-----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, C1HS9/9lLiuaoAPWAsTk1NEdnICFaLDQ03e+pHrt+ImgxiqWSfyZowCK1TsxLTQ8 IKZcUzik+lmdsPfGtbGgRA== 0001021408-99-000719.txt : 19990428 0001021408-99-000719.hdr.sgml : 19990428 ACCESSION NUMBER: 0001021408-99-000719 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990130 FILED AS OF DATE: 19990427 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HOT TOPIC INC /CA/ CENTRAL INDEX KEY: 0001017712 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-RETAIL STORES, NEC [5990] IRS NUMBER: 770198182 STATE OF INCORPORATION: CA FISCAL YEAR END: 0201 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-28784 FILM NUMBER: 99602274 BUSINESS ADDRESS: STREET 1: 3410 POMONA BLVD CITY: POMONA STATE: CA ZIP: 91768 MAIL ADDRESS: STREET 1: 3410 POMONA BLVD CITY: POMONA STATE: CA ZIP: 91768 10-K 1 FORM 10-K ------------------------------------------------------------------------------ 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 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM _____________________________ TO ____________________________________ Commission File No. 0-28784 HOT TOPIC, INC. (Exact name of registrant as specified in its charter) CALIFORNIA 77-0198182 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3410 POMONA BOULEVARD 91768 POMONA, CALIFORNIA (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (909) 869-6373 Securities registered pursuant to Section 12(b) of the Act: none Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, NO PAR VALUE (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K ____. The number of shares outstanding of the Registrant's Common Stock was 4,595,431 as of April 19, 1999. The aggregate market value of Common Stock held by non-affiliates of the registrant as of April 19, 1999 was approximately $59,464,000, based on the closing price on that date of Common Stock on the Nasdaq National Stock Market.* DOCUMENTS INCORPORATED BY REFERENCE Certain portions of the Company's Definitive Proxy Statement for the annual meeting of stockholders to be held on June 1, 1999 to be filed with the Securities and Exchange Commission (the "Commission") no later than 120 days after January 30, 1999, are incorporated by Reference into Part III of this Form 10-K (Items 10 through 13). Certain Exhibits filed with the Registrant's Registration Statement on Form SB-2 (Registration No. 333-5054-LA), as amended, are incorporated by reference into Part IV of this Form 10-K (Item 14). ____________ *Excludes 1,109,833 shares of Common Stock held by directors and officers and shareholders whose beneficial ownership exceeds 10% of the shares outstanding on April 19, 1999. Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the Registrant, or that such person is controlled by or under common control with the Registrant. This Annual Report on Form 10-K contains certain forward-looking statements that involve risks and uncertainties. The Company's actual future results could differ materially from those statements. Factors that could cause or contribute to such differences include, but are not limited to, those found in this Annual Report on Form 10-K in Part I, Item 1 under the caption "Certain Risk Factors Related to the Company's Business," in Part II, Item 7 under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" and additional factors discussed elsewhere in this Annual Report. PART I ITEM 1. BUSINESS GENERAL Hot Topic, Inc. ("Hot Topic" or the "Company") is a rapidly growing, mall- based specialty retailer of music-licensed and music-influenced apparel, accessories and gift items for young men and women principally between the ages of 12 and 22. The Company believes teenagers throughout the United States have similar fashion preferences, largely as a result of the nationwide influence of MTV, music distribution, movies, television programs and fashion magazines. The Company opened its first store in 1989, and operated 158 stores as of January 30, 1999 in 38 states across the United States. During fiscal 1995, the Company significantly accelerated its store expansion program and opened 18 stores, including its first stores in the Northeast and Midwest. The Company opened 26, 40 and 50 additional stores during fiscal 1996, 1997 and 1998, respectively, and in fiscal 1996 relocated two existing stores. In fiscal 1998, the Company opened its first "street stores," which are stores on street fronts rather than in enclosed shopping malls. The Company plans to open approximately 45 new stores in fiscal 1999, eight of which were opened as of April 19, 1999. The Company also maintains a website, (www.hottopic.com) through which it markets its stores and store concept and sells certain of its merchandise. The Company's net sales via the Internet continue to increase significantly, although the total sales are still modest. The company is working to redesign the website which may effect its promotional activities and its Internet sales. THE MARKET The music-licensed apparel industry began in the 1960s with bootleggers selling T-shirts at concert venues. Over the ensuing two decades, artists began to realize the commercial potential of licensing their likenesses and logos to T-shirt manufacturers and others who produced assorted merchandise. Management believes that the single largest impact on the music industry during the last decade has been the success of MTV, which enables fans not only to listen to the latest music and artists 24 hours a day, but also to see a full sight and sound package of appearance and attitude. According to industry estimates, in 1996 MTV programming could be seen in more than 60 million households in the United States and in over 260 million households worldwide. It is also estimated that viewers in over 23 million homes watch MTV every week. As a result, popular artists and the fashions they wear are much more visible today than 30 years ago. Management believes that this increased visibility has contributed to the increase in demand for music-licensed and music-influenced apparel and accessories. Hot Topic's target customers are young men and women between the ages of 12 to 22 years old, who are passionate about music, music videos and music-inspired fashion, and are avid MTV viewers. The Company believes its music-oriented merchandise appeals to teenagers from diverse socio-economic backgrounds, and that its customers are broadly representative of the teenage population in the United States. 2. Teenagers represent both a growing part of the United States population and an increasing source of purchasing power. According to the U.S. Department of Commerce Bureau of the Census, the teenage population in the United States reached approximately 31 million in 1998 and is expected to grow to approximately 35 million by 2008, representing a projected growth rate close to twice the rate of the overall population. By 2010, there likely will be more teenagers in the United States than at any other time in history. The Company also believes, based upon statistics released by an independent research firm, that teenage spending has also been increasing annually, growing to an estimated $111 billion in 1997. BUSINESS STRATEGY The Company's goal is to become the leading retailer of music-licensed and music-influenced apparel and accessories for young men and women. The principal elements of the Company's business strategy are as follows: . FOCUS ON UNIQUE MUSIC-ORIENTED MERCHANDISE. Management believes that fashions and products associated with popular music artists have a significant influence on teenagers today, who often want to emulate their favorite artists. The Company has developed a unique strategy focused exclusively on offering music-licensed and music-influenced merchandise in the mall environment. The Company believes most of the merchandise it offers is not available elsewhere in the mall and is often hard to find other than at alternative shopping venues in major metropolitan areas. Accordingly, the Company believes it is well-positioned to capitalize on the growing teenage population and demand for music related merchandise. . OFFER "EVERYTHING ABOUT THE MUSIC." The Company's stores are designed to serve as a headquarters for music- licensed and music-influenced apparel, accessories and gift items. The Company's slogan, "Everything About The Music," reflects the Company's broad assortment of products, which currently consists of over 12,000 SKUs in 25 different product categories. The Company believes its selection of music- licensed merchandise is the most extensive assortment available in one mall store. The Company complements its licensed merchandise with a unique and eclectic assortment of music-influenced apparel and accessories, and frequently introduces new items and categories in response to changes in trends and demand. The Company believes it has a history of being the first to offer the latest music fashions, which, together with its assortment of merchandise, has made it a destination store for teenagers seeking music-related products. . PROMOTE MUSIC-INSPIRED CULTURE. Hot Topic is committed to addressing the music-oriented lifestyles of its customers by building a culture throughout the organization that reflects a passion for music. Management diligently tracks alternative and rock music trends by regularly monitoring new music, music video releases and radio station air play, visiting nightclubs around the country and attending concerts. The Company also actively solicits feedback from its employees and customers. The Company believes these activities enable it to react quickly to emerging trends, and provide it with a competitive advantage over retailers who do not devote the time and resources necessary to anticipate these trends. . ACTIVELY MANAGE MERCHANDISE MIX. Hot Topic does not dictate fashion trends, but rather seeks to identify music artists and releases that will have strong appeal and related products that will generate strong demand. The Company has developed a disciplined approach to buying and a proactive inventory management program around this 3. strategy. The Company often tests new merchandise in a small number of stores before chain-wide distribution, and orders a majority of its merchandise not more than 60 days before delivery, enabling it to respond quickly to emerging trends. In cases where it does not have return privileges with its vendors, Hot Topic is aggressive in taking prompt markdowns to maintain a fresh merchandise mix. By actively managing the mix of categories and products in its stores, the Company believes it is able to capitalize on emerging trends and minimize its dependence on any particular category. The Company believes that this approach to managing its merchandise mix has contributed to its strong merchandise margins and to consistent markdown rates which the Company believes are lower than industry averages. . CREATE AN ENTERTAINING STORE ENVIRONMENT. The Company seeks to create a compelling shopping environment that brings into the mall elements of the alternative urban shopping experience sought by teenagers. Hot Topic stores are designed with an industrial warehouse theme that incorporates dense merchandising and utilizes a professional sound system playing alternative music releases to create a fun, high-energy store that teens will consider "their place" to shop with friends. The Company believes that this atmosphere enhances the Company's image as a source for music-inspired fashion while encouraging customers to shop in its stores for longer periods of time. . EMPHASIZE CUSTOMER SERVICE. Hot Topic trains its store associates to provide value-added, non-intrusive customer service. Sales associates are taught to greet each customer, provide information about new music and fashion trends and suggest merchandise that matches the customer's lifestyle and music preferences. The Company strives to give its teenage customers the same level of respect and attention that is generally given to adult customers at other retail stores and to provide friendly and informed customer service for parents. The Company believes that a high level of product knowledge and a commitment to music fashion create high credibility and differentiate the Company from other teenage focused retailers. . DEVELOP PRIVATE LABEL PRODUCTS FOR MUSIC-ORIENTED LIFESTYLES. The Company has developed private label product lines to complement and supplement its other product offerings. The Company's private label product lines include, among others, Morbid Threads (apparel and hosiery) and Morbid Metals (body jewelry). The Company believes that these private label products differentiate it from its competition and enhance customer loyalty through the development of a unique brand image. STORE LOCATIONS As of January 30, 1999, the Company operated 158 stores in both metropolitan and middle markets in 38 states across the United States. The following chart sets forth, as of April 19, 1999, the number of stores that Hot Topic operated in each state and the cities in which stores are located. 4.
ARIZONA-2 IDAHO-1 MICHIGAN-4 NEW MEXICO-2 SO. CAROLINA-1 Phoenix Boise* Troy Albuquerque(2) Greenville Tucson Flint ILLINOIS-5 Auburn NEW YORK-11 TENNESSEE-1 CALIFORNIA-33 West Dundee Traverse City* Buffalo Antioch Bakersfield Bloomingdale Rochester Los Angeles(13) Aurora MINNESOTA-5 Staten Island TEXAS-6 Fresno Joliet Bloomington Albany Lewisville Palm Desert Orland Park St. Cloud Victor Austin San Diego(5) Duluth Lake Grove San Antonio San Francisco(5) INDIANA-4 St. Paul West Nyack Mesquite Victor Valley Fort Wayne Mankato Johnson City Woodlands Capitola Evansville Syracuse Corpus Christi* Citrus Heights Lafayette MISSOURI-2 New Hartford Modesto Terre Haute St. Peters Bay Shore UTAH-2 Sacramento St. Louis Salt Lake City San Jose IOWA-1 St. Louis* NO. CAROLINA-1 Sandy Berkeley Coralville NEBRASKA-2 Pineville Lincoln VIRGINIA-1 COLORADO-6 KANSAS-2 Omaha OHIO-5 Springfield Westminster Olathe Parma Colorado Spr-(2) Wichita NEVADA-4 Dayton WASHINGTON-8 Littleton-(2) Las Vegas(3) No. Olmsted Bellingham Denver KENTUCKY-1 Reno Mentor Kennewick Louisville Cincinnati Seattle(2) CONNECTICUT-5 NEW HAMPSHIRE-3 Silverdale Elyria* Spokane(2) Waterford LOUISIANA-2 Manchester OKLAHOMA-2 Tacoma Manchester Metairie Nashua Oklahoma City Danbury Monroe Salem Oklahoma City* WEST VIRGINIA-1 Waterbury Baton Rouge* Charleston Milford MAINE-1 NEW JERSEY-8 OREGON-2 Bangor Mays Landing Portland(2) WISCONSIN-4 DELAWARE-1 Parmus Madison Wilmington Rockaway PENNSYLVANIA-8 Appleton MARYLAND-3 Toms River Philadelphia(3) Brookfield FLORIDA-2 Towson Wayne West Mifflin Eau Claire Altamonte Springs White Marsh Deptford Wilkes-Barre Coral Springs Columbia Woodbridge Media Eatontown York GEORGIA-3 MASS.-6 Altoona Duluth Boston(2) Kennesaw Holyoke Macon Marlborough Saugus Trunton
5. 1. References above to Los Angeles, San Diego, San Francisco, Boston, Las Vegas, Philadelphia and Seattle in each case include the metropolitan area of that city. An asterisk next to a city indicates that a store has been opened in such city during fiscal 1999. EXPANSION STRATEGY The following table provides a history of the Company's store expansion over the last five fiscal years:
FISCAL YEAR -------------------------------------------------- 1994 1995 1996 1997 1998 -------------------------------------------------- (number of stores) Stores at beginning of year 18 24 42 68 108 New Stores opened 6 18 26 40 50 --------------------------------------------------- Stores at end of year 24 42 68 108 158 ---------------------------------------------------
All but two of the Company's stores are currently in shopping malls. During fiscal 1998, the Company opened two "street location" stores, one each in Denver, Colorado and in Berkley, California. The Company's expansion strategy is to open stores in shopping malls in both new and existing markets throughout the United States. The Company may open additional "street stores" in markets that the Company believes can sustain a Hot Topic store outside the mall environment, although the Company may elect not to aggressively expand its "street store" concept. The Company believes it has developed a store concept that is successful in both metropolitan and middle markets. Further, as a result of the nationwide influence of MTV, music distribution, movies, television programs and fashion magazines, the Company believes that its 12 to 22 year old target customers have similar fashion preferences throughout the United States. The Company opened 50 new stores in fiscal 1998 and plans to open approximately 45 new stores during fiscal 1999. The Company selects and evaluates potential store locations based on a variety of criteria including the sales and square footage of the mall, sales of anchor stores, sales of teenage- oriented stores, foot traffic, number of teenagers in trade area, median family income and other factors relevant to the Company's unique merchandising strategy. The Company looks at similar criteria for "street store" locations. Model statements of operations are developed for each potential location and are measured against target financial criteria. Hot Topic has a real estate committee, including its Chief Executive Officer and three outside directors, which reviews and approves all new store locations. The Company generally seeks potential store sites between 1,200 and 2,000 square feet and its stores currently average approximately 1,450 square feet. STORE-LEVEL ECONOMICS During fiscal 1998, the Company's 108 stores that were in operation for all of the fiscal year generated average net sales of approximately $747,000 and average net sales per square foot of approximately $538. These stores also generated average store-level operating cash flow (defined as store operating income before depreciation and excluding changes in working capital) of approximately 6. $203,000, or 27% of average net sales. Capital expenditures, including leasehold improvements, furniture and fixtures and net of landlord construction allowances for the 50 stores opened in fiscal 1998 averaged approximately $170,000, initial gross inventory requirements (which were partially financed by trade credit) averaged $65,000, and pre-opening costs (which were expensed in the periods the stores opened) averaged $19,000. Inventory requirements vary at new stores depending on the season and on current merchandise trends. In fiscal 1998, all of the Company's stores generated positive store-level operating income, but there can be no assurance this trend will continue. There also can be no assurance that in the future the average store-level sales and operating cash flow will not vary from historical results or that the total estimated capital expenditures for new stores will not increase. MERCHANDISING The Company's stores are designed to serve as a headquarters for music- licensed and music-influenced apparel, accessories and gift items. Music- licensed merchandise includes T-shirts, caps, posters, stickers, patches, postcards, books, CDs, videos and other items. Music-influenced merchandise includes woven and knit tops, skirts, pants, shorts, jackets, shoes, costume jewelry, body jewelry, sunglasses, cosmetics and gift items. The Company estimates that approximately half of the Company's products are music-licensed products, and half are music-influenced products. A key strategy of the Company is to offer over 12,000 SKUs in 25 different product categories or "departments." Within each category, the Company seeks to offer a broader assortment of merchandise than is available at any other mall location. For example, on average, over 100 different licensed band T-shirts are carried in each store from alternative artists such as Korn, Blink 182, Limp Bizkit, Deftones, Rage Against the Machine, Orgy, and others; and rock artists such as the Pink Floyd, Rob Zombie, Pantera, Metallica, Jimi Hendrix, The Doors, the Beatles, Led Zeppelin, and others. New items and categories are tested regularly as customer demand and product trends evolve. The Company does not dictate leading edge fashion, but quickly reacts to changes in trends and demand to keep Hot Topic stores fresh and exciting. Further, the Company strives to identify music artists and releases that will have strong appeal, and to quickly acquire related music-licensed products and music-influenced merchandise, featured on music videos or otherwise, associated with such artists and releases. The following table sets forth the Company's four major merchandise groups as an approximate percentage of net sales for fiscal years 1998, 1997 and 1996:
PERCENTAGE OF NET SALES --------------------------- 1998 1997 1996 --------------------------- Apparel and T-Shirts 48% 47% 43% Gifts 19 20 21 Accessories 26 25 26 Hosiery, Shoes, and Outerwear 7 8 10 --------------------------- 100% 100% 100%
The Company has four lines of private label merchandise to complement and supplement its current product offerings. The Company believes that Hot Topic brands play an important part in differentiating its stores from those of its competitors and provide the Company with higher margin opportunities as compared to other merchandise. Management estimates that Hot Topic brands accounted for approximately 20% of the Company's sales in both fiscal 1998 and 1997. The Company's proprietary brands include Morbid Makeup (cosmetics), Morbid Metals (body jewelry), Morbid Scents (incense and oils) and Morbid Threads (men's and women's apparel and hosiery). 7. PURCHASING The Company's purchasing staff consists of a General Merchandise Manager, two Divisional Merchandise Managers, seven buyers, and seven assistant buyers. The purchasing staff reflects the Company's culture in that its decisions and actions are influenced by a passion for music. In determining which merchandise to buy, the purchasing staff spends considerable time viewing music videos, reviewing industry album sales, monitoring alternative radio station air play, consulting with sales associates, reviewing customer requests, attending trade shows and reading music and fashion industry periodicals. In addition, the staff regularly visits nightclubs, and attends concerts and other events that attract young people. The Company also conducts periodic customer focus groups and intercept surveys, and consults with and solicits input from its store employees, in order to draw from many different experiences and perspectives. Approximately half of the Company's products are licensed products. Artists typically license their likeness to a "master licensor", the largest of these being divisions of major record companies such as Warner Electra Atlantic Distribution, Universal Music and Video Distribution and Sony Music Distribution. The master licensor often retains the rights to market T-shirts and then may choose to sublicense to manufacturers other categories of merchandise such as posters, stickers, patches and books. Some artists also retain their licensing rights and negotiate directly with licensees. Hot Topic buys its licensed merchandise from master licensors, licensees and directly from artists. The Company currently purchases licensed T-shirts from over 30 companies and other licensed products from over 50 companies. Because of the Company's knowledge of teenage consumers' music preferences and music-influenced fashion, licensors often seek the Company's advice prior to licensing new artists or product designs. As a result, the Company sometimes receives accommodations such as pre-ticketing of orders, early shipments of merchandise, exclusive merchandise and vendors' acceptance of returns. The Company buys its unlicensed, music-influenced merchandise from a variety of manufacturers. The Company actively searches for new vendors that offer unique and timely music-influenced products. As a result, the Company at any given time has many different vendors of different sizes, including some from which it has not previously purchased. Most of the products purchased from the Company's vendors are sold under the labels of the manufacturers, and some are sold under Hot Topic's private labels. In order to reduce fashion risk and maintain the ability to respond quickly to emerging trends, Hot Topic buys a majority of its merchandise not more than 60 days in advance of delivery, and will often begin with small purchases for testing prior to chain-wide distribution. The Company regularly monitors store sales by merchandise classification, SKU, color and size to determine types and amounts of products to purchase, to detect products and trends that are emerging or declining, and to manage the product mix in its stores to respond to the spending patterns of its customers. The Company also works with its vendors to ensure that sources for new and private label products are maintained and expanded. During fiscal 1998, the Company had approximately 800 vendors, certain of which have limited financial resources and production capabilities. No single vendor accounted for more than 5% of the Company's merchandise purchases. The Company believes that its relationships with its vendors are good. ALLOCATION AND DISTRIBUTION OF MERCHANDISE Allocation and distribution of the Company's inventory is addressed at the store, merchandise classification and SKU levels using integrated third party software. Most merchandise is ordered in bulk and then allocated to each store based on inventory plans and SKU performance by using proprietary software developed by Hot Topic. Buyers determine SKU reorder quantities by using a proprietary 8. automated software program which considers sales history, projected sales, planned inventories by store, store demographics, geographic preferences, store openings and planned markdown dates. The Company's Director of Planning and Allocation and nine inventory analysts work closely with the merchandise buyers and store personnel to meet the requirements of individual stores for appropriate merchandise in sufficient quantities. Hot Topic's headquarters and distribution facility, consisting of approximately 45,000 square feet, is located in Pomona, California. All merchandise is delivered by vendors to this facility, where it is inspected, price marked, entered into the Company's allocation software system, picked and boxed for shipment to the Company's stores. Merchandise is shipped to stores each weekday, providing Hot Topic stores with a steady flow of reordered and new merchandise. Minimal back stock is maintained in the Company's distribution facility and at its stores, so that at all times almost all of the Company's merchandise is available for sale on the floors of its stores. To accommodate its planned expansion in fiscal 1999 and beyond, the Company has leased a larger building to expand the capacity of its headquarters office and merchandise distribution facility. Construction of the offices and installation of the distribution equipment commenced in February 1999. The Company presently plans to move from its existing facility into the new facility early in the Summer of 1999. The presently estimated cost of construction, equipment, fixtures and furniture is approximately $4.0 to $4.5 million. The new facility has a projected capacity of approximately 500 stores. STORE OPERATIONS Hot Topic's store operations are currently managed by four regional managers and 30 district or area managers who each supervise approximately eight stores. Individual stores are managed by a store manager and two or three assistant managers. A typical store has approximately two full time and six to ten part time sales associates, depending on the season. The hiring and training of new employees are the responsibility of the store manager and district manager, and the Company has established training and operations procedures to assist them. Additionally, Hot Topic uses a customized, automated telephone screening system licensed from a third party to help evaluate potential new employees, which helps streamline the Company's interview and hiring processes at the store level. The Company strives to create a store environment that teenagers will consider "their place" to shop with friends. Hot Topic seeks to hire sales associates who fit the profile of its target customer -- energetic people who are knowledgeable and passionate about music and music-inspired fashion. To assist management in properly considering the preferences and opinions of its target customers, selected sales associates accompany Hot Topic's buyers on buying trips. Further, in return for feedback on fashion and other trends, sales associates are reimbursed for the cost of attending concerts and clubs, and are encouraged to communicate customer requests and their own merchandise ideas to management. Hot Topic encourages its sales associates to dress and accessorize themselves with the same fashionable merchandise that is sold in its stores. Management believes its music-based culture and its interaction with and respect for sales associates has led to associate turnover rates that the Company believes are lower than the industry average. The primary objective of sales associates is to provide superior, informed customer service in order to maximize sales and minimize inventory shrinkage. Store management is provided with daily store sales and weekly category sales results so that performance can be measured against set goals. Postage-paid "report cards" are provided in all stores for customers to grade performance and make recommendations to Company management. The Company strives to give its teenage customers the same level of respect and attention that is generally given to adult customers at other retail stores. Associates are trained to greet each customer, to inform the customer about new music fashion trends and to suggest merchandise that matches the customer's lifestyle and music preferences. Hot Topic also strives to provide friendly and informed customer service for parents. The Company provides a listing of music artists' national tour dates at each of its stores. The Company believes that its high level of product knowledge and service differentiates Hot Topic from other teenage- focused retailers. 9. Store and district managers are compensated with a base salary and may qualify to receive a quarterly bonus based on sales and inventory shrinkage. Additionally, district and area managers may also qualify to receive periodic stock option grants, and certain employees are eligible to participate in the Company's Employee Stock Purchase Plan. The Company believes that its continued success is dependent in part on its ability to attract, retain and motivate qualified employees. In particular, the success of the Company's expansion program will be dependent on its ability to promote and/or recruit qualified district and store managers. To date, the majority of its store managers have been promoted from within the Company. STORE ENVIRONMENT Hot Topic stores are designed with an industrial warehouse theme that incorporates dense merchandising, and the latest music releases are played on a professional sound system to create a high-energy and fun shopping environment. The Company believes this atmosphere enhances the Company's image as a source for music-inspired fashion while encouraging customers to shop in its stores for longer periods of time. Stores are constructed and fixtured to maximize merchandising flexibility, which enables the Company to highlight new product offerings and create a compelling shopping environment. Bi-monthly planograms are developed to assist store managers in displaying merchandise in an exciting and dynamic manner. In addition, sales associates are encouraged to wear the Company's products, which the Company believes contributes to the overall atmosphere of its stores. MARKETING AND PROMOTION The Company generally locates its stores in high traffic malls located within areas of high teenage population and relies on existing customers, sales associates, store design and exciting music to attract new customers to its stores. Special artist events are run in conjunction with record companies and licensed merchandise companies to promote new bands, music and movie releases. Hot Topic has found these methods to be more effective than traditional media advertising. The Company also maintains a website, (www.hottopic.com) through which it markets its stores and store concept and sells certain of its merchandise. The Company's net sales via the Internet continue to increase significantly, although the total sales are still modest. The company is working to redesign the website which may effect its promotional activities and its Internet sales. MANAGEMENT INFORMATION SYSTEMS Hot Topic's information systems provide integration of store, merchandising, distribution and financial systems. These systems include SKU and classification inventory tracking, purchase order management, open to buy, merchandise distribution, automated ticket making, general ledger, sales audit, accounts payable, fixed asset management, payroll and integrated financials. These systems operate on a Unix platform with a central IBM minicomputer and a PC NT server network. Sales are updated daily in the merchandising reporting systems by polling sales information from each store's point-of-sale ("POS") terminals. The Company's POS system consists of registers providing price look- up, time and attendance, e-mail and credit card and check authorization. Through automated nightly two-way electronic communication with each store, sales information, payroll hours and e-mail messages are uploaded to the host system, and receiving, price changes and system maintenance are downloaded through the POS devices. The Company evaluates information obtained through daily polling to implement merchandising decisions regarding reorders, markdowns and allocation of merchandise. The Company is presently evaluating future long-term management information system needs and the corresponding hardware and software upgrades at its stores and its office and distribution center that may be necessary. The scope and timing of such upgrades as well as the specific hardware and 10. software have not yet been fully identified and evaluated. However, the Company presently estimates that the expenditures for management information system upgrades in fiscal 1999 and fiscal 2000 will be approximately $3 million for both years combined, which is substantially greater than such historical annual expenditures. YEAR 2000 The year 2000 issue exists because many computer applications currently use two- digit date fields to designate a year. As the century date occurs, time- sensitive software may recognize a date using "00" as the year 1900 rather than that have the year 2000. This could result in the computer shutting down or performing incorrect computations, leading to disruptions in normal business processing. The Company's plan to resolve the Year 2000 issue involves the following four phases: assessment, remediation, testing and implementation. During 1998, the Company completed its assessment of all critical systems and developed a plan to bring these systems into compliance. The Company has obtained information from the vendors for its integrated store, merchandising, distribution and financial systems as to required modifications and timing of those modifications to ensure that the systems will be Year 2000 compliant. These efforts began in mid-1998 and are scheduled to be completed in the second and third quarters of fiscal 1999. Early in 1999, the hardware for these systems was tested and as required, replacement hardware and operating systems were installed. The Company's plans call for the testing of the vendor's revised software in first and second quarters of fiscal 1999, and full implementation during the second and third quarters of fiscal 1999. The cost of the Company's Year 2000 problem initiatives is expected to be less than $100,000. The Company does not have systems that interface directly with significant third party vendors and has queried its significant suppliers of merchandise and services that do not share information systems with the Company (external agents). To date, the Company is not aware of any external agent with a Year 2000 issue that would materially impact the Company's results of operations, liquidity or capital resources. However, the Company has no means of ensuring that external agents will be Year 2000 ready. The inability of external agents to complete their year 2000 resolution process in a timely fashion could have a material impact on the Company. The effect of non-compliance by external agents is not determinable. The Company has not yet completed its contingency plan with respect to a worst case scenario in the event of non-compliance by external agents. The Company does not presently believe that an interruption in the supply of merchandise would have a significant adverse impact on its operations since it purchases merchandise from over 800 vendors, none of which historically supplies more than approximately 5% of the Company's annual purchases. However, the Company may increase inventory levels of certain merchandise late in calendar 1999 to offset the risk that certain vendors may be adversely affected by Year 2000 issues. The Company presently uses United Parcel Service ("UPS") to ship merchandise to its stores. The Company has contacted UPS regarding Year 2000 compliance and received written confirmation from UPS that UPS believes it will be fully compliant by December 31, 1999. While the Company believes its planning efforts are adequate to address its Year 2000 concerns, there can be no guarantee that the systems of other companies on which the Company's systems and operations rely will be converted on a timely basis and will not have a material adverse effect on the Company. 11 TRADEMARKS The Company has registered on the Principal Register of the United States Patent and Trademark Office its mark "Hot Topic" and the "Morbid Threads" mark for clothing. Applications have been made for "Morbid Makeup," "Morbid Scents," "Morbid Metals," "Morbid Adornments," and "Rock Wall." Each federal registration is renewable indefinitely if the mark is in use at the time of the renewal. Applications have been made to register "Everything About the Music" in the United States. The Company is not aware of any claims of infringement or other challenges to the Company's right to use its marks in the United States. The Company also has additional registrations and pending applications in foreign jurisdictions. COMPETITION The teenage retail apparel and accessory industry is highly competitive and the Company expects competition in its niche to increase. The Company competes with other retailers for vendors and for teenage and college age customers, suitable retail locations and qualified employees and management personnel. Hot Topic currently competes with street alternative and vintage clothing stores located primarily in metropolitan areas and with other mall-based teenage- focused retailers such as The Buckle, Millers Outpost, Inc., Pacific Sunwear of California, Inc., Spencer Gifts, Inc., Urban Outfitters, Inc., The Wet Seal, Inc., Gadzooks, Inc. and, to a lesser extent, with music stores. Competition from mail order catalogs of apparel and accessories targeting the teen customer has increased in recent years. Many of the Company's competitors are larger and have substantially greater financial, marketing and other resources than the Company. The principal factors of competition in the Company's business are merchandise selection, customer service, store location and price. EMPLOYEES The Company employed approximately 525 full-time and 1,128 part-time employees at April 10, 1999. Of the Company's 1,653 employees, 124 were corporate and distribution center personnel and 1,529 were store employees. The number of part-time employees fluctuates with seasonal needs. None of the Company's employees is covered by a collective bargaining agreement. The Company considers its employee relations to be good. EXECUTIVE OFFICERS The executive officers of the Company and their ages at April 19, 1999 are as follows:
NAME AGE POSITION Orval D. Madden........... 50 President, Chief Executive Officer and Director Jay A. Johnson............ 53 Chief Financial Officer and Assistant Secretary Elizabeth M. McLaughlin... 38 Senior Vice President, General Merchandise Manager Marc R. Bertone........... 42 Vice President, Real Estate and Construction M. Reid Killen ........... 41 Vice President, Information Technology Roger Shively ............ 51 Vice President, Human Resources
12 Orval D. Madden founded Hot Topic in 1988, and has been the Company's President and Chief Executive Officer and a Director since its inception. Prior to founding Hot Topic, Mr. Madden was a Senior Vice President of Federal Department Stores' Children's Place and Accessory Place divisions, and was a Divisional Vice President for Carter-Hawley-Hale Stores' Broadway and Weinstock's Department Store divisions. In 1993, Mr. Madden was recognized as regional California retailing "Entrepreneur Of The Year" in a competition sponsored by Ernst & Young, Merrill Lynch, and Inc. Magazine. Jay A. Johnson has been Chief Financial Officer and Assistant Secretary of the Company since May 1995. From January 1993 to May 1995, he was Vice President/Chief Financial Officer of Frame-n-Lens Optical, Inc., a national optical retailer with approximately 300 stores. From July 1978 to July 1992, Mr. Johnson held senior financial management positions at one manufacturing and two retail companies. Mr. Johnson is a certified public accountant. Elizabeth M. McLaughlin has been the Company's Senior Vice President, General Merchandise Manager, since June 1998. From June 1996 through May 1998, Ms. McLaughlin was the Company's Vice president, General Merchandise Manager and from May 1993 through May 1996, Ms. McLaughlin was the Company's Vice President, Operations. From 1985 to May 1993, she held various positions with Millers Outpost including, Divisional Merchandise Manager. From 1978 to 1985, she held various positions with The Broadway. Marc R. Bertone has been Vice President, Real Estate and Construction, of the Company since August 1994. Mr. Bertone has 15 years of leasing and legal experience, and from November 1988 to August 1994, served as Vice President and General Counsel for The Wet Seal, Inc., a specialty retailer. Mr. Bertone was admitted to the California Bar in June 1982. M. Reid Killen has been Vice President, Information Technology of the Company since July 1998. From June 1994 to July 1998, Mr. Killen was Director of Applications Development at The Gymboree Corporation. From September 1990 to May 1994, Mr. Killen was a Senior Business Analyst at The Gap, Inc. Roger Shively has been Vice President, Human Resources of the Company since July 1998. Mr. Shively served as the Vice President, Human Resources at Panda Management Company from March 1997 to July 1998 and at CKE Restaurants, Inc. from August 1991 to August 1994. CERTAIN RISK FACTORS RELATED TO THE COMPANY'S BUSINESS In addition to risks identified else where in this Annual Report, the Company is subject to other risks, including the following risk factors: Implementation and Management of Aggressive Growth Strategy The Company's net sales and net income have grown significantly during the past several years, primarily as a result of the opening of stores and, to a lesser extent, the introduction of new products and categories. Fifty of the Company's 158 stores opened as of January 30, 1999 had been open for less than one full year. The Company intends to continue to pursue an aggressive growth strategy for the foreseeable future, and its future operating results will depend largely upon its ability to open and operate stores successfully and to manage a larger business profitably. The Company anticipates opening approximately 45 stores during fiscal 1999, which will result in a significant increase in the number of 13 stores operated by the Company. Through fiscal 1994, all of the Company's stores were located in the Western United States. In fiscal 1995, the Company expanded into new markets by opening stores in the Northeastern and Midwestern regions of the United States. The Company plans to continue to enter new markets in various regions of the United States, and approximately one-half of its stores opened in fiscal years 1996, 1997 and 1998 were in new markets. Operation of a greater number of new stores and expansion into new markets may present competitive and merchandising challenges that are different from those currently encountered by the Company in its existing stores and markets. In addition, there can be no assurance that the Company's expansion within its existing markets will not adversely affect the individual financial performance of the Company's existing stores or its overall results of operations or that new stores will achieve sales and profitability levels consistent with existing stores. The Company will need to continually evaluate the adequacy of its store management and management information and distribution systems to manage its planned expansion. There can be no assurance that the Company will anticipate all of the changing demands that its expanding operations will impose on such systems, and the failure to adapt its systems and procedures to such changing demands could have a material adverse effect on the Company's business, results of operations and financial condition. There can be no assurance that the Company will successfully achieve its expansion targets or, if achieved, that planned expansion will result in profitable operations. The Company's ability to open stores and the performance of such stores will depend upon many factors, including, among others, the Company's ability to identify and enter new markets, locate suitable store sites, negotiate acceptable lease terms, hire and train store managers and sales associates and obtain adequate capital resources on acceptable terms. Early in its history, the Company encountered difficulties in leasing certain store sites. The Company believes these difficulties were in part due to the Company's level of capitalization and its limited operating history at such time. The Company also believes these difficulties were in part due to the Company's new, unproven store concept, and apprehension on the part of mall operators concerning the Company's teenage customers. There can be no assurance that the Company will not face resistance from mall operators or others in the future. Any restrictions on the Company's ability to expand or to offer a broad assortment of merchandise could have a material adverse effect on the Company's business, results of operations and financial condition. Fluctuations in Comparable Store Sales Results A variety of factors affect the Company's comparable store sales including, among others, the timing of releases of new music-related products, music and fashion trends, the general retail sales environment, the Company's ability to efficiently source and distribute products, changes in the Company's merchandise mix and the Company's ability to execute its business strategy efficiently. The Company's comparable store sales results have fluctuated significantly in the past and the Company believes that such fluctuations may continue. The Company's comparable store sales results for fiscal 1994, 1995, 1996, 1997 and 1998 were 20.3%, (0.9%), 8.9%, 2.2% and 0.4%, respectively. The Company's comparable store sales results were 5.7%, 0.7%, 0.6% and 2.7% for the first, second, third and fourth quarters, respectively, of fiscal 1997 and (0.6%), 2.0%, 9.5% and (5.9%) for the first, second, third and fourth quarters, respectively, of fiscal 1998. Past comparable store sales results are no indication of future results, and there can be no assurance that the Company's comparable store sales results will not decrease in the future. The Company's comparable store sales results could cause the price of the Common Stock to fluctuate substantially. Dependence on and Changes in Music and Fashion Trends The Company's profitability is largely dependent upon (i) the continued popularity of alternative and rock music and music videos among teenagers and college age adults, (ii) the emergence of new artists and the success of music releases and music-related products, (iii) the continuance of a significant level of teenage spending on music-licensed and music-influenced products, and (iv) the Company's ability to anticipate and keep pace with the music, fashion and merchandise preferences of its customers. 14 The popularity of particular types of music, artists, styles and brands is subject to change. The Company's failure to anticipate, identify or react appropriately to changing trends, as well as the making of music or fashion misjudgments, could lead to, among other things, excess inventories and higher markdowns, which could have a material adverse effect on the Company's business, results of operations and financial condition, and on its image with its customers. Impact of Economic Conditions; Minimum Wage Rates Certain economic conditions affect the level of consumer spending on merchandise offered by the Company, including, among others, business conditions, interest rates, taxation and consumer confidence in future economic conditions. The Company is also dependent upon the continued popularity of malls as a shopping destination and the ability of mall anchor tenants and other attractions to generate customer traffic for its stores. A decrease in mall traffic would adversely affect the Company's growth, net sales, comparable store sales results and profitability. In addition, a significant number of the Company's stores are concentrated in the Western United States, and as a result a deterioration in economic conditions in that region could particularly affect the Company's business, results of operations and financial condition. Changes to federal minimum wage laws in each of 1996 and 1997 raised the mandatory minimum wage. California and other states have also enacted increases in State required minimum wages that are higher than the Federal requirements. Statutory increases in federal and state minimum wages could adversely affect the Company's profitability. The recent federal and state increase and any other such increases will raise minimum wages above current wage rates of certain of the Company's employees, and competitive factors could require corresponding increases in higher employee wage rates, any of which would increase the Company's expenses and adversely affect results of operations. Quarterly Results and Seasonality The Company's quarterly results of operations have and are expected to continue to fluctuate materially depending on, among other things, the timing of store openings and related pre-opening and other startup expenses, net sales contributed by new stores, increases or decreases in comparable store sales, releases of new music and music-related products, shifts in timing of certain holidays, changes in the Company's merchandise mix and overall economic conditions. The Company's business is also subject to seasonal influences, with heavier concentrations of sales during the Christmas holiday, the back-to-school season and other periods when school is not in session. As is the case with many retailers of apparel, accessories and related merchandise, the Company typically experiences lower net sales and operating losses during the first fiscal quarter. The Company has experienced quarterly losses in the past and may experience such losses in the future. Because of these fluctuations in net sales and net income (loss), the results of operations of any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year or any future quarter. Dependence on Key Vendors The Company's performance depends on its ability to purchase current music- related merchandise in sufficient quantities at competitive prices. The Company has many sources of merchandise, with the largest vendor supplying approximately 5% of the Company's merchandise purchases in fiscal 1998. Substantially all of the Company's music-licensed products are available only from vendors that have exclusive license rights. In addition, many of the Company's music-influenced products are acquired from small, specialized vendors that create unique products primarily for the Company. The Company's smaller vendors generally have limited resources, production capacities and operating histories, and some of the Company's vendors have limited the distribution of their merchandise in the past. The Company has no long-term purchase contracts or other contractual assurances of continued supply, pricing or access to new products. There can be no assurance that the 15 Company will be able to acquire desired merchandise in sufficient quantities on terms acceptable to the Company in the future; or that any inability to acquire suitable merchandise, or the loss of one or more key vendors, will not have a material adverse effect on the Company's business, results of operations and financial condition. Dependence on Key Personnel The Company's performance depends largely on the efforts and abilities of senior management, particularly Orval Madden, the Company's President, Chief Executive Officer and founder. The loss of Mr. Madden's services or the services of other members of the management team could have a material adverse effect on the Company's business, results of operations and financial condition. The Company has a $500,000 key-man life insurance policy on Mr. Madden. There can be no assurance that Mr. Madden and the Company's existing management team will be able to manage the Company or its growth or that the Company will be able to attract and retain additional qualified personnel as needed in the future. Uncertainties Regarding Distribution of Merchandise To accommodate its planned expansion in fiscal 1999 and beyond, the Company has leased a larger building to expand the capacity of its headquarters office and merchandise distribution facility. Construction of the offices and installation of the distribution equipment commenced in February 1999. The Company presently plans to move from its existing facility into the new facility early in the summer of 1999. The presently estimated cost of construction, equipment, fixtures and furniture is approximately $4.0 to $4.5 million. The new facility has a projected capacity of approximately 500 stores. The Company anticipates that in fiscal 1999 the new headquarters office and distribution facility will negatively impact the results of operations, as the Company will be unable to leverage the higher occupancy costs for the larger facility. Although the Company believes that it has carefully has planned the move, there can be no assurance that the move to the new facility will not cause disruptions that could materially adversely affect the Company's business, results of operations and financial condition. Further, the Company relies upon the United Parcel Service and Fedex for its product shipments, including shipments to and from all of its stores, and accordingly is subject to the risks, including employee strikes and inclement weather, associated with United Parcel Service's and Fedex's ability to provide delivery services to meet the Company's shipping needs. The Company is also dependent upon temporary employees to adequately staff its distribution facility, particularly during busy periods, such as during the Christmas season and while multiple stores are opening. There can be no assurance that the Company will continue to receive adequate assistance from its temporary employees, or that there will continue to be sufficient sources of temporary employees. Failure to Authenticate Licensing Rights The Company purchases licensed merchandise from a number of suppliers who hold manufacturing and distribution rights under the terms of certain licenses. The Company generally relies upon vendors' representations concerning manufacturing and distribution rights and does not independently verify whether these vendors legally hold adequate rights to licensed properties they are manufacturing or distributing. If the Company acquires unlicensed merchandise, it could be obligated to remove such merchandise from its stores, incur costs associated with destruction of merchandise if the distributor is unwilling or unable to reimburse the Company, and be subject to liability under various civil and criminal causes of action, including actions to recover unpaid royalties and other damages. Any of these results could have a material adverse effect on the Company's business, results of operations and financial condition. 16 Competition The retail apparel and accessory industry is highly competitive. The Company competes with other retailers for vendors and for teenage and college age customers, suitable retail locations and qualified employees and management personnel. Hot Topic currently competes with street alternative stores located primarily in metropolitan areas and with other mall-based teenage-focused retailers such as The Buckle, Millers Outpost, Inc., Pacific Sunwear of California, Inc., Spencer Gifts, Inc., Urban Outfitters, Inc., The Wet Seal, Inc., Gadzooks, Inc., and, to a lesser extent, with music stores. Competition from mail order catalogs of apparel and accessories targeting the teen customer has increased in recent years. Many of the Company's competitors are larger and have substantially greater financial, marketing and other resources than the Company. Direct competition with these and other retailers may increase significantly in the future, which could require the Company, among other things, to lower its prices and/or take other measures. Increased competition could have a material adverse effect on the Company's business, results of operations and financial condition. Price Volatility The Common Stock is quoted on the Nasdaq National Market, which has experienced and is likely to experience in the future significant price and volume fluctuations which could adversely affect the market price of the Common Stock without regard to the operating performance of the Company. In addition, the Company believes that factors such as quarterly fluctuations in the financial results of the Company, fluctuations in the Company's comparable store sales, announcements by other apparel, accessory and gift item retailers, the trading volume of the Company's Common Stock in the public market, the condition of the overall economy and the condition of the financial markets could cause the price of the Common Stock to fluctuate substantially. Anti-takeover Matters The Company's Amended and Restated Articles of Incorporation and Bylaws contain provisions that may have the effect of delaying, deterring or preventing a takeover of the Company that shareholders may consider to be in their best interests. For instance, the Company's Amended and Restated Articles of Incorporation and Bylaws prohibit shareholder action by written consent and include certain "fair price provisions." Additionally, the Board of Directors has the authority to issue up to 10,000,000 shares of "blank check" preferred stock having such rights, preferences and privileges as designated by the Board of Directors without shareholder approval. Influence of Existing Shareholders As of March 1, 1999, the Company's executive officers, directors and their affiliates beneficially owned approximately 26% of the Company's outstanding shares of Common Stock. As a result, these shareholders, if acting together, would be able to influence matters requiring approval by the shareholders of the Company, including the election of a majority of the directors. The voting power of these shareholders under certain circumstances could have the effect of delaying or preventing a change in control of the Company. The Company has entered into agreements with its executive officers and directors indemnifying them against losses they may incur in legal proceedings arising from their service to the Company. ITEM 2. PROPERTIES All of the Company's existing store locations are leased by the Company, with lease terms expiring between 2001 and 2009. The leases for most of the existing stores are for terms of ten years and provide for contingent rent based upon a percent of sales in excess of specified minimums. Leases for future stores will likely include similar contingent rent provisions. 17 The Company's present headquarters office and distribution center are located in Pomona, California, and are occupied under the terms of a lease covering approximately 45,000 square feet. The lease is scheduled to expire in September 1999. To accommodate its planned expansion in fiscal 1999 and beyond, the Company has leased a 125,000 square foot building to expand the capacity of its headquarters office and merchandise distribution facility. The lease is for a five year term with two options to extend the lease, each for a three year period. Construction of the offices and installation of the distribution equipment commenced in February 1999. The Company presently plans to move from its existing facility into the new facility early in the summer of 1999. The presently estimated cost of construction, equipment, fixtures and furniture is approximately $4.0 to $4.5 million. The new facility has a projected capacity of approximately 500 stores. The annual base rent for the initial five year term is approximately $525,000. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS The Common Stock of the Company is traded on the Nasdaq National Market under the symbol "HOTT". The Company consummated its initial public offering in September 1996 at a price of $18.00 per share. The following table sets forth, for the periods indicated, the high and low "sales" prices of the shares of Common Stock of the Company, as reported on the Nasdaq National Market. Such quotations represent inter-dealer prices without retail markup, markdown or commission and may not necessarily represent actual transactions.
1998 HIGH LOW --------- -------- First Quarter $29 3/4 $22 5/8 Second Quarter $28 7/8 $20 Third Quarter $23 $12 Fourth Quarter 25 1/8 $11 5/16 1997 HIGH LOW --------- --------- First Quarter $29 3/4 $17 1/2 Second Quarter $30 3/4 $15 1/2 Third Quarter $22 1/2 $15 1/8 Fourth Quarter $26 1/8 $16 3/16
On April 1, 1999, the last sales price of the Common Stock as reported on the Nasdaq National Market was $18.75 per share. As of April 1, 1999, there were approximately 250 holders of record of the Company's Common Stock. This number does not reflect the number of beneficial holders of the Company's Common Stock, which the Company believes to be in excess of 800 holders. 18 The Company has not paid any cash dividends since inception and does not anticipate paying any cash dividends in the foreseeable future. 19 ITEM 6. SELECTED FINANCIAL DATA The following selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Financial Statements and Notes thereto included elsewhere in this Annual Report on Form 10-K. HOT TOPIC, INC. AND SUBSIDIARIES SELECTED FINANCIAL DATA:
FISCAL YEAR ---------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------ -------------- --------------- -------------- ------------- (In thousands, except per share data, number of stores, comparable store sales and sales per square foot) STATEMENT OF OPERATIONS DATA: Net sales $103,371 $70,532 $43,618 $23,632 $14,002 Cost of goods sold, including buying, distribution and occupancy costs 65,855 44,417 27,049 15,067 9,059 -------- ------- ------- ------- ------- Gross margin 37,516 26,115 16,569 8,565 4,943 Selling, general and administrative expenses 29,077 19,862 12,846 7,981 4,527 -------- ------- ------- ------- ------- Operating income 8,439 6,253 3,723 584 416 Interest income, net 931 901 382 143 79 -------- ------- ------- ------- ------- Income before income taxes 9,370 7,154 4,105 727 495 Income taxes 3,367 2,611 1,535 291 203 -------- ------- ------- ------- ------- Net income $ 6,003 $ 4,543 $ 2,570 $ 436 $ 292 Net income per share: Basic $1.25 $0.97 $0.71 $0.14 $0.11 Diluted $1.21 $0.92 $0.66 $0.14 $0.11 Weighted average shares outstanding Basic 4,817 4,690 3,628 3,082 2,744 Diluted 4,956 4,940 3,899 3,135 2,759 SELECTED OPERATING DATA: Number of stores at year end 158 108 68 42 24 Comparable stores sales increase (decrease) 0.4% 2.2% 8.9% (0.9%) 20.3% Average sales per square foot $ 542 $ 565 $ 578 $ 572 $ 571 Average sales per store (000s) $ 772 $ 769 $ 748 $ 705 $ 692 BALANCE SHEET DATA: Working capital $ 28,432 $29,230 $29,247 $ 5,857 $ 4,087 Total assets 58,764 51,953 44,033 14,959 9,119 Long-term obligations, including current potion 120 161 48 34 24 Redeemable preferred stock - - - 11,245 6,583 Shareholders' equity $ 48,749 $44,736 $39,069 $ 785 $ 1,004
20. HOT TOPIC ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Hot Topic is a mall-based specialty retailer of music-licensed and music- influenced apparel, accessories and gift items for young men and women principally between the ages of 12 and 22. The Company opened its first store in 1989, and operated 158 stores in 38 states across the United States as of January 30, 1999. The Company opened 18 stores during fiscal 1995, including its first 12 stores in the Midwest and Northeast; 26 stores during fiscal 1996, most of which are in new markets in the Midwest and Northeast adjacent to markets entered in fiscal 1995; 40 stores during fiscal 1997, both in existing markets and in 12 additional states; and 50 stores during fiscal 1998, both in existing markets and in 6 additional states. The Company operates on a 52 or 53 week fiscal year which ends on the Saturday nearest to January 31. Fiscal 1996, 1997 and 1998 were 52-week years. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain selected statement of operations data expressed as a percentage of net sales and certain store data:
FISCAL YEAR ------------------------------------------- 1998 1997 1996 ----------- ---------- ----------- Net sales 100.0% 100.0% 100.0% Cost of goods sold, including buying, distribution & occupancy costs 63.7% 63.0% 62.0% ------------ ----------- ----------- Gross margin 36.3% 37.0% 38.0% Selling, general and administrative expenses 28.1% 28.2% 29.5% ------------ ----------- ----------- Operating income 8.2% 8.8% 8.5% Interest income, net 0.9% 1.3% 0.9% ------------ ----------- ----------- Income before income tax 9.1% 10.1% 9.4% Provision for income taxes 3.3% 3.7% 3.5% ------------ ----------- ----------- Net income 5.8% 6.4% 5.9% ============ =========== =========== Number of stores at year end 158 108 68 ============ =========== =========== Comparable store sales increase 0.4% 2.2% 8.9% ============ =========== ===========
FISCAL 1998 COMPARED TO FISCAL 1997 Net sales increased approximately $32.9 million, or 46.6%, to $103.4 million in fiscal 1998 from $70.5 million in fiscal 1997. Net sales for the 50 stores opened during fiscal 1998 and for those stores not yet qualifying as comparable stores contributed $32.7 million of the net sales increase. Comparable store sales increased 0.4% in fiscal 1998 and contributed $200,000 of the increase in net sales. Apparel and T-shirts increased to 48% of net sales in fiscal 1998 from 47% of net sales in fiscal 1997. 21. HOT TOPIC Gross margin increased approximately $11.4 million to $37.5 million in fiscal 1998 from $26.1 million in fiscal 1997. As a percentage of net sales, gross margin decreased to 36.3% in fiscal 1998 from 37.0% in fiscal 1997, principally due to higher occupancy and distribution expenses, as a percentage of sales. Selling, general and administrative expenses increased approximately $9.2 million to $29.1 million during fiscal 1998 from $19.9 million during fiscal 1997, but decreased slightly as a percentage of net sales to 28.1% in fiscal 1998 from 28.2% in fiscal 1997. The decrease as a percentage of net sales was primarily due to a reduction of corporate overhead expense as a percentage of net sales due to the operating leverage achieved through the Company's larger store base offset in part by an increase in store payroll expense and store operating expenses. Operating income increased approximately $2.2 million to $8.4 million during fiscal 1998 from $6.2 million during fiscal 1997. As a percentage of net sales, operating income decreased to 8.2% in fiscal 1998 from 8.8% in fiscal 1997, principally from the lower gross margin. Interest income, net, increased slightly to $931,000 during fiscal 1998 from $901,000 during fiscal 1997. The Company's effective tax rate was 35.9% in fiscal 1998 and 36.5% in fiscal 1997. The variance from an expected rate of approximately 40% in both fiscal 1998 and 1997 is a result of a significant portion of each fiscal year's interest income being non-taxable. FISCAL 1997 COMPARED TO FISCAL 1996 Net sales increased approximately $26.9 million, or 61.7%, to $70.5 million in fiscal 1997 from $43.6 million in fiscal 1996. Net sales for the 40 stores opened during fiscal 1997 and for those stores not yet qualifying as comparable stores contributed $26.1 million of the net sales increase. Comparable store sales increased 2.2% in fiscal 1997 and contributed $800,000 of the increase in net sales. The increase in net sales in fiscal 1997 was principally attributable to increased apparel and T-shirt sales. Apparel and T-shirts increased to 47% of net sales in fiscal 1997 from 43% of net sales in fiscal 1996. Gross margin increased approximately $9.5 million to $26.1 million in fiscal 1997 from $16.6 million in fiscal 1996. As a percentage of net sales, gross margin decreased to 37.0% in fiscal 1997 from 38.0% in fiscal 1996, principally due to lower margin on the merchandise sold resulting from a shift in the Company's product mix toward apparel categories. Selling, general and administrative expenses increased approximately $7.0 million to $19.9 million during fiscal 1997 from $12.8 million during fiscal 1996, but decreased as a percentage of net sales to 28.2% in fiscal 1997 from 29.5% in fiscal 1996. The decrease as a percentage of net sales was primarily due to a reduction of corporate overhead expense as a percentage of net sales due to the operating leverage achieved through the Company's larger store base offset in part by an increase in store payroll expense. The increase as a percentage of net sales in store payroll expense was principally attributable to increases in Federal and State minimum wage rates. Operating income increased approximately $2.5 million to $6.2 million during fiscal 1997 from $3.7 during fiscal 1996. As a percentage of net sales, operating income increased to 8.8% in fiscal 1997 from 8.5% in fiscal 1996, principally from the leveraging of selling, general and administrative expenses. Interest income, net, increased approximately $519,000 to $901,000 during fiscal 1997 from $382,000 during fiscal 1996, principally due to higher average cash balances in fiscal 1997. 22. HOT TOPIC The Company's effective tax rate was 36.5% in fiscal 1997 and 37.4% in fiscal 1996. The variance from an expected rate of approximately 40% in both fiscal 1997 and 1996 is a result of a significant portion of each fiscal year's interest income being non-taxable. QUARTERLY RESULTS AND SEASONALITY The Company's quarterly results of operations may fluctuate materially depending on, among other things, the timing of store openings and related pre- opening and other startup expenses, net sales contributed by new stores, increases or decreases in comparable store sales, releases of new music and music-related products, shifts in timing of certain holidays, changes in the Company's merchandise mix and overall economic conditions. The Company's business is also subject to seasonal influences, with heavier concentrations of sales during the Christmas holiday, back-to-school season, and other periods when schools are not in session. The Christmas holiday season remains the Company's single most important selling season. The Company believes, however, that the importance of the summer vacation and back-to-school seasons (which affect operating results in the second and third quarters, respectively) and, to a lesser extent, the spring break season (which affects operating results in the first quarter), reduces somewhat the Company's dependence on the Christmas holiday selling season. Furthermore, summer vacation, spring break and the back-to-school season take place at somewhat different times in different parts of the country, spreading the impact of these events on the Company's sales over a longer period. As is the case with many retailers of apparel, accessories and related merchandise, the Company typically experiences lower net sales and operating losses during the first fiscal quarter. The Company has experienced quarterly losses in the past and may experience such losses in the future. The following table sets forth certain statement of operations and operating data for each of the Company's last eight fiscal quarters. The quarterly statement of operations data and selected operating data set forth below were derived from unaudited financial statements of the Company, which in the opinion of management of the Company contain all adjustments (consisting only of normal recurring adjustments) necessary for fair presentation thereof. Results in any quarter are not necessarily indicative of results that may be achieved for a full year. 23. HOT TOPIC
FISCAL YEAR 1997 FISCAL YEAR 1998 -------------------------------------- ---------------------------------------- FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH -------- -------- -------- -------- --------- -------- -------- --------- (In thousands, except selected operating and per share data) STATEMENT OF OPERATIONS DATA: Net sales $11,188 $13,683 $18,753 $26,908 $17,314 $20,787 $28,708 $36,561 Gross margin 3,762 4,619 6,724 11,010 5,722 6,776 10,642 14,376 Operating income (loss) (413) 117 1,600 4,949 (179) 318 2,587 5,713 Net income (loss) (110) 204 1,120 3,329 45 334 1,758 3,866 Net income (loss) per share: Basic ($0.02) $ 0.04 $ 0.24 $ 0.70 $ 0.01 $ 0.07 $ 0.36 $ 0.80 Diluted ($0.02) $ 0.04 $ 0.23 $ 0.67 $ 0.01 $ 0.07 $ 0.36 $ 0.79 Weighted average shares outstanding: Basic 4,607 4,683 4,723 4,749 4,778 4,811 4,831 4,848 Diluted 4,928 4,948 4,928 4,956 4,979 4,984 4,944 4,916 SELECTED OPERATING DATA: Comparable store sales increase 5.7% 0.7% 0.6% 2.7% (0.6%) 2.0% 9.5% (5.9%) Stores open at end of period 81 94 104 108 123 133 145 158
LIQUIDITY AND CAPITAL RESOURCES During the last three fiscal years, the Company's primary uses of cash have been to finance store openings and purchase merchandise inventories. The Company has satisfied its cash requirements principally from cash flows from operations. In fiscal 1996, the Company received additional capital from proceeds from its initial public offering of Common stock in September 1996. The Company completed its initial public offering of 1,495,000 shares in September 1996, and received net proceeds of approximately $24.3 million. The proceeds were used for general corporate purposes and to increase working capital. Cash flows provided by operating activities were $9.3 million, $7.2 million, and $4.1 million in fiscal 1998, 1997 and 1996, respectively. The increases in cash flows from operating activities in each of the fiscal years was primarily attributable to increases in the company's net income. Cash flows used in investing activities were $9.3 million, $8.9 million and $5.9 million in fiscal 1998, 1997 and 1996, respectively. Cash flows used in investing activities relate primarily to store openings and, in 1997, approximately $750,000 was used to expanded the capacity and increased the efficiency of the Company's distribution facility. The Company opened 50, 40 and 26 stores in fiscal 1998, 1997 and 1996, respectively. Cash flows provided by financing activities were ($2.1) million, $1.1 million and $24.4 million in fiscal 1998, 1997 and 1996, respectively. In January 1999, the company used $3.0 million to repurchase 220,000 shares of its Common Stock. In March 1999, the Company's Board of Directors approved an additional repurchase of up to an aggregate of 250,000 shares of its Common Stock. In June 1996, the Company received net proceeds of $72,000 from the exercise of warrants and in September 1996, the Company received $24.3 million from its initial public offering. The Company anticipates that it will spend approximately $8.5 to $9.5 million to open approximately 45 stores in fiscal 1999. During fiscal 1998, the Company's average capital expenditures to open a store, including leasehold improvements and furniture and fixtures, totaled approximately 24. $170,000. The average initial gross inventory for the new 1998 stores was approximately $65,000 (which was partially financed by trade credit) and pre- opening costs averaged approximately $19,000 for these stores. The Company expects the average total costs associated with opening a store will be approximately the same in fiscal 1999. Pre-opening costs are expensed in the period in which the store opens. The actual costs that the Company will incur in connection with opening future stores cannot be predicted with precision because such costs will vary based upon, among other things, geographic location, the size of the stores and the extent of the build-out required at the selected sites. Initial inventory requirements vary at new stores depending on the season and current merchandise trends. To accommodate its planned expansion in fiscal 1999 and beyond, the Company has leased a larger building to expand the capacity of its headquarters office and merchandise distribution facility. Construction of the offices and installation of the distribution equipment commenced in February 1999. The Company presently plans to move from its existing facility into the new facility early in the summer of 1999. Presently, the estimated cost of construction, equipment, fixtures and furniture is approximately $4.0 to $4.5 million. The new facility has a projected capacity of approximately 500 stores. The Company is presently evaluating future long-term management information system needs and the corresponding hardware and software upgrades at its stores and its office and distribution center that may be necessary. The scope and timing of such upgrades as well as the specific hardware and software have not yet been fully identified and evaluated. However, the Company presently estimates that the expenditures for management information system upgrades in fiscal 1999 and fiscal 2000 will be approximately $3 million for both years combined, which is substantially greater than such historical annual expenditures. The Company believes that its existing cash balances and cash generated from operations will be sufficient to fund its operations and planned expansion through the next 12 months. INFLATION The Company does not believe that inflation has had a material adverse effect on net sales or results of operations. The Company has generally been able to pass on increased costs related to inflation through increases in selling prices. YEAR 2000 COMPLIANCE The year 2000 issue exists because many computer applications currently use two-digit date fields to designate a year. As the century date occurs, time- sensitive software may recognize a date using "00" as the year 1900 rather than that have the year 2000. This could result in the computer shutting down or performing incorrect computations, leading to disruptions in normal business processing. The Company's plan to resolve the Year 2000 issue involves the following four phases: assessment, remediation, testing and implementation. During 1998, the Company completed its assessment of all critical systems and developed a plan to bring these systems into compliance. The Company has obtained information from the vendors for its integrated store, merchandising, distribution and financial systems as to required modifications and timing of those modifications to ensure that the systems will be Year 2000 compliant. These efforts began in mid-1998 and are scheduled to be completed in the second and third quarters of fiscal 1999. Early in 1999, the hardware for these systems was tested and as required, replacement hardware and operating systems were installed. The Company's plans call for the testing of the vendor's revised software in first and second quarters of fiscal 1999, and full implementation during the second and third quarters of fiscal 1999. The cost of the Company's Year 2000 problem initiatives is expected to be less than $100,000. 25. The Company does not have systems that interface directly with significant third party vendors and has queried its significant suppliers of merchandise and services that do not share information systems with the Company (external agents). To date, the Company is not aware of any external agent with a Year 2000 issue that would materially impact the Company's results of operations, liquidity or capital resources. However, the Company has no means of ensuring that external agents will be Year 2000 ready. The inability of external agents to complete their year 2000 resolution process in a timely fashion could have a material impact on the Company. The effect of non-compliance by external agents is not determinable. The Company has not yet completed its contingency plan with respect to a worst case scenario in the event of non-compliance by external agents. The Company does not presently believe that an interruption in the supply of merchandise would have a significant adverse impact on its operations since it purchases merchandise from over 600 vendors, none of which historically supplies more than approximately 5% of the Company's annual purchases. However, the Company may increase inventory levels of certain merchandise late in calendar 1999 to offset the risk that certain vendors may be adversely affected by Year 2000 issues. The Company presently uses United Parcel Service ("UPS") to ship merchandise to its stores. The Company has contacted UPS regarding Year 2000 compliance and received written confirmation from UPS that UPS believes it will be fully compliant by December 31, 1999. While the Company believes its planning efforts are adequate to address its Year 2000 concerns, there can be no guarantee that the systems of other companies on which the Company's systems and operations rely will be converted on a timely basis and will not have a material adverse effect on the Company. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's market risks disclosure pursuant to Item 7A are not material and are therefore not required. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA The Financial Statements of the Company listed in Item 14(a) are included herein on pages F-1 through F-14 and are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. Part III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT See the section entitled "Executive Officers" in Part I, Item 1 hereof for information regarding executive officers. The information required by this item with respect to directors is incorporated by reference from the information under the caption "Election of Directors," contained in the Company's Definitive Proxy Statement which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A in connection with the solicitation of proxies for the Company's Annual Meeting of Shareholders to be held on June 1, 1999 (the "Proxy Statement"). 26. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference to the information appearing under the caption "Executive Compensation" in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference to the information appearing under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference to the information appearing under the caption "Certain Transactions" in the Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K (a)(1) Index to Consolidated Financial Statements The financial statements required by this item are submitted in a separate section beginning on page F-1 of this Annual Report on Form 10-K.
PAGE Report of Ernst & Young LLP, Independent Auditors..................................... F-1 --- Consolidated Balance Sheets as of January 30, 1999 and January 31, 1998............... F-2 --- Consolidated Statements of Operations for the years ended January 30, 1999, January 31, 1998 and February 1, 1997........................................................ F-3 --- Consolidated Statements of Shareholders' Equity for the years ended January 30, 1999, January 31, 1998 and February 1, 1997................................................ F-4 --- Consolidated Statements of Cash Flows for the years ended January 30, 1999, January 31, 1998 and February 1, 1997........................................................ F-5 --- Notes to Consolidated Financial Statements............................................ F-6 ---
(a)(2) Index to Financial Statement Schedules All schedules are omitted because they are not required, are not applicable, or the information is included in the Financial statements or notes thereto. (a)(3) Index to Exhibits See Index to Exhibits beginning on page 30. The following management compensatory plans and arrangements are required to be filed as exhibits to this Report on Form 10-K pursuant to Item 14(c): 27.
EXHIBIT Number DESCRIPTION OF DOCUMENT ------ ----------------------- 10.2 1996 Equity Incentive Plan (the "1996 Plan"). (1) 10.3 Form of Nonstatutory Stock Option Agreement of Registrant pursuant to the 1996 Plan. (1) 10.4 Form of Incentive Stock Option Agreement of Registrant pursuant to the 1996 Plan. (1) 10.5 Non-Employee Directors' Stock Option Plan. (1) 10.6 Employee Stock Purchase Plan. (1) 10.11 Letter Agreement regarding Employment Terms, dated August 9, 1994, entered into between Registrant and Elizabeth M. McLaughlin. (1) 10.15 401(k) Defined Contribution Plan of Registrant, effective as of August 1, 1995. (1)
____________ (1) Filed as an exhibit to Registrant's Registration Statement on Form SB-2 (No. 333-5054-LA) and incorporated herein by reference. (b) Reports on Form 8-K Not applicable. (c) Exhibits The exhibits required by this Item are listed under Item 14(a)(3) (d) Financial Statement Schedules The financial statement schedules required by this Item are listed under Item 14(a)(2). 28. SIGNATURE Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Pomona, County of Los Angeles, State of California, on the 22nd day of April, 1999. HOT TOPIC, INC. By: /s/ Orval D. Madden --------------------- Orval D. Madden President, Chief Executive Officer and Director POWER OF ATTORNEY Know all Men by These Presents, that each person whose signature appears below constitutes and appoints Orval D. Madden and Jay A. Johnson, or either of them, his attorney-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
NAME POSITION DATE - -------------------------------------------------- -------------------------------------- -------------------- /s/ ROBERT M. JAFFE Chairman of the Board April 22, 1999 - ---------------------------------------------------- Robert M. Jaffe /s/ ORVAL D. MADDEN President, Chief Executive Officer April 22, 1999 - ---------------------------------------------------- Orval D. Madden and Director (Principal Executive Officer) /s/ JAY A. JOHNSON Chief Financial Officer and Assistant April 22, 1999 - ---------------------------------------------------- Jay A. Johnson Secretary (Principal Financial and Accounting Officer) /s/ EDGAR F. BERNER Director April 22, 1999 - ---------------------------------------------------- Edgar F. Berner /s/ STANLEY E. FOSTER Director April 22, 1999 - ---------------------------------------------------- Stanley E. Foster /s/ CECE SMITH Director April 22, 1999 - ---------------------------------------------------- Cece Smith /s/ CORRADO FEDERICO Director April 22, 1999 - ---------------------------------------------------- Corrado Federico /s/ ANDREW SCHUON Director April 22, 1999 - ---------------------------------------------------- Andrew Schuon /s/ BRUCE A. QUINNELL Director April 22, 1999 - ---------------------------------------------------- Bruce A. Quinnell
29. EXHIBIT INDEX 3.1 Form of Amended and Restated Articles of Incorporation of Registrant. (1) 3.2 Form of amended and restated Bylaws, Registrant. (1) 4.1 Reference is made to Exhibits 3.1 and 3.2. 4.2 Specimen stock certificate. (1) 10.1 Form of Indemnity Agreement to be entered into between Registrant and its directors and officers. (1) 10.2 1996 Equity Incentive Plan (the "1996 Plan"). (1) 10.3 Form of Nonstatutory Stock Option Agreement of Registrant pursuant to the 1996 Plan. (1) 10.4 Form of Incentive Stock Option Agreement of Registrant pursuant to the 1996 Plan. (1) 10.5 Non-Employee Directors' Stock Option Plan. (1) 10.6 Employee Stock Purchase Plan. (1) 10.11 Letter Agreement regarding Employment Terms, dated August 9, 1994, entered into between Registrant and Elizabeth M. McLaughlin. (1) 10.14 Industrial Real Estate Lease (Single Tenant Facility), dated June 30, 1994, entered
30. into between Registrant and New England Mutual Life Insurance Company. (1) 10.15 401(k) Defined Contribution Plan of Registrant, effective as of August 1, 1995. (1) 10.18 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. 10.19 Guaranty of Lease, dated December 10, 1998, entered into between the Registrant and Majestic Realty Co. and Patrician Associates, Inc. 23.1 Consent of Ernst & Young LLP, Independent Auditors. 24.1 Power of Attorney. Reference is made to page 30. 27.1 Financial Data Schedule.
____________ (1) Filed as an exhibit to Registrant's Registration Statement on Form SB-2 (No. 333-5054-LA) and incorporated herein by reference. 31. Report of Independent Auditors The Board of Directors and Shareholders Hot Topic, Inc. We have audited the accompanying consolidated balance sheets of Hot Topic, Inc. as of January 30, 1999 and January 31, 1998, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended January 30, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hot Topic, Inc. and subsidiaries at January 30, 1999 and January 31, 1998, and the results of its consolidated operations and its consolidated cash flows for each of the three years in the period ended January 30, 1999 in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP --------------------- Los Angeles, California March 12, 1999 F-1 Hot Topic, Inc. and Subsidiaries Consolidated Balance Sheets
JANUARY 30, JANUARY 31, 1999 1998 --------------------------------- ASSETS Current assets: Cash and cash equivalents $24,573,874 $26,579,027 Inventory 10,446,626 7,636,596 Prepaid expenses and other 1,440,286 657,749 Deferred tax asset (Note 6) 321,825 338,679 ----------------------------------- Total current assets 36,782,611 35,212,051 Leaseholds, fixtures and equipment, net (Note 2) 21,895,132 16,700,270 Deposits and other 86,922 40,525 ----------------------------------- Total assets $58,764,665 $51,952,846 =================================== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 2,186,462 $ 1,705,659 Accrued payroll and related expenses 4,035,805 2,626,655 Accrued sales and other taxes payable 382,742 263,859 Federal and state income taxes payable 1,715,559 1,351,956 Current portion of obligations under capital leases 29,629 34,407 ----------------------------------- Total current liabilities 8,350,197 5,982,536 Deferred rent (Note 3) 743,711 508,822 Capital lease obligations, less current portion (Note 3) 89,908 126,759 Deferred tax liability (Note 6) 831,703 599,158 Shareholders' equity (Note 4): Common shares, no par value; 50,000,000 shares authorized; 4,654,431 and 4,759,606 shares issued and outstanding at January 30, 1999 and January 31, 1998, respectively 35,675,752 37,700,992 Deferred compensation (42,619) (78,511) Retained earnings 13,116,013 7,113,090 ----------------------------------- Total shareholders' equity 48,749,146 44,735,571 ----------------------------------- Total liabilities and shareholders' equity $58,764,665 $51,952,846 ===================================
See accompanying notes. F-2 Hot Topic, Inc. and Subsidiaries Consolidated Statements of Income
YEARS ENDED JANUARY 30, JANUARY 31, FEBRUARY 1, 1999 1998 1997 -------------------------------------------------- Net sales $103,370,683 $70,531,592 $43,617,823 Cost of goods sold, including buying, distribution and occupancy costs 65,854,559 44,416,873 27,048,928 ------------------------------------------------ Gross margin 37,516,124 26,114,719 16,568,895 Selling, general and administrative expenses 29,077,124 19,861,808 12,845,602 ------------------------------------------------ Operating income 8,439,000 6,252,911 3,723,293 Interest income (951,119) (917,348) (469,241) Interest expense 20,296 16,787 87,516 ------------------------------------------------ Income before income taxes 9,369,823 7,153,472 4,105,018 Provision for income taxes (Note 6) 3,366,900 2,610,800 1,534,600 ------------------------------------------------ Net income $ 6,002,923 $ 4,542,672 $ 2,570,418 ================================================ Net income per share: Basic $1.25 $0.97 $0.71 ================================================ Diluted $1.21 $0.92 $0.66 ================================================ Shares used in computing net income per share: Basic 4,817,024 4,690,490 3,627,975 Diluted 4,955,797 4,939,947 3,898,646
See accompanying notes. F-3 Hot Topic, Inc. and Subsidiaries Consolidated Statements of Shareholders' Equity
Total Common Shares Deferred Retained Shareholders' -------------------------------- Shares Amount Compensation Earnings Equity ---------------------------------------------------------------------------------------- Balance at February 3, 1996 764,000 $ 785,462 - $ - $ 785,462 Issuance of common stock 1,495,397 24,268,160 - - 24,268,160 Accretion of preferred shares redemption value - (528,363) - - (528,363) Conversion of preferred stock 2,305,892 11,845,488 - - 11,845,488 Exercise of stock options 33,964 86,476 - - 86,476 Deferred compensation related to grant of stock options - 143,560 (143,560) - - Amortization of deferred compensation - - 29,157 - 29,157 Tax benefit from exercise of options - 12,365 - - 12,365 Net income - - - 2,570,418 2,570,418 ---------------------------------------------------------------------------------- Balance at February 1, 1997 4,599,253 36,613,148 (114,403) 2,570,418 39,069,163 Exercise of stock options 158,322 446,528 - - 446,528 Employee stock purchase plan 2,031 37,692 - - 37,692 Amortization of deferred compensation - - 35,892 - 35,892 Tax benefit from exercise of options - 603,624 - - 603,624 Net income - - - 4,542,672 4,542,672 ---------------------------------------------------------------------------------- Balance at January 31, 1998 4,759,606 37,700,992 (78,511) 7,113,090 44,735,571 Exercise of stock options 111,077 388,728 - - 388,728 Employee stock purchase plan 3,748 49,500 - - 49,500 Repurchase common stock (220,000) (2,968,565) (2,968,565) Amortization of deferred compensation - - 35,892 - 35,892 Tax benefit from exercise of options - 505,097 - - 505,097 Net income - - - 6,002,923 6,002,923 --------------------------------------------------------------------------------- Balance at January 30, 1999 4,654,431 $35,675,752 $ (42,619) $13,116,013 $48,749,146 ==================================================================================
See accompanying notes. F-4 Hot Topic, Inc. and Subsidiaries Consolidated Statements of Cash Flows
YEARS ENDED JANUARY 30, JANUARY 31, FEBRUARY 1, 1999 1998 1997 ----------------------------------------------------- OPERATING ACTIVITIES Net income $ 6,002,923 $ 4,542,672 $ 2,570,418 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,069,200 2,872,483 1,723,577 Deferred rent 234,889 189,816 73,226 Deferred compensation 35,892 35,892 29,157 Deferred taxes 124,198 104,238 209,253 Loss on disposal of fixed assets - 46,071 79,261 Changes in operating assets and liabilities: Inventory (2,810,030) (2,699,378) (1,775,349) Prepaid expenses and other current assets (782,537) 335,485 (376,962) Deposits and other assets (46,397) (4,982) 322 Accounts payable 480,803 478,556 158,495 Accrued payroll and related expenses 1,409,150 792,152 854,492 Accrued sales and other taxes payable 118,883 54,077 54,148 Income taxes payable 488,804 492,687 474,353 ----------------------------------------------------- Net cash provided by operating activities 9,325,778 7,239,769 4,074,391 INVESTING ACTIVITIES Purchases of property and equipment (9,274,002) (8,869,800) (5,889,793) ----------------------------------------------------- Net cash used in investing activities (9,274,002) (8,869,800) (5,889,793) FINANCING ACTIVITIES Payments on capital lease obligations (31,689) (30,031) (41,610) Proceeds from sale of common shares - - 24,268,160 Repurchase common shares (2,968,565) - - Proceeds from employee stock purchases and exercise of stock options, including related tax benefit 943,325 1,087,844 170,840 ----------------------------------------------------- Net cash (used in) provided by financing activities (2,056,929) 1,057,813 24,397,390 ----------------------------------------------------- (Decrease) increase in cash and cash equivalents (2,005,153) (572,218) 22,581,988 Cash and cash equivalents at beginning of year 26,579,027 27,151,245 4,569,257 ----------------------------------------------------- Cash and cash equivalents at end of year $24,573,874 $26,579,027 $27,151,245 ===================================================== SUPPLEMENTAL INFORMATION Cash paid during the year for interest $ 20,296 $ 16,787 $ 87,516 ===================================================== Cash paid during the year for income taxes $ 2,245,212 $ 1,415,012 $ 832,447 ===================================================== Capital lease obligations entered into for equipment $ - $ 142,990 $ 55,581 =====================================================
See accompanying notes. F-5 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements January 30, 1999 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND BUSINESS ACTIVITY Hot Topic, Inc. (the Company) was incorporated in California in September 1988. The Company sells music licensed and music influenced apparel, accessories and gift items for young men and women through its retail stores. The Company operates mall based retail stores throughout the western, mid-western, southeastern and northeastern regions of the United States. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts have been eliminated in consolidation. On September 23, 1996, the Company completed an initial public offering (the Offering) of 1,495,000 shares of common stock at a price of $18.00 per share. The net proceeds to the Company, net of underwriting discounts and commissions and offering expenses, were $24.3 million. FISCAL YEAR The Company's fiscal year is on a 52-53 week basis and ends on the Saturday nearest to January 31. The fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997 were 52 week years. REVENUE RECOGNITION Retail merchandise sales are recognized at the point of sale less estimated sales returns. CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with maturities of less than three months when purchased to be cash equivalents. The Company is potentially exposed to a concentration of credit risk when cash deposits in banks are in excess of federally insured limits, and as a result of the investment of cash equivalents at two financial institutions. INVENTORY Inventories and related cost of sales are accounted for by the retail method. The cost of inventory is determined at the lower of the first-in, first-out (FIFO) method or market. F-6 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements(continued) 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) STORE PRE-OPENING COSTS Costs incurred in connection with the opening of a new store are expensed as incurred. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost or in the case of capitalized leases, at the present value of future minimum lease payments. Depreciation is provided using the straight-line method over the estimated useful lives of the assets (3-10 years). Leasehold improvements are amortized using the straight- line method over the shorter of the lease term or ten years. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. LONG-LIVED ASSETS The Company accounts for the impairment and disposition of long-lived assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS No. 121). In accordance with SFAS No. 121, long-lived assets to be held are reviewed for events or changes in circumstances which indicate that their carrying value may not be recoverable. At January 30, 1999, the Company believes there has been no impairment of the value of such assets. STOCK-BASED COMPENSATION The Company accounts for stock-based awards to employees using the intrinsic value method as prescribed by Accounting Principle Board Opinion No. 25, "Accounting for stock issued to Employees". F-7 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements 2. LEASEHOLDS, FIXTURES AND EQUIPMENT Leaseholds, fixtures and equipment are summarized as follows:
JANUARY 30, JANUARY 31, 1999 1998 ------------------------------- Furniture, fixtures and equipment $ 17,709,670 $12,452,091 Leasehold improvements 14,725,529 10,726,666 ------------------------------- 32,435,199 23,178,757 Less accumulated depreciation and amortization (10,540,067) (6,478,487) ------------------------------- $ 21,895,132 $16,700,270 ===============================
3. COMMITMENTS LEASES The Company has entered into lease agreements for retail and office space under primarily noncancelable leases with terms ranging from three to approximately ten years. In December 1998, a wholly-owned subsidiary of the Company entered into a lease for a building for a new office and distribution facility. The lease provides for a five year term and two three year lease extensions. The retail space leases provide for rents based upon the greater of the minimum annual rental amounts or 6% to 8% of annual sales volume. Certain of the leases provide for increasing minimum annual rental amounts. Rent expense is recorded evenly over the term of the lease. Accordingly, deferred rent, as reflected in the accompanying balance sheets, represents the difference between rent expense accrued and amounts paid under the terms of the lease agreement. Total rent expense for the years ended January 30, 1999, January 31, 1998 and February 1, 1997 was $7,505,514, $5,138,226 and $3,272,996 respectively, including contingent rentals of $293,759, $272,900 and $260,214, respectively. F-8 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements 3. COMMITMENTS (CONTINUED) LEASES (CONTINUED) The Company leases certain equipment under capital lease obligations. Cost and accumulated depreciation of equipment under capital leases were $168,930 and $49,137, respectively, at January 30, 1999; $186,489 and $41,243, respectively, at January 31, 1998 and $55,581 and $6,338, respectively, at February 1, 1997. Annual future minimum lease payments under operating and capital leases as of January 30, 1999 are as follows:
OPERATING CAPITAL Fiscal year LEASES LEASES - ----------- -------------------------------------- 1999 $ 8,665,722 $ 43,019 2000 8,768,706 72,890 2001 8,706,490 21,840 2002 8,603,086 2003 8,356,836 - Thereafter 28,642,225 - -------------------------------- Total minimum lease payments $71,743,065 137,749 ================ Less amounts representing interest 18,212 ---------------- Present value of future minimum capital lease payments 119,537 Less amounts due in one year 29,629 ---------------- Long-term portion of obligations under capital leases $ 89,908 ================
F-9 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements 4. SHAREHOLDERS' EQUITY STOCK OPTIONS Under the Company's long-term incentive plans (the Plans) the Company may grant stock options to employees, directors or consultants of the Company as deemed appropriate by the Board of Directors. The exercise price of options granted under the Plan shall be determined by the Board of Directors at the date of grant and shall not be lower than (i) 100% of the fair market value of the Company's common stock on the date of grant for incentive stock options, (ii) 85% of the fair market value of the Company's common stock on the date of grant for non-statutory stock options, and (iii) 110% of the fair market value of the Company's common stock on the date of grant for persons possessing 10% or more of the total combined voting power of all classes of stock of the Company. Unless the Board of Directors declares otherwise, options vest over four years and generally expire ten years from the date of grant. An aggregate of 1,330,000 shares of common stock may be issued pursuant to the plans. As of January 30, 1999, 362,203 shares were available for future grants. In June 1996, the Board of Directors adopted the Employee Stock Purchase Plan (the Stock Purchase Plan). The Stock Purchase Plan provides for the issuance of up to 150,000 shares of common stock to employees of the Company. Under the Stock Purchase Plan, all eligible employees are granted identical rights to purchase common stock for each Board-authorized offering under the Stock Purchase Plan. Rights granted pursuant to any offering under the Stock Purchase Plan terminate immediately upon cessation of an employee's employment for any reason. In general, an employee may withdraw from participation in an offering at any time during the purchase period for such offering. Rights granted under the Stock Purchase Plan are not transferable and may be exercised only by the person to whom such rights are granted. The initial offering under the Stock Purchase Plan commenced October 24, 1996 and terminated December 31, 1996. Subsequent offerings occur every six months commencing January 1, 1997. F-10 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. SHAREHOLDERS' EQUITY (CONTINUED) STOCK OPTIONS (CONTINUED) Pro forma information regarding net income and earnings per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1998, 1997 and 1996: weighted-average risk-free interest rates of 6%; dividend yields of 0%; weighted-average volatility factors of the expected market price of the Company's common stock of 0.79 for 1998, 0.53 for 1997 and 0.35 for 1996; and a weighted average expected life of the option of 5 years. The weighted average fair value of options granted during the year is $14.67, $12.87 and $3.32 per share for fiscal 1998, 1997 and 1996, respectively. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows:
1998 1997 1996 --------------------------------------------- Pro forma net income $4,495,809 $3,888,986 $2,517,055 Pro forma earnings per share $ 0.92 $ 0.82 $ 0.66
A summary of the Company's stock option activity and related information follows:
JANUARY 30, 1999 JANUARY 31, 1998 FEBRUARY 1, 1997 -------------------------- --------------------------- -------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE -------------------------- --------------------------- -------------------------- Outstanding at beginning of year 562,310 $16.43 399,122 $ 4.21 328,420 $2.72 Granted 286,588 $21.62 336,352 $24.37 112,666 $8.01 Exercised (111,077) $ 3.50 (158,322) $ 2.83 (33,964) $2.55 Canceled (38,670) $19.21 (14,842) $13.03 (8,000) $3.59 -------------------------- --------------------------- -------------------------- Outstanding at end of year 699,151 $20.45 562,310 $16.43 399,122 $4.21 ========================== =========================== ========================== Exercisable at end of year 196,285 $17.09 121,150 $ 4.07 195,278 $3.28
Exercise prices for options outstanding as of January 30, 1999 ranged from $2.50 to $27.88. Of the 699,151 options outstanding at January 30, 1999, 106,589 have exercise prices ranging from $2.34 to $8.00, 334,506 have exercise prices ranging from $15.38 to $22.75 and 258,056 have exercise prices ranging from $24.25 to $27.88. The weighted average remaining contractual life of those options is 8 years. F-11 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 5. NET INCOME PER SHARE The Company computes net income per share pursuant to Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS 128). Basic net income per share is computed based on the weighted average number of common shares outstanding for the period. Diluted net income per share is computed based on the weighted average number of common and potentially dilutive common stock equivalents outstanding for the period. A reconciliation of the numerator and denominator of basic earnings per share and diluted earnings per share for the year ended, is as follows:
JANUARY 30, JANUARY 31, FEBRUARY 1, 1999 1998 1997 ------------------------------------------ Basic EPS Computation: Numerator $6,002,923 $4,542,672 $2,570,418 Denominator: Weighted average common shares outstanding 4,817,024 4,690,490 3,627,975 ------------------------------------------ Total shares 4,817,024 4,690,490 3,627,975 ------------------------------------------ Basic EPS $ 1.25 $ 0.97 $ 0.71 ========================================== Diluted EPS Computation: Numerator $6,002,923 $4,542,672 $2,570,418 Denominator: Weighted average common shares outstanding 4,817,024 4,690,490 3,627,975 Incremental shares from assumed conversion of options 138,773 249,457 270,671 ------------------------------------------ Total shares 4,955,797 4,939,947 3,898,646 ------------------------------------------ Diluted EPS $ 1.21 $ 0.92 $ 0.66 ==========================================
F-12 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 6. INCOME TAXES Following is the composition of the provision for income taxes for the years ended:
JANUARY 30, JANUARY 31, FEBRUARY 1, 1999 1998 1997 ------------------------------------------------------ Current: Federal $2,770,434 $2,042,664 $1,021,150 State 472,268 463,898 304,197 ------------------------------------------------------ 3,242,702 2,506,562 1,325,347 Deferred: Federal 127,057 89,336 204,132 State (2,859) 14,902 5,121 ------------------------------------------------------ 124,198 104,238 209,253 ------------------------------------------------------ Total income tax expense $3,366,900 $2,610,800 $1,534,600 ======================================================
Significant components of the Company's deferred tax assets and liabilities:
JANUARY 30, JANUARY 31, 1999 1998 ----------------------------- Current deferred tax assets: Accrued vacation and other $ 230,496 $ 100,557 Inventory 291,499 212,663 State taxes 78,833 39,959 Other liabilities (264,503) ----------------------------- Total deferred tax assets 336,325 353,179 Valuation allowance for deferred tax assets (14,500) (14,500) ----------------------------- Net current deferred tax assets 321,825 338,679 Noncurrent deferred tax liabilities: Depreciation (1,033,235) (716,965) Deferred rent 201,532 117,807 ----------------------------- Total noncurrent deferred tax liabilities (831,703) (599,158) ----------------------------- Net deferred tax (liability) asset $ (509,878) $(260,479) =============================
F-13 Hot Topic, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 6. INCOME TAXES (CONTINUED) Reconciliation of provision for taxes to statutory tax rate for the years ended:
JANUARY 30, JANUARY 31, FEBRUARY 1, 1999 1998 1997 --------------------------------------------- Statutory federal rate 34.0% 34.0% 34.0% Permanent differences (2.9) (3.9) (2.4) State and local taxes, net of federal benefit 3.3 4.4 5.0 Change in valuation allowance and other items 1.5 2.0 0.8 --------------------------------------------- Effective income tax rate 35.9% 36.5% 37.4% =============================================
7. EMPLOYEE BENEFIT PLAN Effective January 1, 1995, the Company adopted the Hot Topic 401(k) Retirement Savings Plan (the 401(k) Plan). All employees who have been employed by the Company for at least one year of service (provided that such service represents a minimum of 1,000 hours worked during the year) and are at least 21 years of age are eligible to participate. Employees may contribute to the 401(k) Plan up to 20% of their current compensation, subject to a statutorily prescribed annual limit. The Company may in its discretion contribute certain amounts to eligible employees' accounts. The Company has not made any contributions to the 401(k) Plan. F-14 EX-10.18 2 INDUSTRIAL REAL ESTATE LEASE DATED 12-10-98 EXHIBIT 10.18 Southern California Chapter of the [LOGO] Society of Industrial and Office Realtors, (R) Inc. INDUSTRIAL REAL ESTATE LEASE (MULTI-TENANT FACILITY) ARTICLE ONE: BASIC TERMS This Article One contains the Basic Terms of this Lease between the Landlord and Tenant named below. Other Articles, Sections and Paragraphs of the Lease referred to in this Article One explain and define the Basic Terms and are to be read in conjunction with the Basic Terms. Section 1.01. DATE OF LEASE: December 10, 1998 Section 1.02. LANDLORD (INCLUDE LEGAL ENTITY): MAJESTIC REALTY CO. AND PATRICIAN ASSOCIATES, Inc., both California corporations Address of Landlord: 13191 Crossroads Parkway North, 6th Floor City of Industry, CA 91746 Section 1.03. TENANT (INCLUDE LEGAL ENTITY): Hot Topic Administration, Inc., a California corporation Address of Tenant: 3410 Pomona Boulevard, Pomona, CA Section 1.04. PROPERTY: The Property is part of Landlord's multi-tenant real property development located at 18305 and 18385 E. San Jose Avenue, City of Industry, California and described or depicted in Exhibit "A" (the "Project"). The Project includes the land, the buildings and all other improvements located on the land and the common areas described in Paragraph 4.05(a). The Property is (include street address, approximate square footage and description) that approximately 125,000 square foot portion of an approximately 250,000 square foot building and surrounding area in the Project as outlined in red on Exhibit "A" attached hereto and made a part hereof and more commonly known as 18305 E. San Jose Avenue, City of Industry, CA, subject to the right of adjoining properties to use the area outlined in green labeled "Common Ingress and Egress". Section 1.05 LEASE TERM: five (5) years two (2) months BEGINNING ON March 1, 1999 or such other date as is specified in this Lease, and ENDING ON April 30, 2004 Section 1.06 PERMITTED USES: (See Article Five) Office, warehouse and distribution of consumer products Section 1.07 TENANT'S GUARANTOR: (If none, so state) Hot Topic, Inc., a California corporation Section 1.08 BROKERS: (See Article Fourteen) (If none, so state) Landlord's Broker: Majestic Realty Co. Tenant's Broker: The Staubach Company Section 1.09 COMMISSION PAYABLE TO LANDLORD'S BROKER:(See Article Fourteen) $ per separate agreement Section 1.10 INITIAL SECURITY DEPOSIT: (See Section 3.03) $43,750.00 Section 1.11 VEHICLE PARKING SPACES ALLOCATED TO TENANT: (See Section 4.05) 206 Section 1.12 RENT AND OTHER CHARGES PAYABLE BY TENANT: (a) BASE RENT: FORTY-THREE THOUSAND SEVEN HUNDRED FIFTY AND NO/100---- Dollars ($43,750.00) per month for each month, as provided in Section 3.01, (b) OTHER PERIODIC PAYMENTS. (i) Real Property Taxes (See Section 4.02); (ii) Utilities (See Section 4.03); (iii) Insurance Premiums (See Section 4.04); (iv) Tenant's Initial Pro Rata Share of Common Area Expenses 50% (See Section 4.05); (v) Impounds for Insurance Premiums and Property Taxes (See Section 4.08); (vi) Maintenance, Repairs and Alterations (See Article Six). Section 1.13 LANDLORD'S SHARE OF PROFIT ON ASSIGNMENT OR SUBLEASE: (See Section 9.05) fifty percent (50%) of the Profit (the "Landlord's Share"). Section 1.14 RIDERS: The following Riders are attached to and made a part of this Lease: (If none, so state) Rider pages 1 through 11, Option to Extend Term Lease Rider, and Exhibits "A", "B", "C", "D", "E", "F" and "G". Initials: _____________ _____________ 1 ARTICLE TWO: LEASE TERM Section 2.01. LEASE OF PROPERTY FOR LEASE TERM. Landlord leases the Property to Tenant and Tenant leases the Property from Landlord for the Lease Term. The Lease Term is for the period stated in Section 1.05 above and shall begin and end on the dates specified in Section 1.05 above, unless the beginning or end of the Lease Term is changed under any provision of this Lease. The "Commencement Date" shall be the date specified in Section 1.05 above for the beginning of the Lease Term, unless advanced or delayed under any provision of this Lease. Section 2.02. DELAY IN COMMENCEMENT. Landlord shall not be liable to Tenant if Landlord does not deliver possession of the Property to Tenant on the Commencement Date. Landlord's non-delivery of the Property to Tenant on that date shall not affect this Lease or the obligations of Tenant under this Lease except that the Commencement Date shall be delayed until Landlord delivers possession of the Property to Tenant and the Lease Term shall be extended for a period equal to the delay in delivery of possession of the Property to Tenant, plus the number of days necessary to end the Lease Term on the last day of a month. If Landlord does not deliver possession of the Property to Tenant within sixty (60) days after the Commencement Date, Tenant may elect to cancel this Lease by given written notice to Landlord within ten (10) days after the sixty (60) -day period ends. If Tenant gives such notice, the Lease shall be cancelled and neither Landlord nor Tenant shall have any further obligations to the other. If Tenant does not give such notice, Tenant's right to cancel the Lease shall expire and the Lease Term shall commence upon the delivery of possession of the Property to Tenant. If delivery of possession of the Property to Tenant is delayed, Landlord and Tenant shall, upon such delivery, execute an amendment to this Lease setting forth the actual Commencement Date and expiration date of the Lease. Failure to execute such amendment shall not affect the actual Commencement Date and expiration date of the Lease. Section 2.03. EARLY OCCUPANCY. If Tenant occupies the Property prior to the Commencement Date, Tenant's occupancy of the Property shall be subject to all of the provisions of this Lease. Early occupancy of the Property shall not advance the expiration date of this Lease. Tenant shall pay Base Rent and all other charges specified in this Lease for the early occupancy period. Section 2.04. HOLDING OVER. Tenant shall vacate the Property upon the expiration or earlier termination of this Lease. Tenant shall reimburse Landlord for and indemnify Landlord against all damages which Landlord incurs from Tenant's delay in vacating the Property. If Tenant does not vacate the Property upon the expiration or earlier termination of the Lease and Landlord thereafter accepts rent from Tenant, Tenant's occupancy of the Property shall be a "month-to-month" tenancy, subject to all of the terms of this Lease applicable to a month-to-month tenancy, except that the Base Rent then in effect shall be increased by twenty-five percent (25%). See Rider Section 2.05 ARTICLE THREE: BASE RENT Section 3.01. TIME AND MANNER OF PAYMENT. Upon execution of this Lease by Landlord and Tenant, Tenant shall pay Landlord the Base Rent in the amount stated in Paragraph 1.12(a) above for the first month of the Lease Term. On the first day of the second month of the Lease Term and each month thereafter, Tenant shall pay Landlord the Base Rent, in advance, without offset, deduction or prior demand. The Base Rent shall be payable at Landlord's address or at such other place as Landlord may designate in writing. See Rider Section 3.01 Initials: ______________ ______________ 2 Section 3.03. SECURITY DEPOSIT; INCREASES. (a) Upon the execution of this Lease by Landlord and Tenant, Tenant shall deposit with Landlord a cash Security Deposit in the amount set forth in Section 1.10 above. Landlord may apply all or part of the Security Deposit to any unpaid rent or other charges due from Tenant or to cure any other defaults of Tenant. If Landlord uses any part of the Security Deposit, Tenant shall restore the Security Deposit to its full amount within ten (10) days after Landlord's written request. Tenant's failure to do so shall be a material default under this Lease. No interest shall be paid on the Security Deposit. Landlord shall not be required to keep the Security Deposit separate from its other accounts and no trust relationship is created with respect to the Security Deposit. (b) Each time the Base Rent is increased, Tenant shall deposit additional funds with Landlord sufficient to increase the Security Deposit to an amount which bears the same relationship to the adjusted Base Rent as the initial Security Deposit bore to the initial Base Rent. Section 3.04. TERMINATION; ADVANCE PAYMENTS. Upon termination of this Lease under Article Seven (Damage or Destruction), Article Eight (Condemnation) or any other termination not resulting from Tenant's default, and after Tenant has vacated the Property in the manner required by this Lease, Landlord shall refund or credit to Tenant (or Tenant's successor) the unused portion of the Security Deposit, any advance rent or other advance payments made by Tenant to Landlord, and any amounts paid for real property taxes and other reserves which apply to any time periods after termination of the Lease. ARTICLE FOUR: OTHER CHARGES PAYABLE BY TENANT Section 4.01. ADDITIONAL RENT. All charges payable by Tenant other than Base Rent are called "Additional Rent." Unless this Lease provides otherwise, Tenant shall pay all Additional Rent then due with the next monthly installment of Base Rent. The term "rent" shall mean Base Rent and Additional Rent. Section 4.02. PROPERTY TAXES. (a) REAL PROPERTY TAXES. Tenant shall pay all real property taxes on the Property (including any fees, taxes or assessments against, or as a result of, any tenant improvements installed on the Property by or for the benefit of Tenant) during the Lease Term. Subject to Paragraph 4.02(c) and Section 4.08 below, such payment shall be made at least ten (10) days prior to the delinquency date of the taxes. Within such ten (10) -day period, Tenant shall furnish Landlord with satisfactory evidence that the real property taxes have been paid. Landlord shall reimburse Tenant for any real property taxes paid by Tenant covering any period of time prior to or after the Lease Term. If Tenant fails to pay the real property taxes when due, Landlord may pay the taxes and Tenant shall reimburse Landlord for the amount of such tax payment as Additional Rent. Alternatively, Landlord may elect to bill Tenant in advance for such taxes and Tenant shall pay Landlord the amount of such taxes, as Additional Rent, at least ten (10) days but not more than thirty (30) days prior to delinquency. Landlord shall pay such taxes prior to delinquency provided Tenant has timely made such payments to Landlord. Any penalty caused by Tenant's failure to timely make such payments shall also be Additional Rent owed by Tenant immediately upon demand. (b) DEFINITION OF "REAL PROPERTY TAX." "Real property tax" means: (i) any fee, license fee, license tax, business license fee, commercial rental tax, levy, charge, assessment, penalty or tax imposed by any taxing authority against the Property; (ii) any tax on the Landlord's right to receive, or the receipt of, rent or income from the Property or against Landlord's business of leasing the Property; (iii) any tax or charge for fire protection, streets, sidewalks, road maintenance, refuse or other services provided to the Property by any governmental agency; (iv) any tax imposed upon this transaction or based upon a re-assessment of the Property due to a change of ownership, as defined by applicable law, or other transfer of all or part of Landlord's interest in the Property; and (v) any charge or fee replacing any tax previously included within the definition of real property tax. "Real property tax" does not, however, include Landlord's federal or state income, franchise, inheritance or estate taxes. (c) JOINT ASSESSMENT. SEE RIDER SECTION 4.02(c) (d) PERSONAL PROPERTY TAXES. (i) Tenant shall pay all taxes charged against trade fixtures, furnishings, equipment or any other personal property belonging to Tenant. Tenant shall try to have personal property taxed separately from the Property. (ii) If any of Tenant's personal property is taxed with the Property, Tenant shall pay Landlord the taxes for the personal property within fifteen (15) days after Tenant receives a written statement from Landlord for such personal property taxes. Section 4.03. UTILITIES. Tenant shall pay, directly to the appropriate supplier, the cost of all natural gas, heat, light, power, sewer service, telephone, water, refuse disposal and other utilities, and services supplied to the Property. Initials: ______________ ______________ 3 Section 4.04. INSURANCE POLICIES. (a) LIABILITY INSURANCE. During the Lease Term, Tenant shall maintain a policy of commercial general liability insurance (sometimes known as broad form comprehensive general liability insurance) insuring Tenant against liability for bodily injury, property damage (including loss of use of property) and personal injury arising out of the operation, use or occupancy of the Property. Tenant shall name Landlord as an additional insured under such policy. The initial amount of such insurance shall be Three Million Dollars ($3,000,000) per occurrence and shall be subject to periodic increase based upon increased liability awards against Tenant. The liability insurance obtained by Tenant under this Paragraph 4.04(a) shall (i) be primary and non-contributing; (ii) contain cross-liability endorsements; and (iii) insure Landlord against Tenant's performance under Section 5.05. if the matters giving rise to the indemnity under Section 5.05 result from the negligence of Tenant. The amount and coverage of such insurance shall not limit Tenant's liability nor relieve Tenant of any other obligation under this Lease. Landlord may also obtain comprehensive public liability insurance in an amount and with coverage determined by Landlord insuring Landlord against liability arising out of ownership, operation, use or occupancy of the Property. The policy obtained by Landlord shall not be contributory and shall not provide primary insurance. (b) PROPERTY AND RENTAL INCOME INSURANCE. During the Lease Term, Landlord shall maintain policies of insurance covering loss of or damage to the Property in the full amount of its replacement value. Such policy shall contain an Inflation Guard Endorsement and shall provide protection against all perils included within the classification of fire, extended coverage, vandalism, malicious mischief, special extended perils (all risk), sprinkler leakage and any other perils which Landlord deems reasonably necessary. Landlord shall have the right to obtain flood and earthquake insurance if required by any lender holding a security interest in the Property. Landlord shall not obtain insurance for Tenant's fixtures or equipment or building improvements installed by Tenant on the Property. During the Lease Term, Landlord shall also maintain a rental income insurance policy, with loss payable to Landlord, in an amount equal to one year's Base Rent, plus estimated real property taxes and insurance premiums. Tenant shall be liable for the payment of any deductible amount under all of Tenant's insurance policies maintained pursuant to this Section 4.04. and a deductible not exceed Ten Thousand Dollars ($10,000) under Landlord's insurance policies pursuant to this Section 4.04(b) Tenant shall not do or permit anything to be done which invalidates any such insurance policies. (c) PAYMENT OF PREMIUMS. Subject to Section 4.08, Tenant shall pay all premiums for the insurance policies described in Paragraphs 4.04(a) and (b) (whether obtained by Landlord or Tenant) within fifteen (15) days after Tenant's receipt of a copy of the premium statement or other evidence of the amount due, except Landlord shall pay all premiums for non-primary comprehensive public liability insurance which Landlord elects to obtain as provided in Paragraph 4.04(a). For insurance policies maintained by Landlord which cover improvements on the entire Project, Tenant shall pay Tenant's prorated share of the premiums, in accordance with the formula in Paragraph 4.05(e) for determining Tenant's share of Common Area costs. If insurance policies maintained by Landlord cover improvements on real property other than the Project, Landlord shall deliver to Tenant a statement of the premium applicable to the Property showing in reasonable detail how Tenant's share of the premium was computed. If the Lease Term expires before the expiration of an insurance policy maintained by Landlord, Tenant shall be liable for Tenant's prorated share of the insurance premiums. Before the Commencement Date, Tenant shall deliver to Landlord a copy of any policy of insurance which Tenant is required to maintain under this Section 4.04. At least thirty (30) days prior to the expiration of any such policy, Tenant shall deliver to Landlord a renewal of such policy. As an alternative to providing a policy of insurance, Tenant shall have the right to provide Landlord a certificate of insurance, executed by an authorized officer of the insurance company, showing that the insurance which Tenant is required to maintain under this Section 4.04 is in full force and effect and containing such other information which Landlord reasonably requires. (d) GENERAL INSURANCE PROVISIONS. (i) Any insurance which Tenant is required to maintain under this Lease shall include a provision which requires the insurance carrier to give Landlord not less than thirty (30) days' written notice prior to any cancellation or material modification of such coverage. (ii) If following three (3) days written notice from Landlord, Tenant fails to deliver any policy, certificate or renewal to Landlord required under this Lease within the prescribed time period or if any such policy is cancelled or modified during the Lease Term without Landlord's consent, Landlord may obtain such insurance, in which case Tenant shall reimburse Landlord for the cost of such insurance within fifteen (15) days after receipt of a statement that indicates the cost of such insurance. (iii) Tenant shall maintain all insurance required under this Lease with companies holding a "General Policy Rating" of A-12 or better, as set forth in the most current issue of "Best Key Rating Guide". Landlord and Tenant acknowledge the insurance markets are rapidly changing and that insurance in the form and amounts described in this Section 4.04 may not be available in the future. Tenant acknowledges that the insurance described in this Section 4.04 is for the primary benefit of Landlord. If at any time during the Lease Term, Tenant is unable to maintain the insurance required under the Lease, Tenant shall nevertheless maintain insurance coverage which is customary and commercially reasonable in the insurance industry for Tenant's type of business, as that coverage may change from time to time. Landlord makes no representation as to the adequacy of such insurance to protect Landlord's or Tenant's interest. Therefore, Tenant shall obtain any such additional property or liability insurance which Tenant deems necessary to protect Landlord and Tenant. See Rider Section 4.04(e) Initials: ________________ ________________ 4 (iv) Unless prohibited under any applicable insurance policies maintained, Landlord and Tenant each hereby waive any and all rights of recovery against the other, or against the officers, employees, agents or representatives of the other, for loss of or damage to its property or the property of others under its control. If such loss or damage is covered by any insurance policy in force (whether or not described in this Lease) at the time of such loss or damage. Upon obtaining the required policies of insurance, Landlord and Tenant shall give notice to the insurance carriers of this mutual waiver of subrogation. See Rider Section 4.04(e) Section 4.05. COMMON AREAS; USE, MAINTENANCE AND COSTS. (a) COMMON AREAS. As used in this Lease, "Common Areas" shall mean all areas within the Project which are available for the common use of tenants of the Project and which are not leased or held for the exclusive use of Tenant or other tenants, including, but not limited to, parking areas, driveways, sidewalks, loading areas, access roads, corridors, landscaping and planted areas. Landlord, from time to time, may change the size, location, nature and use of any of the Common Areas, convert Common Areas into leasable areas, construct additional parking facilities (including parking structures) in the Common Areas, and increase or decrease Common Area land and/or facilities, Tenant acknowledges that such activities may result in inconvenience to Tenant. Such activities and changes are permitted if they do not materially affect Tenant's use of the Property or permanently decrease the number of vehicle parking spaces allocated to Tenant pursuant to this Lease. (b) USE OF COMMON AREAS. Tenant shall have the nonexclusive right (in common with other tenants and all others to whom Landlord has granted or may grant such rights) to use the Common Areas for the purposes intended, subject to such reasonable rules and regulations as Landlord may establish from time to time. Tenant shall abide by such reasonable nondiscriminatory rules and regulations and shall use its good faith effort to cause others who use the Common Areas with Tenant's express or implied permission to abide by Landlord's rules and regulations. At any time, Landlord may close any Common Areas to perform any acts in the Common Areas as, in Landlord's judgement, are desirable to improve the Project. Tenant shall not interfere with the rights of Landlord, other tenants or any other person entitled to use the Common Areas. (c) SPECIFIC PROVISION RE: VEHICLE PARKING. Tenant shall be entitled to use the number of vehicle parking spaces in the Property allocated to Tenant in Section 1.11 of the Lease without paying any additional rent. Tenant's parking shall not be reserved and shall be limited to vehicles no larger than standard size automobiles or pickup utility vehicles. Temporary parking of large delivery vehicles in the Property may be permitted by the rules and regulations established by Landlord. Vehicles shall be parked only in striped parking spaces and not in driveways, loading areas or other locations not specifically designated for parking. Handicapped spaces shall only be used by those legally permitted to use them. If Tenant parks more vehicles in the parking area than the number set forth in Section 1.11 of this Lease, such conduct shall be a material breach of this Lease. In addition to Landlord's other remedies under the Lease, Tenant shall pay a daily charge determined by Landlord for each such additional vehicle. See Rider Section 4.05 (c) (d) MAINTENANCE OF COMMON AREAS. Landlord shall maintain the Common Areas in good order, condition and repair and shall operate the Project, in Landlord's sole discretion, as a first-class industrial/commercial real property development. Tenant shall pay Tenant's pro rata share (as determined below) of all costs incurred by Landlord for the operation and maintenance of the Common Areas. Common Area costs include, but are not limited to, costs and expenses for the following: utilities, water and sewage charges; maintenance of signs (other than tenants' signs); premiums for liability, property damage, fire and other types of casualty insurance on the Common Areas and worker's compensation insurance; all property taxes and assessments levied on or attributable to the Common Areas and all Common Area improvements; all personal property taxes levied on or attributable to personal property used in connection with the common Areas; straight-line depreciation on personal property owned by Landlord which is consumed in the operation or maintenance of the Common Areas; rental or lease payments paid by Landlord for rented or leased personal property used in the operation or maintenance of the Common Areas; fees for required licenses and permits; repairing, resurfacing, repaving, maintaining, painting, lighting, cleaning, refuse removal, security and similar items; Landlord may cause any or all of such services to be provided by third parties and the cost of such services shall be included in Common Area costs. Common Area costs shall not include depreciation of real property which forms part of the Common Areas and "Landlord's Work," as that term is defined in Section 6.07 of this Lease. See Rider Section 4.05(d) Initials: ______________ ______________ 5 (e) TENANT'S SHARE AND PAYMENT. Tenant shall pay Tenant's annual pro rata share of all Common area costs (prorated for any fractional month) upon written notice from Landlord that such costs are due and payable, and in any event prior to delinquency, Tenant's pro rata share shall be calculated by dividing the square foot area of the Property, as set forth in Section 1.04 of the Lease, by the aggregate square foot area of the Project which is leased or held for lease by tenants, as of the date on which the computation is made, Tenant's initial pro rata share is set out in Paragraph 1.12(b). Any changes in the Common Area costs and/or the aggregate area of the Project leased or held for lease during the Lease Term shall be effective on the first day of the month after such change occurs. Landlord may, at Landlord's election, estimate in advance and charge to Tenant as Common Area costs, all real property taxes for which Tenant is liable under Section 4.02 of the Lease, all insurance premiums for which Tenant is liable under Section 4.04 of the Lease, all maintenance and repair costs for which Tenant is liable under Section 6.04 of the Lease, and all other Common Area costs payable by Tenant hereunder. At Landlord's election, such statements of estimated Common Area costs shall be delivered monthly, quarterly or at any other periodic intervals to be designated by Landlord. Landlord may adjust such estimates at any time based upon Landlord's experience and reasonable anticipation of costs. Such adjustments shall be effective as of the next rent payment date after notice to Tenant. Within sixty (60) days after the end of each calendar year of the Lease Term, Landlord shall deliver to Tenant a statement prepared in accordance with generally accepted accounting principles setting forth, in reasonable detail, the Common Area costs paid or incurred by Landlord during the preceding calendar year and Tenant's pro rata share. Upon receipt of such statement, there shall be an adjustment between Landlord and Tenant, with payment to or credit given by Landlord (as the case may be) so that Landlord shall receive the entire amount of Tenant's share of such costs and expenses for such period. Section 4.06. LATE CHARGES. Tenant's failure to pay rent promptly may cause Landlord to incur unanticipated costs. The exact amount of such costs are impractical or extremely difficult to ascertain. Such costs may include, but are not limited to, processing and accounting charges and late charges which may be imposed on Landlord by any ground lease, mortgage or trust deed encumbering the Property. Therefore, if Landlord does not receive any rent payment within ten (10) days after it becomes due, Tenant shall pay Landlord a late charge equal to ten percent (10%) of the overdue amount. The parties agree that such late charge represents a fair and reasonable estimate of the costs Landlord will incur by reason of such late payment. Section 4.07. INTEREST ON PAST DUE OBLIGATIONS. Any amount owed by Tenant to Landlord which is not paid when due shall bear interest at the rate of twelve percent (12%) per annum from the due date of such amount. However, interest shall not be payable on late charges to be paid by Tenant under this Lease. The payment of interest on such amounts shall not excuse or cure any default by Tenant under this Lease. If the interest rate specified in this Lease is higher than the rate permitted by law, the interest rate is hereby decreased to the maximum legal interest rate permitted by law. Section 4.08. IMPOUNDS FOR INSURANCE PREMIUMS AND REAL PROPERTY TAXES. If required by any lender to whom Landlord has granted a security interest in the Property, or if Tenant is more than ten (10) days late in the payment of rent more than twice in any consecutive twelve (12) month period, Tenant shall pay Landlord a sum equal to one-twelfth (1/12) of the annual real property taxes and insurance premiums payable by Tenant under this Lease, together with each payment of Base Rent. Landlord shall hold such payments in a non-interest bearing impound account. If unknown, Landlord shall reasonably estimate the amount of real property taxes and insurance premiums when due, Tenant shall pay any deficiency of funds in the impound account to Landlord upon written request. If Tenant defaults under this Lease, Landlord may apply any funds in the impound account to any obligation then due under this Lease. See Rider Section 4.09 ARTICLE FIVE: USE OF PROPERTY Section 5.01. PERMITTED USES. Tenant may use the Property only for the Permitted Uses set forth in Section 1.06 above. Section 5.02. MANNER OF USE. Tenant shall not cause or permit the Property to be used in any way which constitutes a violation of any law, ordinance, or governmental regulation or order, which annoys or interferes with the rights of tenants of the Project, or which constitutes a nuisance or waste. Tenant shall obtain and pay for all permits, including a Certificate of Occupancy, required for Tenant's occupancy of the Property and shall promptly take all actions necessary to comply with all applicable statutes, ordinances, rules, regulations, orders and requirements regulating the use by Tenant of the Property, including the Occupational Safety and Health Act. Initials: _______________ _______________ 6 Section 5.04. SIGNS AND AUCTIONS. Tenant shall not place any signs on the Property without Landlord's prior written consent. Tenant shall not conduct or permit any auctions or sheriff's sales at the Property. See Rider Section 5.04 Section 5.05. INDEMNITY. Tenant shall indemnify Landlord against and hold Landlord harmless from any and all costs, claims or liability to the extent arising from: (a) Tenant's use of the Property; (b) the conduct of Tenant's business or anything else done or permitted by Tenant to be done in or about the Property, including any contamination of the Property or any other property resulting from the presence or use of Hazardous Material caused or permitted by Tenant; (c) any breach or default in the performance of Tenant's obligations under this Lease; (d) any misrepresentation or breach of warranty by Tenant under this Lease; or (e) other acts or omissions of Tenant related to the Property. Tenant shall defend Landlord against any such cost, claim or liability at Tenant's expense with counsel reasonably acceptable to Landlord or, at Landlord's election, Tenant shall reimburse Landlord for any reasonable legal fees or costs incurred by Landlord in connection with any such claim. As a material part of the consideration to Landlord, Tenant assumes all risk of damage to property or injury to persons in or about the Property arising from any cause, and Tenant hereby waives all claims in respect thereof against Landlord, except for any claim arising out of Landlord's active negligence or willful misconduct. As used in this Section, the term "Tenant" shall include Tenant's employees, agents, contractors and invitees, if applicable. Section 5.06. LANDLORD ACCESS. Landlord or its agents may enter the Property upon giving Tenant twenty-four (24) hours notice at all reasonable times to show the Property to potential buyers, investors or tenants or other parties, provided, however, Landlord does not need to give Tenant notice in the case of an emergency; to do any other act or to inspect and conduct tests in order to monitor Tenant's compliance with all applicable environmental laws and all laws governing the presence and use of Hazardous Material; or for any other purpose Landlord deems necessary. Landlord shall give Tenant prior notice of such entry, except in the case of an emergency. During the last six (6) months of the Lease Term, Landlord may place customary "For Sale" or "For Lease" signs on the landscape area of the Property; provided however the foregoing shall not preclude Landlord from attaching signs on the adjoining property. Section 5.07. QUIET POSSESSION. If Tenant pays the rent and complies with all other terms of this Lease, Tenant may occupy and enjoy the Property for the full Lease Term, subject to the provisions of this Lease. ARTICLE SIX: CONDITION OF PROPERTY; MAINTENANCE, REPAIRS AND ALTERATIONS Section 6.01. EXISTING CONDITIONS. Except as provided in Section 6.07 of the Rider, Tenant accepts the Property in its condition as of the execution of the Lease, subject to all recorded matters, laws, ordinances, and governmental regulations and orders. Except as provided herein, Tenant acknowledges that neither Landlord nor any agent of Landlord has made any representation as to the condition of the Property or the suitability of the Property for Tenant's intended use. Tenant represents and warrants that Tenant has made its own inspection of and inquiry regarding the condition of the Property and is not relying on any representations of Landlord or any Broker with respect thereto. If Landlord or Landlord's Broker has provided a Property Information Sheet or other Disclosure Statement regarding the Property, a copy is attached as an exhibit to the Lease. See Rider Section 6.01 Section 6.02. EXEMPTION OF LANDLORD FROM LIABILITY. Landlord shall not be liable for any damage or injury to the person, business (or any loss of income therefrom), goods, wares, merchandise or other property of Tenant, Tenant's employees, invitees, customers or any other person in or about the Property, whether such damage or injury is caused by or results from: (a) fire, steam, electricity, water, gas or rain; (b) the breakage, leakage, obstruction or other defects of pipes, sprinklers, wires, appliances, plumbing, air conditioning or lighting fixtures or any other cause; (c) conditions arising in or about the Property or upon other portions of the Project, or from other sources or places; or (d) any act or omission of any other tenant of the Project, Landlord shall not be liable for any such damage or injury even though the cause of or the means of repairing such damage or injury are not accessible to Tenant. The provisions of this Section 6.02 shall not, however, exempt Landlord from liability for Landlord's active negligence or willful misconduct. Section 6.03. LANDLORD'S OBLIGATIONS. (a) Except as provided in Section 6.04, Article Seven (Damage or Destruction) and Article Eight (Condemnation), Landlord shall keep the following in good order, condition and repair: the foundations, exterior walls and roof of the Property (including painting the exterior surface of the exterior walls of the Property not more often than once every five (5) years, if necessary) and all components of electrical, mechanical, plumbing, heating and air conditioning systems and facilities located in the Property which are concealed or used in common by tenants of the Project. However, Landlord shall not be obligated to maintain or repair windows, doors, plate glass or the interior surfaces of exterior walls, Landlord shall make repairs under this Section 6.03 within a reasonable time after receipt of written notice from Tenant of the need for such repairs. (b) Tenant shall pay or reimburse Landlord for all costs Landlord incurs under Paragraph 6.03(a) above as Common Area costs as provided for in Section 4.05 of the Lease. Tenant waives the benefit of any statute in effect now or in the future which might give Tenant the right to make repairs at Landlord's expense or to terminate this Lease due to Landlord's failure to keep the Property in good order, condition and repair. Initials: _______________ _______________ 7 Sections 6.04 TENANT'S OBLIGATIONS. (a) Except as provided in Section 6.03, Article Seven (Damage or Destruction) and Article Eight (Condemnation), Tenant shall keep all portions of the Property (including structural, nonstructural, interior, systems, Tenant Improvements and equipment) in good order, condition and repair (including interior repainting and refinishing, as needed). If any portion of the Property or any system or equipment in the Property which Tenant is obligated to repair cannot be fully repaired or restored, Tenant shall promptly replace such portion of the Property or system or equipment in the Property, regardless of whether the benefit of such replacement extends beyond the Lease Term; but if the benefit or useful life of such replacement extends beyond the Lease Term (as such term may be extended by exercise of any options), the useful life of such replacement shall be prorated over the remaining portion of the Lease Term (as extended), and Tenant shall be liable only for that portion of the cost which is applicable to the Lease Term (as extended). Tenant shall maintain a preventive maintenance contract providing for the regular inspection and maintenance of the heating and air conditioning system by a licensed heating and air conditioning contractor. If any part of the Property or the Project is damaged by any act or omission of Tenant, Tenant shall pay Landlord the cost of repairing or replacing such damaged property, whether or not Landlord would otherwise be obligated to pay the cost of maintaining or repairing such property. It is the intention of Landlord and Tenant that at all times Tenant shall maintain the portions of the Property which Tenant is obligated to maintain in an attractive, first-class and fully operative condition. (b) Tenant shall fulfill all of Tenant's obligations under this Section 6.04 at Tenant's sole expense. If Tenant fails to maintain, repair or replace the Property as required by this Section 6.04, or diligently commence to rectify and cure the same within ten (10) days after notice from Landlord (except that no notice shall be required in the case of an emergency), Landlord may enter the Property and perform such maintenance or repair (including replacement, as needed) on behalf of Tenant. In such case, Tenant shall reimburse Landlord for all costs incurred in performing such maintenance or repair immediately upon demand. Section 6.05. ALTERATIONS, ADDITIONS, AND IMPROVEMENTS (a) Tenant shall not make any alterations, additions, or improvements to the Property without Landlord's prior written consent, except for non-structural alterations which do not exceed Ten Thousand Dollars ($10,000) in cost cumulatively per twelve (12) month period and which are not visible from the outside of any building of which the Property is part. After the Lease Commencement Date and if Tenant's net worth is less than Twenty-four Million and No/100 Dollars ($24,000,000.00). Landlord may require Tenant to provide demolition and/or lien and completion bonds in form and amount satisfactory to Landlord. Tenant shall promptly remove any alterations, additions, or improvements constructed in violation of this Paragraph 6.05(a) upon Landlord's written request. All alterations, additions, and improvements shall be done in a good and workmanlike manner, in conformity with all applicable laws and regulations, and by a contractor approved by Landlord. Within sixty (60) days after completion of any such work, Tenant shall provide Landlord with "as built" plans, copies of all construction contracts, and proof of payment for all labor and materials. (b) Tenant shall pay when due all claims for labor and material furnished to the Property. Tenant shall give Landlord at least twenty (20) days' prior written notice of the commencement of any work on the Property, regardless of whether Landlord's consent to such work is required. Landlord may elect to record and post notices of non-responsibility on the Property. Section 6.06. CONDITION UPON TERMINATION. Upon termination of the Lease, Tenant shall surrender the Property to Landlord, broom clean and in the same condition as received except for ordinary wear and tear which Tenant was not otherwise obligated to remedy under any provision of this Lease. However, Tenant shall not be obligated to repair any damage which Landlord is required to repair under Article Seven (Damage or Destruction). In addition,it shall be in Landlord's sole discretion whether or not Tenant shall remove the Tenant Improvements, any alterations, additions or improvements (whether or not made with Landlord's consent) prior to the expiration of the Lease and to restore the Property to its prior condition, all at Tenant's expense. Notwithstanding the foregoing, Tenant may request at the time it seeks Landlord's consent to an alteration, addition or improvement, that Landlord state in writing at the time it grants approval whether or not removal will be required at the expiration of this Lease. Such request shall specifically cite this Lease provision and Landlord's obligation to make such statement. All alterations, additions and improvements which Landlord has not required Tenant to remove shall become Landlord's property and shall be surrendered to Landlord upon the expiration or earlier termination of the Lease, except that Tenant may remove any of Tenant's machinery or equipment which can be removed without material damage to the Property. Tenant shall repair, at Tenant's expense, any damage to the Property caused by the removal of any such machinery or equipment. SEE RIDER SECTION 6.07. ARTICLE SEVEN: DAMAGE OR DESTRUCTION Section 7.01 PARTIAL DAMAGE TO PROPERTY. (a) Tenant shall notify Landlord in writing immediately upon the occurrence of any damage to the Property. If the Property is only partially damaged (i.e., less than fifty percent (50%) of the Property is untenantable as a result of such damage or less than fifty (50%) of Tenant's operations are materially impaired) and if the proceeds received by Landlord from the insurance policies described in Paragraph 4.04(b) are sufficient to pay for the necessary repairs, this Lease shall remain in effect and Landlord shall repair the damage as soon as reasonably possible. Landlord may elect (but is not required) to repair any damage to Tenant's fixtures, equipment, or improvements. Initials: ________________ ________________ 8 (b) If the insurance proceeds received by Landlord are not sufficient to pay the entire cost of repair, or if the cause of the damage is not covered by the insurance policies which Landlord is obligated to maintain under Paragraph 4.04(b). Landlord may elect either to (i) repair the damage as soon as reasonably possible, in which case this Lease shall remain in full force and effect, or (ii) terminate this Lease as of the date the damage occurred. Landlord shall notify Tenant within thirty (30) days after receipt of notice of the occurrence of the damage whether Landlord elects to repair the damage or terminate the Lease. If Landlord elects to repair the damage, Tenant shall pay Landlord the "deductible amount" (if any) but not to exceed Ten Thousand Dollars ($10,000.00) in the aggregate for any one (i) occurrence under Landlord's insurance policies and, if the damage was due to an act or omission of Tenant, or Tenant's employees, agents, contractors or invitees, the difference between the actual cost of repair and any insurance proceeds received by Landlord. If Landlord elects to terminate this Lease, Tenant may elect to continue this Lease in full force and effect, in which case Tenant shall repair any damage to the Property and any building in which the Property is located. Tenant shall pay the cost of such repairs, except that upon satisfactory completion of such repairs, Landlord shall deliver to Tenant any insurance proceeds received by Landlord for the damage repaired by Tenant. Tenant shall give Landlord written notice of such election within ten (10) days after receiving Landlord's termination notice. (c) If the damage to the Property occurs during the last twelve (12) months of the Lease Term and such damage will require more than thirty (30) days to repair, either Landlord or Tenant may elect to terminate this Lease as of the date the damage occurred, regardless of the sufficiency of any insurance proceeds. The party electing to terminate this Lease shall give written notification to the other party of such election within thirty (30) days after Tenant's notice to Landlord of the occurrence of the damage. Section 7.02. SUBSTANTIAL OR TOTAL DESTRUCTION. If the Property is substantially or totally destroyed by any cause whatsoever (i.e., the damage to the Property is greater than partial damage as described in Section 7.01), and regardless of whether Landlord receives any insurance proceeds, this Lease shall terminate the later of (i) the date the destruction occurred, and (ii) the date Tenant ceases to do business at the Property. Notwithstanding the preceding sentence, if the Property can be rebuilt within six (6) months after the date of destruction, Landlord may elect to rebuild the Property at Landlord's own expense, in which case this Lease shall remain in full force and effect. Landlord shall notify Tenant of such election within thirty (30) days after Tenant's notice of the occurrence of total or substantial destruction. If Landlord so elects, Landlord shall rebuild the Property at Landlord's sole expense, except that if the destruction was caused by an act or omission of Tenant, Tenant shall pay Landlord the difference between the actual cost of rebuilding and any insurance proceeds received by Landlord. Section 7.03. TEMPORARY REDUCTION OF RENT. If the Property is destroyed or damaged and Landlord or Tenant repairs or restores the Property pursuant to the provisions of this Article Seven, any rent payable during the period of such damage, repair and/or restoration shall be reduced according to the degree, if any, to which Tenant's use of the Property is impaired. Except for such possible reduction in Base Rent, insurance premiums and real property taxes and other periodic payments. Tenant shall not be entitled to any compensation, reduction, or reimbursement from Landlord as a result of any damage, destruction, repair, or restoration of or to the Property. Section 7.04. WAIVER. Tenant waives the protection of any statute, code or judicial decision which grants a tenant the right to terminate a lease in the event of the substantial or total destruction of the leased property. Tenant agrees that the provisions of Section 7.02 above shall govern the rights and obligations of Landlord and Tenant in the event of any substantial or total destruction to the Property. ARTICLE EIGHT: CONDEMNATION If all or any portion of the Property is taken under the power of eminent domain or sold under the threat of that power (all of which are called "Condemnation"), this Lease shall terminate as to the part taken or sold on the date the condemning authority takes title or possession, whichever occurs first. If more than ten percent (10%) of the floor area of the building in which the Property is located, or which is located on the Property, is taken, either Landlord or Tenant may terminate this Lease as of the date the condemning authority takes title or possession, by delivering written notice to the other within ten (10) days after receipt of written notice of such taking (or in the absence of such notice, within ten (10) days after the condemning authority takes title or possession). If neither Landlord nor Tenant terminates this Lease, this Lease shall remain in effect as to the portion of the Property not taken, except that the Base Rent and Additional Rent shall be reduced in proportion to the reduction in the floor area of the Property. Any Condemnation award or payment shall be distributed in the following order: (a) first, to any ground lessor, mortgagee or beneficiary under a deed of trust encumbering the Property, the amount of its interest in the Property; (b) second, to Tenant, only the amount of any award specifically designated for loss of or damage to Tenant's trade fixtures or removable personal property; and (c) third, to Landlord, the remainder of such award, whether as compensation for reduction in the value of the leasehold, the taking of the fee, or otherwise. If this Lease is not terminated, Landlord shall repair any damage to the Property caused by the Condemnation, except that Landlord shall not obligated to repair any damage for which Tenant has been reimbursed by the condemning authority. If the severance damages received by Landlord are not sufficient to pay for such repair, Landlord shall have the right to either terminate this Lease or make such repair at Landlord's expense. Initials: _______________ _______________ 9 ARTICLE NINE: ASSIGNMENT AND SUBLETTING Section 9.01. LANDLORD'S CONSENT REQUIRED. No portion of the Property or of Tenant's interest in this Lease may be acquired by any other person or entity, whether by sale, assignment, mortgage, sublease, transfer, operation of law, or act of Tenant, without Landlord's prior written consent, except as provided in Section 9.02 below. Landlord has the right to grant or withhold its consent as provided in Section 9.05 below. Any attempted transfer without consent shall be void and shall constitute a non-curable breach of this Lease. If Tenant is a partnership, any cumulative transfer of more than twenty percent (20%) of the partnership interests shall require Landlord's consent. Section 9.02. TENANT AFFILIATE. Tenant may assign this Lease or sublease the Property, without Landlord's consent, to any corporation which controls, is controlled by or is under common control with Tenant, or to any corporation resulting from the merger of or consolidation with Tenant or from a sale of substantially all of the stock or assets of Tenant ("Tenant's Affiliate"). In such case, any Tenant's Affiliate shall assume in writing all of Tenant's obligations under this Lease. Section 9.03. NO RELEASE OF TENANT. No transfer permitted by this Article Nine, whether with or without Landlord's consent, shall release Tenant or change Tenant's Primary liability to pay the rent and to perform all other obligations of Tenant under this Lease. Landlord's acceptance of rent from any other person is not a waiver of any provision of this Article Nine. Consent to one transfer is not a consent to any subsequent transfer. If Tenant's transferee defaults under this Lease, Landlord may proceed directly against Tenant without pursuing remedies against the transferee. Landlord may consent to subsequent assignments or modifications of this Lease by Tenant's transferee, without notifying Tenant or obtaining its consent. Such action shall not relieve Tenant's liability under this Lease. Section 9.05. LANDLORD'S CONSENT. (a) Tenant's request for consent to any transfer described in Section 9.01 shall set forth in writing the details of the proposed transfer, including the name, business and financial condition of the prospective transferee, financial details of the proposed transfer (e.g., the term of and the rent and security deposit payable under any proposed assignment or sublease), and any other information Landlord deems relevant. Landlord shall have the right to terminate this Lease or to withhold consent, if reasonable, or to grant consent, based on the following factors: (i) the business of the proposed assignee or subtenant and the proposed use of the Property; (ii) the financial worth and/or financial stability of the proposed assignee or subtenant in light of the responsibilities to be undertaken in connection with the assignment or sublease on the date the consent is requested; (iii) Tenant's compliance with all of its obligations under this Lease; and (iv) such other factors as Landlord may reasonably deem relevant. If Landlord objects to a proposed assignment solely because of the net worth and/or financial reputation of the proposed assignee, Tenant may nonetheless sublease (but not assign), all or a portion of the Property to the proposed transferee, but only on the other terms of the proposed transfer. (b) If Tenant assigns or subleases, the following shall apply: (i) Tenant shall pay to Landlord as Additional Rent under the Lease the Landlord's Share (stated in Section 1.13) of the Profit (defined below) on such transaction as and when received by Tenant, unless Landlord gives written notice to Tenant and the assignee or subtenant that Landlord's Share shall be paid by the assignee or subtenant to Landlord directly. The "Profit" means (A) all amounts paid to Tenant for such assignment or sublease, including "key" money, monthly rent in excess of the monthly rent payable under the Lease, and all fees and other consideration paid for the assignment or sublease, including fees under any collateral agreements, less (B) costs and expenses directly incurred by Tenant in connection with the execution and performance of such assignment or sublease for real estate broker's commissions and costs of renovation or construction of tenant improvements required under such assignment or sublease. Tenant is entitled to recover such costs and expenses before Tenant is obligated to pay the Landlord's Share to Landlord. The Profit in the case of a sublease of less than all the Property is the rent allocable to the subleased space as a percentage on a square footage basis. (ii) Tenant shall provide Landlord a written statement certifying all amounts to be paid from any assignment or sublease of the Property within thirty (30) days after the transaction documentation is signed, and Landlord may inspect Tenant's books and records to verify the accuracy of such statement. On written request, Tenant shall promptly furnish to Landlord copies of all the transaction documentation, all of which shall be certified by Tenant to be complete, true and correct. Landlord's receipt of Landlord's Share shall not be a consent to any further assignment or subletting. The breach of Tenant's obligation under this Paragraph 9.05(b) shall be a material default of the Lease. (c) See Rider Section 9.05(c) Section 9.06. NO MERGER. No merger shall result from Tenant's sublease of the Property under this Article Nine, Tenant's surrender of this Lease or the termination of this Lease in any other manner. In any such event, Landlord may terminate any or all subtenancies or succeed to the interest of Tenant as sublandlord under any or all subtenancies. Initials: __________________ __________________ 10 ARTICLE TEN: DEFAULTS; REMEDIES Section 10.01. COVENANTS AND CONDITIONS. Tenant's performance of each of Tenant's obligations under this Lease is a condition as well as a covenant. Tenant's right to continue in possession of the Property is conditioned upon such performance. Time is of the essence in the performance of all covenants and conditions. Section 10.02 DEFAULTS. Tenant shall be in material default under this Lease: (a) If Tenant abandons the Property and rent payments are discontinued, or if Tenant's vacation of the Property results in the cancellation of any insurance described in Section 4.04; (b) If Tenant fails to pay rent or any other charge when due; See Rider Section 10.02 (b) (c) If Tenant fails to perform any of Tenant's non-monetary obligations under this Lease for a period of thirty (30) days after written notice from Landlord; provided that if more than thirty (30) days are required to complete such performance, Tenant shall not be in default if Tenant commences such performance within the thirty (30) -day period and thereafter diligently pursues its completion. However, Landlord shall not be required to give such notice if it is physically impossible for Tenant to cure a breach of this Lease. The notice required by this Article 10 is intended to satisfy any and all notice requirements imposed by law on Landlord and is not in addition to any such requirement. (d) (i) If Tenant makes a general assignment or general arrangement for the benefit of creditors; (ii) if a petition for adjudication of bankruptcy or for reorganization or rearrangement is filed by or against Tenant and is not dismissed within thirty (30) days; (iii) if a trustee or receiver is appointed to take possession of substantially all of Tenant's assets located at the Property or of Tenant's interest in this Lease and possession is not restored to Tenant within sixty (60) days; or (iv) if substantially all of Tenant's assets located at the Property or of Tenant's interest in this Lease is subjected to attachment, execution or other judicial seizure which is not discharged within thirty (30) days. If a court of competent jurisdiction determines that any of the acts described in this subparagraph (d) is not a default under this Lease, and a trustee is appointed to take possession (or if Tenant remains a debtor in possession) and such trustee or Tenant transfers Tenant's interest hereunder, then Landlord shall receive, as Additional Rent, the excess, if any, of the rent (or any other consideration) paid in connection with such assignment or sublease over the rent payable by Tenant under this Lease. (e) If any guarantor of the Lease revokes or otherwise terminates, or purports to revoke or otherwise terminate, any guaranty of all or any portion of Tenant's obligations under the Lease. Unless otherwise expressly provided, no guaranty of the Lease is revocable. Section 10.03. REMEDIES. On the occurrence of any material default by Tenant, Landlord may, at any time thereafter, with or without notice or demand and without limiting Landlord in the exercise of any right or remedy which Landlord may have: (a) Terminate Tenant's right to possession of the Property by any lawful means, in which case this Lease shall terminate and Tenant shall immediately surrender possession of the Property to Landlord. If Tenant shall be served with a demand for the payment of past due rent or any other charge, any payments rendered thereafter to cure any default by Tenant shall be made only by cashier's check. In such event, Landlord shall be entitled to recover from Tenant all damages incurred by Landlord by reason of Tenant's default, including (i) the worth at the time of the award of the unpaid Base Rent, Additional Rent and other charges which Landlord had earned at the time of the termination; (ii) the worth at the time of the award of the amount by which the unpaid Base Rent, Additional Rent and other charges which Landlord would have earned after termination until the time of the award exceeds the amount of such rental loss that Tenant proves Landlord could have reasonably avoided; (iii) the worth at the time of the award of the amount by which the unpaid Base Rent, Additional Rent and other charges which Tenant would have paid for the balance of the Lease term after the time of award exceeds the amount of such rental loss that Tenant proves Landlord could have reasonably avoided; and (iv) any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under the Lease or which in the ordinary course of things would be likely to result therefrom, including, but not limited to, any costs or expenses Landlord incurs in maintaining or preserving the Property after such default, the cost of recovering possession of the Property, expenses of reletting, including necessary renovation or alteration of the Property, Landlord's reasonable attorneys' fees incurred in connection therewith, and any real estate commission paid or payable. As used in subparts (i) and (ii) above, the "worth at the time of the award" is computed by allowing interest on unpaid amounts at the rate of fifteen percent (15%) per annum, or such lesser amount as may then be the maximum lawful rate. As used in subpart (iii) above, the "worth at the time of the award" is computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of the award, plus one percent (1%). If Tenant has abandoned the Property, Landlord shall have the option of (i) retaking possession of the Property and recovering from Tenant the amount specified in this Paragraph 10.03(a) or (iii) proceeding under Paragraph 10.03(b). (b) Maintain Tenant's right to possession, in which case this Lease shall continue in effect whether or not Tenant has abandoned the Property. In such event, Landlord shall be entitled to enforce all of Landlord's rights and remedies under this Lease, including the right to recover the rent as it becomes due; Landlord shall have the remedy described in California Civil Code Section 1951.4 (lessor may continue lease in effect after lessee's breach and abandonment and recover rent as it becomes due, if lessee has the right to sublet or assign, subject only to reasonable limitations); (c) Pursue any other remedy now or hereafter available to Landlord under the laws or judicial decisions of the state in which the Property is located. Initials: _________________ _________________ 11 Section 10.04. REPAYMENT OF "FREE" RENT. If this Lease provides for a postponement of any monthly rental payments, a period of "free" rent or other rent concession, such postponed rent or "free" rent is called the "Abated Rent". Tenant shall be credited with having paid all of the Abated Rent on the expiration of the Lease Term only if Tenant has fully, faithfully, and punctually performed all of Tenant's obligations hereunder, including the payment of all rent (other than the Abated Rent) and all other monetary obligations and the surrender of the Property in the physical condition required by this Lease. Tenant acknowledges that its right to receive credit for the Abated Rent is absolutely conditioned upon Tenant's full, faithful and punctual performance of its obligations under this Lease. If Tenant defaults and does not cure within any applicable grace period, or within three (3) days after written notice from Landlord if no grace period applies the Abated Rent shall immediately become due and payable in full and this Lease shall be enforced as if there were no such rent abatement or other rent concession. In such case Abated Rent shall be calculated based on the full initial rent payable under this Lease. Section 10.05. AUTOMATIC TERMINATION. Notwithstanding any other term or provision hereof to the contrary, the Lease shall terminate on the occurrence of any act which affirms the Landlord's intention to terminate the Lease as provided in Section 10.03 hereof, including the filing of an unlawful detainer action against Tenant. On such termination, Landlord's damages for default shall include all costs and fees, including reasonable attorneys' fees that Landlord incurs in connection with the filing, commencement, pursuing and/or defending of any action in any bankruptcy court or other court with respect to the Lease; the obtaining of relief from any stay in bankruptcy restraining any action to evict Tenant; or the pursuing of any action with respect to Landlord's right to possession of the Property. All such damages suffered (apart from Base Rent and other rent payable hereunder) shall constitute pecuniary damages which must be reimbursed to Landlord prior to assumption of the Lease by Tenant or any successor to Tenant in any bankruptcy or other proceeding. Section 10.06. CUMULATIVE REMEDIES. Landlord's exercise of any right or remedy shall not prevent it from exercising any other right or remedy. ARTICLE ELEVEN: PROTECTION OF LENDERS Section 11.01. SUBORDINATION. Landlord shall have the right to subordinate this Lease to any ground lease, deed of trust or mortgage encumbering the Property, any advances made on the security thereof and any renewals, modifications, consolidations, replacements or extensions thereof, whenever made or recorded. Tenant shall cooperate with Landlord and any lender which is acquiring a security interest in the Property or the Lease. Tenant shall execute such further documents and assurances as such lender may require, in: the form attached hereto as Exhibit "B" or such other form as is then required by Landlord's lender, provided that Tenant's obligations under this Lease shall not be increased in any material way (the performance of ministerial acts shall not be deemed material), and Tenant shall not be deprived of its rights under this Lease. Tenant's right to quiet possession of the Property during the Lease Term shall not be disturbed if Tenant pays the rent and performs all of Tenant's obligations under this Lease and is not otherwise in default Landlord shall use commercially reasonable efforts to provide Tenant with a nondisturbance agreement in a commercially reasonable form from Landlord's presently existing lender. If any ground lessor, beneficiary or mortgagee elects to have this Lease prior to the lien of its ground lease, deed of trust or mortgage and gives written notice thereof to Tenant, this Lease shall be deemed prior to such ground lease, deed of trust or mortgage whether this Lease is dated prior or subsequent to the date of said ground lease, deed of trust or mortgage or the date of recording thereof. Tenant waives the provisions of any current or future statute, rule or law which may give or purport to give Tenant any right or election to terminate or otherwise adversely affect this Lease and the obligations of the Tenant hereunder in the event of any foreclosure proceeding or sale. Section 11.02. ATTORNMENT. If Landlord's interest in the Property is acquired by any ground lessor, beneficiary under a deed of trust, mortgagee, or purchaser at a foreclosure sale. Tenant shall attorn to the transferee of or successor to Landlord's interest in the Property and recognize such transferee or successor as Landlord under this Lease. Tenant waives the protection of any statute or rule of law which gives or purports to give Tenant any right to terminate this Lease or surrender possession of the Property upon the transfer of Landlord's interest. Section 11.03. SIGNING OF DOCUMENTS. Tenant shall sign and deliver any instrument or documents necessary or appropriate to evidence any such attornment or subordination or agreement to do so. If Tenant fails to do so within ten (10) days after written request the contents of the document shall be deemed true and enforceable against Tenant, and third parties may rely thereon. Section 11.04. ESTOPPEL CERTIFICATES. (a) Upon Landlord's written request. Tenant shall execute, acknowledge and deliver to Landlord a written statement in the form attached hereto as Exhibit "C" or such other commercially reasonable form as is then required by Landlord's lender, certifying: (i) that none of the terms or provisions of this Lease have been changed (or if they have been changed, stating how they have been changed); (ii) that this Lease has not been cancelled or terminated; (iii) the last date of payment of the Base Rent and other charges and the time period covered by such payment; (iv) that Landlord is not default under this Lease (or, if Landlord is claimed to be in default, stating why); and (v) such other representations or information with respect to Tenant or the Lease as Landlord may reasonably request or which any prospective purchaser or encumbrancer of the Property may require. Tenant shall deliver such statement to Landlord within twenty (20) days after Landlord's request. Landlord may give any such statement by Tenant to any prospective purchaser or encumbrancer of the Property. Such purchaser or encumbracer may rely conclusively upon such statement as true and correct. (b) If Tenant does not deliver such statement to Landlord within such ten (10)-day period, Landlord, and any prospective purchaser or encumbrancer, may conclusively presume and rely upon the following facts: (i) that the terms and provisions of this Lease have not been changed except as otherwise represented by Landlord; (ii) that this Lease has not been cancelled or terminated except as otherwise represented by Landlord; (iii) that not more than one month's Base Rent or other charges have been paid in advance; and (iv) that Landlord is not in default under the Lease. In such event, Tenant shall be estopped from denying the truth of such facts. Initials ___________________ ___________________ 12 Section 11.05. TENANT'S FINANCIAL CONDITION. Within ten (10) days after written request from Landlord. Tenant shall deliver to Landlord such financial statements as Landlord reasonably requires to verify the net worth of Tenant or any assignee, subtenant, or guarantor of Tenant. In addition, Tenant shall deliver to any lender designated by Landlord any financial statements required by such lender to facilitate the financing or refinancing of the Property. Tenant represents and warrants to Landlord that each such financial statement is a true and accurate statement as of the date of such statement. All financial statements shall be confidential and shall be used only for the purpose set forth in this Lease. SEE RIDER SECTION 11.05 ARTICLE TWELVE: LEGAL COSTS Section 12.01. LEGAL PROCEEDINGS. If Tenant or Landlord shall be in breach or default under this Lease, such party (the "Defaulting Party") shall reimburse the other party (the "Nondefaulting Party") upon demand for any costs or expenses that the Nondefaulting Party incurs in connection with any breach or default of the Defaulting Party under this Lease, whether or not suit is commenced or judgement entered. Such costs shall include legal fees and costs incurred for the negotiation of a settlement, enforcement of rights or otherwise. Furthermore, if any action for breach of or to enforce the provisions of this Lease is commenced, the court in such action shall award to the party in whose favor a judgement is entered, a reasonable sum as attorneys' fees and cost. The losing party in such action shall pay such attorneys' fees and costs. Tenant shall also indemnify Landlord against and hold Landlord harmless from all cost, expenses, demands and liability Landlord may incur if Landlord becomes or is made a party to any claim or action (a) instituted by Tenant against any third party, or by any third party against Tenant, or by or against any person holding any interest under or using the Property by license of or agreement with Tenant; (b) for foreclosure of any lien for labor or material furnished to or for Tenant or such other person; (c) otherwise arising out of or resulting from any act or transaction of Tenant or such other person; or (d) necessary to protect Landlord's interest under this Lease in a bankruptcy proceeding, or other proceeding under Title 11 of the United States Code, as amended. Tenant shall defend Landlord against any such claim or action at Tenant's expense with counsel reasonably acceptable to Landlord or, at Landlord's election, Tenant shall reimburse Landlord for any legal fees or costs Landlord incurs in any such claim or action. Section 12.02. LANDLORD'S CONSENT. Tenants shall pay Landlord's reasonable attorneys' fees incurred in connection with Tenant's request for Landlord's consent under Article Nine (Assignment and Subletting), or in connection with any other act which Tenant proposes to do and which requires Landlord's consent. ARTICLE THIRTEEN: MISCELLANEOUS PROVISIONS Section 13.01. NON-DISCRIMINATION. Tenant promises, and it is a condition to the continuance of this Lease, that there will be no discrimination against, or segregation of, any person or group of persons on the basis of race, color, sex, creed, national origin or ancestry in the leasing, subleasing, transferring, occupancy, tenure or use of the Property or any portion thereof. Section 13.02. LANDLORD'S LIABILITY; CERTAIN DUTIES. (a) As used in this Lease, the term "Landlord" means only the current owner or owners of the fee title to the Property or Project or the leasehold estate under a ground lease of the Property or Project at the time in question. Each Landlord is obligated to perform the obligations of Landlord under this Lease only during the time such Landlord owns such interest or title. Any Landlord who transfers its title or interest is relieved of all liability, provided that transferee assumes such liability, with respect to the obligations of Landlord under this Lease to be performed on or after the date of transfer. However, each Landlord shall deliver to its transferee all funds that Tenant previously paid if such funds have not yet been applied under the terms of this Lease. (b) Tenant shall give written notice of any failure by Landlord to perform any of its obligations under this Lease to Landlord and to any ground lessor, mortgagee or beneficiary under any deed of trust encumbering the Property whose name and address have been furnished to Tenant in writing. Landlord shall not be in default under this Lease unless Landlord (or such ground lessor, mortgagee or beneficiary) fails to cure such non-performance within thirty (30) days after receipt of Tenant's notice. However, if such non-performance reasonably requires more than thirty (30) days to cure, Landlord shall not be in default if such cure is commenced within such thirty (30) -day period and thereafter diligently pursued to completion. (c) Notwithstanding any term or provision herein to the contrary, the liability of Landlord for the performance of its duties and obligations under this Lease is limited to Landlord's interest in the Property and the Project and all rents, profits and issues therefrom and neither the landlord nor its partners, shareholders, officers or other principals shall have any personal liability under the Lease. Section 13.03. SEVERABILITY. A determination by a court of competent jurisdiction that any provisions of this Lease or any part thereof is illegal or unenforceable shall not cancel or invalidate the remainder of such provision or this Lease, which shall remain in full force and effect. Section 13.04 INTERPRETATION. The captions of the Articles or Sections of this Lease are to assist the parties in reading this Lease and are not a part of the terms or provisions of this Lease. Whenever required by the context of this Lease, the singular shall include the plural and the plural shall include the singular. The masculine, feminine and neuter genders shall each include the other. In any provision relating to the conduct, acts or omissions of Tenant, the term "Tenant" shall include Tenant's agents, employees, contractors, invitees, successors or others using the Property with Tenant's expressed or implied permission. Initials: __________________ __________________ 13 Section 13.05. INCORPORATION OF PRIOR AGREEMENTS; MODIFICATIONS. This Lease is the only agreement between the parties pertaining to the lease of the Property and no other agreements are effective. All amendments to this Lease shall be in writing and signed by all parties. Any other attempted amendment shall be void. Section 13.06. NOTICES. All notices required or permitted under this Lease shall be in writing and shall not be personally delivered or sent by certified mail, return receipt requested, postage prepaid. Notices to Tenant shall be delivered to the address specified in Section 1.03 above, except that upon Tenant's taking possession of the Property, the Property shall be Tenant's address for notice purposes. Notices to Landlord shall be delivered to the address specified in Section 1.02 above. All notices shall be effective upon delivery. Either party may change its notice address upon written notice to the other party. See Rider Section 13.06 Section 13.07. WAIVERS. All waivers must be in writing and signed by the waiving party. Landlord's failure to enforce any provision of this Lease or its acceptance of rent shall not be a waiver and shall not prevent Landlord from enforcing that provision or any other provision of this Lease in the future. No statement on a payment check from Tenant or in a letter accompanying a payment check shall be binding on Landlord. Landlord may, with or without notice to Tenant, negotiate such check without being bound to the conditions of such statement. Section 13.08. NO RECORDATION. Tenant shall not record this Lease without prior written consent from Landlord. However, either Landlord or Tenant may require that a "Short Form" memorandum of this Lease executed by both parties be recorded. The party requiring such recording shall pay all transfer taxes and recording fees. Section 13.09. BINDING EFFECT; CHOICE OF LAW. This Lease binds any party who legally acquires any rights or interest in this Lease from Landlord or Tenant. However, Landlord shall have no obligation to Tenant's successor unless the rights or interests of Tenant's successor are acquired in accordance with the terms of this Lease. The laws of the state in which the Property is located shall govern this Lease. Section 13.10. CORPORATE AUTHORITY; PARTNERSHIP AUTHORITY; If Tenant is a corporation, each person signing this Lease on behalf of Tenant represents and warrants that he has full authority to do so and that this Lease binds the corporation. Within thirty (30) days after this Lease is signed, Tenant shall deliver to Landlord a copy of a general authorizing resolution of Tenant's Board of Directors authorizing the execution of leases and agreements or other evidence of such authority reasonably acceptable to Landlord. If Tenant is a partnership, each person or entity signing this Lease for Tenant represents and warrants that he or it is a general partner of the partnership, that he or it has full authority to sign for the partnership and that this Lease binds the partnership and all general partners of the partnership. Tenant shall give written notice to Landlord of any general partner's withdrawal or addition. Within thirty (30) days after this Lease is signed, Tenant shall deliver to Landlord a copy of Tenant's recorded statement of partnership or certificate of limited partnership. Section 13.11. JOINT AND SEVERAL LIABILITY. All parties signing this Lease as Tenant shall be jointly and severally liable for all obligations of Tenant. Section 13.12. FORCE MAJEURE. If Landlord or Tenant cannot perform any of its obligations due to events beyond such applicable party's control except with respect to rent obligation to be paid by Tenant pursuant to this Lease the time provided for performing such obligations shall be extended by a period of time equal to the duration of such events. Events beyond Landlord's or Tenant's control include, but are not limited to, acts of God, war, civil commotion, labor disputes, strikes, fire, flood or other casualty, shortages of labor or material, government regulation or restriction and weather conditions. Section 3.13. EXECUTION OF LEASE. This Lease may be executed in counterparts and, when all counterpart documents are executed, the counterparts shall constitute a single binding instrument. Landlord's delivery of this Lease to Tenant shall not be deemed to be an offer to lease and shall be binding upon either party until executed and delivered by both parties. Section 13.14. SURVIVAL. All representations and warranties of Landlord and Tenant shall survive the termination of this Lease. ARTICLE FOURTEEN: BROKERS Section 14.01. BROKER'S FEE. When this Lease is signed by and delivered to both Landlord and Tenant. Landlord shall pay a real estate commission to Tenant's Broker pursuant to a separate agreement executed between Landlord and Tenant's Broker prior to lease execution Landlord's Broker named in Section 1.08 above, if any, as provided in the written agreement between Landlord and Landlord's Broker, or the sum stated in Section 1.09 above for services rendered to Landlord by Landlord's Broker in this transaction. Landlord shall pay Landlord's Broker a commission if Tenant exercises any option to extend the Lease Term or to buy the Property, or any similar option or right which Landlord may grant to Tenant, or if Landlord's Broker is the procuring cause of any other lease or sale entered into between Landlord and Tenant covering the Property. Such commission shall be the amount set forth in Landlord's Broker's commission schedule in effect as of the execution of this Lease. If a Tenant's Broker is named in Section 1.08 above, Landlord's Broker shall pay an appropriate portion of its commission to Tenant's Broker if so provided in any agreement between Landlord's Broker and Tenant's Broker. Nothing contained in this Lease shall impose any obligation on Landlord to pay a commission or fee to any party other than Landlord's Broker and Tenant's Broker. Section 14.02. Protection of brokers. If Landlord sells the Property, or assigns Landlord's interest in this Lease, the buyer or assignee shall, by accepting such conveyance of the Property or assignment of the Lease, be conclusively deemed to have agreed to make all payments to Landlord's Broker thereafter required of Landlord under this Article Fourteen. Landlord's Broker and Tenant's Broker shall have the right to bring a legal action to enforce or declare rights under this provision. The prevailing party in such action shall be entitled to reasonable attorneys' fees to be paid by the losing party. Such attorneys' fees shall be fixed by the court in such action. This Paragraph is included in this Lease for the benefit of Landlord's Broker and Tenant's Broker. Initials: ________________ ________________ 14 Section 14.03 BROKER'S DISCLOSURE OF AGENCY. Landlord's Broker hereby discloses to Landlord and Tenant and Landlord and Tenant hereby consent to Landlord's Broker acting in this transaction as the agent of (check one): xx Landlord exclusively or -- [ ] both Landlord and Tenant. Section 14.04. NO OTHER BROKERS. Tenant represents and warrants to Landlord that the brokers named in Section 1.08 above are the only agents, brokers, finders or other parties with whom Tenant has dealt and Tenant has no knowledge of any other brokers who are or may be entitled to any commission or fee with respect to this Lease or the Property. ADDITIONAL PROVISIONS MAY BE SET FORTH IN A RIDER OR RIDERS ATTACHED HERETO OR IN THE BLANK SPACE BELOW. IF NO ADDITIONAL PROVISIONS ARE INSERTED, PLEASE DRAW A LINE THROUGH THE SPACE BELOW. Landlord and Tenant have signed this Lease at the place and on the dates specified adjacent to their signatures below and have initialled all Riders which are attached to or incorporated by reference in this Lease. "LANDLORD" Signed on ------------, 19---- MAJESTIC REALTY CO., A California corporation at---------------------------- By:/s/ [SIGNATURE ILLEGIBLE]^^ --------------------------- Its:__________________________ By:/s/ [SIGNATURE ILLEGIBLE]^^ --------------------------- PATRICIAN ASSOCIATES, INC., a California corporation By: /s/ Jon M Jacobson -------------------------- Its: Vice President ------------------------- By:/s/[SIGNATURE ILLEGIBLE]^^ --------------------------- Its: Vice President ------------------------ "TENANT" Signed on December 21, 1998 HOT TOPIC ADMINISTRATION, INC., a California -------------------- corporation at Pomane, California By: /s/ ORVAL MADDEN --------------------------- ------------------------------- Its: ORVAL MADDEN, PRESIDENT ------------------------------- By: MARC R BERTONE ------------------------------- Its: MARC R. BERTONE VICE PRESIDENT ------------------------------ IN ANY REAL ESTATE TRANSACTION, IT IS RECOMMENDED THAT YOU CONSULT WITH A PROFESSIONAL, SUCH AS A CIVIL ENGINEER, INDUSTRIAL HYGIENIST OR OTHER PERSON WITH EXPERIENCE IN EVALUATING THE CONDITION OF THE PROPERTY, INCLUDING THE POSSIBLE PRESENCE OF ASBESTOS, HAZARDOUS MATERIALS AND UNDERGROUND STORAGE TANKS. THIS PRINTED FORM LEASE HAS BEEN DRAFTED BY LEGAL COUNSEL AT THE DIRECTION OF THE SOUTHERN CALIFORNIA CHAPTER OF THE SOCIETY OF INDUSTRIAL AND OFFICE REALTORS,(R) INC. NO REPRESENTATION OR RECOMMENDATION IS MADE BY THE SOUTHERN CALIFORNIA CHAPTER OF THE SOCIETY OF INDUSTRIAL AND OFFICE REALTORS, (R) INC., ITS LEGAL COUNSEL, THE REAL ESTATE BROKERS NAMED HEREIN, OR THEIR EMPLOYEES OR AGENTS, AS TO THE LEGAL SUFFICIENCY, LEGAL EFFECT OR TAX CONSEQUENCES OF THIS LEASE OR OF THIS TRANSACTION. LANDLORD AND TENANT SHOULD RETAIN LEGAL COUNSEL TO ADVISE THEM ON SUCH MATTERS AND SHOULD RELY UPON THE ADVICE OF SUCH LEGAL COUNSEL. Initials: _________________ _________________ 15 [LOGO OF SIOR APPEARS HERE] OPTION TO EXTEND TERM LEASE RIDER This Rider is attached to and made part of that certain Lease (the "Lease") dated September 8, 1998 between Majestic Realty Co. and Patrician Associates, Inc., both California corporations as Landlord, and Hot Topic Administration, Inc., a California Corporation, as Tenant, covering the Property commonly known as 18305 E. San Jose Avenue, City of Industry, California (the "Property"). The terms used herein shall have the same definitions as set forth in the Lease. The provisions of this Rider shall supersede any inconsistent or conflicting provisions of the Lease. A. Option(s) to Extend Term. 1. Landlord hereby grants to Tenant two (2) option(s) (the "Option(s)") to extend the Lease Term for additional term(s) of three (3) years each (the "Extension(s)"), on the same terms and conditions as set forth in the Lease, but at an increased rent as set forth below. Each Option shall be exercised only by written notice delivered to Landlord at least one hundred eighty (180) days before the expiration of the Lease Term or the preceding Extension of the Lease Term, respectively. If Tenant fails to deliver Landlord written notice of the exercise of an Option within the prescribed time period, such Option and any succeeding Options shall lapse, and there shall be no further right to extend the Lease Term. Each Option shall be exercisable by Tenant on the express conditions that (a) at the time of the exercise, and at all times prior to the commencement of such Extension, Tenant shall not be in default under any of the provisions of this Lease and (b) Tenant has not been ten (10) or more days late in the payment of rent more than a total of two (2) times during a twelve (12) month period. 2. PERSONAL OPTIONS. The Option(s) are personal to the Tenant named in Section 1.03 of the Lease or any Tenant's Affiliate described in Section 9.02 of the Lease. If Tenant subleases any portion of the Property or assigns or otherwise transfers any interest under the Lease to an entity other than a Tenant Affiliate prior to the exercise of an Option (whether with or without Landlord's consent), such Option and any succeeding Options shall lapse. If Tenant subleases any portion of the Property or assigns or otherwise transfers any interest of Tenant under the Lease to an entity other than a Tenant Affiliate after the exercise of an Option but prior to the commencement of the respective Extension (whether with or without Landlord's consent), such Option and any succeeding Options shall lapse and the Lease Term shall expire as if such Option were not exercised. If Tenant subleases any portion of the Property or assigns or otherwise transfers any interest of Tenant under the Lease in accordance with Article 9 of the Lease after the exercise of an Option and after the commencement of the Extension related to such Option, then the term of the Lease shall expire upon the expiration of the Extension during which such sublease or transfer occurred and only the succeeding Options shall lapse. B. CALCULATION OF RENT. The Base Rent during the Extension(s) shall be determined by one or a combination of the following methods (INDICATE YOUR CHOICE UPON EXECUTION OF THE LEASE): 2. Fair Rental Value Adjustment (Section B(2), below) [XX] Initials: ______________ ______________ 2. FAIR RENTAL VALUE ADJUSTMENT. The Base Rent shall be increased on the first day of the first month(s) of the first and second Extension(s) of the Lease Term (the "Rental Adjustment Date(s)") to the "fair rental value" of the Property, determined in the following manner: (a) Not later than one hundred (100) days prior to any applicable Rental Adjustment Date, Landlord and Tenant shall meet in an effort to negotiate in good faith, the fair rental value of the Property as of such Rental Adjustment Date. If Landlord and Tenant have not agreed upon the fair rental value of the Property at least ninety (90) days prior to the applicable Rental Adjustment Date, the fair rental value shall be determined by appraisal, as follows (INDICATE YOUR CHOICE UPON EXECUTION OF THE LEASE): Appraisal by Brokers.[XX] (b) If Landlord and Tenant are not able to agree upon the fair rental value of the Property within the prescribed time period, then Landlord and Tenant shall attempt to agree in good faith upon a single appraiser or broker, as indicated above, not later than seventy-five (75) days prior the applicable Rental Adjustment Date. If Landlord and Tenant are unable to agree upon a single appraiser/broker within such time period, then Landlord and Tenant shall each appoint one appraiser or broker, as indicated above, not later than sixty- five (65) days prior to the applicable Rental Adjustment bate. Within (10) days thereafter, the two appointed appraisers/brokers shall appoint a third appraiser or broker, as indicated above. If either Landlord or Tenant fails to appoint its appraiser/broker- within the prescribed time period, -the single appraiser/broker appointed shall determine the fair rental value of the Property. If both parties fail to appoint appraisers/brokers within the prescribed time periods, then the first appraiser/broker thereafter selected by a party shall determine the fair rental value of the Property. Each party shall bear the cost of its own appraiser or broker and the parties shall share equally the cost of the single or third appraiser or broker, if applicable. If appraisers are used, such appraisers shall have at least five (5) years' experience in the appraisal of commercial/industrial real property in the area in which the Property is located and shall be members of professional organizations such as MAI or equivalent. If brokers are used, such brokers shall have at least five (5) years' experience in the sales and leasing of commercial/industrial real property in the area in which the Property is located and shall be members of professional organizations such as the Society of Industrial Realtors or equivalent. (c) For the purposes of such appraisal, the term "fair market value" shall mean the price that a ready and willing tenant would pay, as of the applicable Rental Adjustment Date, as monthly rent to a ready and willing landlord of property comparable to the Property if such property were exposed for lease on the open market for a reasonable period of time and taking into account all of the purposes for which such property may be used. If a single appraiser/broker is chosen, then such appraiser/broker shall determine the fair rental value of the Property. Otherwise, the fair rental value of the Property shall be the arithmetic average of the two (2) of the three (3) appraisals which are closest in amount, and the third appraisal shall be disregarded. In no event, however, shall the Base Rent be reduced by reason of such computation. Landlord and Tenant shall instruct the appraiser(s)/broker(s) to complete their determination of the fair rental value not later than thirty (30) days prior to the applicable Rental Adjustment Date. If the fair rental value is not determined prior to the applicable Rental Adjustment Date, then Tenant shall continue to pay to Landlord the Base Rent applicable to the Property immediately prior to such Extension, until the fair rental value is determined. When the fair rental value of the Property is determined, Landlord shall deliver notice thereof to Tenant, and Tenant shall pay to Landlord, within (10) days after receipt of such notice, the' difference between the Base Rent actually paid by Tenant to Landlord and the new Base Rent determined hereunder. Initials: ______________ ______________ RIDER TO INDUSTRIAL REAL ESTATE LEASE ------------------------------------- This Rider ("RIDER") is made and entered into by MAJESTIC REALTY CO. and PATRICIAN ASSOCIATES, INC., both California corporations (collectively, "LANDLORD") and HOT TOPIC ADMINISTRATION, INC., a California corporation ("TENANT"), and is dated as of the date set forth on Section 1.01 of the Industrial Real Estate Lease between Landlord and Tenant ("LEASE") to which this Rider is attached. The promises, covenants, agreements and declarations made and set forth herein are intended to and shall have the same force and effect as if set forth at length in the body of the Lease. To the extent that the provisions of this Rider are inconsistent with the terms and conditions of the Lease, the terms and conditions of this Rider shall control. SECTION 2.05 TENANT'S ENTRY INTO THE PROPERTY PRIOR TO COMMENCEMENT DATE: ----------------------------------------------------------- Tenant shall have the right to access of the Property as of February 1, 1999 ("Early ENTRY DATE") for the purpose of installing and/or storing over standard equipment or fixtures and preparing the Property for Tenant's use; provided that: (i) this Lease has been fully executed and delivered; (ii) Landlord has received the Security Deposit and third month's Base Rent; (iii) the previous tenant of the Property's lease has expired and/or terminated and such tenant has vacated the Property; (iv) Tenant and its agents do not interfere with "Landlord's Work", as that term is defined in Section 6.07 of ------------ this Lease; (v) Tenant has obtained its insurance policies as set forth in Section 4.04 of this Lease and Landlord is in receipt of Tenant's insurance binder naming Landlord as additional insured; and (vi) all of the terms and conditions of this Lease shall apply, other than Tenant's obligation to pay (a) Base Rent, (b) Landlord's insurance premiums set forth in Section 4.04, (c) ------------ Landlord's "real property tax", (d) "Landscape Fee," as that term is defined in Article 11 of this Lease and (e) Common Area costs which are not the result of - ---------- Tenant's actions or omissions during this early entry period or Tenant Improvements, as though the Commencement Date had occurred (although the Commencement Date shall not actually occur until the occurrence of the same pursuant to the terms of the third sentence of Section 2.01) upon such entry ------------ into the Property by Tenant. Tenant shall be responsible for payment of utilities during this early entry period. Tenant shall hold Landlord harmless from and indemnify, protect and defend Landlord against any loss or damage to the Property and against injury to any persons caused by Tenant's actions or anyone's actions who are directly or indirectly employed by the Tenant. Tenant shall assume all risk of loss to Tenant's personal property, merchandise and fixtures. SECTION 3.01 TIME AND MANNER OF PAYMENT: --------------------------- Provided that Tenant is not in default under the terms of this Lease, Tenant shall be credited for the following payments due during the first and second months of the Lease Term ("ABATEMENT PERIOD") commencing on the Lease Commencement Date: (i) Base Rent credit in a total amount equal to Eighty-Seven Thousand Five Hundred and No/100 Dollars ($87,500.00), (ii) Landlord's insurance premiums set forth in Section 4.04, (iii) Landlord's "real property tax" and ------------ (iv) Landscape Fee, and (v) Common Area costs which are not the result of Tenant's actions or omissions during the Abatement Period or Tenant Improvements. SECTION 4.02(c) JOINT ASSESSMENT. ---------------- If the Property is not separately assessed, Landlord shall reasonably determine Tenant's share of the "real property tax" payable by Tenant under Paragraph 4.02 from the assessor's worksheets or other reasonably available information. Tenant shall pay such share to Landlord at least ten (10) days but not more than thirty (30) days prior to delinquency. Tenant acknowledges if any "Tenant Improvements," as that term is defined in the Tenant Work Letter attached hereto, or any alterations made by Tenant or for Tenant, increase the "real property tax," such increase shall be Tenant's sole cost and responsibility and shall not be shared with Landlord or any other tenant of the Project. Upon Tenant's request Landlord shall supply Tenant with a copy of the Projects tax bill. SECTION 4.04(e) LANDLORD'S INSURANCE: --------------------- Landlord shall maintain (i) standard fire and extended coverage or all-risk property on the Project, and all other improvements paid for by Landlord which will remain in the Project upon the Initials: ______________ ______________ Rider - Page 1 of 11 expiration or earlier termination of this Lease, in an amount and with such deductible AS are acceptable to Landlord in Landlord's sole discretion; and (ii) commercial general liability insurance against bodily injury, personal injury and property damage to the combined single limit of One Million Dollars ($1,000,000) to one or more than one person as the result of one (1) accident or occurrence. SECTION 4.05(c) VEHICLE PARKING --------------- Tenant shall have the right, at Tenant's sole cost and expense, to paint "Reserved For Hot Topic" on the asphalt of Tenant's parking spaces ("PARKING SIGN"). Upon the termination of this Lease, Tenant shall remove or paint over, in such color approved by Landlord, the above referenced Parking Sign. SECTION 4.05 COMMON AREAS: MAINTENANCE AND COSTS ----------------------------------- Section 4.05(d) is hereby amended by adding the following at the end thereof: "Notwithstanding the foregoing, any Common Area costs that is a capital expenditure shall be amortized (including interest on the amortized cost) over its useful life as Landlord shall reasonably determine." SECTION 4.09 LANDLORD'S BOOKS AND RECORDS: ----------------------------- In the event that Tenant disputes the amount of Additional Rent set forth in any annual statement ("STATEMENT") delivered by Landlord, then within one (1) year after receipt of SUCH Statement by Tenant (the "REVIEW PERIOD"), Tenant shall have the right to notify Landlord in writing that it intends to cause an independent certified public accountant (which accountant must be qualified and experienced and must be employed by a firm which derives its primary revenues from its accounting practice) to inspect and copy (provided Tenant signs Landlord's confidentiality agreement, in such form as is commercially reasonable) Landlord's accounting records relating to the Additional Rent owed by Tenant for the calendar year covered by such Statement, at Landlord's office during normal business hours ("TENANT'S REVIEW"). Landlord shall have the right to reasonably approve the identity of the accountant used by Tenant for Tenant's Review, which accountant must not be paid on a contingency fee basis. Tenant shall provide Landlord with not less than two (2) weeks' prior written notice of its desire to conduct Tenant's Review. In connection with the foregoing review, Landlord shall furnish Tenant with such reasonable supporting documentation relating to the subject Statement as Tenant may reasonably request, including any previous audit conducted by Landlord with respect to the calendar year in question. In no event shall Tenant have the right to conduct Tenant's Review if Tenant is then in default under this Lease with respect to any of Tenant's monetary obligations, including, without limitation, the payment by Tenant of all Additional Rent described in the Statement which is the subject of Tenant's Review, which payment, at Tenant's election, may be made under dispute. In the event that Tenant shall fail to provide Landlord with written notification within the Review Period following receipt of a particular Statement of Tenant's desire to conduct a Tenant's Review, Tenant shall have no further right to dispute the amount of Additional Rent set forth on such Statement. In the event that following Tenant's Review, Tenant and Landlord continue to dispute the amount of Additional Rent shown on Landlord's Statement and Landlord and Tenant are unable to resolve such dispute, then either Landlord or Tenant shall cause a final and determinative audit to be made by Landlord's accountant of the proper amount of the disputed items and/or categories of Additional Rent to be shown on such Statement (the "FINAL AWARD"). The results of such Final Award shall be conclusive and binding upon both Landlord and Tenant. If the resolution of the parties' dispute with regard to the Additional Rent shown on the Statement, whether pursuant to Tenant's Review or the Final Award reveals an error in the calculation of Tenant's Additional Rent to be paid for such calendar year, the parties' sole remedy shall be for the parties to make appropriate payments or reimbursements, as the case may be, to each other as are determined to be owing. Any such payments shall be made within thirty (30) days following the resolution of such dispute. At Landlord's election, the parties shall treat any overpayments resulting from the foregoing resolution of such parties' dispute as a credit against rent until such amounts are otherwise paid by Landlord. Tenant shall be responsible for all costs and expenses associated with Tenant's Review and any Final Award, provided that if the parties' final Initials: _____________ _____________ Rider - Page 2 of 11 resolution of the dispute involves the overstatement by Landlord of Additional Rent for such calendar year in excess of five percent (5%), then Landlord shall be responsible for all reasonable, out-of-pocket costs and expenses associated with Tenant's Review and any Final Award. This provision shall survive the termination of this Lease to allow the parties to enforce their respective rights hereunder. SECTION 5.03 HAZARDOUS MATERIAL: ------------------- 5.03.1 DEFINITIONS. ----------- A. "Hazardous Material" means any substance, whether solid, liquid or gaseous in nature: (i) the presence of which requires investigation or remediation under any federal, state or local statute, regulation, ordinance, order, action, policy or common law; or (ii) which is or becomes defined as a "hazardous waste," "hazardous substance," pollutant or contaminant under any federal, state or local statute, regulation, rule or ordinance or amendments thereto including, without limitation, the Comprehensive Environmental Response, Compensation and Liability Act (42 U.S.C. section 9601 et seq.) and/or the Resource Conservation and Recovery Act (42 U.S.C. section 6901 et seq.), the Hazardous Materials Transportation Act (49 U.S.C. section 1801 et seq.), the Federal Water Pollution Control Act (33 U.S.C. section 1251 et seq.), the Clean Air Act (42 U.S.C. section 7401 et seq.), the Toxic Substances Control Act, as amended (15 U.S.C. section 2601 et seq.), and the Occupational Safety and Health Act (29 U.S.C. section 651 et seq.), as these laws have been amended or supplemented; or (iii) which is toxic, explosive, corrosive, flammable, infectious, radioactive, carcinogenic mutagenic, or otherwise hazardous or is or becomes regulated by any governmental authority, agency, department, commission, board, agency or instrumentality of the United States, the State of California or any political subdivision thereof; or (iv) the presence of which on the Property causes or threatens to cause a nuisance upon the Property or to adjacent properties or poses or threatens to pose a hazard to the health or safety of persons on or about the Property; or (v) the presence of which on adjacent properties could constitute a trespass by Tenant; or (vi) without limitation which contains gasoline, diesel fuel or other petroleum hydrocarbons; or (vii) without limitation which contains polychlorinated biphenyls (PCBs), asbestos or urea formaldehyde foam insulation; or (viii) without limitation which contains radon gas. B. "Environmental Requirements" means all applicable present and future: (i) statutes, regulations, rules, ordinances, codes, licenses, permits, orders, approvals, plans, authorizations, concessions, franchises, and similar items (including, but not limited to those pertaining to reporting, licensing, permitting, investigation and remediation), of all Governmental Agencies; and (ii) all applicable judicial, administrative, and regulatory decrees, judgments, and orders relating to the protection of human health or the environment, including, without limitation, all requirements pertaining to emissions, discharges, releases, or threatened releases of Hazardous Materials or chemical substances into the air, surface water, groundwater or land, or relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport, or handling of Hazardous Materials or chemical substances. Initials: ______________ ______________ Rider - Page 3 of 11 C. "Environmental Damages" means all claims, judgments, damages, losses, penalties, fines, liabilities (including strict liability), encumbrances, liens, costs, and expenses (including the expense of investigation and defense of any claim, whether or not such claim is ultimately defeated, or the amount of any good faith settlement or judgment arising from any such claim) of whatever kind or nature, contingent or otherwise, matured or unmatured, foreseeable or unforeseeable (including without limitation reasonable attorneys' fees and disbursements and consultants' fees) any of which are incurred at any time as a result of the existence of Hazardous Material upon, about, or beneath the Property or migrating or threatening to migrate to or from the Property, or the existence of a violation of Environmental Requirements pertaining to the Property and the activities thereon, regardless of whether the existence of such Hazardous Material or the violation of Environmental Requirements arose prior to. the present ownership or operation of the Property. Environmental Damages include, without limitation: (i) damages for personal injury, or injury to property or natural resources occurring upon or off of the Property, including, without limitation, lost profits, consequential damages, the cost of demolition and rebuilding of any improvements on real property, interest, penalties and damages arising from claims brought by or on behalf of employees of Tenant (with respect to which Tenant waives any right to raise as a defense against Landlord any immunity to which it may be entitled under any industrial or worker's compensation laws); (ii) fees, costs or expenses incurred for the services of attorneys, consultants, contractors, experts, laboratories and all other costs incurred in connection with the investigation or remediation of such Hazardous Materials or violation of such Environmental Requirements, including, but not limited to, the preparation of any feasibility studies or reports or the performance of any cleanup, remediation, removal, response, abatement, containment, closure, restoration or monitoring work required by any Governmental Agency or reasonably necessary to make full economic use of the Property or any other property in a manner consistent with its current use or otherwise expended in connection with such conditions, and including without limitation any attorneys' fees, costs and expenses incurred in enforcing the provisions of this Lease or collecting any sums due hereunder; (iii) liability to any third person or Governmental Agency to indemnify such person or Governmental Agency for costs expended in connection with the items referenced in subparagraph (ii) above; and (iv) diminution in the fair market value of the Property including without limitation any reduction in fair market rental value or life expectancy of the Property or the improvements located thereon or the restriction on the use of or adverse impact on the marketing of the Property or any portion thereof. D. "Governmental Agency" means all governmental agencies, departments, commissions, boards, bureaus or instrumentalities of the United States, states, counties, cities and political subdivisions thereof. E. The "Tenant Group" means Tenant, Tenant's successors, assignees, guarantors, officers, directors, agents, employees, invitees, permitees or other parties under the supervision or control of Tenant or entering the Property during the term of this Lease with the permission or knowledge of Tenant other than Landlord or its agents or employees. 5.03.2 PROHIBITIONS. ------------ A. Other than normal quantities of general office supplies, material handling systems lubrication and except as specified on Exhibit "D" attached hereto, Tenant shall not cause, permit or suffer any Hazardous Material to be brought upon, treated, kept, stored, disposed of, discharged, released, produced, manufactured, generated, refined or used upon, about or beneath the Property by the Tenant Group, or any other person without the prior written consent of Landlord. From time to time during the term of this Lease, Tenant may request Landlord's approval of Tenant's use of other Hazardous Materials, which approval may be withheld in Landlord's sole discretion. Tenant shall, prior to the Commencement Date, provide to Landlord for those Hazardous Materials described on Exhibit "D" (a) a description of handling, storage, use and disposal procedures, and Initials: ______________ ______________ Rider - Page 4 of 11 (b) all "community right to know" plans or disclosures and/or emergency response plans which Tenant is required to supply to local governmental agencies pursuant to any Environmental Requirements. B. Tenant shall not cause, permit or suffer the existence or the commission by the Tenant Group, or by any other person, of a violation of any Environmental Requirements upon, about or beneath the Property. C. Tenant shall neither create or suffer to exist, nor permit the Tenant Group to create or suffer to exist any lien, security interest or other charge or encumbrance of any kind with respect to the Property, including without limitation, any lien imposed pursuant to section 107(f) of the Superfund Amendments and Reauthorization Act of 1986 (42 U.S.C. section 9607(l)) or any similar state statute. D. Tenant shall not install, operate or maintain any above or below grade tank, sump, pit, pond, lagoon or other storage or treatment vessel or device on the property without Landlord's prior written consent. 5.03.3 INDEMNITY. --------- A. Tenant, its successors, assigns and guarantors, agree to indemnify, defend, reimburse and hold harmless: (i) Landlord; and (ii) any other person who acquires all or a portion of the Property in any manner (including purchase at a foreclosure sale) or who becomes entitled to exercise the rights and remedies of Landlord under this Lease; and (iii) the directors, officers, shareholders, employees, partners, agents, contractors, subcontractors, experts, licensees, affiliates, lessees, mortgagees, trustees, heirs, devisees, successors, assigns and invitees of such persons, from and against any and all Environmental Damages which exist as a result of the activities or negligence of the Tenant Group or which exist as a result of the breach of any warranty or covenant or the inaccuracy of any representation of Tenant contained in this Lease, or by Tenant's remediation of the Property or failure to meet its obligations contained in this Lease. B. The obligations contained in this Section 5.03 shall include, but not be limited to, the burden and expense of defending all claims, suits and administrative proceedings, even if such claims, suits or proceedings are groundless, false or fraudulent, and conducting all negotiations of any description, and paying and discharging, when and as the same become due, any and all judgments, penalties or other sums due against such indemnified persons. Landlord, at its sole expense, may employ additional counsel of its choice to associate with counsel representing Tenant. C. Landlord shall have the right but not the obligation to join and participate in, and control, if it so elects, any legal proceedings or actions initiated in connection with Tenant's activities. Landlord may also negotiate, defend, approve and appeal any action taken or issued by any applicable governmental authority with regard to contamination of the Property by a Hazardous Material. D. The obligations of Tenant in this paragraph shall survive the expiration or termination of this Lease. E. The obligations of Tenant under this paragraph shall not be affected by any investigation by or on behalf of Landlord, or by any information which Landlord may have or obtain with respect thereto. Initials: ______________ ______________ Rider - Page 5 of 11 5.03.4 OBLIGATION TO REMEDIATE. ----------------------- In addition to the obligation of Tenant to indemnify Landlord pursuant to this Lease, Tenant shall, upon approval and demand of Landlord, at its sole cost and expense and using contractors approved by Landlord, promptly take all actions to remediate the Property which are required by any Governmental Agency, or which are reasonably necessary to mitigate Environmental Damages or to allow full economic use of the Property, which remediation is necessitated from the presence upon, about or beneath the Property, at any time during or upon termination of this Lease, of a Hazardous Material or a violation of Environmental Requirements existing as a result of the activities or negligence of the Tenant Group. Such actions shall include, but not be limited to, the investigation of the environmental condition of the Property, the preparation of any feasibility studies, reports or remedial plans, and the performance of any cleanup, remediation, containment, operation, maintenance, monitoring or restoration work, whether on or off the Property, which shall be performed in a manner approved by Landlord. Tenant shall take all actions necessary to restore the Property to the condition existing prior to the introduction of Hazardous Material upon, about or beneath the Property, notwithstanding any lesser standard of remediation allowable under applicable law or governmental policies. 5.03.5 RIGHT TO INSPECT. ---------------- Landlord shall have the right in its sole and absolute discretion, but not the duty, to enter and conduct an inspection of the Property, including invasive tests, at any reasonable time to determine whether Tenant is complying with the terms of the Lease, including but not limited to the compliance of the Property and the activities thereon with Environmental Requirements and the existence of Environmental Damages as a result of the condition of the Property or surrounding properties and activities thereon. Landlord shall have the right, but not the duty, to retain any independent professional consultant (the "Consultant") to enter the Property to conduct such an inspection or to review any report prepared by or for Tenant concerning such compliance. The cost of the Consultant shall be paid by Landlord unless such investigation discloses a violation of any Environmental Requirement by the Tenant Group or the existence of a Hazardous Material on the Property or any other property caused by the activities or negligence of the Tenant Group (other than Hazardous Materials used in compliance with all Environmental Requirements and previously approved by Landlord), in which case Tenant shall pay the cost of the Consultant. Tenant hereby grants to Landlord, and the agents, employees, consultants and contractors of Landlord the right to enter the Property and to perform such tests on the Property as are reasonably necessary to conduct such reviews and investigations. Landlord shall use its best efforts to minimize interference with the business of Tenant. 5.03.6 NOTIFICATION. ------------ If Tenant shall become aware of or receive notice or other communication concerning any actual, alleged, suspected or threatened violation of Environmental Requirements, or liability of Tenant for Environmental Damages in connection with the Property or past or present activities of any person thereon, including but not limited to notice or other communication concerning any actual or threatened investigation, inquiry, lawsuit, claim, citation, directive, summons, proceeding, complaint, notice, order, writ, or injunction, relating to same, then Tenant shall deliver to Landlord within ten (I 0) days of the receipt of such notice or communication by Tenant, a written description of said violation, liability, or actual or threatened event or condition, together with copies of any documents evidencing same. Receipt of such notice shall not be deemed to create any obligation on the part of Landlord to defend or otherwise respond to any such notification. If requested by Landlord, Tenant shall disclose to Landlord the names and amounts of all Hazardous Materials other than general office supplies refer-red to in Section 5.03.2 of this Rider, which were used, generated, treated, handled, stored or disposed of on the Property or which Tenant intends to use, generate, treat, handle, store or dispose of on the Property. The foregoing in no way shall limit the necessity for Tenant obtaining Landlord's consent pursuant to Section 5.03.2 of this Rider. Initials: ______________ ______________ Rider - Page 6 of 11 5.03.7 SURRENDER OF PREMISES. --------------------- In the ninety (90) days prior to the expiration or termination of the Lease Term, and for up to ninety (90) days after Tenant fully surrenders possession of the Property, Landlord may have an environmental assessment of the Property performed in accordance with Section 5.03.5 of this Rider. Tenant shall perform, at its sole cost and expense, any clean-up or remedial work recommended by the Consultant which is necessary to remove, mitigate or remediate any Hazardous Materials and/or contamination of the Property caused by the activities or negligence of the Tenant Group. 5.03.8 ASSIGNMENT AND SUBLETTING. ------------------------- In the event the Lease provides that Tenant may assign the Lease or sublet the Property subject to Landlord's consent and/or certain other conditions, and if the proposed assignee's or sublessee's activities in or about the Property involve the use, handling, storage or disposal of any Hazardous Materials other than those used by Tenant and in quantities and processes similar to Tenant's uses in compliance with the Rider, (i) it shall be reasonable for Landlord to withhold its consent to such assignment or sublease in light of the risk of contamination posed by such activities and/or (ii) Landlord may impose an additional condition to such assignment or sublease which requires Tenant to reasonably establish that such assignee's or sublessee's activities pose no materially greater risk of contamination to the Property than do Tenant's permitted activities in view of the (a) quantities, toxicity and other properties of the Hazardous Materials to be used by such assignee or sublessee, (b) the precautions against a release of Hazardous Materials such assignee or sublessee agrees to implement, (c) such assignee's or sublessee 's financial condition as it relates to its ability to fund a major clean-up and (d) such assignee's or sublessee's policy and historical record respecting its willingness to respond to the clean up of a release of Hazardous Materials. 5.03.9 SURVIVAL OF HAZARDOUS MATERIALS OBLIGATION. ------------------------------------------ Tenant's breach of any of its covenants or obligations under this Rider shall constitute a material default under the Lease. The obligations of Tenant under this Rider shall survive the expiration or earlier termination of the Lease without any limitation, and shall constitute obligations that are independent and severable from Tenant's covenants and obligations to pay rent under the Lease. 5.03.10 LANDLORD'S HAZARDOUS MATERIALS OBLIGATIONS. ------------------------------------------ Landlord shall be solely responsible to remediate claims, judgments, damages, penalties, fines, costs, liabilities and losses which arise as a result of any contamination directly arising from the introduction of Hazardous Materials into the Property by Landlord its agents, employees or contractors in compliance with applicable law. SECTION 5.04 SIGNS. ----- Section 5.04 is hereby amended by adding the following at the end thereof: "Notwithstanding the foregoing, subject to Landlord's prior written approval, which shall not be unreasonably withheld, delayed or conditioned, and provided all signs are in keeping with the quality, design and style of the industrial park within which the Property is located, Tenant, at its sole cost and expense, may install identification signage in the Property; provided, however, that (i) the size, color, location, materials and design of such sign shall be subject to Landlord's prior written consent, which shall not be unreasonably withheld, delayed or conditioned; (ii) such sign shall comply with all applicable governmental rules and regulations; (iii) such sign shall be personal to the Tenant named in Section 1.03 of this Lease (the "Original Tenant"); (iv) such sign shall not be painted directly on the building or attached or placed on the roof of the building; (v) such sign shall only advertise Hot Topic Administration, Inc. or Hot Topic; and (vi) Tenant's continuing signage right shall be contingent upon the Original Tenant actually occupying the entire Property. Tenant shall be responsible for all costs incurred in connection with the design, construction, installation, repair and maintenance of Tenant's sign(s). Upon the Initials: _______________ _______________ Rider - Page 7 of 11 expiration or earlier termination of this Lease, Tenant shall cause Tenant's sign(s) to be removed and shall repair any damage caused by such removal. Any signs, notices, logos, pictures, names or advertisements which are installed and that have not been separately approved by Landlord may be removed by Landlord without notice by Landlord to Tenant at Tenant's sole cost and expense." SECTION 6.01 EXISTING CONDITIONS: -------------------- Notwithstanding the foregoing, Landlord shall, at Landlord's expense, repair the existing plumbing, lighting, air conditioning, heating, and ventilating systems in the Property and the roof membrane, structure, foundation and flooring (not including floor covering), if such are not in good operating condition on the Commencement Date, except to the extent such repairs are required (i) due to the negligence or willful misconduct of Tenant, or (ii) as a result of alterations, additions or improvements to the Property made by Tenant or for Tenant; provided, however, that Tenant gives Landlord written notice and sets forth with specificity the nature and extent of such repair, within one (1) year after the Commencement Date. SECTION 6.07 LANDLORD'S WORK: ---------------- Landlord, at its sole cost and expense, shall one-time reslurry and restripe the parking lot to provide 206 parking spaces as set forth on Exhibit A --------- attached hereto and incorporated herein ("LANDLORD'S WORK"). Since Tenant may be occupying the Property pursuant to this Lease while Landlord is performing Landlord's Work, Landlord agrees that it shall use commercially reasonable efforts to perform Landlord's Work in a manner so as to minimize interference with Tenant's business. Tenant hereby acknowledges that, notwithstanding Tenant's occupancy of the Property during the performance of Landlord's Work, Landlord shall be permitted to perform Landlord's Work during normal business hours, and Tenant shall provide a clear working area for Landlord's Work (including, but not limited to, the moving of furniture, fixtures, automobiles and Tenant's property away from the area Landlord is conducting Landlord's Work). Tenant hereby agrees that the performance of Landlord's Work shall in no way constitute a constructive eviction of Tenant nor entitle Tenant to any abatement of rent payable pursuant to this Lease. Landlord shall have no responsibility or for any reason be liable to Tenant for any direct or indirect injury to or interference with Tenant's business arising from Landlord's Work, nor shall Tenant be entitled to any compensation or damages from Landlord (i) for loss of the use of whole or any part of the Property or of Tenant's personal property or improvements resulting from Landlord's Work or Landlord's actions in connection with Landlord's Work, or (ii) for any inconvenience or annoyance occasioned by Landlord's Work or Landlord's actions in connection with Landlord's Work. SECTION 7.05 SUBSTANTIAL OR TOTAL DESTRUCTION: --------------------------------- Notwithstanding anything to the contrary contained in this Lease, if there is any damage or destruction to the Property the repair of which actually takes a period beyond that date which is six (6) months from the date of the occurrence of such damage (the "Outside Date"), then Tenant may, at Tenant's option, terminate this Lease by delivering written notice of such termination to Landlord, no later than thirty (30) days after the Outside Date. Notwithstanding anything to the contrary contained in this Lease, if there is any damage or destruction to the Property, Tenant shall have the right, at any time and from time to time to require Landlord to deliver to Tenant a written notice (the "Contractor Certificate") certifying to both Landlord and Tenant, in the reasonable opinion of Landlord's contractor, the amount of time required to repair or complete the repair of the Property. If in the Contractor Certificate the contractor certifies that the repair of the Property will take a period in excess of six (6) months from receipt of Tenant's request, then within fifteen (I 5) days after the delivery of the Contractor Certificate to Tenant, Tenant may, at Tenant's option, terminate this Lease by delivering written notice of such termination to Landlord within such fifteen (15) day period. Notwithstanding the foregoing, Tenant shall not have any right to terminate this Lease under this Section 7.05 if the damage to the Property or Project was caused by the acts or omissions of Tenant. Initials: ______________ ______________ Rider - Page 8 of 11 SECTION 9.05 LANDLORD'S CONSENT: ------------------- (c) If Landlord elects to terminate this Lease pursuant to Section 9.05(a), Landlord may, if it elects, enter into a new lease covering the Property with the intended assignee or sublessee on such terms as Landlord and such person may agree or enter into a new lease covering the Property with any other person; in such event, Tenant shall not be entitled to any portion of the profit, if any, which Landlord may realize on account of such termination and reletting. From and after the date of such termination of this Lease, Tenant shall have no further obligation to Landlord hereunder, except for matters occurring or obligations arising hereunder prior to the date of such termination and for such obligations as set forth herein that survive the termination of this Lease. SECTION 10.02(b) DEFAULTS: --------- Add to Section 10.02(b) the following: "provided, however, that Landlord shall provide Tenant with written notice of such monetary default and if Tenant corrects such default within three (3) days after receipt of such notice, such failure shall not constitute a default hereunder. Notwithstanding the foregoing, Landlord shall only be required to provide Tenant with two (2) late notices during any consecutive twelve (12) month period;" SECTION 11.05 TENANT'S FINANCIAL CONDITION: ---------------------------- Notwithstanding the foregoing, the Original Tenant shall only be required to deliver to Landlord and Landlord's lender the most recent annual report and 10K filing of its "parent" corporation. Upon execution of this Lease, Tenant's "parent" corporation is Hot Topic, Inc., a California corporation. SECTION 13.06 NOTICES: -------- Notwithstanding the foregoing, notices required or permitted under this Lease may be sent by registered mail or delivered by a nationally recognized overnight courier, postage prepaid. ARTICLE FIFTEEN: REVENUE AND EXPENSE ACCOUNTING: Landlord and Tenant agree that, for all purposes (including any determination under Section 467 of the Internal Revenue Code), rental income will accrue to the Landlord and rental expenses will accrue to the Tenant in the amounts and as of the dates rent is payable under the Lease. ARTICLE SIXTEEN: LANDSCAPE MAINTENANCE: Notwithstanding the provisions of Sections 6.03 and 6.04, Landlord shall maintain, at Tenant's expense, the landscaping of the Property and, if applicable, the common areas. Such maintenance shall include gardening, tree trimming, replacement or repair of landscaping, landscape irrigation systems and similar items. Such maintenance shall also include sweeping and cleaning of asphalt, concrete or other surfaces on the driveway, parking areas, yard areas, loading areas or other paved or covered surfaces. In connection with Landlord's obligations under this Article, Landlord may enter into a contract with a landscape contractor of Landlord's choice to provide some (but not necessarily all) of the maintenance services listed above. Tenant's pro-rata share of the monthly cost of such contract, hereinafter referred to as the "Landscape Fee" is currently SEVEN HUNDRED EIGHTY-NINE AND NO/100 DOLLARS ($789.00). Landlord shall use its commercially reasonable efforts to maintain competitive contracts and shall promptly notify Tenant of any increase in the Landscape Fee. Tenant agrees to pay monthly to Landlord, as additional rent, the Landscape Fee. Tenant shall make such payment together with Tenant's monthly rental payment, without the necessity of notice from Landlord. It is the understanding of the parties that the Landscape Fee only pertains to routine landscape maintenance on the Property and that Landlord Initials: ______________ ______________ Rider - Page 9 of 11 may incur expenses in addition to the Landscape Fee in meeting its obligations set forth above. Tenant shall pay to Landlord, as additional rent, within ten (10) days after demand therefore, the cost of such additional expenses. ARTICLE SEVENTEEN: RIGHT OF FIRST OFFER: 17.1 Right of First Offer. During the Lease Term, Landlord -------------------- hereby grants to the Tenant named in the Summary and not any assignee, sublessee or other transferee of Tenant's interest in this Lease ("ORIGINAL TENANT") a one-time right of first offer with respect to the adjacent 125,000 rentable square feet of space of the 250,000 square foot building located at 18385 E. San Jose Avenue, City of Industry, California (the "EXPANSION SPACE"), as set forth on Exhibit A-1 attached hereto. Notwithstanding the foregoing, such first offer ----------- right of Tenant shall commence only following the expiration or early termination of the existing lease of the Expansion Space (including any renewal of such lease, whether or not such renewal is pursuant to an express written provision in such lease, and regardless of whether any such renewal is consummated pursuant to a lease amendment or a new lease), and such first offer right shall be subordinate to all presently existing rights of all other present tenants (as of September 3, 1998) of Landlord to lease the Expansion Space (whether or not pursuant to rights of first offer, expansion options, must-take requirements or otherwise), and regardless of whether such tenant's exercise of such right is consummated in a new lease or a lease amendment (individually and collectively, the "SUPERIOR RIGHT HOLDER") with respect to such Expansion Space. Tenant's right of first offer shall be on the terms and conditions set forth in this Article 17. ---------- 17.2 Procedure for Offer. Landlord shall notify Tenant (the "FIRST ------------------- OFFER NOTICE") when the Expansion Space or any portion thereof becomes available for lease to third parties, provided that no Superior Right Holder wishes to lease such space. Pursuant to such First OFFER Notice, Landlord shall offer to lease to Tenant the then available Expansion Space. The First OFFER Notice shall describe the space so offered to Tenant and shall set forth the "FIRST OFFER RENT," as that term is defined in Section 17.4 below, and the other economic terms upon which Landlord is willing to lease such space to Tenant. 17.3 Procedure for Acceptance. If Tenant wishes to exercise Tenant's ------------------------ right of first offer with respect to the space described in the First Offer Notice, then within five (5) business days of delivery of the First Offer Notice to Tenant, Tenant shall deliver notice to Landlord of Tenant's intention to exercise its right of first offer with respect to the entire space described in the First Offer Notice on the terms contained in such notice. If Tenant does not so notify Landlord within the first five (5) business day period, then Landlord shall be free to lease the space described in the First Offer Notice to anyone to whom Landlord desires on any terms Landlord desires. Notwithstanding anything to the contrary contained herein, Tenant must elect to exercise its right of first offer, if at all, with respect to all of the space offered by Landlord to Tenant at any particular time, and Tenant may not elect to lease only a portion thereof. 17.4 The Expansion Space Rent. The Base Rent payable by Tenant for ------------------------ the Expansion Space (the "FIRST OFFER RENT") shall be equal to the greater of (i) the same rate at which Base Rent is payable by Tenant under the Lease as of the "First Offer Commencement Date", as that term is defined in Section 17.6 ------------ below, and (ii) ninety percent (90%) of the face or stated rent, including all escalations, being quoted by Landlord for non-sublease, non-encumbered, non- equity space comparable in size, location and quality to the Expansion Space in the Building for the term as stated in the First Offer Notice. 17.5 Construction of the Expansion Space. Tenant shall take the ----------------------------------- Expansion Space in its "as is" condition, and the construction of any improvements in the Expansion Space shall comply with the terms of Section 6.05 ------------ of this Lease. 17.6 Amendment to Lease. If Tenant timely exercises Tenant's right ------------------ to lease the Expansion Space as set forth herein, Landlord and Tenant shall within fifteen (15) days thereafter execute an amendment for such Expansion Space upon the terms and conditions as set forth in the First Offer Notice and this Article 17. Tenant shall commence payment of rent for the Expansion ---------- Initials: ____________ ____________ Rider - Page 10 of 11 Space, and the term of the Expansion Space shall commence upon the date of delivery of the Expansion Space to Tenant (the "FIRST OFFER COMMENCEMENT DATE") and terminate on the date set forth in the First Offer Notice. 17.7 Termination of Right of First Offer. The rights contained in ----------------------------------- this Article 17 shall be personal to the Original Tenant and may only be - --------------- exercised by Original Tenant if as of the date of the attempted exercise of the right of first offer by Tenant and as of the scheduled date of delivery of such Expansion Space to Tenant (i) Original Tenant occupies the entire property and (ii) at least one (1) year of the Lease Term remains, including any extensions of the Lease Term if Tenant has exercised the Option(s) as provided in the Option to Extend Lease Term Rider. The right of first offer granted herein shall terminate upon the failure by Tenant to exercise its right of first offer with respect to the Expansion Space as offered by Landlord. Tenant shall not have the right to lease the Expansion Space, as provided in this, Article 17, ---------- if, as of the date of the attempted exercise of the right of first offer by Tenant, or as of the scheduled date of delivery of the Expansion Space to Tenant, Tenant is in default under Us Lease or Tenant has previously been in default under this Lease more than once. ARTICLE EIGHTEEN ---------------- GUARANTY OF LEASE ----------------- This Lease is subject to and conditioned upon Tenant delivering to Landlord, concurrently with Tenant's execution and delivery of this Lease, a Guaranty (the "Guaranty") in the form attached hereto as Exhibit "E", which Guaranty shall be fully executed by and binding upon Hot Topic, Inc., a California corporation, as guarantor. Tenant hereby expressly waives any and all benefits under California Civil Code Section 2822(a) with respect to the Guaranty, and agrees that Landlord (not Tenant) may designate the portion of Tenant's Lease obligation that is satisfied by partial payment by Tenant. ARTICLE NINETEEN ---------------- TELECOMMUNICATION EQUIPMENT --------------------------- At any time during the Lease Term, Original Tenant may install, at Tenant's sole cost and expense, for Tenant's sole use, telecommunication equipment upon the roof directly above the Property for Tenant's use of up to 5 square feet of space; provided however: (i) the physical appearance and location of any such installation and the size of the equipment shall be subject to Landlord's reasonable approval, and Landlord may require Tenant to install screening around such equipment, at Tenant's sole cost and expense, as reasonably designated by Landlord; (ii) Tenant shall maintain such equipment, at Tenant's sole cost and expense; (iii) Tenant shall be responsible for any utilities related to the operation of the telecommunication equipment; (iv) the telecommunication equipment shall be subject to government rules and regulations and covenants, conditions and restrictions; and (v) Tenant shall exercise its right to install telecommunication equipment by giving Landlord prior written notice thereof and Landlord and Tenant shall execute a Telecommunication Agreement in substantially the form as EXHIBIT "G", attached hereto, covering the installation and ----------- maintenance of such equipment, Tenant's indemnification of Landlord with respect thereto, Tenant's obligation to remove such equipment upon the expiration or earlier termination of this Lease, and other related matters. Initials: ______________ ______________ Rider - Page 11 of 11 EX-10.19 3 GUARANTY OF LEASE DATED 12-10-98 EXHIBIT 10.19 EXHIBIT E --------- GUARANTY OF LEASE ----------------- THIS GUARANTY OF LEASE (this "Guaranty") is made as of December 10, 1998, by HOT TOPIC, INC., a California corporation, (the "Guarantor"), whose address is 3410 Pomona Boulevard, Pomona, California, in favor of MAJESTIC REALTY CO. AND PATRICIAN ASSOCIATES, INC., both California corporations, having an office at 13191 Crossroads Parkway North, Sixth Floor, City of Industry, California 91746 ("Landlord"). WHEREAS, Landlord and Hot Topic Administration, Inc., a California corporation ("Tenant") desire to enter into that certain Industrial Lease (the "Lease") dated December 10, 1998 concerning the property located at 18305 East San Jose Avenue, City of Industry, California; WHEREAS, Guarantor has a financial interest in the Tenant; and WHEREAS, Landlord would not execute the Lease if Guarantor did not execute and deliver to Landlord this Guaranty. NOW THEREFORE, for and in consideration of the execution of the foregoing Lease by Landlord and as a material inducement to Landlord to execute said Lease, Guarantor hereby absolutely, presently, continually, unconditionally and irrevocably guarantees the prompt payment by Tenant of all rentals and all other sums payable by Tenant under said Lease and the faithful and prompt performance by Tenant of each and every one of the terms, conditions and covenants of said Lease to be kept and performed by Tenant, and further agrees as follows: 1. It is specifically agreed and understood that the terms, covenants and conditions of the Lease may be altered, affected, modified, amended, compromised, released or otherwise changed by agreement between Landlord and Tenant, or by course of conduct and Guarantor does guaranty and promise to perform all of the obligations of Tenant under the Lease as so altered, affected, modified, amended, compromised, released or changed and the Lease may be assigned by or with the consent of Landlord or any assignee of Landlord without consent or notice to Guarantor and that this Guaranty shall thereupon and thereafter guaranty the performance of said Lease as so changed, modified, amended, compromised, released, altered or assigned. 2. This Guaranty shall not be released, modified or affected by failure or delay on the part of Landlord to enforce any of the rights or remedies of Landlord under the Lease, whether pursuant to the terms thereof or at law or in equity, or by any release of any person liable under the terms of the Lease (including, without limitation, Tenant) or any other guarantor, including without limitation, any other Guarantor named herein, from any liability with respect to Guarantor's obligations hereunder. 3. Guarantor's liability under this Guaranty shall continue until all rents due under the Lease have been paid in full in cash and until all other obligations to Landlord have been satisfied, and shall not be reduced by virtue of any payment by Tenant of any amount due under the Lease. If all or any portion of Tenant's obligations under the Lease is paid or performed by Tenant, the obligations of Guarantor hereunder shall continue and remain in full force and effect in the event that all or any part of such payment(s) or performance(s) is avoided or recovered directly or indirectly from Landlord as a preference, fraudulent transfer or otherwise. 4. Guarantor warrants and represents to Landlord that Guarantor now has and will continue to have full and complete access to any and all information concerning the Lease, the value of the assets owned or to be acquired by Tenant, Tenant's financial status and its ability to pay and perform the obligations owed to Landlord under the Lease. Guarantor further warrants and represents that Guarantor has reviewed and approved copies of the Lease and is fully informed of the remedies Landlord may pursue, with or without notice to Tenant, in the event of default under the Lease. So long as any of Guarantor's obligations hereunder remains unsatisfied or owing to Landlord, Guarantor shall keep fully informed as to all aspects of Tenant's financial condition and the performance of said obligations. 5. Guarantor hereby covenants and agrees with Landlord that if a default shall at any time occur in the payment of any sums due under the Lease by Tenant or in the performance of any other obligation of Tenant under the Lease, Guarantor shall and will forthwith upon demand pay Initials: _______________ ________________ Exhibit E - Page 1 of 5 such sums, and any arrears thereof, to Landlord in legal currency of the United States of America for payment of public and private debts, and take all other actions necessary to cure such default and perform such obligations of Tenant. 6. The liability of Guarantor under this Guaranty is a guaranty of payment and performance and not of collectibility, and is not conditioned or contingent upon the genuineness, validity, regularity or enforceability of the Lease or the pursuit by Landlord of any remedies which it now has or may hereafter have with respect thereto, at law, in equity or otherwise. 7. Guarantor hereby waives and agrees not to assert or take advantage of to the extent permitted by law: (i) ill notices to Guarantor, to Tenant, or to any other person, including, but not limited to, notices of the acceptance of this Guaranty or the creation, renewal, extension, assignment, modification or accrual of any of the obligations owed to Landlord under the Lease and, except to the extent set forth in Paragraph 9 hereof, enforcement of any right or remedy with respect thereto, and notice of any other matters relating thereto, (ii) notice of acceptance of this Guaranty; (iii) demand of payment, presentation and protest; (iv) any right to require Landlord to apply to any default any security deposit or other security it may hold under the Lease; (v) any statute of limitations affecting Guarantor's liability hereunder or the enforcement thereof; (vi) any right or defense that may arise by reason of the incapability, lack or authority, death or disability of Tenant or any other person; and (vii) all principles or provisions of law which conflict with the terms of this Guaranty. Guarantor further agrees that Landlord may enforce this Guaranty upon the occurrence of a default under the Lease, notwithstanding any dispute between Landlord and Tenant with respect to the existence of said default or performance of the obligations under the Lease or any counterclaim, set-off or other claim which Tenant may allege against Landlord with respect thereto. Moreover, Guarantor agrees that Guarantor's obligations shall not be affected by any circumstances which constitute a legal or equitable discharge of a guarantor or surety. 8. Guarantor agrees that Landlord may enforce this Guaranty without the necessity of proceeding against Tenant or any other guarantor. Guarantor hereby waives the right to require Landlord to proceed against Tenant, to proceed against any other guarantor, to exercise any right or remedy under the Lease or to pursue any other remedy or to enforce any other right. 9. (a) Guarantor agrees that nothing contained herein shall prevent Landlord from suing on the Lease or from exercising any rights available to it thereunder and that the exercise of any of the aforesaid rights shall not constitute a legal or equitable discharge of Guarantor. Without limiting the generality of the foregoing, Guarantor hereby expressly waives any and all benefits under California Civil Code (S)(S) 2809, 2810, 2819, 2845, 2847, 2848, 2849 and 2850; and the second sentence of California Civil Code (S)2822(a). In addition, Guarantor agrees that Landlord (not Tenant) shall have the right to designate the portion of Tenant's obligations under the Lease that is satisfied by a partial payment by Tenant. (b) Guarantor agrees that Guarantor shall have no right of subrogation against Tenant or any right of contribution against any other guarantor hereunder unless and until all amounts due under the Lease have been paid in full and all other obligations under the Lease have been satisfied. Guarantor further agrees that, to the extent the waiver of Guarantor's rights of subrogation and contribution as set forth herein is found by a court of competent jurisdiction to be void or voidable for any reason, any rights of subrogation Guarantor may have against Tenant shall be junior and subordinate to any rights Landlord may have against Tenant, and any rights of contribution Guarantor may have against any other guarantor shall be junior and subordinate to any rights Landlord may have against such other guarantor. (c) The obligations of Guarantor under this Guaranty shall not be altered, limited or affected by any case, voluntary or involuntary, involving the bankruptcy, insolvency, receivership, reorganization, liquidation or arrangement of Tenant or any defense which Tenant may have by reason of order, decree or decision of any court or administrative body resulting from any such case. Landlord shall have the sole right to accept or reject any plan on behalf of Guarantor proposed in such case and to take any other action which Guarantor would be entitled to take, including, without limitation, the decision to file or not file a claim. Guarantor acknowledges and agrees that any payment which accrues with respect to Tenant's obligations under the Lease (including, without limitation, the payment of rent) after the commencement of any such proceeding (or, if any such payment ceases to accrue by operation of law by reason of the commencement of such proceeding, such payment as would have accrued if said proceedings had not been commenced) shall be included in Guarantor's obligations hereunder because it is the intention of the parties that said obligations Initials: _______________ _______________ Exhibit E - Page 2 of 5 should be determined without regard to any rule or law or order which may relieve Tenant of any of its obligations under the Lease. Guarantor hereby permits any trustee in bankruptcy, receiver, debtor-in-possession, assignee for the benefit of creditors or similar person to pay Landlord, or allow the claim of Landlord in respect of, any such payment accruing after the date on which such proceeding is commenced. Guarantor hereby assigns to Landlord Guarantor's right to receive any payments from any trustee in bankruptcy, receiver, debtor- in-possession, assignee for the benefit of creditors or similar person by way of dividend, adequate protection payment or otherwise. 10. Any notice, statement, demand, consent, approval or other communication required or permitted to be given, rendered or made by either party to the other, pursuant to this Guaranty or pursuant to any applicable law or requirement of public authority, shall be in writing (whether or not so stated elsewhere in this Guaranty) and shall be deemed to have been properly given, rendered or made only if hand-delivered or sent by first-class mail, postage pre-paid, addressed to the other party at its respective address set forth below, and shall be deemed to have been given, rendered or made on the day it is hand-delivered or one day after it is mailed, unless it is mailed outside of Los Angeles County, California, in which case it shall be deemed to have been given, rendered or made on the third business day after the day it is mailed. By giving notice as provided above, either party may designate a different address for notices, statements, demands, consents, approvals or other communications intended for it. To Guarantor: Prior to Lease Commencement Date: Hot Topic, Inc. 3410 Pomona Boulevard Pomona, California 91768 After Lease Commencement Date: c/o Hot Topic Administration 18305 E. San Jose Avenue City of Industry, California 91744 To Landlord: Majestic Realty Co. and Patrician Associates 13191 Crossroads Parkway North Sixth Floor City of Industry, California 91746 Attention: Chief Financial Officer 11. Guarantor represents and warrants to Landlord as follows: (a) No consent of any other person, including, without limitation, any creditors of Guarantor, and no license, permit, approval or authorization of, exemption by, notice or report to, or registration, filing or declaration within any governmental authority is required by Guarantor in connection with this Guaranty or the execution, delivery, performance, validity or enforceability of this Guaranty and all obligations required hereunder. This Guaranty has been duly executed and delivered by Guarantor, and constitutes the legally valid and binding obligation of Guarantor enforceable against such Guarantor in accordance with its terms. (b) The execution, delivery and performance of this Guaranty will not violate any provision of any existing law or regulation binding on Guarantor, or any order, judgment, award or decree of any court, arbitrator or governmental authority binding on Guarantor, or of any mortgage, indenture, lease, contract or other agreement, instrument or undertaking to which Guarantor is a party or by which Guarantor or any of Guarantor's assets may be bound, and will not result in, or require, the creation or imposition of any lien on any of such Guarantor's property, assets or revenues pursuant to the provisions of any such mortgage, indenture, lease, contract or other agreement, instrument or undertaking. 12. The obligations of Tenant under the Lease to execute and deliver estoppel statements, as therein provided, shall be deemed to also require the Guarantor hereunder to do and provide the same relative to Guarantor. 13. This Guaranty shall be binding upon each Guarantor, such Guarantor's heirs, representatives, administrators, executors, successors and assigns AND shall inure to the benefit of Initials: ________________ ________________ Exhibit E - Page 3 of 5 and shall be enforceable by Landlord, its successors, endorsees and assigns. Any married person executing this Guaranty agrees that recourse may be had against community assets and against his separate property for the satisfaction of all obligations herein guaranteed. As used herein, the singular shall include the plural, and the masculine shall include the feminine and neuter and vice versa, if the context so requires. 14. The term "Landlord" whenever used herein refers to and means the Landlord specifically named in the Lease and also any assignee of said Landlord, whether by outright assignment or by assignment for security, and also any successor to the interest of said Landlord or of any assignee in the Lease or any part thereof, whether by assignment or otherwise. So long as the Landlord's interest in or to demised premises (as that term is used in the Lease) or the rents, issues and profits therefrom, or in, to or under the Lease, are subject to any mortgage or deed of trust or assignment for security, no acquisition by Guarantor of the Landlord's interest in demised premises or under the Lease shall affect the continuing obligations of Guarantor under this Guaranty, which obligations shall continue in full force and effect for, the benefit of the mortgagee, beneficiary, trustee or assignee under such mortgage, deed of trust or assignment, of any purchaser at sale by judicial foreclosure or under private power of sale, and of the successors and assigns of any such mortgagee, beneficiary, trustee, assignee or purchaser. 15. The term "Tenant" whenever used herein refers to and means the Tenant in the Lease specifically named and also any assignee or sublessee of said Lease and also any successor to the interests of said Tenant, assignee or sublessee of such Lease or any part thereof, whether by assignment, sublease or otherwise. 16. In the event of any dispute or litigation regarding the enforcement or validity of this Guaranty, Guarantor shall be obligated to pay all charges, costs and expenses (including, without limitation, reasonable attorneys' fees) incurred by Landlord, whether or not any action or proceeding is commenced regarding such dispute and whether or not such litigation is prosecuted to judgment. 17. This Guaranty shall be governed by and construed in accordance with the laws of California and in a case involving diversity of citizenship, shall be litigated in and subject to the jurisdiction of the courts of California. 18. Every provision of this Guaranty is intended to be severable. In the event any term or provision hereof is declared to be illegal or invalid for any reason whatsoever by a court of competent jurisdiction, such illegality or invalidity shall not affect the balance of the terms and provisions hereof, which terms and provisions shall remain binding and enforceable. 19. This Guaranty may be executed in any number of counterparts each of which shall be deemed an original and all of which shall constitute one and the same Guaranty with the same effect as if all parties had signed the same signature page. Any signature page of this Guaranty may be detached from any counterpart of this Guaranty and re-attached to any other counterpart of this Guaranty identical in form hereto but having attached to it one or more additional signature pages. 20. No failure or delay on the part of Landlord to exercise any power, right or privilege under this Guaranty shall impair any such power, right or privilege, or be construed to be a waiver of any default or an acquiescence therein, nor shall any single or partial exercise of such power, right or privilege preclude other or further exercise thereof or of any other right, power or privilege. 21. This Guaranty shall constitute the entire agreement between each Guarantor and the Landlord with respect to the subject matter hereof. No provision of this Guaranty or right of Landlord hereunder may be waived nor may Guarantor be released from any obligation hereunder. except by a writing duly executed by an authorized officer, director or trustee of Landlord. 22. The liability of Guarantor and all rights, powers and remedies of Landlord hereunder and under any other agreement now or at any time hereafter in force between Landlord and Guarantor relating to the Lease shall be cumulative and not alternative and such rights, powers and remedies shall be in addition to all rights, powers and remedies given to Landlord by law. Initials: _______________ _______________ Exhibit E - Page 4 of 5 IN WITNESS WHEREOF, Guarantor have executed this Guaranty as of the day and year first above written. HOT TOPIC, INC., a California corporation By: /s/ Orval Madden --------------------------------- Its: President -------------------------------- By: /s/ Marc R. Bertone --------------------------------- Its: Vice President ------------------------------- Exhibit E - Page 5 of 5 Initials: __________________ __________________ EX-23.1 4 CONSENT OF INDEPENDENT AUDITORS Exhibit 23.1 Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-13875), pertaining to the Non-Plan Options, the 1996 Equity Incentive Plan, as amended, and the Non-Employee Directors' Stock Option Plan, as amended, of our report dated March 12, 1999 with respect to the consolidated financials statements of Hot Topic, Inc. included in the Annual Report on Form 10-K for the fiscal year ended January 30, 1999 filed with the Securities and Exchange Commission. /s/ Ernst & Young LLP Los Angeles, California April 26, 1999 EX-27 5 FDS FOR FORM 10-K
5 1,000 $U.S. YEAR JAN-30-1999 FEB-01-1998 JAN-30-1999 1 24,574 0 0 0 10,447 36,783 17,710 14,725 58,765 8,350 0 0 0 35,676 13,073 58,765 103,371 103,371 65,855 0 29,077 0 20 9,370 3,367 6,003 0 0 0 6,003 1.25 1.21
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