Auction-rate blues at Hot Topic…

May 29, 2008

This week The Wall Street Journal reported that at least 400 companies are stuck holding auction-rate securities. Since these securities remain as unmarketable as the recordings of past American Idol Taylor Hicks, some firms (including Google, says the Journal) took partial write-downs in the first quarter.

In skimming some first-quarter disclosures, I sense that companies are determined not to panic about the auction-rate situation, but anxiety levels are rising at some of the smaller players.

Just to pull out one example, retailer Hot Topic (HOTT) – which offers “pop culture-influenced” clothing and accessories for mall-loving teens – liquidated about $10M of its auction-rate holdings and took a write-down on what remained. (10-Q here.)

The write-down was tiny (about $100K) and Hot Topic tempered it with the kind of cheery statement companies typically include: “This decline is deemed temporary as we have the intent and ability to hold these investments until anticipated full or substantial recovery in fair value occurs.” But the company’s message on auction-rates has gotten more somber since the 10-K filing in April.

In the risk factors section of the Q, Hot Topic now warns that continued “uncertainties” in the credit markets could create more auction-rate losses, which could “negatively affect our financial condition or results of operations.”

The filing is also explicit about valuation problems (an issue highlighted by a recent accounting rule change). Lacking “observable market quotes” for auction rate securities, the company must resort to “the valuation model prepared by the broker-dealer that holds these securities on our behalf.” (Hey, if anyone out there still believes Wall Street’s valuation models are foolproof, I have a few funky mortgage-backed securities to sell you.)

BTW, Hot Topic also added a new risk factor this quarter for – you guessed it – oil prices. It warned of a possible “material adverse impact on…profitability” if increases in transportation and production costs get too big to be passed on to customers.

Strangely, the folks at Hot Topic don’t mention the risk that they might not have customers at all, if parents stop allowing teenagers to waste precious fuel speeding to the mall for green hair dye and those chokers with metal spikes.

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