The following graph compares the cumulative total return on the Company's common stock with the cumulative total return of the S & P Smallcap 600 Index and the S & P Department Stores Index for the five-year period commencing January 31, 2003. The stock price performance shown on the graph below is not necessarily indicative of future price performance.

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Item 6. SELECTED FINANCIAL DATA

The Company reports on a 52/53 week fiscal year ending on the Saturday nearest to January 31. The fiscal years ended February 2, 2008, February 3, 2007, January 28, 2006, January 29, 2005 and January 31, 2004 are referred to herein as fiscal 2007, 2006, 2005, 2004 and 2003, respectively. All fiscal years noted include 52 weeks with the exception of fiscal 2006 which includes 53 weeks.

The selected unaudited financial data below should be read in conjunction with Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and the Financial Statements of the Company and related notes included elsewhere herein.

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__________________________

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Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Following is management's discussion and analysis of significant factors that have affected the Company's financial position and its results of operations for the periods presented in the accompanying financial statements.

Fiscal 2007 and 2005 results include 52 weeks. Fiscal 2006 results include 53 weeks.

The Company is a regional department and specialty store chain completing its 103^rd year of operation. As of February 2, 2008, the Company operated 59 full-line "Gottschalks" department stores located in six Western states, with the majority of those stores located in California. The Company also operates 4 "Village East" specialty stores which carry a limited selection of merchandise.

The Company's department stores typically offer a wide range of better to moderate brand-name and private-label merchandise, including men's, women's, juniors' and children's apparel; cosmetics, shoes, fine jewelry and accessories; and home furnishings including china, housewares, domestics, small electric appliances and, in selected locations, furniture and mattresses.

In the fourth quarter of fiscal 2006, the Company announced that its Board of Directors formed a special strategic committee to identify and evaluate various strategic alternatives to maximize shareholder value, including, a revised business plan, operating partnerships, joint ventures, strategic alliances, share repurchases, a recapitalization, and the sale or merger of the Company. The special strategic committee was comprised of the Board's six independent directors. The Company also announced that the Board of Directors retained UBS Investment Bank to assist its special strategic committee in exploring various alternatives available to the Company. The Company continued to use the financial advisory services of Financo, Inc.

On August 30, 2007, the Company announced that the Committee had concluded its evaluation of strategic alternatives and determined it was in the best interest of Gottschalks' shareholders to aggressively focus on a revised business plan. With this decision, the strategic committee was dissolved.

In connection with the conclusion of the strategic alternatives review process, the Company announced its new Value Improvement Program (V.I.P.). Goals of the V.I.P. include increasing top line performance, improving operating margin, and maximizing shareholder value. The V.I.P., developed with the assistance of Financo Inc., includes opening new stores, new creative and targeted marketing programs, significant enhancements to information technology systems and a plan to better utilize the Company's owned real estate. In line with the V.I.P., the Company also plans to accelerate closings of poor performing stores, including the closing of two stores at their lease expirations in the second quarter of fiscal 2008. The Company plans to construct a 55,000 square foot store in Bend, Oregon which will open for business in late fall, fiscal 2008.

The V.I.P. will be carried out into fiscal 2008 and the future, and will be funded through the Company's refinanced credit facility with General Electric Capital Corporation. The Company anticipates seeing near-term benefits to its top and bottom lines in the second half of fiscal 2008 with results more fully realized in fiscal 2009.

The Company's Board of Directors announced its share repurchase program in September 2007, which allows for the repurchase of up to 2 million shares over 12 months subject to certain pricing conditions. During fiscal 2007, the Company repurchased 417,800 shares for $1,487,000, at an average cost of $3.56 per share including commissions. Such shares are reflected as treasury stock in the stockholder's equity section of the condensed balance sheet. Purchases may be made at management's discretion in the open market and in privately negotiated transactions as market and business conditions warrant. There were no share repurchases in fiscal 2006 and 2005.

The retail industry is highly competitive. The Company experiences competitive pressures from department stores, specialty stores, mass merchandisers and other retail channels, and from general consumer spending levels, including the impact of employment levels and other economic conditions. Eighty percent of the Company's revenues are concentrated in California markets that were heavily impacted by the current mortgage credit crisis. These markets continue to endure abnormally high mortgage foreclosure rates, which has had a significant adverse effect on consumer spending.

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During fiscal 2007 the Company closed 2 stores, 1 of which was underperforming, and opened 1 store in Elk Grove, California. The store gross margin dollars lost by these closures were somewhat offset by incremental gross margin dollars generated from a successful new store opening.

The Company signed a second Amended and Restated Credit Agreement with General Electric Capital Corporation to refinance its existing credit facility on September 26, 2007. The new credit facility consists of a $200 million senior secured revolving credit facility (including a $20 million letter of credit sub-facility). Borrowings under the revolving credit facility are limited to the sum of (a) a specified percentage of eligible credit card receivables, (b) a specified percentage of the net recovery value of eligible inventory, as determined by periodic valuation performed by an independent appraiser, and (c) 65% of the fair market value of the Company's real estate. Such borrowings are further limited by a requirement to maintain a minimum of $15 million of excess availability at all times, and other reserves. Substantially all of the Company's assets, including its merchandise inventories, are pledged under the credit facility.

The new credit facility contains restrictive financial and operating covenants, including the requirement to maintain a fixed charge coverage ratio of 1:1 (as defined in the agreement) if the Company's excess borrowing availability is below $20 million. As of February 2, 2008, management believes the Company was in compliance with all restrictive financial covenants applicable to the credit facility. The agreement has a five year term expiring September 26, 2012.

From January 26, 2006 to September 26, 2007, the credit facility, as amended on January 26, 2006, consisted of a revolving credit facility of up to $172 million (including a $20 million letter of credit sub-facility) and a fully funded term loan of $9 million. Borrowings under the revolving credit facility, as amended, were limited to the sum of (a) a specified percentage of eligible credit card receivables, (b) the lesser of specified percentages of (i) the cost of eligible inventory and (ii) the net recovery value of the inventory, as determined by periodic valuation performed by an independent appraiser, and (c) the lesser of (i) up to 60% of the fair market value of the designated properties and (ii) $21.6 million. Such borrowings were further limited by a requirement to maintain a minimum of $5 million of excess availability at all times, and other reserves that were in effect. Substantially all of the Company's assets, including its merchandise inventories, were pledged under the credit facility.

As a result of its stable performance and continued improvement in debt structure, the Company plans to increase its efforts to refresh the presentation of its core store base as well as continue to explore opportunities for controlled new store growth.

The Company's significant accounting policies are described in Note 1 to the Financial Statements included in Part IV, Item 15 of this Form 10-K. The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to its revenue recognition policy, the carrying value of its merchandise inventories, the adequacy of its workers' compensation insurance reserves, and the valuation of its long-lived assets, including goodwill, and its deferred tax assets. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. In the past, actual results have not been materially different from the Company's estimates.

Some of the Company's significant accounting policies involve a higher degree of judgment or complexity than its other accounting policies. The policies described below have been identified as critical to the Company's business operations and the understanding of its results of operations. The impact and associated risks related to these policies on the Company's business operations are discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations.

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Revenue Recognition Policy

Net retail sales are recognized at the point-of-sale, net of estimated sales returns and allowances and exclusive of sales tax. Net retail sales also include all amounts billed to a customer in a sale transaction for shipping and handling, including customer delivery charges. Revenues on special order sales are recognized when the merchandise is delivered to the customer. The Company's policy with respect to gift cards is to record revenue as the gift cards are redeemed for merchandise. Prior to their redemption, the gift cards are recorded as a liability. The liability remains recorded until the earlier of redemption, escheatment, or 60 months. It is the Company's historical experience that the likelihood of redemption after 60 months is remote.

The Company has a private-label credit card agreement with HSBC for which the Company received an upfront program fee in addition to a percentage of net credit card sales. The percentage of net credit card sales associated with the Company's private-label credit card program are recognized as actual net private-label credit card sales occur. Net credit card sales represent gross credit card sales less returns and chargebacks. The prepaid program fee is amortized on a straight-line basis over the life of the Credit Card Program Agreement with HSBC.

The Company records an allowance for estimated sales returns in the period that the related sale occurs. These estimates are based primarily on historical sales returns. If the historical data used to calculate these estimates does not properly reflect future returns, adjustments to the allowance for estimated sales returns may be necessary.

Merchandise inventory, which consists of merchandise held for resale, is valued at the lower of LIFO (last-in, first-out) cost or market using the retail inventory method ("RIM") of accounting. Inherent in the RIM calculation are various judgments and estimates including, among others, merchandise markon, markups, markdowns and shrinkage, which significantly impact the ending inventory valuation at cost, as well as resulting gross margins. The Company applies various methodologies to ensure that the application of the RIM is consistent for all periods presented. Such methodologies include the development of consistent cost-to-retail ratios and the grouping of homogenous classes of merchandise. Estimated inventory shrinkage between physical inventory dates is based on historical experience. Should actual inventory shrinkage results differ from the Company's estimate, year-end revisions to inventory shrinkage expense recognized on an interim basis may be required.

Estimating the market value of the Company's merchandise inventory requires assumptions about future demand and market conditions. Such estimates are based on actual and forecasted sales trends, current inventory levels and aging information by merchandise categories. The Company records markdowns to value merchandise inventories at net realizable value. If forecasted sales are not achieved, or if other indicators of impairment are present, additional markdowns may be needed in future periods to clear excess or slow-moving merchandise, which may result in lower gross margins.

The Company's long-lived assets consist primarily of property and equipment, goodwill, leasehold interests and other long-term assets. Long-lived assets, including intangible assets other than goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The Company performs an evaluation of whether an impairment charge should be recorded whenever a store experiences unfavorable operating performance. A store's assets are evaluated for impairment by comparing its estimated undiscounted cash flows over its estimated remaining lease term to its carrying value. If the cash flows are not sufficient to recover the carrying value, a loss equal to the difference between the carrying value and the estimated fair value of the asset is recognized. Estimates of future cash flows are based on a variety of factors, including historical experience in similar locations, changes in merchandising, promotional or operating strategy that may affect the profitability of a particular location, knowledge of the market area and in some cases, expected sale proceeds or sublease income, and independent appraisals. Goodwill and intangible assets having indefinite lives are not being amortized to earnings, but instead are subject to periodic testing for impairment. Goodwill and other intangible assets of a reporting unit are tested for impairment on an annual basis and more frequently if certain indicators are encountered. The Company has three geographical regions that it considers reporting units and operating segments, as the Company manages operations based on these regions. Various uncertainties, including but not limited to changes in consumer preferences, increased competition or a general deterioration in economic conditions could adversely impact the expected cash flows to be generated by an asset or group of assets. If actual performance or fair value estimates for store locations are less favorable than management's projections, future asset

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impairment charges may be necessary. Similar procedures are used when analyzing other corporate assets for impairment. The Company did not impair any assets in fiscal 2007 as all the impairment tests were performed and no impairment was indicated.

The carrying value of the Company's net deferred tax assets assumes that the Company will be able to generate sufficient future taxable income to realize the value of these assets. In determining the appropriate valuation allowance, management considers all available evidence for the deferred tax assets, including tax credits, net operating loss and capital loss carryforwards that would likely expire prior to their utilization. The Company has established valuation allowances that relate primarily to certain state tax credit carryforwards the realization of which is uncertain. Although these credits do not expire, the utilization is extremely limited and is available only to the extent the Company generates sufficient taxable income apportionable to the respective location. The Company has historically generated the credits at a substantially more rapid rate than it has been able to utilize them. The resulting utilization period is, therefore, unusually long. Although the Company has had, prior to the fiscal 2007 loss, recent profitability, there can be no certainty that the Company will continue to generate sufficient taxable income apportioned to specific locations for an indefinite period of time to fully utilize the state tax credit carryforwards, especially given the cyclical nature of the Company's business. Further, there is no certainty that the Company will operate in these specific locations for an extended period. To the extent that the Company no longer operates within these locations, the tax credits cannot be utilized. The Company considers it appropriate to release this valuation allowance after at least three years of continued operating profits, limited to the projected utilization of the state tax credits based on assumed operation in the specific locations of not more than ten years. In addition, the Company has generated certain capital losses for which there is currently no carryback opportunity available. Based on the Company's current operating strategy it appears more likely than not that there will be no opportunity available during the remaining carryforward period to generate offsetting capital gains. Accordingly the Company considers it appropriate to establish a valuation allowance against such carryforwards. Management believes it is more likely than not that the Company will generate sufficient future taxable income in the appropriate carryforward periods to realize the benefit of its remaining net deferred tax assets. However, if the available evidence were to change in the future, an adjustment to the valuation allowance may be required, resulting in additional income tax expense or benefit.

In June 2006, the Financial Accounting Standards Board (FASB) issued Financial Interpretation No. (FIN) 48, "Accounting for Uncertainty in Income Taxes," which clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." The interpretation prescribes a "more likely than not" recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 applies to all tax positions related to income taxes subject to SFAS 109 and creates a single model to address accounting for uncertainty in tax positions. FIN 48 requires that tax positions accounted for under SFAS 109 be evaluated for recognition based solely on technical merits and the resulting tax benefits be measured using a cumulative probability assessment and the Company's plan for settlement. The Company adopted FIN 48 effective February 4, 2007. The adoption of FIN 48 did not have a material effect on the Company's consolidated financial position or results of operations (see Note 10 to the Financial Statements).

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Results of Operations

The following table sets forth for the periods indicated certain items from the Company's Statements of Operations, expressed as a percent of net sales. The two stores closed in fiscal 2007 were recorded as continuing operation. The Company has reclassified the results of operations of certain stores closed in fiscal 2006 to discontinued operations in fiscal 2006 and 2005.

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Fiscal 2007 Compared to Fiscal 2006

Net Sales

Net sales from continuing operations decreased by approximately $52.4 million, or 7.7%, to $628.6 million in the 52-week fiscal 2007 as compared to $681.0 million in the 53-week fiscal 2006. Total sales for fiscal 2007 excluding the additional week in fiscal 2006 decreased 6.6%. Same store sales for the comparable 52-week fiscal year period decreased 5.1% from fiscal 2006. The fiscal year 2007 sales decrease is primarily attributable to the weak economic environment driven by the mortgage banking crisis and the high price of gasoline, with the greatest impact in the Company's California locations which produce 80% of sales volume. In the Company's Pacific Northwest locations, store-for-store sales increased over fiscal 2006.

The best performing merchandise categories of fiscal 2007, as compared to the comparable 52 week fiscal 2006, were women's accessories such as handbags, cold weather, and fashion accessories; plus size apparel grew by 5% driven by the addition of GW (Gottschalks Women's) Attitude for the junior plus size customer; and sales in dresses grew by 5% in both misses' and juniors'. Sales in home departments continued to erode with comparable 52 week sales in furniture down 13% and textiles down 18%, to the respective fiscal 2006 sales.

The Company operated 59 department stores and 4 specialty stores as of the end of fiscal 2007 as compared to 60 department stores and 5 specialty stores as of the end of fiscal 2006. As described more fully in Note 9 to the accompanying financial statements, during fiscal 2007 the Company closed 2 stores, 1 of which was underperforming, and opened 1 new store in Elk Grove, California.

As described more fully in Note 2 to the accompanying financial statements, in January 2003, pursuant to the terms of a Purchase and Sale Agreement, the Company sold its private label credit card accounts and accounts receivable to HSBC. In connection with the sale, the Company entered into a Credit Card Program Agreement (the "CCA"). The CCA provides that the Company will be paid a percentage of Net Cardholder Charges and a percentage of Other Revenue (each as defined in the CCA). All amounts received under the CCA, including amortization of prepaid program revenue, are reflected in net credit revenues. The CCA had an initial term of five (5) years expiring January 31, 2008 and was cancelable earlier by either party under certain circumstances. On February 4, 2007, the Company and HSBC entered into a new Credit Card Program Agreement which has a term of six (6) years and is cancelable by either party under certain circumstances. The new Credit Card Program Agreement provides the Company will be paid a percentage of Net Credit Card Sales and a percentage of Other Revenue (each as defined in the CCA). In addition, the Company is guaranteed a percentage of net credit card sales (as defined in the CCA) will be used by HSBC to fund marketing programs.

Net credit revenues related to the program in fiscal 2007 was $4.9 million in fiscal 2007 as compared to $3.1 million in fiscal 2006, an increase of 57.7%. As a percent of net sales, net credit revenues were 0.8% of net sales in fiscal 2007 and 0.4% of net sales in fiscal 2006. This increase was attributable to enhanced revenue sharing under the new agreement and a higher credit sales to total sales penetration rate compared to fiscal 2006, but was somewhat offset by lower credit sales year over year.

Net rental income generated by the Company's various leased departments was $3.0 million in fiscal 2007, compared to $3.4 million in fiscal 2006. Leased department sales are presented net of the related costs for financial reporting purposes. Sales generated in the Company's leased departments, consisting primarily of fine jewelry departments and beauty salons, totaled $21.0 million in fiscal 2007 as compared to $23.9 million in fiscal 2006.

Cost of sales from continuing operations, which includes costs associated with the buying, handling and distribution of merchandise, decreased by approximately $25.7 million to $420.9 million in fiscal 2007 as compared to $446.6 million in fiscal 2006, a decrease of 5.8%. The decrease is primarily due to the decrease in sales volume. The Company's gross margin percentage in fiscal 2007 was 33.0% compared to 34.4% in fiscal 2006. The 1.4% decrease was primarily due to increased promotional discounts in all merchandise areas in a very soft and competitive retail environment.

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Selling, General and Administrative Expenses

Selling, general and administrative expenses from continuing operations decreased approximately $2.8 million, or 1.3%, to $209.6 million in fiscal 2007 as compared to $212.4 million in fiscal 2006. As a percentage of net sales, selling, general and administrative expenses increased 2.1% to 33.3% in fiscal 2007 as compared to 31.2% in fiscal 2006. The rate increase is primarily attributable to increases in selling payroll costs which were somewhat offset by reduced workers' compensation expense and a non-recurring $1.1 million increase in the vacation pay reserve in fiscal year 2006 to comply with the VEBA litigation settlement. In addition, higher outside services and increased professional fees, primarily due to legal and other fees of $0.6 million incurred during the strategic review process, contributed to the increase in selling, general and administrative expenses in 2007. Net advertising spending rate has also increased relative to net sales owing to efforts to attract more customers in a slow economy.

Depreciation and amortization expense, which includes the net amortization (accretion) of intangible assets other than goodwill, decreased by approximately $0.1 million or 0.7%, to $15.2 million in fiscal 2007 as compared to $15.3 million in fiscal 2006. As a percent of net sales, depreciation and amortization expense was 2.4% in fiscal 2007 and 2.2% in fiscal 2006. The dollar decrease is a result of merchandising software becoming fully depreciated in June 2007, off-set by the depreciation of capital additions related to the Company's new stores and major remodel projects at certain existing stores. The Company also made substantial upgrades to its planning and allocations and point of sale systems, which were placed in service at various dates during the end of fiscal 2006 and beginning of 2007, respectively.

The Company sold a corporate aircraft on June 30, 2006 for $1,037,000 (net of selling costs) that resulted in a gain of $946,000. The gain is reflected in operating income as the aircraft was reported as an operating asset.

VEBA Litigation

The Company accrued an additional $60,000 in fiscal 2006 related to a reserve for settlement of a class action complaint alleging violation of California law regarding payment of accrued vacation upon termination of employment. The Company had accrued $1.8 million in the fourth quarter of fiscal 2005 for estimated legal fees and costs. The Company believed settlement of this matter was in its best interests and entered into a memorandum of understanding for class settlement, which was given final court approval in September 2006. All payments were made in December 2006 and final accounting for actual expenses took place in fiscal 2007.

New store opening costs, which are expensed as incurred, typically include costs such as payroll and fringe benefits for store associates, store rents, temporary storage, utilities, travel, grand opening advertising, credit solicitation and other costs incurred prior to the opening of a store. The Company recognized new store opening costs totaling $0.5 million in connection with the opening of a new store in Elk Grove, California, which opened November 7, 2007. In fiscal 2006, the Company recognized $0.4 million in new store opening costs related to the opening of a new store in Eugene, Oregon.

Interest expense, which includes the amortization of deferred financing costs, increased by approximately $0.7 million to $10.8 million in fiscal 2007 compared to $10.1 million in fiscal 2006, an increase of 7.4%. As a percent of net sales, interest expense increased to 1.7% in fiscal 2007 as compared to 1.5% in fiscal 2006. These increases are primarily due to a $0.6 million unfavorable fair value adjustment on the Company's $25 million notional amount interest swap compared to a $0.2 million favorable fair value adjustment in fiscal year 2006. Increased borrowings under the Company's GE revolving line of credit were offset by declining interest rates. The weighted average interest rate applicable to the revolving credit facility was 6.9% in fiscal 2007 (5.9% at February 2, 2008) as compared to 7.1% in fiscal 2006.

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Miscellaneous Income

Miscellaneous income, which consists of income from the Company's investment in a partnership and other miscellaneous non- operating income, decreased by approximately $0.9 million to $0.5 million in fiscal 2007 as compared to $1.4 million in fiscal 2006. Miscellaneous income does not include any material offsetting expense items. As a percent of net sales, miscellaneous income was 0.1% in fiscal 2007 and 0.2% in fiscal 2006.

The Company's effective tax rate for continuing operations is 39.1% in fiscal 2007 as compared to 32.2% in fiscal 2006. Including the tax benefit reported in discontinued operations in fiscal 2006, the Company's effective tax rate is 39.1% in fiscal 2007 as compared to 31.6% in fiscal 2006. In fiscal 2007, the Company increased its valuation allowance associated with certain tax credit carryforwards that the Company determined were not more likely than not to be realized, attributable primarily to a reduction in the Company's assessment of future income. In fiscal 2006, the Company benefited from the release of a portion of its valuation allowance associated with certain tax credit carryforwards that the Company determined were more likely than not to be realized. In addition, the increase in effective tax rate is also due to the impact of tax credits. The tax benefit on the fiscal year 2007 loss is increased by tax credits and the tax expense on fiscal year 2006 income is reduced by tax credits.

As a result of the foregoing, the Company reported a loss from continuing operations of $12.4 million, or $0.91 per diluted share, in fiscal 2007 as compared to income of $3.4 million, or $0.25 per diluted share, in fiscal 2006.

The Company closed one underperforming store in the Seattle metro-area during the third quarter of fiscal 2006 and one underperforming store in the Seattle/Tacoma market during the first quarter of fiscal 2006. These closures are reported as discontinued operations due to the Company's exit from the respective market areas. The loss from operations of discontinued stores includes only revenues generated from, and expenses directly associated with, the operations of such stores and consists of the following:

The loss on store closures of $98,000 includes a net gain on the sale of the building associated with the store closed during the first quarter of fiscal 2006 of approximately $147,000, offset by a loss on disposal of assets of $139,000 related to the store closed during the third quarter of fiscal 2006, and store closure costs of approximately $106,000 related to both stores closed in fiscal 2006, primarily consisting of severance and other incremental costs associated with the store closings.

In addition, the Company closed one store in Wasilla, Alaska during the first quarter of fiscal 2007, one store in Tacoma, Washington during the third quarter of fiscal 2007, and closed one store in Danville, California and one store in Moscow, Idaho during the third quarter and fourth quarter of fiscal 2006. These closures are not reported as discontinued operations due to the shift of revenues to other stores in the respective markets.

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Certain of the Company's stores may perform below expectations from time to time. In the event the Company is unable to improve the operating performance of such underperforming stores, the Company may consider the sale, sublease or closure of those stores in the future.

As a result of the foregoing, the Company reported net loss of $12.4 million in fiscal 2007 as compared to net income of $2.6 million in fiscal 2006. On a per diluted share basis net loss was $0.91 per share in fiscal 2007 compared to net income of $0.19 per share in fiscal 2006.

Net Sales

Net sales from continuing operations increased by approximately $15.5 million, or 2.3%, to $681.0 million in fiscal 2006 as compared to $665.5 million in fiscal 2005. The fiscal 2006 sales increase is primarily attributable to the opening of the Company's 120,876 square foot store in Eugene, Oregon. Promotional activity helped drive the sales increases through a continuing soft general economic environment and continuing competitive pressures in much of the Company's market areas. The Company also achieved a 0.6% comparable store sales increase in fiscal 2006 driven predominantly by sales increases in the Company's more fashion forward merchandise categories. Comparable store sales includes sales for stores open for the full period in both years. However, reflecting the effects of the opening of the River Park store in fiscal 2005 on other Fresno area stores, such stores have been excluded from the Company's comparable store base. The Company's 2006 fiscal year consisted of 53 weeks as compared to its 2005 fiscal year, which consisted of 52 weeks. Total sales for fiscal 2006 excluding the additional week decreased 0.3% to $675.2 million. Same store sales for the comparable 52-week fiscal year period increased 0.6% from fiscal 2005.

The Company operated 60 department stores and 5 specialty stores as of the end of fiscal 2006 as compared to 63 department stores and 6 specialty stores as of the end of fiscal 2005. As described more fully in Note 9 to the accompanying financial statements, during fiscal 2006 the Company closed 4 stores, 2 of which were underperforming, and opened 1 new store in Eugene, Oregon.

As described more fully in Note 2 to the accompanying financial statements, in January 2003, pursuant to the terms of a Purchase and Sale Agreement, the Company sold its private label credit card accounts and accounts receivable to HSBC. In connection with the sale, the Company entered into a Credit Card Program Agreement (the "CCA"). The CCA provides that the Company will be paid a percentage of Net Cardholder Charges and a percentage of Other Revenue (each as defined in the CCA). All amounts received under the CCA, including amortization of prepaid program revenue, are reflected in net credit revenues. The CCA had an initial term of five (5) years expiring January 31, 2008 and was cancelable earlier by either party under certain circumstances. On February 4, 2007, the Company and HSBC entered into a new Credit Card Program Agreement which has a term of six (6) years and is cancelable by either party under certain circumstances. The new Credit Card Program Agreement provides the Company will be paid a percentage of Net Credit Card Sales and a percentage of Other Revenue (each as defined in the CCA). In addition, the Company is guaranteed a percentage of net credit card sales (as defined in the CCA) will be used by HSBC to fund marketing programs.

Net credit revenues related to the program in fiscal 2006 were essentially even with fiscal 2005 at $3.1 million. As a percent of net sales, net credit revenues were 0.4% of net sales in fiscal 2006 and 0.5% of net sales in fiscal 2005.

Net rental income generated by the Company's various leased departments was $3.4 million in fiscal 2006, compared to $3.5 million in fiscal 2005. Leased department sales are presented net of the related costs for financial reporting purposes. Sales generated in the Company's leased departments, consisting primarily of fine jewelry departments and beauty salons, totaled $23.9 million in fiscal 2006 as compared to $24.4 million in fiscal 2005.

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Cost of Sales

Cost of sales from continuing operations, which includes costs associated with the buying, handling and distribution of merchandise, increased by approximately $12.2 million to $446.6 million in fiscal 2006 as compared to $434.4 million in fiscal 2005, an increase of 2.8%. The increase is primarily due to the increase in sales volume. The Company's gross margin percentage in fiscal 2006 was 34.4% compared to 34.7% in fiscal 2005.

Selling, general and administrative expenses from continuing operations increased approximately $7.4 million, or 3.6%, to $212.4 million in fiscal 2006 as compared to $204.9 million in fiscal 2005. As a percentage of net sales, selling, general and administrative expenses increased 0.4% to 31.2% in fiscal 2006 as compared to 30.8% in fiscal 2005. The increase is primarily attributable to increases in payroll costs and fringe benefits, including a non-recurring $1.1 million increase in the vacation reserve to comply with the VEBA litigation settlement, and $0.8 million in stock-based compensation. The vacation expense increase was offset by decreases in worker's compensation and health insurance expenses. In addition, higher energy costs, increased professional fees and higher freight surcharges contributed to the increase in selling, general and administrative expenses. Gross advertising spending has also increased relative to the increase in net sales. These increases are partially offset by $0.4 million received as a member of a class of a settled lawsuit against VISA U.S.A. Inc. and MasterCard International Incorporated. The Company expects to see a continuation of higher fuel and energy costs for the foreseeable future.

Depreciation and amortization expense, which includes the net amortization (accretion) of intangible assets other than goodwill, increased by approximately $2.0 million, or 15.4%, to $15.3 million in fiscal 2006 as compared to $13.2 million in fiscal 2005. As a percent of net sales, depreciation and amortization expense was 2.2% in fiscal 2006 and 2.0% in fiscal 2005. This increase includes $0.2 million related to accelerated depreciation of assets due to the closing of the Danville, California store in August 2006. The dollar increase is also a result of capital additions related to the Company's new store, major remodel projects at certain existing stores and upgrades to the planning and allocation and point of sale systems.

The Company sold a corporate aircraft on June 30, 2006 for $1,037,000 (net of selling costs) that resulted in a gain of $946,000. The gain is reflected in operating income as the aircraft was reported as an operating asset.

VEBA Litigation

The VEBA litigation costs represent a reserve for settlement of a class action complaint alleging violation of California law regarding payment of accrued vacation upon termination of employment. The Company believed settlement of this matter was in its best interests and entered into a memorandum of understanding for class settlement, which was given final court approval in September 2006. The Company accrued $1.8 million in the fourth quarter of fiscal 2005 for estimated legal fees and costs and an additional $60,000 in the fourth quarter of fiscal 2006. All payments were made in December 2006 and final accounting for actual expenses took place in fiscal 2007.

New store opening costs, which are expensed as incurred, typically include costs such as payroll and fringe benefits for store associates, store rents, temporary storage, utilities, travel, grand opening advertising, credit solicitation and other costs incurred prior to the opening of a store. The Company recognized new store opening costs totaling $0.4 million in connection with the opening of a new store in Eugene, Oregon, which opened August 31, 2006. In fiscal 2005, the Company recognized $0.7 million in new store opening costs related to the opening of new stores in each of Fresno, California and Albany, Oregon, and the reopening of the Pocatello, Idaho store.

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Interest Expense

Interest expense, which includes the amortization of deferred financing costs, increased by approximately $0.8 million to $10.1 million in fiscal 2006 compared to $9.2 million in fiscal 2005, an increase of 8.8%. As a percent of net sales, interest expense increased to 1.5% in fiscal 2006 as compared to 1.4% in fiscal 2005. These increases are primarily due to continued increases in interest rates charged on the Company's variable rate debt and include a charge of $0.2 million related to the early termination of the Company's 9.39% mortgages. These increases were partially offset by a $0.2 million favorable fair value adjustment on the Company's $25 million notional amount interest swap. The Company anticipates that its interest rate swap will continue to provide protection against rising interest rates for the near term. The weighted average interest rate applicable to the revolving credit facility was 7.1% in fiscal 2006 (7.3% at February 2, 2008) as compared to 6.0% in fiscal 2005. During the third quarter of fiscal 2005, due to the Company's involvement in the construction of the building at its River Park store and other factors, the Company recorded $10.2 million in buildings and equipment under capital leases and $6.0 million in capital lease obligations associated with landlord reimbursements received. Accordingly, fiscal 2006 also includes interest charges of $0.9 million, compared to $0.4 million in fiscal 2005, related to the accounting for rental payments as repayment of the related construction reimbursements utilizing the effective interest method.

Miscellaneous income, which consists of the amortization of long-term deferred credits recorded upon receipt of donated land, income from the Company's investment in a partnership, and other miscellaneous non-operating income decreased by approximately $0.1 million to $1.4 million in fiscal 2006 as compared to $1.5 million in fiscal 2005. Miscellaneous income does not include any material offsetting expense items. As a percent of net sales, miscellaneous income was 0.2% in fiscal 2006 and in fiscal 2005.

The Company's effective tax rate for continuing operations is 32.2% in fiscal 2006 as compared to 33.6% in fiscal 2005. Including the tax benefit reported in discontinued operations, the Company's effective tax rate is 31.6% in fiscal 2006 as compared to 33.5% in fiscal 2005. In both fiscal 2006 and fiscal 2005, the Company benefited from the release of a portion of its valuation allowance associated with certain tax credit carryforwards that the Company determined were more likely than not to be realized.

As a result of the foregoing, the Company reported income from continuing operations of $3.4 million, or $0.25 per diluted share, in fiscal 2006 as compared to $6.1 million, or $0.45 per diluted share, in fiscal 2005.

The Company closed one underperforming store in the Seattle metro-area during the third quarter of fiscal 2006 and one underperforming store in the Seattle/Tacoma market during the first quarter of fiscal 2006. During fiscal 2005, the Company closed two underperforming stores in the Seattle/Tacoma market. These closures are reported as discontinued operations due to the Company's exit from the respective market areas. The loss from operations of discontinued stores includes only revenues generated from, and expenses directly associated with, the operations of such stores and consists of the following:

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The loss on store closures of $98,000 includes a net gain on the sale of the building associated with the store closed during the first quarter of fiscal 2006 of approximately $147,000, offset by a loss on disposal of assets of $139,000 related to the store closed during the third quarter of fiscal 2006, and store closure costs of approximately $106,000 related to both stores closed in fiscal 2006, primarily consisting of severance and other incremental costs associated with the store closings.

In addition, the Company closed one store in Danville, California and one store in Moscow, Idaho during the third quarter and fourth quarter of fiscal 2006. The Company also closed one store in Fresno, California during the first quarter of fiscal 2005. These closures are not reported as discontinued operations due to the shift of revenues to other stores in the respective markets. The Company has a written agreement with the landlord to close the Wasilla, Alaska store in April 2007. This closure is not considered a discontinued operation as the Company has remaining stores in the market area.

Certain of the Company's stores may perform below expectations from time to time. In the event the Company is unable to improve the operating performance of such underperforming stores, the Company may consider the sale, sublease or closure of those stores in the future.

As a result of the foregoing, the Company reported net income of $2.6 million in fiscal 2006 as compared to $5.2 million in fiscal 2005. On a per diluted share basis net income was $0.19 per share in fiscal 2006 compared to $0.38 per share in and fiscal 2005.

The Company's working capital requirements are currently met through a combination of cash provided by operations, borrowings under its senior revolving credit facility, short-term trade and factor credit, and by proceeds from external financings.

In fiscal 2007, the Company generated positive cash flow from operations of $11.0 million as compared to negative cash flow of $4.8 million in fiscal 2006 and positive cash flow of $19.6 million in fiscal 2005. The $15.8 million increase in cash provided by operating activities in fiscal 2007 relative to fiscal 2006 was primarily due to the significant reductions of merchandise inventory which was somewhat offset by reductions in related accounts payables. The increase in cash provided was further offset by the net loss in fiscal 2007 compared to net income in fiscal 2006. Inventory decreased as a result of decreased sales and a planned reduction in inventory levels as compared to fiscal 2006. The Company does not plan any further reductions in inventory levels in fiscal 2008.

Net cash used in investing activities amounted to $20.1 million, $16.9 million, and $21.9 million in fiscal 2007, 2006, and 2005 respectively. The net cash outflow in fiscal 2007 and fiscal 2005 increased from fiscal 2006 due to increased capital expenditures for store remodeling and new store construction (see "Uses of Liquidity"), partially offset in fiscal 2006 by the sale of the Silverdale, Washington store location and the sale of a corporate aircraft.

Net cash provided by financing activities was $7.0 million in fiscal 2007 and primarily the result of increased borrowing on the Company's revolving credit facility to fund inventory purchases and capital expenditures, and somewhat offset by payments on long-term debt and repurchase of the Company's stock. Net cash provided by financing activities was $22.4 million in fiscal 2006 and primarily the result of increased borrowing to fund inventory and capital expenditures and also the pay-off of the 9.39% mortgages on four of the Company's owned properties of approximately $16.6 million. Net cash provided by financing activities of $2.1 million in fiscal 2005 was primarily the result of the $6.0 million landlord reimbursement, offset by repayment of long-term obligations.

The Company signed a second Amended and Restated Credit Agreement with General Electric Capital Corporation to refinance its existing credit facility on September 26, 2007. The new credit facility consists of a $200 million senior secured revolving credit facility (including a $20 million letter of credit sub-facility). Borrowings under the revolving credit facility are limited to the sum of (a) a specified percentage of eligible credit card receivables, (b) a

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specified percentage of the net recovery value of eligible inventory, as determined by periodic valuation performed by an independent appraiser, and (c) 65% of the fair market value of the Company's real estate. Such borrowings are further limited by a requirement to maintain a minimum of $15 million of excess availability at all times, and other reserves. Substantially all of the Company's assets, including its merchandise inventories, are pledged under the credit facility.

As of February 2, 2008, outstanding borrowings under the new credit facility totaled $93.9 million, and availability for additional borrowings under the credit facility, after the deduction of the minimum availability requirement and other reserves, was $40.2 million. Interest charged on amounts borrowed under the credit facility is at the prime rate, or at the Company's option, at the applicable LIBOR rate plus 1.25% per annum. In addition, the Company pays an unused commitment fee equal to 0.20% per annum on the average unused daily balance of the credit facility. The interest rate is adjusted upwards or downwards on a quarterly basis based on a pricing matrix, which is tied to the Company's daily average excess availability for the preceding fiscal quarter (as defined in the agreement). Under the pricing matrix, the applicable interest rate could range from a rate as low as prime or LIBOR plus 1.25%, to as high as prime plus 0.5%, or LIBOR plus 2.5%.

The new credit facility contains restrictive financial and operating covenants, including the requirement to maintain a fixed charge coverage ratio of 1:1 (as defined in the agreement) if the Company's excess borrowing availability is below $20 million. As of February 2, 2008, the Company was in compliance with all restrictive financial covenants applicable to the credit facility. The agreement has a five year term expiring September 26, 2012.

The Company is exposed to market risk associated with changes in interest rates. To provide some protection against potential rate increases associated with its variable-rate facilities, the Company has entered into a derivative financial transaction in the form of an interest rate swap. This interest rate swap, used to hedge a portion of the underlying credit facility, matures in February 2009.

From January 26, 2006 to September 26, 2007, the credit facility, as amended on January 26, 2006, consisted of a revolving credit facility of up to $172 million (including a $20 million letter of credit sub-facility) and a fully funded term loan of $9 million. Borrowings under the revolving credit facility, as amended, were limited to the sum of (a) a specified percentage of eligible credit card receivables, (b) the lesser of specified percentages of (i) the cost of eligible inventory and (ii) the net recovery value of the inventory, as determined by periodic valuation performed by an independent appraiser, and (c) the lesser of (i) up to 60% of the fair market value of the designated properties and (ii) $21.6 million. Such borrowings were further limited by a requirement to maintain a minimum of $5 million of excess availability at all times, and other reserves that were in effect. Substantially all of the Company's assets, including its merchandise inventories, were pledged under the credit facility.

On September 26, 2007, interest charged on amounts borrowed under the revolving portion of the credit facility were at the prime rate, or at the Company's option, at the applicable LIBOR rate plus 1.25% per annum, and interest charged on the term loan was a fixed rate of 6.6% per annum. In addition, the Company paid an unused commitment fee equal to 0.375% per annum on the average unused daily balance of the revolving portion of the credit facility. The interest rate applicable to the revolving portion of the credit facility was adjusted upwards or downwards on a quarterly basis based on a pricing matrix which was tied to the Company's daily average excess availability for the preceding fiscal quarter (as defined in the agreement). Under the pricing matrix, the applicable interest rate could have ranged from a rate as low as prime or LIBOR plus 1.25%, to as high as prime plus 0.5%, or LIBOR plus 2.5%.

The credit facility, as amended, contained restrictive financial and operating covenants, including the requirement to maintain a fixed charge coverage ratio of 1:1 (as defined in the agreement) if the Company's excess borrowing availability was below $15 million.

El Corte Ingles ("ECI") of Spain, and Harris, a wholly owned subsidiary of ECI, became affiliates of the Company in fiscal 1998 when the Company acquired substantially all of the assets and business of Harris. The Company issued a Subordinated Note to Harris, in the principal amount of $22,179,000 as partial consideration for the Harris acquisition (the "Original Note"). The Original Note bore interest at a fixed rate of 8%. On December 7, 2004 a new Subordinated Note due May 30, 2009 superseded the Original Note. The new Subordinated Note bears interest at a fixed rate of 8% payable semi-annually and provides for principal payments of up to $8.0 million prior to its maturity. Such payments are subject to certain liquidity restrictions under the revolving credit facility. The

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Company made principal payments of $1.0 million each upon execution of the new Subordinated Note, on February 20, 2005, February 20, 2006, February 20, 2007, as scheduled. A principal payment of $2.0 million was made subsequent to fiscal year-end on February 20, 2008 and a principal payment of $2.0 million is scheduled for February 20, 2009, with the balance due at maturity subject to the payment in full of the revolving credit facility.

The success of the Company's business is dependent in part upon the adequacy of trade credit offered by key factors and vendors, the vendors' ability and willingness to sell it products at favorable prices and terms, and the willingness of vendors to ship merchandise on a timely basis. The Company has been able to purchase adequate levels of merchandise to support its operations and expects the level of trade credit to be sufficient to support its operations in the foreseeable future.

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

The Company may consider various other sources of liquidity in the future, including but not limited to the issuance of additional securities that might have a dilutive effect on existing shareholders or incurring additional indebtedness which would increase the Company's leverage.

The Company's primary uses of liquidity are for working capital, debt service requirements, and capital expenditures. Capital expenditures in fiscal 2007, of $20.7 million, were primarily related to the construction and fixturing of the Company's new Elk Grove store and renovation and refixturing of certain existing locations, and to certain information system enhancements.

As of February 2, 2008, the Company had issued a total of $1.5 million of standby letters of credit and documentary letters of credit totaling $1.3 million. The standby letters of credit were issued to provide collateral for workers' compensation insurance policies. Management believes that the likelihood of any draws under the workers' compensation standby letters of credit is remote. Documentary letters of credit are issued in the ordinary course of business to facilitate the purchase of merchandise from overseas suppliers. The supplier draws against the documentary letter of credit upon delivery of the merchandise.

The following tables set forth certain information concerning the Company's debt obligations and commitments to make future payments under contracts, such as debt and lease agreements, and under contingent commitments.

Contractual Obligations:

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In the fourth quarter of fiscal 2007, the Company signed a ground lease for a new store in Bend, Oregon. The Company plans to construct a 55,000 square foot store at a cost of $6.8 million, including fixtures. The Company will own the building and anticipates that it will open in late fall 2008. This building will be financed through cash flow from operations and borrowings on the credit facility.

In the ordinary course of business, the Company enters into arrangements with vendors to purchase merchandise up to twelve months in advance of expected delivery. These purchase orders do not contain any significant termination payments or other penalties if cancelled.

The Company has approximately $1.2 million of unrecognized tax benefits not included in the table above that have been recorded as liabilities in accordance with Financial Interpretation No. 48, and management is uncertain as to if, or when, such amounts may be settled.  In addition, the Company has also recorded a liability for potential interest of approximately $0.2 million, related to the unrecognized tax benefits.

Cash generated by operations, together with liquidity provided by the credit facility, and other financial resources are expected to adequately finance the Company's planned cash requirements for fiscal 2008.

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurement. SFAS 157 does not require any new fair value measurement and the Company is currently evaluating the impact, if any, of SFAS 157 on its financial position, results of operations and cash flows. SFAS 157 requires prospective application for fiscal years beginning after November 15, 2007.

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities," (SFAS 159). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to reduce fluctuation in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Most of the provisions of SFAS 159 apply only to entities that elect the fair value option. However, the amendment to FASB Statement No. 115, "Accounting for

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Certain Investments in Debt and Equity Securities," applies to all entities with available-for-sale and trading securities. SFAS 159 is effective for the Company on February 3, 2008. The Company is currently evaluating the impact, if any, of SFAS 159 on its financial position, results of operations and cash flows.

In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities," (SFAS 161). This statement changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. SFAS 161 is effective for the Company on February 1, 2009. The Company

is currently evaluating the impact, if any, of SFAS 161 on its financial position, results of operations and cash flows.

Although inflation has not been a material factor in the Company's operations during the past several years, the Company has experienced increases in the costs of certain merchandise, salaries, employee benefits and other general and administrative costs, including utilities, supplies, and transportation costs. The Company is generally able to offset these increases by adjusting its selling prices or by modifying its operations. The Company's ability to adjust selling prices is limited by competitive pressures in its market areas.

The Company values its merchandise inventories at the lower of LIFO cost or market using the retail inventory method of accounting. Under the LIFO method, which is determined by using the department store price indices published by the Bureau of Labor Statistics, the cost of products sold reported in the financial statements approximates current costs and thus reduces the impact of inflation due to increasing costs on reported income. The valuation of the Company's merchandise inventories under the LIFO method is currently equal to that as determined by the first-in, first-out (FIFO) method of accounting.

The Company's business, like that of most retailers, is subject to seasonal influences, with the major portion of net sales, gross profit and operating income realized during the Christmas selling months of November and December of each year, and, to a lesser extent, during the Easter and Back-to-School selling seasons. The Company's results may also vary from quarter to quarter as a result of, among other things, the timing and level of the Company's sales promotions, weather, fashion trends and the overall health of the economy, both nationally and in the Company's market areas. Working capital requirements also fluctuate during the year, increasing substantially prior to the Christmas selling season when the Company must carry significantly higher inventory levels.

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The following table sets forth unaudited quarterly results of operations for fiscal 2007 and 2006 (in thousands, except per share data). The Company has reclassified the results of operations of certain stores closed in fiscal 2006 to discontinued operations for all periods presented.