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Rating Action:

Moody's affirms Hot Topic's CFR, downgrades senior secured notes to B2

Global Credit Research - 05 May 2017

New York, May 05, 2017 -- Moody's Investors Service ("Moody's") affirmed HT Intermediate Holdings Corp.'s ("Hot Topic") B2 Corporate Family Rating ("CFR") and B2-PD Probability of Default Rating ("PDR") following the company's announcement that it plans to finance the May 26 redemption of its $110 million senior HoldCo PIK notes due 2019 with preferred equity from its private equity sponsor Sycamore Partners. Concurrently, Moody's downgraded the rating on operating subsidiary Hot Topic, Inc.'s senior secured notes due 2021 to B2 from B1. The rating outlook is stable.

Hot Topic's announcement is a credit positive because the equity-financed redemption will improve credit metrics and liquidity. The preferred stock will have a PIK dividend and no mandatory redemption. In accordance with Moody's hybrid equity credit methodology published in January 2017, the new security is treated as 100% equity in the capital structure. As a result of the planned transaction, lease-adjusted leverage will decline from 4.7 times to 4.0 times as of January 28, 2017 (equivalent to funded leverage declining from 4.5 times to 3.4 times). Lease-adjusted EBIT/interest expense will improve from 1.4 times to 1.8 times. The transaction will also extend Hot Topic's nearest dated debt maturity (except for its ABL facility) until 2021 and increase cash flow generation by $14 million by eliminating the HoldCo notes cash interest payments. Nevertheless, Moody's expects liquidity to weaken over time if negative free cash flow generation continues.

Despite the deleveraging transaction, the affirmation reflects Moody's view that Hot Topic faces elevated risk from the challenging apparel retail environment, continued negative free cash flow generation driven by significant store expansion, and history of aggressive financial policies.

The ratings downgrade of the senior secured notes to B2, the same level as the CFR, reflects the elimination of the loss absorption cushion that was previously provided by the HoldCo PIK notes given their junior position in the company's capital structure. The B2 rating of the senior secured notes reflects their predominance in the capital structure on a pro-forma basis.

Moody's took the following rating actions on HT Intermediate Holdings Corp.:

-- Corporate Family Rating, affirmed at B2;

-- Probability of Default Rating, affirmed at B2-PD;

-- Stable outlook

Moody's took the following rating actions on Hot Topic, Inc.:

-- $340 million 9.25% senior secured notes due 2021, downgraded to B2 (LGD4) from B1 (LGD3)

-- Stable outlook

All ratings are subject to the execution of the redemption transaction as currently proposed. Upon close, the company's CFR, PDR and outlook will be moved from HT Intermediate Holdings Corp. to Hot Topic, Inc.

RATINGS RATIONALE

Hot Topic's B2 Corporate Family Rating ("CFR") reflects the company's small scale and reliance on mall traffic and discretionary spending primarily by 12-22 year olds. At the same time, the rating also considers Hot Topic's solid execution over the past several years, established film studio relationships, and relatively low fashion risk relative to other teen retailers. Moody's believes the company has fewer operational improvement levers to exercise in the next 12-24 months, following good execution of its inventory, assortment and omnichannel initiatives since the 2013 leveraged buyout. As a result, Moody's expects that increased efficiency from the new distribution center and the scaling of the Box Lunch concept will be offset by continuing retail traffic declines. Moody's projects flat to slightly lower same store sales and EBITDA in 2017. Hot Topic's credit metrics position the rating well in the B2 category, with pro-forma lease-adjusted debt/EBITDA expected to be in the low-4 times range, and EBIT/interest expense in the high-1 times range in 2017. Liquidity is supported by Hot Topic's ability to curtail growth CapEx and the lack of financial maintenance covenants, but Moody's expects it to weaken over time if negative free cash flow generation continues.

The stable outlook incorporates Moody's expectations for flat to modestly lower earnings and good liquidity in the next 12-18 months.

The ratings could be upgraded if the company achieves and maintains debt/EBITDA below 4.0 times and EBIT/interest expense above 2.25 times, and improves its liquidity, including positive free cash flow generation. An upgrade would also require a commitment to a more conservative financial policy.

The ratings could be downgraded if the company's operating performance shows signs of sustained weakness due to declines in consumer discretionary spending, heightened competition, or execution missteps. The ratings could also be downgraded if liquidity erodes for any reason, or as a result of any shareholder friendly actions, such as dividend distributions. Quantitatively, ratings could be downgraded with expectations for debt/EBITDA sustained above 5.5 times or EBIT/interest expense sustained below 1.25 times.

HT Intermediate Holdings Corp. ("Hot Topic") through its operating subsidiary Hot Topic, Inc., is a City of Industry, CA-based specialty retailer. The company operated 696 Hot Topic stores and 49 BoxLunch stores and generated $772 million in revenues in the year ended January 28, 2017. The company has been majority-owned by Sycamore Partners since the leveraged buyout in June 2013.

The principal methodology used in these ratings was Retail Industry published in October 2015. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Raya Sokolyanska
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Russell Solomon
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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