Shopping mall based specialty retailer Hot Topic Inc. (HOTT) posted second-quarter 2012 results that met our expectations. Loss per share of 2 cents was in line with the Zacks Consensus Estimate, and compared favorably with the prior-year loss of 8 cents per share.
Despite a strong quarterly performance that helped boost net sales by 4.6% year over year to $157.8 million, the company’s losses resulted from increased cost of goods sold and poor operating margins. Quarterly sales were almost in line with the Zacks Consensus Estimate of $158 million. The year-over-year improvement in sales was mainly attributed to improved merchandising, markdown optimization, and other productivity initiatives at both the namesake and Torrid concepts.
Hot Topic’s second-quarter 2012 comparable store sales (comps) were up 3.9% compared with 3.2% reported in the year-ago period. The increase in comps in the reported quarter was driven by a 3.9% rise at the company’s namesake stores and a 4% rise in Torrid stores. The hike also resulted from improvements in fashion attire validating the company’s planned direction.
Cost & Margin Performance
Adjusted cost of goods sold (COGS), including buying, distribution and occupancy costs, increased 1.7% to $104.0 million. As a percentage of revenue, adjusted COGS decreased 180 basis points to 65.9%. However, gross profit surged 10.7% to $53.9 million and gross margin expanded 200 basis points to 34.2%.
Adjusted selling, general & administrative expenses inched up 0.9% to $55.1 million compared with $54.6 million in the prior-year quarter. Based on revenues, it declined 130 basis points to 34.9%. Loss from operations in the quarter came in at $1.2 million compared with an operating loss of $6.0 million in the year-ago quarter.
Other Financial Details
At the end of the second quarter of fiscal 2012, Hot Topic had cash, cash equivalents and short-term investments of $63.6 million, down from $72.6 million at the end of the second quarter of fiscal 2011. Shareholders' equity was $182.7 million compared with $199.8 million in the prior-year period.
The company’s total capital expenditures for the six months ended July 28, 2012 were $19.5 million, primarily related to store construction projects and IT projects. Cash flows from operating activities for the period increased $10 million compared to last year’s $22.3 million.
Store Update
During the quarter, Hot Topic opened 1 Hot Topic store and 10 Torrid stores, closed 5 Hot Topic stores and 3 Torrid stores. Additionally, the company remodeled or relocated nearly 20 Hot Topic stores and 4 Torrid stores. Thus, the company’s net stores at the end of the quarter included 620 Hot Topic stores and 171 Torrid stores.
Guidance
Hot Topic provided its earnings guidance for the third quarter of fiscal 2012 at the time of reporting its second quarter comparable sales result on August 15, 2012. Hot Topic estimates third-quarter 2012 earnings per share between 8 cents and 10 cents compared with 7 cents per share recorded in the year-ago period.
Further, the company guides net sales in the range of $181–$185 million based on comparable-store sales growth in the low single-digit percentage range. The current Zacks Consensus Estimate for the third quarter stands at 9 cents per share.
Looking ahead, the company plans to open nearly 18 new Torrid stores in the third quarter of fiscal 2012 and 3 Torrid stores in the fourth quarter. Additionally, the company’s third quarter store plans include remodeling of 16 Hot Topic stores and 1 Torrid store as well as relocating 2 Torrid stores to strip center locations from malls. Moreover, the company is slated to close down about 3 Torrid stores in the third quarter.
Overall, the company expects nearly 20% of its Torrid stores to be relocated to strip centers by the end of fiscal 2012.
The company’s total planned capital expenditures for fiscal 2012 include nearly $25 million slated for store projects and $12 million for new IT systems. Further, the company expects to make additional capital expenditures in fiscal 2012 for other strategic and operational purposes. Depreciation and amortization is expected to be approximately $35 million for the full year of 2012.
Peer Performance
One of Hot Topic’s closest competitors, Abercrombie & Fitch Co.’s (ANF) adjusted earnings of 19 cents per share for the second quarter of fiscal 2012 beat the Zacks Consensus Estimate of 17 cents. However, the quarterly earnings dipped substantially from the year-ago earnings of 35 cents per share.
Our Recommendation
We believe Hot Topic’s niche market position, strong brand recall, ability to tweak merchandise in line with rapidly changing trends and a debt-free balance sheet augur well for operating performance. However, macroeconomic headwinds, intense competition from other specialty retailers and the seasonal nature of the business severely undermine the company’s future growth prospects.
Currently, we are maintaining our long-term ‘Outperform’ recommendation on Hot Topic. Moreover, the company has a Zacks #1 Rank implying a short-term ‘Strong Buy’ rating on the stock.
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