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HOTT > SEC Filings for HOTT > Form 10-K on 22-Mar-2013All Recent SEC Filings

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Form 10-K for HOT TOPIC INC /CA/


22-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

The following discussion of our results of operations, financial condition and liquidity and other matters should be read in conjunction with the consolidated financial statements and notes included in "Item 8 - Financial Statements and Supplementary Data" elsewhere in this annual report on Form 10-K. These statements have been prepared in conformity with accounting principles generally accepted in the United States of America and require our management to make estimates and assumptions that affect amounts reported and disclosed in the financial statements and related notes. Actual results could differ from these estimates. Our ability to achieve business objectives in fiscal 2013 and beyond will be dependent on many factors, known and unknown, including those outlined in the sections entitled "Cautionary Statement Regarding Forward Looking Disclosure" before Part I and "Item 1A - Risk Factors" included elsewhere in this annual report on Form 10-K.

Overview

Business We are a specialty retailer of apparel, accessories and gift items operating under the Hot Topic and Torrid concepts. We launched a new test retail concept, Blackheart, during the fourth quarter of fiscal 2012. Our business is discussed in more detail in "Item 1 - Business" included elsewhere in this annual report on Form 10-K.

Merger On March 6, 2013, we entered into the Merger Agreement with Sycamore. The Merger is discussed in more detail in "Item 1 - Business" included elsewhere in this annual report on Form 10-K.

Strategic Business Changes We have completed the implementation of all planned initiatives related to the strategic business changes approved by the Board in fiscal 2011 to improve our operating results and to better position us for growth. The business changes involved discontinuing the operations of ShockHound; writing down inventory; writing down property and equipment that are no longer critical to our strategic direction; and implementing other strategic business and operational initiatives. As of the end of the second quarter of fiscal 2011, we had incurred all charges related to the strategic business changes.

Cost Reduction Plan The cost reduction plan, which was designed to meet the challenges of the environment at that time, involved closing approximately 50 underperforming stores, a majority of which closed at the end of the first quarter of fiscal 2011. These closures occurred as a result of natural lease expirations, exercising lease kick out clauses and other negotiations. The implementation of the cost reduction plan was expected to improve annual income of approximately $13 million. The cost reduction plan also included reducing our home office and field management positions, reducing planned capital expenditures in fiscal 2011 to approximately $25 million from $31 million in fiscal 2010 and implementing other non-payroll overhead expense reduction initiatives. As of the end of the second quarter of fiscal 2011, we had recorded all charges related to the cost reduction plan, completed the announced reduction of our home office and field management positions, and completed the implementation of non-payroll overhead expense reduction initiatives as part of the cost reduction plan. As of the end of the second quarter of fiscal 2012, we had closed all underperforming stores related to the cost reduction plan, totaling 41 Hot Topic stores and seven Torrid stores.

The following table details charges related to the strategic business changes and the cost reduction plan recorded since their implementation in the first quarter of fiscal 2011 and the fourth quarter of fiscal 2010, respectively (in thousands).


                                                Non-Store Related
                                                  Severance and         Inventory and
                           Store Related          Outplacement          Asset-Related        Consulting       Stock Option
                          Closure Costs 1             Costs                Costs 2              Fees            Expense           Total
Balance at October 30,
2010                      $              -     $                 -     $              -     $          -     $            -     $       -
Cost Reduction Plan
charges                             (7,077 )                (1,850 )               (830 )              -                  -        (9,757 )
Cash payments                           93                     985                    -                -                  -         1,078
Non-cash adjustments                 6,497                       -                  830                -                  -         7,327
Balance at January 29,
2011                                  (487 )                  (865 )                  -                -                  -        (1,352 )
Cost Reduction Plan
recovery                               365                       -                    -                -                  -           365
Strategic Business
Changes charges                          -                  (1,583 )             (9,605 )         (1,606 )                -       (12,794 )
Cash payments                          699                     889                    -            1,645                  -         3,233
Non-cash adjustments                  (659 )                     -                4,891                -                  -         4,232
Balance at April 30,
2011                                   (82 )                (1,559 )             (4,714 )             39                  -        (6,316 )
Cost Reduction Plan
recovery                               174                       -                    -                -                  -           174
Strategic Business
Changes charges                          -                  (1,330 )               (532 )         (1,383 )           (1,072 )      (4,317 )
Cash payments                          144                     812                  182              753                  -         1,891
Non-cash adjustments                  (455 )                     -                4,866                -              1,072         5,483
Balance at July 30,
2011                                  (219 )                (2,077 )               (198 )           (591 )                -        (3,085 )
Cash payments                          197                     464                    -              473                  -         1,134
Non-cash adjustments                    22                     (43 )                 18               20                  -            17
Balance at October 29,
2011                                     -                  (1,656 )               (180 )            (98 )                -        (1,934 )
Cash payments                            -                     682                   20                -                  -           702
Non-cash adjustments                     -                       -                   75                -                  -            75
Balance at January 28,
2012                                     -                    (974 )                (85 )            (98 )                -        (1,157 )
Cash payments                            -                     476                    -                -                  -           476
Non-cash adjustments                     -                      17                   68               98                  -           183
Balance at April 28,
2012                                     -                    (481 )                (17 )              -                  -          (498 )
Cash payments                            -                     318                    -                -                  -           318
Non-cash adjustments                     -                      23                   17                -                  -            40
Balance at July 28,
2012                                     -                    (140 )                  -                -                  -          (140 )
Cash payments                            -                     133                    -                -                  -           133
Non-cash adjustments                     -                       7                    -                -                  -             7
Balance at October 27,
2012
   and February 2, 2013   $              -     $                 -     $              -     $          -     $            -     $       -

1 Store related closure costs represent charges related to the closure of approximately 50 underperforming stores. Such charges include the write down and accelerated depreciation of store assets, the write down of inventory, early lease terminations and store severance, partially offset by certain credits and allowances.

2 Inventory and asset-related costs represent charges related to the write down and impairment of inventory and non-critical property and equipment.

We recorded charges related to store closures; write down of assets; store severance; non-store related severance and outplacement; consulting fees and stock option expense in selling, general and administrative expenses in our consolidated statements of operations. Charges related to the write down of store inventory; accelerated depreciation of store assets; and early lease terminations were recorded in cost of goods sold in our consolidated statements of operations.

Non-Cash Impairment Charge and Discontinued Operations During the third quarter of fiscal 2010, we concluded that ShockHound's assets had become impaired due to its slower than expected revenue growth. Revenues from partnerships entered into in the earlier part of fiscal 2010, as well as other revenues, did not build as much as we had anticipated. In the third quarter of fiscal 2010, we recorded an impairment charge of approximately $3 million to selling, general and administrative expenses in our consolidated statements of operations. The assessment of our long-lived assets for impairment is discussed in more detail in "NOTE 1 - Organization and Summary of Significant Accounting Policies" contained in the financial statements and notes included elsewhere in this annual report on Form 10-K. In addition, during the second quarter of fiscal 2011, ShockHound's operations were discontinued. See "Strategic Business Changes" above for more information concerning the discontinuation of ShockHound's operations.


Comparable Sales and Store Count We consider a store comparable after it has been open for 15 full fiscal months. If a store is closed during a fiscal year, it is only included in the computation of comparable sales for full fiscal months in which it was open. Partial fiscal months are excluded from the computation of comparable sales. During the first quarter of fiscal 2012, we began including our internet sales in the computation of comparable sales. All prior year comparable sales results included in this annual report on Form 10-K have been adjusted unless otherwise noted. The following table shows our comparable sales results, including internet, by division for fiscal 2012 and other recent periods:

Fiscal Year     2012      2011       2010        2009       2008
Hot Topic         3.5 %     0.7 %     (5.7 )%     (4.6 )%     2.8 %
Torrid            3.1 %     3.8 %      2.3 %       0.8 %      2.1 %
Total Company     3.4 %     1.4 %     (4.0 )%     (3.5 )%     2.7 %

In fiscal 2012, the comparable sales increase in the Hot Topic division resulted from an increase in fashion apparel and tees and hoodies categories, partially offset by a decrease in the accessories category. The comparable sales increase at our Torrid division was due to an increase in apparel and intimates, partially offset by a decrease in the accessories category.

The following table shows our comparable sales results, excluding internet, by division for fiscal 2012 and other recent periods:

Fiscal Year     2012      2011       2010        2009        2008
Hot Topic         3.7 %     0.1 %     (6.5 )%     (5.6 )%      1.8 %
Torrid            3.6 %     2.5 %     (0.7 )%     (2.9 )%     (2.4 )%
Total Company     3.7 %     0.6 %     (5.3 )%     (5.1 )%      1.0 %

Our historical and planned store count, as well as the number of stores included in the comparable store base, is discussed in more detail in "Item 1 - Business" included elsewhere in this annual report on Form 10-K.

Share Repurchase Our recent share repurchase activity is discussed in more detail in "NOTE 12 - Share Repurchase" contained in the consolidated financial statements and notes included elsewhere in this annual report on Form 10-K.

Cash Dividends We began to pay cash dividends during the first quarter of fiscal 2010. Cash dividends are discussed in more detail in "NOTE 4 - Cash Dividends" contained in the consolidated financial statements and notes included elsewhere in this annual report on Form 10-K.

Segment Information We currently have one reportable segment given the similarities of the economic characteristics among the Hot Topic and Torrid concepts and the relatively immaterial business operations of our Blackheart test concept.

Seasonality Our business, particularly at Hot Topic, is subject to seasonal influences. Refer to "Item 1 - Business" included elsewhere in this annual report on Form 10-K for further discussion about the seasonality of our business.


Key Performance Indicators There are several key indicators that we use to help us evaluate the financial condition and operating performance of our business, including:

Store Sales Productivity is used to assess the operational performance of each of our stores. Store productivity metrics include year over year store sales comparisons (or comparable sales results), net store sales per average square foot, number of transactions per store, dollars per transaction, number of units sold per store and number of units per transaction.

Merchandise Margin is used to allocate a variety of resources to each of our concepts, determine initial mark-ups, mark-downs, inventory reserves, freight costs, etc. for our concepts and to measure the general performance of each of our stores. We consider merchandise margin to be the difference between net sales and certain costs associated with our merchandise, such as product costs, markdowns, freight, vendor allowances and inventory reserves.

Gross Margin is the difference between merchandise margin and buying, distribution and store occupancy costs.

Income from Operations is primarily driven by net sales, gross margin, our ability to control selling, general and administrative expenses, and our level of capital expenditures that affect depreciation expense.

Other During the fourth quarter of fiscal 2012, eight stores were tested for impairment as part of our long-lived asset impairment review. Four of these stores were impaired and the remaining four, although not impaired, were considered 'at risk' of impairment, with an aggregate net book value of $0.1 million and undiscounted cash flows that ranged from approximately 160% to 400% of their net book values. We do not expect material changes in the near term to the assumptions underlying our impairment calculations as of the end of fiscal 2012. However, if changes in these assumptions do occur, and should those changes be significant, they could have a material impact on our determination of whether or not impairment exists. We continue to closely monitor these stores and other assets that potentially have carrying values that may not be recoverable.


Results of Operations

The following discussion of our results of operations, financial condition and liquidity and other matters should be read in conjunction with our consolidated financial statements and notes included elsewhere in this annual report on Form 10-K.

The following table shows, for the periods indicated, certain selected statement of operations data expressed as a percentage of net sales. The discussion that follows should be read in conjunction with this table:

                                                                  Fiscal Year
                                                       2012          2011           2010

Net sales                                                100.0 %       100.0 %        100.0 %
Cost of goods sold, including buying,
distribution & occupancy costs                            63.8 %        66.6 %         67.1 %

Gross margin                                              36.2 %        33.4 %         32.9 %
Selling, general and administrative expenses              32.0 %        33.9 %         34.9 %

Income (loss) from operations                              4.2 %        (0.5 )%        (2.0 )%
Other income and interest, net                             0.0 %         0.0 %          0.1 %

Income (loss) before provision (benefit) for
income taxes                                               4.2 %        (0.5 )%        (1.9 )%
Provision (benefit) for income taxes                       1.6 %        (0.2 )%        (0.7 )%

Net income (loss)                                          2.6 %        (0.3 )%        (1.2 )%

Fiscal 2012 Compared to Fiscal 2011

Net sales increased approximately $43.8 million, or 6.3%, to $741.7 million in
fiscal 2012 from $697.9 million in fiscal 2011. Approximately $10.5 million of
this increase was due to the fact that 53-week fiscal 2012 had an extra week of
sales that we did not have in fiscal 2011. The components of this $43.8 million
increase in net sales are as follows:

    Amount
 (in millions)                                 Description
$          27.3   Increase in sales from Torrid comparable and non-comparable stores.
           20.4   Increase in sales from Hot Topic comparable and non-comparable stores.
           10.5   Increase due to 53rd week in fiscal 2012.

(14.4 ) Decrease due to store closures and other. $ 43.8 Total

Gross margin increased approximately $35.3 million, which includes a $1.3 million increase from the internet, or 15.2%, to $268.2 million in fiscal 2012 from $232.9 million in fiscal 2011. As a percentage of net sales, gross margin increased to 36.2% in fiscal 2012 from 33.4% in fiscal 2011. The components of this 2.8 percentage point increase in gross margin as a percentage of net sales are as follows:


     %                                    Description
        2.1   Increase in merchandise margin primarily as a result of higher
              realized markup mainly due to an increase in products designed
              internally and a decrease in clearance sales.
              Decrease in store depreciation expenses related to lower expenses
        0.4   from comparable stores, store closures and leverage on higher sales.
              Decrease in distribution expenses primarily due to lower
        0.3   depreciation, supplies, freight, and leverage on higher sales.
        0.2   Store occupancy percentage decrease due to leverage on higher sales,
              partially offset by higher rent expense as a result of an increase
              in the number of stores and the recognition of deferred rent credits
              in the prior fiscal year as part of our cost reduction plan.

(0.2 ) Increase in buying payroll expenses.
2.8 % Total

Selling, general and administrative expenses increased approximately $1.1 million, or 0.5%, to $237.4 million in fiscal 2012 from $236.3 million in fiscal 2011. As a percentage of net sales, selling, general and administrative expenses were 32.0% in fiscal 2012 compared to 33.9% in fiscal 2011. The components of this 1.9 percentage point decrease in selling, general and administrative expenses as a percentage of net sales are as follows:

     %                                     Description
       (1.7 )  Costs associated with the write-down of non-critical property and
               equipment, severance payments, consulting fees and other costs
               related to the strategic business changes incurred in the prior
               fiscal year.
       (0.8 )  Decrease in other store expenses primarily due to lower utility
               costs, debit/credit card processing fees and supply expenses.
       (0.6 )  Store and internet payroll expenses and related benefits percentage
               decrease as a result of leverage on higher sales and improved
               productivity.
       (0.4 )  Decrease in general and administrative payroll and related benefits
               and depreciation, partially offset by increase in consulting
               services expenses and computer maintenance costs.
        0.2    Increase in preopening expenses as a result of a greater number of
               new, relocated and remodeled stores in fiscal 2012.
               Increase in performance based bonuses (75% of the increase relates
        1.4    to exceeding bonus target).

(1.9 %) Total

Income from operations increased approximately $34.3 million to $30.8 million in fiscal 2012 (includes $2.5 million related to the 53rd week in fiscal 2012) from a loss of $3.5 million in fiscal 2011. As a percentage of net sales, income from operations was 4.2% in fiscal 2012 compared to loss of 0.5% in fiscal 2011. Operating income on an average store basis was approximately $39,000 in fiscal 2012 compared to an operating loss of $4,000 in fiscal 2011. Net loss in fiscal 2011 included net losses from our ShockHound concept of $0.3 million, or $0.01 per share.


As a percentage of net sales, other income and interest, net, was immaterial in fiscal 2012 and 2011.

Our effective tax rate was 37.1% (provision) and 42.2% (benefit) in fiscal 2012 and 2011, respectively. The decrease was primarily due to a change in the liability associated with unrecognized tax benefits.

Fiscal 2011 Compared to Fiscal 2010

Net sales decreased approximately $10.3 million, or 1.5%, to $697.9 million in fiscal 2011 from $708.2 million in fiscal 2010. The components of this $10.3 million decrease in net sales are as follows:

(in millions) Description $ (24.6 ) Decrease due to store closures and other.
5.9 Increase in sales from Hot Topic comparable and non-comparable stores.
8.4 Increase in sales from Torrid comparable and non-comparable stores. $ (10.3 ) Total

Gross margin decreased approximately $0.4 million, which includes a $2.7 million increase from the internet, or 0.2%, to $232.9 million in fiscal 2011 from $233.3 million in fiscal 2010. As a percentage of net sales, gross margin increased to 33.4% in fiscal 2011 from 32.9% in fiscal 2010. The components of this 0.5 percentage point increase in gross margin as a percentage of net sales are as follows:


     %                                    Description
        0.8   Decrease in store depreciation expenses related to store closures,
              ShockHound closure, and the accelerated depreciation taken in the
              prior fiscal year for stores closing as part of our cost reduction
              plan.
        0.3   Decrease in distribution expenses, primarily due to lower freight,
              payroll, and supplies, partially offset by higher depreciation.
        0.2   Decrease in store occupancy expenses, primarily related to charges
              taken in the prior fiscal year and deferred rent credits recognized
              in the current fiscal year as part of our cost reduction plan.

(0.1 ) Increase in buying payroll expenses. (0.7 ) Decrease in merchandise margin as a result of higher markdowns.
0.5 % Total

Selling, general and administrative expenses decreased approximately $10.8 million, or 4.4%, to $236.3 million in fiscal 2011 from $247.1 million in fiscal 2010. As a percentage of net sales, selling, general and administrative expenses were 33.9% in fiscal 2011 compared to 34.9% in fiscal 2010. The components of this 1.0 percentage point decrease in selling, general and administrative expenses as a percentage of net sales are as follows:

     %                                     Description
       (0.8 )  Decrease in store payroll expenses and related costs as a result of
               improved store productivity and store closures, partially offset by
               higher store peformance based bonuses.
       (0.5 )  Decrease in general and administrative payroll and related costs,
               professional fees, and travel/meetings expenses, partially offset by
               an increase in performance based bonuses and relocation expenses.
               Decrease in impairment expenses as a result of the non-cash asset
       (0.5 )  impairment charge taken for ShockHound in the prior fiscal year.
       (0.2 )  Decrease in other store expenses, primarily due to utility expenses,
               inventory service fees, costs associated with the Hot Topic loyalty
               program and debit/credit card processing costs.
       (0.1 )  Decrease in marketing expenses, primarily due to reductions in
               direct marketing programs and marketing events, partially offset by
               increased email and internet marketing programs, higher payroll and
               store signage expenses.
        0.1    Increase in depreciation on computer hardware and software.
               Costs associated with the write-down of non-critical property and
               equipment, severance payments, consulting fees and other costs
        1.0    related to the strategic business changes.

(1.0 )% Total


Loss from operations decreased approximately $10.3 million to $3.5 million in fiscal 2011 from $13.8 million in fiscal 2010. As a percentage of net sales, loss from operations was 0.5% in fiscal 2011 compared to 2.0% in fiscal 2010. Operating loss on an average store basis was approximately $4,000 in fiscal 2011 compared to $17,000 in fiscal 2010. Net loss included net losses from our ShockHound concept of $0.3 million, or $0.01 per share, in fiscal 2011 compared to $4.1 million, or $0.09 per share, in fiscal 2010.

As a percentage of net sales, other interest and income, net, was immaterial in fiscal 2011 and 0.1% in 2010.

Our effective tax rate was 42.2% and 38.7% in fiscal 2011 and 2010, respectively. The increase was primarily due to a change in the liability associated with unrecognized tax benefits and higher state income tax.

Quarterly Results and Seasonality

Our 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, store closings, net sales contributed by new stores, increases or decreases in comparable sales, releases of new music, film, television and music/pop culture-related products, shifts in timing of certain holidays, changes in our merchandise mix and overall economic conditions.

. . .

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