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I only made it down to the Q&A section. I'll continue that on Thursday evening.

Q1 2001

Betsy McLaughlin, CEO
Jim McGinty, CFO
Jay, Sr Strategic Finance Guy (I forget his title)

Jim Speaks:
[Jim doesn't speak well and he seems kind of nervous. This is his first HOTT conference call.]
Jim claimed the 37% net income increase. I'll comment on this later.
Fully diluted share count "increased significantly", 22,246,000 shares now vs 21,016,000 shares last year, an increase of 5.85%.

Gross margin was 37.3% of net sales vs 37.4% last year. Great! margins are holding well. These are both good numbers.

Merchandise margins increased 0.1% due to lower markdowns offset by higher occupancy expense due to higher "common area" charges: a mall charge. I'm not sure why mall expenses would be higher now, sounds like owning malls is a good business. :-)

SG&A expenses were 29.8% of sales vs 29.7% last year, higher (and no leverage) due to the Torrid development costs. Pre-opening expenses were up for the quarter due to the larger number of stores opened this quarter (20 vs 12 HT stores).

Operating income was down to 7.5% from 7.7% last year. The increased number of Hot Topic store openings and the significant costs of the Torrid openings had a 0.8% increase effect on operating income. That's fine. Per store, operating income was up 4%. Seems kind of odd with same store sales increasing by much more than that. I assume this includes the Torrid expense.

20 Hot Topic stores and 3 Torrid stores opened in the 1st quarter. Square footage grew by 10%. The average Hot Topic store is 1,570 sq ft.

Jim claims that inventory was $24.2 million yet the press release claimed it was $26.2 million. Which is it? Inventory per store is $81,000 up about 2% over last year. $56 per square foot (kind of an odd metric), down from $60 per square foot last year (ok, now I see the rationale. this ties in the "The Confession" below).

Betsy Speaks:

8% SSS for the quarter is the 12th consecutive quarter of "solid" positive same store sales growth. All major categories of merchandise produced about the same increases in sales. However, some specific areas had double digit growth such as men's anime and woven lounge tops, women's cartoon characters and word t-shirts, leather goods (belts), and body jewelry. Mens' and women's bottoms started slowing down their growth rate during the quarter (this is an important statement that was placed here carefully, just watch what happens below). The cowboy hat trend is waning (and affecting hat growth), so are the novelty sock and lace trends.

Strongest artists: Korn, Metalica, Slipknot, Limp Bizkit, and Def Tones.

Inventory: Less than 5% of the sku's aged more than 6 months on a per store basis (similar to last year). This number, by the way, shows great inventory control.

18 of the 20 new stores have the new industrial design. The other 2 presumably have the old design. The new stores are operating above plan.

Torrid: Sales continue to exceed expectations. Customer response has been very positive [I've seen this first hand at the Torrid store near me]. 5 of the 6 Torrid stores are now open. The 6th one opens on Thursday (it probably had a soft opening today).

The Confession: [This is one of those carefully crafted statements that you get when things go wrong. It's an ingrained thing in the human genes that first emerges when the kids try to explain to mom why the lamp is broken. In this case, it's important to carefully read through the words to understand what's really being said. It rarely includes the statement "the lamp is broken", it usually begins with something like, "Because Joey kicked the soccer ball at me really hard, it bounced off my foot and..." Anyways, here's the statement:] May merchandise receipts were planned based on the fiscal calendar. On a shifted basis, they should not have allowed the fiscal calendar to dictate the receipt flow, and by doing so, the first and second weeks of the month did not have the appropriate amount of new receipts delivered to stores to support early May business. They have adjusted the receipt flow for the remainder of the year to ensure appropriate [bill of material] inventory levels each month. Due to the merchandise receipt flow and sales in the first two weeks of May, and the difficult men's and women's bottoms comparisons from last year, they are guiding to a flat comp for the month of May.

After this statement, Betsy goes on to say that their Summer inventory is going to be back in shape etc. Also based on feedback from last year, they've learned to target back-to-school sales in June in selected markets: primarily Florida and Texas.

Analysis: I scanned ahead to the questions and answers and heard Betsy give a much better simple explanation that I liked which begins with "we messed up" and then goes into excellent detail about what happened and why. Based on this, I believe it was a one time blip and not a structural or long term problem. If the stock drops far enough because of it, I'm flexible, I'll back up the truck if the price is right. Betsy's response in the Q&A is exactly what I would want to hear if I owned the entire company. No tap dancing, no blaming, just say what happened and why. As I said before, I expect mistakes. I just don't expect BS or trying to hide them.

They continue to lock up a record number of exclusive items and there are lots of new licenses in every category flowing into the stores in the next two months.

For back-to-school, they're "most excited" about Pony the old school brand from the 1970's and 80's. Pony is being re-launched in the Summer. Korn, Limp Bizkit, and Staind have all been spotted wearing the Pony brand. Pony will also be the title sponsor for the Family Values tour, a Fall/Winter tour for metal bands like Linkin Park and Stone Temple Pilots.

[Pony's website has a deal where you can win a free Staind t-shirt with some tie-in with the new release of the Staind CD, Break the Cycle. I've seen a lot of buzz about this band and the new CD (which I promised I would buy) among people I work with. In fact, Staind appeared at a Newbury Comics store in the Boston area today. The cooler people I work with were talking about it and said the place is going to be mobbed. Newbury Comics is a local music store chain with around 26 stores in the New England area that somewhat competes with Hot Topic. I wish this conference call was yesterday rather than today, I would've gone to see Staind and get a sense of the amount of buzz... and look for Pony sneakers. :-) I really hope this isn't a case of someone trying to drive a trend artificially.]

Get this, Hot Topic will be the exclusive retailer to launch Pony in early August. The exclusive will run through the end of the year. This could be a very profitable new business model for Hot Topic. There's more about this in the Q&A section, especially how Pony approached Hot Topic to be the exclusive and the artists agreed on it. Damn!!!! That says it all.

Hot Topic will also be sponsoring Ozzfest again this year as the headline sponsor of the 2nd stage which showcases emerging artists (good choice), which will include a Black Sabbath reunion (I noticed Black Sabbath posters and this explains it).

Jay Speaks:
They position Hot Topic as a 20% to 30% earnings grower. In the near future, this will be accomplished via a 25% square footage growth amid single digit same store sales growth and leveraged SG&A expenses. 23 Hot Topic stores are planned to open in Q2, 15 in Q3, and 7 in Q4. Comp store growth in 1999 and 2000 was very high. They believe they can continue to grow same store sales. Merchandise margins in 2001 should be about the same as 2000. Gross margins should be 39% to 39.5% of net sales, slightly lower due to higher cam charges(?), less leveraging of occupancy expenses (I wonder why there'd be less of this?), and the impact of the Torrid stores [presumably they will have lower sales per fixed expenses]. SG&A should be around 26.3% of net sales for 2001.

The share count for Q2 will grow at a slower rate than Q1 [thankfully]. Earlier estimate this year was for 21.8 million shares, but due to the strong share price and options grant pricing, there are an estimated 22.4 million diluted shares for the full year. Based on this, net income for the full year is guestimated at 27% for 2001. He didn't state explicitly whether this was fully diluted or not, but it works out to be $1.32 a diluted share (using the 22.4 million share estimate) and a 21% growth in earnings in 2001 full year.

(will pick up at 17:39 with the Q&A.)
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