<PAGE>   1
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-Q

(Mark one)

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


                  For quarterly period ended October 26, 1996


                                       OR


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


         For the transition period from                 to
                                        ---------------    ----------------


                         Commission file number 0-12203


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


               Delaware                                       33-0469138
     (State or other jurisdiction of                       (I.R.S. Employer
     incorporation or organization)                      Identification Number)


5325 E. Hunter Avenue, Anaheim, California                       92807
 (Address of principal executive offices)                     (Zip Code)


      Registrant's telephone number, including area code:  (714) 779-5881


                                Not Applicable
-------------------------------------------------------------------------------
              (Former name, former address and former fiscal year,
                         if changed since last report)


         Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  Yes  X    No
                                               ---      ---

                     APPLICABLE ONLY TO CORPORATE ISSUERS:

         Indicate the number of shares outstanding of the issuer's classes of
common stock, as of the latest practicable date:  As of December 12, 1996,
14,198,241 shares of the issuer's common stock, $.001 par value per share, were
outstanding.


                                             This Form 10-Q consists of 22 Pages
                                             Exhibit Index on Page 22
<PAGE>   2

                               INDEX TO FORM 10-Q


                                     INDEX


<TABLE>
<CAPTION>
                                                                                                         PAGE
                                                                                                         ----
<S>                                                                                                      <C>

PART I.   FINANCIAL INFORMATION

Item 1.   Condensed Consolidated Financial Statements (Unaudited) 

          Condensed Consolidated Balance Sheets -  October 26, 1996 and January 27, 1996................   3

          Condensed Consolidated Statements of Operations - Thirteen and
          Thirty-nine weeks ended October 26, 1996 and October 28, 1995 ................................   4

          Condensed Consolidated Statements of Cash Flows- Thirty-nine weeks
          ended October 26, 1996 and October 28, 1995 ..................................................   5

          Notes to Condensed Consolidated Financial Statements - October 26, 1996.......................   6

Item 2.   Management's Discussion and Analysis of Financial Condition and
          Results of Operations.........................................................................  11


PART II.  OTHER INFORMATION

Item 1.   Legal Proceedings.............................................................................  17

Item 5.   Other Information.............................................................................  20

Item 6.   Exhibits and Reports on Form 8-K..............................................................  20

SIGNATURES..............................................................................................  21

EXHIBIT INDEX...........................................................................................  22
</TABLE>


                                                                   Page 2 of 22
<PAGE>   3
THE CLOTHESTIME, INC. 

                       PART I. -- FINANCIAL INFORMATION

ITEM 1. -- CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

<TABLE>
<CAPTION>
                                                                               October 26, 1996     January 27, 1996
                                                                               ----------------     ----------------
<S>                                                                            <C>                  <C>
Assets
Current Assets

  Cash and cash equivalents                                                       $ 24,254,221        $ 34,477,823
  Marketable securities available-for-sale, net of allowances                        3,128,137           3,191,737
    of $95,264 and $16,678
  Merchandise inventories                                                           13,396,698           8,551,207
  Income taxes receivable                                                                 --             9,336,008
  Prepaid expenses and other current assets                                          2,607,188           2,707,926
  Deferred income taxes                                                                471,000             471,000
                                                                                  ------------        ------------
Total Current Assets                                                                43,857,244          58,735,701
                                                                                  ------------        ------------

  Investments                                                                             --             1,174,497
                                                                                  ------------        ------------
  Property, plant and equipment - on the basis of cost                              50,627,676          55,281,631
  Less:  accumulated depreciation & amortization                                   (29,809,902)        (27,384,443)
                                                                                  ------------        ------------
                                                                                    20,817,774          27,897,188
  Other assets                                                                         350,985             472,766
                                                                                  ------------        ------------
Total Assets                                                                      $ 65,026,003        $ 88,280,152
                                                                                  ============        ============

Liabilities and Shareholders' Equity (Deficiency)
Current Liabilities

  Accounts payable                                                                $  6,748,420        $ 11,074,076
  Accrued sales tax                                                                  1,564,691           1,982,300
  Accrued payroll and related taxes                                                  3,593,419           4,629,524
  Other accrued liabilities                                                          8,834,269           8,378,305
                                                                                  ------------        ------------
Total Current Liabilities                                                           20,740,799          26,064,205
                                                                                  ------------        ------------

Long-term Liabilities

  Deferred income taxes                                                                471,000             471,000
  Capital lease obligation                                                             645,000                --
                                                                                  ------------        ------------
Total long-term Liabilities                                                          1,116,000             471,000
                                                                                  ------------        ------------
Liabilities subject to compromise                                                   48,741,499          53,433,703
                                                                                  ------------        ------------

Shareholders' Equity (Deficiency)

  Common Stock, $.001 par value, authorized 50,000,000 shares issued and
  outstanding - 14,198,241 shares at October 26, 1996 and January 27, 1996,
  respectively                                                                          14,763              14,763
Additional paid-in capital                                                          10,861,514          10,861,514
Retained earnings (accumulated deficit)                                            (11,503,093)          2,301,860
Less:  Treasury stock, 565,000 shares at cost at October 26, 1996
  and January 27, 1996, respectively                                                (4,850,215)         (4,850,215)
Securities valuation allowance                                                         (95,264)            (16,678)
                                                                                  ------------        ------------
Total Shareholders' Equity (Deficiency)                                             (5,572,295)          8,311,244
                                                                                  ------------        ------------
Total Liabilities and Shareholders' Equity (Deficiency)                           $ 65,026,003        $ 88,280,152
                                                                                  ============        ============
</TABLE>

See Notes to Condensed Consolidated Financial Statements

                                                                   Page 3 of 22
<PAGE>   4
THE CLOTHESTIME, INC.

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)

<TABLE>
<CAPTION>
                                                            Thirteen Weeks Ended                   Thirty-Nine Weeks Ended
                                                    ------------------------------------      ----------------------------------
                                                       October 26,         October 28,         October 26,           October 28,
                                                          1996                1995                1996                  1995
                                                    --------------       --------------       --------------       --------------
<S>                                                 <C>                  <C>                  <C>                  <C>
Revenues:
  Net sales                                          $  46,401,345        $  78,738,231        $ 149,560,688        $ 240,367,503
  Interest and other income                                552,253               67,618              695,711              508,433
                                                      ------------        -------------        -------------        -------------
                                                        46,953,598           78,805,849          150,256,399          240,875,936
                                                      ------------        -------------        -------------        -------------

Costs and Expenses:
  Cost of sales, including buying and
    distribution and occupancy costs                    31,565,226           56,797,076          102,994,642          176,354,135
  Selling, general and administrative expenses          17,704,158           25,565,500           53,863,862           74,734,229
  Interest expense                                          30,805               92,475              123,200              648,658
  Other losses                                                   -                    -                    -              404,956
                                                     -------------        -------------        -------------        -------------


                                                        49,300,189           82,455,051          156,981,704          252,141,978
                                                     -------------        -------------        -------------        -------------

Loss before reorganization costs
    and income taxes                                    (2,346,591)          (3,649,202)          (6,725,305)         (11,266,042)
  Reorganization costs                                   1,417,080                    -            7,079,648                    -
                                                     -------------        -------------        --------------       -------------


Loss before income taxes                                (3,763,671)          (3,649,202)         (13,804,953)         (11,266,042)
  Benefit for income taxes                                       -           (1,350,204)                   -           (4,168,435)
                                                     -------------        -------------        -------------        -------------



Net Loss                                             $  (3,763,671)       $  (2,298,998)       $ (13,804,953)       $  (7,097,607)
                                                     =============        =============        =============        =============

Loss per share                                       $       (0.27)       $       (0.16)       $       (0.97)       $       (0.50)
                                                     =============        =============        =============        =============

Weighted average number of shares
  outstanding                                           14,198,241           14,193,753           14,198,241           14,187,895
                                                     =============        =============        =============        =============
</TABLE>



See Notes to Condensed Consolidated Financial Statements



                                                                   Page 4 of 22
<PAGE>   5
THE CLOTHESTIME, INC.


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

<TABLE>
<CAPTION>
                                                                          Thirty-nine weeks ended
                                                                   ----------------------------------
                                                                     October 26,          October 28,
                                                                        1996                  1995
                                                                   -------------       --------------
<S>                                                                <C>                 <C>
Operating Activities:
  Net loss                                                          $(13,804,953)       $ (7,097,607)
  Adjustments to reconcile net loss
   to net cash used in operating activities:
  Non cash reorganization costs                                        5,271,457                  --
  Depreciation and amortization                                        4,718,390           6,790,652
  Loss on sales of marketable securities                                      --             404,956
  Gain on sale of investments                                           (375,503)                 --
Changes in operating assets and liabilities:
  Increase in merchandise inventories                                 (4,845,491)        (11,943,308)
  Decrease in income taxes receivable                                  9,336,008           1,174,176
  (Increase) decrease in prepaid expenses and other assets               222,519          (1,804,590)
  Increase (decrease) in accounts payable                             (2,675,500)          1,383,246
  Decrease in accrued payroll and related taxes                       (1,036,105)           (906,263)
  Decrease in accrued sales tax and other accrued liabilities           (809,842)         (1,018,198)
                                                                    ------------        ------------

Net cash used in operating activities                                 (3,999,020)        (13,016,936)
                                                                    ------------        ------------

Investing activities:
  Investment in marketable securities                                    (14,986)            (18,370)
  Proceeds from sales of marketable securities                                --           4,718,600
  Proceeds from sale of investments                                    1,550,000                  --
  Purchases of property, plant, and equipment                            (52,120)           (627,225)
  Proceeds from sale of property, plant and equipment                         --             112,000
                                                                    ------------        ------------

Net cash provided by investing activities                              1,482,894           4,185,005
                                                                    ------------        ------------

Financing Activities:
  Net repayments under revolving credit facility                      (6,507,979)        (30,050,000)
  Proceeds from long-term debt                                                --           1,400,000
  Principal payments under long-term debt                             (1,199,497)           (576,424)
  Proceeds from the exercise of stock options                                 --              32,758
                                                                    ------------        ------------

  Net cash used in financing activities                               (7,707,476)        (29,193,666)
                                                                    ------------        ------------

Decrease in cash and cash equivalents                                (10,223,602)        (38,025,597)
Cash and cash equivalents at beginning of year                        34,477,823          40,829,741
                                                                    ------------        ------------

Cash and cash equivalents at end of quarter                         $ 24,254,221        $  2,804,144
                                                                    ============        ============

Supplemental disclosure of cash flow information:
  Income tax refunds received                                       $  9,443,657        $  5,366,580
  Income taxes paid                                                 $      3,903        $     23,970
  Interest paid                                                     $     56,038        $    648,658
</TABLE>



See Notes to Condensed Consolidated Financial Statements




                                                                   Page 5 of 22
<PAGE>   6
THE CLOTHESTIME, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
OCTOBER 26, 1996

NOTE A - REORGANIZATION AND BASIS OF REPORTING

         On December 8, 1995 (the "Petition Date"), The Clothestime, Inc.
("Clothestime") and five of its subsidiaries, MRJ Industries, Inc. ("MRJ"),
Clothestime Stores, Inc. ("Stores"), Clothestime Investment, Inc.
("Investment"), Clothestime Acquisition Corporation ("Acquisition") and
Clothestime International, Inc. ("International") (collectively, the "Debtors")
commenced reorganization cases (the "Bankruptcy Cases") by filing voluntary
petitions for relief under chapter 11, Title 11 of the United States Code (the
"Bankruptcy Code") in the United States Bankruptcy Court for the Central
District of California, Santa Ana Division (the "Bankruptcy Court").  For
purposes of this report, unless otherwise referenced, the defined term
"Company" shall apply to Clothestime and its consolidated group of
subsidiaries, except that references to the Company in connection with any
disclosure relating to the Debtors' chapter 11 cases refer solely to the
Debtors and exclude Clothestime Insurance Company ("Insurance"), Clothestime's
captive insurance company subsidiary.

         The Debtors decided to seek bankruptcy protection after an extensive
review of the retail environment and the Debtors' operations.  Management of
each of the respective companies determined that filing the chapter 11
petitions would allow the Debtors the needed time and flexibility to
restructure their respective operations.

         Since the Petition Date, the Debtors have continued in possession of
their properties and, as debtors in possession, are authorized to operate and
manage each of their respective businesses and enter into all transactions,
including obtaining services, supplies and inventories, that each could have
entered into in the ordinary course of business had there been no bankruptcy
filings.  As debtors in possession, the Debtors may not engage in transactions
outside of the ordinary course of business without approval of the Bankruptcy
Court, after notice and hearing.

         Liabilities subject to compromise in the accompanying consolidated
balance sheets represent the Company's estimate of liabilities as of October
26, 1996, subject to adjustment in the reorganization process.  Under chapter
11, actions to enforce certain claims against the Company are stayed if the
claims arose, or are based on events that occurred, on or before the Petition
Date.  Other liabilities may arise or be subject to compromise as a result of
rejection of executory contracts and unexpired leases, or the Bankruptcy
Court's resolution of claims for contingencies and other disputed amounts.  As
a general matter, the treatment of these liabilities will be determined as a
part of the formulation and confirmation of a plan of reorganization.  See Note
C - Liabilities Subject to Compromise, herein.

         The accompanying condensed consolidated financial statements have been
presented on the basis that the Company is a going concern, which contemplates
the realization of assets and the satisfaction of liabilities in the normal
course of business.  As a result of the chapter 11 filing and circumstances
relating to this event, realization of assets and satisfaction of liabilities
is subject to uncertainty.  A plan of reorganization could materially change
the amounts reported in the accompanying consolidated financial statements,
which do not give effect to adjustments to the carrying values of assets and
liabilities which may be necessary as a consequence of a plan of
reorganization.  The ability of the Company to continue as a going concern is
dependent on, among other things, confirmation of an acceptable plan of
reorganization, future profitable operations, compliance with the debtor in
possession financing agreement (see Note B - Debtor in Possession Financing,
herein), and the ability to generate sufficient cash from operations and obtain
financing sources to meet future obligations.



                                                                    Page 6 of 22
<PAGE>   7
THE CLOTHESTIME, INC.


NOTE A - REORGANIZATION AND BASIS OF REPORTING (CONTINUED)

         The principal business of the Company is the retail sale of junior
size women's clothing.  As of October 26, 1996, the Company operated stores in
17 states and Puerto Rico, with a large concentration of stores in California,
Florida and Texas.  The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to Form
10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements.  In the opinion of management,
all adjustments (consisting of normal recurring accruals) considered necessary
for a fair presentation have been included.  The condensed consolidated
financial statements include the accounts of The Clothestime, Inc. and its
consolidated group of subsidiaries, MRJ, Stores, Insurance, International,
Investment and Acquisition.  All material intercompany balances and
transactions have been eliminated in consolidation.  The operating results for
the thirty-nine week period ended October 26, 1996 are not necessarily
indicative of the results that may be expected for the year ending January 25,
1997 ("Fiscal 1996").  For further information, refer to the financial
statements and related notes included in the Company's annual report on Form
10-K for the year ended January 27, 1996 ("Fiscal 1995").

NOTE B - DEBTOR IN POSSESSION FINANCING

         The Company, through Stores, has a financing agreement with The CIT
Group/Business Credit, Inc. (the "DIP Lender") for debtor in possession
financing (the "DIP Facility").  At October 26, 1996, the agreement provided
for revolving loans to be made up to the lesser of (a) $25 million or (b) the
lesser of (i) sixty percent (60%) of eligible inventory valued on a cost basis
and (ii) thirty-six and one half percent (36.5%) of eligible inventory valued
on a retail basis, subject to adjustment.  The revolving line of credit may be
in the form of letters of credit determined as provided under the agreement.

         Cash borrowings bear interest at a reference rate plus one half of one
percent (0.5%) per annum or, at the request of Stores, the London Interbank
Rate plus two and one half percent (2.5%).  The agreement calls for a loan
facility fee of $250,000, a semi-annual inventory management fee of $30,000, an
unused line fee of 3/8% per annum and a letter of credit fee of 1% per annum.
As of October 26, 1996, the Company had not used the direct borrowing capacity
on the line and had outstanding letters of credit in the amount of $1.5
million.

         The agreement contains various restrictive covenants requiring, among
other things, minimum levels of earnings before interest, income taxes,
depreciation and amortization ("EBITDA"), the establishment of maximum levels
of capital expenditures, and a prohibition regarding declaring or making any
cash dividends by the Company or its subsidiaries.  In addition, the DIP Lender
required a negative pledge on Stores' merchandise inventory and proceeds.
Effective August 1, 1996, the DIP Facility was amended to revise the covenant
relating to the minimum required level of EBITDA for the third quarter of
Fiscal 1996 and certain other provisions.  The DIP Facility was amended further
in October 1996 to revise the covenant relating to the minimum required level
of EBITDA for the third quarter of Fiscal 1996.  The Company was in compliance
with or had obtained waivers for all such covenants as of October 26, 1996.
The term of the DIP Facility is the earlier of December 8, 1997 or the
effective date of the Debtors' confirmed plan of reorganization, subject to
earlier termination.

         Cash borrowings and letters of credit issued under the agreement have
been granted super priority status by the Bankruptcy Court over all obligations
except certain administrative expenses, as defined in the agreement.



                                                                   Page 7 of 22
<PAGE>   8
THE CLOTHESTIME, INC.


NOTE C - LIABILITIES SUBJECT TO COMPROMISE

         Liabilities subject to compromise include substantially all of the
current and noncurrent liabilities of the Company as of the Petition Date.
Certain prepetition liabilities have been approved by the Bankruptcy Court for
payment.  At October 26, 1996 and January 27, 1996, such amounts to the extent
not paid, were included in accrued expenses and other payables for the periods
set forth below.

                                          October 26, 1996     January 27, 1996 
                                          ----------------     ----------------
Revolving credit facility debt              $18,907,847           $15,607,262
Secured note payable to Well Fargo Bank       1,358,000             1,358,000
Secured notes payable to Union Bank                   -             1,174,497
Capital lease obligation                        345,222             1,001,637
Accounts payable, trade                      12,612,832            20,771,240
Estimated lease rejection claims             11,729,355             8,871,043
Other payables and accrued expenses           3,788,243             4,650,024
                                            -----------           -----------
                                            $48,741,499           $53,433,703
                                            ===========           ===========

         Prior to the Petition Date, the revolving credit facility debt bore
interest at the bank's prime rate plus 1% and was due February 1, 1997. The
banks assert a security interest in substantially all of the assets of the
Company and its subsidiaries, excluding merchandise inventories.  In the third
quarter of Fiscal 1996, pursuant to a settlement of certain claims relating to
the revolving credit facility, the Company paid $6,229,417.34 to Wells Fargo
Bank, N.A. ("Wells"), as agent.  This payment was applied to reduce the amount
owed under the revolving credit facility.  As a result of the settlement
agreement, the Company reclassed $9.8 million previously reported in accounts
payable, trade to the revolving credit facility debt to account for the amounts
paid under the credit facility pursuant to letters of credit.  See Part II, Item
1. Legal Proceedings, of this Report for a complete discussion of the settlement
of certain claims relating to the revolving credit facility.

         The note payable to Wells is secured by an office/warehouse building
and underlying real property that the Company uses to house a portion of its
administrative offices and warehouse facilities.  The note bears interest based
on LIBOR plus 1.5% and was due March 1, 2005.  The interest rates described
above do not consider interest rates that may be applicable in the event of
default.

         The two notes payable to Union Bank of California, N.A. ("Union"),
which were secured by limited partnership interests in low-income housing
projects, bore interest at 6.1% and 6.2% and were due in September 1998 and
January 1999.  On August 28, 1996, the Bankruptcy Court approved the sale of,
and on August 30, 1996, the Company sold, its interest in the two limited
partnerships for an aggregate consideration of $1,550,000.  $1,229,443.46 of
the net proceeds of the sale were paid to Union in full satisfaction of its
secured loans and related accrued interest.  The balance of the net proceeds
were paid into a segregated account, and are subject to any other liens against
the partnership interests, including the lien (if any) of the banks under the
revolving credit facility and will not be used by the Debtors without further
order of the Bankruptcy Court.

         The capital lease obligation at January 27, 1996 was secured by
certain "point of sale" computer equipment and related software (collectively,
the "POS Equipment") acquired in connection with a capital lease with MetLife
Capital Corporation ("MetLife").  On May 13, 1996, MetLife filed a motion (the
"Motion") for relief from the automatic stay in the Company's chapter 11 case,
pursuant to section 362 of the Bankruptcy Code, to permit MetLife to foreclose
upon its liens on the POS Equipment or, alternatively, to require the Company
to make "adequate protection" payments to MetLife to protect against any
diminution to the value of the POS Equipment during the pendency of the
Company's chapter 11 case.  The Company and MetLife entered into an agreement
(the "MetLife Agreement"), which was approved by the Bankruptcy Court on July
22, 1996, settling the matters that were the subject of the Motion and
restructuring the Company's loan obligations to MetLife.  Under the terms of
the MetLife Agreement, MetLife will have an allowed secured claim (the "Secured
Claim") in the Company's chapter 11 case in the amount of $670,000 and the
balance of MetLife's claim will be an allowed unsecured claim (the "Unsecured
Claim") in the Company's chapter 11 case.



                                                                   Page 8 of 22
<PAGE>   9
THE CLOTHESTIME, INC.


NOTE C - LIABILITIES SUBJECT TO COMPROMISE (CONTINUED)

         In order to amortize the Secured Claim, the Company will (i) make 
monthly payments of $5,000 to MetLife, commencing in June 1996, which payments 
will be applied to reduce the principal amount of the Secured Claim, until the
effective date of a plan of reorganization in the Company's chapter 11 case (the
"Effective Date") and (ii) pay the remainder of the Secured Claim by making
monthly payments to MetLife from and after the Effective Date in an amount equal
to remaining principal plus interest at the Bank of America prime rate plus 200
basis points (up to a maximum of 10.5% per annum) amortized over a number of
months equal to the difference between 60 and the number of monthly payments
made to MetLife prior to the Effective Date.  The Secured Claim is reflected on
the balance sheet in long-term liabilities and not in liabilities subject to
compromise.  The Unsecured Claim will be treated and paid in accordance with the
terms of any confirmed plan of reorganization in the Company's chapter 11 case.

         The Company anticipates that it will negotiate with creditors to
reconcile claims filed with the Bankruptcy Court to the Company's financial
records.  The additional liability arising from this reconciliation process, if
any, is not subject to reasonable estimation.  As a result, no provision has
been recorded for these possible claims.  The Company will recognize the
additional liability, if any, as the amounts become subject to reasonable
estimation.  Additional bankruptcy claims and prepetition liabilities may arise
from the rejection of executory contracts and unexpired leases, resolution of
contingent and unliquidated claims and the settlement of disputed claims. A
plan of reorganization ultimately approved by the Company's impaired
prepetition creditors and shareholders and confirmed by the Bankruptcy Court
may materially change the amounts and terms of prepetition liabilities.
Consequently, the amounts included in the condensed consolidated balance sheets
as liabilities subject to compromise may be subject to future adjustment.

         In accordance with the American Institute of Certified Public
Accountants' Statement of Position 90-7, "Financial Reporting by Entities in
Reorganization Under the Bankruptcy Code" (SOP 90-7), the Company is not
required to record interest during chapter 11 proceedings on unsecured or
undersecured prepetition debt.  Interest expense on certain secured debt will
continue to be accrued but is subject to settlement.  No determination has been
made regarding the value of the property interests that secure certain debt
and, consequently, whether interest thereon will be paid.  The Company has
continued accruing interest on its secured prepetition debt obligations, except
for the revolving credit facility debt, which the Company believes is
undersecured.  However, the Bankruptcy Court could determine that postpetition
interest should be paid on this obligation.  Contractual interest (computed
without regard to default rates of interest) exceeds interest expense recorded
in the accompanying condensed consolidated statement of operations for the
thirty-nine week period ended October 26, 1996 by approximately $1,113,392.

NOTE D - REORGANIZATION COSTS

         Reorganization costs recorded in the third quarter of Fiscal 1996 and
the first nine months of Fiscal 1996 consisted of: 

<TABLE>
<CAPTION>
                                             Thirteen weeks ended    Thirty-nine weeks ended 
                                               October 26, 1996          October 26, 1996 
                                             --------------------    -----------------------
<S>                                          <C>                     <C>

Write-off of leasehold improvements and 
  fixtures associated with store closures 
  net of proceeds                                $  146,892                  $2,055,664 
Estimated store lease rejection claims net 
  of proceeds from lease sales                      288,495                   2,858,313 
Other related store closure costs                    15,554                     177,067
Professional fees                                 1,068,874                   2,267,755 
Interest income                                    (235,149)                   (645,626) 
Other                                               132,414                     366,475 
                                                 ----------                  ----------
                                                 $1,417,080                  $7,079,648
                                                 ==========                  ==========
</TABLE>




                                                                   Page 9 of 22
<PAGE>   10
THE CLOTHESTIME, INC.


NOTE E - CAPITAL STOCK AND STOCK OPTION TRANSACTIONS

         The following table summarizes the activity under the Company's Stock
Option Plans during the thirty-nine week period ended October 26, 1996:

                                                                 Shares
                                                                ---------
Options Outstanding, January 27, 1996                           2,815,788
  Activity during the period:

        Options Granted                                            10,000
        (per share amount: $1.00)

        Options Exercised                                               -

        Options Canceled
        (per share amounts: $1.50 to $12.75)                     (721,596)
                                                                ---------
        Options outstanding, October 26, 1996                   2,104,192
                                                                =========

         At October 26, 1996, options to purchase 1,583,710 shares of the
Company's common stock were exercisable on various dates through September 22,
2005, at prices ranging from $1.50 to $12.75 per share.  In addition, at
October 26, 1996, there were options to purchase 1,737,495 shares of the
Company's common stock available for grant under the Company's stock option
plans.  The computation of net loss per common and common equivalent share is
based upon the weighted average number of common shares outstanding during the
period.

         The Company's common stock was delisted from The Nasdaq Stock Market,
Inc., effective with the opening of business on July 26, 1996, because the
Company no longer complies with the criteria established by The Nasdaq Stock
Market, Inc. for continuation of listing.  To the extent the market makers in
the Company's stock continue to enter bids, the Company's common stock will be
quoted in the OTC Bulletin Board, or, in the alternative, in the National
Quotation Bureau's Pink Sheets.

NOTE F - SUBSEQUENT  EVENTS

         During the third quarter of Fiscal 1996, the Company, in consultation
with the official committee of unsecured creditors in the Bankruptcy Cases (the
"Committee"), began actively exploring an investment by a third party as an
alternative strategy for exiting chapter 11.  The Company concluded that one
viable alternative for maximization of creditor recoveries is for the Debtors
and the Committee, with the assistance of a professional investment advisor,
jointly to seek to identify opportunities for a (i) sale or merger of the
Company or (ii) a third party willing to make an investment in the Company's
assets or business.  Accordingly, on November 12, 1996, the Company and the
Committee filed, and the  Bankruptcy Court approved, a joint application to
retain Financo, Inc. ("Financo") as an investment advisor.  The Company and the
Committee anticipate that an investment could take a variety of forms,
including, but not limited to, the provision of new financing, either through
direct loans, the purchase of new debt securities or the assumption of existing
liabilities; a merger, joint venture or other similar business combination; or
the purchase or other acquisition of some or all of the Company's assets.
There can be no assurance whether Financo will be successful in identifying an
investor or whether any transaction will be acceptable to the Company, the
Committee or other creditors and parties in interest.

         On December 9, 1996, the Company filed a motion seeking Bankruptcy
Court approval to (i) close 22 underperforming retail stores, (ii) conduct
store closing sales at certain of the closed stores, (iii) retain a lease
consultant to market the leases for certain of the closed stores, and (iv)
reject the leases for certain of the closed stores unless a motion to assume
and assign such leases has been filed by January 31, 1997.  The motion is
scheduled to be heard on December 30, 1996, and the store closing sales are
scheduled to be completed by January 31, 1997.




                                                                   Page 10 of 22
<PAGE>   11
THE CLOTHESTIME, INC.


ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

CHAPTER 11 REORGANIZATION

         On December 8, 1995, Clothestime and five of its subsidiaries
commenced reorganization cases by filing voluntary petitions for relief under
chapter 11, title 11 of the United States Code in the United States Bankruptcy
Court for the Central District of California, Santa Ana Division (collectively,
the "Chapter 11 Petitions").

         The Company decided to seek bankruptcy protection after an extensive
review of the current retail environment and the Company's operations.
Management determined that filing the Chapter 11 Petitions would allow the
Company the needed time and flexibility to restructure its operations.

         The consolidated financial statements have been presented on the basis
that the Company is a going concern, which contemplates the realization of
assets and the satisfaction of liabilities in the normal course of business.
As a result of the chapter 11 filing and circumstances relating to this event,
realization of assets and satisfaction of liabilities is subject to
uncertainty.  A plan of reorganization could materially change the amounts
reported in the accompanying consolidated financial statements, which do not
give effect to all adjustments to the carrying values of assets and liabilities
which may be necessary as a consequence of the confirmation and implementation
of a plan of reorganization.  The ability of the Company to continue as a going
concern is dependent on, among other things, confirmation of an acceptable plan
of reorganization, future profitable operations, compliance with the
debtor-in-possession financing agreement and the ability to generate sufficient
cash from operations and obtain financing sources to meet future obligations.

CONSOLIDATED RESULTS OF OPERATIONS

         The following table sets forth certain items in the consolidated
statements of operations as a percentage of total revenues for the thirteen
week and thirty-nine week periods ended October 26, 1996 and October 28,
1995.

<TABLE>
<CAPTION>
                                        Thirteen weeks ended            Thirty-nine weeks ended
                                  ------------------------------    ------------------------------
                                  Oct. 26, 1996    Oct. 28, 1995    Oct. 26, 1996    Oct. 28, 1995
                                  -------------    -------------    -------------    -------------
<S>                               <C>              <C>              <C>              <C>
Total revenues                          100%             100%             100%             100% 
Cost of sales, including buying
  and distribution and occupancy 
  costs                                67.2             72.1             68.5             73.2 
Selling, general and 
  administrative expenses              37.7             32.4             35.9             31.0
    Interest expense                    0.1              0.1              0.1              0.3 
    Other losses                          -                -                -              0.2
                                       ----             ----             ----             ----
Loss before reorganization costs 
  and income taxes                     (5.0)            (4.6)            (4.5)            (4.7) 
    Reorganization costs                3.0                -              4.7                -
                                       ----             ----             ----             ----
Loss before income taxes               (8.0)            (4.6)            (9.2)            (4.7) 
Benefit for income taxes                  -             (1.7)               -             (1.7)
                                       ----             ----             ----             ----
Net loss                               (8.0)%           (2.9)%           (9.2)%           (3.0)%
                                       ====             ====             ====             ====
</TABLE>

         Net Sales

         Net sales decreased 41.1% in the third quarter of Fiscal 1996 to $46.4
million compared to $78.7 million in the third quarter of Fiscal 1995.
Comparable store sales (stores in operation for at least 15 months) decreased by
19.1% in the third quarter of Fiscal 1996 as compared with the third quarter of
Fiscal 1995.  For the first nine months of Fiscal 1996, net sales decreased
37.8% to $149.6 million from $240.4 million in the same period of Fiscal 1995.
Comparable store sales decreased by 17.4% for the first nine months of Fiscal
1996 compared with comparable store sales for the first nine months of Fiscal
1995.  Management attributes this decline in sales to two principal factors:
first, the Company ended the third quarter of Fiscal 1996 with 181 fewer stores
than at the end of the comparable period in Fiscal 1995;  second, despite the
Company's new and aggressive advertising campaign, there was a decrease in
customer traffic as well as customer resistance to product and pricing.




                                                                   Page 11 of 22
<PAGE>   12
THE CLOTHESTIME, INC.


         The Company's primary target market is women in the 18 to 34 age
group.  While customer demographics revealed that this age represents a
significant portion of our customers, the Company still maintains a lesser
customer base in the 14 to 17 and 35 and over age groups.  The Company's
business is comprised of two principal selling seasons:  Spring (the first and
second quarters) which includes the periods during which spring and summer
styles are introduced; and, Fall (the third and fourth quarters) which includes
the back-to-school, winter and Christmas selling seasons.  Consistent with the
majority of clothing retailers, the Company normally posts its strongest sales
during the fourth quarter as a result of a stronger Christmas selling period
compared to its summer and early Fall selling periods.  First quarter sales are
generally lower than sales in the other quarters primarily as a result of the
higher sales activity during the fourth quarter.  However, during the past two
fiscal years, the Company has realized higher sales levels during the Spring
seasons rather than the Fall seasons.  Management believes that this was
primarily due to the highly competitive promotional environment surrounding the
holiday seasons as well as the lack of consumer acceptance of merchandise
offered.  As is the case for most clothing retailers, abnormal seasonal weather
also may affect sales because the seasonal merchandise then in the stores may
not correspond to the merchandise consistent with the abnormal weather.  In
addition, since most of the Company's stores are located in non-enclosed retail
locations as opposed to enclosed malls, the Company's sales can be adversely
affected by abnormal rain or other inclement weather.  There was no evidence of
adverse weather affecting sales during the first nine months of Fiscal 1996.

         Interest and Other Income; Interest Expense; Other Losses

         Interest and other income increased to $552 thousand in the third
quarter of Fiscal 1996, compared to $68 thousand in the third quarter of Fiscal
1995.  For the first nine months of Fiscal 1996, interest and other income
increased to $696 thousand from $508 thousand in the same period of Fiscal 1995.
The increase in the third quarter of Fiscal 1996 and for the first nine months
of Fiscal 1996 as compared to the respective periods of Fiscal 1995 was
attributable to a gain (net of expenses) of $309 thousand from the sale of the
Company's interests in two limited partnerships and interest income of $179
thousand earned on segregated cash accounts that have now been released pursuant
to a settlement of certain claims relating to the revolving credit facility,
partially offset by the fact that the Company maintained a lower invested cash
balance during each of the respective periods in Fiscal 1996 after excluding
invested cash balances attributable to the bankruptcy proceeding.  See Part II,
Item 1. Legal Proceedings, in this Report for a complete discussion of the sale
of the limited partnership interests and the settlement of certain claims
relating to the revolving credit facility.

         Interest expense decreased to $30.8 thousand in the third quarter of
Fiscal 1996, compared to $92 thousand in the third quarter of Fiscal 1995.
Interest expense decreased to $123 thousand for the first nine months of Fiscal
1996, from $649 thousand in the same period of Fiscal 1995.  This decrease is
attributable to the Company not recording approximately $390 thousand and $1.1
million in interest during the third quarter and first nine months of Fiscal
1996, respectively, consistent with certain accounting rules applicable to a
company which has filed for chapter 11 protection. The interest expense
recorded in the third quarter and first nine months of Fiscal 1995 resulted
from borrowings of $1.4 million made during the first quarter of Fiscal 1995,
bank loans of $1.9 million taken out in the fourth quarter of Fiscal 1993, a
capital lease obligation of $1.9 million entered into during Fiscal 1993, and
outstanding borrowings under the revolving credit facility in Fiscal 1995.  See
Note C to Condensed Consolidated Financial Statements, herein.

         The $405 thousand in other losses incurred in the first nine months of
Fiscal 1995 was attributable to losses from sales of marketable securities.

         Cost of Sales

         Cost of sales as a percentage of total revenues decreased to 67.2% in
the third quarter of Fiscal 1996 as compared with 72.1% in the third quarter of
Fiscal 1995.  For the first nine months of Fiscal 1996, cost of sales as a
percentage of total revenues decreased to 68.5% from 73.2% for the same period
of Fiscal 1995.  The decrease for the third quarter of Fiscal 1996 and the
first nine months of Fiscal 1996 as compared to the same periods of Fiscal 1995
was primarily the result of the Company taking fewer markdowns due to
conservative inventory planning stemming from negative sales trends and higher
mark-ups on new merchandise made possible through improved buying practices.





                                                                   Page 12 of 22
<PAGE>   13
THE CLOTHESTIME, INC.


         Selling, General and Administrative Expenses

         Selling, general and administrative expenses as a percentage of total
revenues increased to 37.7% for the third quarter in Fiscal 1996 compared with
32.4% for the third quarter in Fiscal 1995.  For the first nine months of
Fiscal 1996 and Fiscal 1995, selling, general and administrative expenses as a
percentage of total revenues were 35.9% and 31.0%, respectively.  The overall
increase in expenses as a percentage of total revenues in the third quarter of
Fiscal 1996 and the first nine months of Fiscal 1996 as compared to the same
periods of Fiscal 1995 was due to increases in (i) store operations and
supervisory payroll; (ii) advertising costs; (iii) employee benefits and (iv)
other fixed operating expenses.  Store operations and supervisory payroll as a
percentage of total revenues were higher as a result of staffing to support
higher than realized sales levels.  Advertising costs as a percentage of total
revenues were higher due to the major advertising campaign launched during
Fiscal 1996.  Employee benefits as a percentage of total revenues were higher
due to increased benefit costs necessary to support the planned staffing levels
referenced above.  As is the case with most operating expenses, increases in
other fixed operating expenses as a percentage of total revenues were incurred
due to decreased leverage on fixed operating expenses resulting from fewer
stores and lower average sales.

         Reorganization Costs

         Reorganization costs includes all costs associated with the
reorganization under chapter 11.  During the third quarter of Fiscal 1996, the
Company incurred reorganization costs of $1.4 million, primarily relating to
professional fees and estimated store lease rejection claims.  Reorganization
costs in the first nine months of Fiscal 1996 were $7.1 million, relating
primarily to estimated lease rejection claims, professional fees, the write-off
of leasehold improvements and fixtures associated with closed stores, and
certain other expenses.  See Note D to Condensed Consolidated Financial
Statements, herein.

         Benefit for Income Taxes

         No income tax benefit has been recorded for the third quarter and
first nine months of Fiscal 1996 because the Company has exhausted its
available net operating loss carrybacks permitted under the Federal and state
tax codes.  The benefit of net operating loss carryforwards will be reflected
in future periods when it becomes more likely than not that the benefit will be
realized.  The Company's effective benefit rate was 37.0% for the third quarter
and first nine months of Fiscal 1995.

         Net Loss and Loss Per Share

         Net loss and loss per share for the third quarter of Fiscal 1996 were
$3.8 million and $0.27, respectively.  This compared with net loss and loss per
share of $2.3 million and $0.16, respectively, for the third quarter of Fiscal
1995.  Net loss and loss per share for the first nine months of Fiscal 1996
were $13.8 million and $0.97, respectively.  This compared with net loss and
loss per share of $7.1 million and $0.50, respectively, for the same period of
Fiscal 1995.  The increase in net loss for the third quarter and first nine
months of Fiscal 1996 as compared to the same periods of Fiscal 1995 was
primarily due to a reduction in comparable store sales, reorganization charges
incurred during the third quarter of Fiscal 1996 and during the first nine
months of Fiscal 1996 of $1.4 million and $7.1 million, respectively, and the
absence of an income tax benefit.

LIQUIDITY AND CAPITAL RESOURCES

         Chapter 11 Filing

         As discussed previously, the Company and five of its subsidiaries
filed voluntary petitions for relief under chapter 11 of title 11 of the United
States Code on December 8, 1995.  Under chapter 11, actions to enforce certain
claims against the Company are stayed if the claims arose, or are based on,
events that occurred on or before the Petition Date.  The ultimate terms of
settlement of these claims will be determined in accordance with a plan of
reorganization which requires the approval of the impaired prepetition
creditors and shareholders and confirmation by the Bankruptcy Court.




                                                                   Page 13 of 22
<PAGE>   14
THE CLOTHESTIME, INC.




         Until a plan of reorganization is confirmed by the Bankruptcy Court,
only such payments on prepetition obligations that are approved or required by
the Bankruptcy Court will be made.  Except as approved by the Bankruptcy Court,
principal and interest payments on prepetition debt have not been made since
the Petition Date and will not be made without the Bankruptcy Court's approval
or until a plan of reorganization, defining the repayment terms, has been
confirmed by the Bankruptcy Court.  At October 26, 1996, liabilities subject to
compromise are estimated at $48.7 million. Other liabilities may arise or be
subject to compromise as a result of rejection of executory contracts and
unexpired leases or the Bankruptcy Court's resolution of claims for
contingencies and other disputed amounts.

         The prohibition on payments of prepetition liabilities as a result of
the chapter 11 filing and income tax refunds received in the second quarter of
Fiscal 1996 enabled the Company to report $24.3 million in cash and cash
equivalents at October 26, 1996.  Included in cash and cash equivalents at
October 26, 1996 is $470 thousand being held in segregated accounts pursuant to
various agreements in the Company's Bankruptcy Cases.

         Inherent in a successful plan of reorganization is a capital structure
which permits the Company to generate sufficient cash flow after reorganization
to meet its restructured obligations and fund the current obligations of the
reorganized Company.  Under the Bankruptcy Code, the rights of and ultimate
payment to prepetition creditors may be substantially altered and, as to some
classes, eliminated.  At this time, it is not possible to predict the outcome
of the chapter 11 filing, in general, or its effects on the business of the
Company or on the interests of creditors or stockholders.

         The Company is in the process of developing a long term business plan
around which the framework of a plan of reorganization will be developed.  As a
part of this process, the Company will be assessing the effects of new
merchandising and marketing strategies on operating results and assessing the
desirability of further store closings. Further store closings and rejections
of leases and other executory contracts will result in increased reorganization
costs.  During the months of June 1996 and July 1996, the Company closed a total
of 33 underperforming stores (the "July Closed Stores").  In July, the Company
rejected the leases for the July Closed Stores and, in August, assumed and
assigned one lease that had been marketed successfully.  These store closings
have resulted in a withdrawal of the Company from the markets in Hawaii, Oregon
and Washington.  On December 9, 1996, the Company filed a motion seeking
Bankruptcy Court approval to (i) close 22 underperforming retail stores (the
"January Closed Stores"), (ii) conduct store closing sales at certain of the
January Closed Stores, (iii) retain a lease consultant to market the leases
for certain of the January Closed Stores, and (iv) reject the leases for
certain of the January Closed Stores unless a motion to assume and assign such
leases has been filed by January 31, 1997.  The motion is scheduled to be heard
on December 30, 1996, and the store closing sales are scheduled to be completed
by January 31, 1997.

         During the third quarter of Fiscal 1996, the Company, in consultation
with the Committee, began actively exploring an investment by a third party as
an alternative strategy for exiting chapter 11.  The Company concluded that one
viable alternative for maximization of creditor recoveries is for the Debtors
and the Committee, with the assistance of a professional investment advisor,
jointly to seek to identify opportunities for a (i) sale or merger of the
Company or (ii) a third party willing to make an investment in the Company's
assets or business.  Accordingly, on November 12, 1996, the Company and the
Committee filed, and the  Bankruptcy Court approved, a joint application to
retain Financo as an investment advisor.  The Company and the Committee
anticipate that an investment could take a variety of forms, including, but not
limited to, the provision of new financing, either through direct loans, the
purchase of new debt securities or the assumption of existing liabilities; a
merger, joint venture or other similar business combination; or the purchase or
other acquisition of some or all of the Company's assets.  There can be no
assurance whether Financo will be successful in identifying an investor or
whether any transaction will be acceptable to the Company, the Committee or
other creditors and parties in interest.




                                                                   Page 14 of 22
<PAGE>   15
THE CLOTHESTIME, INC.


         The exclusive period for the filing of a plan of reorganization has
been extended to January 31, 1997 and to solicit acceptances of a plan of
reorganization to March 31, 1997. The Company may seek a further extension of
the exclusive period; however, there can be no assurance that the Bankruptcy
Court will grant a further extension.  The Company cannot, at the present time,
predict the contents of any proposed plan of reorganization or when or whether
it will be accepted by the creditors or approved by the Bankruptcy Court.

         Subsequent to the chapter 11 filing, the Company reached an agreement
with The CIT Group/Business Credit, Inc. to provide debtor in possession
financing.  The DIP Facility was approved by the Bankruptcy Court on January 9,
1996.  At October 26, 1996, the DIP Facility provided for revolving loans to be
made up to the lesser of (a) $25 million or (b) the lesser of (i) 60% of
eligible inventory valued on a cost basis and (ii) 36.5% of eligible inventory
valued on a retail basis, subject to adjustment. The revolving line of credit
may be in the form of letters of credit determined as provided under the
agreement.  Cash borrowings bear interest at either a reference rate plus 0.5%
or LIBOR plus 2.5%, at the option of the Company.  The agreement contains
various restrictive covenants requiring, among other things, minimum levels of
EBITDA, the establishment of maximum levels of capital expenditures, and a
prohibition regarding declaring or making any cash dividends by the Company or
its subsidiaries.  Effective August 1, 1996, the DIP Facility was amended to
revise the covenant relating to the minimum required level of EBITDA for the
third quarter of Fiscal 1996 and certain other provisions.  The DIP Facility was
amended further in October 1996 to revise the covenant relating to the minimum
required level of EBITDA for the third quarter of Fiscal 1996.  (See Note B to
Condensed Consolidated Financial Statements, herein).

         The Company did not use the direct borrowing capacity on the line
during the third quarter of Fiscal 1996. There were $1.5 million of letters of
credit outstanding at October 26, 1996.  The DIP Facility will terminate on the
earlier of December 8, 1997 or the date of consummation of a plan of
reorganization, subject to earlier termination. Cash borrowings and letters of
credit issued under the agreement have been granted superpriority status by the
Bankruptcy Court over all obligations except certain administrative expenses,
as defined in the agreement.  The DIP Facility is more fully described in Note
B to Condensed Consolidated Financial Statements, herein.

         General

         The Company's principal needs for liquidity are to finance the
purchase of merchandise inventories, fund its operations and pay professional
and administrative fees in connection with its reorganization.

         Net cash used in operating activities was $4.0 million for the third
quarter of Fiscal 1996, compared to $13.0 million for the third quarter of
Fiscal 1995.  The Company's cash used in operations of $4.0 million for the
third quarter of Fiscal 1996 resulted primarily from losses incurred during the
first nine months of Fiscal 1996 and an increase in merchandise inventories,
partially offset by the add back of non-cash charges representing non-cash
reorganization costs and income tax refunds received in the second quarter of
Fiscal 1996.  Merchandise inventories increased to $13.4 million at the end of
the third quarter of Fiscal 1996, from $8.6 million at the end of Fiscal 1995.
The increase in inventory at the end of the third quarter of Fiscal 1996 can be
attributed to seasonal inventory fluctuations and inventory returning to normal
levels following aggressive markdowns taken in the fourth quarter of Fiscal
1995.

         The Company has an indirect relationship with the factoring community,
which assists vendors of merchandise inventories in securing up front payment
(as opposed to payment terms from the Company directly) for goods shipped to
the Company.  Subsequent to the approval of the DIP Facility, most factors have
been willing to extend credit for goods shipped to the Company.  To the extent
that (i) cash provided from operating activities is inadequate to meet the
Company's liquidity requirements, (ii) the factors require greater credit
support and/or (iii) manufacturers are less willing to deliver merchandise
pursuant to payment terms, short or long-term liquidity will be adversely
impacted.




                                                                   Page 15 of 22
<PAGE>   16
THE CLOTHESTIME, INC.


         Income taxes receivable decreased to $0 by the end of the third
quarter of Fiscal 1996, compared to $9.3 million at the end of Fiscal 1995, due
to the Company receiving tax refunds of $9.4 million in the second quarter of
Fiscal 1996. See Part II, Item 1. Legal Proceedings, herein for a discussion of
the settlement involving the tax refund.

         Investments decreased to $0 at the end of the third quarter of Fiscal
1996, compared to $1.2 million at the end of Fiscal 1995.  The decrease was due
to the sale of the Company's interests in two limited partnerships.  See Part
II, Item 1. Legal Proceedings, in this Report for a complete discussion of the
sale of the limited partnership interests.

         Accounts payable decreased to $6.7 million at the end of the third
quarter of Fiscal 1996, from $11.1 million at the end of Fiscal 1995.  The
decrease in accounts payable resulted primarily from (i) professional fees
relating to the Company's chapter 11 filing, which were accrued as part of the
accounts payable balance at the end of Fiscal 1995 and paid primarily in the
second quarter of Fiscal 1996 and (ii) a reclassification of a portion of the
accounts payable balance to liabilities subject to compromise done after Fiscal
1995 year-end.  Accrued sales tax decreased to $1.6 million at the end of the
third quarter of Fiscal 1996 from $2.0 million at the end of Fiscal 1995
primarily due to tax payment timing differences and a reduction in the
Company's store base.  Accrued payroll and related taxes decreased from $4.6
million at the end of Fiscal 1995 to $3.6 million at the end of the third
quarter of Fiscal 1996 primarily due to decreasing group health and payroll-
related tax payments as a result of the Company's reduction in its store base.

         Long-term liabilities consisting of a capital lease obligation
increased to $645 thousand from $0 at the end of Fiscal 1995 due to the Company
reclassifying a portion of the capital lease obligation from liabilities
subject to compromise to long-term liabilities as a result of the settlement
involving the MetLife capital lease obligation.  The capital lease obligation
settlement and the amounts outstanding thereunder are more fully described in
Note C to the Notes to Condensed Consolidated Financial Statements, herein.

         In the first nine months of Fiscal 1996, the Company closed
forty-three stores.  As a result, property, plant and equipment decreased $4.7
million, from $55.3 million at the end of Fiscal 1995 to $50.6 million at
October 26, 1996.  During Fiscal 1996, the Company has a capital spending limit
of $2.0 million under the DIP Facility.  Management believes this amount is more
than adequate to meet the capital requirements of the Company.  Although the
Company plans no new store openings during Fiscal 1996, a small amount of
capital expenditures for store maintenance, system enhancements and various
other corporate expenditures are anticipated.  The DIP Facility, cash on hand,
revenues generated from operations, credit terms extended by the vendor and
factor community, and anticipated expense reduction measures will be the
principal sources of liquidity.  To the extent that results of operations
continue to decline, short and long term liquidity will be adversely affected,
particularly if the availability of funds under the DIP Facility are
significantly decreased or are no longer made available.

FORWARD-LOOKING STATEMENTS

         Included in this Item 2., Management's Discussion and Analysis of
Financial Condition and Results of Operations, and elsewhere in this Report are
certain forward-looking statements reflecting management's current
expectations.  Although the Company believes that its expectations are based
upon reasonable assumptions, there can be no assurance that the Company's
financial goals will be realized.  Numerous factors may affect the Company's
actual results and may cause results to differ materially from those expressed
in forward-looking statements made by or on behalf of the Company.  Some of
these factors include the competition in the retail industry, the general
economic factors affecting consumer spending particularly in the geographic
markets in which the Company competes, customer acceptance of the merchandise
offered by the Company, pricing and other competitive factors. The Company
cannot predict how these factors will be additionally impacted by the Company's
chapter 11 filing.  In addition, there are uncertainties inherent in the
process of reconciling claims, rejecting and assuming executory contracts and
unexpired leases, formulating and confirming a plan of reorganization and other
events in the context of the Company's chapter 11 filing.




                                                                   Page 16 of 22
<PAGE>   17
THE CLOTHESTIME, INC.


                          PART II - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

         The following discussion provides general background information
regarding developments in the Company's chapter 11 cases since January 27, 1996
through approximately December 9, 1996, but is not intended to be an exhaustive
summary.  For additional information regarding the Company's chapter 11 cases
reference should be made to the Company's Annual Report on Form 10-K for the
Fiscal year ended January 27, 1996 (the "Annual Report"), Part I, Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operations of this Report and the Notes to Consolidated Financial Statements
herein.  The Company files routine monthly reports with the Office of the
United States Trustee for the Central District of California and files various
pleadings with the Bankruptcy Court.  Copies of these documents may be
obtained, upon request, from CPT Group, Inc. ("CPT"), 1151 Dove Street, Suite
170, Newport Beach, California 92660, (714) 852-8240; however, the requesting
party will be charged a fee by CPT.

         Since the Petition Date, the Company has continued in possession of
its properties and, as a debtor in possession, is authorized to operate and
manage its business and to enter into all transactions (including obtaining
services, supplies and inventories) that it could have entered into in the
ordinary course of business had there been no bankruptcy.  The Company may not
engage in transactions outside the ordinary course of business without first
complying with the notice and hearing provisions of the Bankruptcy Code and
obtaining Bankruptcy Court approval where necessary.

         The Company has the right, subject to the approval of the Bankruptcy
Court, under relevant provisions of the Bankruptcy Code, to assume or reject
executory contracts and unexpired leases, including real property leases.
Certain parties to such executory contracts and unexpired leases with the
Company, including parties to such real property leases, may file motions with
the Bankruptcy Court seeking to require the Company to assume or reject those
contracts or leases.

         In this context, "assumption" requires that the Company cure, or
provide adequate assurance that it will cure, all existing defaults under the
contract or lease and provide adequate assurance of future performance under
relevant provisions of the Bankruptcy Code; and "rejection" means that the
Company is relieved from its obligations to perform further under the contract
or lease.  Rejection of an executory contract or lease may constitute a breach
of that contract and may afford the non-debtor party the right to assert a
claim against the bankruptcy estate for damages arising out of the breach,
which claim shall be allowed or disallowed as if such claim had arisen before
the date of the filing of the petition. By orders of the Bankruptcy Court, the
Company obtained extensions of time within which to assume or reject its
non-residential real property leases through and including the confirmation
date of its plan of reorganization, except for certain leases of
non-residential real property of certain objecting landlords for which the time
within which such leases must be assumed or rejected was extended to March 31,
1997.  Since the Petition Date and as of December 9, 1996, the Company had
rejected 171 retail store leases.

         By order entered May 6, 1996, the Bankruptcy Court fixed July 15, 1996
as the date by which all creditors (with certain limited exceptions) must file
proofs of claim against the Company with respect to prepetition claims (or be
forever barred from (i) asserting claims that such person or entity possesses
against the Company and (ii) voting upon, or receiving any distribution under,
any plan or reorganization).

         Described below are certain significant actions taken, or proceedings
now pending, in the Bankruptcy Court.

         As discussed in the Company's Annual Report, (i) on January 24, 1996,
Wells, individually and as agent for itself and Union, (collectively, the
"Banks") commenced an adversary proceeding in the Bankruptcy Court, Adversary
Proceeding No. 96-1100, against the Debtors claiming that a tax refund, then
estimated to be approximately $9.3 million, is subject to the Banks' prepetition
lien on certain of the Company's assets (the "Tax Refund Litigation"); and (ii)
on January 5, 1996, the Company commenced an adversary proceeding in the
Bankruptcy Court against the Banks, Adversary Proceeding No. 96-1017, seeking a
judicial determination and declaration that the Banks do not hold a valid and
perfected security interest in certain credit card receivables or a deposit
account or, alternatively, that the security interest, if any, held by the
Banks in such property can be avoided (the "Credit Card Litigation").




                                                                   Page 17 of 22
<PAGE>   18
THE CLOTHESTIME, INC.


         On August 28, 1996, the Bankruptcy Court approved the compromise and
settlement of the Tax Refund Litigation and the Credit Card Litigation
(collectively, the "Adversary Proceedings") and certain related disputes
between the Company and the Banks, pursuant to a Settlement Agreement.  The
Settlement Agreement provides for the resolution of all claims and
controversies relating to the Banks' alleged security interests in the
following Disputed Collateral:  (i) refunds of federal, state and local income
taxes in the amount of $9,452,726.29, representing tax refunds from the
Internal Revenue Service in the amount of $9,450,146.00, from the State of
Illinois in the amount of $2,280.29 and from the City of New York in the amount
of $300.00 (collectively, the "Tax Refund"); (ii) certain funds held on deposit
in segregated accounts pursuant to the terms of the parties' Amended
Stipulation for Order (1) Clarifying Order Approving Centralized Cash
Management Systems, etc., (2) Providing Adequate Protection for Alleged
Collateral of Wells Fargo Bank, as Agent, to the Extent of Valid Liens and (3)
Establishing Schedule for Resolution of Disputes, dated December 27, 1995;
(iii) the Company's prepetition credit card accounts receivable; and (iv) fee
and expense retainers paid by the Company to professionals prior to the
commencement of the Bankruptcy Cases.  The Settlement Agreement also fixes the
allowed amount of the Banks' prepetition claims under the credit facilities
evidenced by the Credit Agreement, dated as of February 28, 1995 between
Stores, as borrower, the other Debtors, as Guarantors, and the Banks (the "Bank
Claims") at $26,306,481.05, subject to increase for prepetition legal fees and
expenses and certain contingent claims on account of letters of credit.  Such
amount has been and will be reduced by certain payments, including payments
made pursuant to the Settlement Agreement.  On or about September 5, 1996,
pursuant to the terms of the Settlement Agreement and on account of the Banks'
alleged security interests in the Disputed Collateral other than the Tax
Refunds, the Banks (i) applied $3.1 million of the funds on deposit in certain
segregated accounts held by the Company to reduce the Bank Claims (the "Initial
Payment"), (ii) released the remainder of all funds (approximately $6.5
million) on deposit in such accounts to the Company and (iii) released the
Banks' security interests in all Disputed Collateral other than the Tax Refund.
In addition, on September 5, 1996, to secure its obligation to make a remaining
payment (the "Remaining Payment"), the Company deposited the sum of
$3,126,363.00 into a segregated account (the "Segregated Account").  On
September 16, 1996, such amount plus interest of $3,054.34 was applied by the
Banks to reduce the amount of the Bank Claims pursuant to the terms of the
Settlement Agreement.

         In consideration for the transactions described above, the Banks:  
(i) have released the balance of the Tax Refund to the Company and (ii) have
released their alleged security interests in the Tax Refund.  In addition,
under the terms of the Settlement Agreement, the Adversary Proceedings have
been dismissed.

         In May 1993, the Company purchased various "point of sale" computer
equipment and related software (collectively, the "POS Equipment") used in
certain of the Company's retail stores to record data regarding sales
transactions.  Such data is simultaneously transferred to the Company's central
computer system and used to track, among other things, inventory levels and
sales performance.  The Company financed the POS Equipment through a capital
lease with MetLife Capital Corporation ("MetLife").  The lease obligation was
in the aggregate original principal amount of $1,909,725 and was secured by the
POS Equipment.  See Note C to Condensed Consolidated Financial Statements.

         As of the Petition Date, the aggregate unpaid amount of the Company's
indebtedness to MetLife, including unpaid principal and accrued interest, was
$1,035,335.  On or about May 13, 1996, MetLife filed a motion (the "Motion")
for relief from the automatic stay in the Company's chapter 11 case, pursuant
to section 362 of the Bankruptcy Code, to permit MetLife to foreclose upon its
liens on the POS Equipment or, alternatively, to require the Company to make
"adequate protection" payments to MetLife to protect against any diminution to
the value of the POS Equipment during the pendency of the Company's chapter 11
case. The Company and MetLife entered into an agreement (the "MetLife
Agreement"), which was approved by the Bankruptcy Court on July 22, 1996,
settling the matters that were the subject of the Motion and restructuring the
Company's loan obligations to MetLife.  Under the terms of the MetLife
agreement, MetLife will have an allowed secured claim (the "Secured Claim") in
the Company's chapter 11 case in the amount of $670,000 and the balance of
MetLife's claim will be an allowed unsecured claim (the "Unsecured Claim") in
the Company's chapter 11 case.  To amortize the Secured Claim, the Company (i)
will make monthly payments to MetLife in the amount of $5,000, commencing in
June 1996, which payments will be applied to reduce the principal amount of the
Secured Claim, until the effective date of a plan of reorganization in the
Company's chapter 11 case (the "Effective Date") and (ii) will pay the
remainder of the Secured Claim by making monthly payments to MetLife from and
after the Effective Date in an amount equal to remaining principal plus
interest at the Bank of America prime rate plus 200 basis points (up to a
maximum of 10.5% per annum) amortized over a number of months equal to the
difference between 60 and the number of monthly payments made to MetLife prior
to the Effective Date.  The Unsecured Claim will be treated and paid in
accordance with the terms of any confirmed plan of reorganization in the
Company's chapter 11 case.




                                                                   Page 18 of 22
<PAGE>   19
THE CLOTHESTIME, INC.


         On July 11, 1996, the Company received Bankruptcy Court approval to
(i) close 33 underperforming retail stores (the "July Closed Stores"), (ii)
retain a liquidation consultant to conduct store closing sales at 18 of these
stores located in Hawaii, Oregon and Washington and (iii) conduct store
closing sales at the other 15 locations in other markets.  On July 22, 1996,
the Company received Bankruptcy Court approval to reject certain of the leases
for the July Closed Stores and to retain a marketing consultant to market
certain of the other leases.  Effective July 31, 1996, the Company rejected the
remaining leases for the July Closed Stores and, in August 1996 assumed and
assigned one lease that had been marketed successfully.  These store closings
have resulted in a withdrawal of the Company from the markets in Hawaii, Oregon
and Washington.  On December 9, 1996, the Company filed a motion seeking
Bankruptcy Court approval to (i) close 22 underperforming retail stores (the
"January Closed Stores"), (ii) conduct store closing sales at certain of the
January Closed Stores, (iii) retain a lease consultant to market the leases
for certain of the January Closed Stores, and (iv) reject the leases for
certain of the January Closed Stores unless a motion to assume and assign such
leases has been filed by January 31, 1997.  The motion is scheduled to be heard
on December 30, 1996, and the store closing sales are scheduled to be
completed by January 31, 1997.

         On August 28, 1996, the Bankruptcy Court approved the sale of, and on
August 30, 1996, the Company sold, its interests in two limited partnerships for
an aggregate consideration of $1,550,000.  $1,229,443.46 of the net proceeds of
the sale were paid to Union in full satisfaction of its secured loans.  See Note
C to Condensed Consolidated Financial Statements.  The balance of the net
proceeds were paid into a segregated account, and are subject to any other liens
against the partnership interests, including the lien (if any) of the Banks, and
will not be used by the Debtors without further order of the Bankruptcy Court.

         On August 28, 1996, the Bankruptcy Court approved the extension of the
Company's exclusive period to file a plan of reorganization until January 31,
1997, and its exclusive period to solicit acceptances of a plan until March 31,
1997. The Company may seek a further extension of the exclusive period;
however, there can be no assurance that the Bankruptcy Court will grant a
further extension.  The Company cannot, at the present time, predict the
contents of any proposed plan of reorganization or when or whether it will be
accepted by the creditors or approved by the Bankruptcy Court.

         On September 30, 1996, the Bankruptcy Court approved the assumption of
a restructured lease for the Company's headquarters space.  The base rent for
the space was reduced, effective May 15, 1996, from 67.7 cents per square foot
per month to 40 cents per square foot per month, or an annual reduction of
approximately $400,000.  The lease as amended also provides for an annualized
adjustment based on the consumer price index of not less than 103% and not more
than 105% of the base rent for the prior year.  Any damages incurred by the
lessor are capped at the annualized amount of the base rent for the year, and
the Company has provided the lessors with a letter of credit for such amount.
The term of the lease was also extended to May 15, 2006.

         During the third quarter of Fiscal 1996, the Company, in consultation
with the Committee, began actively exploring an investment by a third party as
an alternative strategy for exiting chapter 11.  The Company concluded that one
viable alternative for maximization of creditor recoveries is for the Debtors
and the Committee, with the assistance of a professional investment advisor,
jointly to seek to identify opportunities for a (i) sale or merger of the
Company or (ii) a third party willing to make an investment in the Company's
assets or business.  Accordingly, on November 12, 1996, the Company and the
Committee filed, and the Bankruptcy Court approved, a joint application to
retain Financo as an investment advisor.  The Company and the Committee
anticipate that an investment could take a variety of forms, including, but not
limited to, the provision of new financing, either through direct loans, the
purchase of new debt securities or the assumption of existing liabilities; a
merger, joint venture or other similar business combination; or the purchase or
other acquisition of some or all of the Company's assets. There can be no
assurance whether Financo will be successful in identifying an investor or
whether any transaction will be acceptable to the Company, the Committee or
other creditors and parties in interest.




                                                                   Page 19 of 22
<PAGE>   20
THE CLOTHESTIME, INC.


         On June 28, 1996, the Committee filed a motion (the "Compensation
Motion") seeking an order requiring the Company to reduce by 25 percent the
annual base compensation of John Ortega II, the Company's Chairman of the Board
and Chief Executive Officer, and Norman Abramson, the Company's President and
Chief Operating Officer.  Thereafter, the Company, the Committee, Messrs.
Ortega and Abramson and David Sejpal, the Company's Vice President and Chief
Financial Officer, entered into negotiations regarding, and, with the approval
of the Compensation Committee of the Board of Directors, entered into a
compromise and settlement of, the subject matter of the Compensation Motion.

         Under the terms of this compromise and settlement (as modified by a
stipulation approved by the Bankruptcy Court on November 12, 1996), effective
as of August 1, 1996, the annual base compensation paid to Messrs. Ortega and
Abramson was reduced by 12.5 percent, such reduction to remain effective during
the remaining pendency of the Bankruptcy Cases.  In addition, Messrs. Ortega,
Abramson and Sejpal will be eligible to receive certain incentive payments
based on the Company's financial performance for the second half of Fiscal
1996.  If Mr. Sejpal's employment is terminated other than for cause (as
defined in the Severance Agreement, dated as of October 10, 1994  (the
"Severance Agreement")) or if he terminates his employment for Good Reason
within one year after a Change in Control (as defined in the Severance
Agreement and including the conversion of any of the Debtors' cases to a case
under chapter 7 of the Bankruptcy Code or the confirmation of a plan of
reorganization providing for the liquidation of Clothestime or Stores), he
shall be entitled to a severance payment in an amount equal to 12 months of his
base compensation in effect on July 31, 1996 and a lump sum payment in lieu of
benefits.  Such amounts shall be treated as allowed administrative expense
claims against Clothestime.  In addition, Mr. Sejpal agreed to remain employed
with the Company until at least the earlier of (i) 60 days after the date of
any conversion of any of the Debtors' cases to a case under chapter 7 of the
Bankruptcy Code or the date of the confirmation of a plan of reorganization
providing for the liquidation of Clothestime or Stores and (ii) the date on
which the Debtors (or any successor chapter 11 or chapter 7 trustee of the
Debtors) and the Committee notify Mr. Sejpal that his services are no longer
required.  Finally, the Debtors and the Committee released Mr. Sejpal from any
and all claims arising from or related to a bonus payment in the amount of
$50,000 paid by the Company prior to the Petition Date.

         To the best of management's knowledge, there are no other material
pending legal proceedings.  The Company is, however, subject to other legal
proceedings and claims that have arisen in the ordinary course of its business.

ITEM 5.  OTHER INFORMATION

         The information set forth in Part II, Item 1. Legal Proceedings in
this Report is hereby incorporated by reference in its entirety into this 
Item 5.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

         (a)  Exhibits

                 10.1     Amendment to Financing Agreement, dated as of August
                          1, 1996 by and between The CIT Group/Business Credit, 
                          Inc., as Lender, and Clothestime Stores, Inc., as 
                          Borrower.

                 10.2     Amendment to Financing Agreement, dated as of October
                          1, 1996 by and between The CIT Group/Business Credit, 
                          Inc., as Lender, and Clothestime Stores, Inc., as 
                          Borrower.

                 10.3     Agreement, dated as of November 11, 1996 by and among
                          Financo, Inc., as financial advisor, The Clothestime,
                          Inc. and the Creditors' Committee for The
                          Clothestime, Inc.

                 10.4     Assumption and First Amendment to Lease, dated as of
                          August 1, 1996 by and among Raymond Deangelo, August
                          Deangelo, and Michael P. Deangelo, collectively as
                          Lessor, and MRJ Industries, Inc., as Lessee.

                 27.      Financial Data Schedule.

         (b)     Reports on Form 8-K - There were no reports on Form 8-K filed
                 for the quarterly period ended October 26, 1996.




                                                                   Page 20 of 22
<PAGE>   21
THE CLOTHESTIME, INC.


                                   SIGNATURES


         Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.




                                          THE CLOTHESTIME, INC.


Date:  December 16, 1996                  By:  /s/ JOHN ORTEGA II
                                              ------------------------------
                                                   John Ortega II 
                                                   Chairman of the Board 
                                                   and Chief Executive Officer


Date:  December 16, 1996                  By:  /s/ DAVID A. SEJPAL
                                              -------------------------------
                                                   David A. Sejpal
                                                   Vice President -
                                                   Chief Financial Officer 
                                                   (Principal Financial Officer)




                                                                   Page 21 of 22
<PAGE>   22
THE CLOTHESTIME, INC.



                                 EXHIBIT INDEX
                       

EXHIBIT NO.         DESCRIPTION
-----------         -----------
   10.1             Amendment to Financing Agreement, dated as of August 1, 
                    1996 by and between The CIT Group/Business Credit, Inc.,
                    as Lender, and Clothestime Stores, Inc., as Borrower.

   10.2             Amendment to Financing Agreement, dated as of October 1, 
                    1996 by and between The CIT Group/Business Credit, Inc., as 
                    Lender, and Clothestime Stores, Inc., as Borrower.

   10.3             Agreement, dated as of November 11, 1996 by and among
                    Financo, Inc., as financial advisor, The Clothestime, Inc.
                    and the Creditors' Committee for The Clothestime, Inc.

   10.4             Assumption and First Amendment to Lease, dated as of 
                    August 1, 1996 by and among Raymond Deangelo, August
                    Deangelo, and Michael P. Deangelo, collectively as Lessor,
                    and MRJ Industries, Inc., as Lessee.

   27.              Financial Data Schedule.




                                                                   Page 22 of 22