Hot Topic (HOTT)

TOP CONTRIBUTORS

Mike Aboosamra

Jonathan J. Smith

Robyn Bergeron

Hot Topic, Inc. (NASDAQ: HOTT) is a mall and web-based specialty retailer of apparel, accessories, music, and gift items for young men and women whose lifestyles reflect a passion for music, fashion and pop culture. They operate under two primary concepts: Hot Topic and Torrid. Their sub-brand Torrid primarily focuses on providing “fashion forward” plus-size clothing for young women. In fiscal 2010, HOTT posted net sales of $708 million and a net income loss of $8.2 million.^[1]

Like other retailers, HOTT has struggled to improve profit margins and maintain their customer base during and following the 2008-2009 U.S. Recession. In addition, HOTT's dependence on the downtrodden California economy has further put the retailer behind. California still has a $20 billion deficit,^[2] which will cause HOTT to continue to underperform until it can deleverage its dependence on the California economy. Since HOTT sales are highly correlated to the success of music-inspired apparel, its success is affected by changing fashion trends.

Business Overview

Hot Topic, Inc. has a business strategy that is primarily based on a foundation of music and pop culture. They sell a selection of music/pop culture influenced apparel, accessories, music, and other gift items. Their target market is both young men and women between the ages of 12 and 22. There is an important focus on music, which they consider setting themselves aside and creating a more niche market. They have a sub-brand called Torrid. Torrid was developed based on large feedback they received from plus-size female Hot Topic customers who wanted a store that catered to them. |}^[3]

Company History

Hot Topic was founded by Orv Madden in 1988. after the executive became aware of the marketing opportunities which had been created by MTV and other popular forms of alternative youth culture. Previous to starting Hot Topic, Madden had spent the entirety of his working life in the retail industry. The first Hot Topic store was located in a mall in Montclair, California. After his first year as an independent entrepreneur he found no shortage of outside investors willing to aid him in making the company's growth a reality. In the next few years, Madden raised over $11 million for Hot Topic and began to open new stores at strategically located sites around the country. By 1996 Hot Topic had sales of over $44 million and had opened almost 80 locations nationwide. In the fall of that year, Hot Topic went public with an initial public offering of 1.3 million shares of stock. The stock, which initially sold at $18 a share, raised almost $24 million for the company. Madden retained a 30 percent ownership in the company, which only one year later was valued at over $100 million. After going public in the autumn of 1996, Hot Topic's stock had by May of the following year skyrocketed in value, trading at almost double its initial price.

Geographic Locations

Hot topic has stores all over the United States. The states with the most store locations are listed below:

Business Segments

Hot Topic operates two different brands: Hot Topic and Torrid. As stated, at the end of FY 2010 they operated 657 and 153 primarily mall-based Hot Topic and Torrid stores, respectively, in the United States, Puerto Rico and Canada as well. In addition, they offer merchandise through hottopic.com and torrid.com websites, including some internet exclusive items. Customers can also access their hottopic.com website through touch screen kiosk terminals located within each Hot Topic store.

Although Hot Topic has seen decreses in net sales since 2008, they have had increased sales through their online websites. Hot Topic and Torrid both have seen increases in the volume of online sales since 2008 as well as an increase in the percentage of their total sales coming from thier respective sites.

Hot Topic (78.7% of FY 2009 net sales)

Hot Topic’s music/pop culture based merchandise is divided into two sub categories licensed and unlicensed/ influenced merchandise.

• licensed merchandise includes; tee shirts, hats, posters, stickers, patches, books, novelty accessories, CDs and DVDs.
• influenced merchandise includes women’s and men’s apparel and accessories, such as woven and knit tops, skirts, pants, shorts, jackets, shoes, costume jewelry, body jewelry, intimate apparel, sunglasses, cosmetics, leather accessories and gift items.
• In 2010, average sales per Hot Topic store was $0.8 million and average sales per square foot of store space was $426.

^[5]

Torrid (21.3% of FY 2009 net sales)

Torrid was launched in the first half of the fiscal year 2001.The obvious goal being to become the leading specialty retailer of a “fashion forward” plus-size clothing line for young women. They had a target market of females from ages 15 to 29. More specifically those who interested in current fashion trends and pop culture.The sizes targeted were women wearing 12 to 26.

• In 2008, Store count was 159 Torrid stores, in 36 states in both metropolitan and middle markets.The stores generated approximately $334 per foot in fiscal 2008 with the goal being a productivity of $400 per foot. Already planned to close approximately 5 Torrid stores during fiscal year 2009.
• In 2010, Store count was 153, average sales per Torrid store was $0.8 million, and average sales per square foot of store space was $326. A drop in both the number of stores and profitability from 2008.

^[5]

Business Growth

Fiscal 2010 Performance (ended January 29th, 2011)

• HOTT net sales decreased 4% to $708 million.^[1]
• Hot Topic posted a net income loss of $8.2 million for the year.^[1]

Hot Topic is currently implementing a plan to reduce company overhead and close underperforming stores. They have significantly slowed their new store growth and are currently focusing on renegotiating or extending existing leases.

During the first quarter of fiscal 2011, they announced that the business segment ShockHound would be discontinued. Estimates are that they will incur a total pre-tax charge of approximately $15 million primarily in the first quarter of fiscal 2011. However, the estimated costs and charges associated with those initiatives may vary depending on a variety of factors, including the outcome of negotiations with landlords and other third parties. Additionally, the loss of personnel and reduction in the number of stores they operate may result in decreased operational efficiencies, unanticipated operational challenges and decreased revenues.

Trends and Forces

Porter's Five Forces

Rivalry

The apparel, music and accessory categories within the retail industry are highly competitive and are subject to rapidly changing consumer demands and preferences. Hot Topic competes with numerous retailers for vendors, teenage and young adult customers, and suitable store locations. The apparel retail market typically has seen relatively slow growth, which means that there is intense competition for market share. It also very low concentration additionally increasing the rivalry and competition. Hot Topic primarily attempts to differentiate from most of the retail stores by capturing a niche market for music/ and pop culture inspired merchandise. They also attempt to capture an even more differentiated market with their Torrid division for young plus-size women.

Threat of Substitutes

Hot Topic as well as most of its competitors in the apparel industry offer a diverse range of products to their customers. The threat of substitutes to typical clothing is minimal. The threats are primarily with other competitors not with products outside the industry.

Buyer Power

Typically buyer power is very small in the retail-apparel industry. The buyers are fragmented, meaning there are many different buyers. No one buyer has any substantial influence on a product or price.The average customer is not purchasing very large volumes of clothing on a regular basis. However, buyer have limited power because switching from one company to another is as simple as walking into another store. In addition, If Hot Topic or a competitor raises prices, customers will easily go find a more affordable option.

Supplier Power

Supplier power is also low in the retail apparel industry. Due to a large amount of suppliers that offer low costs, the suppliers do not carry very much power.

Threat of New Entrants

The clothing retail industry is very competitive. However, the threat of new entrants to established companies like Hot Topic is relatively low. The industry uses very common or little technology and there is abundant access to distribution channels. While the barriers to start up a store are not impossible to overcome, the ability to establish favorable supply contracts, leases and be competitive is virtually impossible. Their vertical structure and centralized buying gives chain stores a competitive advantage over independent stores. In the case of Hot Topic the licensing for their music related apparel is competitive among large well known companies, making it increasingly unlikely, almost impossible for a small independent retailer to cut in.

SWOT Analysis

The strength of Hot Topic lies within their niche market. Their competitive advantage is appealing to a more specific market selection of music/pop culture influenced apparel, accessories, music, and other gift items. Their ability to quickly identify, source, and oftentimes negotiate exclusivity for, unique and diverse merchandise centered on music and pop culture is one of their competitive strengths. Contrary to other retailers, they commit to a majority of the merchandise in as little as two weeks and as much as three months in advance of delivery, depending on the category, in order to respond quickly to emerging trends.

As with any clothing retailer, Hot Topic is subject to seasonal influences, with heavier concentrations of sales during the back-to-school, Halloween and holiday (defined as the week of Thanksgiving through the first few days of January) seasons and other periods when schools are not in session. The holiday season has historically been the most important selling season. As is the case with many retailers of apparel, accessories and related merchandise, they typically experience lower net sales in the first and second fiscal quarters relative to other quarters.

Hot Topic’s financial performance is largely dependent upon the continued popularity of apparel, accessories and other merchandise inspired by music, film, television, pop culture, and fashion trends, particularly among teenagers and college-age adults. The popularity of such products is influenced by the Internet; music videos and music television networks; the emergence of new artists; the success of music releases, movies and television shows, etc. As a result the styles, trends and brands are constantly changing. Any failure to anticipate, identify and react appropriately to those changing trends and preferences lead to, among other things, excess inventories and higher markdowns.

Hot Topic depends on a number of key licensed products for a portion of their earnings and lower than expected sales of those products or the inability to obtain new licensed products adversely affects their revenues. In addition, they are continually fighting to prevent a licensor from choosing not to renew a license or from licensing a product to one of their competitors. As you can see licensed products makes up about 25% of their revenue for Hot Topic stores. Any loss of licensing has relatively large impacts on their returns.

HOTT Suffers from Struggling U.S. Economy -- Particularly California

The 2008-2009 U.S. Recession had an immediate impact on retailers, as consumer confidence decreased 87% from February 2007 to February 2009.^[6] Because of this, retailers had to face a short-term problem of reduced net sales, as well as long-term problems of suffocating debt and losing customers. Consumer confidence has rebounded since the crash, but some retailers are still failing to meet analyst sales estimates. In April 2010, only four of 22 retail firms beat analyst sales estimates.^[7] Hot Topic was one such retailer with an underperforming April, as comparable store sales were down 12.5%.^[8] Hot Topic continued to underperform in May, as comparable store sales for the month were down 9%.^[9]

Hot Topic has been hit particularly hard by the financial crisis due to its dependence on the California economy. HOTT has 130 stores in California -- almost double the amount in the next leading state.^[10] California was hit much harder than other U.S. states, as unemployment in the state topped at 12.6% compared to the national average of 9.9%.^[11] In addition, despite cutbacks in 2009, California still has a $20 billion deficit.^[2] Until California's economy can improve, or HOTT can de-leverage its dependence on the state, the retailer will continue to struggle getting sales figures.

Hot Topic Depends on Niche Market

Hot Topic's music-inspired products target a select crowd: 12-22 year-olds. Furthermore, the popularity of their products is contingent upon the popularity of the bands represented. In the past two years, they have expanded its product line to include television show (such as Family Guy) and video game (such as Super Mario Bros.) merchandise. To further broaden its clothing line, they began selling Levi Strauss jeans and shirts.

Similarly, Torrid targets a select crowd: 15-29 year-old plus-sized women. Torrid benefits from two fashion trends: the average woman's dress size is getting larger and mainstream designers are refusing to create plus-sized lines. As the Hot Topic brand seems to be going out of style, the retailer may continue to grow the Torrid brand. Torrid stores represent 19% of total HOTT stores, but Torrid sales account for 26% of HOTT net sales.^[12] In addition, while the Hot Topic brand has posted negative comparable store sales growth year-to-date, Torrid comparable store sales have grown 2%.^[9]

Competition

Hot Topic currently competes with street alternative stores located primarily in metropolitan areas; shopping mall based teenage-focused retailers; big-box discount stores; music stores; mail order catalogs and websites; and with numerous potential competitors who may begin or increase efforts to market and sell products competitive with Hot Topic and Torrid products.

• Buckle (BKE) puts a denim-based, Midwestern twist on teen apparel. The company sells its own private label merchandise alongside popular brand name apparel and accessories to young men and women between the ages of 15 and 30 years.
• Wet Seal (WTSLA) offers fashionable and contemporary apparel and accessories designed for juniors (female teenagers from 13 to 19 years old).
• Urban Outfitters (URBN) is a clothing and accessories retailer that focuses on women between the ages of 18 and 45. Urban Outfitters sets itself apart from most other clothing and accessory retailers with its boutique-like atmosphere and its focus on fashion.
• Zumiez (ZUMZ)
• Pacific Sunwear of California (PSUN)

Torrid has fewer competitors, as it caters to an even smaller niche market. Although there are retailers targeting the plus-size female demographic, including Lane Bryant, none specifically target the younger female age group in this demographic; most cater to more mature women and/or focus on career clothing.

FY 2011 Comparison to Competitors

FY 2010 Comparison to Competitors

Revenue/Net Income: As we can see from the tables above, Hot Topic’s revenues are significantly smaller than Urban Outfitters, but compared to Buckle and Wet Seal they are relatively comparable. Unfortunately, Hot Topic is the only one to recognize net losses in FY 2010.

Comparable Store Sales: Net sales decreased approximately $28.5 million, or 3.9% from FY 2009 to FY2010. $36.8 million of that decrease can be attributed to comparable net sales from Hot Topic stores in FY 2010 compared to FY 2009. Sustained negative same store sales are normally a sure telltale that a retailer is in trouble. As large retail chains expand geographically they eventually run out of prime locations and often end up cannibalizing their existing stores to some extent, which leads to a relative decline in this metric. As we can see Hot Topic has almost double the amount of stores than its competitors. A rapid expansion in the number of stores followed by weak same store sales numbers shows (in hindsight) that the store additions might have been careless or rushed.

Performance of Selling Space: It is critical for the success of a business to constantly work towards improving not only the efficiency and productivity of the store's selling space and inventory as well. Hot Topic has had average store sales of $401 and $422 for FY2010 and FY2009, respectively, making them relatively competitive in this regard. However, their average sales per store are substantially lower than their competitors. It is important to keep in mind that they operate almost double the stores as their competitors, but even if you double the avg. sale per store placing them around $1400, it is still much lower than Buckle and Urban Outfitters. In order to remain competitive in the industry they must find a way to increase the sales volume per store. Their profit margins are being crushed by the fixed costs and overhead required to operate so many stores.

Employees:

Hot Topic and Torrid each have a Vice President of Store Operations who leads a divisional operations team. Supporting the VicePresident of Store Operations for each division are regional directors who oversee multiple district managers, and district managers who typically oversee approximately ten stores. A typical store then has a store manager, two assistant managers, and five to eight part-time sales associates, depending on the season.

Hot Topic’s corporate structure is substantially more heavily weighted on upper management than their competitors. In addition, to having more total employees they also have more Headquarter employees. The larger number of high-paid, salaried, executives is much more expensive for the company and also cuts in to the profit margins of the company.

As a percentage of net sales, selling, general and administrative expenses were 34.9% in fiscal 2010 compared to 32.2% in fiscal 2009. The majority of this increase was attributed to Increase in store payroll expense primarily due to deleveraging on lower store sales and higher payroll and related costs according to their annual report.

Key Personnel

Recent News

Chris Daniel Leaves Hot Topic, Inc.

Hot Topic announced Chris Daniel, the President of the company's Torrid division, has resigned effective April 29, 2011. Following the departure of Mr. Daniel, Betsy McLaughlin will assume direct oversight for Torrid. The company will conduct an outside search for a replacement. ^[3]

Lots to enjoy here: http://www.wholesalebagsbest.com

References

1. ↑ ^{1.0 1.1 1.2} Bloomberg, "Hot Topic, Inc. Reports 4th Quarter Financial Results," 03/08/11
2. ↑ ^{2.0 2.1} Business Insider, "16 Reasons Why California Is The Next Greece," 05/11/2010
3. ↑ ^{3.0 3.1} Hot Topic Investor Relations
4. ↑ Hot Topic (HOTT) Form 10-K, Fiscal year 2010, "Annual Report",
5. ↑ ^{5.0 5.1 5.2 5.3 5.4} Hot Topic 10K
6. ↑ Bloomberg, CONCCONF:IND Chart
7. ↑ Seeking Alpha, "Retail Sales Hit the Skids in April," 05/06/2010
8. ↑ Bloomberg, "Hot Topic, Inc. Reports April Comp Store Sales Down 12.5%," 05/05/2010
9. ↑ ^{9.0 9.1} Business Wire, "Hot Topic, Inc. Reports May Comp Store Sales Down 9.0%," 06/02/2010
10. ↑ HOTT FY 2009 10-k, Item 1: Business, Page 5
11. ↑ Business Week, "California Economy May Outperform U.S. in 2011, Comerica Says," 06/01/2010
12. ↑ Seeking Alpha, "Hot Topic: Suddenly the Highest Yielding Retail Stock," 04/08/2010