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Hot Topic Inc. Reports Operating Results (10-Q)

November 20, 2012 | About:
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10qk

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Hot Topic Inc. (HOTT) filed Quarterly Report for the period ended 2012-10-27.

Hot Topic, Inc. has a market cap of $388.2 million; its shares were traded at around $9.5 with a P/E ratio of 24.2 and P/S ratio of 0.6. The dividend yield of Hot Topic, Inc. stocks is 3.5%.

Highlight of Business Operations:

Income from operations increased $2.7 million to $6.9 million during the third quarter of fiscal 2012, from $4.2 million during the third quarter of fiscal 2011. As a percentage of net sales, income from operations was 3.8% in the third quarter of fiscal 2012, compared to 2.4% in the third quarter of fiscal 2011. Provision for income taxes was $2.6 million in the third quarter of fiscal 2012, compared to $1.2 million in the third quarter of fiscal 2011. The effective tax rate was 37.8% for the third quarter of fiscal 2012, compared to 27.8% for the third quarter of fiscal 2011. The effective tax rate increase is due to a reduction in the liability for income tax associated with the unrecognized tax benefits in the third quarter of fiscal 2011. 27

Income from operations increased $2.7 million to $6.9 million during the third quarter of fiscal 2012, from $4.2 million during the third quarter of fiscal 2011. As a percentage of net sales, income from operations was 3.8% in the third quarter of fiscal 2012, compared to 2.4% in the third quarter of fiscal 2011.

Income from operations increased $30.0 million to $11.7 million during fiscal year-to-date 2012, from loss from operations of $18.3 million during fiscal year-to-date 2011. As a percentage of net sales, income from operations was 2.3% in fiscal year-to-date 2012, compared to loss from operations of 3.7% in the fiscal year-to-date 2011. Provision for income taxes was $4.4 million in fiscal year-to-date 2012, compared to a benefit for income taxes of $7.3 million in fiscal year-to-date 2011. The effective tax rate was 37.6% for fiscal year-to-date 2012 compared to 40.3% for fiscal year-to-date 2011. The effective tax rate decrease is due to a reduction in the liability for income tax associated with the unrecognized tax benefits during fiscal year-to-date 2011.

Income from operations increased $30.0 million to $11.7 million during fiscal year-to-date 2012, from loss from operations of $18.3 million during fiscal year-to-date 2011. As a percentage of net sales, income from operations was 2.3% in fiscal year-to-date 2012, compared to loss from operations of 3.7% in the fiscal year-to-date 2011.

We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our condensed consolidated financial statements. For a further discussion about the application of these and other accounting policies, refer to the notes included in our Annual Report on Form 10-K filed on March 21, 2012. Inventories Inventories are valued at the lower of average cost or market, on a weighted average cost basis, using the retail method. Under the retail method, inventory is stated at its current retail selling value and then is converted to a cost basis by applying an average cost factor that represents the average cost-to-retail ratio based on beginning inventory and the purchase activity for the month. Throughout the year, we review our inventory levels in order to identify slow-moving merchandise and use permanent markdowns to sell through selected merchandise. We record a charge to cost of goods sold for permanent markdowns. Inherent in the retail method are certain significant management judgments and estimates including initial merchandise markup, future sales, markdowns and shrinkage, which significantly impact the ending inventory valuation at cost and the resulting gross margins. To the extent our estimated markdowns at period-end prove to be insufficient, additional future markdowns will need to be recorded. Physical inventories are conducted during the year to determine actual inventory on hand and shrinkage. We accrue our estimated inventory shrinkage for the period between the last physical count and current balance sheet date. Thus, the difference between actual and estimated shrink amounts may cause fluctuations in quarterly results, but not for the full fiscal year results. Valuation of Long-Lived Assets We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. For our Hot Topic and Torrid concepts, we group and evaluate long-lived assets for impairment at the individual store level, which is the lowest level at which individual cash flows can be identified. Factors we consider important that could trigger an impairment review of our stores or online operations include a significant underperformance relative to expected historical or projected future operating results, a significant change in the manner of the use of the asset or a significant negative industry or economic trend. When we determine that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the aforementioned factors, impairment is measured based on a projected discounted cash flow method using a discount rate determined by management. These cash flows are calculated by netting future estimated sales of each store against estimated cost of goods sold, occupancy costs and other store operating expenses such as payroll, supplies, repairs and maintenance and credit/debit card fees. The discount rate, the estimated sales and the aforementioned costs and expenses used for this nonrecurring fair value measurement are considered significant Level 3 inputs as defined in “NOTE 8 – Fair Value Measurements.” Changes in these assumptions may cause the fair value to be significantly impacted. In the event future performance is lower than forecasted results, future cash flows may be lower than expected, which could result in future impairment charges. While we believe recently opened stores will provide sufficient cash flow, material changes in results could result in future store impairment charges. Revenue Recognition Revenue is generally recognized at our retail store locations at the point at which the customer receives and pays for the merchandise at the register. For online sales, revenue is recognized upon delivery to the customer. Sales are recognized net of merchandise returns, which are reserved for based on historical experience. Revenue from gift cards, gift certificates and store merchandise credits is recognized at the time of redemption. Shipping and handling revenues from our websites are included as a component of net sales. We recognize estimated gift card breakage as a component of net sales in proportion to actual gift card redemptions over the period that remaining gift card values are redeemed. Gift card breakage is income recognized due to the non-redemption of a portion of gift cards sold by us for which liability was recorded in prior periods. While customer redemption patterns result in estimated gift card breakage, which approximates 5% to 6%, changes in our customers behavior could impact the amount that ultimately is unused and could affect the amount recognized as a component of net sales. 32

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