Form 10-Q

THE WET SEAL, INC.

(Registrant)

September 12, 2003

/s/ PETER D. WHITFORD

Peter D. Whitford

Chief Executive Officer

(Principal Executive Officer)

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

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

The number of shares outstanding of the registrant’s Class A Common Stock and Class B Common Stock, par value $.10 per share, at September 12, 2003 was 25,279,578 and 4,502,833, respectively. There were no shares of Preferred Stock, par value $.01 per share, outstanding at September 12, 2003.

See accompanying notes to unaudited consolidated condensed financial statements.

The information set forth in these consolidated condensed financial statements is unaudited. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. Certain reclassifications have been made to 2002 financial statements to conform with the 2003 presentation.

In the opinion of management, all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation have been included. The results of operations for the quarter ended August 2, 2003 are not necessarily indicative of the results that may be expected for the year ending January 31, 2004. For further information, refer to the consolidated financial statements and notes thereto included in the Annual Report of The Wet Seal, Inc. (the Company) for the year ended February 1, 2003.

In November 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 143 “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated retirement costs. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows.

In July 2002, the FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses financial accounting and reporting for costs associated with exit or disposal activities and supersedes Emerging Issues Task Force (EITF) Issue 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized

when the liability is incurred. Under EITF 94-3, a liability for an exit cost as defined in EITF 94-3 was recognized at the date of an entity’s commitment to an exit plan. SFAS 146 also establishes that the liability should initially be measured and recorded at fair value. The Company adopted the provisions of SFAS 146 for exit or disposal activities initiated after December 31, 2002.

In November 2002, the FASB issued FASB Interpretation No. (FIN) 45, “Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees and Indebtedness of Others,” an interpretation of FASB Statements No. 5, 57 and 107, and rescission of FIN 34, “Disclosure of Indirect Guarantees of Indebtedness of Others.” FIN 45 elaborates on the disclosures to be made by the guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002 while the provisions of the disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of this interpretation did not have a material impact on the Company’s results of operations or financial position.

In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities,” an interpretation of ARB No. 51. FIN 46 requires that variable interest entities be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. FIN 46 also requires disclosures about variable interest entities that companies are not required to consolidate but in which a company has a significant variable interest. The consolidation requirements of FIN 46 will apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements will apply to entities established prior to January 31, 2003 in the first fiscal year or interim period beginning after June 15, 2003. The disclosure requirements will apply in all financial statements issued after January 31, 2003. The Company believes the adoption of FIN 46 will have no impact on its results of operations or financial position, as the Company has no interests in variable interest entities.

have previously been reported as equity, as a liability (or an asset in some circumstances). This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company does not believe that the adoption of SFAS No. 150 will have a significant impact on its results of operations, financial position or cash flows.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123.” This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirement of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS 148 is effective for fiscal years ending after December 15, 2002. The Company determined not to adopt the fair value based method of accounting for stock-based employee compensation, but did adopt the additional disclosure requirements of SFAS 148 in fiscal 2002.

The Company continues to account for its stock-based awards using the intrinsic value method in accordance with APB No. 25, “Accounting for Stock Issued to Employees,” and its related interpretations. Accordingly, no compensation expense has been recognized in the consolidated financial statements for employee incentive stock options or nonqualified stock options.

SFAS No. 123, “Accounting for Stock-Based Compensation,” requires the disclosure of pro forma net income and earnings per share had the Company adopted the fair value method as of the beginning of fiscal 1995. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company’s stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values.

The Company’s calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions:

The Company’s calculations are based on a valuation approach and forfeitures are recognized as they occur. If the computed fair values of the stock option awards had been amortized to expense over the vesting period of the awards, net income (loss) (in thousands) and earnings (loss) per share would have been changed to the pro forma amounts indicated below:

The above pro forma adjustments are not indicative of future period pro forma adjustments, when the calculation will apply to all applicable stock options.

Under an amended secured revolving line-of-credit arrangement with Bank of America, N.A., the Company may borrow up to a maximum of $50.0 million on a revolving basis through July 1, 2004. The cash borrowings under the arrangement bear interest at the bank’s prime rate or, at the Company’s option, LIBOR plus 1.5%.

The credit arrangement imposes quarterly and annual financial covenants requiring the Company to maintain certain financial ratios. In addition, the credit arrangement requires that the bank approve the payment of dividends and restricts the level of capital expenditures. At August 2, 2003, the Company was in compliance with these covenants and the Company had no borrowings outstanding under the credit arrangement. There were $18.1 million in open letters of credit related to imported inventory orders as well as standby letters of credit totaling $0.9 million, yielding availability under the line of credit of $31.0 million, as of August 2, 2003.

Net income (loss) per share, basic, is computed based on the weighted average number of shares of Class A and Class B common stock outstanding for the period.

Net income (loss) per share, diluted, is computed based on the weighted average number of shares of Class A and Class B common stock and potentially dilutive common stock equivalents outstanding for the period. Stock options were not included in the computation of diluted net loss per share for the quarter and six months ended August 2, 2003, because to do so would have been antidilutive.

A reconciliation of the numerators and denominators used in basic and diluted net income (loss) per share is as follows:

On October 1, 2002, the Company’s Board of Directors authorized the repurchase of up to 5,400,000 of the outstanding common stock of the Company’s Class A Common shares. This amount includes the remaining shares previously authorized for repurchase by the Company’s Board of Directors. All shares repurchased under this plan will be retired as authorized by the Company’s Board of Directors. During fiscal 2002, the Company repurchased 947,400 shares for $8.2 million and retired these shares. An additional 124,500 shares were repurchased for $0.9 million in the first quarter of fiscal 2003 and these shares were retired. As of August 2, 2003, there were 4,328,100 shares remaining that are authorized for repurchase.

Item 2— Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated condensed financial statements and the notes thereto.

We are one of the largest national mall-based specialty retailers focusing primarily on young women’s apparel and accessories. We currently operate 622 retail stores in 47 states, Washington D.C. and Puerto Rico. Of the 622 stores, 467 are Wet Seal stores, 20 are Contempo Casuals stores, 104 are Arden B. stores and 31 are Zutopia stores. We opened 65 stores and closed 31 stores during the period from August 3, 2002 to August 2, 2003.

Our consolidated condensed financial statements were prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information, the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.

The preparation of financial statements in conformity with generally accepted accounting principles requires the appropriate application of certain accounting policies, some of which require us to make estimates and assumptions about future events and their impact on amounts reported in our financial statements. Since future events and their impact cannot be determined with absolute certainty, the actual results will inevitably differ from our estimates.

Our accounting policies are generally straightforward, but inventory valuation requires more significant management judgments and estimates.

Merchandise inventories are stated at the lower of cost (first in, first out) or market. Cost is calculated using the retail inventory method. The retail inventory method is used to estimate the ending inventory at cost by employing a cost to retail (selling price) ratio. The ending inventory is first determined at selling price and then converted to cost. Purchases, sales, net markdowns (less mark-ups), charity, discounts and estimated shrink are considered in arriving at the cost to retail ratio. Inventories include items that have been marked down to management’s best estimate of their fair market value. Management’s decision to mark

down merchandise is based on maintaining the freshness of our product offering. Markdowns are taken regularly to effect the rapid sale of slow moving inventory and to make room for new merchandise arriving daily to the stores.

To the extent that management’s estimates differ from actual results, additional markdowns may be required that could reduce our gross margin, operating income and the carrying value of inventories. Our success is largely dependent upon our ability to anticipate the changing fashion tastes of our customers and to respond to those changing tastes in a timely manner. If we fail to anticipate, identify or react appropriately to changing styles, trends or brand preferences of our customers, we may experience lower sales, excess inventories and more frequent and extensive markdowns, which would adversely affect our operating results.

We believe the application of our accounting policies, and the estimates inherently required therein, are reasonable. Our accounting policies and estimates are reevaluated on an ongoing basis, and adjustments are made when facts and circumstances dictate a change. Our accounting policies are more fully described in Note 1 to the consolidated financial statements and in Management’s Discussion and Analysis, respectively, included in our Annual Report for the fiscal year ended February 1, 2003.

We reported a comparable store sales decline of 19.8% for the second quarter, with sequential month-over-month improvement in sales trends during the quarter. The results reflect an improvement in transaction count and units sold per customer transaction, which supports our belief that the Wet Seal chain has a loyal customer base that is returning to our stores as we continue to make improvements to our merchandise mix. The “bottoms” business improved with the re-launch of the Blue Asphalt private label denim line in the last two weeks of the quarter, complemented by sales trend improvement with active-wear and track jackets. These sales improvements were tempered by slow sales in our “tops” business. Meanwhile, we believe that the Arden B. business has been repositioned and returned to a more sophisticated offering, with a good response to newly introduced lines that include boucle, twill and cashmere. Zutopia’s business continues to produce comparable store sales declines in a very price sensitive environment.

Despite the trend improvement in transaction count and units sold per transaction, there was continued deterioration in the average retail price per item sold, the “average unit retail.” The reduction in the average unit retail is largely the result of aggressive markdowns taken on late spring and early summer merchandise, as well as price reductions on selected merchandise. The aggressive markdowns reflect our continued efforts to maintain careful control over the “freshness” of our inventory as we manage our business during a period of negative comparable store sales trends.

Although we have seen only modest improvements in comparable store sales as we progress into the third quarter, we continue to focus on streamlining operations and capturing additional savings to bring our cost structure in line with current sales.

We are encouraged by the rebuilding strategy under the stewardship of our new chief executive officer and the appointment of several key executives who are expected to help us move the business forward. We believe that the appointment of our new Senior Vice President-Creative Director will positively influence the fashion direction of the Wet Seal business as he becomes involved in product design and development as well as with the stores’ visual presentation and the Company’s marketing strategy.

The quarter ended August 2, 2003 compared to the quarter ended August 3, 2002.

Sales for the quarter ended August 2, 2003 were $126.0 million compared to sales for the prior year second quarter of $146.2 million, a decrease of $20.2 million or 13.8%. The decrease in sales was due to a comparable store sales decline of 19.8% for the quarter, partially offset by a net increase of 34 stores compared to the second quarter in the prior year. In the same quarter last year comparable store sales increased 1.6%. We experienced improved sequential monthly comparable store sales trends during the quarter, reflecting an improvement in transaction count and in units sold per customer transaction, offset by a decline in the retail price of the average unit sold.

The cost of sales (including buying, merchandise planning, distribution and occupancy costs) was $107.7 million for the quarter compared to $101.9 million for the same quarter last year, an increase of $5.8 million or 5.7%. As a percentage of sales, cost of sales was 85.5% for the second quarter this year compared to 69.7% for the same quarter last year, an increase of 15.8%. More than half of the increase in cost of sales as a percentage of sales was due to the loss of leverage for occupancy, buying and merchandise planning costs as a result of lower sales. The remainder came from aggressive mark-downs taken during the quarter to clear out late spring and early summer merchandise. There was also a decrease in the initial mark-up, reflecting efforts to improve the price/value relationship in our pricing structure for selected items.

Selling, general and administrative expenses (SG&A) were $39.4 million for the second quarter compared to $39.3 million for the second quarter last year, an increase of $0.1 million. As a percentage of sales, SG&A expenses were 31.2% for the quarter this year compared to 26.9% for the same quarter last year, an increase of 4.3%. While store payroll as a percentage of sales contributed more than half of the 4.3% increase, there were actually less payroll dollars spent per store during the second quarter of this year than in the second quarter of last year, with the increase as a percentage of sales over last year reflecting both the deleverage caused by lower sales as well as the greater number of stores open this year. SG&A costs also increased as a result of investments made over the past year in upgrading our field management. These additional costs were offset by lower advertising expenditures and central office payroll. Additionally, the freight cost per unit to deliver merchandise to the stores declined approximately 9% from the second quarter of last year.

Interest income, net, was $0.4 million for the second quarter compared to $0.9 million for the second quarter last year, a decrease of $0.5 million. This decrease was due to a reduction in the invested balance compared to the same period in the prior year as well as to a reduction in market interest rates on the invested balance.

The income tax provision reflected a $7.2 million benefit for the quarter ended August 2, 2003 compared to a $2.2 million charge for the quarter ended August 3, 2002. The effective income tax rate for the second quarter of this year was 35.0%, compared to the 37.5% rate of the prior year second quarter. The year-over-year reduction in the effective tax rate reflects an expectation that tax exempt interest income and charitable deductions of inventory will be a higher proportion of full year net income or loss than similar expectations at the end of the second quarter last year.

Based on the factors noted above, the net loss was $13.4 million or $0.45 per diluted share for the quarter ended August 2, 2003 compared to net income of $3.7 million or $0.12 per diluted share for the quarter ended August 3, 2002, a decrease of $17.1 million. This represents a net loss of 10.7% of sales for the second quarter this year compared to a net income of 2.5% of sales for the same quarter last year.

The six months ended August 2, 2003 compared to the six months ended August 3, 2002.

Sales for the six months ended August 2, 2003 were $249.7 million compared to sales for the prior year six months of $302.8 million, a decrease of $53.1 million or 17.5%. The decrease in sales was due to the comparable store sales decline of 22.8% for the six months, partially offset by a net increase of 34 stores. In the same six months last year comparable store sales increased 4.9%. We have experienced a slow, but progressive, comparable store sales trend improvement from the first quarter decrease of 25.5% to the second quarter decrease of 19.8%.

The cost of sales (including buying, merchandise planning, distribution and occupancy costs) was $206.6 million for the six months ended August 2, 2003 compared to $206.0 million for the same six months of last year, an increase of $0.6 million or 0.3%. As a percentage of sales, cost of sales was 82.8% for the six months this year compared to 68.0% for the same six months last year, an increase of 14.8%. The increase in cost of sales as a percentage of sales was impacted by two key factors: the loss of leverage for occupancy, buying and merchandise planning costs as a result of lower sales, and the significantly higher mark-down activity this year, reflecting continuing efforts to clear slow-moving inventory during a period of significant negative comparable store sales. Distribution center costs decreased in dollar terms and remained basically flat as a percentage of sales, reflecting gains in efficiency over the prior year which helped offset what could otherwise have been a higher percent of sales due to the fixed cost component of the distribution center costs.

SG&A expenses were $77.6 million for the six months ended August 2, 2003, compared to $78.9 million for the same six months last year, a decrease of $1.3 million. As a percentage of sales, SG&A expenses were 31.1% for the six months this year compared to 26.0% for the same six months last year, an increase of 5.1%. Store payroll as a percentage of sales contributed 3.1% of the 5.1% increase. Similar to this year’s second quarter results, there were actually less payroll dollars spent per store during the first six months of this year than in the first six months of last year. This year’s increase as a

percent of sales reflects the deleverage caused by same store sales declines as well as a greater number of stores open this year. The overall reduction in selling dollars spent in the first six months of this year reflects the scaling back of advertising expenditures and lower merchandise delivery costs, slightly offset by an increase in expenses related to field management positions. Dollar savings in general and administrative expenses were due to a substantial reduction this year in accrued bonus expense as well as payroll savings resulting from the temporary CEO vacancy and the elimination of a number of other key administrative positions.

Interest income, net, was $0.8 million for the six months ended August 2, 2003, compared to $1.9 million for the same six months last year, a decrease of $1.1 million. This decrease was due to a reduction in market interest rates on the invested balance, as well as to a reduction in the invested balance compared to the same period in the prior year.

The income tax provision reflected an $11.8 million benefit for the six months ended August 2, 2003 compared to a $7.4 million charge for the six months ended August 3, 2002. The effective income tax rate for the six months of this year was 35.0%, compared to the 37.5% running rate of the prior year six months. The year-over-year reduction in the effective tax rate reflects an expectation that tax exempt interest income and charitable deductions of inventory will be a higher proportion of full year net income or loss than similar expectations at the end of the second quarter last year.

Based on the factors noted above, the net loss was $21.9 million or $0.74 per diluted share for the six months ended August 2, 2003 compared to net income of $12.4 million or $0.39 per diluted share for the six months ended August 3, 2002, a decrease of $34.3 million. This represents a net loss of 8.8% of sales for the six months this year compared to a net income of 4.1% of sales for the same six months last year.

Working capital at August 2, 2003 was $56.5 million compared to $64.5 million at February 1, 2003, a decrease of $8.0 million. This decrease in working capital was primarily due to an increase in merchandise payables, net of an increase in inventory, and a reduction in prepaid expenses, partially offset by an increase in short-term investments and the income tax receivable.

Net cash provided by operating activities for the first six months of fiscal 2003 was $6.9 million, compared to $8.8 million in the first six months of last year. The $1.9 million decrease reflects a $34.3 million decrease in earnings compared to the six months of the prior

year, offset by a number of items. These offsets include an increase of nearly $3.1 million in non-cash depreciation and amortization expense, a reduction in prepaid rents due to the timing of the rent check distribution, and a $21.2 million increase in payables, reflecting the timing of large inventory receipts near the end of the quarter.

The cash and investment balance at the end of the quarter was $89.9 million, $4.9 million less than it was at February 1, 2003. This reflects the decline in sales over the last six months and expenditures for capital improvements.

Capital improvements totaled $11.0 million during the first six months of this year, compared to $29.5 million during the same period in the prior year. The investment of $11.0 million reflects costs for the 26 new stores and 17 remodels completed during the first two quarters of the year, as well as remodels and new stores under construction for third quarter openings. We expect capital improvements for the remainder of fiscal 2003 to be no more than $4 million.

In September 1998, our Board of Directors authorized the repurchase of up to 20% of the outstanding shares of our Class A common stock. From this authorized plan, 3,077,100 shares (split adjusted) were repurchased at a cost of $20.3 million. These repurchased shares were reflected as Treasury Stock in our consolidated balance sheets, until they were retired on December 2, 2002, as authorized by the Board of Directors. On October 1, 2002, our Board of Directors authorized the repurchase of up to 5.4 million shares of our outstanding Class A common stock. This amount included the remaining shares previously authorized for repurchase by the Board of Directors. During fiscal 2002, the Company repurchased 947,400 shares for $8.2 million and retired these shares. An additional 124,500 shares were repurchased for $0.9 million in the first quarter of fiscal 2003 and these shares were also retired. As of August 2, 2003, there were 4,328,100 shares remaining that are authorized for repurchase.

We have a revolving line-of-credit arrangement with Bank of America, N.A. under which we may borrow up to a maximum of $50 million on a revolving basis through July 1, 2004. At August 2, 2003, there were no outstanding borrowings under the credit arrangement. There were $18.1 million in open letters of credit related to imported inventory orders as well as standby letters of credit totaling $0.9 million. As of August 2, 2003, we were in compliance with all financial covenants of the credit arrangement. We invest our excess funds in short-term investment grade money market funds, investment grade municipal and commercial paper and U.S. Treasury and agency obligations. Assets listed as long-term investments on our balance sheet consist of high credit quality

municipal and corporate bonds with maturities extending no further than three years out.

We believe that our working capital and cash flows from operating activities will be sufficient to meet our operating and capital requirements in the foreseeable future.

Our business is seasonal in nature with the Christmas season, beginning the week of Thanksgiving and ending the first Saturday after Christmas, and the back-to-school season, beginning the last week of July and ending the first week of September, historically accounting for a large percentage of sales volume. For the past three fiscal years, the Christmas and back-to-school seasons together accounted for an average of approximately 30% of our annual sales, after adjusting for sales increases related to new stores. We do not believe that inflation has had a material effect on the results of operations during the past three years. However, we cannot assure you that our business will not be affected by inflation in the future.

Our principal contractual obligations consist of minimum annual rental commitments under non-cancelable leases for our stores, our corporate office, warehouse facility, automobiles, computer equipment and copiers. At August 2, 2003, our contractual obligations under these leases were as follows (in thousands):

Our principal commercial commitments consist of open letters of credit, related primarily to imported inventory orders, secured by our revolving line-of-credit arrangement. At August 2, 2003, our contractual commercial commitments under these letters of credit arrangements were as follows (in thousands):

We do not maintain any long-term or exclusive commitments or arrangements to purchase merchandise from any single supplier.

Certain sections in this Quarterly Report on Form 10-Q, including the preceding “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” may contain various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent our expectations or beliefs concerning future events.

Forward-looking statements include statements that are predictive in nature, which depend upon or refer to future events or conditions, which include words such as “believes,” “plans,” “anticipates,” “estimates,” “expects” or similar expressions. In addition, any statements concerning future financial performance, ongoing business strategies or prospects, and possible future actions, which may be provided by our management, are also forward-looking statements. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about our company, economic and market factors and the industry in which we do business, among other things. These statements are not guaranties of future performance and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

Actual events and results may differ from those expressed in any forward-looking statements due to a number of factors. Factors that could cause our actual performance, future results and actions to differ materially from any forward-looking statements include, but are not limited to, those discussed in Exhibit 99.1 attached to this report and noted elsewhere in this report. We strongly urge you to review and consider the risk factors set forth in Exhibit 99.1.

In November 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated retirement costs. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 did not have a material impact on our consolidated results of operations, financial position or cash flows.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses financial accounting and reporting for costs associated with exit or disposal activities and supersedes Emerging Issues Task Force (EITF) Issue 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs

Incurred in a Restructuring). “SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as defined in EITF 94-3 was recognized at the date of an entity’s commitment to an exit plan. SFAS 146 also establishes that the liability should initially be measured and recorded at fair value. We adopted the provisions of SFAS 146 for exit or disposal activities initiated after December 31, 2002.

In November 2002, the FASB issued (FIN) 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees and Indebtedness of Others,” an interpretation of FASB Statements No. 5, 57 and 107, and rescission of FIN 34, “Disclosure of Indirect Guarantees of Indebtedness of Others.” FIN 45 elaborates on the disclosures to be made by the guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The provisions of the disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of such interpretation did not have a material impact on our results of operations or financial position.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of FASB Statement No. 123.” This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirement of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS 148 is effective for fiscal years ending after December 15, 2002. We have determined not to adopt the fair value based method of accounting for stock-based employee compensation, but did adopt the additional disclosure requirements of SFAS 148 in fiscal 2002.

significant variable interest. The consolidation requirements of FIN 46 will apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements will apply to entities established prior to January 31, 2003 in the first fiscal year or interim period beginning after June 15, 2003. The disclosure requirements will apply in all financial statements issued after January 31, 2003. We believe the adoption of FIN 46 will have no impact on our results of operations or financial position, as we have no interests in variable interest entities.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity,” which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within its scope, which may have previously been reported as equity, as a liability (or an asset in some circumstances). This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We do not believe that the adoption of SFAS No. 150 will have a significant impact on our results of operations, financial position or cash flows.

To the extent that we borrow under our credit facility, we would be exposed to market risk related to changes in interest rates. At August 2, 2003, no borrowings were outstanding under our credit facility. We are not a party to any derivative financial instruments. However, we are exposed to market risk related to changes in interest rates on this investment grade interest-bearing securities which we invest. If there are changes in interest rates, those changes would affect the investment income we earn on those investments.

Our disclosure controls and procedures (as defined in Rule 13a-15(e) under Exchange Act) (“Disclosure Controls”) are controls and procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this quarterly report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure Controls are also designed with the objective of ensuring that this information is accumulated and

communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Our internal control over financial reporting (“Internal Controls”) is a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our Board of Directors, management and other personnel, with the objective of providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal Controls also include policies and procedures that:

1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of our company;

2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of our company are being made only in accordance with authorizations of management and directors of our company; and

3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our company’s assets that could have a material effect on the financial statements.

Our management, including our Chief Executive Officer and our Chief Financial Officer, does not expect that our Disclosure Controls or Internal Controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.

Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the control. Moreover, the design of any system of controls is also based in part upon certain assumptions about the likelihood of future events.

Not withstanding the foregoing limitations, we believe that our Disclosure Controls and Internal Controls provide reasonable assurances that the objectives of our control system are met.

As of August 2, 2003, the last day of the period covered by this report, an evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our Disclosure Controls. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded, subject to the limitations noted above, that:

We are not party to any material legal proceedings. We anticipate that we will be subject to litigation (and arbitration) in the ordinary course of business.

We held our most recent Annual Meeting on May 29, 2003. Following is a brief description of the proposal voted upon at the meeting and the tabulation of the voting therefore:

10.1		Settlement Agreement, dated August 8, 2003 between the Company and Kathy Bronstein

10.2		Employment Agreement, dated August 25, 2003 between the Company and Allan D. Haims

31.1		Certification of the Chief Executive Officer

		filed herewith pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of the Chief Financial Officer filed herewith pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of the Chief Executive Officer furnished herewith pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of the Chief Financial Officer furnished herewith pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

99.1		Factors Affecting Future Financial Results

On May 12, 2003, we filed a current report on Form 8-K reporting that we issued a press release regarding net sales for the four-week and thirteen-week periods ended May 3, 2003. We also announced a range for expected financial results for the first quarter of fiscal 2003 as well as plans to release final first quarter earnings results on May 22, 2003.

On May 23, 2003, we filed a current report on Form 8-K reporting final financial results for the first quarter of fiscal 2003.

On May 30, 2003, we filed a current report on Form 8-K reporting that we issued a press release announcing the appointment of Peter Whitford as Chief Executive Officer of our Company.

On July 11, 2003, we filed a current report on Form 8-K reporting that we issued a press release regarding net sales for the five-week period ended July 5, 2003. We also announced a range for expected financial results for the second quarter of fiscal 2003.

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

26972 Burbank Foothill Ranch, California		92610
(Address of principal executive offices)		(Zip code)


PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated condensed balance sheets (unaudited) as of August 2, 2003 and February 1, 2003	3-4

	Consolidated condensed statements of operations and comprehensive income (loss)(unaudited) for the quarter and six months ended August 2, 2003 and August 3, 2002	5

	Consolidated condensed statements of cash flows (unaudited) for the six months ended August 2, 2003 and August 3, 2002	6

	Notes to consolidated condensed financial statements (unaudited)	7-12

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13-23

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23

Item 4.	Controls and Procedures	23-25

PART II.	OTHER INFORMATION	26-27

	SIGNATURE PAGE	28

	EXHIBIT 10.1	29-45

	EXHIBIT 10.2	46-60

	EXHIBIT 31.1	61-62

	EXHIBIT 31.2	63-64

	EXHIBIT 32.1	65

	EXHIBIT 32.2	66

	EXHIBIT 99.1	67-73

	August 2, 2003			February 1, 2003
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	18,535		$	21,969
Short-term investments		48,484			39,237
Income tax receivable		15,638			11,561
Other receivables		2,851			3,906
Merchandise inventories		48,738			31,967
Prepaid expenses		3,744			11,992
Deferred tax charges		2,472			2,472

Total current assets		140,462			123,104

EQUIPMENT AND LEASEHOLD IMPROVEMENTS:
Leasehold improvements		132,595			127,792
Furniture, fixtures and equipment		89,673			86,062
Leasehold rights		2,350			2,350

		224,618			216,204
Less accumulated depreciation		(116,475	)		(106,423	)

Net equipment and leasehold improvements		108,143			109,781

LONG-TERM INVESTMENTS		22,924			33,639
OTHER ASSETS:
Deferred taxes and other assets		11,611			11,778
Goodwill		6,323			6,323

Total other assets		17,934			18,101

TOTAL ASSETS	$	289,463		$	284,625

	August 2, 2003		February 1, 2003
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable—merchandise	$	49,799	$	22,248
Accounts payable—other		12,213		13,827
Accrued liabilities		21,953		22,520

Total current liabilities		83,965		58,595

LONG-TERM LIABILITIES:
Deferred rent		9,657		9,315
Other long-term liabilities		5,606		5,392

Total long-term liabilities		15,263		14,707

Total liabilities		99,228		73,302

COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY:
Preferred Stock, $.01 par value, authorized 2,000,000 shares; none issued and outstanding at August 2, 2003 and February 1, 2003, respectively		—		—
Common Stock, Class A, $.10 par value, authorized 60,000,000 shares; 25,089,544 and 24,836,386 shares issued and outstanding at August 2, 2003 and February 1, 2003, respectively		2,509		2,484
Common Stock, Class B Convertible, $.10 par value, authorized 10,000,000 shares; 4,604,249 and 4,804,249 shares issued and outstanding at August 2, 2003 and February 1, 2003, respectively		460		480
Paid-in capital		59,884		59,036
Retained earnings		127,382		149,323

Total stockholders’ equity		190,235		211,323

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	289,463	$	284,625

	Six Months Ended
	August 2, 2003			August 3, 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	(21,941	)	$	12,386
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		13,340			10,302
Loss on disposal of equipment and leasehold improvements		301			316
Stock compensation		677			—
Changes in operating assets and liabilities:
Income tax receivable		(4,077	)		—
Other receivables		1,055			(2,389	)
Merchandise inventories		(16,771	)		(10,999	)
Prepaid expenses		8,248			(2,274	)
Other assets		167			(35	)
Accounts payable and accrued liabilities		25,370			4,878
Income taxes payable		—			(3,834	)
Deferred rent		342			57
Other long-term liabilities		214			383

Net cash provided by operating activities		6,925			8,791
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in equipment and leasehold improvements		(10,998	)		(29,503	)
Investment in marketable securities		(16,122	)		(43,211	)
Proceeds from sale of marketable securities		16,585			54,448

Net cash (used in) investing activities		(10,535	)		(18,266	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of treasury stock		(854	)		—
Proceeds from issuance of stock		1,030			4,154

Net cash provided by financing activities		176			4,154

NET (DECREASE) IN CASH AND CASH EQUIVALENTS		(3,434	)		(5,321	)
CASH AND CASH EQUIVALENTS, beginning of period		21,969			34,345

CASH AND CASH EQUIVALENTS, end of period	$	18,535		$	29,024

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest—credit facility	$	8		$	15
Income taxes, net	$	—		$	12,659

	Quarter Ended				Six Months Ended
	August 2, 2003		August 3, 2002		August 2, 2003		August 3, 2002
Dividend Yield	0.00	%	0.00	%	0.00	%	0.00	%
Expected Stock Volatility	70.17	%	70.85	%	70.17	%	70.85	%
Risk-Free Interest Rate	3.37	%	3.02	%	3.37	%	3.02	%
Expected Life of Option following vesting (in months)	60		60		60		60

(In thousands, except share and per share data)	Quarter Ended					Six Months Ended
	August 2, 2003			August 3, 2002		August 2, 2003			August 3, 2002
Net income (loss)	$	(13,428	)	$	3,666	$	(21,941	)	$	12,386

Weighted average Number of common shares:
Basic		29,608,362			30,351,080		29,591,762			30,236,446
Effect of dilutive Securities—stock Options		—			1,340,573		—			1,411,700

Diluted		29,608,362			31,691,653		29,591,762			31,648,146

Net income (loss) per share:
Basic	$	(0.45	)	$	0.12	$	(0.74	)	$	0.41
Effect of dilutive Securities—stock Options		—			—		—			0.02

Diluted	$	(0.45	)	$	0.12	$	(0.74	)	$	0.39

	Number of Votes
Nominee	For	Withheld	Broker Non-Votes

1. George H. Benter, Jr.	32,659,871	630,284	0

2. Barry J. Entous	32,659,871	630,284	0

3. Stephen Gross	32,956,505	333,650	0

4. Walter F. Loeb	32,956,505	333,650	0

5. Wilfred Posluns	32,659,871	630,284	0

6. Alan Siegel	32,659,871	630,284	0

7. Irving Teitelbaum	27,456,654	5,833,501	0