UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended January 31, 200930, 2010

OR

Commission file number 0-18632

THE WET SEAL, INC.

(Exact name of registrant as specified in its charter)

(949) 699-3900

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  þ

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  þ    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a nonaccelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act:

Large accelerated filer:  ¨        Accelerated filer:  þ        Nonaccelerated filer:  ¨        Smaller reporting company:  ¨

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  þ

The aggregate market value of voting stock held by nonaffiliates of the registrant as of August 2, 20081, 2009 was approximately $425,452,000$320,398,000 based on the closing sale price of $4.44$3.30 per share as reported on the NASDAQ Global Market on August 1, 2008.July 31, 2009.

The number of shares outstanding of the registrant’s Class A common stock, par value $0.10 per share, at March 30, 2009,26, 2010, was 96,858,731.96,994,139. There were no shares outstanding of the registrant’s Class B common stock, par value $0.10 per share, at March 30, 2009.26, 2010.

DOCUMENTS INCORPORATED BY REFERENCE

PART III of this Annual Report incorporates information by reference from the registrant’s definitive Proxy Statement for its Annual Meeting of Stockholders to be filed with the SEC within 120 days of January 31, 2009.30, 2010.

THE WET SEAL, INC.

Annual Report on Form 10-K

For the Fiscal Year Ended January 31, 200930, 2010

TABLE OF CONTENTS

PART I

Statement Regarding Forward-Looking Disclosure and Risk Factors

Certain sections of this Annual Report on Form 10-K (the “Annual Report”), including “Item 1. Business” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” 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 and Exchange Act of 1934, as amended (the “Exchange Act”), 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, and/or which include words such as “believes,” “plans,” “anticipates,” “estimates,” “expects,” “may,” “will,” or similar expressions. In addition, any statements concerning future financial performance, ongoing divisional 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 guarantees 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 materially from those expressed or forecasted in 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 “Item 1A. Risk Factors” below and discussed elsewhere in this Annual Report.

General

We are a national specialty retailer operating stores selling fashionable and contemporary apparel and accessory items designed for female customers aged 13 to 35 years old. As of January 31, 2009,30, 2010, we operated 496504 retail stores in 47 states, Puerto Rico and Washington D.C. Our products can also be purchased online.

All references to “we,” “our,” “us,” and “our company” in this Annual Report mean The Wet Seal, Inc. and its wholly owned subsidiaries. All references in this Annual Report to “fiscal 2010,” “fiscal 2009,” “fiscal 2008,” “fiscal 2007,” “fiscal 2006,” “fiscal 2005,” and “fiscal 2004” mean the fiscal year ending January 30, 2010,29, 2011, and the fiscal years ended January 30, 2010, January 31, 2009, February 2, 2008, February 3, 2007, January 28, 2006, and January 29, 2005, respectively. Our Annual Report, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports and the proxy statement for our annual meeting of stockholders are made available, free of charge, on our corporate web site,www.wetsealinc.com, as soon as reasonably practicable after such reports have been electronically filed with or furnished to the Securities and Exchange Commission (SEC)the “SEC”. Our Code of Business Ethics and Conduct is also located within the Corporate Information section of our corporate web site. These documents are also available in print to any stockholder who requests a copy from our Investor Relations department. The public may also read and copy any materials that we have filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. In addition, these materials may be obtained at the web site maintained by the SEC atwww.sec.gov. The content of our web sites (www.wetsealinc.com,www.wetseal.com, andwww.ardenb.com) is not intended to be incorporated by reference in this Annual Report.

The names “Wet Seal” and “Arden B” (which are registered in the retail store services and other classes) are trademarks and service marks of our company. Each trademark, trade name, or service mark of any other company appearing in this Annual Report belongs to its respective owner.

Business Segments

We operate two nationwide, primarily mall-based, chains of retail stores under the names “Wet Seal” and “Arden B.”B”. Although the two operating segments are similarhave many similarities in their products, production processes, distribution methods, and regulatory environment, theythere are differences in most of these areas and distinct differences in their economic characteristics. As a result, we consider these segments to be two distinct reportable segments.

Wet Seal. Wet Seal is a junior apparel brand for teenage girls thatwho seek trend-focused and value-competitive clothing, with a target customer age of 13 to 19 years old. Wet Seal seeks to provide its customer base with a balance of affordably priced, fashionable and basic apparel and accessories.

Arden B. Arden B is a fashion brand at value price points for the feminine contemporary woman with sex appeal. Arden B targets customers aged 25 to 35 years old and seeks to deliver contemporary collections of fashion and basic separates and accessories for various aspects of the customers’ lifestyles.

We maintain a Web-based store located atwww.wetseal.com, offering Wet Seal merchandise comparable to that carried in our stores to customers over the Internet. We also maintain a Web-based store located atwww.ardenb.com, offering Arden B apparel and accessories comparable to those carried in our stores to customers over the Internet. Our online stores are designed to serve as an extension of the in-store experience and offer a wide selection of merchandise, which helps expand in-store sales. Internet operations for both Wet Seal and Arden B are included in their respective operating segments. In fiscal 2009, 2008, 2007, and 2006,2007, we experienced rapid growth in both visitor traffic and our online sales, and we will continue to develop our Wet Seal and Arden B websites to increase their effectiveness in marketing our brands.

See Note 1513 of the notes to consolidated financial statements for financial information regarding segment reporting, which information is incorporated herein by reference.

Our Stores

Wet Seal stores average approximately 3,900 square feet in size and in fiscal 20082009 had average sales per square foot of $292.$268. As of January 31, 2009,30, 2010, we operated 409424 Wet Seal stores. Arden B stores average approximately 3,100 square feet in size and in fiscal 20082009 had average sales per square foot of $326.$339. As of January 31, 2009,30, 2010, we operated 87 Arden B stores.

During fiscal 2006, we opened 34 and closed four Wet Seal stores and opened four and closed four80 Arden B stores.

During fiscal 2007, we opened 71 and closed 10 Wet Seal stores and opened seven and closed four Arden B stores.

In late fiscal 2007, we scaled back plans to open new stores to concentrate our efforts on managing our core businesses. During fiscal 2008, we opened 13 and closed three Wet Seal stores and closed eight Arden B stores. During fiscal 2009, we opened 17 and closed two Wet Seal stores and opened one and closed eight Arden B stores.

We expect to open 25 to 40 Wet Seal stores, net of closings, during fiscal 2010. We currently expect to have no net change in the number of Arden B stores during fiscal 2010. However, if we sustain recent improved performance in the Arden B business through the first quarter of fiscal 2010, we may begin to pursue growth of the Arden B store base later in the year. We believe future closures for at least the next 12 months following the date of this Annual Report will primarily result from lease expirations where we decide not to extend, or are unable to extend, a store lease.leases. We may, however, accelerate the closure of underperforming Arden B stores prior to their lease expirations in cases where we can obtain favorable early lease terminations with the landlords or may rebrand a limited number of underperforming Arden B stores as Wet Seal stores.

We expect our store count to remain relatively flatexercise certain rights contained in fiscal 2009 to allow time to build our backlog of store opening opportunities and focus on managing our existing store base through a challenging retail environment that we expect will persist through at least the end of fiscal 2009.leases. We have approximately 5738 existing store leases scheduled to expire in fiscal 2009.2010. Additionally, we plan to remodel or relocate approximately 40 Wet Seal and Arden B stores during fiscal 2010 upon lease renewals. We expect to negotiate new leases that will allow us to remain in a substantial majority of these locations. Our ability to increase the number of Wet Seal and Arden B stores in the future will depend, in part, on satisfactory cash flows from existing operations, the demand for our merchandise, our ability to

find suitable mall or other locations with acceptable sites, and satisfactory terms and satisfactory general business conditions. Our management does not believe there are significant geographic constraints on the locations of future stores.

Competitive Strengths

Experienced Management Team is in Place.Team. Although we have recently had changes among our senior management team, the current members of our senior management have extensive knowledge of our business and operations, which will be instrumental in managing our company through the current difficult economic environment and driving our company into the next phase of its growth cycle. Mr. Edmond S. Thomas, our president and chief executive officer since October 2007, formerly served as the president and chief operating officer of our company from 1992 to 2000. Our Chief Financial Officer, Mr. Steven H. Benrubi, served as our controller for over two years prior to his appointment as chief financial officer in September 2007. Ms. Maria Comfort,Sharon Hughes, our new president and chief merchandise officer for our Wet SealArden B division, who most recently served as chief merchandise officer of the Hot Topic division of Hot Topic, Inc., has held a broad range of leadership roles during her merchandising career spanning more than 25 years. Ms. Sharon Hughes, the consultant that we hired to lead therun our Arden B merchandising efforts on an interim basis,team starting in February 2008, was an employee of our company from 1990 through 2002, during which period Ms. Hughes was involved in the formation of the Arden B division and held several different merchant roles, including senior vice president of merchandising. Ms. Kim Bajrech and Ms. Debbie Shinn, vice presidents and divisional merchandise managers for our Wet Seal division, joined the company in 2009 and have extensive experience in the junior apparel business. In addition, Ms. Bajrech was an employee of our company from 1990 to 2002. We are currently undergoing a search for a chief merchandise officer for our Wet Seal division.

Merchandising ModelModels at Wet Seal isand Arden B are Focused on Fast Fashion at Affordable Prices. At Wet Seal, we have developed considerable expertise in identifying, stocking and selling a broad assortment of fresh and fashionable apparel and accessories at competitive prices.prices to its teenage customers. Since rejoining our company as a consultant in February 2008, and later becoming president and chief merchandise officer at Arden B, Ms. Hughes has also converted Arden B to the fast fashion merchandising model for its young contemporary business. Our buyers work closely with senior management to determine the optimal product selection and promotion and pricing strategies. A significant portion of our merchandise is sourced domestically.domestically or from domestic importers. This sourcing strategy enables us to ship new merchandise to the stores with high frequency and react quickly to changing fashion trends. We also take regular markdowns to effect the rapid sale of slow-moving inventory.

Improved Financial Condition. Since the completion of a recapitalization of our company in May 2005, our financial condition has improved significantly. From fiscal 2005 through 2007, we experienced positive comparable store sales growth, on a consolidated basis, in eight out of 12 fiscal quarters and generated positive cash flows from operations in each of those fiscal years. During fiscal 2008 and fiscal 2009, due in part to an extremely challenging economic environment, we experienced a comparable store sales declinedeclines on a consolidated basis. However, in spite of this decline,these declines, as a result of our taking actions to reduce costs and more conservatively manage inventories, as well as significant recovery in the financial performance of our Arden B division beginning in fiscal 2009, we experienced continued growth in ourcontinue to experience strong cash flows from operations.

In recent years, we have increased our cash position and substantially reduced our outstandingcontinue to maintain a low level of indebtedness. Through fiscal 2008,2009, $51.3 million in principal amount of our convertible notes and $23.0 million in face amount of our convertible preferred stock had been converted into shares of our Class A common stock. We used the proceeds from a May 2005 financing transaction to repay a bridge loan that we received from investors in January 2005 as part of the recapitalization of our company. In addition, in March 2006, we repaid the $8.0 million outstanding balance of a junior secured term loan under our then-existing credit facility. Also, in fiscal 2009, 2007, and 2006, we repurchased 2.0 million, 3.6 million, shares and 2.4 million shares of our Class A common stock for $7.3 million, $20.1 million, and $15.1 million, respectively. We repurchased no common stock during fiscal 2008. As of January 31, 2009,30, 2010, our cash and cash equivalents were $142.1$161.7 million; total debt, net of discount, was $2.7$3.5 million; and stockholders’ equity was $171.2$266.7 million.

Strategy

As part of a strategic review of business operations, we have identified what we believe are significant opportunities to improve our business trends and drive sales improvement. The key elements of our opportunities are to:

Manage Business Conservatively in the Near Term Through the Difficult Economic Environment.We have taken many actions to ensure we remain financially strong through a difficult economic environment over

the near term and to position ourselves to capitalize on the company’s growth and operating leverage

opportunities when such environment improves. In anticipation of a prolongedcontinuing difficult retail environment, our near term goals include preserving a strong balance sheet, exercising prudence inresuming moderate growth of our Wet Seal division store base, ensuring our capital expenditure investments made are accretive or provide efficiencies to the business, maintaining clean inventory levels and reducing costs opportunistically. As part of our cost-cutting initiatives, in January 2008 and January 2009, we eliminated 49 and 37 positions, respectively, in our corporate offices, and two and four positions, respectively, in our field operations, across numerous functional areas. We ended fiscal 20082009 with an improved balance sheet, including a substantial cash position and nominal debt. To continue to maintain our strong cash position, we will remain cautious with our capital expenditure investments. We plan to maintain a relatively flat store count inopen 25 to 40 Wet Seal stores, net of closings, during fiscal 2009 as we continue to monitor the retail and leasing environment.2010. Additionally, we will utilize significantlycontinue to leverage our improved inventory management processes that were implemented in fiscal 2008 and new systems recently implemented and expected to be implemented in fiscal 2010; and plan to maintain conservativeclosely monitor inventory positions during fiscal 2009.2010. Lastly, we will continue to operate with a much more cost-efficient, streamlined management organization by maintaining our past cost reductions and continuing to reduce excess costsidentify any new cost reduction opportunities across all areas of our business.

Improve Merchandise Margin.In our Wet Seal division, we have identified and began acting upon opportunities to improve our planning and allocation function, merchandise mix, and markdown cadence.cadence in response to declining merchandise margin performance over the course of fiscal 2009. During fiscal 2009,2010, we will enhanceleverage our previously enhanced merchandising profiles of each Wet Seal store and further integrate them into our planning and allocation function. We planwill also continue to improve upon our markdown cadence and size offerings through implementation ofby fully utilizing our markdown and size optimization systems, increasecontinue our focus on key merchandise item categories, continue tofurther develop branded and private label assortments, and expandfurther optimize our expanded bottoms offerings in the merchandise mix. In our Arden B division, we have identified opportunities towill further improve our inventory management, merchandise mix and sourcing, and to reduce overall price points and modifyenhance our planning of promotional strategies across all product categories.categories in order to build upon significant merchandise margin improvement generated in this division during fiscal 2009. We plan to better align ourwill stay focused on maintaining a merchandise mix balanced with customer needs by improving the balance of wear-to-work, everyday and occasion apparel, and adding fashion basics across key categories. Additionally, we will refinecontinue to make improvements to our sourcing processprocesses and employ more consistent pricing practices and improved promotional disciplines.expand our sourcing base.

Improve Store Operations. Our store operation opportunities include better utilization ofimproving customer service through continuing to obtain customer feedback and acting upon it to improve our business, continued simplification and/or elimination of nonselling activities, and improved performance in underperforming stores. We will continue to evaluate store tasksactivities to determine if excess tasks can be eliminated to facilitate greater focus on sales, and we plan to employ more detailed analysis and monitoring of the operating results of underperforming stores.

Improve Real Estate. We will continue to seek to improve our new and remodeled store economics and address pressure from rising occupancy and store construction costs. We will utilize acontinue to rollout our new Wet Seal store prototype and enhanced fixturing developed in fiscal 2008 to take advantage of a more attractive store design and enhance ease of merchandising to produce a more shopper-friendly environment. Additionally, we will continue to test off-mall locations by opening a small number of Wet Seal stores in regional “power centers” during fiscal 2009.2010. We planwill continue to rebuildbuild the pipeline for store growth and maintain a conservative near term capital expenditure investment plan,will begin moderately growing our store base, which we estimate will result in fiscal 20092010 store openings of approximately 2025 to 40 new Wet Seal stores, net of store closings, and nomay possibly begin to pursue growth of the Arden B stores.store base starting in late fiscal 2010. Additionally, we plan to remodel or relocate approximately 40 Wet Seal and Arden B stores during fiscal 2009 as a result of2010 upon lease renewal.renewals.

Improve Marketing. We believe we have the opportunity to continue to improve our marketing planning and our divisional merchandising strategies. We are developing specific plans for each division for fiscal 2009.2010. We intend to place more emphasis on Internet marketing, including social networking, and will continue leveraging visual merchandising, celebrity-related promotions, and direct and grass roots marketing. Additionally, we will buildenhance our focus on marketing strategies based on past successes of our frequent buyer and loyalty programs and we will continue to utilize Internet marketing to drive sales and increase store traffic.

Improve Information Systems. In addition to markdown and size optimization systems, weWe will implementcomplete implementation of a new point-of-sale system in all stores during fiscal 2009,2010, which will improve system reliability and increase store operational efficiency when

processing promotional transactions. We will also begincomplete implementation

activities for of an updated retail merchandising system to be completed in fiscal 2010, which will improve merchandising decision support and increase efficiency of inventory management practices. Additionally, we will update short-term and long-term information systems strategies and install improved project managementthat will provide further efficiencies and cost controls.

Improve Physical Distribution and Transport. We will reconfigure and automate our existing distribution center, which will produce increased efficiencies and lead to cost savings. Preliminarily, we intend to beginWe began this project in late fiscal 2009 but the project may be subject to delay depending upon the status of other capital expenditure priorities.and estimate completion by July 2010.

Resume Our Positive Comparable Store Sales Trend. From fiscal 2005 through fiscal 2006,2007, we experienced seveneight out of eight12 quarters of positive comparable store sales results, on a consolidated basis. This resulted primarily from increased transaction counts and the number of items purchased per customer, partially offset by a decrease in average retail price per item sold due to a transition of the Wet Seal business to a “fast fashion” merchandising model and an accompanying change in pricing strategy. After positive comparable store sales results in the first quarter of fiscal 2007, we experienced three consecutive quarters of comparable store sales declines, on a consolidated basis, in the low single digits. As a result, consolidated comparable store sales for fiscal 2007 declined 1.1%, with the comparable sales at the Wet Seal stores increasing 1.2% and at the Arden B stores declining 8.2%. In fiscal 2008, as a result of an extremely challenging economic environment and continued deterioration of the Arden B business, we experienced an 8.5% decrease in comparable store sales, with the comparable sales at the Wet Seal stores declining 4.5% and at the Arden B stores declining 23.5%. In fiscal 2009, resulting from a continuation of a challenging economic environment and some merchandising misses, we experienced a 7.1% decrease in comparable stores sales, with the comparable sales at the Wet Seal stores declining 8.5%, partially offset by a 0.2% increase at the Arden B stores as we began to experience success in the second half of the year from the conversion of the Arden B business to a lower-priced fast fashion merchandising model.

Note: The numbers in the foregoing charts do not include sales from discontinued operations. In fiscal 2004, the Zutopia concept was designated as a discontinued operation, which had no significant impact on comparable store sales.

In fiscal 2009,2010, we plan to improve comparable store sales with the implementation of strategic initiatives noted above, which, among other things, includes better alignment of our merchandise mix with customer needs,continued focus on key trends, increased efficiencies in our planning and allocation functions improvementsfrom markdown and size optimization systems, improved promotional planning, ensuring inventory is maintained at sufficient levels to the pricing and promotional strategies in our Arden Bmaximize business, and implementation of enhanced merchandising and point-of-sale systems.

ReviveBuild Upon and Sustain Arden B.B Recovery. In February 2008, we engaged Ms. Sharon Hughes as a consultant to serve as the chief merchandise officer for Arden B under the direction and supervision of Mr. Thomas. In November 2009, Ms. Hughes was appointed president and chief merchandise officer for our Arden B division. Since theirher arrival, we have significantly reduced the size and cost of the Arden B merchandising organization. As a result, we have reduced in-house design activities andorganization, refined the product development and sourcing processes to include more partnering with merchandise suppliers. Nonetheless, Arden B continues to underperform, having incurred 23 consecutive months of comparable store sales declines through February 2009.

We believe our primary opportunity for the Arden B division is in the adjustment ofsuppliers, and adjusted our merchandise mix and our pricing and promotional strategies. We have adjusted our assortments at Arden B to include more fashion basic merchandise. Additionally, we have implementedOur new pricing and promotional strategies at Arden B which includeincluded significant reductions in price points across all categories. WeAs a result, during the third and fourth quarters of fiscal 2009, Arden B experienced positive comparable store sales results. However, we believe Arden B has yet to achieve its full potential with its target young contemporary customers. We aim to drive further sales and profitability improvement at Arden B through our distinctive, quality merchandise, unified apparel and accessory assortments, the newour value-pricing strategy, new fixturing to increase store capacity, and an improvedcontinually improving the in-store customer experience. We may also accelerate the closure of underperforming Arden B stores prior to their lease expirations in cases where we can obtain favorable early lease terminations with the landlords or may rebrand a limited number of Arden B stores as Wet Seal stores.

Expand our Online Business. We plan to continue to grow our Internet business through several initiatives, including a focus on integrated branding and targeted marketing programs utilizingexpanding our customer databasedatabases by leveraging social networks and customer loyaltyby more targeted Internet marketing programs. Although our Internet sales are modest compared to consolidated net sales, we are experiencingexperienced substantial growth. A combination of several changes contributedgrowth in fiscal 2009. We believe our focus on introducing new channels to the improvement, including hiring staffs withcapture customers, continuing to increase Internet marketing, experience, making processes scalable, aligning themaintaining a consistent brand message across both channels, and being more focused with targeted marketing will allow us to continue to grow our online sites with the look of the physical stores, and implementing appropriate targeted marketing.business. We are optimizing inventory allocated to the Internet business to better meet the demand of our Internet customers and have strengthened our buying and planning staff fully to meet the anticipated sales growth in this area. We also plan to continue to grow our Internet business through continued improvements to inventory planning, fulfillment, and customer service. The growth in our website traffic continues to be substantial, and the Internet is a key component for driving store traffic. Prior to the 2007 holiday season, we launched new website platforms for both divisions. The new websites support advanced merchandising capabilities, personalization based on browsing behavior and past purchase history, and testing tools to measure and determine the most effective content and promotionpromotional strategies. In fiscal 2009, we launched website features that allow for selling to countries outside the U.S., customers to search for and reserve denim at stores near them, customers to invite friends to shop with them online whereby each person can control and see the same screen, customers to shop online from their mobile devices and other features that continue to enhance our website and customer experience.

Design Buying, and Product DevelopmentBuying

Our design and buying teams are responsible for identifying evolving fashion trends and developing themes to guide our merchandising strategy. Each retail division has a separate buying team. The merchandising teams for each retail division develop fashion themes and strategies by assessing customer responses to current trends, shopping international and appropriate domestic markets, using fashion services, and gathering references from industry publications. After selecting fashion themes, the design and buying teams work closely with vendors to use colors, materials, and designs that create images consistent with the themes for our product offerings.

Since fiscal 2004 for our Wet Seal division, and beginning in fiscal 2008 for our Arden B division, we have decreased our dependency on internally designed merchandise. This allows us more flexibility to respond to the changing fashion trends of our target customers, to buy in smaller lots, and to reduce product developmentsourcing lead times. See also “Allocation and Distribution” below.

Marketing, Advertising, and Promotion

We believe that our brands are among our most important assets. Our ability to successfully increase brand awareness is dependent upon our ability to address the changing needs and priorities of each brand’s target

customers. To that end, we will placecontinue our emphasis on visual merchandising, celebrity-related promotions, and direct and grass roots marketing. Additionally, we will build marketing strategies based on past successes of our frequent buyer and loyalty programs and will place more focus on building these programs. We will also heighten our focus onbe more aggressive with customer acquisition and increase our use of Internet marketing to drive increased store traffic.

During fiscal 2009, 2008, 2007, and 2006,2007, we spent 0.5%0.4%, 1.1%0.5%, and 1.1%, respectively, of net sales on advertising. The decreasedecreases in fiscal 2009 and fiscal 2008 waswere primarily due to the elimination of print advertising programs and the decision not to execute certain advertising activities at our Arden B division untildue to merchandise content improves.issues in fiscal 2008. In fiscal 2008,2009, our primary marketing focus was on in-store promotion programs and Internet marketing for theboth Wet Seal stores and direct marketing for the Arden B stores, which included mailings of various catalogs and postcards throughout the year.stores.

As discussed further in Note 1 of the notes to consolidated financial statements, contained elsewhere within this Annual Report, we offer a frequent buyer program in our Wet Seal stores in order to build loyalty to the brand, increase the frequency of visits, promote multiple item purchases, and gain direct access to the customer. As part of this program, we send e-mails to participants to notify them of special in-storein- store promotions. Our Arden B division also offers a loyalty program, “B Rewarded,” designed for the same purposes as that of our Wet Seal division.

Sourcing and Vendor Relationships

We purchase our merchandise from both domestic and foreign vendors. For fiscal 2008,2009, approximately 15%18% of our retail merchandising receipts were directly imported from foreign vendors. Although in fiscal 20082009 no single vendor provided more than 10% of our merchandise, management believes we are one of the largest customers of many of our smaller vendors. Quality control is monitored at the distribution points of our largest vendors and manufacturers, and merchandise is inspected upon arrival at our Foothill Ranch, California, facility.

We do not maintain any long-term or exclusive commitments or arrangements to purchase merchandise from any single supplier, and there are many vendors who could supply our merchandise.

Allocation and Distribution

Our merchandising effort primarily focuses on maintaining a regular flow of fresh, fashionable merchandise into our stores. Successful execution depends in large partlargely on our integrated planning, allocation, and distribution functions. By working closely with store operations management and merchandise buyers, our teams of planners and allocators manage inventory levels and coordinate the allocation of merchandise to each of our stores based on sales volume and store size, demographics, climate, and other factors that may influence an individual store’s product mix. During fiscal 2008, we implemented merchandise planning software that assists us in streamlining the planning process. In fiscal 2009, we began and completed implementation of size optimization software that will improve our allocation of sizes to better align with each store’s needs.

All merchandise for retail stores is received from vendors at our Foothill Ranch, California distribution center, where items are inspected and prepared for shipping to our stores. We ship all of our merchandise to our stores by common carrier. Consistent with our goal of maintaining the freshness of our product offerings, we frequently ship new merchandise to stores, and markdowns are taken regularly to effect the rapid sale of slow-slow-moving inventory. In fiscal 2009, we implemented markdown optimization at our Wet Seal division to improve the speed of moving inventory.slow product and improve merchandise margins. Marked-down merchandise that remains unsold is either sent to clearance centers for deep discounting and rapid movement,sale, sent to the Internet store for selling, sold to an outside clearance company, or given to charity. The fulfillment process and distribution of merchandise for our online business is performed at our Foothill Ranch, California, distribution center.

Information and Control Systems

Our merchandise, financial, and store computer systems are integrated and operate using primarily Oracle^® technology. We have invested in a large data warehouse that provides management, buyers, and planners

comprehensive data that helps us identify emerging trends and manage inventories. The core merchandise system is provided by a leading retail enterprise resource planning, or “ERP,” software provider, and is frequently enhanced to support strategic business initiatives.

All of our stores have a point-of-sale system operating on software provided by a leading provider of specialty retailing point-of-sale systems. This system facilitates bar-coded ticket scanning, automatic price lookups, and centralized credit authorizations. All stores are networked to the corporate office via a centrally managed virtual private network. We utilize a store portal that is integrated with the corporate merchandise ERP system to provide the stores and corporate staff with current information regarding sales, promotions, inventory, and shipments, and enables more efficient communications with the corporate office. In fiscal 2007, we installed new wide area networking hardware at all stores, which incorporate securityincorporated upgrades to guard against security breaches to our stores point-of-sale system, completed our merchandise allocation system, upgraded our financial system, and launched new website platforms for the online businesses. In fiscal 2008,2009, in order to further enhance store efficiency and improve gross margin through the use of technology, we acquiredcompleted implementation of Oracle Markdown Optimization for our Wet Seal stores and began implementation of SAS Size Optimization. To enhance store efficiency, we began implementation activities for Oracle Retail Price Optimization andPoint-of-Sale that will be completed in fiscal 2010. A major upgrade to the Oracle Retail Point-of-Sale, whichMerchandising system will also be fully implemented in fiscal 2009, and Oracle Retail Merchandising, which will be fully implemented in fiscal 2010. Additionally, in fiscal 2008, we implemented a new time and attendance labor system. In fiscal 2009, we also intend to acquire and implement a size optimization system to support merchandise allocation by item sizes in our Wet Seal stores.

Seasonality and Inflation

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 during September, historically accounting for a large percentage of our sales volume. For the past three fiscal years, the Christmas and back-to-school seasons together accounted for an average of slightly less than 30% of our annual sales. Our profitability depends, to a significant degree, on the sales generated during these peak periods. We do not believe that inflation has had a material effect on our results of operations during the past three years. However, we cannot be certain that our business will not be affected by inflation in the future. Any decrease in sales or margins during these periods, whether as a result of economic conditions, poor weather, or other factors, could have a material adverse effect on our company.

Trademarks

Our primary trademarks and service marks are WET SEAL and ARDEN B, which are registered in the United States Patent and Trademark Office. We also have registered, or have applications pending for, a number of other trademarks including, but not limited to, ACCOMPLICE, B. FIRST, B. REWARDED, ENR EVOLUTION NOT REVOLUTION, FASHION INSIDER, FIT IN. STAND OUT., GET IT. WEAR IT. FLAUNT IT., SEAL STASH, BLUE ASPHALT, CONTEMPO CASUALS, TREND SPOT, STYLIZER, REBELLIOUS, REBELLIOUS BY WET SEAL, A. AUBREY, and URBAN VIBE. In general, the registrations for these trademarks and service marks are renewable indefinitely as long as the marks are used as required under applicable regulations. We are not aware of any adverse claims or infringement actions relating to our trademarks or service marks.

Competition

The women’s retail apparel industry is highly competitive, with fashion, quality, price, location, and service being the principal competitive factors. Our Wet Seal and Arden B stores compete with specialty apparel retailers, department stores, and certain other apparel retailers, including Aeropostale, Anthropologie, Abercrombie & Fitch, Charlotte Russe, Gap, Banana Republic, H&M, Old Navy, Pacific Sunwear, American Eagle, Target, Urban Outfitters, Forever 21, Express, J.C. Penney, Nordstrom, bebe, Zara, Guess?, BCBG, Rue 21, and other regional retailers. Many of our competitors are large national chains that have substantially greater

financial, marketing, and other resources than we do. While we believe we compete effectively for favorable site locations and lease terms, competition for prime locations within malls is intense, and we cannot ensure that we will be able to obtain new locations on terms favorable to us, if at all.

Customers

Our company’s business is not dependent upon a single customer or small group of customers.

Environmental Matters

We are not aware of any federal, state, or local environmental laws or regulations that will materially affect our earnings or competitive position, or result in material capital expenditures. However, we cannot predict the effect on our operations of possible future environmental legislation or regulations. During fiscal 2008,2009, there were no material capital expenditures for environmental control facilities and no such material expenditures are anticipated for fiscal 2009.2010.

Government Regulation

Our company is subject to various federal, state, and local laws affecting our business. Each of our company’s stores must comply with licensing and regulation by a number of governmental authorities in jurisdictions in which the store is located. To date, our company has not been significantly affected by any difficulty, delay, or failure to obtain required licenses or approvals.

Our company is also subject to federal and state laws governing such matters as employment and pay practices, overtime, and working conditions. The bulk of our company’s employees are paid on an hourly basis at rates related to the federal and state minimum wages. In the past, we have been assessed penalties or paid settlements to gain dismissal of lawsuits for noncompliance with certain of these laws, and future noncompliance could result in a material adverse effect on our company’s operations. In July 2006, May 2007, September 2008 and March 2009, we were served with class action complaints alleging violations under certain State of California labor laws. In November 2006, we reached an agreement to settle the July 2006 class action complaint for approximately $0.3 million, and as of February 2, 2008, we had accrued within accrued liabilities in our consolidated balance sheet an amount equal to this settlement amount. We have continued to retain this accrued amount within accrued liabilities in our consolidated balance sheet as of January 31, 2009.30, 2010. In February 2008, the court issued its order granting final approval of the class action settlement, subject to appeal. On April 28, 2008, a notice of appeal of the judgment was filed. On May 6, 2009, the Court reversed and remanded the case to the Superior Court to re-evaluate the fairness of the settlement, and a final hearing will take place in April 2010. We anticipate receiving the appellate decision by March 2010. In October 2009, we reached an agreement to settle the March 2009 complaint for approximately $0.2 million, subject to Superior Court approval, and as of January 30, 2010, we had accrued within accrued liabilities in our consolidated balance sheet an amount equal to this settlement. The Court has preliminarily approved the settlement and set a final approval hearing for June 2009.3, 2010. We are vigorously defending the May 2007 and September 2008 and March 2009 complaints and are unable to predict the likely outcomeoutcomes and whether such outcomeoutcomes may have a material adverse effect on our results of operations or financial condition. Accordingly, no provisions for loss contingencies for the May 2007 and September 2008 and March 2009 complaints have been accrued as of January 31, 2009.

Our company is also subject to the Fair Credit Reporting Act (the “FCRA”) under federal law, as well as to state laws with similar requirements, with respect to the protection of our customers’ credit and debit card and other personal data. The FCRA provides in part that expiration dates may not be printed together with certain parts of the customer’s account number on credit or debit card receipts given to customers. The FCRA imposes significant penalties upon violators of these rules and regulations if the lack of compliance is deemed to have been willful. Otherwise, damages are limited to actual losses incurred. In January and February 2007, we were served with two class action complaints alleging violations of the act. The plaintiffs in the February 2007 complaint dismissed the complaint with prejudice in August 2007. On December 11, 2007, we reached a tentative agreement to settle the January 2007 complaint for less than $0.1 million. However, prior to the receipt of the executed settlement agreement, on February 8, 2008, we were named in another action, alleging the same violation, in the U.S. District Court, Western District of Pennsylvania. As a result, we withdrew our offer to settle the January 2007 action noted above. On June 3, 2008, the Credit and Debit Card Receipt Clarification Act of 2007 was enacted. This measure amended the FCRA to declare that a company that printed an expiration date on any receipt provided to a consumer cardholder at the point of sale or transaction between December 4, 2004, and the enactment of this legislation, but otherwise complied with FCRA requirements for such receipt, shall not be in willful noncompliance by reason of printing such expiration date on it. On July 1, 2008, and July 14, 2008,

dismissals were filed by the plaintiffs in the United States District Court Central District of California and the United States District Court for the Western District of Pennsylvania, respectively. We made nominal settlement payments for both claims and all parties agreed that the actions were dismissed with prejudice and that each party was to bear all of its own costs and attorney’s fees.30, 2010.

We continue to monitor our facilities for compliance with the Americans with Disabilities Act, or the ADA, in order to conform to its requirements. Under the ADA, we could be required to expend funds to modify stores to better provide service to, or make reasonable accommodation for the employment of, disabled persons. We believe that expenditures, if required, would not have a material adverse effect on our company’s operations.

Employees

As of January 31, 2009, our operations30, 2010, we had 5,8966,148 employees, consisting of 1,8511,897 full-time employees and 4,0454,251 part-time employees. Full-time personnel consisted of 612630 salaried employees and 1,2391,267 hourly employees. All part-time personnel are hourly employees. Of all employees, 5,5825,824 were sales personnel and 314324 were administrative and distribution center personnel. Personnel at all levels of store operations are provided various opportunities for cash and/or other incentives based upon various individual store sales and other performance targets. All of our employees are nonunion, and, in management’s opinion, are paid competitively at current industry standards. We believe that our relationship with our employees is good.

Risks Related to our Business

The recent changes in generalGeneral economic conditions, perceptions of such conditions by our customers and the impact on consumer confidence and consumer spending have adversely impacted our results of operations and may continue to do so.

Recently, consumer confidence and consumer spending have deteriorated significantly and could remain depressed for an extended period. Our performance is subject to general economic conditions and their impact on levels of consumer confidence and consumer spending, and we believe ourthe decline in comparable store sales in fiscal 2008 and fiscal 2009 was due at least due in part to thesecontinued difficult economic conditions. Consumer purchases of discretionary items, including our merchandise, generally decline during periods when disposable income is adversely affected or there is economic uncertainty. As a result of this generalthe continued difficult economic slowdown,conditions, we may face new risks that will impact many facets of our operations, including, among other things, the ability of one or more of our vendors to deliver their merchandise in a timely manner or otherwise meet their obligations to us. If the conditions in the U.S. and world economic markets remain uncertain or continue to be volatile, or if they deteriorate further, our business, financial condition, and results of operations may be adversely affected.

The financial performanceWe may be unable to reverse declines in comparable store sales in our Wet Seal division.

Our comparable store sales results in our Wet Seal division have declined in each of our Arden B division has been poor over the past two years, and our abilitywe cannot assure you that comparable store sales will not continue to decline in the future. In order to improve the financial performance of this division may not be successful.

We have experienced prolonged deterioration in the financial performance of our Arden B division over the past two years. Althoughcomparable store sales results, we have engaged Ms. Sharon Hughes as a consultant to serve as the chief merchandise officer for our Arden B division andwill need to focus on providinga variety of factors, including fashion appropriatetrends, our merchandise to Arden B’s target customer in an attractive shopping environment, ourmix, holiday periods, actions of competitors, weather conditions and general economic conditions.

Improving comparable store sales continued to worsen during fiscal 2008 amidsale results has been further challenged following the economic slowdown and such trend may continue in fiscal 2009.

Our Boardresignation of Directors and senior management team are continually reviewing the financial performance and turnaround efforts involving our Arden B division. In fiscal 2008, we closed eight Arden B stores and we may close more Arden B stores in fiscal 2009, or rebrand some underperforming Arden B stores as Wet Seal stores. There is no assurance that our rebranding efforts will be successful or such rebranded Wet Seal stores will no longer suffer continuing financial losses. We have incurred and may continue to incur impairment charges in connection with the closing of Arden B stores, which is a noncash event that would negatively impact our

earnings and earnings per share. If we decide to close any stores before the expiration of the lease term, we may incur payments to landlords to terminate or “buy out” the remaining term of the lease. We also may incur employee termination and inventory liquidation costs at such stores. These costs would negatively impact our financial results and cash position.

Recently, we have had significant changes in our senior management and these changes may impact our ability to execute our business strategy in the near term.

In February 2008, our chief operating officer and our president of Arden B merchandise resigned. Mr. Edmond S. Thomas, our president and chief executive officer, and Mr. Steven H. Benrubi, our executive vice president and chief financial officer, and others within management assumed the duties ofMs. Maria Comfort, our former chief operating officer, while Ms. Sharon Hughes serves as chief merchandise officer of Arden B under the direct supervision of Mr. Thomas. In May 2008, ourpresident and chief merchandise officer of the Wet Seal division, in November 2009. We have a search underway to find a replacement for Ms. Dyan M. Jozwick, resignedComfort, but competition for qualified employees is intense and we may have difficulty attracting individuals to serve in July 2008, we appointed Ms. Maria Comfort as the president and chief merchandise officerrole of oursenior management of the Wet Seal division. In addition, in fiscal 2007our search may divert the attention of senior management from the business and fiscal 2008,operations of our company. Once we reduced our workforce in reaction toidentify and in anticipation ofattract a prolonged economic slowdown and shrinking consumer spending.

Wesuitable replacement for Ms. Comfort, we anticipate that we will experience a transition period before our new key employees arethe successor is fully integrated into the Wet Seal division.

Our improvements in their new roles. In addition,comparable store sales and operating results of our Arden B division in fiscal 2009 may not be indicative of our future performance trends, and we cannot assure you that we will be able to sustain such rate of improvement.

Previously, we experienced poor financial performance in our Arden B division. Following efforts by our Board of Directors and our senior management team, including the hiring of Sharon Hughes as president and chief merchandise officer, the closing or rebranding of underperforming stores, and changes to promotional and pricing strategies, comparable store sales and operating results of our Arden B division have improved. However, there can be no assuranceguarantee that this improvement of our remaining workforce is sufficient, or individually or collectively hasArden B division will continue.

Our company’s ability to attract customers to our stores depends heavily on the experience needed to carry out our future operations. Anysuccess of the above factors couldshopping centers in which many of our stores are located.

Substantially all of our stores are located in shopping centers. Factors beyond our control impact shopping center traffic, such as general economic conditions and consumer spending levels. Accordingly, consumer spending and reduced shopping center traffic remain depressed due to the continued difficult economic conditions. As a result, mall operators have been facing increasing operational and financial difficulties. The increasing inability of mall “anchor” tenants and other area attractions to generate consumer traffic around our abilitystores, the increasing inability of mall operators to addressattract “anchor” tenants and maintain viable operations and the business challenges that confront our company.

We do not expectincreasing departures of existing “anchor” and other mall tenants due to significantly increase our net store countdeclines in the near termsales volume and this decision mayin the popularity of malls as shopping destinations, have a negative impact onreduced and will continue to reduce our sales volume and, consequently, adversely affect our financial condition, results of operations and/or cash flows.

Our ability to procure merchandise could be adversely affected by changes in our vendors’ factoring arrangements.

DueChanges in our vendors’ factoring arrangements may threaten the factors’ financial viability and ability to difficult economic conditions,provide factoring services to its customers. Although we do not have a need to rebuild our pipeline of potential real estate opportunities, and the weak performancedirect relationship with factors, a portion of our Arden B division, we expectvendors who supply our company with merchandise have direct factoring arrangements. Vendors who engage in factoring transactions will typically sell their accounts receivable to close a limited numberfactor at a discount in exchange for cash payments, which can be used to finance the business and operations of Arden B storesthe vendors.

If the financial condition of our vendors’ factors were to deteriorate and do not anticipate opening any new Arden B stores in fiscal 2009. We also expectcertain of our vendors were unable to open a limited numberprocure alternative factoring arrangements from competitors of new Wet Seal stores, net of closures, duringtheir factor on the same period. We have redirectedor substantially similar terms, our focusability to improving the financial performance of our existing stores and finding the correct mix oftimely procure merchandise for our customers. Tostores could be adversely affected. This could require the extent we are unabledevotion of significant time and attention by our management to improve the sales and profitability and reduce the selling expenses ofadequately resolve such matters. In turn, our existing stores, our financial position, results of operations, and/or cash flows mayoperation and financial condition could suffer.

Our ability to use net operating loss carryforwards to offset future taxable income for U.S. federal income tax purposes is subject to limitation.

In general, Section 382 of the Internal Revenue Code, or Section 382, contains provisions that may limit the availability of federal net operating loss carryforwards, or NOLs, to be used to offset taxable income in any given year upon the occurrence of certain events, including significant changes in ownership interests. Under Section 382, potential limitations on NOLs are triggered when there has been an “ownership change” (generally defined as a greater than 50% change (by value) in our stock ownership over a three-year period).

Our ownership changes onin April 1, 2005 and December 28, 2006 resulted in Section 382 limitations applying to NOLs generated prior to those dates, which were approximately $172.1 million. As a result of these ownership changes, of our $117.9$116.6 million NOLs as of January 31, 2009,30, 2010, we may utilize up to $59.5$62.4 million of our NOLs to offset taxable income in fiscal 2009.2010. Future transactions involving the sale or other transfer of our stock may result in additional ownership changes for purposes of Section 382. The occurrence of such additional ownership changes could limit our ability to utilize our remaining NOLs and possibly other tax attributes. Limitations imposed on our ability to use NOLs and other tax attributes to offset future taxable income could cause us to pay U.S. federal income taxes earlier than we otherwise would if such limitations were not in effect. Any further ownership change also could cause such NOLs and other tax attributes to expire unused, thereby reducing or eliminating the benefit of such NOLs and other tax attributes to us and adversely affecting our future cash flows.

We may not be successful in achieving improvements in the business and operations of our company that have been identified by our president and chief executive officer.

Since his appointment in October 2007, Mr. Thomas has identified several areas in which our company’s business and operations can be improved. Mr. Thomas has focused on seeking to increase comparable store sales for our retail divisions, improving our company’s gross margin, enhancing in-store productivity, reviving the Arden B business, and expanding our online business. Although Mr. Thomas is highly qualified and has extensive experience in the retail industry, including with our company, in light of the economic slowdown and continued decrease in consumer confidence and discretionary spending, we may not be able to implement our strategy in the desired time frame and/or achieve the intended results and level of improvement desired by our senior management team and Board of Directors.

If we are unable to anticipate and react to new fashion trends, our financial condition and results of operations could be adversely affected.

We rely on a limited demographic customer base for a large percentage of our sales. Our brand image is dependent upon our ability to anticipate, identify and provide fresh inventory reflecting current fashion trends.

Furthermore, the continued difficult economic conditions make it increasingly difficult for us to accurately predict product demand trends. If we fail to anticipate, identify or react appropriately or in a timely manner to these fashion trends, we could experience reduced consumer acceptance of our products, a diminished brand image and higher markdowns. These factors could result in lower selling prices and sales volumes for our products, which could adversely affect our financial condition and results of operations.

Our company’s abilityIf we decrease the price that we charge for our products or offer extensive, continued promotions on our products, we may earn lower gross margins and our revenues and profitability may be adversely affected.

The prices that we are able to attract customers to its stores depends heavilycharge for our products depend on the successtype of product offered, the shopping centers in which many of our stores are located.

Substantially, all of our stores are located in shopping centers. Factors beyond our control impact shopping center traffic, such as general economic conditionsconsumer and consumer spending levels. Accordingly,retailer response to the slowdown in the U.S. economy has negatively affected consumer spending and reduced shopping center traffic. As a result, mall operators have been facing increasing operational and financial difficulties. The increasing inability of mall “anchor” tenants and other area attractions to generate consumer traffic around our stores, the increasing inability of mall operators to attract “anchor” tenants and maintain viable operations,product and the increasing departures of existing “anchor”prices charged by our competitors. To the extent that we are forced to lower our prices, our gross margins will be lower and other mall tenants due to declines in the sales volumeour revenues and in the popularity of malls as shopping destinations, have reduced and will continue to reduce our sales volume and, consequently,profitability may be adversely affect our financial condition, results of operations, and/or cash flows.affected.

We depend upon a single center for our corporate offices and distribution activities, and any significant disruption in the operation of this center could harm our business, financial condition, results of operations and/or cash flows.

Our corporate offices and the distribution functions for all of our stores and Internet business are handled from a single, leased facility in Foothill Ranch, California. In general, this area of California is subject to earthquakes and wildfires. Any significant interruption in the operation of this facility due to a natural disaster, arson, accident, system failure or other unforeseen event could delay or impair our ability to distribute merchandise to our stores and, consequently, lead to a decrease in sales. The financial losses incurred may exceed our insurance for earthquake damages and business interruption costs related to any such disruption. As a result, our business, financial condition, results of operations and/or cash flows could be adversely affected. Furthermore, we have little experience operating essential functions away from our main corporate offices and are uncertain what effect operating satellite facilities might have on our business, personnel and results of operations.

Fluctuations in our results of operations for the third fiscal quarter and the fourth fiscal quarter have a disproportionate effect on our overall financial condition, results of operations and/or cash flows.

We experience seasonal fluctuations in revenues and operating income, with a disproportionate amount of our revenues and a majority of our income being generated in the third fiscal quarter “back-to-school” season,

which begins the last week of July and ends during September, and the fourth fiscal quarter “holiday” season. Our revenues and income are generally lower during the first and second fiscal quarters. In addition, any factors that harm our third and fourth fiscal quarter operating results, including adverse weather or unfavorable economic conditions, could have a disproportionate effect on our results of operations for the entire fiscal year.

In order to prepare for our peak shopping seasons, we must order and keep in stock significantly more merchandise than we would carry at other times of the year. An unanticipated decrease in demand for our products during our peak shopping seasons could require us to sell excess inventory at a substantial markdown, which could reduce our net sales and gross profit. Alternatively, an unanticipated increase in demand for certain of our products could leave us unable to fulfill customer demand and result in lost sales and customer dissatisfaction.

Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the merchandise mix and the timing and level of inventory markdowns. As a result, historical period-to-period comparisons of our revenues and operating results are not necessarily indicative of future period-to-period results. You should not rely on the results of a single fiscal quarter, particularly the third fiscal quarter “back-to-school” season or fourth fiscal quarter “holiday” season, as an indication of our annual results or our future performance.

Our failure to effectively compete with other retailers for sales and locations could have a material adverse effect on our financial condition, results of operations and/or cash flows.

The women’s retail apparel industry is highly competitive, with fashion, quality, price, location and service being the principal competitive factors. Our Wet Seal and Arden B stores compete with specialty apparel retailers, department stores and certain other apparel retailers, including Aeropostale, Anthropologie, Abercrombie & Fitch, Charlotte Russe, Gap, Banana Republic, H&M, Old Navy, Pacific Sunwear, American Eagle, Target, Urban Outfitters, Forever 21, Express, J.C. Penney, Nordstrom, bebe, Zara, Guess?, BCBG, Rue 21, and BCBG.other regional retailers. Many of our competitors are large national chains that have substantially greater financial, marketing and other resources than we do. We face a variety of competitive challenges, including:

Our industry has low barriers to entry that allow the introduction of new products or new competitors at a fast pace. Any of these factors could result in reductions in sales or the prices of our products which, in turn, could have a material adverse effect on our financial condition, results of operations and/or cash flows.

Furthermore, competition for prime locations and lease terms within shopping malls, in particular, is intense, and we may not be able to obtain new locations or maintain our existing locations on terms favorable to us. We expect to open 25 to 40 Wet Seal stores, net of closures, in fiscal 2010. At this time, we do not expect to open a significant number of Arden B stores in fiscal 2010, aside for replacing closures, but may possibly decide to begin growing the Arden B store base starting late fiscal 2010. While we believe we compete effectively for favorable site locations and lease terms, competition for prime locations within malls, in particular, and within other locations is intense and we cannot assure you that we will be able to obtain new locations on terms favorable to us, if at all.

In addition, actions of our competitors, particularly increased promotional activity, can negatively impact our business. In light of the continued difficult economic conditions, pricing is a significant driver of consumer choice in our industry and we regularly engage in price competition, particularly through our promotional programs. To the extent that our competitors lower prices, through increased promotional activity or otherwise, our ability to maintain gross profit margins and sales levels may be negatively impacted. There can be no assurance that our competitors’ increased promotional activity will not negatively impact our business

The upcoming expiration of leases for approximately 5738 of our existing stores could lead to increased costs associated with renegotiating our leases and/or relocating our stores.

We have approximately 5738 existing store leases scheduled to expire in fiscal 2009.2010. In connection with the expiration of these leases, we will have to renegotiate new leases, which could result in higher rental amounts for

each store and landlord requirements to remodel existing locations as a condition for renewal. Although we expect to negotiate new leases with acceptable terms that will allow us to remain in a substantial majority of these locations, weWe may not be

able to obtain new terms that are favorable to us. In addition, as a result of renewal negotiations, we may be required by the landlord to remodel, which could result in significant capital expenditures. In addition, some landlords may refuse to renew our leases due to our lower sales per square foot as compared with other prospective tenants. If we are unable to agree to new terms with our landlords, we will have to close or relocate these stores, which could result in a significant expenditure and could lead to an interruption in the operation of our business at the affected stores, and we could be required to relocate to less desirable locations or may not be able to find viable locations at all.

Because of the importance of our brand names, we may lose market share to our competitors if we fail to adequately protect our intellectual property rights.

We believe that our trademarks and other proprietary rights are important to our success and our competitive position. We have registered trademarks for Wet Seal and Arden B (which are registered in the retail store services and other classes). We take actions to establish and protect our intellectual property. However, others may infringe on our intellectual property rights or seek to block the sale of our products as violative of their intellectual property rights. If we are required to stop using any of our registered or nonregistered trademarks, our sales could decline and, consequently, our business and results of operations could be adversely affected.

Covenants contained in agreements governing our existing indebtednesssenior credit facility restrict the manner in which we conduct our business, and our failure to comply with these covenants could result in a default under these agreements, which would have a material adverse effect on our business, financial condition, growth prospects and ability to procure merchandise for our stores.

Our senior revolving credit facility and the indenture, as amended, governing our secured convertible notes containcontains covenants that restrict the manner in which we conduct our business. Subject to certain exceptions, (including an exception to permit limited stock repurchases), these covenants restrict or limit our ability to, among other things:

A breach of any of these covenants could result in a default under the agreements governing our existing indebtedness, acceleration of any amounts then outstanding, the foreclosure upon collateral securing the debt obligations, or the unavailability of the lines of credit. While as of the date of this Annual Report there are not any secured convertible notes outstanding, we have not completed the satisfaction and discharge of our obligations under the indenture governing such notes. We anticipate completing the satisfaction and discharge process promptly.

We do not authenticate the license rights of our suppliers.

We purchase merchandise from a number of vendors who purport to hold manufacturing and distribution rights under the terms of license agreements or that assert that their products are not subject to any restrictions as to distribution. We generally rely upon each vendor’s representation concerning those manufacturing and distribution rights and do not independently verify whether each vendor legally holds adequate rights to the

licensed properties they are manufacturing or distributing. If we acquire unlicensed merchandise or merchandise violating a registered trademark, we could be obligated to remove it from our stores, incur costs associated with

destruction of the merchandise if the vendor is unwilling or unable to reimburse us and be subject to civil and criminal liability. The occurrence of any of these events could adversely affect our financial condition, results of operations and/or cash flows.

We are subject to risks associated with our procurement of products from non U.S.-basednon-U.S. based vendors and U.S. vendors that purchase products internationally, any of which could have a material adverse effect on our business, financial condition, results of operations and/or cash flows.

A portion of our products is manufactured outside the U.S. As a result, we are susceptible to greater losses as a result of a number of risks inherent in doing business in international markets and from a number of factors beyond our control, any of which could have a material adverse effect on our business, financial condition, results of operations and/or cash flows.

These factors include:

The U.S. and the countries in which our products are produced or sold may also, from time to time, impose new quotas, duties, tariffs or other restrictions, or adversely adjust prevailing quota, duty or tariff levels. In addition, none of our international suppliers or international manufacturers supplies or manufactures our products exclusively. As a result, we compete with other companies for the production capacity of independent manufacturers and import quota capacity. If we were unable to obtain our raw materials and finished apparel from the countries where we wish to purchase them, either because room under the necessary quotas was unavailable or for any other reason, or if the cost of doing so should increase, it could have a material adverse effect on our business, financial condition, results of operations and/or cash flows.

Violation of labor laws and practices by our suppliers could harm our business and results of operations.

Our company’s policy is to use only those sourcing agents and independent manufacturers who operate in material compliance with applicable laws and regulations. The violation of laws, particularly labor laws, by an independent manufacturer, or by one of the sourcing agents, or the divergence of an independent manufacturer’s or sourcing agent’s labor practices from those generally accepted as ethical in the U.S. or in the country in which the manufacturing facility is located, and the public revelation of those illegal or unethical practices, could cause significant damage to our company’s reputation. Although our manufacturer operating guidelines promote ethical business practices, we do not control the business and operations of the manufacturers and cannot guarantee their legal and regulatory compliance.

We are exposed to business risks as a result of our Internet operations.

We operate online stores atwww.wetseal.com andwww.ardenb.com. Our Internet operations are subject to numerous risks, including unanticipated operating problems, reliance on third-party computer hardware and software providers, system failures and the need to invest in additional computer systems. Specific risks include: (i) diversion of sales from our stores; (ii) rapid technological change; (iii) liability for online content; and

(iv) risks related to the failure of the computer systems that operate the website and its related support systems, including computer viruses, telecommunication failures and electronic break-ins and similar disruptions. In addition, Internet operations involve risks which are beyond our control that could have a direct material adverse

effect on our operational results, including: (i) price competition involving the items we intend to sell; (ii) the entry of our vendors into the Internet business in direct competition with us; (iii) the level of merchandise returns experienced by us; (iv) governmental regulation; (v) online security breaches involving unauthorized access to our and/or customer information; (vi) credit card fraud; and (vii) competition and general economic conditions specific to the Internet, online commerce and the apparel industry. Our inability to effectively address these risks and any other risks that we face in connection with our Internet operations could adversely affect the profitability of our Internet operations.

Risks Related to our Common Stock

Our stockholders may experience dilution due to conversions and exercises of outstanding convertible securities and/or the antidilution protection of the securities.securities.

Since May 2004,As of January 30, 2010, we have completedissued 64,484,279 shares of our Class A common stock in connection with prior private placements of Class A common stock and warrants, convertible notes, and shares of preferred stock that are convertible into or exercisable for shares of Class A common stock. Through January 31, 2009, we have issued 61,572,759 shares of our Class A common stock as a result of these private placements and exercises and conversions of these securities. An additional 14,391,8839,740,230 shares of Class A common stock may be issued under the convertible notes, preferred stock, and warrants that remained outstanding as of January 31, 2009,30, 2010, and this number of shares of Class A common stock is subject to antidilution adjustments based upon the antidilution provisions contained in these instruments. The issuance of the additional shares of Class A common stock upon conversion and exercise could cause the market price of our Class A common stock to decline. In March 2010, we completed a series of exercises and conversions of Series E warrants, convertible notes and shares of preferred stock that resulted in the issuance of 4,273,111 shares of our Class A common stock. The Company also repurchased an insignificant remaining convertible note balance from another holder of the convertible notes. As a result of the conversions and repurchase, there are no longer any remaining convertible notes and preferred stock outstanding.

The price of our Class A common stock has fluctuated significantly during the past few years and may fluctuate significantly in the future.

Our Class A common stock, which is traded on the NASDAQ Global Market, has experienced and may continue to experience significant price and volume fluctuations that could adversely affect the market price of our Class A common stock. The market price of our Class A common stock is likely to fluctuate, both because of actual and perceived changes in our operating results and prospects and because of general volatility in the stock market. The market price of our Class A common stock could continue to fluctuate widely in response to factors such as:

Fluctuations in the price and trading volume of our Class A common stock in response to factors such as those set forth above could be unrelated or disproportionate to our actual operating performance.

We have never paid dividends on our Class A common stock and do not plan to do so in the future.

Holders of shares of our Class A common stock are entitled to receive any dividends that may be declared by our Board of Directors. However, we have not paid any cash dividends on our Class A common stock and we do not expect to for the foreseeable future. Also, our agreements with our senior lenders and the indenture governing our notes restrict the payment of dividends to our stockholders.

Our charter provisions and Delaware law may have anti-takeover effects.

Our certificate of incorporation permits our Board of Directors to designate and issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, conversion and other rights and preferences that could differentially and adversely affect the voting power or other rights of the holders of our Class A common stock, which could be used to discourage an unsolicited acquisition proposal. Furthermore, certain provisions of Delaware law applicable to our company could also delay or make more difficult a merger, tender offer or proxy contest involving our company, including Section 203 of the Delaware General Corporation Law, which prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years unless certain conditions are met.

The possible issuance of preferred stock and the application of anti-takeover provisions of Delaware law could each have the effect of delaying, deferring or preventing a change in control of our company, including, without limitation, discouraging a proxy contest, making the acquisition of a substantial block of Class A common stock more difficult and limiting the price that investors might in the future be willing to pay for shares of our Class A common stock.

None.

Our principal executive offices are located at 26972 Burbank, Foothill Ranch, California, with 301,408 square feet of leased office and distribution facility space. Our principal executive offices contain 215,192 square feet of merchandise handling and storage space in the distribution facility and 86,216 square feet of office space. Our lease for this space runs through December 4, 2017, with the option for us to terminate on December 4, 2014, upon payment by us of an early termination fee of $0.7 million.

We lease all of our stores. Lease terms for our stores typically are 10 years. The leases generally provide for a fixed minimum rental and, on occasion, additional rental based on a percentage of sales once a minimum sales level has been reached. Certain leases include cash reimbursements received from landlords for leasehold improvements and other cash payments received from landlords as lease incentives. When a lease expires, we generally renew that lease at current market terms. However, each renewal is based upon an analysis of the individual store’s profitability and sales potential. At the end of fiscal 2008,2009, we had 1,879,3951,918,309 square feet of leased space under retail store leases.

The following table sets forth our 496504 retail stores by state or territory as of January 31, 2009:30, 2010:

The following table sets forth information with respect to store openings and closings since fiscal 2004:2005:

Total Company

Wet Seal

Arden B

Zutopia (discontinued in fiscal 2004)

On July 19, 2006, a complaint was filed in the Superior Court of the State of California for the County of Los Angeles or the Superior Court, on behalf of certain of our current and former employees that were employed and paid by us on an hourly basis during the four-year period from July 19, 2002 through July 19, 2006. We were named as a defendant. The complaint alleged various violations under the State of California Labor Code, the State of California Business and Professions Code, and orders issued by the Industrial Welfare Commission. On November 30, 2006, we reached an agreement to pay approximately $0.3 million to settle this matter, subject to Superior Court approval. On May 18, 2007, the Superior Court entered an order granting preliminary approval of the class action settlement. On February 29, 2008, the court issued its order granting final approval of the class action settlement, subject to appeal. On April 28, 2008, a notice of appeal of the judgment was filed. We anticipate receivingOn May 6, 2009, the appellate decision by June 2009.Court reversed and remanded the case to the Superior Court to re-evaluate the fairness of the settlement, and a final hearing will take place in April 2010. As of January 31, 2009,30, 2010, we have accrued an amount equal to the settlement amount in accrued liabilities in our consolidated balance sheet an amount equal to the settlement amount.

In January 2007, a class action complaint was filed against us in the Central District of the United States District Court of California, Southern Division, alleging violations of the FCRA, and in February 2007 a class action complaint was filed against us alleging similar violations in United States District Court, Central District of California, Western Division. The plaintiffs in the February 2007 complaint dismissed the complaint with prejudice in August 2007. The FCRA provides in part that portions of the credit card number may not be printed together with expiration dates on credit or debit card receipts given to customers. The FCRA imposes significant penalties upon violators of these rules and regulations where the violation is deemed to have been willful. Otherwise, damages are limited to actual losses incurred by the cardholder. On December 11, 2007, we reached a tentative agreement to settle the January 2007 complaint for less than $0.1 million. However, prior to the receipt of the executed settlement agreement, on February 8, 2008, we were named in another action, alleging the same violation, in the U.S. District Court, Western District of Pennsylvania. As a result, we withdrew our offer to settle the January 2007 action noted above. On June 3, 2008, the Credit and Debit Card Receipt Clarification Act of 2007 was enacted. This measure amended the FCRA to declare that a company that printed an expiration date on any receipt provided to a consumer cardholder at the point of sale or transaction between December 4, 2004, and the enactment of this legislation, but otherwise complied with FCRA requirements for such receipt, shall not be in willful noncompliance by reason of printing such expiration date on it. On July 1, 2008, and July 14, 2008, dismissals were filed by the plaintiffs in the United States District Court for the Central District of California and the United States District Court for the Western District of Pennsylvania, respectively. We made nominal

settlement payments for both claims and all parties agreed that the actions were dismissed with prejudice and that each party was to bear all of its own costs and attorney’s fees.sheet.

On May 22, 2007, a complaint was filed in the Superior Court of the State of California for the County of Orange on behalf of certain of our current and former employees who were employed and paid by us during the four-year period from May 21,22, 2003 through May 21,22, 2007. We were named as a defendant. The complaint alleged various violations under the State of California Labor Code, the State of California Business and Professions Code, and orders issued by the Industrial Welfare Commission. Discovery is ongoing and the Court has set a class certification filing deadline of May 21, 2010. We are vigorously defending this litigation and are unable to predict the likely outcome and whether such outcome may have a material adverse effect on our results of operations or financial condition. Accordingly, no provision for a loss contingency has been accrued as of January 31, 2009.30, 2010.

On September 29, 2008, a complaint was filed in the Superior Court of the State of California for the County of San Francisco on behalf of certain of our current and former employees who were employed and paid by us during the four-year period from September 29, 2004 through September 29, 2008. We were named as a defendant. The complaint alleges various violations under the State of California Labor Code and the State of California Business and Professions Code. Our responsive plea wasPlaintiffs recently filed an amended complaint, and we filed a motion to strike positions of the third amended complaint on November 14, 2008.or about February 16, 2010. The parties have stipulated that the case behas been transferred to the complex panel of the San Francisco Superior Court for case management purposes. We are vigorously defending this litigation and are unable to predict the likely outcome and whether such outcome may have a material adverse effect on our results of operations or financial condition. Accordingly, no provision for a loss contingency has been accrued as of January 31, 200930, 2010.

On March 18, 2009, a complaint was filed in the Superior Court of the State of California for the County of Orange on behalf of certain of our current and former employees that were employed and paid by us during the four-year period fromsince March 18, 2005 through March 18, 2009.2005. We were named as a defendant. The complaint alleged various violations under the State of California Labor Code, the State of California Business and Professions Code, and orders issued by the Industrial Welfare Commission. On October 23, 2009, we reached an agreement to pay approximately $0.2 million to settle this matter, subject to Superior Court approval. The Court has preliminarily approved the settlement and set a final approval hearing for June 3, 2010. As of January 30, 2010, we had accrued an amount equal to the settlement amount in accrued liabilities on our consolidated balance sheet.

On April 24, 2009 the Pennsylvania Equal Employment Opportunity Commission requested information and records relevant to several charges of discrimination. In the course of this investigation, the EEOC recently served us with a subpoena seeking information related to current and former employees throughout the United States. We have filed a petition to revoke or modify the subpoena and will, if necessary, oppose any attempt by the EEOC to enforce the subpoena in U.S. District Court. We are vigorously defending this litigationagainst the EEOC’s investigation and are unable to predict the likely outcome and whether such outcome may have a material adverse effect on our results of operations or financial condition. Accordingly, no provision for a loss contingency has been accrued as of January 31, 2009.30, 2010.

From time to time, we are involved in other litigation matters relating to claims arising out of our operations in the normal course of business. We believe that, in the event of a settlement or an adverse judgment on certain of the pending litigation,these claims arising out of normal course of business, we have insurance coverage to cover a portion of such losses; however, certain other matters may exist or arise for which we do not have insurance coverage. As of January 31, 2009,30, 2010, we were not engaged in any other legal proceedings that are expected, individually or in the aggregate, to have a material adverse effect on our results of operations or financial condition.

PART II

None.

PART II

We have two classes of common stock: Class A and Class B. Our Class A common stock is listed on the NASDAQ Global Market under the symbol “WTSLA.”“WTSLA”. As of March 30, 2009,26, 2010, there were 658647 stockholders of record of our Class A common stock. The closing price of our Class A common stock on March 30, 2009,26, 2010, was $3.47$4.79 per share. As of March 30, 2009,26, 2010, there were no shares of our Class B common stock outstanding.

Price Range of Stock

The following table reflects the high and low closing sale prices of our Class A common stock as reported by NASDAQ for the last two fiscal years:

Dividend Policy

We have reinvested earnings in the business and have never paid any cash dividends to holders of our common stock. The declaration and payment of future dividends, which are subject to the terms and covenants contained in the agreements governing our existing indebtedness, are at the sole discretion of the Board of Directors and will depend upon our profitability, financial condition, cash requirements, future prospects, and other factors deemed relevant by our Board of Directors. Our senior revolving credit facility and the indenture associated with our notes restrictlimits our ability to declare or pay dividends on any of our shares without consent from the lenders. The Company has no intention of paying cash dividends in the immediate future.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information as of January 31, 2009,30, 2010, about our common stock that may be issued upon the exercise of options, warrants, and rights granted to employees, consultants, or members of our Board of Directors under all of our existing equity compensation plans, including our 1996 Long-Term Incentive Plan, as amended; the 2000 Stock Incentive Plan; and the 2005 Stock Incentive Plan, as amended:

Stock Price Performance Graph

The following graph compares the cumulative stockholder return on our Class A common stock with the return on the Total Return Index for the NASDAQ Stock Market (US) and the NASDAQ Retail Trade Stocks. The graph assumes $100 invested on January 30, 2004,28, 2005, in the stock of Wet Seal, the NASDAQ Global Stock Market (US), and the NASDAQ Retail Trade Stocks. It also assumes that all dividends are reinvested.

Comparison of Cumulative Total Return for the Class A Common Stock

of Wet Seal, January 30, 200428, 2005 through January 30, 200929, 2010 (1)

(1) Returns are based upon the premise that $100 is invested in each of (a) our Class A common stock, (b) NASDAQ Stock Market, and (c) the index of NASDAQ Retail Trade Stocks on January 30, 2004,28, 2005, and that all dividends (if any) were reinvested. Over a five-year period, and based on the actual price movement of these investments, the original $100 would have turned into the amounts shown as of the end of each Wet Seal fiscal year. Stockholder returns over the indicated period should not be considered indicative of future shareholder returns.

The historical stock performance shown on the graph is not necessarily indicative of future price performance.

Unregistered Sales of Equity Securities

(a) None.

(b) None.

(c) None.Issuer Purchases of Equity Securities

As of January 30, 2010, 6,019,420 repurchased shares, at a cost of $29.8 million, as well as 2,823,451 shares reacquired by the Company, at no cost, upon employee, director, and consultant forfeitures of stock-based compensation, were not yet retired.

Item 6.

Selected Financial Data

The following table sets forth selected consolidated financial and other data as of and for the 20042005 through 20082009 fiscal years. The following selected financial data has been derived from our audited consolidated financial statements. The data set forth below should be read in conjunction with the consolidated financial statements and notes thereto, which are included elsewhere in this Annual Report.

Five-Year Financial Summary

(In thousands, except per-share and per square foot amounts, ratios, share data, store data, and square footage data)

The following discussion should be read in conjunction with our audited consolidated financial statements and notes thereto included elsewhere in this Annual Report. The following discussion and analysis contains forward-looking statements which involve risks and uncertainties, and our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under the heading “Statement Regarding Forward LookingForward-Looking Disclosure and Risk Factors” included elsewhere in this Annual Report.

Executive Overview

We are a national specialty retailer operating stores selling fashionable and contemporary apparel and accessory items designed for female customers aged 13 to 35 years old. We operate two nationwide, primarily mall-based, chains of retail stores under the names “Wet Seal” and “Arden B”. At January 31, 2009,30, 2010, we had 496504 retail stores in 47 states, Puerto Rico and Washington D.C. Of the 496504 stores, there were 409424 Wet Seal stores and 8780 Arden B stores.

We report our results of operations as two reportable segments representing our two retail divisions (“Wet Seal” and “Arden B”). Internet operations for Wet Seal and Arden B are included in their respective operating segments. Although the two operating segments are similarhave many similarities in their products, production processes, distribution methods and regulatory environment, there are differences in fiscal 2007, due to the poor profit performancemost of the Arden B divisionthese areas and the disparitydistinct differences in financial performance between the two segments, we concluded that we no longer considered these operating segments to be economically similar.their economic characteristics.

Our fiscal year ends on the Saturday closest to the end of January. Fiscal 2009, fiscal 2008, and fiscal 2007 each include 52 weeks of operations and fiscal 2006 includes 53 weeks of operations.

We consider the following to be key performance indicators in evaluating our performance:

Comparable store sales—For purposes of measuring comparable store sales, sales include merchandise sales as well as membership fee revenues recognized under our Wet Seal division’s frequent buyer program during the applicable period. Stores are deemed comparable stores on the first day of the month following the one-year anniversary of their opening or significant remodel/relocation, which we define to be a square footage increase or decrease of at least 20%. Stores that are remodeled or relocated with a resulting square footage change of less than 20% are maintained in the comparable store base with no interruption. However, stores that are closed for four or more than three days in a fiscal month, due to remodel, relocation or other reasons, are removed from the comparable store base for that fiscal month as well as for the comparable fiscal month in

the following fiscal year. Comparable store sales results are important in achieving operating leverage on certain expenses such as store payroll, occupancy, depreciation and amortization, general and administrative expenses, and other costs that

are at least partially fixed. Positive comparable store sales results generate greater operating

leverage on expenses while negative comparable store sales results negatively affect operating leverage. Comparable store sales results also have a direct impact on our total net sales, cash, and working capital.

Average transaction countscounts——We consider the trend in the average number of sales transactions occurring in our stores to be a key performance metric. To the extent we are able to increase transaction counts in our stores that more than offset any decrease in the average dollar sale per transaction, we will generate increases in our comparable store sales.

Gross marginsmargins——We analyze the components of gross margin, specifically cumulative mark-on, markups, markdowns, shrink, buying costs, distribution costs and store occupancy costs. Any inability to obtain acceptable levels of initial markups, a significant increase in our use of markdowns or in inventory shrink, or an inability to generate sufficient sales leverage on other components of cost of sales could have an adverse impact on our gross margin results and results of operations.

Operating incomeincome——We view operating income as a key indicator of our financial success. The key drivers of operating income are comparable store sales, gross margins and the changes we experience in operating costs.

Cash flow and liquidity (working capital)——We evaluate cash flow from operations, liquidity and working capital to determine our short-term operational financing needs.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 consolidated financial statements. Since future events and their impact cannot be determined with absolute certainty, the actual results will inevitably differ from our estimates.

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 of Notesnotes to Consolidated Financial Statements included elsewhere in this Annual Report. consolidated financial statements.

The policies and estimates discussed below involve the selection or application of alternative accounting policies that are material to our consolidated financial statements. Management has discussed the development and selection of these critical accounting policies and estimates with the Audit Committee of our Board of Directors.

We have certain accounting policies that require more significant management judgment and estimates than others. These include our accounting policies with respect to revenue recognition, merchandise inventories, long-lived assets, impairment of goodwill, stock-based compensation, accounting for income taxes and insurance reserves.

Revenue Recognition

Sales are recognized upon purchases by customers at our retail store locations. Taxes collected from our customers are and have been recorded on a net basis. For online sales, revenue is recognized at the estimated time goods are received by customers. Customers typically receive goods within four days of being shipped. Shipping and handling fees billed to customers for online sales are included in net sales. For fiscal 2009, 2008 2007 and 2006,2007, shipping and handling fee revenues were $2.9 million, $2.4 million, and $1.9 million, and $1.5 million, respectively.respectively, within net sales on the consolidated statements of operations.

We have recorded accruals to estimate sales returns by customers based on historical sales return results. Historically, a customer generally could return merchandise within 30 days of the original purchase date. Beginning in the third quarter of fiscal 2008, we modified our sales return policy to allow customers to return merchandise only within 21 days of original purchase. We also modified our sales return policy such that Wet Seal

retail store merchandise may be returned for store credit only and Arden B retail store and online merchandise may be returned for cash refund or store credit within seven days of the original purchase date, and for store credit only thereafter. For Wet Seal and Arden B online sales, merchandise may be returned within 21 days for a full refund. Actual return rates have historically been within management’s estimates and the accruals established. As the accrual for merchandise returns is based on estimates, the actual returns could differ from the accrual, which could impact net sales. The accrual for merchandise returns is recorded in accrued liabilities on the consolidated balance sheets and was $0.4$0.3 million and $0.7$0.4 million at January 30, 2010, and January 31, 2009, and February 2, 2008, respectively.

We recognize the sales from gift cards, gift certificates, and store credits as they are redeemed for merchandise. Prior to redemption, we maintain an unearned revenue liability for gift cards, gift certificates, and store credits until we are released from such liability, which includes consideration of potential obligations arising from state escheatment laws.liability. Our gift cards, gift certificates, and store credits do not have expiration dates; however, over time, a percentage of gift cards, gift certificates, and store credits are not redeemed or recovered (“breakage”). Historically, due to the lack of sufficient historical redemption trend data, we had not recognized breakage on gift cards, gift certificates, and store credits. In the fourth quarter of fiscal 2007, we analyzed company-specific historical redemption patterns and determined that the likelihood of redemption of unredeemed gift cards, gift certificates, and store credits three years after their issuance is remote. Beginning in the fourth quarter of fiscal 2007, we adjusted our unearned revenue liability to recognize estimated unredeemed amounts and began to record breakage as additional sales for gift cards, gift certificates, and store credits that remained unredeemed three years after their issuance. Our net sales in the fourth quarter of fiscal 2007 included a benefit of $3.7 million to reduce our unearned revenue liability for estimated unredeemed amounts. Our net sales for fiscal 2008 included a benefit of $0.9 million to reduce our unearned revenue liability for estimated unredeemed amounts. Additionally, based upon an analysis completed by us during the second fiscal quarter of 2009, historical redemption patterns indicated that the likelihood of redemption of unredeemed gift cards, gift certificates, and store credits greater than two years after their issuance is remote. As a result, beginning in the second quarter of fiscal 2009, we adjusted our unearned revenue liability to recognize the change in estimated timing of when breakage of gift cards, gift certificates and store credits is recognized from greater than three years after their issuance dates to greater than two years after their issuance dates. Our net sales in the second quarter of fiscal 2009 included a benefit of $1.2 million due to this change in estimate to reduce our unearned revenue liability for estimated unredeemed amounts. Our net sales for fiscal 2009 included a benefit of $2.2 million to reduce our unearned revenue liability for estimated unredeemed amounts. The unearned revenue for gift cards, gift certificates, and store credits is recorded in accrued liabilities in the consolidated balance sheets and was $6.5$5.4 million and $6.3$6.5 million at January 30, 2010 and January 31, 2009, and February 2, 2008, respectively. If actual redemptions ultimately differ from the assumptions underlying our breakage adjustments, or our future experience indicates the likelihood of redemption of gift cards, gift certificates, and store credits becomes remote at a different point in time after issuance, we may recognize further significant adjustments to our accruals for such unearned revenue, which could have a significant effect on our net sales and results of operations.

We maintain a frequent buyer program through our Wet Seal division. Under the program, customers receive a 10% to 20% discount on all purchases made during a 12-month period and are provided $5-off coupons that may be used on purchases during such period. The annual membership fee of $20 is nonrefundable. Discounts received by customers on purchases using the frequent buyer program are recognized at the time of such purchases.

We have historically recognized membership fee revenue under the frequent buyer program on a straight-line basis over the 12-month membership period due to a lack of sufficient program history to determine customer usage patterns. During November 2007, we changed from in-store delivery to e-mail delivery of the program’s $5-off coupons, which eliminated the customer’s ability to use such coupons at the time of initial purchases. We believe this change affects customer usage patterns. We also continue to test alternative program structures, and promotions tied to the program, and may decide to further modify the program in ways that could

also affect customer usage patterns. As a result of the recent program change and potential further modifications, we believe it is appropriate to maintain straight-line recognition of membership fee revenue. We may, in the future, determine that recognition of membership fee revenue on a different basis is appropriate, which would affect net sales. The unearned revenue for this program is recorded in accrued liabilities in the consolidated balance sheets and was $5.0$4.7 million and $9.6$5.0 million at January 30, 2010, and January 31, 2009, and February 2, 2008, respectively.

We maintain a customer loyalty program through our Arden B division. Under the program, customers accumulate points based on purchase activity. Once a loyalty program member achieves a certain point level, the member earns awards that may be redeemed for merchandise. Merchandise redemptions are accrued as unearned revenue and recorded as a reduction of net sales as points are accumulated by the member.

During fiscal 2006, we modified the terms of the Arden B loyalty program with respect to the number of points required to earn an award and the value of awards when earned. At the time of the program change, we also established expiration terms (i) for prospectively earned awards of two months from the date the award is earned and (ii) for preexisting awards of either two or 12 months from the program change date. This resulted in a reduction to our estimate of ultimate award redemptions under the program. Additionally, during fiscal 2006, we further reduced our estimate of ultimate redemptions based upon lower-than-anticipated redemption levels under the program’s revised terms. As a result, in fiscal 2006, we recorded a benefit of $3.7 million, which was recorded as an increase to net sales and a decrease to accrued liabilities.

During fiscal 2007, we further modified the terms of the Arden B loyalty program whereby, quarterly, we convert into fractional awards the points accumulated by customers who have not made purchases within the preceding 18 months. Similar to all other awards currently being granted under the program, such fractional awards expire if unredeemed after 60 days.

The unearned revenue for this program is recorded in accrued liabilities on the consolidated balance sheets and was $1.6$1.4 million and $2.0$1.6 million at January 30, 2010, and January 31, 2009, and February 2, 2008, respectively. If actual redemptions ultimately differ from accrued redemption levels, or if we further modify the terms of the program in a way that affects expected redemption value and levels, we could record adjustments to the unearned revenue accrual, which would affect net sales.

Merchandise Inventories

Merchandise inventories are stated at the lower of cost or market. Market is determined based on the estimated net realizable value, which generally is the merchandise selling price. Cost is calculated using the retail inventory method. Under the retail inventory method, inventory is stated at its current retail selling value and then is converted to a cost basis by applying a cost-to-retail ratio 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.

Markdowns are recorded when the sales value 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. Total markdowns, including permanent and promotional markdowns, on a cost basis in fiscal 2009, 2008 and 2007 and 2006 were $78.6 million, $77.4 million $84.5 million and $72.2$84.5 million, respectively, and represented 13.1%14.0%, 13.8%13.1% and 12.8%13.8% of net sales, respectively. We accrued $1.8$2.4 million and $3.5$1.8 million for planned but unexecuted markdowns, including markdowns related to slow moving merchandise, as of January 30, 2010, and January 31, 2009, and February 2, 2008, respectively.