Retailer Picks Up Beat of Teen Fashion Fringe

By JERRY HIRSCH

Dec. 10, 2000 12 AM PT

TIMES STAFF WRITER

Hot Topic’s counterculture approach is evident at the industrial complex just east of Los Angeles where three stone gargoyles guard the entrance to the teen retailer’s headquarters.

The gothic guardians sit above arched double wooden dungeon doors that lead inside, where a black-clad receptionist named Serena--with streaked blond hair and a nose ring--cheerily greets visitors.

Beyond Serena lies a 30,000-square-foot sea of desks and computers. In one niche, candles flicker in front of portraits of Elvis Presley, Jerry Garcia and Kurt Cobain at a shrine to dead rockers. MTV streams from dozens of monitors throughout the building. Audio equipment lines one wall, evidence of a corporate sound system worthy of a record label.

This un-corporate-like headquarters belies a serious business. At a time of mixed performance for retailers catering to teens, investors have snapped up shares of Hot Topic with the ardor of music fans lining up for tickets to the latest Limp Bizkit concert. Wall Street is impressed with how Hot Topic’s tight inventory control, smart marketing and savvy research--including the use of employees as a sort of teen intelligence patrol--add up to some of the best growth in the retailing industry.

Hot Topic Inc. shares have risen 77% this year as teens flock to its 274 stores to purchase its mix of extreme apparel, cutting-edge music CDs and odd sundries such as leopard-skin license-plate holders. Early this month, the Industry-based retailer announced its second 2-for-1 stock split within a year. On Friday, its shares closed up $1.25 at $41.19 on Nasdaq.

Virtually all the inspiration for the product mix at Hot Topic stores comes from what’s happening in the alternative music and modern rock scene. The theory is that one of the main drivers of teen fashion is what popular musicians wear. Hot Topic has grabbed this slice of the market outside the mainstream. Britney Spears and Christina Aguilera wannabees best shop elsewhere.

Lack of debt, strong cash flow and soaring earnings have powered the stock through one of the worst Nasdaq stock markets in almost two decades. Earnings in its third quarter ended Oct. 28 jumped 70% to $7.3 million, or 68 cents a share, compared with the same period a year earlier.

Revenue increased 51% to $72.2 million in the same period. Same-store sales, a key measure in the retailing industry, rose 15.3%.

That’s in contrast to many of the retailers catering to the teen and early-20s market. Shares of Abercrombie & Fitch Co., which saw same-store sales drop 8% in November, have sunk 22% this year.

Shares of Pacific Sunwear of California Inc. have dropped 20% this year. Other teen retailers with declines include Urban Outfitters Inc., off 73%; Delia’s Inc., down 93%; Charlotte Russe Holding Inc., off 31%; and American Eagle Outfitters, down 11%.

“It was a tough spring and summer for teen retailers,” said Elizabeth Pierce of Wedbush Morgan Securities in Los Angeles. “Nothing was driving store traffic. There was a lack of newness, a feeling of sameness.”

Not at Hot Topic. Indeed, it is Hot Topic’s contrarian approach, its willingness to cater to underground teen cultures such as punk, goth and rave that has set the chain apart.

“There’s not another store in the Laguna Hills Mall where you can get belts with spikes, shirts that say ‘So many boys, such little minds,’ and T-shirts for like Nine Inch Nails and Blink-182,” said Ariana Sandoval, an 18-year-old shopper from nearby Mission Viejo.

“Music too loud? Just buy a gift certificate,” reads the sign outside the Hot Topic store where she shops.

That thought be confirmed by the heavy-metal sound of the Deftones blasting into the mall from the store’s interior, a brick-and-concrete design Hot Topic describes as “club/industrial.”

Inside, 18-year-old Jesse Kowalski of Aliso Viejo walks by a row of studded belts, racks of body-piercing jewelry and a women’s snug black T-shirt that reads “I do bad things” as he purchases a $40 sweatshirt emblazoned with the Deftones’ “White Pony” CD logo.

Shannon Tucknies, a bright-smiled employee with fuchsia hair, works the cash register--the hair dye is one aisle over and is good for 20 washes, she informs a visitor.

Kowalski attributes Hot Topic’s success to its ability to understand what his fellow teens want to buy. Pink hair and loud music are part of the package.

“The clerks are like us. They know what’s good,” Kowalski said. “The music we like, the clothes, it’s all right there.”

The Saddleback College student’s sense of kinship with the clerk results from one of the savviest uses of grass-roots market research in the retailing industry, according to analysts.

Tucknies not only sells Kowalski a sweatshirt and a $17 Slipknot T-shirt with gruesome portraits of the band’s eight members on the back, she also keeps tabs on what the Kowalskis of the world wear, how they act and what they listen to at local concerts.

Hot Topic buys concert tickets for employees if they write a fashion report detailing what they observe at the concert.

“We ask them what the band was wearing, what the fans wore, which of our products did they see? Did they see any products that we should carry?” said Elizabeth McLaughlin, 39, the chain’s president and chief executive.

“Being in touch with the consumer is the key to our success. And we have found that if you ask teenagers what they think, and you are willing to listen, you will get more information than you can comprehend,” said McLaughlin, a former Millers Outpost executive who joined Hot Topic in 1993 when it had only 15 stores.

“We are selling to the kids who want to be first with a fashion,” said McLaughlin, whose own music taste leans to hip adult--the Dixie Chicks and the Brian Setzer Orchestra. “When it starts to show up in other specialty stores we move out of it.”

A key part of this strategy is one of the tightest inventory-control systems in retailing, according to Marcia Aaron, an analyst with Deutsche Banc Alex. Brown in San Francisco.

Hot Topic plays a constant game of chicken with its inventory, holding off orders until the last minute and distributing goods to its stores based upon sales trends just days’ old. Hot Topic is helped by its reliance on a network of domestic suppliers that lets it avoid the longer lead times of foreign manufactures, Aaron said.

“Most of Gap’s products are planned a year in advance,” said Aaron. “Hot Topic couldn’t tell you what its going to sell in holiday 2001.”

Being small certainly helps. Hot Topic has less than 10% of the 3,100 Gap, Old Navy and Banana Republic stores that Gap Inc. operates. As the company grows, inventory and distribution problems could become more complicated. But corporate culture also plays a role. Analysts say Hot Topic’s grass-roots approach to fashion places it closer to its youthful customers than more traditional retailers such as Pacific Sunwear or Wet Seal.

Such a system leaves the chain vulnerable to not having enough merchandise to ride a hot trend to its peak, but also reduces its risk of having stacks of leftovers it can move only through markdowns.

McLaughlin said she’s willing to give up some sales for an element of control in what is a notoriously fickle market. “What teens like today is history three months from now,” she said.

And with sales at Hot Topic stores averaging $632 per square foot, one of the highest ratios in the industry, she’s not about to change a winning formula.

The dark atmosphere of its stores and the macabre nature of much of its product line--including its private-label Morbid brand apparel and makeup--has on occasion landed Hot Topic in hot water. When the company opened a store in Terra Haute, Ind., community members sought a meeting with company officials because they feared the store encouraged Satanic worship.

McLaughlin gave the protestors a tour of the store and explained how the company “edits” product offerings to make sure there are no pentagrams or Satanic references.

Orval Madden, a former senior vice president of children’s clothes at Federated Department Stores, opened the first Hot Topic 11 years ago in Montclair to sell the types of clothes and fashions kids saw on music videos.

His concept worked and attracted outside funding for expansion into what is now 45 states. The company first sold stock to the public in 1996 and has a market value approaching $400 million.

Madden, 51, who is developing a new chain for the company that will target plus-size teens, still owns almost 6% of Hot Topic.

The company’s first store for plus-size teenage girls and young women--to be called Torrid--will open at Brea Mall in April. Torrid will focus exclusively on clothing and accessories and won’t have the music focus of its sister chain.

McLaughlin, however, said the overarching strategies pursued by Hot Topic and Torrid are similar. They both target underserved niches.

“We are talking about groups of kids who previously could not find what they wanted to buy in a mall,” she said.

Wall Street is excited about the growth prospects for both concepts. Analysts estimate the number of Hot Topic stores can easily double and that the potential for Torrid also is in the 500-store range.

McLaughlin figures the company can fund that type of growth out of cash flow. Finding good employees in a tight labor market, even at Hot Topic’s minimum-wage salaries, shouldn’t be a problem either, she said.

“Where else can you have a pierced nose, dyed hair and listen to your music at work?” she asked. “We don’t care. Just be yourself.”

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Alternative Route to Success

Hot Topic: Soaring sales and income growth have made the teen-focused retailer a hot topic on Wall Street.

Sales (in millions)

1995: $23.6

1996: $43.6

1997: $70.5

1998: $103.4

1999: $168.9

Profit (in millions)

1995: $0.4