Apparel Company Succeeds By Shunning Mainstream.

IF Britney Spears or the Backstreet Boys are wearing it, then it's passe to youth apparel retailer Hot Topic Inc.

A cutting-edge approach to fashion targeted at youths has spelled success for the City of Industry-based retailer. And just as Hot Topic's alternative fashions and "Morbid" line of merchandise buck mainstream trends, so too has Hot Topic's stock. Over the past year, its share value has shot up 89 percent, while the Dow Jones Retail, Apparel Industry Index saw its value drop nearly 7 percent. Hot Topic's stock last week was trading at between $26 and $27 a share, just below its 52-week high of $29.87 on Feb. 12 and well above its 52-week low of $10.28 last May.

Hot Topic operates 273 mall-based stores in 45 states and an online store, all focused on what it calls "music-influenced fashions" targeted at 12- to 22-year-olds.

That could describe almost any apparel store at a mall, but Hot Topic sets itself apart by taking its fashion and merchandising cues from hard rock, punk rock and heavy metal music and quickly turning those ideas into products.

Retail analysts call it the "fast forward fashion" approach, in which the retailer is constantly changing inventory to keep ahead of the mainstream trends.

It's a risky approach to retail.

"They're tapping into the most volatile retail market, but they've done extremely well and have a wonderful following," said Ilse Metchek, executive director of the California Fashion Association.

Risk at Hot Topic is lessened, in part, because of the company's grassroots approach to buying.

"The buying decision is made by a community -- mostly of store employees -- that's tuned into this niche," Metchek said. "That's one of the secrets of their success. They're really listening to their customer."

For example, Hot Topic will pay its employees to attend concerts and clubs if they write about the fashions and accessories they observe.

"It's an enlightened way of management to put that much trust in employees," said Elizabeth Pierce, an analyst with Wedbush Morgan Securities. "In return, they get tremendous loyalty at the employee base."

Hot Topic also hit upon the customer that the Gap, 3. Crew, the Limited forgot. By doggedly avoiding the fashion trends followed by mainstream retailers, Hot Topic has cultivated its loyal following. Its shoppers have continued spending while overall retail sales lagged in February, the third decline in the retail sector in five months.

"The core competency of the company is understanding and serving the needs of a disenfranchised customer -- a customer not serviced by other companies," Pierce said.

The average Hot Topic store generated over $1 million in sales last year ($669 per square foot), and each store was profitable, according to Hot Topic.

The company reported a net income of $10.3 million (51 cents per share) for the fiscal fourth quarter ended Feb. 3, 2001, compared to $7.4 million (39 cents per share) in the like year-earlier quarter.

Its fourth-quarter revenues were $88.4 million, up from $72.2 million in the previous quarter ended Oct. 28 and up from $59.9 million in the like year-earlier quarter.

Hot Topic also opened 62 new stores last year, increasing its chainwide square footage by 36 percent to 427,000 square feet. The company plans to open 65 new stores this year and six new "Torrid" stores.

The Torrid line will target young female consumers between the ages of 15 and 30 who wear sizes 14 to 26. More than 30 percent of young American women wear size 14 or larger, which contributed to a market segment that totaled more than $29 billion in sales last year, according to Hot Topic.

It's another disenfranchised customer just waiting to be served, according to Pierce, who rates Hot Topic's stock a "strong buy" with a 12-month target share price of $40.

                              Hot Topic Inc.
                               Stock Prices
YEAR (Feb.3)            2000   1999
Revenue (millions)    $257.2 $168.9
Operating Expenses
(millions)             222.2  148.7
Operating Income
(millions)              34.9   20.2
Net Income (millions)   23.2   13.5
Earnings Per Share     $1.18  $0.73

Quarterly Net Income (millions)

SUMMARY

Business: Music-influenced retail apparel

Headquarters: City of Industry

CEO: Betsy McLaughlin 

Market Cap: $490.6 million Dividend Yield: N/A [*]

Total Liabilities: $17.88 million P/E Ratio: 22.55

Long-Term Debt: None

(*.)Hot Topic does not pay dividends.