GOTTSCHALKS INC. AND SUBSIDIARY

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

We have audited the accompanying consolidated balance sheets of Gottschalks Inc. and Subsidiary (the "Company") as of February 1, 2003 and February 2, 2002, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three fiscal years in the period ended February 1, 2003. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Gottschalks Inc. and Subsidiary at February 1, 2003 and February 2, 2002, and the results of their operations and their cash flows for each of the three fiscal years in the period ended February 1, 2003 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note 4 to the consolidated financial statements, in 2002 the Company changed its method of accounting for goodwill and other intangible assets.

In addition, as discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for early extinguishment of debt and retroactively restated fiscal 2001 consolidated financial statements for the change.

/s/ Deloitte & Touche LLP

Fresno, California
April 30, 2003

GOTTSCHALKS INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In thousands)

                                                        February 1,  February 2,
                                                           2003         2002
                                                        -----------  -----------
ASSETS
CURRENT ASSETS:
  Cash................................................ $     6,215  $     2,741
  Retained interest in receivables sold...............                   19,222
  Receivables - net...................................      10,641       11,331
  Merchandise inventories.............................     164,615      161,041
  Other...............................................      12,614       17,171
                                                        -----------  -----------
    Total current assets..............................     194,085      211,506

PROPERTY AND EQUIPMENT - net..........................     139,888      153,200

OTHER ASSETS:
  Goodwill - net......................................       7,501        7,635
  Other intangibles - net.............................         658        9,148
  Other...............................................       6,597       10,704
                                                        -----------  -----------
                                                            14,756       27,487
                                                        -----------  -----------
                                                       $   348,729  $   392,193
                                                        ===========  ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
  Trade accounts payable and accrued expenses......... $    79,973  $    77,957
  Revolving line of credit............................      28,845       20,908
  Current portion of long-term debt...................       1,719        5,525
  Current portion of capitalized lease obligations....       2,970        2,738
  Deferred income taxes...............................         629
                                                        -----------  -----------
    Total current liabilities.........................     114,136      107,128

LONG-TERM OBLIGATIONS, less current portion...........      75,097      110,216

OTHER LIABILITIES.....................................      18,917       18,199

DEFERRED INCOME TAXES.................................      12,266       16,832

SUBORDINATED NOTE PAYABLE TO AFFILIATE - net..........      21,989       21,646

COMMITMENTS AND CONTINGENCIES (Notes 8 and 16)

STOCKHOLDERS' EQUITY:
  Common stock, par value of $.01 per share;
    30,000,000 shares authorized; 12,801,669
    and 12,726,364 issued.............................         128          127
  Additional paid-in capital..........................      71,313       71,189
  Retained earnings...................................      34,883       46,856
                                                        -----------  -----------
                                                           106,324      118,172
                                                        -----------  -----------
                                                       $   348,729  $   392,193
                                                        ===========  ===========

See notes to consolidated financial statements.

GOTTSCHALKS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

                                               2002        2001        2000
                                            ----------  ----------  ----------
Net sales................................. $  691,428  $  710,702  $  663,868
Net credit revenues.......................      8,225       8,420       9,150
Net leased department revenues............      3,557       4,093       3,948
                                            ----------  ----------  ----------
    Total revenues........................    703,210     723,215     676,966
                                            ----------  ----------  ----------
Costs and expenses:
  Cost of sales...........................    457,095     470,281     433,724
  Selling, general and
    administrative expenses...............    218,797     223,926     201,765
  Depreciation and amortization...........     14,259      14,123      11,505
  Asset impairment charges................     10,867          --          --
  Store closure costs.....................      3,436         729          --
  Receivables sale costs..................      1,749          --          --
  New store pre-opening costs.............         --          --       6,183
                                            ----------  ----------  ----------
     Total costs and expenses.............    706,203     709,059     653,177
                                            ----------  ----------  ----------
Operating income (loss)...................     (2,993)     14,156      23,789
                                            ----------  ----------  ----------
Other (income) expense:
  Interest expense........................     15,883      14,364      13,750
  Losses on early extinguishment of debt..      3,695         696          --
  Miscellaneous income....................     (1,808)     (1,595)     (1,414)
                                            ----------  ----------  ----------
                                               17,770      13,465      12,336
                                            ----------  ----------  ----------
Income (loss) before income taxes.........    (20,763)        691      11,453

Income tax expense (benefit)..............     (8,790)        266       4,374
                                            ----------  ----------  ----------

Net income (loss)......................... $  (11,973) $      425  $    7,079
                                            ==========  ==========  ==========
Net income (loss) per common share
 (basic and diluted)
                                           $    (0.94) $     0.03  $     0.56
                                            ==========  ==========  ==========

See notes to consolidated financial statements.

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

                                  Common Stock   Additional
                            -------------------   Paid-in    Retained
                              Shares     Amount   Capital    Earnings    Total
                            -----------  ------  ----------  ---------  --------
BALANCE, JANUARY 29, 2000.. 12,596,837  $  126  $   70,760  $  39,352  $110,238
  Net income...............         --      --          --      7,079     7,079
  Shares issued under
   stock purchase plan.....     59,932       1         255         --       256
                            -----------  ------  ----------  ---------  --------
BALANCE, FEBRUARY 3, 2001.. 12,656,769     127      71,015     46,431   117,573
  Net income...............         --      --          --        425       425
  Shares issued under
   stock purchase plan.....     69,595      --         174         --       174
                            -----------  ------  ----------  ---------  --------
BALANCE, FEBRUARY 2, 2002.. 12,726,364  $  127  $   71,189  $  46,856  $118,172
  Net loss.................                                   (11,973)  (11,973)
  Shares issued under
   stock purchase plan.....     75,305       1         124                  125
                            -----------  ------  ----------  ---------  --------
BALANCE, FEBRUARY 1, 2003.. 12,801,669  $  128  $   71,313  $  34,883  $106,324
                            ===========  ======  ==========  =========  ========

See notes to consolidated financial statements.

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

                                                                 2002       2001       2000
                                                               ---------  ---------  ---------
OPERATING ACTIVITIES:
Net income (loss)............................................ $ (11,973) $     425  $   7,079
Adjustments:
  Depreciation and amortization..............................    14,259     14,123     11,505
  Deferred income taxes......................................    (2,613)      (300)     3,522
  Amortization of deferred income and
    other deferred items.....................................       718     (1,017)    (1,695)
  Provision for credit losses................................       825      1,247      1,025
  Asset impairment charges...................................    10,867
  Store closure costs........................................     3,436        729
  Net loss from sale of assets...............................       131        122        151
  Other non-cash items, net..................................      (139)     1,777        604
Decrease (increase) in assets, excluding effect
  of business acquisition:
     Receivables.............................................    (2,972)    (3,275)    (2,017)
     Merchandise inventories.................................    (2,370)    24,951    (54,409)
     Other current and long-term assets......................     9,420      4,997     (7,824)
Increase (decrease) in liabilities,
  excluding effect of business acquisition:
     Trade accounts payable and accrued expenses.............     5,951     (2,372)    16,039
     Other current and long-term liabilities.................    (4,669)     2,123     (5,306)
                                                               ---------  ---------  ---------
         Net cash provided by (used in) operating activities.    20,871     43,530    (31,326)

INVESTING ACTIVITIES:
Available-for-sale securities:
  Maturities.................................................  (383,147)  (345,638)  (330,131)
  Purchases..................................................   377,982    344,269    321,416
Purchases of property and equipment..........................    (8,279)   (18,683)   (29,635)
Acquisitions of assets and business..........................                         (19,522)
Proceeds from sale of lease rights, fixtures and equipment...     1,010      1,306
Proceeds from investment in limited partnership..............       216        194        194
                                                               ---------  ---------  ---------
        Net cash used in investing activities................   (12,218)   (18,552)   (57,678)

FINANCING ACTIVITIES:
Net proceeds (repayments) under retired revolving
  credit facility............................................             (112,828)    57,349
Net proceeds (repayments) from new revolving credit facility.   (37,062)    95,908
Proceeds from sale of credit card accounts receivable........   100,319         --         --
Net proceeds from 2000-1 Series Certificates.................        --      2,000     18,000
Principal payments on retired 1999-1 Series Certificate......   (53,000)        --         --
Principal payments on retired 2000-1 Series Certificate......   (20,000)        --         --
Proceeds from sale and leaseback transactions................     1,334      8,116         --
Proceeds from long-term obligations..........................    20,010      4,000     10,000
Principal payments on long-term obligations..................   (14,737)    (8,419)    (6,016)
Changes in cash management liability.........................    (1,195)    (7,610)    11,433
Debt issuance costs..........................................      (973)    (6,405)    (1,091)
Proceeds from sale of stock under employee
  stock purchase plan........................................       125        174        255
                                                               ---------  ---------  ---------
Net cash provided by (used in) financing activities..........    (5,179)   (25,064)    89,930
                                                               ---------  ---------  ---------
INCREASE (DECREASE) IN CASH..................................     3,474        (86)       926
CASH AT BEGINNING OF YEAR....................................     2,741      2,827      1,901
                                                               ---------  ---------  ---------
CASH AT END OF YEAR.......................................... $   6,215  $   2,741  $   2,827
                                                               =========  =========  =========
SUPPLEMENTAL SCHEDULE OF NON-CASH
 FINANCING ACTIVITIES:
  Acquisition of equipment under capital leases.............. $          $     233  $     411
                                                               =========  =========  =========

See notes to consolidated financial statements.

GOTTSCHALKS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

Gottschalks Inc. (the "Company") is a regional department and specialty store chain based in Fresno, California. As of February 1, 2003, the Company operated 69 full-line department stores located in six Western states, with 39 stores located in California, 17 in Washington, 6 in Alaska, 3 in Oregon and 2 in both Nevada and Idaho. The Company also operated 12 specialty stores which carry a limited selection of merchandise. The Company's department stores typically offer a wide range of better to moderate brand-name and private-label merchandise, including men's, women's, junior's and children's apparel, cosmetics, shoes and accessories, and also a wide array of home furnishings, including domestics, china, housewares, small electrics and, in certain locations, furniture and mattresses.

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

Principles of Consolidation - The accompanying financial statements include the accounts of Gottschalks Inc., and its wholly-owned subsidiary, Gottschalks Credit Receivables Corporation ("GCRC") (collectively, the "Company"). All significant intercompany transactions and balances have been eliminated in consolidation.

Fiscal Year - The Company's fiscal year ends on the Saturday nearest January 31. Fiscal years 2002, 2001 and 2000 ended on February 1, 2003, February 2, 2002 and February 3, 2001, respectively. Fiscal 2002 and 2001 each included 52 weeks. Fiscal 2000 included 53 weeks.

Revenue Recognition - Net retail sales are recorded at the point-of-sale and include sales of merchandise, net of estimated returns and exclusive of sales tax. Net retail sales also include all amounts billed to customers for shipping and handling, including customer delivery charges. Revenues on special order sales are recognized when the merchandise is delivered to the customer and has been paid for in its entirety. The Company does not sell merchandise on layaway.

Net leased department revenues consist of rental income from lessees and sub-lessees. Sales generated in such leased departments totaled $24,878,000, $28,933,000 and $27,738,000 in 2002, 2001 and 2000, respectively.

Transfers and Servicing of Financial Assets - On January 31, 2003, the Company terminated its receivables securitization program and sold substantially all of its customer credit card receivables to Household Bank (SB), N.A. ("Household") (Note 2).

At that time the Company also entered into an interim servicing agreement to service the receivables on behalf of Household until such time as they are able to convert the accounts to their systems and a program agreement whereby the Company will participate in revenues generated from the portfolio. The transaction was accounted for as a sale of financial assets in accordance with Statement of Financial Accounting Standards ("SFAS") No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". Servicing fees to be received under the interim servicing agreement are considered to approximate the fair value of the cost to service the receivables during the interim servicing period, expected to be not more than 120 days, resulting in no servicing asset or liability. A portion of the program fees to be paid represents residual interest in the assets transferred at the time of the transaction. Accordingly, the Company recorded an interest only strip in the amount of $312,000 that will be amortized as a charge to results of operations over the estimated life of the underlying assets sold on the transaction date.

Prior to January 31, 2003, the Company accounted for the transfer and sale of receivables pursuant to its receivables securitization program in accordance with SFAS No. 140. SFAS No. 140 required the Company to recognize gains and losses on transfers of financial assets (securitizations) that qualified as sales and to recognize as assets certain financial components that were retained as a result of such sales, which consisted primarily of the retained interest in receivables sold and the retained rights to future interest income from the serviced assets in excess of the contractually specified servicing fee (interest-only strips). The estimated cost to service the assets was equal to the contractually specified servicing fee, resulting in no servicing asset or liability at February 2, 2002.

The retained interest in receivables sold was initially recorded at the date of the sale by allocating the previous carrying amount between the assets sold and the retained interests based on their relative fair values. Any gain or loss on the sale was dependent upon the allocation of the previous carrying amount of the receivables sold to the retained interests. Retained interests were subsequently carried at their respective fair values, which were estimated based upon the present value of the expected future cash flows, calculated using management's best estimates of key assumptions about anticipated credit losses, account repayment speeds, discount rates and other factors necessary to derive estimates of fair value.

The certificated portion of the retained interest was considered readily marketable and was classified as available-for-sale in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Due to the short-term revolving nature of the credit card portfolio, the carrying value of the Company's retained interest approximated its fair value, resulting in no unrealized gains or losses.

Receivables - As of February 1, 2003, receivables consist of vendor claims. As of February 2, 2002, receivables consist primarily of customer credit card receivables that did not meet certain eligibility requirements of the Company's receivables securitization program and vendor claims (Note 2).

Merchandise Inventories - Inventories, which consist of merchandise held for resale, are valued by the retail method and are stated at last-in, first-out (LIFO) cost, which is not in excess of market. Current cost, which approximates replacement cost, under the first-in, first-out (FIFO) method is equal to the LIFO value of inventories at February 1, 2003 and February 2, 2002. The Company includes in inventory the capitalization of certain indirect buying handling and distribution costs to better match these costs with the related sales.

Store Closure Costs - In the event a store is closed before its lease has expired, the remaining lease obligation after the closing date (less anticipated sublease rental income or proceeds from lease settlements, if any), asset impairment charges related to furniture, fixtures and equipment, leasehold improvements, goodwill and leasehold interests are expensed in the period in which management determines to close it. Severance and other incremental costs associated with a store closure are expensed as incurred.

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

Property and Equipment - Property and equipment is stated on the basis of cost or appraised value as to certain contributed land. Depreciation and amortization is computed by the straight-line method for financial reporting purposes over the shorter of the estimated useful lives of the assets or the lease term, which range from 20 to 40 years for buildings and leasehold improvements and 3 to 15 years for furniture, fixtures and equipment. The amortization of buildings and equipment under capital leases is computed by the straight-line method over the term of the lease or the estimated economic life of the asset, depending on the criteria used to classify the lease, and such amortization is combined with depreciation in the accompanying income statements. Maintenance and repairs are charged to expense as incurred and major improvements are capitalized.

Software Development Costs - Costs associated with the acquisition or development of software for internal use that meet the criteria of AICPA Statement of Position No. 98-1, "Accounting for Costs of Computer Software Developed or Obtained for Internal Use" are capitalized and amortized over the expected useful life of the software, which generally ranges from 3 to 10 years. Software development costs capitalized under SOP No. 98-1 in fiscal 2002 and 2001 totaled $673,000 and $1,057,000, respectively. No such costs were capitalized in 2000. In 2002, the Company completed and placed in service all information systems projects to which such costs were capitalized and commenced the amortization of such costs over their estimated useful lives at that time. Amortization of such costs in fiscal 2002 was $260,000. There was no amortization of software development costs in 2001 or 2000.

Goodwill - The Company adopted the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets" effective the beginning of fiscal 2002 and discontinued the amortization of previously recorded goodwill as of that date (Note 5). During the first six months of fiscal 2002, as required by the statement, the Company performed an initial impairment review of goodwill. The Company also performed the required annual impairment review of goodwill for fiscal 2002. As a result of these reviews, the Company concluded that there was no impairment charge as of the respective measurement dates.

Leasehold Interests - Leasehold interests associated with acquired leases are amortized on a straight-line basis over the respective lease terms, including option renewal periods if renewal of the lease is probable, which range from 1 to 40 years.

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

Deferred Income - Deferred income consists primarily of donated land and cash incentives received to construct a store and enter into a lease arrangement, and the prepaid program fee arising from the receivables sale to Household. Land contributed to the Company is included in land and recorded at appraised fair market values. Deferred income relating to contributed land is amortized over the average depreciable life of the related fixed assets built on the land for locations that are owned by the Company, and over the minimum lease periods of the related building leases with respect to locations that are leased by the Company, ranging from 10 to 32 years. Beginning in fiscal 2003, the prepaid program fee will be amortized over the five-year term of the program agreement. Deferred income, net of accumulated amortization, totaling $14,837,000 and $13,340,000 as of February 1, 2003 and February 2, 2002, respectively, is included in other long-term liabilities.

Deferred Lease Payments - Certain of the Company's department store operating leases provide for rent abatements and scheduled rent increases during the lease terms. The Company recognizes rental expense for such leases on a straight-line basis over the respective lease terms and records the difference between rental expense and amounts paid under the leases as deferred lease payments. Deferred lease payments, totaling $3,778,000 at February 1, 2003 and $4,162,000 at February 2, 2002, are included in other liabilities.

Advertising Costs - Advertising costs, totaling $31,245,000, $33,053,000 and $30,111,000 in 2002, 2001 and 2000, respectively, are included in selling, general and administrative expenses for financial reporting purposes and are expensed when the related advertisement first takes place. Cash payments and credits received from vendors to reimburse advertising costs are recorded as reductions of advertising costs.

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

Stock-Based Compensation - At February 1, 2003, the Company has two stock-based employee compensation plans, which are more fully described in Note 13. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of the grant.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation. The Company's calculations were made using the Black-Scholes option pricing model, which is more fully described in Note 13.

(In thousands, except per share data)               2002       2001       2000
- -----------------------------------------------   --------   --------   --------
Net income (loss) as reported.................. $ (11,973) $     425  $   7,079
Deduct: Total stock-based compensation expense
  determined under fair value based method
  for all awards, net of related tax effects...      (347)      (527)      (823)
                                                  --------   --------   --------
Pro forma net income (loss).................... $ (12,320) $    (102) $   6,256
                                                  ========   ========   ========

Earnings (loss) per share (basic and diluted):
  As reported.................................. $   (0.94) $    0.03  $    0.56
  Pro-forma.................................... $   (0.97) $   (0.01) $    0.50

Long-Lived Assets - The Company periodically evaluates the carrying value of long-lived assets to be held and used, including intangible assets other than goodwill, when events and circumstances warrant such a review. When the anticipated undiscounted cash flow from a long-lived asset is less than its carrying value, a loss is recognized based on the amount by which its carrying value exceeds its fair market value. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risks involved, and in some cases, the expected proceeds from the sale or sublease of a particular asset, or independent appraisals. In 2002, the Company recognized asset impairment charges of $10,867,000 relating to underperforming stores (Note 10) and $3,158,000 in connection with the closure of six stores (Note 9). In 2001, the Company recognized asset impairment charges of $775,000 in connection with the closure of six stores (Note 9). There were no asset impairment charges recognized in 2000.

Fair Value of Financial Instruments - The carrying value of the Company's cash and cash management liability, receivables, notes receivable, the interest only strip arising from the sale of receivables to Household, trade payables and other accrued expenses, revolving line of credit and letters of credit approximate their estimated fair values because of the short maturities or variable interest rates underlying those instruments. The retained interest in receivables sold, the retained right to future interest income under the securitization program (interest-only strip) and the Subordinated Note are carried at their estimated fair values. The following methods and assumptions were used to estimate the fair values for each remaining class of financial instruments:

Derivatives - Effective the beginning of 2001, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities". SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133 requires the recognition of all derivative instruments as either assets or liabilities in the balance sheet measured at fair value. SFAS No. 133 also establishes criteria for a derivative to qualify as a hedge for accounting purposes. The adoption of SFAS No. 133 did not have a significant impact on the Company's financial position, results of its operations or its cash flows.

Segment Reporting - The Company operates in one reportable segment.

Comprehensive Income - There were no items of other comprehensive income in 2002, 2001 or 2000, and therefore net income is equal to comprehensive income for each of those years.

Recently Issued Accounting Standards - In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The Company will adopt SFAS No. 143 effective the beginning of fiscal 2003 and does not currently expect that its adoption will have a significant effect on the Company's financial position or its results of operations.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145, among other things, eliminates the prior requirement that all gains and losses from the early extinguishment of debt were to be classified as an extraordinary item. Upon adoption of SFAS No. 145, gains and losses from the early extinguishment of debt are now classified as an extraordinary item only if they meet the "unusual and infrequent" criteria contained in Accounting Principles Board Opinion ("APBO") No. 30. In addition, upon adoption of SFAS No. 145, all gains and losses from the early extinguishment of debt that had previously been classified as an extraordinary item are to be reassessed to determine if they would have met the "unusual and infrequent" criteria of APBO No. 30. Any such gain or loss that would not have met the APBO No. 30 criteria is retroactively reclassified and reported as a component of income before extraordinary item. The Company has determined that its previously-recognized loss from the early extinguishment of debt that occurred in fiscal 2001 would not have met the APBO No. 30 criteria for classification as an extraordinary item, and accordingly such previously-reported loss from the early extinguishment of debt has been retroactively reclassified and is now reported as a component of income before income taxes. The Company has also determined that the fiscal 2002 loss from the early extinguishment of debt does not meet the APBO No. 30 criteria for extraordinary item classification, and accordingly such 2002 loss is reported as a component of income before income taxes.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost was recognized at the date of the Company's commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized. The Company will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002.

In November 2002, the Emerging Issues Task Force ("EITF") of the FASB issued EITF Issue No. 02-16, "Accounting by a Reseller for Cash Consideration Received from a Vendor". The Company will adopt the provisions of EITF 02-16 effective with the beginning of fiscal 2003 and does not expect its adoption will have a significant impact on the Company's financial position or results of operations.

Reclassifications - Certain amounts in the accompanying 2001 and 2000 consolidated financial statements have been reclassified to conform with the 2002 presentation.

On January 31, 2003, pursuant to the terms of a Purchase and Sale Agreement between the Company and Household, the Company sold substantially all of its private label credit card accounts and the related accounts receivable to Household. The $102,819,000 purchase price was paid in cash at closing, $100,319,000 of which was allocated to the purchase of such credit card accounts and receivables and $2,500,000 of which comprised prepaid program revenue. Proceeds from the sale were used to pay in full $73,225,000 principal and accrued interest due to the Series 1999-1 and Series 2000-1 certificateholders under the Company's accounts receivable securitization program plus $3,362,000 in prepayment penalties. The remaining proceeds of $26,233,000 and $3,845,000 of cash remaining on deposit in certain bank accounts relating to the securitization was released to the Company at closing. All of the $30,078,000 released to the Company was applied as a reduction of outstanding borrowings under the Company's revolving credit facility. Concurrently, the Company's obligation to sell its accounts receivable to the securitization trust was terminated pursuant to Amendment No. 1 to the Amended and Restated Receivables Purchase Agreement between the Company and GCRC. Fiscal 2002 results of operations include a charge for receivables sale costs of $1,749,000.

In connection with the sale, on January 31, 2003 the Company entered into two additional agreements with Household: an Interim Servicing Agreement (the "ISA") and a Credit Card Program Agreement (the "CCA"). Under the terms of the ISA, the Company will continue to service the credit card receivables until such time that Household takes over their servicing (the "Conversion Date"). The planned Conversion Date is currently May 14, 2003, but such date may be extended to June 1, 2003 upon notice from Household to the Company. Household is compensating the Company for providing the services during the interim servicing period. The Company believes this compensation will at least be equal to the cost of providing such services.

The CCA sets forth the terms and conditions under which Household will issue credit cards to the Company's customers and pay the Company for sales made on the cards. Under the terms of the CCA, the Company is required to perform certain duties, including the duties to receive in-store customer payments on behalf of Household and remit such payments to Household. The CCA has a term of five (5) years and is cancelable earlier by either party under certain circumstances. The CCA further provides the Company will be paid a percentage of Net Cardholder Charges and a percentage of Other Revenue (each as defined in the CCA). The Company believes the amounts received under the CCA, including the amortization of the prepaid program revenue, will equal or exceed the net revenues from its former in-house credit card operations, net of operating expenses and interest expense.

In connection with the sale the Company recorded receivable sale transaction costs of $2,062,000 including consulting, legal, and other fees, and the net non-cash write-off of the remaining accounts of GCRC. These charges are partially offset by a $313,000 interest only strip that will be amortized over the estimated life of the underlying assets sold (estimated to be approximately five months). The interest only strip represents the portion of the initial program fees to be received that is considered a residual interest in the assets sold.

In addition to the receivable sale transaction costs, the Company recorded a loss on the extinguishment of debt of $3,695,000 arising from securitization program prepayment penalties and the write-off of unamortized deferred loan fees related to the program.

Prior to the termination of the receivables securitization program on January 31, 2003, the Company conveyed all of its accounts receivable arising under its private label customer credit cards on a daily basis to its wholly-owned subsidiary, GCRC. Those receivables that met certain eligibility requirements of the program were simultaneously conveyed to Gottschalks Credit Card Master Trust ("GCC Trust"), to be used as collateral for securities issued to investors. GCC Trust was a qualified special purpose entity under SFAS No. 140, and was not consolidated in the Company's financial statements. The transfer of receivables under the program were accounted for as sales for financial reporting purposes under SFAS No. 140, and as such, the transferred receivables were removed from the Company's balance sheet at the time of the transfer. Securities issued under the program were issued by GCC Trust, which was not consolidated in the Company's financial statements. Certain of the securities issued by GCC Trust represented the Company's retained interest in the receivables sold. The Company also retained receivables that were ineligible for transfer to GCC Trust. The Company serviced and administered the portfolio for a 3% per annum monthly servicing fee, which totaled $2,301,000 in 2002, $2,254,000 in 2001 and $1,926,000 in 2000. Under the program, monthly cash flows generated by the Company's credit card portfolio, consisting of principal and interest collections, were first used to pay certain costs of the program, which included the payment of principal (when required) and interest to the investors, and monthly servicing fees to the Company. Any excess cash flows were then available to fund additional purchases of newly generated receivables, ultimately serving as a source of working capital financing for the Company.

On March 1, 1999, GCC Trust issued a $53.0 million principal amount 7.66% Fixed Base Class A-1 Credit Card Certificate (the "1999-1 Series Certificate") to a single investor through a private placement. Interest on the 1999-1 Series Certificate was earned by the certificate holder on a monthly basis at a fixed interest rate of 7.66%.

On November 16, 2000, GCC Trust issued a $24.0 million Variable Base Class A-1 Credit Card Certificate (the "2000-1 Series Certificates"). Upon the expiration of the original 2000-1 Series Certificate, GCC Trust issued two new 2000-1 Series Certificates on November 15, 2001 in an aggregate principal amount of up to $20.0 million. The Company borrowed against the 2000-1 Series Certificates on a revolving basis, similar to a revolving line of credit arrangement, and such borrowings bore interest at variable rates equal to the one-month LIBOR rate plus 2.75%, with a minimum rate of 5.0%. Borrowings against the Series 2000-1 Certificates were limited to a specified percentage of the outstanding balance of receivables underlying the certificates, and therefore varied depending on seasonal fluctuations in the underlying receivables.

The Company retained a beneficial ownership interest in certain of the receivables transferred under the program, represented by Exchangeable and Subordinated Certificates, and also retained an uncertificated ownership interest in the retained right to receive future interest income (interest-only strip) and other receivables that did not meet certain eligibility requirements of the program. These retained interests were pledged as collateral under the Company's senior revolving credit facility (see Note 6). The fair value of the retained interests totaled $19,222,000 at February 2, 2002.

As of February 2, 2002, the outstanding balance of the serviced portfolio totaled $94,829,000, with $3,442,000 of that amount in delinquency as of that date. Delinquent receivables are defined as any account for which the required minimum payment has not been received for more than 30 days. Credit losses as a percentage of net sales were 0.69%, 0.64% and 0.55% in 2002, 2001 and 2000, respectively.

Receivables, including customer credit card receivables that did not meet certain eligibility requirements of the receivables securitization program, and receivables from vendors, consists of the following:

                                                    February 1, February 2,
(In thousands)                                         2003        2002
- --------------------------------------------------  ----------  ----------
Credit card receivables........................... $       --  $    3,942
Vendor claims.....................................     10,722       7,834
                                                    ----------  ----------
                                                       10,722      11,776

Less allowance for doubtful accounts..............        (81)       (445)
                                                    ----------  ----------
                                                   $   10,641  $   11,331
                                                    ==========  ==========

Net credit revenues associated with the Company's credit card receivable portfolio, including securitized receivables, consists of the following:

(In thousands)                                   2002        2001        2000
- --------------------------------------------  ----------  ----------  ----------
Service charge revenues..................... $   17,813  $   17,817  $   16,832
Interest expense on securitized receivables.     (4,863)     (4,902)     (4,425)
Charge-offs on receivables sold and
  provision for credit losses on
  receivables ineligible for sale...........     (4,821)     (4,550)     (3,642)
Gain on sale of receivables.................         96          55         385
                                              ----------  ----------  ----------
                                             $    8,225  $    8,420  $    9,150
                                              ==========  ==========  ==========

Property and equipment consists of the following:

                                              February 1, February 2,
(In thousands)                                   2003        2002
- --------------------------------------------  ----------  ----------
Furniture, fixtures and equipment........... $  113,188  $  112,003
Buildings and leasehold improvements........     84,545      87,426
Land........................................     15,185      15,185
Buildings and equipment under
  capital leases............................     18,720      17,954
Construction in progress....................      1,223       4,553
                                              ----------  ----------
                                                232,861     237,121
Less accumulated depreciation
  and amortization..........................    (92,973)    (83,921)
                                              ----------  ----------
                                             $  139,888  $  153,200
                                              ==========  ==========

The Company adopted the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets" effective February 3, 2002 and discontinued the amortization of previously recorded goodwill as of that date. Previously recorded goodwill arising from the Lamonts acquisition in 2000 of $0.6 million as of February 2, 2002, has been reallocated to property and equipment. The remainder of the Company's previously recorded goodwill, net of accumulated amortization, totaled $7.6 million as of February 2, 2002. The majority of goodwill arose from the acquisition of nine stores (one of which was subsequently closed as planned) in a business combination which occurred in 1998 and the remainder was attributable to a store acquired in a business combination which occurred in 1987. These acquired stores had a history of profitability prior to their acquisition and have continued to generate operating profit in excess of the Company average store operating profit.

The Company has completed step one of the two-step process prescribed by SFAS No. 142 to test its previously recorded goodwill for impairment and has determined that each store location represents a reporting unit for such purpose. As part of this process the Company allocated associated goodwill to relevant reporting units. The Company engaged an independent third party to provide estimates of the fair value of the reporting units and compared such estimated fair values to the net carrying values of the reporting units. As a result of this process the Company concluded that there was no impairment as of the measurement dates of February 2, 2002 and November 2, 2002. In addition there have been no events or changes in circumstances since November 2, 2002 that would indicate that a potential impairment has arisen. Accordingly, step two of the SFAS No. 142 process is unnecessary.

The following table shows the pro-forma effect for 2001 and 2000 of no longer amortizing goodwill:

(In thousands, except per share data)             2002       2001       2000
- ---------------------------------------------   --------   --------   --------
Net income (loss):
   Net income (loss) as reported............. $ (11,973) $     425  $   7,079
   Goodwill amortization, net of related
    income tax benefit.......................        --        350        342
                                                --------   --------   --------
Adjusted net income (loss)................... $ (11,973) $     775  $   7,421
                                                ========   ========   ========

Net income (loss) per share (basic and diluted):
   Net income (loss) as reported............. $   (0.94) $    0.03  $    0.56
   Goodwill amortization, net of related
    income tax benefit.......................        --       0.03       0.03
                                                --------   --------   --------
Adjusted net income (loss)................... $   (0.94) $    0.06  $    0.59
                                                ========   ========   ========

SFAS No. 142 also requires disclosure of intangible assets which are subject to amortization. As of February 1, 2003 and February 2, 2002, the following lease-related interests are classified as intangible assets:

                                                    February 1, February 2,
(In thousands)                                         2003        2002
- --------------------------------------------------  ----------  ----------
Intangible assets - leasehold interests........... $      509  $    9,940
Accumulated accretion (amortization)..............        149        (792)
                                                    ----------  ----------
Net............................................... $      658  $    9,148
                                                    ==========  ==========

These leasehold interests relate to leases purchased in the Lamonts acquisition which were adjusted to reflect fair value. The underlying leases had lives of three to forty years. The decrease in leasehold interests in fiscal 2002 is primarily attributable to asset impairment charges and, to a lesser extent, store closing costs (see Notes 9 and 10).

During 2002, 2001 and 2000, amortization expense related to certain of these leasehold interests was $535,000, $424,000 and $113,000, respectively, net of accretion related to certain of these leasehold interests of $273,000, $341,000, and $298,000, respectively. The Company anticipates amortization on certain of these intangible assets of $57,000 in each of fiscal years 2003 through 2007. Additionally, the Company anticipates accretion on certain of these intangible assets of approximately $96,000 in 2003, $92,000 in 2004 and $86,000 in each of fiscal years 2005 through 2007.

Trade accounts payable and accrued expenses consist of the following:

                                              February 1, February 2,
(In thousands)                                   2003        2002
- --------------------------------------------  ----------  ----------
Trade accounts payable...................... $   22,648  $   19,761
Cash management liability...................     15,005      13,850
Accrued expenses............................     23,010      22,303
Accrued payroll and related liabilities.....      7,179       7,870
Taxes, other than income taxes..............     12,115      11,503
Federal and state income taxes payable......         16       2,670
                                              ----------  ----------
                                             $   79,973  $   77,957
                                              ==========  ==========

On February 1, 2002, the Company finalized a three-year senior revolving credit facility with General Electric Capital Corporation ("GE Capital") as agent, and The CIT Group/Business Credit as syndication agent (the "GE facility"). The GE facility replaced the Company's previous revolving credit facility, which was scheduled to expire on March 31, 2002. The GE facility provides up to $165.0 million of working capital financing through January 31, 2005, with $159.0 million provided under a Tranche A revolving credit facility (including a $20.0 million letter of credit sub-facility) and the remaining $6.0 million provided through a fully funded Tranche B facility. Borrowings under the facility are limited to the lesser of specified percentages of (i) the cost of eligible inventory and (ii) the net recovery value of the inventory, as determined by a monthly valuation performed by an independent appraiser. Such borrowings are further limited by a requirement to maintain a minimum of $10.0 million of excess availability at all times, and other reserves that are in effect. As of February 1, 2003, outstanding borrowings under the facility totaled $58.8 million , and excess borrowing availability under the facility, after the deduction of the minimum availability requirement and other reserves, totaled $36.9 million. The Company classified a total of $30.0 million and $75.0 million as of February 1, 2003 and February 2, 2002, respectively, as long-term in the accompanying financial statements, representing that portion of outstanding borrowings under the facility which are not expected to be repaid within one year of the respective balance sheet dates. Initial proceeds from the GE facility were used to repay all outstanding borrowings under the previous revolving credit facility, including a prepayment penalty, and other transaction fees and costs. Fiscal 2001 results of operations include a $696,000 charge for the prepayment penalty and the write-off of unamortized loan fees related to the early retirement of the previous credit facility. Substantially all of the Company's assets, including its merchandise inventories, are pledged to GE Capital under this facility.

As of February 1, 2003, interest charged on amounts borrowed under the Tranche A revolving facility were at the prime rate plus 0.5% per annum (4.75% at February 1, 2003), or at the Company's option, at the applicable LIBOR rate plus 2.75.% per annum (4.11% at February 1, 2003). In addition, the Company pays an unused commitment fee equal to 0.375% per annum on the average unused daily balance of the Tranche A facility. Amounts borrowed under the Tranche B facility bear interest at prime plus 10%, or at the Company's option, at LIBOR plus 12.0%. Beginning in fiscal 2003, the interest rate applicable to the Tranche A facility may be adjusted upwards or downwards on a quarterly basis based on a pricing matrix which is tied to the Company's Leverage Ratio (as defined in the agreement). Under the pricing matrix, the applicable interest rate can range from a rate as low as prime plus 0.00% or LIBOR plus 2.75%, to as high as prime plus 0.75%, or LIBOR plus 3.50%.

The GE facility contains restrictive financial and operating covenants, including the requirement to maintain a minimum twelve-month trailing EBITDA and a minimum accounts payable to inventory ratio. In addition, the GE facility also does not permit the repayment of the Subordinated Note on its scheduled maturity date of August 20, 2003, which has resulted in the maturity of that note automatically being extended to August 20, 2006. As of February 1, 2003, management believes the Company was in compliance with all restrictive financial covenants applicable to the GE facility.

Long-term obligations consist of the following:

                                              February 1, February 2,
(In thousands)                                   2003        2002
- --------------------------------------------  ----------  ----------
Revolving line of credit.................... $   30,000  $   75,000
9.39% mortgage loans payable, due 2010......     17,926      18,302
12.0% note payable, due 2005................     14,200          --
Capital lease obligations...................     10,613      12,156
Variable rate note payable, due 2005........      3,700          --
Variable rate note payable, due 2003
 (repaid March 2002)........................         --       5,278
Variable rate mortgage loan payable, due
  2003 (repaid March 2002)..................         --       3,533
9.97% mortgage loan payable, due 2004.......
 (repaid March 2002)........................         --       1,857
Other mortgage loans and notes payable......      3,347       2,353
                                              ----------  ----------
                                             $   79,786  $  118,479
  Less current portion......................      4,689       8,263
                                              ----------  ----------
                                             $   75,097  $  110,216
                                              ==========  ==========

On March 22, 2002, the Company entered into a $15.0 million financing with Kimco Capital Corp. (the "Kimco facility"). The Kimco facility is secured by first priority liens on three of the Company's owned stores and with subordinate liens on substantially all other assets of the Company securing the GE facility. Proceeds from the Kimco facility were used to repay previously existing mortgage loans on two of those properties and one term loan and to pay certain fees and costs associated with the transaction. The remaining $4.1 million of proceeds was used to reduce outstanding borrowings under the GE facility. The Kimco facility is co-terminus with the GE facility, with monthly principal payments of $80,000 plus interest at a fixed rate of 12% per annum, and a balloon payment upon maturity on January 31, 2005 of $12.4 million. In addition, on February 19, 2002, the Company completed a $1.0 million seven-year term loan financing of its corporate aircraft.

On May 24, 2002, the Company completed the financing of its ownership interest in the partnership that owns the Company's corporate headquarters. Proceeds from this transaction, totaling $3.7 million, were used to reduce outstanding borrowings under the GE facility. The related note payable bears interest at a variable rate of prime plus 1.5% per annum (5.75% at February 1, 2003), which is payable monthly. The $3.7 million principal portion of the note payable is due in full upon maturity on May 24, 2005.

The scheduled annual principal maturities of the Company's mortgage loans and notes payable are $1,719,000, $1,841,000, $16,924,000, $905,000 and $976,000 for 2003 through 2007, with $16,808,000 payable thereafter.

Deferred debt issuance costs related to the Company's various financing arrangements are included in other current and long-term assets and are charged to income as additional interest expense over the life of the related indebtedness. Such costs, net of accumulated amortization, totaled $4,481,000 at February 1, 2003 and $6,389,000 at February 2, 2002.

Interest paid, net of amounts capitalized, was $18,041,000 in 2002, $17,395,000 in 2001 and $17,713,000 in 2000. Capitalized interest expense was $159,000 in 2002, $209,000 in 2001 and $360,000 in 2000. The weighted- average interest rate charged on the Company's revolving line of credit was 5.47% in 2002, 5.48% in 2001 and 8.76% in 2000.

Substantially all of the Company's assets, including its merchandise inventories, are pledged as collateral under the Company's various debt agreements. Certain of the Company's long-term debt agreements contain financial and other restrictive covenants, as well as cross default provisions. Accordingly, the failure to comply with these restrictions and covenants, if not waived, would cause a cross-default under the majority of all of the Company's debt agreements, including the GE facility. Management believes the Company was in compliance with all applicable financial covenants as of February 1, 2003.

The Company issued a Subordinated Note to Harris in the principal amount of $22,179,000 on August 20, 1998 as partial consideration for the Harris acquisition. (See Note 15.) The Subordinated Note, discounted to an effective interest rate of 10% at issuance, bears interest at a fixed rate of 8%, which is payable semi-annually. The principal portion of the Subordinated Note was originally due and payable on August 20, 2003, unless such payment would result in a default on any of the Company's other credit facilities, in which case its maturity would automatically be extended by three years to August 2006. Because the GE facility does not permit the repayment of the Subordinated Note on its scheduled maturity date of August 20, 2003, its maturity date was extended to August 20, 2006. The Subordinated Note is unsecured, contains no restrictive financial covenants and is subordinate to the payment of all debt, including trade credit, of the Company. The discount on the Subordinated Note is being amortized as additional interest expense over the term of the note. The unamortized discount totaled $191,000 as of February 1, 2003 and $534,000 as of February 2, 2002. Interest paid to Harris totaled $2,117,000 in 2002, 2001 and 2000, respectively.

The Company leases certain retail department stores, specialty stores, land, furniture and fixtures and equipment under capital and noncancellable operating leases that expire in various years through 2021. Certain of the leases provide for the payment of additional contingent rentals based on a percentage of sales, require the payment of property taxes, insurance and maintenance costs and have renewal options for one or more periods ranging from five to twenty years. The Company leases three of its department stores from El Corte Ingles ("ECI") of Spain. ECI is the parent company of Harris, and both Harris and ECI are affiliates of the Company. (See Note 15.) Rent paid or accrued to ECI totaled $864,000 in 2002, $872,000 in 2001 and $886,000 in 2000.

Future minimum lease payments as of February 1, 2003, by year and in the aggregate, under capital leases and noncancellable operating leases with initial or remaining terms in excess of one year are as follows:

                                               Capital    Operating
(In thousands)                                  Leases      Leases
- --------------------------------------------  ----------  ----------
2003........................................ $    3,900  $   24,820
2004........................................      2,589      24,004
2005........................................      2,207      22,458
2006........................................      1,466      21,658
2007........................................        947      18,644
Thereafter..................................      3,156      88,450
                                              ----------  ----------
Total minimum lease payments................     14,265  $  200,034
  Amount representing interest..............     (3,652)  ==========
                                              ----------
Present value of minimum lease payments.....     10,613
  Less current portion......................     (2,970)
                                              ----------
                                             $    7,643
                                              ==========

Rental expense consists of the following:

(In thousands)                                   2002        2001        2000
- --------------------------------------------  ----------  ----------  ----------
Operating leases:
  Buildings:
    Minimum rentals......................... $   17,206  $   17,052  $   15,946
    Contingent rentals......................      3,016       3,074       2,994
  Fixtures and equipment....................      1,618       1,972       2,342
                                              ----------  ----------  ----------
                                             $   21,840  $   22,098  $   21,282
                                              ==========  ==========  ==========

One of the Company's lease agreements contains a restrictive financial covenant pertaining to the debt to tangible net worth ratio with which management believes the Company was in compliance at February 1, 2003.

On July 24, 2000, the Company entered into a definitive asset purchase agreement (the "Agreement") with Lamonts Apparel, Inc. ("Lamonts"). The Agreement, as subsequently amended, provided for the Company to acquire 37 of Lamonts' 38 store leases, related store fixtures and equipment, and one store building for a cash purchase price of $20,100,000. Concurrent with the closing of the transaction on July 24, 2000, the Company sold one of the store leases for $2,500,000, and subsequently terminated two other store leases, resulting in a net cash purchase price of $17,600,000 for 34 store leases, related store fixtures and equipment, and one store building. The Company did not acquire any of Lamonts' merchandise inventory, customer credit card receivables or other corporate assets in the transaction, nor did the Company assume any material liabilities, other than the 34 store leases. The 34 stores are located in five Western states, with 19 stores in Washington, seven in Alaska, five in Idaho, two in Oregon and one in Utah. The newly acquired stores were converted to the Gottschalks banner, re-merchandised and re-opened in stages beginning in late August, with all stores completely open by September 7, 2000. The Company incurred $5,632,000 in 2000 of non-recurring new store pre-opening costs in connection with the re-opening of the stores.

The $17,600,000 net cash purchase price for the assets was partially financed with proceeds from a $10,000,000 note payable, with the remainder provided from the Company's revolving credit facility. Direct transaction costs include investment banking, legal and accounting fees and other costs. The asset acquisition was accounted for under the purchase method of accounting and, accordingly, the results of operations of the acquired stores are included in the Company's financial statements from the acquisition date of July 24, 2000.

The purchase price was allocated to the acquired assets on the basis of their estimated fair values as of the date of the acquisition, as follows (in thousands):

       Fair value of note payable................. $   10,000
       Cash.......................................      7,580
       Direct transaction costs...................      1,942
                                                    ----------
          Total purchase price.................... $   19,522
                                                    ==========


       Favorable lease rights..................... $    9,857
       Property and equipment.....................      9,000
       Goodwill...................................        665
                                                    ----------
          Total purchase price.................... $   19,522
                                                    ==========

The Company closed six of the 34 acquired stores during the second quarter of 2001 that were determined to be either underperforming or inconsistent with the long-term operating strategy of the Company. One of those stores was subsequently re-opened in the third quarter of fiscal 2001. As planned, the Company also discontinued the use of an outsourced distribution center facility located in Kent, Washington, in June 2001 and consolidated all of the Company's distribution functions into its distribution facility in Madera, California. One additional store was closed in January 2002. Net costs associated with closure of those stores and the outsourced distribution center facility totaled $729,000. This amount consists of estimated lease termination costs, non-cash asset impairment charges (including the write-off of allocated goodwill and leasehold interests), severance and other incremental costs associated with the closure of the stores totaling $2,035,000, less $1,306,000 of cash proceeds received as a result of the sale of lease rights, fixtures and equipment.

In June and December, 2002, the Company developed plans for the closure of another eight of the acquired stores. These stores were also determined to be either underperforming or inconsistent with the Company's long-term operating strategy. Two of these stores were closed in each of June 2002, January 2003 and February 2003 and one store was closed in each of March 2003 and April 2003. Net costs associated with the closure of these stores totaled $3,436,000. This amount consists of estimated lease termination costs, non-cash asset impairment charges, severance and other incremental costs associated with the store closings totaling $4,486,000, less $1,050,000 of cash proceeds received from the sale of lease rights and fixtures and equipment. After the eight store closures are completed, the Company will continue to operate 20 of the original 34 stores acquired from Lamonts. However, certain of those stores have continued to perform below expectations.

In the event the Company is unable to improve the operating performance of the remaining underperforming stores, the Company may consider the sale, sublease or closure of those stores in the future. In the past, the Company has successfully improved the operating results and cash flows of other underperforming stores through a variety of strategies, including revising the merchandise mix, changing store management, revising marketing strategies, renegotiating lease agreements and reducing operating costs. However, there can be no assurance that these strategies will improve the operating results and cash flows of those remaining underperforming stores, or that the Company will be able to sell, sublease or close those stores in the event their performance does not improve. In addition, the Company may incur certain costs and expenses in connection with the sale or closure of those locations that may not be fully offset by sale proceeds, sublease income or favorable lease terminations.

As of February 1, 2003, the Company had a reserve for store closure costs totaling $618,000, which consisted primarily of estimated future lease obligations for two of the store locations closed in fiscal 2001 and the four locations closed fiscal 2003. In the event the Company is not successful in selling or subleasing the two locations closed in fiscal 2001 as soon as management expects, additional reserves for store closure costs may be recorded. In addition, in the event the Company decides to close additional store locations in fiscal 2003 or beyond, additional reserves for store closure costs, which may be material, may be incurred.

During 2002, the Company recorded non-cash asset impairment charges of $10.9 million to write down long-lived assets related to certain underperforming stores, primarily former Lamonts locations. These charges consisted of $4.3 million of property and equipment, $6.5 million of leasehold interests and $0.1 million of goodwill. The charges were determined by comparing projected net operating cash flows, including estimated proceeds from the sale of certain assets, to the carrying value of the stores' long-lived assets. No such costs were recorded in 2001.

The components of income tax expense (benefit) are as follows:

(In thousands)                                   2002        2001        2000
- --------------------------------------------  ----------  ----------  ----------
Current:
  Federal................................... $   (5,394) $      127  $      302
  State.....................................       (783)        439         550
                                              ----------  ----------  ----------
                                                 (6,177)        566         852
                                              ----------  ----------  ----------
Deferred:
  Federal...................................     (3,115)         81       3,548
  State.....................................        502        (381)        (26)
                                              ----------  ----------  ----------
                                                 (2,613)       (300)      3,522
                                              ----------  ----------  ----------
                                             $   (8,790) $      266  $    4,374
                                              ==========  ==========  ==========

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

                                      February 1,             February 2,
                                         2003                    2002
                                ----------------------  ----------------------
                                Deferred    Deferred    Deferred    Deferred
                                   Tax         Tax         Tax         Tax
                                 Assets    Liabilities   Assets    Liabilities
                                ---------  -----------  ---------  -----------
Current:
  Accrued employee benefits... $   1,037  $            $   1,284  $
  Credit losses...............                               150
  State income taxes..........         1                     268
  LIFO inventory reserve......                 (2,115)                   (768)
  Supplies inventory..........                   (554)                   (675)
  Workers' compensation.......       678                   1,203
  Other items, net............     1,312         (988)     1,322       (1,460)
                                ---------  -----------  ---------  -----------
                                   3,028       (3,657)     4,227       (2,903)
                                ---------  -----------  ---------  -----------
Long-Term:
  Net operating loss and tax
    credit carryforwards......     6,378                   3,200
  State income taxes..........       612                     442
  Property and equipment......                (18,154)                (15,194)
  Accounting for leases.......       678       (2,985)       699       (2,723)
  Impaired assets.............     5,761
  Deferred income.............       675       (3,303)     1,103       (3,048)
  Valuation allowance.........    (1,438)                   (645)
  Other items, net............       858       (1,348)       424       (1,090)
                                ---------  -----------  ---------  -----------
                                  13,524      (25,790)     5,223      (22,055)
                                ---------  -----------  ---------  -----------
                               $  16,552  $   (29,447) $   9,450  $   (24,958)
                                =========  ===========  =========  ===========

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

                                                  2002       2001       2000
- ---------------------------------------------   --------   --------   --------
Statutory rate...............................     (35.0)%     35.0 %     35.0 %
State income taxes, net of
 federal income tax benefit..................      (0.9)       5.5        3.0
General business credits.....................      (1.3)     (15.2)      (2.9)
Amortization of goodwill.....................                  5.8        0.4
Tax refund claims............................      (4.0)
Other items, net.............................      (1.1)       7.4        2.7
                                                --------   --------   --------
Effective rate...............................     (42.3)%     38.5 %     38.2 %
                                                ========   ========   ========

Realization of the total deferred tax assets of $16,552,000 is dependent upon generating sufficient taxable income in future periods.

At February 1, 2003, the Company has, for federal tax purposes, general business credits of $2,792,000 that expire in the years 2004 through 2022, and alternative minimum tax credits of $913,000 which may be used for an indefinite period. At February 1, 2003, the Company also has, for state tax purposes, $2,047,000 of enterprise zone credits which may be used for an indefinite period. These carryforwards are available to offset future taxable income. The Company established valuation allowances of $1,438,000 and $645,000 at February 1, 2003 and February 2, 2002, respectively, which relate primarily to certain tax credit carryforwards whose realizability is uncertain.

The Company received income tax refunds, net of payments, of $1,235,000 in 2002 and paid income taxes, net of refunds, of $1,526,000 in 2001 and $2,541,000 in 2000. The income tax refunds received in 2002 were, in part, attributable to a final settlement of certain federal net operating loss carryback refund claims filed with the Internal Revenue Service. The Company recognized a federal income tax benefit of $826,000 and interest income of $569,000 (included in miscellaneous income) in 2002 related to the federal income tax refund claims.

12. EARNINGS PER SHARE

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

(Shares in thousands)                             2002       2001       2000
- ---------------------------------------------   --------   --------   --------
Weighted average number of
  shares - basic.............................    12,747     12,681     12,614
Effect of assumed option exercises...........                   10         18
                                                --------   --------   --------
Weighted average number of
  shares - diluted...........................    12,747     12,691     12,632
                                                ========   ========   ========

Options with an exercise price greater than the average market price of the Company's common stock during the period are excluded from the computation of the weighted-average number of shares on a diluted basis as such options are anti-dilutive. Anti-dilutive options were outstanding for 1,685,624, 1,335,720 and 924,728 shares as of the end of 2002, 2001 and 2000, respectively.

13. STOCK OPTION AND STOCK PURCHASE PLANS

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

The Company has stock option plans for directors, officers and key employees which provide for the grant of non-qualified and incentive stock options. Under the plans, the option exercise price may not be lower than 100% of the fair market value of such shares at the date of the grant. Options granted generally vest on a ratable basis over five years and expire ten years from the date of the grant. At February 1, 2003, options for 1,137,000 shares were available for future grants under the plans.

Option activity under the plans is as follows:

                             2002                 2001                 2000
                     -------------------- -------------------- --------------------
                                 Weighted-            Weighted-            Weighted-
                       Number    Average    Number    Average    Number    Average
                         of      Exercise     of      Exercise     of      Exercise
                       Shares     Price     Shares     Price     Shares     Price
                     ----------  -------- ----------  -------- ----------  --------
Options outstanding
  at beginning of
  year.............. 1,535,500  $   6.68  1,364,500  $   7.34    953,000  $   8.47
Granted.............   295,500      2.61    262,500      3.26    457,500      5.08
Cancelled...........  (118,000)     6.42    (91,500)     6.59    (46,000)     8.30
                     ----------  -------- ----------  -------- ----------  --------
Options outstanding
 at end of year..... 1,713,000  $   5.99  1,535,500  $   6.68  1,364,500  $   7.34
                     ==========  ======== ==========  ======== ==========  ========
Options exercisable
 at end of year..... 1,009,250  $   7.47    798,500  $   8.06    590,500  $   8.70
                     ==========  ======== ==========  ======== ==========  ========

Additional information regarding options outstanding as of February 1, 2003 is a follows:

                                Weighted-
                                 Average    Weighted-
                                Remaining    Average
    Range of         Number    Contractual  Exercise
 Exercise Prices  Outstanding  Life (yrs.)    Price
- ----------------- ------------ -----------  ---------
$1.62 to $4.63        637,500        8.71  $    3.22
$5.25 to $8.00        590,500        6.21  $    6.28
$8.13 to $10.87       485,000        3.71  $    9.26
- ----------------- ------------ -----------  ---------
$1.62 to $10.87     1,713,000        6.43  $    5.99
================= ============ ===========  =========

The Company also has a statutory Employee Stock Purchase Plan, which allows its employees to purchase Company common stock at a 15% discount. Employees can purchase stock under the Plan through payroll deductions ranging from 1% to 10% of their annual compensation, up to a maximum of $21,250 per employee per year. A total of 500,000 shares were originally registered under the Plan, with 226,110 shares issued through February 1, 2003.

SFAS 123 requires the disclosure of pro forma net income and net income per share had the Company adopted the fair value method of accounting for stock-based compensation as of the beginning of 1995 (see Note 1). Under SFAS 123, the fair value of stock-based awards is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values.

The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions:

                                           2002       2001       2000
                                         ---------  ---------  ---------
Risk-free interest rate................       2.3 %      4.2 %      4.8 %
Expected dividend yield................        --         --         --
Expected volatility....................      57.0 %    51.50 %    51.21 %
Expected option life (years)...........         5          5          5
Fair value of options granted..........     $1.09      $1.35      $3.01

As allowed by SFAS No. 123, the impact of outstanding non-vested stock options granted prior to 1995 has been excluded from the pro-forma calculations. Accordingly the 2002, 2001 and 2000 pro-forma adjustments may not be indicative of future period pro- forma adjustments.

The Company has a Retirement Savings Plan ("Plan") which qualifies as an employee retirement plan under Section 401(k) of the Internal Revenue Code. Full-time employees meeting certain requirements are eligible to participate in the Plan and may elect to have up to 20% of their annual eligible compensation, subject to certain limitations, deferred and deposited with a qualified trustee. Participants in the Plan may receive an employer matching contribution of up to 4% of the participants' eligible compensation, depending on the Company's quarterly and annual financial performance. Beginning 2001, the Company amended the Plan to provide for a guaranteed annual match of 3%, including the ability for participants to earn an additional 1% depending on the Company's annual financial performance. The Company recognized $1,415,000, $1,454,000 and $1,073,000 in expense related to the Plan in 2002, 2001 and 2000, respectively.

Harris and ECI became affiliates of the Company in fiscal 1998 when the Company acquired substantially all of the assets and business of Harris. The purchase price for the assets consisted of 2,095,900 shares of the Company's common stock and a Subordinated Note Payable in the amount of $22,179,000, due August 2006. (See Note 7).

On February 22, 2002, the Company entered into a Credit Facilitation Agreement with Harris. Under the Credit Facilitation Agreement, Harris agreed to guarantee an irrevocable standby letter of credit (the "Harris letter of credit") issued by a bank to GE Capital in the amount of $7.0 million for the purpose of providing additional credit enhancement to the GE facility. The Harris letter of credit was used to collateralize standby letters of credit that were subsequently issued under the GE facility to key factors. During 2002, the Credit Facilitation Agreement was amended three times to provide for extensions of the expiration date of the Harris letter of credit. Under the terms of the third amendment, the Harris letter of credit was cancelled and the Credit Facilitation Agreement was terminated as a result of the closing of the sale of receivables to Household.

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

The Company presently has no commitments to open or remodel any stores in fiscal 2003. As of February 1, 2003, the Company had issued a total of $11.3 million of standby letters of credit and documentary letters of credit totaling $2.0 million. The standby letters of credit were issued to secure credit lines with key factors and to provide collateral for a workers compensation insurance policy. The factor letters of credit currently expire at the end of June 2003. Management believes the likelihood of any draws under the standby letters of credit are remote. Documentary letters of credit are issued in the ordinary course of business to facilitate the purchase of merchandise from overseas suppliers. The supplier draws against the documentary letter of credit upon delivery of the merchandise.

The Company had no outstanding standby or documentary letters of credit as of February 2, 2002.

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

GOTTSCHALKS INC. AND SUBSIDIARY

                                                    ADDITIONS
                                          ------------------------
          COL. A               COL. B       COL. C        COL. D         COL. E          COL. F
- ---------------------------  -----------  ----------     ---------     -----------     -----------
                                                          Charged
                             Balance at   Charged to     to Other                      Balance at
                              Beginning   Costs and      Accounts      Deductions        End of
Description                   of Period    Expenses      Describe       Describe         Period
- ---------------------------  -----------  ----------     ---------     -----------     -----------
Year ended February 1, 2003:

  Allowance for doubtful
    accounts............... $   354,544  $  825,061 (1) $             $(1,179,605)(2) $
  Store closure reserve.... $   529,000  $  581,000 (3) $             $  (492,000)(4) $   618,000
  Deferred tax asset
    valuation allowance.... $   645,000  $  793,000 (5) $             $               $ 1,438,000
  Allowance for vendor
    claims receivable...... $    91,000  $              $             $   (10,000)(6) $    81,000



Year ended February 2, 2002:

  Allowance for doubtful
    accounts............... $   368,634  $1,247,269 (1) $             $(1,261,359)(2) $   354,544
  Store closure reserve.... $        --   2,035,000 (3) $             $(1,506,000)(4) $   529,000
  Deferred tax asset
    valuation allowance.... $        --  $  645,000 (5) $             $               $   645,000
  Allowance for vendor
    claims receivable...... $    86,000  $    5,000 (7) $             $               $    91,000


Year ended February 3, 2001:

  Allowance for doubtful
    accounts............... $   406,688  $1,024,964 (1) $             $(1,063,018)(2) $   368,634
  Allowance for vendor
    claims receivable...... $    90,000  $              $             $    (4,000)(6) $    86,000