Filling Hot Topic Full of Hot Lead

Today's topic: Is your teen-oriented retailer playing fair? Are options shenanigans in the offing?

With consumers and the economy in general facing a whirlwind of problems, it seems there isn’t anyone who has been stung harder than the shareholders who own portions of these companies. 



1-Year Return

Pacific Sunwear (Nasdaq: PSUN  )  


Abercrombie & Fitch (NYSE: ANF  )


American Eagle (NYSE: AEO  )  


Hot Topic (Nasdaq: HOTT  )


Quiksilver (NYSE: ZQK  )  


Both PacSun and Quiksilver have been smacked by the economic malaise, but the surf and skate look hasn't gone out of fashion. T-shirts and board shorts remain as hot as ever, and can even cross over to increasingly popular sports such as snowboarding. When the blahs pass, and they will, these teen-oriented retailers will still have a ready market of customers.

That's not necessarily true of Hot Topic, which has found the appeal of goth attire to be very limiting, and has been struggling for some time to please its niche customers. The stock has suffered, trading at roughly half the level it did at the start of last year, and it seems hopelessly bereft of any chance of regaining the highs of the glory year of 2004, when it hit $30 a share.

So we can all pity the poor Hot Topic shareholder, perhaps none more so than management and directors, who got stock options that haven't been in the money for quite some time. Although options are technically supposed to align the interests of shareholders and insiders, we know it's really just a ruse for managers to gain additional profits. What else are suffering common shareholders to think when Hot Topic's board of directors decides to change the rules after the fact?

After the markets closed last Friday, Hot Topic filed an 8-K with the SEC stating that last Tuesday -- the date of Hot Topic's annual meeting -- the board extended the "post-termination exercise period" for options that had been granted to nonemployee directors.

Not so coincidentally, two directors had announced earlier this year that they would not stand for re-election. That means that the stock options they had would have to be exercised within four months. With the market price of the stock well below the exercise price, the options would most likely expire worthless, leaving the departing directors to walk away empty handed. So the board extended the exercise period by three months, hoping the stock would rise above the exercise price in that time, and allow the directors to cash out.

Investors had been hopeful after the last earnings report that things might be looking up, as management had said the second quarter's loss should be narrower than (or equal to) the year-ago period. Given the tweaking of the options dates, this might actually come to pass, as management might be expecting near-term good news that will boost the market price. After all, shares have risen some 40% over the past three months.

Yet, while investors’ expectations might be in line with management’s interests in helping Hot Topic’s share price recover in the near term, you can only wonder if questionable steps are being taken to quickly push the stock to higher levels, and if management’s long-term interests still align with shareholders'.

When companies turn sour, seeming game-playing and options shenanigans can lead investors to distrust the executives running their companies. Fiddling around with options dates has left executives at Brocade Communications (Nasdaq: BRCD  ) behind bars and forced former CEO William McGuire of UnitedHealth (NYSE: UNH  ) to give back millions of dollars. In other words, this action by Hot Topic doesn’t bode well for the creditability of its management, and adds one more reason why this company might just be burning investors.

Related Foolishness:

UnitedHealth Group is a Motley Fool Inside Value recommendation. UnitedHealth Group and Pacific Sunwear are Stock Advisor recommendations. Try any of our Foolish newsletters, free for 30 days.

Fool contributor Rich Duprey owns shares of PacSun, but does not have a financial position in any of the other stocks mentioned in this article. You can see his holdings. The Motley Fool owns shares of American Eagle Outfitters. The Fool has a disclosure policy.

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