Hot Topic (HOTT)

Fiscal 2006 Compared to Fiscal 2005

Net sales increased approximately $26.4 million, or 3.6%, to $751.6 million in fiscal 2006 from $725.2 million in fiscal 2005. Approximately $10.8 million of this increase is due to the 53^rd week in fiscal 2006. The components of this $26.4 million increase in net sales are as follows:

The annual average Hot Topic store volume was $0.9 million in fiscal 2006 compared to $1.0 million in fiscal 2005. Hot Topic sales of apparel category merchandise, as a percentage of total net sales, were 55% in both fiscal 2006 and 2005.

Gross margin increased approximately $13.0 million to $249.2 million in fiscal 2006 from $236.2 million in fiscal 2005. As a percentage of net sales, gross margin increased to 33.2% in fiscal 2006 from 32.6% in fiscal 2005. The significant components of this 0.6% increase in gross margin, as a percentage of net sales, are as follows:

32

Table of Contents

Selling, general and administrative expenses increased approximately $23.6 million to $227.6 million during fiscal 2006 from $204.0 million during fiscal 2005. As a percentage of net sales, selling, general and administrative expenses were 30.3% for fiscal 2006 compared to 28.2% in fiscal 2005. The total dollar increase in selling, general and administrative expenses was primarily attributable to recognizing additional impairment losses on some of our under-performing store locations, and additional payroll and other expenses required to support store growth from 783 stores at the end of fiscal 2005 to 825 stores at the end of fiscal 2006. The significant components of this 2.1% increase in selling, general and administrative expenses as a percentage of net sales are as follows:

Operating income decreased to $21.6 million during fiscal 2006 from $32.2 million during fiscal 2005. As a percentage of net sales, operating income was 2.9% in fiscal 2006 compared to 4.4% in fiscal 2005. Operating income on an average store basis was approximately $26,000 in fiscal 2006 compared to $45,000 in fiscal 2005.

Interest income, net of interest expense, and other income decreased to $1.5 million in fiscal 2006 from $4.0 million in fiscal 2005, principally from a decrease in the gift card breakage income of $3.1 million. In fiscal 2005, we recognized $3.1 million in estimated gift card breakage as a component of other income. In fiscal 2006, we recorded $1.2 million in gift card breakage as a component of net sales. 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. Fiscal 2005 was the initial adoption year in which we recognized income from gift card breakage and as a result, this income was recorded in other income. Such income has been recognized as a component of net sales in fiscal 2006, and will continue to be recognized in net sales in subsequent years.

Our effective tax rate was 40.8% and 38.1% for fiscal 2006 and 2005, respectively. The increase is due to the provision for additional contingency for tax exposure items and the implementation of SFAS 123R, which increased stock-based compensation expense for which a portion is not deductible for tax purposes.

Fiscal 2006 Compared to Fiscal 2005

Net sales increased approximately $26.4 million, or 3.6%, to $751.6 million in fiscal 2006 from $725.2 million in fiscal 2005. Approximately $10.8 million of this increase is due to the 53^rd week in fiscal 2006. The components of this $26.4 million increase in net sales are as follows:

The annual average Hot Topic store volume was $0.9 million in fiscal 2006 compared to $1.0 million in fiscal 2005. Hot Topic sales of apparel category merchandise, as a percentage of total net sales, were 55% in both fiscal 2006 and 2005.

Gross margin increased approximately $13.0 million to $249.2 million in fiscal 2006 from $236.2 million in fiscal 2005. As a percentage of net sales, gross margin increased to 33.2% in fiscal 2006 from 32.6% in fiscal 2005. The significant components of this 0.6% increase in gross margin, as a percentage of net sales, are as follows:

29

Table of Contents

Selling, general and administrative expenses increased approximately $23.6 million to $227.6 million during fiscal 2006 from $204.0 million during fiscal 2005. As a percentage of net sales, selling, general and administrative expenses were 30.3% for fiscal 2006 compared to 28.2% in fiscal 2005. The total dollar increase in selling, general and administrative expenses was primarily attributable to recognizing additional impairment losses on some of our under-performing store locations, and additional payroll and other expenses required to support store growth from 783 stores at the end of fiscal 2005 to 825 stores at the end of fiscal 2006. The significant components of this 2.1% increase in selling, general and administrative expenses as a percentage of net sales are as follows:

Operating income decreased to $21.6 million during fiscal 2006 from $32.2 million during fiscal 2005. As a percentage of net sales, operating income was 2.9% in fiscal 2006 compared to 4.4% in fiscal 2005. Operating income on an average store basis was approximately $26,000 in fiscal 2006 compared to $45,000 in fiscal 2005.

Interest income, net of interest expense, and other income decreased to $1.5 million in fiscal 2006 from $4.0 million in fiscal 2005, principally from a decrease in the gift card breakage income of $3.1 million. In fiscal 2005, we recognized $3.1 million in estimated gift card breakage as a component of other income. In fiscal 2006, we recorded $1.2 million in gift card breakage as a component of net sales. 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. Fiscal 2005 was the initial adoption year in which we recognized income from gift card breakage and as a result, this income was recorded in other income. Such income has been recognized as a component of net sales in fiscal 2006, and will continue to be recognized in net sales in subsequent years.

Our effective tax rate was 40.8% and 38.1% for fiscal 2006 and 2005, respectively. The increase is due to the provision for additional contingency for tax exposure items and the implementation of SFAS 123R, which increased stock-based compensation expense for which a portion is not deductible for tax purposes.

30

Table of Contents