THE UNITED STATES
                          SECURITIES AND EXCHANGE COMMISSION
                               WASHINGTON, D.C.  20549


                                      FORM 10-Q


                X   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
              ---------          THE SECURITIES EXCHANGE ACT OF 1934

              ----    FOR THE QUARTERLY PERIOD ENDED NOVEMBER 2, 1996MAY 3, 1997

                                          OR

                   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
              -----
                            THE SECURITIES EXCHANGE ACT OF 1934

                            COMMISSION FILE NUMBER 0-18632

                                  THE WET SEAL, INC.
                (Exact name of registrant as specified in its charter)


       DELAWARE                        33-0415940
(State of Incorporation)     (I.R.S. Employer Identification No.)


             64 FAIRBANKS
          IRVINE, CALIFORNIA                     92718
(Address of principal executive offices)       (Zip code)


                                    (714) 583-9029
                 (Registrant's telephone number, including area code)

         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.
YesYES X  No
   ---NO
   ----  ---

    The number of shares outstanding of the registrant's Class A
Common stockStock and Class B Common stock,Stock, par value $.10 per share, at December 10, 1996May 30, 1997
were 10,618,56610,645,374 and 2,912,665, respectively.  There were no shares of Preferred
stock,Stock, par value $.01 per share, outstanding at December 10, 1996.May 30, 1997.




                                  THE WET SEAL, INC.
                                      FORM 10-Q

                                        INDEX


PART I.   FINANCIAL INFORMATION

Item 1.   Consolidated Financial Statements

         Consolidated

          Balance Sheets as of November 2, 1996May 3, 1997 (unaudited) and
          February 3, 1996............................................3-4

         Consolidated1, 1997.......................................3-4

          Statements of Operations (unaudited) for the 13 and 39 weeks
          ended November 2, 1996May 3, 1997 and October 28, 1995..................................................5

         ConsolidatedMay 4, 1996........................5

          Statements of Cash Flows (unaudited) for the 3913 weeks
          ended November 2, 1996May 3, 1997 and October 28, 1995..................................................6May 4, 1996........................6

          Notes to Consolidated Financial Statements......................7-9Statements..........................7-8


Item 2.   Management's Discussion and Analysis of Financial
          Condition and Results of Operations...........................10-17Operations...................9-13


PART II.  OTHER INFORMATION................................................18INFORMATION.......................................14

          SIGNATURE PAGE...................................................19PAGE..........................................15




                                  THE WET SEAL, INC.
                                    AND SUBSIDIARY
                     CONSOLIDATED BALANCE SHEETS
(unaudited)

                                                     November 2,    February 3,
                                                            1996           1996
May 3, February 1, 1997 1997 ------------- -------------- (unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $65,631,000 $71,483,000 Marketable securities 24,200,000 17,700,000 Other receivables 1,812,000 1,577,000 Merchandise inventories 30,271,000 22,589,000 Prepaid expenses, including $5,500,000 of prepaid rent as of May 3, 1997 6,200,000 - Deferred tax charges 693,000 693,000 ------------- ------------- Total current assets 128,807,000 114,042,000 ------------- ------------- EQUIPMENT AND LEASEHOLD IMPROVEMENTS: Leasehold improvements 55,871,000 55,429,000 Furniture, fixtures and equipment 22,094,000 21,742,000 Leasehold rights 3,342,000 3,342,000 Construction in progress 1,324,000 2,000 ------------- ------------- 82,631,000 80,515,000 Less accumulated depreciation (50,072,000) (47,285,000) ------------- ------------- Net equipment and leasehold improvements 32,559,000 33,230,000 ------------- ------------- OTHER ASSETS: Deferred tax charges and other assets 6,916,000 6,914,000 Goodwill, net of accumulated amortization of $577,000 and $566,000 as of May 3, 1997 and February 1, 1997, respectively 555,000 566,000 ------------- ------------- Total other assets 7,471,000 7,480,000 ------------- ------------- $168,837,000 $154,752,000 ------------- ------------- ------------- ------------- ------------ ASSETS CURRENT ASSETS: Cash and cash equivalents $78,544,000 $57,153,000 Other receivables 519,000 523,000 Merchandise inventories 25,283,000 16,241,000 Prepaid expenses 5,006,000 428,000 Deferred tax charges 1,100,000 1,100,000 ------------- ------------ Total current assets 110,452,000 75,445,000 ------------- ------------ EQUIPMENT AND LEASEHOLD IMPROVEMENTS: Leasehold improvements 57,407,000 55,438,000 Furniture, fixtures and equipment 22,224,000 21,606,000 Leasehold rights 4,017,000 2,009,000 Construction in progress 2,000 9,000 ------------- ------------ 83,650,000 79,062,000 Less accumulated depreciation (49,807,000) (41,015,000) ------------- ------------ Net equipment and leasehold improvements 33,843,000 38,047,000 ------------- ------------ OTHER ASSETS: Deferred tax charges and other assets 4,437,000 3,461,000 Goodwill, net of accumulated amortization of $555,000 and $521,000 as of November 2, 1996 and February 3, 1996, respectively 577,000 611,000 ------------- ------------ Total other assets 5,014,000 4,072,000 ------------- ------------ $149,309,000 $117,564,000 ------------- ------------ ------------- ------------
THE WET SEAL, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (unaudited)
November 2, FebruaryMAY 3, 1996 1996 ------------- ------------FEBRUARY 1, 1997 1997 -------------- -------------- (unaudited) LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $32,630,000 $19,491,000$41,426,000 $26,035,000 Accrued liabilities 22,936,000 22,813,00019,851,000 24,064,000 Income taxes payable -- 3,354,0001,984,000 2,152,000 Current portion of long-term debt 2,000,000 3,736,0002,000,000 ------------- ------------ Total current liabilities 57,566,000 49,394,00065,261,000 54,251,000 ------------- ------------ LONG-TERM LIABILITIES: Long-term debt 3,764,000 5,264,0002,764,000 3,264,000 Deferred rent 5,839,000 5,171,0006,177,000 6,117,000 ------------- ------------ Total long-term liabilities 9,603,000 10,435,0008,941,000 9,381,000 ------------- ------------ Total liabilities 67,169,000 59,829,00074,202,000 63,632,000 ------------- ------------ STOCKHOLDERS' EQUITY: Preferred Stock, $.01 par value, authorized 2,000,000 shares; none issued and outstanding -- --- - Common Stock, Class A, $.10 par value, authorized 20,000,000 shares; 10,618,566 and 5,687,06610,628,874 shares issued and outstanding at November 2, 1996May 3, 1997 and February 3, 1996,1, 1997, respectively 1,062,000 568,0001,063,000 1,063,000 Common Stock, Class B Convertible, $.10 par value, authorized 10,000,000 shares; 2,912,665 and 6,807,665 shares issued and outstanding at November 2, 1996May 3, 1997 and February 3, 1996,1, 1997, respectively 291,000 681,000291,000 Paid-in capital 54,638,000 38,568,00056,596,000 56,596,000 Retained earnings 26,149,000 17,918,00036,685,000 33,170,000 ------------- ------------ Total Stockholders' Equity 82,140,000 57,735,000stockholders' equity 94,635,000 91,120,000 ------------- ------------ $149,309,000 $117,564,000$168,837,000 $154,752,000 ------------- ------------ ------------- ------------
THE WET SEAL, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
13 Weeks Ended 39 Weeks Ended ---------------------------- ---------------------------- November 2, October 28, November 2, October 28,WEEKS ENDED ---------------------------------- MAY 3, MAY 4, 1997 1996 1995 1996 1995 ------------- ------------ ------------- --------------------------- SALES $95,571,000 $88,674,000 $270,502,000 $163,396,000$95,563,000 $80,575,000 COST OF SALES (including buying, distribution and occupancy costs) 69,152,000 67,013,000 200,259,000 127,149,000 -------------70,122,000 61,537,000 ------------ ------------- ------------ GROSS MARGIN 26,419,000 21,661,000 70,243,000 36,247,00025,441,000 19,038,000 SELLING, GENERAL AND ADMINISTRATIVE EXPENSE 20,046,000 19,066,000 58,005,000 36,432,00020,197,000 18,264,000 INTEREST INCOME, NET (834,000) (330,000) (1,916,000) (900,000) -------------(714,000) (477,000) ------------ ------------- ------------ NET OPERATING EXPENSES 19,212,000 18,736,000 56,089,000 35,532,000 -------------19,483,000 17,787,000 ------------ ------------- ------------ INCOME BEFORE PROVISION FOR INCOME TAXES 7,207,000 2,925,000 14,154,000 715,0005,958,000 1,251,000 PROVISION FOR INCOME TAXES 3,013,000 1,103,000 5,923,000 297,000 -------------2,443,000 529,000 ------------ ------------- ------------ NET INCOME $4,194,000 $1,822,000 $8,231,000 $418,000 -------------$3,515,000 $722,000 ------------ ------------- ------------ ------------- ------------ ------------- ------------ NET INCOME PER COMMON SHARE $0.30 $0.15 $0.61 $0.03 -------------$0.25 $0.06 ------------ ------------- ------------ ------------- ------------ ------------- ------------ WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 13,526,605 12,492,586 13,114,293 12,349,030 ------------- ------------ ------------- ------------ ------------- ------------ ------------- ------------ WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING 13,838,943 12,492,586 13,508,126 12,349,030 -------------13,832,051 12,497,842 ------------ ------------- ------------ ------------- ------------ ------------- ------------
THE WET SEAL, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
39 Weeks Ended ---------------------------- November 2, October 28,13 WEEKS ENDED ------------------------------- MAY 3, MAY 4, 1997 1996 1995 ------------- ----------------------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $8,231,000 $418,000$3,515,000 $722,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 9,229,000 7,656,0002,798,000 3,178,000 Loss on disposal of equipment and leasehold improvements 70,000 13,000- 2,000 Changes in operating assets and liabilities, net of acquisition:liabilities: (Increase) decrease in: Other receivables 4,000 (516,000) Tax refund receivable 59,000(235,000) 442,000 Merchandise inventories (9,042,000) (7,106,000)(7,682,000) (8,431,000) Prepaid expenses (4,578,000) (389,000)(6,200,000) (5,045,000) Other assets (976,000) (40,000)(2,000) 22,000 (Decrease) increase in: Accounts payable and accrued liabilities 14,743,000 13,168,00011,178,000 13,910,000 Income taxes payable (3,354,000) (1,000)(168,000) (2,965,000) Deferred rent 668,000 712,000 ------------- ------------60,000 211,000 ----------- ----------- Total adjustments 6,764,000 13,556,000 ------------- ------------(251,000) 1,324,000 ----------- ----------- Net cash provided by operating activities 14,995,000 13,974,000 ------------- ------------3,264,000 2,046,000 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of marketable securities 4,000,000 - Investment in equipment and leasehold improvements (6,542,000) (2,017,000) Cash paid for acquisition, less cash acquired (20,000) ------------- ------------(2,116,000) (2,356,000) Investment in marketable securities (10,500,000) - ----------- ----------- Net cash used in investing activities (6,542,000) (2,037,000) ------------- ------------(8,616,000) (2,356,000) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments on long-term debt (3,236,000) -(500,000) (500,000) Proceeds from issuance of stock 16,174,000 7,000 Proceeds from issuance of debt - 10,000,000 ------------- ------------27,000 ----------- ----------- Net cash provided byused in financing activities 12,938,000 10,007,000 ------------- ------------(500,000) (473,000 ----------- ----------- NET INCREASEDECREASE IN CASH AND CASH EQUIVALENTS 21,391,000 21,944,000(5,852,000) (783,000) CASH AND CASH EQUIVALENTS,beginning of period 71,483,000 57,153,000 25,369,000 ------------- ----------------------- ----------- CASH AND CASH EQUIVALENTS,end of period $78,544,000 $47,313,000 ------------- ------------ ------------- ------------$65,631,000 $56,370,000 ----------- ----------- ----------- ----------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $432,000 $290,000$98,000 $172,000 Income taxes net 10,288,000 336,0002,611,000 3,494,000
SCHEDULE OF NONCASH TRANSACTIONS: During the thirty-nine weeks ended November 2, 1996, the Company reduced certain estimated liabilities assumed in connection with the acquisition of Contempo Casuals. As a result, a reduction in accounts payable of $1,481,000 was recorded with a corresponding reduction in fixed assets. During the thirty-nine weeks ended October 28, 1995, the Company acquired the assets of Contempo Casuals for common stock valued at $1,178,000. THE WET SEAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - BASIS OF PRESENTATION: The information set forth in these consolidated financial statements is unaudited except for the February 3, 19961, 1997 balance sheet. These statements have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The accompanying consolidated financial statements consolidate the accounts of Contempo Casuals, Inc. ("Contempo") which was acquired on July 1, 1995. All significant intercompany transactions have been eliminated. In the opinion of management, all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation have been included. The results of operations for the 13 and 39 weeks ended November 2, 1996May 3, 1997 are not necessarily indicative of the results that may be expected for the year ending February 1, 1997.January 31, 1998. For further information, refer to the financial statements and notes thereto included in the Company's Annual Report for the year ended February 3, 1996. Certain reclassifications have been made to conform the October 28, 1995 financial statements to the November1, 1997. Effective February 2, 1996 financial statements. 1997, Contempo Casuals, Inc. was merged with and into The Wet Seal, Inc. NOTE 2 - NEW ACCOUNTING PRONOUNCEMENTS: In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation" which became effective for the Company beginning February 4, 1996. SFAS No. 123 requires expanded disclosures of stock-based compensation arrangements with employees and encourages (but does not require) compensation cost to be measured based on the fair value of the equity instrument awarded. Companies are permitted, however, to continue to apply APB Opinion No. 25, which recognizes compensation cost based on the intrinsic value of the equity instrument awarded. The Company will continue to apply APB Opinion No. 25 to its stock based compensation awards to employees and will disclose the required pro forma effect on net income and earnings per share. NOTE 3 -LINE OF CREDIT AND LOAN PAYABLE TO BANK AND LINES OF CREDIT: OnBANK: Under an unsecured revolving line-of-credit arrangement with a bank, the Company may borrow up to a maximum of $30 million on a revolving basis through July 1, 1996, the Company renewed its three bank credit facilities which consisted of two revolving lines of credit for an aggregate of $30,000,000 and which expire on July 1, 1998, and one term loan for $10,000,000 which expires on July 31, 2000.1998. The cash borrowings under the two revolving credit linesarrangement bear interest at the bank's prime rate or, at the Company's option, the London Interbank Offered Rate (LIBOR) plus 1.75% for both facilities. The Wet Seal facility is guaranteed by Contempo. The Contempo facility is guaranteed by Wet Seal and is also secured by the stock of Contempo. As of November 2, 1996 there were no borrowings against either of the lines. The Company's five year amortizing term loan in the amount of $10,000,000 is repayable in twenty equal quarterly installments of $500,000 which commenced October 31, 1995. The borrowing bears interest at the bank's prime rate or, at the Company's option, LIBOR plus 1.75%. As of May 3, 1997, the Company had no borrowings outstanding under the credit arrangement. In June 1995, the Company entered into an unsecured five-year, $10 million term loan. The loan bears interest at the bank's prime rate plus .25% or, at the Company's option, LIBOR plus 1.75%. The estimated annual principal payments on the loan are $2,000,000 payable in quarterly installments of $500,000 which commenced October 31, 1995. As of May 3, 1997, the loan has a remaining outstanding balance of $4,764,000. The credit arrangement and the term loan is guaranteed by Contempo. All ofimpose quarterly and annual financial covenants requiring the above facilities are subjectCompany to maintain certain financial covenantsratios and conditions with whichachieve certain levels of annual income. In addition, the credit arrangement and the term loan NOTE 2 - LOAN PAYABLE TO BANK AND LINE OF CREDIT (CONTINUED): require that the bank approve the payment of dividends and restrict the level of capital expenditures. At May 3, 1997, the Company was in compliance as of November 2, 1996. with these covenants. NOTE 43 - EARNINGS PER COMMON SHARE: Earnings per common share are based on the weighted average number of common and common stock equivalent shares outstanding, if dilutive, shares outstanding during the periods. NOTE 5 - ISSUANCE OF STOCK: OnIn February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128") which is effective for financial statements issued for periods ending after December 15, 1997. SFAS No. 128 requires the disclosure of basic and diluted earnings per share. For the periods ended May 24,3, 1997 and May 4, 1996, the Company completed its previously announced public offering of 3,565,000 shares of its Class A Common Stock, ofamount reported as net income per common and common equivalent share is not materially different than that which 765,000 shares were sold by the Companywould have been reported for basic and 2,800,000 were sold by Selling Stockholders. The shares were sold to the public at an initial offering price of $20diluted earnings per share. The net proceeds to the Company from the sale of the 765,000 shares were $14,459,000. The proceeds are being used for general corporate purposes, which may include repayment of certain indebtedness, remodeling and opening of stores and upgrading of the Company's point-of-sale system.share in accordance with SFAS No. 128. ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION The Company is one of the largest national mall-based specialty retailers focusing primarily on young women's apparel, and currently operates 363 retail stores in 34 states and Puerto Rico under the names "Wet Seal", "Contempo Casuals", "Limbo Lounge" and "Next". The Company sells moderately priced, fashionable, casual apparel and accessory items designed for consumers with a young, active lifestyle. On July 1, 1995, the Company acquired Contempo Casuals. The transaction was accounted for under the purchase method. During the second quarter ended August 3, 1996, the Company reduced certain estimated liabilities assumed in connection with the acquisition of Contempo Casuals. As a result, a reduction in accounts payable of $1,481,000 was recorded with a corresponding reduction in fixed assets. The acquisition of Contempo Casuals increased the number of stores the Company operates by 237 stores. As of November 2, 1996 the Company operated 361 stores as compared to 368 stores as of October 28, 1995, the end of the third quarter of fiscal 1995. Acquiring Contempo Casuals enabled the Company to significantly reduce fixed expenses as a percentage of sales through the consolidation and integration of the two companies' management teams, corporate offices and distribution centers. This process was substantially completed at the time of the acquisition. The following discussion and analysisAs of financial condition and resultsMay 3, 1997 the Company operated 363 stores as compared to 362 stores as of operations include a comparisonMay 4, 1996, the end of the resultsfirst quarter of operations forfiscal 1996. The Company opened eleven stores during the thirdperiod from May 5, 1996 to May 3, 1997 and closed ten stores. Effective February 2, 1997, Contempo Casuals, Inc. was merged with and into The Wet Seal, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Company's Financial Statements and the Notes related thereto. RESULTS OF OPERATIONS THE 13 WEEKS ENDED MAY 3, 1997 (FIRST QUARTER OF FISCAL 1997) AS COMPARED TO THE 13 WEEKS ENDED MAY 4, 1996 (FIRST QUARTER OF FISCAL 1996) Sales in the first quarter yearof fiscal 1997 were $95,563,000 compared to datesales in the first quarter of fiscal 1996 which containedof $80,575,000, an increase of $14,988,000 or 18.6%. The dollar increase in sales was primarily due to an increase of 14.7% in comparable store sales. Comparable store sales are defined as sales in stores that were open throughout the full period results of bothfiscal year and throughout the Wet Seal stores and the Contempo Casuals stores,full prior fiscal year. The comparable store sales increase is due in part to the third quarter year to date of fiscal 1995, which contained the full period results of the Wet Seal stores, and only the July 1995 to October 1995 results for the Contempo Casuals stores, due to the fact that the Contempo Casuals acquisition occurred on July 1, 1995. Therefore, the results of operations for the third quarter year to date of fiscal 1996 are not directly comparable to the third quarter year to date of fiscal 1995. The third quarter results, however, are comparable given that both the current year and the prior year period contain the full impact of the Contempo acquisition.increase in inventory levels ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED Management's discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements and the Notes related thereto. RESULTS OF OPERATIONS THE 13 WEEKS ENDED NOVEMBER 2, 1996 (THIRD QUARTER OF FISCAL 1996) AS COMPARED TO THE 13 WEEKS ENDED OCTOBER 28, 1995 (THIRD QUARTER OF FISCAL 1995) Sales in the 13 weeks ended November 2, 1996 were $95,571,000CONTINUED: compared to salesprior year. Inventory levels were considered to be below plan in the 13 weeks ended October 28, 1995 of $88,674,000, an increase of $6,897,000 or 7.8%. The dollar increase in sales was primarily due to an increase of 10.5% in the comparable store sales for the combined Wet Seal and Contempo chains. Comparable store sales is calculated based on the 13 weeks ended November 2, 1996 comparedprior year. Further contributing to the same 13 week period ended November 4, 1995. This increase in sales due toincreases were the comparableopening of eleven new stores with a higher sales productivity per store sales is slightly offset by the fact that there were 361 stores opened at the end of the current year third quarter as compared to 368 stores opened at the end of the prior year period. Additionally, the third quarter of fiscal 1996 started and ended one week later than the third quarter of fiscal 1995 resulting in a historically 'net' weaker 13 weeks of sales in the third quarter of fiscal 1996 as compared to the 13 weeks of sales in the third quarter of fiscal 1995.ten closed stores. Cost of sales, including buying, distribution and occupancy costs, was $69,152,000$70,122,000 in the thirdfirst quarter of fiscal 1997 compared to $61,537,000 in the first quarter of fiscal 1996, compared to $67,013,000 in the third quarter of fiscal 1995, an increase of $2,139,000.$8,585,000. The dollar increase in cost of sales was due to the increase in the sales. As a percentage of sales, cost of sales decreased from 75.6%76.4% in the third quarter of fiscal 1995 to 72.4% in the thirdfirst quarter of fiscal 1996 to 73.4% in the first quarter of fiscal 1997, a decrease of 3.2%3.0%. This decrease in cost of sales as a percentage of sales was related to a decrease in occupancy costs as a percentage of 2.1%sales of 3.9%, a decrease in distribution costs of 0.6%, and a decreaseoffset slightly by an increase in the cost of merchandise of 0.5%.merchandise. The decreasesdecrease in occupancy costs and distribution costs werewas associated primarily with the improved leverage in fixed costs which was due to the increase in comparable store sales.sales as well as a decrease in depreciation due to the impact of fully depreciated assets. The decreaseincrease in the cost of merchandise was due to an increase in the initial markup ratesmarkdowns in the thirdfirst quarter of fiscal 1997 as compared to the first quarter of fiscal 1996. Markdowns in the first quarter of fiscal 1996 as comparedwere low due to the third quarter of fiscal 1995. ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED:inventory levels that were below plan. Selling, general and administrative expenses were $20,046,000expense was $20,197,000 in the thirdfirst quarter of fiscal 1997 compared to $18,264,000 in the first quarter of fiscal 1996, compared to $19,066,000 in the third quarter of fiscal 1995, an increase of $980,000$1,933,000 or 5.1%10.6%. The dollar increase in selling, general and administrative expensesexpense was primarily related to the increase in sales. As a percentage of sales, selling, general and administrative expensesexpense decreased from 21.5%22.7% in the third quarter of fiscal 1995 to 21.0% in the thirdfirst quarter of fiscal 1996 to 21.1% in the first quarter of fiscal 1997, a decrease of 0.5%1.6%. The decrease as a percentage of sales was related to the leverage of the fixed components of this expense, primarily store wages, as a result of the increase in the comparable store sales. Interest income, net, was $834,000$714,000 in the thirdfirst quarter of fiscal 1997 compared to $477,000 in the first quarter of fiscal 1996, compared to $330,000 in the third quarter of fiscal 1995, an increase of $504,000.$237,000. The increase was due to an increase in the average cash balance invested in the current year period as compared to the prior year. Due to the factors noted above, net incomeIncome tax provision was $4,194,000$2,443,000 in the thirdfirst quarter of fiscal 19961997 compared to $1,822,000$529,000 in the thirdfirst quarter of fiscal 1995. As a percentage of sales, net income1996. The effective tax rate was 4.4%41.0% compared to 42.3% in the third quarter of fiscal 1996 compared to 2.1% in the third quarter of fiscal 1995. THE 39 WEEKS ENDED NOVEMBER 2, 1996 (THIRD QUARTER YEAR TO DATE OF FISCAL 1996) AS COMPARED TO THE 39 WEEKS ENDED OCTOBER 28, 1995 (THIRD QUARTER YEAR TO DATE OF FISCAL 1995): Sales in the 39 weeks ended November 2, 1996 were $270,502,000 compared to sales in the 39 weeks ended October 28, 1995 of $163,396,000, an increase of $107,106,000 or 65.5%. The dollar increase in sales was primarily due to the acquisition of Contempo Casuals. The increase in sales is also due, to a significantly lesser extent, to the 10.6% increase in comparable store sales for the combined Wet Seal and Contempo chains. Cost of sales, including buying, distribution and occupancy costs, was $200,259,000 in the third quarter year to date of fiscal 1996 compared to $127,149,000 in the third quarter year to date of fiscal 1995, an increase of $73,110,000. The dollar increase in cost of sales was due to the increase in the number of stores as a result of the acquisition of Contempo Casuals. As a percentage of sales, cost of sales decreased from 77.8% in the third quarter year to date of fiscal 1995 to 74.0% in the third quarter year to date of fiscal 1996, a decrease of 3.8%. This decrease in cost of sales as a percentage of sales was related primarily to a decrease in occupancy costs of 2.9%, a decrease in buying and distribution costs of 0.6%, and a decrease in the cost of merchandise of 0.3%. The decrease in occupancy costs was associated primarily with a decrease in depreciation resulting from the lower net book value per store of the depreciable assets of Contempo Casuals, as compared to Wet Seal, as well as to the improved leverage in fixed costs related to the increase in the comparable store sales. The decrease in the buying and distribution costs relate to the improved leverage in the fixed components of these costs related to the increase in comparable store sales. The decrease in the cost of merchandise was due to the increase in the initial markup rates. Selling, general and administrative expenses were $58,005,000 in the third quarter year to date of fiscal 1996 compared to $36,432,000 in the third quarter year to date of fiscal 1995, an increase of $21,573,000. The dollar increase in selling, general and administrative expenses was primarily due to the acquisition of Contempo Casuals which served to substantially increase the number of stores.prior year. ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED As a percentage of sales, selling, general and administrative expenses decreased from 22.3%Due to the factors noted above, net income was $3,515,000 in the thirdfirst quarter year to date of fiscal 19951997 compared to 21.4%$722,000 in the thirdfirst quarter year to date of fiscal 1996, a decrease year to date of 0.9%. The decrease as a percentage of sales was related to the economies of scale the Company achieved as a result of the Contempo acquisition and to the increase in comparable store sales. The decrease was most notable in store payroll expense. Interest income, net, was $1,916,000 in the third quarter year to date of fiscal 1996 compared to $900,000 in the third quarter year to date of fiscal 1995, an increase of $1,016,000. The increase was due primarily to an increase in the average cash balance invested and was partially offset by an increase in interest expense in fiscal 1996. Income tax provision was $5,923,000 in the third quarter year to date of fiscal 1996 compared to $297,000 in the third quarter year to date of fiscal 1995. Net income was $8,231,000 in the third quarter year to date of fiscal 1996 compared to $418,000 in the third quarter year to date of fiscal 1995. As a percentage of sales, net income was 3.0%3.7% in the thirdfirst quarter year to date of fiscal 19961997 compared to 0.3%0.9% in the thirdfirst quarter year to date of fiscal 1995. The Company's return to profitability, which began in the second half of fiscal 1995, was related in part to the acquisition of Contempo Casuals. With this acquisition, the Company achieved significant economies of scale in areas such as buying, distribution and general and administrative costs. At the same time, the acquisition enabled the Company to reduce its average depreciation cost per store due, in part, to the favorable acquisition price. Also contributing to the improvements in profitability is the increase in comparable store sales. ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED1996. LIQUIDITY AND CAPITAL RESOURCES Working capital at November 2, 1996May 3, 1997 was $52,886,000$63,546,000 compared to $26,051,000$59,791,000 at February 3, 1996,1, 1997, an increase of $26,835,000.$3,755,000. The Company's primary source of working capital has historically been cash flows from operating activities. Net cash flows provided by operating activities for the 39 weeks ended November 2, 1996first quarter of fiscal 1997 was $14,995,000$3,264,000 compared to $13,974,000$2,046,000 for the 39 weeks ended October 28, 1995.first quarter of fiscal 1996. Inventory increased $9,042,000$7,682,000 at November 2, 1996May 3, 1997 compared to the fiscal year end due to the seasonal nature of the business; inventory levels are typically at a low point at year end. The increase in accounts payable and accrued liabilities increase of $14,743,000$11,178,000 more than offset this increase in inventory due to the terms of the payments in relation to the receipt of the inventory. In the thirdfirst quarter year to date of fiscal 1996,1997, the Company invested $6,542,000$2,116,000 in equipment leasehold improvements and leasehold rights.improvements. These expenditures related primarily to the purchase of leasehold rights for three stores that the Companyone store opened and seven additional stores that the Company will open in the fourthfirst quarter of this fiscal year.1997 along with construction in progress for additional new and remodeled stores. The Company currently estimates that the capital expenditures for the remainder of fiscal 19961997 will be $4,400,000.approximately $28,000,000. These planned expenditures relate primarily to store openings and remodels as well as a new corporate office and distribution center. Under an unsecured revolving line-of-credit arrangement with a bank, the Company may borrow up to a new point-of-sale system. Cash provided by financing activities was $12,938,000 inmaximum of $30 million on a revolving basis through July 1, 1998. The cash borrowings under the third quarter year to datearrangement bear interest at the bank's prime rate or, at the Company's option, LIBOR plus 1.75%. As of fiscal 1996 due to the proceeds received from the sale byMay 3, 1997, the Company of 765,000 shares of Class A Common Stock in a public offering which closed on May 24, 1996.had no borrowings outstanding under the credit arrangement. In July 1996, the Company renewed its lines of credit with Bank of America National Trust and Savings Association ("Bank of America") in an aggregate principal amount of $30,000,000 (the "Revolving Credit Facilities"), and a five year amortizing term loan with Bank of America in the amount of $10,000,000 (the "Term Loan"). In connection with the Contempo Casuals acquisition,June 1995, the Company entered into an unsecured five-year, $10 million term loan. The loan bears interest at the Term Loan to satisfy certain net worth requirements related tobank's prime rate plus .25% or, at the assignmentCompany's option, LIBOR plus 1.75%. The estimated annual principal payments on the loan are $2,000,000 payable in quarterly installments of leases.$500,000 which commenced October 31, 1995. As of November 2, 1996, there were no borrowings underMay 3, 1997, the Revolving Creditloan ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED Facilities,has a remaining outstanding balance of $4,764,000. The credit arrangement and the term loan impose quarterly and annual financial covenants requiring the Company to maintain certain financial ratios and achieve certain levels of annual income. In addition, the credit arrangement and the term loan require that the bank approve the payment of dividends and restrict the level of capital expenditures. At May 3, 1997, the Company was in compliance with all terms and covenants of such agreements.these covenants. The Company invests its excess funds primarily in a short-term investment grade money market fund, investment grade commercial paper and U.S. Treasury and Agency obligations. Management believes the Company's working capital and cash flows from operating activities will be sufficient to meet the Company's operating and capital requirements in the foreseeable future. SEASONALITY AND QUARTERLY OPERATING RESULTS The Company's business is seasonal by nature with the Christmas season (beginning the week of Thanksgiving and ending the first Saturday after Christmas) and the back-to-school season (beginning the last week of July and ending the first week of September) historically accounting for the largest percentage of sales volume. In the Company's three fiscal years ended February 3, 1996,1, 1997, the Christmas and back-to-school seasons together accounted for an average of approximately 32% of the Company's annual sales, after adjusting for sales increases related to new stores. The Company does not believe that inflation has had a material effect on the results of operations during the past three years. However, there can be no assurance that the Company's business will not be affected by inflation in the future. STATEMENT REGARDING FORWARD LOOKING DISCLOSURE Certain sections of this Quarterly Report on Form 10-Q, including the preceding "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 (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended, which represent the Company's expectations or beliefs concerning future events. The Company cautions that these statements are further qualified by important factors that could ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED cause actual results to differ materially from those in the forward looking statements, including, without limitation, the retention by the Company of suppliers for both brand name and Company-developed merchandise, the ability of the Company to expand and to continue to increase comparable store sales, the sufficiency of the Company's working capital and cash flows from operating activities, a decline in demand for the merchandise offered by the Company, the ability of the Company to locate and obtain acceptable store sites and lease terms or renew existing leases, the ability of the Company to obtain adequate merchandise supply, the ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUEDability of the Company to hire and train employees, the ability of the Company to gauge the fashion tastes of its customercustomers and provide merchandise that satisfies customer demand, management's ability to manage the Company's expansion, the effect of economic conditions, the effect of severe weather or natural disasters and the effect of competitive pressures from other retailers. NEW ACCOUNTING PRONOUNCEMENTS In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128") which is effective for financial statements issued for periods ending after December 15, 1997. SFAS No. 128 requires the disclosure of basic and diluted earnings per share. For the periods ended May 3, 1997 and May 4, 1996, the amount reported as net income per common and common equivalent share is not materially different than that which would have been reported for basic and diluted earnings per share in accordance with SFAS No. 128. PART II - OTHER INFORMATION ITEM 1 - LEGAL PROCEEDINGS. The Company is not party to any material legal proceedings, other than ordinary routine litigation incidental to the Company's business. ITEM 2 - CHANGES IN SECURITIES. Not Applicable ITEM 3 - DEFAULTS UPON SENIOR SECURITIES. Not Applicable ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not Applicable ITEM 5 - OTHER INFORMATION. Not Applicable ITEM 6(A) - EXHIBITS. Not Applicable ITEM 6(B) - REPORTS ON FORM 8-K. Not Applicable SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The Wet Seal, Inc. (Registrant) Date: December 16, 1996JUNE 13, 1997 /S/KATHY BRONSTEIN -------------------------- --------------------------------------------------------- --------------------------- Kathy Bronstein Vice Chairman and Chief Executive Officer (Principal Executive Officer) Date: December 16, 1996JUNE 13, 1997 /S/EDMOND THOMAS -------------------------- --------------------------------------------------------- --------------------------- Edmond Thomas President and Chief Operating Officer Date: December 16, 1996JUNE 13, 1997 /S/ANN CADIER KIM -------------------------- --------------------------------------------------------- --------------------------- Ann Cadier Kim Vice President of Finance and Chief Financial Officer (Principal Financial and Accounting Officer)