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Hot Topic Inc. (HOTT)

Q3 2008 Earnings Call

November 19, 2008 4:30 pm ET

Executives

James McGinty – Chief Financial Officer

Elizabeth McLaughlin – Chief Executive Officer

Gerald Cook – Chief Operating Officer

Christopher Daniel – President of Torrid

Analysts

Adrienne Tennant – Friedman, Billings, Ramsey.

Kimberly Greenberger – Citigroup

Jeffrey Klinefelter – Piper Jaffrey

Elizabeth Pierce – Roth Capital Partners

Janet Kloppenburg – JJK Research

Jeff Van Sinderen – B. Riley

Hollie Guthrie – Boenning & Scattergood

Barbara Wyckoff – Buckingham Research Group

Crystal Kallik – D.A. Davidson

Dana Telsey – Telsey Advisor Group

Presentation

Operator

Welcome to Hot Topic's third quarter 2008 earnings release conference call. (Operator Instructions) I would like to remind you that in the course of this conference call the company will be making certain forward-looking statements such as statements relating to financial results, guidance and future financial performance, economic conditions affecting consumer demand, merchandise assortment, new initiatives, operational issues and related matters.

These statements as well as related information posted on the Hot Topic investor relations web site involve risks and uncertainties that may cause actual results to differ materially from those projected in the forward-looking statements. These risks and uncertainties are discussed from time to time by the company and are more fully set forth in the periodic reports that Hot Topic files with the Securities and Exchange Commission including the most recent quarterly report on Form 10-Q and annual report on Form 10-K.

All forward-looking statements made on this call speak only as at the time they are made and Hot Topics undertakes no obligation to update these statements to reflect subsequent events or circumstances. To more effectively disseminate the information discussed this afternoon, this call is being web cast on the company's investor relations web site at investorrelations.hottopic.com and a replay will be available on that site. A replay will also be available at 888-286-8010, pass code 98453240 for approximately two weeks.

Now I'll hand the call over to Hot Topics Chief Financial Officer Jim McGinty.

James McGinty

Hi. This is Jim and welcome to the call. While on hold, you've been listening to Decode, a song from Paramore created for the Twilight movie soundtrack. My partners on the call today are Betsy McLaughlin, Gerald Cook and Chris Daniel.

For competitive reasons we will not be discussing any specific forward-looking product information during this call. I will begin by discussing the third quarter results, then comment on the balance sheet and cash flow. Following these details, I will turn it over to Betsy who will provide you with additional color on the quarter and the outlook.

First, the results of the third quarter. All comparisons discussed are to the same period a year ago unless otherwise noted. Overall total company net sales during the quarter increased by $8.8 million due to a $4.2 million increase in internet sales, a $3.6 million sales gain from new and non comparable Torrid stores, a $2.4 million sales gain related to the Hot Topic comparable store sales increases of 1.7%, a $1.4 million sales gain from new and non comparable Hot Topic stores, a $0.4 million sales gain from relocated or remodeled Hot Topic stores.

These gains were offset in part by an $800,000 sales reduction related to the Torrid comparable store sales decline of 3% and a $2.4 million sales reduction from closed stores. For the quarter, the total company consolidated comp increase was the result of a 5% in the average number of transactions in comparable stores, partially offset by a 4% decrease in the consolidated average transaction value.

At Hot Topic, apparel was 53% of the total sales in the third quarter versus 56% last year. At Torrid, apparel was 75% of the total sales in the third quarter versus 78% last year.

Gross margin was 37.6% of sales compared to 36.3% last year. The 130 basis point increase breaks down into the following categories. Store occupancy expenses declined 60 basis points due to the leverage on the higher sales base and slightly lower negotiated reduced rents.

Distribution costs improved by 50 basis points due to reduced expenses related to savings resulting from productivity improvements, lower depreciation and lower freight costs. Store depreciation expenses declined 40 basis points due to fewer store remodels and relocations.

Merchandise margin was 20 basis points lower primarily due to higher mark downs partially offset by a higher realized mark up driven by a favorable merchandise mix. The higher mark downs for the quarter related primarily to our prompt post Halloween liquidation of all remaining Halloween product.

In the third quarter, selling and general administrative expenses were 31.6% of net sales compared to 30.8% last year. SG&A expenses in the third quarter of fiscal 2008 included approximately $300,000 of charges associated with store impairment and asset write offs. Impairment in the third quarter a year ago was approximately $800,000.

Excluding these non recurring charges both this year and last, SG&A expenses were 110 basis points higher this year. This breaks down into the following categories. Performance based bonus expenses and stock option expense increased 130 basis points to last year. Marketing expenses increased 60 basis points. Of this increase, approximately 40 basis points related to one time expenses associated with Rock Band game advertisement and the balance of the increase is related to Shock Hound and other marketing dedicated to drive online sales.

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