a6518455.htm

Hot Topic, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share amounts)

	October 30, 2010			January 30, 2010
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	41,362		$	117,764
Short-term investments		16,590			5,301
Inventory		90,743			76,483
Prepaid expenses and other		22,421			14,395
Deferred tax assets		6,036			6,192
Total current assets		177,152			220,135

Property and equipment, net		130,522			140,252
Deposits and other		4,258			3,304
Long-term investments		2,480			8,192
Deferred tax assets		6,113			4,511
Total assets	$	320,525		$	376,394

Liabilities and shareholders’ equity
Current liabilities:
Accounts payable	$	29,785		$	20,235
Accrued liabilities		35,023			40,824
Income taxes payable		538			545
Total current liabilities		65,346			61,604

Deferred rent and other		28,594			32,376
Income taxes payable		2,380			2,380
Deferred compensation		4,094			2,987

Commitments and contingencies

Shareholders’ equity:
Preferred shares, no par value; 10,000,000 shares
authorized; no shares issued and outstanding		-			-
Common shares, no par value; 150,000,000 shares authorized;
44,586,144 and 44,339,711 shares issued and
outstanding at October 30, 2010 and January 30, 2010, respectively		127,078			122,552
Retained earnings		93,358			154,905
Accumulated other comprehensive loss		(325	)		(410	)
Total shareholders’ equity		220,111			277,047
Total liabilities and shareholders’ equity	$	320,525		$	376,394

Hot Topic, Inc. and Subsidiaries
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)


	Three Months Ended				Nine Months Ended
	October 30, 2010		October 31, 2009		October 30, 2010			October 31, 2009

Net sales	$	183,219	$	189,568	$	495,873		$	522,485
Cost of goods sold, including buying,
distribution and occupancy costs		118,669		119,674		330,838			342,803
Gross margin		64,550		69,894		165,035			179,682

Selling, general and administrative expenses		64,229		60,260		178,066			173,622
Income (loss) from operations		321		9,634		(13,031	)		6,060

Interest income, net		114		93		246			446
Income (loss) before provision (benefit) for income taxes		435		9,727		(12,785	)		6,506

Provision (benefit) for income taxes		45		3,878		(5,128	)		2,609
Net income (loss)	$	390	$	5,849	$	(7,657	)	$	3,897

Earnings (loss) per share:
Basic and diluted	$	0.01	$	0.13	$	(0.17	)	$	0.09

Cash dividends declared and paid per share	$	0.07		-	$	1.21			-

Shares used in computing earnings (loss) per share:
Basic		44,616		44,143		44,526			44,069
Diluted		44,662		44,497		44,526			44,413

Hot Topic, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
	Nine Months Ended
	October 30, 2010			October 31, 2009
OPERATING ACTIVITIES
Net (loss) income	$	(7,657	)	$	3,897
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation and amortization		29,397			28,438
Stock-based compensation		3,241			3,061
Loss on disposal of fixed assets		185			461
Impairment of long-lived assets		3,888			663
Deferred taxes		(1,640	)		(1,596	)
Gift card breakage		(505	)		(480	)
Changes in operating assets and liabilities:
Inventory		(14,260	)		(11,470	)
Prepaid expenses and other current assets		(8,026	)		(606	)
Deposits and other assets		(954	)		(1,522	)
Accounts payable		9,549			8,474
Accrued liabilities		(3,961	)		(8,663	)
Deferred rent		(3,593	)		(3,690	)
Income taxes payable		(7	)		(6,947	)
Net cash provided by operating activities		5,657			10,020

INVESTING ACTIVITIES
Purchases of property and equipment		(23,739	)		(19,518	)
(Purchases) proceeds from sale of short- and long-term investments, net		(5,480	)		3,701
Net cash used in investing activities		(29,219	)		(15,817	)

FINANCING ACTIVITIES
Excess tax benefit from stock-based compensation		246			573
Proceeds from employee stock purchases and exercise
of stock options		1,160			1,457
Payment of capital lease obligation		(382	)		-
Payment of cash dividends		(53,890	)		-
Net cash (used in) provided by financing activities		(52,866	)		2,030
Decrease in cash and cash equivalents		(76,428	)		(3,767	)
Effect of exchange rate changes in cash		26			-
Cash and cash equivalents at beginning of period		117,764			90,135
Cash and cash equivalents at end of period	$	41,362		$	86,368

SUPPLEMENTAL INFORMATION
Cash paid during the period for interest	$	29		$	5
Cash paid during the period for income taxes	$	2,616		$	11,710

We are a mall and web-based specialty retailer operating the Hot Topic® and Torrid® concepts, as well as the e-space music concept, ShockHoundTM. At Hot Topic we believe that music, along with pop culture, plays a primary and integral role in the minds, activities and preferences of our target teen customers. We sell a selection of music/pop culture-licensed and music/pop culture-influenced apparel, accessories, music and gift items for young men and women principally between the ages of 12 and 22. At Torrid, we sell apparel, lingerie, shoes and accessories designed for various lifestyles for plus-size females principally between the ages of 15 and 29. We sell merchandise on our websites www.hottopic.com and www.torrid.com, which reflect the Hot Topic and Torrid store concepts and sell merchandise similar to that sold in the respective stores. At ShockHound, through our website www.shockhound.com, we sell music merchandise and MP3s and provide access to an online community and exclusive editorial and video content.

Our fiscal year ends on the Saturday nearest to January 31. References to the third quarter of fiscal 2010 and 2009 refer to the thirteen week periods ended October 30, 2010 and October 31, 2009, respectively. References to fiscal year-to-date 2010 and 2009 refer to the thirty-nine week periods ended October 30, 2010 and October 31, 2009, respectively. References to fiscal 2011, 2010, 2009, 2008 and 2007 refer to the 52-week periods ending January 28, 2012, January 29, 2011, January 30, 2010, January 31, 2009 and February 2, 2008.

The information set forth in these condensed consolidated financial statements is unaudited except for the January 30, 2010 consolidated balance sheet data. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, the instructions to Form 10-Q, and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K filed on March 19, 2010.

Under our 1996 Equity Incentive Plan, or the 1996 Plan, we granted stock options, stock bonuses and other awards to our employees, directors and consultants as deemed appropriate by the Board of Directors, or the Board. On June 14, 2006, the 1996 Plan expired and was replaced with the 2006 Equity Incentive Plan, or the 2006 Plan. The 2006 Plan was approved by the Board on March 17, 2006 and by our shareholders on June 13, 2006. Upon expiration of the 1996 Plan, no shares had been granted to consultants and 732,456 shares out of an aggregate of 18,300,000 shares of common stock were authorized and available for grant.

The 2006 Plan provides for the grant of incentive stock options, non-statutory stock options, restricted stock awards, restricted stock unit awards, stock appreciation rights, performance stock awards and other forms of equity compensation to our employees, consultants and directors as deemed appropriate by the Board. Both incentive and non-statutory stock options granted by us under the 2006 Plan must carry an exercise price of at least 100% of the fair market value of our common stock on the date of grant or 110% of the fair market value of our common stock on the date of grant for persons possessing 10% or more of the total combined voting power of all classes of stock. Options granted may be subject to different vesting terms as determined by the Board and the maximum term of options granted is 10 years. In addition, the maximum number of shares of common stock available for future issuance may not exceed the sum of (a) the 732,456 shares of common stock remaining available for issuance under the 1996 Plan as of June 13, 2006, (b) an additional 2,350,000 shares and (c) the number of shares subject to stock awards as of June 13, 2006 under the 1996 Plan pursuant to the terms of the 1996 Plan. As of the end of the third quarter of fiscal 2010, 441,314 shares were available for future grants under the 2006 Plan. These available shares include a portion of the 300,000 shares that were set aside for the issuance of up to 200,000 performance stock awards previously granted to Elizabeth McLaughlin in March 2008 which, on June 8, 2010, were voluntarily cancelled in exchange for a nominal payment to Ms. McLaughlin of $1.00. This cancellation effectively lowered the requirement to set aside 537,000 shares (for the potential issuance of up to 358,000 performance stock awards granted in March 2008) to 237,000 shares (for the potential issuance of up to 158,000 performance stock awards granted in March 2008). All awards to date under the 2006 Plan have been granted to our employees and none have been granted to consultants.

In March 2009 and 2008, we granted performance stock awards under the 2006 Plan to certain members of our management. None of these awards have vested and no shares have been issued pursuant to the grants. The 2009 and 2008 awards provide for the issuance of up to 430,000 and 158,000 shares of our common stock, respectively, net of forfeitures, with vesting and issuance contingent upon achieving performance goals for fiscal 2011 and 2010, respectively, based upon our operating income for those fiscal years; and prior to vesting (or termination without vesting), the awards constitute an agreement by us to issue shares to the extent these performance goals are ultimately met. The market values of our common stock as of the 2009 and 2008 grant dates of these performance stock awards were $9.56 and $4.75, respectively. Compensation expense for these awards is required to be recorded over the three-year terms of the awards, based on the market values as of the grant dates, with actual amounts expensed dependent upon the likelihood from period to period of vesting of these awards at the end of fiscal 2011 and 2010, respectively. As of the end of the third quarter of fiscal 2010, it is our best estimate that none of the 2009 or 2008 performance stock awards will be earned at the end of the respective three-year terms. In aggregate, we have not recognized any compensation expense for these 2009 and 2008 awards.

Under our 1996 Non-Employee Directors’ Stock Option Plan, or the 1996 NEDSOP, we may grant and have granted stock options to non-employee directors. The exercise price of options granted under the 1996 NEDSOP shall be determined by the Board at the date of grant and shall be 100% of the fair market value of our common stock on the date of grant. Unless the Board determines otherwise, options vest over four years and generally expire ten years from the date of grant. The total share reserve under the 1996 NEDSOP is 720,000 shares, of which as of the end of the third quarter of fiscal 2010, 1,226 shares were available for future grants. No options under the 1996 NEDSOP have been granted to consultants.

In October 2010, June 2010 and June 2009, we granted non-employee directors an aggregate of 5,638, 31,763 and 20,559 shares of restricted common stock, respectively, under the 2006 Plan. Restricted shares generally vest in one installment in the year subsequent to the grant year. All awarded common shares remain restricted (i.e., not transferable by the holders) until such time as the recipient is no longer a member of our Board. The value of these grants is expensed over the vesting period. During the third quarter of fiscal 2010, $43,000 was expensed. During the third quarter of fiscal 2009, $39,000 was expensed. During fiscal year-to-date 2010, $121,000, of which $52,000 relates to the fiscal 2009 grant, was expensed. During fiscal year-to-date 2009, $116,000, of which $52,000 related to the fiscal 2008 grant, was expensed.

	Options			Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value (in thousands)
Outstanding at January 30, 2010		6,689,496		$	12.36

Granted		970,100		$	6.00
Exercised		(173,343	)	$	5.39
Forfeited or expired		(238,366	)	$	9.02

Outstanding at October 30, 2010		7,247,887		$	11.78		5.64	$	919

Exercisable at October 30, 2010		5,025,324		$	13.83		4.33	$	427

In June 1996, the Board adopted the Employee Stock Purchase Plan, or the Stock Purchase Plan. The Stock Purchase Plan provides for the issuance of up to 1,350,000 shares of common stock to our employees. All eligible employees are granted identical rights to purchase common stock for each Board authorized offering under the Stock Purchase Plan. Rights granted pursuant to any offering under the Stock Purchase Plan terminate immediately upon cessation of an employee’s employment for any reason. In general, an employee may reduce their contribution or withdraw from participation in an offering at any time during the purchase period for such offering. Employees receive a 15% discount on shares purchased under the Stock Purchase Plan. Rights granted under the Stock Purchase Plan are not transferable and may be exercised only by the person to whom such rights are granted. The initial offering under the Stock Purchase Plan commenced October 24, 1996 and terminated December 31, 1996. Subsequent offerings have occurred every six months commencing January 1, 1997. 843,979 shares could still be sold to employees under the Stock Purchase Plan as of the end of the third quarter of fiscal 2010. Compensation expense for the third quarter of fiscal 2010 and 2009 was $41,000 and $37,000, respectively, related to the fair value of the rights granted to participants under the plan. Compensation expense for fiscal year-to-date 2010 and 2009 was $134,000 and $111,000, respectively.

	Three Months Ended						Nine Months Ended
	October 30, 2010			October 31, 2009			October 30, 2010			October 31, 2009
Stock-based compensation by type of award:
Employee and director stock options and awards	$	993		$	1,049		$	3,108		$	2,969
Restricted stock units		-			(329	)		-			(19	)
Employee stock purchase plan		41			37			133			111

Total stock-based compensation expense	$	1,034		$	757		$	3,241		$	3,061
Tax effect on stock-based compensation expense		(380	)		(272	)		(1,195	)		(1,134	)

Net effect on net income (loss)	$	654		$	485		$	2,046		$	1,927

Effect on income (loss) per share:
Basic and diluted	$	0.01		$	0.01		$	0.05		$	0.04

The Black-Scholes option valuation model used to determine the fair value of stock-based compensation incorporates various assumptions including the expected term of awards, volatility of stock price, risk-free rates of return and dividend yield. The expected term of an award is generally no less than the option vesting period and is based on our historical experience. Expected volatility is based upon the historical volatility of our stock price. The risk-free interest rate is approximated using rates available on U.S. Treasury securities with a remaining term equal to the option’s expected life. The dividend yield is based on the expected dividend yield as of the date of option grant. We began to pay dividends during the first quarter of fiscal 2010.

In April 2010, the Board authorized a $1.00 per share special one-time cash dividend that was paid to shareholders of record at the close of business on April 19, 2010 and a $0.07 per share regular quarterly cash dividend that was also paid to shareholders of record at the close of business on April 19, 2010. Subsequent payments of the $0.07 per share regular quarterly cash dividend have occurred every quarter since then, the most recent being in October 2010 to shareholders of record at the close of business on October 18, 2010. We released the funds used to pay for this regular quarterly cash dividend during the third quarter of fiscal 2010. Our Board will determine future regular quarterly cash dividends after giving consideration to our then existing levels of profit and cash flow, capital requirements, current and forecasted liquidity, as well as financial and other business conditions existing at the time. As of the end of the third quarter of fiscal 2010, total dividends paid amounted to $53.9 million consisting of $44.5 million for the $1.00 per share special one-time cash dividend paid in the first quarter of fiscal 2010 and $9.4 million (of which $3.1 million was paid in the third quarter of fiscal 2010) for the $0.07 per share regular quarterly cash dividends initiated in the first quarter of fiscal 2010. We did not make any dividend payments during fiscal 2009.

Basic earnings or loss per share is computed by dividing net income or net loss, respectively, by the weighted average number of common shares outstanding for the period. Diluted earnings per share is applicable only in periods of net income and is computed by dividing net income by the weighted average number of common shares outstanding for the period and potentially dilutive common stock equivalents outstanding for the period. Periods of net loss require the diluted computation to be the same as the basic computation. As of the end of the third quarter of fiscal 2010 and 2009, options to purchase 6,596,289 and 5,561,555 shares, respectively, of potentially anti-dilutive common stock equivalents were outstanding. For fiscal year-to-date 2010 and 2009, options to purchase 6,407,514 and 5,461,136 shares, respectively, of potentially anti-dilutive common stock equivalents were outstanding. The calculation of dilutive shares also excludes the portion of the performance stock awards granted to certain members of our management in March 2009 and March 2008 that are not expected to be earned or vest as the issuance of the underlying shares is contingent upon achieving certain performance goals in fiscal 2011 and 2010, respectively.

	Three Months Ended				Nine Months Ended
	October 30, 2010		October 31, 2009		October 30, 2010			October 31, 2009
Basic and diluted earnings (loss) per share computation:
Numerator	$	390	$	5,849	$	(7,657	)	$	3,897
Denominator:
Weighted average common shares outstanding		44,616		44,143		44,526			44,069
Incremental shares from assumed exercise/issuance of options and awards		46		354		-			344
Total shares		44,662		44,497		44,526			44,413

Basic and diluted earnings (loss) per share	$	0.01	$	0.13	$	(0.17	)	$	0.09

Our short-term investments consist of highly-rated interest-bearing municipal bonds that have maturities that are less than one year and are accounted for as available for sale and certificates of deposit that are guaranteed by the Federal Deposit Insurance Corporation, classified as held to maturity and have maturities that are less than one year. As of the end of the third quarter of fiscal 2010, short-term investments consisted of certificates of deposit of $5.0 million and municipal bonds of $11.6 million. As of the end of fiscal 2009, short-term investments consisted of municipal bonds of $5.3 million. (Refer to “NOTE 8 – Fair Value Measurements” for further discussion on how we determined the fair value of our short-term investments). The associated unrealized gains in the third quarter of fiscal 2010 and in fiscal year-to-date 2010 were immaterial and have been recorded in accumulated other comprehensive loss, or OCL, reflected in the shareholders’ equity section of the consolidated balance sheet. The associated unrealized gain in the full year of fiscal 2009 was $0.1 million.

As of the end of the third quarter of fiscal 2010, our long-term investments comprised of auction rate securities. As of the end of fiscal 2009, our long-term investments comprised of auction rate securities and certificates of deposit. The fair value of our certificates of deposit as of the end of fiscal 2009 was $5.0 million and the immaterial associated unrealized losses were recorded in OCL reflected in the shareholders’ equity section of the consolidated balance sheet.

Our auction rate securities are AAA/Aaa/A3-rated debt instruments with maturities that range from 23 to 30 years. They are accounted for as available for sale and backed by pools of student loans guaranteed by the U.S. Department of Education. Their interest rates are reset through an auction process, most commonly at intervals of 7, 28 and 35 days. This same auction process is designed to provide a means by which these securities can be sold and prior to 2008 had provided a liquid market for them. There continues to be uncertainty in the global credit and capital markets, which has resulted in the failure of auctions representing the auction rate securities we hold as the amount of securities submitted for sale in those auctions exceed the amount of bids. While we have continued to earn and receive interest on our auction rate securities through the date of this report, we concluded that their estimated fair value no longer approximates par value. Due to the lack of availability of observable market quotes on our auction rate securities, the fair market value of these securities has been based on a valuation model using current assumptions. (Refer to “NOTE 8 – Fair Value Measurements” for further discussion on how we determined the fair value of our investment in auction rate securities).

As of the end of the third quarter of fiscal 2010 and as of the end of fiscal 2009, the fair value of our auction rate securities was $2.5 million and $3.2 million, respectively. The $0.7 million decline in fair value from the beginning of the fiscal year represents a $0.8 million redemption of certain auction rate securities at par during the second quarter of fiscal 2010 and a $0.1 million net decrease in fair value of the remaining auction rate securities, of which $16,000 relates to the third quarter of fiscal 2010. The decrease is offset by the recovery in fair value of $0.2 million which was previously temporarily impaired. The fair value of our remaining auction rate securities as of the end of the third quarter of fiscal 2010 reflects a cumulative decline of $0.6 million from the par value. This cumulative $0.6 million decline ($0.4 million net of tax) is deemed temporary as we do not have the intent to sell these securities and it is not likely that we will be required to sell the securities before the recovery of their amortized cost basis. If uncertainties in the credit and capital markets continue, we may incur additional losses, some of which may be other-than-temporary, which could negatively affect our financial condition or results of operations. In addition, in the event that we decide to sell these securities and it becomes likely that we will be required to sell the securities before the recovery of their amortized cost basis, we may be required to recognize impairment charges against income. We have classified all auction rate securities as non-current assets on our consolidated balance sheet, as we do not expect them to successfully auction and recover their full or par value within the next 12 months.

In January 2010, the Financial Accounting Standards Board, or FASB, issued guidance titled “Improving Disclosures About Fair Value Measurements” that amends existing disclosure requirements by adding required disclosures about items transferring into and out of levels 1 and 2 in the fair value hierarchy; adding separate disclosures about purchase, sales, issuances, and settlements relative to level 3 measurements; and clarifying, among other things, the existing fair value disclosures about the level of disaggregation. Except for the separate level 3 disclosures, this guidance was effective for financial statements issued for interim or fiscal years beginning after December 15, 2009, and our adoption of it on January 31, 2010 did not have a material impact on our financial condition or results of operations. The rest of the guidance is effective for financial statements issued for interim or fiscal years beginning after December 15, 2010. Since these are disclosure requirements only, our adoption of this guidance will not have a material impact on our financial condition or results of operations.

Our financial assets and liabilities are valued at the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. We determine fair value based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, we prioritize the inputs used in measuring fair value into a three-tier fair value hierarchy, which are as follows:

	Balance at October 30, 2010		Quoted Prices in Active Markets for Identical Items (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Marketable securities (current)	$	11,624	$	11,624	$	-	$	-
Certificates of deposit (current)		4,966		4,966		-		-
Auction rate securities (non-current)		2,480		-		-		2,480
Total assets	$	19,070	$	16,590	$	-	$	2,480
Liabilities:
Deferred compensation plan (non-current)	$	4,094	$	4,094	$	-	$	-

The fair value of our short-term marketable securities, certificates of deposit and deferred compensation plan liability is determined based on quoted prices of identical assets that are trading in active markets as of the end of the period for which the values are determined. The deferred compensation plan liability represents the amount that would be earned by participants if the funds were invested in securities traded in active markets. Due to the lack of availability of observable market quotes on our auction rate securities, the fair market value of these securities has been determined based on a valuation model using current assumptions. The model values the securities by estimating the present value of future principal and interest payments discounted at rates considered to reflect current market conditions. Assumptions used in the valuation include those made about the liquidity horizon, or period of time expected, before the securities are successfully auctioned; coupon rates; weighted average cost of capital; and holding spreads and yields. Other factors that impact our valuation include changes to credit ratings of our auction rate securities as well as to the underlying assets supporting these securities and the ongoing strength and quality of the credit markets. Our valuation is subject to uncertainties that are difficult to predict and could change significantly based on future market conditions.

In August 2006, we adopted the Hot Topic Inc. Management Deferred Compensation Plan, or the Deferred Compensation Plan, for the purpose of providing highly compensated employees and members of our Board a program to meet their financial planning needs. The Deferred Compensation Plan provides participants with the opportunity to defer up to 80% of their base salary and up to 100% of their annual earned bonus, or, in the case of members of our Board, 100% of their earned cash fees, all of which, together with the associated investment returns, are 100% vested from the outset. The Deferred Compensation Plan, which is designed to be exempt from most provisions of the Employee Retirement Security Act of 1974, is informally funded by us in order to preserve the tax-deferred savings advantages of a non-qualified plan. As such, all deferrals and associated earnings are general unsecured obligations of Hot Topic, Inc. held within a “rabbi trust” on our consolidated balance sheet. We may at our discretion contribute certain amounts to eligible employees’ accounts. In January 2009, to the extent participants were ineligible to receive such contributions from participation in our 401(k) Plan, we began to contribute 50% of the first 4% of participants’ eligible contributions into their Deferred Compensation Plan accounts. As of the end of the third quarter of fiscal 2010, assets and associated liabilities of the Deferred Compensation Plan were $4.0 million and $4.1 million, respectively, and are included in other non-current assets and non-current liabilities, respectively, in our consolidated balance sheets. As of the end of fiscal 2009, assets and associated liabilities of the Deferred Compensation Plan were $3.1 million and $3.0 million, respectively.

We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. For our Hot Topic and Torrid concepts, we group and evaluate long-lived assets for impairment at the individual store level, which is the lowest level at which individual cash flows can be identified. For the purposes of evaluating the impairment of ShockHound, our e-space music concept launched in the third quarter of fiscal 2008, we consider all assets within ShockHound to be one asset group and the lowest level at which individual cash flows can be identified. Factors we consider important that could trigger an impairment review of our stores or online operations include a significant underperformance relative to expected historical or projected future operating results, a significant change in the manner of the use of the asset or a significant negative industry or economic trend. When we determine that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the aforementioned factors, impairment is measured based on a projected discounted cash flow method using a discount rate determined by management. These cash flows are calculated by netting future estimated sales against associated merchandise costs and other related expenses such as payroll, occupancy and marketing. The estimated sales, net of the aforementioned costs and expenses, used for this nonrecurring fair value measurement is considered a Level 3 input as defined in “NOTE 8 – Fair Value Measurements.”

In the event future performance is lower than forecasted results, future cash flows may be lower than expected, which could result in future impairment charges. While we believe recently opened stores will provide sufficient cash flow, material changes in results could result in future store impairment charges. For the third quarter of fiscal 2010 and 2009, we recorded store impairment charges of $457,000 and $300,000, respectively, which are included in selling, general and administrative expenses in our consolidated statements of operations. For fiscal year-to-date 2010 and 2009, we recorded store impairment charges of $913,000 and $571,000, respectively, which are included in selling, general and administrative expenses in our consolidated statements of operations.

During the third quarter of fiscal 2010, ShockHound’s slower than expected revenue growth led us to conclude that its assets had become impaired. Revenues from partnerships entered into in the earlier part of fiscal 2010, as well as other revenues, did not build as much as we had anticipated. In the third quarter of fiscal 2010, we recorded an impairment charge of $3.0 million to selling, general and administrative expenses in our consolidated statements of operations. We did not record any impairment charges for ShockHound in fiscal 2009.

As of the end of the third quarter of fiscal 2010 and as of the end of fiscal 2009, the liability for income tax associated with unrecognized tax benefits was $2.9 million ($2.4 million net of federal benefit), of which $0.3 million ($0.2 million net of federal benefit) related to interest and $0.4 million related to penalties. Our effective tax rate will be affected by any portion of the liability we may recognize.

We believe that it is reasonably possible that $0.5 million ($0.4 million net of federal benefit) of our liability for unrecognized tax benefits, including $0.1 million ($0.1 million net of federal benefit) of associated interest, may be recognized in the next 12 months due to the settlement of audits and the expiration of statutes of limitations. As such, we have classified this amount as a current liability.

We operate stores throughout the United States, Canada and Puerto Rico, and as a result, we file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. In the normal course of business, we are subject to examination by taxing authorities. With few exceptions, we are no longer subject to U.S. federal, state and local or non-U.S. income tax examinations for years before fiscal 2004. While it is often difficult to predict the final outcome or the timing or resolution of any particular uncertain tax position, we believe our reserves for income taxes represent the most probable outcome. We adjust these reserves, as well as the related interest and penalties, in light of changing facts and circumstances.

On July 14, 2010, an employee filed a lawsuit against us in the Superior Court of California, County of Los Angeles, on behalf of herself and a putative class. The lawsuit asserts claims for failure to provide adequate meal or rest breaks, failure to pay regular and overtime wages, failure to timely pay wages at end of employment, failure to indemnify employees for necessary expenditures and unfair business practices. The lawsuit seeks compensatory damages, restitution, special damages, statutory penalties, punitive damages, attorneys' fees and injunctive relief. We intend to vigorously defend ourselves against the various claims, though at the present time we are unable to predict the outcome of this matter.

In November 2010, the Board approved a cost reduction plan which will involve closing approximately 40 to 50 underperforming stores by the end of the first quarter of fiscal 2011. These closures will occur as a result of natural lease expirations, exercising lease kick out clauses and other negotiations. The cost reduction plan also includes reducing planned capital expenditures in fiscal 2011 to approximately $20 million from approximately $30 to $32 million in fiscal 2010. In addition, we expect to reduce approximately 14% of our home office and field management positions in fiscal 2010 and implement other non-payroll overhead expense reduction initiatives as part of the cost reduction plan.

In connection with the cost reduction plan, we estimate that we will incur a total pre-tax charge of approximately $8 million primarily in the fourth quarter of fiscal 2010, a portion of which will be a non-cash charge of approximately $4 million. Of the approximately $8 million charge, we expect that approximately $6 million will be incurred primarily during the fourth quarter of fiscal 2010 for the write down of store assets, early lease terminations and store management severance. We also expect that approximately $2 million of the approximately $8 million charge will be incurred for severance and outplacement in the fourth quarter of fiscal 2010.

Our current estimates and assumptions regarding the implementation of the cost reduction plan, particularly surrounding the closure of underperforming stores, are subject to significant uncertainty, including negotiations with landlords, fluctuations in store sales trends and unpredictable results of internal initiatives. As a result, our estimated charges, cash outlays and expense savings related to the cost reduction plan may differ from actual, and any of these factors may result in us not realizing the anticipated benefits from the plan.

From time to time, in both written reports (such as this report) and oral statements, we make “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. We intend that such forward-looking statements be subject to the “safe harbors” created by these sections. Generally, the words “believes,” “anticipates,” “expects,” “continue,” “intends,” “will,” “may,” “plans” and similar expressions identify such forward-looking statements, although not all forward-looking statements contain these identifying words. These statements include, for example, statements regarding our expectations, beliefs, intentions or strategies regarding the future, such as the extent and timing of future revenues and expenses, economic conditions affecting consumer demand, ability to grow or maintain comparable store sales, response to new concepts and other expected financial results and information. All forward-looking statements included in this report are based on information available to us as of the date of this report and we assume no obligation to update or revise any forward-looking statements to reflect events or circumstances that occur after such statements are made. Readers are cautioned not to place undue reliance on these forward-looking statements as they involve risks and uncertainties which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements. These risks, as well as other risks and uncertainties, are located, among other places, in this Part I, Item 2 and in Part II, Item 1A under the caption “Risk Factors.”

We are a mall and web-based specialty retailer operating the Hot Topic® and Torrid® concepts, as well as the e-space music concept, ShockHoundTM. Our business is discussed in more detail in “NOTE 1 – Organization and Basis of Presentation” contained in the accompanying financial statements. During the fourth quarter of 2009, we launched our Hot Topic loyalty program, HT+1. HT+1 is free to join and is designed to build customer loyalty and encourage repeat sales by allowing members an opportunity to earn points in a variety of ways, including store visits, store purchases and online purchases. In addition, HT+1 allows us to communicate to members about products and events that are relevant to them, as well as giving members access to exclusive events that are not available to other customers. Since the launch, over 6 million people have become HT+1 members. In fiscal 2009, touchscreen kiosk terminals which gave customers the ability to listen to a selection of music sold in the store were installed in all Hot Topic stores. In the second quarter of fiscal 2010, we expanded the kiosks’ capabilities to provide our customers access to purchase merchandise available on hottopic.com and shockhound.com as well as purchase MP3s. The kiosks also provide HT+1 members convenient access to their HT+1 loyalty accounts.

In November 2010, the Board approved a cost reduction plan that, beginning in fiscal 2011, is expected to result in an estimated annual pre-tax income improvement of approximately $13 million. The cost reduction plan, which is designed to meet the challenges of the current environment, will involve closing approximately 40 to 50 underperforming stores by the end of the first quarter of fiscal 2011. These closures will occur as a result of natural lease expirations, exercising lease kick out clauses and other negotiations. The cost reduction plan also includes reducing planned capital expenditures in fiscal 2011 to approximately $20 million from approximately $30 to $32 million in fiscal 2010. In addition, we expect to reduce approximately 14% of our home office and field management positions in fiscal 2010 and implement other non-payroll overhead expense reduction initiatives as part of the cost reduction plan.

During the third quarter of fiscal 2010, ShockHound’s slower than expected revenue growth led us to conclude that the assets related to it have become impaired. Revenues from partnerships entered into in the earlier part of fiscal 2010, as well as other revenues, have generated sales slower than anticipated. In the third quarter of fiscal 2010, we recorded an impairment charge of $3.0 million to selling, general and administrative expenses in our consolidated statements of operations. The assessment of our long-lived assets for impairment is discussed in more detail in “NOTE 10 – Valuation of Long-Lived Assets” contained in the accompanying financial statements.

At the end of the third quarter of fiscal 2010, we operated 680 Hot Topic stores and 155 Torrid stores throughout the United States, Canada and Puerto Rico, compared to 680 Hot Topic stores and 156 Torrid stores at the end of the third quarter of fiscal 2009. We continue to evaluate the need to close, remodel, relocate or open new stores. The following table shows our store expansion and closure activity during the third quarter of fiscal 2010, fiscal year-to-date 2010 and our planned activity in fiscal 2010.

We consider a store comparable after it has been open for 15 full months. If a store is closed during a period, it is included in the computation of comparable store sales for that fiscal month, quarter and year-to-date period, only for the days in which the store was operating as compared to the full month in the comparable period. The following table shows our comparable store sales results by division for the third quarter of fiscal 2010 and 2009 and fiscal year-to-date 2010 and 2009:

During the third quarter of fiscal 2010, the comparable store sales decline in the Hot Topic division resulted primarily from a decrease in Halloween, fashion apparel and fashion accessories categories, partially offset by an increase in the license category. During the same period, the comparable store sales decline at our Torrid division was due to declines in apparel, primarily bottoms, partially offset by an increase in accessories.

For the three months ended:	October 30, 2010			October 31, 2009

Net sales		100.0	%		100.0	%
Cost of goods sold, including buying, distribution and occupancy costs		64.8			63.1

Gross margin		35.2			36.9
Selling, general and administrative expenses		35.0			31.8

Income from operations		0.2			5.1
Interest and other income, net		0.0			0.0

Income before provision for income taxes		0.2			5.1
Provision for income taxes		0.0			2.0

Net income		0.2	%		3.1	%

Amount
(in millions)			Description
$	(9.0	)	Decrease in comparable net sales from Hot Topic stores in the third quarter of fiscal 2010 compared to the corresponding period from the prior fiscal year.
	(1.2	)	Decrease in net sales due to the closure of seven Hot Topic stores and three Torrid stores since the third quarter of the prior year.
	(0.5	)	Decrease in comparable net sales from Torrid stores in the third quarter of fiscal 2010 compared to the corresponding period from the prior fiscal year.
	0.3		Increase in net sales from two new Torrid stores opened since the third quarter of the prior year.
	1.1		Increase in net sales from Hot Topic stores not yet qualifying as comparable stores (includes seven new stores opened since the third quarter of the prior year).
	2.9		Increase in internet sales.
$	(6.4	)	Total

At the end of the third quarter of fiscal 2010, 648 of the 680 Hot Topic stores were included in the comparable store base, compared to 655 of the 680 Hot Topic stores open at the end of the third quarter of fiscal 2009. At the end of the third quarter of fiscal 2010, 153 of the 155 Torrid stores were included in the comparable store base, compared to 151 of the 156 Torrid stores open at the end of the third quarter of fiscal 2009.

Gross margin decreased $5.3 million, or 7.6%, to $64.6 million during the third quarter of fiscal 2010 from $69.9 million during the third quarter of fiscal 2009. As a percentage of net sales, gross margin decreased to 35.2% during the third quarter of fiscal 2010 from 36.9% in the third quarter of fiscal 2009. The significant components of this 1.7 percentage point decrease in gross margin as a percentage of net sales are as follows:

%			Description
	(0.8	)	Decrease in merchandise margin primarily as a result of higher markdowns as a percentage of sales.
	(0.4	)	Increase in distribution expense primarily due to an increase in freight expenses and the deleveraging on lower store sales.
	(0.3	)	Store occupancy percentage increase primarily due to deleveraging on lower store sales.
	(0.1	)	Store depreciation percentage increase as a result of deleveraging on lower store sales.
	(0.1	)	Increase in buying payroll expense and deleveraging on lower store sales.
	(1.7	)	Total

Selling, general and administrative expenses increased $3.9 million, or 6.5%, to $64.2 million during the third quarter of fiscal 2010 compared to $60.3 million during the third quarter of fiscal 2009. As a percentage of net sales, selling, general and administrative expenses increased to 35.0% in the third quarter of fiscal 2010 compared to 31.8% in the third quarter of fiscal 2009. The significant components of the 3.2 percentage point increase in selling, general and administrative expenses as a percentage of net sales are as follows:

%		Description
	1.7	Increase in impairment expenses due to the non-cash asset impairment charge taken for ShockHound.
	0.6	Increase in store payroll expense due to deleveraging on lower store sales.
	0.4	Increase in general and administrative payroll cost, state taxes/fees and deleveraging on lower store sales, partially offset by lower performance based bonuses.
	0.2	Increase in depreciation on computer hardware and software.
	0.2	Increase in marketing expenses primarily due to increased spending on internet and direct marketing, partially offset by decrease spending on marketing events and in-store signage.
	0.1	Increase in preopening expenses primarily associated with the opening of new stores in Canada.
	3.2	Total

For the nine months ended:	October 30, 2010			October 31, 2009

Net sales		100.0	%		100.0	%
Cost of goods sold, including buying, distribution and occupancy costs		66.7			65.6

Gross margin		33.3			34.4
Selling, general and administrative expenses		35.9			33.2

(Loss) income from operations		(2.6	)		1.2
Interest and other income, net		0.0			0.0

(Loss) income before (benefit) provision for income taxes		(2.6	)		1.2
(Benefit) provision for income taxes		(1.0	)		0.5

Net (loss) income		(1.6	) %		0.7	%

Amount
(in millions)			Description
$	(31.3	)	Decrease in comparable net sales from Hot Topic stores in fiscal year-to-date 2010 compared to the corresponding period from the previous fiscal year.
	(2.7	)	Decrease in net sales due to the closure of seven Hot Topic stores and three Torrid stores since the third quarter of the prior year.
	(0.7	)	Decrease in comparable net sales from Torrid stores in fiscal year-to-date 2010 compared to the corresponding period from the previous fiscal year.
	0.9		Increase in net sales from two new Torrid stores opened since the third quarter of the prior year.
	1.2		Increase in net sales from Hot Topic stores not yet qualifying as comparable stores (includes seven new stores opened since the third quarter of the prior year).
	6.0		Increase in internet sales.
$	(26.6	)	Total

Gross margin decreased $14.7 million, or 8.2%, to $165.0 million during fiscal year-to-date 2010 from $179.7 million during fiscal year-to-date 2009. As a percentage of net sales, gross margin decreased to 33.3% during fiscal year-to-date 2010 from 34.4% during fiscal year-to-date 2009. The significant components of this 1.1 percentage point decrease in gross margin as a percentage of net sales are as follows:

%			Description
	(0.4	)	Store occupancy percentage increase primarily due to deleveraging on lower store sales.
	(0.2	)	Store depreciation percentage increase mainly related to deleveraging on lower store sales.
	(0.2	)	Increase in distribution expense primarily due to increase in freight expenses and the deleveraging on lower store sales.
	(0.2	)	Decrease in merchandise margin as a result of higher markdowns, partially offset by higher realized markup as a percentage of sales.
	(0.1	)	Increase in buying payroll expense and deleveraging on lower store sales.
	(1.1	)	Total

Selling, general and administrative expenses increased $4.5 million, or 2.6%, to $178.1 million during fiscal year-to-date 2010 compared to $173.6 million during fiscal year-to-date 2009. As a percentage of net sales, selling, general and administrative expenses increased to 35.9% during fiscal year-to-date 2010 compared to 33.2% during fiscal year-to-date 2009. The significant components of the 2.7 percentage point increase in selling, general and administrative expenses as a percentage of net sales are as follows:

%		Description
	0.9	Increase in store payroll expense primarily due to deleveraging on lower store sales and higher medical expenses.
	0.6	Increase in impairment expenses due to the non-cash asset impairment charge taken for ShockHound.
	0.4	Increase in marketing expenses primarily due to increased spending on internet marketing and direct marketing costs, partially offset by decreased spending on marketing events.
	0.3	Increase in depreciation on computer hardware and software.
	0.2	Increase in general and administrative payroll, state taxes/fees and medical costs and deleveraging on lower store sales, partially offset by a decrease in performance based bonuses.
	0.2	Other store expense percentage increase primarily due to deleveraging on lower store sales and higher telecommunication costs and loyalty program expenses, partially offset by lower repair and maintenance costs and inventory service costs.
	0.1	Increase in preopening expenses associated with the opening of new stores, including stores in Canada.
	2.7	Total

Historically and during the third quarter of fiscal 2010, other uses of cash have been to purchase merchandise inventories, improve our information technology infrastructure and fund store remodels, relocations and to a lesser extent, new store openings. In the past we have also made periodic repurchases of our common stock. We have typically satisfied our cash requirements principally from cash flows from operations and we also maintain a $5.0 million unsecured credit agreement (discussed in more detail in “NOTE 11 – Bank Credit Agreement” contained in the accompanying financial statements).

Cash, cash equivalents and short- and long-term investments, including auction rate securities, held by us were $60.4 million and $131.3 million as of the end of the third quarter of fiscal 2010 and as of the end of fiscal 2009, respectively, (discussed in more detail in “NOTE 5 – Short- and Long-Term Investments” contained in the accompanying financial statements). We believe our current cash balances and cash generated from operations will be sufficient to fund our operations through at least the next 12 months. Auctions representing the auction rate securities we hold have continued to fail and will limit our ability to liquidate these investments for some period of time. However, we do not believe the auction failures will impact our ability to fund our working capital needs, capital expenditures or other business requirements.

Net cash flows provided by operating activities were $5.7 million during fiscal year-to-date 2010 compared to $10.0 million during fiscal year-to-date 2009. The $4.7 million decrease in cash flows provided by operating activities was primarily attributable to an operating loss in fiscal year-to-date 2010, increases in inventory and a decrease in accrued liabilities, partially offset by an increase in accounts payable.

	Payments due by period (in thousands)
Contractual obligations	Total		Less Than 1 Year		1-3 Years		3-5 Years		More than 5 Years

Operating leases	$	265,409	$	57,385	$	96,852	$	64,490	$	46,682
Purchase obligations		100,522		100,522		-		-		-
Letters of credit and other obligations		8,250		4,362		2,950		938		-
Income tax audit settlements¹		354		354		-		-		-
Total contractual obligations	$	374,535	$	162,623	$	99,802	$	65,428	$	46,682

(1)

The $0.4 million of income tax audit settlements relate to certain open audits we expect to be fully settled in fiscal 2010 and to gross unrecognized tax benefits for which the statutes of limitation are expected to expire in fiscal 2010. Due to the uncertainty regarding the timing of future cash outflows associated with other noncurrent unrecognized tax benefits of $1.8 million, we are unable to make a reliable estimate of the periods of cash settlement with the respective tax authorities and have not included such amount in the contractual obligations table above.

We anticipate we will spend approximately $30 to $32 million on capital expenditures in fiscal 2010. Of the $30 to $32 million, we plan to spend approximately $17 to $19 million for store construction and other improvements to existing stores, including the remodel or relocation of approximately 24 existing Hot Topic stores, new store fixtures and new store front signs. We plan to spend the remaining capital expenditures on various improvements in our information technology infrastructure, including technological improvements at the store level, new computer hardware and software and the further development and improvement of our Internet websites.

Management’s discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate estimates, including those related primarily to inventories, long-lived assets and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Inventories: Inventories are valued at the lower of average cost or market, on a weighted average cost basis, using the retail method. Under the retail method, inventory is stated at its current retail selling value and then is converted to a cost basis by applying an average cost factor that represents the average cost-to-retail ratio based on beginning inventory and the purchase activity for the month. Throughout the year, we review our inventory levels in order to identify slow-moving merchandise and use permanent markdowns to sell through selected merchandise. We record a charge to cost of goods sold for permanent markdowns. Inherent in the retail method are certain significant management judgments and estimates including initial merchandise markup, future sales, markdowns and shrinkage, which significantly impact the ending inventory valuation at cost and the resulting gross margins. To the extent our estimated markdowns at period-end prove to be insufficient, additional future markdowns will need to be recorded. Physical inventories are conducted during the year to determine actual inventory on hand and shrinkage. We accrue our estimated inventory shrinkage for the period between the last physical count and current balance sheet date. Thus, the difference between actual and estimated shrink amounts may cause fluctuations in quarterly results, but not for the full fiscal year results.

Valuation of Long-Lived Assets: We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. For our Hot Topic and Torrid concepts, we group and evaluate long-lived assets for impairment at the individual store level, which is the lowest level at which individual cash flows can be identified. For the purposes of evaluating the impairment of ShockHound, our e-space music concept launched in the third quarter of fiscal 2008, we consider all assets within ShockHound to be one asset group and the lowest level at which individual cash flows can be identified. Factors we consider important that could trigger an impairment review of our stores or online operations include a significant underperformance relative to expected historical or projected future operating results, a significant change in the manner of the use of the asset or a significant negative industry or economic trend. When we determine that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the aforementioned factors, impairment is measured based on a projected discounted cash flow method using a discount rate determined by management. These cash flows are calculated by netting future estimated sales against associated merchandise costs and other related expenses such as payroll, occupancy and marketing. The estimated sales, net of the aforementioned costs and expenses, used for this nonrecurring fair value measurement is considered a Level 3 input as defined in “NOTE 8 – Fair Value Measurements” contained in the accompanying financial statements. In the event future store performance is lower than forecasted results, future cash flows may be lower than expected, which could result in future impairment charges. While we believe recently opened stores will provide sufficient cash flow, material changes in results could result in future impairment charges.

Revenue Recognition: Revenue is generally recognized at our retail store locations at the point at which the customer receives and pays for the merchandise at the register. For online sales, revenue is recognized upon delivery to the customer. Sales are recognized net of merchandise returns, which are reserved for based on historical experience. Revenue from gift cards, gift certificates and store merchandise credits is recognized at the time of redemption. Shipping and handling revenues from our websites are included as a component of net sales.

We recognize estimated gift card breakage as a component of net sales in proportion to actual gift card redemptions over the period that remaining gift card values are redeemed. Gift card breakage is income recognized due to the non-redemption of a portion of gift cards sold by us for which liability was recorded in prior periods. While customer redemption patterns result in estimated gift card breakage, which approximates 5 to 6%, changes in our customers’ behavior could impact the amount that ultimately is unused and could affect the amount recognized as a component of net sales.

Vendor Allowances: We receive certain allowances from our vendors primarily related to damaged merchandise, markdowns and pricing. Allowances received from vendors related to damaged merchandise and pricing are reflected as a reduction of inventory in the period they are received and allocated to cost of sales during the period in which the items are sold. Markdown allowances received from vendors are reflected as reductions to cost of sales in the period they are received as these allowances are received after goods have been sold or marked down.

Stock-Based Payments: We estimate the fair value of stock options granted using the Black-Scholes option-pricing formula and a single option award approach. This fair value is then amortized over the requisite service periods of the awards. This option-pricing model requires the input of highly subjective assumptions, including the option’s expected life, price volatility of the underlying stock, risk free interest rate and expected dividend rate. As stock-based compensation expense is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience.

Self-Insurance: We are self-insured for certain losses related to medical and workers compensation claims although we maintain stop loss coverage with third party insurers to limit our total liability exposure. The estimate of our self-insurance liability involves uncertainty since we must use judgment to estimate the ultimate cost that will be incurred to settle reported claims and unreported claims for incidents incurred but not reported as of the balance sheet date. When estimating our self-insurance liability, we consider a number of factors, which include historical claim experience and valuations provided by independent third party actuaries. As claims develop, the actual ultimate losses may differ from actuarial estimates. Therefore, an analysis is performed quarterly to determine if modifications to the accrual are required.

Rent Expense: Rent expense under our operating leases typically provides for fixed non-contingent rent escalations. We recognize rent expense on a straight-line basis over the non-cancelable term of each lease, commencing when we take possession of the property. Construction allowances are recorded as a deferred rent liability, which we amortize as a reduction of rent expense over the non-cancelable term of each lease.

Income Taxes: We account for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting bases and tax bases of assets and liabilities and are measured using the enacted tax rates expected to apply to taxable income in the periods in which the deferred tax asset or liability is expected to be realized or settled. Deferred tax assets are reduced by valuation allowances if we believe it is more likely than not that some portion or the entire asset will not be realized.

We prescribe a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.

We are not a party to any derivative financial instruments. Our exposure to market risk primarily relates to changes in interest rates on our investments with maturities of less than three months (which are considered to be cash and cash equivalents) and short- and long-term investments with maturities in excess of three months. A 100 basis point change in interest rates over a three-month period would not have a material impact on the fair value of our investment portfolio as of the end of the third quarter of fiscal 2010. Cash, cash equivalents and short- and long-term investments, including auction rate securities, are discussed in more detail in “NOTE 5 – Short- and Long-Term Investments” contained in the accompanying financial statements. Auctions representing the auction rate securities we hold have continued to fail and will limit our ability to liquidate these investments for some period of time. However, we do not believe the auction failures will impact our ability to fund our working capital needs, capital expenditures or other business requirements.

Our management maintains disclosure controls and procedures that are designed to ensure that the information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, as appropriate, to allow timely decisions regarding required disclosure.

We have carried out an evaluation, under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of our most recent fiscal quarter. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) are effective as of the end of our most recent fiscal quarter. There has been no change in our internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Before deciding to invest in Hot Topic, Inc. or to maintain or increase an investment in Hot Topic, Inc., readers should carefully consider the risks described below, in addition to the other information contained in this Quarterly Report on Form 10-Q and in our other filings with the SEC, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. The risks described below are not the only risks we face. Additional risks that are not presently known to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks actually occur, our business, financial condition and results of operations could be seriously harmed, and our stock price could decline. The risks described below include certain changes to the “Risk Factors” set forth in our Annual Report on Form 10-K filed on March 19, 2010.

Certain economic conditions could affect the level of consumer spending on merchandise we offer, including, among others, employment levels; salary and wage levels, particularly of teens; interest rates; availability of consumer credit; taxation; and consumer confidence in future economic conditions. For example, the global economic downturn has significantly reduced consumer spending levels and mall customer traffic in general. An ongoing slowdown in the United States economy or an uncertain economic outlook could continue to cause lower consumer spending levels and mall customer traffic which could adversely affect our sales results and financial performance.

Our financial performance is largely dependent upon the continued popularity of music, the Internet and digital music, music videos and music television networks among teenagers and college-age adults; the emergence of new artists and the success of music releases and music/pop culture-related products; the continuance of a significant level of teenage spending on music/pop culture-licensed and music/pop culture-influenced products; and our ability to anticipate and keep pace with the music, fashion and merchandise preferences of our customers. The popularity of particular types of music, artists, styles, trends and brands is subject to change. Our failure to anticipate, identify and react appropriately to changing trends could lead to, among other things, excess inventories and higher markdowns, which could have a material adverse effect on our results of operations and financial condition and on our image with customers. There can be no assurance that our new products will be met with the same level of acceptance as in the past or that the failure of any new products will not have a material adverse effect on our business, results of operations and financial condition.

We are currently implementing a plan to reduce company overhead and close underperforming stores. The estimated costs and charges associated with these initiatives may vary materially and adversely based upon a variety of factors, including the timing of the execution of the plan, the outcome of negotiations with landlords and other third parties, and unexpected costs. Any such factor could result in our not realizing the anticipated benefits from the plan. Even if we are successful in implementing these initiatives, the loss of personnel and reduction in the number of stores we operate may result in decreased operational efficiencies, unanticipated operational challenges, decreased revenues or leave us unprepared to take advantage of growth opportunities in the future.

A variety of factors affect our comparable store sales including, among others, the timing of new music, film and television releases, music/pop culture-related products and related promotional events; music and fashion trends; the general retail sales environment and the effect of the overall economic environment, including the global economic downturn; our ability to efficiently source and distribute products; changes in our merchandise mix and the challenges involved in getting the right mix into stores at the right time; our ability to attain certain pop culture-related licenses including on an exclusive basis; competition from other retailers; calendar shifts of holiday or seasonal periods; and our ability to execute our business strategy efficiently. The following table shows our comparable store sales results for fiscal 2010 and other recent periods:

We have expanded our business beyond the Hot Topic concept to include, in fiscal 2001, our Torrid concept and in 2008, our ShockHound concept. We may implement other new concepts in the future. Starting and operating new concepts presents new and challenging risks and uncertainties, including, among others, unanticipated operational problems; lack of experience; lack of customer acceptance; the inability to market a new concept effectively; new vendor relationships; competition from existing and new retailers; and diversion of management’s attention from our existing concepts. For example, during the third quarter of fiscal 2010, we recorded an impairment charge of $3.0 million because ShockHound’s revenue growth was slower than we had previously expected. If we do not operate ShockHound or any new concept effectively, it could materially impact our business.

We license from others the rights to produce and/or sell certain products that contain a third party’s trademarks, designs and other intellectual property. If the popularity of those licensed products diminishes, consumer acceptance of and demand for those licensed products could decline. Furthermore, if we are unable to obtain new licensed products with comparable consumer demand, our sales could decline. A decrease in customer demand for any of these products could have a material adverse effect on our results of operations and financial condition.

We may enter into contracts with third-party providers and/or distributors to offer their digital content and related merchandise for sale online. We may be negatively impacted by a number of factors, including among others: the malfunction of third-party sites, hardware, software and other equipment; service outages of third-party sites; third-party claims of data privacy and security breaches and intellectual property infringements; and poor integration of our technology into their software and services. If we are unable to prevent one or more of these occurrences, our results could be negatively impacted.

The global economic downturn has diminished the ability of shopping mall operators to operate profitably and in some cases, forced them to declare bankruptcy or cease operations entirely. We are dependent upon the continued popularity of malls as a shopping destination and the ability of shopping mall anchor tenants and other attractions to generate customer traffic. An ongoing slowdown in the United States economy or an uncertain economic outlook could continue to curtail shopping mall development, decrease shopping mall traffic, reduce the number of hours shopping mall operators keep their shopping malls open, cause shopping mall operators to lower their operational standards or in certain circumstances, negatively impact our lease contracts, each of which could adversely affect our sales results and financial performance. Consolidation of ownership of shopping malls may give landlords more leverage in negotiations and adversely affect our ability to effectively control our lease costs.

The success of our business depends on establishing and maintaining good relationships with shopping mall operators and developers, and problems with those relationships could make it more difficult for us to expand, remodel or relocate to certain sites or offer certain products. Any restrictions on our ability to expand to new store sites, remodel or relocate stores where we feel it necessary or to offer a broad assortment of merchandise could have a material adverse effect on our business, results of operations and financial condition. If our relations with shopping mall operators or developers become strained, or we otherwise encounter difficulties in leasing store sites, we may not grow as planned and may not reach certain revenue levels and other operating targets. Risks associated with these relationships are more acute given recent consolidation in the shopping mall operation and development industry and the recent negative economic climate, and we have seen certain increases in expenses as a result of such consolidation that could continue.

To be successful we must innovate our products, our stores, and the shopping experience our customers have. For example, our Hot Topic concept recently developed a new store design which we are selectively including in new and remodeled stores. The Hot Topic concept also recently began offering a print-on-demand product which allows us to print designs, including customer-generated designs, on tees, sweatshirts and hoodies. Such innovation involves risks, including that we will not properly anticipate the need for or rate of change, that we are not able to successfully bring about such change, that we will not be able to produce anticipated results, and that our customers will not be receptive to the change.

In order to open, remodel and relocate stores, among other things, we will need to locate suitable store sites, negotiate acceptable lease terms, obtain or maintain adequate capital resources on acceptable terms, source sufficient levels of inventory, hire and train store managers and sales associates, integrate new or relocated stores into our existing operations and maintain/update adequate distribution center space and information technology and other operations systems. Achieving and maintaining operating efficiencies in multiple distribution centers is subject to numerous risks and uncertainties.

We continue to evaluate the adequacy of our management information and distribution systems. Implementing new systems and changes made to existing systems could present challenges we do not anticipate and could negatively impact our business. We cannot anticipate all of the changing demands that our expanding and changing operations will impose on our business, systems and procedures, and our failure to adapt to such changing demands could have a material adverse effect on our results of operations and financial condition. Our failure to timely implement initiatives necessary to support our operations could also materially impact our business.

We depend on our ability to manage our existing store base, improve the performance of our remodeled and relocated stores, open new stores and close underperforming stores. Moving or expanding store locations and operating stores in new markets may present competitive and merchandising challenges that are different from those currently encountered by us in our existing stores and markets. There can be no assurance that our strategy will not adversely affect the individual financial performance of our existing stores or our overall results of operations. In the event that the number of our stores increases, we may face risks associated with market saturation of our products and concepts.

Similarly, there can be no assurance that remodeling or relocating existing stores will not adversely affect either the individual financial performance of the store prior to the change, or our overall results of operations. Furthermore, there can be no assurance that we will successfully achieve our remodel or expansion targets or, if achieved, that planned remodel or expansion will result in profitable operations.

The profitability of our business depends to a certain degree upon the price of certain commodities, including petroleum and cotton products. We are affected by the changes in such prices to the extent that the commodities are part of the costs of delivery of merchandise to our stores and to the extent that the commodities are used in the production of our merchandise. We are unable to predict what the price of these commodities will be in the future and we may be unable to pass along to our customers the increased costs that would result from higher commodity prices.

Substantially all of our foreign purchases of merchandise have been negotiated and paid for in U.S. dollars. As a result, our sourcing operations may be adversely affected by significant fluctuation in the value of the U.S. dollar against foreign currencies, restrictions on the transfer of funds and other trade disruptions. A portion of our revenues come from foreign markets. Changes in foreign exchange rates applicable to these markets may adversely affect our revenues, even if the volume of sales remains the same. We may not be able to repatriate revenues earned in foreign markets.

We hold cash, cash equivalents and short- and long-term investments, including auction rate securities (discussed in more detail in “NOTE 5 – Short- and Long-Term Investments” contained in the accompanying financial statements). Auctions representing the auction rate securities we hold have continued to fail and will limit our ability to liquidate these investments for some period of time. Although the money market funds and municipal bonds we hold are highly rated and are comprised of high-quality, liquid instruments, if the financial markets trading the underlying assets experience a disruption, we may need to temporarily rely on other forms of liquidity. In addition, the risk exists that our cash and investments may not always be optimally managed and this may affect our profitability and results of operations.

We are required to assess, and where appropriate, record a charge for, the impairment of underperforming assets. This may negatively impact our reported and future financial condition and results of operations. In addition, we continue to close stores that do not meet our expectations of profitability which may cause us to impair or accelerate the depreciation of certain store assets and incur additional amounts for lease termination, severance and other closing costs. There can be no assurance that we will not incur future impairment charges and store closure expenses for underperforming assets or that store closures will have a significant positive impact on our operating results.

In addition to increased regulatory compliance requirements, recent changes in laws and any future changes could make ordinary conduct of our business more expensive or require us to change the way we do business. For example, changes in federal and state minimum wage laws could cause us to reexamine our entire wage structure for stores. Other laws related to treatment of employees, including laws related to employee benefits and privacy, could also negatively impact us such as by increasing benefits costs such as medical expenses. Moreover, changes in product safety or other consumer protection laws could lead to increased costs to us for certain merchandise, or additional labor costs associated with readying merchandise for sale. It is often difficult for us to plan and prepare for potential changes to applicable laws.

We are subject to regulation by the Consumer Product Safety Commission and similar state and international regulatory authorities, and our products could be subject to involuntary recalls and other actions by these authorities. We purchase merchandise from suppliers domestically as well as outside the United States. One or more of our suppliers might not adhere to product safety requirements or our quality control standards, and we might not identify the deficiency before merchandise ships to our stores. Any issues of product safety could result in a recall of our products. Additionally, the U.S. legislature, as well as various states and regulatory agencies, including the Consumer Product Safety Commission, have undertaken reviews of product safety, specifically for lead content in jewelry, and other consumer products, and have enacted or are considering various proposals for additional more stringent laws and regulations. In particular, the U.S. Congress has enacted the Consumer Product Safety Improvement Act of 2008, which imposes significant new requirements on the retail industry as well as enhancing the penalties for noncompliance. Some of these new mandates could result in lost sales, the rejection of our products by consumers, damage to our reputation or material increases in our costs, and may have a material adverse effect on our business. Moreover, individuals may assert claims that they have sustained injuries from products we sell, and we may be subject to lawsuits relating to these claims. There is a risk that these claims or liabilities may exceed, or fall outside of the scope of our insurance coverage. Any of the issues mentioned above could result in damage to our reputation, diversion of development and management resources, reduction of sales and an increase in costs and liabilities, any of which could have a material adverse effect on our reputation or financial performance.

Our business, particularly our Hot Topic division, is subject to seasonal influences, with heavier concentrations of sales during the back-to-school, Halloween and holiday (defined as the week of Thanksgiving through the first few days of January) seasons and other periods when schools are not in session. Our results of operations may fluctuate materially depending on, among other things, the timing of store openings and related pre-opening and other startup expenses; net sales contributed by new stores; increases or decreases in comparable store sales; timing and popularity of certain licensed products; releases of new music and music/pop culture-related products; shifts in timing of certain holidays; changes in our merchandise mix; weather conditions; and overall economic and political conditions.

Our financial performance depends on our ability to purchase desired merchandise in sufficient quantities at competitive prices. Although we have many sources of merchandise, substantially all of our music/pop culture-licensed products are available from vendors that have exclusive license rights. In addition, small, specialized vendors, some of which create unique products primarily for us, supply certain of our products. Our smaller vendors generally have limited resources, production capacities and operating histories and some of our vendors have restricted the distribution of their merchandise in the past. We generally have no long-term purchase contracts or other contractual assurances of continued supply, pricing or access to new products. There can be no assurance that we will be able to acquire desired merchandise in sufficient quantities on acceptable terms in the future. Any inability to acquire suitable merchandise, or the loss of one or more key vendors, may have a material adverse effect on our business, results of operations and financial condition.

Changes in our vendor compliance and certification procedures may delay delivery of merchandise and increase costs. Our relationships with our vendors may be adversely affected as a result of these changes, making us more dependent on a smaller number of vendors. Some vendors may choose not to continue to do business with us to the extent that they have done in the past. In addition, we may not be able to depend upon the cooperation of our vendors to meet market demand for products in a timely manner. There can be no assurance that existing and future events will not require us to adopt additional requirements and incur additional costs, and impose those requirements and costs on our vendors, which may adversely affect our relationship with those vendors.

We do not own or operate any production or manufacturing facilities, and we depend on independent contractors and vendors to manufacture our merchandise. We receive apparel and other merchandise from foreign sources, both purchased directly in foreign markets and indirectly through domestic vendors with foreign sources. As a result of our reliance on international vendors and manufacturers, we are subject to the risks generally associated with global trade and doing business abroad, which include foreign laws and regulations, political unrest, disruptions or delays in cross-border shipments and changes in economic conditions in countries in which our merchandise is manufactured. In addition, disease outbreaks, terrorist acts and military conflict have increased the risks of doing business with foreign suppliers. We cannot predict the effect that such factors will have on our business arrangements with foreign manufacturing sources. These factors, among others, could affect our ability to have our merchandise manufactured abroad, our ability to import merchandise, and our cost of doing business.

To the extent that any of our vendors are located overseas or rely on overseas sources for a large portion of their products, any event causing a disruption of imports, including the imposition of import restrictions, could harm our, or our vendors’, ability to source products. This disruption could materially limit the merchandise that we would have available for sale and reduce our revenues and earnings. Trade restrictions in the form of tariffs or quotas, or both, that are applicable to the products that we sell also could affect the import of those products and could increase the cost and reduce the supply of products available to us. Further, changes in tariffs or quotas for merchandise imported from individual foreign countries could lead us to shift our sources of supply among various countries. Any shift we might undertake in the future could result in a disruption of our sources of supply and lead to a reduction in our revenues and earnings. Supply chain security initiatives undertaken by the United States government that impede the normal flow of product could also negatively impact our business.

We expect to source a greater percentage of our merchandise directly from manufacturers in the future. We have limited experience in sourcing and importing merchandise directly from manufacturers. We may encounter administrative challenges and operational difficulties with our direct manufacturers that we use to source our merchandise. Operational difficulties could include reductions in the availability of production capacity, errors in complying with merchandise specifications, insufficient quality control and failures to meet production deadlines. A manufacturer’s failure to ship merchandise to us on a timely basis or to meet the required quality standards could cause supply shortages that could result in lost sales. As a result of any of these events or circumstances, delays and unexpected costs may occur, which could result in our not realizing all or any of the anticipated benefits of contracting directly with manufacturers.

We expect our vendors to operate in compliance with applicable laws, rules and regulations regarding working conditions, employment practices, environmental compliance and trademark and copyright licensing. However, we do not control their labor and other business practices. Further, we do not inspect our manufacturers’ overseas operations and would not be immediately aware of any noncompliance by our vendors with applicable domestic or international laws, or certain of the standards set forth in our vendor manual. If one of our vendors violates labor or other laws or implements labor or other business practices that are regarded as unethical, the shipment of merchandise to us could be interrupted, orders could be canceled, relationships could be terminated and our reputation could be damaged. Any of these events could have a material adverse effect on our business, results of operations and financial condition.

We purchase licensed merchandise from vendors that hold, or represent that they hold, manufacturing and distribution rights under the terms of certain licenses. We also contract directly with licensors to obtain the manufacturing and distribution rights. We currently purchase a majority of our licensed merchandise from vendors, where we rely upon the vendors’ representations concerning manufacturing and distribution rights and do not independently verify whether these vendors legally hold adequate rights to the licensed properties they are manufacturing or distributing. If we acquire either directly, or through our vendors, licensed merchandise to which we have not legally obtained rights, we could be obligated to remove such merchandise from our stores, incur costs associated with destruction of merchandise (if the vendor is unwilling or unable to reimburse us in situations where we relied on the vendor to hold the manufacturing and distribution rights) and be subject to liability under various civil and criminal causes of action, including actions to recover unpaid royalties and other damages. As we expand our efforts to contract directly with manufacturers and licensors for licensed merchandise, we may incur difficulties securing the necessary manufacturing and distribution rights. Any of these results could have a material adverse effect on our business, results of operations and financial condition.

We sell merchandise over the Internet through our websites www.hottopic.com, www.torrid.com and www.shockhound.com. Our Internet sales encompass a portion of our total sales and are dependent on our ability to drive Internet traffic to our websites. Our Internet operations are subject to numerous risks and pose risks to our overall business, including, among other things, the inability to successfully establish partnerships that are instrumental in driving traffic to our websites; diversion of sales from our stores; liability for online content; computer privacy concerns; rapid technological change and the need to invest in additional computer hardware and software to support sales; hiring, retention and training of personnel to conduct the Internet operations; failure of computer hardware and software, including computer viruses, telecommunication failures, online security breaches and similar disruptions; governmental regulation; and credit card fraud. There can be no assurance that our Internet operations will achieve sales and profitability levels that justify our investment in them.

Experienced computer programmers and hackers may be able to penetrate our network security and misappropriate our confidential information or that of third parties, create system disruptions or cause shutdowns. As a result, we could incur significant expenses addressing problems created by security breaches of our network. Moreover, we could incur significant expenses in connection with system failures. In addition, sophisticated hardware and operating system software and applications that we procure from third parties may contain defects in design or manufacture, including “bugs” and other problems that could unexpectedly interfere with the operation of the system. The costs to us to eliminate or alleviate security problems, viruses and bugs could be significant, and the efforts to address these problems could result in interruptions, delays or cessation of service that may impede our sales, distribution or other critical functions.

Our ability to achieve and maintain operating efficiency and to anticipate and effectively respond to changing trends and consumer preferences depends in part on our ability to retain and attract senior management and other key personnel in our operations, merchandising, music and other departments. Competition for these personnel is intense, and we cannot be sure that we will be able to retain or attract qualified personnel as needed. In particular, the sudden loss of the services of Elizabeth McLaughlin, our Chief Executive Officer, who has been with us since 1993, or the services of other key people could have a material adverse effect on our business, results of operations and financial condition.

We have historically used stock options as a component of our total employee compensation program in order to align employees’ interests with the interests of our shareholders, encourage employee retention and provide competitive compensation and benefit packages. As a result of the decline in our stock price that took place prior to fiscal 2008, many of our employee stock options have exercise prices in excess of our current stock price, which reduces their value and could affect our ability to retain present, or attract prospective employees. There are other forms of stock-based compensation available to us, but these are similarly less attractive when a company’s stock price has declined. In addition, we began recording expenses for stock-based payments, including stock options, in the first quarter of fiscal 2006. As a result, we now incur increased compensation costs associated with our stock-based compensation programs. Moreover, difficulties relating to obtaining shareholder approval of equity compensation plans could make it harder or more expensive for us to grant stock-based payments to employees in the future. Like other companies, we periodically review our equity compensation strategy in light of regulatory and competitive environments, as well as the number of shares available for grant under our equity compensation plans, and we recently have reduced the total number of options and/or the form of stock awards, granted to employees, and reduced the number of employees who receive stock-based payments. Due to this change in our stock-based compensation strategy, we may find it more difficult to attract, retain and motivate employees, and any such difficulty could materially adversely affect our business.

The retail apparel, music and accessory industries in which we operate are highly competitive. We compete with other retailers for vendors, teenage and young adult customers, suitable store locations and qualified associates and management personnel. We currently compete with street alternative stores located primarily in metropolitan areas; shopping mall-based teenage-focused retailers; big-box discount stores; music stores; and with mail order catalogs and websites. Torrid has additional competitors who operate plus-size departments in department stores and discount stores as well as numerous potential competitors who may begin or increase efforts to market and sell products competitive with Torrid products. ShockHound faces substantial competition from online music providers and record labels. Increased competition could have a material adverse effect on our business, results of operations and financial condition.

The effects of war or acts of terrorism could have a material adverse effect on our business, operating results and financial condition. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions and create further uncertainties. To the extent that such disruptions or uncertainties negatively impact shopping patterns and/or shopping mall traffic, or adversely affect consumer confidence or the economy in general, our business, operating results and financial condition could be materially and adversely affected.

Our principal executive offices, a distribution center and a significant number of our stores are located in California. If we experience a sustained disruption in energy supplies, or if electricity and gas costs in California fluctuate dramatically, our results of operations could be materially and adversely affected. In addition, California is subject to natural disasters such as earthquakes, fires and floods. Another distribution center is located in Tennessee which is also subject to natural disasters such as floods and tornados. A significant natural disaster or other catastrophic event affecting our facilities could have a material adverse impact on our business, financial condition and operating results.

Our common stock is quoted on the Nasdaq Stock Market, which has experienced and is likely to experience in the future, significant price and volume fluctuations, which could adversely affect our stock price without regard to our financial performance. In addition, we believe that factors such as quarterly fluctuations in our financial results and comparable store sales; announcements by other apparel, accessory, music and gift item retailers; the trading volume of our stock; changes in estimates of our performance by securities analysts; litigation; overall economic and political conditions, including the global economic downturn; the condition of the financial markets, including the credit crisis; and other events or factors outside of our control could cause our stock price to fluctuate substantially, including significant declines in our stock price. In the past, shareholders have brought securities class action litigation against a company following a decline in the market price of its securities. To date, we have not been subject to securities class action litigation. However, we may in the future be the target of such litigation, which could result in substantial costs and divert our management’s attention and resources, and could harm our business.

Our Articles of Incorporation and Bylaws contain provisions that may have the effect of delaying, deterring or preventing a takeover of Hot Topic, Inc. For instance, our Articles of Incorporation include certain “fair price provisions” generally prohibiting business combinations with controlling or significant shareholders unless certain minimum price or procedural requirements are satisfied, and our Bylaws prohibit shareholder action by written consent. Additionally, our Board has the authority to issue, without shareholder approval, up to 10,000,000 shares of “blank check” preferred stock having such rights, preferences and privileges as designated by the Board. The issuance of these shares could have a dilutive effect on shareholders and potentially prohibit a takeover of Hot Topic, Inc. by requiring the preferred shareholders to approve such a transaction.

We also have a significant number of authorized and unissued shares of our common stock available under our Articles of Incorporation. These shares provide us with the flexibility to issue our common stock for future business and financial purposes including stock splits, raising capital and providing equity incentives to employees, officers and directors. However, the issuance of these shares could result in dilution to our shareholders.

There are numerous regulations and standards associated with our business operations. These regulations may include more stringent accounting standards, taxation requirements, (including changes in applicable income tax rate, new tax laws and revised tax law interpretations), trade restrictions, regulations regarding financial matters, privacy and data security, environmental regulations, advertising, safety and product liability. For example, an independent standards-setting organization working with credit card companies has developed regulations concerning payment card account security throughout the transaction process, called the Payment Card Industry (PCI) Data Security Standard. All merchants and service providers that store, process and transmit payment card data are required to comply with the regulations as a condition to accepting credit cards, and fines may be levied for non-compliance. As another example, we may in the future be required to adopt International Financial Reporting Standards, and doing so could be time-consuming and cause us to incur significant expense.

If we do not satisfactorily or timely comply with these requirements, possible consequences could include sanction or investigation by regulatory authorities such as the SEC or the Nasdaq Stock Market; fines and penalties; incomplete or late filing of our periodic reports, including our annual report on Form 10-K or quarterly reports on Form 10-Q or civil or criminal liability. Our stock price and business could also be adversely affected.

We have some exposure to risks arising out of environmental matters and existing and potential laws relating to the protection of the environment. We receive apparel and other merchandise from foreign sources, both purchased directly in foreign markets and indirectly through domestic vendors with foreign sources. Stricter global and domestic greenhouse gas emission requirements may cause our vendors to incur higher costs, including increased transportation costs, which may result in an adverse effect on our business and results of operations. There is a risk that we may occupy retail space that has violated environmental standards and will require remediation. In addition to the incurrence of such costs, the cleanup process may cause the store to be closed for an extended period of time, resulting in loss of sales.

We are involved from time to time with litigation and other claims against us. These matters arise primarily in the ordinary course of our business, and include employee claims, commercial disputes, intellectual property issues and product-oriented allegations. Often these cases raise complex factual and legal issues, which are subject to risks and uncertainties and which could require significant management time. Although we do not currently believe that the outcome of any current litigation and claims against us will have a material adverse effect on our overall financial condition, we have, in the past, incurred unexpected expense in connection with litigation matters. In the future, adverse settlements or resolutions may occur and negatively impact earnings, injunctions against us could have an adverse effect on our business by requiring us to do or prohibiting us from doing certain things, and other unexpected events could have a negative impact on us.

Exhibit
Number	Description of Document
3.1	Amended and Restated Articles of Incorporation. (Filed as an exhibit to Registrant’s Registration Statement on Form SB-2 (333-5054-LA) and incorporated herein by reference.)
3.2	Certificate of Amendment of Amended and Restated Articles of Incorporation. (Filed as Exhibit 3.2 to Registrant’s Annual Report on Form 10-K for the year ended January 29, 2005 and incorporated herein by reference.)
3.3	Amended and Restated Bylaws, as amended. (Filed as Exhibit 3.3 to Registrant’s Annual Report on Form 10-K for the year ended January 29, 2005 and incorporated herein by reference.)
4.1	Reference is made to Exhibits 3.1, 3.2 and 3.3.
4.2	Specimen stock certificate. (Filed as an exhibit to Registrant’s Registration Statement on Form SB-2 (333-5054-LA) and incorporated herein by reference.)
10.1	Agreement, dated as of September 19, 2010, by and among Hot Topic, Inc., Steven R. Becker, Matthew A. Drapkin, Becker Drapkin Management, L.P., Becker Drapkin Partners (QP), L.P., Becker Drapkin Partners, L.P., BD Partners I, L.P. and BC Advisors, LLC . (filed as Exhibit 10.1 to Registrant’s current report on Form 8-K filed on September 20, 2010 and incorporated herein by reference.)
10.2	Agreement, dated as of September 19, 2010, by and among Hot Topic, Inc., Clint D. Carlson, Black Diamond Offshore Ltd., Double Black Diamond Offshore Ltd., Carlson Capital L.P. and Asgard Investment Corp. (filed as Exhibit 10.2 to Registrant’s current report on Form 8-K filed on September 20, 2010 and incorporated herein by reference.)
31.1	Certification, dated November 19, 2010, of Registrant’s Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification, dated November 19, 2010, of Registrant’s Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certifications, dated November 19, 2010, of Registrant’s Chief Executive Officer and Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002.

Exhibit
Number	Description of Document
3.1	Amended and Restated Articles of Incorporation. (Filed as an exhibit to Registrant’s Registration Statement on Form SB-2 (333-5054-LA) and incorporated herein by reference.)
3.2	Certificate of Amendment of Amended and Restated Articles of Incorporation. (Filed as Exhibit 3.2 to Registrant’s Annual Report on Form 10-K for the year ended January 29, 2005 and incorporated herein by reference.)
3.3	Amended and Restated Bylaws, as amended. (Filed as Exhibit 3.3 to Registrant’s Annual Report on Form 10-K for the year ended January 29, 2005 and incorporated herein by reference.)
4.1	Reference is made to Exhibits 3.1, 3.2 and 3.3.
4.2	Specimen stock certificate. (Filed as an exhibit to Registrant’s Registration Statement on Form SB-2 (333-5054-LA) and incorporated herein by reference.)
10.1	Agreement, dated as of September 19, 2010, by and among Hot Topic, Inc., Steven R. Becker, Matthew A. Drapkin, Becker Drapkin Management, L.P., Becker Drapkin Partners (QP), L.P., Becker Drapkin Partners, L.P., BD Partners I, L.P. and BC Advisors, LLC . (filed as Exhibit 10.1 to Registrant’s current report on Form 8-K filed on September 20, 2010 and incorporated herein by reference.)
10.2	Agreement, dated as of September 19, 2010, by and among Hot Topic, Inc., Clint D. Carlson, Black Diamond Offshore Ltd., Double Black Diamond Offshore Ltd., Carlson Capital L.P. and Asgard Investment Corp. (filed as Exhibit 10.2 to Registrant’s current report on Form 8-K filed on September 20, 2010 and incorporated herein by reference.)
31.1	Certification, dated November 19, 2010, of Registrant’s Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification, dated November 19, 2010, of Registrant’s Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certifications, dated November 19, 2010, of Registrant’s Chief Executive Officer and Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002.

CALIFORNIA	77-0198182
(State of incorporation)	(IRS Employer Identification No.)

18305 EAST SAN JOSE AVE., CITY OF INDUSTRY, CA	91748
(Address of principal executive offices)	(Zip Code)

Large accelerated filer o		Accelerated filer x

Non-accelerated filer o	(Do not check if a smaller reporting company)	Smaller reporting company o

		Page
		No.
PART I. FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements (Unaudited)

Consolidated Balance Sheets – October 30, 2010 and January 30, 2010		4

Consolidated Statements of Operations for the three months and nine months ended October 30, 2010 and October 31, 2009		5

Consolidated Statements of Cash Flows for the nine months ended October 30, 2010 and October 31, 2009		6

Notes to Condensed Consolidated Financial Statements		7

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	20

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	32

Item 4.	Controls and Procedures	32

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	33

Item 1A.	Risk Factors	33

Item 6.	Exhibits	45

SIGNATURES		46

	Three Months Ended						Nine Months Ended
	October 30, 2010			October 31, 2009			October 30, 2010			October 31, 2009
Risk free interest rate		2	%		3	%		2	%		2	%
Expected life	5 years			5 years			5 years			5 years
Expected volatility		58	%		57	%		57	%		56	%
Expected dividend yield		5	%		0	%		3	%		0	%
Weighted average fair value at grant date	$	2.07			n/a	*	$	2.84		$	4.53

	Non-current
Carrying value as of January 30, 2010	$	3,220
Redemptions*		(800	)
Total gains
Included in earnings		-
Included in other comprehensive loss**		60
Carrying value as of October 30, 2010	$	2,480

	Number of Stores
	Actual				Plan
	Three Months Ended		Nine Months Ended
	October 30, 2010		October 30, 2010		Fiscal 2010
Hot Topic
Beginning of Period		679		680		680
Opened*		4		6		6
Closed**		3		6		20
Remodel/relocate		9		20		24
End of Period		680		680		666

Torrid
Beginning of Period		155		156		156
Opened		-		2		3
Closed**		-		3		5
End of Period		155		155		154

	Comparable Store
	Sales % Change
Third Quarter	2010	2009
Hot Topic	(5.8)%	(5.8)%
Torrid	(1.5)%	(1.4)%
Total Company	(5.0)%	(5.0)%

Year-To-Date
Hot Topic	(8.2)%	(1.7)%
Torrid	(0.8)%	(3.9)%
Total Company	(6.7)%	(2.2)%

Fiscal Year	2010	2009	2008	2007
Year-to-Date / Total Year	(6.7)%	(5.1)%	1.0%	(4.4)%
1st Quarter	(8.7)%	7.1%	(2.8)%	(2.3)%
2nd Quarter	(6.4)%	(7.7)%	(0.9)%	(5.8)%
3rd Quarter	(5.0)%	(5.0)%	1.0%	(2.6)%
4th Quarter	N/A	(11.5)%	5.2%	(6.3)%

		Hot Topic, Inc.
		(Registrant)


Date:	November 19, 2010	/s/ Elizabeth McLaughlin
		Elizabeth McLaughlin
		Chief Executive Officer
		(Principal Executive Officer)


Date:	November 19, 2010	/s/ James McGinty
		James McGinty
		Chief Financial Officer
		(Principal Financial
		And Accounting Officer)