UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended July 30,October 29, 2005

OR

Commission file number 0-18632

THE WET SEAL, INC.

(Exact name of registrant as specified in its charter)

(949) 583-9029699-3900

(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. Yes þ No ¨

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

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

The number of shares outstanding of the Registrant’s Preferred Stock, par value $0.01 per share, at SeptemberDecember 2, 2005 was 12,222.9,660. The number of shares outstanding of the Registrant’s Class A Common Stock, par value $.10$0.10 per share, at SeptemberDecember 2, 2005 was 58,569,126.62,916,812. There were no shares outstanding of the Registrant’s Class B Common Stock, par value $.10$0.10 per share, at SeptemberDecember 2, 2005.

THE WET SEAL, INC.

FORM 10-Q

Index

Part I. Financial Information

Item 1. Financial Statements (Unaudited)

THE WET SEAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

THE WET SEAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share data)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

THE WET SEAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands, except share data)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 2639 weeks ended July 30,October 29, 2005 and July 31,October 30, 2004 (as restated)

(Unaudited)

NOTE 1 – Basis of Presentation, Significant Accounting Policies and New Accounting Pronouncements

Basis of Presentation

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

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 2639 weeks ended July 30,October 29, 2005 are not necessarily indicative of the results that may be expected for the year ending January 28, 2006. For further information, refer to the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K, and amendments thereto, of The Wet Seal, Inc. (the Company) for the year ended January 29, 2005.

Significant Accounting Policies

Merchandise Inventories

Merchandise inventories are stated at the lower of cost (first in, first out) 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. Inventory retail values arevalue, then converted to a cost basis by applying a specific average cost factor that represents the average 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 for clearance activities are recorded when the utility of the inventory has diminished. Factors considered in the determination of permanent markdowns include current and anticipated demand, customer preferences, and age of the merchandise and fashion trends. When a decision is made to permanently mark down merchandise, the resulting gross profit reduction is recognized in the period the markdown is recorded. Total markdowns on a cost basis for the 13 and 2639 weeks ended July 30,October 29, 2005, and the 13 and 2639 weeks ended July 31,October 30, 2004, were $14.8$17.7 million, $23.6$41.3 million, $22.3$20.8 million and $35.4$56.1 million, respectively, and represented 11.8%13.7%, 10.3%11.5%, 21.1%18.7% and 17.2%17.7% of sales, respectively.

Long-Lived Assets

The Company evaluates the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment of Long-Lived Assets”. Factors that are considered important that could trigger an impairment review include a current-period operating or cash flow loss combined with a history of operating or cash flow losses and a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset or asset group. Other factors include a significant change in the manner of the use of the asset or a significant negative industry or economic trend. This evaluation is performed based on estimated undiscounted future cash flows from operating activities compared with the carrying value of the related assets. If the undiscounted future cash flows are less than the carrying value, an impairment loss is recognized, measured by the difference between the carrying value and the estimated fair value of the assets, with such estimated fair values determined using the best information available, generally the discounted future cash flows of the assets using a rate that approximates the Company’s weighted average cost of capital.

Quarterly, the Company assesses whether events or changes in circumstances have occurred that potentially indicate the carrying value of long-lived assets may not be recoverable. The Company’s evaluationevaluations for the 13 weeks ended October 29, 2005 and July 30, 2005 indicated that operating losses existed at certain retail stores with a projection that the operating losses for these locations will continue. As such, the Company recorded non-cash charges for the 13 and 39 weeks ended October 29, 2005 of $0.3$0.1 million and $0.4 million, respectively, in the condensed consolidated statements of operations to write-down the carrying value of these stores’ long-lived assets to their estimated fair value as of July 30, 2005.value.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 2639 weeks ended July 30,October 29, 2005 and July 31,October 30, 2004 (as restated)

(Unaudited)

NOTE 1 – Basis of Presentation, Significant Accounting Policies and New Accounting Pronouncements (continued)

As of July 31, 2004, based on disappointing sales results during the fiscal 2004 back-to-school period, the then expectation of continued operating losses through the end of fiscal 2004 and the Company’s historical operating performance, the Company concluded that an indication of impairment existed at July 31, 2004, with respect to a large number of its retail stores. Accordingly, the Company conducted an impairment evaluation as of July 31, 2004. Based on the results of this analysis, the Company recorded non-cash charges in its consolidated statementsstatement of operations to write down the carrying value of impaired long-lived assets as of July 31,during the 39 weeks ended October 30, 2004, by $40.4 million.

Revenue Recognition

Sales are recognized upon purchasepurchases by customers at the Company’s retail store locations. For online sales, revenue is recognized at the estimated time goods are received by customers. Shipping and handling fees billed to customers for on-line sales are included in net sales. Customers typically receive goods within 5 to 7 days of being shipped. The Company has recorded reserves to estimate sales returns by customers based on historical sales return results. A customer may return regular or promotionally priced merchandise within 30 days of the original purchase date. Actual return rates have historically been within management’s estimates and the reserves established. As the reserve for merchandise returns is based on estimates, the actual returns could differ from the reserve, which could impact sales. The reserve for merchandise returns is recorded in accrued liabilities on the condensed consolidated balance sheets and was $0.9$0.7 million and $0.5 million at July 30,October 29, 2005, and January 29, 2005, respectively. For the 13 and 2639 weeks ended July 30,October 29, 2005 and the 13 and 2639 weeks ended July 31,October 30, 2004, shipping and handling fee revenues were $0.1$0.2 million, $0.3$0.4 million, $0.1 million and $0.2 million, respectively.

The Company recognizes the sales from gift cards and gift certificates and the issuance of store credits as they are redeemed. The unearned revenue for gift cards, gift certificates and store credits is recorded in accrued liabilities on the condensed consolidated balance sheets and was $6.0$6.1 million and $6.8 million at July 30,October 29, 2005 and January 29, 2005, respectively.

The Company, through its Wet Seal division, has a Frequent Buyer Card program that entitles the customer to receive between a 1010% and 20 percent20% discount on all purchases made during a twelve-month period. The revenue from the annual membership fee of $20.00 is non-refundable. Based upon historical spending patterns for Wet Seal customers, revenue is recognized on a straight-line basis over the twelve-month membership period.

The Company, through its Arden B. division, introduced a customer loyalty program in August of 2004. Under the program, customers accumulate points based on purchase activity. Once a loyalty member achieves a certain point threshold, the member earns awards that may be redeemed at any time for merchandise. Merchandise redemptions are accrued as unearned revenue and recorded as a reduction of sales at the time awards are earned by the member. The program has been in effect for less thanjust over one year, resulting in the Company having limited history for assessing redemption patterns. However, the Company has anticipated partial non-redemption of awards based on the program’s redemption history to date. The unearned revenue for this customer loyalty program is recorded in accrued liabilities on the condensed consolidated balance sheets and was $5.1$5.4 million and $3.5 million at July 30,October 29, 2005 and January 29, 2005, respectively. If actual redemptions ultimately differ from accrued redemption levels, the Company could record adjustments to the unearned revenue accrual, which would affect sales.

Advertising Costs

Costs for advertising related to operations, consisting of magazine ads, in-store signage and promotions are expensed as incurred. Total advertising expenses related primarily to retail operations for the 13 and 2639 weeks ended July 30,October 29, 2005 and the 13 and 2639 weeks ended July 31,October 30, 2004 were $0.4$1.3 million, $1.4$2.7 million, $1.0$3.3 million and $2.7$6.0 million, respectively.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 2639 weeks ended July 30,October 29, 2005 and July 31,October 30, 2004 (as restated)

(Unaudited)

NOTE 1 – Basis of Presentation, Significant Accounting Policies and New Accounting Pronouncements (continued)

Insurance/Self-Insurance

The Company uses a combination of insurance and self-insurance for its workers’ compensation and employee related health care programs, a portion of which is paid by its employees. Under the workers’ compensation insurance program, the Company is liable for a deductible of $250,000 for each individual claim and an aggregate annual liability of $5.0 million. Under the Company’s group health plan, the Company is liable for a deductible of $150,000 for each individual claim and an aggregate monthly liability of $0.5 million. The monthly aggregate liability is subject to the number of participants in the plan each month. For both of the insurance plans, the Company records a liability for the costs associated with reported claims and a projected estimate for unreported claims based on historical experience and industry standards. The Company adjusts these liabilities based on historical claims experience, demographic factors, severity factors and other actuarial assumptions. A significant change in the number or dollar amount of claims could cause the Company to revise its estimate of potential losses, which would affect its reported results.

Deferred Income Taxes

The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”), which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS No. 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the net deferred tax asset will not be realized. As a result of disappointing sales results in the 2004 back-to-school season and the Company’s historical operating performance, the Company concluded as of July 31, 2004, that it was more likely than not that the Company would not realize its net deferred tax assets. As a result of this conclusion, the Company reduced its deferred tax assets by establishing a tax valuation allowance of $38.9 million as of July 31, 2004. In addition, the Company discontinued recording income tax benefits in the condensed consolidated statements of operations at that time, and since has not recorded such income tax benefits. The Company will not record such income tax benefits until it is determined that it is more likely than not that the Company will generate sufficient taxable income to realize the deferred income tax assets. Also,

As of January 29, 2005, the Company is currently evaluating whether an ownership change has occurred underhad a $164.9 million of federal net operating loss carryforward. Section 382 of the Internal Revenue Code §382. If it is determined(“Section 382”) contains provisions that an ownership change has occurred,may limit the ability to utilizeavailability of net operating loss carryforwards mayto be limited.used to offset taxable income in any given year upon the occurrence of certain events, including significant changes in ownership interests. Under Section 382, an ownership change that triggers potential limitations on net operating loss carryforwards occurs when there has been a greater than 50% change in ownership interest by shareholders owning 5% or more of the Company over a period of three years or less. Based on its analysis, the Company has undergone an ownership change, but, assuming the Company generates sufficient taxable income, the applicable annual loss limitations will be high enough to allow for full utilization of the Company’s federal net operating loss carryforward as of January 29, 2005, prior to its expiration between 2023 and 2025. However, if the Company’s future taxable income were to exceed the applicable annual loss limitation in any given fiscal year, the Company would be required to pay federal and state income taxes on such excess amount. The Company has not yet made a final determination of the amounts of the applicable annual loss limitations.

Stock BasedStock-Based Compensation

The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion (“APB”) No. 25 “Accounting for Stock Issued to Employees”. Accordingly, compensation expense has been recognized for restricted stock grants, but no compensation expense has been recognized in the condensed consolidated financial statements for employee stock options or nonqualified stock options since the options granted were at prices that equaled or exceeded the fair market value of the related stock at the grant date.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 39 weeks ended October 29, 2005 and October 30, 2004 (as restated)

(Unaudited)

NOTE 1 – Basis of Presentation, Significant Accounting Policies and New Accounting Pronouncements (continued)

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

The Company’s calculations were made usingCompany uses the Black-Scholes option-pricing model for stock options and other plans with fixed terms with the following weighted average assumptions:

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 26 weeks ended July 30, 2005 and July 31, 2004 (as restated)

(Unaudited)

NOTE 1 – Basis of Presentation, Significant Accounting Policies and New Accounting Pronouncements (continued)terms.

Upon approval by vote of the Company’s stockholders on January 10, 2005, the Company established the 2005 Stock Incentive Plan to attract and retain directors, officers, employees and consultants. The 2005 Stock Incentive Plan was subsequently amended with shareholder approval on July 20, 2005. The Company has reserved 12.5 million shares of Class A common stock for issuance under this incentive plan. As of July 30,October 29, 2005, 10,050,000 shares of restricted Class A common stock had been granted under this incentive plan to Joel N. Waller,certain officers and directors of the Company’s Chief Executive Officer,Company and to Michael Gold, a consultant engaged to assist with the turnaround of the Company’s Wet Seal Division, the Executive Vice President of the Wet Seal Division and the Company’s non-employee directors.Division. In the near term the Company anticipates granting additional restricted shares in connection with the hiring or appointment of individuals, as well as company management. As a result of the granting of restricted shares, the Company has and will continue to incur non-cash compensation charges to its earnings over the vesting periods or when the restrictions lapse. Such charges are $14.4were $2.4 million and $14.8$17.2 million for the 13 and 2639 weeks ended July 30,October 29, 2005, respectively. As a result, the shares issued and to be issued under the 2005 Stock Incentive Plan will have a significant adverse effect on the results of operation and on earnings per share.

As noted above, during the 2639 weeks ended July 30,October 29, 2005, the Company granted restricted stock to twocertain of its key executivesofficers and to Michael Gold (see Note 7, “Consulting Agreement with Michael Gold”). Such stock has variable vesting, subject to certain stock price performance targets. In accordance with APB No. 25, compensation expense has been recognized, and will continue to be recognized, for the portion of the restricted stock granted to the two key executivesofficers for which the stock price performance target has been achieved, and additional compensation expense will be recognized if and when the other stock price performance targets related to such grants are achieved. In addition, as discussed further in Note 7 herein, the Company has recognized consulting expense with respect to the restricted stock granted to Michael Gold prior to achievement of the related stock price performance targets, in accordance with accounting guidance applicable to stock-based compensation granted to non-employees. The Company’s calculations for determining fair value for thesethe stock grants to the Company officers and Michael Gold were made using both the Black-Scholes option pricing model and Monte-Carlo simulation. TheAs required, with respect to the restricted stock granted to the Company officers, the Company used the following weighted average assumptions:fair value of the restricted stock as of the respective grant dates, and assumed amortization of such fair values over the derived service periods, for purposes of disclosing pro forma net loss and net loss per share.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 2639 weeks ended July 30,October 29, 2005 and July 31,October 30, 2004 (as restated)

(Unaudited)

NOTE 1 – Basis of Presentation, Significant Accounting Policies and New Accounting Pronouncements (continued)

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

New Accounting Pronouncements

In October 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. 13-1, “Accounting for Rental Costs Incurred During a Construction Period” (“FSP No. 13-1”), which requires rental costs associated with ground or building operating leases that are incurred during a construction period to be recognized as rental expense. FSP No. 13-1 is effective for periods beginning after December 15, 2005. The Company will be adopting this pronouncement beginning with its fiscal year 2006. The adoption of FSP No. 13-1 is not expected to have a material impact on the Company’s consolidated financial statements.

In June 2005, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 05-6, “Determining the Amortization Period for Leasehold Improvements” (“EITF No. 05-6”), which requires that leasehold improvements acquired in a business combination or purchased significantly after and not contemplated at the inception of a lease be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonably assured at the date of the business combination or purchase. EITF No. 05-6 is effective for periods beginning after June 29, 2005. The Company does not expect the provisions of this consensus todid not have a materialany impact on the Company’s financial position, results of operation or cash flows.

In May 2005, the Financial Accounting Standards Board (“FASB”)FASB issued SFAS No. 154, “Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS No. 154”). SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application as the required method for reporting a change in accounting principle. SFAS No. 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. SFAS No. 154 also addresses the reporting of a correction of an error by restating previously issued financial statements. SFAS No. 154 is effective for accounting changes and error corrections made in fiscal years beginning after December 15, 2005. The Company will be adopting this pronouncement beginning with its fiscal year 2006.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 2639 weeks ended July 30,October 29, 2005 and July 31,October 30, 2004 (as restated)

(Unaudited)

NOTE 1 – Basis of Presentation, Significant Accounting Policies and New Accounting Pronouncements (continued)

In March 2005, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 107, which provides guidance on the implementation of SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”) (see discussion below). In particular, SAB No. 107 provides key guidance related to valuation methods (including assumptions such as expected volatility and expected term), the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123(R), the modification of employee share options prior to the adoption of SFAS No. 123(R), the classification of compensation expense, capitalization of compensation cost related to share-based payment arrangements, first-time adoption of SFAS No. 123(R) in an interim period, and disclosures in Management’s Discussion and Analysis subsequent to the adoption of SFAS No. 123(R). SAB No. 107 became effective on March 29, 2005. The Company will apply the principles of SAB No. 107 in conjunction with its adoption of SFAS No. 123(R).

In December 2004, the FASB issued SFAS No. 123(R). SFAS No. 123(R) requires an entity to recognize compensation expense in an amount equal to the fair value of share-based payments granted to employees. For any unvested portion of previously issued and outstanding awards, compensation expense is required to be recorded based on the previously disclosed SFAS No. 123 methodology and amounts. Prior periods presented do not require restatement. This statement is effective for the first fiscal year beginning after June 15, 2005. The Company will be adopting this pronouncement during the first quarter of its fiscal year 2006, and is currently evaluating its provisions andat which time the impact on its consolidated financial statements.Company will begin to record stock compensation expense over the remaining vesting period for prior stock option grants to employees that are not fully vested as of the end of fiscal 2005. The adoption of SFAS No. 123(R) willcould also have a significant adverse effect on the Company’s results of operations and earnings per share to the extent the Company continues to make share-based payments. The Company is currently evaluating the impact of SFAS No. 123(R) will have on its consolidated financial statements.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets - an amendment of APB Opinion No. 29” (“SFAS No. 153”). This statement addresses the measurement of exchanges of nonmonetary assets, and eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets as defined in paragraph 21(b) of APB Opinion No. 29, and replaces it with an exception for exchanges that do not have commercial substance. This statement specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 iswas effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The adoption of SFAS No. 153 isdid not expected to have a material impact on the Company’s consolidated financial statements.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs—Costs - an Amendment of ARB No. 43, Chapter 4” (“SFAS No. 151”). SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material and requires that these items be recognized as current period charges. SFAS No. 151 is effective for the first fiscal year beginning after June 15, 2005. The adoption of SFAS No. 151 is not expected to have a material impact on the Company’s consolidated financial statements.

NOTE 2: Restatement of Financial Statements

Accounting for Leases

On February 7, 2005, the Office of the Chief Accountant of the Securities and Exchange Commission (“SEC”) issued a letter to the American Institute of Certified Public Accountants expressing its views regarding certain operating lease accounting issues and their application under GAAP. In light of this letter, the Company re-evaluated its lease accounting practices and has determined that certain of its lease accounting methods were not in accordance with GAAP, as described below.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 39 weeks ended October 29, 2005 and October 30, 2004 (as restated)

(Unaudited)

NOTE 2: Restatement of Financial Statements (continued)

Tenant Improvement Allowances

The Company had historically accounted for tenant improvement allowances as reductions to the related store leasehold improvement in the consolidated balance sheets and as a reduction in capital expenditures in investing activities in the consolidated statements of cash flows. In addition, although the Company typically amortized tenant improvement allowances over the life of the lease term, this amortization was reflected as a reduction to depreciation expense instead of a reduction to rent expense. Both depreciation expense and rent expense are included in cost of sales. The Company has determined that the appropriate interpretation of FASB Technical Bulletin 88-1, “Issues Relating to Accounting for Leases,” requires these allowances to be recorded as deferred rent liabilities in the consolidated balance sheets and as a component of operating activities in the consolidated statements of cash flows.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 26 weeks ended July 30, 2005 and July 31, 2004 (as restated)

(Unaudited)

NOTE 2: Restatement of Financial Statements (continued)

Rent Holiday Periods

Under the requirements of FASB Technical Bulletin 85-3, “Accounting for Operating Leases with Scheduled Rent Increases,” rent expense should be amortized on a straight-line basis over the term of the lease. Historically, the Company recognized rent holiday periods on a straight-line basis over the lease term commencing with the lease commencement date, which was typically the store opening date. The Company re-evaluated its accounting for rent holidays and determined that the lease term should commence on the date the Company takes possession of the leased space for construction purposes, which is generally two months prior to a store opening date. This correction in accounting affects the recognition of rent expense and the deferred rent liabilities balance.

Disclosure of cash flows pertainingCash Flows Pertaining to Discontinued Operations

The Company determined that net cash flows from discontinued operations in the condensed consolidated statements of cash flows should be presented in the appropriate cash flow categories rather than being shown as a separate component of net cash flows, as was previously reported. Accordingly, the Company has reclassified net cash used in discontinued operations of $3.1$4.7 million for the 2639 weeks ended July 31,October 30, 2004 to the appropriate cash flow categories for such period.

As a result of the above, the Company has restated the accompanying condensed consolidated financial statements for the 13 and 2639 weeks ended July 31,October 30, 2004 from amounts previously reported as follows (in thousands, except per share data):

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 2639 weeks ended July 30,October 29, 2005 and July 31,October 30, 2004 (as restated)

(Unaudited)

NOTE 2: Restatement of Financial Statements (continued)

NOTE 3: Store Closures

On December 28, 2004, the Company announced that it would close approximately 150 of its underperforming Wet Seal stores as part of a plan to return the Company to profitability. To assist with the closing of these stores, the Company entered into an Agency Agreement with Hilco Merchant Resources, LLC (“Hilco”) pursuant to which Hilco would liquidate closing store inventories by means of promotional, store closing or similar sales. Under the terms of this arrangement with Hilco, the Company was to receive cash proceeds from the liquidating stores of not less than 22.9% of the initial retail value of the merchandise inventory in the closing stores. Additionally, the Company also entered into a consulting and advisory services agreement with Hilco Real Estate, LLC (“Hilco Advisors”) for the purpose of selling, terminating or otherwise mitigating lease obligations related to the closing stores.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 26 weeks ended July 30, 2005 and July 31, 2004 (as restated)

(Unaudited)

NOTE 3: Store Closures (continued)

The Company initially completed its inventory liquidation sales and closing of 153 Wet Seal stores in March 2005. Subsequent to March 2005, the Company closed three additional Wet Seal stores and foureight stores were re-opened duringas of the 13-week period ended July 30, 2005, since it was determined their cost to operate would be less than the cost to terminate their respective leases. The Company anticipates re-opening three more Wet Seal stores during its third quarter of fiscalOctober 29, 2005. During the 13-weeks ended April 30, 2005, the Company recognized $5.2 million in store closure costs associated with the closure of 50 Wet Seal stores during the quarter. The store closure costs consisted of $4.9 million for estimated lease termination costs and related expenses, $0.6 million for liquidation fees and expenses and a $0.3 million benefit related to the write-off of deferred rent. As a result of expected favorable dispositions and related lease termination costs, the Company reduced its store closure reserve by $0.5 million and $0.1 million during the 13 weeks ended July 30, 2005.2005 and October 29, 2005, respectively.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 39 weeks ended October 29, 2005 and October 30, 2004 (as restated)

(Unaudited)

NOTE 3: Store Closures (continued)

The following summarizes the store closure reserve activity for the 13 and 2639 weeks ended July 30,October 29, 2005:

NOTE 4: Discontinued Operations

On January 6, 2004, the Board of Directors authorized the Company to proceed with its strategic decision to close all Zutopia stores by the end of the first quarter or early in the second quarter of fiscal year 2004 due to their poor financial results and perceived limited ability to become profitable in the future. As of the end of the second quarter of fiscal year 2004, all 31 Zutopia stores were closed.

The operating results of the discontinued Zutopia division included in the accompanying condensed consolidated statements of operations were as follows:

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 26 weeks ended July 30, 2005 and July 31, 2004 (as restated)

(Unaudited)

NOTE 5: Bridge Loan Payable, Long-Term Debt and Secured Convertible Notes

The Company maintains a $50.0 million senior revolving credit facility, as amended, (the “Facility”) with a $50.0 million sub-limit for letters of credit with Fleet Retail Group, Inc. (the “Lender”), which matures on May 26, 2007. Under the terms of the Facility, the Company and the subsidiary borrowers are subject to borrowing base limitations on the amount that can be borrowed and certain customary covenants, including covenants restricting their ability to incur additional indebtedness, make investments and acquisitions, grant liens, pay dividends, close stores and dispose of their assets, subject to certain exceptions, without the Lender’s consent. The ability of the Company and its subsidiary borrowers to borrow and request the issuance of letters of credit is also subject to the requirement that the Company and its subsidiary borrowers maintain an excess of the borrowing base over the outstanding credit extensions of not less than the lesser of 15% of such borrowing base or $5.0 million. The interest rate on the revolving line-of-credit under the Facility is the prime rate or, if elected, LIBOR plus a margin ranging from 1.25% to 2.00%. The applicable LIBOR margin is based on the level of “Excess Availability” as defined under the Facility at the time of election.

The Facility accommodates an $8.0 million junior secured term loan. The term loan under the Facility is junior in payment to the $50.0 million senior revolving line of credit. The term loan bears interest at prime plus 7.0% and matures on May 27, 2007. Monthly payments of interest are payable through the maturity date, and the principal payment of $8.0 million is due on the maturity date. The average interest rate on the term loan for the 13 weeks ended July 30,October 29, 2005 was 13.1%13.6%. Effective March 22, 2006, the Company can prepay a portion or all of the junior secured term loan subject to a prepayment penalty in the amount of 1.0% of the principal balance that is prepaid.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 39 weeks ended October 29, 2005 and October 30, 2004 (as restated)

(Unaudited)

NOTE 5: Bridge Loan Payable, Long-Term Debt and Secured Convertible Notes (continued)

Borrowings under the Facility are secured by all presently owned and hereafter acquired assets of the Company and its wholly-owned subsidiaries, The Wet Seal Retail, Inc. and Wet Seal Catalog, Inc., each of which may be a borrower under the Facility. The obligations of the Company and the subsidiary borrowers under the Facility are guaranteed by another wholly owned subsidiary of the Company, Wet Seal GC, Inc.

At July 30,October 29, 2005, the amount outstanding under the Facility consisted of the $8.0 million junior secured term loan as well as $18.8$10.9 million in open documentary letters of credit related to merchandise purchases and $14.0$12.5 million in outstanding standby letters of credit, which included $10.6 million for inventory purchases. At July 30,October 29, 2005, the Company had $17.2$26.6 million available for cash advances and/or the issuance of additional letters of credit.

On November 9, 2004, the Company entered into a Securities Purchase Agreement (the “Financing”) with certain investors (the “Investors”) to issue and sell its new Secured Convertible Notes (the “Notes”), and certain other securities. Also on November 9, 2004, the Company entered into an agreement with the Investors and its lenders under the Facility whereby a secured term loan of $10.0 million was made to the Company as a bridge financing facility (the “Bridge Financing”). On December 13, 2004, the Company amended the Financing agreements to increase the aggregate amount of Notes to be issued from $40.0 million to $56.0 million and to relieve the Company of its obligation to issue certain securities originally issuable under the Securities Purchase Agreement. As consideration for entering into the amendments, the participating Investors were granted an additional 1.3 million Series A Warrant Shares.

On January 14, 2005, the Company issued $56.0 million in aggregate principal amount of its Notes due January 14, 2012 to the Investors and certain other parties. The Notes have an initial conversion price of $1.50 per share of the Company’s Class A common stock (subject to anti-dilution adjustments) and bear interest at an annual rate of 3.76% (interest may be paid in cash or capitalized at the Company’s discretion) and are immediately exercisable into Class A common stock. The initial conversion price assigned to the Notes was lower than the fair market value of the stock on the commitment date, creating a beneficial conversion feature. On January 14, 2005, the Company also issued the Series B Warrants, Series C Warrants and Series D Warrants (collectively with the Series A Warrants, the “Warrants”) to acquire initially up to 3.4 million, 4.5 million and 4.7 million shares of the Company’s Class A common stock, respectively. The warrants have strike prices that range from $1.75 to $2.50. Each Investor is prohibited from converting any of the secured convertible notes or exercising any warrants if as a result it would own beneficially at any time more than 9.99% of the outstanding Class A Common Stock of the Company.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 26 weeks ended July 30, 2005 and July 31, 2004 (as restated)

(Unaudited)

NOTE 5: Bridge Loan Payable, Long-Term Debt and Secured Convertible Notes (continued)

In accordance with the accounting guidelines established in Emerging Issues Task Force (EITF) Issue No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios”Ratios,” and EITF Issue No. 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments,” the Company determined the relative fair value of the Warrants issued and the beneficial conversion feature of the Notes. Fair value was first determined for the Warrants using the Black-Scholes option pricing model. The Warrants were allocated a value of $14.4 million and reduced the face value of the Notes and increased paid-in capital using a method that approximates the relative fair value method. Based on the reduced value of the Notes and their conversionconvertibility into 37,333,333 shares of Class A common stock, the effective conversion price was determined and compared to the market price of Class A Common Stock on the commitment date (January 11, 2005), the difference representing the beneficial conversion feature on a per share basis. The face value of the Notes was further reduced by $30.1 million, the value allocated to the beneficial conversion feature, and paid-in capital was increased.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 39 weeks ended October 29, 2005 and October 30, 2004 (as restated)

(Unaudited)

NOTE 5: Bridge Loan Payable, Long-Term Debt and Secured Convertible Notes (continued)

Additionally, the Notes contain an embedded derivative, which upon the occurrence of a change of control, as defined, allows each note holder the option to require the Company to redeem all or a portion of the Notes at a price equal to the greater of (i) the product of (x) the conversion amount being redeemed and (y) the quotient determined by dividing (A) the closing sale price of the Class A common stock on the business day on which the first public announcement of such proposed change of control is made by (B) the conversion price and (ii) 125% of the conversion amount being redeemed. The Company accounts for its derivative at fair value on the condensed consolidated balance sheet within other long-term liabilities in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”). The Company determines the fair value of the derivative instrument each periodfiscal quarter using both the Black-Scholes model and Monte-Carlo simulation model. Such models are complex and require significant judgments and estimates in the estimation of fair values in the absence of quoted market prices. The face value of the Notes was reduced by $0.7$0.5 million to record this liability. Changes in the fair market value of the derivative liability are recognized in earnings. During the 13 and 2639 weeks ending July 30,October 29, 2005, there was a $150,000$100,000 increase and a $50,000 decrease, respectively, in the fair value of the embedded derivative, which the Company recognized as an increase and a decrease, respectively, to the carrying value of the derivative liability and a charge and a credit, respectively, to interest expense in the condensed consolidated statements of operations for such periods.

The resulting discount to the Notes is amortized under the interest method over the 7-year life of the Notes and charged to interest expense. The Notes have a yield to maturity of 27.1%. For the 13 and 2639 weeks ended July 30,October 29, 2005, the Company recognized $0.3 million and $0.3$0.7 million, respectively, in interest expense related to the discount amortization. As of July 30,October 29, 2005, the net carrying value of the Notes was $12.7$11.9 million, including accrued interest.

During the 13 weeks ended October 29, 2005, investors converted $6.7 million of the Notes into 4,487,967 shares of Class A Common Stock. The Company recorded net non-cash interest charges of $5.7 million during the period to write-off a ratable portion of unamortized debt discount, deferred financing costs and accrued interest associated with the Notes.

On May 3, 2005, the Company repaid the amounts owed under the Bridge Financing, including capitalized interest (see Note 6).

The Facility ranks senior in right of payment to the Notes. At July 30,October 29, 2005, the Company was in compliance with all covenant requirements related to the Facility and the Notes.

NOTE 6: Convertible Preferred Stock and Common Stock Warrants

On April 29, 2005, the Company signed a Securities Purchase Agreement and a related Registration Rights Agreement with several investors that participated in the Company’s January 2005 financing. Pursuant to the Securities Purchase Agreement, on May 3, 2005, the Company issued to the investors 24,600 shares of Series C Convertible Preferred Stock (the “Preferred Stock”), for an aggregate purchase price of $24.6 million. The Company received approximately $19.1 million in net proceeds (including the exercise of the Series A and Series B Warrants discussed below and after the retirement of the Bridge Financing) before transaction costs. The Preferred Stock is convertible into 8.2 million shares of Class A common stock, reflecting an initial $3.00 per share conversion price. The effective conversion price assigned to the Preferred Stock was lower than the fair value of the common stock on the commitment date, creating a beneficial conversion feature. The Preferred Stock is not entitled to any special dividend payments or mandatory redemption or voting rights. The Preferred Stock has customary weighted-average anti-dilution protection for future stock issuances below the applicable per share conversion price.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 26 weeks ended July 30, 2005 and July 31, 2004 (as restated)

(Unaudited)

NOTE 6: Convertible Preferred Stock (continued)

Pursuant to the Securities Purchase Agreement, the investors agreed to exercise all of their outstanding Series A Warrants and a pro rata portion of their outstanding Series B Warrants that were issued in the January 2005 Private Placement. The Company issued approximately 3.4 million shares of Class A common stockCommon Stock related to the exercise of the Warrants at an aggregate exercise price of approximately $6.4 million.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 39 weeks ended October 29, 2005 and October 30, 2004 (as restated)

(Unaudited)

NOTE 6: Convertible Preferred Stock and Common Stock Warrants (continued)

The Company also issued new Series E Warrants to purchase up to 7.5 million shares of Class A Common Stock. The Series E Warrants are exercisable beginning November 3, 2005, and expire on November 3, 2010, and have an initial exercise price of $3.68, reflecting the closing bid price of the Class A Common Stock on the business day immediately before the signing of the Securities Purchase Agreement. The Series E Warrants have anti-dilution protection for stock splits, stock dividends, distributions and similar transactions.

The Company used approximately $11.9 million of the proceeds from the financing to retire the outstanding Bridge Financing and approximately $1.5 million to pay transaction costs. The remainder of the proceeds, approximately $17.6 million, will beare being used for general working capital purposes.

In accordance with the accounting guidelines established in EITF Issue No. 98-5, EITF Issue No. 00-27 and other related accounting guidance, the Company determined the relative fair values of the Series E Warrants issued, the Preferred Stock and the Registration Rights Agreement to be approximately $8.5 million, $16.0 million and $0.1 million, respectively. The relative fair value allocated to the Series E Warrants reduced the face value of the Preferred Stock and increased paid-in capital. The relative fair value allocated to the Registration Rights Agreement also reduced the face value of the Preferred Stock and increased other long-term liabilities (see below). Based on the reduced value of the Preferred stock and its convertibility into 8.2 million shares of Class A common stock, the effective conversion price was determined and compared to the market price of Class A Common Stock on the commitment date (April 29, 2005), with the difference representing the beneficial conversion feature on a per share basis. The value allocated to the beneficial conversion feature reduced the face value of the Preferred Stock by approximately $14.7 million and increased paid-in capital.

The Preferred Stock is generally a perpetual security unless and until it is converted into Class A Common Stock. However, notwithstanding the fact that the Company has a Shareholder Rights Plan that provides anti-takeover protections that would go into effect if another entity or group acquires 12% or more of the outstanding voting stock of the Company, certain “change of control” events, as defined in the Certificate of Designations, Preferences and Rights of the Preferred Stock (the “Certificate”), may still be out of the Company’s control, which could require cash redemption of the Preferred Stock. Upon such a change of control or certain other liquidation events, as defined in the Certificate, the holders of the Preferred Stock would be entitled to receive cash equal to the stated value of the Preferred Stock ($1,000 per share) before any amount is paid to the Company’s common stockholders. As such, in accordance with EITF Topic No. D-98, “Classification and Measurement of Redeemable Securities,” the Preferred Stock is presented outside of stockholders’ equity in the condensed consolidated balance sheets. If such a change of control event were to occur, the Preferred Stock would be recognized as a liability in the condensed consolidated balance sheets until redeemed.

Because the Preferred Stock is immediately convertible and has no stated redemption date, in accordance with EITF Issue No. 98-5 and EITF Issue No. 00-27, the $23.3 million discount on the Preferred Stock was recognized as a non-cash deemed dividend in its entirety on May 3, 2005, the Preferred Stock issuance date. The non-cash deemed dividend is recognized in the condensed consolidated statements of operations as a reduction to arrive at net loss attributable to common stockholders.

In accordance with the provisions of EITF Issue No. 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128,” the Company will include the shares issuable upon conversion of the Preferred Stock in its calculations of basic and diluted earnings per share to the extent such inclusion would be dilutive. Because the effect would have been anti-dilutive for the 13 and 2639 weeks ended July 30,October 29, 2005, the Company did not include such shares in its calculations of basic and diluted earnings per share for such periods.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 2639 weeks ended July 30,October 29, 2005 and July 31,October 30, 2004 (as restated)

(Unaudited)

NOTE 6: Convertible Preferred Stock and Common Stock Warrants (continued)

The Company determined the Registration Rights Agreement associated with the Preferred Stock to be a derivative financial instrument subject to the provisions of SFAS No. 133. In accordance with SFAS No. 133, the Company accounts for this derivative at fair value on the condensed consolidated balance sheets within other long-term liabilities. Changes in the fair market value of this derivative liability are recognized in earnings. On July 29, 2005, the SEC declared effective an S-3 registration statement filed by the Company to register Class A common stock underlying the Preferred Stock and Series E Warrants, which reduced the derivative value of the Registration Rights Agreement to zero. As a result, during the 13 and 2639 weeks ending July 30,October 29, 2005, the Company recognized a $0.1 million decreaseincrease in the fair value of this derivative as a decreaseincrease to the carrying value of the derivative liability and a credit to interest expense in the condensed consolidated statements of operations for such periods.period.

During the 13 weeks ended October 29, 2005, investors in the Preferred Stock converted $14.1 million of such preferred stock into 4,699,000 shares of Class A Common Stock, resulting in $10.5 million of Preferred Stock remaining outstanding as of October 29, 2005. Investors also exercised portions of outstanding Series B, C and D Warrants during the 13 weeks ended October 29, 2005, resulting in issuance of 379,894 shares of Class A Common Stock in exchange for $0.9 million of proceeds to the Company.

On October 18, 2005, the Company and certain of its securityholders entered into an amendment to each of the Company’s Amended and Restated Securities Purchase Agreement, dated as of December 13, 2004, and the Company’s Securities Purchase Agreement, dated as of April 29, 2005. Pursuant to the Amendments, the Company has agreed to permit Henry Winterstern, the Chairman of the Board, to sell up to 250,000 shares of the Company’s restricted Class A common stock, which he received for his efforts in negotiating and completing the Company’s private placement in January 2005. In November 2005, the Company filed, and the SEC declared effective, a registration statement on Form S-3 to register the sale of the shares by Mr. Winterstern.

NOTE 7: Consulting Agreement with Michael Gold

Since late 2004, Michael Gold, a well-regarded retailer, has been assisting the Company with its merchandising initiatives for its Wet Seal business. On July 7, 2005, the Company entered into a consulting agreement and an associated stock award agreement with Mr. Gold to compensate him for his part in the sales turnaround of the Company and to provide incentives for his future assistance in achieving the Company’s return to profitability. Mr. Gold’s consulting agreement extends through January 31, 2007.

Under the terms of the consulting agreement, the Company paid Mr. Gold $2.1 million upon agreement execution and will pay Mr. Gold $100,000 per month from July 2005 through January 2007. The Company recorded $2.1$0.3 million and $2.2$2.5 million of consulting expense within general and administrative expenses in its condensed consolidated statements of operations for the 13 and 2639 week periods ended July 30,October 29, 2005, respectively, to recognize Mr. Gold’s cash compensation earned to date.

Under the terms of the stock award agreement, the Company awarded Mr. Gold 2.0 million shares of non-forfeitable restricted stock to vest on January 28, 2006, and two tranches of performance shares (the “Performance Shares”) of 1.75 million shares each. Tranche one of the performance shares will vest as follows: 350,000 shares will vest if, at any time after January 1, 2006 and before January 1, 2008, the trailing 20-day weighted average closing price of the Company’s Class A common stock,Common Stock, or the “20-day Average Price,” equals or exceeds $3.50 per share; an additional 350,000 shares will vest (until tranche one is 100% vested) each time the 20-day Average Price during the vesting period equals or exceeds $4.00, $4.50, $5.00 and $5.50 per share, respectively. Tranche two of the performance shares will vest as follows: 350,000 shares will vest if, at any time after January 1, 2007 and before January 1, 2008, the 20-day Average Price equals or exceeds $6.00 per share; an additional 350,000 shares will vest (until tranche two is 100% vested) each time the 20-day Average Price during the vesting period equals or exceeds $6.50, $7.00, $7.50 and $8.00 per share, respectively. In addition, the tranche two performance shares to be otherwise earned in calendar year 2007 can vest earlier if sales of the Company’s Wet Seal division average $350 per square foot for any trailing 12-month period and an agreed merchandise margin is maintained.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 39 weeks ended October 29, 2005 and October 30, 2004 (as restated)

(Unaudited)

NOTE 7: Consulting Agreement with Michael Gold (continued)

In accordance with accounting standards established within EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods and Services,” and EITF Issue No. 00-18, “Accounting Recognition for Certain Transactions involving Equity Instruments Granted to Other Than Employees,” and SFAS No. 123, the Company recorded $13.3 million of non-cash consulting expense within general and administrative expenses during the 1339 weeks ended July 30,October 29, 2005, for the value of the 2.0 million shares of non-forfeitable restricted stock as of the grant date.

Also in accordance with EITF Issue No. 96-18, EITF Issue No. 00-18 and SFAS No. 123, the Company will recognize consulting expenses for the fair value of the Performance Shares over the periods from the stock award agreement date to each tranche’s 350,000 share blocks’ respective vesting dates. The Company recorded $0.7$2.0 million and $2.7 million of non-cash consulting expense within general and administrative expenses during the 13 and 39 weeks ended July 30,October 29, 2005, respectively, based on the then fair value of the Performance Shares as of October 29, 2005 and the portion of the consulting agreement period of July 2005 through January 2007 that had elapsed through July 30,October 29, 2005.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 26 weeks ended July 30, 2005 and July 31, 2004 (as restated)

(Unaudited)

NOTE 7: Consulting Agreement with Michael Gold (continued)

For reporting periods leading up to the vesting dates of the respective blocks of 350,000 shares, the Company will record consulting expenses based upon the then fair value of the Performance Shares and the time elapsed during such reporting period relative to the term of Mr. Gold’s consulting agreement. However, upon vesting of each block of 350,000 Performance Shares, based on the above vesting criteria, the Company will record any then unrecorded consulting expense associated with such share block based upon the Company’s common stock price on the day such vesting occurs. As such, the Company’s cumulative consulting expense for each such block of vested shares recognized through the vesting date will be an amount equal to (i) the Company’s common stock price on the vesting date multiplied by (ii) 350,000. Accordingly, the timing and amount of consulting expenses associated with the Performance Shares will fluctuate significantly depending upon changes in the Company’s common stock price and the related timing of achievement of the common stock price vesting thresholds.

NOTE 8: Net Income Per Share

For purposes of calculating basic and diluted earnings per share, the calculation of weighted average shares outstanding for the 13 and 2639 weeks ended July 30,October 29, 2005 exclude the impact of the 10,050,000 shares of restricted Class A Common Stock issued and outstanding under the Company’s 2005 Stock Incentive Plan since such shares have not vested as of July 30,October 29, 2005, and, in some cases, will vest only upon achievement of certain performance conditions.

Potentially dilutive securities of 51,739,544, 47,121,576, 7,99144,257,817, 46,186,654, none, and 109,3492,718 for the 13 and 2639 weeks ended July 30,October 29, 2005 and the 13 and 2639 weeks ended July 31,October 30, 2004, respectively, were not included in the calculation of diluted earnings per share because of their anti-dilutive effect.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 39 weeks ended October 29, 2005 and October 30, 2004 (as restated)

(Unaudited)

NOTE 9: Commitments and Contingencies - Litigation

Between August 26, 2004 and October 12, 2004, six securities class action lawsuits were filed in the United States District Court for the Central District of California (the “Court”), on behalf of persons who purchased the Company’s common stock between January 7, 2003 and August 19, 2004. The Company and certain of its present and former directors and executives were named as defendants. The complaints allege violations of Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5 of the Exchange Act, on the grounds that, among other things, the Company failed to disclose and misrepresented material adverse facts that were known to the defendants or disregarded by them. On November 17, 2004, the Court consolidated the actions and appointed lead plaintiffs and counsel. On January 29, 2005, the lead plaintiffs filed their consolidated class action complaint with the Court, which consolidated all of the previously reported class actions. The consolidated complaint alleges that the defendants, including the Company, violated the federal securities laws by making material misstatements of fact or failing to disclose material facts during the class period, from March 2003 to August 2004, concerning its prospects to stem ongoing losses in its Wet Seal division and return that business to profitability. The consolidated complaint also alleges that certain former directors and La Senza Corporation, a Canadian company controlled by them, unlawfully utilized material non-public information in connection with the sale of the Company’s common stock by La Senza. The consolidated complaint seeks class certification, compensatory damages, interest, costs, attorney’s fees and injunctive relief. The Company is vigorously defending this litigation and filed a motion to dismiss the consolidated complaint in April 2005. On September 15, 2005, the consolidated class action was dismissed against all defendants in the lawsuit. However, the plaintiffs were granted leave to file an amended complaint, which they did file on November 23, 2005. There can be no assurance that this litigation will be resolved in a favorable manner. Additionally, the Company is unable to predict the likely outcome in this matter and whether such outcome may have a material adverse effect on the Company’s results of operations or financial condition. Accordingly, no provision for a loss contingency has been accrued at July 30,October 29, 2005.

On February 8, 2005, the Company announced that the Pacific Regional Office of the Securities and Exchange Commission (“SEC”)SEC had commenced an informal, non-public inquiry regarding the Company. The Company indicated that the SEC’s inquiry generally related to the events and announcements regarding the Company’s 2004 second quarter earnings and the sale of Company stock by La Senza Corporation and its affiliates during 2004. The SEC has advised the Company that on April 19, 2005, it issued a formal order of investigation in connection with its review of matters relating to the Company. Consistent with the previous announcements, the Company intends to cooperate fully with the SEC’s inquiry. It is too soon to determine, and the Company is unable to predict, the likely outcome in this matter and whether such outcome will have a material adverse effect on the Company’s results of operations or financial condition. Accordingly, no provision for a loss contingency has been accrued at July 30,as of October 29, 2005.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 26 weeks ended July 30, 2005 and July 31, 2004 (as restated)

(Unaudited)

NOTE 9: Commitments and Contingencies – Litigation (continued)

In May 2004, the Company was notified by a consumer group, alleging that five products consisting of certain rings and necklaces contained an amount of lead that exceeded the maximum .1 parts per million of lead under Proposition 65 of the California Health and Safety Code; however, no money damages were requested. Each such contact constitutes a separate violation. The maximum civil penalty for each such violation is $2,500. The vendor of the products confirmed that the jewelry in question contained some lead. The vendor has confirmed, however, that it will accept the Company’s tender of liability. The Company has no outstanding invoices with the vendor. The Company has placed all future jewelry orders, effective October 2004, as lead-free orders, which may lead to a 10% to 30% increase in cost. On June 22, 2004, the California Attorney General filed a complaint on behalf of the Center for Environmental Health. On June 24, 2004, the Company was added to that complaint as a named defendant. The case is currently being mediated for resolution on industry standards. Additionally, the Company is unable to predict the likely outcome in this matter and whether such outcome may have a material adverse effect on the Company’s results of operations or financial condition. Accordingly, no provision forHowever, the Company believes it will incur at least $25,000 to settle this matter. Such amount has been accrued as a loss contingency has been accrued at July 30,October 29, 2005.

From time to time, the Company is involved in other litigation matters relating to claims arising out of its operations in the normal course of business. Management believes that, in the event of a settlement or an adverse judgment of any of the pending litigation, the Company is adequately covered by insurance. As of July 30,October 29, 2005, the Company was not engaged in any such other legal proceedings that are expected, individually or in the aggregate, to have a material adverse effect on its results of operations or financial condition.

THE WET SEAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the 39 weeks ended October 29, 2005 and October 30, 2004 (as restated)

(Unaudited)

NOTE 10: Subsequent Event

On December 5, 2005, the Company’s Board of Directors approved the accelerated vesting of certain unvested and significantly “out-of-the-money” stock options previously awarded to employees and officers with exercise prices equal to or greater than $19.00. The Company will be required to recognize the expense associated with its outstanding unvested stock options upon adoption of SFAS No. 123(R) in the first quarter of fiscal 2006. As a result of this vesting acceleration, the Company expects to reduce the pre-tax expense it otherwise would be required to record in connection with such stock options by approximately $0.5 million in fiscal 2006 and $0.1 million in fiscal 2007.

In making the decision to accelerate these stock options, the Board of Directors considered the interest of the Company’s stockholders in not having earnings materially affected by stock compensation expense incurred for options with exercise prices significantly above the Company’s current common stock price. Also, because these stock options have exercise prices significantly in excess of the Company’s current common stock price, the Board of Directors believed such stock options are no longer achieving their original objectives of incentive compensation and employee retention.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction

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

Restatement of Prior Financial Information

Throughout this report, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” all referenced amounts for affected prior periods and prior period comparisons reflect the balances and amounts on a restated basis as discussed in Note 2 of the Notes to Condensed Consolidated Financial Statements.

Executive Overview

We are a national specialty retailer operating stores selling fashionable and contemporary apparel and accessory items designed for female customers. We are a Delaware corporation that operates two nationwide, primarily mall-based, chains of retail stores under the names “Wet Seal” and “Arden B.”. At July 30,October 29, 2005, we had 396402 retail stores in 46 states, Puerto Rico and Washington D.C. Of the 396402 stores, there were 305309 locations within the Wet Seal chain and 91 were93 Arden B. locations. As a part of our financial turn-around strategy to improve our company’s operating results, we announced on December 28, 2004 our plans to close approximately 150 Wet Seal stores. We initially completed the closure of 153 Wet Seal stores by March 5, 2005. Subsequently, we decided to close three additional Wet Seal stores and, in addition, re-open seveneight previously closed Wet Seal stores (of which four had re-opened as of July 30, 2005).October 29, 2005.

We operated a chain, Zutopia, which was not successful in generating profits. We made the determination to discontinue this chain of 31 stores at the end of fiscal year 2003. The 26-week39-week period ending JulyOctober 30, 2004 included a $4.2 million loss from discontinued operations, net of income taxes, for the Zutopia chain during the period.chain.

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

Comparable store sales –Stores are deemed comparable stores on the first day of the month following the thirteen full month of operation after opening or expansion/relocation. We consider comparable store sales to be an important indicator of current performance. Comparable store sales results are important in achieving operating leverage on certain expenses such as store payroll, store occupancy, depreciation, 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.

Transaction counts – We consider the trend in the 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 without a commensurate decrease in the average dollar sale per transaction, we will generate increases in our comparable store sales.

Merchandise margins – We analyze the components of merchandise margins, specifically initial markup and markdowns as a percentage of net sales. Any inability to obtain acceptable levels of initial markups or any significant increase in our use of markdowns could have an adverse impact on our gross margin results and results of operations.

Operating income – We view operating income as a key indicator of our success. The key drivers of operating income are comparable store sales, merchandise margins, and our ability to control operating costs. For a discussion of the changes in the components comprising operating income, see “Results of Operations” in this section.

Cash flow and liquidity (working capital) – We evaluate cash flow from operations, liquidity and working capital to determine our short-term operational financing needs. We expect our cash on hand, cash flows from operations, and proceeds from our issuance of convertible preferred stock on May 3, 2005, will be sufficient to finance operations without borrowing under our Facility during fiscal 2005.

Store Formats

Wet Seal.Founded in 1962, Wet Seal targets the fashion-conscious junior customer by providing a balance of moderately priced fashionable brand name and company-developed apparel and accessories. While Wet Seal targets fashion-forward teens, we believe that Wet Seal’s core customer is between the ages of 17 and 19 years old. Wet Seal stores average approximately 4,000 square feet in size. As of July 30,October 29, 2005, we operated 305309 Wet Seal stores.

Arden B.In the fourth quarter of fiscal 1998, we opened our first Arden B. store. Arden B. stores cater to the fashionable, sophisticated contemporary woman. With a unique mix of high quality European and custom in-house designs, Arden B. delivers a hip,feminine, contemporary, sophisticated wardrobe of branded fashion separates and accessories for all facetsevery facet of the customer’s lifestyle: from everyday wear-to-work,to special occasion, and casual,by offering unique, high quality, European inspired, in-house designs, predominantly under the “Arden B.” brand name. Arden B. stores average approximately 3,200 square feet in size. As of July 30,October 29, 2005, we operated 9193 Arden B. locations.stores.