Hot Topic, Inc.
Filed 5/02/02
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED FEBRUARY 2, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM
_____________________________ TO ____________________________________
COMMISSION FILE NO. 0-28784
HOT TOPIC, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 77-0198182
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
18305 E. SAN JOSE AVE.
CITY OF INDUSTRY, CALIFORNIA 91748
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (626) 839-4681
Securities registered pursuant to Section 12(b) of the Act: none Securities registered pursuant to Section 12(g) of
the Act:
COMMON STOCK, NO PAR VALUE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this
chapter) is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K ___.
The number of shares outstanding of the registrant's Common Stock was 31,525,436 as of April 10, 2002.
The aggregate market value of Common Stock held by non-affiliates of the registrant as of April 10, 2002 was approximately
$722,687,000, based on the closing price on that date of Common Stock on the Nasdaq National Stock Market.*
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's Definitive proxy Statement for the Annual Meeting of Shareholders to be held on June 13,
2002, to be filed with the Securities and Exchange Commission (the "SEC") no later than 120 days after February 2, 2002, are
incorporated by reference into Part III of this Form 10-K (Items 10 through 13).
*Excludes 428,728 shares of Common Stock held by directors and officers on April 10, 2002. Exclusion of shares held by any
person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the
direction of the management or policies of the Registrant, or that such person is controlled by or under common control with the
Registrant.
THE STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K THAT ARE NOT HISTORICAL
ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND SECTION 21E OF THE SECURITIES EXCHANGE
ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"), INCLUDING STATEMENTS REGARDING THE
COMPANY'S EXPECTATIONS, BELIEFS, INTENTIONS OR STRATEGIES REGARDING THE FUTURE.
FORWARD-LOOKING STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS REGARDING THE
EXTENT AND TIMING OF FUTURE REVENUES AND EXPENSES AND CUSTOMER DEMAND, STATEMENTS
REGARDING EXPECTED FINANCIAL RESULTS, THE PROFITABILITY OF FUTURE SALES OF THE
COMPANY'S PRODUCTS, NEW STORE OPENINGS AND NEW STORE CONCEPTS. ALL
FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ARE BASED ON INFORMATION
AVAILABLE TO US AS OF THE DATE HEREOF AND WE ASSUME NO OBLIGATION TO UPDATE ANY
FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS INVOLVE KNOWN OR
UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH MAY CAUSE OUR ACTUAL RESULTS,
PERFORMANCE OR ACHIEVEMENTS, OR INDUSTRY RESULTS TO BE MATERIALLY DIFFERENT FROM
ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH
FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH
DIFFERENCES INCLUDE BUT ARE NOT LIMITED TO:
RELATIONSHIPS WITH MALL DEVELOPERS AND OPERATORS, THE AVAILABILITY OF CASH AND/OR
MALL SPACE FOR PLANNED EXPANSION, FLUCTUATIONS IN SALES AND STORE SALE RESULTS,
UNCERTAINTIES RELATED TO NEW STORE OPENINGS, NEW STORE CONCEPTS, MUSIC AND FASHION
TRENDS, COMPETITION FROM OTHER RETAILERS, SUCCESS OF JOINT VENTURES AND RELATIONSHIPS
WITH AND RELIANCE UPON THIRD PARTIES, UNCERTAINTIES GENERALLY ASSOCIATED WITH
SPECIALTY RETAILING, POLITICAL AND OR SOCIAL CHANGES OR EVENTS THAT COULD NEGATIVELY
IMPACT SHOPPING PATTERNS AND/OR MALL TRAFFIC AND THE OTHER FACTORS REFERRED TO
HEREIN INCLUDING, BUT NOT LIMITED TO, THE ITEMS DISCUSSED IN
PART I, ITEM 1 UNDER THE CAPTION "CERTAIN RISK FACTORS RELATED TO THE COMPANY'S
BUSINESS" AND IN PART II, ITEM 7 UNDER THE CAPTION "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
PART I
ITEM 1. BUSINESS
GENERAL
Hot Topic, Inc. (together with its subsidiaries, "Hot Topic" or the "Company") operates Hot Topic stores, 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. In the first half of fiscal 2001 (the fiscal year ended February 2, 2002) the Company
launched a second retail concept with the opening of six stores under the trade name Torrid(TM). Torrid offers a selection of
music influenced apparel, lingerie, shoes and accessories centered around various lifestyles for plus-size young women between
the ages of 15 and 29. The Company opened its first Hot Topic store in 1989 and at the end of fiscal 2001, the Company
operated 346 Hot Topic stores and six Torrid stores in 48 states. The Company also maintains two distinct websites,
www.hottopic.com and www.torrid.com which reflect the Hot Topic and Torrid store concepts and sell certain items of
merchandise. The Company believes teenagers throughout the United States have similar fashion preferences, largely as a result
of the nationwide influence of MTV, music distribution, movies and television programs.
The Company opened 73 Hot Topic and six Torrid stores during fiscal 2001. The Company also occasionally relocates or
expands existing stores. During fiscal 2001, the Company expanded or relocated seven stores. The Company plans to open
approximately 70 new Hot Topic stores and 15 Torrid stores in the fiscal year ending February 1, 2003 ("fiscal 2002"); and 17
of these new Hot Topic stores and none of the Torrid stores were open as of April 10, 2002.
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
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believes that the single largest impact on the music industry during recent years has been the success of the MTV music
network, which enables fans not only to listen to the latest music and artists 24 hours a day, but also to experience a full sight
and sound package of appearance and attitude. According to the Neilson Media Research Report, in 2001 MTV music
network programming could be seen in more than 83 million households in the United States and in over 384 million households
worldwide. As a result, popular artists and fashions are much more visible today than 30 years ago. Hot Topic's management
believes that this increased visibility has contributed to the increase in demand for music-licensed and music-influenced apparel
and accessories.
MTV Networks has also achieved great success with specialized programming. For instance, "The Osbournes" drew more
than 4 million viewers to its regular time slot on March 26, 2002. Through the Company's continued sponsorship of the largest
summer rock tour, Ozzfest, Hot Topic expects to benefit from this broader audience.
Hot Topic's target customers are young men and women between the ages of 12 to 22 years old, who are passionate about
music, music videos, music-inspired fashion, and are avid MTV viewers. The Company believes its music-oriented
merchandise appeals to teenagers from diverse socio-economic backgrounds, and that its customers are broadly representative
of the teenage population in the United States.
Torrid targets customers that are plus-size females ages 15 to 29 years old and influenced by music and pop-culture. Hot Topic
actively listens to customer feedback, and based on requests from plus-size customers, the Company launched Torrid, its new
junior plus-size store. Hot Topic believes young women wearing sizes 14 to 26 can now match the style, excitement and
selection available at other junior retailers with the assortment found in Torrid. Torrid is a new specialty retail concept largely
inspired by requests from young, female shoppers at Hot Topic stores and www.hottopic.com. After analyzing customer
feedback and researching the market demographics, the Torrid concept was born. Torrid was launched in the first half of fiscal
2001, with the opening of six locations across the country and a website, www.torrid.com. The performance of these first six
stores prompted the planned expansion of 15 additional stores starting in the second quarter of fiscal 2002.
Teenagers represent both a growing part of the United States population and an increasing source of purchasing power.
According to Teenage Research Unlimited, it is estimated that the teenage population in the United States reached
approximately 32 million in 2000 and is expected to grow to approximately 34 million by 2005, representing a projected
growth rate close to twice the rate of the overall population. By 2010, there are likely to be more teenagers in the United States
than at any other time in history. Teenage spending has also increased annually. The average American teen spent more than
$104 a week in 2001 according to the marketing research firm Teen Research Unlimited, an increase of $26 from $78 in 1998.
In the past five years, teenage spending has grown from an estimated $122 billion a year to $172 billion a year.
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HOT TOPIC BUSINESS STRATEGY
The Company's goal is to become the leading retailer of music-licensed and music-influenced apparel and accessories for
young men and women. The principal elements of the Company's business strategy are as follows:
O FOCUS ON UNIQUE MUSIC-ORIENTED MERCHANDISE
Hot Topic's management believes that fashions and products associated with popular music artists have a significant influence
on teenagers. The Company has developed a unique strategy focused exclusively on offering music-licensed and
music-influenced merchandise in the mall environment. Accordingly, the Company believes it is well positioned to capitalize on
the growing teenage population and demand for music-related merchandise.
O OFFER "EVERYTHING ABOUT THE MUSIC"
The Company's stores are designed to serve as a headquarters for music-licensed and music-influenced apparel, accessories
and gift items. The Company's slogan, "Everything About The Music," reflects the Company's broad assortment of products,
which include over 10,000 Stock Keeping Units ("SKUs") in approximately 20 different product categories. The Company
believes its selection of music-licensed merchandise is the most extensive assortment available in a single mall store. The
Company complements its licensed merchandise with a unique and eclectic assortment of music-influenced apparel and
accessories, and frequently introduces new items and categories in response to changes in trends and demand. The Company
believes it has a history of being the first to offer the latest music fashions, which, together with its assortment of merchandise,
has made it a destination store for teenagers seeking music-related products.
O PROMOTE MUSIC-INSPIRED CULTURE
Hot Topic is committed to addressing the music-oriented lifestyles of its customers by building a culture throughout the
organization that reflects a passion for music. Management diligently tracks alternative and rock music trends by regularly
monitoring new music, music video releases, and radio station air play, visiting nightclubs around the country and attending
concerts. The Company also actively solicits feedback from its associates and customers. The Company believes these
activities enable it to react quickly to emerging trends, and provide it with a competitive advantage over retailers who do not
devote the time and resources necessary to anticipate these trends.
O LISTENING TO THE CUSTOMER
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
dynamic inventory management process to support the merchandise strategy. The Company regularly tests new merchandise in
select 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. Hot Topic is aggressive in taking prompt markdowns to maintain a fresh
merchandise mix. By actively managing the mix of categories and products in its stores, the Company believes it is able to
capitalize on emerging trends and minimize its dependence on any particular category. The Company believes that this
approach to managing its merchandise mix has contributed to its strong merchandise margins and consistent markdown rates.
The Company believes this markdown rate is lower than industry averages.
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O EMPHASIZE CUSTOMER SERVICE
Hot Topic trains its store associates to provide value-added, non-intrusive customer service. Sales associates are trained to
greet each customer, provide information about new music and fashion trends and suggest merchandise that matches the
customer's lifestyle and music preferences. The Company strives to give its teenage customers the same level of respect and
attention that is generally given to adult customers at other retail stores and to provide friendly and informed customer service
for parents. The Company believes that a high level of product knowledge and a commitment to music fashion create high
credibility and differentiate the Company from other teenage-focused retailers.
O CREATE AN ENTERTAINING STORE ENVIRONMENT
The Company seeks to create a compelling shopping environment that brings to the mall the elements of the alternative urban
shopping experience sought by teenagers. The Company has always focused on the lifestyles of the youth generation. Hot
Topic stores are designed with an industrial theme that incorporates dense merchandising and utilizes a professional sound
system playing alternative music releases to create a fun, high-energy store that teens will consider "their place" to shop with
friends. The Company believes that this atmosphere enhances the Company's image as a source for music-inspired fashion
while encouraging customers to shop in its stores for longer periods of time. Late in fiscal 2000, the Company tested a new
store design in two locations in California. Continuing to focus on the world of music and musicians as inspiration, the objective
of the new design is to provide a more kinetic and industrial-club feel, while portraying a less gothic appearance than the
Company's previous store design. This new look was inspired by the markets, clubs and old warehouse districts in London
where the Company's designers toured and created this new "industrial club" theme. Virtually all of the 73 new Hot Topic
stores opened in fiscal 2001 were built with this new design. The Company plans to continue with this design for the 70 Hot
Topic stores it expects to open in fiscal 2002.
TORRID BUSINESS STRATEGY
The Company's goal for the Torrid division is to become the leading specialty retailer of fashion forward plus-size junior
apparel. The principal elements of the Company's business strategy for Torrid are as follows:
O FOCUS ON FASHION FORWARD PLUS-SIZE APPAREL AND ACCESSORIES
THAT ARE MUSIC-INSPIRED
Torrid's merchandising team is focused on providing a fashion forward merchandise assortment that reflects the influence of
music and provides the plus-size customer with fun, hip, trendy apparel and accessories. The Company believes that it is the
first mall concept to offer a complete store assortment of fashion junior plus-size apparel.
O LISTENING TO THE CUSTOMER
Torrid does not dictate fashion trends, but rather listens to customers and watches music pop culture influences to determine
emerging trends in order to provide merchandise that will have strong customer appeal. Torrid, like Hot Topic, receives direct
feedback from Torrid store associates and customers. This feedback has a direct influence on future purchases of Torrid
merchandise.
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O EMPHASIZE CUSTOMER SERVICE AND CREATING A FUN, EXCITING
ENVIRONMENT
Torrid trains its store associates to provide one-on-one service to customers. Since the plus-size customer has been previously
unable to find the same fashion forward merchandise available to their smaller friends, Torrid's customer service approach
focuses on suggesting outfits and ensuring the correct fit.
Through a focus on customer service and an edgy fashion-forward merchandise offering, the Company seeks to create a
compelling shopping environment that will be sought after by the plus-size female customer. The warm reception, great
selection, and honest customer service by associates help to create a comfortable and exciting environment that will be
attractive and welcoming to the Torrid customer.
STORE LOCATIONS
As of February 2, 2002, the Company operated 346 Hot Topic stores in both metropolitan and middle markets in 48 states
across the United States and six Torrid stores in five states (California, Maryland, Nebraska, Maryland and Colorado).
Between February 2, 2002 and April 10, 2002, the Company opened an additional 17 Hot Topic stores. The following chart
sets forth, as of April 10, 2002, the number of Hot Topic and Torrid stores the Company operates in each state in which those
stores are located:
6
HOT TOPIC, INC.
STORES BY STATE
----------------------------------------------------------------------------------
HOT TOPIC STORES TORRID STORES TOTAL CO.
----------------------------------------------------------------------------------
OPEN NEW HT HT OPEN NEW
AT FY02 AT OPEN AT TORRID OPEN AT OPEN AT
2/2/2002 TO DATE 4/10/2002 2/2/2002 FY02 TO DATE 4/10/2002 4/10/2002
Alabama 1 1 0 0 1
Arizona 6 6 0 0 6
Arkansas 2 2 0 0 2
California 51 4 55 2 2 57
Colorado 8 2 10 1 1 11
Connecticut 6 6 0 0 6
Delaware 2 2 0 0 2
Florida 18 18 0 0 18
Georgia 7 1 8 0 0 8
Hawaii 3 3 0 0 3
Idaho 1 1 0 0 1
Illinois 14 14 0 0 14
Indiana 8 8 0 0 8
Iowa 5 5 0 0 5
Kansas 4 4 0 0 4
Kentucky 4 4 0 0 4
Louisiana 3 3 0 0 3
Maine 1 1 0 0 1
Maryland 9 9 1 1 10
Massachusetts 7 7 1 1 8
Michigan 11 1 12 0 0 12
Minnesota 9 1 10 0 0 10
Mississippi 1 1 0 0 1
Missouri 7 7 0 0 7
Montana 1 1 2 0 0 2
Nebraska 2 2 1 1 3
Nevada 5 5 0 0 5
New Hampshire 4 4 0 0 4
New Jersey 12 2 14 0 0 14
New Mexico 3 3 0 0 3
New York 16 16 0 0 16
North Carolina 6 1 7 0 0 7
North Dakota 1 1 0 0 1
Ohio 10 10 0 0 10
Oklahoma 4 4 0 0 4
Oregon 3 3 0 0 3
Pennsylvania 19 19 0 0 19
Rhode Island 1 1 0 0 1
South Carolina 4 4 0 0 4
South Dakota 2 2 0 0 2
Tennessee 8 1 9 0 0 9
Texas 26 2 28 0 0 28
Utah 3 3 0 0 3
Vermont 1 1 0 0 1
Virginia 4 1 5 0 0 5
Washington 14 14 0 0 14
West Virginia 2 2 0 0 2
Wisconsin 7 7 0 0 7
TOTAL 346 17 363 6 0 6 369
# OF STATES 48 11 48 5 0 5 48
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EXPANSION STRATEGY
The following table provides a history of the Company's store expansion over the last five fiscal years:
FISCAL YEAR
----------------------------------------------------------
2002
THROUGH
1997 1998 1999 2000 2001 4-10-02
----------------------------------------------------------
(Number of stores)
Stores at beginning of year 68 108 158 212 274 352
Hot Topic store closing/reopening* (1) 1
New stores opened - Hot Topic 40 50 54 62 73 16
New stores opened - Torrid 6
----------------------------------------------------------
Stores at end of year 108 158 212 274 352 369
----------------------------------------------------------
* Victorville, CA store re-opened in first quarter of fiscal 2002.
The Company's expansion strategy is to open stores primarily in shopping malls and selected entertainment centers in both new
and existing markets throughout the United States. The Company believes it has developed a store concept that is successful in
both metropolitan and middle markets. Further, as a result of the nationwide influence of MTV, music distribution, movies and
television programs, the Company believes that its 12 to 22 year-old target customers have similar fashion preferences
throughout the United States.
The Company opened 73 new Hot Topic stores and six Torrid stores in fiscal 2001 as well as expanded or relocated seven
existing Hot Topic stores. The Company closed one store in fiscal 2001 that was at the end of its lease. During fiscal 2002, the
Company plans to open approximately 70 new Hot Topic stores (16 stores of which the Company has opened in the first
quarter of fiscal 2002 and one re-opening of the store closed in fiscal 2001) and 15 new Torrid stores, in addition to expanding
or relocating 10 existing Hot Topic stores. The Company selects and evaluates potential store locations based on a variety of
criteria including the sales and square footage of the mall, sales of anchor stores, sales of teenage-oriented stores, foot traffic,
number of teenagers in the trade area, median family income and other factors relevant to the Company's unique merchandising
strategy. Hot Topic has a real estate committee, consisting of its Chief Executive Officer, Chief Operating Officer, Chief
Financial Officer, Vice President of Store Operations, Vice President of Real Estate and the Torrid General Manager. The
Company generally seeks potential store sites between 1,600 square feet and 2,200 square feet for Hot Topic stores between
2,200 square feet and 2,800 square feet for Torrid stores. The average size of the Company's fiscal 2001 Hot Topic openings
was 1,877 square feet and 2,452 square feet for the Company's Torrid openings.
The Company's Hot Topic stores currently average approximately 1,617 square feet and 2,452 square feet for Torrid stores.
STORE-LEVEL ECONOMICS
During fiscal 2001, the Company achieved average Hot Topic store net sales of approximately $1,038,000 and average Hot
Topic store net sales per square foot of approximately $642. Store-level operating cash flow (defined as store operating
income before depreciation and excluding changes in working capital) for Hot Topic stores open the entire year in fiscal 2001
was approximately $311,000, or 30% of average net sales. In fiscal 2001, all of the
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Company's Hot Topic 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.
HOT TOPIC MERCHANDISING
The Company's stores are designed to serve as a headquarters for music-licensed and music-influenced apparel, accessories
and gift items. Music-licensed merchandise includes T-shirts, hats, posters, stickers, patches, postcards, books, shoes, intimate
apparel, novelty accessories, compact discs and albums. Music-influenced merchandise includes woven and knit tops, skirts,
pants, shorts, jackets, shoes, costume jewelry, body jewelry, sunglasses, cosmetics, leather accessories and gift items.
Additional licensed apparel and accessories are influenced by television shows, cartoons and major motion pictures.
Approximately half of the Company's products are licensed, and the other half are music-influenced products. A key strategy of
the Company is to offer over 10,000 SKUs in 20 different product categories or "departments." On average, over 100
different licensed band T-shirts are carried in each store from current artists such as SlipKnot, System of a Down, Linkin Park,
Tool and the Strokes as well as classic rock artists such as Pink Floyd, Nirvana, Metallica, Jimi Hendrix, The Doors, Beatles
and Led Zeppelin. New items and categories are regularly tested as customer demand and product trends evolve.
The Company's merchandising staff consists of a Vice President, General Merchandise Manager, two divisional merchandise
managers, nine buyers, three associate buyers and ten assistant buyers. The merchandising staff reflects the Company's culture
in that its decisions and actions are influenced by music. In determining which merchandise to buy, the staff spends considerable
time viewing music videos, reviewing industry music sales, monitoring alternative radio station air play, consulting with sales
associates, reviewing customer requests, attending trade shows and reading music and fashion industry periodicals. In addition,
the merchandising staff regularly visits nightclubs and attends concerts and other events that attract young people. The
Company also solicits input from its store associates, in order to draw from many different experiences and perspectives.
The following table sets forth the Company's four major merchandise groups as an approximate percentage of net sales for
fiscal years 2001, 2000 and 1999:
PERCENTAGE OF NET SALES
2001 2000 1999
---------------------------------------
Apparel and T-Shirts 53% 51% 50%
Gifts 15 15 16
Accessories 26 27 27
Intimate Apparel and Shoes 6 7 7
---------------------------------------
100% 100% 100%
=======================================
Approximately half of the Company's products are licensed products. Artists typically license their likeness to a "master
licensor." The master licensor often retains the rights to market T-shirts and then may choose to sub-license to manufacturers,
other categories of merchandise such as posters, stickers and patches. Some artists also retain their licensing rights and
negotiate directly with licensees. Hot Topic buys its licensed merchandise from master licensors, licensees and directly from
artists. The Company currently purchases licensed T-shirts from over 30 companies and other licensed products from over 100
companies. Because of the Company's knowledge of teenage consumers' music preferences and music-influenced fashion,
licensors often seek the Company's advice prior to licensing new artists or product designs. As a result, the Company often
receives accommodations such as early shipments of new releases, exclusive merchandise, advanced lead times, exclusive
designs and vendors' acceptance of returns.
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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.
The Company has five lines of private label merchandise to complement and supplement current product offerings. The
Company believes that Hot Topic brands play an important part in differentiating its stores from those of its competitors and
provide the Company with higher margin opportunities as compared to other merchandise. The Company's management
estimates that in fiscal 2001 Hot Topic brands accounted for approximately 25% of the Company's sales, the same percentage
as in fiscal 2000. The Company's proprietary brands include Morbid Makeup (cosmetics), Morbid Metals (body jewelry),
Morbid Threads (men's and women's apparel and hosiery) and MT:2 (men's and women's apparel). Shoes are also sold under
the Hot Topic label.
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 smaller test purchases 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 2001, the Company had approximately 944 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.
TORRID MERCHANDISING
The Company's Torrid stores are designed to serve as the destination for fashion forward apparel and accessories for the
plus-size junior woman. The Company believes that the Torrid customer wants to wear the same merchandise as her
smaller-sized peers. Torrid's merchandise includes novelty t-shirts, fashion tops, pants, shorts, skirts, dresses, jackets, intimate
apparel, shoes, hosiery, accessories, gifts, and beauty products. Torrid apparel is sized 14 to 26. Approximately 30% of the
products come from established branded vendors, including Paris Blues, Z Cavaricchi, Necessary Objects, Kikwear, Macgirl,
Dollhouse, Fine and Hot Kiss and more fashion-forward vendors such as Serious, Lip Service, and Tripp. The Company
worked with these and other vendors, to develop plus-size junior apparel fit specifications. The Company believes its selection
of fashion items from these and similar vendors gives the Torrid customer an opportunity to buy the same or similar branded
items that have historically been available to other young women of the same age who are not plus-size. Working together with
vendors, fashion trends and customer requests are researched, designed and manufactured for Torrid. Torrid, through its own
fit specialist, works with the manufacturers' design teams to help ensure that quality standards are achieved and maintained.
During fiscal 2001, approximately 75% of Torrid's net sales were generated in apparel merchandise categories and 25% of
Torrid's sales were produced in accessories, including intimate apparel and shoes.
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The Torrid merchandising staff consists of a divisional merchandise manager, two buyers, one associate buyer and one assistant
buyer. The Company's culture of soliciting and listening to customers and store associates is evidenced by the Torrid
merchandising staff's decisions and actions. Furthermore, the Company believes that Torrid's merchandising direction is
influenced by music and music related activities. The range of music and music artists that influence Torrid fashion is much
broader than those influencing fashion at Hot Topic stores, consistent with the broader target customer base of females ages 15
to 29.
Merchandising decisions for Torrid are also influenced by emerging fashions in the junior market. The decisions of the Torrid
merchandising group are heavily influenced by feedback from customers and associates, in order to draw from many different
experiences and perspectives. The staff also spends considerable time visiting nightclubs, attending concerts, attending trade
shows and other events that attract young people. Approximately 30% of Torrid merchandise is purchased from established
branded vendors. The remaining 70% is Torrid private label merchandise that provides the customer with unique,
fashion-forward merchandise, often at more competitive price points than branded merchandise. Private label merchandise also
often provides the Company with higher margin opportunities as compared to other merchandise. In order to reduce fashion
risk and maintain the ability to respond quickly to emerging trends, Torrid buys a majority of its merchandise not more than 90
days, and many times less than 60 days, in advance of delivery, and will often begin with small purchases for testing.
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 store
inventory plans and SKU performance by using Arthur Allocation software. Buyers determine SKU reorder quantities by using
a proprietary automated software program which considers sales history, projected sales, planned inventories by store, store
demographics, geographic preferences, store openings and planned markdown dates.
The Company's Vice President of Planning and Allocation, two directors of Planning and Allocation and 20 inventory analysts
work closely with the merchandise buyers and store associates to meet the appropriate inventory requirements of each store.
Hot Topic's headquarters and distribution facility consists of approximately 250,000 square feet located in City of Industry,
California. All merchandise is delivered by vendors to this facility, where it is inspected, priced, allocated, 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 new and reordered merchandise. Minimal back stock is maintained in the Company's distribution facility and at its
stores; so that most of the Company's merchandise is available for sale on the selling floors of its stores.
In March 2001, the Company entered into a lease for an additional 125,000 square feet in the same building as is its current
headquarters and distribution facility in the City of Industry, California bringing the total square feet to approximately 250,000.
Late in the fourth quarter of fiscal 2001, the Company began construction to expand its office and distribution center into the
additional space. The expansion is planned to be completed during the second quarter of fiscal 2002 at an estimated cost of
approximately $4.2 million. The Company estimates that the operating capacity gained from this additional space and the
related offices and equipment will allow for growth to approximately 700 stores.
HOT TOPIC STORE OPERATIONS
Hot Topic's store operations are currently managed by six regional managers and 57 district or area managers who each
supervise approximately four to eight stores. Individual stores are managed by a store manager and two or three assistant
managers. In addition to managers and assistant managers, a typical store has approximately six to ten part-time sales
associates, depending on the season. The hiring and training of new associates is 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 associates,
which helps streamline the Company's interview and hiring processes at the store level.
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The Company strives to create a store environment that teenagers will consider "their place" to shop with friends. Hot Topic
seeks to hire sales associates who fit the profile of its target customer -- energetic people who are knowledgeable and
passionate about music and music-inspired fashion. To assist management in properly considering the preferences and opinions
of its target customers, selected sales associates accompany Hot Topic's buyers on buying trips. Further, in return for feedback
on fashion and other trends, sales associates are reimbursed for the cost of attending concerts and frequenting clubs, and are
encouraged to communicate customer requests and their own merchandise ideas to the buyers and management. Hot Topic
encourages its sales associates to dress and accessorize themselves with the same fashionable merchandise that is sold in its
stores. To further encourage its associates to dress and accessorize themselves with Hot Topic merchandise, the Company
offers a 40% employee discount on merchandise. 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 category results so that performance can
be measured against set goals. Postage-paid "report cards" are provided in all stores for customers to grade performance and
make recommendations to Company management. The Company strives to give its teenage customers the same level of
respect and attention that is generally given to adult customers at other retail stores. Associates are trained to greet each
customer, to inform the customer about new music fashion trends and to suggest merchandise that matches the customer's
lifestyle and music preferences. Hot Topic also strives to provide friendly and informed customer service for parents. The
Company provides a listing of music artists' national tour dates at each of its stores. The Company believes that its high level of
product knowledge and service differentiates Hot Topic from other teenage-focused retailers.
Store, district and area managers are compensated with a base salary and may qualify to receive a quarterly bonus based on
sales and inventory shrinkage. Additionally, district, area and store managers may also qualify to receive periodic stock option
grants, and certain associates 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 associates. In
particular, the success of the Company's expansion program will be dependent on its ability to promote and/or recruit qualified
district and store managers. To date, a significant number of its store managers have been promoted from within the Company.
TORRID STORE OPERATIONS
Torrid store operations are currently supervised by one district manager and one area manager. Individual stores are managed
by one store manager and two or three assistant managers. In addition, each store has six to ten part-time associates,
depending on the season. The store and district managers are responsible for associate training, and the Torrid division has
established training programs and operating procedures.
Similar to Hot Topic stores, Torrid district, area and store managers are compensated with a base salary and may qualify for
quarterly bonuses based on sales and inventory shrinkage results. District, area and store managers may also qualify to receive
periodic stock option grants, and certain associates are eligible to participate in the Company's Employee Stock Purchase Plan.
The division believes that its continued success is dependent in part on its ability to attract, retain and motivate qualified
associates. In particular, the success of the Torrid division's expansion program will be dependent on its ability to promote
and/or recruit qualified district and store managers.
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MARKETING, PROMOTION AND INTERNET
The Company generally locates its stores in high traffic malls within areas of high teenage population and relies on existing
customers, sales associates, store design and exciting music to attract new customers to its stores. During fiscal 2000 and fiscal
2001 the Company co-sponsored a major summer rock tour, Ozzfest. As sponsor, the Company's name was associated with
all promotional activities at each venue. The Company has entered into a similar sponsorship of Ozzfest in fiscal 2002.
The Company continued to operate its core website, www.hottopic.com, which offers merchandise, tour dates, contests, job
postings, store locations and community features such as band reviews. An additional website was also launched to support the
Torrid concept: www.torrid.com. The Torrid website also markets merchandise and announces new store locations. The
Company's net sales from Internet operations (with www.torrid.com) rose by 47% and contributed approximately 1.5% of
total sales in fiscal 2001. The Company intends to relaunch each of the websites in fiscal 2002 with improved functionality to
better drive sales and support customer needs.
INFORMATION TECHNOLOGY
Hot Topic's information systems provide integration of store, merchandising, distribution, financial, and human resources. 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, integrated financials and human resources/payroll. Most
of these systems operate on software licensed from GERS Retail Systems ("GERS") running on an Oracle database platform.
Sales are updated daily in the merchandising reporting systems by polling sales information from each store's point-of-sale
("POS") terminals. The Company's POS system consists of registers providing price look-up, time and attendance, e-mail and
credit card/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, system
maintenance and e-mail are downloaded through the POS system. The Company evaluates information obtained through nightly
polling to implement merchandising decisions, including product purchasing/reorders, markdowns and allocation of merchandise
on a daily basis.
During fiscal 2001, the Company had two main areas of focus in information technology. The Company's POS system upgrade
was completed in all existing stores, at a cost of approximately $3.0 million. Advanced features of the GERS Retail Systems
("GERS") were implemented, along with informational report development.
In addition, in fiscal 2002 the Company plans to invest approximately $1.4 million in a new Wide Area Network to connect all
Company stores. The Company expects this new technology to improve efficiency and assist in communicating more effectively
with all store locations nationwide.
TRADEMARKS
The Company has registered on the Principal Register of the United States Patent and Trademark Office its retail store service
mark Hot Topic(R) and various trademarks for merchandise including Hot Topic(R), Morbid Make-Up(R), Morbid
Scents(R), Morbid Metals(R), Morbid Adornments(R), Tragedy(R), Misery(R), MT:2(R), Morbid Threads(R) and Everything
About the Music(R). Each federal registration is renewable indefinitely if the mark is in use at the time of the renewal.
Applications have been made to register Naturally Morbid(TM), Torrid(TM), Torrid & Design(TM) and Torrid Flaming Heart
Design(TM) in the United States. The Company is not aware of any claims of infringement or other challenges to the
Company's right to use its marks in the United States. The Company also has additional registrations and pending applications
in foreign jurisdictions. All other trademarks, tradenames and servicemarks referenced herein are the property of their
respective owners.
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HOT TOPIC 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, customers, suitable retail locations and qualified associates.
Hot Topic currently competes with street alternative and vintage clothing stores located primarily in metropolitan areas and with
other mall-based teenage-focused retailers such as The Buckle, Claire's Stores, Inc., Charlotte Russe Inc., Delias Inc., d.e.m.o.
(a divison of Pacific Sunwear, Inc.), Gadzooks, Inc., Millers Outpost, Inc., Pacific Sunwear of California, Inc., Spencer Gifts,
Inc., Urban Outfitters, Inc., The Wet Seal, Inc., and, to a lesser extent, with music stores. 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.
TORRID COMPETITION
Based on direct customer research conducted by the Company, Hot Topic believes that teen plus-size females have historically
shopped for apparel at department stores and specialty stores such as Lane Bryant. The Company believes such stores
generally target an older customer than does Torrid. While the Company is not aware of other mall-based chains that are
specifically targeting junior, plus-size fashion-forward customers, Torrid competes with traditional department stores, local
specialty stores and junior teen retailers that offer some larger-sized merchandise, such as Deb Shops, and certain traditional
and web-based catalogs. Many companies compete for the junior customers and additional competitors may enter into the
plus-size female market.
EMPLOYEES
The Company employed approximately 1,200 full-time and 2,800 part-time associates as of April 20, 2002. Of the
Company's 4,000 associates, approximately 290 were corporate headquarters and distribution center personnel, 60 regional
and district managers and approximately 3,650 were store associates. The number of part-time associates fluctuates with
seasonal needs. None of the Company's associates are covered by collective bargaining agreements. The Company considers
its associate relations to be good.
EXECUTIVE OFFICERS AND KEY EMPLOYEES
The executive officers and key employees of the Company and their ages at April 20, 2001 are as follows:
NAME AGE POSITION
---- --- --------
Elizabeth M. McLaughlin 41 President and Chief Executive Officer and Director
Gerald A. Cook 49 Chief Operating Officer
James J. McGinty 39 Chief Financial Officer
Jay A. Johnson 56 Senior Vice President of Strategic Analysis and Investor
Relations
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Thomas A. Rail 51 Senior Vice President and General Manager, Torrid
Jane Cruz 42 Senior Vice President, Human Resources
Cindy Levitt 41 Vice President, General Merchandise Manager
Darrell Kinsley 39 Vice President, Store Operations
John Neppl 45 Vice President, Real Estate and Construction
Alain Krakirian 36 Vice President, Planning and Allocation
Sue McPherson-Spissu 34 Vice President, Distribution Center and Internet
John Horwath 42 Vice President, Information Technology
George Wehlitz, Jr. 41 Vice President, Controller
Karen Talley 44 Divisional Vice President and Divisional Merchandise Manager,
Accessories
ELIZABETH M. MCLAUGHLIN has served as Chief Executive Officer of the Company since August 2000 and President
since February 2000, and has served on the Board since May 2000. From June 1996 through February 2000, Ms.
McLaughlin served as Senior Vice President and General Merchandise Manager of the Company. From May 1993 through
May 1996, Ms. McLaughlin was the Company's Vice President, Operations. Prior to joining the Company, Ms. McLaughlin
held various positions with Millers Outpost, a privately-held teen retailer, where she served as Divisional Merchandise
Manager, Director of Store Operations, and Director of Financial Planning and Budgeting. Prior to joining Millers Outpost, Ms.
McLaughlin held various financial analyst and store positions with The Broadway. Ms. McLaughlin holds a B.A. degree in
Economics from the University of California at Irvine.
GERALD A. COOK has been Chief Operating Officer of the Company since February 2001. From February 1999 until
joining the Company, he was the President and Chief Operating Officer of Travel 2000, Inc. Subsequent to his leaving Travel
2000, Inc., the company filed for chapter 11 bankruptcy in March 2001. From 1995 to April 1998, Mr. Cook was Senior
Vice President, Operations for The Bombay Company, Inc. and from 1989 to 1995, Mr. Cook was the Vice President,
Stores and the Vice President, General Merchandising Manager of Woman's World Stores. Prior to 1989, he held
management positions with Barnes & Noble/B Dalton, The Gap Stores and the Limited, Inc. Mr. Cook holds a B.S. degree in
Business Administration from the University of Minnesota.
JAMES J. MCGINTY has served as Chief Financial Officer of the Company since February 2001. Mr. McGinty joined Hot
Topic in August 2000 as its Vice President, Finance and was promoted to Chief Financial Officer in February 2001. From July
1996 to July 2000, Mr. McGinty was Vice President-Controller at Victoria's Secret Stores, the leading brand and largest
specialty retailer in the Limited, Inc. From 1984 to 1996, he held various financial and accounting positions within the Structure
and Express divisions of the Limited, Inc. Mr. McGinty holds a B.S. degree in Accounting from Miami University in Oxford,
Ohio.
JAY A. JOHNSON has served as the Senior Vice President, Strategic Analysis and Investor Relations of the Company since
February 2001. Since May 1995 he also has served as the Company's Assistant Secretary. From May 1995 to February
2001, he was the Chief Financial Officer of the Company. From January 1993 to May 1995, he was Vice President/Chief
Financial Officer of Frame-n-Lens Optical, Inc., a national optical retailer then with approximately 300 stores.
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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. Mr. Johnson holds a B.S. degree in Accounting from the California
State University, Northridge.
THOMAS A. RAIL has been Senior Vice President and General Manager of Torrid since May 2001. From January 1999 to
April 2001, Mr. Rail was President of Retail for Aris Industries where he was responsible for the XOXO boutique and outlet
stores, an XOXO Internet site, and the coordination of retail licensees. From August 1995 to December 1998, he was
President of Retail for Designer Holdings where he was responsible for developing 37 Calvin Klein Outlet stores and, upon its
acquisition by Warnaco in the Fall of 1997, assumed the additional responsibilities for approximately 85 Olga Warner stores.
Mr. Rail spent June 1985 through August of 1996 in various management positions with Millers Outpost, including six years as
the General Manager of Levi's Outlet by MOST (a start-up division for Millers). Mr. Rail has a B.S. in Business Management
from Brigham Young University.
JANE CRUZ joined the Company in August 2001 as Senior Vice President, Human Resources. Ms. Cruz has over 18 years
of human resource experience. From July 1996 to July 2001, Ms. Cruz held human resource management positions with
Universal Studios' Television and Networks Group, including most recently, Senior Vice President, Human Resources. At
Universal Studios her responsibilities included both domestic and international operations. From November 1994 to July 1996,
Ms. Cruz was Director, Human Resources of EQE International, an engineering consulting firm. She spent March 1983 through
November of 1994 in various Human Resource positions with Viacom - Cable Division, including Regional Director, Human
Resources. Ms. Cruz has a B.S. in Economics from the University of San Francisco and an M.B.A. from the University of
California, Berkeley.
CINDY LEVITT has been Vice President, General Merchandise Manager of the Company since February 2000. From June
1996 to February 2000, she served as the Company's Divisional Merchandise Manager, Apparel and Music. Since 1989, Ms.
Levitt has held senior buying positions at the Company. Prior to her career at Hot Topic, Ms. Levitt held buying positions at
May Department Stores.
DARRELL KINSLEY has been Vice President, Stores of the Company since February 2000. From June 1998 through
February 2000, Mr. Kinsley was the Company's Regional Director for the western United States. From February 1997
through June 1998, he was the Company's Regional Director for the eastern United States. Mr. Kinsley joined the Company in
February 1995 as the District Manager for the eastern United States. Mr. Kinsley holds a business management leadership
certificate from the Anderson School of Business at the University of California, Los Angeles.
JOHN NEPPL joined the Company in October 2001 as Vice-President of Real Estate and Contruction. From January 1995
to September 2001 Mr. Neppl served as Vice-President of Real Estate and Construction for Eastern Mountain Sports, Inc., a
specialty retailer based out of New Hampshire. Mr. Neppl served as Director of Real Estate at Miller's Outpost/Anchor Blue
from October 1987 to December 1994. Mr. Neppl held various financial positions with Mervyn's department stores, a division
of Target Corporation, from October 1978 to September 1987. Mr. Neppl received a B.S. in Accounting from Villanova
University in 1978.
ALAIN KRAKIRIAN has been the Company's Vice President, Planning and Allocation since February 2000. From July
1997 through February 2000, Mr. Krakirian was the Company's Director of Planning and Allocation. Mr. Krakirian was the
Planning Manager at Disney Stores from December 1996 to July 1997 and the Director of Merchandise Planning and
Allocation at Kids Mart from February 1996 to December 1996. From September 1991 to January 1996, Mr. Krakirian held
various merchandise control and planning positions at Clothestime Stores, including Director of Merchandise Control and
Information Office from October 1994 to January 1996. Mr. Krakirian holds a B.S. degree in Finance from the University of
LaVerne and an M.B.A. degree from Pepperdine University.
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SUE MCPHERSON-SPISSU was promoted to the Company's Vice President of Distribution Center and Internet in October
2001. Ms. McPherson-Spissu was the Company's Vice-President, Distribution Center from February 2001 to October 2001
and was the Company's Divisional Vice President of Distribution Center from February 2000 to February 2001. From March
1995 to February 2000, she was the Company's Director of the Distribution Center. Ms. McPherson-Spissu joined the
Company in 1989 as a store associate in its first store while attending the University of Southern California. Ms.
McPherson-Spissu holds a B.S. degree in Business from the University of Southern California.
JOHN HORWATH has been the Company's Vice President, Information Technology since June 2001. Mr. Horwath has over
24 years of Information Technology experience. From May 2000 until joining the Company, he was Director of Information
Technology at World Wide Restaurants, Inc. From August 1998 until May 2000, Mr. Horwath was the Vice President and
Chief Information Officer for Wherehouse Entertainment, Inc. From February 1992 to July 1998, he was Regional Vice
President of Information Technology for PolyGram Holding, Inc. Prior to 1992, he held management positions with LA Gear,
Inc., Pic`N'Save, Inc., Tutor/Saliba, Inc., and Kasler Corporation.
GEORGE WEHLITZ, JR. joined Hot Topic in February 2002 as its Vice President, Controller. From August 2000 to
February 2002, Mr. Wehlitz was Chief Financial Officer at The Popcorn Factory, Inc., a catalog company for gourmet
popcorn gifts. From 1987 to 2000 Mr. Wehlitz held various financial related positions, at the divisional and corporate level, for
The Bombay Company, Inc. Mr. Wehlitz holds a B.A. degree in Accounting from Texas Christian University and is a Certified
Public Accountant.
KAREN TALLEY has served as Divisional Vice President and Divisional Merchandise Manager, Accessories of the
Company since February 2000. Ms. Talley joined the Company in 1993 as the Senior Accessory Buyer. She was the
Company's Divisional Merchandise Manager of Accessories from April 1996 to February 2000. Prior to joining the Company,
Ms. Talley held buying positions at Jay Jacobs and Nordstrom.
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CERTAIN RISK FACTORS RELATED TO THE COMPANY'S BUSINESS
Certain sections of this Annual Report on Form 10-K, including the preceding "Management's Discussion and Analysis of
Financial Condition and Results of Operations," contain various forward looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which
represent the Company's expectations or beliefs concerning future events. These forward looking statements involve risks and
uncertainties, and the Company cautions that these statements are further qualified by important factors that could cause actual
results to differ materially from those in the forward looking statements, including, without limitation, the sufficiency of the
Company's working capital and cash flows from operating activities, the effect of economic conditions, the effect of severe
weather or natural disasters, political and/or social changes or events that could negatively impact shopping patterns and/or mall
traffic and the effect of competitive pressures from other retailers as well as other risks detailed below:
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. Seventy-nine of the Company's 352
stores opened as of February 2, 2002 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 85
stores, consisting of 70 Hot Topic and 15 Torrid stores, during fiscal 2002, which will result in a significant increase in the
number of stores operated by the Company. Operation of a greater number of new stores and expansion into new markets
may present competitive and merchandising challenges that are different from those currently encountered by the Company in
its existing stores and markets. In addition, there can be no assurance that the Company's expansion within its existing markets
will not adversely affect the individual financial performance of the Company's existing stores or its overall results of operations,
or that new stores will achieve sales and profitability levels consistent with existing stores. The Company will need to continually
evaluate the adequacy of its store management and management information and distribution systems to manage its planned
expansion. There can be no assurance that the Company will anticipate all of the changing demands that its expanding
operations will impose on such systems, and the failure to adapt its systems and procedures to such changing demands could
have a material adverse effect on the Company's business, results of operations and financial condition. There can be no
assurance that the Company will successfully achieve its expansion targets or, if achieved, that planned expansion will result in
profitable operations.
The Company's ability to open stores and the performance of such stores will depend upon many factors, including and among
others, the Company's ability to identify and enter new markets, locate suitable store sites, negotiate acceptable lease terms,
hire and train store managers and sales associates and obtain adequate capital resources on acceptable terms. Early in its
history, the Company encountered difficulties in leasing certain store sites. The Company believes these difficulties were in part
due to the Company's level of capitalization, its limited operating history at such time, its then unproven store concept, and
apprehension on the part of mall operators concerning the Company's teenage customers. In fiscal 1999, a major mall
developer asserted that the Company had violated a "use clause" applicable to certain or all of the Company's leases with that
developer. As a result, the developer ceased ongoing discussions relating to potential new Hot Topic stores and told the
Company that no new leases would be entered into. Upon notice of the alleged violation, the Company adjusted its
merchandise mix in stores leased from that developer (and to a somewhat lesser extent, in all other stores) and took certain
other actions to ensure ongoing "use clause" compliance. These actions and continuing discussions with the developer resulted
in an amended "use clause" for all leases with the developer. In early 2000, the Company satisfied the concerns of the
developer and resumed discussions with the developer concerning potential new stores for fiscal 2000 and beyond.
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There can be no assurance that the Company will not face similar resistance from mall operators or others in the future. If the
Company's relations with mall operators or developers are ever again strained, the Company may not grow as planned, may
not reach certain revenue levels and other targets, and may suffer a decline in stock price. Any restrictions on the Company's
ability to expand to new store sites or to offer a broad assortment of merchandise could have a material adverse effect on the
Company's business, results of operations and financial condition.
FLUCTUATIONS IN COMPARABLE STORE SALES RESULTS
A variety of factors affect the Company's comparable store sales including, among others, the timing of releases of new
music-related products, music and fashion trends, the general retail sales environment, the Company's ability to efficiently
source and distribute products, changes in the Company's merchandise mix and the Company's ability to execute its business
strategy efficiently. The Company's comparable store sales results have fluctuated significantly in the past and the Company
believes that such fluctuations may continue. The Company's comparable store sales results for fiscal 1997, 1998, 1999, 2000
and 2001 were 2.2%, 0.4%, 22.8%, 16.7% and 3.9% respectively. The Company's comparable store sales results were
8.0%, 2.4%, 2.2% and 3.8% for the first, second, third and fourth quarters, respectively, of fiscal 2001 and 24.1%, 21.8%,
15.3% and 11.2% for the first, second, third and fourth quarters, respectively, of fiscal 2000. Past comparable store sales
results are not an indicator of future results, and there can be no assurance that the Company's comparable store sales results
will not decrease in the future. The Company's comparable store sales results could cause the price of the Common Stock to
fluctuate substantially.
DEPENDENCE ON AND CHANGES IN MUSIC AND FASHION TRENDS
The Company's profitability is largely dependent upon (i) the continued popularity of alternative and rock music, music videos,
and MTV among teenagers and college age adults, (ii) the emergence of new artists and the success of music releases and
music-related products, (iii) the continuance of a significant level of teenage spending on music-licensed and music-influenced
products, and (iv) the Company's ability to anticipate and keep pace with the music, fashion and merchandise preferences of its
customers. The popularity of particular types of music, artists, styles and brands is subject to change. The Company's failure to
anticipate, identify and react appropriately to changing trends, could lead to, among other things, excess inventories and higher
markdowns, and poor customer acceptance of its new store design, which could have a material adverse effect on the
Company's results of operations and financial condition, and on its image with customers. There can be no assurance that the
Company's new products and new store design will be met with the same level of acceptance as in the past or that the failure of
the new products and/or new store design will not have an adverse material effect on the Company business, results of
operations and financial condition.
IMPACT OF ECONOMIC CONDITIONS; MINIMUM WAGE RATES
Certain economic conditions affect the level of consumer spending on merchandise offered by the Company, including, among
others, business conditions, interest rates, taxation and consumer confidence in future economic conditions. The Company is
also dependent upon the continued popularity of malls as a shopping destination and the ability of mall anchor tenants and other
attractions to generate customer traffic for its stores. A decrease in mall traffic would adversely affect the Company's growth,
sales results and profitability.
Changes to Federal minimum wage laws in each of 1996 and 1997 raised the mandatory minimum wage. California,
Connecticut, Washington, Massachusetts and other states have also enacted increases in state-required minimum wages that
are higher than the Federal requirements. The most recent increases in states where the Company currently operates took effect
on January 1, 2002 in California, Connecticut, Delaware, Hawaii, Maine, Massachusetts, Oregon, Rhode Island, Vermont and
Washington. The Company operated a total of 96 stores in
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those states as of April 10, 2002. Statutory increases in Federal and state minimum wages could adversely affect the
Company's profitability. The recent state increases in minimum wage and any other such increases will raise minimum wages
above current wage rates of certain of the Company's associates, and competitive factors could require corresponding
increases in higher associate 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 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 and political conditions.
The Company's business is also subject to seasonal influences, with heavier concentrations of sales during the back-to-school,
Halloween and Holiday seasons (defined as the week of Thanksgiving through the first few days of January), and other periods
when schools are not in session. The Holiday season remains 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) as well as Halloween (which affects operating results in the third quarter), all reduce the Company's
dependence on the Holiday selling season. As is the case with many retailers of apparel, accessories and related merchandise,
the Company typically experiences lower first fiscal quarter net sales relative to other quarters.
DEPENDENCE ON KEY VENDORS
The Company's performance depends on its ability to purchase current music-related merchandise in sufficient quantities at
competitive prices. The Company has many sources of merchandise. Its largest vendor, Changes Manufacturing, supplied just
under 5% of the Company's merchandise purchases in fiscal 2001. Substantially all of the Company's music-licensed products
are available only from vendors that have exclusive license rights. In addition, many of the Company's music-influenced
products are supplied by small, specialized vendors that create unique products primarily for the Company. The Company's
smaller vendors generally have limited resources, production capacities and operating histories, and some of the Company's
vendors have limited the distribution of their merchandise in the past. The Company has no long-term purchase contracts or
other contractual assurances of continued supply, pricing or access to new products. There can be no assurance that the
Company will be able to acquire desired merchandise in sufficient quantities on terms acceptable to the Company in the future
or that any inability to acquire suitable merchandise, or the loss of one or more key vendors, will not have a material adverse
effect on the Company's business, results of operations and financial condition.
NEW TORRID STORES AND ASSOCIATED RISKS
The Company's ability to expand into new concepts has not been fully tested. Accordingly, the operation of its Torrid stores
and the sale of Torrid merchandise over the Internet at www.torrid.com, are subject to numerous risks, including unanticipated
operating problems, lack of experience, lack of customer acceptance, new vendor relationships and competition from existing
and new retailers. For example, it may be that the Company will not be able to generate continued customer interest in Torrid
stores and Torrid products, or that this concept may not be able to support the store format. There can be no assurance that
the Company's Torrid stores or Torrid website will achieve sales and
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profitability levels that justify the Company's investment in this new retail format. Establishing and increasing the number of
Torrid stores also involves other risks that could have a material adverse effect on the Company, including
(i) the risk of diversion of management's attention from the Company's core business and products, (ii) difficulties with the
hiring, retention and training of management and personnel for the Torrid stores, (iii) risks associated with new vendors and (iv)
difficulties with locating and obtaining favorable store sites and acceptable lease terms. Risks inherent in any new concept are
particularly acute in the Company's case with respect to Torrid, because this is the first significant new venture by the
Company. The Company has traditionally concentrated its expansion efforts on increasing the number of and sales in Hot Topic
stores.
UNCERTAINTIES REGARDING IMPLEMENTATION OF NEW MANAGEMENT INFORMATION
SYSTEM
During fiscal 1999, after completing an evaluation of its long-term management information system needs, the Company
selected new hardware and software for its stores, office and distribution center. The Company implemented the host hardware
and software systems at its office and distribution center during the second half of fiscal 2000 and installed certain point-of-sale
upgrades at its stores in fiscal 2001. In addition, in fiscal 2002 the Company plans to install a new Wide Area Network at its
stores. If the information systems and software do not work effectively, the Company may experience delays or failures in its
operations. These delays or failures could adversely impact the promptness and accuracy of the Company's transaction
processing, financial accounting and reporting and ability to properly forecast earnings and cash requirements. The Company's
current and planned systems, transaction processing, procedures and controls may not be adequate to support future
operations. To manage growth of its operations and personnel, the Company may need to continue to improve its operational
and financial systems, transaction processing, procedures and controls.
DEPENDENCE ON KEY PERSONNEL
The Company's performance depends largely on the efforts and abilities of senior management, especially Elizabeth
McLaughlin, the Company's Chief Executive Officer and President, who has been with the Company since 1993. The
Company has a $2,000,000, key-person life insurance policy on Ms. McLaughlin. However, the sudden loss of Ms.
McLaughlin's services or the services of other members of the management team could have a material adverse effect on the
Company's business, results of operations and financial condition. Furthermore, there can be no assurance that Ms. McLaughlin
and the Company's existing management team will be able to manage the Company or its growth or that the Company will be
able to attract and retain additional qualified personnel as needed in the future.
UNCERTAINTIES REGARDING DISTRIBUTION OF MERCHANDISE
The Company relies upon the United Parcel Service for its product shipments, including shipments to and from all of its stores,
and, accordingly, is subject to the risks, including employee strikes and inclement weather, associated with United Parcel
Service's ability to provide delivery services to meet the Company's shipping needs. The Company is also dependent upon
temporary associates 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 associates, or that there will continue to be sufficient sources of temporary associates.
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
21
associated with destruction of merchandise if the distributor is unwilling or unable to reimburse the Company, and be subject to
liability under various civil and criminal causes of action, including actions to recover unpaid royalties and other damages. Any
of these results could have a material adverse effect on the Company's business, results of operations and financial condition.
COMPETITION
The retail apparel and accessory industry is highly competitive. The Company competes with other retailers for vendors,
teenage and college age customers, suitable retail locations and qualified associates and management personnel. Hot Topic
currently competes with street alternative stores located primarily in metropolitan areas and with other mall-based
teenage-focused retailers such as The Buckle, Charlotte Russe, Claire's Stores, Inc., Delias Inc., d.e.m.o. (a division of Pacific
Sunwear, Inc.), Gadzooks, Inc., Millers Outpost, Inc., Pacific Sunwear of California, Inc., Spencer Gifts, Inc., Urban
Outfitters, Inc., The Wet Seal, Inc., and, to a lesser extent, with music stores and mail order catalogs and websites. Torrid has
other competitors, such as Lane Bryant, Deb Shops and plus size departments at traditional department stores as well as
numerous potential competitors who may begin or increase efforts to market and sell products competitive with Torrid. Many
of the Company's competitors are larger and have substantially greater financial, marketing and other resources than the
Company. Direct competition with these and other retailers may increase significantly in the future, which could require the
Company, among other things, to lower its prices and/or take other measures. Increased competition could have a material
adverse effect on the Company's business, results of operations and financial condition.
PRICE VOLATILITY
The Company's Common Stock is quoted on the Nasdaq National Market, which has experienced and is likely to experience
in the future significant price and volume fluctuations, which could adversely affect the market price of the Common Stock
without regard to the operating performance of the Company. In addition, the Company believes that factors such as quarterly
fluctuations in the financial results of the Company, fluctuations in the Company's comparable store sales, announcements by
other apparel, accessory and gift item retailers, the trading volume of the Company's Common Stock in the public market, the
condition of the overall economy and the condition of the financial markets could cause the price of the Common Stock to
fluctuate substantially.
ANTI-TAKEOVER MATTERS
The Company's Amended and Restated Articles of Incorporation and Amended and Restated Bylaws contain provisions that
may have the effect of delaying, deterring or preventing a takeover of the Company that shareholders may not consider being in
their best interests. For instance, the Company's Amended and Restated Articles of Incorporation and Amended and Restated
Bylaws prohibit shareholder action by written consent and include certain "fair price provisions." Additionally, the Board of
Directors has the authority to issue up to 10,000,000 shares of "blank check" Preferred Stock having such rights, preferences
and privileges as designated by the Board of Directors without shareholder approval.
ITEM 2 PROPERTIES
The Company leases all of the Company's existing store locations, with lease terms expiring between 2002 and 2012. The
leases for most of the existing stores are for ten-year years and provide for contingent rent based upon a percent of sales in
excess of specified minimums. Leases for future stores will likely include similar contingent rent provisions.
Beginning August 1, 2001, the Company doubled the size of its leased office and distribution center space, located in City of
Industry, California, and has entered into an amended lease with its existing landlord. The additional space will be fully utilized
by the middle of fiscal 2002. The amended lease is
22
for a five-year term (from the beginning of the original lease) with two options to extend the lease, each for a three-year period.
The initial five-year term will expire in April 2004. The annual base rent for the initial five-year term is approximately
$1,131,900 including the additional space.
The original lease terms of the Company's headquarters and distribution facility granted the Company the right of first refusal on
the remaining 125,000 square feet of space in the building at 90% of the fair market lease rates for such space. In February
2001, the Company was notified that the space would become available in 2001 and was provided with comparable market
lease rates. The Company believes the property covered by the amended lease will allow for growth of to up to 700 stores.
ITEM 3 LEGAL PROCEEDINGS
The Company is not a party to any material pending legal proceedings.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Common Stock of the Company is traded on the Nasdaq National Market under the symbol "HOTT". A three-for-two
stock split of the Company's Common Stock became effective February 6, 2002. The stock split was affected by way of a
stock dividend. The dividend was distributed to shareholders of record as of January 23, 2002. This was the first three-for-two
stock split for the Company. The Company also effected two-for-one stock splits of the Company's Common Stock in
December 1999 and December 2000. All share and per share amounts have been restated to reflect each of these three splits.
The following table sets forth, for the periods indicated, the high and low end of day closing 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.
2001 FISCAL YEAR QUARTERS HIGH LOW
----------------------
First Quarter $23.33 $15.46
Second Quarter $24.86 $17.01
Third Quarter $22.75 $15.00
Fourth Quarter $22.97 $16.17
2000 FISCAL YEAR QUARTERS HIGH LOW
----------------------
First Quarter $11.96 $5.29
Second Quarter $11.90 $7.59
Third Quarter $13.17 $9.17
Fourth Quarter $17.79 $9.71
On April 15, 2002, the last sales price of the Common Stock as reported on the Nasdaq National Market was $23.51 per
share. As of April 15, 2002, there were approximately 213 holders of record of the Company's Common Stock. This number
does not reflect the actual number of beneficial holders of the Company's Common Stock, which the Company believes to be
in excess of 9,000 holders.
23
The Company has not paid any cash dividends since inception and does not anticipate paying any cash dividends in the
foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Consolidated Financial Statements and Notes thereto included elsewhere in this
Annual Report on Form 10-K.
HOT TOPIC, INC. and SUBSIDIARIES
Selected financial data:
Fiscal Year
---------------------------------------------------------------------
2001 2000 1999 1998 1997
--------- --------- --------- --------- ---------
(In thousands, except per share data, number of
stores, comparable store sales and sales per square
foot)
Statement of Operations Data:
Net sales $336,094 $257,187 $168,949 $103,371 $ 70,532
Cost of goods sold, including buying, distribution
and occupancy costs 204,993 154,298 103,998 65,855 44,417
--------- --------- --------- --------- ---------
Gross margin 131,101 102,889 64,951 37,516 26,115
Selling, general and administrative expenses 86,950 67,917 44,749 29,077 19,862
--------- --------- --------- --------- ---------
Operating income 44,151 34,972 20,202 8,439 6,253
Interest income, net 1,884 1,925 933 931 901
--------- --------- --------- --------- ---------
Income before income taxes 46,035 36,897 21,135 9,370 7,154
Income taxes 17,435 13,652 7,634 3,367 2,611
--------- --------- --------- --------- ---------
Net income $ 28,600 $ 23,245 $ 13,501 $ 6,003 $ 4,543
Net income per share:
Basic $ 0.92 $ 0.78 $ 0.49 $ 0.21 $ 0.16
Diluted $ 0.86 $ 0.72 $ 0.46 $ 0.20 $ 0.15
Weighted average shares outstanding:
Basic 30,978 29,668 27,801 28,902 28,143
Diluted 33,219 32,069 29,392 29,736 29,640
Selected Operating Data:
Number of stores at year end 352 274 212 158 108
Comparable stores sales increase 3.9% 16.7% 22.8% 0.4% 2.2%
Average sales per square foot $ 636 $ 669 $ 623 $ 542 $ 565
Average sales per store (000s) $ 1,036 $ 1,020 $ 909 $ 772 $ 769
Balance sheet data:
Cash and short-term investments $ 71,310 $ 51,288 $ 39,550 $ 26,579 $ 27,151
Working capital 82,369 61,253 37,564 28,432 29,230
Total assets 162,662 118,646 89,022 58,764 51,953
Long-term obligations including current portion 218 123 231 120 161
Shareholders' equity $135,368 $ 99,291 $ 67,278 $ 48,749 $ 44,736
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS GENERAL
Hot Topic Inc. (the "Company") operates Hot Topic stores, 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. In the first half of fiscal 2001 (the fiscal year ended February 2, 2002) the Company launched a second retail concept with
the opening of six stores under the trade name Torrid(TM). Torrid offers a selection of apparel, lingerie, shoes and accessories
centered around various lifestyles for plus-size young women between the ages of 15 and 29. At the end of fiscal 2001, the
Company operated 346 Hot Topic stores and six Torrid stores in 48 states and websites hottopic.com and torrid.com.
The Company considers a store comparable after it has been open for 15 full months. If a store is relocated or expanded by
more than 15% in total square footage, it is removed from the comparable store base and, similar to new stores, becomes
comparable after 15 full months. At the end of fiscal 2001, 255 of the Company's 346 Hot Topic stores were included in the
comparable store base, compared to 189 of the 274 stores open at the end of fiscal 2000.
The Company operates on a 52 or 53-week fiscal year, which ends on the Saturday nearest to January 31. Fiscal 2001 and
fiscal 1999 were 52-week years. Fiscal 2000 was a 53-week year.
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
-------------------------------
2001 2000 1999
------ ------ ------
Net sales 100.0% 100.0% 100.0%
Cost of goods sold, including
buying, distribution & occupancy costs 61.0% 60.0% 61.6%
----- ----- -----
Gross margin 39.0% 40.0% 38.4%
Selling, general and administrative expenses 25.9% 26.4% 26.4%
----- ----- -----
Operating income 13.1% 13.6% 12.0%
Interest income, net 0.6% 0.7% 0.6%
----- ----- -----
Income before income tax 13.7% 14.3% 12.6%
Provision for income taxes 5.2% 5.3% 4.6%
----- ----- -----
Net income 8.5% 9.0% 8.0%
===== ===== =====
Number of stores at year end 352 274 212
Comparable store sales increase 3.9% 16.7% 22.8%
FISCAL 2001 COMPARED TO FISCAL 2000
Net sales increased approximately $78.9 million, or 31%, to $336.1 million in fiscal 2001 from $257.2 million in fiscal 2000.
Net sales for the 73 Hot Topic stores opened during fiscal 2001 and for the other Hot Topic stores not yet qualifying as
comparable stores contributed $65.8 million of the net sales increase. Comparable store sales increased 3.9% in fiscal 2001
and contributed $8.6 million of the increase in net sales. The six Torrid stores and torrid.com contributed to approximately $4.5
million of the increase. Hottopic.com sales were approximately one percent of total Company sales.
25
The annual average Hot Topic store volume increased to $1,038,000 in fiscal 2001 from $1,020,000 in fiscal 2000. The sales
mix in Hot Topic stores in fiscal 2001 saw a slight shift toward apparel and T-shirts, with this category contributing
approximately 53% of net sales in 2001 as compared to approximately 51% in 2000.
The Company experienced lower sales increases during the September 2001 (0.6% comp increase) and October 2001 (4.4%
comp decrease) periods. The Company attributes this to reduced mall traffic primarily due to the events of September 11,
2001 relative to the balance of fiscal 2001.
Gross margin increased approximately $28.2 million to $131.1 million in fiscal 2001 from $102.9 million in fiscal 2000. As a
percentage of net sales, gross margin decreased to 39.0% in fiscal 2001 from 40.0% in fiscal 2000. This
1.0% reduction in gross margin was due to a 0.5% increase in store occupancy expenses, a 0.4% reduction in merchandise
margin and a 0.1% increase in buying expenses all as a percentage of net sales. Occupancy expenses were 0.5% higher
primarily due to higher common area charges. The 0.4% reduction in merchandise margin was a result of three major factors:
merchandise mix changes at Hot Topic from accessories toward increased apparel, with apparel achieving lower overall
merchandise margins compared to accessories; the leveraging of markdowns in fiscal 2000 relative to the extra week of sales
volume in 2000 compared to 2001 and higher Torrid markdowns. The higher Torrid markdowns were related to minimum
purchases of merchandise required in excess of what was needed for the small store base. The remaining 0.1% increase was
due to a rise in buying expense as a percent of sales primarily due to the addition of the Torrid merchandising staffing in fiscal
2001.
Selling, general and administrative expenses increased approximately $19.0 million to $86.9 million during fiscal 2001 from
$67.9 million during fiscal 2000. As a percentage of net sales, selling, general and administrative expense was 25.9% for fiscal
2001 compared to 26.4% in fiscal 2000. The total dollar increase in selling, general and administrative expenses was primarily
attributable to an increase in the number of retail stores from 274 at the end of fiscal 2000 to 352 at the end of fiscal 2001 and
the corresponding additional payroll and other expenses required to support these additional stores. The decrease as a
percentage of net sales was primarily attributable to leveraging administrative expenses over the greater sales base in fiscal
2001 and lower store operating expenses resulting from management's efforts to control such expenses. This leverage was
partially offset by higher selling payroll expense as a percentage of sales, due to slightly higher pay rates and increased benefit
coverage.
Operating income increased approximately $9.2 million to $44.2 million during fiscal 2001 from $35.0 million during fiscal
2000. As a percentage of net sales, operating income was 13.1% in fiscal 2001 compared to 13.6% in fiscal 2000. Operating
income on an average store basis was approximately $137,000 in fiscal 2001.
Net interest income was $1.9 million in both fiscal 2001 and fiscal 2000, but it was a lower percentage of sales in fiscal 2001.
Average cash balances were higher in fiscal 2001 but interest rates were significantly lower.
The Company's effective tax rate was 37.9% in fiscal 2001 and 37.0% in fiscal 2000. The higher rate for fiscal 2001 is
principally attributable to the tax-exempt interest income that is a smaller percentage of pre-tax income in 2001 as compared to
2000 and higher effective state income tax rates in fiscal 2001.
26
FISCAL 2000 COMPARED TO FISCAL 1999
Net sales increased approximately $88.3 million, or 52%, to $257.2 million in fiscal 2000 from $168.9 million in fiscal 1999.
Net sales for the 62 stores opened during fiscal 2000 and for the other stores not yet qualifying as comparable stores
contributed $62.8 million of the net sales increase. Comparable store sales increased 16.7% in fiscal 2000 and contributed
$25.5 million of the increase in net sales. The average store volume increased to $1,020,000 from $909,000 in fiscal 1999.
The sales mix in fiscal 2000 saw a slight shift toward apparel and T-shirts, with this category contributing approximately 51% of
net sales in 2000 as compared to approximately 50% in 1999.
Gross margin increased approximately $38.0 million to $102.9 million in fiscal 2000 from $64.9 million in fiscal 1999. As a
percentage of net sales, gross margin increased to 40.0% in fiscal 2000 from 38.4% in fiscal 1999. The increase, as a
percentage of sales, reflected the leveraging of store occupancy expense achieved from the significant increase in the average
store sales volume and an increase in merchandise margin. Merchandise margin increased approximately 1.0%, as a percentage
of sales compared to the prior year, principally from an average higher initial markup and lower markdowns, shrinkage and
freight, all as a percentage of sales.
Selling, general and administrative expenses increased approximately $23.2 million to $67.9 million during fiscal 2000 from
$44.7 million during fiscal 1999. The total dollar increase in selling, general and administrative expenses was primarily
attributable to an increase in the number of retail stores from 212 at the end of fiscal 1999 to 274 at the end of fiscal 2000 and
the corresponding additional payroll and other expenses required to support these additional stores. As a percentage of net
sales, selling, general and administrative expense was 26.4% for fiscal 2000, the same percentage as in fiscal 1999. Many of
the fiscal 2000 selling, general and administrative expenses decreased as a percent of net sales due to the operating leverage
achieved through the Company's larger store base and higher average store sales volume. This leverage was off-set by higher
performance based bonuses, development costs for the new Torrid concept, higher store management payroll, increased
benefit coverage and continued investment in management infrastructure.
Operating income increased approximately $14.8 million to $35.0 million during fiscal 2000 from $20.2 million during fiscal
1999. As a percentage of net sales, operating income increased significantly to 13.6% in fiscal 2000 from 12.0% in fiscal 1999,
principally from the larger store base, higher average store sales and higher margins. Operating income on an average per store
basis was approximately $142,000 in fiscal 2000, up 30% from last year's $109,000.
Net interest income increased by $1.0 million to $1.9 million or 0.7% of sales during fiscal 2000, from $0.9 million or 0.6% of
sales during fiscal 1999, principally a result of higher average cash balances.
The Company's effective tax rate was 37.0% in fiscal 2000 and 36.1% in fiscal 1999. The variance from an expected rate of
approximately 40% in both fiscal 2000 and fiscal 1999 was a result of a significant portion of each 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 back-to-school,
Halloween and Holiday seasons (defined as the week of Thanksgiving through the first few days of January), and other periods
when schools are not in session. The Holiday season remains the Company's single most important selling season. The
Company believes, however, that the importance of the summer vacation and back-to-school
27
seasons (which affect operating results in the second and third quarters, respectively) and to a lesser extent, the spring break
season (which affects operating results in the first quarter) as well as Halloween (which affects operating results in the third
quarter), all reduce the Company's dependence on the Holiday selling season. As is the case with many retailers of apparel,
accessories and related merchandise, the Company typically experiences lower first fiscal quarter net sales relative to other
quarters.
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.