<PAGE>
 
 ------------------------------------------------------------------------------
                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549

                                   FORM 10-K

[X]             ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
                  FOR THE FISCAL YEAR ENDED JANUARY 30, 1999

                                      OR

[ ]           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                    SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

FOR THE TRANSITION PERIOD FROM
_____________________________ TO ____________________________________

                          Commission File No. 0-28784

                                HOT TOPIC, INC.
            (Exact name of registrant as specified in its charter)

          CALIFORNIA                                        77-0198182
     (State or other jurisdiction of                   (I.R.S. Employer
     incorporation or organization)                    Identification No.)
 
     3410 POMONA BOULEVARD                                   91768
      POMONA, CALIFORNIA                                   (Zip Code)
   (Address of principal executive offices)

      Registrant's telephone number, including area code:  (909) 869-6373
       Securities registered pursuant to Section 12(b) of the Act:  none
          Securities registered pursuant to Section 12(g) of the Act:
                          COMMON STOCK, NO PAR VALUE
                               (Title of Class)

     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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K ____.

     The number of shares outstanding of the Registrant's Common Stock was
4,595,431 as of April 19, 1999.

     The aggregate market value of Common Stock held by non-affiliates of the
registrant as of April 19, 1999 was approximately $59,464,000, based on the
closing price on that date of Common Stock on the Nasdaq National Stock Market.*

                      DOCUMENTS INCORPORATED BY REFERENCE

     Certain portions of the Company's Definitive Proxy Statement for the annual
meeting of stockholders to be held on June 1, 1999 to be filed with the
Securities and Exchange Commission (the "Commission") no later than 120 days
after January 30, 1999, are incorporated by Reference into Part III of this Form
10-K (Items 10 through 13).

     Certain Exhibits filed with the Registrant's Registration Statement on Form
SB-2 (Registration No. 333-5054-LA), as amended, are incorporated by reference
into Part IV of this Form 10-K (Item 14).

____________
*Excludes 1,109,833 shares of Common Stock held by directors and officers and
shareholders whose beneficial ownership exceeds 10% of the shares outstanding on
April 19, 1999.  Exclusion of shares held by any person should not be construed
to indicate that such person possesses the power, direct or indirect, to direct
or cause the direction of the management or policies of the Registrant, or that
such person is controlled by or under common control with the Registrant.
<PAGE>
 
     This Annual Report on Form 10-K contains certain forward-looking statements
that involve risks and uncertainties.  The Company's actual future results could
differ materially from those statements.  Factors that could cause or contribute
to such differences include, but are not limited to, those found in this Annual
Report on Form 10-K in Part I, Item 1 under the caption "Certain Risk Factors
Related to the Company's Business," in Part II, Item 7 under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and additional factors discussed elsewhere in this Annual Report.

                                    PART I

ITEM 1.  BUSINESS

GENERAL

     Hot Topic, Inc. ("Hot Topic" or the "Company") is a rapidly growing, mall-
based specialty retailer of music-licensed and music-influenced apparel,
accessories and gift items for young men and women principally between the ages
of 12 and 22.  The Company believes teenagers throughout the United States have
similar fashion preferences, largely as a result of the nationwide influence of
MTV, music distribution, movies, television programs and fashion magazines.  The
Company opened its first store in 1989, and operated 158 stores as of January
30, 1999 in 38 states across the United States.  During fiscal 1995, the Company
significantly accelerated its store expansion program and opened 18 stores,
including its first stores in the Northeast and Midwest.  The Company opened 26,
40 and 50 additional stores during fiscal 1996, 1997 and 1998, respectively, and
in fiscal 1996 relocated two existing stores.  In fiscal 1998, the Company
opened its first "street stores," which are stores on street fronts rather than
in enclosed shopping malls.  The Company plans to open approximately 45 new
stores in fiscal 1999, eight of which were opened as of April 19, 1999. The
Company also maintains a website, (www.hottopic.com) through which it markets
its stores and store concept and sells certain of its merchandise.  The
Company's  net sales via the Internet continue to increase significantly,
although the total sales are still modest.  The company is working to redesign
the website which may effect its promotional activities and its Internet sales.

THE MARKET

     The music-licensed apparel industry began in the 1960s with bootleggers
selling T-shirts at concert venues.  Over the ensuing two decades, artists began
to realize the commercial potential of licensing their likenesses and logos to
T-shirt manufacturers and others who produced assorted merchandise.  Management
believes that the single largest impact on the music industry during the last
decade has been the success of MTV, which enables fans not only to listen to the
latest music and artists 24 hours a day, but also to see a full sight and sound
package of appearance and attitude.  According to industry estimates, in 1996
MTV programming could be seen in more than 60 million households in the United
States and in over 260 million households worldwide.  It is also estimated that
viewers in over 23 million homes watch MTV every week.  As a result, popular
artists and the fashions they wear are much more visible today than 30 years
ago.  Management believes that this increased visibility has contributed to the
increase in demand for music-licensed and music-influenced apparel and
accessories.

     Hot Topic's target customers are young men and women between the ages of 12
to 22 years old, who are passionate about music, music videos and music-inspired
fashion, and are avid MTV viewers.  The Company believes its music-oriented
merchandise appeals to teenagers from diverse socio-economic backgrounds, and
that its customers are broadly representative of the teenage population in the
United States.

                                       2.
<PAGE>
 
     Teenagers represent both a growing part of the United States population and
an increasing source of purchasing power.  According to the U.S. Department of
Commerce Bureau of the Census, the teenage population in the United States
reached approximately 31 million in 1998 and is expected to grow to
approximately 35 million by 2008, representing a projected growth rate close to
twice the rate of the overall population.  By 2010, there likely will be more
teenagers in the United States than at any other time in history.  The Company
also believes, based upon statistics released by an independent research firm,
that teenage spending has also been increasing annually, growing to an estimated
$111 billion in 1997.

BUSINESS STRATEGY

     The Company's goal is to become the leading retailer of music-licensed and
music-influenced apparel and accessories for young men and women.  The principal
elements of the Company's business strategy are as follows:

     .      FOCUS ON UNIQUE MUSIC-ORIENTED MERCHANDISE.

     Management believes that fashions and products associated with popular
music artists have a significant influence on teenagers today, who often want to
emulate their favorite artists.  The Company has developed a unique strategy
focused exclusively on offering music-licensed and music-influenced merchandise
in the mall environment.  The Company believes most of the merchandise it offers
is not available elsewhere in the mall and is often hard to find other than at
alternative shopping venues in major metropolitan areas.  Accordingly, the
Company believes it is well-positioned to capitalize on the growing teenage
population and demand for music related merchandise.

     .      OFFER "EVERYTHING ABOUT THE MUSIC."

     The Company's stores are designed to serve as a headquarters for music-
licensed and music-influenced apparel, accessories and gift items.  The
Company's slogan, "Everything About The Music," reflects the Company's broad
assortment of products, which currently consists of over 12,000 SKUs in 25
different product categories.  The Company believes its selection of music-
licensed merchandise is the most extensive assortment available in one mall
store.  The Company complements its licensed merchandise with a unique and
eclectic assortment of music-influenced apparel and accessories, and frequently
introduces new items and categories in response to changes in trends and demand.
The Company believes it has a history of being the first to offer the latest
music fashions, which, together with its assortment of merchandise, has made it
a destination store for teenagers seeking music-related products.

     .      PROMOTE MUSIC-INSPIRED CULTURE.

     Hot Topic is committed to addressing the music-oriented lifestyles of its
customers by building a culture throughout the organization that reflects a
passion for music.  Management diligently tracks alternative and rock music
trends by regularly monitoring new music, music video releases and radio station
air play, visiting nightclubs around the country and attending concerts.  The
Company also actively solicits feedback from its employees and customers.  The
Company believes these activities enable it to react quickly to emerging trends,
and provide it with a competitive advantage over retailers who do not devote the
time and resources necessary to anticipate these trends.

     .    ACTIVELY MANAGE MERCHANDISE MIX.

     Hot Topic does not dictate fashion trends, but rather seeks to identify
music artists and releases that will have strong appeal and related products
that will generate strong demand.  The Company has developed a disciplined
approach to buying and a proactive inventory management program around this

                                       3.
<PAGE>
 
strategy.  The Company often tests new merchandise in a small number of stores
before chain-wide distribution, and orders a majority of its merchandise not
more than 60 days before delivery, enabling it to respond quickly to emerging
trends.  In cases where it does not have return privileges with its vendors, Hot
Topic is aggressive in taking prompt markdowns to maintain a fresh merchandise
mix.  By actively managing the mix of categories and products in its stores, the
Company believes it is able to capitalize on emerging trends and minimize its
dependence on any particular category.  The Company believes that this approach
to managing its merchandise mix has contributed to its strong merchandise
margins and to consistent markdown rates which the Company believes are lower
than industry averages.

     .      CREATE AN ENTERTAINING STORE ENVIRONMENT.

     The Company seeks to create a compelling shopping environment that brings
into the mall elements of the alternative urban shopping experience sought by
teenagers.  Hot Topic stores are designed with an industrial warehouse theme
that incorporates dense merchandising and utilizes a professional sound system
playing alternative music releases to create a fun, high-energy store that teens
will consider "their place" to shop with friends.  The Company believes that
this atmosphere enhances the Company's image as a source for music-inspired
fashion while encouraging customers to shop in its stores for longer periods of
time.

     .      EMPHASIZE CUSTOMER SERVICE.

     Hot Topic trains its store associates to provide value-added, non-intrusive
customer service.  Sales associates are taught to greet each customer, provide
information about new music and fashion trends and suggest merchandise that
matches the customer's lifestyle and music preferences.  The Company strives to
give its teenage customers the same level of respect and attention that is
generally given to adult customers at other retail stores and to provide
friendly and informed customer service for parents.  The Company believes that a
high level of product knowledge and a commitment to music fashion create high
credibility and differentiate the Company from other teenage focused retailers.

     .      DEVELOP PRIVATE LABEL PRODUCTS FOR MUSIC-ORIENTED LIFESTYLES.

     The Company has developed private label product lines to complement and
supplement its other product offerings.  The Company's private label product
lines include, among others, Morbid Threads (apparel and hosiery) and Morbid
Metals (body jewelry).  The Company believes that these private label products
differentiate it from its competition and enhance customer loyalty through the
development of a unique brand image.

STORE LOCATIONS

     As of January 30, 1999, the Company operated 158 stores in both
metropolitan and middle markets in 38 states across the United States. The
following chart sets forth, as of  April 19, 1999, the number of stores that Hot
Topic operated in each state and the cities in which stores are located.

                                       4.
<PAGE>
 
<TABLE>
<CAPTION>
ARIZONA-2            IDAHO-1            MICHIGAN-4             NEW MEXICO-2          SO. CAROLINA-1
<S>                  <C>                <C>                    <C>                   <C>
Phoenix              Boise*             Troy                   Albuquerque(2)        Greenville
Tucson                                  Flint
                     ILLINOIS-5         Auburn                 NEW YORK-11           TENNESSEE-1
CALIFORNIA-33        West Dundee        Traverse City*         Buffalo               Antioch
Bakersfield          Bloomingdale                              Rochester
Los Angeles(13)      Aurora             MINNESOTA-5            Staten Island         TEXAS-6
Fresno               Joliet             Bloomington            Albany                Lewisville
Palm Desert          Orland Park        St. Cloud              Victor                Austin
San Diego(5)                            Duluth                 Lake Grove            San Antonio
San Francisco(5)     INDIANA-4          St. Paul               West Nyack            Mesquite
Victor Valley        Fort Wayne         Mankato                Johnson City          Woodlands
Capitola             Evansville                                Syracuse              Corpus Christi*
Citrus Heights       Lafayette          MISSOURI-2             New Hartford
Modesto              Terre Haute        St. Peters             Bay Shore             UTAH-2
Sacramento                              St. Louis                                    Salt Lake City
San Jose             IOWA-1             St. Louis*             NO. CAROLINA-1        Sandy
Berkeley             Coralville         NEBRASKA-2             Pineville
                                        Lincoln                                      VIRGINIA-1
COLORADO-6           KANSAS-2           Omaha                  OHIO-5                Springfield
Westminster          Olathe                                    Parma
Colorado Spr-(2)     Wichita            NEVADA-4               Dayton                WASHINGTON-8
Littleton-(2)                           Las Vegas(3)           No. Olmsted           Bellingham
Denver               KENTUCKY-1         Reno                   Mentor                Kennewick
                     Louisville                                Cincinnati            Seattle(2)
CONNECTICUT-5                           NEW HAMPSHIRE-3                              Silverdale
                                        Elyria*                                      Spokane(2)
Waterford            LOUISIANA-2        Manchester             OKLAHOMA-2            Tacoma
Manchester           Metairie           Nashua                 Oklahoma City        
Danbury              Monroe             Salem                  Oklahoma City*        WEST VIRGINIA-1
Waterbury            Baton Rouge*                                                    Charleston
Milford              MAINE-1            NEW JERSEY-8           OREGON-2              
                     Bangor             Mays Landing           Portland(2)           WISCONSIN-4
DELAWARE-1                              Parmus                                       Madison
Wilmington                              Rockaway               PENNSYLVANIA-8        Appleton
                     MARYLAND-3         Toms River             Philadelphia(3)       Brookfield
FLORIDA-2            Towson             Wayne                  West Mifflin          Eau Claire
Altamonte Springs    White Marsh        Deptford               Wilkes-Barre          
Coral Springs        Columbia           Woodbridge             Media
                                        Eatontown              York
GEORGIA-3            MASS.-6                                   Altoona
Duluth               Boston(2)
Kennesaw             Holyoke
Macon                Marlborough
                     Saugus
                     Trunton
</TABLE>

                                       5.
<PAGE>
 
1.  References above to Los Angeles, San Diego, San Francisco, Boston, Las
Vegas, Philadelphia and Seattle in each case include the metropolitan area of
that city. An asterisk next to a city indicates that a store has been opened in
such city during fiscal 1999.


EXPANSION STRATEGY

     The following table provides a history of the Company's store expansion
over the last five fiscal years:


<TABLE>
<CAPTION>
                                                FISCAL YEAR
                             -------------------------------------------------- 
                                1994      1995      1996     1997        1998
                             --------------------------------------------------
                                     (number of stores)
<S>                          <C>          <C>       <C>      <C>         <C>     
Stores at beginning of year      18        24          42       68         108
New Stores opened                 6        18          26       40          50
                             ---------------------------------------------------
Stores at end of year            24        42          68      108         158
                             ---------------------------------------------------
</TABLE>


     All but two of the Company's stores are currently in shopping malls.
During fiscal 1998, the Company opened two "street location" stores, one each in
Denver, Colorado and in Berkley, California.  The Company's expansion strategy
is to open stores in shopping malls in both new and existing markets throughout
the United States. The Company may open additional "street stores" in markets
that the Company believes can sustain a Hot Topic store outside the mall
environment, although the Company may elect not to aggressively expand its
"street store" concept.  The Company believes it has developed a store concept
that is successful in both metropolitan and middle markets.  Further, as a
result of the nationwide influence of MTV, music distribution, movies,
television programs and fashion magazines, the Company believes that its 12 to
22 year old target customers have similar fashion preferences throughout the
United States.

     The Company opened 50 new stores in fiscal 1998 and plans to open
approximately 45 new stores during fiscal 1999.  The Company selects and
evaluates potential store locations based on a variety of criteria including the
sales and square footage of the mall, sales of anchor stores, sales of teenage-
oriented stores, foot traffic, number of teenagers in trade area, median family
income and other factors relevant to the Company's unique merchandising
strategy.  The Company looks at similar criteria for "street store" locations.
Model statements of operations are developed for each potential location and are
measured against target financial criteria.  Hot Topic has a real estate
committee, including its Chief Executive Officer and three outside directors,
which reviews and approves all new store locations.  The Company generally seeks
potential store sites between 1,200 and 2,000 square feet and its stores
currently average approximately 1,450 square feet.

STORE-LEVEL ECONOMICS

     During fiscal 1998, the Company's 108 stores that were in operation for all
of the fiscal year generated average net sales of approximately $747,000 and
average net sales per square foot of approximately $538.  These stores also
generated average store-level operating cash flow (defined as store operating
income before depreciation and excluding changes in working capital) of
approximately

                                       6.
<PAGE>
 
$203,000, or 27% of average net sales. Capital expenditures, including leasehold
improvements, furniture and fixtures and net of landlord construction allowances
for the 50 stores opened in fiscal 1998 averaged approximately $170,000, initial
gross inventory requirements (which were partially financed by trade credit)
averaged $65,000, and pre-opening costs (which were expensed in the periods the
stores opened) averaged $19,000. Inventory requirements vary at new stores
depending on the season and on current merchandise trends. In fiscal 1998, all
of the Company's stores generated positive store-level operating income, but
there can be no assurance this trend will continue. There also can be no
assurance that in the future the average store-level sales and operating cash
flow will not vary from historical results or that the total estimated capital
expenditures for new stores will not increase.

MERCHANDISING

     The Company's stores are designed to serve as a headquarters for music-
licensed and music-influenced apparel, accessories and gift items.  Music-
licensed merchandise includes T-shirts, caps, posters, stickers, patches,
postcards, books, CDs, videos and other items.  Music-influenced merchandise
includes woven and knit tops, skirts, pants, shorts, jackets, shoes, costume
jewelry, body jewelry, sunglasses, cosmetics and gift items.  The Company
estimates that approximately half of the Company's products are music-licensed
products, and half are music-influenced products.  A key strategy of the Company
is to offer over 12,000 SKUs in 25 different product categories or
"departments." Within each category, the Company seeks to offer a broader
assortment of merchandise than is available at any other mall location.  For
example, on average, over 100 different licensed band T-shirts are carried in
each store from alternative artists such as Korn, Blink 182, Limp Bizkit,
Deftones, Rage Against the Machine, Orgy, and others; and rock artists such as
the Pink Floyd, Rob Zombie, Pantera, Metallica, Jimi Hendrix, The Doors, the
Beatles, Led Zeppelin, and others.  New items and categories are tested
regularly as customer demand and product trends evolve.

     The Company does not dictate leading edge fashion, but quickly reacts to
changes in trends and demand to keep Hot Topic stores fresh and exciting.
Further, the Company strives to identify music artists and releases that will
have strong appeal, and to quickly acquire related music-licensed products and
music-influenced merchandise, featured on music videos or otherwise, associated
with such artists and releases.

     The following table sets forth the Company's four major merchandise groups
as an approximate percentage of net sales for fiscal years 1998, 1997 and 1996:

<TABLE>
<CAPTION>
                                         PERCENTAGE OF NET SALES
                                      ---------------------------
                                      1998       1997      1996
                                      ---------------------------
<S>                                   <C>        <C>       <C>
Apparel and T-Shirts                   48%       47%       43%
Gifts                                  19        20        21
Accessories                            26        25        26
Hosiery, Shoes, and Outerwear           7         8        10
                                      ---------------------------
                                      100%      100%      100%
</TABLE>

     The Company has four lines of private label merchandise to complement and
supplement its current product offerings.  The Company believes that Hot Topic
brands play an important part in differentiating its stores from those of its
competitors and provide the Company with higher margin opportunities as compared
to other merchandise.  Management estimates that Hot Topic brands accounted for
approximately 20% of the Company's sales in both fiscal 1998 and 1997.  The
Company's proprietary brands include Morbid Makeup (cosmetics), Morbid Metals
(body jewelry), Morbid Scents (incense and oils) and Morbid Threads (men's and
women's apparel and hosiery).

                                       7.
<PAGE>
 
PURCHASING

     The Company's purchasing staff consists of a General Merchandise Manager,
two Divisional Merchandise Managers, seven buyers, and seven assistant buyers.
The purchasing staff reflects the Company's culture in that its decisions and
actions are influenced by a passion for music.  In determining which merchandise
to buy, the purchasing staff spends considerable time viewing music videos,
reviewing industry album sales, monitoring alternative radio station air play,
consulting with sales associates, reviewing customer requests, attending trade
shows and reading music and fashion industry periodicals.  In addition, the
staff regularly visits nightclubs, and attends concerts and other events that
attract young people.  The Company also conducts periodic customer focus groups
and intercept surveys, and consults with and solicits input from its store
employees, in order to draw from many different experiences and perspectives.

     Approximately half of the Company's products are licensed products.
Artists typically license their likeness to a "master licensor", the largest of
these being divisions of major record companies such as Warner Electra Atlantic
Distribution, Universal Music and Video Distribution and Sony Music
Distribution.  The master licensor often retains the rights to market T-shirts
and then may choose to sublicense to manufacturers other categories of
merchandise such as posters, stickers, patches and books.  Some artists also
retain their licensing rights and negotiate directly with licensees.  Hot Topic
buys its licensed merchandise from master licensors, licensees and directly from
artists.  The Company currently purchases licensed T-shirts from over 30
companies and other licensed products from over 50 companies.  Because of the
Company's knowledge of teenage consumers' music preferences and music-influenced
fashion, licensors often seek the Company's advice prior to licensing new
artists or product designs.  As a result, the Company sometimes receives
accommodations such as pre-ticketing of orders, early shipments of merchandise,
exclusive merchandise and vendors' acceptance of returns.

     The Company buys its unlicensed, music-influenced merchandise from a
variety of manufacturers.  The Company actively searches for new vendors that
offer unique and timely music-influenced products.  As a result, the Company at
any given time has many different vendors of different sizes, including some
from which it has not previously purchased.  Most of the products purchased from
the Company's vendors are sold under the labels of the manufacturers, and some
are sold under Hot Topic's private labels.

     In order to reduce fashion risk and maintain the ability to respond quickly
to emerging trends, Hot Topic buys a majority of its merchandise not more than
60 days in advance of delivery, and will often begin with small purchases for
testing prior to chain-wide distribution.  The Company regularly monitors store
sales by merchandise classification, SKU, color and size to determine types and
amounts of products to purchase, to detect products and trends that are emerging
or declining, and to manage the product mix in its stores to respond to the
spending patterns of its customers.  The Company also works with its vendors to
ensure that sources for new and private label products are maintained and
expanded.

     During fiscal 1998, the Company had approximately 800 vendors, certain of
which have limited financial resources and production capabilities.  No single
vendor accounted for more than 5% of the Company's merchandise purchases.  The
Company believes that its relationships with its vendors are good.

ALLOCATION AND DISTRIBUTION OF MERCHANDISE

     Allocation and distribution of the Company's inventory is addressed at the
store, merchandise classification and SKU levels using integrated third party
software.  Most merchandise is ordered in bulk and then allocated to each store
based on inventory plans and SKU performance by using proprietary software
developed by Hot Topic.  Buyers determine SKU reorder quantities by using a
proprietary

                                       8.
<PAGE>
 
automated software program which considers sales history, projected sales,
planned inventories by store, store demographics, geographic preferences, store
openings and planned markdown dates.

     The Company's Director of Planning and Allocation and nine inventory
analysts work closely with the merchandise buyers and store personnel to meet
the requirements of individual stores for appropriate merchandise in sufficient
quantities.  Hot Topic's headquarters and distribution facility, consisting of
approximately 45,000 square feet, is located in Pomona, California.  All
merchandise is delivered by vendors to this facility, where it is inspected,
price marked, entered into the Company's allocation software system, picked and
boxed for shipment to the Company's stores.  Merchandise is shipped to stores
each weekday, providing Hot Topic stores with a steady flow of reordered and new
merchandise.  Minimal back stock is maintained in the Company's distribution
facility and at its stores, so that at all times almost all of the Company's
merchandise is available for sale on the floors of its stores. To accommodate
its planned expansion in fiscal 1999 and beyond, the Company has leased a larger
building to expand the capacity of its headquarters office and merchandise
distribution facility.  Construction of the offices and installation of the
distribution equipment commenced in February 1999.  The Company presently plans
to move from its existing facility into the new facility early in the Summer of
1999.  The presently estimated cost of construction, equipment, fixtures and
furniture is approximately $4.0 to $4.5 million.  The new facility has a
projected capacity of approximately 500 stores.

STORE OPERATIONS

     Hot Topic's store operations are currently managed by  four regional
managers and 30 district or area managers who each supervise approximately eight
stores.  Individual stores are managed by a store manager and two or three
assistant managers.  A typical store has approximately two full time and six to
ten part time sales associates, depending on the season.  The hiring and
training of new employees are the responsibility of the store manager and
district manager, and the Company has established training and operations
procedures to assist them.  Additionally, Hot Topic uses a customized, automated
telephone screening system licensed from a third party to help evaluate
potential new employees, which helps streamline the Company's interview and
hiring processes at the store level.

     The Company strives to create a store environment that teenagers will
consider "their place" to shop with friends.  Hot Topic seeks to hire sales
associates who fit the profile of its target customer -- energetic people who
are knowledgeable and passionate about music and music-inspired fashion.  To
assist management in properly considering the preferences and opinions of its
target customers, selected sales associates accompany Hot Topic's buyers on
buying trips.  Further, in return for feedback on fashion and other trends,
sales associates are reimbursed for the cost of attending concerts and clubs,
and are encouraged to communicate customer requests and their own merchandise
ideas to management.  Hot Topic encourages its sales associates to dress and
accessorize themselves with the same fashionable merchandise that is sold in its
stores.  Management believes its music-based culture and its interaction with
and respect for sales associates has led to associate turnover rates that the
Company believes are lower than the industry average.

     The primary objective of sales associates is to provide superior, informed
customer service in order to maximize sales and minimize inventory shrinkage.
Store management is provided with daily store sales and weekly category sales
results so that performance can be measured against set goals.  Postage-paid
"report cards" are provided in all stores for customers to grade performance and
make recommendations to Company management.  The Company strives to give its
teenage customers the same level of respect and attention that is generally
given to adult customers at other retail stores.  Associates are trained to
greet each customer, to inform the customer about new music fashion trends and
to suggest merchandise that matches the customer's lifestyle and music
preferences.  Hot Topic also strives to provide friendly and informed customer
service for parents.  The Company provides a listing of music artists' national
tour dates at each of its stores.  The Company believes that its high level of
product knowledge and service differentiates Hot Topic from other teenage-
focused retailers.

                                       9.
<PAGE>
 
     Store and district managers are compensated with a base salary and may
qualify to receive a quarterly bonus based on sales and inventory shrinkage.
Additionally, district and area managers may also qualify to receive periodic
stock option grants, and certain employees are eligible to participate in the
Company's Employee Stock Purchase Plan.  The Company believes that its continued
success is dependent in part on its ability to attract, retain and motivate
qualified employees.  In particular, the success of the Company's expansion
program will be dependent on its ability to promote and/or recruit qualified
district and store managers.  To date, the majority of its store managers have
been promoted from within the Company.

STORE ENVIRONMENT

     Hot Topic stores are designed with an industrial warehouse theme that
incorporates dense merchandising, and the latest music releases are played on a
professional sound system to create a high-energy and fun shopping environment.
The Company believes this atmosphere enhances the Company's image as a source
for music-inspired fashion while encouraging customers to shop in its stores for
longer periods of time.

     Stores are constructed and fixtured to maximize merchandising flexibility,
which enables the Company to highlight new product offerings and create a
compelling shopping environment.  Bi-monthly planograms are developed to assist
store managers in displaying merchandise in an exciting and dynamic manner.  In
addition, sales associates are encouraged to wear the Company's products, which
the Company believes contributes to the overall atmosphere of its stores.

MARKETING AND PROMOTION

     The Company generally locates its stores in high traffic malls located
within areas of high teenage population and relies on existing customers, sales
associates, store design and exciting music to attract new customers to its
stores.  Special artist events are run in conjunction with record companies and
licensed merchandise companies to promote new bands, music and movie releases.
Hot Topic has found these methods to be more effective than traditional media
advertising. The Company also maintains a website, (www.hottopic.com) through
which it markets its stores and store concept and sells certain of its
merchandise.  The Company's  net sales via the Internet continue to increase
significantly, although the total sales are still modest.  The company is
working to redesign the website which may effect its promotional activities and
its Internet sales.

MANAGEMENT INFORMATION SYSTEMS

     Hot Topic's information systems provide integration of store,
merchandising, distribution and financial systems.  These systems include SKU
and classification inventory tracking, purchase order management, open to buy,
merchandise distribution, automated ticket making, general ledger, sales audit,
accounts payable, fixed asset management, payroll and integrated financials.
These systems operate on a Unix platform with a central IBM minicomputer and a
PC NT server network.  Sales are updated daily in the merchandising reporting
systems by polling sales information from each store's point-of-sale ("POS")
terminals.  The Company's POS system consists of registers providing price look-
up, time and attendance, e-mail and credit card and check authorization.
Through automated nightly two-way electronic communication with each store,
sales information, payroll hours and e-mail messages are uploaded to the host
system, and receiving, price changes and system maintenance are downloaded
through the POS devices.  The Company evaluates information obtained through
daily polling to implement merchandising decisions regarding reorders, markdowns
and allocation of merchandise.

     The Company is presently evaluating future long-term management information
system needs and the corresponding hardware and software upgrades at its stores
and its office and distribution center that may be necessary.  The scope and
timing of such upgrades as well as the specific hardware and

                                      10.
<PAGE>
 
software have not yet been fully identified and evaluated. However, the Company
presently estimates that the expenditures for management information system
upgrades in fiscal 1999 and fiscal 2000 will be approximately $3 million for
both years combined, which is substantially greater than such historical annual
expenditures.

YEAR 2000

The year 2000 issue exists because many computer applications currently use two-
digit date fields to designate a year. As the century date occurs, time-
sensitive software may recognize a date using "00" as the year 1900 rather than
that have the year 2000. This could result in the computer shutting down or
performing incorrect computations, leading to disruptions in normal business
processing.

The Company's plan to resolve the Year 2000 issue involves the following four
phases: assessment, remediation, testing and implementation. During 1998, the
Company completed its assessment of all critical systems and developed a plan to
bring these systems into compliance. The Company has obtained information from
the vendors for its integrated store, merchandising, distribution and financial
systems as to required modifications and timing of those modifications to ensure
that the systems will be Year 2000 compliant. These efforts began in mid-1998
and are scheduled to be completed in the second and third quarters of fiscal
1999. Early in 1999, the hardware for these systems was tested and as required,
replacement hardware and operating systems were installed. The Company's plans
call for the testing of the vendor's revised software in first and second
quarters of fiscal 1999, and full implementation during the second and third
quarters of fiscal 1999. The cost of the Company's Year 2000 problem initiatives
is expected to be less than $100,000.

The Company does not have systems that interface directly with significant third
party vendors and has queried its significant suppliers of merchandise and
services that do not share information systems with the Company (external
agents).  To date, the Company is not aware of any external agent with a Year
2000 issue that would materially impact the Company's results of operations,
liquidity or capital resources.  However, the Company has no means of ensuring
that external agents will be Year 2000 ready.  The inability of external agents
to complete their year 2000 resolution process in a timely fashion could have a
material impact on the Company.  The effect of non-compliance by external agents
is not determinable.

The Company has not yet completed its contingency plan with respect to a worst
case scenario in the event of non-compliance by external agents.  The Company
does not presently believe that an interruption in the supply of merchandise
would  have a significant adverse impact on its operations since it purchases
merchandise from over 800 vendors, none of which historically supplies more than
approximately 5% of the Company's annual purchases.  However,  the Company may
increase inventory levels of certain merchandise late in calendar 1999 to offset
the risk that certain vendors may be adversely affected by Year 2000 issues.
The Company presently uses United Parcel Service ("UPS") to ship merchandise to
its stores.   The Company has contacted UPS regarding Year 2000 compliance and
received written confirmation from UPS that UPS believes it will be fully
compliant by December 31, 1999.

While the Company believes its planning efforts are adequate to address its Year
2000 concerns, there can be no guarantee that the systems of other companies on
which the Company's systems and operations rely will be converted on a timely
basis and will not have a material adverse effect on the Company.

                                       11
<PAGE>
 
TRADEMARKS

     The Company has registered on the Principal Register of the United States
Patent and Trademark Office its mark "Hot Topic" and the "Morbid Threads" mark
for clothing.  Applications have been made for "Morbid Makeup," "Morbid Scents,"
"Morbid Metals," "Morbid Adornments," and "Rock Wall."  Each federal
registration is renewable indefinitely if the mark is in use at the time of the
renewal.  Applications have been made to register "Everything About the Music"
in the United States.  The Company is not aware of any claims of infringement or
other challenges to the Company's right to use its marks in the United States.
The Company also has additional registrations and pending applications in
foreign jurisdictions.

COMPETITION

     The teenage retail apparel and accessory industry is highly competitive and
the Company expects competition in its niche to increase.  The Company competes
with other retailers for vendors and for teenage and college age customers,
suitable retail locations and qualified employees and management personnel.  Hot
Topic currently competes with street alternative and vintage clothing stores
located primarily in metropolitan areas and with other mall-based teenage-
focused retailers such as The Buckle, Millers Outpost, Inc., Pacific Sunwear of
California, Inc., Spencer Gifts, Inc., Urban Outfitters, Inc., The Wet Seal,
Inc., Gadzooks, Inc. and, to a lesser extent, with music stores. Competition
from mail order catalogs of apparel and accessories targeting the teen customer
has increased in recent years.  Many of the Company's competitors are larger and
have substantially greater financial, marketing and other resources than the
Company.  The principal factors of competition in the Company's business are
merchandise selection, customer service, store location and price.

EMPLOYEES

     The Company employed approximately 525 full-time and 1,128 part-time
employees at April 10, 1999.  Of the Company's 1,653 employees, 124 were
corporate and distribution center personnel and 1,529 were store employees.  The
number of part-time employees fluctuates with seasonal needs.  None of the
Company's employees is covered by a collective bargaining agreement.  The
Company considers its employee relations to be good.

EXECUTIVE OFFICERS

     The executive officers of the Company and their ages at April 19, 1999 are
as follows:

<TABLE>
<CAPTION>
         NAME              AGE                POSITION

<S>                        <C>  <C>
Orval D. Madden...........  50  President, Chief Executive Officer and Director

Jay A. Johnson............  53  Chief Financial Officer and Assistant Secretary

Elizabeth M. McLaughlin...  38  Senior Vice President, General Merchandise
                                 Manager

Marc R. Bertone...........  42  Vice President, Real Estate and Construction

M. Reid Killen ...........  41  Vice President, Information Technology

Roger Shively ............  51  Vice President, Human Resources
</TABLE>

                                       12
<PAGE>
 
     Orval D. Madden founded Hot Topic in 1988, and has been the Company's
President and Chief Executive Officer and a Director since its inception.  Prior
to founding Hot Topic, Mr. Madden was a Senior Vice President of Federal
Department Stores' Children's Place and Accessory Place divisions, and was a
Divisional Vice President for Carter-Hawley-Hale Stores' Broadway and
Weinstock's Department Store divisions.  In 1993, Mr. Madden was recognized as
regional California retailing "Entrepreneur Of The Year" in a competition
sponsored by Ernst & Young, Merrill Lynch, and Inc. Magazine.

     Jay A. Johnson has been Chief Financial Officer and Assistant Secretary of
the Company since May 1995.  From January 1993 to May 1995, he was Vice
President/Chief Financial Officer of Frame-n-Lens Optical, Inc., a national
optical retailer with approximately 300 stores.  From July 1978 to July 1992,
Mr. Johnson held senior financial management positions at one manufacturing and
two retail companies.  Mr. Johnson is a certified public accountant.

     Elizabeth M. McLaughlin has been the Company's Senior Vice President,
General Merchandise Manager, since June 1998.  From June 1996 through May 1998,
Ms. McLaughlin was the Company's Vice president, General Merchandise Manager and
from May 1993 through May 1996, Ms. McLaughlin was the Company's Vice President,
Operations.  From 1985 to May 1993, she held various positions with Millers
Outpost including, Divisional Merchandise Manager.  From 1978 to 1985, she held
various positions with The Broadway.

     Marc R. Bertone has been Vice President, Real Estate and Construction, of
the Company since August 1994.  Mr. Bertone has 15 years of leasing and legal
experience, and from November 1988 to August 1994, served as Vice President and
General Counsel for The Wet Seal, Inc., a specialty retailer.  Mr. Bertone was
admitted to the California Bar in June 1982.

     M. Reid Killen has been Vice President, Information Technology of the
Company since July 1998.  From June 1994 to July 1998, Mr. Killen was Director
of  Applications Development at The Gymboree Corporation.  From  September 1990
to May 1994, Mr. Killen was a Senior Business Analyst at The Gap, Inc.

     Roger Shively has been Vice President, Human Resources of the Company since
July 1998.   Mr. Shively served as the Vice President, Human Resources at Panda
Management Company from March 1997 to July 1998 and at CKE Restaurants, Inc.
from August 1991 to August 1994.


            CERTAIN RISK FACTORS RELATED TO THE COMPANY'S BUSINESS

     In addition to risks identified else where in this Annual Report, the
Company is subject to other risks, including the following risk factors:

     Implementation and Management of Aggressive Growth Strategy

     The Company's net sales and net income have grown significantly during the
past several years, primarily as a result of the opening of stores and, to a
lesser extent, the introduction of new products and categories.  Fifty of the
Company's 158 stores opened as of January 30, 1999 had been open for less than
one full year.  The Company intends to continue to pursue an aggressive growth
strategy for the foreseeable future, and its future operating results will
depend largely upon its ability to open and operate stores successfully and to
manage a larger business profitably.  The Company anticipates opening
approximately 45 stores during fiscal 1999, which will result in a significant
increase in the number of

                                       13
<PAGE>
 
stores operated by the Company. Through fiscal 1994, all of the Company's stores
were located in the Western United States. In fiscal 1995, the Company expanded
into new markets by opening stores in the Northeastern and Midwestern regions of
the United States. The Company plans to continue to enter new markets in various
regions of the United States, and approximately one-half of its stores opened in
fiscal years 1996, 1997 and 1998 were in new markets. 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
the Company in its existing stores and markets. In addition, there can be no
assurance that the Company's expansion within its existing markets will not
adversely affect the individual financial performance of the Company's existing
stores or its overall results of operations or that new stores will achieve
sales and profitability levels consistent with existing stores. The Company will
need to continually evaluate the adequacy of its store management and management
information and distribution systems to manage its planned expansion. There can
be no assurance that the Company will anticipate all of the changing demands
that its expanding operations will impose on such systems, and the failure to
adapt its systems and procedures to such changing demands could have a material
adverse effect on the Company's business, results of operations and financial
condition. There can be no assurance that the Company will successfully achieve
its expansion targets or, if achieved, that planned expansion will result in
profitable operations.

     The Company's ability to open stores and the performance of such stores
will depend upon many factors, including, among others, the Company's ability to
identify and enter new markets, locate suitable store sites, negotiate
acceptable lease terms, hire and train store managers and sales associates and
obtain adequate capital resources on acceptable terms.  Early in its history,
the Company encountered difficulties in leasing certain store sites.  The
Company believes these difficulties were in part due to the Company's level of
capitalization and its limited operating history at such time.  The Company also
believes these difficulties were in part due to the Company's new, unproven
store concept, and apprehension on the part of mall operators concerning the
Company's teenage customers.  There can be no assurance that the Company will
not face resistance from mall operators or others in the future.  Any
restrictions on the Company's ability to expand or to offer a broad assortment
of merchandise could have a material adverse effect on the Company's business,
results of operations and financial condition.

     Fluctuations in Comparable Store Sales Results

     A variety of factors affect the Company's comparable store sales including,
among others, the timing of releases of new music-related products, music and
fashion trends, the general retail sales environment, the Company's ability to
efficiently source and distribute products, changes in the Company's merchandise
mix and the Company's ability to execute its business strategy efficiently.  The
Company's comparable store sales results have fluctuated significantly in the
past and the Company believes that such fluctuations may continue.  The
Company's comparable store sales results for fiscal  1994, 1995, 1996, 1997 and
1998 were 20.3%, (0.9%), 8.9%, 2.2% and 0.4%, respectively.  The Company's
comparable store sales results were 5.7%, 0.7%, 0.6% and 2.7% for the first,
second, third and fourth quarters, respectively, of fiscal 1997 and  (0.6%),
2.0%, 9.5% and (5.9%) for the first, second, third and fourth quarters,
respectively, of fiscal 1998.  Past comparable store sales results are no
indication of future results, and there can be no assurance that the Company's
comparable store sales results will not decrease in the future.  The Company's
comparable store sales results could cause the price of the Common Stock to
fluctuate substantially.

     Dependence on and Changes in Music and Fashion Trends

     The Company's profitability is largely dependent upon (i) the continued
popularity of alternative and rock music and music videos among teenagers and
college age adults, (ii) the emergence of new artists and the success of music
releases and music-related products, (iii) the continuance of a significant
level of teenage spending on music-licensed and music-influenced products, and
(iv) the Company's ability to anticipate and keep pace with the music, fashion
and merchandise preferences of its customers.

                                       14
<PAGE>
 
The popularity of particular types of music, artists, styles and brands is
subject to change. The Company's failure to anticipate, identify or react
appropriately to changing trends, as well as the making of music or fashion
misjudgments, could lead to, among other things, excess inventories and higher
markdowns, which could have a material adverse effect on the Company's business,
results of operations and financial condition, and on its image with its
customers.

     Impact of Economic Conditions; Minimum Wage Rates

     Certain economic conditions affect the level of consumer spending on
merchandise offered by the Company, including, among others, business
conditions, interest rates, taxation and consumer confidence in future economic
conditions.  The Company is also dependent upon the continued popularity of
malls as a shopping destination and the ability of mall anchor tenants and other
attractions to generate customer traffic for its stores.  A decrease in mall
traffic would adversely affect the Company's growth, net sales, comparable store
sales results and profitability.  In addition, a significant number of the
Company's stores are concentrated in the Western United States, and as a result
a deterioration in economic conditions in that region could particularly affect
the Company's business, results of operations and financial condition.

     Changes to federal minimum wage laws in each of 1996 and 1997 raised the
mandatory minimum wage.  California and other states have also enacted increases
in State required minimum wages that are higher than the Federal requirements.
Statutory increases in federal and state minimum wages could adversely affect
the Company's profitability.  The recent federal and state increase and any
other such increases will raise minimum wages above current wage rates of
certain of the Company's employees, and competitive factors could require
corresponding increases in higher employee wage rates, any of which would
increase the Company's expenses and adversely affect results of operations.

     Quarterly Results and Seasonality

     The Company's quarterly results of operations have and are expected to
continue to 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-related products, shifts in timing of certain
holidays, changes in the Company's merchandise mix and overall economic
conditions.  The Company's business is also subject to seasonal influences, with
heavier concentrations of sales during the Christmas holiday, the back-to-school
season and other periods when school is not in session.  As is the case with
many retailers of apparel, accessories and related merchandise, the Company
typically experiences lower net sales and operating losses during the first
fiscal quarter.  The Company has experienced quarterly losses in the past and
may experience such losses in the future.  Because of these fluctuations in net
sales and net income (loss), the results of operations of any quarter are not
necessarily indicative of the results that may be achieved for a full fiscal
year or any future quarter.

     Dependence on Key Vendors

     The Company's performance depends on its ability to purchase current music-
related merchandise in sufficient quantities at competitive prices. The Company
has many sources of merchandise, with the largest vendor supplying approximately
5% of the Company's merchandise purchases in fiscal 1998.  Substantially all of
the Company's music-licensed products are available only from vendors that have
exclusive license rights.  In addition, many of the Company's music-influenced
products are acquired from small, specialized vendors that create unique
products primarily for the Company.  The Company's smaller vendors generally
have limited resources, production capacities and operating histories, and some
of the Company's vendors have limited the distribution of their merchandise in
the past.  The Company has no long-term purchase contracts or other contractual
assurances of continued supply, pricing or access to new products.  There can be
no assurance that the

                                       15
<PAGE>
 
Company will be able to acquire desired merchandise in sufficient quantities on
terms acceptable to the Company in the future; or that any inability to acquire
suitable merchandise, or the loss of one or more key vendors, will not have a
material adverse effect on the Company's business, results of operations and
financial condition.

     Dependence on Key Personnel

     The Company's performance depends largely on the efforts and abilities of
senior management, particularly Orval Madden, the Company's President, Chief
Executive Officer and founder.  The loss of Mr. Madden's services or the
services of other members of the management team could have a material adverse
effect on the Company's business, results of operations and financial condition.
The Company has a $500,000 key-man life insurance policy on Mr. Madden.  There
can be no assurance that Mr. Madden and the Company's existing management team
will be able to manage the Company or its growth or that the Company will be
able to attract and retain additional qualified personnel as needed in the
future.

     Uncertainties Regarding Distribution of Merchandise

     To accommodate its planned expansion in fiscal 1999 and beyond, the Company
has leased a larger building to expand the capacity of its headquarters office
and merchandise distribution facility.  Construction of the offices and
installation of the distribution equipment commenced in February 1999.  The
Company presently plans to move from its existing facility into the new facility
early in the summer of 1999.  The presently estimated cost of construction,
equipment, fixtures and furniture is approximately $4.0 to $4.5 million.  The
new facility has a projected capacity of approximately 500 stores. The Company
anticipates that in fiscal 1999 the new headquarters office and distribution
facility will negatively impact the results of operations, as the Company will
be unable to leverage the higher occupancy costs for the larger facility.
Although the Company believes that it has carefully has planned the move, there
can be no assurance that the move to the new facility will not cause disruptions
that could materially adversely affect the Company's business, results of
operations and financial condition.

     Further, the Company relies upon the United Parcel Service and Fedex for
its product shipments, including shipments to and from all of its stores, and
accordingly is subject to the risks, including employee strikes and inclement
weather, associated with United Parcel Service's and Fedex's ability to provide
delivery services to meet the Company's shipping needs.  The Company is also
dependent upon temporary employees to adequately staff its distribution
facility, particularly during busy periods, such as during the Christmas season
and while multiple stores are opening.  There can be no assurance that the
Company will continue to receive adequate assistance from its temporary
employees, or that there will continue to be sufficient sources of temporary
employees.

     Failure to Authenticate Licensing Rights

     The Company purchases licensed merchandise from a number of suppliers who
hold manufacturing and distribution rights under the terms of certain licenses.
The Company generally relies upon vendors' representations concerning
manufacturing and distribution rights and does not independently verify whether
these vendors legally hold adequate rights to licensed properties they are
manufacturing or distributing.  If the Company acquires unlicensed merchandise,
it could be obligated to remove such merchandise from its stores, incur costs
associated with destruction of merchandise if the distributor is unwilling or
unable to reimburse the Company, 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 the
Company's business, results of operations and financial condition.

                                       16
<PAGE>
 
     Competition

     The retail apparel and accessory industry is highly competitive.  The
Company competes with other retailers for vendors and for teenage and college
age customers, suitable retail locations and qualified employees and management
personnel.  Hot Topic currently competes with street alternative stores located
primarily in metropolitan areas and with other mall-based teenage-focused
retailers such as The Buckle, Millers Outpost, Inc., Pacific Sunwear of
California, Inc., Spencer Gifts, Inc., Urban Outfitters, Inc., The Wet Seal,
Inc., Gadzooks, Inc., and, to a lesser extent, with music stores.  Competition
from mail order catalogs of apparel and accessories targeting the teen customer
has increased in recent years.  Many of the Company's competitors are larger and
have substantially greater financial, marketing and other resources than the
Company.  Direct competition with these and other retailers may increase
significantly in the future, which could require the Company, among other
things, to lower its prices and/or take other measures.  Increased competition
could have a material adverse effect on the Company's business, results of
operations and financial condition.

     Price Volatility

     The 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 the market price of the Common
Stock without regard to the operating performance of the Company.  In addition,
the Company believes that factors such as quarterly fluctuations in the
financial results of the Company, fluctuations in the Company's comparable store
sales, announcements by other apparel, accessory and gift item retailers, the
trading volume of the Company's Common Stock in the public market, the condition
of the overall economy and the condition of the financial markets could cause
the price of the Common Stock to fluctuate substantially.

     Anti-takeover Matters

     The Company's Amended and Restated Articles of Incorporation and Bylaws
contain provisions that may have the effect of delaying, deterring or preventing
a takeover of the Company that shareholders may consider to be in their best
interests.  For instance, the Company's Amended and Restated Articles of
Incorporation and Bylaws prohibit shareholder action by written consent and
include certain "fair price provisions." Additionally, the Board of Directors
has the authority to issue up to 10,000,000 shares of "blank check" preferred
stock having such rights, preferences and privileges as designated by the Board
of Directors without shareholder approval.

     Influence of Existing Shareholders

     As of March 1, 1999, the Company's executive officers, directors and their
affiliates beneficially owned approximately 26% of the Company's outstanding
shares of Common Stock.  As a result, these shareholders, if acting together,
would be able to influence matters requiring approval by the shareholders of the
Company, including the election of a majority of the directors.  The voting
power of these shareholders under certain circumstances could have the effect of
delaying or preventing a change in control of the Company.  The Company has
entered into agreements with its executive officers and directors indemnifying
them against losses they may incur in legal proceedings arising from their
service to the Company.

ITEM 2.    PROPERTIES

     All of the Company's existing store locations are leased by the Company,
with lease terms expiring between 2001 and 2009.  The leases for most of the
existing stores are for terms of ten years and provide for contingent rent based
upon a percent of sales in excess of specified minimums.  Leases for future
stores will likely include similar contingent rent provisions.

                                       17
<PAGE>
 
     The Company's present headquarters office and distribution center are
located in Pomona, California, and are occupied under the terms of a lease
covering approximately 45,000 square feet.  The lease is scheduled to expire in
September 1999.

     To accommodate its planned expansion in fiscal 1999 and beyond, the Company
has leased a 125,000 square foot building to expand the capacity of its
headquarters office and merchandise distribution facility.  The lease is for a
five year term with two options to extend the lease, each for a three year
period.  Construction of the offices and installation of the distribution
equipment commenced in February 1999.  The Company presently plans to move from
its existing facility into the new facility early in the summer of 1999.  The
presently estimated cost of construction, equipment, fixtures and furniture is
approximately $4.0 to $4.5 million.  The new facility has a projected capacity
of approximately 500 stores.   The annual base rent for the initial five year
term is approximately $525,000.

ITEM 3.    LEGAL PROCEEDINGS

     The Company is not a party to any material legal proceedings.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     Not applicable.

                                    PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

     The Common Stock of the Company is traded on the Nasdaq National Market
under the symbol "HOTT".  The Company consummated its initial public offering in
September 1996 at a price of $18.00 per share.  The following table sets forth,
for the periods indicated, the high and low "sales" prices of the shares of
Common Stock of the Company, as reported on the Nasdaq National Market.  Such
quotations represent inter-dealer prices without retail markup, markdown or
commission and may not necessarily represent actual transactions.

<TABLE>
<CAPTION>
      1998                    HIGH          LOW
                           ---------      --------
<S>                        <C>            <C>
First Quarter              $29 3/4        $22 5/8
Second Quarter             $28 7/8        $20
Third Quarter              $23            $12
Fourth Quarter              25 1/8        $11 5/16
 
      1997                    HIGH          LOW
                           ---------      ---------
First Quarter              $29 3/4        $17 1/2
Second Quarter             $30 3/4        $15 1/2
Third Quarter              $22 1/2        $15 1/8
Fourth Quarter             $26 1/8        $16 3/16
</TABLE>


     On April 1, 1999, the last sales price of the Common Stock as reported on
the Nasdaq National Market was $18.75 per share.  As of April 1, 1999, there
were approximately 250 holders of record of the Company's Common Stock.  This
number does not reflect the number of beneficial holders of the Company's Common
Stock, which the Company believes to be in excess of 800 holders.

                                       18
<PAGE>
 
     The Company has not paid any cash dividends since inception and does not
anticipate paying any cash dividends in the foreseeable future.

                                       19
<PAGE>
 
ITEM 6.   SELECTED FINANCIAL DATA

     The following selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Financial Statements and Notes thereto included elsewhere in
this Annual Report on Form 10-K.

HOT TOPIC, INC. AND 
SUBSIDIARIES
SELECTED FINANCIAL DATA:

<TABLE> 
<CAPTION> 
                                                                     FISCAL YEAR
                                     ----------------------------------------------------------------------------
                                         1998           1997            1996             1995           1994
                                     ------------  --------------  ---------------  --------------  -------------
                                     (In thousands, except per share data, number of stores, comparable store
                                     sales and sales per square foot)
<S>                                  <C>           <C>             <C>             <C>              <C>     
STATEMENT OF OPERATIONS DATA:
Net sales                               $103,371         $70,532          $43,618        $23,632         $14,002
Cost of goods sold, including
buying, distribution and
occupancy costs                           65,855          44,417           27,049         15,067           9,059
                                        --------         -------          -------        -------         -------
Gross margin                              37,516          26,115           16,569          8,565           4,943
Selling, general and
administrative expenses                   29,077          19,862           12,846          7,981           4,527
                                        --------         -------          -------        -------         -------
Operating income                           8,439           6,253            3,723            584             416
Interest income, net                         931             901              382            143              79
                                        --------         -------          -------        -------         -------
Income before income taxes                 9,370           7,154            4,105            727             495
Income taxes                               3,367           2,611            1,535            291             203
                                        --------         -------          -------        -------         -------
Net income                              $  6,003         $ 4,543          $ 2,570        $   436         $   292
Net income per share:
    Basic                                  $1.25           $0.97            $0.71          $0.14           $0.11
    Diluted                                $1.21           $0.92            $0.66          $0.14           $0.11
Weighted average shares outstanding
   Basic                                   4,817           4,690            3,628          3,082           2,744
   Diluted                                 4,956           4,940            3,899          3,135           2,759
 
SELECTED OPERATING DATA:
Number of stores at year end                 158             108               68             42              24
Comparable stores sales
increase (decrease)                          0.4%            2.2%             8.9%          (0.9%)          20.3%
Average sales per square foot           $    542         $   565          $   578        $   572         $   571
Average sales per store (000s)          $    772         $   769          $   748        $   705         $   692
BALANCE SHEET DATA:
Working capital                         $ 28,432         $29,230          $29,247        $ 5,857         $ 4,087
Total assets                              58,764          51,953           44,033         14,959           9,119
Long-term obligations,
including current potion                     120             161               48             34              24
Redeemable preferred stock                     -               -                -         11,245           6,583
Shareholders' equity                    $ 48,749         $44,736          $39,069        $   785         $ 1,004
</TABLE>

                                       20.
<PAGE>
 
                                   HOT TOPIC



ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
          RESULTS OF OPERATIONS

GENERAL

     Hot Topic is a mall-based specialty retailer of music-licensed and music-
influenced apparel, accessories and gift items for young men and women
principally between the ages of 12 and 22.  The Company opened its first store
in 1989, and operated 158 stores in 38 states across the United States as of
January 30, 1999.  The Company opened 18 stores during fiscal 1995, including
its first 12 stores in the Midwest and Northeast; 26 stores during fiscal 1996,
most of which are in new markets in the Midwest and Northeast adjacent to
markets entered in fiscal 1995; 40 stores during fiscal 1997, both in existing
markets and in 12 additional states; and 50 stores during fiscal 1998, both in
existing markets and in 6 additional states.

     The Company operates on a 52 or 53 week fiscal year which ends on the
Saturday nearest to January 31.  Fiscal 1996, 1997 and 1998 were 52-week years.

RESULTS OF OPERATIONS

     The following table sets forth, for the periods indicated, certain selected
statement of operations data expressed as a percentage of net sales and certain
store data:

<TABLE>
<CAPTION>
                                                                             FISCAL YEAR
                                                                -------------------------------------------
                                                                   1998             1997            1996
                                                                -----------      ----------     -----------  
<S>                                                             <C>              <C>            <C>
Net sales                                                          100.0%           100.0%           100.0%
Cost of goods sold, including buying, distribution &
occupancy costs                                                     63.7%            63.0%            62.0%
                                                               ------------     -----------     ----------- 
Gross margin                                                        36.3%            37.0%            38.0%
Selling, general and
  administrative expenses                                           28.1%            28.2%            29.5%
                                                               ------------     -----------     -----------
Operating income                                                     8.2%             8.8%             8.5%
Interest income, net                                                 0.9%             1.3%             0.9%
                                                               ------------     -----------     -----------
Income before income tax                                             9.1%            10.1%             9.4%
Provision for income taxes                                           3.3%             3.7%             3.5%
                                                               ------------     -----------     -----------
Net income                                                           5.8%             6.4%             5.9%
                                                               ============     ===========     =========== 
Number of stores at year end                                       158              108               68
                                                               ============     ===========     ===========
Comparable store sales increase                                      0.4%             2.2%             8.9%
                                                               ============     ===========     ===========
</TABLE> 

FISCAL 1998 COMPARED TO FISCAL 1997

     Net sales increased approximately $32.9 million, or 46.6%, to $103.4
million in fiscal 1998 from $70.5 million in fiscal 1997.  Net sales for the 50
stores opened during fiscal 1998 and for those stores not yet qualifying as
comparable stores contributed $32.7 million of the net sales increase.
Comparable store sales increased 0.4% in fiscal 1998 and contributed $200,000 of
the increase in net sales.    Apparel and T-shirts increased to 48% of net sales
in fiscal 1998 from 47% of net sales in fiscal 1997.

                                      21.
<PAGE>
 
                                   HOT TOPIC


     Gross margin increased approximately $11.4 million to $37.5 million in
fiscal 1998 from $26.1 million in fiscal 1997.  As a percentage of net sales,
gross margin decreased to 36.3% in fiscal 1998 from 37.0% in fiscal 1997,
principally due to higher occupancy and distribution expenses, as a percentage
of sales.

     Selling, general and administrative expenses increased approximately $9.2
million to $29.1 million during fiscal 1998 from $19.9 million during fiscal
1997, but decreased slightly as a percentage of net sales to 28.1% in fiscal
1998 from 28.2% in fiscal 1997.  The decrease as a percentage of net sales was
primarily due to a reduction of corporate overhead expense as a percentage of
net sales due to the operating leverage achieved through the Company's larger
store base offset in part by an increase in store payroll expense and store
operating expenses.

     Operating income increased approximately $2.2 million to $8.4 million
during fiscal 1998 from $6.2 million during fiscal 1997.  As a percentage of net
sales, operating income decreased to 8.2% in fiscal 1998 from 8.8% in fiscal
1997, principally from the lower gross margin.

     Interest income, net, increased slightly to $931,000 during fiscal 1998
from $901,000 during fiscal 1997.

     The Company's effective tax rate was 35.9% in fiscal 1998 and 36.5% in
fiscal 1997.  The variance from an expected rate of approximately 40% in both
fiscal 1998 and 1997 is a result of a significant portion of each fiscal year's
interest income being non-taxable.

FISCAL 1997 COMPARED TO FISCAL 1996

     Net sales increased approximately $26.9 million, or 61.7%, to $70.5 million
in fiscal 1997 from $43.6 million in fiscal 1996.  Net sales for the 40 stores
opened during fiscal 1997 and for those stores not yet qualifying as comparable
stores contributed $26.1 million of the net sales increase.  Comparable store
sales increased 2.2% in fiscal 1997 and contributed $800,000 of the increase in
net sales.  The increase in net sales in fiscal 1997 was principally
attributable to increased apparel and T-shirt sales.  Apparel and T-shirts
increased to 47% of net sales in fiscal 1997 from 43% of net sales in fiscal
1996.

     Gross margin increased approximately $9.5 million to $26.1 million in
fiscal 1997 from $16.6 million in fiscal 1996.  As a percentage of net sales,
gross margin decreased to 37.0% in fiscal 1997 from 38.0% in fiscal 1996,
principally due to lower margin on the merchandise sold resulting from a shift
in the Company's product mix toward apparel categories.

     Selling, general and administrative expenses increased approximately $7.0
million to $19.9 million during fiscal 1997 from $12.8 million during fiscal
1996, but decreased as a percentage of net sales to 28.2% in fiscal 1997 from
29.5% in fiscal 1996.  The decrease as a percentage of net sales was primarily
due to a reduction of corporate overhead expense as a percentage of net sales
due to the operating leverage achieved through the Company's larger store base
offset in part by an increase in store payroll expense.  The increase as a
percentage of net sales in store payroll expense was principally attributable to
increases in Federal and State minimum wage rates.

     Operating income increased approximately $2.5 million to $6.2 million
during fiscal 1997 from $3.7 during fiscal 1996.  As a percentage of net sales,
operating income increased to 8.8% in fiscal 1997 from 8.5% in fiscal 1996,
principally from the leveraging of selling, general and administrative expenses.

     Interest income, net, increased approximately $519,000 to $901,000 during
fiscal 1997 from $382,000 during fiscal 1996, principally due to higher average
cash balances in fiscal 1997.

                                      22.
<PAGE>

                                  HOT TOPIC 



     The Company's effective tax rate was 36.5% in fiscal 1997 and 37.4% in
fiscal 1996.  The variance from an expected rate of approximately 40% in both
fiscal 1997 and 1996 is a result of a significant portion of each fiscal year's
interest income being non-taxable.

QUARTERLY RESULTS AND SEASONALITY

     The Company's 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-related products, shifts in timing of certain holidays, changes in the
Company's merchandise mix and overall economic conditions.

     The Company's business is also subject to seasonal influences, with heavier
concentrations of sales during the Christmas holiday, back-to-school season, and
other periods when schools are not in session.  The Christmas holiday season
remains the Company's single most important selling season.  The Company
believes, however, that the importance of the summer vacation and back-to-school
seasons (which affect operating results in the second and third quarters,
respectively) and, to a lesser extent, the spring break season (which affects
operating results in the first quarter), reduces somewhat the Company's
dependence on the Christmas holiday selling season.  Furthermore, summer
vacation, spring break and the back-to-school season take place at somewhat
different times in different parts of the country, spreading the impact of these
events on the Company's sales over a longer period.  As is the case with many
retailers of apparel, accessories and related merchandise, the Company typically
experiences lower net sales and operating losses during the first fiscal
quarter.  The Company has experienced quarterly losses in the past and may
experience such losses in the future.

     The following table sets forth certain statement of operations and
operating data for each of the Company's last eight fiscal quarters.  The
quarterly statement of operations data and selected operating data set forth
below were derived from unaudited financial statements of the Company, which in
the opinion of management of the Company contain all adjustments (consisting
only of normal recurring adjustments) necessary for fair presentation thereof.
Results in any quarter are not necessarily indicative of results that may be
achieved for a full year.

                                      23.
<PAGE>

                                   HOT TOPIC


 
<TABLE>
<CAPTION>
                                      FISCAL YEAR 1997                         FISCAL YEAR 1998
                           --------------------------------------  ----------------------------------------
                            FIRST     SECOND    THIRD     FOURTH     FIRST     SECOND    THIRD     FOURTH
                           --------  --------  --------  --------  ---------  --------  --------  ---------
<S>                        <C>       <C>       <C>       <C>       <C>        <C>       <C>       <C>
                                    (In thousands, except selected operating and per share data)
STATEMENT OF 
OPERATIONS DATA:
 Net sales                 $11,188   $13,683   $18,753   $26,908   $17,314    $20,787   $28,708   $36,561
 Gross margin                3,762     4,619     6,724    11,010     5,722      6,776    10,642    14,376
 Operating income 
   (loss)                     (413)      117     1,600     4,949      (179)       318     2,587     5,713
 Net income (loss)            (110)      204     1,120     3,329        45        334     1,758     3,866
 Net income (loss) per
  share:
    Basic                   ($0.02)  $  0.04   $  0.24   $  0.70   $  0.01    $  0.07   $  0.36   $  0.80
    Diluted                 ($0.02)  $  0.04   $  0.23   $  0.67   $  0.01    $  0.07   $  0.36   $  0.79
 
 Weighted average 
   shares outstanding:
     Basic                   4,607     4,683     4,723     4,749     4,778      4,811     4,831     4,848    
    Diluted                  4,928     4,948     4,928     4,956     4,979      4,984     4,944     4,916
                                                                               
SELECTED OPERATING
 DATA:
   Comparable store
     sales increase            5.7%      0.7%      0.6%      2.7%     (0.6%)      2.0%      9.5%     (5.9%)
   Stores open at end of
     period                     81        94       104       108       123        133       145       158
 </TABLE>

LIQUIDITY AND CAPITAL RESOURCES

     During the last three fiscal years, the Company's primary uses of cash have
been to finance store openings and purchase merchandise inventories.  The
Company has satisfied its cash requirements principally from cash flows from
operations. In fiscal 1996, the Company received additional capital from
proceeds from its initial public offering of Common stock in September 1996.

     The Company completed its initial public offering of 1,495,000 shares in
September 1996, and received net proceeds of approximately $24.3 million.  The
proceeds were used for general corporate purposes and to increase working
capital.

     Cash flows provided by operating activities were $9.3 million, $7.2
million, and $4.1 million in fiscal 1998, 1997 and 1996, respectively.   The
increases in cash flows from operating activities in each of the fiscal years
was primarily attributable to increases in the company's net income.

     Cash flows used in investing activities were $9.3 million, $8.9 million and
$5.9 million in fiscal 1998, 1997 and 1996, respectively.  Cash flows used in
investing activities relate primarily to store openings and, in 1997,
approximately $750,000 was used to expanded the capacity and increased the
efficiency of the Company's distribution facility.  The Company opened 50, 40
and 26 stores in fiscal 1998, 1997 and 1996, respectively.

     Cash flows provided by financing activities were ($2.1) million, $1.1
million and $24.4 million in fiscal 1998, 1997 and 1996, respectively.   In
January 1999, the company used $3.0 million to repurchase 220,000 shares of its
Common Stock.  In March 1999, the Company's Board of Directors approved an
additional repurchase of up to an aggregate of 250,000 shares of its Common
Stock.  In June 1996, the Company received net proceeds of $72,000 from the
exercise of warrants and in September 1996, the Company received $24.3 million
from its initial public offering.

     The Company anticipates that it will spend approximately $8.5 to $9.5
million to open approximately 45 stores in fiscal 1999.  During fiscal 1998, the
Company's average capital expenditures to open a store, including leasehold
improvements and furniture and fixtures, totaled approximately

                                      24.
<PAGE>
 
$170,000. The average initial gross inventory for the new 1998 stores was
approximately $65,000 (which was partially financed by trade credit) and pre-
opening costs averaged approximately $19,000 for these stores. The Company
expects the average total costs associated with opening a store will be
approximately the same in fiscal 1999. Pre-opening costs are expensed in the
period in which the store opens. The actual costs that the Company will incur in
connection with opening future stores cannot be predicted with precision because
such costs will vary based upon, among other things, geographic location, the
size of the stores and the extent of the build-out required at the selected
sites. Initial inventory requirements vary at new stores depending on the season
and current merchandise trends.

     To accommodate its planned expansion in fiscal 1999 and beyond, the Company
has leased a larger building to expand the capacity of its headquarters office
and merchandise distribution facility.  Construction of the offices and
installation of the distribution equipment commenced in February 1999.  The
Company presently plans to move from its existing facility into the new facility
early in the summer of 1999.  Presently, the estimated cost of construction,
equipment, fixtures and furniture is approximately $4.0 to $4.5 million.  The
new facility has a projected capacity of approximately 500 stores.

     The Company is presently evaluating future long-term management information
system needs and the corresponding hardware and software upgrades at its stores
and its office and distribution center that may be necessary.  The scope and
timing of such upgrades as well as the specific hardware and software have not
yet been fully identified and evaluated. However, the Company presently
estimates that the expenditures for management information system upgrades in
fiscal 1999 and fiscal 2000 will be approximately  $3 million for both years
combined, which is substantially greater than such historical annual
expenditures.

     The Company believes that its existing cash balances and cash generated
from operations will be sufficient to fund its operations and planned expansion
through the next 12 months.

INFLATION

     The Company does not believe that inflation has had a material adverse
effect on net sales or results of operations.  The Company has generally been
able to pass on increased costs related to inflation through increases in
selling prices.

YEAR 2000 COMPLIANCE

     The year 2000 issue exists because many computer applications currently use
two-digit date fields to designate a year.    As the century date occurs, time-
sensitive software may recognize a date using "00" as the year 1900 rather than
that have the year 2000.  This could result in the computer shutting down or
performing incorrect computations, leading to disruptions in normal business
processing.

     The Company's plan to resolve the Year 2000 issue involves the following
four phases: assessment, remediation, testing and implementation.    During
1998, the Company completed its assessment of all critical systems and developed
a plan to bring these systems into compliance.     The Company has obtained
information from the vendors for its integrated store, merchandising,
distribution and financial systems as to required modifications and timing of
those modifications to ensure that the systems will be Year 2000 compliant.
These efforts began in mid-1998 and are scheduled to be completed in  the second
and third quarters of fiscal 1999.  Early in 1999, the hardware for these
systems was tested and as required, replacement hardware and operating systems
were installed.  The Company's plans call for the testing of the vendor's
revised software in first and second quarters of fiscal 1999, and full
implementation during the second and third quarters of fiscal 1999.  The cost of
the Company's Year 2000 problem initiatives is expected to be less than
$100,000.

                                      25.
<PAGE>
 
     The Company does not have systems that interface directly with significant
third party vendors and has queried its significant suppliers of merchandise and
services that do not share information systems with the Company (external
agents).  To date, the Company is not aware of any external agent with a Year
2000 issue that would materially impact the Company's results of operations,
liquidity or capital resources.  However, the Company has no means of ensuring
that external agents will be Year 2000 ready.  The inability of external agents
to complete their year 2000 resolution process in a timely fashion could have a
material impact on the Company.  The effect of non-compliance by external agents
is not determinable.

     The Company has not yet completed its contingency plan with respect to a
worst case scenario in the event of non-compliance by external agents.  The
Company does not presently believe that an interruption in the supply of
merchandise would  have a significant adverse impact on its operations since it
purchases merchandise from over 600 vendors, none of which historically supplies
more than approximately 5% of the Company's annual purchases.  However,  the
Company may increase inventory levels of certain merchandise late in calendar
1999 to offset the risk that certain vendors may be adversely affected by Year
2000 issues.  The Company presently uses United Parcel Service ("UPS") to ship
merchandise to its stores.   The Company has contacted UPS regarding Year 2000
compliance and received written confirmation from UPS that UPS believes it will
be fully compliant by December 31, 1999.

     While the Company believes its planning efforts are adequate to address its
Year 2000 concerns, there can be no guarantee that the systems of other
companies on which the Company's systems and operations rely will be converted
on a timely basis and will not have a material adverse effect on the Company.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The Company's market risks disclosure pursuant to Item 7A are not material
and are therefore not required.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

     The Financial Statements of the Company listed in Item 14(a) are included
herein on pages F-1 through F-14 and are incorporated herein by reference.

ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE

     Not applicable.

                                   Part III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     See the section entitled "Executive Officers" in Part I, Item 1 hereof for
information regarding executive officers.

     The information required by this item with respect to directors is
incorporated by reference from the information under the caption "Election of
Directors," contained in the Company's Definitive Proxy Statement which will be
filed with the Securities and Exchange Commission pursuant to Regulation 14A in
connection with the solicitation of proxies for the Company's Annual Meeting of
Shareholders to be held on June 1, 1999 (the "Proxy Statement").

                                      26.
<PAGE>
 
ITEM 11.  EXECUTIVE COMPENSATION

     The information required by this item is incorporated by reference to the
information appearing under the caption "Executive Compensation" in the Proxy
Statement.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The information required by this item is incorporated by reference to the
information appearing under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information required by this item is incorporated by reference to the
information appearing under the caption "Certain Transactions" in the Proxy
Statement.

                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K

     (a)(1) Index to Consolidated Financial Statements

            The financial statements required by this item are submitted in a
separate section beginning on page F-1 of this Annual Report on Form 10-K.

<TABLE>
<CAPTION>
                                                                                        PAGE
<S>                                                                                     <C>
Report of Ernst & Young LLP, Independent Auditors.....................................  F-1
                                                                                        ---
Consolidated Balance Sheets as of January 30, 1999 and January 31, 1998...............  F-2
                                                                                        ---
Consolidated Statements of Operations for the years ended January 30, 1999, January        
 31, 1998 and February 1, 1997........................................................  F-3
                                                                                        --- 
Consolidated Statements of Shareholders' Equity for the years ended January 30, 1999,   
 January 31, 1998 and February 1, 1997................................................  F-4        
                                                                                        ---
                                                                                           
Consolidated Statements of Cash Flows for the years ended January 30, 1999, January        
 31, 1998 and February 1, 1997........................................................  F-5
                                                                                        ---
                                                                                           
Notes to Consolidated Financial Statements............................................  F-6
                                                                                        ---
</TABLE>

     (a)(2) Index to Financial Statement Schedules

            All schedules are omitted because they are not required, are not
applicable, or the information is included in the Financial statements or notes
thereto.

     (a)(3) Index to Exhibits

            See Index to Exhibits beginning on page 30.

            The following management compensatory plans and arrangements are
required to be filed as exhibits to this Report on Form 10-K pursuant to Item
14(c):

                                      27.
<PAGE>
 
<TABLE>
<CAPTION>
           EXHIBIT
           Number                               DESCRIPTION OF DOCUMENT  
           ------                               -----------------------
           <S>                                  <C> 
             10.2  1996 Equity Incentive Plan (the "1996 Plan").  (1)

             10.3  Form of Nonstatutory Stock Option Agreement of Registrant pursuant to the 1996
                   Plan.  (1)

             10.4  Form of Incentive Stock Option Agreement of Registrant pursuant to the 1996 Plan.
                   (1)

             10.5  Non-Employee Directors' Stock Option Plan.  (1)

             10.6  Employee Stock Purchase Plan.  (1)

            10.11  Letter Agreement regarding Employment Terms, dated August 9, 1994, entered into
                   between Registrant and Elizabeth M. McLaughlin.  (1)

            10.15  401(k) Defined Contribution Plan of Registrant, effective as of August 1, 1995.
                   (1)
</TABLE>
____________
(1)  Filed as an exhibit to Registrant's Registration Statement on Form SB-2
     (No. 333-5054-LA) and incorporated herein by reference.

     (b)  Reports on Form 8-K

          Not applicable.

     (c)  Exhibits

          The exhibits required by this Item are listed under Item 14(a)(3)

     (d)  Financial Statement Schedules

          The financial statement schedules required by this Item are listed
          under Item 14(a)(2).

                                      28.
<PAGE>
 
                                   SIGNATURE

    Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Pomona,
County of Los Angeles, State of California, on the 22nd day of April, 1999.

                            HOT TOPIC, INC. 
                            
                            
                            
                            By:  /s/ Orval D. Madden
                               --------------------- 
                                Orval D. Madden                                
                                President, Chief Executive Officer and Director 

                               POWER OF ATTORNEY

     Know all Men by These Presents, that each person whose signature appears
below constitutes and appoints Orval D. Madden and Jay A. Johnson, or either of
them, his attorney-in-fact, each with the power of substitution, for him in any
and all capacities, to sign any amendments to this Report, and to file the same,
with exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his substitute or substitutes, may do or
cause to be done by virtue hereof.

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
                NAME                                         POSITION                               DATE
--------------------------------------------------  --------------------------------------  --------------------
<S>                                                   <C>                                     <C>
     /s/ ROBERT M. JAFFE                              Chairman of the Board                      April 22, 1999
----------------------------------------------------
          Robert M. Jaffe

     /s/ ORVAL D. MADDEN                              President, Chief Executive Officer         April 22, 1999
----------------------------------------------------                               
          Orval D. Madden                             and Director                 
                                                      (Principal Executive Officer)

     /s/ JAY A. JOHNSON                               Chief Financial Officer and Assistant      April 22, 1999  
----------------------------------------------------                                                             
          Jay A. Johnson                              Secretary
                                                      (Principal Financial and Accounting
                                                      Officer)

     /s/ EDGAR F. BERNER                              Director                                   April 22, 1999
----------------------------------------------------
          Edgar F. Berner

     /s/ STANLEY E. FOSTER                            Director                                   April 22, 1999
----------------------------------------------------
         Stanley E. Foster

     /s/ CECE SMITH                                   Director                                   April 22, 1999
----------------------------------------------------
         Cece Smith

     /s/ CORRADO FEDERICO                             Director                                   April 22, 1999
----------------------------------------------------
         Corrado Federico

     /s/ ANDREW SCHUON                                Director                                   April 22, 1999
----------------------------------------------------
         Andrew Schuon

     /s/ BRUCE A. QUINNELL                             Director                                   April 22, 1999
----------------------------------------------------
         Bruce A. Quinnell
</TABLE>

                                      29.
<PAGE>
 
                                 EXHIBIT INDEX


<TABLE>
            <S>   <C> 
             3.1  Form of Amended and Restated Articles of Incorporation of Registrant.  (1)

             3.2  Form of amended and restated Bylaws, Registrant.  (1)

             4.1  Reference is made to Exhibits 3.1 and 3.2.

             4.2  Specimen stock certificate.  (1)

            10.1  Form of Indemnity Agreement to be entered into between Registrant and its directors
                  and officers.  (1)

            10.2  1996 Equity Incentive Plan (the "1996 Plan").  (1)

            10.3  Form of Nonstatutory Stock Option Agreement of Registrant pursuant to the 1996
                  Plan.  (1)

            10.4  Form of Incentive Stock Option Agreement of Registrant pursuant to the 1996 Plan.
                  (1)

            10.5  Non-Employee Directors' Stock Option Plan.  (1)

            10.6  Employee Stock Purchase Plan.  (1)

           10.11  Letter Agreement regarding Employment Terms, dated August 9, 1994, entered into
                  between Registrant and Elizabeth M. McLaughlin.  (1)

           10.14  Industrial Real Estate Lease (Single Tenant Facility), dated June 30, 1994, entered
</TABLE> 

                                      30.
<PAGE>
 
<TABLE> 
           <S>    <C> 
                  into between Registrant and New England Mutual Life Insurance Company.  (1)

           10.15  401(k) Defined Contribution Plan of Registrant, effective as of August 1, 1995.  (1)

           10.18  Industrial Real Estate Lease (Multi-Tenant Facility), dated December 10, 1998,
                  entered into between Registrant's wholly owned subsidiary, Hot Topic
                  Administration, Inc. and Majestic Realty Co. and Patrician Associates, Inc.

           10.19  Guaranty of Lease, dated December 10, 1998, entered into between the Registrant and
                  Majestic Realty Co. and Patrician Associates, Inc.

            23.1  Consent of Ernst & Young LLP, Independent Auditors.

            24.1  Power of Attorney.  Reference is made to page  30.

            27.1  Financial Data Schedule.
</TABLE>

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

                                      31.
<PAGE>
 
                        Report of Independent Auditors

The Board of Directors and Shareholders
Hot Topic, Inc.

We have audited the accompanying consolidated balance sheets of Hot Topic, Inc.
as of January 30, 1999 and January 31, 1998, and the related consolidated
statements of income, shareholders' equity, and cash flows for each of the three
years in the period ended January 30, 1999. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Hot
Topic, Inc. and subsidiaries at January 30, 1999 and January 31, 1998, and the
results of its consolidated operations and its consolidated cash flows for each
of the three years in the period ended January 30, 1999 in conformity with
generally accepted accounting principles.

                                         /s/ Ernst & Young LLP
                                         ---------------------

                                         Los Angeles, California
                                         March 12, 1999

                                      F-1
<PAGE>
 
                       Hot Topic, Inc. and Subsidiaries

                          Consolidated Balance Sheets


<TABLE>
<CAPTION>
                                                                  JANUARY 30,     JANUARY 31, 
                                                                      1999           1998
                                                               ---------------------------------
<S>                                                            <C>                <C>  
ASSETS
Current assets:
 Cash and cash equivalents                                     $24,573,874         $26,579,027
 Inventory                                                      10,446,626           7,636,596
 Prepaid expenses and other                                      1,440,286             657,749
 Deferred tax asset (Note 6)                                       321,825             338,679
                                                              -----------------------------------
Total current assets                                            36,782,611          35,212,051
 
Leaseholds, fixtures and equipment, net (Note 2)                21,895,132          16,700,270
Deposits and other                                                  86,922              40,525
                                                              -----------------------------------
Total assets                                                   $58,764,665         $51,952,846
                                                              ===================================
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
 Accounts payable                                              $ 2,186,462         $ 1,705,659
 Accrued payroll and related expenses                            4,035,805           2,626,655
 Accrued sales and other taxes payable                             382,742             263,859
 Federal and state income taxes payable                          1,715,559           1,351,956
 Current portion of obligations under capital leases                29,629              34,407
                                                              -----------------------------------
Total current liabilities                                        8,350,197           5,982,536
 
Deferred rent (Note 3)                                             743,711             508,822
Capital lease obligations, less current portion (Note 3)            89,908             126,759
Deferred tax liability (Note 6)                                    831,703             599,158
 
Shareholders' equity (Note 4):
 Common shares, no par value; 50,000,000 shares authorized;
  4,654,431 and 4,759,606 shares issued and outstanding
 at January 30, 1999 and January 31, 1998, respectively         35,675,752          37,700,992
 
 Deferred compensation                                             (42,619)            (78,511)
 Retained earnings                                              13,116,013           7,113,090
                                                              -----------------------------------
Total shareholders' equity                                      48,749,146          44,735,571
                                                              -----------------------------------
Total liabilities and shareholders' equity                     $58,764,665         $51,952,846
                                                              ===================================
</TABLE>

See accompanying notes.

                                      F-2
<PAGE>
 
                       Hot Topic, Inc. and Subsidiaries

                       Consolidated Statements of Income


<TABLE>
<CAPTION>
                                                      YEARS ENDED
                                      JANUARY 30,     JANUARY 31,     FEBRUARY 1,
                                         1999             1998            1997
                                  --------------------------------------------------
<S>                                   <C>             <C>             <C>
Net sales                             $103,370,683     $70,531,592     $43,617,823
Cost of goods sold, including
 buying, distribution and               
 occupancy costs                        65,854,559      44,416,873      27,048,928 
                                   ------------------------------------------------
Gross margin                            37,516,124      26,114,719      16,568,895
 
Selling, general and
 administrative expenses                29,077,124      19,861,808      12,845,602
                                  ------------------------------------------------
Operating income                         8,439,000       6,252,911       3,723,293
 
Interest income                           (951,119)       (917,348)       (469,241)
Interest expense                            20,296          16,787          87,516
                                  ------------------------------------------------
Income before income taxes               9,369,823       7,153,472       4,105,018
 
Provision for income taxes (Note     
 6)                                      3,366,900       2,610,800       1,534,600
                                  ------------------------------------------------
Net income                            $  6,002,923     $ 4,542,672     $ 2,570,418
                                  ================================================
 
Net income per share:
 Basic                                       $1.25           $0.97           $0.71
                                  ================================================ 
 Diluted                                     $1.21           $0.92           $0.66
                                  ================================================ 
 
Shares used in computing net
 income
per share:
  Basic                                  4,817,024       4,690,490       3,627,975
  Diluted                                4,955,797       4,939,947       3,898,646
</TABLE>

See accompanying notes.

                                      F-3
<PAGE>
 
                       Hot Topic, Inc. and Subsidiaries

                Consolidated Statements of Shareholders' Equity


<TABLE>
<CAPTION>
                                                                                                                   Total
                                                 Common Shares             Deferred            Retained         Shareholders'
                                      --------------------------------     
                                            Shares          Amount        Compensation          Earnings            Equity
                                      ----------------------------------------------------------------------------------------
<S>                                   <C>                  <C>            <C>                <C>             <C>
Balance at February 3, 1996                   764,000      $   785,462                -      $         -     $   785,462
 Issuance of common stock                   1,495,397       24,268,160                -                -      24,268,160
 Accretion of preferred shares
  redemption value                                  -         (528,363)               -                -        (528,363)
 
 Conversion of preferred stock              2,305,892       11,845,488                -                -      11,845,488
 Exercise of stock options                     33,964           86,476                -                -          86,476
 Deferred compensation related to
  grant of stock options                            -          143,560         (143,560)               -               -
 
 Amortization of deferred compensation              -                -           29,157                -          29,157
                                                  
 Tax benefit from exercise of
  options                                           -           12,365                -                -          12,365
 Net income                                         -                -                -        2,570,418       2,570,418
                                      ----------------------------------------------------------------------------------
Balance at February 1, 1997                 4,599,253       36,613,148         (114,403)       2,570,418      39,069,163
 Exercise of stock options                    158,322          446,528                -                -         446,528
 Employee stock purchase plan                   2,031           37,692                -                -          37,692
 Amortization of deferred compensation              -                -           35,892                -          35,892 
 Tax benefit from exercise of
  options                                           -          603,624                -                -         603,624
 Net income                                         -                -                -        4,542,672       4,542,672
                                      ----------------------------------------------------------------------------------
 Balance at January 31, 1998                4,759,606       37,700,992          (78,511)       7,113,090      44,735,571
 Exercise of stock options                    111,077          388,728                -                -         388,728
 Employee stock purchase plan                   3,748           49,500                -                -          49,500
 Repurchase common stock                     (220,000)      (2,968,565)                                       (2,968,565)
 Amortization of deferred
 compensation                                       -                -           35,892                -          35,892
 Tax benefit from exercise of
 options                                            -          505,097                -                -         505,097
 Net income                                         -                -                -        6,002,923       6,002,923
                                       ---------------------------------------------------------------------------------
Balance at January 30, 1999                 4,654,431      $35,675,752        $ (42,619)     $13,116,013     $48,749,146
                                      ==================================================================================
</TABLE>

See accompanying notes.

                                      F-4
<PAGE>
 
                       Hot Topic, Inc. and Subsidiaries

                     Consolidated Statements of Cash Flows


<TABLE>
<CAPTION>
                                                                         YEARS ENDED
                                                       JANUARY 30,       JANUARY 31,     FEBRUARY 1, 
                                                           1999              1998          1997
                                                   -----------------------------------------------------
<S>                                                <C>                   <C>             <C>
OPERATING ACTIVITIES
Net income                                               $ 6,002,923       $ 4,542,672       $ 2,570,418

Adjustments to reconcile net income to net cash
 provided by operating activities:
  Depreciation and amortization                            4,069,200         2,872,483         1,723,577
  Deferred rent                                              234,889           189,816            73,226
  Deferred compensation                                       35,892            35,892            29,157
  Deferred taxes                                             124,198           104,238           209,253
  Loss on disposal of fixed assets                                 -            46,071            79,261
  Changes in operating assets and liabilities:
   Inventory                                              (2,810,030)       (2,699,378)       (1,775,349)
   Prepaid expenses and other current assets                (782,537)          335,485          (376,962)
   Deposits and other assets                                 (46,397)           (4,982)              322
   Accounts payable                                          480,803           478,556           158,495
   Accrued payroll and related expenses                    1,409,150           792,152           854,492
   Accrued sales and other taxes payable                     118,883            54,077            54,148
   Income taxes payable                                      488,804           492,687           474,353
                                                   -----------------------------------------------------
Net cash provided by operating activities                  9,325,778         7,239,769         4,074,391
 
INVESTING ACTIVITIES
Purchases of property and equipment                       (9,274,002)       (8,869,800)       (5,889,793)
                                                   -----------------------------------------------------
Net cash used in investing activities                     (9,274,002)       (8,869,800)       (5,889,793)
 
FINANCING ACTIVITIES
Payments on capital lease obligations                        (31,689)          (30,031)          (41,610)
Proceeds from sale of common shares                                -                 -        24,268,160
Repurchase common shares                                  (2,968,565)                -                 -
Proceeds from employee stock purchases and
 exercise of stock options, including related
 tax benefit                                                 943,325         1,087,844           170,840
                                                   -----------------------------------------------------
Net cash (used in) provided by financing activities       (2,056,929)        1,057,813        24,397,390
                                                   -----------------------------------------------------
 
(Decrease) increase in cash and cash equivalents          (2,005,153)         (572,218)       22,581,988
Cash and cash equivalents at beginning of year            26,579,027        27,151,245         4,569,257
                                                   -----------------------------------------------------
Cash and cash equivalents at end of year                 $24,573,874       $26,579,027       $27,151,245
                                                   =====================================================
 
SUPPLEMENTAL INFORMATION
Cash paid during the year for interest                   $    20,296       $    16,787       $    87,516
                                                   =====================================================     
Cash paid during the year for income taxes               $ 2,245,212       $ 1,415,012       $   832,447
                                                   =====================================================
Capital lease obligations entered into for equipment     $         -       $   142,990       $    55,581
                                                   =====================================================
</TABLE>

See accompanying notes.
                                      F-5
<PAGE>
 
                       Hot Topic, Inc. and Subsidiaries

                  Notes to Consolidated Financial Statements

                               January 30, 1999

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND BUSINESS ACTIVITY

Hot Topic, Inc. (the Company) was incorporated in California in September 1988.
The Company sells music licensed and music influenced apparel, accessories and
gift items for young men and women through its retail stores. The Company
operates mall based retail stores throughout the western, mid-western,
southeastern and northeastern regions of the United States.  The consolidated
financial statements include the accounts of the Company and its wholly owned
subsidiaries.  All intercompany accounts have been eliminated in consolidation.

On September 23, 1996, the Company completed an initial public offering (the
Offering) of 1,495,000 shares of common stock at a price of $18.00 per share.
The net proceeds to the Company, net of underwriting discounts and commissions
and offering expenses, were $24.3 million.

FISCAL YEAR

The Company's fiscal year is on a 52-53 week basis and ends on the Saturday
nearest to January 31. The fiscal years ended January 30, 1999, January 31, 1998
and February 1, 1997 were 52 week years.

REVENUE RECOGNITION

Retail merchandise sales are recognized at the point of sale less estimated
sales returns.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments with maturities of less than
three months when purchased to be cash equivalents. The Company is potentially
exposed to a concentration of credit risk when cash deposits in banks are in
excess of federally insured limits, and as a result of the investment of cash
equivalents at two financial institutions.

INVENTORY

Inventories and related cost of sales are accounted for by the retail method.
The cost of inventory is determined at the lower of the first-in, first-out
(FIFO) method or market.

                                      F-6
<PAGE>
 
                       Hot Topic, Inc. and Subsidiaries

             Notes to Consolidated Financial Statements(continued)


1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

STORE PRE-OPENING COSTS

Costs incurred in connection with the opening of a new store are expensed as
incurred.

PROPERTY AND EQUIPMENT

Property and equipment are recorded at cost or in the case of capitalized
leases, at the present value of future minimum lease payments. Depreciation is
provided using the straight-line method over the estimated useful lives of the
assets (3-10 years). Leasehold improvements are amortized using the straight-
line method over the shorter of the lease term or ten years.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.

LONG-LIVED ASSETS

The Company accounts for the impairment and disposition of long-lived assets in
accordance with Statement of Financial Accounting Standards (SFAS) No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of" (SFAS No. 121). In accordance with SFAS No. 121, long-lived
assets to be held are reviewed for events or changes in circumstances which
indicate that their carrying value may not be recoverable.  At January 30, 1999,
the Company believes there has been no impairment of the value of such assets.

STOCK-BASED COMPENSATION

The Company accounts for stock-based awards to employees using the intrinsic
value method as prescribed by Accounting Principle Board Opinion No. 25,
"Accounting for stock issued to Employees".

                                      F-7
<PAGE>
 
                       Hot Topic, Inc. and Subsidiaries

                  Notes to Consolidated Financial Statements


2. LEASEHOLDS, FIXTURES AND EQUIPMENT

Leaseholds, fixtures and equipment are summarized as follows:

<TABLE>
<CAPTION>
                                               JANUARY 30,     JANUARY 31,
                                                   1999            1998
                                            -------------------------------
<S>                                         <C>               <C>
Furniture, fixtures and equipment              $ 17,709,670     $12,452,091
Leasehold improvements                           14,725,529      10,726,666
                                            -------------------------------
                                                 32,435,199      23,178,757
Less accumulated depreciation and             
 amortization                                   (10,540,067)     (6,478,487)
                                            -------------------------------
                                               $ 21,895,132     $16,700,270
                                            ===============================
</TABLE>

3. COMMITMENTS

LEASES

The Company has entered into lease agreements for retail and office space under
primarily noncancelable leases with terms ranging from three to approximately
ten years. In December 1998, a wholly-owned subsidiary of the Company entered
into a lease for a building for a new office and distribution facility. The
lease provides for a five year term and two three year lease extensions.  The
retail space leases provide for rents based upon the greater of the minimum
annual rental amounts or 6% to 8% of annual sales volume. Certain of the leases
provide for increasing minimum annual rental amounts. Rent expense is recorded
evenly over the term of the lease. Accordingly, deferred rent, as reflected in
the accompanying balance sheets, represents the difference between rent expense
accrued and amounts paid under the terms of the lease agreement. Total rent
expense for the years ended January 30, 1999, January  31, 1998 and February 1,
1997 was $7,505,514, $5,138,226 and $3,272,996  respectively, including
contingent rentals of $293,759, $272,900 and $260,214, respectively.

                                      F-8
<PAGE>
 
                       Hot Topic, Inc. and Subsidiaries

                  Notes to Consolidated Financial Statements


3. COMMITMENTS (CONTINUED)

LEASES (CONTINUED)

The Company leases certain equipment under capital lease obligations. Cost and
accumulated depreciation of equipment under capital leases were $168,930 and
$49,137, respectively, at January 30, 1999; $186,489 and $41,243, respectively,
at January 31, 1998 and $55,581 and $6,338, respectively, at February 1, 1997.

Annual future minimum lease payments under operating and capital leases as of
January 30, 1999 are as follows:

<TABLE>
<CAPTION>
                                                            OPERATING        CAPITAL
Fiscal year                                                   LEASES          LEASES
-----------                                           --------------------------------------
<S>                                                   <C>                    <C> 
1999                                                         $ 8,665,722        $ 43,019
2000                                                           8,768,706          72,890
2001                                                           8,706,490          21,840
2002                                                           8,603,086
2003                                                           8,356,836               -
Thereafter                                                    28,642,225               -
                                                        --------------------------------
Total minimum lease payments                                 $71,743,065         137,749
                                                        ================
Less amounts representing interest                                                18,212
                                                                        ----------------
Present value of future minimum capital lease payments                           119,537
Less amounts due in one year                                                      29,629
                                                                        ----------------
Long-term portion of obligations under capital leases                           $ 89,908
                                                                        ================
</TABLE>
                                        

                                      F-9
<PAGE>
 
                       Hot Topic, Inc. and Subsidiaries

                  Notes to Consolidated Financial Statements

4. SHAREHOLDERS' EQUITY

STOCK OPTIONS

Under the Company's long-term incentive plans (the Plans) the Company may grant
stock options to employees, directors or consultants of the Company as deemed
appropriate by the Board of Directors. The exercise price of options granted
under the Plan shall be determined by the Board of Directors at the date of
grant and shall not be lower than (i) 100% of the fair market value of the
Company's common stock on the date of grant for incentive stock options, (ii)
85% of the fair market value of the Company's common stock on the date of grant
for non-statutory stock options, and (iii) 110% of the fair market value of the
Company's common stock on the date of grant for persons possessing 10% or more
of the total combined voting power of all classes of stock of the Company.
Unless the Board of Directors declares otherwise, options vest over four years
and generally expire ten years from the date of grant.  An aggregate of
1,330,000 shares of common stock may be issued pursuant to the plans.  As of
January 30, 1999,  362,203 shares were available for future grants.

In June 1996, the Board of Directors adopted the Employee Stock Purchase Plan
(the Stock Purchase Plan). The Stock Purchase Plan provides for the issuance of
up to 150,000 shares of common stock to employees of the Company. Under the
Stock Purchase Plan, all eligible employees are granted identical rights to
purchase common stock for each Board-authorized offering under the Stock
Purchase Plan. Rights granted pursuant to any offering under the Stock Purchase
Plan terminate immediately upon cessation of an employee's employment for any
reason.  In general, an employee may withdraw from participation in an offering
at any time during the purchase period for such offering.  Rights granted under
the Stock Purchase Plan are not transferable and may be exercised only by the
person to whom such rights are granted. The initial offering under the Stock
Purchase Plan commenced October 24, 1996 and terminated December 31, 1996.
Subsequent offerings occur every six months commencing January 1, 1997.

                                      F-10
<PAGE>
 
                       Hot Topic, Inc. and Subsidiaries

            Notes to Consolidated Financial Statements (continued)


4. SHAREHOLDERS' EQUITY (CONTINUED)

STOCK OPTIONS (CONTINUED)

Pro forma information regarding net income and earnings per share is required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that Statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for 1998,
1997 and 1996: weighted-average risk-free interest rates of 6%; dividend yields
of 0%; weighted-average volatility factors of the expected market price of the
Company's common stock of 0.79 for 1998, 0.53 for 1997 and 0.35 for 1996; and a
weighted average expected life of the option of 5 years.  The weighted average
fair value of options granted during the year is $14.67, $12.87 and $3.32 per
share for fiscal 1998, 1997 and 1996, respectively.

For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows:

<TABLE>
<CAPTION>
                                                  1998           1997           1996
                                            ---------------------------------------------
<S>                                         <C>                 <C>            <C>
   Pro forma net income                          $4,495,809     $3,888,986     $2,517,055
   Pro forma earnings per share                  $     0.92     $     0.82     $     0.66
</TABLE>

A summary of the Company's stock option activity and related information
follows:

<TABLE>
<CAPTION>
                                        JANUARY 30, 1999             JANUARY 31, 1998              FEBRUARY 1, 1997
                                  --------------------------   ---------------------------   --------------------------
                                                  WEIGHTED                      WEIGHTED                     WEIGHTED
                                                   AVERAGE                       AVERAGE                      AVERAGE
                                                  EXERCISE                      EXERCISE                     EXERCISE
                                      OPTIONS       PRICE          OPTIONS        PRICE          OPTIONS       PRICE
                                  --------------------------   ---------------------------   --------------------------
<S>                               <C>             <C>          <C>              <C>          <C>             <C>
Outstanding at beginning of year       562,310        $16.43         399,122        $ 4.21        328,420         $2.72
 Granted                               286,588        $21.62         336,352        $24.37        112,666         $8.01
 Exercised                            (111,077)       $ 3.50        (158,322)       $ 2.83        (33,964)        $2.55
 Canceled                              (38,670)       $19.21         (14,842)       $13.03         (8,000)        $3.59
                                  --------------------------   ---------------------------   --------------------------
Outstanding at end of year             699,151        $20.45         562,310        $16.43        399,122         $4.21
                                  ==========================   ===========================   ==========================
 
Exercisable at end of year             196,285        $17.09         121,150        $ 4.07        195,278         $3.28
</TABLE>

Exercise prices for options outstanding as of January 30, 1999 ranged from $2.50
to $27.88. Of the 699,151 options outstanding at January 30, 1999, 106,589 have
exercise prices ranging from $2.34 to $8.00, 334,506 have exercise prices
ranging from $15.38 to $22.75 and 258,056 have exercise prices ranging from
$24.25 to $27.88.  The weighted average remaining contractual life of those
options is 8 years.

                                      F-11
<PAGE>
 
                       Hot Topic, Inc. and Subsidiaries

            Notes to Consolidated Financial Statements (continued)


5. NET INCOME PER SHARE

The Company computes net income per share pursuant to Statement of Financial
Accounting Standards No. 128, "Earnings Per Share" (SFAS 128). 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 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 for the year ended, is as follows:

<TABLE>
<CAPTION>
                                       JANUARY 30,     JANUARY 31,  FEBRUARY 1,
                                           1999           1998        1997
                                     ------------------------------------------
<S>                                  <C>               <C>          <C>
Basic EPS Computation:
 Numerator                               $6,002,923    $4,542,672    $2,570,418
 Denominator:
  Weighted average common shares
   outstanding                            4,817,024     4,690,490     3,627,975
                                     ------------------------------------------
  Total shares                            4,817,024     4,690,490     3,627,975
                                     ------------------------------------------
Basic EPS                                $     1.25    $     0.97    $     0.71
                                     ==========================================
 
Diluted EPS Computation:
 Numerator                               $6,002,923    $4,542,672    $2,570,418
 Denominator:
  Weighted average common shares
   outstanding                            4,817,024     4,690,490     3,627,975
  Incremental shares from assumed
   conversion of options                    138,773       249,457       270,671
                                     ------------------------------------------
  Total shares                            4,955,797     4,939,947     3,898,646
                                     ------------------------------------------
Diluted EPS                              $     1.21    $     0.92    $     0.66
                                     ==========================================
</TABLE>

                                      F-12
<PAGE>
 
                       Hot Topic, Inc. and Subsidiaries

            Notes to Consolidated Financial Statements (continued)


6. INCOME TAXES

Following is the composition of the provision for income taxes for the years
ended:

<TABLE>
<CAPTION>
                                            JANUARY 30,       JANUARY 31,      FEBRUARY 1,
                                               1999              1998              1997
                                       ------------------------------------------------------
<S>                                    <C>                    <C>              <C> 
   Current:
    Federal                                    $2,770,434        $2,042,664        $1,021,150
    State                                         472,268           463,898           304,197
                                       ------------------------------------------------------
                                                3,242,702         2,506,562         1,325,347
 
   Deferred:
    Federal                                       127,057            89,336           204,132
    State                                          (2,859)           14,902             5,121
                                       ------------------------------------------------------
                                                  124,198           104,238           209,253
                                       ------------------------------------------------------
   Total income tax expense                    $3,366,900        $2,610,800        $1,534,600
                                       ======================================================
</TABLE>

Significant components of the Company's deferred tax assets and liabilities:

<TABLE>
<CAPTION>
                                                 JANUARY 30,    JANUARY 31,
                                                    1999           1998
                                              -----------------------------
<S>                                           <C>               <C> 
  Current deferred tax assets:
   Accrued vacation and other                    $   230,496      $ 100,557
   Inventory                                         291,499        212,663
   State taxes                                        78,833         39,959
   Other liabilities                                (264,503)
                                              -----------------------------
  Total deferred tax assets                          336,325        353,179
  Valuation allowance for deferred tax assets        (14,500)       (14,500)
                                              -----------------------------
  Net current deferred tax assets                    321,825        338,679
 
  Noncurrent deferred tax liabilities:
   Depreciation                                   (1,033,235)      (716,965)
   Deferred rent                                     201,532        117,807
                                              -----------------------------
  Total noncurrent deferred tax liabilities         (831,703)      (599,158)
                                              -----------------------------
  Net deferred tax (liability) asset             $  (509,878)     $(260,479)
                                              =============================
</TABLE>

                                      F-13
<PAGE>
 
                       Hot Topic, Inc. and Subsidiaries

            Notes to Consolidated Financial Statements (continued)


6. INCOME TAXES (CONTINUED)

Reconciliation of provision for taxes to statutory tax rate for the years ended:

<TABLE>
<CAPTION>
                                  JANUARY 30,    JANUARY 31,    FEBRUARY 1,
                                     1999           1998            1997
                               ---------------------------------------------
<S>                            <C>               <C>            <C>
   Statutory federal rate                34.0%          34.0%           34.0%

   Permanent differences                 (2.9)          (3.9)           (2.4)
   State and local taxes, net of
    federal benefit                       3.3            4.4             5.0
   Change in valuation allowance
    and other items                       1.5            2.0             0.8
                               ---------------------------------------------
   Effective income tax rate             35.9%          36.5%           37.4%
                               =============================================
</TABLE>

7. EMPLOYEE BENEFIT PLAN

Effective January 1, 1995, the Company adopted the Hot Topic 401(k) Retirement
Savings Plan (the 401(k) Plan). All employees who have been employed by the
Company for at least one year of service (provided that such service represents
a minimum of 1,000 hours worked during the year) and are at least 21 years of
age are eligible to participate. Employees may contribute to the 401(k) Plan up
to 20% of their current compensation, subject to a statutorily prescribed annual
limit. The Company may in its discretion contribute certain amounts to eligible
employees' accounts. The Company has not made any contributions to the 401(k)
Plan.

                                      F-14