - - ----------------------------------------------------------------------- TOTAL CONTRACTUAL OBLIGATIONS $398,330 $104,614 $90,800 $82,495 $120,421 =======================================================================
See Note 6 to our consolidated financial statements for additional disclosure related to operating lease obligations. On March 19, 2004, we announced that our Board of Directors approved the repurchase of up to an aggregate of 2,000,000 shares of our common stock during the period ending January 29, 2005. As of July 31, 2004 we had completed the repurchase of 2,000,000 shares of our common stock at a cost of $46.8 million at an average price of $23.41. On August 18, 2004, we announced that our Board of Directors approved an additional repurchase of up to an aggregate of 2,000,000 shares of our common stock during the period ending January 29, 2005. As of January 29, 2005 we had completed the repurchase of 2,000,000 shares of our common stock at a cost of $32.8 million at an average price of $16.42. We believe that our existing cash balances and cash generated from operations will be sufficient to fund our operations, planned expansion and repurchase of our common stock through at least the next 12 months. CRITICAL ACCOUNTING POLICIES Management's discussion and analysis of Hot Topic, Inc.'s financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate estimates, including those related primarily to inventories, long-lived assets and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. For a further discussion about the application of these and other accounting policies, see Note 1 to our audited consolidated financial statements included elsewhere in this report. INVENTORIES: Inventories and related cost of sales are accounted for by the retail method. The cost of inventory is valued at the lower of average cost or market, on a first-in, first-out (FIFO) basis, utilizing the retail method. Each month, slow moving or seasonally obsolete merchandise is marked down. The first markdown is typically 25% to 50% of the original retail price. Typically, in cases where the merchandise does not sell after the first markdown, an additional markdown is made in a subsequent month. Any marked down merchandise that does not sell is typically marked down to a zero value and removed from the store, approximately three months after the original markdown. In determining the lower of average cost or market value of period-ending inventories, consistently applied valuation criteria are used. Consideration is given to a number of quantitative factors, including anticipated subsequent permanent markdowns and aging of inventories. To the extent our estimated markdowns at year-end prove to be insufficient, additional future markdowns will need to be recorded. 35. VALUATION OF LONG-LIVED ASSETS: We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered important that could trigger an impairment review include a significant underperformance relative to expected historical or projected future operating results, a significant change in the manner of the use of the asset or a significant negative industry or economic trend. If we were to determine that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, we would measure any impairment based on a projected discounted cash flow method using a discount rate determined by management. To date, we have not recorded any significant impairment of a long-lived asset. In the event future store performance is lower than forecasted results, future cash flows may be lower than expected, which could result in future impairment charges. While we believe recently opened stores will provide sufficient cash flow, material changes in results could result in future impairment charges. REVENUE RECOGNITION: Sales are recognized upon the purchase by customers at our retail store locations and websites, less merchandise returned by customers. We provide a reserve for projected merchandise returns based on historical experience. As the reserve for merchandise returns is based on estimates the actual returns could differ from the reserve, which could impact sales. Revenue from gift cards, gift certificates and store merchandise credits is recognized at the time of redemption. Shipping and handling revenues from our websites are included as a component of net sales. RENT EXPENSE: Rent expense under our operating leases typically provide for fixed non-contingent rent escalations. We recognize rent expense on a straight-line over the non-cancelable term of each lease, commencing when we take possession of the property. Construction allowances are recorded as a deferred rent liability, which we amortize as a reduction of rent expense over the non-cancelable term of each lease. SELF-INSURANCE: We are self-insured for medical insurance coverage and workers compensation insurance coverage, up to maximum exposure limits, above which we are covered by insurance policies. We maintain a liability for estimated claims based on historical claims experience and other actuarial assumptions. INCOME TAXES: Current income tax expense is the amount of income taxes expected to be payable for the current year. The combined federal, state and local income tax expense is calculated using estimated effective annual tax rates. A deferred income tax asset or liability is established for the expected future consequences of temporary differences in the financial reporting and tax bases of assets and liabilities. We consider future taxable income and ongoing prudent and feasible tax planning in assessing the value of our deferred tax assets. Evaluating the value of these assets is necessarily based on our judgment. If we were to determine that it is more likely than not that these assets will not be realized, we would reduce the value of these assets to their expected realizable value through a valuation allowance, thereby decreasing net income. If we subsequently were to determine that the deferred tax assets, which had been written down, would be realized in the future, the value of the deferred tax assets would be increased, thereby increasing net income in the period when that determination was made. We have recorded tax contingencies based on our estimates of current tax exposures and adjust our estimates as circumstances or regulations change. INFLATION We do not believe that inflation has had a material adverse effect on our net sales or results of operations. We have generally been able to pass along increased costs related to inflation through increases in selling prices. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are not a party to any derivative financial instruments. Our exposure to market risk primarily relates to changes in interest rates on our investments with maturities of less than three months (which are considered to be cash and cash equivalents) and short-term investments with maturities in excess of three months. Changes in interest rates affect the investment income earned on those investments. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Our consolidated financial statements and notes listed in Item 15(a) are incorporated herein by reference. 36. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. ITEM 9A. CONTROLS AND PROCEDURES a) CONCLUSION REGARDING THE EFFECTIVENESS OF DISCLOSURE CONTROLS AND PROCEDURES The management of the company maintains disclosure controls and procedures that are designed to ensure that the information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized and reported within the time periods specified in the Security and Exchange Commissions's (the "SEC") rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), as appropriate, to allow timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of inherent limitations, our disclosure controls and procedures may not prevent or detect misstatements. In addition, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures in connection with the preparation of this annual report, under the supervision of and with the participation of our management, including the CEO and CFO. In making our assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control--Integrated Framework. Based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were not effective as of January 29, 2005, for the following reason: On March 2, 2005, we announced that our financial statements were to be restated, relating to certain lease accounting and leasehold depreciation accounting practices, consistent with similar adjustments made by many other retailers and other publicly traded companies concerning these practices. This restatement is described elsewhere in this annual report. Although prior to the end of fiscal 2004, management surfaced certain lease accounting issues based upon the internal control practice of reviewing industry publications and financial statement filings and brought this to the attention of our independent registered public accounting firm, the decision to modify our lease accounting policy and practices was not made prior to the end of the fiscal year. Our conclusion to change our accounting policy and restate was made, among other things, in consideration of the views of the Office of the Chief Accountant of the SEC expressed in its letter related to these matters dated February 7, 2005. Accordingly, we concluded that our controls over the selection of appropriate assumptions and factors affecting lease accounting practices were not effective as of January 29, 2005. REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING We are responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. 37. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. Our management has assessed the effectiveness of our internal control over financial reporting as of January 29, 2005. In making our assessment, management used the criteria set forth by the COSO in Internal Control--Integrated Framework. In particular, our management evaluated the impact of the lease accounting corrections described above on such assessment and concluded that the control deficiency that resulted in the restatement of previously issued financial statements for understatement of rent expense and deferred rent represented a material weakness. As a result, management concluded that, as of January 29, 2005, our internal control over financial reporting was not effective based on the criteria set forth by COSO in Internal Control--Integrated Framework. A material weakness in internal control over financial reporting is a control deficiency (within the meaning of the Public Company Accounting Oversight Board ("PCAOB") Auditing Standard No. 2), or combination of control deficiencies, that results in there being more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. PCAOB Auditing Standard No. 2 identifies a number of circumstances that, because of their likely significant negative effect on internal control over financial reporting, are to be regarded as at least significant deficiencies as well as strong indicators that a material weakness exists, including the restatement of previously issued financial statements to reflect the correction of a misstatement. Our independent registered public accounting firm, Ernst & Young LLP, has issued an attestation report on management's assessment of our internal control over financial reporting. This report appears below. REMEDIATION STEPS We have remediated the material weakness in internal control by correcting our application of lease accounting principles for free rent periods. We have implemented controls to ensure all future leases will be reviewed and accounted for in accordance with SFAS No. 13, FTB No. 85-3 and FTB No. 88-1. We believe these steps will help ensure continued compliance with, among other things, the views of the Office of the Chief Accountant of the SEC expressed as of February 7, 2005 and described above. b) CHANGE IN INTERNAL CONTROL OVER FINANCIAL REPORTING During our last fiscal quarter, ended January 29, 2005, as part of our review of lease accounting policies discussed above, we remediated our controls associated with our accounting for tenant improvement allowances and the related deferred rent credit and depreciation expense. These changes in internal control identified the need to restate previously issued financial statements to record tenant improvement allowances as a deferred rent credit, to record the related fixed assets at their gross amount, and to record adjustments to depreciation and rent expense. c) REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING We have audited management's assessment, included in the accompanying Report of Management on Internal Control over Financial Reporting, that Hot Topic, Inc. did not maintain effective internal control over financial reporting as of January 29, 2005, because of the effect of the Company's insufficient controls over the selection and monitoring of appropriate assumptions and factors affecting lease accounting, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Hot Topic, Inc.'s management is responsible for maintaining effective internal 38. control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management's assessment: In its assessment as of January 29, 2005, management identified as a material weakness the Company's insufficient controls over the selection and monitoring of appropriate assumptions and factors affecting lease accounting. As a result of this material weakness in internal control, Hot Topic, Inc. concluded the Company's previously reported rent expense and deferred rent liabilities had been understated and that previously issued financial statements should be restated. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2004 financial statements, and this report does not affect our report dated March 11, 2005 on those financial statements. In our opinion, management's assessment that Hot Topic, Inc. did not maintain effective internal control over financial reporting as of January 29, 2005 is fairly stated, in all material respects, based on the COSO control criteria. Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Hot Topic, Inc. has not maintained effective internal control over financial reporting as of January 29, 2005, based on the COSO control criteria. /s/ Ernst & Young LLP Los Angeles, California March 11, 2005 39. ITEM 9B. OTHER INFORMATION Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT See the section entitled "Executive Officers and Key Employees" in Part I, Item 1 hereof for information regarding our executive officers. The information required by this item with respect to directors is incorporated by reference to the information appearing under the caption "Election of Directors", contained in our Definitive Proxy Statement which will be filed with the SEC within 120 days of January 29, 2005 pursuant to Regulation 14A in connection with the solicitation of proxies for our Annual Meeting of Shareholders to be held on June 15, 2005 (the "2005 Proxy Statement"). Certain other information required by this item is incorporated by reference to the information appearing under the captions "Section 16(a) Beneficial Ownership Reporting Compliance" and "Standards of Business Ethics" in the 2005 Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference to the information appearing under the caption "Executive Compensation" in the 2005 Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS The information required by this item is incorporated by reference to the information appearing under the captions "Security Ownership of Certain Beneficial Owners and Management" and "Equity Compensation Plan Information" in the 2005 Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference to the information appearing under the caption "Certain Transactions" in the 2005 Proxy Statement. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this item is incorporated by reference to the information appearing under the caption "Ratification of Selection of Independent Auditors" in the 2005 Proxy Statement. PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a)(1) CONSOLIDATED FINANCIAL STATEMENTS The following consolidated financial statements required by this item are submitted in a separate section beginning on page F-1 of this Annual Report on Form 10-K: 40. PAGE Report of Ernst & Young LLP, Independent Registered Public Accounting Firm...... F-1 Consolidated Balance Sheets as of January 29, 2005 and January 31, 2004......... F-2 Consolidated Statements of Income for the years ended January 29, 2005, January 31, 2004, and February 1, 2003 ................................... F-3 Consolidated Statements of Shareholders' Equity for the years ended January 29, 2005, January 31, 2004, and February 1, 2003.................. F-4 Consolidated Statements of Cash Flows for the years ended January 29, 2005, January 31, 2004, and February 1, 2003.................................... F-5 Notes to Consolidated Financial Statements...................................... F-6
(a)(2) FINANCIAL STATEMENT SCHEDULES Schedule II - Valuation and Qualifying Accounts All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission other than the ones listed above are not required under the related instructions or are not applicable, and therefore, have been omitted. SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS) FOR THE FISCAL YEARS ENDED JANUARY 29, 2005, JANUARY 31, 2004, AND FEBRUARY 1, 2003 Provision Balance at Charged to Balance Beginning Costs and at End of Year Expenses Deductions of Year --------- --------- --------- --------- FISCAL 2004 - ----------- Allowance for sales returns $ 512 $ 65 $ - $ 577 Allowance for aged inventory 1,057 453 - 1,510 --------- --------- --------- --------- $ 1,569 $ 518 $ - $ 2,087 ========= ========= ========= ========= FISCAL 2003 - ----------- Allowance for sales returns $ 350 $ 162 $ - $ 512 Allowance for aged inventory 866 191 - 1,057 --------- --------- --------- --------- $ 1,216 $ 353 $ - $ 1,569 ========= ========= ========= ========= FISCAL 2002 - ----------- Allowance for sales returns $ - $ 350 $ - $ 350 Allowance for aged inventory 490 376 - 866 --------- --------- --------- --------- $ 490 $ 726 $ - $ 1,216 ========= ========= ========= ========= 41. (a)(3) EXHIBITS The exhibits listed under Item 15(c) hereof are filed with, and incorporated by reference into, this Annual Report on Form 10-K. Management contracts or compensatory plans or arrangements required to be filed pursuant to Item 15(c) are so identified therein. EXHIBIT NUMBER DESCRIPTION OF DOCUMENT ------- ----------------------- 3.1 Amended and Restated Articles of Incorporation. (1) 3.2 Certificate of Amendment of Amended and Restated Articles of Incorporation 3.3 Amended and Restated Bylaws, as amended. 4.1 Reference is made to Exhibits 3.1 and 3.2. 4.2 Specimen stock certificate. (1) 10.1a Form of Indemnity Agreement to be entered into between Registrant and its directors and officers. (1) 10.2a 1996 Equity Incentive Plan (the "1996 Plan"), as amended. 10.3a Form of Nonstatutory Stock Option Agreement of Registrant pursuant to the 1996 Plan. (1) 10.4a Form of Incentive Stock Option Agreement of Registrant pursuant to the 1996 Plan. (1) 10.5a Non-Employee Directors' Stock Option Plan, as amended. 10.6a Employee Stock Purchase Plan, as amended. 10.7a 401(k) Defined Contribution Plan of Registrant, effective as of August 1, 1995, as amended. 10.8 Industrial Real Estate Lease (Multi-Tenant Facility), dated December 10, 1998, entered into between Registrant's wholly owned subsidiary, Hot Topic Administration, Inc. and Majestic Realty Co. and Patrician Associates, Inc. (2) 10.9 Guaranty of Lease, dated December 10, 1998, entered into between the Registrant and Majestic Realty Co. and Patrician Associates, Inc. (2) 10.10 First Amendment to Industrial Real Estate Lease, dated March 19, 2001, by and between Majestic - Fullerton Road, LLC, PFG Fullerton Limited Partnership, and Hot Topic Administration, Inc. (3) 10.11a Employment Offer Letter dated January 12, 2001, between the Registrant and Gerald Cook. (3) 10.12a Form of Restricted Stock Bonus Agreement between the Registrant and each of its non-employee directors as of March 7, 2001 (with Robert Jaffe for 1,905 shares, and with each of Bruce Quinnell, Edgar Berner, Andrew Schuon and Corrado Federico for 1,587 shares) and as of September 24, 2001 (with Cynthia Cohen for 1,178 shares and vesting from September 24, 2001) and as of January 28, 2002 (with W. Scott Hedrick for 618 shares and vesting from January 28, 2002). (4) 10.13a Employment Offer Letter dated August 14, 2002, between the Registrant and Patricia Van Cleave. (6) 10.14a Employment Letter dated January 23, 2003, between the Registrant and James McGinty. (6) 10.15 Third Amendment to Industrial Real Estate Lease, dated February 25, 2004, by and among Majestic-Fullerton Road, LLC, PFG Fullerton Limited Partnership, and Hot Topic Administration, Inc. (7) 42. 10.16 Employment Offer Letter dated March 15, 2004, between the Registrant and Christopher J. Kearns. (7) 10.17 Centre Pointe Distribution Park Lease, dated June 1, 2004, by and among Crescent Resources, LLC and Hot Topic, Inc. (8) 10.18 Employment Offer Letter dated May 13, 2004, between the Registrant and Thomas Beauchamp. (8) 21 Hot Topic, Inc. List of Subsidiaries 23.1 Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm. 24.1 Power of Attorney is contained on the signature page. 31.1 Certification, dated April 13, 2005, of Registrant's Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification, dated April 13, 2005, of Registrant's Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certifications, dated April 13, 2005, of Registrant's Chief Executive Officer and Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002. - ------------ (1) Filed as an exhibit to Registrant's Registration Statement on Form SB-2 (No. 333-5054-LA) and incorporated herein by reference. (2) Filed as an exhibit to Registrant's Annual Report on Form 10-K for the year ended January 30, 1999 and incorporated herein by reference. (3) Filed as an exhibit to Registrant's Annual Report on Form 10-K for the year ended February 3, 2001 and incorporated herein by reference. (4) Filed as an exhibit to Registrant's Quarterly Report on Form 10-Q for the quarter ended May 5, 2001 and incorporated herein by reference. (5) Filed as an exhibit to Registrant's Annual Report on Form 10-K for the year ended February 2, 2002 and incorporated herein by reference. (6) Filed as an exhibit to Registrant's Annual Report on Form 10-K for the year ended February 1, 2003 and incorporated herein by reference. (7) Filed as an exhibit to Registrant's Quarterly Report on Form 10-Q for the quarter ended May 1, 2004 and incorporated herein by reference. (8) Filed as an exhibit to Registrant's Quarterly Report on Form 10-Q for the quarter ended July 31, 2004 and incorporated herein by reference. a Denotes management contract or compensatory plan or arrangement. (d) FINANCIAL STATEMENT SCHEDULES Reference is made to Item 15(a)(2). 43. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HOT TOPIC, INC. By: /s/ Elizabeth McLaughlin ----------------------------- Elizabeth McLaughlin Chief Executive Officer and Director April 13, 2005 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Elizabeth McLaughlin and James McGinty, or either of them, his attorney-in-fact, each with the power of substitution, for him or her in any and all capacities, to sign any amendments to this Report, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. NAME POSITION DATE - ---------------------------- ------------------------------- --------------- /s/ ELIZABETH MCLAUGHLIN Chief Executive Officer and April 13, 2005 - ---------------------------- Director (PRINCIPAL EXECUTIVE Elizabeth McLaughlin OFFICER) /s/ JAMES MCGINTY Chief Financial Officer April 13, 2005 - ---------------------------- (PRINCIPAL FINANCIAL OFFICER) James McGinty /s/ GEORGE WEHLITZ, JR. Vice President, Finance April 13, 2005 - ---------------------------- (PRINCIPAL ACCOUNTING George Wehlitz, Jr. OFFICER) /s/ BRUCE QUINNELL Chairman of the Board April 8, 2005 - ---------------------------- Bruce Quinnell /s/ KATHLEEN MASON Director April 7, 2005 - ---------------------------- Kathleen Mason /s/ CORRADO FEDERICO Director April 7, 2005 - ---------------------------- Corrado Federico /s/ ANDREW SCHUON Director April 11, 2005 - ---------------------------- Andrew Schuon /s/ CYNTHIA COHEN Director April 8, 2005 - ---------------------------- Cynthia Cohen /s/ W. SCOTT HEDRICK Director April 10, 2005 - ---------------------------- W. Scott Hedrick 44. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Shareholders of Hot Topic, Inc. We have audited the accompanying consolidated balance sheets of Hot Topic, Inc. and subsidiaries as of January 29, 2005 and January 31, 2004 (restated) and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended January 29, 2005. Our audit also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hot Topic, Inc. and its subsidiaries at January 29, 2005 and January 31, 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended January 29, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth herein. As described in Note 2, Restatement of the Financial Statements, the Company has corrected its accounting for leases and restated previously issued financial statements. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Hot Topic, Inc. and subsidiaries internal control over financial reporting as of January 29, 2005, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 11, 2005 expressed an unqualified opinion on management's assessment of the effectiveness of internal control over financial reporting and an adverse opinion on the effectiveness of internal control over financial reporting. /s/ ERNST & YOUNG LLP Los Angeles, California March 11, 2005 F-1 HOT TOPIC, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts) January 29, January 31, 2005 2004 (As Restated) ---------------------------- ASSETS Current assets: Cash and cash equivalents $ 5,248 $ 11,886 Short-term investments 61,091 116,319 Inventory 60,481 51,937 Prepaid expenses and other 12,390 10,654 Deferred tax assets 2,541 2,259 ---------------------------- Total current assets 141,751 193,055 Leaseholds, fixtures and equipment, net 136,401 102,838 Deposits and other 243 189 ---------------------------- Total assets $ 278,395 $ 296,082 ============================ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 17,874 $ 15,841 Accrued liabilities 27,769 28,133 Income taxes payable 8,887 7,278 ---------------------------- Total current liabilities 54,530 51,252 Deferred rent 30,227 21,843 Deferred tax liability 6,076 1,708 Commitments and contingencies - - Shareholders' equity: Preferred shares, no par value; 10,000,000 shares authorized; no shares issued and outstanding - - Common shares, no par value; 150,000,000 shares authorized; 44,592,836 and 48,120,989 shares issued and outstanding at January 29, 2005 and January 31, 2004, respectively 90,921 86,238 Retained earnings 96,847 135,242 Accumulated other comprehensive loss (206) (201) ---------------------------- Total shareholders' equity 187,562 221,279 ---------------------------- Total liabilities and shareholders' equity $ 278,395 $ 296,082 ============================ See notes to consolidated financial statements. F-2
HOT TOPIC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share amounts) Years Ended ------------------------------------------ January 29, January 31, February 1, 2005 2004 2003 (As Restated) (As Restated) ------------------------------------------ Net sales $ 656,468 $ 572,039 $ 443,250 Cost of goods sold, including buying, distribution and occupancy costs 422,712 352,277 274,008 ------------------------------------------ Gross margin 233,756 219,762 169,242 Selling, general and administrative expenses 170,384 143,952 115,634 ------------------------------------------ Operating income 63,372 75,810 53,608 Interest income, net 919 1,318 1,371 ------------------------------------------ Income before income taxes 64,291 77,128 54,979 Provision for income taxes 24,618 29,539 20,892 ------------------------------------------ Net income $ 39,673 $ 47,589 $ 34,087 ========================================== Net income per share: Basic $ 0.86 $ 1.00 $ 0.72 ========================================== Diluted $ 0.83 $ 0.96 $ 0.69 ========================================== Shares used in computing net income per share: Basic 46,379 47,479 47,027 Diluted 47,875 49,588 49,276 See notes to consolidated financial statements. F-3
Hot Topic, Inc. and Subsidiaries Consolidated Statements of Shareholders' Equity (In thousands) Common Shares Accumulated Other Total ----------------------------- Retained Comprehensive Shareholders' Shares Amount Earnings Loss Equity ---------------------------------------------------------------------------- BALANCE AT FEBRUARY 2, 2002 (As restated) 47,063 $ 60,643 $ 73,095 $ - $ 133,738 Exercise of stock options 1,195 4,942 - - 4,942 Employee stock purchase plan 33 418 - - 418 Restricted stock awards 15 153 - - 153 Repurchase of common stock (1,500) (171) (19,529) - (19,700) Tax benefit from exercise of stock options - 5,118 - - 5,118 Net income (As restated) - - 34,087 - 34,087 ---------------------------------------------------------------------------- BALANCE AT FEBRUARY 1, 2003 (As restated) 46,806 71,103 87,653 - 158,756 Exercise of stock options 1,261 7,696 - - 7,696 Employee stock purchase plan 46 666 - - 666 Restricted stock awards 8 180 - - 180 Fractional shares purchased in 3-for-2 stock split - (23) - - (23) Tax benefit from exercise of stock options - 6,616 - - 6,616 Comprehensive income: Net income (As restated) - - 47,589 - 47,589 Unrealized loss on marketable securities, net - - - (201) (201) ------------ Total comprehensive income 47,388 ---------------------------------------------------------------------------- BALANCE AT JANUARY 31, 2004 (As restated) 48,121 86,238 135,242 (201) 221,279 Exercise of stock options 409 3,662 - - 3,662 Employee stock purchase plan 54 862 - - 862 Restricted stock awards 9 155 - - 155 Repurchase of common stock (4,000) (1,581) (78,068) (79,649) Tax benefit from exercise of stock options - 1,585 - - 1,585 Comprehensive Income: Net income - - 39,673 - 39,673 Unrealized loss on marketable securities, net - - - (5) (5) ------------ Total comprehensive income 39,668 ---------------------------------------------------------------------------- BALANCE AT January 29, 2005 44,593 $ 90,921 $ 96,847 $ (206) $ 187,562 ============================================================================ F-4
HOT TOPIC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Years Ended -------------------------------------------- January 29, January 31, February 1, 2005 2004 2003 (As Restated) (As Restated) -------------------------------------------- OPERATING ACTIVITIES Net income $ 39,673 $ 47,589 $ 34,087 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 24,635 20,360 16,364 Tax benefit from exercise of stock options 1,585 6,616 5,118 Stock-based compensation 155 155 142 Loss on disposal of fixed assets 751 656 278 Changes in operating assets and liabilities: Inventory (8,544) (13,528) (8,856) Prepaid expenses and other current assets (1,736) (2,787) (2,431) Deposits and other assets (53) (18) 3 Accounts payable 2,033 434 4,155 Accrued liabilities (1,459) 8,519 7,528 Deferred rent 8,383 6,270 4,940 Deferred taxes 4,086 3,793 (655) Income taxes payable 1,609 548 4,166 -------------------------------------------- Net cash provided by operating activities 71,118 78,607 64,839 INVESTING ACTIVITIES Purchases of leasehold, fixtures and equipment (57,853) (41,959) (38,401) Proceeds from sale of short-term investments 162,931 52,906 46,105 Purchases of short-term investments (107,709) (99,146) (49,296) -------------------------------------------- Net cash used in investing activities (2,631) (88,199) (41,592) FINANCING ACTIVITIES Repurchase of common stock (79,649) (23) (19,700) Proceeds from employee stock purchases and exercise of stock options 4,524 8,362 5,370 -------------------------------------------- Net cash (used in) provided by financing activities (75,125) 8,339 (14,330) -------------------------------------------- (Decrease) increase in cash and cash equivalents (6,638) (1,253) 8,917 Cash and cash equivalents at beginning of year 11,886 13,139 4,222 -------------------------------------------- Cash and cash equivalents at end of year $ 5,248 $ 11,886 $ 13,139 ============================================ SUPPLEMENTAL INFORMATION Cash paid during the year for interest $ 8 $ 40 $ 19 ============================================ Cash paid during the year for income taxes $ 17,400 $ 18,614 $ 12,317 ============================================ See notes to consolidated financial statements. F-5
HOT TOPIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 29, 2005 NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND BUSINESS ACTIVITIES Hot Topic, Inc. is a mall-based specialty retailer operating the Hot Topic and Torrid store concepts. Hot Topic sells a selection of music/pop culture-licensed and music/pop culture-influenced apparel, accessories and gift items for young men and women principally between the ages of 12 and 22. In fiscal 2001 (the fiscal year ended February 2, 2002), we launched a second retail concept under the trade name Torrid. Torrid sells apparel, lingerie, shoes and accessories designed for various lifestyles for plus-size females between the ages of 15 and 29. At the end of the fiscal year ending January 29, 2005, we operated 592 Hot Topic stores in 50 states and Puerto Rico, and 76 Torrid stores. We also maintain two distinct websites, www.hottopic.com ("hottopic.com") and www.torrid.com ("torrid.com"), which reflect the Hot Topic and Torrid store concepts and sell merchandise similar to that sold in the respective stores. We have one reportable segment given the similarities of the economic characteristics among the store formats. Throughout this report, the terms "our", "we" and "us" refer to Hot Topic, Inc. and its subsidiaries. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Hot Topic, Inc. and our wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. RECLASSIFICATIONS Certain reclassifications have been made to prior year amounts to conform to current year presentation. The common stock and retained earnings balances at January 31, 2004 and February 1, 2003 have been reclassified to reflect the excess of the repurchase cost of common stock over its issuance price (as determined on a first-in, first-out basis) as a reduction of retained earnings. Previously, all common stock repurchases had been charged against common stock. FISCAL YEAR Our fiscal year is on a 52-53 week basis and ends on the Saturday nearest to January 31. The fiscal years ended January 29, 2005, January 31, 2004 and February 1, 2003 were 52-week years. CASH AND CASH EQUIVALENTS We consider all highly liquid investments with maturities of less than three months when purchased to be cash equivalents. We are potentially exposed to a concentration of credit risk when cash deposits in banks are in excess of federally insured limits. F-6 FAIR VALUE OF FINANCIAL INSTRUMENTS We consider carrying amounts of cash and cash equivalents, receivables, and accounts payable to approximate fair value because of the short maturity of these financial instruments. Amounts outstanding under the unsecured bank credit agreement are held at their estimated fair values because they accrue interest at rates which generally fluctuate with interest rate trends. SHORT-TERM INVESTMENTS Short-term investments with maturities in excess of three months consist primarily of interest bearing bonds that are highly liquid, low risk with a minimum credit quality rating of A-1 (Standard and Poor's), SP-1 (Moody's Investor Service) or equivalent, and are available for sale. At January 29, 2005 and January 31, 2004, short-term investments consisted of municipal bonds of $37.7 million and $96.0 million, government obligations of $15.3 million and $12.7 million, and corporate bonds of $8.0 million and $7.6 million, respectively. Short-term investments are recorded at fair market value, based on established market prices as of the end of the period for which the values are determined. Unrealized gains and losses, net, from short-term investments comprise accumulated other comprehensive loss, reflected in the Shareholders' Equity section of the Consolidated Balance Sheets, which for the fiscal years ended January 29, 2005 and January 31, 2004 were $5,000 and $201,000, respectively. As a result, for the years ended January 29, 2005 and January 31, 2004, the Company's other comprehensive income was lower than its net income. INVENTORY Inventories and related cost of sales are accounted for by the retail method. The cost of inventory is valued at the lower of average cost or market, on a first-in, first-out (FIFO) basis. LEASEHOLD, FIXTURES AND EQUIPMENT Leasehold, fixtures and equipment are recorded at cost or in the case of capitalized leases, at the present value of future minimum lease payments. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets (3-10 years). Leasehold improvements are amortized using the straight-line method over the shorter of ten years or the life of the lease. Expenditures for repairs that do not significantly extend the life of the asset are expensed as incurred. REVENUE RECOGNITION Sales are recognized upon the purchase by customers at our retail store locations and websites, less merchandise returned by customers. We provide a reserve for projected merchandise returns based on historical experience. Revenue from gift cards, gift certificates and store merchandise credits is recognized at the time of redemption. Shipping and handling revenues from our websites are included as a component of net sales. F-7 COST OF GOODS SOLD, INCLUDING BUYING, DISTRIBUTION AND OCCUPANCY COSTS Cost of goods sold, including buying, distribution and occupancy costs includes: merchandise costs, freight, inventory shrink, payroll expenses associated with the merchandising and distribution departments, distribution center expenses including rent, common area maintenance charges, real estate taxes, depreciation, utilities, supplies and maintenance; and store expenses including rents, common area maintenance charges, real estate taxes, and depreciation. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses include: payroll expenses associated with stores, store operating expenses, store pre-opening costs, marketing expenses; and payroll and other expenses associated with headquarters and administrative functions. STORE PRE-OPENING COSTS Costs incurred in connection with the opening of a new store are expensed as incurred. SHIPPING AND HANDLING COSTS We classify shipping and handling costs in costs of goods sold, including buying, distribution and occupancy costs in the accompanying statements of income. LEASES Rent expense under non-cancelable operating leases with scheduled rent increases or free rent periods is accounted for on a straight-line basis over the lease term, beginning on the date of initial possession, which is generally when we enter the space and begin construction build-out. The amount of the excess of straight-line rent expense over scheduled payments is recorded as a deferred rent liability. Construction allowances and other such lease incentives are recorded as deferred credits, and are amortized on a straight-line basis as a reduction of rent expense. ADVERTISING COSTS Advertising costs are expensed the first time the event occurs or as incurred. Advertising expenses were $1,152,000, $1,065,000, and $521,000 for the years ended January 29, 2005, January 31, 2004, and February 1, 2003, respectively. At January 29, 2005 and January 31, 2004, the amount of advertising costs reported as prepaid advertising was $49,000 and $42,000, respectively. INCOME TAXES We utilize Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes", which prescribes the use of the liability method to compute the difference between the tax basis of assets and liabilities and the related financial reporting amounts using currently enacted tax laws and rates. NET INCOME PER SHARE Net income per share has been computed in accordance with Financial Accounting Standards Board ("FASB") Statement No. 128, "Earnings per Share" (see Note 8). A three-for-two stock split became effective September 2, 2003. All share and per share amounts prior to that date have been restated to reflect the stock split and all previous stock splits. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. F-8 LONG-LIVED ASSETS Long-lived assets are reviewed for events or changes in circumstances that indicate that their carrying value may not be recoverable. The review is based on comparing the expected undiscounted cash flows to the carrying amount of such assets. If it is determined that the carrying amount of the long-lived assets is not recoverable, we will recognize an impairment loss, measured by the future discounted cash flow method. At January 29, 2005, we believe there has been no impairment of the value of such assets to date. In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which establishes accounting and reporting standards for impairment and disposition of long-lived assets, including discontinued operations. SFAS No. 144 became effective for all financial statements issued for fiscal years beginning after December 15, 2001 and, generally, its provisions are to be applied prospectively. The adoption of SFAS No. 144 did not have a significant impact on our results of operations or financial condition. STOCK-BASED COMPENSATION SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure an Amendment of SFAS No. 123", amends the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation", to require more prominent disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We account for stock-based awards to employees and directors using the intrinsic value method of accounting in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." We follow the disclosure provisions of SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 requires disclosures of the effects of an entity's accounting policy with respect to stock-based employee compensation on reported net income (loss) and earnings (loss) per share in annual and interim financial statements. We are required to follow the prescribed disclosure format and have provided the additional disclosures required by SFAS No. 148 for the fiscal years ended January 29, 2005, January 31, 2004 and February 1, 2003. Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined as if we accounted for our employee stock incentives under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for fiscal 2004, 2003, and 2002: weighted average risk-free interest rates of 5%; dividend yields of 0%; weighted average volatility factors of the expected market price of our common stock of 0.48 for fiscal 2004, 0.40 for fiscal 2003, and 0.61 for fiscal 2002; and a weighted average expected life of the options of 3.6 years for fiscal 2004, 5 years for fiscal 2003 and 2002. The weighted average fair value of options granted during the year are $8.57, $6.70, and $8.53 per share for fiscal 2004, 2003, and 2002, respectively. F-9 For purposes of pro forma disclosures, the estimated fair value of the options, based on the Black-Scholes option pricing model, is amortized to expense over the options' vesting periods. The following is the pro forma information using the fair value method under SFAS No. 123, as amended by SFAS No. 148 (in thousands, except per share amounts): Years Ended -------------------------------------------- January 31, February 1, January 29, 2004 2003 2005 (As Restated) (As Restated) ------------ ------------ ------------ Net income As reported $39,673 $47,589 $34,087 Add: Stock-based compensation expense included in reported net income, net of related tax effects 96 96 88 Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of related tax effects (11,804) (5,166) (4,189) ------------ ------------ ------------ Pro forma $27,965 $42,519 $29,986 ============ ============ ============ Basic earnings per share: As reported $0.86 $1.00 $0.72 Pro forma $0.60 $0.90 $0.64 Diluted earnings per share: As reported $0.83 $0.96 $0.69 Pro forma $0.59 $0.87 $0.61
ACCELERATED OPTIONS We accelerated the vesting of certain stock options awarded to employees, officers and directors under various stock option plans, which had exercise prices that were below market closing price on January 4, 2005. Options to purchase approximately 1.38 million shares became exercisable immediately as a result of the vesting acceleration. Our Board approved the vesting acceleration as a result of SFAS No. 123 requiring the expensing of stock options effective later in 2005 which with respect to such accelerated options would have negatively impacted our results from operations. COMPREHENSIVE INCOME We report comprehensive income in accordance with the provisions of SFAS 130, "Reporting Comprehensive Income." SFAS 130 established standards for the reporting and display of comprehensive income. Components of comprehensive income include net earnings (loss), foreign currency translation adjustments and gains/losses associated with investments available for sale. Comprehensive income for the fiscal years ended January 29, 2005 and January 31, 2004 were $39.7 million and $47.4 million, respectively. F-10 NEW ACCOUNTING PRONOUNCEMENTS In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities." In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46(R) clarifies the application of ARB No. 51, "Consolidated Financial Statements," to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without subordinated financial support from other parties. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. FIN 46(R) applies immediately to variable interest entities created after December 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies no later than the first reporting period ending after March 15, 2004, to variable interest entities in which an enterprise holds a variable interest (other than special purpose) that it acquired before January 1, 2004. FIN 46(R) applies to public enterprises as of the beginning of the applicable interim or annual period. We do not currently have any variable interest entities and the adoption of the provisions of FIN 46 and FIN 46(R) did not have a material impact on our results of operations or financial condition. In November 2003, consensus was reached on Emerging Issues Task Force ("EITF") Issue No. 03-10, "Application of EITF Issue No. 02-16, `Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor,' by Resellers to Sales Incentives Offered to Consumers by Manufacturers." Under Issue 02-16, cash consideration received by a customer from a vendor is presumed to be a price reduction of the vendor's products or services and should therefore be characterized as a reduction of cost of sales when recognized in the income statement of the customer. Issue No. 03-10 is effective for fiscal periods beginning after November 25, 2003. The adoption of Issue No. 03-10 did not have a material impact on our operating results or financial condition. In March 2004, the EITF reached a consensus on EITF Issue No. 03-1 ("EITF 03-1"), "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments," for which the measurement and recognition provisions were to be effective for reporting periods beginning after June 15, 2004. However, in September 2004, the EITF issued FASB Staff Position EITF Issue No. 03-1-1, "Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, `The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,'" which postponed the measurement and recognition provisions of EITF 03-1, but maintained the disclosure requirements for all investments within the scope of the guidance to be effective in annual financial statements for fiscal years ending after June 15, 2004. EITF 03-1 provides a three-step process for determining whether investments, including debt securities, are other than temporarily impaired and requires additional disclosures in annual financial statements. An investment is impaired if the fair value of the investment is less than its cost. EITF 03-1 outlines that an impairment would be considered other-than-temporary unless: a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment, and b) evidence F-11 indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. Although not presumptive, a pattern of selling investments prior to the forecasted recovery of fair value may call into question the investor's intent. In addition, the severity and duration of the impairment should also be considered in determining whether the impairment is other-than-temporary. We do not expect the adoption of EITF 03-1 to have a material impact on our results of operations or financial condition because our investments are short-term in nature and consist primarily of interest bearing bonds that are highly liquid and low risk with a minimum credit quality rating of A-1 (Standard and Poor's), SP-1 (Moody's Investor Service) or equivalent In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - an Amendment of ARB No. 43, Chapter 4". SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges. In addition, SFAS No. 151 requires the allocation of fixed production overheads to the cost of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005. We do not expect the adoption of SFAS No. 151 to have a material impact on our operating results or financial condition. In December 2004, the FASB issued SFAS No. 153, "Exchange of Nonmentary Assets, an amendment of APB Opinion No. 29". SFAS No. 153 eliminates the exception for nonmonetary exchanges of similar productive assets, which were previously required to be recorded on a carryover basis rather than a fair value basis. Instead, this statement provides that exchanges of nonmonetary assets that do not have commercial substance be reported at carryover basis rather than a fair value basis. A nonmonetary exchange is considered to have commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of this statement are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We do not expect the adoption of SFAS No. 153 to have a material impact on our operating results or financial condition. In December 2004, the FASB issued Statement No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123R"), which is a revision of SFAS No. 123. SFAS No. 123R supersedes APB No. 25 and amends Statement No. 95, "Statement of Cash Flows." Under SFAS No. 123, companies must calculate and record in the income statement the cost of equity instruments, such as stock options, awarded to employees for services received and pro forma disclosure is no longer permitted. The cost of the equity instruments will be measured based on fair value of the instruments on the date they are granted (with certain exceptions) and will be required to be recognized over the period during which the employees are required to provide services in exchange for the equity instruments. The statement is effective in the first interim or annual reporting period beginning after June 15, 2005. SFAS No. 123R provides two alternatives for adoption: (1) a "modified prospective" method in which compensation cost is recognized for all awards granted subsequent to the effective date of this statement as well as for the unvested portion of awards outstanding as of the effective date; or (2) a "modified retrospective" method which follows the approach in the "modified prospective" method, but also permits entities to restate prior periods to record compensations cost calculated under SFAS No. 123 for the pro forma disclosure. We are currently evaluating our share-based payment programs on our results of operations, and do not expect the adoption of SFAS No. 123 to have a material impact on our overall financial position but could significantly impact results of operations. The impact of adopting SFAS No. 123R cannot be accurately estimated at this time because it will depend on levels of share-based awards granted in the future. However, had we adopted SFAS No. 123R in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the F-12 disclosure of pro forma net income and earnings per share in Note 1 to our consolidated financial statements. SFAS No 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow. This change will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While the amount of this change cannot be estimated at this time, the amount of operating cash flows recognized in prior periods for such excess tax deductions were $1.6 million, $6.6 million, and $5.1 million in fiscal 2004, 2003 and 2002, respectively. NOTE 2. RESTATEMENT OF FINANCIAL STATEMENTS In accordance with SFAS No. 13, "Accounting for Leases" and Financial Accounting Standards Board Technical Bulletin No. 88-1, "Issues Relating to Accounting for Leases" ("FTB 88-1"), we account for rental expense for step provisions and escalation clauses on a straight-line basis over the minimum lease term, with such amounts being included along with other related rent expense as part of "Cost of goods sold, including buying, distribution and occupancy costs." Construction allowances and other lease concessions received from landlords are amortized over the minimum lease term on a straight-line basis as part of "Cost of goods sold, including buying, distribution and occupancy costs." However, in our detailed accounts, we had previously recorded this amortization as a reduction of depreciation expense, rather than rent expense. Both depreciation and rent expense are reflected within "Cost of goods sold, including buying, distribution and occupancy costs" on the statements of income. Historically, our balance sheets have reflected the unamortized portion of construction allowances and other lease concessions as a reduction of "Leaseholds, fixtures and equipment, net," instead of as a component of deferred rent liability. Further, our historical statements of cash flows have reflected construction allowances and other lease concessions received as a reduction of "Leaseholds, fixtures and equipment, net" (within "investing" cash flows), rather than as an operating lease activity (within "operating" cash flows). We had historically recognized rent expense on a straight-line basis over the lease term. Our leases typically have a rent commencement date to coincide with the initial occupancy date, or store opening date. The store opening date coincided with the commencement of business operations, which is the intended use of the property. Management re-evaluated FASB Technical Bulletin No. 85-3, "Accounting for Operating Leases with Scheduled Rent Increases" and determined that the lease term for amortization purposes should commence on the date we take possession of the leased space for construction purposes, which is generally two months prior to a store opening date. Excluding tax impacts, the correction of this accounting requires us to record additional rent credits in "Deferred rent" and to adjust "Retained earnings" on the consolidated balance sheets, as well as to record additional rent expense in the form of deferred rent amortization in "Costs of goods sold, including, buying, distribution and occupancy costs" on the consolidated statements of income for the years ended January 31, 2004 and February 1, 2003. The cumulative effect of these changes is a reduction to retained earnings of $1.6 million as of the beginning of fiscal 2002 and incremental decreases to retained earnings of $543,000 and $453,000, for the fiscal years ended 2002 and 2003, respectively. The impact of these adjustments reduced net income recorded in the first, second and third quarters of fiscal 2004 by $82,000, $119,000, and $132,000, respectively and changed net income recorded in the first, second, third and fourth quarters of fiscal 2003 by ($156,000), ($150,000), ($178,000) and $31,000, respectively. F-13 The following is a summary of the effects of these changes on our consolidated balance sheets as of January 31, 2004 and February 1, 2003, as well as the effects of these changes on our consolidated statements of income and cash flows for fiscal years 2003 and 2002 (in thousands, except share data): Consolidated Statements of Income -------------------------------------------- As Previously Fiscal Year Ended January 31, 2004 Reported Adjustments As Restated - ---------------------------------------------------------------------- ------------ ------------ ------------ Cost of goods sold, including buying, distribution and occupancy costs $ 351,542 $ 735 $ 352,277 Operating income 76,545 (735) 75,810 Income before income taxes 77,863 (735) 77,128 Provision for income taxes 29,821 (282) 29,539 Net income 48,042 (453) 47,589 Net income per share - basic 1.01 (0.01) 1.00 Net income per share - diluted 0.97 (0.01) 0.96 Fiscal Year Ended February 1, 2003 - ---------------------------------------------------------------------- Cost of goods sold, including buying, distribution and occupancy costs $ 273,132 $ 876 $ 274,008 Operating income 54,484 (876) 53,608 Income before income taxes 55,855 (876) 54,979 Provision for income taxes 21,225 (333) 20,892 Net income 34,630 (543) 34,087 Net income per share - basic 0.74 (0.01) 0.72 Net income per share - diluted 0.70 (0.01) 0.69
Consolidated Balance Sheets -------------------------------------------- As Previously January 31, 2004 Reported Adjustments As Restated - ---------------------------------------------------------------------- ------------ ------------ ------------ Leasehold, fixtures and equipment, net $ 88,348 $ 14,490 $ 102,838 Total assets 281,592 14,490 296,082 Income taxes payable 7,242 36 7,278 Deferred rent 3,155 18,688 21,843 Deferred taxes, net 3,316 (1,608) 1,708 Retained earnings 137,868 (2,626) 135,242 Total shareholders' equity 223,905 (2,626) 221,279 Total liabilities and shareholders' equity 281,592 14,490 296,082
F-14 Consolidated Statements of Cash Flows -------------------------------------------- As Previously Fiscal Year Ended January 31, 2004 Reported Adjustments As Restated - ---------------------------------------------------------------------- ------------ ------------ ------------ Net cash provided by operating activities $ 72,302 $ 6,305 $ 78,607 Net cash provided by investing activities (81,894) (6,305) (88,199) Fiscal Year Ended February 1, 2003 - ---------------------------------------------------------------------- Net cash provided by operating activities $ 60,317 $ 4,522 $ 64,839 Net cash provided by investing activities (37,070) (4,522) (41,592)
Consolidated Statements of Shareholders' Equity ----------------------------------------------- As Previously February 2, 2002 Reported Adjustments As Restated - ---------------------------------------------------------------------- ------------ ------------ ------------ Retained earnings $ 74,725 $ (1,630) $ 73,095
NOTE 3. LEASEHOLDS, FIXTURES AND EQUIPMENT Leaseholds, fixtures and equipment are summarized as follows (in thousands): January 31, January 29, 2004 2005 (As Restated) ----------- ----------- Furniture, fixtures and equipment $ 110,503 $ 78,476 Leasehold improvements 115,579 91,175 ----------- ----------- 226,082 169,651 Less: accumulated depreciation and amortization (89,681) (66,813) ----------- ----------- $ 136,401 $ 102,838 =========== =========== F-15 NOTE 4. ACCRUED LIABILITIES Accrued liabilities consist of the following (in thousands): January 31, January 29, 2004 2005 (As Restated) ----------- ----------- Accrued payroll and related expenses $ 4,194 $ 9,833 Gift cards, gift certificates and store merchandise credits 7,943 5,713 Accrued percentage rents 1,858 4,012 Other 13,774 8,575 ----------- ----------- $ 27,769 $ 28,133 =========== =========== NOTE 5. BANK CREDIT AGREEMENT We maintain an unsecured bank credit agreement of $5.0 million. The credit agreement will expire in August 2005 and we expect to renew the credit agreement under similar terms. Letters of credit are issued under the credit agreement, which are primarily used for inventory purchases. At January 29, 2005, we had $130,000 of outstanding letters of credit issued under the credit agreement. NOTE 6. COMMITMENTS AND CONTINGENCIES LEASES We have entered into lease agreements for retail, distribution and office space, vehicles, and equipment under primarily noncancelable leases with terms ranging from approximately two to ten years. The retail space leases provide for rents based upon the greater of the minimum annual rental amounts or 5% to 8% of annual sales volume. Certain leases provide for increasing minimum annual rental amounts. Rent expense is recorded on a straight-line basis over the term of the lease based on us taking possession of premises. Accordingly, deferred rent, as reflected in the accompanying balance sheets, represents the difference between rent expense accrued and amounts paid under the terms of the lease agreements. Total rent expense for the years ended January 29, 2005, January 31, 2004, and February 1, 2003 was $44,341,000, $38,572,000, and $30,787,000, respectively, including contingent rentals of $4,259,000, $4,866,000, and $3,670,000, respectively. F-16 Annual future minimum lease payments under operating leases as of January 29, 2005 are as follows (in thousands): Fiscal Year Operating Leases - ----------- ---------------- 2005 $ 45,969 2006 45,875 2007 44,663 2008 42,504 2009 39,991 Thereafter 120,420 ---------- Total minimum operating lease payments $ 339,422 ========== LITIGATION We are involved in various matters of litigation during the ordinary course of business. Management does not currently believe any such matters will have a material adverse effect on our financial condition or results of operations. INDEMNITIES, COMMITMENTS AND GUARANTEES During the ordinary course of business, we have made certain indemnities, commitments and guarantees under which we may be required to make payments in relation to certain transactions. These indemnities include those given to various lessors in connection with facility leases for certain claims arising from such facility or lease and indemnities to our directors and officers to the maximum extent permitted under the laws of the State of California. We have issued guarantees in the form of letters of credit as security for some merchandise shipments from overseas. There were $130,000 of these letters of credit outstanding at January 29, 2005. The durations of these indemnities, commitments and guarantees vary. Some of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments we could be obligated to make. We have not recorded any liability for these indemnities, commitments and guarantees in the accompanying consolidated financial statements. NOTE 7. SHAREHOLDERS' EQUITY STOCK SPLIT On August 12, 2003, we announced that our Board of Directors approved a three-for-two stock split (in the form of a dividend) of our common stock. On the effective date of September 2, 2003, shareholders received a dividend of one additional share for every two shares they owned at the close of business on the record date of August 21, 2003. All share and per share amounts have been restated to reflect this stock split and all previous stock splits effectuated by us. F-17 STOCK REPURCHASE On May 8, 2002, we announced that our Board of Directors approved the repurchase of up to an aggregate of 1,500,000 shares of our common stock during the period ending January 31, 2003. As of January 31, 2003, we completed the repurchase of 1,500,000 shares of our common stock at a cost of $19.7 million, at an average price of $13.13 per common share. On March 19, 2004, we announced that our Board of Directors approved the repurchase of up to an aggregate of 2,000,000 shares of our common stock during the period ending January 29, 2005. As of July 31, 2004 we completed the repurchase of 2,000,000 shares of our common stock at a cost of $46.8 million at an average price of $23.41. On August 18, 2004, we announced that our Board of Directors approved an additional repurchase of up to an aggregate of 2,000,000 shares of our common stock during the period ending January 29, 2005. As of January 29, 2005, we completed the repurchase of 2,000,000 shares of our common stock at a cost of $32.8 million at an average price of $16.42. EMPLOYEE STOCK PURCHASE PLAN In June 1996, the Board of Directors adopted the Employee Stock Purchase Plan (the "Stock Purchase Plan"). The Stock Purchase Plan provides for the issuance of up to 1,350,000 shares of common stock to our employees. All eligible employees are granted identical rights to purchase common stock for each Board authorized offering under the Stock Purchase Plan. Rights granted pursuant to any offering under the Stock Purchase Plan terminate immediately upon cessation of an employee's employment for any reason. In general, an employee may withdraw from participation in an offering at any time during the purchase period for such offering. Rights granted under the Stock Purchase Plan are not transferable and may be exercised only by the person to whom such rights are granted. The initial offering under the Stock Purchase Plan commenced October 24, 1996 and terminated December 31, 1996. Subsequent offerings occur every six months commencing January 1, 1997. EQUITY INCENTIVE AND STOCK OPTION PLANS Under the our 1996 Equity Incentive Plan, we may grant stock options, stock bonuses, restricted stock purchase rights and stock appreciation rights to employees, our directors or consultants, as deemed appropriate by the Board of Directors. Under our 1996 Non-Employee Directors' Stock Option Plan and together with the 1996 Equity Incentive Plan (the "Plans"), we may grant stock options to non-employee directors. The exercise price of options granted under the Plans shall be determined by the Board of Directors at the date of grant and shall not be lower than (i) 100% of the fair market value of our common stock on the date of grant for incentive stock options, (ii) 85% of the fair market value our common stock on the date of grant for non-statutory stock options, and (iii) 110% of the fair market value of our common stock on the date of grant for persons possessing 10% or more of the total combined voting power of all classes of stock. Unless the Board of Directors declares otherwise, options vest over four years and generally expire ten years from the date of grant. An aggregate of 19,020,000 shares of common stock may be issued pursuant to the Plans. During fiscal 2003, the Plans were amended to increase the aggregate number of shares of common stock authorized for issuance by 2,775,000 shares. As of January 29, 2005, 2,388,671 shares were available for future grants. No options, under the Plans, have been granted to consultants. F-18 We granted 7,737; 8,855; and 8,424 shares of restricted common stock in the year ended January 29, 2005, January 31, 2004, and February 1, 2003, respectively, to non-employee directors under the 1996 Equity Incentive Plan. The 7,737 restricted shares issued in fiscal 2004 will vest in the year ending January 28, 2006, the 8,855 restricted shares issued in fiscal 2003 vested in the year ended January 29, 2005, the 8,424 restricted shares issued in fiscal 2002 vested in the year ended January 31, 2004. All awarded common shares will remain restricted until such time the recipient is no longer a member of our Board of Directors. The value of these grants is expensed over the vesting period and $155,000, $155,000, and $142,000 was expensed in the years ended January 29, 2005, January 31, 2004, and February 1, 2003, respectively. A summary of our stock option activity and related information follows: January 29, 2005 January 31, 2004 February 1, 2003 ---------------------- ---------------------- ---------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price ---------------------- ---------------------- ---------------------- Outstanding at beginning of year 4,813,795 $ 11.28 4,876,941 $ 8.70 4,891,268 $ 5.85 Granted 1,447,750 $ 24.75 1,396,931 $ 15.78 1,394,475 $ 15.14 Exercised (409,446) $ 8.94 (1,260,630) $ 6.11 (1,195,529) $ 4.13 Forfeited (159,254) $ 19.51 (199,447) $ 12.37 (213,273) $ 10.88 ---------------------- ---------------------- ---------------------- Outstanding at end of year 5,692,845 $ 14.67 4,813,795 $ 11.28 4,876,941 $ 8.70 ====================== ====================== ====================== ---------------------- ---------------------- ---------------------- Exercisable at end of year 4,417,071 $ 14.48 2,146,586 $ 7.80 2,000,054 $ 5.06 ====================== ====================== ======================
F-19 Exercise prices for the 5,692,845 options outstanding as of January 29, 2005 ranged from $1.51 to $27.60. The weighted average contractual life of those options is 7.2 years. The following table summarizes information about stock options outstanding as of January 29, 2005: Outstanding Options ------------------------------------------------------------------------- Range of Exercise Prices Weighted Weighted Weighted Average Average Average Number Exercise Contractual Number Exercise Outstanding Price Life Exercisable Price - ------------------------------------------------------------------------------------------------------ $1.51 - $3.73 780,942 $ 2.88 4.4 780,942 $ 2.88 $5.97 - $11.00 1,112,878 $ 8.90 5.9 1,040,596 $ 8.80 $11.23 - $15.33 1,139,378 $ 14.77 7.1 739,432 $ 14.77 $15.61 - $25.06 1,491,697 $ 16.56 8.3 691,589 $ 17.25 $25.51 - $27.60 1,167,950 $ 25.52 9.1 1,164,512 $ 25.52 ------------------------------------------------------------------------- $1.51 - $27.60 5,692,845 $ 14.67 7.2 4,417,071 $ 14.48 =========================================================================
We recorded tax benefits associated with the exercise of non-qualified stock options and non-qualifying dispositions of incentive stock options. The tax benefits increased shareholders' equity and decreased income taxes payable in the amounts of $1,585,000, $6,616,000, and $5,118,000 for the years ended January 29, 2005, January 31, 2004, and February 1, 2003, respectively. NOTE 8. NET INCOME PER SHARE We compute net income per share pursuant to Statement of Financial Accounting Standards No. 128 "Earnings Per Share." Basic net income per share is computed based on the weighted average number of common shares outstanding for the period. Diluted net income per share is computed based on the weighted average number of common shares outstanding for the period and potentially dilutive common stock equivalents outstanding for the period. A reconciliation of the numerator and denominator of basic earnings per share and diluted earnings per share is as follows (all amounts in thousands except per share amounts): January 29, January 31, February 1, 2005 2004 2003 (As Restated) (As Restated) ----------- ----------- ----------- Basic Earnings Per Share Computation: Numerator $ 39,673 $ 47,589 $ 34,087 Denominator: Weighted average common shares outstanding 46,379 47,479 47,027 ----------- ----------- ----------- Total shares 46,379 47,479 47,027 =========== =========== =========== Basic earnings per share $ 0.86 $ 1.00 $ 0.72 =========== =========== =========== Diluted Earnings Per Share Computation: Numerator $ 39,673 $ 47,589 $ 34,087 Denominator: Weighted average common shares outstanding 46,379 47,479 47,027 Incremental shares from assumed conversion of options 1,496 2,109 2,249 ----------- ----------- ----------- Total shares 47,875 49,588 49,276 =========== =========== =========== Diluted earnings per share $ 0.83 $ 0.96 $ 0.69 =========== =========== ===========
F-20 NOTE 9. INCOME TAXES Composition of the provision for income taxes for the years ended (in thousands): January 29, January 31, February 1, 2005 2004 2003 (As Restated) (As Restated) ----------- ----------- ----------- Current: Federal $ 17,141 $ 21,169 $ 18,570 State 3,574 4,577 2,963 ----------- ----------- ----------- 20,715 25,746 21,533 ----------- ----------- ----------- Deferred: Federal 3,949 4,155 (415) State (46) (362) (226) ----------- ----------- ----------- 3,903 3,793 (641) ----------- ----------- ----------- Total income tax expense $ 24,618 $ 29,539 $ 20,892 =========== =========== =========== Significant components of our deferred tax assets and liabilities as of (in thousands): January 29, January 31, 2005 2004 (As Restated) ----------- ----------- Current deferred tax assets: Inventory $ 940 $ 701 Accrued vacation and other 779 727 State taxes 566 597 Other assets 256 234 ----------- ----------- Net current deferred tax assets 2,541 2,259 ----------- ----------- Noncurrent deferred tax assets (liabilities): Depreciation (6,600) (2,447) Deferred rent 524 739 ----------- ----------- Total noncurrent deferred tax liabilities (6,076) (1,708) ----------- ----------- Net deferred tax liabilities $ (3,535) $ (551) =========== =========== F-21 Reconciliation of the provision for income taxes to the statutory tax rate for the years ended: January 29, January 31, February 1, 2005 2004 2003 ----------- ----------- ----------- Statutory federal rate 35.0% 35.0% 35.0% Permanent differences (0.2) (0.4) (0.5) State and local taxes, net of federal benefit 3.6 3.6 3.7 Other items (0.1) 0.1 (0.2) ----------- ----------- ----------- Effective income tax rate 38.3% 38.3% 38.0% =========== =========== ===========
We operate in numerous tax jurisdictions and are subject to routine tax examinations. Any such examinations could involve difficult issues and multiple years. Although we cannot predict the outcome of future examinations, amounts that could be owed in excess of amounts accrued will impact future tax expense but will not impact our financial condition. NOTE 10. EMPLOYEE BENEFIT PLAN Effective January 1, 1995, we adopted the Hot Topic 401(k) Retirement Savings Plan (the "401(k) Plan"). All employees who have been employed by us for at least one year of service, maintained a minimum of 1,000 hours worked during the year and are at least 21 years of age are eligible to participate. Employees may contribute to the 401(k) Plan up to 25% of their current compensation, subject to a statutorily prescribed annual limit. We may at our discretion contribute certain amounts to eligible employees' accounts. We have not made any contributions to the 401(k) Plan. F-22 EX-3.2 2 hottopic_10kex3-2.txt EXHIBIT 3.2 STATE OF CALIFORNIA SECRETARY OF STATE I, BILL JONES, Secretary of State of the State of California, hereby certify: That the attached transcript of 1 page(s) has been compared with the record on file in this office, of which it purports to be a copy, and that it is full, true and correct. IN WITNESS WHEREOF, I execute this certificate and affix the Great Seal of the State of California this day of Jul - 5 2002 -------------------------------------------- /s/ Bill Jones [Seal of the State of California] Secretary of State CERTIFICATE OF AMENDMENT OF AMENDED AND RESTATED ARTICLES OF INCORPORATION OF HOT TOPIC, INC. Elizabeth M. McLaughlin and James J. McGinty certify that: ONE: They are the duly elected and acting Chief Executive Officer and President, and Chief Financial Officer and Secretary, respectively, of Hot Topic, Inc., a California corporation. TWO: The first paragraph of Article III of the Amended and Restated Articles of Incorporation of this corporation is amended in its entirety to read as follows: III "The Corporation is authorized to issue two classes of shares designated "Common Stock" and "Preferred Stock," respectively. The number of shares of Common Stock authorized to be issued is one hundred fifty million (150,000,000) and the number of shares of Preferred Stock authorized to be issued is ten million (10,000,000)." THREE: The foregoing Amendment of Amended and Restated Articles of Incorporation has been duly approved by the Board of Directors of the corporation. FOUR: The foregoing Amendment of Amended and Restated Articles of Incorporation has been duly approved by the required vote of shareholders in accordance with Section 902 of the California Corporations Code. The total number of outstanding shares of the corporation entitled to vote on the approval of the amendment was 31,569,255 shares of Common Stock. The number of shares voting in favor of the amendment equaled or exceeded the vote required. The percentage vote required was more than fifty percent (50%) of the outstanding shares of Common Stock. There are no outstanding shares of Preferred Stock. We further declare under penalty of perjury under the laws of the State of California that the matters set forth in this certificate are true and correct of our own knowledge. Date: June 13, 2002 /s/ Elizabeth M. McLaughlin ---------------------------------------- Elizabeth M. McLaughlin Chief Executive Officer and President /s/ James J. McGinty ---------------------------------------- Jame J. McGinty EX-3.3 3 hottopic_10kex3-3.txt EXHIBIT 3.3 ================================================================================ AMENDED AND RESTATED BYLAWS (AS AMENDED) OF HOT TOPIC, INC. ================================================================================ 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........................................................................8 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.................................................................14 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 (AS AMENDED) 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 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, 1 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 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. 2 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, 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. 5 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. 6 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 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. 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 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). 7 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. 8 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. 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. 9 SECTION 11. ADJOURNMENT. A majority of the directors present, whether or not constituting a quorum, may adjourn any meeting to another time and place. 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 and date of certificates issued for the same, and the number and date of cancellation of every certificate surrendered for cancellation. 12 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 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. 13 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 to any shareholder demanding an examination of any such statement or a copy shall be mailed to any such shareholder. 14 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, 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. 15 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 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. 16 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 (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. 19 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-10.2A 4 hottopic_10kex10-2a.txt EXHIBIT 10.2a HOT TOPIC, INC. 1996 EQUITY INCENTIVE PLAN ADOPTED ON JANUARY 20, 1993 AMENDED ON JULY 8, 1994 AMENDED ON MARCH 27, 1996 AMENDED AND RESTATED ON JUNE 14, 1996 AMENDED ON FEBRUARY 18, 1998 APPROVED BY SHAREHOLDERS ON MAY 27, 1998 AMENDED ON FEBRUARY 24, 2000 APPROVED BY SHAREHOLDERS ON JUNE 28, 2000 AMENDED ON MARCH 20, 2003 APPROVED BY SHAREHOLDERS ON JUNE 12, 2003 SHARES SUBJECT TO THE PLAN AUTOMATICALLY ADJUSTED ON DECEMBER 27, 1999, DECEMBER 27, 2000, FEBRUARY 6, 2002 AND SEPTEMBER 2, 2003. INTRODUCTION Originally adopted on January 20, 1993 as the "1993 Stock Option Plan of Hot Topic, Inc.," the plan is hereby amended and restated and retitled the "1996 Equity Incentive Plan." 1. PURPOSES. (a) The purpose of the Plan is to provide a means by which selected Employees and Directors of and Consultants to the Company, and its Affiliates, may be given an opportunity to benefit from increases in value of the stock of the Company through the granting of (i) Incentive Stock Options, (ii) Nonstatutory Stock Options, (iii) stock bonuses, (iv) rights to purchase restricted stock, and (v) stock appreciation rights, all as defined below. (b) The Company, by means of the Plan, seeks to retain the services of persons who are now Employees or Directors of or Consultants to the Company or its Affiliates, to secure and retain the services of new Employees, Directors and Consultants, and to provide incentives for such persons to exert maximum efforts for the success of the Company and its Affiliates. (c) The Company intends that the Stock Awards issued under the Plan shall, in the discretion of the Board or any Committee to which responsibility for administration of the Plan has been delegated pursuant to subsection 3(c), be either (i) Options granted pursuant to Section 6 hereof, including Incentive Stock Options and Nonstatutory Stock Options, (ii) stock bonuses or rights to purchase restricted stock granted pursuant to Section 7 hereof, or (iii) stock appreciation rights granted pursuant to Section 8 hereof. All Options shall be separately designated Incentive Stock Options or Nonstatutory Stock Options at the time of grant, and in such form as issued pursuant to Section 6, and a separate certificate or certificates will be issued for shares purchased on exercise of each type of Option. 1 2. DEFINITIONS. (a) "AFFILIATE" means any parent corporation or subsidiary corporation, whether now or hereafter existing, as those terms are defined in Sections 424(e) and (f) respectively, of the Code. (b) "BOARD" means the Board of Directors of the Company. (c) "CODE" means the Internal Revenue Code of 1986, as amended. (d) "COMMITTEE" means a Committee appointed by the Board in accordance with subsection 3(c) of the Plan. (e) "COMPANY" means Hot Topic, Inc., a California corporation. (f) "CONCURRENT STOCK APPRECIATION RIGHT" or "CONCURRENT RIGHT" means a right granted pursuant to subsection 8(b)(2) of the Plan. (g) "CONSULTANT" means any person, including an advisor, engaged by the Company or an Affiliate to render consulting services and who is compensated for such services, provided that the term "Consultant" shall not include Directors who are paid only a director's fee by the Company or who are not compensated by the Company for their services as Directors. (h) "CONTINUOUS STATUS AS AN EMPLOYEE, DIRECTOR OR CONSULTANT" means the employment or relationship as a Director or Consultant is not interrupted or terminated. The Chief Executive Officer of the Company may determine, in his or her sole discretion, whether Continuous Status as an Employee, Director or Consultant shall be considered interrupted in the case of: (i) any leave of absence approved by the Board or the Chief Executive Officer of the Company, including sick leave, military leave, or any other personal leave; or (ii) transfers between locations of the Company or between the Company, Affiliates or their successors. (i) "COVERED EMPLOYEE" means the chief executive officer and the four (4) other highest compensated officers of the Company for whom total compensation is required to be reported to shareholders under the Exchange Act, as determined for purposes of Section 162(m) of the Code. 2 (j) "DIRECTOR" means a member of the Board. (k) "DISABILITY" means total and permanent disability as defined in Section 22(e)(3) of the Code. (l) "EMPLOYEE" means any person, including Officers and Directors, employed by the Company or any Affiliate of the Company. Neither service as a Director nor payment of a director's fee by the Company shall be sufficient to constitute "employment" by the Company. (m) "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended. (n) "FAIR MARKET VALUE" means, as of any date, the value of the common stock of the Company determined as follows: (1) If the common stock is listed on any established stock exchange or a national market system, including without limitation The Nasdaq Stock Market, the Fair Market Value of a share of common stock shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such system or exchange (or the exchange with the greatest volume of trading in common stock) on the last market trading day prior to the day of determination, as reported in the Wall Street Journal or such other source as the Board deems reliable; (2) If the common stock is quoted on The Nasdaq Stock Market (but not on the National Market thereof) or is regularly quoted by a recognized securities dealer but selling prices are not reported, the Fair Market Value of a share of common stock shall be the mean between the bid and asked prices for the common stock on the last market trading day prior to the day of determination, as reported in the Wall Street Journal or such other source as the Board deems reliable; (3) In the absence of an established market for the common stock, the Fair Market Value shall be determined in good faith by the Board. (o) "INCENTIVE STOCK OPTION" means an Option intended to qualify as an incentive stock option within the meaning of Section 422 of the Code and the regulations promulgated thereunder. (p) "NON-EMPLOYEE DIRECTOR" means a Director who either (i) is not a current Employee or Officer of the Company or its parent or subsidiary, does not receive compensation (directly or indirectly) from the Company or its parent or subsidiary for services rendered as a consultant or in any capacity other than as a Director (except for an amount as to which disclosure would not be required under Item 404(a) of Regulation S-K promulgated pursuant to the Securities Act of 1933 ("Regulation S-K"), does not possess an interest in any other transaction as to which disclosure would be required under Item 404(a) of Regulation S-K, and is not engaged in a business relationship as to which disclosure would be required under Item 404(b) of Regulation S-K; or (ii) is otherwise considered a "non-employee director" for purposes of Rule 16b-3. 3 (q) "INDEPENDENT STOCK APPRECIATION RIGHT" or "INDEPENDENT RIGHT" means a right granted pursuant to subsection 8(b)(3) of the Plan. (r) "NONSTATUTORY STOCK OPTION" means an Option not intended to qualify as an Incentive Stock Option. (s) "OFFICER" means a person who is an officer of the Company within the meaning of Section 16 of the Exchange Act and the rules and regulations promulgated thereunder. (t) "OPTION" means a stock option granted pursuant to the Plan. (u) "OPTION AGREEMENT" means a written agreement between the Company and an Optionee evidencing the terms and conditions of an individual Option grant. Each Option Agreement shall be subject to the terms and conditions of the Plan. (v) "OPTIONEE" means a person who holds an outstanding Option. (w) "OUTSIDE DIRECTOR" means a Director who either (i) is not a current employee of the Company or an "affiliated corporation" (within the meaning of Treasury regulations promulgated under Section 162(m) of the Code), is not a former employee of the Company or an "affiliated corporation" receiving compensation for prior services (other than benefits under a tax qualified pension plan), was not an officer of the Company or an "affiliated corporation" at any time, and is not currently receiving direct or indirect remuneration from the Company or an "affiliated corporation" for services in any capacity other than as a Director, or (ii) is otherwise considered an "outside director" for purposes of Section 162(m) of the Code. (x) "PLAN" means this Hot Topic, Inc. 1996 Equity Incentive Plan. (y) "RULE 16B-3" means Rule 16b-3 of the Exchange Act or any successor to Rule 16b-3, as in effect when discretion is being exercised with respect to the Plan. (z) "STOCK APPRECIATION RIGHT" means any of the various types of rights which may be granted under Section 8 of the Plan. (aa) "STOCK AWARD" means any right granted under the Plan, including any Option, any stock bonus, any right to purchase restricted stock, and any Stock Appreciation Right. 4 (bb) "STOCK AWARD AGREEMENT" means a written agreement between the Company and a holder of a Stock Award evidencing the terms and conditions of an individual Stock Award grant. Each Stock Award Agreement shall be subject to the terms and conditions of the Plan. (cc) "TANDEM STOCK APPRECIATION RIGHT" or "TANDEM RIGHT" means a right granted pursuant to subsection 8(b)(1) of the Plan. 3. ADMINISTRATION. (a) The Plan shall be administered by the Board unless and until the Board delegates administration to a Committee, as provided in subsection 3(c). (b) The Board shall have the power, subject to, and within the limitations of, the express provisions of the Plan: (1) To determine from time to time which of the persons eligible under the Plan shall be granted Stock Awards; when and how each Stock Award shall be granted; whether a Stock Award will be an Incentive Stock Option, a Nonstatutory Stock Option, a stock bonus, a right to purchase restricted stock, a Stock Appreciation Right, or a combination of the foregoing; the provisions of each Stock Award granted (which need not be identical), including the time or times when a person shall be permitted to receive stock pursuant to a Stock Award; whether a person shall be permitted to receive stock upon exercise of an Independent Stock Appreciation Right; and the number of shares with respect to which a Stock Award shall be granted to each such person. (2) To construe and interpret the Plan and Stock Awards granted under it, and to establish, amend and revoke rules and regulations for its administration. The Board, in the exercise of this power, may correct any defect, omission or inconsistency in the Plan or in any Stock Award Agreement, in a manner and to the extent it shall deem necessary or expedient to make the Plan fully effective. (3) To amend the Plan or a Stock Award as provided in Section 13. (4) Generally, to exercise such powers and to perform such acts as the Board deems necessary or expedient to promote the best interests of the Company which are not in conflict with the provisions of the Plan. (c) The Board may delegate administration of the Plan to a committee of the Board composed of not fewer than two (2) members (the "Committee"), all of the members of which Committee may be, in the discretion of the Board, Non-Employee Directors and/or Outside Directors. If administration is delegated to a Committee, the Committee shall have, in connection with the administration of the Plan, the powers theretofore possessed by the Board, including the power to delegate to a subcommittee of two (2) or more Outside Directors any of the administrative powers the Committee is authorized to exercise (and references in this Plan to the Board shall thereafter be to the Committee or such 5 Subcommittee), subject, however, to such resolutions, not inconsistent with the provisions of the Plan, as may be adopted from time to time by the Board. The Board may abolish the Committee at any time and revest in the Board the administration of the Plan. Notwithstanding anything in this Section 3 to the contrary, at any time the Board or the Committee may delegate to a committee of one or more members of the Board the authority to grant Stock Awards to eligible persons who (1) are not then subject to Section 16 of the Exchange Act and/or (2) are either (i) not then Covered Employees and are not expected to be Covered Employees at the time of recognition of income resulting from such Stock Award, or (ii) not persons with respect to whom the Company wishes to avoid the application of Section 162(m) of the Code. (d) Any requirement that an administrator of the Plan be a Disinterested Person shall not apply if the Board or the Committee expressly declares that such requirement shall not apply. Any Disinterested Person shall otherwise comply with the requirements of Rule 16b-3. 4. SHARES SUBJECT TO THE PLAN. (a) Subject to the provisions of Section 12 relating to adjustments upon changes in stock, the stock that may be issued pursuant to Stock Awards shall not exceed in the aggregate Eighteen Million Three Hundred Thousand (18,300,000) shares of the Company's common stock. If any Stock Award shall for any reason expire or otherwise terminate, in whole or in part, without having been exercised in full, the stock not acquired under such Stock Award shall revert to and again become available for issuance under the Plan. Shares subject to Stock Appreciation Rights exercised in accordance with Section 8 of the Plan shall not be available for subsequent issuance under the Plan. (b) The stock subject to the Plan may be unissued shares or reacquired shares, bought on the market or otherwise. 5. ELIGIBILITY. (a) Incentive Stock Options and Stock Appreciation Rights appurtenant thereto may be granted only to Employees. Stock Awards other than Incentive Stock Options and Stock Appreciation Rights appurtenant thereto may be granted only to Employees, Directors or Consultants. Notwithstanding the foregoing, no Stock Awards shall be granted to a Director (including a Director who is an Employee or a Consultant) prior to August 15, 1996 (or such later date as the amendments to Rule 16b-3 adopted by the Securities and Exchange Commission pursuant to Release No. 34-37260 become effective as to the Company), unless such Director is expressly declared eligible to participate in the Plan by action of the Board or the Committee. 6 (b) No person shall be eligible for the grant of an Option or an award to purchase restricted stock if, at the time of grant, such person owns (or is deemed to own pursuant to Section 424(d) of the Code) stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or of any of its Affiliates unless the exercise price of such Option is at least one hundred ten percent (110%) of the Fair Market Value of such stock at the date of grant and the Option is not exercisable after the expiration of five (5) years from the date of grant, or in the case of a restricted stock purchase award, the purchase price is at least one hundred percent (100%) of the Fair Market Value of such stock at the date of grant. (c) Subject to the provisions of Section 12 relating to adjustments upon changes in stock, no person shall be eligible to be granted Options and Stock Appreciation Rights covering more than One Million Eight Hundred Thousand (1,800,000) shares of the Company's common stock in any twelve (12) month period. This subsection 5(c) shall not apply prior to the date of the first registration of an equity security of the Company under Section 12 of the Exchange Act and, following such registration, shall not apply until (i) the earliest of: (A) the first material modification of the Plan (including any increase to the number of shares reserved for issuance under the Plan in accordance with Section 4); (B) the issuance of all of the shares of common stock reserved for issuance under the Plan; (C) the expiration of the Plan; or (D) the first meeting of shareholders at which directors are to be elected that occurs after the close of the third calendar year following the calendar year in which occurred the first registration of an equity security under Section 12 of the Exchange Act; or (ii) such other date required by Section 162(m) of the Code and the rules and regulations promulgated thereunder. 6. OPTION PROVISIONS. Each Option shall be in such form and shall contain such terms and conditions as the Board shall deem appropriate. The provisions of separate Options need not be identical, but each Option shall include (through incorporation of provisions hereof by reference in the Option or otherwise) the substance of each of the following provisions: (a) TERM. No Option shall be exercisable after the expiration of ten (10) years from the date it was granted. (b) PRICE. The exercise price of each Incentive Stock Option shall be not less than one hundred percent (100%) of the Fair Market Value of the stock subject to the Option on the date the Option is granted; the exercise price of each Nonstatutory Stock Option granted on or after March 20, 2003 shall be not less than one hundred percent (100%) of the Fair Market Value of the stock subject to the Option on the date the Option is granted; and the exercise price of each Nonstatutory Stock Option granted prior to March 20, 2003 shall be not less than eighty-five percent (85%) of the Fair Market Value of the stock subject to the Option on the date the Option is granted. Notwithstanding the foregoing, an Option (whether an Incentive Stock Option or a Nonstatutory Stock Option) may be granted with an exercise price lower than that set forth in the preceding sentence if such Option is granted pursuant to an assumption or substitution for another option in a manner satisfying the provisions of Section 424(a) of the Code. 7 (c) CONSIDERATION. The purchase price of stock acquired pursuant to an Option shall be paid, to the extent permitted by applicable statutes and regulations, either (i) in cash at the time the Option is exercised, or (ii) at the discretion of the Board or the Committee, at the time of the grant of the Option, (A) by delivery to the Company of other common stock of the Company, (B) according to a deferred payment or other arrangement (which may include, without limiting the generality of the foregoing, the use of other common stock of the Company) with the person to whom the Option is granted or to whom the Option is transferred pursuant to subsection 6(d), or (C) in any other form of legal consideration that may be acceptable to the Board. In the case of any deferred payment arrangement, interest shall be payable at least annually and shall be charged at the minimum rate of interest necessary to avoid the treatment as interest, under any applicable provisions of the Code, of any amounts other than amounts stated to be interest under the deferred payment arrangement. (d) TRANSFERABILITY. An Incentive Stock Option shall not be transferable except by will or by the laws of descent and distribution, and shall be exercisable during the lifetime of the person to whom the Incentive Stock Option is granted only by such person. A Nonstatutory Stock Option may be transferred by the Optionee upon such terms and conditions as are set forth in the Option Agreement for such Nonstatutory Option, as the Board or the Committee shall determine in its discretion, including (without limitation) pursuant to a "domestic relations order" within the meaning of such rules, regulations or interpretations of the Securities and Exchange Commission as are applicable for purposes of Section 16 of the Exchange Act (a "DRO"). In the event of a transfer of a Nonstatutory Option as provided in the Option Agreement, the transferee shall be entitled to exercise such Nonstatutory Option to the extent of his or her interest received in such transfer, subject to the terms and conditions of the Option Agreement. Notwithstanding the foregoing, the person to whom the Option is granted may, by delivering written notice to the Company, in a form satisfactory to the Company, designate a third party who, in the event of the death of the Optionee, shall thereafter be entitled to exercise the Option. (e) VESTING. The total number of shares of stock subject to an Option may, but need not, be allotted in periodic installments (which may, but need not, be equal). The Option Agreement may provide that from time to time during each of such installment periods, the Option may become exercisable ("vest") with respect to some or all of the shares allotted to that period, and may be exercised with respect to some or all of the shares allotted to such period and/or any prior period as to which the Option became vested but was not fully exercised. The Option may be subject to such other terms and conditions on the time or times when it may be exercised (which may be based on performance or other criteria) as the Board may deem appropriate. The provisions of this subsection 6(e) are subject to any Option provisions governing the minimum number of shares as to which an Option may be exercised. 8 (f) TERMINATION OF EMPLOYMENT OR RELATIONSHIP AS A DIRECTOR OR CONSULTANT. In the event an Optionee's Continuous Status as an Employee, Director or Consultant terminates (other than upon the Optionee's death or disability), the Optionee may exercise his or her Option (to the extent that the Optionee was entitled to exercise it at the date of termination) but only within such period of time ending on the earlier of (i) the date thirty (30) days after the termination of the Optionee's Continuous Status as an Employee, Director or Consultant (or such longer or shorter period specified in the Option Agreement), or (ii) the expiration of the term of the Option as set forth in the Option Agreement. If, after termination, the Optionee does not exercise his or her Option within the time specified in the Option Agreement, the Option shall terminate, and the shares covered by such Option shall revert to and again become available for issuance under the Plan. An Optionee's Option Agreement may also provide that if the exercise of the Option following the termination of the Optionee's Continuous Status as an Employee, Director, or Consultant (other than upon the Optionee's death or disability) would result in liability under Section 16(b) of the Exchange Act, then the Option shall terminate on the earlier of (i) the expiration of the term of the Option set forth in the Option Agreement, or (ii) the tenth (10th) day after the last date on which such exercise would result in such liability under Section 16(b) of the Exchange Act. Finally, an Optionee's Option Agreement may also provide that if the exercise of the Option following the termination of the Optionee's Continuous Status as an Employee, Director or Consultant (other than upon the Optionee's death or disability) would be prohibited at any time solely because the issuance of shares would violate the registration requirements under the Act, then the Option shall terminate on the earlier of (i) the expiration of the term of the Option set forth in the first paragraph of this subsection 6(f), or (ii) the expiration of a period of thirty (30) days after the termination of the Optionee's Continuous Status as an Employee, Director or Consultant during which the exercise of the Option would not be in violation of such registration requirements. (g) DISABILITY OF OPTIONEE. In the event an Optionee's Continuous Status as an Employee, Director or Consultant terminates as a result of the Optionee's disability, the Optionee may exercise his or her Option (to the extent that the Optionee was entitled to exercise it at the date of termination), but only within such period of time ending on the earlier of (i) the date twelve (12) months following such termination (or such longer or shorter period specified in the Option Agreement), or (ii) the expiration of the term of the Option as set forth in the Option Agreement. If, at the date of termination, the Optionee is not entitled to exercise his or her entire Option, the shares covered by the unexercisable portion of the Option shall revert to and again become available for issuance under the Plan. If, after termination, the Optionee does not exercise his or her Option within the time specified herein, the Option shall terminate, and the shares covered by such Option shall revert to and again become available for issuance under the Plan. 9 (h) DEATH OF OPTIONEE. In the event of the death of an Optionee during, or within a period specified in the Option after the termination of, the Optionee's Continuous Status as an Employee, Director or Consultant, the Option may be exercised (to the extent the Optionee was entitled to exercise the Option at the date of death) by the Optionee's estate, by a person who acquired the right to exercise the Option by bequest or inheritance or by a person designated to exercise the option upon the Optionee's death pursuant to subsection 6(d), but only within the period ending on the earlier of (i) the date twelve (12) months following the date of death (or such longer or shorter period specified in the Option Agreement), or (ii) the expiration of the term of such Option as set forth in the Option Agreement. If, at the time of death, the Optionee was not entitled to exercise his or her entire Option, the shares covered by the unexercisable portion of the Option shall revert to and again become available for issuance under the Plan. If, after death, the Option is not exercised within the time specified herein, the Option shall terminate, and the shares covered by such Option shall revert to and again become available for issuance under the Plan. (i) EARLY EXERCISE. The Option may, but need not, include a provision whereby the Optionee may elect at any time while an Employee, Director or Consultant to exercise the Option as to any part or all of the shares subject to the Option prior to the full vesting of the Option. Any unvested shares so purchased may be subject to a repurchase right in favor of the Company or to any other restriction the Board determines to be appropriate. 7. TERMS OF STOCK BONUSES AND PURCHASES OF RESTRICTED STOCK. Each stock bonus or restricted stock purchase agreement shall be in such form and shall contain such terms and conditions as the Board or the Committee shall deem appropriate. The terms and conditions of stock bonus or restricted stock purchase agreements may change from time to time, and the terms and conditions of separate agreements need not be identical, but each stock bonus or restricted stock purchase agreement shall include (through incorporation of provisions hereof by reference in the agreement or otherwise) the substance of each of the following provisions as appropriate: (a) PURCHASE PRICE. The purchase price under each restricted stock purchase agreement shall be such amount as the Board or Committee shall determine and designate in such agreement, but in no event shall the purchase price be less than eighty-five percent (85%) of the stock's Fair Market Value on the date such award is made. Notwithstanding the foregoing, the Board or the Committee may determine that eligible participants in the Plan may be awarded stock pursuant to a stock bonus agreement in consideration for past services actually rendered to the Company or for its benefit. Subject to the provisions of Section 12 relating to adjustments upon changes in stock, stock awarded on or after March 20, 2003 pursuant to restricted stock purchase agreements or stock bonus agreements shall not exceed in the aggregate Ninety Three Thousand (93,000) shares of the Company's common stock. 10 (b) TRANSFERABILITY. No rights under a stock bonus or restricted stock purchase agreement shall be transferable except by will or the laws of descent and distribution or, if the agreement so provides, pursuant to a DRO (as defined in subsection 6(d) hereof), so long as stock awarded under such agreement remains subject to the terms of the agreement. (c) CONSIDERATION. The purchase price of stock acquired pursuant to a stock purchase agreement shall be paid either: (i) in cash at the time of purchase; (ii) at the discretion of the Board or the Committee, according to a deferred payment or other arrangement with the person to whom the stock is sold; or (iii) in any other form of legal consideration that may be acceptable to the Board or the Committee in its discretion. Notwithstanding the foregoing, the Board or the Committee to which administration of the Plan has been delegated may award stock pursuant to a stock bonus agreement in consideration for past services actually rendered to the Company or for its benefit. (d) VESTING. Shares of stock sold or awarded under the Plan may, but need not, be subject to a repurchase option in favor of the Company in accordance with a vesting schedule to be determined by the Board or the Committee. (e) TERMINATION OF EMPLOYMENT OR RELATIONSHIP AS A DIRECTOR OR CONSULTANT. In the event a Participant's Continuous Status as an Employee, Director or Consultant terminates, the Company may repurchase or otherwise reacquire any or all of the shares of stock held by that person which have not vested as of the date of termination under the terms of the stock bonus or restricted stock purchase agreement between the Company and such person. 8. STOCK APPRECIATION RIGHTS. (a) The Board or Committee shall have full power and authority, exercisable in its sole discretion, to grant Stock Appreciation Rights under the Plan to Employees or Directors of or Consultants to, the Company or its Affiliates. To exercise any outstanding Stock Appreciation Right, the holder must provide written notice of exercise to the Company in compliance with the provisions of the Stock Award Agreement evidencing such right. If a Stock Appreciation Right is granted to an individual who is at the time subject to Section 16(b) of the Exchange Act (a "Section 16(b) Insider"), the Stock Award Agreement of grant shall incorporate all the terms and conditions at the time necessary to assure that the subsequent exercise of such right shall qualify for the safe-harbor exemption from short-swing profit liability provided by Rule 16b-3 promulgated under the Exchange Act (or any successor rule or regulation). Except as provided in subsection 5(d), no limitation shall exist on the aggregate amount of cash payments the Company may make under the Plan in connection with the exercise of a Stock Appreciation Rights. 11 (b) Three types of Stock Appreciation Rights shall be authorized for issuance under the Plan: (1) TANDEM STOCK APPRECIATION RIGHTS. Tandem Stock Appreciation Rights will be granted appurtenant to an Option, and shall, except as specifically set forth in this Section 8, be subject to the same terms and conditions applicable to the particular Option grant to which it pertains. Tandem Stock Appreciation Rights will require the holder to elect between the exercise of the underlying Option for shares of stock and the surrender, in whole or in part, of such Option for an appreciation distribution. The appreciation distribution payable on the exercised Tandem Right shall be in cash (or, if so provided, in an equivalent number of shares of stock based on Fair Market Value on the date of the Option surrender) in an amount up to the excess of (A) the Fair Market Value (on the date of the Option surrender) of the number of shares of stock covered by that portion of the surrendered Option in which the Optionee is vested over (B) the aggregate exercise price payable for such vested shares. (2) CONCURRENT STOCK APPRECIATION RIGHTS. Concurrent Rights will be granted appurtenant to an Option and may apply to all or any portion of the shares of stock subject to the underlying Option and shall, except as specifically set forth in this Section 8, be subject to the same terms and conditions applicable to the particular Option grant to which it pertains. A Concurrent Right shall be exercised automatically at the same time the underlying Option is exercised with respect to the particular shares of stock to which the Concurrent Right pertains. The appreciation distribution payable on an exercised Concurrent Right shall be in cash (or, if so provided, in an equivalent number of shares of stock based on Fair Market Value on the date of the exercise of the Concurrent Right) in an amount equal to such portion as shall be determined by the Board or the Committee at the time of the grant of the excess of (A) the aggregate Fair Market Value (on the date of the exercise of the Concurrent Right) of the vested shares of stock purchased under the underlying Option which have Concurrent Rights appurtenant to them over (B) the aggregate exercise price paid for such shares. (3) INDEPENDENT STOCK APPRECIATION RIGHTS. Independent Rights will be granted independently of any Option and shall, except as specifically set forth in this Section 8, be subject to the same terms and conditions applicable to Nonstatutory Stock Options as set forth in Section 6. They shall be denominated in share equivalents. The appreciation distribution payable on the exercised Independent Right shall be not greater than an amount equal to the excess of (A) the aggregate Fair Market Value (on the date of the exercise of the Independent Right) of a number of shares of Company stock equal to the number of share equivalents in which the holder is vested under such Independent Right, and with respect to which the holder is exercising the Independent Right on such date, over (B) the aggregate Fair Market Value (on the date of the grant of the Independent Right) of such number of shares of Company stock. The appreciation distribution payable on the exercised Independent Right shall be in cash or, if so provided, in an equivalent number of shares of stock based on Fair Market Value on the date of the exercise of the Independent Right. 12 9. COVENANTS OF THE COMPANY. (a) During the terms of the Stock Awards, the Company shall keep available at all times the number of shares of stock required to satisfy such Stock Awards. (b) The Company shall seek to obtain from each regulatory commission or agency having jurisdiction over the Plan such authority as may be required to issue and sell shares of stock under Stock Awards; provided, however, that this undertaking shall not require the Company to register under the Securities Act of 1933, as amended (the "Securities Act") either the Plan, any Stock Award or any stock issued or issuable pursuant to any such Stock Award. If, after reasonable efforts, the Company is unable to obtain from any such regulatory commission or agency the authority which counsel for the Company deems necessary for the lawful issuance and sale of stock under the Plan, the Company shall be relieved from any liability for failure to issue and sell stock under such Stock Awards unless and until such authority is obtained. 10. USE OF PROCEEDS FROM STOCK. Proceeds from the sale of stock pursuant to Stock Awards shall constitute general funds of the Company. 11. MISCELLANEOUS. (a) The Board shall have the power to accelerate the time at which a Stock Award may first be exercised or the time during which a Stock Award or any part thereof will vest pursuant to subsection 6(e), 7(d) or 8(b), notwithstanding the provisions in the Stock Award stating the time at which it may first be exercised or the time during which it will vest. (b) Neither an Employee, Director or Consultant nor any person to whom a Stock Award is transferred under subsection 6(d), 7(b), or 8(b) shall be deemed to be the holder of, or to have any of the rights of a holder with respect to, any shares subject to such Stock Award unless and until such person has satisfied all requirements for exercise of the Stock Award pursuant to its terms. 13 (c) Nothing in the Plan or any instrument executed or Stock Award granted pursuant thereto shall confer upon any Employee, Director, Consultant or other holder of Stock Awards any right to continue in the employ of the Company or any Affiliate (or to continue acting as a Director or Consultant) or shall affect the right of the Company or any Affiliate to terminate the employment of any Employee with or without cause the right of the Company's Board of Directors and/or the Company's shareholders to remove any Director pursuant to the terms of the Company's Bylaws and the provisions of the California Corporations Code (or the applicable laws of the Company's state of incorporation if the Company's state of incorporation should change in the future), or the right to terminate the relationship of any Consultant pursuant to the terms of such Consultant's agreement with the Company or Affiliate. (d) To the extent that the aggregate Fair Market Value (determined at the time of grant) of stock with respect to which Incentive Stock Options are exercisable for the first time by any Optionee during any calendar year under all plans of the Company and its Affiliates exceeds one hundred thousand dollars ($100,000), the Options or portions thereof which exceed such limit (according to the order in which they were granted) shall be treated as Nonstatutory Stock Options. (e) The Company may require any person to whom a Stock Award is granted, or any person to whom a Stock Award is transferred pursuant to subsection 6(d), 7(b) or 8(b), as a condition of exercising or acquiring stock under any Stock Award, (1) to give written assurances satisfactory to the Company as to such person's knowledge and experience in financial and business matters and/or to employ a purchaser representative reasonably satisfactory to the Company who is knowledgeable and experienced in financial and business matters, and that he or she is capable of evaluating, alone or together with the purchaser representative, the merits and risks of exercising the Stock Award; and (2) to give written assurances satisfactory to the Company stating that such person is acquiring the stock subject to the Stock Award for such person's own account and not with any present intention of selling or otherwise distributing the stock. The foregoing requirements, and any assurances given pursuant to such requirements, shall be inoperative if (i) the issuance of the shares upon the exercise or acquisition of stock under the Stock Award has been registered under a then currently effective registration statement under the Securities Act, or (ii) as to any particular requirement, a determination is made by counsel for the Company that such requirement need not be met in the circumstances under the then applicable securities laws. The Company may, upon advice of counsel to the Company, place legends on stock certificates issued under the Plan as such counsel deems necessary or appropriate in order to comply with applicable securities laws, including, but not limited to, legends restricting the transfer of the stock. 14 (f) To the extent provided by the terms of a Stock Award Agreement, the person to whom a Stock Award is granted may satisfy any federal, state or local tax withholding obligation relating to the exercise or acquisition of stock under a Stock Award by any of the following means or by a combination of such means: (1) tendering a cash payment; (2) authorizing the Company to withhold shares from the shares of the common stock otherwise issuable to the participant as a result of the exercise or acquisition of stock under the Stock Award; or (3) delivering to the Company owned and unencumbered shares of the common stock of the Company. 12. ADJUSTMENTS UPON CHANGES IN STOCK. (a) If any change is made in the stock subject to the Plan, or subject to any Stock Award, without the receipt of consideration by the Company (through merger, consolidation, reorganization, recapitalization, reincorporation, stock dividend, dividend in property other than cash, stock split, liquidating dividend, combination of shares, exchange of shares, change in corporate structure or other transaction not involving the receipt of consideration by the Company), the Plan will be appropriately adjusted in the class(es) and maximum number of shares subject to the Plan pursuant to subsection 4(a), the maximum number of shares subject to award to any person during any twelve (12) month period pursuant to subsection 5(c), the maximum number of shares subject to award pursuant to restricted stock purchase agreements or stock bonus agreements under subsection 7(a) and the outstanding Stock Awards will be appropriately adjusted in the class(es) and number of shares and price per share of stock subject to such outstanding Stock Awards. Such adjustments shall be made by the Board or the Committee, the determination of which shall be final, binding and conclusive. (The conversion of any convertible securities of the Company shall not be treated as a "transaction not involving the receipt of consideration by the Company".) (b) In the event of: (1) a dissolution, liquidation or sale of substantially all of the assets of the Company; (2) a merger or consolidation in which the Company is not the surviving corporation; (3) a reverse merger in which the Company is the surviving corporation but the shares of the Company's common stock outstanding immediately preceding the merger are converted by virtue of the merger into other property, whether in the form of securities, cash or otherwise; or (4) the 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 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, then: (i) any surviving or acquiring corporation shall assume any Stock Awards outstanding under the Plan or shall substitute similar Stock Awards (including an award to acquire the same consideration paid to the shareholders in the transaction described in this subsection 12(b)) for those outstanding under the Plan; or (ii) in the event any surviving or acquiring corporation refuses to assume such Stock Awards or to substitute similar awards for those outstanding under the Plan, then, (A) with respect to Stock Awards held by persons then performing services as Employees, Directors or Consultants, the vesting of such Stock Awards and, if applicable, exercisability of such Stock Awards shall be accelerated prior to such event and the Stock Awards terminated if not exercised after such acceleration and at or prior to such event, and (B) with respect to any other Stock Awards outstanding under the Plan, such Stock Awards shall be terminated if not exercised prior to such event. 15 13. AMENDMENT OF THE PLAN AND STOCK AWARDS. (a) The Board at any time, and from time to time, may amend the Plan. However, except as provided in Section 12 relating to adjustments upon changes in stock, no amendment shall be effective unless approved by the shareholders of the Company within twelve (12) months before or after the adoption of the amendment, where the amendment will: (i) Increase the number of shares reserved for Stock Awards under the Plan; (ii) Modify the requirements as to eligibility for participation in the Plan (to the extent such modification requires shareholder approval in order for the Plan to satisfy the requirements of Section 422 of the Code); (iii) Materially increase the benefits accruing to participants under the Plan; or (iv) Modify the Plan in any other way if such modification requires shareholder approval in order for the Plan to satisfy the requirements of Section 422 of the Code or to comply with the requirements of Rule 16b-3. (b) The Board may in its sole discretion submit any other amendment to the Plan for shareholder approval, including, but not limited to, amendments to the Plan intended to satisfy the requirements of Section 162(m) of the Code and the regulations promulgated thereunder regarding the exclusion of performance-based compensation from the limit on corporate deductibility of compensation paid to certain executive officers. (c) It is expressly contemplated that the Board may amend the Plan in any respect the Board deems necessary or advisable to provide eligible Employees, Directors or Consultants with the maximum benefits provided or to be provided under the provisions of the Code and the regulations promulgated thereunder relating to Incentive Stock Options and/or to bring the Plan and/or Incentive Stock Options granted under it into compliance therewith. 16 (d) Rights and obligations under any Stock Award granted before amendment of the Plan shall not be impaired by any amendment of the Plan unless (i) the Company requests the consent of the person to whom the Stock Award was granted and (ii) such person consents in writing. (e) The Board at any time, and from time to time, may amend the terms of any one or more Stock Award; provided, however, that the rights and obligations under any Stock Award shall not be impaired by any such amendment unless (i) the Company requests the consent of the person to whom the Stock Award was granted and (ii) such person consents in writing. 14. TERMINATION OR SUSPENSION OF THE PLAN. (a) The Board may suspend or terminate the Plan at any time. Unless sooner terminated, the Plan shall terminate on the day before the date that is ten (10) years following the earlier of (i) the date of the amendment and restatement of the Plan as determined by the Board, or (ii) the date such amendment and restatement is approved by the shareholders of the Company. No Stock Awards may be granted under the Plan while the Plan is suspended or after it is terminated. (b) Rights and obligations under any Stock Award granted while the Plan is in effect shall not be impaired by suspension or termination of the Plan, except with the consent of the person to whom the Stock Award was granted. 15. EFFECTIVE DATE OF PLAN. The Plan, as amended by the Board on June 14, 1996, shall become effective on the same day that the Company's initial public offering of shares of common stock becomes effective. Prior to the effectiveness of such initial public offering, the terms and conditions of the Plan as in effect prior to its amendment by the Board on June 14, 1996 shall continue to apply. No Stock Awards granted under the Plan shall be exercised unless and until the Plan has been approved by the shareholders of the Company, which approval shall be within twelve (12) months before or after the date the Plan is adopted by the Board. 17 EX-10.5A 5 hottopic_10kex10-5a.txt EXHIBIT 10.5a HOT TOPIC, INC. 1996 NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN ADOPTED ON JUNE 14, 1996 APPROVED BY SHAREHOLDERS ON JULY 9, 1996 AMENDED ON FEBRUARY 18, 1998 APPROVED BY SHAREHOLDERS ON MAY 27, 1998 AMENDED ON FEBRUARY 24, 2000 APPROVED BY SHAREHOLDERS ON JUNE 28, 2000 SHARES SUBJECT TO THE PLAN AUTOMATICALLY ADJUSTED ON DECEMBER 27, 1999, DECEMBER 27, 2000, FEBRUARY 6, 2002 AND SEPTEMBER 2, 2003. 1. PURPOSE. (a) The purpose of the 1996 Non-Employee Directors' Stock Option Plan (the "Plan") is to provide a means by which each director of Hot Topic, Inc. (the "Company") who is not otherwise at the time of grant an employee of or consultant to the Company or of any Affiliate of the Company (each such person being hereafter referred to as a "Non-Employee Director") will be given an opportunity to purchase stock of the Company. (b) The word "Affiliate" as used in the Plan means any parent corporation or subsidiary corporation of the Company as those terms are defined in Sections 424(e) and (f), respectively, of the Internal Revenue Code of 1986, as amended from time to time (the "Code"). (c) The Company, by means of the Plan, seeks to retain the services of persons now serving as Non-Employee Directors of the Company, to secure and retain the services of persons capable of serving in such capacity, and to provide incentives for such persons to exert maximum efforts for the success of the Company. 2. ADMINISTRATION. (a) The Plan shall be administered by the Board of Directors of the Company (the "Board"), unless and until the Board delegates administration to a committee, as provided in subparagraph 2(b). (b) The Board may delegate administration of the Plan to a committee composed of not fewer than two (2) members of the Board (the "Committee"). If administration is delegated to a Committee, the Committee shall have, in connection with the administration of the Plan, the powers theretofore possessed by the Board, subject, however, to such resolutions, not inconsistent with the provisions of the Plan, as may be adopted from time to time by the Board. The Board may abolish the Committee at any time and revest in the Board the administration of the Plan. 1 3. SHARES SUBJECT TO THE PLAN. (a) Subject to the provisions of paragraph 10 relating to adjustments upon changes in stock, the stock that may be sold pursuant to options granted under the Plan shall not exceed in the aggregate seven hundred twenty thousand (720,000) shares of the Company's common stock. If any option granted under the Plan shall for any reason expire or otherwise terminate without having been exercised in full, the stock not purchased under such option shall again become available for the Plan. (b) The stock subject to the Plan may be unissued shares or reacquired shares, bought on the market or otherwise. 4. ELIGIBILITY. Options shall be granted only to Non-Employee Directors of the Company. 5. GRANTS. (a) Each person who is elected or appointed for the first time to be a Non-Employee Director shall automatically be granted, upon the date of his or her initial election or appointment, an option to purchase ten thousand (10,000) shares of common stock (an "Initial Grant"), PROVIDED HOWEVER that in the case of a new Non-Employee Chairman of the Board, such person shall automatically be granted, upon the date of his or her initial election or appointment, an option to purchase fifteen thousand (15,000) shares of common stock. (b) On the date of each annual meeting of shareholders, commencing with the 2000 annual meeting, each person who is then a Non-Employee Director shall automatically be granted an option to purchase two thousand five hundred (2,500) shares of common stock (an "Annual Grant"), PROVIDED HOWEVER that in the case of a Non-Employee Chairman of the Board, such person shall automatically be granted, on each such annual meeting date, an option to purchase three thousand seven hundred fifty (3,750) shares. Notwithstanding the foregoing, a Non-Employee Director shall not be entitled to an Annual Grant if (i) such Non-Employee Director has served as a Non-Employee Director for less than three (3) months, or (ii) such Non-Employee failed to attend at least seventy five percent (75%) of the meetings (A) of the Board which occurred while the Non-Employee Director was a member of the Board and (B) of each committee of which such Non-Employee Director was a member. 2 (c) Non-Employee Directors may also be granted options to purchase shares in amounts deemed appropriate by the Board of Directors. 6. OPTION PROVISIONS. Each option shall be subject to the following terms and conditions: (a) The term of each option commences on the date it is granted and, unless sooner terminated as set forth herein, expires on the date ("Expiration Date") ten (10) years from the date of grant. If the optionee's service as a Non-Employee Director or employee of or consultant to the Company or any Affiliate terminates for any reason or for no reason, the option shall terminate on the earlier of the Expiration Date or the date three (3) months following the date of termination of such service; PROVIDED HOWEVER that if such termination of service is due to the optionee's death, the option shall terminate on the earlier of the Expiration Date or twelve (12) months following the date of the optionee's death. In any and all circumstances, an option may be exercised following termination of the optionee's service as a Non-Employee Director or employee of or consultant to the Company or any Affiliate only as to that number of shares as to which it was exercisable as of the date of termination of all such service under the provisions of subparagraph 6(e). (b) The exercise price of each option shall be one hundred percent (100%) of the fair market value of the stock subject to such option on the date such option is granted. (c) Payment of the exercise price of each option is due in full in cash upon any exercise when the number of shares being purchased upon such exercise is less than 100 shares; but when the number of shares being purchased upon an exercise is 100 or more shares, the optionee may elect to make payment of the exercise price under one of the following alternatives: (i) Payment of the exercise price per share in cash at the time of exercise; (ii) Provided that at the time of the exercise the Company's common stock is publicly traded and quoted regularly in THE WALL STREET JOURNAL, payment by delivery of shares of common stock of the Company already owned by the optionee, held for the period required to avoid a charge to the Company's reported earnings, and owned free and clear of any liens, claims, encumbrances or security interest, which common stock shall be valued at its fair market value on the date preceding the date of exercise; or 3 (iii) Provided that at the time of the exercise the Company's common stock is publicly traded and quoted regularly in THE WALL STREET JOURNAL, payment pursuant to a program developed under Regulation T as promulgated by the Federal Reserve Board which results in the receipt of cash (or check) by the Company either prior to the issuance of shares of the Company's common stock or pursuant to the terms of irrevocable instructions issued by the optionee prior to the issuance of shares of the Company's common stock. (iv) Payment by a combination of the methods of payment specified in subparagraph 6(c)(i) and 6(c)(iii) above. (d) An option shall not be transferable except by will or by the laws of descent and distribution, or pursuant to a domestic relations order, and shall be exercisable during the lifetime of the person to whom the option is granted only by such person (or by his guardian or legal representative) or transferee pursuant to such an order. Notwithstanding the foregoing, the optionee may, by delivering written notice to the Company in a form satisfactory to the Company, designate a third party who, in the event of the death of the optionee, shall thereafter be entitled to exercise the option. (e) The option shall become exercisable in installments over a period of four (4) years from the date of grant as follows: twenty-five percent (25%) shall be exercisable commencing on the date one year after the date of grant of the option and six and one-quarter percent (6.25%) shall be exercisable at the end of each calendar quarter thereafter, provided that the optionee has, during the entire period prior to such vesting date, continuously served as a Non-Employee Director or employee of or consultant to the Company or any Affiliate of the Company, whereupon such option shall become fully exercisable in accordance with its terms with respect to that portion of the shares represented by that installment. (f) The Company may require any optionee, or any person to whom an option is transferred under subparagraph 6(d), as a condition of exercising any such option: (i) to give written assurances satisfactory to the Company as to the optionee's knowledge and experience in financial and business matters; and (ii) to give written assurances satisfactory to the Company stating that such person is acquiring the stock subject to the option for such person's own account and not with any present intention of selling or otherwise distributing the stock. These requirements, and any assurances given pursuant to such requirements, shall be inoperative if (i) the issuance of the shares upon the exercise of the option has been registered under a then-currently-effective registration statement under the Securities Act of 1933, as amended (the "Securities Act"), or (ii), as to any particular requirement, a determination is made by counsel for the Company that such requirement need not be met in the circumstances under the then applicable securities laws. The Company may require any optionee to provide such other representations, written assurances or information which the Company shall determine is necessary, desirable or appropriate to comply with applicable securities laws as a condition of granting an option to the optionee or permitting the optionee to exercise the option. The Company may, upon advice of counsel to the Company, place legends on stock certificates issued under the Plan as such counsel deems necessary or appropriate in order to comply with applicable securities laws, including, but not limited to, legends restricting the transfer of the stock. 4 (g) Notwithstanding anything to the contrary contained herein, an option may not be exercised unless the shares issuable upon exercise of such option are then registered under the Securities Act or, if such shares are not then so registered, the Company has determined that such exercise and issuance would be exempt from the registration requirements of the Securities Act. 7. COVENANTS OF THE COMPANY. (a) During the terms of the options granted under the Plan, the Company shall keep available at all times the number of shares of stock required to satisfy such options. (b) The Company shall seek to obtain from each regulatory commission or agency having jurisdiction over the Plan such authority as may be required to issue and sell shares of stock upon exercise of the options granted under the Plan; PROVIDED HOWEVER that this undertaking shall not require the Company to register under the Securities Act either the Plan, any option granted under the Plan, or any stock issued or issuable pursuant to any such option. If, after reasonable efforts, the Company is unable to obtain from any such regulatory commission or agency the authority which counsel for the Company deems necessary for the lawful issuance and sale of stock under the Plan, the Company shall be relieved from any liability for failure to issue and sell stock upon exercise of such options. 8. USE OF PROCEEDS FROM STOCK. Proceeds from the sale of stock pursuant to options granted under the Plan shall constitute general funds of the Company. 9. MISCELLANEOUS. (a) Neither an optionee nor any person to whom an option is transferred under subparagraph 6(d) shall be deemed to be the holder of, or to have any of the rights of a holder with respect to, any shares subject to such option unless and until such person has satisfied all requirements for exercise of the option pursuant to its terms. (b) Nothing in the Plan, or in any instrument executed pursuant thereto, shall confer upon any Non-Employee Director any right to continue in the service of the Company or any Affiliate in any capacity or shall affect any right of the Company, its Board or shareholders or any Affiliate to remove any Non-Employee Director pursuant to the Company's Bylaws and the provisions of the laws of the Company's state of incorporation. 5 (c) No Non-Employee Director, individually or as a member of a group, and no beneficiary or other person claiming under or through him, shall have any right, title or interest in or to any option reserved for the purposes of the Plan except as to such shares of common stock, if any, as shall have been reserved for him pursuant to an option granted to him. (d) In connection with each option made pursuant to the Plan, it shall be a condition precedent to the Company's obligation to issue or transfer shares to a Non-Employee Director, or to evidence the removal of any restrictions on transfer, that such Non-Employee Director make arrangements satisfactory to the Company to insure that the amount of any federal or other withholding tax required to be withheld with respect to such sale or transfer, or such removal or lapse, is made available to the Company for timely payment of such tax. (e) As used in this Plan, "fair market value" means, as of any date, the value of the common stock of the Company determined as follows: (i) If the common stock is listed on any established stock exchange or a national market system, including without limitation The Nasdaq Stock Market, the fair market value of a share of common stock shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such system or exchange (or the exchange with the greatest volume of trading in common stock) on the last market trading day prior to the day of determination, as reported in THE WALL STREET JOURNAL or such other source as the Board deems reliable. (ii) If the common stock is quoted on The Nasdaq Stock Market (but not on the National Market thereof) or is regularly quoted by a recognized securities dealer but selling prices are not reported, the fair market value of a share of common stock shall be the mean between the bid and asked prices for the common stock on the last market trading day prior to the day of determination, as reported in THE WALL STREET JOURNAL or such other source as the Board deems reliable. (iii) In the absence of an established market for the common stock, the fair market value shall be determined in good faith by the Board. 10. ADJUSTMENTS UPON CHANGES IN STOCK. (a) If any change is made in the stock subject to the Plan, or subject to any option granted under the Plan (through merger, consolidation, reorganization, recapitalization, stock dividend, dividend in property other than cash, stock split, liquidating dividend, combination of shares, exchange of shares, change in corporate structure or other transaction not involving the receipt of consideration by the Company), the Plan and outstanding options will 6 be appropriately adjusted in the class(es) and maximum number of shares subject to the Plan and the class(es) and number of shares and price per share of stock subject to outstanding options. Such adjustments shall be made by the Board, the determination of which shall be final, binding and conclusive. (The conversion of any convertible securities of the Company shall not be treated as a "transaction not involving the receipt of consideration by the Company.") (b) In the event of: (1) a dissolution, liquidation, or sale of all or substantially all of the assets of the Company; (2) a merger or consolidation in which the Company is not the surviving corporation; (3) a reverse merger in which the Company is the surviving corporation but the shares of the Company's common stock outstanding immediately preceding the merger are converted by virtue of the merger into other property, whether in the form of securities, cash or otherwise; or (4) the acquisition by any person, entity or group within the meaning of Section 13(d) or 14(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") or any comparable successor provisions (excluding any employee benefit plan, or related trust, sponsored or maintained by the Company or any Affiliate of 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, then the time during which options outstanding under the Plan may be exercised shall be accelerated prior to such event and the options terminated if not exercised after such acceleration and at or prior to such event. 11. AMENDMENT OF THE PLAN. (a) The Board at any time, and from time to time, may amend the Plan and/or some or all outstanding options granted under the Plan. Except as provided in paragraph 10 relating to adjustments upon changes in stock, no amendment shall be effective unless approved by the shareholders of the Company within twelve (12) months before or after the adoption of the amendment if such amendment requires shareholder approval in order for the Plan to comply with the requirements of Rule 16b-3 promulgated under the Exchange Act, Section 162(m) of the Internal Revenue Code or any Nasdaq or securities exchange requirements. (b) Rights and obligations under any option granted before any amendment of the Plan shall not be impaired by such amendment unless (i) the Company requests the consent of the person to whom the option was granted and (ii) such person consents in writing. 7 12. TERMINATION OR SUSPENSION OF THE PLAN. (a) The Board may suspend or terminate the Plan at any time. No options may be granted under the Plan while the Plan is suspended or after it is terminated. (b) Rights and obligations under any option granted while the Plan is in effect shall not be impaired by suspension or termination of the Plan, except with the consent of the person to whom the option was granted. (c) The Plan shall terminate upon the occurrence of any of the events described in Section 10(b) above. 13. EFFECTIVE DATE OF PLAN; CONDITIONS OF EXERCISE. (a) The Plan shall become effective upon adoption by the Board of Directors, subject to the condition subsequent that the Plan is approved by the shareholders of the Company. (b) No option granted under the Plan shall be exercised or exercisable unless and until the condition of subparagraph 13(a) above has been met. 8 EX-10.6A 6 hottopic_10kex10-6a.txt EXHIBIT 10.6a HOT TOPIC, INC. EMPLOYEE STOCK PURCHASE PLAN ADOPTED JUNE 14, 1996 APPROVED BY THE STOCKHOLDERS ON JULY 9, 1996 SHARES SUBJECT TO THE PLAN AUTOMATICALLY ADJUSTED ON DECEMBER 27, 1999, DECEMBER 27, 2000, FEBRUARY 6, 2002 AND SEPTEMBER 2, 2003 1. PURPOSE. (a) The purpose of the Employee Stock Purchase Plan (the "Plan") is to provide a means by which employees of Hot Topic, Inc., a California corporation (the "Company"), and its Affiliates, as defined in subparagraph 1(b), which are designated as provided in subparagraph 2(b), may be given an opportunity to purchase stock of the Company. (b) The word "Affiliate" as used in the Plan means any parent corporation or subsidiary corporation of the Company, as those terms are defined in Sections 424(e) and (f), respectively, of the Internal Revenue Code of 1986, as amended (the "Code"). (c) The Company, by means of the Plan, seeks to retain the services of its employees, to secure and retain the services of new employees, and to provide incentives for such persons to exert maximum efforts for the success of the Company. (d) The Company intends that the rights to purchase stock of the Company granted under the Plan be considered options issued under an "employee stock purchase plan" as that term is defined in Section 423(b) of the Code. 2. ADMINISTRATION. (a) The Plan shall be administered by the Board of Directors (the "Board") of the Company unless and until the Board delegates administration to a Committee, as provided in subparagraph 2(c). Whether or not the Board has delegated administration, the Board shall have the final power to determine all questions of policy and expediency that may arise in the administration of the Plan. (b) The Board shall have the power, subject to, and within the limitations of, the express provisions of the Plan: (i) To determine when and how rights to purchase stock of the Company shall be granted and the provisions of each offering of such rights (which need not be identical). (ii) To designate from time to time which Affiliates of the Company shall be eligible to participate in the Plan. (iii) To construe and interpret the Plan and rights granted under it, and to establish, amend and revoke rules and regulations for its administration. The Board, in the exercise of this power, may correct any defect, omission or inconsistency in the Plan, in a manner and to the extent it shall deem necessary or expedient to make the Plan fully effective. 1 (iv) To amend the Plan as provided in paragraph 13. (v) Generally, to exercise such powers and to perform such acts as the Board deems necessary or expedient to promote the best interests of the Company and its Affiliates and to carry out the intent that the Plan be treated as an "employee stock purchase plan" within the meaning of Section 423 of the Code. (c) The Board may delegate administration of the Plan to a Committee composed of not fewer than two (2) members of the Board (the "Committee"). If administration is delegated to a Committee, the Committee shall have, in connection with the administration of the Plan, the powers theretofore possessed by the Board, subject, however, to such resolutions, not inconsistent with the provisions of the Plan, as may be adopted from time to time by the Board. The Board may abolish the Committee at any time and revest in the Board the administration of the Plan. 3. SHARES SUBJECT TO THE PLAN. (a) Subject to the provisions of paragraph 12 relating to adjustments upon changes in stock, the stock that may be sold pursuant to rights granted under the Plan shall not exceed in the aggregate one million three hundred fifty thousand (1,350,000) shares of the Company's common stock (the "Common Stock"). If any right granted under the Plan shall for any reason terminate without having been exercised, the Common Stock not purchased under such right shall again become available for the Plan. (b) The stock subject to the Plan may be unissued shares or reacquired shares, bought on the market or otherwise. 4. GRANT OF RIGHTS; OFFERING. (a) The Board or the Committee may from time to time grant or provide for the grant of rights to purchase Common Stock of the Company under the Plan to eligible employees (an "Offering") on a date or dates (the "Offering Date(s)") selected by the Board or the Committee. Each Offering shall be in such form and shall contain such terms and conditions as the Board or the Committee shall deem appropriate, which shall comply with the requirements of Section 423(b)(5) of the Code that all employees granted rights to purchase stock under the Plan shall have the same rights and privileges. The terms and conditions of an Offering shall be incorporated by reference into the Plan and treated as part of the Plan. The provisions of separate Offerings need not be identical, but each Offering shall include (through incorporation of the provisions of this Plan by reference in the document comprising the Offering or otherwise) the period during which the Offering shall be effective, which period shall not exceed twenty-seven (27) months beginning with the Offering Date, and the substance of the provisions contained in paragraphs 5 through 8, inclusive. (b) If an employee has more than one right outstanding under the Plan, unless he or she otherwise indicates in agreements or notices delivered hereunder: (1) each agreement or notice delivered by that employee will be deemed to apply to all of his or her rights under the Plan, and (2) a right with a lower exercise price (or an earlier-granted right, if two rights have identical exercise prices), will be exercised to the fullest possible extent before a right with a higher exercise price (or a later-granted right, if two rights have identical exercise prices) will be exercised. 2 5. ELIGIBILITY. (a) Rights may be granted only to employees of the Company or, as the Board or the Committee may designate as provided in subparagraph 2(b), to employees of any Affiliate of the Company. Except as provided in subparagraph 5(b), an employee of the Company or any Affiliate shall not be eligible to be granted rights under the Plan, unless, on the Offering Date, such employee has been in the employ of the Company or any Affiliate for such continuous period preceding such grant as the Board or the Committee may require, but in no event shall the required period of continuous employment be equal to or greater than two (2) years. In addition, unless otherwise determined by the Board or the Committee and set forth in the terms of the applicable Offering, no employee of the Company or any Affiliate shall be eligible to be granted rights under the Plan, unless, on the Offering Date, such employee's customary employment with the Company or such Affiliate is for at least twenty (20) hours per week and at least five (5) months per calendar year. (b) The Board or the Committee may provide that each person who, during the course of an Offering, first becomes an eligible employee of the Company or designated Affiliate will, on a date or dates specified in the Offering which coincides with the day on which such person becomes an eligible employee or occurs thereafter, receive a right under that Offering, which right shall thereafter be deemed to be a part of that Offering. Such right shall have the same characteristics as any rights originally granted under that Offering, as described herein, except that: (i) the date on which such right is granted shall be the "Offering Date" of such right for all purposes, including determination of the exercise price of such right; (ii) the period of the Offering with respect to such right shall begin on its Offering Date and end coincident with the end of such Offering; and (iii) the Board or the Committee may provide that if such person first becomes an eligible employee within a specified period of time before the end of the Offering, he or she will not receive any right under that Offering. (c) No employee shall be eligible for the grant of any rights under the Plan if, immediately after any such rights are granted, such employee owns stock possessing five percent (5%) or more of the total combined voting power or value of all classes of stock of the Company or of any Affiliate. For purposes of this subparagraph 5(c), the rules of Section 424(d) of the Code shall apply in determining the stock ownership of any employee, and stock which such employee may purchase under all outstanding rights and options shall be treated as stock owned by such employee. 3 (d) An eligible employee may be granted rights under the Plan only if such rights, together with any other rights granted under "employee stock purchase plans" of the Company and any Affiliates, as specified by Section 423(b)(8) of the Code, do not permit such employee's rights to purchase stock of the Company or any Affiliate to accrue at a rate which exceeds twenty-five thousand dollars ($25,000) of fair market value of such stock (determined at the time such rights are granted) for each calendar year in which such rights are outstanding at any time. (e) Officers of the Company and any designated Affiliate shall be eligible to participate in Offerings under the Plan, provided, however, that the Board may provide in an Offering that certain employees who are highly compensated employees within the meaning of Section 423(b)(4)(D) of the Code shall not be eligible to participate. 6. RIGHTS; PURCHASE PRICE. (a) On each Offering Date, each eligible employee, pursuant to an Offering made under the Plan, shall be granted the right to purchase up to the number of shares of Common Stock of the Company purchasable with a percentage designated by the Board or the Committee not exceeding ten percent (10%) of such employee's Earnings (as defined in subparagraph 7(a)) during the period which begins on the Offering Date (or such later date as the Board or the Committee determines for a particular Offering) and ends on the date stated in the Offering, which date shall be no later than the end of the Offering. The Board or the Committee shall establish one or more dates during an Offering (the "Purchase Date(s)") on which rights granted under the Plan shall be exercised and purchases of Common Stock carried out in accordance with such Offering. (b) In connection with each Offering made under the Plan, the Board or the Committee may specify a maximum number of shares that may be purchased by any employee as well as a maximum aggregate number of shares that may be purchased by all eligible employees pursuant to such Offering. In addition, in connection with each Offering that contains more than one Purchase Date, the Board or the Committee may specify a maximum aggregate number of shares which may be purchased by all eligible employees on any given Purchase Date under the Offering. If the aggregate purchase of shares upon exercise of rights granted under the Offering would exceed any such maximum aggregate number, the Board or the Committee shall make a pro rata allocation of the shares available in as nearly a uniform manner as shall be practicable and as it shall deem to be equitable. (c) The purchase price of stock acquired pursuant to rights granted under the Plan shall be not less than the lesser of: (i) an amount equal to eighty-five percent (85%) of the fair market value of the stock on the Offering Date; or (ii) an amount equal to eighty-five percent (85%) of the fair market value of the stock on the Purchase Date. 4 7. PARTICIPATION; WITHDRAWAL; TERMINATION. (a) An eligible employee may become a participant in the Plan pursuant to an Offering by delivering a participation agreement to the Company within the time specified in the Offering, in such form as the Company provides. Each such agreement shall authorize payroll deductions of up to the maximum percentage specified by the Board or the Committee of such employee's Earnings during the Offering. "Earnings" is defined as an employee's regular salary or wages (including amounts thereof elected to be deferred by the employee, that would otherwise have been paid, under any arrangement established by the Company intended to comply with Section 401(k), Section 402(e)(3), Section 125, Section 402(h), or Section 403(b) of the Code, and also including any deferrals under a non-qualified deferred compensation plan or arrangement established by the Company), which shall include or exclude (as provided for each Offering) the following items of compensation: bonuses, commissions, overtime pay, incentive pay, profit sharing, other remuneration paid directly to the employee, the cost of employee benefits paid for by the Company or an Affiliate, education or tuition reimbursements, imputed income arising under any group insurance or benefit program, traveling expenses, business and moving expense reimbursements, income received in connection with stock options, contributions made by the Company or an Affiliate under any employee benefit plan, and similar items of compensation, as determined by the Board or Committee. The payroll deductions made for each participant shall be credited to an account for such participant under the Plan and shall be deposited with the general funds of the Company. A participant may reduce (including to zero) or increase such payroll deductions, and an eligible employee may begin such payroll deductions, after the beginning of any Offering only as provided for in the Offering. A participant may make additional payments into his or her account only if specifically provided for in the Offering and only if the participant has not had the maximum amount withheld during the Offering. (b) At any time during an Offering, a participant may terminate his or her payroll deductions under the Plan and withdraw from the Offering by delivering to the Company a notice of withdrawal in such form as the Company provides. Such withdrawal may be elected at any time prior to the end of the Offering except as provided by the Board or the Committee in the Offering. Upon such withdrawal from the Offering by a participant, the Company shall distribute to such participant all of his or her accumulated payroll deductions (reduced to the extent, if any, such deductions have been used to acquire stock for the participant) under the Offering, without interest, and such participant's interest in that Offering shall be automatically terminated. A participant's withdrawal from an Offering will have no effect upon such participant's eligibility to participate in any other Offerings under the Plan but such participant will be required to deliver a new participation agreement in order to participate in subsequent Offerings under the Plan. (c) Rights granted pursuant to any Offering under the Plan shall terminate immediately upon cessation of any participating employee's employment with the Company and any designated Affiliate, for any reason, and the Company shall distribute to such terminated employee all of his or her accumulated payroll deductions (reduced to the extent, if any, such deductions have been used to acquire stock for the terminated employee) under the Offering, without interest. 5 (d) Rights granted under the Plan shall not be transferable by a participant otherwise than by will or the laws of descent and distribution, or by a beneficiary designation as provided in paragraph 14 and, otherwise during his or her lifetime, shall be exercisable only by the person to whom such rights are granted. 8. EXERCISE. (a) On each Purchase Date specified therefor in the relevant Offering, each participant's accumulated payroll deductions and other additional payments specifically provided for in the Offering (without any increase for interest) will be applied to the purchase of whole shares of stock of the Company, up to the maximum number of shares permitted pursuant to the terms of the Plan and the applicable Offering, at the purchase price specified in the Offering. No fractional shares shall be issued upon the exercise of rights granted under the Plan. The amount, if any, of accumulated payroll deductions remaining in each participant's account after the purchase of shares which is less than the amount required to purchase one share of stock on the final Purchase Date of an Offering shall be held in each such participant's account for the purchase of shares under the next Offering under the Plan, unless such participant withdraws from such next Offering, as provided in subparagraph 7(b), or is no longer eligible to be granted rights under the Plan, as provided in paragraph 5, in which case such amount shall be distributed to the participant after such final Purchase Date, without interest. The amount, if any, of accumulated payroll deductions remaining in any participant's account after the purchase of shares which is equal to the amount required to purchase whole shares of stock on the final Purchase Date of an Offering shall be distributed in full to the participant after such Purchase Date, without interest. (b) No rights granted under the Plan may be exercised to any extent unless the shares to be issued upon such exercise under the Plan (including rights granted thereunder) are covered by an effective registration statement pursuant to the Securities Act of 1933, as amended (the "Securities Act") and the Plan is in material compliance with all applicable state, foreign and other securities and other laws applicable to the Plan. If on a Purchase Date in any Offering hereunder the Plan is not so registered or in such compliance, no rights granted under the Plan or any Offering shall be exercised on such Purchase Date, and the Purchase Date shall be delayed until the Plan is subject to such an effective registration statement and such compliance, except that the Purchase Date shall not be delayed more than twelve (12) months and the Purchase Date shall in no event be more than twenty-seven (27) months from the Offering Date. If on the Purchase Date of any Offering hereunder, as delayed to the maximum extent permissible, the Plan is not registered and in such compliance, no rights granted under the Plan or any Offering shall be exercised and all payroll deductions accumulated during the Offering (reduced to the extent, if any, such deductions have been used to acquire stock) shall be distributed to the participants, without interest. 9. COVENANTS OF THE COMPANY. (a) During the terms of the rights granted under the Plan, the Company shall keep available at all times the number of shares of stock required to satisfy such rights. 6 (b) The Company shall seek to obtain from each federal, state, foreign or other regulatory commission or agency having jurisdiction over the Plan such authority as may be required to issue and sell shares of stock upon exercise of the rights granted under the Plan. If, after reasonable efforts, the Company is unable to obtain from any such regulatory commission or agency the authority which counsel for the Company deems necessary for the lawful issuance and sale of stock under the Plan, the Company shall be relieved from any liability for failure to issue and sell stock upon exercise of such rights unless and until such authority is obtained. 10. USE OF PROCEEDS FROM STOCK. Proceeds from the sale of stock pursuant to rights granted under the Plan shall constitute general funds of the Company. 11. RIGHTS AS A SHAREHOLDER. A participant shall not be deemed to be the holder of, or to have any of the rights of a holder with respect to, any shares subject to rights granted under the Plan unless and until the participant's shareholdings acquired upon exercise of rights hereunder are recorded in the books of the Company. 12. ADJUSTMENTS UPON CHANGES IN STOCK. (a) If any change is made in the stock subject to the Plan, or subject to any rights granted under the Plan (through merger, consolidation, reorganization, recapitalization, stock dividend, dividend in property other than cash, stock split, liquidating dividend, combination of shares, exchange of shares, change in corporate structure or other transaction not involving the receipt of consideration by the Company), the Plan and outstanding rights will be appropriately adjusted in the class(es) and maximum number of shares subject to the Plan and the class(es) and number of shares and price per share of stock subject to outstanding rights. Such adjustments shall be made by the Board or the Committee, the determination of which shall be final, binding and conclusive. (The conversion of any convertible securities of the Company shall not be treated as a "transaction not involving the receipt of consideration by the Company.") (b) In the event of: (1) a dissolution or liquidation of the Company; (2) a merger or consolidation in which the Company is not the surviving corporation; (3) a reverse merger in which the Company is the surviving corporation but the shares of the Company's Common Stock outstanding immediately preceding the merger are converted by virtue of the merger into other property, whether in the form of securities, cash or otherwise; or (4) the acquisition by any person, entity or group within the meaning of Section 13(d) or 14(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act" or any comparable successor provisions (excluding any employee benefit plan, or related trust, sponsored or maintained by the Company or any Affiliate of 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, then, as determined by the Board in its sole discretion (i) any surviving or acquiring corporation may assume outstanding rights or substitute similar rights for those under the Plan, (ii) such rights may continue in full force and effect, or (iii) participants' accumulated payroll deductions may be used to purchase Common Stock immediately prior to the transaction described above and the participants' rights under the ongoing Offering terminated. 7 13. AMENDMENT OF THE PLAN. (a) The Board at any time, and from time to time, may amend the Plan. However, except as provided in paragraph 12 relating to adjustments upon changes in stock, no amendment shall be effective unless approved by the shareholders of the Company within twelve (12) months before or after the adoption of the amendment, where the amendment will: (i) Increase the number of shares reserved for rights under the Plan; (ii) Modify the provisions as to eligibility for participation in the Plan (to the extent such modification requires shareholder approval in order for the Plan to obtain employee stock purchase plan treatment under Section 423 of the Code or to comply with the requirements of Rule 16b-3 promulgated under the Securities Exchange Act of 1934, as amended ("Rule 16b-3")); or (iii) Modify the Plan in any other way if such modification requires shareholder approval in order for the Plan to obtain employee stock purchase plan treatment under Section 423 of the Code or to comply with the requirements of Rule 16b-3. It is expressly contemplated that the Board may amend the Plan in any respect the Board deems necessary or advisable to provide eligible employees with the maximum benefits provided or to be provided under the provisions of the Code and the regulations promulgated thereunder relating to employee stock purchase plans and/or to bring the Plan and/or rights granted under it into compliance therewith. (b) Rights and obligations under any rights granted before amendment of the Plan shall not be altered or impaired by any amendment of the Plan, except with the consent of the person to whom such rights were granted, or except as necessary to comply with any laws or governmental regulations, or except as necessary to ensure that the Plan and/or rights granted under the Plan comply with the requirements of Section 423 of the Code. 14. DESIGNATION OF BENEFICIARY. (a) A participant may file a written designation of a beneficiary who is to receive any shares and cash, if any, from the participant's account under the Plan in the event of such participant's death subsequent to the end of an Offering but prior to delivery to the participant of such shares and cash. In addition, a participant may file a written designation of a beneficiary who is to receive any cash from the participant's account under the Plan in the event of such participant's death during an Offering. 8 (b) Such designation of beneficiary may be changed by the participant at any time by written notice. In the event of the death of a participant and in the absence of a beneficiary validly designated under the Plan who is living at the time of such participant's death, the Company shall deliver such shares and/or cash to the executor or administrator of the estate of the participant, or if no such executor or administrator has been appointed (to the knowledge of the Company), the Company, in its sole discretion, may deliver such shares and/or cash to the spouse or to any one or more dependents or relatives of the participant, or if no spouse, dependent or relative is known to the Company, then to such other person as the Company may designate. 15. TERMINATION OR SUSPENSION OF THE PLAN. (a) The Board in its discretion, may suspend or terminate the Plan at any time. No rights may be granted under the Plan while the Plan is suspended or after it is terminated. (b) Rights and obligations under any rights granted while the Plan is in effect shall not be altered or impaired by suspension or termination of the Plan, except as expressly provided in the Plan or with the consent of the person to whom such rights were granted, or except as necessary to comply with any laws or governmental regulation, or except as necessary to ensure that the Plan and/or rights granted under the Plan comply with the requirements of Section 423 of the Code. 16. EFFECTIVE DATE OF PLAN. The Plan shall become effective on the same day that the Company's initial public offering of shares of common stock becomes effective (the "Effective Date"), but no rights granted under the Plan shall be exercised unless and until the Plan has been approved by the shareholders of the Company within twelve (12) months before or after the date the Plan is adopted by the Board or the Committee, which date may be prior to the Effective Date. 9 EX-10.7A 7 hottopic_10kex10-7a.txt EXHIBIT 10.7a HOT TOPIC, INC. 401(k) PROFIT SHARING PLAN TABLE OF CONTENTS ARTICLE 1..................................................................- 2 - DEFINITIONS................................................................- 2 - 1.1 ACP or ACP TEST.................................................- 2 - 1.2 ACTUAL DEFERRAL PERCENTAGE TEST.................................- 2 - 1.3 ADP or ADP TEST.................................................- 4 - 1.4 ADMINISTRATOR...................................................- 4 - 1.5 ADOPTING EMPLOYER...............................................- 4 - 1.6 AFFILIATED EMPLOYER.............................................- 5 - 1.7 AGE.............................................................- 5 - 1.8 ANNIVERSARY DATE................................................- 5 - 1.9 ANNUITY STARTING DATE...........................................- 5 - 1.10 AVERAGE CONTRIBUTION PERCENTAGE TEST............................- 5 - 1.11 BENEFICIARY.....................................................- 8 - 1.12 BREAK IN SERVICE................................................- 8 - 1.13 CODE............................................................- 8 - 1.14 CODE ss.3401 COMPENSATION.......................................- 9 - 1.15 CODE ss.415 COMPENSATION........................................- 9 - 1.16 COMPENSATION....................................................- 9 - 1.17 DISABILITY.....................................................- 11 - 1.18 EARLY RETIREMENT AGE...........................................- 11 - 1.19 EARNED INCOME..................................................- 11 - 1.20 ELECTIVE DEFERRAL..............................................- 11 - 1.21 ELECTIVE DEFERRAL ACCOUNT......................................- 12 - 1.22 ELIGIBLE PARTICIPANT...........................................- 12 - 1.23 EMPLOYEE.......................................................- 12 - 1.24 EMPLOYER.......................................................- 13 - 1.25 ERISA..........................................................- 13 - 1.26 EXCESS AGGREGATE CONTRIBUTIONS.................................- 13 - 1.27 EXCESS CONTRIBUTIONS...........................................- 13 - 1.28 EXCESS ELECTIVE DEFERRALS......................................- 13 - 1.29 FIDUCIARY......................................................- 13 - 1.30 FISCAL YEAR....................................................- 13 - 1.31 FORFEITURE.....................................................- 13 - 1.32 FORM W-2 COMPENSATION..........................................- 14 - 1.33 HCE............................................................- 14 - 1.34 HIGHLY COMPENSATED EMPLOYEE....................................- 14 - 1.35 HOUR OF SERVICE................................................- 14 - 1.36 KEY EMPLOYEE...................................................- 15 - 1.37 LEASED EMPLOYEE................................................- 16 - 1.38 LIMITATION YEAR................................................- 16 - 1.39 MATCHING CONTRIBUTION..........................................- 16 - 1.40 MATCHING CONTRIBUTION ACCOUNT..................................- 16 - 1.41 MATERNITY OR PATERNITY LEAVE...................................- 16 - 1.42 NHCE...........................................................- 16 - 1.43 NON-ELECTIVE CONTRIBUTIONS.....................................- 16 - 1.44 NON-ELECTIVE CONTRIBUTION ACCOUNT..............................- 17 - 1.45 NON-HIGHLY COMPENSATED EMPLOYEE................................- 17 - 1.46 NON-KEY EMPLOYEE...............................................- 17 - 1.47 NORMAL RETIREMENT AGE..........................................- 17 - 1.48 NORMAL RETIREMENT DATE.........................................- 17 - 1.49 OWNER-EMPLOYEE.................................................- 17 - 1.50 PARTICIPANT....................................................- 17 - 1.51 PARTICIPANT'S ACCOUNT..........................................- 17 - 1.52 PERIOD OF SERVICE..............................................- 17 - 1.53 PERIOD OF SEVERANCE............................................- 20 - 1.54 PERMISSIVE AGGREGATION GROUP...................................- 20 - 1.55 PLAN...........................................................- 20 - 1.56 PLAN YEAR......................................................- 20 - 1.57 POLICY.........................................................- 20 - 1.58 QMAC...........................................................- 20 - 1.59 QNEC...........................................................- 20 - 1.60 QUALIFIED JOINT AND SURVIVOR ANNUITY...........................- 20 - 1.61 QUALIFIED MATCHING CONTRIBUTION................................- 20 - 1.62 QUALIFIED NON-ELECTIVE CONTRIBUTION............................- 21 - 1.63 QUALIFIED PRERETIREMENT SURVIVOR ANNUITY.......................- 21 - 1.64 REQUIRED AGGREGATION GROUP.....................................- 21 - 1.65 REQUIRED BEGINNING DATE........................................- 21 - 1.66 ROLLOVER ACCOUNT...............................................- 22 - 1.67 ROLLOVER CONTRIBUTION..........................................- 22 - 1.68 SAFE HARBOR CONTRIBUTION ACCOUNT...............................- 22 - 1.69 SELF-EMPLOYED INDIVIDUAL.......................................- 22 - 1.70 SHAREHOLDER-EMPLOYEE...........................................- 22 - 1.71 SPONSOR........................................................- 23 - 1.72 SPOUSE.........................................................- 23 - 1.73 TERMINATION OF EMPLOYMENT......................................- 23 - 1.74 TERMINATED PARTICIPANT.........................................- 23 - 1.75 TOP HEAVY......................................................- 23 - 1.76 TOP HEAVY MINIMUM ALLOCATION...................................- 23 - 1.77 TOP HEAVY RATIO................................................- 23 - 1.78 TRUSTEE........................................................- 24 - 1.79 TRUST FUND.....................................................- 24 - 1.80 VALUATION DATE.................................................- 24 - 1.81 VESTED AGGREGATE ACCOUNT.......................................- 25 - 1.82 VESTED, VESTED INTEREST or VESTING.............................- 25 - 1.83 VOLUNTARY EMPLOYEE CONTRIBUTION................................- 25 - 1.84 VOLUNTARY EMPLOYEE CONTRIBUTION ACCOUNT........................- 25 - ARTICLE 2.................................................................- 26 - PLAN PARTICIPATION........................................................- 26 - 2.1 ELIGIBILITY REQUIREMENTS.......................................- 26 - 2.2 ENTRY DATE.....................................................- 27 - 2.3 WAIVER OF PARTICIPATION........................................- 27 - 2.4 PARTICIPATION UPON REEMPLOYMENT................................- 27 - 2.5 EXCLUSION OF ELIGIBLE EMPLOYEE.................................- 27 - 2.6 INCLUSION OF INELIGIBLE EMPLOYEE...............................- 27 - ARTICLE 3.................................................................- 28 - CONTRIBUTIONS AND ALLOCATIONS.............................................- 28 - 3.1 EMPLOYER CONTRIBUTIONS.........................................- 28 - 3.2 ALLOCATION OF EMPLOYER CONTRIBUTIONS...........................- 30 - 3.3 ALLOCATION OF EARNINGS AND LOSSES..............................- 34 - 3.4 ALLOCATION OF FORFEITURES......................................- 34 - 3.5 TOP HEAVY MINIMUM ALLOCATION...................................- 35 - 3.6 SAFE HARBOR CONTRIBUTIONS......................................- 36 - 3.7 ROLLOVER CONTRIBUTIONS.........................................- 39 - 3.8 VOLUNTARY EMPLOYEE CONTRIBUTIONS...............................- 41 - ARTICLE 4.................................................................- 42 - PLAN BENEFITS.............................................................- 42 - 4.1 BENEFIT UPON NORMAL RETIREMENT.................................- 42 - 4.2 BENEFIT UPON LATE RETIREMENT...................................- 42 - 4.3 BENEFIT UPON DEATH.............................................- 42 - 4.4 BENEFIT UPON DISABILITY........................................- 42 - 4.5 BENEFIT UPON TERMINATION.......................................- 42 - 4.6 DETERMINATION OF VESTED INTEREST...............................- 43 - ARTICLE 5.................................................................- 44 - DISTRIBUTION OF BENEFITS..................................................- 44 - 5.1 BENEFIT UPON RETIREMENT........................................- 44 - 5.2 BENEFIT UPON DEATH.............................................- 44 - 5.3 DISABILITY BENEFITS............................................- 45 - 5.4 BENEFIT UPON TERMINATION.......................................- 46 - 5.5 CASH-OUT OF BENEFITS...........................................- 46 - 5.6 RESTRICTIONS ON IMMEDIATE DISTRIBUTIONS........................- 47 - 5.7 RESTORATION OF FORFEITED ACCOUNT BALANCE.......................- 48 - 5.8 SPOUSAL CONSENT REQUIREMENTS...................................- 49 - 5.9 APPLICATION OF CODE ss.401(a)(9) REQUIREMENTS..................- 49 - 5.10 STATUTORY COMMENCEMENT OF BENEFITS.............................- 49 - 5.11 SEGREGATION OF BENEFIT BEFORE DISTRIBUTION.....................- 49 - 5.12 DISTRIBUTION IN EVENT OF INCAPACITY............................- 50 - 5.13 MISSING PARTICIPANTS AND UNCLAIMED BENEFITS....................- 50 - 5.14 DIRECT ROLLOVERS...............................................- 51 - 5.15 DISTRIBUTION OF PROPERTY.......................................- 51 - 5.16 DISTRIBUTIONS SUBJECT TO CODE ss.401(a)(11) REQUIREMENTS.......- 52 - 5.17 FINANCIAL HARDSHIP DISTRIBUTIONS...............................- 55 - 5.18 IN-SERVICE DISTRIBUTIONS.......................................- 56 - 5.19 DISTRIBUTION OF EXCESS ELECTIVE DEFERRALS......................- 56 - 5.20 DISTRIBUTION OF EXCESS CONTRIBUTIONS...........................- 57 - 5.21 DISTRIBUTION OF EXCESS AGGREGATE CONTRIBUTIONS.................- 59 - 5.22 ELIMINATION OF CERTAIN FORMS OF PAYMENT........................- 60 - ARTICLE 6.................................................................- 61 - CODE SS.415 LIMITATIONS...................................................- 61 - 6.1 MAXIMUM ANNUAL ADDITION........................................- 61 - 6.2 ADJUSTMENTS TO MAXIMUM ANNUAL ADDITION.........................- 61 - 6.3 MULTIPLE PLANS AND MULTIPLE EMPLOYERS..........................- 62 - 6.4 ADJUSTMENT FOR EXCESSIVE ANNUAL ADDITIONS......................- 62 - 6.5 MULTIPLE PLAN REDUCTION........................................- 62 - ARTICLE 7.................................................................- 65 - DUTIES OF THE TRUSTEE.....................................................- 65 - 7.1 APPOINTMENT, RESIGNATION, REMOVAL AND SUCCESSION...............- 65 - 7.2 INVESTMENT ALTERNATIVES OF THE TRUSTEE.........................- 65 - 7.3 VALUATION OF THE TRUST FUND....................................- 67 - 7.4 COMPENSATION AND EXPENSES......................................- 68 - 7.5 PAYMENTS FROM THE TRUST FUND...................................- 68 - 7.6 PAYMENT OF TAXES...............................................- 68 - 7.7 ACCOUNTS, RECORDS AND REPORTS..................................- 68 - 7.8 EMPLOYMENT OF AGENTS AND COUNSEL...............................- 68 - 7.9 DIVISION OF DUTIES AND INDEMNIFICATION.........................- 69 - 7.10 APPOINTMENT OF INVESTMENT MANAGER..............................- 70 - 7.11 ASSIGNMENT AND ALIENATION OF BENEFITS..........................- 70 - 7.12 EXCLUSIVE BENEFIT RULE.........................................- 70 - 7.13 PURCHASE OF INSURANCE..........................................- 71 - 7.14 LOANS TO PARTICIPANTS..........................................- 72 - 7.15 DIRECTED INVESTMENT ACCOUNTS...................................- 74 - 7.16 SUPERSEDING TRUST OR CUSTODIAL AGREEMENT.......................- 76 - ARTICLE 8.................................................................- 77 - DUTIES OF THE ADMINISTRATOR...............................................- 77 - 8.1 APPOINTMENT, RESIGNATION, REMOVAL AND SUCCESSION...............- 77 - 8.2 POWERS AND DUTIES OF THE ADMINISTRATOR.........................- 77 - 8.3 APPOINTMENT OF ADMINISTRATIVE COMMITTEE........................- 77 - 8.4 FINALITY OF ADMINISTRATIVE DECISIONS...........................- 77 - 8.5 MULTIPLE ADMINISTRATORS........................................- 77 - 8.6 COMPENSATION AND EXPENSES......................................- 77 - 8.7 APPOINTMENT OF AGENTS AND COUNSEL..............................- 78 - 8.8 CORRECTING ADMINISTRATIVE ERRORS...............................- 78 - 8.9 PROMULGATING NOTICES AND PROCEDURES............................- 78 - 8.10 CLAIMS PROCEDURES..............................................- 78 - 8.11 QUALIFIED DOMESTIC RELATIONS ORDERS............................- 81 - ARTICLE 9.................................................................- 83 - AMENDMENT, TERMINATION AND MERGER.........................................- 83 - 9.1 AMENDMENT OF THE PLAN..........................................- 83 - 9.2 TERMINATION OF PLAN BY SPONSOR.................................- 83 - 9.3 TERMINATION OF PARTICIPATION BY ADOPTING EMPLOYER..............- 84 - 9.4 MERGER OR CONSOLIDATION........................................- 84 - ARTICLE 10................................................................- 85 - MISCELLANEOUS PROVISIONS..................................................- 85 - 10.1 NO CONTRACT OF EMPLOYMENT......................................- 85 - 10.2 TITLE TO ASSETS................................................- 85 - 10.3 QUALIFIED MILITARY SERVICE.....................................- 85 - 10.4 BONDING OF FIDUCIARIES.........................................- 85 - 10.5 SEVERABILITY OF PROVISIONS.....................................- 85 - 10.6 GENDER AND NUMBER..............................................- 85 - 10.7 HEADINGS AND SUBHEADINGS.......................................- 85 - 10.8 LEGAL ACTION...................................................- 85 - 10.9 QUALIFIED PLAN STATUS..........................................- 86 - 10.10 MAILING OF NOTICES TO ADMINISTRATOR, EMPLOYER OR TRUSTEE.......- 86 - 10.11 PARTICIPANT NOTICES AND WAIVERS OF NOTICES TO PARTICIPANTS.....- 86 - 10.12 NO DUPLICATION OF BENEFITS.....................................- 86 - 10.13 EVIDENCE FURNISHED CONCLUSIVE..................................- 86 - 10.14 RELEASE OF CLAIMS..............................................- 86 - 10.15 MULTIPLE COPIES OF PLAN AND/OR TRUST...........................- 86 - 10.16 LIMITATION OF LIABILITY AND INDEMNIFICATION....................- 86 - HOT TOPIC, INC. 401(k) PROFIT SHARING PLAN THIS AGREEMENT is made and entered into as of the _______ day of ____________________, __________, between HOT TOPIC, INC. (hereafter referred to as the "Sponsor") and JAMES MCGINTY, ELIZABETH MCLAUGHLIN, JANE CRUZ, GERALD COOK AND GEORGE WEHLITZ (hereafter collectively referred to as the Trustee). W I T N E S S E T H: WHEREAS, the Sponsor originally established a Code ss.401(k) plan (hereafter referred to as the "Plan"), effective August 1, 1995, in order to provide retirement and other incidental benefits to Employees who are eligible to participate therein; and WHEREAS, in accordance with the terms of the Plan, the Sponsor has the ability at any time, and from time to time, to amend the Plan; NOW, THEREFORE, effective January 1, 2003 (except for those specific provisions that have an earlier effective date), the Sponsor hereby amends and restates the Plan in its entirety in order to comply with the requirements of the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986, as amended by the Uruguay Round Agreements Act, the Small Business Job Protection Act of 1996, the Taxpayer Relief Act of 1997, the Uniformed Services Employment and Reemployment Rights Act of 1994, the Internal Revenue Service Restructuring and Reform Act of 1998, the Community Renewal Tax Relief Act of 2000, and all applicable rulings and regulations issued thereunder, and the Trustee accepts the Plan under the following terms and conditions: ARTICLE 1 - 1 - DEFINITIONS 1.1 ACP OR ACP TEST The term ACP means the Average Contribution Percentage as defined in Section 1.10(c). The term ACP Test means the Average Contribution Percentage Test. 1.2 ACTUAL DEFERRAL PERCENTAGE TEST The term Actual Deferral Percentage Test (or ADP Test) means either of the following nondiscrimination tests for Elective Deferrals: (1) the ADP for Participants who are HCEs will not exceed the ADP for Participants who are NHCEs multiplied by 1.25; or (2) the ADP for Participants who are HCEs will not exceed the ADP for Participants who are NHCEs multiplied by 2.0, provided that the ADP for Participants who are HCEs does not exceed the ADP for Participants who are NHCEs by more than 2 percentage points. The ADP Test for any Plan Year will be determined in accordance with the following provisions: (a) TESTING METHOD: The ADP Test will be determined each Plan Year by either Current Year Testing or Prior Year Testing (as described in paragraph (b) below) as follows: Current Year Testing is used for the 1997 Plan Year; Current Year Testing is used for the 1998 Plan Year; Current Year Testing is used for the 1999 Plan Year; Current Year Testing is used for the 2000 Plan Year; Current Year Testing is used for the 2001 Plan Year; and Prior Year Testing is used for the 2002 Plan Year and for each Plan Year thereafter until otherwise elected by the Employer by means of a Plan amendment. (b) DEFINITION OF CURRENT AND PRIOR YEAR TESTING: The term Current Year Testing means the ADP Test will be determined for a Plan Year by comparing the ADP of Participants who are Highly Compensated Employees for that Plan Year to the ADP of Participants who were Non-Highly Compensated Employees for that Plan Year. The term Prior Year Testing means the ADP Test will be determined for a Plan Year by comparing the ADP of Participants who are Highly Compensated Employees for that Plan Year to the ADP of Participants who were Non-Highly Compensated Employees for the prior Plan Year. If Prior Year Testing is specified in paragraph (a), then in the case of the first Plan Year in which the Plan permits any Participant to make Elective Deferrals (unless this is a successor Plan), the ADP used for Participants who were Non-Highly Compensated Employees in the prior Plan Year will be the greater of 3% or their actual ADP for the first Plan Year in which Elective Deferrals were permitted. Prior Year Testing cannot be used in any Plan Year in which a supplemental Safe Harbor Notice is issued that reduces or eliminates a Safe Harbor Matching Contribution for that Plan Year. (c) DEFINITION OF ACTUAL DEFERRAL PERCENTAGE: The term Actual Deferral Percentage (ADP) means, for a specified group of Participants for a Plan Year, the average of the ratios calculated separately for each Participant in such group of (1) the amount of Employer contributions actually paid on behalf of such Participant for the Plan Year to (2) the Compensation of such Participant for such Plan Year. (d) CONTRIBUTIONS USED TO DETERMINE ADP TEST: Employer contributions used to determine the ADP Test include Elective Deferrals, including Excess Elective Deferrals as defined in Section 1.28, but excluding Excess Elective Deferrals of NHCEs that arise solely from Elective Deferrals made to this Plan or any other plans maintained by this Employer and Elective Deferrals that are taken into account in the ACP Test if the ADP Test is satisfied both with and without exclusion of these Elective Deferrals. The Employer may also elect each Plan Year - 2 - to include QMACs and/or QNECs, and in any Plan Year in which Current Year Testing is used, may further elect to include such QNECs and/or QMACs only to the extent necessary to pass the ADP Test. In computing ADPs, an Employee who would be a Participant but for the failure to make Elective Deferrals will be treated as a Participant on whose behalf no Elective Deferrals are made. (e) HIGHLY COMPENSATED EMPLOYEES: A Participant is a Highly Compensated Employee for a particular Plan Year if he or she meets the definition of a Highly Compensated Employee in effect for that Plan Year. A Participant is a Non-Highly Compensated Employee for a particular Plan Year if he or she does not meet the definition of a Highly Compensated Employee in effect for that Plan Year. The ADP for any Participant who is a HCE for the Plan Year and who is eligible to have Elective Deferrals (and QNECs or QMACs, or both, if treated as Elective Deferrals for purposes of the ADP Test) allocated to his or her accounts under two or more arrangements described in Code ss.401(k) that are maintained by this Employer will be determined as if such Elective Deferrals (and, if applicable, QNECs or QMACs, or both) were made under a single arrangement. If a HCE participates in two or more cash or deferred arrangements that have different Plan Years, all cash or deferred arrangements ending with or within the same calendar year will be treated as a single arrangement; except that certain plans will be treated as separate if mandatorily disaggregated under regulations under Code ss.401(k). (f) OTHER RULES: In determining the ADP Test, (1) if this Plan satisfies the requirements of Code ss.401(k), ss.401(a)(4), or ss.410(b) only if aggregated with one or more other plans, or if one or more other plans satisfy such requirements only if aggregated with this Plan, then this section will be applied by determining the ADP of Employees as if all such plans were a single plan. For any Plan Year in which the Employer elects prior year testing under this Section, adjustments to the ADP of Non-Highly Compensated Employees for the prior Plan Year will be made in accordance with Notice 98-1 and any superseding guidance. Plans may be aggregated to satisfy Code ss.401(k) only if they have the same Plan Year and use the same ADP testing method; (2) Elective Deferrals, QNECs and QMACs must be made before the last day of the 12-month period immediately following the Plan Year to which contributions relate; (3) the Employer will maintain records sufficient to demonstrate satisfaction of the ADP test and the amount of QNECs or QMACs, or both, used in such test; and (4) the determination and treatment of the ADP amounts of any Participant will satisfy such other requirements as may be prescribed by the Secretary of the Treasury. (g) CHANGE TO PRIOR YEAR TESTING: If the Employer elects Current Year Testing for any Plan Year, the Employer can only elect to change to Prior Year Testing in accordance with the requirements in Notice 98-1 (or superseding guidance). If the Employer elects to change to Prior Year Testing, the ADP for NHCEs for the prior year will be determined by counting only (1) Elective Deferrals for those NHCEs that were counted for purposes of the ADP Test (and not the ACP Test) under the Current Year Testing method for the prior year, and (2) QNECs that were allocated to the accounts of those NHCEs for the prior year but that were not used to satisfy the ADP Test or the ACP Test under the Current Year Testing method for the prior year. Thus, if the Employer elects to change to Prior Year Testing, the following contributions made for the prior year will be disregarded: QNECs used to satisfy either the ADP Test or ACP Test under the Current Year Testing method for the - 3 - prior testing year, Elective Deferrals taken into account for purposes of the ACP Test, and all QMACs. The limitations on double counting do not apply for testing years beginning before January 1, 2001, and if the Plan changes to Prior Year Testing for the first time for any Plan Year after 1997, the ADP for NHCEs will be the same as for the Plan Year immediately preceding the Plan Year for which the change to Prior Year Testing was effective. 1.3 ADP OR ADP TEST The term ADP means the Actual Deferral Percentage as defined in Section 1.2(c). The term ADP Test means the Actual Deferral Percentage Test. 1.4 ADMINISTRATOR The term Administrator means the Employer unless another Administrator is appointed by the Employer pursuant to the provisions of Section 8.1 of the Plan. 1.5 ADOPTING EMPLOYER The term Adopting Employer means any entity that adopts this Plan with the consent of the Sponsor. An Employee's transfer to or from any Employer or Adopting Employer will not affect his or her Participant's Account balance, total Years of Service (or Periods of Service) and total Years of Service as a Participant (or Periods of Service as a Participant). All Adopting Employers will be subject to the following provisions: (a) MULTIPLE EMPLOYER PLAN PROVISIONS UNDER CODE SS.413(C): Notwithstanding any other provision in the Plan to the contrary, unless the Plan is a collectively bargained plan described in Regulation ss.1.413-1(a), the following provisions will apply with respect to any Adopting Employer that is not an Affiliated Employer of the Sponsor: (1) INSTANCES OF SEPARATE EMPLOYER TESTING: Employees of any such Adopting Employer will be treated separately for purposes of testing under the provisions of Code ss.401(a)(4), Code ss.401(k), Code ss.401(m) and, if the Sponsor and the Adopting Employer do not share Employees, Code ss.416. Furthermore, the terms of Code ss.410(b) will be applied separately on an employer-by-employer basis by the Sponsor (and the Adopting Employers which are part of the Affiliated Group which includes the Sponsor) and each Adopting Employer that is not an Affiliated Employer of the Sponsor, taking into account the generally applicable rules described in Code ss.401(a)(5), ss.414(b) and ss.414(c). (2) INSTANCES OF SINGLE EMPLOYER TESTING: Employees of the Adopting Employer will be treated as part of a single employer plan for purposes of eligibility to participate under Article 2 and under the provisions of Code ss.410(a). Furthermore, the terms of Code ss.411 relating to Vesting will be applied as if all Employees of all such Adopting Employers and the Sponsor were employed by a single employer, except that the rules regarding Breaks in Service will be applied under such regulations as may be prescribed by the Secretary of Labor. (3) COMMON TRUST: Contributions made by any such Adopting Employer will be held in a common Trust Fund with contributions made by the Sponsor, and all such contributions will be available to pay the benefits of any Participant or Beneficiary who is an Employee of the Sponsor or any such Adopting Employer. (4) COMMON DISQUALIFICATION PROVISION: The failure of either the Sponsor or any such Adopting Employer to satisfy the qualification requirements under Code ss.401(a), as modified by the provisions of Code ss.413(c), will result in the disqualification of the Plan for all such Employers maintaining the Plan. - 4 - (b) TERMINATION OF ADOPTION: An Adopting Employer may terminate participation in the Plan by delivering written notice to the Sponsor, the Administrator and the Trustee; but in accordance with Article 9, only the Sponsor can terminate the Plan. If a request for and approval of a transfer of assets from this Plan to any successor qualified retirement plan maintained by the Adopting Employer or its successor is not made in accordance with Section 9.3, Participants who are no longer Employees because the Adopting Employer terminates Plan participation will only be entitled to the commencement of their benefits (1) in the case of Participants who are no longer Employees of an Adopting Employer that is an Affiliated Employer of the Sponsor, in accordance with Article 5 after their death, retirement, Disability or Termination of Employment from the Adopting Employer or former Adopting Employer; and (2) in the case of Participants who are no longer Employees of an Adopting Employer that is not an Affiliated Employer of the Sponsor, within a reasonable time thereafter as if the Plan had been terminated under Section 9.2. 1.6 AFFILIATED EMPLOYER The term Affiliated Employer means any of the following of which the Employer is a part: (1) a controlled group of corporations as defined in Code ss.414(b); (2) a trade or business (whether or not incorporated) under common control under Code ss.414(c); (3) any organization (whether or not incorporated) which is a member of an affiliated service group under Code ss.414(m); and (4) any other entity required to be aggregated under Code ss.414(o). 1.7 AGE The term Age means an Employee's actual attained age. 1.8 ANNIVERSARY DATE The term Anniversary Date means December 31st. 1.9 ANNUITY STARTING DATE The term Annuity Starting Date means the first day of the first period for which an amount is paid as an annuity, or, in the case of a benefit not payable as an annuity, the first day all events have occurred which entitle the Participant to such benefit. The first day of the first period for which a benefit is to be received by reason of Disability will be treated as the Annuity Starting Date only if such benefit is not an auxiliary benefit. 1.10 AVERAGE CONTRIBUTION PERCENTAGE TEST The term Average Contribution Percentage (or ACP) Test means the greater of one of the following nondiscrimination tests for Matching Contributions and Employee contributions: (1) the ACP for Participants who are HCEs will not exceed the ACP for Participants who are NHCEs multiplied by 1.25; or (b) the ACP for Participants who are HCEs will not exceed the ACP for Participants who are NHCEs multiplied by 2.0, provided that the ACP for Participants who are HCEs does not exceed the ACP for Participants who are NHCEs by more than 2 percentage points. The ACP Test for any Plan Year will be determined in accordance with the following: (a) TESTING METHOD: The ACP Test will be determined each Plan Year by the Current Year Testing method as described in paragraph (b) below. (b) DEFINITION OF CURRENT AND PRIOR YEAR TESTING: The term Current Year Testing means the ACP Test will be determined for a Plan Year by comparing the ACP of Participants who are Highly Compensated Employees for that Plan Year to the ACP of Participants who were Non-Highly Compensated Employees for that Plan Year. The term Prior Year Testing means the ACP Test will be determined for a Plan Year by comparing the ACP of Participants who are Highly Compensated Employees for that Plan Year to the ACP of Participants who were Non-Highly Compensated Employees for the prior Plan Year. If Prior Year - 5 - Testing is specified in paragraph (a), then for the first Plan Year in which the Plan permits any Participant to make Voluntary Employee Contributions, provides for Matching Contributions, or both (unless this Plan is a successor Plan), the ACP used for Participants who were Non-Highly Compensated Employees in the prior Plan Year will be the greater of 3% or their actual ACP for the first Plan Year. Prior Year Testing cannot be used in any Plan Year in which a supplemental Safe Harbor Notice is issued that reduces or eliminates a Safe Harbor Matching Contribution for that Plan Year. (c) DEFINITION OF AVERAGE CONTRIBUTION PERCENTAGE: For purposes of this Section, the term Average Contribution Percentage (or ACP) means the average of the Contribution Percentages of the "eligible" Participants in a group. (d) DEFINITION OF CONTRIBUTION PERCENTAGE: For purposes of this Section, the term Contribution Percentage means the ratio (expressed as a percentage) of the Participant's Contribution Percentage Amounts to the Participant's Compensation for the Plan Year. (e) DEFINITION OF CONTRIBUTION PERCENTAGE AMOUNTS: For purposes of this Section, the term Contribution Percentage Amounts means the sum of the Employee Contributions, Matching Contributions and Qualified Non-Elective Contributions (to the extent not used in the ADP Test) made under the plan on behalf of the participant for the Plan Year. (f) CONTRIBUTIONS USED IN DETERMINING CONTRIBUTION PERCENTAGE AMOUNTS: Contribution Percentage Amounts will not include Matching Contributions that are forfeited either to correct Excess Aggregate Contributions or because the contributions to which they relate are Excess Deferrals, Excess Contributions, or Excess Aggregate Contributions. The Employer may elect each Plan Year to include as Contribution Percentage Amounts QNECs and/or Elective Deferrals so long as the ADP Test is met before the Elective Deferrals are used in the ACP Test and continues to be met following the exclusion of those Elective Deferrals that are used to meet the ACP Test. For any Plan Year in which Current Year Testing is specified in paragraph (a) above, the Employer may further elect to include such QNECs and/or Elective Deferrals as Contribution Percentage Amounts only to the extent necessary to satisfy the ACP (and Multiple Use) Test. (g) MULTIPLE USE: If one or more HCEs participate in both a cash or deferred arrangement and in a plan subject to the ACP Test maintained by the Employer, and if the sum of the ADP and ACP of those HCEs subject to either or both tests exceeds the Aggregate Limit, then the ACP of those HCEs who also participate in a cash or deferred arrangement will be reduced as described in Section 5.21 so that the limit is not exceeded. The amount by which each HCE's Contribution Percentage Amount is reduced will be treated as an Excess Aggregate Contribution. The ADP and ACP of HCEs are determined after any corrections required to meet the ADP Test and the ACP Test and are deemed to be the maximum permitted under such tests for the Plan Year. Multiple use does not occur if either the ADP or the ACP of the HCEs does not exceed 1.25 multiplied by the ADP and the ACP of the NHCEs. (h) HIGHLY COMPENSATED EMPLOYEES: A Participant is a HCE for a particular Plan Year if he or she meets the definition of a HCE in effect for that Plan Year; and a Participant is a NHCE for a particular Plan Year if he or she does not meet the definition of a HCE in effect for that Plan Year. The Contribution Percentage for any Participant who is a HCE and who is eligible to have Contribution Percentage Amounts allocated to his or her account under two or more plans described in Code ss.401(a), or arrangements described in Code ss.401(k) that are maintained by the Employer, will be - 6 - determined as if the total of such Contribution Percentage Amounts was made under each plan. If a HCE participates in two or more cash or deferred arrangements that have different plan years, all cash or deferred arrangements ending with or within the same calendar year will be treated as a single arrangement. Notwithstanding the foregoing, certain plans will be treated as separate if mandatorily disaggregated under regulations under Code ss.401(m). (i) OTHER RULES: In determining the ACP Test, if this Plan satisfies the requirements of Code ss.401(m), ss.401(a)(4) or ss.410(b) only if aggregated with one or more other plans, or if one or more other plans satisfy such requirements only if aggregated with this Plan, then this section will be applied by determining the Contribution Percentage of Employees as if all such plans were a single plan. For any Plan Year in which the Employer elects Prior Year Testing under this Section, adjustments to the ACP of Non-Highly Compensated Employees for the prior Plan Year will be made in accordance with Notice 98-1 and any superseding guidance. Plans with the same Plan Year may be aggregated to satisfy Code ss.401(m). In determining the Contribution Percentage test, Employee contributions are considered to have been made in the Plan Year in which contributed to the Plan, and Matching Contributions and QNECs will be considered made for a Plan Year if made no later than the end of the twelve-month period beginning on the day after the close of the Plan Year. The Employer will maintain records sufficient to demonstrate satisfaction of the ACP Test and the amount of QNECs or QMACs, or both, used in such test. The determination and treatment of the Contribution Percentage of any Participant will satisfy such other requirements as may be prescribed by the Secretary of the Treasury. (j) AGGREGATE LIMIT: The term Aggregate Limit means the sum of (1) 125% of the greater of the ADP of Participants who are NHCEs for the current Plan Year (or for the prior Plan Year for any Plan Year for which prior year testing has been elected) or the ACP of Participants who are NHCEs subject to Code ss.401(m) for the Plan Year beginning with or within the current Plan Year (or for the prior Plan Year for any Plan Year for which prior year testing has been elected) of the cash or deferred arrangement (2) the lesser of 200% or two plus the lesser of such ADP or ACP. The word "lesser" will be substituted for "greater" in (1) above, and the word "greater" will be substituted for "lesser" after "two plus the" in (2) above if that would result in a larger Aggregate Limit. (k) "ELIGIBLE" PARTICIPANT: For purposes of this Section, an "eligible" Participant is any Employee who is eligible to make an Employee Contribution, or an Elective Deferral (if the Employer takes such contributions into account in the calculation of the Contribution Percentage), or to receive a Matching Contribution (including forfeitures) or a QMAC. If an Employee Contribution is required as a condition of Plan participation, any Employee who would be a Participant if such Participant made such a contribution will be treated as an "eligible" Participant on behalf of whom no Employee Contributions are made. An Employee Contribution means any contribution made by or on behalf of a Participant that is included in the Participant's gross income in the year in which made and that is maintained under a separate account to which earnings and losses are allocated. (l) CHANGE TO PRIOR YEAR TESTING: If the Employer elects Current Year Testing for any Plan Year, the Employer can only elect to change to prior year testing in accordance with the requirements in Notice 98-1 (or superseding guidance). If the Employer amends the Plan to elect prior year testing, the ACP for NHCEs for the prior year will be determined by taking into account only (1) Voluntary Employee Contributions for those NHCEs for the prior year, and (2) Matching Contributions for those NHCEs that were taken into account in the ACP Test (and - 7 - not the ADP Test) under the current year testing method for the prior year, and (3) QNECs that were allocated to the accounts of those NHCEs for the prior year but that were not used to satisfy the ACP Test or the ADP Test under the current year testing method for the prior year. Thus, if the Employer elects to change to prior year testing, the following contributions made for the prior year will be disregarded: QNECs used to satisfy either the ADP or ACP Test under the current year testing method for the prior testing year, QMACs taken into account in the ADP Test, and all Elective Deferrals. These limitations on double counting do not apply for testing years beginning before January 1, 1999, and if the Plan changes to prior year testing for the first time for the 1998 Plan Year, the ACP for NHCEs will be the same as for the 1997 Plan Year. 1.11 BENEFICIARY The term Beneficiary means the recipient designated by the Participant to receive the Plan benefits payable upon the death of the Participant, or the recipient designated by a Beneficiary to receive any benefits which may be payable in the event of the Beneficiary's death prior to receiving the entire death benefit to which the Beneficiary is entitled. All such Beneficiary designations will be made in accordance with the following provisions: (a) BENEFICIARY DESIGNATIONS BY A PARTICIPANT: Subject to the provisions of Section 5.8 regarding the rights of a Participant's Spouse, each Participant may designate a Beneficiary on a form supplied by the Administrator, and may change or revoke that designation by filing written notice with the Administrator. If a Participant completes or has completed a Beneficiary designation form in which the Participant designates his or her Spouse as the Beneficiary, and the Participant and the Participant's Spouse are legally divorced subsequent to the date of such designation, then the designation of such Spouse as a Beneficiary hereunder will be deemed null and void unless the Participant, subsequent to the legal divorce, reaffirms the designation by completing a new Beneficiary designation form. In the absence of a written Beneficiary designation form, the Participant will be deemed to have designated the following Beneficiaries in the following order: (1) the Participant's Spouse, if then living; (2) the Participant's issue, per stirpes; and (3) the Participant's estate. (b) BENEFICIARY DESIGNATIONS BY A BENEFICIARY: In the absence of a Beneficiary designation or other directive from the deceased Participant to the contrary, any Beneficiary may name his or her own Beneficiary in accordance with Section 5.2(e) to receive any benefits which may be payable in the event of the Beneficiary's death prior to the receipt of all the Participant's death benefits to which the Beneficiary was entitled. (c) BENEFICIARIES CONSIDERED CONTINGENT UNTIL DEATH OF PARTICIPANT: Notwithstanding any provision in this Section, any Beneficiary named hereunder will be considered a contingent Beneficiary until the death of the Participant (or Beneficiary, as the case may be), and until such time will have no rights granted to Beneficiaries under the Plan. 1.12 BREAK IN SERVICE The term Break in Service means a 1-Year Period of Severance. Notwithstanding the foregoing, a Participant who incurs a Break in Service but does not terminate employment with the Employer will continue to be eligible to make Elective Deferrals to the Plan, but will no longer be eligible to receive an allocation of any other Employer contributions. 1.13 CODE The term Code means the Internal Revenue Code of 1986, as amended, and the regulations and rulings promulgated thereunder by the Internal Revenue Service. - 8 - 1.14 CODE SS.3401 COMPENSATION The term Code ss.3401 Compensation means wages within the meaning of Code ss.3401(a) that are actually paid or made available in gross income for the purposes of income tax withholding at the source but determined without regard to any rules under Code ss.3401 that limit the remuneration included in wages based on the nature or location of the employment or the services performed (such as the exception for agricultural labor in Code ss.3401(a)(2)). 1.15 CODE SS.415 COMPENSATION The term Code ss.415 Compensation means Earned Income, wages, salaries, fees for professional services and other amounts received (without regard to whether or not an amount is paid in cash) for personal services actually rendered in the course of employment with the Employer maintaining the Plan, including, but not limited to, commissions paid salespersons, compensation for services based on a percentage of profits, commissions on insurance premiums, tips, bonuses, fringe benefits, and reimbursements, or other expense allowances under a non-accountable plan as described in IRS regulation ss.1.62-2(c). A Participant's Code ss.415 Compensation will be determined subject to the following provisions: (a) AMOUNTS EXCLUDED FROM CODE SS.415 COMPENSATION: Code ss.415 Compensation does not include (1) Employer contributions to a plan of deferred compensation which are not includible in gross income for the taxable year in which contributed, or Employer contributions to a simplified employee pension plan to the extent such contributions are deductible by the Employee, or any distributions from a plan of deferred compensation; (2) amounts realized from a non-qualified stock option, or when restricted stock or property held by the Employee either becomes freely transferable or is no longer subject to a substantial risk of forfeiture; (3) amounts realized from the sale, exchange or other disposition of stock acquired under a qualified stock option; and (4) other amounts which receive special tax benefits, or contributions made by an Employer (whether or not under a salary reduction agreement) towards the purchase of an annuity described in Code ss.403(b) (whether or not the amounts are excludible from an Employee's gross income). (b) TREATMENT OF ELECTIVE DEFERRALS AND OTHER AMOUNTS: For Limitation Years beginning on or after January 1, 1998, Code ss.415 Compensation will include any elective deferrals as defined in Code ss.402(g)(3), and any amounts contributed or deferred at the election of the Employee that were not includible in the gross income by reason of Code ss.125 or ss.457. Code ss.415 Compensation will also include elective amounts that are not includible in the gross income of the Employee by reason of Code ss.132(f)(4) for Limitation Years beginning on or after January 1, 2001 (or if elected by the Administrator on a non-discriminatory basis, any earlier Limitation Year beginning on or after January 1, 1998). 1.16 COMPENSATION The term Compensation means amounts received by a Participant from the Employer during a Compensation Determination Period, determined subject to the following provisions: (a) COMPENSATION USED TO DETERMINE ELECTIVE DEFERRALS: In determining the amount of a Participant's Elective Deferrals for a Plan Year, the term Compensation means a Participant's Form W-2 Compensation actually paid during a Compensation Determination Period, determined subject to the following provisions: (1) COMPENSATION DETERMINATION PERIOD: Under this paragraph (a), the Compensation Determination Period is the Plan Year. - 9 - (2) TREATMENT OF ELECTIVE DEFERRALS: For purposes of this paragraph (a), Employer contribution amounts made pursuant to a salary reduction agreement which are not currently includible in the gross income of an Employee by reason of Code ss.125, ss.402(e)(3), ss.402(h)(1)(B), or ss.403(b) will, at the election of the Administrator on a non-discriminatory basis, be included in determining Compensation. In addition, if elected by the Administrator on a non-discriminatory basis, Compensation will also include elective amounts that are not includible in the gross income of the Employee by reason of Code ss.132(f)(4), beginning with the Plan Year elected by the Administrator but not earlier than the Plan Year beginning on or after January 1, 1998. (3) CERTAIN AMOUNTS EXCLUDED FROM COMPENSATION: For purposes of this paragraph (a), any amount which would otherwise be considered Compensation under this paragraph but which is received by a Participant under the following circumstances will not be considered Compensation for purposes of this paragraph: (1) any amount received as a bonus; (2) any amount received as a commission; (3) any amount intended as reimbursement for moving expenses; (4) any amount intended as reimbursement for car expenses; and (5) any amount taxable for purposes of Domestic Partner medical coverage and Stock Options. (4) AMOUNTS RECEIVED PRIOR TO BECOMING A PARTICIPANT: All amounts which would be considered Compensation under this paragraph but which are received by an Employee prior to the date the Employee becomes a Participant in the Plan will be considered Compensation for purposes of this paragraph (a). However, the Administrator may elect to limit Compensation under this paragraph to Compensation received during the period during which the cash or deferred arrangement was in effect under the Plan. (5) COMPENSATION RECEIVED WHILE IN AN INELIGIBLE CLASS OF EMPLOYEES: Compensation for purposes of this paragraph (a) will exclude any amount received while an Employee is a member of an ineligible class of Employees as described in Section 2.1(a)(2). (b) COMPENSATION USED TO DETERMINE MATCHING CONTRIBUTIONS: Matching Contributions are not currently permitted under the terms of the Plan. (c) COMPENSATION USED TO DETERMINE NON-ELECTIVE CONTRIBUTIONS: Non-Elective Contributions are not currently permitted under the terms of the Plan. (d) COMPENSATION USED IN DETERMINING THE ACP TEST AND ADP TEST: In determining the ACP Test, the term Compensation means a Participant's Form W-2 Compensation. In determining the ADP Test, the term Compensation means a Participant's Form W-2 Compensation. However, in determining a Participant's ADP or ACP, the Administrator may elect (1) to include or exclude Elective Deferrals; (2) to include or exclude any items of compensation includible or excludible under Code ss.414(s) and the regulations thereunder, provided such adjusted definition conforms to the nondiscrimination requirements of those regulations; and/or (3) to limit Compensation taken into account in computing a Participant's ADP or ACP to Compensation received only for the portion of the Plan Year in which the Participant was a Participant and only for the portion of the Plan Year during which the Plan contained a cash or deferred arrangement. The Plan Administrator's election as described above must be consistent and uniform with respect to all Participants and all plans of the Employer for any particular Plan Year. - 10 - (e) COMPENSATION USED FOR TOP HEAVY PURPOSES: Notwithstanding anything in this Section to the contrary, in determining Top Heavy allocations under Section 3.5, the term Compensation means the Code ss.415 Compensation received by an Employee during an entire Compensation Determination Period excluding amounts received while a member of an ineligible class of Employees as described in Section 2.1(a)(2). (f) COMPENSATION OF OWNER-EMPLOYEES AND SHAREHOLDER-EMPLOYEES: For purposes of this Plan, the Compensation of an Owner-Employee or a Self-Employed Individual will equal his or her Earned Income up to the dollar limit described in the next paragraph. (g) DOLLAR LIMITATION ON COMPENSATION: Notwithstanding anything in this Section to the contrary, a Participant's Compensation for any Compensation Determination Period will not exceed the limitation set forth in Code ss.401(a)(17) as in effect for that determination period. If a Compensation Determination Period consists of fewer than 12 months, the Code ss.401(a)(17) limitation will be multiplied by a fraction, the numerator of which is the number of months in that determination period, and the denominator of which is 12. (h) COMPENSATION LIMITATION ELECTION AVAILABLE TO CERTAIN PARTICIPANTS: Except for purposes of determining Top Heavy allocation requirements under Section 3.5 or the Code ss.415 limitations under Article 6, any Participant who is a Key Employee, an Owner-Employee, a Self-Employed Individual, or a Highly Compensated Employee may elect for any Plan Year, on a form prescribed by the Administrator to limit Compensation for all purposes under this Plan. (i) REPEAL OF FAMILY AGGREGATION RULES: The family aggregation rules that were described in Code ss.401(a)(17)(A) as in effect prior to January 1, 1997 will not apply to this Plan for Plan Years beginning on or after January 1, 1997. 1.17 DISABILITY The term Disability means a physical or mental condition arising after an Employee has become a Participant that qualifies the Participant for disability benefits under the Social Security Act in effect on the date the Participant suffers the Disability. 1.18 EARLY RETIREMENT AGE There is no Early Retirement Age under the Plan. 1.19 EARNED INCOME The term Earned Income means net earnings from self-employment in the trade or business with respect to which the Plan is established and for which personal services of the individual are a material income-producing factor. Net earnings (1) will be determined without regard to items not included in gross income and the deductions allocable thereto, and for taxable years beginning after December 31, 1989, with regard to the deduction allowed by Code ss.164(f); and (2) will be reduced by deductible Employer contributions to a qualified retirement plan for taxable years beginning after December 31, 1989. 1.20 ELECTIVE DEFERRAL The term Elective Deferrals means Employer contributions made to the Plan at the election of the Participant in lieu of cash compensation, and will include contributions made pursuant to a salary reduction agreement or other deferral mechanism, as follows: - 11 - (a) DETERMINATION OF AMOUNT: In any taxable year, a Participant's Elective Deferral is the sum of all Employer contributions made on behalf of such Participant pursuant to an election to defer under any qualified cash or deferred arrangement under Code ss.401(k), any simplified employee pension cash or deferred arrangement under Code ss.402(h)(1)(B), any SIMPLE individual retirement plan under Code ss.408(p), any eligible deferred compensation plan under Code ss.457, any plan under Code ss.501(c)(18), and any Employer contributions made on the behalf of a Participant for the purchase of an annuity contract under Code ss.403(b) pursuant to a salary reduction agreement. Elective Deferrals will not include any deferrals properly distributed as excess Annual Additions. (b) RESTRICTIONS ON WITHDRAWAL: Elective Deferrals (exclusive of earnings thereon) can only be withdrawn upon the earlier of the date (1) a Participant incurs a Termination of Employment; (2) a Participant dies; (3) a Participant suffers a Disability; (4) an event described in Code ss.401(k)(10) occurs; (5) a Participant receives a hardship distribution if hardship distributions are permitted by the Employer under Section 5.17; and (6) a Participant reaches Age 59 1/2 if on or after such date a pre-retirement in-service withdrawal of Elective Deferrals is permitted by the Employer under Section 5.18. 1.21 ELECTIVE DEFERRAL ACCOUNT The term Elective Deferral Account means the sub-account of a Participant's Account to which the Participant's Elective Deferrals are credited. 1.22 ELIGIBLE PARTICIPANT The term Eligible Participant means a Participant eligible in accordance with the following provisions to receive an allocation of any Matching Contributions, Non-Elective Contributions and Forfeitures that are allocable for the Plan Year: (a) MATCHING CONTRIBUTIONS AND RELATED FORFEITURES: Matching Contributions are not currently permitted under the terms of the Plan. (b) NON-ELECTIVE CONTRIBUTIONS AND RELATED FORFEITURES: Non-Elective Contributions are not currently permitted under the terms of the Plan. 1.23 EMPLOYEE The term Employee means (a) any person reported on the payroll records of the Employer as an employee who is deemed by the Employer to be a common law employee; (b) except for determining eligibility to participate in this Plan, any person reported on the payroll records of an Affiliated Employer of the Sponsor or an Adopting Employer as an employee who is deemed by the Affiliated Employer to be a common law employee, even if the Affiliated Employer is not an Adopting Employer; (c) any Self-Employed Individual who derives Earned Income from the Employer; (d) any Owner-Employee; and (e) any person who is considered a Leased Employee but who (1) is not covered by a plan described in Code ss.414(n)(5), or (2) is covered by a plan described in Code ss.414(n)(5), but Leased Employees constitute more than 20% of the Employer's non-highly compensated workforce. However, the term Employee will not include any individual who is not reported on the payroll records of the Employer or an Affiliated Employer as a common law employee. If such person is later determined by the Sponsor or by a court or governmental agency to be or to have been an Employee, he or she will only be eligible for participation prospectively and may participate in the Plan as of the next entry date in Section 2.2 following such determination and after the satisfaction of all other eligibility requirements. - 12 - 1.24 EMPLOYER The term Employer means the Sponsor, any Adopting Employer, and any direct predecessor business entity of the Sponsor or an Adopting Employer that was or would have been considered an Affiliated Employer of the Sponsor or an Adopting Employer. Where applicable, such as determining Hours of Service, Periods of Service and Years of Service, the term Employer or Adopting Employer will also mean any business entity that was an Adopting Employer. As to any Employee, the term Employer at the time of reference means the employer of such Employee. 1.25 ERISA The term ERISA means the Employee Retirement Income Security Act of 1974, as amended, and the regulations and rulings promulgated thereunder. 1.26 EXCESS AGGREGATE CONTRIBUTIONS The term Excess Aggregate Contributions means, with respect to any Plan Year, the excess of (1) the aggregate Contribution Percentage Amounts used in computing the numerator of the Contribution Percentage actually made on behalf of Participants who are Highly Compensated Employees for such Plan Year, over (2) the maximum Contribution Percentage Amounts permitted by the ACP Test (determined by hypothetically reducing contributions made on behalf of Participants who are Highly Compensated Employees in order of their Contribution Percentages beginning with the highest of such percentages). Such determination will be made after first determining Excess Elective Deferrals and then determining Excess Contributions. The terms Average Contribution Percentage, Contribution Percentage and Contribution Percentage Amount are defined in Sections 1.10(c), 1.10(d) and 1.10(e). 1.27 EXCESS CONTRIBUTIONS The term Excess Contributions means, with respect to any Plan Year, the excess of the aggregate amount of Employer contributions actually taken into account in computing the ADP of Participants who are Highly Compensated Employees for such Plan Year, over the maximum amount of such contributions permitted by the ADP Test (determined by hypothetically reducing contributions made for Participants who are Highly Compensated Employees in order of their ADPs, beginning with the highest of such percentages). 1.28 EXCESS ELECTIVE DEFERRALS The term Excess Elective Deferrals means Elective Deferrals that are includible in a Participant's gross income under Code ss.402(g) to the extent such Participant's Elective Deferrals for a taxable year exceed the dollar limit under such Code Section. 1.29 FIDUCIARY The term Fiduciary means any individual or entity which exercises any discretionary authority or control over the management of the Plan or over the disposition of the assets of the Plan; renders investment advice for a fee or other compensation (direct or indirect); has any discretionary authority or responsibility over Plan administration; or acts to carry out a fiduciary responsibility, when designated by a named Fiduciary pursuant to authority granted by the Plan; subject, however, to any exception granted directly or indirectly by the provisions of ERISA or any applicable regulations. The Sponsor is the "named Fiduciary" for purposes of ERISA ss.402(a)(2). 1.30 FISCAL YEAR The term Fiscal Year means the Employer's accounting year beginning February 1st and ending the following January 31st. 1.31 FORFEITURE The term Forfeiture means the amount by which a Participant's Account balance exceeds his or her Vested Interest upon the earlier to occur of (a) the date the Participant receives a distribution of his or her - 13 - Vested Interest under Article 5; or (b) the date the Participant incurs 5 consecutive Breaks in Service after Termination of Employment. No Forfeitures will occur solely as a result of the withdrawal of a Participant's own contributions to the Plan or a Participant's transfer to an Affiliated Employer or Adopting Employer. All Forfeitures will be placed in the Forfeiture Account pending allocation pursuant to Section 3.4. 1.32 FORM W-2 COMPENSATION The term Form W-2 Compensation means wages within the meaning of Code ss.3401(a) and all other payments of compensation actually paid or made available in gross income to an Employee by the Employer in the course of the Employer's trade or business for which the Employer is required to furnish the Employee a Form W-2 under Code ss.6041(d), ss.6051(a)(3) and ss.6052. Compensation must be determined without regard to any rules under Code ss.3401(a) limiting remuneration included in wages based on the nature or location of the employment or services performed (such as the exception for agricultural labor in Code ss.3401(a)(2)). 1.33 HCE The term HCE means a Highly Compensated Employee. 1.34 HIGHLY COMPENSATED EMPLOYEE The term Highly Compensated Employee means, for Plan Years beginning after December 31, 1996, any Employee who during the Plan Year or during the look-back year was a 5% owner as defined in Code ss.416(i)(1), or who for the look-back year had Code ss.415 Compensation in excess of $80,000 as adjusted in accordance with Code ss.415(d) (except that the base year will be the calendar quarter ending September 30, 1996). In determining who is a highly compensated former Employee, the rules for determining Highly Compensated Employee status as in effect for the Plan Year or look-back year for which the determination is being made (in accordance with temporary regulation 1.414(q)-1T, A-4 and Notice 97-45) will be applied. In determining if an Employee is a Highly Compensated Employee for Plan Years beginning in 1997, the amendments to Code ss.414(q) are deemed to have been in effect for years beginning in 1996. If the Employer maintains more than one qualified retirement plan, the definition of Highly Compensated Employee must be consistently applied to all such plans. (a) DETERMINATION OF LOOK-BACK YEAR: The look-back year will be the 12 month period immediately preceding the Plan Year for which the determination is being made. (b) TOP PAID GROUP ELECTION: In determining if an Employee is a Highly Compensated Employee based on Code ss.415 Compensation, the top paid group election set forth in Code ss.414(q)(3) is not being applied for any Plan Year beginning on or after January 1, 1997. (c) REPEAL OF FAMILY AGGREGATION RULES: The family aggregation rules that were described in Code ss.414(q)(6) as in effect prior to January 1, 1997 will not apply to this Plan for Plan Years beginning on or after January 1, 1997. 1.35 HOUR OF SERVICE The term Hour of Service means, with respect to any provision of the Plan in which service is determined by reference to an Employee's Periods of Service, each hour for which an Employee is paid, or is entitled to payment, by the Employer or an Affiliated Employer for the performance of duties. With respect to any provision of the Plan in which service is determined by reference to an Employee's Years of Service, the term Hour of Service means the following: - 14 - (a) DETERMINATION OF HOURS: The term Hour of Service means (1) each hour an Employee is paid, or entitled to payment, for the performance of duties for the Employer or an Affiliated Employer, which will be credited to the Employee for the computation period in which the duties are performed; (2) each hour for which an Employee is paid, or entitled to payment, by the Employer or an Affiliated Employer on account of a period of time during which no duties are performed (irrespective of whether the employment relationship has terminated) due to vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence, except that no more than 501 hours will be credited under this clause (2) for any single continuous period (whether or not such period occurs in a single computation period); and (3) each hour for which back pay, irrespective of mitigation of damages, is either awarded or agreed to by the Employer or an Affiliated Employer, except that the same hours will not be credited both under clause (1) or clause (2) and under this clause (3), and these hours will be credited for the computation period or periods to which the award or agreement pertains rather than the computation period in which the award, agreement or payment is made. Hours of Service will be calculated and credited pursuant to DOL regulation 2530.200b-2(b) and (c), which are incorporated herein by reference. (b) MATERNITY OR PATERNITY LEAVE: In determining if a Break in Service for participation and vesting has occurred in a computation period, an individual on Maternity or Paternity Leave will receive credit for up to 501 Hours of Service which would otherwise have been credited but for such absence, or in any case in which such Hours of Service cannot be determined, 8 Hours of Service per day of such absence. Hours of Service credited for Maternity or Paternity Leave will be credited in the computation period in which the absence begins if the crediting is necessary to prevent a Break in Service in that period, or in all other cases, in the following computation period. (c) USE OF EQUIVALENCIES: Notwithstanding paragraph (a), the Administrator may elect for all Employees or for one or more different classifications of Employees (provided such classifications are reasonable and are consistently applied) to apply one or more of the following equivalency methods in determining the Hours of Service of an Employee paid on an hourly or salaried basis. Under such equivalency methods, an Employee will be credited with either (1) 190 Hours of Service for each month in which he or she is paid or entitled to payment for at least one Hour of Service; or (2) 95 Hours of Service for each semi-monthly period in which he or she is paid or entitled to payment for at least one Hour of Service; or (3) 45 Hours of Service for each week in which he or she is paid or entitled to payment for at least one Hour of Service; or (4) 10 Hours of Service for each day in which he or she is paid or entitled to payment for at least one Hour of Service. 1.36 KEY EMPLOYEE The term Key Employee means any Employee, Former Employee, deceased Employee, or Beneficiary who at any time during the Plan Year containing the Determination Date for the Plan Year in question or any of the prior 4 Plan Years was one of the following: (a) OFFICERS: An officer of the Employer whose Code ss.415 Compensation exceeds 50% of the amount in effect under Code ss.415(b)(1)(A), except that no more than fifty Employees (or, if lesser, the greater of three or 10% of the Employees) will be treated as officers. (b) OWNERS: An owner (or was considered an owner under Code ss.318) of one of the ten largest interests in the Employer whose Code ss.415 Compensation exceeds 100% of the dollar limitation in effect under Code ss.415(c)(1)(A), but if two Employees own the same interest in the Employer, the Employee - 15 - with the greater annual Code ss.415 Compensation will be treated as owning a larger interest; or a 5% owner of the Employer as defined in Code ss.416(i)(1)(B)(i); or a 1% owner of the Employer as defined in Code ss.416(i)(1)(B)(ii) whose annual Code ss.415 Compensation is more than $150,000. 1.37 LEASED EMPLOYEE The term Leased Employee means, for Plan Years beginning on or after January 1, 1997, any person within the meaning of Code ss.414(n)(2) and ss.414(o) who is not reported on the payroll records of the Employer as a common law employee and who provides services to the Employer if (a) the services are provided under an agreement between the Employer and a leasing organization; (b) the person has performed services for the Employer or for the Employer and related persons as determined under Code ss.414(n)(6) on a substantially full time basis for a period of at least one year; and (c) the services are performed under the primary direction and control of the Employer. Contributions or benefits provided to a Leased Employee by the leasing organization attributable to services performed for the Employer will be treated as provided by the Employer. A Leased Employee will not be considered an Employee of the recipient if he is covered by a money purchase plan providing (a) a non-integrated Employer contribution rate of at least 10% of Code ss.415 Compensation, including amounts contributed by the Employer pursuant to a salary reduction agreement which are excludible from the Leased Employee's gross income under a cafeteria plan covered by Code ss.125, a cash or deferred plan under Code ss.401(k), a SEP under Code ss.408(k) or a tax-deferred annuity under Code ss.403(b), and also including, for Plan Years beginning on or after January 1, 2001, any elective amounts that are not includible in the gross income of the Leased Employee because of Code ss.132(f)(4); (b) immediate participation; and (c) full and immediate vesting. This exclusion is only available if Leased Employees do not constitute more than 20% of the recipient's non-highly compensated work force. 1.38 LIMITATION YEAR The term Limitation Year means the Plan Year. 1.39 MATCHING CONTRIBUTION The term Matching Contribution means an Employer contribution made to this or any other defined contribution plan on behalf of a Participant on account of Voluntary Employee Contributions made by such Participant, or on account of a Participant's Elective Deferral, under a Plan maintained by the Employer. 1.40 MATCHING CONTRIBUTION ACCOUNT The term Matching Contribution Account means the sub-account of a Participant's Account to which Matching Contributions are credited. 1.41 MATERNITY OR PATERNITY LEAVE The term Maternity or Paternity Leave means that an Employee is absent from work because of the Employee's pregnancy; because of the birth of the Employee's child; because of the placement of a child with the Employee in connection with the adoption of such child by the Employee; or because of the need to care for such child for a period beginning immediately following the child's birth or placement as set forth above. 1.42 NHCE The term NHCE means a Non-Highly Compensated Employee. 1.43 NON-ELECTIVE CONTRIBUTIONS The term Non-Elective Contribution means an Employer contribution other than a Matching Contribution or a QMAC that the Participant may not elect to receive in cash until such contributions are distributed from the Plan. - 16 - 1.44 NON-ELECTIVE CONTRIBUTION ACCOUNT The term Non-Elective Contribution Account means the sub-account of a Participant's Account to which Non-Elective Contributions are credited. 1.45 NON-HIGHLY COMPENSATED EMPLOYEE The term Non-Highly Compensated Employee means any Employee who is not a Highly Compensated Employee. 1.46 NON-KEY EMPLOYEE The term Non-Key Employee means any Employee who is not a Key Employee. 1.47 NORMAL RETIREMENT AGE The term Normal Retirement Age means the date a Participant reaches Age 59 1/2. There is no mandatory retirement age. 1.48 NORMAL RETIREMENT DATE The term Normal Retirement Date means the date a Participant reaches Normal Retirement Age. 1.49 OWNER-EMPLOYEE The term Owner-Employee means (1) in the case of an Employer or Affiliated Employer which is an unincorporated trade or business, an individual who owns the entire interest in such Employer or Affiliated Employer; and (2) in the case of an Employer or Affiliated Employer which is a partnership, an individual who owns more than 10% of either the capital interest or the profit interest in such Employer or Affiliated Employer. 1.50 PARTICIPANT The term Participant means any Employee who has met the eligibility and participation requirements of the Plan. However, an individual who is no longer an Employee will not be deemed a Participant if his or her entire Plan benefit (a) is fully guaranteed by an insurance company and is legally enforceable at the sole choice of such individual against such insurance company, provided that a contract, Policy, or certificate describing the benefits to which such individual is entitled under the Plan has been issued to such individual; or (b) is paid in a lump sum distribution which represents such individual's entire interest in the Plan; or (c) is paid in some other form of distribution and the final payment thereunder has been made. 1.51 PARTICIPANT'S ACCOUNT The term Participant's Account means the account to which is credited a Participant's share of Employer contributions, Forfeitures (if any) that are allocated under Section 3.4, investment earnings or losses allocated under Section 3.3, and the proceeds of insurance Policies (if any) that are purchased on a Participant's life under Section 7.13. Each Participant's Account will be divided into the following Employer contribution sub-accounts for accounting purposes: the Elective Deferral Account, and if applicable, the Matching Contribution Account, the Qualified Matching Contribution Account, the Non-Elective Contribution Account, the Qualified Non-Elective Contribution Account, the Safe Harbor Contribution Account, and any other sub-accounts as the Administrator may determine necessary from time to time. 1.52 PERIOD OF SERVICE The term Period of Service means a period during which an Employee is employed by an Employer or an Affiliated Employer beginning on an Employee's Employment Commencement Date or Re-employment Commencement Date as defined in paragraph (b), and ending on the Severance from Service Date as defined in paragraph (d). For any provision of the Plan in which an Employee's service is determined by his or her Period of Service, a 1-Year Period of Service and all other Periods of Service will be determined in accordance with the following provisions: - 17 - (a) CREDIT FOR AN HOUR OF SERVICE AS A PERIOD OF SERVICE: If an Employee performs an Hour of Service during a period which would otherwise be considered a Period of Severance as indicated in paragraph (c) below, the Plan must take into account such period and the Employee will receive credit for such as a Period of Service. (b) DEFINITION OF EMPLOYMENT COMMENCEMENT DATE: The term Employment Commencement Date means the first day an Employee performs an Hour of Service for an Employer or an Affiliated Employer; and the term Reemployment Commencement Date means the first day following a Period of Severance on which an Employee performs an Hour of Service for an Employer or an Affiliated Employer. (c) DEFINITION OF PERIOD OF SEVERANCE: The term Period of Severance means the period beginning on the Severance from Service Date and ending on the Reemployment Commencement Date. A Participant will incur a 1-Year Period of Severance if the Employee fails to perform an Hour of Service during a 12-consecutive month period following the earlier of either (1) the Severance from Service Date on which an Employee retires, dies, quits or is discharged from employment by an Employer or an Affiliated Employer, or (2) the Severance from Service Date on which an Employee remains absent from service with an Employer or an Affiliated Employer (with or without pay) for any reason other than the Employee retiring, dying, quitting or being discharged from employment by an Employer or an Affiliated Employer, such as for vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence. In the case of a Participant who is on Maternity or Paternity Leave, the 12-consecutive month period beginning on the first anniversary of the first day of such Maternity or Paternity Leave will not constitute a Period of Severance. If the Employee does perform an Hour of Service during the periods indicated in clauses (1) or (2) above, the Plan must take into account such period and the Employee will receive credit for such as a Period of Service. (d) DEFINITION OF SEVERANCE FROM SERVICE DATE: The term Severance from Service Date means the date on which an Employee retires, dies, quits or is discharged from employment by an Employer or an Affiliated Employer; or if earlier the first anniversary of the date on which an Employee remains absent from service with an Employer or an Affiliated Employer (with or without pay) for any reason other than the Employee retiring, dying, quitting or being discharged from employment by an Employer or an Affiliated Employer, such as for vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence. (e) AGGREGATING PERIODS OF SERVICE AND FRACTIONAL PERIODS OF SERVICE: A 1-Year Period of Service is a 12-consecutive month Period of Service. An Employee will receive credit for Periods of Service of less than 12 consecutive months, by aggregating, subject to the limitations below, all non-successive Periods of Service and all Periods of Service which are fractional years or which do not constitute a whole 1-Year Period of Service, whether or not consecutive. Fractional periods of a year are expressed in terms of days, on the basis that a day of service is credited if an Employee completes an Hour of Service during such day, and on the basis that 12 months of service (30 days being deemed to be a month in the case of the aggregation of fractional months) or 365 days of service equals a 1-Year Period of Service. - 18 - (f) PRIOR SERVICE CREDIT: An Employee will not receive credit for Periods of Service with any other entity except as otherwise set forth herein with respect to the Employer, an Affiliated Employer, and any business that was an Adopting Employer. (g) REEMPLOYMENT BEFORE A 1-YEAR PERIOD OF SEVERANCE: If an Employee terminates employment but is re-employed by the Employer before a Period of Severance, his or her Periods of Service and employment will not be deemed to have been interrupted during such Plan Year and, if the Employee was a Participant (or otherwise satisfied the requirements for participation specified in Section 2.1 of the Plan), he or she will remain (or become) a Participant immediately upon his or her re-employment by the Employer. If an Employee was not a Participant in the Plan but otherwise satisfied the requirements for participation specified in the Plan, he or she will become a Participant on the later of the date the Employee would have entered the Plan had he or she not terminated employment with the Employer, or upon his Reemployment Commencement Date. (h) REEMPLOYMENT AFTER A 1-YEAR PERIOD OF SEVERANCE: If a former Employee terminates employment and is re-employed by an Employer or an Affiliated Employer after a 1-Year Period of Severance, Periods of Service completed prior to the 1-Year Period of Severance will be counted, subject to the following: (1) DETERMINATION OF PERIODS OF SERVICE FOR ELIGIBILITY: For eligibility purposes, if such Employee did not have a Vested Interest in his or her Participant's Account before the 1-Year Period of Severance and the number of the Employee's consecutive 1-Year Periods of Severance equals or exceeds the greater of five or the aggregate number of 1-Year Periods of Service, Periods of Service completed prior to the 1-Year Period of Severance will not be counted. The aggregate number of 1-Year Periods of Service will not include any Period of Service previously disregarded hereunder by reason of prior 1-Year Periods of Severance. If such Employee's Periods of Service are disregarded under this paragraph, he or she will be treated as a new Employee for eligibility purposes. (2) DETERMINATION OF PERIODS OF SERVICE FOR PURPOSES OTHER THAN ELIGIBILITY: For all purposes other than eligibility, if the Employee has incurred five consecutive 1-Year Periods of Severance, Periods of Service completed prior to such five consecutive 1-Year Periods of Severance will not be counted for such purposes if the Participant did not have a Vested Interest in his or her Participant's Account and the number of the Employee's consecutive 1-Year Periods of Severance equals or exceeds the aggregate number of 1-Year Periods of Service before such period. (3) ENTRY OR REENTRY INTO THE PLAN: If such Employee was a Participant before the 1-Year Period of Severance, such Employee will be reinstated as a Participant upon his or her Reemployment Commencement Date. If the Employee was not a Participant before incurring the 1-Year Period of Severance but (A) had satisfied the eligibility requirements in Section 2.1, such Employee will enter the Plan as a Participant on the later of his or her Reemployment Commencement Date or the date the Employee would have entered the Plan had he or she not terminated employment with the Employer; or (B) had not satisfied the eligibility requirements set forth in Section 2.1, such Employee will be eligible to enter the Plan as a Participant after satisfaction of any such eligibility requirements, in which event the Employee will enter the Plan as a Participant on the applicable entry date set forth in Section 2.2. In all events, the Employee will receive credit for all Periods of Service which were completed prior to the 1-Year Period of Severance. - 19 - (4) RE-ENTRY FOR PURPOSES OF MAKING DEFERRALS: Notwithstanding the preceding subparagraph, such Employee, solely for the purpose of making Elective Deferrals, will re-enter the Plan immediately upon re-employment. (i) IGNORING SERVICE FOR ELIGIBILITY IF MORE THAN 1-YEAR PERIOD OF SERVICE IS REQUIRED: If this Plan at any time provides that an Employee must complete more than either a 1-Year Period of Service or 12 months of service for eligibility purposes, and provides that an Employee will have a 100% Vested Interest in his or her Participant's Account upon becoming a Participant in the Plan, then the Period of Service of an Employee who incurs a 1-Year Period of Severance before satisfying such eligibility requirement will not be counted for eligibility purposes. 1.53 PERIOD OF SEVERANCE See Section 1.52(c). 1.54 PERMISSIVE AGGREGATION GROUP The term Permissive Aggregation Group means a Required Aggregation Group plus any Employer plan(s) which when considered as a group with the Required Aggregation Group would continue to satisfy Code ss.401(a)(4) and ss.410. 1.55 PLAN The term Plan means this plan and trust agreement, which is named the Hot Topic, Inc. 401(k) Profit Sharing Plan. 1.56 PLAN YEAR The term Plan Year means the Plan's accounting year beginning January 1st and ending the following December 31st. 1.57 POLICY The term Policy means a life insurance policy or annuity contract purchased pursuant to the provisions of Section 7.13 of the Plan. 1.58 QMAC The term QMAC means a Qualified Matching Contribution. 1.59 QNEC The term QNEC means a Qualified Non-Elective Contribution. 1.60 QUALIFIED JOINT AND SURVIVOR ANNUITY The term Qualified Joint and Survivor Annuity means an immediate annuity for the life of the Participant with a survivor benefit for the life of the Participant's Spouse that is not less than 50% or more than 100% of the annuity payable during the joint lives of the Participant and his or her Spouse and is the benefit that can be purchased with the Participant's Vested Aggregate Account. The survivor benefit will be 50% unless a higher percentage is elected by the Participant. 1.61 QUALIFIED MATCHING CONTRIBUTION The term Qualified Matching Contribution means a Matching Contribution that (a) is used for the purpose of satisfying the ADP Test or the ACP Test; (b) a Participant may not elect to receive in cash until distributed from the Plan; and (c) is subject to the distribution and nonforfeitability requirements of Code ss.401(k) when made to the Plan. - 20 - 1.62 QUALIFIED NON-ELECTIVE CONTRIBUTION The term Qualified Non-Elective Contribution means a contribution (other than a Matching Contribution or a Qualified Matching Contribution) that is made by the Employer that (a) is used for the purpose of satisfying the ADP Test or the ACP Test; (b) a Participant may not elect to receive in cash until distributed from the Plan; and (c) is subject to the distribution and nonforfeitability requirements of Code ss.401(k) when made to the Plan. Qualified Non-Elective Contributions may be considered in determining the Top Heavy Minimum Contribution under Section 3.5. For any Plan Year in which the Employer elects Current Year Testing under Sections 1.2 and/or 1.10, in lieu of distributing Excess Contributions under Section 5.20 or Excess Aggregate Contributions under Section 5.21, the Employer may make a Qualified Non-Elective Contribution on behalf of Participants in an amount sufficient to satisfy the ADP Test and/or the ACP Test, to the extent permitted in Sections 1.2 and 1.10. 1.63 QUALIFIED PRERETIREMENT SURVIVOR ANNUITY The term Qualified Preretirement Survivor Annuity means a survivor annuity for the life of a deceased Participant's surviving Spouse that is equal to the amount of benefit that can be purchased by 50% of the deceased Participant's Vested Aggregate Account balance determined at the date of death. In determining a Participant's Vested Aggregate Account balance for purposes of this Section, any security interest held by the Plan because of a loan outstanding to the Participant will be taken into consideration. 1.64 REQUIRED AGGREGATION GROUP The term Required Aggregation Group means (a) each qualified deferred compensation Plan of the Employer in which at least one Key Employee participates or participated at any time during the determination period (regardless of whether the plan has terminated), and (b) any other qualified deferred compensation plan of the Employer which enables a plan described in (a) to meet the requirements of Code ss.401(a)(4) or ss.410. 1.65 REQUIRED BEGINNING DATE The term Required Beginning Date means, for Plan Years beginning on or after January 1, 1997, for a Participant who is not a 5% owner, April 1st of the calendar year following the later of the calendar year in which the Participant reaches Age 70 1/2 or the calendar year in which the Participant actually retires. For a Participant who is a 5% owner, the term Required Beginning Date means April 1st of the calendar year following the calendar year in which the Participant reaches Age 70 1/2. A Participant will be treated as a 5% owner if he or she is a 5% owner as defined in Code ss.416 at any time during the Plan Year ending with or within the calendar year in which such Participant reaches Age 70 1/2. Once distributions have begun to a 5% owner, they must continue even if the Participant ceases to be a 5% owner in a subsequent year. Notwithstanding the foregoing to the contrary, however, a Participant may have a later Required Beginning Date determined as follows: (a) ELIMINATION OF PRE-RETIREMENT AGE 70 1/2 DISTRIBUTION OPTION: The pre-retirement Age 70 1/2 distribution option will only be eliminated for Employees who reach Age 70 1/2 in or after a calendar year that begins after the later of December 31, 1998, or the adoption date of this amended Plan. The pre-retirement Age 70 1/2 distribution option is an optional form of benefit under which benefits payable in a particular distribution form (including any modifications that may be elected after benefit commencement) begin at a time during the period that begins on or after January 1st of the calendar year in which an Employee reaches Age 70 1/2 and ends April 1 of the immediately following calendar year. - 21 - (b) ELECTION TO DEFER: If the Administrator offered an election to defer distributions, a Participant who is not a 5% owner who reaches Age 70 1/2 in years after 1995 and who made the election by April 1st of the calendar year following the year in which he or she reached Age 70 1/2 (or by December 31, 1997 in the case of a Participant who reached Age 70 1/2 in 1996) may defer distribution until the calendar year following the calendar year in which his or her retirement occurs. If the Administrator does not offer such an election, or if the election is offered but not made, the Participant will begin receiving distributions by April 1st of the calendar year following the year in which he or she reaches age 70 1/2 (or by December 31, 1997 in the case of a Participant who reached Age 70 1/2 in 1996). (c) ELECTION TO SUSPEND: If the Administrator offered an election to suspend distributions, a Participant who is not a 5% owner who reaches Age 70 1/2 prior to 1997 and who made the election may stop distributions and recommence by April 1st of the calendar year following the year in which the Participant actually retires. In such an event, the Administrator may, on a uniform non-discriminatory basis, elect that a new Annuity Starting Date will begin upon the distribution recommencement date. 1.66 ROLLOVER ACCOUNT The term Rollover Account means the account to which a Participant's Rollover Contributions (if permitted under Section 3.7) are allocated. A Participant will at all times have a 100% Vested Interest in all amounts credited to his or her Rollover Account. 1.67 ROLLOVER CONTRIBUTION The term Rollover Contribution means an amount transferred to this Plan (a) in a trustee to trustee transfer from another qualified plan; (b) from another qualified plan as a distribution eligible for tax free rollover treatment and which is transferred by the Participant to this Plan within 60 days following his receipt thereof; (c) from a conduit individual retirement account if the only assets therein were previously distributed to the Participant by another qualified plan as a distribution eligible for a tax free rollover within 60 days of receipt thereof and earnings on the assets; or (d) from a conduit individual retirement account meeting the requirements of (a) and transferred to this Plan within 60 days of receipt thereof.. Any portion of a Rollover Contribution made under clause (a) as part of a trustee to trustee transfer which was subject at the time of the transfer to the Qualified Joint and Survivor Annuity and Qualified Pre-retirement Survivor Annuity requirements of Code ss.401(a)(11) must be distributed in accordance with Section 5.16. 1.68 SAFE HARBOR CONTRIBUTION ACCOUNT The term Safe Harbor Contribution Account means the sub-account of a Participant's Account to which is credited any Employer "safe harbor" contributions that are made to the Plan pursuant to the provisions of Section 3.6. 1.69 SELF-EMPLOYED INDIVIDUAL The term Self-Employed Individual means anyone who owns an interest (other than stock) in the Employer and has Earned Income for the Plan Year or who would have had Earned Income but for the fact the Employer had no net profits for the Plan Year. 1.70 SHAREHOLDER-EMPLOYEE The term Shareholder-Employee means, in the case of an Employer or Affiliated Employer which is an electing small business corporation, an individual who is an employee or officer of such electing small business corporation and owns, or is considered as owning within the meaning of Code ss.318(a)(1), on any day during the taxable year of such corporation, more than 5% of the outstanding stock of the corporation. - 22 - 1.71 SPONSOR The term Sponsor means Hot Topic, Inc. (and any successor thereto that elects to assume sponsorship of this Plan). 1.72 SPOUSE The term Spouse means the person to whom a Participant is legally married; provided, however, that such person has been married to the Participant throughout the one year period ending on the earlier of the Annuity Starting Date or the date of the Participant's death. 1.73 TERMINATION OF EMPLOYMENT The term Termination of Employment means that a Participant has ceased to be an Employee for reasons other than retirement, death, or Disability. 1.74 TERMINATED PARTICIPANT The term Terminated Participant means a Participant who has ceased to be an Employee for reasons other than retirement, death or Disability. 1.75 TOP HEAVY The term Top Heavy means for any Plan Year beginning after December 31, 1983 (a) that the Top Heavy Ratio exceeds 60% and the Plan is not part of a Required Aggregation Group or Permissive Aggregation Group; or (b) that the Plan is a part of a Required Aggregation Group but not a Permissive Aggregation Group and the Top Heavy Ratio for the group exceeds 60%; or (c) that the Plan is a part of a Required Aggregation Group and a Permissive Aggregation Group and the Top Heavy Ratio for the Permissive Aggregation Group exceeds 60%. 1.76 TOP HEAVY MINIMUM ALLOCATION The term Top Heavy Minimum Allocation means an amount of Employer contributions and Forfeitures equal to 3% of an Employee's Compensation (or such higher or lesser percentage of Compensation as may otherwise be indicated in Section 3.5). 1.77 TOP HEAVY RATIO In determining if this Plan is Top Heavy or Super Top Heavy, the Top Heavy Ratio will be determined in accordance with the following provisions: (a) RULE 1: If the Employer maintains one or more defined contribution plans (including any simplified employee pension plans) and has not maintained any defined benefit plan which during the 5-year period ending on the Determination Date had accrued benefits, the Top Heavy Ratio for this Plan alone or for the Required or Permissive Aggregation Group is a fraction, the numerator of which is the sum of the account balances of all Key Employees as of the Determination Date (including any part of any account balance distributed during the 5-year period ending on the Determination Date), and the denominator of which is the sum of the account balances (including any part of any account balance distributed during the 5-year period ending on the Determination Date) determined under Code ss.416 and the regulations thereunder. Both the numerator and the denominator of the Top Heavy Ratio will be increased to reflect any contribution that are not actually made as of the Determination Date but that are required to be taken into account under Code ss.416 and the regulations thereunder. (b) RULE 2: If the Employer maintains one or more defined contribution plans (including a simplified employee pension plan) and maintains or has maintained one or more defined benefit plans which during the 5-year period ending on the Determination Date has had any accrued benefits, the Top Heavy Ratio for any Required or Permissive Aggregation Group is a fraction, the numerator of which is the sum of account - 23 - balances under the aggregated defined contribution plans for all Key Employees determined in accordance with paragraph (a) above, and the present value of accrued benefits under the aggregated defined benefit plans for all Key Employees as of the Determination Date, and the denominator of which is the sum of the account balances under the aggregated defined contribution plans for all Participants, determined in accordance with paragraph (a), and the present value of accrued benefits under the aggregated defined benefit plans for all Participants as of the Determination Date, all determined under Code ss.416 and the regulations thereunder. The accrued benefits under a defined benefit plan in both the numerator and denominator of the Top Heavy Ratio are increased for any distribution made in the 5-year period ending on the Determination Date. (c) RULE 3: For purposes of paragraphs (a) and (b), the value of account balances and the present value of accrued benefits will be determined as of the most recent Valuation Date that falls within or ends with the 12-month period ending on the Determination Date, except as provided in Code ss.416 and the regulations thereunder for the first and second Plan Years of a defined benefit plan. The account balances and accrued benefits will be disregarded for a Participant who (1) is not a Key Employee but who was a Key Employee in a prior year or (2) has not been credited with at least 1 Hour of Service with any Employer maintaining the Plan at any time during the 5-year period ending on the Determination Date. The calculation of the Top Heavy Ratio and the extent to which distributions, rollovers, and transfers are taken into account will be made in accordance with Code ss.416 and the regulations thereunder. When aggregating plans, the value of accounts and accrued benefits will be calculated with reference to the Determination Date that falls within the same calendar year. The accrued benefit of a Participant other than a Key Employee will be determined under (1) the method, if any, that uniformly applies for accrual purposes under all defined benefit plans maintained by the Employer, or (2) effective as of the first Plan Year beginning after December 31, 1986, if there is no such method, as if such benefit accrued not more rapidly than the slowest accrual rate permitted under the fractional rule of Code ss.411(b)(1)(C). Deductible employee contributions will not be taken into account in determining the Top Heavy Ratio. (d) DEFINITION OF DETERMINATION DATE: In determining the Top Heavy Ratio, the term Determination Date means the last day of the preceding Plan Year except for the first Plan Year when the Determination Date means the last day of such first Plan Year. 1.78 TRUSTEE The term Trustee means the person(s) or entity named as trustee or trustees in this Plan, or in any superseding trust under Section 7.16, and any successor to such Trustee or Trustees. 1.79 TRUST FUND The term Trust Fund or Trust means the assets of the Plan. 1.80 VALUATION DATE Except as otherwise provided in paragraph (c) of the definition of Top Heavy Ratio, the term Valuation Date means the date on which the Trustee determines the value of the Trust Fund. The Trust Fund must be valued at least annually as of the last day of the Plan Year, but the Administrator can elect to have all or any portion of the assets of the Trust Fund valued more frequently, including, but not limited to, semi-annually, quarterly, monthly, or daily. - 24 - 1.81 VESTED AGGREGATE ACCOUNT The term Vested Aggregate Account means the aggregate amount in a Participant's Account, Rollover Account (if any), Voluntary Employee Contribution Account (if any), and any other accounts as the Administrator may determine necessary from time to time, in which the Participant has a Vested Interest. 1.82 VESTED, VESTED INTEREST OR VESTING The terms Vested, Vested Interest, and Vesting mean a Participant's nonforfeitable percentage in an account maintained on his or her behalf under the terms of the Plan. A Participant's Vested Interest in his or her Participant's Account will be determined under the provisions of Section 4.6. 1.83 VOLUNTARY EMPLOYEE CONTRIBUTION The term Voluntary Employee Contribution means a non-deductible contribution made to the Plan by a Participant. 1.84 VOLUNTARY EMPLOYEE CONTRIBUTION ACCOUNT The term Voluntary Employee Contribution Account means the account to which a Participant's Voluntary Employee Contributions are allocated. A Participant will at all times have a 100% Vested Interest in all amounts credited to his or her Voluntary Employee Contribution Account. - 25 - ARTICLE 2 PLAN PARTICIPATION 2.1 ELIGIBILITY REQUIREMENTS Any Employee who was a Participant on December 31, 2002 will be eligible to continue as a Participant. Any other Employee who was not already a Participant on December 31, 2002 and is in an eligible class of Employees as described in paragraphs (a), (b) and (c) below, and who for purposes of this Article 2 is hereafter referred to as an Eligible Employee, will become eligible to enter the Plan as a Participant on the applicable entry date described in Section 2.2 in accordance with the following provisions: (a) ELIGIBILITY FOR ELECTIVE DEFERRALS: The eligibility requirements for the purpose of making Elective Deferrals to the Plan are as follows: (1) GENERAL ELIGIBILITY REQUIREMENTS: For the purpose of making Elective Deferrals only, an Eligible Employee described in subparagraph (2) will enter the Plan as a Participant on the applicable entry date in Section 2.2 upon reaching Age 21 and completing a 1-Year Period of Service. (2) ELIGIBLE CLASSES OF EMPLOYEES: For the purpose of making Elective Deferrals, all Employees are eligible to participate in the Plan upon satisfying the eligibility requirements in subparagraph (1) except for the following ineligible classes of Employees: (1) Employees whose employment is governed by the terms of a collective bargaining agreement between Employee representatives and the Employer in which retirement benefits were the subject of good faith bargaining, unless such agreement expressly provides for the inclusion of such Employees as Participants in the Plan; (2) Employees who are non-resident aliens who do not receive any earned income from the Employer which constitutes income from sources within the United States; and (3) Any person who is considered a Leased Employee but who (A) is not covered by a plan described in Code ss.414(n)(5), or (B) is covered by a plan described in Code ss.414(n)(5) but Leased Employees constitute more than 20% of the Employer's non-highly compensated workforce. (b) ELIGIBILITY FOR MATCHING CONTRIBUTIONS: Matching Contributions are not currently permitted under the terms of the Plan. (c) ELIGIBILITY FOR NON-ELECTIVE CONTRIBUTIONS: Non-Elective Contributions are not currently permitted under the terms of the Plan. (d) PARTICIPATION BY EMPLOYEES WHOSE STATUS CHANGES: If an Employee who is not an Eligible Employee under paragraphs (a), (b) or (c) above becomes an Eligible Employee thereunder, such Employee will participate in the Plan immediately solely for the purpose set forth therein if he or she satisfies the eligibility requirements set forth in such paragraph and would have previously become a Participant for the purpose set forth in such paragraph had he or she been an Eligible Employee under such paragraph. The participation of a Participant who becomes a member of an ineligible class will be suspended, and such Participant will be entitled to an allocation of Employer contributions and Forfeitures for the Plan Year only to the extent of Hours of Service completed while an Eligible Employee. Upon returning to an eligible class of Employees, a suspended Participant will immediately participate again in the Plan. The Vested Interest of an Employee who ceases to be an Eligible Employee will continue to increase in accordance with Section 4.6. - 26 - (e) PARTICIPATION BY FORMER PARTICIPANTS: A Participant who terminates employment with the Employer for any reason but who is reemployed as an Eligible Employee will again become a Participant in the Plan as provided in the definition of Period of Service. 2.2 ENTRY DATE An Eligible Employee who has satisfied the eligibility requirements set forth in Section 2.1 will enter the Plan as a Participant in accordance with the following provisions: (a) ENTRY DATE FOR ELECTIVE DEFERRALS: In order to make Elective Deferrals, an Eligible Employee described in Section 2.1(a)(2) who satisfies the eligibility requirements in Section 2.1(a)(1) will enter the Plan as a Participant on the first day of the month that coincides with or next follows the date on which the Employee first satisfies such eligibility requirements. (b) ENTRY DATE FOR MATCHING CONTRIBUTIONS: Matching Contributions are not currently permitted under the terms of this Plan (c) ENTRY DATE FOR NON-ELECTIVE CONTRIBUTIONS: Non-Elective Contributions are not currently permitted under the terms of this Plan 2.3 WAIVER OF PARTICIPATION Employees who have satisfied the eligibility requirements set forth in Section 2.1 are not permitted to waive participation in the Plan. 2.4 PARTICIPATION UPON REEMPLOYMENT If an Employee terminates employment and is re-employed by the Employer or an Affiliated Employer, his or her Period of Service for purposes of eligibility (as well as the time such Employee enters or re-enters the Plan as a Participant) will be determined in accordance with the rules described in the definition of Period of Service. 2.5 EXCLUSION OF ELIGIBLE EMPLOYEE If any Employee who should have been included as a Participant is erroneously excluded from the Plan in any Plan Year and discovery of such omission is not made until after a contribution for that Plan Year has been allocated, the Employer will correct the omission so that the omitted Employee receives the same amount which the Employee would have received had he or she not been omitted. Such omission can be corrected by one or more of the following methods: (a) by making an additional contribution to the Plan on behalf of the omitted Employee; (b) by allocating any available Forfeitures on behalf of the omitted Employee; and/or (c) by any other method of correction permitted under Revenue Procedure 2000-16 or any subsequent Revenue Procedure or guidance issued by the Internal Revenue Service. 2.6 INCLUSION OF INELIGIBLE EMPLOYEE If any person who should not have been included as a Participant is erroneously included in any Plan Year and discovery of that incorrect inclusion is not made until after a contribution for that Plan Year has been allocated, and such ineligible Employee has not received a distribution of the amount erroneously allocated to him or her, then the amount erroneously contributed with respect to the ineligible Employee cannot be refunded to the Employer and will be applied as a Forfeiture (other than Elective Deferrals, which will be distributed to the ineligible Employee) for the Plan Year in which the error is discovered. - 27 - ARTICLE 3 CONTRIBUTIONS AND ALLOCATIONS 3.1 EMPLOYER CONTRIBUTIONS Each Plan Year the Employer will make a contribution to the Plan, the amount of which will be determined in accordance with the following provisions: (a) ELECTIVE DEFERRALS: Each Participant may enter into a Salary Deferral Agreement authorizing the Employer to withhold a percentage of the Participant's Compensation as an Elective Deferral. The amount of each Participant's Elective Deferral for any Plan Year will be determined in accordance with the following provisions, subject to any limitations thereon that may be imposed by the Administrator: (1) DEFERRAL PERCENTAGE: For each contribution period, a Participant may elect that up to the maximum amount of Compensation that will not cause the Plan to violate the ADP Test for the Plan Year be withheld as an Elective Deferral. Elective Deferrals may be made in whole percentages of Compensation or in specific dollar amounts as designated by the Participant. The Administrator will have the right to direct that such percentages of Compensation be rounded to the next highest or lowest dollar. Furthermore, on a uniform nondiscriminatory basis, the Administrator may permit a Participant to identify separate components of the Participant's Compensation (such as base salary, bonuses, etc.) and to specify that a different percentage (or dollar amount) apply to each such component. (2) ANNUAL DOLLAR LIMITATION: The actual dollar amount withheld during the course of a Plan Year under subparagraph (1) cannot exceed the lesser of (A) the maximum dollar amount permitted for that Plan Year under Code ss.402(g)(5), or (B) the maximum amount permitted for that Plan Year under subparagraph (1). (3) DEFERRAL ELECTION WITH RESPECT TO BONUSES AND SEVERANCE: On a uniform nondiscriminatory basis, and subject to the limits set forth in subparagraph (2) above, the Administrator may permit a Participant to make an election to defer up to 100% of (A) Compensation received as a bonus that is paid after the end of the Plan Year for which the bonus is payable, but which is not paid more than two and one-half months after the last day of the Plan Year; and (B) Compensation received as severance pay provided such Compensation is received in a single lump sum payment. Severance pay that is received in the form of installment payments is not eligible for Elective Deferrals under this Plan. (4) SALARY REDUCTION AGREEMENT: In accordance with such procedures as may be specified by the Administrator, each Participant will complete a Salary Deferral Agreement on a form made available by, and filed with, the Administrator. A Participant may, in accordance with those procedures, (A) amend the agreement to increase or decrease the percentage being withheld; and (B) suspend or cancel the agreement. If a Participant cancels or suspends the agreement, the Participant will not be permitted to put a new agreement into effect until such time as set forth in the procedures established by the Administrator. If necessary to insure that the Plan satisfies the ADP Test, the Administrator may also amend or terminate a Participant's agreement on written notice to the Participant. - 28 - (5) PARTICIPANT ELECTION TO DEFER UP TO 100% OF COMPENSATION: On a uniform nondiscriminatory basis, the Administrator may permit a Participant whose Salary Deferral Agreement has not authorized the Employer to withhold at the maximum rate permitted under subparagraph (1) to increase the total amount withheld for a Plan Year to the maximum rate permitted under subparagraph (1), in which event the Participant may authorize the Employer to withhold a supplemental amount up to 100% of his or her eligible Compensation for one or more pay periods. In no event can the sum of the amount withheld under the Salary Deferral Agreement plus the supplemental withholding exceed the lesser of (A) the maximum amount permitted under subparagraph (1) above; or (B) the maximum dollar amount permitted for that Plan Year under Code ss.402(g)(5); or (C) 25% of the Participant's Code ss.415 Compensation for that Plan Year. (6) ELECTIVE DEFERRALS MUST SATISFY ADP TEST: All Elective Deferrals made for a Plan Year must satisfy the ADP Test. Elective Deferrals that exceed the Code ss.402(g)(5) dollar limitation will be deemed Excess Elective Deferrals and will be returned under Section 5.19. Elective Deferrals that do not satisfy the ADP Test will be deemed Excess Contributions and will be returned under Section 5.20. (7) PAYROLL DEDUCTION AUTHORIZATION: An Elective Deferral will constitute a payroll deduction authorization for purposes of applicable state law. (b) MATCHING CONTRIBUTIONS: Matching Contributions are not currently permitted. (c) NON-ELECTIVE CONTRIBUTIONS: Non-Elective Contributions are not currently permitted. (d) QUALIFIED MATCHING CONTRIBUTIONS: The Employer may make a Qualified Matching Contribution each Plan Year in such amount as the Employer, in its sole discretion, may determine. The Employer may also elect to treat all or any portion of a Matching Contribution as a Qualified Matching Contribution. (e) QUALIFIED NON-ELECTIVE CONTRIBUTIONS: The Employer may elect to make a Qualified Non-Elective Contribution each Plan Year in such amount as the Employer determines. The Employer may also elect to treat as a Qualified Non-Elective Contribution all or any portion of a Non-Elective Contribution not yet allocated under Section 3.2(c). (f) CONTRIBUTION PERIOD: Each Plan Year, any contribution that is made under the terms of the Plan may, at the election of the Administrator, be contributed to the Plan each payroll period; each month; each Plan quarter; on an annual basis; or on any other less than annual contribution period basis as determined by the Employer, provided such contribution period does not discriminate in favor of Highly Compensated Employees. The Employer may elect a different contribution period for each type of contribution. (g) CONTRIBUTION LIMITATIONS: Notwithstanding paragraphs (a), (b) and (c), (1) the sum of all Employer contributions will not exceed the maximum amount deductible under Code ss.404 and will not exceed the limitations set forth in Code ss.415; and (2) for Plan Years beginning on or after January 1, 1997, if this Plan provides contributions or benefits for Employees some or all of whom are Owner-Employees, such contributions or benefits can only be provided with respect to the Earned Income of such Owner-Employee which is derived from the trade or business with respect to which the Plan is established. (h) REFUND OF CONTRIBUTIONS: Contributions made to the Plan by the Employer can only be returned to the Employer in accordance with the following provisions: - 29 - (1) FAILURE TO INITIALLY QUALIFY: If the Plan fails to initially satisfy the requirements of Code ss.401(a) and the Employer declines to amend the Plan to satisfy such requirements, contributions made prior to the date such qualification is denied must be returned to the Employer within 1 year of the date of such denial, but only if the application for the qualification is made by the time prescribed by law for filing the Employer's tax return for the taxable year in which the Plan is adopted, or by such later date as the Secretary of the Treasury may prescribe. (2) CONTRIBUTIONS MADE UNDER A MISTAKE OF FACT: If a contribution is attributable in whole or in part to a good faith mistake of fact, including a good faith mistake in determining the deductibility of the contribution under Code ss.404, then an amount may be returned to the Employer which is equal to the excess of the amount contributed over the amount which would have been contributed had the mistake not occurred. Earnings attributable to any such excess contribution will not be returned, but losses attributable to the excess contribution will reduce the amount so returned. Such amount will be returned within one year of the date the contribution was made or the deduction disallowed, as the case may be. (3) NONDEDUCTIBLE CONTRIBUTIONS: Except to the extent an Employer may intentionally make a nondeductible contribution, for example to correct an administrative error or restore a Forfeiture, any contribution by the Employer is conditioned on its deductibility and will otherwise be returned to the Employer. (i) FORM OF CONTRIBUTION: The Employer's contribution (if any) may consist of (1) cash; (2) qualifying employer securities or qualifying employer real property as defined in ss.407(d) of ERISA, provided the acquisition of such qualifying employer securities or qualifying real property securities satisfies the requirements of ss.408(e) of ERISA; or (3) any other property that is permitted under Code ss.4975 and is acceptable to the Trustee. 3.2 ALLOCATION OF EMPLOYER CONTRIBUTIONS Subject to the Top Heavy allocation requirements under Section 3.5 and the Code ss.415 limitations of Article 6, each Eligible Participant's share of the various types of Employer contributions made under the Plan will be allocated to his or her Participant's Account in accordance with the following provisions: (a) ELECTIVE DEFERRALS: Each Participant's Elective Deferrals contributed under Section 3.1(a) will be allocated to the Participant's Elective Deferral Account. (b) MATCHING CONTRIBUTIONS: Matching Contributions are not currently permitted. (c) NON-ELECTIVE CONTRIBUTIONS: Non-Elective Contributions are not currently permitted. (d) QUALIFIED MATCHING CONTRIBUTIONS: Qualified Matching Contributions contributed under Section 3.1(d) and any Matching Contributions permitted and contributed under Section 3.1(b) that are treated as QMACs will be allocated in accordance with the following provisions to the Qualified Matching Contribution Account of each Participant for whom a Qualified Matching Contribution is made for the Plan Year: (1) PARTICIPANTS ELIGIBLE FOR ALLOCATION: Qualified Matching Contributions will be allocated on behalf of each Eligible Participant who for the Plan Year is a Non-Highly Compensated Employee who made an Elective Deferral for the Plan Year and is considered an Eligible Participant for the purpose of receiving a - 30 - Matching Contribution allocation, or if eligibility for Matching Contributions is more restrictive than for Elective Deferrals, is considered an Eligible Participant only for the purpose of making Elective Deferrals. (2) PERMISSIBLE METHODS OF ALLOCATION: Any allocation of Qualified Matching Contributions to an Eligible Participant who is described in subparagraph (1) above will be made using one of the methods described in subparagraphs (2)(A) through (F) below. However, the actual method used for a particular Plan Year will be the method set forth in subparagraph (3) below. (A) PRO-RATA METHOD: The allocation will be made in the ratio that the Elective Deferral of each such Eligible Participant bears to the total Elective Deferrals of all such Eligible Participants, except that any Elective Deferrals that are not used to determine the basic Matching Contribution allocated to a Participant under Section 3.1(b) or Section 3.2(b) will not be counted. (B) PRO-RATA METHOD USING BOTTOM-UP BASED ON COMPENSATION: The allocation will be made beginning with a group of one or more of such Eligible Participants and who have the lowest Compensation for the Plan Year and continuing with the next one or more such Eligible Participants who have the next lowest Compensation until no further allocations are required to pass the ADP or ACP Tests. The amount so allocated for the Plan Year to any such Eligible Participant will be in the ratio that such Eligible Participant's Elective Deferral bears to the total Elective Deferrals of all such Eligible Participants, except that any Elective Deferrals not used to determine basic Matching Contributions allocated to a Participant under Section 3.1(b) or 3.2(b) will not be counted. (C) PRO-RATA METHOD USING BOTTOM-UP BASED ON ELECTIVE DEFERRALS: The allocation will be made beginning with a group of one or more of such Eligible Participants for the Plan Year and who have the lowest Elective Deferral amount for the Plan Year and continuing with the next one or more Eligible Participants who have the next lowest Elective Deferral amount until no further allocations are required for the Plan to pass the ADP or ACP Tests. The amount so allocated for the Plan Year to any such Eligible Participant will be in the ratio that such Eligible Participant's Elective Deferral bears to the total Elective Deferrals of all such Eligible Participants, except that any Elective Deferrals not used to determine the basic Matching Contributions allocated to a Participant under Section 3.1(b) or 3.2(b) will not be counted. (D) PER CAPITA METHOD: The amount that is allocated for the Plan Year to any such Eligible Participant for the Plan Year will be on a per capita (equal dollar amount) basis to each such Eligible Participant. (E) PER CAPITA METHOD USING BOTTOM-UP BASED ON COMPENSATION: The allocation will be made beginning with a group of one or more of such Eligible Participants who have the lowest Compensation for the Plan Year and continuing with the next one or more such Eligible Participants who have the next lowest Compensation until no further - 31 - allocations are required for the Plan to pass the ADP or ACP Tests. The amount so allocated for the Plan Year to any such Eligible Participant will be on a per capita (equal dollar amount) basis to each such Eligible Participant. (F) PER CAPITA METHOD USING BOTTOM-UP BASED ON ELECTIVE DEFERRALS: The allocation will be made beginning with a group of one or more of such Eligible Participants who have the lowest Elective Deferral amount for the Plan Year and continuing with the next one or more such Eligible Participants who have the next lowest Elective Deferral amount until no further allocations are required for the Plan to pass the ADP or ACP Tests. The amount so allocated for the Plan Year to any such Eligible Participant will be on a per capita (equal dollar) basis to each such Eligible Participant. (3) ACTUAL METHOD OF QMAC ALLOCATION: Until this subparagraph (3) is amended by the Employer to specify a different method of allocation, QMACs will be allocated using the method described in subparagraph (2)(A) above. (4) PERMISSIBLE DISAGGREGATION: Permissible disaggregation under Code ss.410(b)(4) or ss.401(k)(3)(F) will be used for the ADP and/or ACP Test for the Plan Year to further limit the number of Eligible Participants who receive such allocation to those Participants (i) who also satisfy the maximum minimum age and service requirements of Code ss.410(a)(1)(A) for the purpose of making Elective Deferrals or eligibility to share in Matching Contributions, or (ii) to those Participants who do not satisfy the maximum minimum age and service requirements of Code ss.410(a)(1)(A) for the purpose of making Elective Deferrals or eligibility to share in Matching Contributions; and if permissible disaggregation under Code ss.410(b)(4) is used for the ADP and/or ACP Tests for the Plan Year, the Employer will separately determine the amount to be allocated hereunder with respect to such Eligible Participants in clauses (i) and (ii). (5) ALLOCATION TO HCES: If the Employer makes an additional Qualified Matching Contribution after no further allocation of QMACs is required for the Plan to pass the ADP and/or ACP Tests, any such contribution will be allocated in the same manner described in subparagraph (3) above (provided however that the ADP and/or ACP Tests continue to be satisfied) to all such Eligible Participants who for the Plan Year are HCEs (or to all such Eligible Participants who are HCEs or NHCEs) who made an Elective Deferral and are considered Eligible Participants for the purpose of receiving a Matching Contribution allocation. (e) QUALIFIED NON-ELECTIVE CONTRIBUTIONS: Qualified Non-Elective Contributions contributed under Section 3.1(e) and Non-Elective Contributions contributed under Section 3.1(c) that are treated as QNECS will be allocated to the Qualified Non-Elective Contribution Account of an Eligible Participant in accordance with the following: (1) PARTICIPANTS ELIGIBLE FOR ALLOCATION: Subject to subparagraphs (2) and (3) below, Qualified Non-Elective Contributions will be allocated on behalf of each Eligible Participant who for the Plan Year is a Non-Highly Compensated Employee and is considered an Eligible Participant for the purpose of receiving a Non-Elective Contribution allocation for the Plan Year, or if Non-Elective Contributions are not permitted or if eligibility for Non-Elective Contributions is more restrictive than for Elective Deferrals, is considered an Eligible Participant only for the purpose of making Elective Deferrals. - 32 - (2) PERMISSIBLE METHODS OF ALLOCATION: Any allocation of Qualified Non-Elective Contributions under this Section to an Eligible Participant who is described in subparagraph (1) above will be made using one of the methods described in subparagraphs (2)(A) through (D) below. However, the actual method used for a particular Plan Year will be the method set forth in subparagraph (3) below. (A) PRO-RATA METHOD: The amount that is so allocated for any such Eligible Participant will be in the ratio that his or her Compensation bears to the total Compensation of all such Eligible Participants. (B) PRO-RATA METHOD USING BOTTOM-UP BASED ON COMPENSATION: The allocation will be made beginning with a group of one or more of such Eligible Participants who have the lowest Compensation for the Plan Year and continuing with the next one or more such Eligible Participants who have the next lowest Compensation until no further allocations are required to pass the ADP or ACP Tests. The amount that is so allocated for the Plan Year to any such Eligible Participant will be in the ratio that the Compensation of each such Eligible Participant bears to the total Compensation of all such Eligible Participants. (C) PER CAPITA METHOD: The amount that is so allocated for the Plan Year to any such Eligible Participant will be on a per capita (equal dollar amount) basis to each Eligible Participant. (D) PER CAPITA METHOD USING BOTTOM-UP BASED ON COMPENSATION: The allocation will be made beginning with a group of one or more of such Eligible Participants who have the lowest Compensation for the Plan Year and continuing with the next one or more Eligible Participants who have the next lowest Compensation until no further allocations are required for the Plan to pass the ADP or ACP Tests. The amount so allocated for the Plan Year to any such Eligible Participant will be on a per capita (equal dollar amount) basis to each such Eligible Participant. (3) ACTUAL METHOD OF QNEC ALLOCATION: Until this subparagraph (3) is amended by the Employer to specify a different method of allocation, QNECs will be allocated using the method described in subparagraph (2)(A) above. (4) PERMISSIBLE DISAGGREGATION: Permissable disaggregation under Code ss.410(b)(4) or ss.401(k)(3)(F) will be used for the ADP and/or ACP Test for the Plan Year to further limit the number of Eligible Participants who receive such allocation to those Participants (i) who also satisfy the maximum minimum age and service requirements of Code ss.410(a)(1)(A) for the purpose of making Elective Deferrals or eligibility to share in Matching Contributions, or (ii) to those Participants who do not satisfy the maximum minimum age and service requirements of Code ss.410(a)(1)(A) for the purpose of making Elective Deferrals or eligibility to share in Matching Contributions; and if permissable disaggregation under Code ss.410(b)(4) is used for the ADP and/or ACP Tests for the Plan Year, the Employer will separately determine the amount to be allocated hereunder with respect to such Eligible Participants in clauses (i) and (ii). - 33 - (5) ALLOCATION TO HCES: If the Employer makes an additional Qualified Non-Elective Contribution after no further allocation of QNECs is required for the Plan to pass the ADP and/or ACP Tests, any such contribution will be allocated in the same manner described in subparagraph (3) (provided however that the ADP and/or ACP Tests continue to be satisfied) to all such Eligible Participants who for the Plan Year are HCEs (or to all such Eligible Participants who are HCEs or NHCEs) and are considered Eligible Participants for the purpose of receiving a Non-Elective Contribution allocation for the Plan Year. 3.3 ALLOCATION OF EARNINGS AND LOSSES As of each Valuation Date, accounts which have not been distributed since the prior Valuation Date will have the net income of the Trust Fund earned since the prior Valuation Date allocated in accordance with such rules and procedures as may be established by the Administrator, and applied in a uniform and nondiscriminatory manner; or accounts will be valued and adjusted as hereinafter set forth in this Section. Net income is the net of any interest, dividends, unrealized appreciation and depreciation, capital gains and losses, and investment expenses of the Trust Fund determined on each Valuation Date. (a) NON-SEGREGATED ELECTIVE DEFERRAL ACCOUNTS: Elective Deferral Accounts which have not been segregated from the general Trust Fund for investment will have net income allocated thereto in the ratio that the value of each such non-segregated account bears to the total value of all such non-segregated accounts on the Valuation Date. For purposes of this paragraph, the value of each such account on the Valuation Date will be determined on a time-weighted basis as determined by the Administrator. (b) NON-SEGREGATED MATCHING CONTRIBUTION ACCOUNTS: Matching Contributions are not currently permitted under the terms of this Plan. (c) NON-SEGREGATED NON-ELECTIVE CONTRIBUTION ACCOUNTS: Non-Elective Contributions are not currently permitted under the terms of this Plan. (d) FORFEITURE ACCOUNT: The Forfeiture Account will share in the allocation of the Plan's earnings and losses under this Section. (e) SEGREGATED ACCOUNTS AND POLICY DIVIDENDS: Any accounts which have been segregated for investment purposes, including any Directed Investment Accounts that may be established in accordance with Section 7.15 and any other accounts (including Directed Investment Accounts) which are valued on a daily basis, will only have the net income earned thereon allocated thereto. Any insurance Policy dividends or credits will be allocated to the Participant's Account for whose benefit the Policy is held. 3.4 ALLOCATION OF FORFEITURES The Administrator may elect each Plan Year to first use all or any portion of the Forfeiture Account to pay administration costs of the Plan, and/or to restore previously forfeited Account balances as provided under Section 5.7 or Section 5.13. Subject to the Top Heavy allocation requirements under Section 3.5 and the Code ss.415 limitations of Article 6, any remaining Forfeitures will be used by the Administrator in the following manner: (a) FORFEITURES OF MATCHING CONTRIBUTIONS: Matching Contributions are not currently permitted under the terms of the Plan. - 34 - (b) FORFEITURES OF NON-ELECTIVE CONTRIBUTIONS: Non-Elective Contributions are not currently permitted under the terms of the Plan. (c) EXCESS AGGREGATE CONTRIBUTIONS: The Administrator may elect that all of any portion of the Forfeitures which are attributable to Excess Aggregate Contributions will (1) be allocated (after all other Forfeitures) to the Matching Contribution Account of each Participant who is a Non-Highly Compensated Employee who made Elective Deferrals or Employee contributions. The allocation will be made in the ratio which each such Participant's Compensation for the Plan Year bears to the total Compensation of all such Participants for such Plan Year; and/or (2) be applied to reduce Employer contributions for the Plan Year in which the excess arose to the extent it exceeds Employer contributions or the Employer has already contributed for such Plan Year. 3.5 TOP HEAVY MINIMUM ALLOCATION In any Top Heavy Plan Year in which a Key Employee receives an allocation of Employer contributions or Forfeitures, each Employee who is described in paragraph (a) below will receive the Top Heavy benefit required under the provisions of Code ss.416, such benefit to be determined in accordance with the following provisions: (a) PARTICIPANTS WHO MUST RECEIVE TOP HEAVY MINIMUM ALLOCATION: For each Plan Year in which a Top Heavy contribution is required, the Top Heavy Minimum Allocation (or such lesser amount as may be permitted under paragraph (b) below) will be made for each Participant who is a Non-Key Employee employed by an Employer on the last day of the Plan Year in an eligible class of Employees as described in Section 2.1, even if such Participant (1) fails to complete any minimum Hours of Service or Period of Service required to receive an allocation of Employer contributions or Forfeitures for the Plan Year; (2) fails to make elective contributions to the Plan in the case of a cash or deferred arrangement; (3) receives Compensation that is less than a stated amount; or (4) declines to make a mandatory Employee contribution to the Plan. (b) LESSER ALLOCATION ALLOWED: If the amount of Employer contributions and Forfeitures allocated to the Participant's Account of each Key Employee for the Plan Year is less than 3% of his or her Compensation, and if this Plan is not required to be included in an Aggregation Group to enable a defined benefit plan to meet the requirements of Code ss.401(a)(4) or ss.410, then the amount allocated under this Section for each Participant who is described in paragraph (a) above will be equal to the largest percentage of Employer contributions and Forfeitures allocated to the Participant's Account of a Key Employee for that Plan Year, determined after taking into account elective contributions made by a Key Employee to a cash or deferred arrangement maintained by the Employer. (c) PARTICIPATION IN MULTIPLE DEFINED CONTRIBUTION PLANS: If a Participant described in paragraph (a) above participates in this Plan and in one or more defined contribution plans that are included with this Plan in a Required Aggregation Group, and if the allocation of Employer contributions and Forfeitures in this Plan or any other such defined contribution plan is insufficient to satisfy the Top Heavy requirement with respect to such Participant, such requirement will nevertheless be deemed to be satisfied if the aggregate allocation of Employer contributions and Forfeitures made under this Plan and all other such plans on behalf of such Participant is sufficient to satisfy the Top Heavy requirement. If not, the Employer will make an additional contribution to this Plan and/or to one or more such plans on behalf of the Participant in order that the aggregate allocation of Employer contributions and Forfeitures to this Plan and all such plans satisfies the Top Heavy requirements with respect to such Participant. - 35 - (d) PARTICIPATION IN DEFINED BENEFIT PLAN AND DEFINED CONTRIBUTION PLAN: Any Participant described in paragraph (a) above who participates in this Plan and in a defined benefit plan which is included with this Plan in a Required Aggregation Group will, in lieu of the allocation provided under paragraph (a) above, receive an allocation under this Plan (or any other defined contribution plan sponsored by the Employer) which is equal to 5% of Compensation. However, in any Top Heavy Limitation Year beginning before January 1, 2000 in which the Employer wishes to avail itself of the adjustment described in Section 6.5(f), (1) the 5% allocation described herein will be increased to 7.5%; and (2) the allocation under paragraph (a) above for each Non-Key Employee described therein who is a Participant only in this Plan will be increased from 3% to 4% of Compensation. Notwithstanding the foregoing to the contrary however, the Administrator may determine, in a uniform non-discriminatory manner which is intended to satisfy the requirements of Code ss.416(f) regarding the preclusion of required duplication and inappropriate omission of Top Heavy minimum benefits or contributions, that such Non-Key Employee will receive the minimum Top Heavy benefit required under Code ss.416 under the defined benefit plan in lieu of any such benefit under the terms of this Plan. (e) CONTRIBUTIONS THAT CAN BE USED TO SATISFY TOP HEAVY MINIMUM: The following contributions will be taken into account in determining if the Employer has contributed an amount necessary to satisfy the requirements of this Section: Non-Elective Contributions; Qualified Non-Elective Contributions; Safe Harbor Non-Elective Contributions under Section ; and any other contributions as may be permitted by law. However, Elective Deferrals cannot be used to satisfy the Top Heavy requirements. 3.6 SAFE HARBOR CONTRIBUTIONS For Plan Years beginning on or after January 1, 1999, this Section will apply for any such Plan Year in which the Sponsor, by the Sponsor's written resolution and issuance of a Safe Harbor Notice (as described in paragraph (d) below), elects to administer the Plan pursuant to the "safe harbor" provisions of Code ss.401(k)(12) (pertaining to alternative methods of satisfying the ADP Test) and/or Code ss.401(m)(11) (pertaining to additional alternative methods of satisfying the ACP Test). The Sponsor's written resolution must specify the Plan Year for which the safe harbor is elected, the method by which the safe harbor is to be satisfied, and whether "safe harbor" contributions will be made to HCEs as well as NHCEs. The Sponsor's written resolution will be deemed to be an amendment to this Plan if made in accordance with Notice 98-52, Notice 2000-3 and any subsequent guidance issued by the Internal Revenue Service. (a) DEFINITIONS: For any Plan Year in which the Sponsor elects to administer the Plan in accordance with this Section, the following definitions will apply: (1) ACP TEST SAFE HARBOR MATCHING CONTRIBUTION: The term ACP Test Safe Harbor Matching Contribution means a Matching Contribution described in paragraph (c) below. (2) ADP TEST SAFE HARBOR CONTRIBUTION: The term ADP Test Safe Harbor Contribution means a "Basic Matching Contribution" as described in paragraph (b)(1); an "Enhanced Matching Contribution" as described in paragraph (b)(2); and a Non-Elective Contribution as described in paragraph (b)(3). (3) COMPENSATION: The term Compensation is defined in Section 1.16, except that for purposes of this Section: (1) no dollar limitation other than the Code ss.401(a)(17) limitation will apply under this paragraph to Non-Highly Compensated Employees; and - 36 - (2) Compensation may, at the discretion of the Administrator, be excluded (i) for any period during which an Employee was not a Participant in the Plan; and (ii) for any period during which a cash or deferred election was not in effect under the terms of the Plan. However, solely for purposes of determining Compensation subject to a Participant's deferral election, the Employer may use an alternative definition to the one described in the preceding sentence, provided such alternative definition is a reasonable definition within the meaning of regulation ss.1.414(s)-1(d)(2) and permits each Participant to make sufficient Elective Deferrals to receive the maximum amount of Matching Contributions (determined using the definition of Compensation described in the preceding sentence) available under the Plan. (4) MATCHING CONTRIBUTION: The term Matching Contribution means a contribution made by the Employer because of a Safe Harbor Participant's Elective Deferrals. (5) SAFE HARBOR PARTICIPANT: The term Safe Harbor Participant means each Participant who (i) is a Non-Highly Compensated Employee (and if the Employer elects, one or more Highly Compensated Employees) for the Plan Year; and (ii) was eligible to make an Elective Deferral at any time during the Plan Year or who would have been eligible to make Elective Deferrals but for a suspension due to a hardship distribution or a statutory limitation (such as Code ss.402(g) and ss.415). However, for Plan Years beginning on or after January 1, 1999, a Safe Harbor Participant will only include those Participants described in the preceding sentence who have reached Age 21 and completed 1 at least Year of Service. (b) ADP TEST SAFE HARBOR CONTRIBUTIONS: For a Plan Year in which the Employer wishes to utilize the alternative method of satisfying the ADP Test, the Employer must make an ADP Test Safe Harbor Contribution to the Plan in the form of a "Basic Matching Contribution", an "Enhanced Matching Contribution" and/or a "Safe Harbor Non-Elective Contribution", or a "Safe Harbor Alternative Contribution". The Employer must specify in the Safe Harbor Notice which ADP Test Safe Harbor Contribution it intends to make for the Plan Year, and any such contribution will be made in accordance with one of the following provisions: (1) BASIC MATCHING CONTRIBUTION: If the Employer elects to make a Basic Matching Contribution, it will be made on behalf of each Safe Harbor Participant in an amount equal to the sum of (i) 100% of the amount such Participant's Elective Deferrals that do not exceed 3% of his or her Compensation; plus (ii) 50% of the amount of such Participant's Elective Deferrals that exceed 3% of his or her Compensation but do not exceed 5% of Compensation ("Basic Matching Contributions"). The maximum match that can be made under this Basic Matching Contribution formula is 4% of Compensation which would apply to any Safe Harbor Participant who defers at least 5% of Compensation. (2) ENHANCED MATCHING CONTRIBUTION: If the Employer elects to make an "Enhanced Matching Contribution" on behalf of each Safe Harbor Participant, such contribution will be an amount equal to the sum of (A) and (B) as follows: (A) The amount of such Participant's Elective Deferrals that do not exceed the percentage specified in the Safe Harbor Notice (which percentage must be at least 3% but not more than 6%) of Compensation; plus - 37 - (B) The percentage specified in the Safe Harbor Notice of such Participant's Elective Deferrals that exceed the percentage specified in the Safe Harbor Notice (which percentage must be at least 3% but not more than 6%) of the Participant's Compensation for the Plan Year and that do not exceed the percentage specified in the Safe Harbor Notice of the Employee's Compensation for the Plan Year. Notwithstanding the foregoing, Matching Contributions contributed under this subparagraph must, at any rate of Elective Deferrals, equal at least the Matching Contribution the Participant would have received if the Employer were making Basic Matching Contributions, but the rate of match cannot increase as deferrals increase. (3) SAFE HARBOR NON-ELECTIVE CONTRIBUTION: If the Employer elects to make a Safe Harbor Non-Elective Contribution for each Safe Harbor Participant, it will be an amount equal to at least 3% of each such Participant's Compensation. (4) ALLOCATION OF ADP TEST SAFE HARBOR CONTRIBUTIONS: All ADP Test Safe Harbor Contributions (other than Safe Harbor Alternative Contributions) will be allocated to a Participant's Safe Harbor Contribution Account; and under no circumstances will such contributions be allocated with regard to permitted disparity under Code ss.401(1). (5) VESTING AND DISTRIBUTION OF ADP TEST SAFE HARBOR CONTRIBUTIONS: ADP Test Safe Harbor Contributions allocated to a Participant's Safe Harbor Contribution Account will be 100% Vested at all times, and can only be distributed upon the earlier of the date a Participant incurs a Termination of Employment; the date a Participant dies; the date a Participant suffers a Disability; the date a Participant reaches Age 59 1/2 if on or after such date in-service withdrawals are permitted under Section 5.18; or the date an event described in Code ss.401(k)(10) occurs. ADP Test Safe Harbor Contributions may not be distributed because of hardship. (6) TRUE-UP ELECTION: If for any Plan Year "Basic Matching Contributions" or "Enhanced Matching Contributions" are made to the Plan on a basis that is more frequent than annual, and if on the last day of any such Plan Year the dollar amount of any such contribution made on behalf of a Safe Harbor Participant is less than the dollar amount that would have been made if such contribution for that Plan Year had been contributed on an annual basis only, then the Employer may elect for any such Plan Year to make an additional contribution in order to make the amount contributed for a Safe Harbor Participant for the full Plan Year equal to the amount that would have been made if the contribution for that Plan Year had been contributed on an annual basis only. However, any such additional contribution can only be made to the Plan on a uniform nondiscriminatory basis. (c) ACP TEST SAFE HARBOR MATCHING CONTRIBUTIONS: In order to use the alternative method of satisfying the ACP Test, the Employer may, in addition to the ADP Test Safe Harbor Contributions described in paragraph (b) above, elect in its Safe Harbor Notice to make an ACP Test Safe Harbor Matching Contribution to the Plan on behalf of each Safe Harbor Participant. Such contribution will be made in accordance with the following provisions, and must be equal to one of the following amounts: - 38 - (1) SINGLE TIER FIXED FORMULA: The amount determined by multiplying the Safe Harbor Participant's Elective Deferrals for the Plan Year by the matching percentage specified in the Safe Harbor Notice; provided, however, that such amount cannot exceed 6% of the Safe Harbor Participant's Compensation. (2) TWO TIERED FIXED FORMULA: The amount determined by multiplying the Safe Harbor Participant's Elective Deferrals that do not exceed the percentage specified in the Safe Harbor Notice of such Participant's Compensation for the Plan Year by the "first tier" matching percentage specified in the Safe Harbor Notice, plus the amount determined by multiplying the Safe Harbor Participant's Elective Deferrals thereafter by the "second tier percentage" specified in the Safe Harbor Notice, but no such contribution will be made with respect to Elective Deferrals that exceed 6% of the Participants Compensation. Notwithstanding the foregoing, the "second tier percentage" cannot exceed the "first tier percentage". (3) SINGLE TIER DISCRETIONARY FORMULA: An amount determined by multiplying the Safe Harbor Participant's Elective Deferrals for the Plan Year by a discretionary percentage, excluding any such Elective Deferrals in excess of 6% of the Safe Harbor Participant's Compensation; provided, however, that such amount cannot exceed 4% of the Safe Harbor Participant's Compensation. (4) OTHER FORMULAS: An amount determined by any other formula in which (i) Matching Contributions are not made on Elective Deferrals in excess of 6% of Compensation, (ii) the amount of Matching Contributions subject to the Employer's discretion cannot exceed 4% of Compensation, (iii) no HCE can receive a greater rate of Matching Contributions than an NHCE at the same rate of Elective Deferrals, and (iv) the rate of Matching Contributions cannot increase as a Participant's Elective Deferrals increase. (5) VESTING AND DISTRIBUTION OF ACP TEST SAFE HARBOR CONTRIBUTIONS: Unless otherwise indicated in the Safe Harbor Notice to be nonforfeitable, ACP Test Safe Harbor Matching Contributions will be Vested in accordance with the Vesting schedule in Section 4.6(c). Forfeitures of non-Vested ACP Test Safe Harbor Matching Contributions will be used to reduce Employer contributions. (d) SAFE HARBOR NOTICE: The term Safe Harbor Notice means a written notice provided by the Employer to all eligible Employees in accordance with Notice 98-52 and 2000-3, and any subsequent guidance issued by the Internal Revenue Service. In addition to any other election periods provided under the Plan, each Participant may make or modify a deferral election during the 30-day period immediately following receipt of the Notice. 3.7 ROLLOVER CONTRIBUTIONS Subject to any rules or procedures that may be established by the Administrator under paragraph (f) below, any Employee who is in an eligible class of Employees, regardless of whether such Employee has satisfied the Plan's eligibility requirements, may, with the consent of the Administrator, make Rollover Contributions to the Plan. Rollover Contributions will be allocated to a Participant's Rollover Account and, subject to any rules or procedures established hereunder, will be administered in accordance with the following provisions: (a) INVESTMENT OF ROLLOVER ACCOUNTS: Except for that portion which a Participant may be permitted to self-direct under Section 7.15, the Administrator may choose for investment purposes to either segregate Rollover Accounts into separate interest bearing accounts or to invest Rollover Accounts as part of the general Trust Fund, in which case such accounts will share in the allocation of earnings and losses under Section 3.3(a). - 39 - (b) WITHDRAWAL OF ROLLOVERS: Subject to paragraph (c) below, an Employee may request a withdrawal of all or any portion of his or her Rollover Account at any time prior to becoming a Participant in the Plan, and thereafter upon the earlier of (1) the date the Employee is entitled to a distribution of his or her Participant's Account under the provisions of Article 5, or (2) within an administratively reasonable time after the Employee's Termination of Employment. An Employee may also request a withdrawal of all or any portion of his or her Rollover Account at any time prior to the dates described in (1) and (2) above. The Administrator may require up to 60 days notice in advance of the requested date of withdrawal. A Rollover withdrawal will not prevent an Employee from accruing future benefits from Employer contributions. Any amount withdrawn may be redeposited to the Participant's Rollover Account if such prior withdrawn distribution continues to qualify as a Rollover Contribution except for the fact that the amount originated from this Plan. (c) SPOUSAL CONSENT REQUIREMENTS UPON WITHDRAWAL: Any Rollover Contribution that at the time it is made to this Plan is no longer subject to the requirements of Code ss.401(a)(11) can be withdrawn from the Plan without the consent of the Participant's Spouse. However, the withdrawal of any Rollover Contribution that was a direct or indirect transfer as defined in Code ss.401(a)(11) from a defined benefit plan, a money purchase plan, a target benefit plan, a stock bonus plan, or a profit sharing plan that provided for a life annuity form of payment to the Participant will be subject to the spousal consent requirements in Section 5.16. (d) FORM OF DISTRIBUTION: Any Rollover Contribution a Participant withdraws from the Plan prior to the time the Participant is entitled to a distribution of his or her Participant's Account will only be distributed in a lump sum. Any amount remaining in a Participant's Rollover Account at the time the Participant is entitled to a distribution of his or her Participant's Account that is not subject to the spousal consent requirements in paragraph (c) above will be distributed, at the election of the Participant, in a lump-sum or in the same manner as the Participant's Account under Article 5. Any amount remaining in the Participant's Rollover Account at the time the Participant is entitled to a distribution of his or her Participant's Account that is subject to the spousal consent requirements will be distributed in accordance with Section 5.16. (e) SPECIAL RULE FOR WITHDRAWAL OF ELECTIVE DEFERRALS: Notwithstanding paragraph (b) to the contrary, the limitations described in regulation 1.401(k)-1(d) will apply to the withdrawal of any Rollover Contributions which are attributable to a Participant's elective contributions as defined in regulation 1.401(k)-1(g)(3) and which are transferred to this Plan in a trustee to trustee transfer from another qualified plan. (f) ESTABLISHMENT OF ADMINISTRATIVE PROCEDURES: The Administrator may, in a separate written document, establish rules or procedures regarding the conditions under which Rollover Contributions can be made to and/or withdrawn from the Plan by an Employee. Such separate written document, when properly executed, will be deemed incorporated in this Plan. The rules or procedures set forth therein may be modified or amended by the Administrator without the necessity of amending this Section of the Plan, but any such modifications must be communicated to Participants in the manner described in Section 8.9. Notwithstanding the foregoing, (1) a summary plan description or summary of material modifications thereto in which the rules or procedures regarding the making and/or withdrawal of Rollover Contributions are described will be considered a separate written document sufficient to satisfy the requirements (including the execution requirement) of this paragraph; and (2) any rules or procedures established under this paragraph must be applied by the Administrator in a uniform nondiscriminatory manner. - 40 - 3.8 VOLUNTARY EMPLOYEE CONTRIBUTIONS Voluntary Employee Contributions are not currently permitted. - 41 - ARTICLE 4 PLAN BENEFITS 4.1 BENEFIT UPON NORMAL RETIREMENT Every Participant who has reached Normal Retirement Age will be entitled upon termination of employment to receive his or her Vested Aggregate Account balance determined as of the most recent Valuation Date coinciding with or immediately preceding the date of distribution. Distribution will be made under Section 5.1. 4.2 BENEFIT UPON LATE RETIREMENT A Participant who has reached Normal Retirement Age and who remains employed by the Employer will continue to participate in the Plan and will continue to receive allocations under Article 3 until he or she terminates employment with the Employer. However, notwithstanding Section 4.1 to the contrary, such Participant may at any time after reaching Normal Retirement Age (1) choose to have distributed prior to actual retirement all or part of his or her Vested Aggregate Account balance determined as of the most recent Valuation Date coinciding with or immediately preceding the date of distribution (but any portion thereof which is attributable to elective contributions, qualified matching contributions and/or qualified non-elective contributions made to a cash or deferred arrangement can only be distributed if the Participant has also reached Age 59 1/2); or (2) choose to have such Vested Aggregate Account balance transferred to another qualified retirement plan maintained by the Employer. Upon actual retirement, the Participant will be entitled to his or her undistributed Vested Aggregate Account balance determined as of the most recent Valuation Date coinciding with or immediately preceding the date of distribution. Distribution will be made under Section 5.1. 4.3 BENEFIT UPON DEATH Upon the death of a Participant prior to Termination of Employment, or upon the death of a Terminated Participant prior to distribution of his or her Vested Aggregate Account, his or her Beneficiary will be entitled to the Participant's Vested Aggregate Account balance determined as of the most recent Valuation Date coinciding with or immediately preceding the date of distribution. If any Beneficiary who is alive on the date of the Participant's death dies before receiving the entire death benefit to which he or she is entitled, the balance of the death benefit will be distributed to the Beneficiary's beneficiary in accordance with Section 5.2. The Administrator's determination that a Participant has died and that a particular person has a right to receive a death benefit will be final. Distribution will be made in accordance with Section 5.2. 4.4 BENEFIT UPON DISABILITY If a Participant suffers a Disability prior to Termination of Employment and terminates employment with the Employer as a result of that Disability, or if a Terminated Participant suffers a Disability prior to a distribution of his or her Vested Aggregate Account balance, he or she will be entitled to his or her Vested Aggregate Account balance determined as of the most recent Valuation Date coinciding with or immediately preceding the date of distribution. Distribution will be made in accordance with Section 5.3. 4.5 BENEFIT UPON TERMINATION A Participant who incurs a Termination of Employment will be entitled to his or her Vested Aggregate Account balance determined as of the most recent Valuation Date coinciding with or immediately preceding the date of distribution. A Terminated Participant's Vested Aggregate Account will be distributed under Section 5.4 unless, prior to the time of distribution set forth therein, the Participant (1) dies, in which case distribution will be made under 5.2; or (2) suffers a Disability, in which case distribution will be made under Section 5.3. - 42 - 4.6 DETERMINATION OF VESTED INTEREST A Participant's Vested Interest in his or her Participant's Account will be determined in accordance with the following provisions: (a) VESTING UPON RETIREMENT, DEATH OR DISABILITY: A Participant's Account will be 100% Vested upon reaching Normal Retirement Age prior to Termination of Employment, and also upon death or Disability prior to Termination of Employment. (b) 100% VESTING OF ELECTIVE DEFERRALS, QMACS AND QNECS: A Participant will at all times have a 100% Vested Interest in his or her Elective Deferral Account, Qualified Matching Contribution Account and Qualified Non-Elective Contribution Account. (c) VESTING OF MATCHING CONTRIBUTIONS: Matching Contributions are not currently permitted under the terms of the Plan. (d) VESTING OF NON-ELECTIVE CONTRIBUTIONS: Non-Elective Contributions are not currently permitted under the terms of the Plan. (e) AMENDMENTS TO VESTING SCHEDULE: No amendment may directly or indirectly reduce a Participant's Vested Interest in his or her Participant's Account. If the Plan is amended in any way that directly or indirectly affects the computation of a Participant's Vested Interest in his or her Participant's Account or the Plan is deemed amended by an automatic change to or from a Top Heavy vesting schedule, the following will apply: (1) PARTICIPANT ELECTION: Any Participant with at least three 1-Year Periods of Service may, by filing a written request with the Administrator, elect to have the Vested Interest in his or her Participant's Account computed by the vesting schedule in effect prior to the amendment. A Participant who fails to make an election will have his or her Vested Interest computed under the new schedule. The period in which the election may be made will begin on the date the amendment is adopted or is deemed to be made and will end on the latest of (1) 60 days after the date the amendment is adopted; (2) 60 days after the date the amendment becomes effective; or (3) 60 days after the date the Participant is issued written notice of the amendment by the Employer or Administrator. (2) PRESERVATION OF VESTED INTEREST: Notwithstanding the foregoing to the contrary, if the vesting schedule is amended, then in the case of an Employee who is a Participant as of the later of the date such amendment is adopted or the date it becomes effective, the Vested Interest in his or her Participant's Account determined as of such date will not be less than his or her Vested Interest computed under the Plan without regard to such amendment. - 43 - ARTICLE 5 DISTRIBUTION OF BENEFITS 5.1 BENEFIT UPON RETIREMENT Unless a cash-out occurs under Section 5.5, and except as otherwise provided in Section 5.16 regarding the distribution of benefits that remain subject to the Qualified Joint and Survivor Annuity requirements of Code ss.401(a)(11), the retirement benefit a Participant is entitled to receive under Section 4.1 or Section 4.2 will be distributed as follows: (a) FORMS OF DISTRIBUTION: A Participant can elect to have his or her retirement benefit distributed as follows: (1) in one lump sum payment; or (2) in substantially equal monthly, quarterly, semi-annual or annual cash installments over a period certain that does not extend beyond the Participant's life, or beyond the lives of the Participant and his or her designated Beneficiary (or beyond the life expectancy of the Participant or the joint and last survivor expectancy of the Participant and his or her designated Beneficiary), which will either be paid from the Plan or paid by a nontransferable immediate or deferred annuity selected by the Trustee which provides for the installment payments. (b) TIME OF DISTRIBUTION: Distribution will begin within an administratively reasonable time after the date (1) a Participant actually retires; or (2) a Participant who elects late retirement under Section 4.2 requests payment as permitted therein. However, distribution must begin under this Section no later than the Required Beginning Date. 5.2 BENEFIT UPON DEATH Unless a cash-out occurs under Section 5.5, a deceased Participant's death benefit as determined under Section 4.3 will be distributed as follows: (a) SURVIVING SPOUSE: If a Participant dies before the Annuity Starting Date and is married on the date of his or her death, the Participant's surviving Spouse will be entitled to receive 100% of the Participant's death benefit unless the surviving Spouse has waived that right under Section 5.8. Unless the Participant directed through a Beneficiary designation form that the benefit be paid in a specific form of distribution permitted under Section 5.1(a), the surviving Spouse can elect any form of distribution permitted under Section 5.1(a). If the surviving Spouse elects to receive installment payments, the death benefit will either be paid from the Plan or be paid by a nontransferable immediate or deferred annuity selected by the Trustee which provides for the installment payments. Upon the death of a Participant, distribution will be made to the surviving Spouse within an administratively reasonable time after he or she requests payment, but distribution must begin no later than December 31st of the calendar year in which the Participant would have attained Age 70 1/2. (b) DEATH OF SURVIVING SPOUSE BEFORE DISTRIBUTION BEGINS: If the surviving Spouse dies before distribution of the benefit begins, distribution will be made as if the surviving Spouse were the Participant. Distribution will be considered as having commenced when the deceased Participant would have reached Age 70 1/2 even if payments have been made to the surviving Spouse before that date. (c) NON-SPOUSE BENEFICIARY: Unless the Participant directed through a Beneficiary designation form that the death benefit be paid in a specific form of distribution permitted under Section 5.1(a), a non-Spouse Beneficiary can elect any form of distribution permitted under Section 5.1(a). If the Beneficiary elects to receive installment payments, the death - 44 - benefit will either be paid from the Plan or be paid by a nontransferable immediate or deferred annuity selected by the Trustee which provides for the installment payments. Upon the death of a Participant, distribution will be made within an administratively reasonable time after a non-Spouse Beneficiary requests payment; but distribution of the entire death benefit must be made by December 31st of the calendar year which contains the 5th anniversary of the date of the Participant's death unless installment payments begin no later than December 31st of the calendar year immediately following the calendar year in which the Participant died. (d) DISTRIBUTION IF THE PARTICIPANT OR OTHER PAYEE IS IN PAY STATUS: If a Participant or Beneficiary who has started receiving distribution of his or her benefit dies before the entire benefit has been distributed, the balance of the benefit will be distributed to the Participant's Beneficiary (or Beneficiary's beneficiary) at least as rapidly as under the method of distribution being used on the date of the Participant's or Beneficiary's death. (e) PAYMENTS TO A BENEFICIARY OF A BENEFICIARY: In the absence of a Beneficiary designation or other directive from the deceased Participant to the contrary, any Beneficiary may name his or her own Beneficiary to receive any benefits payable in the event of the Beneficiary's death prior to receiving the entire death benefit to which the Beneficiary is entitled; and if a Beneficiary has not named his or her own Beneficiary, the Beneficiary's estate will be the Beneficiary. If any benefit is payable under this paragraph to a Beneficiary of the deceased Participant's Beneficiary or to the estate of the deceased Participant's Beneficiary, or to any other Beneficiary or the estate thereof, subject to the limitations regarding the latest dates for benefit payment in paragraphs (a) and (c) above, the Administrator may (1) continue to pay the remaining value of such benefits in the amount and form already commenced, or pay such benefits in any other manner permitted under the Plan for a Participant or Beneficiary, and (2) if payments have not already commenced, pay such benefits in any other manner permitted under the Plan. Distribution to the Beneficiary of a Beneficiary must begin no later than the date distribution would have been made to the Participant's Beneficiary. The Administrator's determination under this paragraph will be final and will be applied in a non-discriminatory manner that does not discriminate in favor of HCEs. 5.3 DISABILITY BENEFITS Unless a cash-out occurs under Section 5.5, and except as otherwise provided in Section 5.16 regarding the distribution of benefits that remain subject to the Qualified Joint and Survivor Annuity requirements of Code ss.401(a)(11), the Disability benefit a Participant is entitled to receive under Section 4.4 will be distributed as follows: (a) FORMS OF DISTRIBUTION: A Participant can elect to have his or her benefit distributed as follows: (1) in one lump sum payment; or (2) in substantially equal monthly, quarterly, semi-annual or annual cash installments over a period certain that does not extend beyond the Participant's life, or beyond the lives of the Participant and his or her designated Beneficiary (or beyond the life expectancy of the Participant or the joint and last survivor expectancy of the Participant and his or her designated Beneficiary), which will either be paid from the Plan or paid by a nontransferable immediate or deferred annuity selected by the Trustee which provides for the installment payments. (b) TIME OF DISTRIBUTION: Distribution will begin within an administratively reasonable time after the date on which a Participant who suffers a Disability terminates employment with the Employer on account of the Disability. However, distribution must begin under this Section no later than the Participant's Required Beginning Date. - 45 - 5.4 BENEFIT UPON TERMINATION Unless a cash-out occurs under Section 5.5, and except as otherwise provided in Section 5.16 regarding the distribution of benefits that remain subject to the Qualified Joint and Survivor Annuity requirements of Code ss.401(a)(11), the benefit a Terminated Participant is entitled to receive under Section 4.5 will be distributed as follows: (a) FORMS OF DISTRIBUTION: A Terminated Participant can elect to have his or her benefit distributed as follows: (1) in one lump sum payment; or (2) in substantially equal monthly, quarterly, semi-annual or annual cash installments over a period certain that does not extend beyond the Participant's life, or beyond the lives of the Participant and his or her designated Beneficiary (or beyond the life expectancy of the Participant or the joint and last survivor expectancy of the Participant and his or her designated Beneficiary), which will either be paid from the Plan or paid by a nontransferable immediate or deferred annuity selected by the Trustee which provides for the installment payments. (b) TIME OF DISTRIBUTION: Distribution will begin under this Section within an administratively reasonable time after Termination of Employment occurs, but in no event later than the earlier to occur of (1) the date the Terminated Participant reaches Normal Retirement Age, or (2) the Required Beginning Date. 5.5 CASH-OUT OF BENEFITS The Administrator, without the consent of the Participant, may distribute a Participant's Vested Aggregate Account balance in a lump sum any time after a Participant terminates employment, subject to the following provisions: (a) GENERAL RULE: The Administrator can only make distribution under this Section (1) with regard to distributions made for Plan Years beginning prior to August 6, 1997, if the Participant's Vested Aggregate Account balance (determined before taking into account the Participant's Rollover Account and Voluntary Employee Contribution Account) on the date he or she terminates employment with the Employer does not exceed, or at the time of any prior distribution did not exceed, $3,500 (or such lesser amount as may be designated by the Administrator); and (2) for Plan Years beginning on or after August 6, 1997, if a Participant's Vested Aggregate Account balance (determined before taking into account the Participant's Rollover Account and Voluntary Employee Contribution Account) on the date he or she terminates employment with the Employer does not exceed, or at the time of any prior distribution did not exceed, $5,000 (or such lesser amount as may be designated by the Administrator). Any such distribution will be made as soon as administratively feasible after the date the Participant terminates employment, and any portion of the Participant's Account which is not Vested will be treated as a Forfeiture. (b) LATER DISTRIBUTION IF ACCOUNT FALLS TO $5,000: With regard to distributions made for Plan Years beginning on or after October 17, 2000, if a Participant would have received a distribution under paragraph (a) but for the fact that the Participant's Vested Aggregate Account (determined before taking into account the Participant's Rollover Account and Voluntary Employee Contribution Account) exceeded $5,000 (or such lesser amount as may be designated by the Administrator) when the Participant terminated employment, and if at a later time the Participant's Vested Aggregate Account (determined before taking into account the Participant's Rollover Account - 46 - and Voluntary Employee Contribution Account) is reduced to an amount not greater than $5,000 (or such lesser amount as may be designated by the Administrator), the Administrator may distribute such remaining amount in a lump sum without the Participant's consent as soon as administratively feasible after the date the Participant terminates employment with the Employer, and any portion of the Participant's Account which is not Vested will be treated as a Forfeiture. (c) DEEMED DISTRIBUTION: If a Participant's Vested Interest in his or her Participant's Account is zero on the date the Participant terminates employment, the Participant will be deemed to have received a distribution of such Vested Interest on the date of termination. (d) FORM OF DISTRIBUTION: If the whereabouts of a terminated Participant are known, distribution under this Section will be made in the form of a lump sum cash payment unless such Participant elects a direct rollover under Section 5.14. If the whereabouts of a terminated Participant are not known, the provisions of Section 5.13 will apply. 5.6 RESTRICTIONS ON IMMEDIATE DISTRIBUTIONS If a Participant's Vested Aggregate Account balance exceeds the amount set forth in paragraph (a) of this Section and is immediately distributable, such account can only be distributed in accordance with the following provisions: (a) GENERAL RULE: If a Participant's Vested Aggregate Account (determined before taking into account the Participant's Rollover Account and Voluntary Employee Contribution Account) exceeds $5,000, and if such amount is immediately distributable, the Participant must consent to any distribution of such amount. Any portion of the Participant's Account which is not Vested will be treated as a Forfeiture. If less than the entire Vested Aggregate Account balance is distributed, the part of the non-Vested portion that will be treated as a Forfeiture is the total non-Vested portion multiplied by a fraction, the numerator of which is the amount of the distribution attributable to Employer contributions and the denominator of which is the total value of the Vested Interest in the Participant's Account. (b) TRANSITION RULE: Notwithstanding paragraph (a), with regard to distributions made before October 17, 2000, if a Participant's Vested Aggregate Account balance (determined before taking into account the Rollover Account and Voluntary Employee Contribution Account) (1) exceeded $3,500 (or exceeded $3,500 at the time of any prior distribution) for Plan Years beginning before August 6, 1997, or (2) exceeded $5,000 (or exceeded $5,000 at the time of any prior distribution) for Plan Years beginning on or after August 6, 1997 and for a distribution made before October 17, 2000; or (3) either exceeded $5,000 or was a remaining payment under a selected optional form of payment that exceeded $5,000 at the time the selected payment began for Plan Years beginning after August 5, 1997 and for a distribution made on or after October 17, 2000, and if the account balance is immediately distributable, then the Participant and the Participant's Spouse (or where either one has died, the survivor) must consent to any distribution of such account. (c) DEFINITION OF IMMEDIATELY DISTRIBUTABLE: A Participant's benefit is immediately distributable if any part of the benefit could be distributed to the Participant (or the Participant's surviving Spouse) before the Participant reaches (or would have reached if not deceased) the later of his or her Normal Retirement Age or Age 62. - 47 - (d) GENERAL CONSENT REQUIREMENT: The consent of the Participant to any benefit that is immediately distributable must be obtained in writing within the 90-day period ending on the Annuity Starting Date. However, the Participant will not be required to consent to a distribution that is required by Code ss.401(a)(9) or ss.415. (e) NOTIFICATION REQUIREMENTS: The Administrator must notify the Participant of the right to defer any distribution until the benefit is no longer immediately distributable. Notification will include a general explanation of the material features and relative values of the optional forms of benefit available under the Plan in a manner that would satisfy the notice requirements of Code ss.417(a)(3); and will be provided no less than 30 days or more than 90 days prior to the Annuity Starting Date. (f) WAIVER OF 30-DAY REQUIREMENT: For Plan Years beginning on or after January 1, 1997, distribution of a Participant's benefit may begin less than 30 days after the notice in paragraph (e) is given, provided (1) the Administrator clearly informs the Participant that the Participant has a right to a period of at least 30 days after receiving notice to consider the decision of whether or not to elect a distribution; (2) the Participant, after receiving the notice, affirmatively elects a distribution or a particular distribution option. (g) CONSENT NOT NEEDED ON PLAN TERMINATION: If upon Plan termination neither the Employer nor an Affiliated Employer maintains another defined contribution plan other than an employee stock ownership plan (ESOP) as defined in Code ss.4975(e)(7), the Participant's benefit will, without the Participant's consent, be distributed to the Participant. If the Employer or an Affiliated Employer maintains another defined contribution plan other than an ESOP, the Participant's benefit will, without the Participant's consent, be transferred to the other plan if the Participant does not consent to an immediate distribution under this Section. 5.7 RESTORATION OF FORFEITED ACCOUNT BALANCE If a Participant who does not have a 100% Vested Interest in his or her Participant's Account terminates employment with the Employer and receives (or is deemed to have received) a distribution of such Vested Interest from the Plan, and such Participant is subsequently rehired by the Employer, his or her Participant's Account upon such reemployment will be administered in accordance with the following provisions: (a) REEMPLOYMENT BEFORE FIVE CONSECUTIVE BREAKS IN SERVICE: If a terminated Participant is reemployed before incurring five consecutive Breaks in Service, such Participant's Account balance will be restored in accordance with the following: (1) PARTIALLY VESTED PARTICIPANTS: If upon termination of employment a Participant has at least a partially Vested Participant's Account, then upon reemployment by the Employer prior to incurring five consecutive Breaks in Service, such Participant's Account balance will be restored to the amount on the date of distribution if the Participant repays to the Plan the full amount of the distribution which was attributable to Employer contributions. Repayment must be made before the earlier of five years after the first date on which the Participant is subsequently re-employed by the Employer or the date on which the Participant incurs five consecutive Breaks in Service following the date of distribution. (2) NON-VESTED PARTICIPANTS: If upon termination of employment a Participant's Vested Interest in his or her Participant's Account is zero, such Participant is deemed to have received a distribution of such Vested Interest before the date he or she incurs five consecutive Breaks in Service, and upon re-employment with the Employer prior to incurring five consecutive Breaks in Service, such Participant's Account balance attributable to Employer contributions will be restored to the amount on the date of the deemed distribution. - 48 - (3) SOURCE OF FUNDS: The Administrator, on a case-by-case basis, may elect to restore a Participant's Account balance under this Section by the use of Forfeitures, by the use of earnings from non-segregated Trust Fund accounts, by the use of Employer contributions, or by the use of any combination thereof. (b) REEMPLOYMENT AFTER FIVE CONSECUTIVE BREAKS IN SERVICE: If a terminated Participant is reemployed by the Employer after incurring five consecutive Breaks in Service, that portion, if any, of his or her Participant's Account which was (or was deemed to be) a Forfeiture will be permanently forfeited under the terms of this Plan. 5.8 SPOUSAL CONSENT REQUIREMENTS A surviving Spouse's election not to receive a death benefit under Section 5.2 will not be effective unless (1) the election is in writing; (2) the election designates a specific Beneficiary or form of benefit which may not be changed without spousal consent (or the Spouse's consent expressly permits designations by the Participant without any requirement of further spousal consent); and (3) the Spouse's consent acknowledges the effect of the election and is witnessed by the Administrator or a notary public. 5.9 APPLICATION OF CODE SS.401(A)(9) REQUIREMENTS All distributions made under the terms of the Plan will be determined and made in accordance with the regulations issued under Code ss.401(a)(9), including the minimum distribution incidental benefit requirement of regulation ss.1.401(a)(9)-2, and any provisions in this Plan which reflect Code ss.401(a)(9) will override any distribution options which are inconsistent with such Code section and regulations. If Participant's Vested Aggregate Account is paid in a form that is based on life expectancies through other than the purchase of an immediate annuity, the joint life expectancies of the Participant and his or her Spouse will only be recalculated annually if the Participant elects the recalculation method of determining life expectancy. In the case of any other Beneficiary, life expectancy will be calculated at the time payment first commences, and payments for any 12-consecutive month period will be based on such life expectancy minus the number of whole years passed since distribution first commenced. 5.10 STATUTORY COMMENCEMENT OF BENEFITS Unless a Participant otherwise elects, distribution of his or her benefit must begin no later than the 60th day after the latest of the close of the Plan Year in which the Participant (1) reaches the earlier of Age 65 or Normal Retirement Age; (2) reaches the 10th anniversary of the year the Participant commenced Plan participation; or (3) terminates service with the Employer. However, the failure of a Participant to consent to a distribution while a benefit is immediately distributable within the meaning of Section 5.6 will be deemed to be an election to defer commencement of payment of any benefit sufficient to satisfy this Section. If this Plan provides for early retirement, a Participant who satisfies the service requirement for early retirement prior to Termination of Employment will be entitled to receive his or her Vested Aggregate Account, if any, upon satisfaction of the age requirement for early retirement. 5.11 SEGREGATION OF BENEFIT BEFORE DISTRIBUTION With respect to that portion of a Participant's Vested Aggregate Account which the Participant is not permitted to self-direct under Section 7.15, as of the Valuation Date coinciding with or next following the date a Participant terminates employment with the Employer for any reason, the Administrator will, until a distribution is made to the Participant or the Participant's Beneficiary under the - 49 - Plan, direct the Trustee in a uniform nondiscriminatory manner to either (1) invest such Vested Aggregate Account determined as of such Valuation Date in a separate interest bearing account; or (2) leave such Vested Aggregate Account as part of the general Trust Fund, in which case such account will share in the allocation of earnings and losses under Section 3.3(a). 5.12 DISTRIBUTION IN EVENT OF INCAPACITY If any person who is entitled to receive a distribution of benefits (the "Payee") suffers from a Disability or is under a legal incapacity, payments may be made in one or more of the following ways as directed by the Administrator: (a) to the Payee directly; (b) to the guardian or legal representative of the Payee's person or estate; (c) to a relative of the Payee, to be expended for the Payee's benefit; or (d) to the custodian of the Payee under any Uniform Transfers to Minors Act or under any Uniform Gifts To Minors Act. The Administrator's determination of the minority or incapacity of any payee will be final. 5.13 MISSING PARTICIPANTS AND UNCLAIMED BENEFITS Neither the Trustee nor the Administrator will be required to search for or ascertain the whereabouts of any Participant or Beneficiary. With respect to a Participant or Beneficiary who has not claimed any benefit (the "missing payee") to which such missing payee is entitled, and with respect to any Participant or Beneficiary who has not satisfied the administrative requirements for benefit payment, the following provisions will apply: (a) ATTEMPT TO CONTACT AND FORFEITURE OF BENEFIT: The Administrator will notify a missing payee that he or she is entitled to a distribution under the Plan, by certified or registered mail addressed to the missing payee's last known address. The Administrator, in its sole discretion, may also utilize other methods of locating a missing payee, including letter forwarding programs offered by the Internal Revenue Service or the Social Security Administration, or internet or other search services offered by the Pension Benefit Guaranty Corporation (PBGC) if such services are made available to defined contributions plans; or by placing public notices in a local newspaper. If a missing payee fails to make his or her whereabouts known in writing to the Trustee or Administrator or otherwise fails to claim a benefit, or the administrative requirements for benefit payment for any payee are not satisfied, upon the earlier to occur of (1) the later of the date the Plan is terminated or discontinued or six months from the date the notice was mailed or (2) the date which is two years from the date the notice was mailed, the Administrator may, but will not be required to, treat the payee's benefit as a forfeiture, subject to paragraphs (b) and (c) below. (b) ALTERNATIVE METHODS TO FORFEITURE: In lieu of Forfeiture under paragraph (a), the Administrator may elect one the following alternatives described below: (1) DIRECT ROLLOVER TO IRA: If a Participant's Vested Aggregate Account balance (determined before taking into account his or her Rollover Account and Voluntary Employee Contribution Account) on the date he or she terminated employment with the Employer does not exceed $5,000 (or such lesser amount as may be designated by the Administrator), the Administrator may elect to make distribution hereunder in the form of a direct rollover to an individual retirement account (IRA) if the IRA can be established by the Administrator at a qualified financial institution. In establishing the IRA on behalf of the Participant or other payee, the - 50 - Administrator will select an IRA trustee, custodian or issuer unrelated to the Employer or the Administrator and will make the initial investment choices for the IRA. The default direct rollover will occur not less than 30 days and not more than 90 days after the Code ss.402(f) notice with the explanation of the default direct rollover is provided to the Participant or other payee. (2) ESCHEAT TO THE STATE: The Administrator may elect to escheat the payee's benefit to the state in which the Sponsor's principal place of business is located. (3) OTHER METHODS OF DISTRIBUTION: The Administrator may elect to distribute a payee's benefit by any other method approved by the United States Department of the Treasury and/or by the United States Department of Labor. (c) CONDITIONS FOR RESTORATION OF FORFEITED BENEFIT: If a payee whose benefit has been forfeited under paragraph (a) is located, or if a payee whose benefit has been forfeited under paragraph (a) for failure to satisfy the administrative requirements for benefit payment subsequently satisfies the administrative requirements for benefit payment and claims his or her benefit, and if the Plan has not terminated (or if the Plan has, all benefits have not yet been paid), then the benefit will be restored. The Administrator, on a case-by-case basis, may elect to restore the benefit by the use of either earnings from non-segregated Trust Fund assets, or Employer contributions, or any combination thereof. However, if such missing payee has not been located by the time the Plan terminates and all benefits are distributed, the Forfeiture of such unpaid benefit will be irrevocable. 5.14 DIRECT ROLLOVERS A distributee may elect to have all or any portion of an eligible rollover distribution paid directly to an eligible retirement plan specified by the distributee in a direct rollover, which is a payment by the Plan to the eligible retirement plan specified by the distributee. (a) ELIGIBLE ROLLOVER DISTRIBUTION: An eligible rollover distribution is any distribution of all or any portion of the balance to the credit of the distributee, except that an eligible rollover distribution does not include (1) any distribution that is one of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the distributee or for the joint lives (or joint life expectancies) of the distributee and the distributee's designated beneficiary, or for a specified period of ten years or more; (2) any distribution to the extent such distribution is required under Code ss.401(a)(9); (3) the portion of any distribution that is not includible in gross income (determined without regard to the exclusion for net unrealized appreciation on Employer securities); and (4) the portion of any distribution made on or after January 1, 2000 which is attributable to a hardship distribution described in Code ss.401(k)(2)(B)(i)(IV). (b) ELIGIBLE RETIREMENT PLAN: An eligible retirement plan is an individual retirement account described in Code ss.408(a), an individual retirement annuity described in Code ss.408(b), an annuity plan described in Code ss.403(a), or a qualified trust described in Code ss.401(a), that accepts the distributee's eligible rollover distribution. However, in the case of an eligible rollover distribution to the surviving Spouse, an eligible retirement plan is an individual retirement account or individual retirement annuity. (c) DEFINITION OF DISTRIBUTEE: For purposes of this Section, a distributee includes an Employee or former Employee. In addition, an Employee's or former Employee's surviving Spouse and an Employee's or former Employee's Spouse or former Spouse who is the alternate payee under a qualified domestic relations order as defined in Code ss.414(p), are distributees with regard to the interest of the Spouse or former Spouse. 5.15 DISTRIBUTION OF PROPERTY The determination to pay all or a part of a lump sum in property will be made by the Administrator in its sole discretion applied in a non-discriminatory manner that does not discriminate in favor of Highly Compensated Employees; except that if this is an amended or restated - 51 - Plan, the payee will have the right to elect a full or partial distribution in property within the period described in Section 9.1(a)(2) if the Plan as in effect one day prior to this amendment or restatement provided for a property distribution at the payee's option. 5.16 DISTRIBUTIONS SUBJECT TO CODE SS.401(A)(11) REQUIREMENTS Unless a cash-out occurs under Section 5.5 or unless otherwise elected under paragraph (c) below, upon distribution of a Participant's Vested Aggregate Account for any reason, any portion thereof which was transferred to this Plan in a trustee to trustee transfer from a money purchase plan, a target benefit plan, a defined benefit plan, or a profit sharing plan which was subject to requirements of Code ss.401(a)(11) at the time of the transfer, or any portion thereof which is to be distributed in an optional form protected under this Plan and which is subject to the requirements of Code ss.401(a)(11), will be distributed in accordance with the following provisions: (a) DISTRIBUTIONS OTHER THAN DEATH: Any portion of a Participant's benefit which is distributed under Sections 5.1, 5.3 or 5.4 and which is subject to the requirements of this Section will be distributed as a Qualified Joint and Survivor Annuity if the Participant is married on the Annuity Starting Date and has not died before such date. If the Participant is unmarried on the Annuity Starting Date and has not died before such date, any such portion of the Participant's benefit will be distributed as a life annuity. If a Participant elects not to receive the annuity of form of payment described above, any portion of the Participant's benefit that is subject to the requirements of this Section will be distributed in the manner described in Sections 5.1, 5.3 or 5.4 of the Plan, as applicable. (b) DISTRIBUTIONS UPON DEATH: Notwithstanding any other Beneficiary designation made by a Participant, if a Participant is married on the date of his or her death and dies before the Annuity Starting Date, the Participant's surviving Spouse will, with respect to any portion of a deceased Participant's benefit which is subject to the requirements of this Section, receive a minimum death benefit as a Qualified Preretirement Survivor Annuity unless such annuity has been waived under paragraph (c) below, in which event any such death benefit will be distributed to the surviving Spouse in the manner described in Section 5.2. Any portion of a deceased Participant's death benefit which a non-Spouse Beneficiary is entitled to receive under Section 4.3 and which is subject to the requirements of this Section will be distributed in the manner described in Section 5.2(c). (c) SPOUSAL CONSENT REQUIRED TO WAIVE QJSA AND QPSA REQUIREMENTS: A married Participant's election not to receive a Qualified Joint and Survivor Annuity (QJSA) or a Qualified Pre-retirement Survivor Annuity (QPSA) as set forth in paragraph (a) above, or an unmarried Participant's election not to receive a life annuity as set forth in paragraph (a) above, must be made in accordance with the following provisions: (1) ELECTION NOT TO RECEIVE A QJSA: A Participant's election not to receive a Qualified Joint and Survivor Annuity or a life annuity as set forth in paragraph (a) must be in writing and must be made during the 90-day period ending on the Annuity Starting Date. Such election may be revoked in writing and a new election made at any time and any number of times during the election period. (2) ELECTION NOT TO RECEIVE A QPSA: A Participant's election not to receive a Qualified Preretirement Survivor Annuity as set forth in subparagraph (2) must be in writing and must be made during an election period beginning on the first day of the Plan Year in which the Participant reaches Age 35 and ending on the date of his or her death. The election - 52 - may be revoked in writing and a new election made at any time and any number of times during the election period. A Terminated Participant's election period concerning his or her Vested Aggregate Account before his or her termination will not begin later than such date. Notwithstanding the foregoing, if the Participant has not completed a Beneficiary designation form specifying the time or form of payment, the surviving Spouse may waive the Qualified Preretirement Survivor Annuity. (3) SPECIAL PRE-AGE 35 QPSA ELECTION: A Participant who has not yet reached Age 35 as of the end of any current Plan Year may make a special election not to receive a Qualified Preretirement Survivor Annuity for the period beginning on the date of such election and ending on the first day of the Plan Year in which such Participant reaches Age 35. This election will not be valid unless the Participant receives the same written explanation of the Qualified Preretirement Survivor Annuity as described in subparagraph (4). Qualified Preretirement Survivor Annuity coverage will be automatically reinstated as of the first day of the Plan Year in which the Participant reaches Age 35. Any new election on or after such date will be subject to the full requirements of this Section. (4) REQUIRED WRITTEN EXPLANATION: In connection with an election not to receive a QJSA, the Administrator will, no less than 30 days and no more than 90 days prior to the Annuity Starting Date, provide the Participant with a written explanation of the terms and conditions of the QJSA; the Participant's right to make (and the effect of) an election to waive the QJSA; the rights of the Participant's Spouse; and the right of the Participant to revoke such election (and the effect thereof). In connection with an election not to receive a QPSA, the Administrator will provide each Participant within the Applicable Period as defined in subparagraph (3) with a written explanation of the QPSA in such terms and in such manner as would be comparable to the written explanation applicable to a QJSA as set forth in this paragraph. (5) APPLICABLE PERIOD: The Applicable Period for a Participant is whichever of the following periods ends last: (1) the period beginning with the first day of the Plan Year in which the Participant attains Age 32 and ending with the close of the Plan Year preceding the Plan Year in which the Participant attains Age 35; (2) a reasonable period after the individual becomes a Participant; (3) a reasonable period ending after Code ss.401(a)(11) applies to the Participant; or (4) a reasonable period ending after Code ss.417(a)(5) ceases to apply to the Participant. A reasonable period is the end of the two-year period beginning one year prior to the date the applicable event occurs, and ending one year after that date. (6) PARTICIPANTS WHO TERMINATE BEFORE AGE 35: In the case of a Participant who separates from service before the Plan Year in which the Participant reaches Age 35, the notice under subparagraph (4) will be provided within the two year period beginning one year prior to separation from service and ending one year after such separation. If such Participant thereafter returns to employment with the Employer, the Applicable Period for such Participant will be redetermined. (7) ELECTIONS MUST HAVE SPOUSAL CONSENT: A Participant's election not to receive a Qualified Joint and Survivor Annuity or a Participant's election not to receive a Qualified Preretirement Survivor Annuity will not be effective (1) unless the Participant's Spouse consents in writing to the election; (2) - 53 - unless the election designates a specific Beneficiary (or form of benefit) which may not be changed without spousal consent (or the consent of the Spouse expressly permits designations by the Participant without any requirement of further spousal consent); and (3) unless the Spouse's consent acknowledges the effect of the election and is witnessed by the Administrator or a notary public. (8) ADDITIONAL REQUIREMENTS FOR SPOUSAL CONSENT: A Spouse's consent will not be required if there is no Spouse or if the Spouse cannot be located, or if there are other circumstances present which preclude the necessity of such Spouse's consent. Any consent by a Participant's Spouse (or establishment that consent cannot be obtained) will be effective only with respect to such Spouse. A consent that permits designations by the Participant without any requirement of further spousal consent must acknowledge that the Spouse has the right to limit consent to a specific Beneficiary, and a specific form of benefit where applicable, and that the Spouse voluntarily elects to relinquish either or both of such rights. A revocation of a prior election may be made by a Participant without the Spouse's consent at any time before benefits begin. No consent obtained under subparagraph (7) will be valid unless the Participant has received notice as provided in subparagraph (4). (d) SPOUSAL CONSENT REQUIRED FOR IMMEDIATELY DISTRIBUTABLE BENEFITS: Notwithstanding Section 5.6, a Participant's Spouse must give written consent as set forth in paragraph (c) above to the distribution of any portion of a Participant's Vested Aggregate Account balance which is immediately distributable and which at the time of distribution is subject to the Qualified Joint and Survivor Annuity and Qualified Preretirement Survivor Annuity requirements of Code ss.401(a)(11), subject to the following provisions: (1) GENERAL REQUIREMENT: The consent of the Participant and the Participant's Spouse (or where either the Participant or the Participant's Spouse has died, the survivor) must be obtained in writing within the 90-day period ending on the Annuity Starting Date. However, (1) only the Participant need consent to the distribution of a QJSA while the benefit is immediately distributable; and (2) neither the Participant nor the Participant's Spouse will be required to consent to a distribution that is required by Code ss.401(a)(9) or ss.415. (2) NOTIFICATION REQUIREMENTS: The Administrator must notify the Participant and the Participant's Spouse of the right to defer any such distribution until the benefit is no longer immediately distributable. The content of the notification must comply with all of the requirements in Section 5.6(e), and must be provided no less than 30 days or more than 90 days prior to the Annuity Starting Date. (3) CONSENT NOT NEEDED ON PLAN TERMINATION: If this Plan upon termination does not offer an annuity option (purchased from a commercial provider), and neither the Employer nor an Affiliated Employer maintains another defined contribution plan other than an employee stock ownership plan (ESOP) as defined in Code ss.4975(e)(7), then such portion of the Participant's benefit will, without the Participant's consent, be distributed to the Participant. If the Employer or an Affiliated Employer maintains another defined contribution plan other than an ESOP, such portion of the Participant's benefit will, without the Participant's consent, be transferred to the other plan if the Participant does not consent to an immediate distribution as described in Section 5.6 of the Plan. - 54 - 5.17 FINANCIAL HARDSHIP DISTRIBUTIONS Subject to any rules or procedures that may be established by the Administrator under paragraph (g) below, a Participant who is still an Employee may withdraw up to 100% of his or her Elective Deferral Account (excluding any earnings allocated thereto) because of financial hardship. If permitted by the rules and procedures, such Participant may also withdraw up to 100% of the Vested Interest in his or her Matching Contribution Account and/or Non-Elective Contribution Account because of financial hardship. Unless modified by the rules and procedures, hardship distributions will be made in accordance with the following provisions: (a) AMOUNT AND FORM OF DISTRIBUTION: The maximum amount distributable will be based on the Participant's Account balance as of the Valuation Date immediately preceding the date of the request, and the amount actually distributed cannot exceed the amount required to relieve the financial hardship, including amounts necessary to pay any federal, state or local income taxes or penalties reasonably anticipated to result from the distribution. Distribution will only be made to the Participant in one lump sum. The Administrator, on a uniform nondiscriminatory basis, will determine from which account any distribution hereunder will be made. (b) DEFINITION OF FINANCIAL HARDSHIP: Financial hardship means an immediate and heavy financial need that the Participant lacks available resources to satisfy. Only the following financial needs will be considered immediate and heavy: (1) payment of medical expenses within the meaning of Code ss.213(d) that are incurred by the Participant, his or her Spouse or his or her children; (2) the purchase (excluding mortgage payments) of a principal residence for the Participant; (3) payment of tuition and related educational fees for the next 12 months of post-secondary education for the Participant, the Participant's Spouse or the Participant's children; (4) the need to prevent the eviction of the Participant from his or her principal residence or foreclosure on the mortgage of the Participant's principal residence; (5) payment of funeral expenses for a member of the Participant's family; or (6) any other immediate and heavy financial need of the Participant that the Administrator determines on the basis of all relevant facts and circumstances cannot be satisfied from other resources reasonably available to the Participant. (c) PARTICIPANT'S WRITTEN REPRESENTATIONS: Except as otherwise provided in paragraph (d) below, a hardship distribution can only be made to the extent a Participant's financial hardship cannot be satisfied from other resources reasonably available to the Participant, as determined by the Administrator on the basis of all relevant facts and circumstances. However, the Administrator may treat a distribution as necessary to satisfy a financial hardship if the Administrator, in the absence of actual knowledge to the contrary, elects to rely upon the Participant's written representation that the financial hardship cannot be relieved (1) through reimbursement or compensation by insurance or otherwise; (2) by liquidation of the Participant's assets, to the extent such liquidation would not itself cause a financial hardship; (3) by cessation of the Participant's Elective Deferrals or Voluntary Employee Contributions to the Plan; or (4) by other distributions or nontaxable (at the time of the loan) loans from any other Employer-maintained plans or from any other employer, or by borrowing from commercial sources on reasonable commercial terms. (d) SAFE HARBOR DEEMED DISTRIBUTIONS: With respect to a distribution made for one of the reasons in paragraph (b)(1), (2), (3) or (4), if the Administrator does not elect to rely upon a Participant's written representation as set forth in paragraph (c), or if the Administrator offers to rely upon a Participant written representation and the Participant fails to provide such written representation, then any such distribution will be deemed to be necessary to satisfy a - 55 - financial hardship if the Participant has obtained all distributions (other than financial hardship distributions) and all nontaxable loans currently available under all plans maintained by the Employer. Furthermore, if the Administrator offers to rely on the written representation requirements of paragraph (c) but the Participant elects not to comply with such written requirements, and if any portion of the amount distributed is from the Participant's Elective Deferral Account, then the Participant cannot make Elective Deferrals and Voluntary Employee Contributions to this Plan or any other plan maintained by the Employer for at least 12 months after receipt of the distribution; and for the Participant's taxable year immediately following the taxable year of the hardship distribution, the Participant cannot make Elective Deferrals to this Plan or any other plan maintained by the Employer in excess of the applicable limit under Code ss.402(g)(5) for such taxable year, minus the amount of such Participant's Elective Deferrals made for the taxable year in which the financial hardship distribution was made. (e) ORDER OF DISTRIBUTION: If hardship distributions are permitted to be made from a Participant's Matching Contribution Account and/or Non-Elective Contribution Account as well as from his or her Elective Deferral Account, the Administrator will determine the portion (including zero) of the distribution that will be made from each such account, provided that any such determination is made in a uniform nondiscriminatory manner. (f) RESTRICTION ON CERTAIN TRANSFERRED ASSETS: Notwithstanding any provision in this Section, no hardship distribution can be made with respect to benefits attributable to assets (including post-transfer earnings thereon) and liabilities that are transferred, within the meaning of Code ss.414(l), to this Plan from a money purchase pension plan or target benefit pension plan qualified under Code ss.401(a) (other than any portion of those assets and liabilities that are attributable to Voluntary Employee Contributions). (g) ESTABLISHMENT OF ADMINISTRATIVE PROCEDURES: The Administrator may, in a separate written document, establish rules or procedures regarding hardship distributions under this Section. Such separate written document, when properly executed, will be deemed incorporated in this Plan. The rules or procedures set forth therein may be modified or amended by the Administrator without the necessity of amending this Section of the Plan, but any such modifications must be communicated to Participants in the manner described in Section 8.9. Notwithstanding the foregoing, (1) a summary plan description or summary of material modifications thereto in which the rules or procedures regarding the making of hardship distributions are described will be considered a separate written document sufficient to satisfy the requirements (including the execution requirement) of this paragraph; and (2) any such rules or procedures that are established under this paragraph must be applied in a uniform nondiscriminatory manner. 5.18 IN-SERVICE DISTRIBUTIONS Except as may otherwise be permitted under Section 4.2, no distributions are permitted before a Participant terminates employment with the Employer. 5.19 DISTRIBUTION OF EXCESS ELECTIVE DEFERRALS Elective Deferrals that exceed the Code ss.402(g)(5) dollar limitation will be deemed Excess Elective Deferrals, and all Excess Elective Deferrals, plus any income and minus any loss allocable thereto, will be distributed no later than April 15th to any Participant to whose account Excess Elective Deferrals were allocated for the preceding year and who claims Excess Elective Deferrals for such taxable year. Distribution of Excess Elective Deferrals will be made in accordance with the following provisions: - 56 - (a) ASSIGNMENT OF EXCESS ELECTIVE DEFERRALS: A Participant may assign to this Plan any Excess Elective Deferrals made during a taxable year of the Participant by notifying the Administrator on or before April 15th of the amount of the Excess Elective Deferrals to be assigned to the Plan. A Participant will be deemed to notify the Administrator of any Excess Elective Deferrals that arise by taking into account only those Elective Deferrals made to this Plan and any other plans of the Employer. (b) TREATMENT AS ANNUAL ADDITIONS: Excess Elective Deferrals will be treated as Annual Additions under Section 6.1 of the Plan unless such amounts are distributed no later than the first April 15th following the close of the Participant's taxable year. Excess Elective Deferrals that are distributed after April 15th are includible in the Participant's gross income in the taxable year in which deferred and the taxable year in which distributed. (c) DETERMINATION OF INCOME OR LOSS: Excess Elective Deferrals will be adjusted for any income or loss up to the end of the Participant's taxable year and, at the discretion of the Administrator, may be adjusted for income or loss up to the date of distribution. The period between the end of the Participant's taxable year and the date of distribution will be referred to as the gap period, and any income earned therein will be allocated at the discretion of the Administrator applied consistently to all Participants and to all corrective distributions for the taxable year. The income or loss allocable to a Participant's Excess Elective Deferrals will be the amount determined by either the method in subparagraph (1) or subparagraph (2) below plus, if applicable the amount determined in subparagraph (3) below: (1) The amount determined by multiplying the income or loss allocable to the Participant's Elective Deferrals for the taxable year (and the gap period) by a fraction, the numerator of which is the Participant's Excess Elective Deferrals for the year and the denominator of which is (A) the Participant's Elective Deferral Account balance as of the beginning of the Participant's taxable year plus any Elective Deferrals allocated to the Participant's Elective Deferral Account during such taxable year and the gap period, or (B) solely with respect to taxable years beginning before January 1, 1992, the Participant's Elective Deferral Account balance as of the end of the Participant's taxable year, reduced by any gain and increased by any loss allocable thereto during the taxable year; or (2) The amount determined by any reasonable method of allocating income or loss to Excess Elective Deferrals for the taxable year and for the gap period provided the method used is the same method used by this Plan for allocating income or losses to Participant's Accounts; and (3) 10% of the amount determined under (1) multiplied by the number of whole months between the end of the Participant's taxable year and the distribution date, counting the month of distribution if it occurs after the 15th of such month. (d) SOURCE OF DISTRIBUTION: Distribution of Excess Elective Deferrals will be taken from a Participant's investment options based on rules established by the Administrator. 5.20 DISTRIBUTION OF EXCESS CONTRIBUTIONS Excess Contributions, plus any income and minus any loss allocable thereto, will be distributed no later than the last day of each Plan Year to Participants to whose accounts such Excess Contributions were allocated for the preceding Plan Year. The amount of Excess Contributions to be distributed to a Participant under this Section will be reduced by any Excess Elective Deferrals previously distributed - 57 - to the Participant under Section 5.19 for the Participant's taxable year ending with or within the Plan Year. Distribution of Excess Contributions will be made in accordance with the following provisions: (a) ALLOCATION TO HIGHLY COMPENSATED EMPLOYEES: Excess Contributions will be allocated to the Highly Compensated Employees with the largest amounts of Employer contributions taken into account in calculating the ADP Test for the year in which the Excess Contributions arose, beginning with the HCE with the largest amount of such Employer contributions and continuing in descending order until all the Excess Contributions have been allocated. For purposes of the preceding sentence, the "largest amount" is determined after distribution of any Excess Deferrals. If excess amounts are distributed more than 2 1/2 months after the last day of the Plan Year in which they arose, a 10% excise tax will be imposed on the Employer. Excess Contributions will be treated as Annual Additions pursuant to Section 6.1. (b) DETERMINATION OF INCOME OR LOSS: Excess Contributions will be adjusted for any income or loss up to the end of the Plan Year and, at the discretion of the Administrator, may be adjusted for income or loss up to the date of distribution. The period, if any, between the end of the Plan Year and the date of distribution will be referred to as gap period, and any income earned therein will be allocated at the Administrator's discretion applied consistently to all Participants and to all corrective distributions made for the Plan Year. The income or loss allocable to each Participant's Excess Contributions will be the amount determined by either the method in subparagraph (1) or subparagraph (2) plus, if applicable, the amount determined under subparagraph (3), as follows: (1) The amount determined by multiplying the income or loss allocable to the Participant's Elective Deferrals (and, if applicable, QNECs or QMACs, or both) for the Plan Year (and the gap period, if applicable) by a fraction, the numerator of which is the Participant's Excess Contributions for the year and the denominator of which is (A) the Participant's Elective Deferral Account balance (and QNECs or QMACs, or both, if any of such contributions are used in the ADP test) as of the beginning of the Plan Year plus any Elective Deferrals (and QNECs or QMACs, or both, if any of such contributions are included in the ADP test) allocated to the Participant during such Plan Year and the gap period, if applicable, or (B) solely with respect to Plan Years beginning before January 1, 1992, the Participant's Elective Deferral Account balance (and QNECs or QMACs or both, if any such contributions are included in the ADP Test) as of the end of the Plan Year reduced by any gain and increased by any loss allocable thereto during the Plan Year; or (2) The amount determined by any reasonable method of allocating income or loss to the Participant's Elective Deferrals (and if applicable, QNECs or QMACS, or both) for the Plan Year and for the gap period provided the method used is the same method used for allocating income or losses to Participants' Accounts; and (3) 10% of the amount determined under (1) multiplied by the number of whole months between the end of the Plan Year and the distribution date, counting the month of distribution if it occurs after the 15th of such month. (c) ACCOUNTING FOR EXCESS CONTRIBUTIONS: Excess Contributions will be distributed from the Participant's Elective Deferral Account and Qualified Matching Contribution Account in proportion to the Participant's Elective Deferrals and Qualified Matching Contributions (to the extent used in the - 58 - ADP Test) for the Plan Year. Excess Contributions will be distributed from the Participant's Qualified Non-Elective Contribution Account only to the extent the Excess Contributions exceed the balance in the Participant's Elective Deferral Account and Qualified Matching Contribution Account. (d) SOURCE OF DISTRIBUTION: Distribution of Excess Contributions will be taken from a Participant's investment options based on rules established by the Administrator. 5.21 DISTRIBUTION OF EXCESS AGGREGATE CONTRIBUTIONS All Excess Aggregate Contributions (plus any income and minus any loss allocable thereto) which are not Vested will be used to reduce Employer contributions for the current Plan Year or a future Plan Year. All Excess Aggregate Contributions (plus any income and minus any loss allocable thereto) which are Vested will be distributed no later than the last day of each Plan Year to Participants to whose Accounts Excess Aggregate Contributions were allocated for the preceding Plan Year. Distribution of Excess Aggregate Contributions will be made in accordance with the following provisions: (a) ALLOCATION TO HIGHLY COMPENSATED EMPLOYEES: Excess Aggregate Contributions will be allocated to the HCEs with the largest Contribution Percentage Amounts taken into account in calculating the ACP Test for the year in which the Excess Aggregate Contributions arose, beginning with the HCE with the largest amount of such Contribution Percentage Amounts and continuing in descending order until all the Excess Aggregate Contributions have been allocated. For purposes of the preceding sentence, the "largest amount" is determined after distribution of any Excess Contributions. (b) EXCISE TAX ON CERTAIN DISTRIBUTIONS: If Excess Aggregate Contributions are distributed more than 2 1/2 months after the last day of the Plan Year in which they arose, a 10% excise tax will be imposed on the Employer with respect to those amounts. (c) TREATMENT AS ANNUAL ADDITIONS: Excess Aggregate Contributions will be treated as Annual Additions under Section 6.1. (d) FORFEITURE OF CERTAIN MATCHING CONTRIBUTIONS: Matching Contributions made on behalf of an Employee which are attributable to Excess Elective Deferrals and Excess Contributions will be treated as Forfeitures and will be used in the manner described in Section 3.4(c). (e) DETERMINATION OF INCOME: Excess Aggregate Contributions will be adjusted for any income or loss up to the end of the Plan Year and, at the discretion of the Administrator, may be adjusted for income or loss up to the date of distribution. The period between the end of the Plan Year and the date of distribution will be referred to as the gap period, and any income earned during the gap period will be allocated at the discretion of the Administrator applied consistently to all Participants and to all corrective distributions for the Plan Year. The income or loss allocable to a Participant's Excess Aggregate Contributions will be the amount determined by either the method in subparagraph (1) or subparagraph (2) plus, if applicable, the amount determined under subparagraph (3): (1) The amount determined by multiplying the income or loss allocable to the Participant's Voluntary Employee Contributions, Matching Contributions (if not used in the ADP Test), Qualified Non-Elective Contributions and, to the extent applicable, Elective Deferrals for the Plan Year (and the gap period, if applicable) by a fraction, the numerator of which is - 59 - such Participant's Excess Aggregate Contributions for the year and the denominator of which is (A) the Participant's Account balance(s) attributable to Contribution Percentage Amounts as of the beginning of the Plan Year, plus any additional amounts attributable to Contribution Percentage Amounts allocated to the Participant during such Plan Year and the gap period, if applicable, or (B) solely with respect to Plan Years beginning before January 1, 1992, the Participant's Account balance attributable to Contribution Percentage Amounts as of the end of the Plan Year, reduced by any gain and increased by any loss allocable thereto during the Plan Year; or (2) The amount determined by any reasonable method of allocating income or loss to the Participant's Voluntary Contributions, Matching Contributions and Qualified Non-Elective Contribution for the Plan Year and for the gap period, if applicable, provided the method used is the same one used for allocating income or losses to Participants' Accounts; and (3) 10% of the amount determined under (1) multiplied by the number of whole months between the end of the Plan Year and the distribution date, counting the month of distribution if it occurs after the 15th of such month. (f) ACCOUNTING FOR EXCESS AGGREGATE CONTRIBUTIONS: Excess Aggregate Contributions will be forfeited if forfeitable, or will be distributed on a pro-rata basis from the Participant's Voluntary Employee Contribution Account, Matching Contribution Account and Qualified Matching Contribution Account, and if applicable, from the Qualified Non-Elective Contribution Account or Elective Deferral Account, or from both. (g) SOURCE OF DISTRIBUTION: Distribution of Excess Aggregate Contributions will be taken from a Participant's investment options based on rules established by the Administrator. 5.22 ELIMINATION OF CERTAIN FORMS OF PAYMENT The form or forms of distribution described in Section 5.1, 5.3 and 5.4 are intended to satisfy the requirements of regulation ss.1.411(d)-4, Q&A-2(e). Accordingly, the form or forms of distribution described therein are intended to be the only form or forms of distribution permitted under this Plan, and subject to the provisions of Section 9.1(a)(2), any other form of distribution permitted by the Plan on December 31, 2002 is eliminated. - 60 - ARTICLE 6 CODE SS.415 LIMITATIONS 6.1 MAXIMUM ANNUAL ADDITION The maximum Annual Addition as defined in paragraph (c) below made to a Participant's various accounts maintained under the Plan for any Limitation Year beginning after December 31, 1986 will not exceed the lesser of the Dollar Limitation set forth in paragraph (a) or the Compensation Limitation set forth in paragraph (b), as follows: (a) DOLLAR LIMITATION: For Limitation Years beginning after December 31, 1994, the Dollar Limitation is $30,000 as annually adjusted pursuant to Code ss.415(d). (b) COMPENSATION LIMITATION: The Compensation Limitation is equal to 25% of the Participant's Section 415 Compensation for the Limitation Year. This limitation will not apply to any contribution made for medical benefits within the meaning of Code ss.419A(f)(2) after separation from service which is otherwise treated as an Annual Addition or to any amount treated as an Annual Addition under Code ss.415(l)(1). (c) ANNUAL ADDITIONS: The term Annual Additions means the sum of the following amounts credited to a Participant's Account for the Limitation Year: (1) Employer contributions; (2) Employee contributions; (3) Forfeitures; (4) amounts allocated after March 31, 1984 to an individual medical account, as defined in Code ss.415(l)(2), which is part of a pension or annuity plan maintained by the Employer; and (5) amounts derived from contributions paid or accrued after December 31, 1985, in taxable years ending after such date, attributable to post-retirement medical benefits, allocated to the separate account of a key employee, as defined in Code ss.419A(d)(3), under a welfare fund, as defined in Code ss.419(e), maintained by the Employer. Annual Additions do not include a Participant's rollovers, loan repayments, repayments of prior Plan distributions or prior distributions of mandatory contributions, direct transfers of contributions from another plan to this Plan, deductible contributions to a SEP, or voluntary deductible contributions. 6.2 ADJUSTMENTS TO MAXIMUM ANNUAL ADDITION In applying the limitation on Annual Additions set forth in Section 6.1, the following adjustments must be made to the limitation: (a) SHORT LIMITATION YEAR: In a Limitation Year of less than 12 months, the Defined Contribution Dollar Limitation in Section 6.1(a) will be adjusted by multiplying it by the ratio that the number of months in the short Limitation Year bears to 12. (b) MULTIPLE DEFINED CONTRIBUTION PLANS: If a Participant participates in multiple defined contribution plans sponsored by the Employer which have different Anniversary Dates, the maximum Annual Addition in this Plan for the Limitation Year will be reduced by the Annual Additions credited to the Participant's accounts in the other defined contribution plans in the Limitation Year. If a Participant participates in multiple defined contribution plans sponsored by the Employer which have the same Anniversary Date, (1) if only one of the plans is subject to Code ss.412, Annual Additions will first be credited to the Participant's account in the plan subject to Code ss.412; and (2) if more than one of the plans is - 61 - subject to Code ss.412, the maximum Annual Addition in this Plan for a given Limitation Year will be equal to the product of the maximum Annual Addition for such Limitation Year minus any other Annual Additions previously credited to the Participant's account under clause (1), multiplied by the ratio the Annual Additions which would be credited to a Participant's accounts hereunder without regard to the limitations in Section 6.1 bears to the Annual Additions for all plans described in this clause (2). 6.3 MULTIPLE PLANS AND MULTIPLE EMPLOYERS All defined benefit plans (whether terminated or not) of the Employer will be treated as one defined benefit plan, and all defined contribution plans (whether terminated or not) of the Employer will be treated as one defined contribution plan. In addition, all Affiliated Employers will be considered a single employer. 6.4 ADJUSTMENT FOR EXCESSIVE ANNUAL ADDITIONS If for any Limitation Year the Annual Additions allocated to a Participant's Account exceeds the maximum amount permitted under Section 6.1 above because of an allocation of Forfeitures, a reasonable error in estimating a Participant's Compensation, a reasonable error in determining the amount of elective contributions (within the meaning of Code ss.402(g)(3)), or because of other limited facts and circumstances that the Commissioner finds justify the availability of the rules set forth in this Section, then such Participant's Account will be adjusted in accordance with the following provisions in order to reduce the excess Annual Additions: (a) RETURN OF EMPLOYEE CONTRIBUTIONS: First, Voluntary Employee Contributions, if any, and second, the amount of elective deferrals and corresponding Employer matching contributions, if any, to the extent that they would reduce the excess amount, will be calculated. Such elective deferrals and Voluntary Employee Contributions plus attributable earnings, will be returned to the Participant. Any Employer matching contribution amount will be applied as described in (b) or (c) below, depending on whether the Participant is covered by the Plan at the end of the Limitation Year. (b) EXCESS USED TO REDUCE EMPLOYER CONTRIBUTIONS IF PARTICIPANT IS STILL COVERED BY THE PLAN: If, after the application of paragraph (a), an excess amount still exists and the Participant is covered by the Plan at the end of the Limitation Year, the excess amount in the Participant's Account plus applicable earnings thereon, if any, will be used to reduce Employer contributions (including any allocation of Forfeitures) for such Participant in the next Limitation Year, and in each succeeding Limitation Year if necessary. (c) EXCESS USED TO REDUCE EMPLOYER CONTRIBUTIONS IF PARTICIPANT IS NOT COVERED BY THE PLAN: If, after the application of paragraph (a), an excess amount still exists and the Participant is not covered by the Plan at the end of a Limitation Year, the excess amount, plus applicable earnings thereon, if any, will be held unallocated in a suspense account. The suspense account will be applied to reduce future Employer contributions (including the allocation of any Forfeitures) for all remaining Participants in the next Limitation Year, and in each succeeding Limitation Year if necessary. (d) SUSPENSE ACCOUNT: If a suspense account is in existence at any time during a Limitation Year pursuant to this Section, such suspense account will not participate in the allocation of the Trust's investment gains and losses. If a suspense account is in existence at any time during a particular Limitation Year, all amounts in the suspense account must be allocated and reallocated to Participants' Accounts before any Employer Contributions or any Employee contributions may be made to the Plan for that Limitation Year. Excess amounts may not be distributed to Participants or former Participants. 6.5 MULTIPLE PLAN REDUCTION For Limitation Years beginning before January 1, 2000, if an Employee is, or has been, a Participant in one or more Employer-sponsored defined benefit plans and in one or more Employer-sponsored defined contribution plans, the sum of the defined benefit plan fraction and the defined contribution plan fraction for any Limitation Year may not exceed 1.0, determined in accordance with the following provisions: - 62 - (a) DEFINED BENEFIT FRACTION: The defined benefit fraction has as its numerator the Participant's Projected Annual Benefits determined as of the close of the Limitation Year and has as its denominator the lesser of 125% of the dollar limitation for the Limitation Year determined under Code ss.415(b) and ss.415(d), or 140% of the amount which may be taken into account under Code ss.415(b)(1)(B) for such Limitation Year. However, with respect to anyone who was a Participant as of the first day of the first Limitation Year beginning after December 31, 1987, in one or more defined benefit plans maintained by the Employer which were in existence on May 6, 1986, the denominator of the defined benefit fraction will not be less than 125% of the Current Accrued Benefit. (b) DEFINITIONS: The term Projected Annual Benefits means the annual benefits payable to a Participant under all defined benefit plans (whether terminated or not) of the Employer as determined under regulation ss.1.415-7(b)(3); and the term Current Accrued Benefit means a Participant's accrued benefit under a defined benefit plan, determined as if the Participant had separated from service as of the close of the last Limitation Year beginning before January 1, 1987, when expressed as an annual benefit within the meaning of Code ss.415(b)(2). In determining a Participant's Current Accrued Benefit, the Administrator will disregard any changes to the Plan after May 5, 1986, and any cost of living adjustment after May 5, 1986. The Current Accrued Benefit will only be used as set forth above if the defined benefit plans individually and in the aggregate satisfied the requirements of Code ss.415 for all Limitation Years beginning before January 1, 1987. (c) DEFINED CONTRIBUTION FRACTION: The defined contribution fraction has as its numerator the sum of the Annual Additions to the Participant's Account under all the defined contribution plans (whether terminated or not) maintained by the Employer for the current Limitation Year and all prior Limitation Years (including the Annual Additions attributable to the Participant's non-deductible contributions to all Employer maintained defined benefit plans, whether terminated or not, and the Annual Additions attributable to all welfare benefit funds, as defined in Code ss.419(e), and individual medical accounts, as defined in Code ss.415(l)(2) maintained by the Employer), and has as its denominator the sum of the maximum aggregate amounts for the current Limitation Year and all prior Limitation Years the Employee was employed by the Employer (regardless of whether a defined contribution plan was maintained by the Employer). The maximum permissible aggregate amount in any Limitation Year is the lesser of (1) 125% of the dollar limitation in effect in Code ss.415(c)(1)(A) for such Limitation Year determined without regard to Code ss.415(c)(6) and adjusted per regulation ss.1.415-7(d)(1) and Notice 83-10, or (2) 35% of the Participant's Section 415 Compensation. (d) TRANSITION RULE FOR DENOMINATOR: For defined contribution plans in effect on or before July 1, 1982, the Administrator may elect for any Limitation Year ending after December 31, 1982 that the denominator be the product of the denominator for the Limitation Year ending in 1982 determined under the law in effect for such Limitation Year, multiplied by the Transition Fraction, which is a fraction which has as its numerator the lesser of $51,875 or 1.4 multiplied by 25% of the Participant's Section 415 Compensation for the Plan Year ending in 1981, and which has as its denominator the lesser of $41,500 or 25% of the Participant's Section 415 Compensation for the Plan Year ending in 1981. In any Top Heavy Limitation Year, $41,500 will be substituted for $51,875 in determining the Transition Fraction unless the Extra Minimum Allocation is being provided in Section 3.5. In a Super Top Heavy Plan Year, $41,500 will always be substituted for $51,875. - 63 - (e) ADJUSTMENT OF FRACTION: If an Employee was a Participant as of the end of the first day of the first Limitation Year beginning after December 31, 1986 in one or more defined contribution plans maintained by the Employer which were in existence on May 6, 1986, the numerator of the defined contribution fraction will be adjusted if the sum of such defined contribution fraction and the defined benefit fraction would otherwise exceed 1.0 under the terms of this Plan. Under the adjustment, an amount equal to the product of the excess of the sum of the defined benefit fraction and the defined contribution fraction over 1.0 multiplied by the denominator of the defined contribution fraction will be permanently subtracted from the numerator of the defined contribution fraction. The adjustment will be calculated using the fractions as they would be computed as of the end of the last Limitation Year beginning before January 1, 1987, disregarding any changes in the terms and conditions of the Plan made after May 5, 1986, but using the Code ss.415 limitation applicable to the first Limitation Year beginning on or after January 1, 1987. (f) TOP HEAVY ADJUSTMENTS: In any Top Heavy Limitation Year, 100% will be substituted for 125% in paragraphs (a) and (c) unless an eligible Non-Key Employee (1) is being provided a 7.5% allocation under Section 3.5(d); or (2) is being provided a retirement benefit under a defined benefit plan equal to 3% of average monthly Code ss.415 Compensation. However, in any Super Top Heavy Limitation Year (which means the Top Heavy Ratio exceeds 90% for that Limitation Year), 100% will be substituted for 125% in any event. If the 100% limitation is exceeded for any Participant in any Limitation Year, then (1) the Participant's accrued benefit in the defined benefit plan will not be increased; (2) no Annual Additions may be credited to the Participant's accounts under this Plan; and (3) the Participant may not make any contributions, whether voluntary or mandatory, to this Plan or any other Employer-sponsored qualified plan. - 64 - ARTICLE 7 DUTIES OF THE TRUSTEE 7.1 APPOINTMENT, RESIGNATION, REMOVAL AND SUCCESSION The Plan will have one or more individual Trustees, a corporate Trustee or any combination thereof appointed as follows: (a) APPOINTMENT OF TRUSTEE: Each Trustee will be appointed by the Sponsor and will serve until its successor has been named or until such Trustee's resignation, death, incapacity, or removal, in which event the Employer will name a successor Trustee. The term Trustee will include the original and any successor Trustees. (b) RESIGNATION OF TRUSTEE: A Trustee may resign by giving 30 days written notice in advance to the Sponsor, unless such notice is waived by the Sponsor. The Sponsor may remove a Trustee any time, with or without cause, by giving written notice of the removal to the Trustee. Unless waived in writing by the Sponsor, if any Trustee who is an Employee, a Self-Employed Individual or an Owner-Employee resigns or terminates employment with, or ownership of, the Sponsor or an Adopting Employer for any reason, such termination will constitute an immediate resignation as a Trustee of the Plan. (c) SUCCESSOR TRUSTEE: Each successor Trustee will succeed to title to the Trust by filing a written acceptance of appointment with the former Trustee and the Sponsor. The former Trustee, upon receipt of such acceptance, will execute all documents and perform all acts necessary to vest the Trust Fund's title of record in any successor Trustee. No successor Trustee will be personally liable for any act or failure to act of any predecessor Trustee. (d) MERGER OF CORPORATE TRUSTEE: If any corporate Trustee, before or after qualification, changes its name, consolidates or merges with another corporation, or otherwise reorganizes, any resulting corporation which succeeds to the fiduciary business of such Trustee will become a Trustee hereunder in lieu of such corporate Trustee. 7.2 INVESTMENT ALTERNATIVES OF THE TRUSTEE The Trustees will implement an investment program based on the Employer's investment objectives and the Employee Retirement Income Security Act. In addition to powers given by law, the Trustees may engage in the following investment activities on behalf of the Trust: (a) PROPERTY: The Trustee may invest assets in any form of property, including common and preferred stocks, exchange covered call options, bonds, money market instruments, mutual funds, savings accounts, certificates of deposit, Treasury bills, insurance policies and contracts, or in any other property, real or personal, foreign or domestic, having a ready market including securities issued by an institutional Trustee and/or affiliate of the institutional Trustee. An institutional Trustee may invest in its own deposits if such deposits bear a reasonable interest rate. The Trustee may retain, manage, operate, repair, improve and mortgage or lease for any period on such terms as it deems proper any real estate or personal property held by the Trustee, including the power to demolish any building or other improvements in whole or part. The Trustee may erect buildings or other improvements, make leases that extend beyond the term of this Trust, and foreclose, extend, renew, assign, release or partially release and discharge mortgages or other liens. (b) POOLED FUNDS AND COMMON TRUSTS: If the Sponsor maintains more than one qualified retirement plan, the assets of two or more of such plans may be maintained by the Trustee in a single trust established by the Sponsor. In addition, the Trustee may transfer any Trust assets to a collective trust established to permit the pooling of funds of separate pension and - 65 - profit-sharing trusts provided the Internal Revenue Service has ruled such collective trust to be qualified under Code ss.401(a) and exempt under Code ss.501(a) (or under the applicable corresponding provision of any other Revenue Act) or to any other common, collective, or commingled trust fund which has been or may hereafter be established and maintained by the Trustee and/or affiliates of an institutional Trustee. Such commingling of assets of the Fund with assets of other qualified trusts is specifically authorized, and to the extent of the investment of the Trust Fund in such a group or collective trust, the terms of the instrument establishing the group or collective trust will be a part hereof as though set forth herein. (c) EMPLOYER STOCK: The Trustee may invest assets in the common stock, debt obligations, or any other security issued by the Employer within the limitations provided under ERISA ss.406, ss.407 and ss.408 if such investment does not constitute a prohibited transaction under Code ss.4975. Any such investment will only be made upon written direction of the Employer, which will be solely responsible for its propriety. (d) CASH RESERVES: The Trustee may retain in cash such Trust Fund assets as the Trustee may deem advisable to satisfy the liquidity needs of the Plan and to deposit any cash held in the Trust Fund in a bank account without liability for the highest rate of interest available. If a bank is acting as Trustee, such Trustee is specifically given authority to invest in deposits of such Trustee. The Trustee may also hold cash un-invested at any time and from time to time and in such amount or to such extent as the Trustee deems prudent, and the Trustee will not be liable for any losses that may be incurred as the result of the failure to invest same, except to the extent provided herein or in ERISA. (e) REORGANIZATIONS, RECAPITALIZATIONS, CONSOLIDATIONS, SALES OR MERGERS: The Trustee may join in or oppose the reorganization, recapitalization, consolidation, sale or merger of corporations or properties, upon such terms as the Trustee deems wise. (f) REGISTRATION OF SECURITIES: The Trustee may cause any securities or other property to be registered in the Trustee's own name or in the name of the Trustee's nominee or nominees, and may hold any investments in bearer form, but the records of the Trustee will at all times show all such investments as part of the Trust Fund. (g) PROXIES: The Trustee may vote proxies and if appropriate pass them on to any investment manager which may have directed the investment in the equity giving rise to the proxy. (h) OWNERSHIP RIGHTS: The Trustee may exercise all ownership rights with respect to any assets held in the Trust Fund. (i) OTHER INVESTMENTS: The Trustee may accept and retain for such time as the Trustee deems advisable any securities or other property received or acquired as Trustee, whether or not such securities or property would normally be purchased as investments hereunder. (j) KEY MAN INSURANCE: The Trustee, with the consent of the Administrator, may purchase insurance Policies on the life of any Participant whose employment is deemed to be key to the Employer's financial success. Such key man Policies will be deemed to be an investment of the Trust Fund and will be payable to the Trust Fund as the beneficiary thereof. The Trustee may exercise any and all rights granted under such Policies. Neither the Trustee, Employer, Administrator, nor any Fiduciary will be responsible for the validity of any - 66 - Policy or the failure of any insurer to make payments thereunder, or for the action of any person which delays payment or renders a Policy void in whole or in part. No insurer that issues a Policy will be deemed a party to this Plan for any purpose or to be responsible for its validity; nor will it be required to look into the terms of the Plan nor to question any action of the Trustee. The obligations of the insurer will be determined solely by the Policy's terms and any other written agreements between it and the Trustee. The insurer will act only at the written direction of the Trustee, and will be discharged from all liability with respect to any amount paid to the Trustee. The insurer will not be obligated to see that any money paid by it to the Trustee or any other person is properly distributed or applied. (k) LOANS TO THE TRUST: The Trustee may borrow or raise money for purposes of the Plan in such amounts, and upon such terms and conditions, as the Trustee deems advisable; and for any sum so borrowed, the Trustee may issue a promissory note as Trustee, and secure repayment of the loan by pledging all, or any part, of the Trust Fund as collateral. No person lending money to the Trustee will be bound to see to the application of the money lent or to inquire into the validity or propriety of any borrowing. (l) AGREEMENTS WITH BANKS: The Trustee may with the consent of the Sponsor and upon such terms as they deem necessary, enter into an agreement with a bank or trust company providing for the deposit of all or part of the Trust assets with such bank or trust company, and the appointment of such bank or trust company as the agent or custodian of the Trustees for investment purposes, with such discretion in investing and reinvesting the funds of the Trust as the Trustees deem it necessary or desirable to delegate. (m) LITIGATION: The Trustee may begin, maintain, or defend any litigation necessary in connection with the administration of the Plan, except that the Trustee will not be obliged or required to do so unless indemnified to its satisfaction. (n) CLAIMS, DEBTS OR DAMAGES: The Trustee may settle, compromise, or submit to arbitration any claims, debts, or damages due or owing to or from the Plan. (o) MARGIN ACCOUNTS, OPTIONS AND COMMODITIES TRADING: The Trustee may engage in the following activities: borrowing on margin, buying options, writing covered options, options spreads/straddles, and future/commodities trading. (p) MISCELLANEOUS: The Trustee may do all such acts (including, but not limited to, margin trading and futures and commodities trading) and exercise all such rights, although not specifically mentioned herein, as the Trustee deems necessary. The Trustee will not be restricted to securities or other property of the character expressly authorized by applicable law for trust investments, provided the Trustee discharges its duties with the care, skill, prudence, and diligence, under the circumstances then prevailing, that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of similar character and with similar aims by diversifying the investments to minimize the risks of large losses unless under the circumstances it is clearly prudent not to do so. 7.3 VALUATION OF THE TRUST FUND On each Valuation Date, the Trustee will determine the net worth of the Trust Fund. The fair market value of securities listed on a registered stock exchange will be the prices at which they were last traded on such exchange preceding the close of business on the Valuation Date. If the securities were not traded on the Valuation Date, or if the exchange on which they are traded was not open for business on the Valuation Date, then the securities will be valued at the prices at - 67 - which they were last traded prior to the Valuation Date. Any unlisted security will be valued at its bid price next preceding the close of business on the Valuation Date, which bid price will be obtained from a registered broker or an investment banker. To determine the fair market value of assets other than securities for which trading or bid prices can be obtained, the Trustee may use any reasonable method to determine the value of such assets, or may elect to employ one or more appraisers for that purpose and rely on the values established by such appraiser or appraisers. 7.4 COMPENSATION AND EXPENSES The Trustee, either from the Trust Fund or from the Employer, will be reimbursed for all of its expenses and will be paid reasonable compensation as agreed upon from time to time with the Employer; but no person who receives full-time pay from the Employer will receive any fees for services to the Plan as Trustee or in any other capacity. Expenses will be paid by each Adopting Employer in the ratio that each Adopting Employer's Participants' Accounts bears to the total of all the Participants' Accounts maintained by this Plan. 7.5 PAYMENTS FROM THE TRUST FUND The Trustee will pay Plan benefits and other payments as the Administrator directs, and except as provided by ERISA, the Trustee will not be responsible for the propriety of such payments. Any payment made to a Participant, or a Participant's legal representative or Beneficiary in accordance with the terms of the Plan will, to the extent of such payment, be in full satisfaction of all claims arising against the Trust, the Trustee, the Employer, and the Administrator. Any payment or distribution made from the Trust is contingent on the recipient executing a receipt and release acceptable to the Trustee, Administrator, or Employer. 7.6 PAYMENT OF TAXES The Trustee will pay all taxes of the Trust Fund, including property, income, transfer and other taxes which may be levied or assessed upon or in respect of the Trust Fund or any money, property or securities forming a part of the Trust Fund. The Trustee may withhold from distributions to any payee such sum as the Trustee may reasonably estimate as necessary to cover federal and state taxes for which the Trustee may be liable, which are, or may be, assessed with regard to the amount distributable to such payee. Prior to making any payment, the Trustee may require such releases or other documents from any lawful taxing authority and may require such indemnity from any payee or distributee as the Trustee deems necessary. 7.7 ACCOUNTS, RECORDS AND REPORTS The Trustee will keep accurate records reflecting its administration of the Trust Fund and will make them available to the Administrator for review and audit. At the request of the Administrator, the Trustee will, within 90 days of such request, file with the Administrator an accounting of its administration of the Trust Fund during such period or periods as the Administrator determines. The Administrator will review the accounting and notify the Trustee within 90 days if the report is disapproved, providing the Trustee with a written description of the items in question. The Trustee will have 60 days to provide the Administrator with a written explanation of the items in question. If the Administrator again disapproves of the report, the Trustee will file its accounting in a court of competent jurisdiction for audit and adjudication. 7.8 EMPLOYMENT OF AGENTS AND COUNSEL The Trustee may employ such agents, counsel, consultants, or service companies as it deems necessary and may pay their reasonable expenses and compensation. The Trustee will not be liable for any action taken or omitted by the Trustee in good faith pursuant to the advice of such agents and counsel. Any agent, counsel, consultant, service company and/or its successors will exercise no discretionary authority over investments or the disposition of Trust assets, and their services and duties will be ministerial only and will be to provide the Plan with those things required by law or by the terms of the Plan without in any - 68 - way exercising any fiduciary authority or responsibility under the Plan. The duties of a third party administrator will be to safe-keep the individual records for all Participants and to prepare all required actuarial services and disclosure forms under the supervision of the Administrator and any Fiduciaries of the Plan. It is expressly stated that the third party administrator's services are only ministerial in nature and that under no circumstances will such third party administrator exercise any discretionary authority whatsoever over Plan Participants, Plan investments, or Plan benefits. 7.9 DIVISION OF DUTIES AND INDEMNIFICATION The division of duties and the indemnification of the Trustee of this Plan will be governed by the following provisions: (a) NO GUARANTEE AGAINST LOSS: The Trustee will have the authority and discretion to manage and control the Trust Fund to the extent provided in this instrument, but does not guarantee the Fund in any manner against investment loss or depreciation in asset value, or guarantee the adequacy of the Fund to meet and discharge all or any liabilities of the Plan. Furthermore, the Trustee will not be liable for the making, retention or sale of any investment or reinvestment made by it, as herein provided, or for any loss to or diminution of the Fund, or for any other loss or damage which may result from the discharge of its duties hereunder, except to the extent it is judicially determined that the Trustee failed to exercise the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and like aims. (b) REPRESENTATIONS OF THE SPONSOR: The Sponsor warrants that all directions issued to the Trustee by it or the Plan Administrator will be in accordance with the terms of the Plan and not contrary to the provisions of the Employee Retirement Income Security Act of 1974 and the regulations issued thereunder. (c) DIRECTIONS BY OTHERS: The Trustee will not be answerable for any action taken pursuant to any direction, consent, certificate, or other paper or document on the belief that the same is genuine and signed by the proper person. All directions by the Employer, a Participant or the Plan Administrator will be in writing. The Plan Administrator will deliver to the Trustee certificates evidencing the individual or individuals authorized to act as the Administrator and will deliver to the Trustee specimens of their signatures. (d) DUTIES AND OBLIGATIONS LIMITED BY THE PLAN: The duties and obligations of the Trustee will be limited to those expressly imposed upon it by this Plan or subsequently agreed upon by the parties. Responsibility for administrative duties required under the Plan or applicable law not expressly imposed upon or agreed to by the Trustee, will rest solely with the Sponsor and with the Administrator. (e) INDEMNIFICATION OF TRUSTEE: The Trustee will be indemnified and saved harmless by the Employer against any and all liability to which the Trustee may be subjected, including all expenses reasonably incurred in its defense, for any action or failure to act resulting from compliance with the Employer's instructions, the Employer's employees or agents, the Administrator, or any other Plan Fiduciary, and for any liability arising from the actions or non-actions of any predecessor Trustees or Plan Fiduciary. (f) TRUSTEE NOT RESPONSIBLE FOR APPLICATION OF PAYMENTS: The Trustee will not be responsible in any way for the application of any payments it is directed to make or for the adequacy of the Fund to meet and discharge any and all liabilities under the Plan. - 69 - (g) MULTIPLE TRUSTEES: If more than one Trustee is appointed, any single Trustee may act independently in undertaking any act and/or transaction on behalf of the Trust unless the Trustees have agreed by a majority vote that a particular action, including signing documents or checks, must be approved by a majority vote before it can be undertaken. (h) LIMITATION OF LIABILITY: No Trustee will be liable for the act of any other Trustee or Fiduciary unless the Trustee has knowledge of such act. (i) TRUSTEE AS PARTICIPANT OR BENEFICIARY: Trustee will not be prevented from receiving any benefits to which it may be entitled as a Participant or Beneficiary in the Plan, so long as the benefits are computed and paid on a basis that is consistent with the terms of the Plan as applied to all other Participants and Beneficiaries. (j) NO SELF-DEALING: The Trustee will not (1) deal with the assets of the Trust Fund in its own interest or for its own account; (2) in its individual or in any other capacity, act in any transaction involving the Trust Fund on behalf of a party (or represent a party) whose interests are adverse to the interests of the Plan, or its Participants or Beneficiaries; or (3) receive any consideration for its own personal accounts from any party dealing with the Plan in connection with a transaction involving assets of the Trust Fund. 7.10 APPOINTMENT OF INVESTMENT MANAGER The Trustee, if so directed by the Sponsor, will appoint an Investment Manager to manage and control the investment of all or any portion of the Trust Fund. Each Investment Manager will be either (a) an investment advisor registered under the Investment Advisors Act of 1940; (b) a bank as defined in that Act; or (c) an insurance company qualified to manage, acquire or dispose of any asset of the Trust under the laws of more than one state. An Investment Manager must acknowledge in writing that it is a Fiduciary. The Sponsor will enter into an agreement with an Investment Manager specifying the duties and compensation of the Investment Manager and further specifying any other terms and conditions under which the Investment Manager will be retained. The Trustee will not be liable for any act or omission of an Investment Manager, and will not be liable for following the advice of an Investment Manager with respect to any duties delegated by the Sponsor to the Investment Manager. The Sponsor will determine the portion of the Trust Fund to be invested by an Investment Manager and will establish investment objectives and guidelines for the Investment Manager to follow. 7.11 ASSIGNMENT AND ALIENATION OF BENEFITS Except as may otherwise be permitted under Code ss.401(a)(13)(C) effective August 5, 1997, or as may otherwise be permitted under a Qualified Domestic Relations Order as provided in Section 8.11, or as otherwise be permitted under Section 7.14 if loans to Participants are permitted, no right or claim to, or interest in, any part of the Trust Fund, or any payment therefrom, will be assignable, transferable, or subject to sale, mortgage, pledge, hypothecation, commutation, anticipation, garnishment, attachment, execution, or levy of any kind, and the Trustees will not recognize any attempt to assign, transfer, sell, mortgage, pledge, hypothecate, commute, or anticipate the same, except to the extent required by law. 7.12 EXCLUSIVE BENEFIT RULE All contributions made by an Employer (whether or not the Employer is an Affiliated Employer with one or more other Adopting Employers) to the Trust Fund will be used for the exclusive benefit of all Participants and their Beneficiaries and will not be used for nor diverted to any other purpose except the payment of the costs of maintaining the Plan. - 70 - 7.13 PURCHASE OF INSURANCE Subject to any rules or procedures that may be established by the Administrator under paragraph (k) below, the Trustee may purchase life insurance Policies on the life of a Participant and/or the Participant's Spouse in accordance with the following provisions: (a) OWNERSHIP OF POLICIES: All life insurance Policies will be vested exclusively in the Trustee and will be payable to the Trustee, subject to the rights of the Beneficiaries hereunder unless the Trustee permits the designation of a named beneficiary other than the Trustee. However, notwithstanding the foregoing, no Trustee who is also a Participant may, except in a fiduciary capacity, exercise any ownership rights with respect to any Policy insuring the life of such Trustee in his or her capacity as a Participant. (b) PRIMARY LIMIT ON PREMIUMS: At the direction of the Administrator, the Trustee will purchase Policies on the life of the Participant, provided that the aggregate premiums on ordinary life insurance Policies must be less than 50% of the Participant's Account balance; (2) the aggregate premiums on term life insurance Policies, universal life insurance Policies and all other life insurance Policies which are not ordinary life insurance Policies must be less than 25% of the Participant's Account balance; and (3) the sum of one-half of the premiums on ordinary life insurance Policies and the total of all other life insurance premiums cannot exceed 25% of the Participant's Account balance. For purposes of this Section, an ordinary life insurance Policy is an insurance policy that has a non-decreasing death benefit and also has a non-increasing premium. (c) ALTERNATE LIMIT ON PREMIUMS: Notwithstanding paragraph (a), a Participant may elect that up to 100% of his or her Rollover Account, and up to 100% of the portion of his or her Vested Participant's Account that has accumulated in the Plan for at least 2 years, be used to purchase Policies on the life of the Participant's life, the life of the Participant's Spouse, and/or the joint lives of the Participant and the Participant's Spouse. Likewise, a Participant who has participated in the Plan for at least 5 years may elect that up to 100% of his or her Rollover Account, and up to 100% of his or her Vested Participant's Account balance, be used to purchase Policies on the life of the Participant, the life of the Participant's Spouse, and/or the joint lives of the Participant and his or her Spouse. (d) PAYMENT OF PREMIUMS: If Employer contributions are inadequate to pay all premiums on Policies, the Trustees may, at the direction of the Plan Administrator, utilize other amounts remaining in the Trust Fund to pay the premiums, allow the Policies to lapse, reduce the Policies to a level at which they may be maintained, or borrow against the Policies on a prorated basis if borrowing does not discriminate in favor of Policies issued on the lives of officers, Shareholder-Employees and/or Highly Compensated Employees. (e) PAYMENT OF PREMIUMS FROM LOANS: The Trustees may pay premiums when due from the loan values of the Policies themselves if (1) any such loan is made against all of the Policies in proportion to their respective cash surrender values, and (2) all such loans are repaid in proportion to the cash surrender value of such Policies. (f) POLICY DIVIDENDS: Any insurer payments that are paid to the Trustee on account of experience credits, dividends, or surrender or cancellation credits, will be applied by the Employer within the current or next succeeding Plan Year toward premiums due. (g) CONFLICT WITH PLAN: Subject to the provisions of paragraph (j) below, if the provisions of any insurance Policy purchased hereunder conflict with the terms of this Plan, the provisions of the Plan will control. - 71 - (h) DISPOSITION OF POLICIES UPON TERMINATION: If a Terminated Participant's Vested Interest equals or exceeds the cash surrender value of any Policies issued on his life, the Trustee, with the consent of both the Administrator and the Terminated Participant, will transfer such Policies to the Terminated Participant, together with any restrictions the Administrator may impose concerning the Terminated Participant's right to surrender, assign, or otherwise realize cash on such Policies prior to his Normal Retirement Date. If the Terminated Participant's Vested Interest in his Participant's Account is less than the cash surrender values of such Policies, the Administrator may permit him to pay the Trustee the sum required to make distribution equal to the value of the Policies being assigned or transferred, or the Trustee may borrow the cash surrender values of the Policies from the insurer and then assign the Policies to the Terminated Participant. (i) DISPOSITION OF POLICIES AT RETIREMENT: When a Participant retires, the Trustee, at the direction of the Administrator, must, with respect to any Policies purchased on the life of such Participant under paragraph (b), either (1) transfer them to the Participant, (2) with the Participant's consent, borrow their cash surrender values and transfer them to the Participant subject to the loan, or (3) surrender them for their cash surrender values. If options (2) or (3) are elected, the cash surrender values will be added to the Participant's Account for distribution in accordance with Section 5.1. (j) FIDUCIARIES AND INSURERS PROTECTED: Neither the Trustee, Employer, Administrator, nor any Fiduciary will be responsible for the validity of any Policy or the failure of any insurer to make payments thereunder, or for the action of any person which may delay payment or render a Policy void in whole or in part. No insurer which issues a Policy will be deemed a party to this Plan for any purpose or to be responsible for its validity; nor will it be required to look into the terms of the Plan nor to question any action of the Trustee. The obligations of the insurer will be determined solely by the Policy's terms and any other written agreements between it and the Trustee. The insurer will act only at the written direction of the Trustee, and will be discharged from all liability with respect to any amount paid to the Trustee. The insurer will not be obligated to see that any money paid by it to the Trustee or any other person is properly distributed or applied. (k) ESTABLISHMENT OF ADMINISTRATIVE PROCEDURES: The Administrator may in a separate written document establish rules or procedures regarding the conditions under which Policies can be purchased by the Trustee. Such separate written document, when properly executed, will be deemed incorporated in this Plan. The rules or procedures therein may be modified or amended by the Administrator without the necessity of amending this Section, but any such modifications must be communicated to Participants in the manner described in Section 8.9. Notwithstanding the foregoing, (1) a summary plan description or summary of material modifications thereto in which the rules or procedures regarding the purchase of insurance Policies is described will be considered a separate written document sufficient to satisfy the requirements (including the execution requirement) of this paragraph; and (2) any rules or procedures established under this paragraph must be applied by the Administrator in a uniform nondiscriminatory manner. 7.14 LOANS TO PARTICIPANTS Subject to any rules or procedures set forth in a written loan policy that may be established by the Administrator under paragraph (m) below, the Trustee may permit loans to be made from the Trust Fund to Participants and Beneficiaries, and subject to any such rules or procedures, all loans will be made in accordance with the following provisions: - 72 - (a) LOANS MUST BE NONDISCRIMINATORY: The Administrator will have the sole right to approve or disapprove a loan application, but loans will be made available to all Participants on a reasonably equivalent basis. Loans will not be made available to HCEs in an amount greater than the amount made available to other Employees. (b) LOANS TO OWNER-EMPLOYEES OR SHAREHOLDER-EMPLOYEES: No loan will be made to or continued in effect for a Participant who is or who becomes an Owner-Employee or a Shareholder-Employee except to the extent any such loan is treated as a prohibited transaction (if required) under Code ss.4975 or other applicable Code provision. (c) WRITTEN LOAN AGREEMENT: All loans must be evidenced by a legally enforceable agreement (which may include more than one document) set forth in writing or in such other form as may be approved by the Internal Revenue Service, and the terms of such agreement must specify the amount and term of the loan, and the repayment schedule. (d) MINIMUM PERMITTED LOAN AMOUNT: The Administrator, as part of the written loan policy, may set a minimum permitted loan amount not to exceed $1,000. (e) MAXIMUM PERMITTED LOAN AMOUNT: No loan, when added to the outstanding balance of all other loans to the Participant, will exceed the lesser of (1) $50,000 reduced by the excess, if any, of the Participant's highest outstanding balance of loans during the 1-year period ending on the day before the loan was made, over the Participant's outstanding balance of loans on the day the loan was made; or (2) one-half of the Participant's Vested Aggregate Account. However, notwithstanding the limitation in (2), the Administrator may, as part of a written loan policy, permit a Participant whose Vested Aggregate Account balance is $20,000 or less to borrow an amount that does not exceed the lesser of $10,000 or 100% of the Participant's Vested Aggregate Account balance if adequate security is provided on the loan amount in excess of that determined in (2) above. (f) AGGREGATION OF PLANS: In applying the limitations in paragraph (e) above, all loans from all plans of the Employer and Affiliated Employers will be aggregated. An assignment or pledge of any portion of the Participant's Vested Aggregate Account balance, and a loan, pledge, or assignment with respect to any insurance contract purchased by the Plan, will be treated as a loan under the terms of this Section. (g) LOANS MUST BEAR REASONABLE INTEREST: Any loan must bear interest at a rate reasonable at the time of application, considering the purpose of the loan and the rate being charged by representative commercial banks in the local area for a similar loan, unless the Administrator sets forth a different method for determining loan interest rates in its loan procedures such as using the prime rate or some other rate based on the prime rate. The loan agreement will also provide for the payment of principal and interest not less frequently than quarterly. Such interest will be credited either directly to the Participant's Account, or in the alternative to the general Trust Fund, as set forth in the loan policy. (h) LOANS MUST BE SECURED: If a Participant's loan application is approved by the Administrator, such Participant will be required to execute a note, a loan agreement and an assignment of his or her Vested Aggregate Account as collateral for the loan. The Administrator, on a nondiscriminatory basis, may permit a Participant to pledge outside security in lieu of pledging his or her Vested Aggregate Account as collateral. (i) TERMS OF REPAYMENT: The term of a loan will not exceed five years except, if permitted by the loan policy, in the case of a loan made for the purpose of acquiring any house, apartment, condominium, or mobile home (not used on a transient basis) which is used or is to be used within a reasonable time as the - 73 - principal residence of the Participant. The term of a loan will be determined by the Administrator considering the maturity dates quoted by representative commercial banks in the local area for a similar loan. (j) SUSPENSION OF INSTALLMENT PAYMENTS: The loan policy may provide that loan installment payments will be suspended as permitted under Code ss.414(u)(4) effective December 12, 1994. The loan policy may also provide that installment payments will be suspended for a period not longer than one year in which the Participant is on a leave of absence, either without pay or at a rate of pay (after income and employment tax withholding) that is less than the amount of the installment payments required under the terms of the loan. However, even if installments payment are suspended due to a leave of absence, the loan must still be repaid by the latest date permitted under the original terms of the loan and the installments due after the leave ends (or, if earlier, after the first year of the leave) must not be less than those required under the original terms of the loan. (k) LOANS MAY BE LIMITED TO HARDSHIP: The loan policy may provide that loans will only be made to Participants who have a financial hardship and lack available resources to satisfy the hardship. The loan policy will set forth the criteria for financial hardship. (l) CONTRIBUTIONS THAT CAN BE LOANED: As part of the loan policy, the Administrator may limit loans to a Participant's balance in a specified account or accounts. (m) ESTABLISHMENT OF ADMINISTRATIVE PROCEDURES: The Administrator may, in a separate written loan policy, establish rules or procedures regarding the conditions under which the Trustee can make loans to Participants. Such separate written document, when properly executed, will be deemed incorporated in this Plan. The rules or procedures therein may be modified or amended by the Administrator without the necessity of amending this Section, but any such modifications must be communicated to Participants in the manner described in Section 8.9. Notwithstanding the foregoing, (1) a summary plan description or summary of material modifications thereto in which the rules or procedures regarding loans to Participants are described will be considered a separate written document sufficient to satisfy the requirements (including the execution requirement) of this paragraph; and (2) any rules or procedures established hereunder must be applied by the Administrator in a uniform nondiscriminatory manner. 7.15 DIRECTED INVESTMENT ACCOUNTS Subject to any rules or procedures that may be established by the Administrator under paragraph (h) below, the Trustee may permit Participants to direct the investment of one or more of their accounts, and subject to any such rules or procedures, investment directives will be given in accordance with the following provisions: (a) ACCOUNTS THAT CAN BE DIRECTED: The Administrator will designate which accounts a Participant or other payee can direct, and whether the Participant or payee can direct all or only a portion of each such account. Any such designation can be changed by the Administrator from time to time by communicating new procedures to the Participants. (b) INVESTMENT FUNDS: Any amount a Participant or other payee directs will be put into a segregated investment selected by the Participant; or alternative investment funds established by the Trustee as part of the overall Trust Fund. Such alternative investment funds will be under the full control and management of the Trustee. Alternatively, if investments outside the Trustee's control are allowed, Participants and - 74 - other payees may not direct that investments be made in collectibles, other than U.S. Government gold and silver coins. The Administrator or Trustee will have the authority to refuse any investment directed by the Participant or other payee if that investment would be administratively burdensome, or if for any reason the Administrator or Trustee believes such investment would or might constitute a prohibited transaction as defined in ERISA ss.406 or Code ss.4975. In the event a Participant or other payee fails to make a timely investment election, at the Administrator's discretion either no election will be deemed to have been made or the Participant or other payee will be considered to have made an election to invest 100% of his or her account in an investment option, the primary objective of which is the preservation of principal, until such time as an investment decision by the Participant or other payee becomes effective. (c) INVESTMENT DESIGNATION FORM: A Participant's investment direction will be made in a form acceptable to, and in accordance with procedures established by, the Administrator. Unless changed by procedures established by the Administrator and communicated to Participants and other payees, (1) a Participant or other payee may change an investment election by filing a new investment designation form with the Administrator or the Administrator's designee; (2) any change will be effective no later than the first day of the next investment election period; and (3) investment election periods will be established at the discretion of the Administrator but in any event will occur no less frequently than once in every 12-month period or, at the discretion of the Administrator and the Trustee, once in every 3-month or 6-month period or at such other more frequent time which is uniformly available as determined and promulgated by the Administrator and the Trustee. (d) TRANSFERS BETWEEN FUNDS: Unless changed by procedures established by the Administrator and communicated to Participants and other payees, if multiple investment fund options are made available, a Participant or other payee may elect to transfer all or part of his or her Account in one or more of the investment funds from one investment fund to another investment fund by filing an investment designation form with the Administrator or with the Administrator's designee within a reasonable administrative period prior to the next period for which investment options may be elected to be transferred. The funds will be transferred by the Trustee or the Administrator's designee as soon as practicable prior to, or by the start of, the new election period. If made available, telephone or other electronic or computer transfers will be permitted under uniform procedures approved adopted by the Administrator and agreed to by the Trustee. (e) ADMINISTRATOR RESPONSIBILITY: Either the Administrator or the Administrator's designee will be responsible when transmitting Employer and Employee contributions or other Trust Fund assets to indicate the dollar amount which is to be credited to each investment fund on behalf of each Participant or other payee. (f) NO ADMINISTRATOR LIABILITY: Except as otherwise provided herein, neither the Trustee, nor the Administrator, nor the Employer, nor any Fiduciary of the Plan will be liable to the Participant or other payee (or to his or her Beneficiaries) for any loss resulting from action taken under this Section at the direction of the Participant or other payee. (g) CHARGES AND FEES: Any charge or fee which may be imposed by the Trustee or by any broker, investment advisor, or otherwise, including legal fees, incurred in connection with a Participant's direction under this Section of any Plan account maintained on the Participant's behalf may be charged to and paid from the assets of such account. - 75 - (h) ESTABLISHMENT OF ADMINISTRATIVE PROCEDURES: All investment designations made by Participants are to be made subject to and in accordance with such rules or procedures as the Administrator may adopt. At the discretion of the Administrator and the Trustee, such rules or procedures will permit sufficient selection among investment alternatives to satisfy the provisions of DOL Regulation ss.2550.404(c)-1. Such rules or procedures, when properly executed in a written document, will be deemed incorporated in this Plan. The rules or procedures therein may be modified or amended by the Administrator without the necessity of amending this Section, but any such modifications must be communicated to Participants in the manner described in Section 8.9. Notwithstanding the foregoing, (1) a summary plan description or summary of material modifications thereto in which the rules or procedures regarding investment designations are described will be considered a separate written document sufficient to satisfy the requirements (including the execution requirement) of this paragraph; and (2) any rules or procedures established under this paragraph must be applied in a uniform nondiscriminatory manner. 7.16 SUPERSEDING TRUST OR CUSTODIAL AGREEMENT If any assets of the Plan are invested in a separate trust or custodial account maintained by a Trustee or custodian, the provisions of such separate trust or custodial agreement will supersede all provisions of this Article 7 except Sections 7.11, 7.12, 7.13 and 7.14. In addition, in the absence of a specific provision in such separate trust or custodial agreement regarding the valuation of securities held by the Trust Fund, Section 7.3 will not be superseded by any such separate trust or custodial account. If such separate trust or custodial account should for any reason fail, be found invalid or terminate prior to the termination of this Plan and the distribution of all the assets hereof, this Article 7 will be deemed to have again become effective immediately prior to such failure, invalidity or termination. - 76 - ARTICLE 8 DUTIES OF THE ADMINISTRATOR 8.1 APPOINTMENT, RESIGNATION, REMOVAL AND SUCCESSION Each Administrator appointed by the Sponsor will continue until his or her death, resignation, or removal at any time, with or without cause, by the Sponsor, and any Administrator may resign by giving 30 days written notice to the Sponsor. If an Administrator dies, resigns, or is removed by the Sponsor, such Administrator's successor will be appointed as promptly as possible, and such appointment will become effective upon its acceptance in writing by such successor Administrator. Pending the appointment and acceptance of any successor Administrator, any then acting or remaining Administrator will have full power to act. 8.2 POWERS AND DUTIES OF THE ADMINISTRATOR The powers and duties of the Administrator will include (a) appointing the Plan's attorney, accountant, actuary, or any other party needed to administer the Plan; (b) directing the Trustees with respect to payments from the Trust Fund; (c) deciding if an applicant is entitled to a benefit from the Plan, which will be paid only if the Administrator in its sole discretion decides that the applicant is entitled to it; (d) communicating with Employees regarding their participation and benefits, including the administration of all claims procedures; (e) filing any returns and reports with the Internal Revenue Service, Department of Labor, or any other governmental agency; (f) reviewing and approving any financial reports, investment reviews, or other reports prepared by any party under (a) above; (g) establishing a funding policy and investment objectives consistent with the purposes of the Plan and the Employee Retirement Income Security Act of 1974; (h) construing and resolving any question of Plan interpretation; and (i) making any findings of fact the Administrator deems necessary to proper Plan administration. 8.3 APPOINTMENT OF ADMINISTRATIVE COMMITTEE The Employer may elect to appoint one or more members to an Administrative/Advisory Committee (to be known as the "Committee"), to which the Sponsor may elect to delegate certain of its responsibilities as Plan Administrator. Members of the Committee need not be Participants or Beneficiaries, and officers and directors of the Sponsor will not be precluded from serving as members. A member will serve until his or her resignation, death, or disability, or until removed by the Sponsor. In the event of any vacancy arising by reason of the death, disability, removal, or resignation of a member of the Committee, the Sponsor may, but is not required to, appoint a successor to serve in his or her place. The Committee will select a chairman and a secretary from among its members. Members of the Committee will serve in such capacity without compensation. The Committee will act by majority vote. 8.4 FINALITY OF ADMINISTRATIVE DECISIONS The Administrator's interpretation of Plan provisions, and any findings of fact, including eligibility to participate and eligibility for benefits, are final and will not be subject to "de novo" review unless shown to be arbitrary and capricious. 8.5 MULTIPLE ADMINISTRATORS If there is more than one Administrator, the Administrators may delegate specific responsibilities among themselves, including the authority to execute documents unless the Sponsor revokes such delegation. The Sponsor and Trustee will be notified in writing of any such delegation of responsibilities, and the Trustee thereafter may rely upon any documents executed by the appropriate Administrator. 8.6 COMPENSATION AND EXPENSES The Administrator, the Committee and any party appointed by the Administrator under Section 8.7 may receive such compensation as agreed upon by the Sponsor, provided that any person who already receives full-time pay from the Employer may not receive any fees for services - 77 - to the Plan as Administrator or in any other capacity. The Sponsor will pay all "settlor" expenses (as described in DOL Advisory Opinion 2001-01-A) incurred by the Administrator, the Committee or any party appointed under Section 8.7 in the performance of their duties. The Sponsor may, but is not required to pay, all "non-settlor" expenses incurred by the Administrator, the Committee, or any party appointed under Section 8.7 in the performance of their duties. Any "non-settlor" expenses incurred by the Administrator, the Committee or any party appointed under Section 8.7 that the Sponsor elects not to pay will be reimbursed from Trust Fund assets. Any expenses paid from the Trust Fund will be charged to each Adopting Employer in the ratio that each Adopting Employer's Participants' Accounts bears to the total of all the Participants' Accounts maintained by this Plan, or in any other reasonable method elected by the Administrator. 8.7 APPOINTMENT OF AGENTS AND COUNSEL The Administrator (or Committee) may appoint such actuaries, accountants, custodians, counsel, agents, consultants, and other persons the Administrator (or Committee) deems necessary to the administration and operation of the Plan. The actions of any such third parties will be subject to the limitations described in Section 7.8 of the Plan; and no such third parties will be given any authority or discretion concerning the management and operation of the Plan that would cause them to become Fiduciaries of the Plan. 8.8 CORRECTING ADMINISTRATIVE ERRORS The Administrator may take such steps as it considers necessary and appropriate in its discretion to remedy administrative or operational errors. Such steps may include, but will not be limited to the following: (a) taking any action required under the employee plans compliance resolution system of the Internal Revenue Service, any asset management or fiduciary conduct error correction program available through the Internal Revenue Service, United States Department of Labor or other governmental administrative agency; (b) a reallocation of Plan assets; (c) adjustments in amounts of future payments to Participants, Beneficiaries or Alternate Payees; and (d) institution and prosecution of actions to recover benefit payments made in error or on the basis of incorrect or incomplete information. 8.9 PROMULGATING NOTICES AND PROCEDURES The Sponsor and Administrator are given the power and responsibility to promulgate certain written notices, policies and/or procedures under the terms of the Plan and disseminate same to the Participants, and the Administrator may satisfy such responsibility by the preparation of any such notice, policy and/or procedure in a written form which can be published and communicated to a Participant in one or more of the following ways: (a) by distribution in hard copy; (b) through distribution of a summary plan description or summary of material modifications thereto which sets forth the policy or procedure with respect to a right, benefit or feature offered under the Plan; (c) by e-mail, either to a Participant's personal e-mail address or his or her Employer-maintained e-mail address; and (d) by publication on a web-site accessible by the Participant, provided the Participant is notified of the web-site publication. Any notice, policy and/or procedure provided through an electronic medium will only be valid if the electronic medium which is used is reasonably designed to provide the notice, policy and/or procedure in a manner no less understandable to the Participant than a written document, and under such medium, at the time the notice, policy and/or procedure is provided, the Employee may request and receive the notice, policy and/or procedure on a written paper document at no charge. 8.10 CLAIMS PROCEDURES The procedures in this Section will be the sole and exclusive remedy for an Employee, Participant or Beneficiary ("Claimant") to make a claim for benefits under the Plan. These procedures will be administered and interpreted in a manner consistent with the requirements of ERISA ss.503 and the regulations thereunder. Any - 78 - electronic notices provided by the Administrator will comply with the standards imposed under regulations issued by the Department of Labor. All claims determinations made by the Administrator (and when applicable by the Committee if one has been appointed under Section 8.3) and will be made in accordance with the provisions of this Section and the Plan, and will be applied consistently to similarly situated Claimants. For purposes of this Section 8.10, if a Committee has not been appointed under Section 8.3, any reference to Committee will be considered a reference to the Administrator. (a) WRITTEN CLAIM: A Claimant, or the Claimant's duly authorized representative, may file a claim for a benefit to which the Claimant believes that he or she is entitled under the Plan. Any such claim must be filed in writing with the Administrator. (b) DENIAL OF CLAIM: The Administrator, in its sole and complete discretion, will make all initial determinations as to the right of any person to benefits. If the claim is denied in whole or in part, the Administrator will send the Claimant a written or electronic notice, informing the Claimant of the denial. The notice must be written in a manner calculated to be understood by the Claimant and must contain the following information: the specific reason(s) for the denial; a specific reference to pertinent Plan provisions on which the denial is based; if additional material or information is necessary for the Claimant to perfect the claim, a description of such material or information and an explanation of why such material or information is necessary; and an explanation of the Plan's claim review (i.e., appeal) procedures, the time limits applicable to such procedures, and the Claimant's right to request arbitration if the claim denial is upheld in whole or in part on appeal. Written or electronic notice of the denial will be given within a reasonable period of time (but no later than 90 days) from the date the Administrator receives the claim, unless special circumstances require an extension of time for processing the claim. In no event may the extension exceed 90 days from the end of the initial 90-day period. If an extension is necessary, prior to the expiration of the initial 90-day period, the Administrator will send the Claimant a written notice, indicating the special circumstances requiring an extension and the date by which the Administrator expects to render a decision. (c) REQUEST FOR APPEAL: If the Administrator denies a claim in whole or in part, the Claimant may elect to appeal the denial. If the Claimant does not appeal the denial pursuant to the procedures set forth herein, the denial will be final, binding and unappealable. A written request for appeal must be filed by the Claimant (or the Claimant's duly authorized representative) with the Committee within 60 days after the date on which the Claimant receives the Administrator's notice of denial. If a request for appeal is timely filed, the Claimant will be afforded a full and fair review of the claim and the denial. As part of this review, the Claimant may submit written comments, documents, records, and other information relating to the claim, and the review will take into account all such comments, documents, records, or other information submitted by the Claimant, without regard to whether such information was submitted or considered in the Administrator's initial benefit determination. The Claimant also may obtain, free of charge and upon request, records and other information relevant to the claim, without regard to whether such information was relied upon by the Administrator in making the initial benefit determination. (d) REVIEW OF APPEAL: The Committee will determine, in its sole and complete discretion, whether to uphold all or a portion of the initial claim denial. If, on appeal, the Committee determines that all or a portion of the initial denial should - 79 - be upheld, the Committee will send the Claimant a written or electronic notice informing the Claimant of its decision to uphold all or a portion of the initial denial, written in a manner calculated to be understood by the Claimant and containing the following information: the specific reason(s) for the denial; a specific reference to pertinent Plan provisions on which the denial is based; a statement that the Claimant is entitled to receive, upon request and free of charge, reasonable access to and copies of all documents and other information relevant to the claim; and an explanation of the Claimant's right to request arbitration and the applicable time limits for doing so. Written or electronic notice will be given within a reasonable period of time (but no later than 60 days) from the date the Committee receives the request for appeal, unless special circumstances require an extension of time for reviewing the claim, but in no event may the extension exceed 60 days from the end of the initial 60-day period. If an extension is necessary, prior to the expiration of the initial 60-day period, the Committee will send the Claimant a written notice, indicating the special circumstances requiring an extension and the date by which the Committee expects to render a decision. (e) ALTERNATIVE TIME FOR AN APPEAL TO BE DECIDED: Notwithstanding paragraph (d), if the Committee holds regularly scheduled meetings on a quarterly or more frequent basis, the Committee may make its determination of the claim on appeal at its next regularly scheduled meeting if the Committee receives the written request for appeal more than 30 days prior to its next regularly scheduled meeting or at the regularly scheduled meeting immediately following the next regularly scheduled meeting if the Committee receives the written request for appeal within 30 days of the next regularly scheduled meeting. If special circumstances require an extension, the decision may be postponed to the third regularly scheduled meeting following the Committee's receipt of the written request for appeal if, prior to the expiration of the initial time period for review, the Claimant is provided with written notice, indicating the special circumstances requiring an extension and the date by which the Committee expects to render a decision. If the extension is required because the Claimant has not provided information that is necessary to decide the claim, the Committee may suspend the review period from the date on which notice of the extension is sent to the Claimant until the date on which the Claimant responds to the request for additional information. (f) RIGHT OF ARBITRATION: If a Claimant wishes to contest a final decision of the Committee, the Claimant may request arbitration. If the Claimant does not request arbitration pursuant to the procedures herein, the decision of the Committee will be final, binding and unappealable. A written request for arbitration must be filed by the Claimant (or the Claimant's authorized representative) with the Committee within 15 days after the date the Claimant receives the written decision of the Committee. If a request for arbitration is timely filed, the Claimant and the Committee will each name an arbitrator within 20 days after the Committee receives the Claimant's written request for arbitration. The two arbitrators will jointly name a third arbitrator within 15 days after their appointment. If either party fails to select an arbitrator within the 20 day period, or if the two arbitrators fail to select a third arbitrator within 15 days after their appointment, then the presiding judge of the county court (or its equivalent) in the county in which the principal office of the Sponsor is located will appoint such other arbitrator or arbitrators. The arbitrators will render a decision within 60 days after their appointment - 80 - and will conduct all proceedings pursuant to the laws of the state in which the Sponsor's principal place of business is located and the then current Rules of the American Arbitration Association governing commercial transactions, to the extent that such rules are not inconsistent with applicable state law. The cost of the arbitration procedure will be borne by the losing party or, if the decision is not clearly in favor of one party or the other, in the manner determined by the arbitrators. The arbitration proceeding provided for in this Section will be the sole and exclusive remedy of a Claimant to contest decisions of the Committee under this Plan, and the arbitrators' decision will be final, binding and unappealable. 8.11 QUALIFIED DOMESTIC RELATIONS ORDERS A Qualified Domestic Relations Order, or QDRO, is a signed domestic relations order issued by a State Court that creates, recognizes or assigns to an alternate payee(s) the right to receive all or part of a Participant's Plan benefit. An alternate payee is a Spouse, former Spouse, child, or other dependent of a Participant who is treated as a Beneficiary under the Plan as a result of the QDRO. The Administrator may establish QDRO procedures, but in the absence of such procedures, the Administrator will determine if a domestic relations order is a Qualified Domestic Relations Order in accordance with the following provisions: (a) ADMINISTRATOR'S DETERMINATION: Promptly upon receipt of a domestic relations order, the Administrator will notify the Participant and any alternate payee(s) named in the order of such receipt, and will include a copy of this Section. Within a reasonable time after receipt of the order, the Administrator will make a determination as to whether or not the order is a QDRO as defined in Code ss.414(p) and will promptly notify the Participant and any alternate payee(s) in writing of the determination. (b) SPECIFIC REQUIREMENTS OF QDRO: In order for a domestic relations order to be a Qualified Domestic Relations Order, it must specifically state all of the following: (1) the name and last known mailing address (if any) of the Participant and each alternate payee covered by the order; (2) the dollar amount or percentage of the benefit to be paid to each alternate payee, or the manner in which the amount or percentage will be determined; (3) the number of payments or period for which the order applies; and (4) the name of the plan to which the order applies. The domestic relations order will not be deemed a Qualified Domestic Relations Order if it requires the Plan to provide any type or form of benefit, or any option not already provided for in the Plan, or increased benefits, or benefits in excess of the Participant's Vested Interest, or payment of benefits to an alternate payee required to be paid to another alternate payee under another QDRO. (c) DISPUTED ORDERS: If there is a question as to whether or not a domestic relations order is a Qualified Domestic Relations Order, there will be a delay in any payout to any payee including the Participant, until the status is resolved. In such event, the Administrator will segregate the amount that would have been payable to the alternate payee(s) if the order had been deemed a QDRO. If the order is not determined to be a QDRO, or the status is not resolved (for example, it has been sent back to the Court for clarification or modification) within 18 months beginning with the date the first payment would have to be made under the order, the Administrator will pay the segregated amounts plus interest to the person(s) who would have been entitled to the benefits had there been no order. If a determination as to the Qualified status of the order is made after the 18-month period, then the order will only be applied on a prospective basis. If the order is determined to be a QDRO, the Participant and alternate payee(s) will again be notified promptly after such determination. Once an order is deemed a QDRO, the Administrator will pay to the alternate payee(s) all the amounts due under the QDRO, including segregated amounts plus interest that may have accrued during a dispute as to the order's qualification. (d) PAYMENT PRIOR TO TERMINATION OF EMPLOYMENT: A QDRO may provide for the payment of benefits to an alternate payee prior to the time a Participant has terminated employment. Further, such payment can be made even if the affected Participant has not yet reached the Earliest Retirement Age, which is the earlier of (1) the date on which the Participant is entitled to a distribution under this Plan, or (2) the later of the date the Participant attains age 50 or the earliest date on which the Participant could receive benefits hereunder if the Participant terminated employment with the Employer. - 81 - (e) EFFECT OF QDRO ON SURVIVOR ANNUITY REQUIREMENTS: Notwithstanding Sections 5.1, 5.2, 5.3 and 5.4 to the contrary, a Participant's benefits which are payable in the form of a Qualified Joint and Survivor Annuity or in the form of a Qualified Preretirement Survivor Annuity need not be paid in such form if such payment is inconsistent with, or has been modified by, the terms of a Qualified Domestic Relations Order. - 82 - ARTICLE 9 AMENDMENT, TERMINATION AND MERGER 9.1 AMENDMENT OF THE PLAN The Sponsor, or, if there is no Sponsor, the Trustee, will have the right to amend the Plan at any time subject to the following provisions: (a) GENERAL REQUIREMENTS: Amendments must be in writing and cannot (1) increase the responsibilities of the Trustee or Administrator without written consent; (2) deprive any Participant or Beneficiary of benefits to which he or she is entitled; (3) decrease the amount of any Participant's Account except as permitted under Code ss.412(c)(8); (4) permit any part of the Trust to be used for or diverted to purposes other than the exclusive benefit of the Participants or their Beneficiaries except as required to pay taxes and administration expenses, or cause or permit any portion of the Trust Fund to revert to or become the property of the Employer; or (5) have the effect of eliminating or restricting the ability of a Participant or other payee to receive payment of his or her Account balance or benefit entitlement under a particular optional form of benefit provided under the Plan unless the provisions of subparagraphs (1) and (2) below are satisfied: (1) LUMP SUM REQUIREMENT: The amendment provides a lump sum distribution form that is otherwise identical to the optional form of benefit that is restricted or eliminated. For this purpose, a lump sum distribution form is otherwise identical only if it is identical in all respects to the eliminated or restricted optional form of benefit (or would be identical except that it provides greater rights to the payee) except with respect to the timing of payments after commencement. (2) EFFECTIVE DATE: The amendment cannot apply to any distribution with an Annuity Starting Date which is earlier than the earlier of (A) the 90th day after a Participant has been furnished with a summary plan description or other summary that reflects the amendment and that satisfies the ERISA requirements at 29 CFR 2520.104b-3 relating to a summary of material modifications; or (B) the first day of the second Plan Year following the Plan Year in which this amended Plan is adopted. (b) CERTAIN CORRECTIVE AMENDMENTS: For purposes of satisfying the minimum coverage requirements of Code ss.410(b), the nondiscriminatory amount requirement of regulation ss.1.401(a)(4)-1(b)(2), or the nondiscriminatory plan amendment requirement of regulation ss.1.401(a)(4)-1(b)(4), a corrective amendment may retroactively increase allocations for Employees who benefited under the Plan during the Plan Year being corrected, or may grant allocations to Employees who did not benefit under the Plan during the Plan Year being corrected. In addition, to satisfy the nondiscriminatory current availability requirement of regulation ss.1.401(a)(4)-4(b) for benefits, rights or features, a corrective amendment may make a benefit, right or feature available to Employees to whom it was previously not available. A corrective amendment will not be taken into account prior to the date of its adoption unless the amendment satisfies the applicable requirements of regulation ss.1.401(a)(4)-11(g)(3)(ii) through (vii), including the requirement that, in order to be effective for the preceding Plan Year, such amendment must be adopted by the 15th day of the 10th month after the close of the preceding Plan Year. 9.2 TERMINATION OF PLAN BY SPONSOR The Sponsor at any time can terminate the Plan and Trust in whole or in part in accordance with the following provisions: - 83 - (a) TERMINATION OF PLAN: The Sponsor can terminate the Plan and Trust by filing written notice thereof with the Administrator and Trustee and by completely discontinuing contributions to the Plan. Upon any such termination, the Trustee will continue to administer the Trust until distribution has been made to the Participants and other payees, which distribution must occur as soon as administratively feasible after the termination of the Plan, and must be made in accordance with the provisions of Article 5 of the Plan, including Section 5.6(g) where applicable. However, the Administrator may elect not to distribute the Accounts of Participants and other payees upon termination of the Plan but instead to transfer the entire Trust Fund assets and liabilities attributable to this terminated Plan to another qualified plan maintained by the Employer or its successor. (b) VESTING REQUIREMENT: Upon complete termination of the Plan, or upon a complete discontinuance of contributions, all Participants who are affected by the termination, all Participants who have not incurred a Termination of Employment, and all Participants who have incurred a Termination of Employment but have not incurred a 5-year Break in Service will have a 100% Vested Interest in their unpaid Participant's Accounts. Upon partial termination of the Plan only those Participants who have incurred a Termination of Employment on account of the event which caused the partial termination but have not incurred a 5-year Break in Service will automatically have a 100% Vested Interest in their unpaid Participant's Accounts to the date of partial termination. (c) DISCONTINUANCE OF CONTRIBUTIONS ONLY: The Sponsor may elect at any time to completely discontinue contributions to the Plan but continue the Plan in operation in all other respects, in which event the Trustee will continue to administer the Trust until eventual full distribution of all benefits has been made to the Participants and other payees in accordance with Article 5 after their death, retirement, Disability or Termination of Employment. Any such discontinuance of contributions without an additional notice of termination from the Sponsor to the Administrator and Trustee will not constitute a termination of the Plan. 9.3 TERMINATION OF PARTICIPATION BY ADOPTING EMPLOYER Any Adopting Employer may by written resolution terminate participation in the Plan at any time by notification to the Sponsor, the Administrator, and the Trustee. Such Adopting Employer may thereupon request a transfer of Trust Fund assets attributable to its Employees from this Plan to any successor qualified retirement plan maintained by the Adopting Employer or its successor. The Administrator may, however, refuse to make such transfer if in its considered opinion such transfer would operate to the detriment of any Participant, jeopardize the continued qualification of the Plan, or if such transfer does not comply with any requirements of the Internal Revenue Service. If no transfer is made, the provisions in the definition of Adopting Employer in Article 1 will apply with respect to the payment of benefits for Employees of such Adopting Employer. 9.4 MERGER OR CONSOLIDATION This Plan and Trust may not be merged or consolidated with, nor may any of its assets or liabilities be transferred to, any other plan, unless the benefits payable to each Participant if the Plan was terminated immediately after such merger, consolidation or transfer would be equal to or greater than the benefits such Participant would have been entitled to if this Plan had been terminated immediately before such merger, consolidation or transfer. - 84 - ARTICLE 10 MISCELLANEOUS PROVISIONS 10.1 NO CONTRACT OF EMPLOYMENT Except as otherwise provided by law, neither the establishment of this Plan, nor any modification hereto, nor the creation of any fund or account, nor the payment of any benefits, will be construed as giving any Participant or other person any legal or equitable rights against the Employer, any officer or Employee thereof, or the Trustee, except as herein provided; and the terms of employment of any Participant will not be modified or affected by this Plan. 10.2 TITLE TO ASSETS No Participant or Beneficiary will have any right to, or any interest in, any assets of the Trust upon separation from service with the Employer, Affiliated Employer, or Adopting Employer, except as otherwise provided by the terms of the Plan. 10.3 QUALIFIED MILITARY SERVICE Notwithstanding any other provision of the Plan to the contrary, effective December 12, 1994, contributions, benefits and service credit with respect to qualified military service will be provided in accordance with the requirements of Code ss.414(u). 10.4 BONDING OF FIDUCIARIES Fiduciaries of this Plan will have only those duties that are specifically given to the Fiduciaries under the terms of this Plan. In addition, every Fiduciary other than a bank, an insurance company, or a Fiduciary of an Employer which has no common-law employees, will be bonded in an amount not less than 10% of the amount of funds under such Fiduciary's supervision, but such bond will not be less than $1,000 or more than $500,000. The bond will provide protection to the Plan against any loss for acts of fraud or dishonesty by a Fiduciary acting alone or in concert with others. The cost of such bond will be an expense of either the Employer or the Trust, at the election of the Employer. 10.5 SEVERABILITY OF PROVISIONS If any Plan provision is held invalid or unenforceable, such invalidity or unenforceability will not affect any other provision of this Plan, and this Plan will be construed and enforced as if such provision had not been included. 10.6 GENDER AND NUMBER Words used in the masculine gender will be construed as though they were also used in the feminine or neuter gender where applicable, and words used in the singular will be construed as though they were also used in the plural where applicable. 10.7 HEADINGS AND SUBHEADINGS Headings and subheadings are inserted for convenience of reference. They constitute no part of this Plan and are not to be considered in its construction. 10.8 LEGAL ACTION In any claim, suit or proceeding concerning the Plan and/or Trust which is brought against the Trustee or Administrator, the Plan and Trust will be construed and enforced according to the laws of the state in which the Employer maintains its principal place of business, to the extent that it is not preempted by ERISA; and unless otherwise prohibited by law, either the Employer or the Trust, in the sole discretion of the Employer, will reimburse the Trustee and/or Administrator for all costs, attorneys fees and other expenses associated with any such claim, suit or proceeding. - 85 - 10.9 QUALIFIED PLAN STATUS This Plan and the related Trust Agreement are intended to be a qualified retirement plan under the provisions of Code ss.401(a) and ss.501(a). 10.10 MAILING OF NOTICES TO ADMINISTRATOR, EMPLOYER OR TRUSTEE Any notices, documents or forms required to be given to or filed with the Administrator, the Employer or the Committee will be hand delivered or mailed by first class mail, postage prepaid, to the Committee or Employer at the Employer's principal place of business. Any notices, documents or forms required to be given to or filed with the Trustee will be hand delivered or mailed by first class mail, postage prepaid, to the Trustee at its principal place of business. 10.11 PARTICIPANT NOTICES AND WAIVERS OF NOTICES TO PARTICIPANTS Whenever written notice is required to be given under the terms of this Plan, such notice will be deemed to be given on the date that such written notice is either hand delivered to the recipient or deposited at a United States Postal Service Station, first class mail, postage paid. Notice may be waived by any party otherwise entitled to receive written notice concerning any matter under the terms of this Plan. 10.12 NO DUPLICATION OF BENEFITS There will be no duplication of benefits under the Plan because of employment by more than one participating employer. 10.13 EVIDENCE FURNISHED CONCLUSIVE Anyone required to give evidence under the terms of the Plan may do so by certificate, affidavit, document or other information which the person to act in reliance may consider pertinent, reliable and genuine, and to have been signed, made or presented by the proper party or parties. The Fiduciaries under the Plan will be fully protected in acting and relying upon any evidence described under this Section. 10.14 RELEASE OF CLAIMS Any payment to any Participant or Beneficiary, his or her legal representative, or to any guardian or committee appointed for such Participant or Beneficiary, will, to the extent thereof, be in full satisfaction of all claims hereunder against the Administrator and the Trustee, either of whom may require such Participant, legal representative, Beneficiary, guardian or committee, as a condition precedent to such payment, to execute a receipt and release thereof in such form as determined by the Administrator or the Trustee. 10.15 MULTIPLE COPIES OF PLAN AND/OR TRUST This Plan and the related Trust Agreement may be executed in any number of counterparts, each of which will be deemed an original, but all of which will constitute one and the same Agreement or Trust Agreement, as the case may be, and will be binding on the respective successors and assigns of the Employer and all other parties. 10.16 LIMITATION OF LIABILITY AND INDEMNIFICATION In addition to and in furtherance of any other limitations provided in the Plan, and to the extent permitted by applicable law, the Employer will indemnify and hold harmless its board of directors (collectively and individually), if any, the Administrative/Advisory Committee (collectively and individually), if any, and its officers, partners who serve as a Trustee, Employees, and agents against and with respect to any and all expenses, losses, liabilities, costs, and claims, including legal fees to defend against such liabilities and claims, arising out of their good-faith discharge of responsibilities under or incident to the Plan, excepting only expenses and liabilities resulting from willful misconduct. This indemnity will not preclude such further - 86 - indemnities as may be available under insurance purchased by the Employer or as may be provided by the Employer under any by-law, agreement, vote of shareholders or disinterested directors, or otherwise, as such indemnities are permitted under state law. Payments with respect to any indemnity and payment of expenses or fees under this Section will be made only from assets of the Employer, and will not be made directly or indirectly from assets of the Trust Fund. - 87 - IN WITNESS WHEREOF, this Plan and Trust have been executed by the Employer and the Trustees as of the day, month and year set forth on page 1 of this Agreement. HOT TOPIC, INC. By___________________________________________ TRUSTEES _____________________________________________ James McGinty _____________________________________________ Elizabeth McLaughlin _____________________________________________ Jane Cruz _____________________________________________ Gerald Cook _____________________________________________ George Wehlitz - 88 - CERTIFICATE OF CORPORATE RESOLUTIONS OF HOT TOPIC, INC. The undersigned Secretary of the above named corporation certifies that the following resolutions were adopted by the board of directors on the date set forth below. RESOLVED, that the Hot Topic, Inc. 401(k) Profit Sharing Plan, as amended and restated effective January 1, 2003, a copy of which is attached hereto, is hereby adopted; RESOLVED, that the amendment regarding minimum distribution requirements under Internal Revenue Service final regulations under Code ss.401(a)(9) and Internal Revenue Service Announcement 2002-29, a copy of which is attached hereto, is hereby adopted; RESOLVED, that the "Good Faith" amendment to the Plan for conformance with EGTRRA, a copy of which is attached hereto, is hereby adopted; RESOLVED, that the amendment to increase the maximum Elective Deferral amount, a copy of which is attached hereto, is hereby adopted; RESOLVED, that an authorized representative should deliver an executed copy of the Plan to the trustees named therein; and RESOLVED, that an authorized representative should take any and all steps necessary to effectuate the foregoing resolutions. THIS CERTIFICATE is executed this __________ day of _________________________, 200____. _____________________________________________ Corporate Secretary PARTICIPANT LOAN POLICY HOT TOPIC, INC. 401(K) PROFIT SHARING PLAN (the "Plan") The Administrator for the Plan hereby adopts this loan policy pursuant to the terms of the Plan: A. LOAN REQUEST A Participant's request for a Plan loan will be made in the manner specified by the Trustee and/or Plan Administrator. Any Plan Participant may obtain a loan from the Plan. For purposes of this loan policy, the term "Participant" means any Participant who is an Employee of an Adopting Employer and any former Participant who is an Employee of an Affiliated Employer. B. SOURCE OF LOAN AMOUNT A Participant may borrow funds from the following sources: a Participant's voluntary contributions, rollover contributions, or other transferred monies for which an account balance is maintained and/or a Participant's vested account balance. C. PARTICIPANT FEES 1. LOAN PROCESSING FEES: No loan processing fees will be charged to the Participant for the initiation of each loan or refinancing or replacement of a loan. 2. LOAN MAINTENANCE FEES: No annual maintenance fee for the loan will be charged to the Participant. D. LIMITATIONS ON LOAN AMOUNT / PURPOSE OF LOAN 1. LOAN AMOUNT: No loan amount may exceed the lesser of (a) or (b) following, from all Plans of the Employer and any Affiliated Employer: (a) 50% of the sum of (i) a Participant's vested account plus (ii) a Participant's voluntary contributions, rollover contributions, or other transferred or segregated monies for which an account balance is maintained; both as reflected by the books and records of the Plan at the end of the most recent computation period for which an accounting has been completed. (b) $50,000 reduced by the excess, if any, of the Participant's highest outstanding balance of loans during the 1-year period ending the day before the loan was made, over the Participant's outstanding balance of loans on the day the loan was made. A Participant may not request a loan for less than $1,000. 2. PURPOSE OF LOAN: A loan may be made to a Participant for any purpose. Page -1- E. TERMS OF LOAN 1. SECURITY FOR LOAN: A Participant must secure each loan with an irrevocable pledge and assignment of the sum of a Participant's voluntary contributions, rollover contributions, or other transferred or segregated monies for which an account balance is maintained, plus a Participant's vested account balance; both as reflected by the books and records of the Plan at the end of the most recent computation period for which an accounting has been completed. In addition, other security or substitute collateral acceptable to the Administrator will also be permitted for a loan. 2. SOURCE OF LOAN: If a loan is secured by and obtained from more than one Participant-directed investment account for which an account balance is maintained under the Plan, the source of the loan will be in proportion to the respective Participant-directed accounts of the Participant unless otherwise directed by election of the Participant and approved by the Administrator. 3. TERM OF LOAN REPAYMENT: The term of repayment may not be greater than five years. PARTICIPANTS SHOULD NOTE THAT THE LAW MAY TREAT THE AMOUNT OF ANY LOAN THAT IS NOT REPAID WITHIN FIVE YEARS AFTER THE DATE OF THE LOAN AS A TAXABLE DISTRIBUTION ON THE LAST DAY OF THE FIVE-YEAR PERIOD OR, IF SOONER, AT THE TIME THE LOAN IS IN DEFAULT. IF A PARTICIPANT EXTENDS A LOAN HAVING A TERM OF FIVE YEARS OR LESS BEYOND FIVE YEARS, THE BALANCE OF THE LOAN AT THE TIME OF THE EXTENSION MAY BE A TAXABLE DISTRIBUTION. 4. LOAN DOCUMENTATION AND LOAN INTEREST RATE: Every loan will be documented with a promissory note signed by the Participant for the face amount of the loan, with an interest rate established at the inception of the loan set as determined by the Administrator on the basis of relevant factors including but not limited to the rates charged by commercial U.S. banks available within a reasonable geographic vicinity for loans of similar duration and security level. The rate of interest on the loan will be fixed and will not change for the duration of the loan repayment period. 5. ALLOCATION OF LOAN INTEREST: If the Participant's loan is secured by an account balance which is a Participant-directed investment, interest will be credited directly to such Participant-directed investment account. If the Participant's loan is not secured by an account balance which is a Participant-directed investment, then interest repayments for any Participant loan will be credited directly to the Participant's account. 6. LOAN REPAYMENT: The loan must provide for repayment on a level amortization schedule by regular payroll deduction repayments (not less than quarterly) as of each payroll withholding period. If a Participant revokes his or her payroll deduction election, the entire unpaid principal sum, accrued interest and all other amounts due under the loan will become due and payable. If a Participant ceases employment with an Adopting Employer but continues employment with an Affiliated Employer who is not an Adopting Employer, payroll withholding for loan repayments will continue from such Affiliated Employer. 7. TERMINATION OF EMPLOYMENT: If a Participant who is employed by an Adopting Employer or an Affiliated Employer terminates employment with an outstanding loan, the entire unpaid principal sum, accrued interest and all other amounts due under the loan will become due and payable. 8. EARLY REPAYMENT: Early repayment of the outstanding loan may be made at any time in either full or partial repayments of the outstanding loan balance. Page -2- 9. APPROVED LEAVE OF ABSENCE: Suspension of loan repayments during an approved leave of absence is permitted for a period not exceeding one (1) year which occurs during an approved leave of absence either without pay from the Adopting Employer or an Affiliated Employer at a rate of pay (after income and employment tax withholding) that is less than the amount of the installment repayments required under the terms of the loan. In no event may the suspension of repayments cause the term of the loan to exceed five years from the original date of the loan. 10. REPAYMENT SUSPENSION WHILE ON QUALIFIED MILITARY SERVICE: Suspension of loan repayments during leave due to qualified military service will be as permitted under Section 414(u)(4) of the Internal Revenue Code. F. NEW LOANS, REPLACEMENT (REFINANCED) LOANS 1. ADDITIONAL LOAN OR REPLACEMENT LOAN: A Participant may, subject to D. above and F.2. and F.3. below, elect to receive a new additional loan in addition to an existing loan, or a replacement loan of an existing loan, provided that no more than two loans are issued in any calendar year. NOTE: IF THE AMOUNT OF THE REPLACEMENT LOAN EXCEEDS THE OUTSTANDING BALANCE OF THE PRIOR EXISTING LOAN, OR THE TERM OF THE REPLACEMENT LOAN EXCEEDS THE REMAINING TERM OF THE PRIOR EXISTING LOAN, IRS REGULATIONS MAY REQUIRE THAT THE MAXIMUM LOAN LIMITS BE COMPUTED APPLYING THE SUM OF THE AMOUNT OF THE REPLACEMENT LOAN PLUS THE OUTSTANDING BALANCE OF THE PRIOR EXISTING LOAN. ANY LOAN IN EXCESS OF SUCH LIMIT MAY BE CONSIDERED A DEEMED DISTRIBUTION. SEE 3. BELOW. THE MAXIMUM LOAN LIMITS FOR TWO SEPARATE LOANS DO NOT REQUIRE SUCH CALCULATION. 2. REPLACEMENT LOAN AVAILABILITY: A replacement loan will be permitted regardless of the applicable interest rate on either the existing loan or the new refinanced loan. The Administrator will permit the refinancing of an existing loan only under the following conditions: (a) the remaining number of repayments on the existing loan is at least the equivalent of six months of payments; (b) the existing loan has been in effect for at least six months; (c) the minimum reduction in the amount of each periodic repayment is (or could be, if the number of repayments were to be the same as was remaining on the prior loan) at least the equivalent of $20 per month; and (d) a loan may be refinanced a maximum of two times. 3. REPLACEMENT LOAN RULES: The following rules will apply to a replacement loan: (a) If the amount of the replacement loan is the same as the outstanding loan balance of the prior existing loan, and the amortization period of the replacement loan is equal to or less than the remaining repayment period for the outstanding loan balance of the prior existing loan, then the repayment amount of the replacement loan will be determined based on the applicable interest rate and amount of the replacement loan/outstanding loan balance. In such event the maximum loan amount will be determined as in D1. (b) If either (i) the amount of the replacement loan is the same as the outstanding loan balance of the prior existing loan and the amortization period of the replacement loan is greater than the remaining repayment period for the outstanding loan balance of the prior existing loan, or (ii) the amount of the replacement loan exceeds the outstanding loan balance of the prior existing loan, then the repayment amount of the replacement loan will be determined based on the applicable interest rate and amount of the replacement loan. In such event the maximum loan will be determined as in D1. provided the provisions of Q&A-20(a)(2) of Page -3- IRS proposed regulations under IRC Section 72(p) issued in 2000 are satisfied. Otherwise, the maximum loan amount will be determined by applying the SUM of the amount of the replacement loan plus the outstanding balance of the prior existing loan to the maximum limits in D1. G. SPOUSAL CONSENT FOR LOAN If the portion of the Participant's assets which is used to secure the loan is subject to the Qualified Joint and Survivor rules regarding benefit distributions, any loan pledge or agreement will be signed by the Participant and consented to by the eligible Spouse of a Participant who is or was an Employee of an Adopting Employer within the 90-day period ending on the date of the inception of the loan. In addition, if the portion of the Participant's assets which is used to secure the loan is not subject to the Qualified Joint and Survivor rules regarding benefit distributions, the Administrator may in its discretion applied on a consistent basis (after taking into account the amount of the required loan repayment and the Employee's net after-tax take home pay) determine that the eligible Spouse of a Participant who is or was an Employee of an Adopting Employer must consent to any loan within the 90-day period ending on the date of the inception of the loan. H. REPAYMENT OF LOANS AND DEFAULT ON LOANS 1. REQUIRED REPAYMENT OF LOANS (a) If a Participant has an outstanding balance remaining on a loan and the Participant (or the Participant's spouse or beneficiary) is entitled to a payment from the Trust Fund before the loan is repaid in full, the Trustee will offset at the time of distribution the unpaid loan balance (including accrued interest) from the total amount otherwise due. (b) In the event of the failure of a Participant to repay the loan in a timely manner, the Administrator may charge the Participant's account balance or other benefit with expenses directly related to the implementation, administration and collection of the loan. 2. DEFAULT ON LOANS (a) A loan will be considered in default if any scheduled repayment remains unpaid as of the end of the "cure period". For these purposes the "cure period" will end on the last day of the calendar quarter following the calendar quarter in which the required repayment(s) was/were due, or such later date if permitted by Internal Revenue Service rules and regulations. (b) After default occurs, if a distribution to the Participant (1) is currently permissible under the Plan, the vested amount of the Participant's account balance will be reduced or offset by the outstanding principal and interest of the defaulted loan. In such event the loan will be considered to have been repaid and the amount of such reduction or offset will be deemed to have been distributed from the Plan; or (2) is not currently permissible under the Plan, the entire outstanding balance of the loan will be treated as a deemed distribution. A deemed distribution is treated as a distribution to the Participant only for certain tax purposes (income, premature distribution penalty, etc.) and is not a distribution of the account or accrued benefit. Pending final disposition of the note, the Participant remains obligated to repay the outstanding balance of the defaulted loan including any unpaid principal and accrued interest to the date of repayment in full. Page -4- If the Participant's vested account balance is less than the loan amount due in (1) or (2) above, the Administrator will take any steps necessary to collect the balance due directly from the Participant. However, no foreclosure on the promissory note or attachment of the vested account balance will occur until a distributable event occurs in the Plan. By_________________________________________ Dated______________________ PLAN ADMINISTRATOR Page -5- EGTRRA "GOOD FAITH" PLAN AMENDMENT FOR DEFINED CONTRIBUTION PLANS WHICH INCLUDE 401(k) PROVISIONS PER IRS NOTICES 2001-42, 2001-56, AND 2001-57 AND THE JOB CREATION AND WORKER ASSISTANCE ACT OF 2002 (THE 2002 TAX ACT) NAME OF PLAN: Hot Topic, Inc. 401(k) Profit Sharing Plan (the "Plan") PLAN SPONSOR: Hot Topic, Inc. (the "Sponsor") THIS AMENDMENT is adopted by the Sponsor to reflect certain provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), is intended as good faith compliance with the requirements of EGTRRA, and is to be construed in accordance with EGTRRA and guidance issued thereunder, including IRS Notices 2001-42, 2001-56, and 2001-57, and with the Job Creation and Worker Assistance Act of 2002 (the 2002 Tax Act). This amendment will supersede the provisions of the Plan to the extent they are inconsistent with the provisions of this amendment, and except as otherwise indicated, is effective as of the first day of the first Plan Year beginning after December 31, 2001. o SS.611(b) AND SS.632 OF EGTRRA - LIMITATIONS ON CONTRIBUTIONS MAXIMUM ANNUAL ADDITION: Except to the extent permitted under this amendment which provides for catch-up contributions under EGTRRA ss.631 and Code ss.414(v), if applicable, the Annual Addition that may be contributed or allocated to a Participant's Account under the Plan for any Limitation Year will not exceed the lesser of (a) $40,000, as adjusted for increases in the cost-of-living under Code ss.415(d), or (b) 100 percent of the Participant's Compensation, within the meaning of Code ss.415(c)(3), for the Limitation Year. The Compensation limit referred to in (b) will not apply to any contribution for medical benefits after separation from service (within the meaning of Code ss.401(h) or Code ss.419A(f)(2)) which is otherwise treated as an Annual Addition. o SS.611(c) OF EGTRRA - INCREASE IN COMPENSATION LIMIT The annual Compensation of each Participant used in determining allocations (including Top-Heavy Minimum Allocations) will not exceed $200,000 as adjusted for cost-of-living increases under Code ss.401(a)(17)(B). Annual Compensation means Compensation during the plan year or such other consecutive 12-month period over which Compensation is otherwise determined under the Plan (the determination period). The cost-of-living adjustment in effect for a calendar year applies to annual Compensation for the determination period that begins with or within such calendar year. o SS.612 OF EGTRRA - PLAN LOANS FOR OWNER-EMPLOYEES / SHAREHOLDER EMPLOYEES Effective for Plan loans made after December 31, 2001, Plan provisions prohibiting or otherwise restricting loans to any Owner-Employee or Shareholder-Employee will cease to apply. o SS.613 OF EGTRRA - MODIFICATION OF TOP-HEAVY RULES 1. EFFECTIVE DATE: This section will apply for purposes of determining whether the Plan is a Top-Heavy Plan under Code ss.416(g) for Plan Years beginning after December 31, 2001, and whether the Plan satisfies the minimum benefits requirements of Code ss.416(c) for such years. This section amends the sections of the Plan that include Top-Heavy provisions. 2. DETERMINATION OF TOP-HEAVY STATUS: (a) KEY EMPLOYEE: Key Employee means any employee or former Employee (including any deceased Employee) who at any time during the Plan Year that includes the determination date was an officer of the Employer having annual Compensation greater than $130,000 (as adjusted under Code ss.416(i)(1) for Plan Years beginning after December 31, 2002), a 5-percent owner of the Employer, or a 1-percent owner of the Employer having annual Compensation of more than $150,000. For this purpose, annual Compensation means Compensation within the meaning of Code ss.415(c)(3). The determination of who is a Key Employee will be made in accordance with Code ss.416(i)(1) and the applicable regulations and other guidance of general applicability issued thereunder. (b) DETERMINATION OF PRESENT VALUES AND AMOUNTS: This section 2 will apply for purposes of determining the present values of accrued benefits and the amounts of Account balances of Employees as of the determination date. (1) DISTRIBUTIONS DURING THE YEAR ENDING ON THE DETERMINATION DATE: The present values of accrued benefits and the amounts of Account balances of an Employee as of the determination date will be increased by the distributions made with respect to the Employee under the Plan and any Plan aggregated with the Plan under Code ss.416(g)(2) during the 1-year period ending on the determination date. The preceding sentence will also apply to distributions under a terminated Plan which had it not been terminated would have been aggregated with the Plan under Code ss.416(g)(2)(A)(i). In the case of a distribution made for a reason other than severance from employment, death, or disability, this provision will apply by substituting "5-year period" for "1-year period." (2) EMPLOYEES NOT PERFORMING SERVICES DURING THE YEAR ENDING ON THE DETERMINATION DATE: The accrued benefits and the amounts of Account balances of any individual who has not performed services for the Employer during the 1-year period ending on the determination date will not be taken into account. 3. MINIMUM BENEFITS (a) MATCHING CONTRIBUTIONS: Employer Matching Contributions will be taken into account for purposes of satisfying the minimum contribution requirements of Code ss.416(c)(2). The preceding sentence will apply with respect to Matching Contributions under the Plan or, if the Plan provides that the minimum contribution requirement will be met in another Plan, such other Plan. Matching Contributions that are used to satisfy the minimum contribution requirements will be treated as Matching Contributions for purposes of the actual contribution percentage test and other requirements of Code ss.401(m). (b) CONTRIBUTIONS UNDER OTHER PLANS: The Sponsor may provide that the minimum benefit requirement will be met in another Plan (including one that consists solely of a cash or deferred arrangement which meets the requirements of Code ss.401(k)(12) and Matching Contributions with respect to which the requirements of Code ss.401(m)(11) are met). o SS.631 OF EGTRRA - CATCH-UP CONTRIBUTIONS All Employees eligible to make Elective Deferrals under this Plan and who have attained age 50 before the close of the Plan Year will be eligible to make catch-up contributions in accordance with, and subject to the limitations of, Code ss.414(v) and the 2002 Tax Act. Such catch-up contributions will not be taken into account for purposes of the provisions of the Plan implementing the required limitations of Code ss.402(g) and ss.415. The Plan will not be treated as failing to satisfy the provisions of the Plan implementing the requirements of Code ss.401(k)(3), ss.401(k)(11), ss.401(k)(12), ss.410(b), or ss.416, as applicable, by reason of the making of such catch-up contributions. In accordance with the 2002 Tax Act, (a) the amount of catch-up contributions that a Participant may exclude from income is limited to the catch-up contribution limit, which will apply on an aggregate basis to all plans of the Employer and the group of Affiliated Employers of which the Employer is a part (except that for this purpose an Affiliated Employer will not include a trade or business which is acquired as part of an asset or stock acquisition, merger, or similar Code ss.410(b)(6)(C) transaction involving a change in the employer of the employees of a trade or business, during the period beginning on the date of the transaction and ending on the last day of the first Plan Year beginning after the date of the transaction); and (b) a Participant who attains Age 50 during a Plan Year will be considered to be Age 50 on the first day of the Plan Year. Catch-up contributions will apply to contributions on or after January 1, 2002. o SS.641, SS.642 AND SS.643 OF EGTRRA - DIRECT ROLLOVERS OF PLAN DISTRIBUTIONS 1. EFFECTIVE DATE: This section will apply to distributions made after December 31, 2001. 2. MODIFICATION OF DEFINITION OF ELIGIBLE RETIREMENT PLAN: For purposes of the Direct Rollover section of the Plan, an eligible retirement plan will also mean an annuity contract described in Code ss.403(b) and an eligible plan under Code ss.457(b) which is maintained by a state, political subdivision of a state, or any agency or instrumentality of a state or political subdivision of a state and which agrees to separately account for amounts transferred into such plan from this Plan. The definition of eligible retirement plan will also apply in the case of a distribution to a surviving spouse, or to a spouse or former spouse who is the alternate payee under a qualified domestic relation order, as defined in Code ss.414(p). 3. MODIFICATION OF DEFINITION OF ELIGIBLE ROLLOVER DISTRIBUTION TO INCLUDE AFTER-TAX EMPLOYEE CONTRIBUTIONS: For purposes of the Direct Rollover provisions of the Plan, a portion of a distribution will not fail to be an eligible rollover distribution merely because the portion consists of after-tax or non-deductible Employee contributions which are not includible in gross income. However, such portion may be paid only to an individual retirement account or annuity described in Code ss.408(a) or (b), or to a qualified defined contribution plan described in Code ss.401(a) or ss.403(a) that agrees to separately account for amounts so transferred, including separately accounting for the portion of such distribution which is includible in gross income and the portion of such distribution which is not so includible. In accordance with the 2002 Tax Act, when a distribution includes after-tax Employee contributions which are not includible in gross income, the amount that is rolled over will first be attributed to amounts includible in gross income. 4. MODIFICATION OF THE DEFINITION OF ELIGIBLE ROLLOVER DISTRIBUTION TO EXCLUDE HARDSHIP DISTRIBUTIONS: For purposes of the Direct Rollover provisions of the Plan, any amount distributed on account of hardship will not be an eligible Rollover distribution and the distributee may not elect to have any portion of such a distribution paid directly to an eligible retirement plan. 5. ADDITIONAL TYPES OF ROLLOVERS ACCEPTED PURSUANT TO EGTRRA SS.641, SS.642 AND SS.643 (a) DIRECT ROLLOVERS OR PARTICIPANT ROLLOVER CONTRIBUTIONS FROM OTHER PLANS: The Plan will accept a direct rollover of an eligible rollover distribution of a Participant contribution of an eligible rollover distribution from the following: (1) a qualified Plan described in IRC Section 401(a) or 403(a), excluding after-tax Employee Contributions; (2) an annuity contract described in IRC Section 403(b), excluding after-tax Employee Contributions; and(3) an eligible Plan under IRC Section 457(b) which is maintained by a state, political subdivision of a state, or any agency or instrumentality of a state or political subdivision of a state. (b) PARTICIPANT ROLLOVER CONTRIBUTIONS FROM IRAS: The Plan will accept a Participant rollover contribution of the portion of a distribution from an individual retirement account or annuity described in Code ss.408(a) or ss.408(b) that is eligible to be rolled over and would otherwise be includible in gross income. 6. EFFECTIVE DATE OF DIRECT ROLLOVER AND PARTICIPANT ROLLOVER CONTRIBUTION PROVISIONS: This section will be effective January 1, 2002 for rollovers to and from the Plan. o SS.646 OF EGTRRA - DISTRIBUTION UPON SEVERANCE FROM EMPLOYMENT 1. EFFECTIVE DATE: This section will apply for distributions and severance from employment occurring after January 1, 2002 regardless of when the severance from employment occurred. 2. NEW DISTRIBUTABLE EVENT: A Participant's Elective Deferrals, Qualified Non-Elective Contributions, Qualified Matching Contributions, and earnings attributable to these contributions will be distributed on account of the Participant's severance from employment. However, such a distribution will be subject to the other provisions of the Plan regarding distributions, other than provisions that require a severance from employment before such amounts may be distributed. o SS.648 OF EGTRRA - ROLLOVERS DISREGARDED IN INVOLUNTARY CASH-OUTS For purposes of the Plan provisions that provide for the involuntary distribution of vested Accrued Benefits of $5,000 or less, the value of a Participant's nonforfeitable Account balance shall be determined without regard to that portion of the Account balance that is attributable to Rollover Contributions (and earnings allocable thereto) within the meaning of Code ss.402(c), ss.403(a)(4), ss.403(b)(8), ss.408(d)(3)(A)(ii), and ss.457(e)(16). If the value of the Participant's non-forfeitable Account balance as so determined is $5,000 or less, the Participant's entire non-forfeitable Account balance shall be considered immediately distributable. This election shall apply with respect to distributions made on or after January 1, 2002 with respect to Participants who separated from service with the Employer or an Affiliated Employer on or after January 1, 2002. o SS.666 OF EGTRRA - REPEAL OF MULTIPLE USE TEST The multiple use test described in Treasury Regulation Code ss.1.401(m)-2 and in the Plan will not apply for Plan Years beginning after December 31, 2001. o SS.636(a) OF EGTRRA - SUSPENSION PERIOD FOLLOWING HARDSHIP DISTRIBUTION A Participant who receives a distribution of Elective Deferrals after December 31, 2001 on account of hardship will be prohibited from making Elective Deferrals and Employee contributions under this and all other Plans of the Employer for 6 months after receipt of the distribution. A Participant who receives a distribution of Elective Deferrals in calendar year 2001 on account of hardship will be prohibited from making Elective Deferrals and Employee contributions under this and all other Plans of the Employer for the period specified in the provisions of the Plan relating to suspension of Elective Deferrals that were in effect prior to this amendment. In addition, the following phrase at the end of Section 5.17(d) is hereby deleted: " ; and for the Participant's taxable year immediately following the taxable year of the hardship distribution, the Participant cannot make Elective Deferrals to this Plan or any other plan maintained by the Employer in excess of the applicable limit under Code ss.402(g)(5) for such taxable year, minus the amount of such Participant's Elective Deferrals made for the taxable year in which the financial hardship distribution was made" HOT TOPIC, INC. By_________________________ Date_______________________ AMENDMENT TO INCREASE THE MAXIMUM ELECTIVE DEFERRAL AMOUNT NAME OF PLAN: Hot Topic, Inc. 401(k) Profit Sharing Plan (the "Plan") PLAN SPONSOR: Hot Topic, Inc. (the "Sponsor") THIS AMENDMENT is hereby adopted by the Sponsor in order to increase the maximum allowable Elective Deferral contributions under the Plan to up to 100% of each Eligible Participant's Compensation. Accordingly, the following amendment shall be effective for the Plan Year which begins in 2002: SECTION 3.1(a)(1) IS HEREBY AMENDED IN ITS ENTIRETY TO READ AS FOLLOWS: - ----------------------------------------------------------------------- (1) DEFERRAL PERCENTAGE: For each contribution period, a Participant may elect that up to 100% of his or her Compensation received during the contribution period be withheld as an Elective Deferral, inclusive of any other amounts allocated to such Participant and counted under Code ss.415(c) and ss.ss.611(b) and 632 of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), to the maximum dollar amount permitted under Code ss.402(g). Elective Deferrals may be made in whole percentages (or if permitted by the Administrator, in fractional percentages) of Compensation or in specific dollar amounts as designated by the Participant. The Administrator will have the right to direct that such percentages of Compensation be rounded to the next highest or lowest dollar. Furthermore, on a uniform nondiscriminatory basis, the Administrator may permit a Participant to identify separate components of the Participant's Compensation (such as base salary, bonuses, etc.) and to specify that a different percentage (or dollar amount) apply to each such component. SECTION 3.1(a)(5) IS HEREBY AMENDED IN ITS ENTIRETY TO READ AS FOLLOWS: - ----------------------------------------------------------------------- (5) PARTICIPANT ELECTION TO DEFER UP TO 100% OF COMPENSATION: On a uniform nondiscriminatory basis, the Administrator may permit a Participant whose Salary Deferral Agreement has not authorized the Employer to withhold at the maximum rate permitted under subparagraph (1) above to increase the total amount withheld for a Plan Year to the maximum rate permitted under subparagraph (1), in which event the Participant may authorize the Employer to withhold a supplemental amount up to 100% of his or her eligible Compensation for one or more pay periods. In no event can the sum of the amount withheld under the Salary Deferral Agreement plus the supplemental withholding exceed the lesser of (A) the maximum amount permitted under subparagraph (1) above; or (B) the maximum dollar amount permitted for that Plan Year under Code ss.402(g)(5); or (C) 100% of the Participant's Code ss.415 Compensation for that Plan Year. SECTION 1.16(a)(2) IS HEREBY AMENDED IN ITS ENTIRETY TO READ AS FOLLOWS: - ------------------------------------------------------------------------ (2) TREATMENT OF ELECTIVE DEFERRALS: For purposes of this paragraph (a), Employer contribution amounts made pursuant to a salary reduction agreement which are not currently includible in the gross income of an Employee by reason of Code ss.125, ss.402(e)(3), ss.402(h)(1)(B), or ss.403(b) will be included in determining Compensation. In addition, if elected by the Administrator on a non-discriminatory basis, Compensation will also include elective amounts not includible in the gross income of the Employee by reason of Code ss.132(f)(4), beginning with the Plan Year elected by the Administrator but not earlier than the Plan Year beginning on or after January 1, 1998. HOT TOPIC, INC. By_________________________ Date_______________________ FINAL CODE SS.401(a)(9) AMENDMENT REGARDING MINIMUM DISTRIBUTION REQUIREMENTS NAME OF PLAN: Hot Topic, Inc. 401(k) Profit Sharing Plan (the "Plan") PLAN SPONSOR: Hot Topic, Inc. (the "Sponsor") THIS AMENDMENT is hereby adopted by the Sponsor to permit the Plan to make required minimum distributions in accordance with final Internal Revenue Service regulations under Code ss.401(a)(9) effective no later than for calendar years which begin in 2003 in accordance with Rev. Proc. 2002-29. SECTION 1. GENERAL RULES 1.1. EFFECTIVE DATE. The provisions of this amendment will apply for purposes of determining required minimum distributions for calendar years beginning with the 2002 calendar year. 1.2. COORDINATION WITH MINIMUM DISTRIBUTION REQUIREMENTS PREVIOUSLY IN EFFECT. Required minimum distributions for calendar 2002 will be determined as follows: If the total amount of 2002 required minimum distributions under the Plan made to a distributee for calendar 2002 (a) equals or exceeds the required minimum distributions determined under this amendment, then no additional distributions will be required to be made for 2002 on or after such date to the distribute; or (b) is less than the amount determined under this amendment, then required minimum distributions for 2002 on and after such date will be determined so that the total amount of required minimum distributions for 2002 made to the distributee will be the amount determined under this amendment. 1.3. PRECEDENCE. The requirements of this amendment will take precedence over any inconsistent provisions of the Plan and any prior amendments thereto. 1.4. REQUIREMENTS OF INTERNAL REVENUE SERVICE REGULATIONS INCORPORATED. All distributions required under this amendment will be determined and made in accordance with the Internal Revenue Service regulations under Code ss.401(a)(9). 1.5. TEFRA SS.242(B)(2) ELECTIONS. Notwithstanding the other provisions of this amendment, distributions may be made under a designation made before January 1, 1984, in accordance with ss.242(b)(2) of the Tax Equity and Fiscal Responsibility Act (TEFRA) and the provisions of the Plan that relate to ss.242(b)(2) of TEFRA. SECTION 2. TIME AND MANNER OF DISTRIBUTION 2.1. REQUIRED BEGINNING DATE. The Participant's entire interest will be distributed, or begin to be distributed, to the Participant no later than the Participant's Required Beginning Date. 2.2. DEATH OF PARTICIPANT BEFORE DISTRIBUTION BEGIN. If the Participant dies before distributions begin, his or her entire interest will be distributed, or begin to be distributed, no later than as follows: (a) If the Participant's surviving Spouse is the Participant's sole designated Beneficiary, then subject to section 2.2 (e) below distributions to the surviving Spouse will begin by December 31 of the calendar year immediately following the calendar year in which the Participant died, or by December 31 of the calendar year in which the Participant would have attained age 70 1/2, if later. Page -1- (b) If the Participant's surviving Spouse is not the Participant's sole designated Beneficiary, then subject to section 2.2(e) below distributions to the designated Beneficiary will begin by December 31 of the calendar year immediately following the calendar year in which the Participant died. (c) If there is no designated Beneficiary as of September 30 of the year following the year of the Participant's death, the Participant's entire interest will be distributed by December 31 of the calendar year containing the fifth anniversary of the Participant's death. (d) If the Participant's surviving Spouse is the Participant's sole designated Beneficiary and the surviving Spouse dies after the Participant but before distributions to the surviving Spouse begin, this section 2.2, other than section 2.2(a), will apply as if the surviving Spouse were the Participant. (e) If the Participant dies before distributions begin and there is a designated Beneficiary, distribution to the designated Beneficiary is not required to begin by the date specified in sections 2.2(a) or (b) above if the Participant's entire interest is distributed to the designated Beneficiary by December 31 of the calendar year containing the fifth anniversary of the Participant's death. In addition, a designated Beneficiary who is receiving payments under this 5-year rule may make a new election to receive payments under the life expectancy rule until December 31, 2003, provided that all amounts that would have been required to be distributed under the life expectancy rule for all distribution calendar years before 2004 are distributed by the earlier of December 31, 2003 or the end of the 5-year period. For purposes of this section 2.2 and section 4, unless section 2.2(d) applies, distributions are considered to begin on the Participant's Required Beginning Date. If section 2.2(d) applies, distributions are considered to begin on the date distributions are required to begin to the surviving Spouse under section 2.2(a). If distributions under an annuity purchased from an insurance company irrevocably commence to the Participant before the Participant's Required Beginning Date (or to the Participant's surviving Spouse before the date distributions are required to begin to the surviving Spouse under section 2.2(a)), the date distributions are considered to begin is the date distributions actually commence. 2.3. FORMS OF DISTRIBUTION. Unless the Participant's interest is distributed in the form of an annuity purchased from an insurance company or in a single sum on or before the Required Beginning Date, as of the first distribution calendar year distributions will be made in accordance with sections 3 and 4 of this amendment. If the Participant's interest is distributed in the form of an annuity purchased from an insurance company, distributions thereunder will be made in accordance with the requirements of Code ss.401(a)(9) and the IRS regulations. SECTION 3. REQUIRED MINIMUM DISTRIBUTIONS DURING PARTICIPANT'S LIFETIME 3.1. AMOUNT OF REQUIRED MINIMUM DISTRIBUTION FOR EACH DISTRIBUTION CALENDAR YEAR. During the Participant's lifetime, the minimum amount that will be distributed each distribution calendar year is the lesser of (a) the quotient obtained by dividing the Participant's account balance by the distribution period in the Uniform Lifetime Table in ss.1.401(a)(9)-9 of the IRS regulations using the Participant's age as of his or her birthday in the distribution calendar year; or (b) if the Participant's sole designated Beneficiary for the distribution calendar year is the Participant's Spouse, the quotient obtained by dividing the Participant's account balance by the number in the Joint and Last Survivor Table in ss.1.401(a)(9)-9 of the IRS regulations using the Participant's and Spouse's attained ages as of the Participant's and Spouse's birthdays in the distribution calendar year. Page -2- 3.2. LIFETIME REQUIRED MINIMUM DISTRIBUTIONS CONTINUE THROUGH YEAR OF PARTICIPANT'S DEATH. Required minimum distributions will be determined under this section 3 beginning with the first distribution calendar year and up to and including the distribution calendar year that includes the Participant's date of death. SECTION 4. REQUIRED MINIMUM DISTRIBUTIONS AFTER PARTICIPANT'S DEATH 4.1. DEATH ON OR AFTER DATE DISTRIBUTIONS BEGIN (a) PARTICIPANT SURVIVED BY DESIGNATED BENEFICIARY. If the Participant dies on or after the date distributions begin and there is a designated Beneficiary, the minimum amount that will be distributed for each distribution calendar year after the year of the Participant's death is the quotient obtained by dividing the Participant's account balance by the longer of the remaining life expectancy of the Participant or the remaining life expectancy of the Participant's designated Beneficiary, determined as follows: (1) the Participant's remaining life expectancy is calculated using the age of the Participant in the year of death, reduced by one for each subsequent year; (2) if the Participant's surviving Spouse is the sole designated Beneficiary, the remaining life expectancy of the surviving Spouse is calculated for each distribution calendar year after the year of the Participant's death using the surviving Spouse's age as of the Spouse's birthday in that year. For distribution calendar years after the year of the surviving Spouse's death, the remaining life expectancy of the surviving Spouse is calculated using the age of the surviving Spouse as of the Spouse's birthday in the calendar year of the Spouse's death, reduced by one for each subsequent calendar year; and (3) if the Participant's surviving Spouse is not the Participant's sole designated Beneficiary, the designated Beneficiary's remaining life expectancy is calculated using the age of the Beneficiary in the year following the year of the Participant's death, reduced by one for each subsequent year. (b) NO DESIGNATED BENEFICIARY. If the Participant dies on or after the date distributions begin and there is no designated Beneficiary as of September 30 of the year after the year of the Participant's death, the minimum amount that will be distributed for each distribution calendar year after the year of the Participant's death is the quotient obtained by dividing the Participant's account balance by the Participant's remaining life expectancy calculated using the age of the Participant in the year of death, reduced by one each subsequent year. 4.2. DEATH BEFORE DATE DISTRIBUTIONS BEGIN (a) PARTICIPANT SURVIVED BY DESIGNATED BENEFICIARY. If the Participant dies before the date distributions begin and there is a designated Beneficiary, the minimum amount that will be distributed for each distribution calendar year after the year of the Participant's death is the quotient obtained by dividing the Participant's account balance by the remaining life expectancy of the Participant's designated Beneficiary, as determined in section 4.1. (b) NO DESIGNATED BENEFICIARY. If the Participant dies before distributions begin and there is no designated Beneficiary as of September 30 of the year following the year of the Participant's death, distribution of the Participant's entire interest will be completed by December 31 of the calendar year containing the 5th anniversary of the Participant's death. (c) DEATH OF SURVIVING SPOUSE BEFORE DISTRIBUTIONS TO SURVIVING SPOUSE ARE REQUIRED TO BEGIN. If the Participant dies before the date distributions begin, the Participant's surviving Spouse is the Participant's sole designated Beneficiary, and the surviving Spouse dies before distributions are required to begin to the surviving Spouse under section 2.2(a), this section 4.2 will apply as if the surviving Spouse were the Participant. Page -3- SECTION 5. DEFINITIONS 5.1. DESIGNATED BENEFICIARY. The Beneficiary designated by the Participant is the designated Beneficiary under Code ss.401(a)(9) and ss.1.401(a)(9)-1, Q&A-4 of the IRS regulations. 5.2. DISTRIBUTION CALENDAR YEAR. A calendar year for which a minimum distribution is required. For distributions beginning before the Participant's death, the first distribution calendar year is the calendar year immediately preceding the calendar year which contains the Participant's Required Beginning Date. For distributions beginning after the Participant's death, the first distribution calendar year is the calendar year in which distributions are required to begin under section 2.2. The required minimum distribution for the Participant's first distribution calendar year will be made on or before the Participant's Required Beginning Date. The required minimum distribution for other distribution calendar years, including the required minimum distribution for the distribution calendar year in which the Participant's Required Beginning Date occurs, will be made on or before December 31 of that distribution calendar year. 5.3. LIFE EXPECTANCY. Life expectancy as computed by use of the Single Life Table in ss.1.401(a)(9)-9 of the IRS regulations. 5.4. PARTICIPANT'S ACCOUNT BALANCE. For purposes of determining minimum distributions the Account balance as of the last Valuation Date in the calendar year immediately preceding the distribution calendar year (valuation calendar year) increased by the amount of any contributions made and allocated or forfeitures allocated to the Account balance as of dates in the valuation calendar year after the Valuation Date and decreased by distributions made in the valuation calendar year after the Valuation Date. The Account balance for the valuation calendar year includes any amounts rolled over or transferred to the Plan either in the valuation calendar year or in the distribution calendar year if distributed or transferred in the valuation calendar year. HOT TOPIC, INC. By_________________________ Date_______________________ Page -4- EX-21 8 hottopic_10kex21.txt EXHIBIT 21 HOT TOPIC, INC. LIST OF SUBSIDIARIES ENTITY ENTITY TYPE STATE/PLACE OF INCORPORATION - ------ ----------- ---------------------------- Hot Topic Administration, Inc. Corporation California Hot Topic Merchandising, Inc. Corporation California hottopic.com, Inc. Corporation California Hot Topic Tennessee, Inc. Corporation California EX-23.1 9 hottopic_10kex23-1.txt EXHIBIT 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in the following Registration Statements: (1) Registration Statement (Form S-8 No. 333-13875) pertaining to the Non-Plan Stock Options, 1996 Equity Incentive Plan, 1996 Non-Employee Directors' Stock Option Plan and Employee Stock Purchase Plan, (2) Registration Statement (Form S-8 No. 333-43992) pertaining to the 1996 Equity Incentive Plan, (3) Registration Statement (Form S-8 No. 333-58173) pertaining to the Non-Plan Stock Options, 1996 Equity Incentive Plan, as amended, and 1996 Non-Employee Directors' Stock Option Plan, as amended, and (4) Registration Statement (Form S-8 No. 333-108324) pertaining to the 1996 Equity Incentive Plan, as amended of our reports dated March 11, 2005, with respect to the consolidated financial statements of Hot Topic, Inc., Hot Topic, Inc. management's assessment of the effectiveness of internal control over financial reporting, and the effectiveness of internal control over financial reporting of Hot Topic, Inc., included in this Annual Report (Form 10-K) of Hot Topic, Inc. for the year ended January 29, 2005. Los Angeles, California April 11, 2005 EX-31.1 10 hottopic_10kex31-1.txt EXHIBIT 31.1 CERTIFICATION I, Elizabeth McLaughlin, certify that: 1. I have reviewed this annual report on Form 10-K of Hot Topic, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: April 13, 2005 /s/ Elizabeth McLaughlin Elizabeth McLaughlin Chief Executive Officer (Principal Executive Officer) EX-31.2 11 hottopic_10kex31-2.txt EXHIBIT 31.2 CERTIFICATION I, James McGinty, certify that: 1. I have reviewed this annual report on Form 10-K of Hot Topic, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: April 13, 2005 /s/ James McGinty James McGinty Chief Financial Officer (Principal Financial Officer) EX-32.1 12 hottopic_10kex32-1.txt EXHIBIT 32.1 Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. ss. 1350, as adopted). I, Elizabeth McLaughlin, Chief Executive Officer of Hot Topic, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of Hot Topic, Inc.; 2. Based on my knowledge, this annual report fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended; and 3. Based on my knowledge, the financial statements, and other information included in this annual report, fairly present in all material respects the financial condition and results of operations of the registrant as of, and for, the periods presented in this annual report. Date: April 13, 2005 /s/ Elizabeth McLaughlin ------------------------ Elizabeth McLaughlin Chief Executive Officer (Principal Executive Officer) A signed original of this written statement required by Section 906 has been provided to Hot Topic, Inc. and will be retained by Hot Topic, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. This certification "accompanies" the Form 10-K, is not deemed filed with the SEC and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-K), irrespective of any general incorporation language contained in such filing. I, James McGinty, Chief Financial Officer of Hot Topic, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of Hot Topic, Inc.; 2. Based on my knowledge, this annual report fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended; and 3. Based on my knowledge, the financial statements, and other information included in this annual report, fairly present in all material respects the financial condition and results of operations of the registrant as of, and for, the periods presented in this annual report. Date: April 13, 2005 /s/ James McGinty ------------------------ James McGinty Chief Financial Officer (Principal Financial Officer) A signed original of this written statement required by Section 906 has been provided to Hot Topic, Inc. and will be retained by Hot Topic, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. This certification "accompanies" the Form 10-K, is not deemed filed with the SEC and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-K), irrespective of any general incorporation language contained in such filing. -----END PRIVACY-ENHANCED MESSAGE-----