ANNUAL REPORT ON FORM 10-K

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
Gottschalks Inc.
Fresno, California

We have audited the accompanying balance sheets of Gottschalks Inc. (the "Company") as of January 28, 2006 and January 29, 2005, and the related statements of income, stockholders' equity and cash flows for each of the three fiscal years in the period ended January 28, 2006. Our audits also included the financial statement schedule listed in the Index at Item 15 (a) (2). We also have audited management's assessment, included in the accompanying "Management's Report on Internal Control over Financial Reporting," that the Company maintained effective internal control over financial reporting as of January 28, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements and financial statement schedule, an opinion on management's assessment, and an opinion on the effectiveness of the company's internal control over financial reporting based on our audits.

We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those 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 the 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 the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Gottschalks Inc. at January 28, 2006 and January 29, 2005, and the results of its operations and its cash flows for each of the three fiscal years in the period ended January 28, 2006 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. Also, in our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of January 28, 2006, is fairly stated, in all material respects, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 28, 2006, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

/s/ Deloitte & Touche LLP

San Francisco, California
April 7, 2006

GOTTSCHALKS INC.
BALANCE SHEETS
(In thousands)

                                                        January 28,  January 29,
                                                           2006         2005
                                                        -----------  -----------
ASSETS
CURRENT ASSETS:
  Cash................................................ $     5,368  $     5,470
  Receivables - net...................................       7,284        6,920
  Merchandise inventories.............................     159,986      152,753
  Other...............................................      15,354       15,447
                                                        -----------  -----------
    Total current assets..............................     187,992      180,590

PROPERTY AND EQUIPMENT - net..........................     133,545      126,509

OTHER ASSETS:
  Goodwill - net......................................       7,501        7,501
  Other intangibles - net.............................         615          652
  Other...............................................       5,189        6,101
                                                        -----------  -----------
                                                            13,305       14,254
                                                        -----------  -----------
                                                       $   334,842  $   321,353
                                                        ===========  ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
  Trade accounts payable and accrued expenses......... $    86,441  $    81,192
  Current portion of long-term debt...................       1,625        1,525
  Current portion of capitalized lease obligations....       1,145        1,717
  Deferred income taxes...............................       1,851        1,717
                                                        -----------  -----------
    Total current liabilities.........................      91,062       86,151

LONG-TERM OBLIGATIONS, less current portion...........      76,906       71,403

OTHER LIABILITIES.....................................      14,077       18,298

DEFERRED INCOME TAXES.................................      12,713       11,965

SUBORDINATED NOTE PAYABLE TO AFFILIATE................      20,180       21,180

COMMITMENTS AND CONTINGENCIES (Notes 7 and 14)

STOCKHOLDERS' EQUITY:
  Common stock, par value of $.01 per share;
    30,000,000 shares authorized; 13,361,149
    and 13,030,269 issued.............................         134          130
  Additional paid-in capital..........................      74,490       72,146
  Retained earnings...................................      45,280       40,080
                                                        -----------  -----------
                                                           119,904      112,356
                                                        -----------  -----------
                                                       $   334,842  $   321,353
                                                        ===========  ===========

See notes to financial statements.

GOTTSCHALKS INC.
INCOME STATEMENTS
(In thousands, except per share data)

                                                                Fiscal Years Ended
                                                        ----------------------------------
                                                        January 28, January 29, January 31,
                                                           2006        2005        2004
                                                        ----------  ----------  ----------
Net sales............................................. $  670,236  $  654,792  $  653,386
Net credit revenues...................................      3,084       3,106       3,729
Net leased department revenues........................      3,506       3,515       3,525
                                                        ----------  ----------  ----------
    Total revenues....................................    676,826     661,413     660,640
                                                        ----------  ----------  ----------
Costs and expenses:
  Cost of sales.......................................    437,474     427,792     431,094
  Selling, general and
    administrative expenses...........................    207,407     203,597     200,129
  Depreciation and amortization.......................     13,497      13,087      14,263
  VEBA litigation.....................................      1,811
  New store opening...................................        688
                                                        ----------  ----------  ----------
     Total costs and expenses.........................    660,877     644,476     645,486
                                                        ----------  ----------  ----------
Operating income .....................................     15,949      16,937      15,154
                                                        ----------  ----------  ----------
Other (income) expense:
  Interest expense....................................      9,242       9,509      13,296
  Miscellaneous income................................     (1,515)     (1,565)     (2,262)
                                                        ----------  ----------  ----------
                                                            7,727       7,944      11,034
                                                        ----------  ----------  ----------
Income from continuing operations
  before income tax ..................................      8,222       8,993       4,120

Income tax expense....................................      2,757       3,247       1,461
                                                        ----------  ----------  ----------

Income from continuing operations.....................      5,465       5,746       2,659

Discontinued operations:
  Loss from operations of closed stores...............       (581)       (674)     (1,188)
  Gain (loss) on store closures.......................        180         (31)       (789)
  Income tax benefit..................................        136         240         672
                                                        ----------  ----------  ----------
  Loss on discontinued operations.....................       (265)       (465)     (1,305)
                                                        ----------  ----------  ----------
  Net income ......................................... $    5,200  $    5,281  $    1,354
                                                        ==========  ==========  ==========

Net income per common share:
Basic
  Income from continuing operations................... $     0.41  $     0.45  $     0.20
  Loss on discontinued operations .................... $    (0.02) $    (0.04) $    (0.10)
  Net income per common share......................... $     0.39  $     0.41  $     0.10
Diluted
  Income from continuing operations................... $     0.40  $     0.43  $     0.20
  Loss on discontinued operations .................... $    (0.02) $    (0.03) $    (0.10)
  Net income per common share......................... $     0.38  $     0.40  $     0.10
Weighted average number of common shares outstanding
  Basic...............................................     13,245      12,922      12,830
  Diluted.............................................     13,797      13,352      12,919

See notes to financial statements.

GOTTSCHALKS INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except per share data)

                                   Common Stock     Additional
                               -------------------   Paid-in    Retained
                                 Shares     Amount   Capital    Earnings      Total
                               -----------  ------  ----------  ---------   ---------

BALANCE, FEBRUARY 1, 2003..... 12,801,669  $  128  $   71,313  $  33,445   $ 104,886
  Net income..................                                     1,354       1,354
  Issuance of common stock
   pursuant to nonqualified
   stock purchase plan and
   related tax benefit........      9,000                  27                     27
  Shares issued under
   stock purchase plan and
   related tax benefit........     68,133       1         100                    101
                               -----------  ------  ----------  ---------   ---------

BALANCE, JANUARY 31, 2004..... 12,878,802     129      71,440     34,799     106,368
  Net income..................                                     5,281       5,281
  Issuance of common stock
   pursuant to nonqualified
   stock purchase plan and
   related tax benefit........    132,250       1         634                    635
  Shares issued under
   stock purchase plan and
   related tax benefit........     19,217                  72                     72
                               -----------  ------  ----------  ---------   ---------
BALANCE, JANUARY 29, 2005..... 13,030,269  $  130  $   72,146  $  40,080   $ 112,356
  Net income..................                                     5,200       5,200
  Issuance of common stock
   pursuant to nonqualified
   stock purchase plan and
   related tax benefit........    321,650       4       2,276                  2,280
  Shares issued under
   stock purchase plan and
   related tax benefit........      9,230                  68                     68
                               -----------  ------  ----------  ---------   ---------
BALANCE, JANUARY 28, 2006..... 13,361,149  $  134  $   74,490  $  45,280 $$  119,904
                               ===========  ======  ==========  =========   =========

See notes to financial statements.

GOTTSCHALKS INC.
STATEMENTS OF CASH FLOWS
(In thousands of dollars)

                                                                                   Fiscal Years Ended
                                                                        ----------------------------------------
                                                                        January 28,   January 29,   January 31,
                                                                            2006          2005          2004
                                                                        ------------  ------------  ------------
Net income............................................................ $      5,200  $      5,281  $      1,354
Adjustments:
  Depreciation and amortization.......................................       13,654        13,326        14,569
  Deferred income taxes...............................................          882         1,761            24
  Amortization of deferred income and
    other deferred items..............................................       (1,955)       (2,336)       (2,446)
  Provision for credit losses.........................................                                      200
  Store closure costs.................................................          120            31           789
  Net loss from sale of assets........................................          131            16            59
Changes in assets and liabilities:
     Receivables......................................................         (364)        2,225         1,295
     Merchandise inventories..........................................       (5,790)        5,287         9,332
     Other current and long-term assets...............................          872        (1,335)        2,456
     Trade accounts payable and accrued expenses......................        9,587        10,064        (4,782)
     Other current and long-term liabilities..........................       (2,721)        4,086           212
                                                                        ------------  ------------  ------------
         Net cash provided by operating activities....................       19,616        38,406        23,062

INVESTING ACTIVITIES:
Purchases of property and equipment...................................      (22,227)      (13,745)       (4,363)
Proceeds from sale of fixtures and equipment..........................           --             3            27
Proceeds from investment in limited partnership.......................          365           365           352
                                                                        ------------  ------------  ------------
        Net cash used in investing activities.........................      (21,862)      (13,377)       (3,984)

FINANCING ACTIVITIES:
Net proceeds (repayments) from new revolving credit facility..........        2,182       (14,256)       (7,836)
Proceeds from long-term obligations...................................        6,000         9,000            --
Principal payments on long-term obligations...........................       (4,156)      (17,135)       (4,568)
Changes in cash management liability..................................       (3,284)       (1,843)       (7,845)
Debt issuance costs...................................................         (232)       (1,060)           --
Proceeds from exercise of options.....................................        1,566           491            27
Proceeds from sale of stock under employee
  stock purchase plans................................................           68            72           101
                                                                        ------------  ------------  ------------
Net cash provided by (used in) financing activities...................        2,144       (24,731)      (20,121)
                                                                        ------------  ------------  ------------
INCREASE (DECREASE) IN CASH...........................................         (102)          298        (1,043)
CASH AT BEGINNING OF YEAR.............................................        5,470         5,172         6,215
                                                                        ------------  ------------  ------------
CASH AT END OF YEAR................................................... $      5,368  $      5,470  $      5,172
                                                                        ============  ============  ============

See notes to financial statements.

GOTTSCHALKS INC.
NOTES TO FINANCIAL STATEMENTS

Gottschalks Inc. (the "Company") is a regional department and specialty store chain based in Fresno, California. As of January 29, 2005, the Company operated 63 full-line department stores located in six Western states, with 39 stores located in California, 10 in Washington, 6 in Alaska, 3 in Oregon, 2 in Nevada and 3 in Idaho. The Company also operated 6 specialty stores which carry a limited selection of merchandise. The Company's department stores typically offer a wide range of better to moderate brand-name and private-label merchandise, including men's, women's, junior's and children's apparel, cosmetics, shoes and accessories, and also a wide array of home furnishings, including domestics, china, housewares, small electrics and, in certain locations, furniture and mattresses.

Use of Estimates - The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Such estimates and assumptions are subject to inherent uncertainties which may cause actual results to differ from reported amounts.

Fiscal Year - The Company's fiscal year ends on the Saturday nearest January 31. Fiscal years 2005, 2004 and 2003 ended on January 28, 2006, January 29, 2005 and January 31, 2004, respectively. Fiscal 2005, 2004 and 2003 each included 52 weeks.

Revenue Recognition - Net retail sales are recorded at the point-of-sale and include sales of merchandise, net of estimated returns and exclusive of sales tax. Net retail sales also include all amounts billed to customers for shipping and handling, including customer delivery charges. Revenues on special order sales are recognized when the merchandise is delivered to the customer and has been paid for in its entirety. The Company does not sell merchandise on layaway. The Company's policy with respect to gift certificates is to record revenue as the certificates are redeemed for merchandise. Prior to their redemption, the certificates are recorded as a liability. The company records an allowance for estimated sales returns in the period in which the related sale occurs. These estimates are based primarily on historical sales returns. If the historical data used to calculate these estimates does not properly reflect future returns, adjustments to the allowance for estimated sales returns may be necessary.

The Company offers its private label credit card customers a points based rewards program. The program offers one point for every one dollar in net annual spending using the Company's private label credit card. At the end of each calendar year qualifying customers are sent a merchandise certificate for up to 5% of the total points accumulated, up to a maximum of 10,000 points. As points are earned throughout the year the Company accrues for the estimated costs of goods to be sold via redemption of the merchandise certificates based on historical redemption rates.

Net leased department revenues consist of rental income from lessees and sub-lessees and are based on a percentage of total sales generated in such leased departments during respective fiscal periods. Sales generated in such leased departments totaled $24,406,000, $24,295,000 and $24,460,000 in 2005, 2004 and 2003, respectively.

Net credit revenues consist primarily of a percentage of collected finance charges and late fees billed to cardholders by Household Bank (SB), N.A. (now "HSBC") during the period and the amortization of the pre-paid program fee. (Note 2)

Receivables - As of January 28, 2006 and January 29, 2005, receivables consist of vendor claims of $7,374,000, less allowances of $90,000, and vendor claims of $7,010,000, less allowances of $90,000, respectively.

Merchandise Inventories - Inventories, which consist of merchandise held for resale, are valued by the retail method and are stated at last-in, first-out (LIFO) cost, which is not in excess of market. Current cost, which approximates replacement cost, under the first-in, first-out (FIFO) method is equal to the LIFO value of inventories at January 28, 2006 and January 29, 2005. The Company includes in inventory the capitalization of certain indirect buying handling and distribution costs to better match these costs with the related sales.

Under the retail inventory method, inventory is segregated into departments of merchandise having similar characteristics, and is stated at its current retail selling value. Inventory retail values are converted to a cost basis by applying specific average cost factors for each merchandise department. Cost factors represent the average cost-to-retail ratio for each merchandise department based on beginning inventory and the fiscal year purchase activity. The retail inventory method inherently requires management judgments and estimates, such as the amount and timing of permanent markdowns to clear unproductive or slow-moving inventory, which may impact the ending inventory valuation as well as gross margins.

Permanent markdowns designated for clearance activity are recorded when the utility of the inventory has diminished. Factors considered in the determination of permanent markdowns include current and anticipated demand, customer preferences, age of the merchandise and fashion trends. When a decision is made to permanently mark down merchandise, the resulting gross margin reduction is recognized in the period the markdown is recorded.

Shrinkage is estimated as a percentage of sales for the period from the last inventory date to the end of the fiscal period. Such estimates are based on experience and the most recent physical inventory results. Physical inventories are taken within each merchandise department annually and inventory records are adjusted accordingly.

The Company receives cash or allowances from merchandise vendors as purchase price adjustments and in connection with cooperative advertising programs. Purchase price adjustments are credited to cost of sales and cooperative advertising allowances are credited against advertising expense in accordance with Emerging Issues Task Force ("EITF") Issue No. 02-16, "Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor."

Store Closure Costs - In the event a store is closed before its lease has expired, the remaining lease obligation after the closing date (less anticipated sublease rental income or proceeds from lease settlements, if any) is expensed at the date the store ceases operations. Asset impairment charges, if any, related to furniture, fixtures and equipment, leasehold improvements, goodwill and leasehold interests are expensed in the period in which management adopts a plan to close the store if impairment is considered likely as a result of such planned store closure or at such other time as impairment becomes likely. Severance and other incremental costs associated with a store closure are expensed as incurred.

New Store Opening Costs - New store opening costs are expensed as incurred and may vary significantly from year to year depending on the number of new stores opened.

Property and Equipment - Depreciation of owned properties is provided primarily on a straight-line basis over the estimated asset lives, which range from 15 to 40 years for buildings and leasehold improvements and 3 to 15 years for furniture, fixtures and equipment. Buildings on leased land and leasehold improvements are amortized over the shorter of their economic lives or the lease term, beginning on the date the asset is put into use. The lease term, which includes all renewal periods that are considered to be reasonably assured, begins on the date the Company has access to the leased property. The amortization of buildings and equipment under capital leases is computed by the straight-line method over the term of the lease or the estimated economic life of the asset, depending on the criteria used to classify the lease, and such amortization is combined with depreciation in the accompanying statement of operations.

Operating Leases - The Company recognizes operating lease minimum rentals on a straight-line basis over the lease term. The Company receives contributions from landlords to fund buildings and leasehold improvements. Such contributions are primarily recorded as deferred rent and amortized as reductions to lease expense over the lease term. During the third quarter of fiscal 2005, due to the Company's involvement in the construction of the building at its River Park store and other factors, the Company recorded $10.2 million in building and equipment under capital leases and $6.0 million in capital lease obligations associated with landlord reimbursements received. Executory costs such as real estate taxes and maintenance, and contingent rentals such as those based on a percentage of sales are recognized as incurred. The lease term, which includes all renewal periods that are considered to be reasonably assured, begins on the date the Company has access to the leased property. The excess in rent expense over actual cash paid is recorded as deferred rent.

Software Development Costs - Costs associated with the acquisition or development of software for internal use that meet the criteria of AICPA Statement of Position No. 98-1, "Accounting for Costs of Computer Software Developed or Obtained for Internal Use" are capitalized and amortized over the expected useful life of the software, which generally ranges from 3 to 10 years. Software development costs capitalized under SOP No. 98-1 in fiscal 2005, 2004 and 2003 totaled $177,000, $74,000 and $29,000 respectively. Amortization of such costs totaled $420,000, $428,000 and $408,000 in fiscal 2005, 2004 and 2003 respectively.

Goodwill - Goodwill and intangible assets having indefinite lives are not being amortized to earnings, but instead are subject to periodic testing for impairment. Goodwill and other intangible assets of a reporting unit are tested for impairment on an annual basis and more frequently if certain indicators are encountered. The Company has performed the required annual impairment review of goodwill for each of the fiscal years reported and concluded that there was no indication of impairment as of the respective measurement dates.

Leasehold Interests - Leasehold interests associated with acquired leases are amortized on a straight-line basis over the respective lease terms, including option renewal periods if renewal of the lease is probable, which range from 1 to 20 years.

Cash Management Liability - Under the Company's cash management program, checks issued by the Company and not yet presented for payment frequently result in overdraft balances for accounting purposes. Such amounts represent interest-free, short-term borrowings by the Company.

Miscellaneous Income - Miscellaneous income consists of amortization of long-term deferred credits recorded upon receipt of donated land, income from the Company's investment in a partnership, and miscellaneous non-operating income and expense. Miscellaneous income does not include any material offsetting expense items.

Advertising Costs - Advertising costs, net of cooperative advertising allowances, totaling $28,946,000, $29,964,000 and $30,597,000 in 2005, 2004 and 2003, respectively, are included in selling, general and administrative expenses for financial reporting purposes and are expensed when the related advertisement first takes place. Cooperative advertising allowances were $12,097,000, $11,250,000 and $9,077,000 in 2005, 2004 and 2003 respectively.

Income Taxes - Deferred tax assets and liabilities are generally recognized for the expected future tax consequences of events that have been included in the financial statements or tax returns, determined based on the differences between the financial statement and tax basis of assets and liabilities and net operating loss and tax credit carryforwards, and by using enacted tax rates in effect when the differences are expected to reverse. A valuation allowance is recorded when it is more likely than not that the carrying amounts of deferred tax assets will not be fully realized.

Stock-Based Compensation - At January 28, 2006, the Company has two stock-based employee compensation plans, which are more fully described in Note 12. The Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of the grant.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standard ("SFAS") No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation. The Company's calculations were made using the Black-Scholes option pricing model, which is more fully described in Note 12.

(In thousands, except per share data)               2005       2004       2003
-----------------------------------------------   --------   --------   --------
Net income as reported......................... $   5,200  $   5,281  $   1,354
Deduct: Total stock-based compensation expense
  determined under fair value based method
  for all awards, net of related tax effects...      (584)      (308)       (99)
                                                  --------   --------   --------
Pro forma net income........................... $   4,616  $   4,973  $   1,255
                                                  ========   ========   ========

Earnings per share:
  As reported:
   Basic....................................... $    0.39  $    0.41  $    0.10
   Diluted..................................... $    0.38  $    0.40  $    0.10

  Pro-forma:
   Basic....................................... $    0.35  $    0.38  $    0.10
   Diluted..................................... $    0.33  $    0.37  $    0.10

Long-Lived Assets - The Company periodically evaluates the carrying value of long-lived assets to be held and used, including intangible assets other than goodwill, when events and circumstances warrant such a review. When the anticipated undiscounted cash flow from a long-lived asset is less than its carrying value, a loss is recognized based on the amount by which its carrying value exceeds its fair market value. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risks involved, and in some cases, the expected proceeds from the sale or sublease of a particular asset, or independent appraisals. There were no asset impairment charges from continuing operations recognized in 2005, 2004 or 2003.

Discontinued Operations - The Company has determined that due to the regional concentration of certain of the stores closed during fiscal 2005 and 2003, and certain other factors, a significant portion of the operations and cash flows of the closed stores have been eliminated from the ongoing operations of the Company. Accordingly, as prescribed by SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived Assets," results of operations of certain stores closed during 2005 and 2003 are excluded from continuing operations and reported separately in discontinued operations for all periods affected.

Fair Value of Financial Instruments - The carrying value of the Company's cash and cash management liability, receivables, trade payables and other accrued expenses, revolving line of credit and letters of credit approximate their estimated fair values because of the short maturities or variable interest rates underlying those instruments. The carrying value of the Subordinated Note approximates its estimated fair value.

The fair values of the Company's mortgage loans and notes payable are estimated using discounted cash flow analysis, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. Borrowings with aggregate carrying values of $21,747,000 and $23,186,000 at January 28, 2006 and January 29, 2005, had estimated fair values of $24,028,000 and $25,033,000 at January 28, 2006 and January 29, 2005, respectively. The estimated fair value of the Company's derivative financial instrument is disclosed in Note 6.

Segment Reporting - The Company operates in one reportable segment.

Comprehensive Income - There were no items of other comprehensive income in 2005, 2004 or 2003, and therefore net income is equal to comprehensive income for each of those years.

Recently Issued Accounting Standards -  In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 151, "Inventory Costs - An Amendment of Accounting Research Bulletin (ARB) No. 43, Chapter 4." This statement amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) and is effective for fiscal years beginning after June 15, 2005. The Company does not anticipate that the adoption of this statement will have a material impact on the Company's financial position, results of operations or cash flows.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R"). This statement is a revision of SFAS No. 123, "Accounting for Stock-Based Compensation," and supersedes Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. Under the provisions of this statement, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition alternatives include retrospective and prospective adoption methods. Under the retrospective method, prior periods may be restated based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosures either for all periods presented or as of the beginning of the year of adoption. The prospective method requires that compensation expense be recognized beginning with the effective date, based on the requirements of this statement, for all share-based payments granted after the effective date, and based on the requirements of SFAS 123, for all awards granted to employees prior to the effective date of this statement that remain unvested on the effective date. The provisions of this statement are effective as of the beginning of the first annual reporting period that begins after June 15, 2005. The full impact of SFAS No. 123R adoption cannot be predicted at this time as it will depend on levels of share-based payments granted in the future. However, had the Company adopted SFAS No. 123R in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 previously described in the disclosure of pro forma net income and earnings per share in Note 1 Stock-Based Compensation. SFAS No. 123R also requires that benefits of tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. The Company is unable to estimate what those amounts will be in the future as they depend on, among other things, when employees exercise stock options.

In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions." This statement eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, and replaces it with an exception for exchanges that do not have commercial substance. The provisions of the statement are effective for fiscal periods beginning after June 15, 2005. The Company does not anticipate that the adoption of this statement will have a material impact on the Company's financial position, results of operations or cash flows.

In March 2005 the FASB issued Financial Interpretation No. 47 "Accounting for Conditional Asset Retirement Obligations" ("FIN 47"), which is effective for fiscal years ending after December 15, 2005. This Interpretation clarifies that the term conditional asset retirement obligation as used in FASB Statement No. 143, Accounting for Asset Retirement Obligations, refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and (or) method of settlement. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. This interpretation also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The Company adopted FIN 47 in the fourth quarter of fiscal 2005 and such adoption did not have a material impact on the Company's financial position, results of operations, or cash flows.

Reclassifications -An insurance deposit of $5,778,000 has been reclassified to other current assets that was previously reported as an offset to the Company's workers' compensation liability within trade accounts payable and accrued expenses as of January 29, 2005 to conform with the January 28, 2006 presentation.

On January 31, 2003, the Company terminated its receivables securitization program and sold substantially all of its customer credit card receivables to HSBC pursuant to the terms of a Purchase and Sale Agreement between the Company and HSBC.

At that time the Company also entered into an interim servicing agreement to service the receivables on behalf of HSBC until such time as they were able to convert the accounts to their systems and a program agreement whereby the Company will participate in revenues generated from the portfolio. The transaction was accounted for a sale of financial assets in accordance with SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."

In connection with the sale, on January 31, 2003 the Company entered into two additional agreements with HSBC: an Interim Servicing Agreement (the "ISA") and a Credit Card Program Agreement (the "CCA"). Under the terms of the ISA, the Company continued to service the credit card receivables until HSBC assumed the servicing on May 14, 2003, as planned. Net credit revenues for fiscal 2003 include $1,088,000 representing the excess of interim servicing compensation over the direct servicing costs. A portion of the program fees paid represented residual interest in the assets transferred at the time of the transaction. Accordingly, the Company recorded an interest only strip in the amount of $313,000 that was amortized as a charge to results of operations over the estimated life of the underlying assets sold on the transaction date.

The CCA sets forth the terms and conditions under which HSBC will issue credit cards to the Company's customers and pay the Company for sales made on the cards. Under the terms of the CCA, the Company is required to perform certain duties, including the duties to receive in-store customer payments on behalf of HSBC and remit such payments to HSBC. The CCA has a term of five (5) years and is cancelable earlier by either party under certain circumstances. The CCA further provides the Company will be paid a percentage of Net Cardholder Charges and a percentage of Other Revenue (each as defined in the CCA).

Net credit revenues associated with the Company's private label credit card program currently consists primarily of a percentage of collected finance charges and late fees billed to cardholders by HSBC during the period and the amortization of the pre-paid program fee ("service charge revenues") as follows:

(In thousands)                                   2005         2004         2003
--------------------------------------------  -----------  -----------  -----------
Service charge revenues..................... $     3,037  $     2,955  $     2,649
Interim servicing compensation - net........                                 1,088
Amortization of interest-only strip.........                                  (313)
Recoveries of charged-off receivables.......
 ineligible for sale........................          47          151          305
                                              -----------  -----------  -----------
                                             $     3,084  $     3,106  $     3,729
                                              ===========  ===========  ===========

Property and equipment consists of the following:

                                              January 28,  January 29,
(In thousands)                                   2006         2005
--------------------------------------------  -----------  -----------
Furniture, fixtures and equipment........... $   111,334  $   100,871
Buildings and leasehold improvements........      97,113       92,974
Land........................................      15,185       15,185
Buildings and equipment under
  capital leases............................      28,936       18,720
Construction in progress....................       3,167        7,095
                                              -----------  -----------
                                                 255,735      234,845
Less accumulated depreciation
  and amortization..........................    (122,190)    (108,336)
                                              -----------  -----------
                                             $   133,545  $   126,509
                                              ===========  ===========

During the third quarter of fiscal 2005, due to the Company's involvement in the construction of the building at its River Park store and other factors, the Company recorded $10.2 million in building and equipment under capital leases and $6.0 million in capital lease obligations associated with landlord reimbursements received.

Trade accounts payable and accrued expenses consist of the following:

                                              January 28,  January 29,
(In thousands)                                   2006         2005
--------------------------------------------  -----------  -----------
Trade accounts payable...................... $    29,156  $    24,548
Accrued expenses............................      33,535       29,162
Taxes, other than income taxes..............      12,663       12,059
Accrued payroll and related liabilities.....       6,074        8,139
Cash management liability...................       2,199        5,483
Federal and state income taxes payable......       2,814        1,801
                                              -----------  -----------
                                             $    86,441  $    81,192
                                              ===========  ===========

On March 1, 2004 the Company amended and restated its senior revolving credit facility (the "credit facility") to provide up to $165.0 million of working capital financing through February 2, 2009. On January 26, 2006 the Company finalized an amendment to the credit facility increasing the commitment to $181 million, reducing the interest rate charged on outstanding borrowing by 25 basis points, and allowing for the payoff of approximately $16.6 million of outstanding balances on higher interest rate mortgages related to four of the Company's owned properties (the "designated properties"), which payoff occurred subsequent to the end of fiscal 2005. In addition, the amendment provides for an optional additional increase in the commitment of $19.0 million, and an optional extension of the credit facility through February 2, 2011. The credit facility, as amended, currently consists of a revolving credit facility of up to $172.0 million (including a $20.0 million letter of credit sub-facility) and a fully funded term loan of $9.0 million. Borrowings under the revolving credit facility, as amended, are limited to the sum of (a) a specified percentage of eligible credit card receivables, (b) the lesser of specified percentages of (i) the cost of eligible inventory and (ii) the net recovery value of the inventory, as determined by periodic valuation performed by an independent appraiser, and (c) the lesser of (i) up to 60% of the fair market value of the designated properties and (ii) $21.6 million. Such borrowings are further limited by a requirement to maintain a minimum of $5.0 million of excess availability at all times, and other reserves that are in effect. As of January 28, 2006, outstanding borrowings under the credit facility totaled $47.9 million, and excess borrowing availability under the facility, after the deduction of the minimum availability requirement and other reserves, totaled $58.6 million.

As of January 28, 2006, interest charged on amounts borrowed under the revolving portion of the credit facility are at the prime rate (7.25% at January 28, 2006), or at the Company's option, at the applicable LIBOR rate plus 1.25% per annum (5.74% at January 28, 2006), and interest charged on the term loan is a fixed rate of 6.6% per annum. In addition, the Company pays an unused commitment fee equal to 0.375% per annum on the average unused daily balance of the revolving portion of the credit facility. The interest rate applicable to the revolving portion of the credit facility is adjusted upwards or downwards on a quarterly basis based on a pricing matrix which is tied to the Company's daily average excess availability for the preceding fiscal quarter (as defined in the agreement). Under the pricing matrix, the applicable interest rate could range from a rate as low as prime, or LIBOR plus 1.25%, to as high as prime plus 0.50%, or LIBOR plus 2.50%.

The credit facility, as amended, contains restrictive financial and operating covenants, including the requirement to maintain a fixed charge coverage ratio of 1:1 (as defined in the agreement) if the Company's excess borrowing availability is below $15.0 million. As of January 29, 2005, management believes the Company was in compliance with all restrictive financial covenants applicable to the credit facility.

Long-term obligations consist of the following:

                                              January 28,  January 29,
(In thousands)                                   2006         2005
--------------------------------------------  -----------  -----------
Revolving line of credit.................... $    47,935  $    45,753
9.39% mortgage loans payable, due 2010......      16,561       17,059
Capital lease obligations...................       9,993        5,707
Variable rate note payable, due 2005........          --        3,700
7.5% note payable due 2010..................       3,127           --
Other mortgage loans and notes payable......       2,060        2,426
                                              -----------  -----------
                                             $    79,676  $    74,645
  Less current portion......................       2,770        3,242
                                              -----------  -----------
                                             $    76,906  $    71,403
                                              ===========  ===========

During the third quarter of fiscal 2005, due to the Company's involvement in the construction of the building at its River Park store and other factors, the Company recorded $10.2 million in building and equipment under capital leases and $6.0 million in capital lease obligations associated with landlord reimbursements received.

On February 14, 2005, the Company amended and extended the financing of its ownership interest in the partnership that owns the Company's corporate headquarters building. The related note payable of $3.7 million, which originally provided for interest only payments at a variable rate of interest of prime plus 1.5% per annum, and was due in full upon maturity on May 24, 2005, has been modified to a fully amortizing note bearing interest at a fixed rate of 7.50% per annum and maturing on February 24, 2010. There is no prepayment penalty associated with the note.

The $16.6 million outstanding balance of the 9.39% mortgage loans was paid off subsequent to year end on February 1, 2006 utilizing funds available through the Company's revolving credit facility. The scheduled annual principal maturities of the Company's notes payable excluding such mortgage loans are $1,078, $1,097, $1,123, $982 and $202 for 2006 through 2010, with $704 payable thereafter.

Deferred debt issuance costs related to the Company's various financing arrangements are included in other current and long-term assets and are charged to income as additional interest expense over the life of the related indebtedness. Such costs, net of accumulated amortization, totaled $1,929,000 at January 28, 2006 and $2,251,000 at January 29, 2005.

Interest paid, net of amounts capitalized, was $8,466,000 in 2005, $8,075,000 in 2004 and $11,140,000 in 2003. The Company capitalized $114,000 in interest in 2005 in connection with new store construction. No interest was capitalized in 2004 or 2003. The weighted-average interest rate charged on the Company's revolving line of credit was 5.98% in 2005, 4.56% in 2004 and 5.16% in 2003.

Substantially all of the Company's assets, including its merchandise inventories, are pledged as collateral under the Company's various debt agreements. Certain of the Company's long-term debt agreements contain financial and other restrictive covenants, as well as cross default provisions. Accordingly, the failure to comply with these restrictions and covenants, if not waived, would cause a cross-default under the majority of all of the Company's debt agreements, including the credit facility. The Company was in compliance with all applicable financial covenants as of January 28, 2006.

On December 9, 2005 the Company entered into an interest rate swap agreement, effective December 14, 2005, to change the fixed/variable interest rate mix of the debt portfolio in order to maintain the percentage of fixed-rate and variable-rate debt within parameters set by management. The Company currently has an interest rate swap contract outstanding to effectively convert a portion of its variable-rate debt to fixed-rate debt. This contract entails the exchange of fixed-rate and floating-rate interest payments periodically over the agreement life. The following table indicates the notional amount as of January 28, 2006 and the range of interest rates paid and received by the Company during the fiscal year then ended:

In accordance with SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"), and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities," the Company recognizes all derivatives on the balance sheet at fair value. Although the swap essentially provides for matched terms to its underlying, and effectively mitigates its variability, it currently does not qualify for hedge accounting under SFAS No. 133.

The $25 million interest rate swap held at January 28, 2006 will expire February 2, 2009. The net income or expense from the exchange of interest rate payments is included in interest expense. The estimated fair value of the interest rate swap agreement, based on dealer quotes, at January 28, 2006 was a loss of $143,809 and represents the amount the Company would pay if the agreement was terminated as of that date. Changes in the fair value of derivatives not designated as qualifying cash flow hedges are reported in interest expense. Accordingly, interest expense for fiscal 2005 includes losses related to the interest rate swap of $143,809 and as of January 28, 2006, the Company reflected a derivative liability in other liabilities for such amount to recognize the fair value of the interest rate swap. All charges recorded pursuant to SFAS No. 133 are considered non-cash items in the statements of cash flows.

El Corte Ingles ("ECI") of Spain, and Harris, a wholly owned subsidiary of ECI, became affiliates of the Company in fiscal 1998 when the Company acquired substantially all of the assets and business of Harris. The Company issued a Subordinated Note to Harris, in the principal amount of $22,179,000 as partial consideration for the Harris acquisition (the "Original Note"). The Original Note, discounted to an effective interest rate of 10% at issuance, bore interest at a fixed rate of 8%. On December 7, 2004 a new Subordinated Note due May 30, 2009 superseded the Original Note. The new Subordinated Note bears interest at a fixed rate of 8% payable semi-annually and provides for principal payments of up to $8.0 million prior to its maturity. Such payments are subject to certain liquidity restrictions under the revolving credit facility. The Company made principal payments of $1.0 million each upon execution of the note, on February 20, 2005, and subsequent to fiscal year end on February 20, 2006 as scheduled. An additional principal payment of $1.0 million is scheduled for February 2007 and principal payments of $2.0 million are scheduled for each of February 2008 and 2009, with the balance due at maturity subject to the payment in full of the revolving credit facility. The Subordinated Note is unsecured, contains no restrictive financial covenants and is subordinate to the payment of all debt, including trade credit, of the Company. Interest paid to Harris totaled $1,679,500 in 2005 and $1,774,400 in 2004 and 2003.

The Company leases certain retail department stores, specialty stores, land, furniture and fixtures and equipment under capital and noncancellable operating leases that expire in various years through 2025. Certain of the leases provide for the payment of additional contingent rentals based on a percentage of sales, require the payment of property taxes, insurance and maintenance costs and have renewal options for one or more periods ranging from five to twenty years. The Company leases three of its department stores from an affiliate of the Company. (See Note 7.) Rent paid or accrued to ECI totaled $874,000 in 2005, $856,000 in 2004 and $859,000 in 2003.

Future minimum lease payments as of January 28, 2006, by year and in the aggregate, under capital leases and noncancellable operating leases with initial or remaining terms in excess of one year are as follows:

                                                Capital     Operating
(In thousands)                                  Leases       Leases
--------------------------------------------  -----------  -----------
2006........................................ $     2,366  $    22,776
2007........................................       1,847       20,207
2008........................................       1,376       18,588
2009........................................       1,376       16,068
2010........................................       1,417       13,366
Thereafter..................................      17,062       61,093
                                              -----------  -----------
Total minimum lease payments................      25,444  $   152,098
  Amount representing interest..............     (15,451)  ===========
                                              -----------
Present value of minimum lease payments.....       9,993
  Less current portion......................      (1,145)
                                              -----------
                                             $     8,848
                                              ===========

Rental expense consists of the following:

(In thousands)                                   2005         2004         2003
--------------------------------------------  -----------  -----------  -----------
Operating leases:
  Buildings:
    Minimum rentals......................... $    23,430  $    23,360  $    23,125
    Contingent rentals......................       3,175        2,839        2,895
  Fixtures and equipment....................       2,057        1,910        1,994
                                              -----------  -----------  -----------
                                             $    28,662  $    28,109  $    28,014
                                              ===========  ===========  ===========

One of the Company's lease agreements contains a restrictive financial covenant pertaining to the debt to tangible net worth ratio that management believes the Company was in compliance with at January 28, 2006.

During fiscal 2005 the Company closed 2 underperforming store locations in the Seattle/Tacoma market, and during fiscal 2003 the Company closed five other store locations in Washington and one store in Oregon. These stores were determined to be either underperforming or inconsistent with the Company's long-term operating strategy and due to the Company's exit from the respective market areas are considered discontinued operations. The closure of the Company's Fig Garden store during the first quarter of fiscal 2005 is not considered a discontinued operation due to the shift in revenues to other stores in the Fresno market, including the Fresno River Park store, which opened during the third quarter of fiscal 2005. The loss from operation of discontinued stores includes only revenues generated from, and expenses directly associated with, the operation of such stores and consists of the following:

(In thousands)                                               2005        2004         2003
--------------------------------------------------------  ----------  ----------  ------------
Net sales from closed stores............................ $    6,703  $    7,200  $     14,162

Cost of sales...........................................      4,355       4,336         8,714
Selling, general and administrative expenses............      2,772       3,300         6,332
Depreciation and amortization...........................        157         238           304
                                                          ----------  ----------  ------------
  Total costs and expenses..............................      7,284       7,874        15,350
                                                          ----------  ----------  ------------

Loss from operations of closed stores................... $     (581) $     (674) $     (1,188)
                                                          ==========  ==========  ============

Net costs associated with the closure of stores in fiscal 2005 were $0.1 million, consisting of severance and other incremental costs associated with the store closings. Such costs were offset by $0.3 million of income from an early termination fee received when the landlord exercised its right to terminate the lease. Net costs associated with the closure of stores were minor in fiscal 2004, primarily consisting of incremental costs associated with the closure of one store at January 31, 2004. Net costs associated with the closure of stores totaled $0.8 million in fiscal 2003 primarily consisting of lease termination costs, severance, and other incremental costs associated with the store closings.

As of January 28, 2006, the Company had no reserves for store closure costs. In the event the Company decides to close additional stores in fiscal 2006 or beyond, additional store closure costs, which may be material, may be incurred.

The components of income tax expense from continuing operations are as follows:

(In thousands)                                   2005         2004         2003
--------------------------------------------  -----------  -----------  -----------
Current:
  Federal................................... $     2,007  $     1,504  $     2,270
  State.....................................         561          180          221
                                              -----------  -----------  -----------
                                                   2,568        1,684        2,491
                                              -----------  -----------  -----------
Deferred:
  Federal...................................       1,036        1,203       (1,101)
  State.....................................        (847)         360           71
                                              -----------  -----------  -----------
                                                     189        1,563       (1,030)
                                              -----------  -----------  -----------
                                             $     2,757  $     3,247  $     1,461
                                              ===========  ===========  ===========

The principal components of deferred tax assets and liabilities are as follows (in thousands):

                                      January 28,             January 29,
                                         2006                    2005
                                ----------------------  ----------------------
                                Deferred    Deferred    Deferred    Deferred
                                   Tax         Tax         Tax         Tax
                                 Assets    Liabilities   Assets    Liabilities
                                ---------  -----------  ---------  -----------
Current:
  Accrued employee benefits... $   1,002  $            $   1,094  $
  State income taxes..........       254                     110
  LIFO inventory reserve......                 (5,098)                 (3,897)
  Workers' compensation.......     2,947                   2,718
  Legal reserve...............       952                     314
  Deferred income.............       831                     625
  Valuation Allowance.........      (912)                   (750)
  Other items, net............       261       (2,088)       271       (2,202)
                                ---------  -----------  ---------  -----------
                                   5,335       (7,186)     4,382       (6,099)
                                ---------  -----------  ---------  -----------
Long-Term:
  Net operating loss and tax
    credit carryforwards......     3,223                   4,514
  State income taxes..........       402                     690
  Property and equipment......                (11,036)                (12,087)
  Accounting for leases.......     1,093       (2,686)     1,206       (3,180)
  Leasehold interests.........       175                     878
  Deferred income.............       663       (4,066)     1,063       (3,813)
  Valuation allowance.........      (951)                 (1,504)
  Other items, net............     1,423         (953)     1,228         (960)
                                ---------  -----------  ---------  -----------
                                   6,028      (18,741)     8,075      (20,040)
                                ---------  -----------  ---------  -----------
                               $  11,363  $   (25,927) $  12,457  $   (26,139)
                                =========  ===========  =========  ===========

Income tax expense varies from the amount computed by applying the statutory federal income tax rate to income from continuing operations before income taxes. The reasons for this difference are as follows:

                                                    2005       2004       2003
-----------------------------------------------   --------   --------   --------
Statutory rate.................................      35.0 %     35.0 %     35.0 %
State income taxes, net of
 federal income tax benefit....................      (2.4)       4.3        8.0
General business credits.......................      (2.6)      (2.3)      (6.7)
Valuation allowance............................       4.6
Other items, net...............................      (1.1)      (0.9)      (0.8)
                                                  --------   --------   --------
Effective rate.................................      33.5 %     36.1 %     35.5 %
                                                  ========   ========   ========

The carrying value of the Company's net deferred tax assets assumes that the Company will be able to generate sufficient future taxable income to realize the value of these assets. In determining the appropriate valuation allowance, management considers all available evidence for the deferred tax assets, including tax credits, net operating loss and capital loss carryforwards that would likely expire prior to their utilization. The Company has established valuation allowances that relate primarily to certain state tax credit carryforwards whose realizability is uncertain. Although these credits do not expire, the utilization is extremely limited and is available only to the extent the Company generates sufficient taxable income apportionable to the respective location. The Company has historically generated the credits at a substantially more rapid rate than it has been able to utilize them. The resulting utilization period is, therefore, unusually long. Although the Company has had recent profitability, there can be no certainty that the Company will continue to generate sufficient taxable income apportioned to specific locations for an indefinite period of time to fully utilize the state tax credit carryforwards, especially given the cyclical nature of the company's business. Further, there is no certainty that the Company will operate in these specific locations for an extended period. To the extent that the Company no longer operates within these locations, the tax credits cannot be utilized. The Company considers it appropriate to release this valuation allowance after at least three years of continued operating profits, limited to the projected utilization of the state tax credits based on assumed operation in the specific locations of not more than ten years. The utilization of certain of the state tax credits and the release of a portion of the related valuation allowance resulted in a state tax benefit in 2005.

In addition, the Company has generated certain capital losses for which there is currently no carryback opportunity available. Based on the company's current operating strategy it appears more likely than not that there will be no opportunity available during the remaining carryforward period to generate offsetting capital gains. Accordingly the Company considers it appropriate to establish a valuation allowance against such carryforwards. Management believes it is more likely than not that the Company will generate sufficient future taxable income in the appropriate carryforward periods to realize the benefit of its remaining net deferred tax assets. However, if the available evidence were to change in the future, an adjustment to the valuation allowance may be required, resulting in additional income tax expense or benefit.

At January 28, 2006, the Company has, for federal tax purposes, general business credits of 92,000 that expire in the year 2025, and alternative minimum tax credits of $412,000 which may be used for an indefinite period. At January 28, 2006, the Company also has, for state tax purposes, $2,719,000 of state tax credits which may be used for an indefinite period. These carryforwards are available to offset future taxable income.

The Company paid income taxes, net of refunds, of $12,000 in 2005 and received income tax refunds, net of payments, of $44,000 in 2004, and $2,164,000 in 2003. The income tax refund received in 2003 were, in part, attributable to a final settlement of certain federal net operating loss carryback refund claims filed with the Internal Revenue Service.

11. EARNINGS PER SHARE

Net earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding during the year. Stock options represent potential common shares and are included in computing diluted earnings per share when the effect is dilutive. A reconciliation of the weighted-average shares used in the basic and diluted earnings per share calculation is as follows:

(Shares in thousands)                               2005       2004       2003
-----------------------------------------------   --------   --------   --------
Weighted average number of
  shares - basic...............................    13,245     12,922     12,830
Effect of assumed option exercises.............       552        430         89
                                                  --------   --------   --------
Weighted average number of
  shares - diluted.............................    13,797     13,352     12,919
                                                  ========   ========   ========

Options with an exercise price greater than the average market price of the Company's common stock during the period are excluded from the computation of the weighted-average number of shares on a diluted basis as such options are anti-dilutive. Anti-dilutive options excluded from the calculation were 183,463 and 496,775, 1,522,568 shares as of the end of 2005, 2004 and 2003, respectively.

12. STOCK OPTION AND STOCK PURCHASE PLANS

The Company has certain stock option plans and an Employee Stock Purchase Plan, as described below. All of these plans have been approved by the Company's stockholders.

The Company has stock option plans for directors, officers and key employees which provide for the grant of non-qualified and incentive stock options. Under the plans, the option exercise price may not be lower than 100% of the fair market value of such shares at the date of the grant. Options granted generally vest on a ratable basis over four years and expire ten years from the date of the grant. At January 28, 2006, options for 1,440,000 shares were available for future grants under the plans.

Option activity under the plans is as follows:

                             2005                 2004                 2003
                     -------------------- -------------------- --------------------
                                 Weighted-            Weighted-            Weighted-
                       Number    Average    Number    Average    Number    Average
                         of      Exercise     of      Exercise     of      Exercise
                       Shares     Price     Shares     Price     Shares     Price
                     ----------  -------- ----------  -------- ----------  --------
Options outstanding
  at beginning of
  year.............. 1,547,750  $   4.99  1,688,500  $   5.36  1,713,000  $   5.99
Granted.............   310,000     10.37    261,500      6.10    279,500      1.64
Exercised...........  (319,400)     4.88   (132,250)     3.71     (9,000)     3.03
Cancelled...........  (137,875)     6.70   (270,000)     9.34   (295,000)     5.57
                     ----------  -------- ----------  -------- ----------  --------
Options outstanding
 at end of year..... 1,400,475  $   6.19  1,547,750  $   4.96  1,688,500  $   5.36
                     ==========  ======== ==========  ======== ==========  ========
Options exercisable
 at end of year.....   777,100  $   5.45    941,375  $   5.69  1,067,625  $   6.95
                     ==========  ======== ==========  ======== ==========  ========

Additional information regarding options outstanding as of January 28, 2006 is a follows:

                                Weighted-
                                 Average    Weighted-
                                Remaining    Average
    Range of         Number    Contractual  Exercise
 Exercise Prices  Outstanding  Life (yrs.)    Price
----------------- ------------ -----------  ---------
$1.13 to $3.28        336,125        6.54  $    2.13
$3.52 to $6.03        489,850        6.11  $    5.32
$6.19 to $9.21        307,000        3.92  $    8.17
$10.20 to $11.75      267,500        9.33      10.62
----------------- ------------ -----------  ---------
$1.13 to $11.75     1,400,475        6.35  $    6.19
================= ============ ===========  =========

The Company also has a statutory Employee Stock Purchase Plan, which allows its employees to purchase Company common stock at a 15% discount. Employees can purchase stock under the Plan through payroll deductions ranging from 1% to 10% of their annual compensation, up to a maximum of $21,250 per employee per year. A total of 500,000 shares were originally registered under the Plan, with 322,690 shares issued through January 28, 2006.

SFAS 123 requires the disclosure of pro forma net income and net income per share had the Company adopted the fair value method of accounting for stock-based compensation as of the beginning of 1995 (see Note 1). Under SFAS 123, the fair value of stock-based awards 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 weighted average fair values of options on their grant date during fiscal 2005, 2004 and 2003, where the exercise price equaled the market price on the date of grant, were $6.39, $3.41 and $0.68, respectively. The estimated fair value of each option grant is calculated using the Black-Scholes option pricing model with the following weighted average assumptions:

                                           2005       2004       2003
                                         ---------  ---------  ---------
Risk-free interest rate................       3.8 %      3.4 %      1.3 %
Expected dividend yield................        --         --         --
Expected volatility....................      56.1 %     55.0 %     57.0 %
Expected option life (years)...........         5          5          5

The Company has a Retirement Savings Plan ("Plan") which qualifies as an employee retirement plan under Section 401(k) of the Internal Revenue Code. Full-time employees meeting certain requirements are eligible to participate in the Plan and may elect to have up to 20% of their annual eligible compensation, subject to statutory limitations, deferred and deposited with a qualified trustee. Participants in the Plan may receive an employer matching contribution of up to 4% of the participants' eligible compensation, depending on the Company's quarterly and annual financial performance. Beginning 2001, the Company amended the Plan to provide for a guaranteed annual match of 3%, including the ability for participants to earn an additional 1% depending on the Company's annual financial performance. The Company recognized $1,139,000, $1,166,000 and $1,251,000 in expense related to the Plan in 2005, 2004 and 2003, respectively.

14. COMMITMENTS AND CONTINGENCIES

On September 19, 2005, the Company became subject to a complaint filed in the Superior Court of California for the County of Santa Cruz alleging violation of California law regarding payment of accrued vacation upon termination of employment. The complaint seeks wage payments for employees who allegedly forfeited accrued vacation, waiting time penalties, interest, injunctive relief and costs. The Company believes settlement of this matter is in its best interests and has entered into a memorandum of understanding for class settlement, which is pending court approval. The Company accrued $1.8 million during the fourth quarter of fiscal 2005 for estimated legal fees and settlement costs and management does not believe the ultimate resolution will have a material adverse effect on the Company's business, financial condition or results of operations.

The Company is party to other legal proceedings and claims which have arisen during the ordinary course of business. In the opinion of management, the ultimate outcome of such litigation and claims is not expected to have a material adverse effect on the Company's financial position or results of its operations.

As of January 28, 2006, the Company had outstanding a total of $2.1 million of standby letters of credit and documentary letters of credit totaling $0.7 million. As of January 29, 2005, the Company had issued a total of $3.3 million of standby letters of credit and documentary letters of credit totaling $2.1 million. The standby letters of credit were issued to provide collateral for workers compensation insurance policies. Management believes the likelihood of any draws under the workers compensation standby letters of credit are remote. Documentary letters of credit are issued in the ordinary course of business to facilitate the purchase of merchandise from overseas suppliers. The supplier draws against the documentary letter of credit upon delivery of the merchandise.

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

                                                    ADDITIONS
                                             ------------------------
            COL. A                COL. B       COL. C        COL. D         COL. E          COL. F
------------------------------  -----------  ----------     ---------     -----------     -----------
                                                             Charged
                                Balance at   Charged to     to Other                      Balance at
                                 Beginning   Costs and      Accounts      Deductions        End of
Description                      of Period    Expenses      Describe       Describe         Period
------------------------------  -----------  ----------     ---------     -----------     -----------
Year ended January 28, 2006:
  Deferred tax asset
    valuation allowance....... $ 2,254,000  $       --     $             $  (390,000)(5) $ 1,864,000
  Allowance for vendor
    claims receivable......... $    90,000  $              $             $               $    90,000
  Sales return reserve.........$    87,000  $   11,000 (6) $             $               $    98,000

Year ended January 29, 2005:
  Store closure reserve....... $   337,000  $              $             $  (337,000)(2) $        --
  Deferred tax asset
    valuation allowance....... $ 1,818,000  $  436,000 (3) $             $               $ 2,254,000
  Allowance for vendor
    claims receivable......... $   281,000  $              $             $  (191,000)(4) $    90,000
  Sales return reserve.........$    94,000  $              $             $    (7,000)    $    87,000

Year ended January 31, 2004:
  Store closure reserve....... $   618,000  $  542,000 (1) $             $  (823,000)(2) $   337,000
  Deferred tax asset
    valuation allowance....... $ 1,438,000  $  380,000 (3) $             $               $ 1,818,000
  Allowance for vendor
    claims receivable......... $    81,000  $  200,000 (4) $             $               $   281,000
  Sales return reserve.........$    92,000  $    2,000 (6) $             $               $    94,000