MARKET WATCH: Hot Topic Quarter Ended Nov. 1st - Why Do We Care?

Jeff Harbaugh

• December 08 2008
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• 4 comments

Let’s ignore the numbers for a bit and start with how Hot Topic Describes itself.

“We are a mall- and web-based specialty retailer operating the Hot Topic and Torrid concepts, as well as the e-space music discovery concept, ShockHound. At Hot Topic, our business strategy is built on the foundation of pop culture and its relevance to our target teen customer. Within pop culture, we believe music plays a primary and integral role in the minds, activities and preferences of our target customers. We sell a selection of music/pop culture-licensed and music/pop culture-influenced apparel, accessories, music and gift items for young men and women principally between the ages of 12 and 22.”

They give equal billing to brick and mortar and internet retailing. That’s pretty forward looking. Guess they’ve decided how they expect the market to evolve. They have 841 stores in the U.S. and Puerto Rico.

Here’s what some other companies say about who they are and how they compete. All the quotes are taken from their most recent 10Q filings.

Volcom: “We seek to offer products that appeal to participants in skateboarding, snowboarding and surfing, and those who affiliate themselves with the broader action sports youth lifestyle.”

Zumiez: “We are a mall based specialty retailer of action sports related apparel, footwear, equipment and accessories operating under the Zumiez brand name. Our stores cater to young men and women between the ages of 12 and 24 who seek brands representing a lifestyle centered on activities that include skateboarding, surfing, snowboarding, BMX, and motocross.”

PacSun: “…a leading lifestyle specialty retailer rooted in the youth culture and fashion vibe of Southern California. We sell casual apparel with a limited selection of accessories and footwear designed to meet the needs of teens and young adults.”

Quiksilver: “…a leading global brand representing the casual, youth lifestyle associated with boardriding sports.”

Interesting comparison isn’t it? Quik, Volcom, and Zumiez, to nobody’s surprise, all focus on action sports/boardriding participants and nonparticipants attracted by the lifestyle. PacSun’s statement seems kind of generic, and is maybe a reflection of some of the issues they’ve had recently.

All four of these companies are interested in the non participants (as is everybody in the industry) because that’s where a big chunk of sales and growth can come from. Hot Topic doesn’t make that distinction. They focus on what’s cool and up and coming in pop culture and tie it together with music. Why am I impressed with it?

I don’t want to make too much out of a couple of lines in 10Qs, but I perceive that a lot of thought went into what Hot Topic said. I notice that they lead with it in the filing. It’s note one to the financial statements and the first paragraph of text after the actual statements.

Their business strategy doesn’t tie them to an action sports base. Hot Topic doesn’t have to convince anybody that what they are involved in is cool and that you should want to be associated with it. It’s the other way around. Hot Topic works to find out what their customers think is cool and then scurries to get it for them. Are they at a disadvantage when it comes to committed actions sports participants? Probably, but they seem better positioned for the broader market. Is their strategy “right” and those of some of our leading companies “wrong?” No. But when you talk about strategies and opportunities for growth and market penetration, the difference is food for thought.

Okay, that’s really what I wanted to talk about, but I suppose I should throw a few numbers in. The balance sheet is rock solid. It doesn’t even have any goodwill on it. It’s strong enough that they can say, in their discussion of their liquidity, “We believe our current cash balances and cash generated from operations will be sufficient to fund our operations through at least the next 12 months.” They have a bank line- they just don’t expect to need it.

A note on goodwill. When you buy a company, under a certain type of accounting, you have to allocate the purchase price to the assets you buy. Usually, you end up paying more than the accounting value of the assets. That excess shows up on the balance sheet as goodwill. Think of it as the value of the brand. It’s real, but it’s not exactly liquid, so I like to see less, rather than more, goodwill.

For the quarter, sales grew 4.7% to $197.3 million compared to the same quarter the previous year. They were up only 3.1% for nine months. Gross profit for the quarter grew 8.3% to $74.2 million as their gross profit margin rose from 36.3% to 37.6%. Operating and net income both grew with the result that earnings per share were up from $0.15 to $0.17.

It’s interesting to note that $4.2 million of their $8.8 million net sales increase during the quarter came from an increase in internet sales.

Their comparable store sales are kind of puzzling. The best thing I can do is show you the table they provided.

Interesting huh? Up this quarter, but down most quarters in recent years. They include new stores in comparable store sales only after they’ve been opened 15 months, which makes the calculation a bit different from some other retailers.

I can’t really tell what’s going on here. It may have something to do with stores coming and going. Of the $15.7 million sales increase for the nine months ended Nov. 1st, There was a $13.6 million increase from the opening of new Torrid stores (their stores for plus size women), a decline of $6.8 million for Hot Topic stores they closed, a $7.3 million increase in internet sales, and a $4.2 million increase from new Hot Topic stores. I can see why this would mess with your comparable store sales a bit.

Anyway, they’re growing their sales and EPS when some others aren’t, so good for them.

Jeff Harbaugh is a consultant for the action sports industry and works with companies to identify and focus on critical business issues and opportunities fundamental to the bottom line. For more information, visit www.jeffharbaugh.com.