Hot Topic Inc Q3 2008 Earnings Call Transcript

Nov.19.08 | About: Hot Topic, (HOTT)

Hot Topic Inc. (NASDAQ: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

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.

Store payroll declined 20 basis points due to leverage on the positive comparable store sales and lower medical benefits costs. And lastly, other store expenses declined 60 basis points due to savings primarily related to the reduced telecommunications costs as well as reduced pre-opening expenses, traveling expenses and property taxes.

The third quarter operating income increased $1.3 million to $11.8 million. Operating margin for the third quarter was 6% of sales versus 5.6% last year. Our effective tax rate was 39.4% for the third quarter versus 38.9% last year.

During the quarter we opened one new Hot Topics store and one new Torrid store and closed two Hot Topics stores and one Torrid store. We also remodeled two Hot Topics stores during the quarter.

Cash, cash equivalents and short term investments were up 69% to $60 million versus a year ago. The significant increase in cash investments is a result of our improved earnings results coupled with lower capital expenditures this year. We continue to have approximately $10 million in Triple A rated auction rate securities classified as long term investments.

Total inventory cost was approximately $95 million. On a per square foot basis, inventory was down over 10% at the end of the third quarter.

Capital expenditures were $5.7 million in the quarter primarily related to the development of Shock Hound, the two new stores, two Hot Topic remodels as well as the additional stores scheduled to be opened, remodeled or relocated in the fourth quarter of 2008.

Now, I'll turn the call over to Betsy.

Elizabeth McLaughlin

We are very pleased to report both the comp store sales increase and positive earnings growth for the third quarter. October was our strongest month which benefited from a favorable calendar of Halloween fell on a Friday, versus the Wednesday last year.

Going into the last 10 days of October, our trend was running flat. The increased traffic and resulting sales of both Halloween specific items and non Halloween items allowed us to produce a high single digit comp for the full month.

In the Hot Topics division, we achieved a 1.7% comp increase, our best quarterly comp sales performance in 17 quarters. Average number of transactions per store per day were up a high single digit, offset by a mid single digit decline in the average transaction amount. Hottopic.com achieved a 29% increase in sales.

By geographic regions, Texas and the Northeast have the strongest performances with the Southeast and Southwest continuing to perform the weakest. Throughout the quarter, we increased promotion over the last year and maintained tight control inventory. We are entering the fourth quarter in a strong, clean inventory position. As Jim said, overall inventory per square foot is down 10% and our aged inventory at Hot Topic is 28% lower at the end of the third quarter this year versus the end of the third quarter last year.

Here are the details of Hot Topic by major categories. Accessories was up 9%. Fashion accessories led the way, producing a double digit comp increase. Solid sales performance across all of the fashion categories validates our item focus. Although licensed accessories declined in the high single digit range, this is a significant improvement from the prior quarter.

The women's category increased by 1%. Novelties produced a mid single digit comp increase, a meaningful acceleration from prior quarters driven primarily by the success of Twilight product. Women's bottoms also continued to produce positive comps.

The music category comped flat for the quarter. Continued strength in junior rock apparel and CD's was offset by a decline in men's rock tees. We've experienced a significant shift in the sales mix by genre and have adjusted receipts going forward.

The men's category comped down 8%. Men's novelty tees comped down in the double digit range although the category performance improved in October. Men's fashion bottoms comped positive; however it was offset by the decline in men's fashion tops.

During the third quarter we continued to make progress with our music initiatives. First, we achieved a significant milestone in October with the launch of Shock Hound, our online music initiative. We continue to be very excited about the opportunity to be the first music site that combines DRM free music downloads, merchandise, editorial content and community. As we move through Q4 of this year and Q1 of next year, our efforts at Shock Hound are focused on building a member base.

Second, we are featured in the rock band two Battle of the Bands video game that launched in September. Hot Topic is integrated into the game in a way that enables gamers, after achieving a level of success, to be sponsored by Hot Topic, perform on the Hot Topic stage and sell their tees in a virtual Hot Topic Store.

On to the Torrid division, Torrid was down 3% in comp store sales during the third quarter consistent with the low single digit comp decline experienced during the first half of the year. The comp decline was attributable to a mid single digit increase in the number of transactions partially offset by a low single digit increase in the average transaction amount.

Torrid.com continued its strong performance, generating a 45% increase in sales over LY. We continue to generate improved gross margin supported by better initial mark up and promotional activity consistent to LY.

The west coast continued to be the weakest region at Torrid however the performance gap narrowed during the quarter. Apparel comps down 6%, accessories comped up 7%.

Also during the quarter, Torrid launched a preferred credit card program called Diva Status. The average purchase on a Diva Status card is approximately 80% higher than the average Torrid purchase.

For the fourth quarter on a consolidated basis, we continue to be cautious given the macro environment. We will continue to manage inventory closely, control expenses and preserve cash. November month to date, Hot Topic is running a mid single digit comp increase and Torrid is running a high single digit comp decrease.

At Hot Topic, the entire comp month to date has been driven by the strength of the Twilight license. In addition to the cast member signing event that occurred in malls across the country last week, the remainder of the chain has seen significant increases in Twilight product as we approach the movie release scheduled for this Friday, November 21.

Torrid shifted their promotional cadence in line with the later holiday, so comparisons were difficult during week two. However, the most difficult comparisons in November are still ahead of us due to the Thanksgiving calendar shift. We continue to view November cautiously and expect that our monthly comp will be down a low single digit.

Jim will now discuss our guidance.

James McGinty

Regarding our guidance for the fourth quarter of 2008 ending January 31, 2009, we expect our fourth quarter sales to be in the range of $220 million to $225 million based on a comp store sales decline in the low single digits. As Betsy previously mentioned, November will be negatively impacted by the later calendar timing of the Thanksgiving holiday versus last year.

Given this shift, we anticipate November's comp to be negatively impacted by approximately 300 to 500 basis points and December's comp to benefit by approximately 100 to 150 basis points.

In addition, we are reiterating our fourth quarter earnings per share guidance in the range of $0.25 to $0.28 per diluted share. Included in this guidance are additional costs of approximately $0.02 per diluted share of expenses related to Shock Hound.

We expect inventory at the end of the fourth quarter to be roughly flat to last year on a per square foot basis. We continue to expect some gross margin expansion due to the more favorable sales mix and tight inventory control. We continue to expect to open one Hot Topic store and two Torrid stores. We now expect to close four Hot Topic stores and no Torrid during the quarter.

This will bring our fiscal 2008 ending store count to 680 Hot Topic stores and 160 Torrid stores.

For fiscal 2008 we continue to expect total capital expenditures to be in the range of $24 million to $26 million. For fiscal 2009 we expect to open a small number of new Hot Top and Torrid stores. We also expect to close approximately 15 Hot Topic stores and five Torrid stores. In addition, we plan to remodel or expand approximately 20 to 25 Hot Topic stores based on the timing of lease expirations.

We are expecting capital expenditures for the full year of 2009 to be $33 million to #36 million with a larger percentage relating to technology initiatives in our internet development.

For first quarter 2009, we will be providing earnings guidance as we gain better visibility into the fourth quarter trends. At this time we'll take questions relating to the results and outlook.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Adrienne Tennant – Friedman, Billings, Ramsey.

Adrienne Tennant – Friedman, Billings, Ramsey

Congratulations first of all. This is an incredibly difficult environment and a welcome surprise here. Can you talk about Twilight and compare it as a license in terms of size and the pattern of build up to peak, how long it lasts in terms of life cycle of that license? I read an article where I think you were quoted saying this type of license comes around once every decade or something like that if you could help us out with that.

I've also seen the options on the movies for books two, three and four are now out there in terms of producing a movie around those, so how long, for example with Harry Potter, how long did it take for the next movie to come into circulation.

Elizabeth McLaughlin

As I did mention, I think it was quoted in an article. Twilight is a great license for us. It will settle in probably in the top three of all time licenses at Hot Topic with Sponge Bob obviously being very strong and back in the late '90's South Park, although that's hard to compare because I think we were the only ones in the license business back in the late '90's. Now we've got some competition.

We've been very excited about it. It is a phenomenon and has ramped up very, very quickly. Summit is the studio. They're a young studio, 18 months old so they don't have the millions and millions of dollars that many of the other studios would throw into the marketing property, but they have done an absolutely fantastic job at building the buzz, and just to get some of you caught up if you don't know, the fourth book in the series was released at the beginning of August.

This movie that is due out on Friday is the first movie in the series. So this has been around and kind of underground for quite a period of time and it's just now hit pop culture radar. So yes, it's a very, very strong license. It has built very, very quickly. We certainly saw the build start in August and as goods came in through September and October and certainly into the first couple of weeks of November, we've continued to see that particular business ascend.

We're not sure what's going to happen after the movie. It is a great gift giving item though, so we still feel confident that we'll do good business for December with the Twilight license, but it is clearly girls and there's some boys in there, I don't want to offend any boys, but it the majority are girls and they range from age eight all the way to 68.

It's going to be a great mother/daughter kind of license as well. So we certainly peaked I think just as far as a percentage of our business last week as we hosted the signing events across the country, and were able to drive traffic into the stores and having a catalyst that will drive traffic to the malls and the stores is a great thing right now, so we feel very fortunate that we've been able to do that.

I don't know how long it's going to last. I do know that we've got product flowing and it will remain a major presence on our floor through holiday and into next year. That's all I can tell you right now.

Adrienne Tennant – Friedman, Billings, Ramsey

With the Harry Potter movies, how long did it take between movie releases?

Elizabeth McLaughlin

You mean for the whole series?

Adrienne Tennant – Friedman, Billings, Ramsey

Just from one movie to the next time the next opportunity to have fresh product on a new movie. How long did it take for the Harry Potter movies?

Elizabeth McLaughlin

Between 12 and 18 months depending on when the movie was released and obviously whenever the first release comes out, that usually the most powerful. I think in this particular case it's definitely true because this is such a wide, wide build. It's usually a year to a year and a half in between.

Adrienne Tennant – Friedman, Billings, Ramsey

On the music category, can you talk a little bit more about the shift in the genres of music and what the lead time is and when you feel that will be appropriately merchandised?

Elizabeth McLaughlin

We saw the shift in genre start mid September and we certainly saw it as we moved through October. Again, I think the presence of Twilight and Halloween in our stores for October made music a secondary priority so I'm sure that had something to do with it as well. There are times when you see these big genre shifts and it may be out of metal and into pop or out of pop, get into hard core with so many different genres of music.

What we've seen, we've been able to adjust. November receipts have been adjusted to reflect the shift. Our rock tees have a four week lead time, so we were able to adjust quickly, so we will have our inventories in position by December BLM.

Adrienne Tennant – Friedman, Billings, Ramsey

What exactly is the shift this time?

Elizabeth McLaughlin

I'm not going to tell you.

Operator

Your next question comes from Kimberly Greenberger – Citigroup.

Kimberly Greenberger – Citigroup

Can you remind us on Shock Hound and how it relates to your retail store strategy? Do you think it's helping in terms of number of transactions or if that would be a potential catalyst going forward? And secondly, we wanted to ask about your views on the move towards Twilight and the Gothic trends and if that has any kind of correlation with the credit crisis?

Elizabeth McLaughlin

The Hot Topics, Shock Hound, currently it's separate. Shock Hound is a much broader offering of music and in addition to music it certainly is that whole experience online. We are taking our music areas within our Hot Topic stores and rebranding them as Shock Hound, so if you've gone into our stores you'll see that CD's are stickered with the ShockhHound.com on them and we are using our Hot Topics stores to help market Shock Hound by passing out free downloads and certainly spreading the word.

As it stands right now, I think there's some overlap although I can tell you from the sale we are seeing on Shock Hound that it appears to be incremental, that because there's such a wider assortment of music on Shock Hound, people tend to be buying non Hot Topic traditional music, so I think that's a good sign for us going forward.

As we move into next year, we'll find other ways to work Shock Hound and Hot Topic together. Shock Hound has an amazing amount of proprietary, not only information but exposure to artists and we'll certainly use that to help drive traffic in our Hot Topic stores.

As for Twilight, I think it's important to separate out vampires from gothic. Two different things, and if you read the book, certainly if you've gone to the signings, I'll tell you those 8,000 girls who showed up at King of Prussia on Thursday, not a single one of them you would have typified as gothic based on the way they looked. It is a very all American pop culture bordering main stream sensibility. So we don't even see them as being in the same universe. I would caution you to not think about Twilight as being a gothic property.

I'm not sure about the credit crisis and Twilight. I can tell you though that in the conversations I've had with many parents, for sure they are having to cut back within their household, and I think that the fact that they've got a property like this, that their daughter or son is really into is kind of a breath of fresh air amongst the sea of sameness that seems to be happening in the mall.

I also think that the opportunity and the access to be able to get them certainly to a Twilight signing last week was something they felt really good about being able to do for their daughters. I think that's the only way I could remotely try to tie the credit crisis into Twilight.

Kimberly Greenberger – Citigroup

Do you think in terms of your highlighting of cutting back any particular categories have had outside benefits, maybe accessories in terms of adding units at a lower price point?

Elizabeth McLaughlin

I think we've struggled with the accessory business for quite some time, and the nature of the accessory business is a lower price point, although I will tell you that one of the great drivers of accessories is lingerie, and that's at a higher price point than typically accessories are. I do think there's been some shift. I do think we're positioned well when you talk about an average sale of $21.00 and an average unit in your inventory of $8.00, you can certainly put together a purchase of two transactions that averages about $20.00.

I think that positions us well and just the natural shift of the accessory trend and the execution of the team to be able to get those items in the stores at the right time certainly has helped.

Operator

Your next question comes from Jeffrey Klinefelter – Piper Jaffrey.

Jeffrey Klinefelter – Piper Jaffrey

I think you might be the only retailer so far actually making any guidance for the fourth quarter, so that's fantastic. I just wanted to clarify on your month to date trending again. You said Hot Topic is up mid single digits? Is that what you said?

Elizabeth McLaughlin

I did say that.

Jeffrey Klinefelter – Piper Jaffrey

Torrid down high single. You said for the month in total you were expecting down low singles?

Elizabeth McLaughlin

I did. Yes. Because we've got remember the shift at the end of the month. We also had the Twilight build up last week with all of the store signings which was an incremental boost.

Jeffrey Klinefelter – Piper Jaffrey

So if November is down low singles, and being pressured 300 to 500 basis points because of the shift with December giving back 100 to 150, I'm just trying to figure out how the three months of the fourth quarter add up to negative low single digits with that kind of a start to the month. Are you going to get ... If by the end of the month November is down low singles, December is going to be up because of the shift, how do you get back to negative low singles?

Elizabeth McLaughlin

I think we're trying to be cautious and I think we're very clear what the Twilight impact was on our business for the first two weeks of November and we still have 11 weeks to go in the quarter. We're not planning to be more promotional this year so I think we're just being very cautious about it.

We also have Torrid, remember, so you've got the Torrid mix that comes in and what's going to happen with women's apparel as we move through the fourth quarter. For us to say that we're feeling better about business is a little premature at this point.

Jeffrey Klinefelter – Piper Jaffrey

So the month has started off well and would be putting you a little bit ahead of that quarterly guidance but there's a lot of business left to go. What percent of your business, or how can you divide out or segment out the Twilight at this point so we can kind of get an underlying sense of the demand for the product or the sales demand outside of Twilight?

Elizabeth McLaughlin

We know that percentage, but we're not going to communicate that percentage. I will tell you it's much less in December than it is in November.

Jeffrey Klinefelter – Piper Jaffrey

In terms of the real estate, Jim gave some details on stores that are going to be closed and then remodeled. I'm curious on two things. You also made a comment that is really interesting and probably very important in that you got a little bit more leverage on occupancy I believe because of some concessions or lower costs associated with the real estate. One questions is how many leases do you actually have coming up for renewal over the next three years, and are you starting to get concessions either fewer stores, for the relationship of stores on base rent or percent rent? How are you seeing the cost of that occupancy come down?

James McGinty

There's a couple of things feeding into the lower occupancy cost. One is the fact that we're doing some remodels and relocations. A year ago when we had almost 70 stores remodeled or relocated, we had double occupancy in certain situations so that fed into it. In terms of how many leases we'll have coming up for expiration in the next three years, the 20 to 25 kind of gives you an idea of those leases which will come up for expiration next year.

Keep in mind that most all of our stores are on a ten year lease and when we did 70 remodels and relocations last year, we accelerated a number of those lease renewals. So we don't have quite the same number as we had in terms of new openings ten years ago.

But we can say that next year we'll have 20 to 25 and then we'll probably have a bit more than that over the next couple of years.

Elizabeth McLaughlin

It's probably I would say about 200 leases over the next three years.

Jeffrey Klinefelter – Piper Jaffrey

So given that, and given the state of the malls, are you seeing more favorable rents or renegotiated rents, or how should we all think about occupancy costs and your leverage potential against that going forward?

Gerald Cook

It falls into several buckets. Typically if you look A malls, that's a whole category into itself, probably not significant change in how that works. As you get to the second and third tier of malls, it is a very different story, and as Jim was talking about renewals, there's a situation out there of renewal/extensions where typically a standard renewal we may extend in a margin or mediocre kind of mall. And you can potentially get favorable terms there on an extension and/or renewal.

So it's a mixed bag and there isn't one formula that applies to all. But if you look at the non A malls to answer you questions, yes there are opportunities to get better rents, yes.

Operator

Your next question comes from Elizabeth Pierce – Roth Capital Partners.

Elizabeth Pierce – Roth Capital Partners

I have a question about Torrid. Thinking about Torrid's big picture and the strength that you have had on the online component, is there a thought that you stop opening Torrid stores at some point and this becomes more, put more of the marketing and efforts and really blowing out on the online segment of it?

Christopher Daniel

Certainly in the short term we're really interested in the dot.com. We think there's a lot of opportunity there. We've been beefing up the team back there trying to track some new talent to that business. I think certainly in the short term we think there's more potential there.

In terms of our stores, as we've said before, we continue to work on shortening the payback on new stores and increasing the dollars per square foot. We continue to maintain both of those things as a priority and then I think we'll just have to see about more new stores when the time comes.

Elizabeth Pierce – Roth Capital Partners

I can't remember, have you in the past articulated or set a goal like 400, or did you never do that or backed away from something? I can't remember.

Christopher Daniel

We have said that and your memory is very good. That's exactly what we said. We haven't backed away from but $400 per square foot is where we're still targeting.

Elizabeth Pierce – Roth Capital Partners

That's on the sales per square foot. I was actually thinking the number of stores.

Christopher Daniel

No, I don't think we've ever said how many in total we see in the chain.

Elizabeth Pierce – Roth Capital Partners

On the Twilight merchandise in terms of the percent of business that it does in December, you said it's less and that's just because we don't have all the marketing and the surrounding release and the tour, or is that because of other things you expect to kick in in December.

Elizabeth McLaughlin

I think having a catalyst to drive traffic is really important and right now in November the catalyst driving traffic into our stores is Twilight, therefore it represents a greater percentage of the business just like in October, Halloween was the catalyst to drive customers into our stores.

As you get to December, I think the holiday is the catalyst and so there are many different customers who come into the stores for reasons and while Twilight will certainly be a strong item, rock tees are always strong, many of our fashion apparel items post holiday are very strong and certainly the accessory items that we saw do so well during back to school will carry through for the holiday as well.

So I think it's more that the pie is a lot wider in December from a consumer preference standpoint than it is currently in November.

Elizabeth Pierce – Roth Capital Partners

As you think about it on the women's side, obviously you've had great success with skinny denim, colored denim, from what your reads are in your travels is there something that's sustainable into the spring?

Elizabeth McLaughlin

I think the skinny denim silhouette is sustainable into the spring and I think that our women's team has done a terrific job to reinvent what skinny denim looks like as we move through the first and second quarters of next year. So we feel very strong that skinny denim will continue to remain an item for us in women's apparel.

Elizabeth Pierce – Roth Capital Partners

I also noticed that, and maybe it was just one store, so I'll preface my comment with that, I noticed a rounder kind of traditional hunk, the big baggy suspender, things like that. Is that something that's happening, or happening with any kind of conviction?

Elizabeth McLaughlin

You mean the wide leg pants with the hardware detail on them? That has been a part of our business for 15 years and depending on which store you are in and what the specific customer make up is, we have that, we certainly have that represented very well on the internet, but we also have selected stores that have continued to sell what we would call street pants.

Operator

Your next question comes from Janet Kloppenburg – JJK Research.

Janet Koppenburg – JJK Research

Do you think this transition on the rock tee inventories you saw will be correctly aligned to this transition as we move into the holiday season? And on Twilight, do you think that your inventory levels will be able to meet demand? And on Twilight, what kind of life should we be expecting on the license. I don't know a lot about follow on for the movies, or shows or other related media activity around the title, so I'm just wondering if this is something that we should be modeling into the growth outlook for the company through '09.

Elizabeth McLaughlin

I'll start with the rock tee question. I mentioned that the genre shift, we saw that in September so the receipts that are coming in in the month of November represents that shifted mix. So for the holiday we should be positioned with where we believe the sales are.

As far as Twilight is concerned, will we have enough? We think we're going to have enough. We've programmed it out and we've got receipt flow every week so I think we feel good that we've got enough in wide enough categories within the stores both tee shirts and accessories, and we also believe that we have enough newness to sustain the excitement of the property as we move more into holiday and gift giving items.

We don't know how long this is going to last. There are four books and we'd love it if there were four movies. I'm sure very much like other licenses that we've had that have been strong, the best sales happen when there's a movie release or a book release and you certainly can see a spike, so depending on that timing, we don't know that timing yet. As that timing happens, we certainly will work with inventory in the stores.

I don't know that you model in any particular license. I think we can say that the license categories are good, are benefiting from this. I think we won't be looking at double digit decreases in license product for awhile. So I think that certainly helps and it's been a drag on both the men's and women's categories, so we feel better about that.

Until we get through holiday, this license has only been around now for two and a half months for us so we still need a little bit more time and data to analyze to be able to forecast it correctly.

Operator

Your next question comes from Jeff Van Sinderen – B. Riley.

Jeff Van Sinderen – B. Riley

The first question I have is in terms of the promotional cadence of both Hot Topic and Torrid for holiday, any more color you can give us on that versus last year. Should we be looking for something a little bit different given the general promotional environment out there?

Elizabeth McLaughlin

At Hot Topic we are planning for a very similar cadence to last year. Our history has been that the more we promote, the less we sell, which is very odd. I think that as we tried to architect the strategy a couple of year ago, we said we had to have the right IM's. It can't be available at other places and we want to be able to sell it at regular price and we stuck with that as we took ourselves from a promotionally driven business back to more of a fundamentally price business.

So we don't have any intentions right now. I sit here today saying that. We certainly will remain flexible as we move through the holiday period, but as we sit here Hot Topic is planned very similar to LY as far as promotional dollars are concerned.

Christopher Daniel

I would say the same thing is true, we're trending towards, we have an opportunity to do a better job of marketing with the promotions that we have and we have been working on that all year, but the promotional level is about the same.

Jeff Van Sinderen – B. Riley

In terms of Shock Hound, I'm wondering where you might focus in terms of further developing that site and also what we should look for in terms of incremental expenses for Shock Hound going forward?

Elizabeth McLaughlin

As far as where our focus is for Shock Hound it is driving the member base that's out there. We've now had many people comment on us. We've had some very good reviews from people who are typically not complimentary in the technology business, so we think we've gotten through step one which is launch the site, make sure it works, then of course garner some good will amongst those people who are experts in the area.

Now, over the next year it's really our time to build that base. In addition to making changes and tweaks and adding more enhancements on a regular basis which any roll out would do from a technology standpoint, our major focus in on driving eyes to the site.

James McGinty

In terms of how this is going to impact expenses going into 2009, it's greatly dependent upon the volume that's driven to the site and how much we are able to take in and what the mix is between the amount of merchandise sold versus the amount of downloads that we sell. I think what we could probably figure is that a penny of additional expense in the first couple of quarters would probably be a reasonable expectation.

Operator

Your next question comes from Hollie Guthrie – Boenning & Scattergood.

Hollie Guthrie – Boenning & Scattergood

Merchandising margins down 20 bits from one of the things you mentioned was higher mark downs post Halloween as you pushed some of that Halloween to be liquidated a little bit earlier. Can you talk about how that might impact Q4, what kind of margin mark down with the impact on Q4 last year from Halloween?

James McGinty

Certainly our mark downs were up a little bit but we would expect that unlike the third quarter in the fourth quarter we have a good opportunity to generate a merchandise margin rate increase in Q4 because we don't expect to be higher in mark downs in the fourth quarter relative to sales as we were in the third.

Hollie Guthrie – Boenning & Scattergood

What was the impact again for Shock Hound in the third quarter?

James McGinty

About $0.01 a share.

Hollie Guthrie – Boenning & Scattergood

Is that $0.01 less? Were you looking for $0.02 originally so is it performing a little bit better than what you were looking for or is $0.01 what you were looking for?

James McGinty

You're correct. We initially say $0.01 to $0.02 in the third quarter. Because of the later launch some of the expenses were moved out and we'll recognize some of those in the fourth which is what we included in the guidance.

Hollie Guthrie – Boenning & Scattergood

I'm just trying to understand the genesis of your ability to have three very strong dynamic trends kind of emerge for you and work so well at the same time looking at Shock Hound, the launch of that which has been talked about for awhile and you have been talking about it, Rock Band Two and then of course Twilight.

Can you go back to, my best memory is going back 18 months where you said you were going to make some changes, bring some new people on to try and find trends emerging a little bit earlier and trying to find these trends. Could you talk about some of those things and how the changes that you made will affect the business going forward?

Elizabeth McLaughlin

When we embarked on the music strategy, the same time we announced that we also announced that we were bringing on a Chief Music Officer and John has certainly brought to the table his experience which is different from any of our experiences both from a marketing perspective and a label sensibility. He has certainly been part of the team that has put some of these items before us.

If you look at the three that you mentioned, Shock Hound has been planned for three years now and it started, if you go back to those conference calls a year and a half ago, it started as, we needed to be able to play in the digital music world, and how do we do that within Hot Topic. And I think it was called the hottopic.com music initiative for quite some time before we recognized that there really was an opportunity to be a wider space and to bring our authenticity and credibility to the table online.

That's really been over the years a forum that we knew we would have to jump into and certainly the addition of many different people including both our Editor-in-Chief Randy Bocasta and our head writer, Dan Ebstein. The two of them along with John and then certainly the rest of the team have come together to put this Shock Hound before us as a potential growth vehicle. That's the Shock Hound deal.

We have said, and I'll just reiterate that we know that any technology concept is awhile before it breaks even and we've given ourselves three years to get to that point. I don't think we're looking at Shock Hound as being a huge driver of earnings at this point but it certainly can help re-stimulate the relevance of music as part of the Hot Topic concept and the experience of new music.

Rock Band was brought to the table by John also based on some of the connections that he had had, and Rock Band is really a marketing play, and it's a long term marketing play. We did not build sales into the plan this year or next year, but we knew that there is an entire generation of under 15 kids out there who are learning about music and being exposed to music via Rock Band or Guitar Hero, both of them.

As we've seen over the years, the classic rock business build, it's because many of these consumers are learning about Jimmy Hendrix and Guns 'n Roses and Poison for that matter because they're in their living rooms playing Rock Bank or Guitar Hero. We felt that it was very good positioning for us, especially since there aren't a lot of other retailers other than true music credible retailers involved in the game, that if we could put ourselves in the game as an authentic place that when you are successful with your band, you connect that to Hot Topic, that would be very good for us going forward with this generation of young teens.

So that's a long term approach for Rock Band, and as I said, we didn't plan on having it increase our short term comp.

Twilight, we did plan on having it increase our short term comps. We knew that it was a strong license. We saw the build. I think when we entered into it we didn't know what it was going to be but we did get a sense as I said before in August and September that the product came in and we were selling out of the product, that this was something that could really be a helpful short term driver of comps.

So we are doing out best to maximize that to get the product load in and to make sure that it has the exposure both in our stores and within our marketing material to certainly help our short terms business.

Hollie Guthrie – Boenning & Scattergood

The Twilight license, did that come out of your licensing group, somebody in there, or is that somebody new that came into the organization?

Elizabeth McLaughlin

This was actually brought to us. We heard about it through customers and employees first and we went to the studio. The studio came to us simultaneously so it was the best of both worlds.

Hollie Guthrie – Boenning & Scattergood

You mentioned that you thought that Twilight could be in the top three. Sponge Bob and South Park being the other two strong licenses for you. You didn't mention Harry Potter so I'm assuming you think Twilight can be stronger than Harry Potter?

Elizabeth McLaughlin

You have to remember that Potter always releases in June and July and so those are not typically as strong volume months as August, September, November, December. Right now it is tracking much higher than Harry Potter.

Hollie Guthrie – Boenning & Scattergood

Does any of that have to do also; is there spillover from the Twilight CD which is performing really well and the genre from the music from the CD?

Elizabeth McLaughlin

Well the CD is a mix of many different artists that cover many different genres of music and so I don't know that it has any connection to what we're seeing with rock tees. The CD did very well. We ethically were very close to, it may have been our number two all time selling CD when it was released two weeks ago. I think it all helps with the hype.

Operator

Your next question comes from Barbara Wyckoff – Buckingham Research Group.

Barbara Wyckoff – Buckingham Research Group

Isn't Twilight an exclusive license and if so how long does the license last?

Elizabeth McLaughlin

There is no exclusive license for Twilight.

Barbara Wyckoff – Buckingham Research Group

But you were on it first? It seems that way to me.

Elizabeth McLaughlin

Yes.

Barbara Wyckoff – Buckingham Research Group

What are customers telling you regionally about the mix? Are there big differences in mix from one region versus the others? I remember initially there was a big difference between the east coast and California. Is that still going on or has it all sort of moved towards the middle?

Christopher Daniel

I think it's all moved in the direction of fashion and that has been what has been working in our business and that seems to be a common denominator. We've been doing, we've been around for eight years so we're getting the hang of seasonal merchandise, more coats in the east and more light weight knits in the southwest. But other than that, I think we are settling on a brand direction that seems to work most places.

Elizabeth McLaughlin

I should probably mention that while Twilight is not an exclusive license because they do not want it to be an exclusive license, the gentleman who has the rights for the licenses has been a long term partner with Hot Topics and so the deal that we have with him is to be the mall retailer of choice for Twilight, so that's how we negotiated the deal.

Barbara Wyckoff – Buckingham Research Group

You talked about Twilight really appealing to the eight year olds which I know is a middle school kind of a thing but I've also noticed in the Hot Topic stores that a younger licenses have started to come in too. Is that a shift or is that just the way it is with the reappearance of [inaudible] and some of those things?

Elizabeth McLaughlin

I think I said that Twilight appeals to ages eight to 68. I think the majority of Twilight readers are between 13 and 20. And it depends on when you say younger licenses, I'm not sure what you're speaking of but we did a fantastic business with Hello Kitty and Fosters two years ago which may look like it's a younger license but it sells to teenagers.

It depends on sometimes the younger licenses, the Anna Mae licenses look a bit younger than what they really are.

Operator

Your next question comes from Crystal Kallik – D.A. Davidson.

Crystal Kallik – D.A. Davidson

I wanted to ask your thoughts of you're seeing what's out there coming down the pipeline over the next several quarters. Are you excited about what you're seeing as far as fashion and youth culture coming down the pipeline, or what is interesting to you? What's the newness like, the level of newness, anything you can give us as far as feedback? I know you don't like to give specifics but just as a general perspective.

Elizabeth McLaughlin

Right now, everybody is very much focused on what's going to happen over the next six weeks. I certainly have not heard, when you say what's out there, I certainly have not heard a lot of excitement about next year just because of everyone's trying to keep their heads above water for fourth quarter.

I certainly think that there's places that we can carve out and there are certainly trending areas that we see within our own business that we will develop a proprietary product for. But as far as a general rule or feeling out there amongst the vendor community, I think it's tough.

Christopher Daniel

I would absolutely agree. I think the market is a bit skittish now in terms of newness and it turns out to have been a pretty good year and we're focused on developing and internal design group because I think our best ideas are being generated internally. I think the market is a little bit in hibernation right now.

Crystal Kallik – D.A. Davidson

On you commentary on Twilight, I know you don't like to give specifics about licenses, but in general how do you feel about not only the license coming down over the next couple of quarters but as well as the music schedule on broad terms.

Elizabeth McLaughlin

I think we've become less and less dependent on music release schedules as we've shifted our business into more of the mid tier and smaller tier bands. There are a couple of good releases scheduled for next year if they actually happen which could be top ten releases of all time kind of thing. But as far as the month to month cadence, I don't see much difference this year to last year.

As far as licensing is concerned, we're emerging out of a very difficult couple of years with licensed product and in addition to Twilight and certainly not before Christmas because we don't want to slight Nightmare, it's also performing well. There are some other licenses that are bubbling up to give us some freshness for next year so licensing in general I feel better about.

Crystal Kallik – D.A. Davidson

I just wanted to clarify, when you talked about the rock tees business, you talked about shifting genre. Does that also include further shifts in silhouette and color or is it just primarily the genre of music that you're talking about?

Elizabeth McLaughlin

I'm speaking specifically about music genres.

Operator

Your next question comes from Dana Telsey – Telsey Advisor Group.

Dana Telsey – Telsey Advisor Group

Can you talk a little bit about any holes in the management team that need to be filled or planning an allocation and do you see the structural changing from what you may have expected? And also, is there any holes on Torrid that need to be filled too, and any update in terms of Torrid and how that concept is changing, what you expect for it next year.

Elizabeth McLaughlin

On the Hot Topics side, we certainly have a chief merchant opening and we continue to look for the right person to be in that role. That's really the only key opening we have. We are full up in planning and allocation and I think another area for the company where we want to be right now especially right now going into what might be a rocky year, and as we look at where we save expenses on the P&L, we're not looking to fill just to fill, we're looking for the right person that can add value immediately.

Other than the chief merchant, we're in a good position on the Hot Topics side.

Christopher Daniel

On the Torrid side we continue to push the fashion ball uphill. We continue to look for talent if talent is available. There are no particular openings at this point. Anybody new we brought on board would be newly created position. We're always looking for talent for the internet.

Dana Telsey – Telsey Advisor Group

The Torrid concept overall, how do you see that changing next year?

Christopher Daniel

I think the concept is solid and we are well positioned as A mall based fashion, junior plus plan. As long as we stick to what we're supposed to be in the customers mind, we have a very loyal customer, and I'm pretty happy with the way the brand is developing.

Operator

This concludes the question and answer session. I would now like to pass the call back over to Miss Betsy McLaughlin for any closing remarks.

Elizabeth McLaughlin

Thanks for joining us on the call and happy holidays.

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