Form 10-Q

10-Q 1 d10q.htm FORM 10-Q Form 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 30, 2005

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR l5(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 0-28784

HOT TOPIC, INC.

(Exact name of registrant as specified in its charter)


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)

(626) 839-4681

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨

APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: August 15, 2005 – 45,228,952 shares of common stock, no par value.

HOT TOPIC, INC.

INDEX TO FORM 10-Q


		Page No.
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited):

Consolidated Balance Sheets – July 30, 2005 and January 29, 2005		3

Consolidated Statements of Income for the three months and six months ended July 30, 2005 and July 31, 2004 (As Restated)		4

Consolidated Statements of Cash Flows for the six months ended July 30, 2005 and July 31, 2004 (As Restated)		5

Notes to Consolidated Financial Statements		6-12

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		13-29

Item 3. Quantitative and Qualitative Disclosures about Market Risk		29

Item 4. Controls and Procedures		29-30

PART II. OTHER INFORMATION

Item 1. Legal Proceedings		30

Item 4. Submission of Matters to a Vote of Security Holders		31

Item 6. Exhibits and Reports on Form 8-K		32

SIGNATURES		33

Hot Topic, Inc. and Subsidiaries

Consolidated Balance Sheets

(In thousands, except share amounts)

(Unaudited)


	July 30, 2005			July 31, 2004 (As Restated)			January 29, 2005 (Audited)
Assets
Current assets:
Cash and cash equivalents	$	444		$	20,903		$	5,248
Short-term investments		33,316			50,732			61,091
Inventory		94,524			80,906			60,481
Prepaid expenses and other		18,330			11,704			12,390
Deferred tax assets		2,541			2,259			2,541

Total current assets		149,155			166,504			141,751
Property and equipment, net		171,022			121,361			136,401
Deposits and other		247			204			243

Total assets	$	320,424		$	288,069		$	278,395

Liabilities and shareholders’ equity
Current liabilities:
Accounts payable	$	44,138		$	47,060		$	17,874
Accrued liabilities		32,350			22,966			27,769
Income taxes payable		76			1,130			8,887

Total current liabilities		76,564			71,156			54,530
Deferred rent		35,664			26,437			30,227
Deferred tax liability		6,076			1,583			6,076
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; 45,228,952; 46,463,425 and 44,592,836 shares issued and outstanding at July 30, 2005, July 31, 2004 and January 29, 2005, respectively		99,574			122,120			90,921
Retained earnings		102,739			66,979			96,847
Accumulated other comprehensive loss		(193	)		(206	)		(206	)

Total shareholders’ equity		202,120			188,893			187,562

Total liabilities and shareholders’ equity	$	320,424		$	288,069		$	278,395

See notes to consolidated financial statements.

Hot Topic, Inc. and Subsidiaries

Consolidated Statements of Income

(In thousands, except per share amounts)

(Unaudited)


	Three Months Ended				Six Months Ended
	July 30, 2005		July 31, 2004 (As Restated)		July 30, 2005		July 31, 2004 (As Restated)
Net sales	$	152,234	$	136,263	$	301,996	$	264,406
Cost of goods sold, including buying, distribution and occupancy costs		104,612		89,613		203,208		173,571

Gross margin		47,622		46,650		98,788		90,835
Selling, general and administrative expenses		46,498		39,515		89,899		75,500

Operating income		1,124		7,135		8,889		15,335
Interest income, net		323		204		660		556

Income before income taxes		1,447		7,339		9,549		15,891
Provision for income taxes		554		2,811		3,657		6,086

Net income	$	893	$	4,528	$	5,892	$	9,805

Net income per share:
Basic	$	0.02	$	0.10	$	0.13	$	0.21

Diluted	$	0.02	$	0.09	$	0.13	$	0.20

Shares used in computing net income per share:
Basic		45,065		46,565		44,907		47,242
Diluted		46,246		48,023		46,207		49,055

See notes to consolidated financial statements.

Hot Topic, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)


	Six Months Ended
	July 30, 2005			July 31, 2004 (As Restated)
OPERATING ACTIVITIES
Net income	$	5,892		$	9,805
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		14,587			11,496
Tax benefit from exercise of stock options		2,600			1,390
Stock-based compensation		77			77
Loss on disposal of fixed assets		213			146
Changes in operating assets and liabilities:
Inventory		(34,043	)		(28,969	)
Prepaid expenses and other current assets		(5,940	)		(1,050	)
Deposits and other assets		(4	)		(15	)
Accounts payable		26,264			31,219
Accrued liabilities		4,659			(5,031	)
Deferred rent		5,437			4,594
Deferred taxes		—			(125	)
Income taxes payable		(8,811	)		(6,149	)

Net cash provided by operating activities		10,931			17,388

INVESTING ACTIVITIES
Purchases of property and equipment		(49,421	)		(30,221	)
Proceeds from sale of short-term investments		65,525			116,764
Purchases of short-term investments		(37,736	)		(51,183	)

Net cash (used in) provided by investing activities		(21,632	)		35,360

FINANCING ACTIVITIES
Repurchase of common stock		—			(46,812	)
Proceeds from employee stock purchases and exercise of stock options		5,897			3,081

Net cash provided by (used in) financing activities		5,897			(43,731	)

(Decrease) increase in cash and cash equivalents		(4,804	)		9,017
Cash and cash equivalents at beginning of period		5,248			11,886

Cash and cash equivalents at end of period	$	444		$	20,903

SUPPLEMENTAL INFORMATION
Cash paid during the period for interest	$	2		$	3

Cash paid during the period for income taxes	$	13,616		$	9,601

See notes to consolidated financial statements.

HOT TOPIC, INC. and SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1. Organization and Basis of Presentation

Hot Topic, Inc. is a mall-based specialty retailer operating the Hot Topic and Torrid store concepts. Hot Topic sells a selection of music/pop culture-licensed and music/pop culture-influenced apparel, accessories and gift items for young men and women principally between the ages of 12 and 22. In fiscal 2001 (the fiscal year ended February 2, 2002), we launched a second retail concept under the trade name Torrid. Torrid sells apparel, lingerie, shoes and accessories designed for various lifestyles for plus-size females between the ages of 15 and 29. At the end of the second quarter (July 30, 2005) of fiscal 2005 (the fiscal year ending January 28, 2006), we operated 628 Hot Topic stores in 50 states and Puerto Rico, and 100 Torrid stores. We also maintain two distinct websites, www.hottopic.com (“hottopic.com”) and www.torrid.com (“torrid.com”), which reflect the Hot Topic and Torrid store concepts and sell merchandise similar to that sold in the respective stores. We have one reportable segment given the similarities of the economic characteristics among the store formats. Throughout this report, the terms “our”, “we” and “us” refer to Hot Topic, Inc. and its subsidiaries.

The information set forth in these financial statements is unaudited except for the January 29, 2005 Consolidated Balance Sheet. These statements have been prepared in accordance with accounting principles generally accepted in the United States 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 for complete financial statements.

In the opinion of management, all adjustments, consisting only of normal recurring entries, necessary for a fair presentation have been included. The results of operations for the six months ended July 30, 2005 are not necessarily indicative of the results that may be expected for the year ending January 28, 2006.

Certain reclassifications have been made to prior year periods to conform to current period presentation. For further information, refer to the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended January 29, 2005.

NOTE 2. Restatement of Prior Financial Information

In March 2005, we restated our consolidated financial statements for fiscal 2004, which included our consolidated balance sheet at July 31, 2004, and our consolidated statements of income for the three months and six months ended July 31, 2004 and cash flows for the six months ended July 31, 2004. The restatement also affected periods prior to fiscal 2004. The restatement corrected our historical accounting for operating leases. For information with respect to the restatement, See Note 2 to the consolidated financial statements contained in our Annual Report on Form 10-K for fiscal 2004. We did not amend our previously filed Quarterly Reports on Form 10-Q for the restatement, therefore the financial statements and related financial information contained in such reports should no longer be relied upon. Throughout this Form 10-Q, all reference amounts for affected prior periods and prior period comparisons reflect the balances and amounts on a restated basis.

As a result of this restatement, our financial results have been adjusted as follows (in thousands, except per share data):


	Consolidated Statement of Income
Three months ended July 31, 2004	As Previously Reported		Adjustments			As Restated
Cost of goods sold, including buying, distribution and occupancy costs	$	89,420	$	193		$	89,613
Operating income		7,328		(193	)		7,135
Income before income taxes		7,532		(193	)		7,339
Provision for income taxes		2,885		(74	)		2,811
Net income		4,647		(119	)		4,528
Net income per share - basic		0.10		—			0.10
Net income per share - diluted		0.10		—			0.09

	Consolidated Statement of Income
Six months ended July 31, 2004	As Previously Reported		Adjustments			As Restated
Cost of goods sold, including buying, distribution and occupancy costs	$	173,246	$	325		$	173,571
Operating income		15,660		(325	)		15,335
Income before income taxes		16,216		(325	)		15,891
Provision for income taxes		6,211		(125	)		6,086
Net income		10,005		(200	)		9,805
Net income per share - basic		0.21		—			0.21
Net income per share - diluted		0.20		—			0.20

	Consolidated Balance Sheet
At July 31, 2004	As Previously Reported		Adjustments			As Restated
Property and equipment, net	$	103,044	$	18,317		$	121,361
Total assets		269,752		18,317			288,069
Income taxes payable		1,094		36			1,130
Deferred rent		3,597		22,840			26,437
Deferred taxes, net		3,316		(1,733	)		1,583
Retained earnings		69,805		(2,826	)		66,979
Total shareholders’ equity		191,719		(2,826	)		188,893
Total liabilities and shareholders’ equity		269,752		18,317			288,069


	Consolidated Statement of Cash Flows
Six months ended July 31, 2004	As Previously Reported		Adjustments			As Restated
Net cash provided by operating activities	$	12,505	$	4,883		$	17,388
Net cash provided by investing activities		40,243		(4,883	)		35,360

NOTE 3. Net Income Per Share

We compute net income per share pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 128 “Earnings Per Share.” Basic net income per share is computed based on the weighted average number of common shares outstanding for the period. Diluted net income per share is computed based on the weighted average number of common shares outstanding for the period and potentially dilutive common stock equivalents outstanding for the period.

A reconciliation of the numerator and denominator of basic earnings per share and diluted earnings per share is as follows (all amounts in thousands except per share amounts):


	Three Months Ended				Six Months Ended
	July 30, 2005		July 31, 2004 (As Restated)		July 30, 2005		July 31, 2004 (As Restated)
Basic EPS Computation:
Numerator	$	893	$	4,528	$	5,892	$	9,805
Denominator:
Weighted average common shares outstanding		45,065		46,565		44,907		47,242

Total shares		45,065		46,565		44,907		47,242

Basic EPS	$	0.02	$	0.10	$	0.13	$	0.21

Diluted EPS Computation:
Numerator	$	893	$	4,528	$	5,892	$	9,805
Denominator:
Weighted average common shares outstanding		45,065		46,565		44,907		47,242
Incremental shares from assumed conversion of options		1,181		1,458		1,300		1,813

Total Shares		46,246		48,023		46,207		49,055

Diluted EPS	$	0.02	$	0.09	$	0.13	$	0.20

NOTE 4. Comprehensive Income

Comprehensive income for the three months and six months ended July 30, 2005 and July 31, 2004 is as follows (in thousands):


	Three Months Ended				Six Months Ended
	July 30, 2005		July 31, 2004 (As Restated)		July 30, 2005		July 31, 2004 (As Restated)
Comprehensive Income
Net income	$	893	$	4,528	$	5,892	$	9,805
Unrealized gain (loss) on marketable securities, net		29		122		13		(5	)

Total comprehensive income	$	922	$	4,650	$	5,905	$	9,800

NOTE 5. Shareholders’ Equity

On March 19, 2004, we announced that our Board of Directors approved the repurchase of up to an aggregate of 2,000,000 shares of our common stock during the period ending January 29, 2005. As of July 31, 2004 we had completed the repurchase of 2,000,000 shares of our common stock at a cost of $46.8 million at an average price of $23.41.

On August 18, 2004, we announced that our Board of Directors approved an additional repurchase of up to an aggregate of 2,000,000 shares of our common stock during the period ending January 29, 2005. As of January 29, 2005, we completed the repurchase of 2,000,000 shares of our common stock at a cost of $32.8 million at an average price of $16.42.

NOTE 6. Bank Credit Agreement

We maintain an unsecured bank credit agreement of $5.0 million. The credit agreement will expire in August 2007 and we expect to renew the credit agreement under similar terms. Letters of credit are issued under the credit agreement, which are primarily used for inventory purchases. At July 30, 2005, we had $641,000 of outstanding letters of credit issued under the credit agreement.

NOTE 7. Commitments and Contingencies

Litigation

injury. In August 2004, we were served another complaint, filed in the Circuit Court of Shelby County, Tennessee, claiming we are liable due to alleged lead content in our costume jewelry we allegedly target to children. This complaint is an alleged class action, again excluding any personal injury claim, with counts of negligence and breach of implied warranty. Similar claims had been made in Tennessee, prior to service upon us, against other retailers in the same jurisdiction by plaintiffs represented by the same law firm. In the first such Tennessee case with significant activity, a motion to dismiss the claims in their entirety has been granted. The plaintiff in that case is appealing the ruling, and the Tennessee case against us will be delayed pending the outcome of appeal. The plaintiffs in the above California cases seek unspecified fines and penalties, attorneys’ fees and costs, and injunctive and other equitable relief; and the plaintiff in the Tennessee case seeks unspecified money damages, punitive damages, attorneys’ fees and injunctive relief on behalf of the alleged class. We continue to evaluate appropriate action in each of these cases with our counsel. In each case, we believe we have meritorious defenses to the plaintiff’s claims and intend to defend against such claims; though it is impossible to predict the outcome of the proceeding, and it is possible the plaintiff will be awarded requested remedies or that we may determine it appropriate to settle the lawsuit which could require us to take or not take certain actions.

On September 17, 2004, a former Torrid employee filed a lawsuit against us in Superior Court of Los Angeles County, on behalf of a purported class. The lawsuit asserts claims for failure to provide adequate meal or rest breaks, improper payment of overtime wages, failure to timely pay wages at end of employment and unfair business practices. The lawsuit seeks compensatory damages, statutory penalties, punitive damages, attorneys’ fees and injunctive relief. On October 21, 2004, we filed an answer denying the material allegations of the complaint, and we intend to vigorously defend ourselves against the various claims. Discovery has begun in connection with this matter but at the present time we are unable to predict the outcome of the matter.

On November 18, 2004, a former Torrid employee filed a lawsuit against us in Superior Court of Los Angeles County, on behalf of a purported class, with allegations relating to failure to pay overtime wages. In August 2005, we reached a tentative settlement in the case for which we recorded an expense of $500,000 in the second quarter of 2005.

We are involved in various matters of litigation during the ordinary course of business. Management does not currently believe any such matters will have a material adverse effect on our financial condition or results of operations.

Indemnities, Commitments and Guarantees

During the ordinary course of business, we have made certain indemnities, commitments and guarantees under which we may be required to make payments in relation to certain transactions. These indemnities include those given to various lessors in connection with facility leases for certain claims arising from such facility or lease and indemnities to our directors and officers to the maximum extent permitted under the laws of the State of California. We have issued guarantees in the form of letters of credit as security for some merchandise shipments from overseas. There were $641,000 of these letters of credit outstanding at July 30, 2005. The durations of these indemnities, commitments and guarantees vary. Some of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments we could be obligated to make. We have not recorded any liability for these indemnities, commitments and guarantees in the accompanying consolidated financial statements.

NOTE 8. Stock-Based Compensation

We account for stock-based awards to employees and directors using the intrinsic value method of accounting in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” We follow the disclosure provisions of SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS No. 148 requires disclosures of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. We are required to follow the prescribed disclosure format and have provided the additional disclosures required by SFAS No. 148 for the six months ended July 30, 2005.

Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined as if we accounted for our employee stock incentives under the fair value method of that Statement. For purposes of pro forma disclosures, the estimated fair value of the options, based on the Black-Scholes option pricing model, is amortized to expense over the options’ vesting periods. The following is the pro forma information using the fair value method under SFAS No. 123, as amended by SFAS No. 148 (in thousands, except per share amounts):


	Three Months Ended						Six Months Ended
	July 30, 2005			July 31, 2004 (As Restated)			July 30, 2005			July 31, 2004 (As Restated)
Net income (loss)
As reported	$	893		$	4,528		$	5,892		$	9,805
Add: Stock-based compensation expense included in reported net income, net of related tax effects		24			24			48			48
Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of related tax effects		(1,225	)		(1,759	)		(2,300	)		(3,308	)

Pro forma	$	(308	)	$	2,793		$	3,640		$	6,545

Basic earnings (loss) per share:
As reported	$	0.02		$	0.10		$	0.13		$	0.21
Pro forma	$	(0.01	)	$	0.06		$	0.08		$	0.14
Diluted earnings (loss) per share:
As reported	$	0.02		$	0.09		$	0.13		$	0.20
Pro forma	$	(0.01	)	$	0.06		$	0.08		$	0.13

NOTE 9. Impact of Recently Issued Accounting Standards

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs – an Amendment of ARB No. 43, Chapter 4”. SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges. In addition, SFAS No. 151 requires the allocation of fixed production overheads to the cost of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005. We do not expect the adoption of SFAS No. 151 to have a material impact on our operating results or financial condition.

In December 2004, the FASB issued SFAS No. 153, “Exchange of Nonmentary Assets, an amendment of APB Opinion No. 29”. SFAS No. 153 eliminates the exception for nonmonetary exchanges of similar productive assets, which were previously required to be recorded on a carryover basis rather than a fair value basis. Instead, this statement provides that exchanges of nonmonetary assets that do not have commercial substance be reported at carryover basis rather than a fair value basis. A nonmonetary exchange is considered to have commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of this statement are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We do not expect the adoption of SFAS No. 153 to have a material impact on our operating results or financial condition.

In December 2004, the FASB issued Statement No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), which is a revision of SFAS No. 123. SFAS No. 123R supersedes APB No. 25 and amends Statement No. 95, “Statement of Cash Flows.” Under SFAS No. 123, companies must calculate and record in the income statement the cost of equity instruments, such as stock options, awarded to employees for services received and pro forma disclosure is no longer permitted. The cost of the equity instruments will be measured based on fair value of the instruments on the date they are granted (with certain exceptions) and will be required to be recognized over the period during which the employees are required to provide services in exchange for the equity instruments. The statement is effective in the first annual reporting period beginning after June 15, 2005.

SFAS No. 123R provides two alternatives for adoption: (1) a “modified prospective” method in which compensation cost is recognized for all awards granted subsequent to the effective date of this statement as well as for the unvested portion of awards outstanding as of the effective date; or (2) a “modified retrospective” method which follows the approach in the “modified prospective” method, but also permits entities to restate prior periods to record compensation cost calculated under SFAS No. 123 for the pro forma disclosure. We are currently evaluating the probable impact of our share-based payment programs on our results of operations. We do not expect the adoption of SFAS No. 123 to have a material impact on our overall financial position, but it could significantly impact results of operations.

The impact of adopting SFAS No. 123R cannot be accurately estimated at this time because it will depend on levels of share-based awards granted in the future. However, had we adopted SFAS No. 123R in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income and earnings per share in Note 3 to our consolidated financial statements. SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow. This change will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While the amount of this change cannot be estimated at this time, the amount of operating cash flows recognized in prior periods for such excess tax deductions was $1.6 million, $6.6 million, and $5.1 million in fiscal 2004, 2003 and 2002, respectively.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our results of operations, financial condition and liquidity, and other matters should be read in conjunction with our Consolidated Financial Statements and the Notes related thereto.

Our fiscal year is on a 52-53 week basis and ends on the Saturday nearest to January 31. The fiscal year ending January 28, 2006 and fiscal years ended January 29, 2005, January 31, 2004, and February 1, 2003 are 52-week years.

The discussion below includes references to “comparable stores.” We consider a store comparable after it has been open for 15 full months. If a store is relocated or expanded by more than 15% in total square footage, it is removed from the comparable store base and, similar to new stores, becomes comparable after 15 full subsequent months.

RESTATEMENT OF PRIOR FINANCIAL INFORMATION

In March 2005, we restated our consolidated financial statements for fiscal 2004, which included our consolidated balance sheet at July 31, 2004, consolidated statements of operations for the three and six months ended July 31, 2004 and cash flows for the six months ended July 31, 2004 in this Quarterly Report on Form 10-Q. The restatement corrected our historical accounting for operating leases. The restatement adjustments are non-cash and had no impact on revenues, comparable store sales or overall cash flows. For information with respect to the restatement, see “Note 2” to the consolidated financial statements contained in our Annual Report on Form 10-K for fiscal 2004. We did not amend our previously filed Quarterly Reports on Form 10-Q for the restatement; therefore, the financial statements and related financial information contained in such reports should no longer be relied upon. Throughout this report, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” all referenced amounts for affected prior periods and prior period comparisons reflect the balances and amounts on a restated basis.

RESULTS OF OPERATIONS

Three Months Ended July 30, 2005 Compared to Three Months Ended July 31, 2004

The following table sets forth selected data from our income statement expressed as a percentage of net sales for the periods indicated. The discussion that follows should be read in conjunction with this table:


For the three months ended:	July 30, 2005		July 31, 2004
Net sales	100.0	%	100.0	%
Cost of goods sold (including buying, distribution and occupancy costs)	68.7		65.8

Gross margin	31.3		34.2
Selling, general and administrative expenses	30.5		29.0

Operating income	0.8		5.2
Interest income, net	0.2		0.2

Income before income tax expense	1.0		5.4
Income tax expense	0.4		2.1

Net income	0.6	%	3.3	%

Net sales increased $16.0 million, or 11.7%, to $152.2 million during the second quarter of fiscal 2005 from $136.3 million during the second quarter of fiscal 2004. The components of this $16.0 million increase in net sales are as follows:


Amount ($ millions)			Description
$	11.2		Net sales from new Hot Topic stores opened during the second quarter of fiscal 2005 and Hot Topic stores not yet qualifying as comparable stores
	8.0		Net sales from new Torrid stores opened during the second quarter of fiscal 2005 and Torrid stores not yet qualifying as comparable stores
	0.8		Internet sales (hottopic.com and torrid.com)
	0.1		Net sales from 14 expanded or relocated Hot Topic and Torrid stores
	(4.1	)	3.5% decrease in comparable store net sales in the second quarter of fiscal 2005 compared to the second quarter of fiscal 2004

$	16.0		Total

At the end of the second quarter of fiscal 2005, 548 of our 728 stores (Hot Topic and Torrid) were included in the comparable store base, compared to 445 of our 613 stores (Hot Topic and Torrid) open at the end of the second quarter of fiscal 2004. Sales of Hot Topic’s apparel and tee-shirts, as a percentage

of total net sales, were 55% for the second quarter of fiscal 2005 compared to 54% for the second quarter of fiscal 2004. The increase of the apparel category in the product mix was driven by increased sales of music-licensed apparel, men’s novelty tees and women’s tops, partially offset by a decline in men’s and women’s bottoms, and dresses.

Gross margin increased $1.0 million to $47.6 million during the second quarter of fiscal 2005 from $46.6 million during the second quarter of fiscal 2004. As a percentage of net sales, gross margin decreased to 31.3% during the second quarter of fiscal 2005 from 34.2% in the second quarter of fiscal 2004. The significant components of this 2.9% decrease in gross margin as a percentage of net sales are as follows:


%		Description
(1.3	)%	Decrease in merchandise margin, principally due to higher markdowns
(1.2	)	Increase in store occupancy and depreciation expenses, primarily due to deleveraging store expenses over lower comparable store sales and an increase in average store size
(0.3	)	Increase in distribution expenses, primarily due to the opening of our additional distribution center location, partially offset by improved freight costs
(0.1	)	Increase in buying costs due to higher payroll expenses

(2.9	)%	Total

Selling, general and administrative expenses increased $7.0 million, or 17.7%, to $46.5 million during the second quarter of fiscal 2005 compared to $39.5 million during the second quarter of fiscal 2004. As a percentage of net sales, selling, general and administrative expenses increased to 30.5% in the second quarter of fiscal 2005 compared to 29.0% in the second quarter of fiscal 2004. The total dollar increase in selling, general and administrative expenses was primarily attributable to a 18.8% increase in the number of retail stores from 613 at the end of the second quarter of fiscal 2004 to 728 at the end of the second quarter of fiscal 2005 and the corresponding additional payroll and other expenses required to support these additional stores. The significant components of this 1.5% increase in selling, general and administrative expenses as a percentage of net sales are as follows:


%		Description
0.6	%	Increase in other general and administrative expenses primarily due to costs associated with tentative settlement of employment related lawsuit and higher payroll related costs
0.5		Increase in other store expenses, primarily due to higher supplies costs and credit card processing fees
0.3		Increase in store payroll expenses due to deleveraging of payroll costs over lower comparable store sales
0.1		Increase in store pre-opening expenses due to higher costs per store

1.5	%	Total

Operating income decreased $6.0 million to $1.1 million during the second quarter of fiscal 2005 from $7.1 million during the second quarter of fiscal 2004. As a percentage of net sales, operating income was 0.7% in the second quarter of fiscal 2005 compared to 5.2% in the second quarter of fiscal 2004.

Net interest income remained at 0.2% for the second quarter of fiscal 2005 compared to the second quarter of fiscal 2004.

Income tax expense was $0.6 million for the second quarter of fiscal 2005 compared to $2.8 million for the second quarter of fiscal 2004. The effective tax rate was 38.3% for both the second quarter of fiscal 2005 and fiscal 2004.

Six Months Ended July 30, 2005 Compared to Six Months Ended July 31, 2004


For the six months ended:	July 30, 2005		July 31, 2004
Net sales	100.0	%	100.0	%
Cost of goods sold (including buying, distribution and occupancy costs)	67.3		65.6

Gross margin	32.7		34.4
Selling, general and administrative expenses	29.8		28.6

Operating income	2.9		5.8
Interest income, net	0.2		0.2

Income before income tax expense	3.1		6.0
Income tax expense	1.2		2.3

Net income	1.9	%	3.7	%

Net sales increased $37.6 million, or 14.2%, to $302.0 million during the first six months of fiscal 2005 from $264.4 million during the first six months of fiscal 2004. The components of this $37.6 million increase in net sales are as follows:


Amount ($ million)			Description
$	25.3		Net sales from new Hot Topic stores opened during the first six months of fiscal 2005 and Hot Topic stores not yet qualifying as comparable stores
	13.9		Net sales from new Torrid stores opened during the first six months of fiscal 2005 and Torrid stores not yet qualifying as comparable stores
	1.3		Internet sales (hottopic.com and torrid.com)
	0.4		Net sales from 14 expanded or relocated Hot Topic and Torrid stores
	(3.3	)	1.4 % decrease in comparable store net sales in the first six months of fiscal 2005 compared to the first six months of fiscal 2004

$	37.6		Total

Sales of Hot Topic’s apparel and tee-shirts, as a percentage of total net sales, were 55% in the first six months of fiscal 2005 compared to 53% in the first six months of fiscal 2004. The increase in apparel and tee-shirt sales as a percentage of net sales was due primarily to increased sales of music-related apparel, women’s tops and men’s novelty tees, partially offset by decreases in sales of men’s and women’s bottoms, and dresses.

Gross margin increased approximately $8.0 million to $98.8 million during the first six months of fiscal 2005 from $90.8 million during the first six months of fiscal 2004. As a percentage of net sales, gross margin decreased to 32.7% during the first six months of fiscal 2005 from 34.4% in the first six months of fiscal 2004. The significant components of this 1.7% decrease in gross margin as a percentage of net sales are as follows:


%		Description
(0.8	)%	Increase in store occupancy and depreciation expenses, primarily due to deleveraging store expenses over lower comparable store sales and an increase in average store size
(0.4	)	Decrease in merchandise margin, principally due to higher markdowns
(0.4	)	Increase in distribution expenses, primarily due to the opening of our additional distribution center location, partially offset by improved freight costs
(0.1	)	Increase in buying costs due to higher payroll expenses

(1.7	)%	Total

Selling, general and administrative expenses increased $14.4 million, or 19.1%, to $89.9 million during the first six months of fiscal 2005 compared to $75.5 million during the first six months of fiscal 2004. As a percentage of net sales, selling, general and administrative expenses increased to 29.8% in the first six months of fiscal 2005 compared to 28.6% in the first six months of fiscal 2004. The total dollar increase in selling, general and administrative expenses is primarily attributable to an increase in the number of retail stores from 613 at the end of the first six months of fiscal 2004 to 728 at the end of the first six months of fiscal 2005 and the corresponding additional payroll and other expenses required to support these additional stores. The significant components of this 1.2% increase in selling, general and administrative expenses as a percentage of net sales are as follows:


%		Description
0.6	%	Increase in other store expenses, primarily due to higher supplies costs and credit card processing fees
0.2		Increase in store payroll expenses due to deleveraging of payroll costs over lower comparable store sales
0.2		Increase in other general and administrative expenses due to costs associated with tentative settlement of employment related lawsuit and higher payroll related costs
0.2		Increase in store pre-opening expenses due to higher costs per store

1.2	%	Total

Operating income decreased $6.4 million to $8.9 million during the first six months of fiscal 2005 from $15.3 million during the first six months of fiscal 2004. As a percentage of net sales, operating income was 2.9% in the first six months of fiscal 2005 compared to 5.8% in the first six months of fiscal 2004.

Net interest income remained at 0.2% for the first six months of fiscal 2005 compared to the first six months of fiscal 2004.

Income tax expense was $3.7 million for the first six months of fiscal 2005 compared to $6.1 million for the first six months of fiscal 2004. The effective tax rate was 38.3% for both the first six months of fiscal 2005 and fiscal 2004.

LIQUIDITY AND CAPITAL RESOURCES

Historically and during the first six months of fiscal 2005, our primary uses of cash have been to finance store openings and purchase merchandise inventories, as well as periodic repurchases of our common shares. In addition, during the second quarter of 2005, we completed the purchase of the land, building and other improvements comprising our distribution center in Tennessee, for which we paid $14.3 million. In recent years, we have satisfied our cash requirements principally from cash flows from operations and to a lesser extent proceeds from the exercise of stock options. We also maintain a $5.0 million unsecured credit agreement for the purpose of issuing letters of credit, primarily for inventory purchases. At July 30, 2005, we had $641,000 of outstanding letters of credit under the credit agreement.

Cash flows provided by operating activities were $10.9 million in the first six months of fiscal 2005 compared to $17.4 million provided by operating activities in the first six months of fiscal 2004.

The decrease of $6.5 million in cash flows from operating activities in the first six months of 2005 compared to the first six months of 2004 resulted primarily from an increase in inventory, increase in prepaid expenses and other current assets, decrease in accounts payable and income taxes payable, offset partially by an increase in accrued liabilities, deferred rent, depreciation expense and tax benefit from stock options exercised.

Cash flows used in investing activities were $21.6 million in the first six months of fiscal 2005 compared to $35.4 million provided by investing activities in the first six months of fiscal 2004. The $57.0 million decrease in net cash from investing activities is due to a decrease ($37.8 million) in the proceeds from the sale of short-term investments (net of purchases) and an increase ($19.2 million) in purchases of property and equipment associated primarily with the acquisition of our Tennessee distribution center, new hardware and software systems, and to support store openings.

Cash flows provided by financing activities were $5.9 million in the first six months of fiscal 2005 compared to cash flows used in financing activities of $43.7 million in the first six months of fiscal 2004. The $49.6 million increase in cash flows from financing activities is principally the result of the fact that we did not repurchase shares of our common stock in the first six months of fiscal 2005, whereas we repurchased shares of our common stock for $46.8 million in the first six months of fiscal 2004; and there was also a $2.8 million increase in proceeds from exercise of stock options in the first six months of fiscal 2005.

The following table summarizes our contractual obligations as of July 30, 2005, and the timing and effect that such commitments are expected to have on our liquidity and capital requirements in future periods:


	Payments due by period ($ in thousands)
Contractual obligations	Total		Within 1 Year		2-3 Years		4-5 Years		More than 5 Years
Operating leases	$	354,642	$	48,959	$	96,068	$	87,320	$	122,295
Purchase obligations		87,086		87,086		—		—		—
Letters of credit and other obligations		2,213		2,213		—		—		—

Total contractual obligations	$	443,941	$	138,258	$	96,068	$	87,320	$	122,295

We believe our current cash balances and cash generated from operations will be sufficient to fund our operations, planned expansion and repurchase of our common stock through at least the next 12 months.

CRITICAL ACCOUNTING POLICIES

Management’s discussion and analysis of Hot Topic, Inc.’s 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.

We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. For a further discussion about the application of these and other accounting policies, refer to the notes included in our Annual Report on Form 10-K for the year ended January 29, 2005.

Inventories: Inventories and related costs of sales are accounted for by the retail method. The cost of inventory is valued at the lower of average cost or market, on a first-in, first-out (FIFO) basis, utilizing the retail method. Each month, slow moving or seasonally obsolete merchandise is marked down. The first markdown is typically 25% to 50% of the original retail price. Typically, in cases where the merchandise does not sell after the first markdown, an additional markdown is made in a subsequent month. Any marked down merchandise that does not sell is typically marked down to a zero value, and removed from the store within three months after the final markdown. In determining the lower of average cost or market value of period-ending inventories, consistently applied valuation criteria are used. Consideration is given to a number of quantitative factors, including anticipated subsequent permanent markdowns and aging of inventories. To the extent our estimated markdowns at period-end prove to be insufficient, additional future markdowns will need to be recorded.

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. Factors considered important that could trigger an impairment review 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. If we were to determine that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, we would measure any impairment based on a projected discounted cash flow method using a discount rate determined by management. To date, we have not recorded any significant impairment of a long-lived asset. 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: Sales are recognized upon the purchase by customers at our retail store locations and websites, less merchandise returned by customers. We provide a reserve for projected merchandise returns based on historical experience. As the reserve for merchandise returns is based on estimates the actual returns could differ from the reserve, which could impact sales. 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.

Self-Insurance: We are self-insured for medical insurance coverage and workers compensation insurance coverage, up to maximum exposure limits, above which we are covered by insurance policies. We maintain a liability for estimated claims based on historical claims experience and other actuarial assumptions.

Income Taxes: Current income tax expense is the amount of income taxes expected to be payable for the current year. The combined federal, state and local income tax expense is calculated using estimated effective annual tax rates. A deferred income tax asset or liability is established for the expected future consequences of temporary differences in the financial reporting and tax bases of assets and liabilities. We consider future taxable income and ongoing prudent and feasible tax planning in assessing the value of our deferred tax assets. Evaluating the value of these assets is necessarily based on our judgment. If we were to determine that it is more likely than not that these assets will not be realized, we would reduce the value of these assets to their expected realizable value through a valuation allowance, thereby decreasing net income. If we subsequently were to determine that the deferred tax assets, which had been written down, would be realized in the future, the value of the deferred tax assets would be increased, thereby increasing net income in the period when that determination was made. We have recorded tax contingencies based on our estimates of current tax exposures and adjust our estimates as circumstances or regulations change.

INFLATION

We do not believe that inflation has had a material adverse effect on our net sales or results of operations. We have generally been able to pass along increased costs related to inflation through increases in selling prices.

STATEMENT REGARDING FORWARD LOOKING DISCLOSURE

This Quarterly Report on Form 10-Q contains various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by these sections, including statements regarding our expectations, beliefs, intentions or strategies regarding the future. Forward-looking statements include, without limitation, statements regarding the extent and timing of future revenues and expenses and customer demand, expected financial results, the profitability of future sales of our products, new store openings and new store concepts. All forward-looking statements included in this report are based on information available to us as of the date hereof and we assume no obligation to update any forward-looking statements. Forward-looking statements involve known or unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements, or industry results to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such risks, uncertainties and other factors include but are not limited to the items discussed under the captions “Certain Risks Related to the Our Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Item 2.

CERTAIN RISKS RELATED TO OUR BUSINESS

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 our Annual Report on Form 10-K and in other filings with the SEC, including our 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.

Our aggressive growth strategy anticipates a significant number of new store openings, which could create challenges we may not be able to adequately meet.

Our net sales have grown significantly during the past several years, primarily as a result of the opening of new stores and, to a lesser extent, the introduction of new products. We intend to continue to pursue an aggressive growth strategy for the foreseeable future, and our future operating results will depend largely upon our ability to open and operate stores successfully and to profitably manage a larger business. We currently anticipate opening approximately 110 stores, consisting of 65 Hot Topic and 45 Torrid stores, during fiscal 2005, which will result in a significant increase in the number of stores we operate. Operation of a greater number of new stores and expansion into new markets may present competitive and merchandising challenges that are different from those currently encountered by us in our existing stores and markets. In addition, as the number of stores increases, we may face risks associated with market saturation of our products and concepts. There can be no assurance that our expansion will not adversely affect the individual financial performance of our existing stores or our overall results of operations, or that new stores will achieve sales and profitability levels consistent with existing stores. Further, there can be no assurance that we will successfully achieve our expansion targets or, if achieved, that planned expansion will result in profitable operations.

This growth strategy requires effective upscaling of our operations, and we may not be able to do this sufficiently to effectively prevent negative impact on our operations and financial results.

In order to manage our planned expansion, 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 stores into our existing operations; and maintain adequate distribution center space and information technology and other operations systems. Our recent opening of a second distribution center in Tennessee was designed to address some of our growth challenges, but achieving and maintaining operating efficiencies in multiple distribution centers is subject to numerous risks and uncertainties.

We also need to continually 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 impact our business (for example, we experienced some delay in product distribution during our second quarter of fiscal 2004 upon implementing our new warehouse management system). We cannot anticipate all of the changing demands that our expanding 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 expanding operations could also materially impact our business.

Expanding our operations to include an increasing number of Torrid stores and any other new concepts presents risks we have faced with the Hot Topic concept but also new risks due to differences in concept objectives and strategies.

Our ability to expand into new concepts, and in particular our Torrid concept, has not been fully tested. Accordingly, the operation of Torrid stores and the sale of Torrid merchandise over the Internet are subject to numerous risks, including unanticipated operational problems; lack of experience; lack of customer acceptance; new vendor relationships; competition from existing and new retailers; and diversion of management’s attention from the Hot Topic concept. The Torrid concept involves

implementation of a retail apparel concept which is subject to most of the same risks as the Hot Topic concept, as well as additional risks inherent in a concept that concentrates on apparel and fashion, including risks of difficulty in merchandising, uncertainty of customer acceptance, fluctuations in fashion trends and customer tastes, extreme competition with a less differentiated product offering, and attendant markdown risks. We may not be able to generate continued customer interest in Torrid stores and products, and the Torrid concept may not be able to support the store or Internet sales format. Risks inherent in any new concept are particularly acute with respect to Torrid, because this is our first significant new venture, and the nature of the Torrid business differs in certain respects from that of the Hot Topic business. There can be no assurance that the Torrid stores or website will achieve sales and profitability levels that justify our investment.

The success of our business depends on establishing and maintaining good relationships with mall operators and developers, and problems with those relationships could make it more difficult for us to expand to certain sites or offer certain products.

Any restrictions on our ability to expand to new store sites 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 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 that industry, and we have seen certain increases in expenses as a result of such consolidation that could continue.

Our comparable store sales are subject to fluctuation resulting from factors within and outside our control, and lower than expected comparable store sales could impact our business and our stock price.

A variety of factors affects our comparable store sales including, among others, the timing of new music releases and music/pop culture-related products; music and fashion trends; the general retail sales environment and the effect of the overall economic environment; our ability to efficiently source and distribute products; changes in our merchandise mix; competition from other retailers; opening of new stores in existing markets and our ability to execute our business strategy efficiently. Our comparable store sales results have fluctuated significantly in the past and we believe that such fluctuations will continue. Our comparable store sales results were 0.9% and (3.5)% for the first and second quarters of fiscal 2005, respectively, and the following table shows our comparable store sales results for other recent periods:


Fiscal Year	2004		2003		2002		2001
	(2.9	)%	7.4	%	5.0	%	3.9	%


	FY 2004		FY 2003
1^stQuarter	4.0	%	2.6	%
2^nd Quarter	(2.1	)%	5.2	%
3^rd Quarter	(4.2	)%	10.8	%
4^th Quarter	(6.0	)%	8.5	%

Past comparable store sales results are not an indicator of future results, and there can be no assurance that our comparable store sales results will not decrease in the future. Changes in our comparable store sales results could cause our stock price to fluctuate substantially.

Our success relies on popularity with young people of music, pop culture, and fashion trends, and we may not be able to react to trends in a way to prevent declining popularity and sales of our products.

Our financial performance is largely dependent upon the continued popularity of alternative and rock music, the Internet and digital music, music videos, and MTV and other 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 an adverse material effect on our business, results of operations and financial condition.

Economic conditions could change in ways that reduce our sales or increase our expenses.

Certain economic conditions affect the level of consumer spending on merchandise we offer, including, among others, employment levels; salary and wage levels; interest rates; taxation; and consumer confidence in future economic conditions. We are also dependent upon the continued popularity of malls as a shopping destination, the ability of mall anchor tenants and other attractions to generate customer traffic, and the development of new malls. A slowdown in the United States economy or an uncertain economic outlook could lower consumer spending levels and cause a decrease in mall traffic or new mall development, each of which would adversely affect our growth, sales results and financial performance.

Changes in laws, including employment laws and laws related to our merchandise, could make conducting our business more expensive or change the way we do business.

In addition to increased regulatory compliance requirements, changes in laws 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 raise the wage requirements for certain of our associates, which would likely cause us to reexamine our entire wage structure for stores. Other laws related to employee benefits and treatment of employees could also negatively impact us such as by increasing benefits costs like 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.

Timing and seasonal issues could negatively impact our financial performance for given periods.

Our quarterly 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, releases of new music and music/pop culture-related products, shifts in timing of certain holidays, changes in our merchandise mix and overall economic and political conditions.

Our business is also 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. The Holiday season has historically been our single most important selling season. We believe that the importance of the summer vacation and back-to-school seasons (which affect operating results in the second and third quarters) and to a lesser extent, the spring break season (which affects operating results in the first quarter) as well as Halloween (which affects operating results in the third quarter), all reduce our dependence on the Holiday selling season, but this will not always be the case to the same degree. As is the case with many retailers of apparel, accessories and related merchandise, we typically experience lower net sales in the first fiscal quarter relative to other quarters.

We have many important vendor relationships, and our ability to get merchandise could be hurt by changes in those relationships and events harmful to our vendors could impact our results of operation.

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 only from vendors that have exclusive license rights. In addition, certain of our products are supplied by small, specialized vendors, some of which create unique products primarily for us. 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.

Technology and other risks associated with our Internet sales could hinder our overall financial performance.

We sell merchandise over the Internet through the websites hottopic.com and torrid.com. Our Internet operations are subject to numerous risks and pose risks to our overall business, including, among other things: hiring; retention and training of personnel to conduct the Internet operations; diversion of sales from our stores; rapid technological change and the need to invest in additional computer hardware and software to support sales; liability for online content; 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.

We have made and plan to continue to make significant changes to information systems and software used in operation of our business, and we may not be able to effectively adopt changes in a way to prevent failures in our operations or negative impact on our financial performance and reporting.

Over the past several years, we have made improvements to existing hardware and software systems, as well as implemented new systems. Among other things, we have enhanced the functionality of our current GERS Retail Systems software and implemented new financial system software from Lawson. In addition, we have made significant investments to a new warehouse management software system, a new Internet order management software system, and a new customer loyalty software system; as well as modifying existing systems that were impacted by our second distribution center that opened in the second quarter of 2005. We expect to significantly increase our reliance on these systems in fiscal

2005. If these information systems and software do not work effectively, we may experience delays or failures in our operations. These delays or failures could adversely impact the promptness and accuracy of our merchandise distribution, transaction processing, financial accounting and reporting and ability to properly forecast earnings and cash requirements. For example, in the second quarter of 2004, we experienced some delay in product distribution upon implementation of our new warehouse management system. To manage growth of our operations and personnel, we may need to continue to improve our operational and financial systems, transaction processing, and procedures and controls, and in doing so, we could incur substantial additional expenses.

Loss of key people or an inability to hire necessary and significant personnel could hurt our business.

Our financial performance depends largely on the efforts and abilities of senior management, especially Elizabeth McLaughlin, our Chief Executive Officer, who has been with us since 1993. We have a $2,000,000 key-person life insurance policy on Ms. McLaughlin. However, the sudden loss of Ms. McLaughlin’s services or the services of other members of our management team could have a material adverse effect on our business, results of operations and financial condition. Furthermore, there can be no assurance that Ms. McLaughlin and our existing management team will be able to manage our growth or that we will be able to attract and retain additional qualified personnel as needed in the future.

Our reliance on United Parcel Service, temporary employees and other mechanics of shipping of our merchandise creates distribution risks and uncertainties that could hurt our sales and business.

We rely upon United Parcel Service for our product shipments, including shipments to and from a significant number of our stores. Our reliance on this source for shipments is subject to risks, including employee strikes and inclement weather, associated with United Parcel Service’s ability to provide delivery services that adequately meet our shipping needs. We are also dependent upon temporary associates to adequately staff our distribution facility, particularly during busy periods such as the Holiday season and while multiple stores are opening. There can be no assurance that we will continue to receive adequate assistance from our temporary associates, or that there will continue to be sufficient sources of temporary associates. We opened a second distribution center in Tennessee during the second quarter of 2005, and as a result we also now face risks and uncertainties associated with achieving and maintaining operating efficiencies in two distribution centers that are located approximately 2,000 miles apart. Additionally, certain products are imported and subject to delivery delays based on availability and ports capacity.

There is a risk we could acquire merchandise without full rights to sell it, which could lead to disputes or litigation and hurt our financial performance and stock price.

We purchase licensed merchandise from a number of suppliers who hold manufacturing and distribution rights under the terms of certain licenses. We generally rely upon vendors’ representations concerning manufacturing and distribution rights and do not independently verify whether these vendors legally hold adequate rights to licensed properties they are manufacturing or distributing. If we acquire unlicensed merchandise, we could be obligated to remove such merchandise from our stores, incur costs associated with destruction of merchandise if the distributor is unwilling or unable to reimburse us, and be subject to liability under various civil and criminal causes of action, including actions to recover unpaid royalties and other damages. Any of these results could have a material adverse effect on our business, results of operations and financial condition.

We face intense competition, and an inability to adequately address it, or the success of our competitors, could limit or prevent our business growth and success.

The retail apparel and accessory industry is highly competitive. We compete with other retailers for vendors, teenage and young adult customers, suitable store locations and qualified associates and management personnel. Hot Topic currently competes with street alternative stores located primarily in metropolitan areas; with other mall-based teenage-focused retailers such as Abercrombie & Fitch, Aeropostale, American Eagle Outfitters, Anchor Blue, Charlotte Russe Inc., Claire’s Stores, Inc., Forever 21, Pacific Sunwear of California, Inc., Spencer Gifts, Inc., H&M, The Buckle, Wet Seal, Inc., and Urban Outfitters, Inc.; and, to a lesser extent, with music stores and mail order catalogs and websites. Torrid has additional competitors, such as Alloy, Inc., Deb Shops, Delia’s Corp., Old Navy (a division of Gap Inc.), Lane Bryant, and 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’s products. Some of our competitors are larger and may have greater financial, marketing and other resources. Direct competition with these and other retailers may increase significantly in the future, which could require us, among other things, to lower our prices. Increased competition could have a material adverse effect on our business, results of operations and financial condition.

War, terrorism and other catastrophes could negatively impact our customers, places where we do business, and our expenses, all of which could hurt our business.

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 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.

In addition, a few years ago, California experienced substantially increased costs of electricity and gas caused by, among other things, disruption in energy supplies. 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. California is also subject to natural disasters such as earthquakes and floods. 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.

There are numerous risks that could cause our stock price to fluctuate substantially.

Our common stock is quoted on the Nasdaq National 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 and gift item retailers; the trading volume of our stock; changes in estimates of our performance by securities analysts; overall economic and political conditions; the condition of the financial markets; and other events or factors outside of our control could cause our stock price to fluctuate substantially.

Our charter documents and other circumstances could prevent a takeover or cause dilution of our existing shareholders, which could be detrimental to existing shareholders and hinder business success.

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 of Directors 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 of Directors. The issuance of these shares could have a dilutive effect on certain 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.

We incur costs associated with regulatory compliance, and this cost could be significant.

There are numerous regulatory requirements for public companies, including the provisions of the Sarbanes-Oxley Act of 2002. With regard to the Sarbanes-Oxley Act, we have and will continue to incur significant expense as we continue to address the implications of applicable rules and our operations relative thereto, and as we work to respond to and comply with applicable requirements. Among other things, we have incurred and will incur additional expenses as we implement Section 404 of the Sarbanes Oxley Act. Section 404 requires management to report on, and our independent auditors to attest to, our internal controls. Compliance with these rules could also result in continued diversion of management’s time and attention, which could be disruptive to normal business operations.

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

There are litigation and other claims against us from time to time, which could distract management from our business activities, and could lead to adverse consequences to our business and financial condition.

As a growing company with expanding operations, we are increasingly involved from time to time with litigation and other claims against us. These 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 us, 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.

Recent accounting regulation changes will require the expensing of stock options.

Recently effective accounting regulation changes require that all publicly traded companies begin recording compensation expense related to all unvested and newly granted stock options prospectively for annual periods beginning after June 15, 2005. Currently, we include such expenses on a pro forma basis in the notes to our quarterly and annual financial statements in accordance with accounting principles generally accepted in the United States of America and do not include compensation expense related to stock options in our reported earnings in the financial statements. When we begin expensing stock options as provided above, our reported earnings will be negatively impacted and our stock price could decline.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

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-term investments with maturities in excess of three months. Changes in interest rates affect the investment income earned on those investments.

Item 4.

Controls and Procedures

The management of the company maintains disclosure controls and procedures that are designed to ensure that the information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (the “SEC”) rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of inherent limitations, our disclosure controls and procedures may not prevent or detect misstatements. In addition, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.

We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, under the supervision of and with the participation of our management, including the CEO and CFO. In performing our evaluation for fiscal 2004, management and the Audit Committee discussed our lease accounting policies with our independent registered public accounting firm and determined that our application of the lease accounting principles for free rent periods was not consistent with the views expressed by the SEC in their letter issued on February 7, 2005. Due to this inconsistency management concluded it had a material weakness in internal control over financial reporting as of the year ended January 29, 2005. However, during the quarter ended April 30, 2005 we remediated the material weakness in internal control over financial reporting by correcting our application of lease accounting principles for free rent periods. As a result, the CEO and CFO have concluded our disclosure controls and procedures are effective as of July 30, 2005.

Other than as described above, there were no changes in our internal controls over financial reporting that occurred during the period covered by this report, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

On June 23, 2004, a non-profit corporation named Center for Environmental Health filed a lawsuit in Federal district court in Alameda, California against over two dozen retailers, large and small, including Hot Topic, Inc. Other defendants include teen retailers like Claire’s and Wet Seal, department stores like Sears, Nordstrom, Macy’s and J.C. Penney, and large retailers like Wal-Mart and Target. Certain of the defendants, but not Hot Topic, were also named defendants in a substantially similar lawsuit filed by the State of California. The complaint in each case alleges, in general, that the defendant retailers have violated certain California statutes by not providing sufficient warning about an alleged potential for lead exposure relating to costume jewelry sold in stores. The complaints do not contain allegations of personal injury. In August 2004, we were served another complaint, filed in the Circuit Court of Shelby County, Tennessee, claiming we are liable due to alleged lead content in our costume jewelry we allegedly target to children. This complaint is an alleged class action, again excluding any personal injury claim, with counts of negligence and breach of implied warranty. Similar claims had been made in Tennessee, prior to service upon us, against other retailers in the same jurisdiction by plaintiffs represented by the same law firm. In the first such Tennessee case with significant activity, a motion to dismiss the claims in their entirety has been granted. The plaintiff in that case is appealing the ruling, and the Tennessee case against us will be delayed pending the outcome of appeal. The plaintiffs in the above California cases seek unspecified fines and penalties, attorneys’ fees and costs, and injunctive and other equitable relief; and the plaintiff in the Tennessee case seeks unspecified money damages, punitive damages, attorneys’ fees and injunctive relief on behalf of the alleged class. We continue to evaluate appropriate action in each of these cases with our counsel. In each case, we believe we have meritorious defenses to the plaintiff’s claims and intend to defend against such claims; though it is impossible to predict the outcome of the proceeding, and it is possible the plaintiff will be awarded requested remedies or that we may determine it appropriate to settle the lawsuit which could require us to take or not take certain actions.

Though significant litigation or awards against us could seriously harm our business and financial results, we do not at this time expect any of the above-described litigation to have a material adverse effect on us.

Items 2, 3 & 5 are not applicable.

Item 4.

Submission of Matters to a Vote of Security Holders

The annual meeting of shareholders of the Company (the “Annual Meeting”) was held on June 15, 2005 in the City of Industry, California. The Company had 44,920,744 shares of common stock outstanding as of the close of business on April 21, 2005, the record date for the Annual Meeting.

Proposal 1 – Each of the candidates listed below was duly elected to the Board of Directors at the Annual Meeting by the tally indicated.


Candidate	Votes in Favor	Votes Withheld
Cynthia Cohen	42,505,630	270,596
Corrado Federico	40,338,904	2,437,322
W. Scott Hedrick	40,553,433	2,222,793
Kathleen Mason	36,210,308	6,565,918
Elizabeth McLaughlin	42,719,677	56,549
Bruce Quinnell	42,648,921	127,305
Andrew Schuon	40,552,732	2,223,494

Proposal 2 – Amendment of 1996 Equity Incentive Plan was ratified by the tally indicated.


Votes in Favor	Votes Against	Votes Abstained
25,820,671	11,922,817	67,601

Proposal 3 – Amendment of 1996 Non-Employee Directors’ Stock Option Plan was ratified by the tally indicated.


Votes in Favor	Votes Against	Votes Abstained
33,919,762	3,828,352	62,975

Proposal 4 – The selection of Ernst & Young LLP as Independent Registered Public Accounting Firm of the Company for its fiscal year ending January 28, 2006 was ratified by the tally indicated.


Votes in Favor	Votes Against	Votes Abstained
42,109,854	651,727	14,645

Item 6.

Exhibits and Reports on Form 8-K

(a) Exhibits:


Exhibit Number		Description of Document

3.1		Amended and Restated Articles of Incorporation. (1)

3.2		Certificate of Amendment of Amended and Restated Articles of Incorporation. (2)

3.3		Amended and Restated Bylaws, as amended. (2)

4.1		Reference is made to Exhibits 3.1 and 3.2.

4.2		Specimen stock certificate. (1)

10.1		Purchase and Sale Agreement dated as of June 15, 2005 by and between Crescent Resources, LLC and Hot Topic Tennessee, Inc. (3)

10.2a		Employment Offer Letter dated July 11, 2005, between Hot Topic, Inc. and Maria Comfort. (4)

10.3a		1996 Equity Incentive Plan, as amended, including the forms of incentive stock option agreement and nonstatutory stock option agreement thereunder.

10.4a		1996 Non-Employee Directors’ Stock Option Plan, as amended.

31.1		Certification, dated August 19, 2005, of Registrant’s Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification, dated August 19, 2005, of Registrant’s Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certifications, dated August 19, 2005, of Registrant’s Chief Executive Officer and Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C § 1350, as adopted).

(1)	Filed as an exhibit to Registrant’s Registration Statement on Form SB – 2 (No. 333-5054-LA) and incorporated herein by reference.

(2)	Filed as an exhibit to Registrant’s Annual Report on Form 10-K for the year ended January 29, 2005 and incorporated herein by reference.

(3)	Filed as an exhibit to Registrant’s Current Report on Form 8-K filed with the Commission on June 20, 2005 and incorporated herein by reference.

(4)	Filed as an exhibit to Registrant’s Current Report on Form 8-K filed with the Commission on August 17, 2005 and incorporated herein by reference.

a.	Denotes management contract or compensatory plan or arrangement.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


				Hot Topic, Inc. (Registrant)
Date: August 19, 2005

				/s/ Elizabeth McLaughlin
				Elizabeth McLaughlin Chief Executive Officer (Principal Executive Officer)

Date: August 19, 2005				/s/ James McGinty
				James McGinty Chief Financial Officer (Principal Financial Officer)

Exhibit Index


Exhibit No.		Document

10.3		1996 Equity Incentive Plan, as amended, including the forms of incentive stock option agreement and nonstatutory stock option agreement thereunder.

10.4		1996 Non-Employee Directors’ Stock Option Plan, as amended.

31.1		Certification, dated August 19, 2005, of Registrant’s Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification, dated August 19, 2005, of Registrant’s Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certifications, dated August 19, 2005, of Registrant’s Chief Executive Officer and Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C § 1350, as adopted).

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