**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


WASHINGTON
      D.C. 20549





**FORM
      10-K**





(MARK
      ONE)


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


FOR
      THE
      FISCAL YEAR ENDED DECEMBER 31, 2006





OR





o  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: 0-22963





**BIG
      DOG HOLDINGS, INC.**


(EXACT
      NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)










DELAWARE
            
            52-1868665(STATE
                OR OTHER JURISDICTION OF OR ORGANIZATION)
            
            (I.R.S.
                EMPLOYER INCORPORATION IDENTIFICATION NO.)121
                GRAY AVENUE, SANTA BARBARA, CALIFORNIA
            
            93101(ADDRESS
                OF PRINCIPAL EXECUTIVE OFFICE)
            
            (ZIP
                CODE)





(805)
      963-8727


(REGISTRANT’S
      TELEPHONE NUMBER INCLUDING AREA CODE)





SECURITIES
      REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE





SECURITIES
      REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, $0.01 per
      share





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act. Yes o No x





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the
      Act. Yes o No x





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 o





Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
      be contained, to the best of registrant’s knowledge, in definitive proxy or
      information statements incorporated by reference in Part III of this
      Form 10-K or any amendment to this Form 10-K. x





Indicate
      by check mark whether registrant is a large accelerated filer, an accelerated
      filer, or a non-accelerated filer. See definition of “accelerated filer and
      large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):





Large
      accelerated filer o Accelerated filer o Non-accelerated filer x





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




As
      of the
      close of business on June 30, 2006, the last business day of the registrant’s
      most recently completed second fiscal quarter, the aggregate market value of
      the
      Common Stock held by non-affiliates of the registrant was $37,295,000 based
      upon
      the closing price of **$** 12.48
      on
      NASDAQ on such date. All
      outstanding shares of Common Stock, other than those held by executive officers,
      directors and 10% shareholders are deemed to be held by
      non-affiliates.





As
      of the
      close of business on March 6, 2007, the registrant had 9,352,631 shares of
      common stock outstanding.




**DOCUMENTS
      INCOPORATED BY REFERENCE**




Part
      III
      incorporates information by reference from the definitive Proxy Statement for
      the 2006 Annual Meeting of Shareholders, to be filed with the Commission no
      later than 120 days after the end of the registrant’s fiscal year covered by
      this Form 10-K.

















(THIS
      PAGE INTENTIONALLY LEFT BLANK)






2




PART
      I





ITEM
                1.
            BUSINESS





Unless
      the context indicates otherwise, when this Annual Report on Form 10-K refers
      to
“we,” “us” or “the Company,” we are referring to Big Dog Holdings, Inc. and its
      subsidiaries on a consolidated basis.





The
      following discussion should be read in conjunction with the audited financial
      statements and notes thereto included elsewhere in this Annual Report on Form
      10-K.





GENERAL





Big
      Dog
      Holdings, Inc. is the parent company of two retail chains, Big Dog USA, Inc.
      (“Big Dogs”) and The Walking Company (“TWC”). Big Dogs develops, markets and
      retails a branded, lifestyle collection of unique, high-quality, popular-priced
      consumer products, including active wear, casual sportswear, accessories and
      gifts for men and women of all ages. TWC is the world’s leading specialty
      retailer of authentic comfort footwear and accessories.





The
      Company’s Big Dogs products were first sold in 1983 and operations remained
      limited through 1992 when the current controlling stockholders acquired the
      BIG
      DOGS® brand and related assets. Following the acquisition of Big Dogs, the
      Company initiated a strategy of leveraging the brand through dramatic expansion
      of the Big Dog’s product line and rapid growth in our retail stores. The number
      of Big Dog stores grew from five in 1993 to a peak of 231 in 2001 and has
      subsequently been reduced to 145 in March, 2007. After early years of rapid
      growth, Big Dogs has reached a level of maturity in the number of stores and
      breadth of products. In recent years the Company has focused on profitability
      and brand management for Big Dogs.





In
      March
      2004, the Company, through a newly-formed subsidiary, acquired substantially
      all
      of the assets of TWC out of bankruptcy. TWC is the world’s leading specialty
      retailer of authentic comfort footwear, operating 151 specialty stores as of
      December 31, 2006 in premium malls across the nation. TWC
      sells high-quality, technically designed comfort footwear and accessories
      for men and women from leading comfort brands from around the world. During
      2005, the Company added to the TWC chain through the acquisition of Footworks.
      Footworks operated a chain of seven comfort footwear stores in strategic
      locations, including several high profile locations on the Las Vegas Strip.
      Substantially all of such stores were converted to TWC stores. During 2006,
      the
      Company acquired the assets of Steve’s Shoes, Inc. out of bankruptcy. Steve’s
      Shoes, Inc. operated a chain of footwear stores, featuring a wide variety of
      brands (including some comfort brands) throughout the US under the names Steve’s
      Shoes, Overland Trading Company and Sole Outdoor. As a result of this
      acquisition, TWC acquired 37 stores.





BUSINESS
      OF BIG DOGS





BIG
      DOGS®
is an All-American, family-oriented brand that we believe has established a
      unique niche in its dedication to providing quality, value and fun. Our products
      are centered around the signature BIG DOGS® name, logo and "Big Dog" characters
      and are designed to appeal to a broad range of customers. The BIG DOGS® brand
      conveys a sense of fun, humor and a "Big Dog attitude," whereby each customer
      can feel that he or she is a "Big Dog." The Big Dog attitude and sense of fun
      are brought to life through our graphic capabilities that portray the Big Dog
      characters in a number of engaging, positive and inspiring situations and
      activities. The Big Dog attitude is further defined by a number of slogans
      such
      as "If You Can't Run with the Big Dogs Stay on the Porch"®, "I am the Big Dog”
and “Attitude is Everything." These graphics and slogans combine a bold,
      spirited attitude with wry, lighthearted humor. The appeal of the brand is
      further strengthened through a customer's personal identification with
      particular sports and other activities depicted in these graphics. As part
      of
      the Big Dog attitude and sense of fun, our graphics frequently parody and poke
      fun at current popular trends and events. In addition to our focus on fun,
      Big
      Dogs develops customer loyalty and enhances its brand image by providing a
      consistently high level of quality at moderate price points. We accomplish
      this
      primarily through (i) selling our own brand directly to the consumer, (ii)
      low-cost product development, and (iii) sourcing high-volume/low-cost basic
      apparel with limited fashion risk.





The
      BIG
      DOGS® brand is designed to appeal to men, women and children of all ages,
      especially when they are engaged in leisure or recreational activities. We
      develop our apparel products, which include a wide variety of basic apparel
      and
      related products, with an emphasis on being functional rather than
      fashion-forward or trendy. These apparel products include graphic T-shirts,
      shorts, knit and woven shirts, fleece items, loungewear and boxer shorts. In
      addition to its BIG DOGS® line of activewear and casual sportswear for men and
      women, we have a LITTLE BIG DOGS® line of infants' and children's apparel and a
      BIG BIG DOGS® line of big-size apparel. We also sell a line of non-apparel
      products, including plush animals, stationery and pet products, which feature
      Big Dog graphics and are developed to complement our apparel.





3





BIG
      DOGS®
is sold through 145 company-owned stores and through its customer-direct
      business of catalog and online sales.





BUSINESS
      STRATEGY





Promote
      the Big Dog Spirit of Fun .
      A key
      and unique element in our Big Dogs brand image is the focus on fun. This spirit
      of fun revolves around our Big Dog character that has broad appeal to men,
      women
      and children of all ages. We foster this spirit by creating positive, humorous,
      topical and inspiring graphics and slogans that we apply to our merchandise.
      More than just a logo, “the Big Dog” represents the leader, athlete, child,
      comedian, musician, boss, traveler, parent and dog lover that a wide range
      of
      customers can identify with. Big Dog products are fun, not only because of
      their
      graphics and slogans, but also because they are designed for recreational,
      sports and leisure activities and make ideal gifts.





Deliver
      High Quality at a Good Value .
      Big
      Dogs' products are constructed using high-quality fabrics and other materials.
      Many of our products feature unique graphics characterized by advanced print
      techniques, as well as unique appliqués and embroideries on many of our apparel
      products. We believe this combination of quality fabrics and graphics in our
      apparel products provides the customer with a product that has an exceptional
      look and feel. We are able to deliver this level of quality at reasonable prices
      primarily as a result of (i) selling our own brand direct to the consumer,
      (ii)
      low-cost product development, (iii) sourcing of basic apparel, and (iv) low
      marketing costs. We believe that delivering quality and value is instrumental
      in
      generating customer appeal and brand loyalty for our products, particularly
      those that do not prominently feature Big Dog graphics.




Enhance
      Functional Products with Graphics .
      Big
      Dogs develops functional rather than fashion-forward products. We believe we
      have a special competency in creating distinctive, popular graphics which we
      use
      to differentiate our products from those of our competitors. We have developed
      a
      broad assortment of classic, functional clothing ("basics") in traditional,
      less
      fashion-forward colors. Our focus on basics and our ability to leverage our
      graphics across multiple product categories have allowed us to eliminate the
      need for a traditional buyer or design staff, and thereby lower our product
      development costs compared to most fashion apparel companies. Furthermore,
      since
      our graphics are added in the last stage of production, we are able to be more
      responsive to customer preferences while also lowering our inventory
      risk.




Target
      a Broad, Diverse Customer Base .
      We
      believe we have established Big Dogs as an All-American, family-oriented brand
      featuring products, graphic themes, slogans and promotions that appeal to a
      broad range of consumers. Although our marketing focus is on baby boomers and
      their kids, our customers include men, women and children of all ages, who
      span
      a wide range of geographic areas and income levels. Furthermore, we believe
      that
      the millions of dog and other pet owners in the United States have a strong
      natural affinity for the dog-related images and themes in Big Dogs graphics.
      In
      addition, we believe that the positive image the brand brings to being a "Big
      Dog" has a special appeal to big-size customers.





Emphasize
      Grassroots Marketing .
      We
      believe Big Dogs’ most effective marketing is by the products themselves and
      their presentation in our retail stores, catalog and website. As a result,
      we
      have spent relatively little on advertising. Also important to our marketing
      strategy is our targeted "grassroots" marketing activities. These activities
      include local and charity sponsorships (such as high school sports teams) and
      community-oriented promotional events (such as the Company's annual dog parade
      in Santa Barbara).





MERCHANDISING





The
      Big
      Dogs’ product line features a branded, lifestyle collection of unique,
      high-quality, popular-priced consumer products, including activewear, casual
      sportswear, accessories and gifts. Our apparel lines include full collections
      of
      classic unisex casual sportswear and activewear for adults and for big sizes,
      as
      well as collections for infants and children. We continuously explore
      opportunities to further leverage our brand and graphics into new product
      lines.





4





Our
      apparel products are manufactured from premium cotton or quality synthetic
      fabrics. Big Dogs' apparel is characterized by quality fabrics, construction
      and
      embellishments, and is distinguished from other apparel lines by the BIG DOGS’®
name, dog logo, graphics and slogans. In addition to our distinctive graphics,
      we believe we have achieved recognition for the quality and performance of
      our
      products.





The
      majority of Big Dogs’ products range from between $5 and $40. The following
      table sets forth the approximate contribution that each of Big Dogs’ product
      categories made to total net sales in our retail stores for the year ended
      December 31:





%
                OF RETAIL STORE* NET SALES
              YEARS
                ENDED DECEMBER 31,2006
            
            2005
            
            2004Adult
                Apparel and Accessories.
            
            
            54.3
            %
            
            54.4
            %
            
            53.9
            %Big-sizeApparel
            
            
            27.4
            
            
            26.1
            
            
            23.7Infants'
                and Children's Apparel and Accessories
            
            
            12.8
            
            
            14.3
            
            
            16.8Non-Apparel
                Products
            
            
            5.5
            
            
            5.2
            
            
            5.6Total
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %*Does
                not include catalog, wholesale and internet sales, which are skewed
                toward
                larger sizes.





Adult
      Apparel and Accessories .
      Big
      Dogs sells a complete line of adult unisex activewear and casual sportswear.
      We
      offer screen-printed and embroidered T-shirts and sweatshirts, in a variety
      of
      styles and colors that prominently display the Big Dogs’ graphics and slogans.
      In addition, we offer shorts, knit and woven casual shirts, fleece tops and
      bottoms, loungewear, boxer shorts, swimwear and sleepwear, all of which feature
      print designs or simply the BIG DOGS’® name and/or dog logo. Our adult apparel
      line primarily focuses on basic items that recur with relatively minor variation
      from season-to-season and year-to-year. While certain of our classic, popular
      items and graphics have been in the Big Dogs’ line with very little change for
      over ten years, we introduce new apparel and other products throughout the
      year
      to ensure that the merchandise assortments are consistent with the top sellers
      within our competitive market.





We
      leverage the Big Dogs’ trademarks, characters and more popular graphics by
      carefully translating them to a wide variety of apparel accessories, including
      caps, socks, sunglasses, bags, and wallets. These products are
      developed and introduced based on their consistency with Big Dog's brand image
      and whether they complement our other products. Our accessories not only provide
      an opportunity to create add-on purchases, but also minimize product development
      costs and inventory risk by utilizing graphics and slogans that have first
      proven popular on our graphic T-shirts.





Big-Size
      Apparel .
      We
      believe the BIG DOGS’® image and the positive emphasis the brand gives to being
      a "Big Dog" have a unique appeal to consumers who wear big sizes. Our BIG BIG
      DOGS’® category offers a line of unisex activewear and casual sportswear. As
      with the regular adult sizes, this category features screen-printed and
      embroidered T-shirts and sweatshirts, in a variety of styles and colors that
      prominently display the BIG DOGS’ graphic themes and slogans. In addition, we
      offer shorts, knit and woven casual and sports shirts, fleece tops and bottoms,
      loungewear, boxer shorts, swimwear and sleepwear, which may feature print
      designs or simply the BIG DOGS’® name and/or dog logo.





Infants’
      and Children’s Apparel and Accessories .
      The
      LITTLE BIG DOGS® line includes infants, toddlers, kids and youth sizes. Products
      in this line include graphic T-shirts, shirts, fleece items, infant and toddler
      one-pieces, boxer shorts, dresses and shorts, virtually all of which feature
      distinctive graphics. The graphics and fabrics of this line are designed to
      mirror many of the more popular graphics and fabrics in the BIG DOGS® adult line
      in order to encourage family purchases and leverage overall product development
      costs. Our sales of children’s apparel have decreased in recent years, primarily
      due to increased competitive pressure in that category in pricing and from
      the
      mass market.





Non-Apparel
      Products .
      We
      further leverage our trademarks, characters and more popular graphics by
      applying them to a wide variety of adult's and children's non-apparel items,
      including pet products, plush animals and other toys, sporting goods,
      stationery, calendars and lunch boxes. As with apparel accessories, new
      non-apparel products are developed and introduced based on whether they are
      consistent with Big Dogs' brand image and complement our other products. As
      with
      apparel accessories, the graphics applied to these products have first proven
      popular on our T-shirts, resulting in lower product development costs and
      inventory risk.





5





MARKETING





Big
      Dogs
      strives to maintain a consistent brand image through the coordination of our
      merchandising, marketing and sales efforts. The goal of our marketing efforts
      is
      to present a distinctive image of quality, value and fun that consumers will
      associate with our products and thereby enhance the BIG DOGS® brand image. The
      BIG DOGS® brand image has been developed with relatively little advertising, as
      we believe its most effective marketing is its products themselves and their
      presentation in our retail stores, catalog and website. Our catalog and website
      serve not only as a means of product distribution, but also as key marketing
      pieces for our retail stores.





Also
      important to our marketing strategy is our targeted "grassroots" marketing
      activities. These activities include local and charity sponsorships (such as
      high school sports teams) and community-oriented promotional events (such as
      our
      annual dog parade in Santa Barbara). We train and incentivize our store managers
      to actively involve their stores in local, grassroots activities. In addition,
      we utilize billboard advertising designed to direct customers to local Big
      Dogs
      retail stores.





RETAIL
      STORES





We
      seek
      to create a distinctive and fun shopping environment in Big Dogs stores through
      the innovative display of our graphic art and humor, including in-store "T-shirt
      walls" and other displays designed to immediately put the customer in a fun,
      relaxed state of mind. In addition, our cross-merchandising and colorful signage
      is designed to add excitement in the stores and prompt add-on purchases. By
      showcasing our complete product line and broad assortment, Big Dogs’ stores
      offer something for everyone in the family and are particularly appealing to
      the
      dedicated Big Dogs customer.




In
      2006,
      2005 and 2004 our retail stores contributed approximately 93%, 94% and 94%
      of
      Big Dog Sportswear total net sales, respectively. As of December 31, 2006 we
      operated a total of 155 stores in 37 states. Big Dogs’ stores are typically
      located in outlet malls, many of which are in tourist and recreation-oriented
      shopping locations and other casual environments where the Company believes
      consumers are more likely to be in a fun, relaxed state of mind. In making
      site
      selections, we also consider a variety of other factors, including proximity
      to
      large population centers, area income, the prestige and potential customer-draw
      of the other tenants in the center or area, projected profitability, store
      location and visibility within the center, and the accessibility and visibility
      of the center from nearby thoroughfares.





The
      table
      below sets forth the number of Big Dogs’ stores located in each state as of
      December 31, 2006.





**State**
            
            **No.
                of Stores**
            
            **State**
            
            **No.
                of Stores**Alabama
            
            1
            
            Minnesota
            
            4Arizona
            
            6
            
            Mississippi
            
            3California
            
            26
            
            Missouri
            
            7Colorado
            
            3
            
            Nevada
            
            3Connecticut
            
            1
            
            New
                Hampshire
            
            2Delaware
            
            2
            
            New
                Jersey
            
            1Florida
            
            12
            
            New
                Mexico
            
            1Georgia
            
            5
            
            New
                York
            
            4Hawaii
            
            1
            
            North
                Carolina
            
            4Idaho
            
            2
            
            Ohio
            
            3Illinois
            
            2
            
            Oregon
            
            5Indiana
            
            3
            
            Pennsylvania
            
            6Iowa
            
            1
            
            South
                Carolina
            
            6Kentucky
            
            1
            
            Tennessee
            
            7Louisiana
            
            2
            
            Texas
            
            9Maine
            
            1
            
            Virginia
            
            1Maryland
            
            5
            
            Washington
            
            5Massachusetts
            
            3
            
            Wisconsin
            
            3Michigan
            
            4


6




We
      operate Big Dogs’ retail stores primarily in outlet malls. Big Dogs' traditional
      emphasis has been on outlet malls because those malls are often located in
      tourist areas and attract significant numbers of Big Dogs' targeted customers.





Our
      outlet mall stores average approximately 2,800 square feet. Our outlet stores
      offer a complete and current line of our products priced approximately 25%
      less
      than the same items are sold for in our catalog and website, our full-price
      stores and by other retailers.





Our
      Big
      Dogs’ store operations are managed by an Executive Vice
      President-Merchandising/Retail, Director of Retail Operations, five regional
      managers and 25 district and area managers. Each of the stores is managed and
      operated by a store manager, an assistant manager and full-time and part-time
      sales associates. We seek to further enhance our customers' shopping experience
      by developing a knowledgeable and enthusiastic sales staff to distinguish Big
      Dogs from its competition. In this regard, we have implemented employee training
      and incentive programs and encourage our sales associates to be friendly and
      courteous and to guide customers to graphics and products that tie into their
      individual interests. We believe that the fun nature of our products create
      employee enthusiasm and positive morale that in turn enhance customer service
      and contribute to the fun shopping experience.





DIRECT
      SALES (CATALOG AND INTERNET)





Non-retail
      distribution channels, primarily catalog and internet sales, represent
      approximately 7%, 6%, and 6% of Big Dog Sportswear total net sales in 2006,
      2005
      and 2004, respectively.





Catalog
      and Internet .
      In
      addition to generating their own sales, our catalog and website serve as key
      marketing pieces for our products and stores. Such sales have had growth in
      recent years, on a relatively small base. We have the benefit of being able
      to
      develop names for our mailing list through our retail store chain, which has
      been the primary source for such list.





SOURCING





Domestic
      and International Sourcing .
      Big
      Dogs does not own or operate any manufacturing facilities but we instead source
      our products through third-party contractors with manufacturing facilities
      that
      are primarily overseas and to a limited extent, in Central America. We believe
      that outsourcing allows us to enhance production flexibility and capacity,
      while
      substantially reducing capital expenditures and avoiding the costs of managing
      a
      large production workforce. In addition, outsourcing allows us to leverage
      working capital, transfer risk and focus our energy and resources on
      merchandising, marketing and sales.





Big
      Dogs’
domestic sourcing is primarily limited to graphic T-shirts. Our graphic
      T-shirt business is managed in-house. This includes management of screen
      printing art and blanks, but not the actual screen-printing operations
      which are outsourced. Almost all other products, excluding T-shirts, are
      manufactured overseas, primarily in Asia, the Near and Middle East and Central
      Africa. In order to reduce our exposure to production risks and delays arising
      from trade disputes, political disruption or other factors relating to any
      one
      vendor or country, we utilize a diverse group of vendors. We source the majority
      of our product from trading companies. Through these trading companies and
      directly, we source from approximately 45 unaffiliated vendors, including 32
      foreign vendors in a number of countries. In order to enhance our sourcing
      flexibility, we use trading companies rather than operate our own foreign
      sourcing office. These trading companies assist us in selecting and overseeing
      third-party vendors, sourcing fabric and monitoring quotas and other trade
      regulations. We do not have supply contracts with any of our suppliers. Although
      the loss of major suppliers could have a significant effect on our immediate
      operating results, since we are focused on basic apparel, we believe alternate
      sources of merchandise for most product categories are available at comparable
      prices and that we could replace these suppliers without any long-term adverse
      effect.





Quality
      Control. Our
      quality control program is designed to ensure that all goods bearing BIG DOGS®
trademarks meet our standards. With respect to our products, Big Dogs, through
      its employees and sourcing agents, develops and inspects prototypes of each
      product prior to manufacture. For apparel products, Big Dogs, through its
      employees and sourcing agents, inspects the prototypes and fabrics prior to
      cutting by the contractors, establishes fittings based on the prototype and
      inspects samples. We or our sourcing agents inspect the final product prior
      to
      shipment to our warehouse or at the warehouse generally prior to payment.





7





BUSINESS
      OF TWC





TWC
      is a
      chain of specialty retail stores selling high-quality, technically designed
      comfort footwear and accessories from around the world to both men and
      women, including such brands as ECCO®, Mephisto®, Dansko®, Merrell® and
      Pikolinos®.





TWC
      was
      founded in 1991 and grew rapidly from a base of 20 stores in 1995
      to over 100 stores in 2003.  As a result of its rapid expansion,
      TWC made certain real estate and merchandising mistakes and eventually
      declared bankruptcy in July 2003.  The bankruptcy process
      allowed TWC to reject its non-performing stores and
      liquidate excess and obsolete inventory.





Having
      purchased the assets of TWC out of bankruptcy in March 2004, the Company has
      re-focused TWC’s operations on its original core business of operating small
      specialty stores in premium malls selling the best brands in the comfort
      shoe category.  We acquired the business of TWC based on, among other
      factors, our favorable assessment of its market niche, the favorable
      demographics of that market, and an anticipated ability to realize efficiencies
      and increase profitability by utilizing the retail store expertise of the
      Company and by consolidating TWC’s corporate overhead operations with those of
      the Company. The footwear products sold by TWC appeal to a large and
      growing demographic.





During
      2005, the Company added to the TWC chain through the acquisition of Footworks.
      Footworks operated a chain of seven comfort footwear stores in strategic
      locations, including several high profile locations on the Las Vegas Strip.
      Substantially all of such stores are being converted to TWC stores.





In
      January 2006, the Company acquired 37 store locations of Steve’s Shoes, Inc. out
      of bankruptcy. Steve’s Shoes had operated a chain of comfort footwear stores
      throughout the US under the names Steve’s Shoes, Overland Trading Company and
      Sole Outdoor. By early 2006, the chain was a distressed operation that had
      been
      paired down from over 80 stores. After the acquisition, TWC’s focus for this
      chain for the remainder of 2006 was a turn-around of its operations, which
      included converting the stores’ merchandise focus to comfort shoes, training and
      hiring personnel (as many turned over), and converting the names and operations
      of these stores to The Walking Company stores.





BUSINESS
      STRATEGY





Offer
      the Best Brands from Around the World .
      TWC
      seeks out and offers to its customers shoe brands that are of high quality,
      integrate comfort features, and are not widely distributed. TWC features a
      number of European and other foreign comfort shoe brands not widely found in
      other US shoe retailers. By editing the assortment of comfort brand for its
      customers and then explaining to them their benefits, TWC provides a unique
      and
      valued service to it customer, creating brand loyalty and repeat customers.





Authentic
      ComfortTM .
      Each
      brand carried integrates comfort features such as shock absorbing EVA midsoles,
      hydrophobic foam insoles, waterproof leathers, anatomically contoured footbeds,
      and roomy toe boxes that follow the shape of the foot. TWC is uniquely
      positioned to be the only national retail shoe chain that markets comfort.





Target
      a Large and Growing Demographic. The
      Company has established TWC as the leading specialty retailer of comfort
      footwear appealing to a broad range of consumers. Although marketing focus
      is on
      baby boomers and working professionals, our customers include men and women
      of
      all ages. As the baby boomers age, there is an increasing focus on comfort
      footwear for both work and play. In addition, many of our brands are popular
      with working professionals such as teachers, medical staff, foodservice
      personnel and others who spend long days on their feet.





Utilize
      Strong Market Position. Through
      store expansion and a focus on comfort, TWC is now established as the only
      national specialty retailer of comfort footwear. TWC utilizes its preeminence
      in
      the comfort market to seek strong vendor relationships and widespread customer
      recognition.





8





MERCHANDISING





The
      TWC
      product line features high-quality branded comfort footwear and accessories
      from
      around the world. The professional comfort line focuses on working professionals
      who spend long hours on their feet. The dress comfort line includes more formal
      styles while maintaining the comfort for which TWC is known. The sport &
active comfort line combines function and performance with style and design
      to
      create products that fit an active lifestyle. The casual comfort line includes
      comfort footwear for casual, everyday use. TWC also sells accessories that
      are
      designed to add to the comfort of the walking experience. TWC believes that
      all
      types of footwear are trending towards comfort and will merchandise
      accordingly.





TWC
      experiences a level of seasonality in the types of products it sells. During
      spring/summer, the focus shifts toward sandals. During the fall/winter, the
      focus shifts toward boots, slippers and all-weather footwear.





The
      majority of our footwear products range from between **$** 80
      and
      $150. The following table sets forth the approximate contribution made to total
      TWC net sales in our retail stores:





%
                OF RETAIL STORE* NET SALES YEARS ENDED DECEMBER 31,2006
            
            2005
            
            2004Women’s
                footwear
            
            
            55.2
            %
            
            54.2
            %
            
            52.5
            %Men’s
                footwear
            
            
            30.7
            
            
            30.0
            
            
            32.7Accessories
            
            
            14.1
            
            
            15.8
            
            
            14.8Total
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %





MARKETING





Historically,
      TWC lacked a coherent marketing strategy for THE WALKING COMPANY brand. A
      significant focus of the Company’s efforts since its acquisition of TWC has been
      the development of an effective, coherent marketing image and strategy. This
      strategy is being implemented through a newly-developed store design and
      supporting marketing endeavors. TWC believes that over a period of two to three
      years, through new store development and refitting old stores, the large
      majority of its chain will look like the new design. TWC further continues
      its
      brand awareness through consistent store layout and image, collateral materials
      (in-store posters, etc.), and development of brand-identifying trademarks and
      slogans (Authentic ComfortTM, The Best Brands From Around the World, etc.) Such
      strategy is being implemented with relatively little media advertising, as
      we
      believe TWC’s most cost-effective marketing is through its stores themselves and
      our catalog and website. Also, almost all of the brands we carry contribute
      to a
      cooperative marketing fund with TWC, largely offsetting our collateral costs.
      In
      addition, many of the brands we feature engage in their own media advertising,
      which acts to support our stores. TWC is also able to leverage its marketing
      dollars by co-marketing with the companies whose brands it sells and with the
      malls in which it has stores.




RETAIL
      STORES





In
      2006,
      our retail stores contributed over 99% of TWC total net sales. As of December
      31, 2006, we operated a total of 151 stores in 37 states and the District of
      Columbia. TWC stores are typically located in leading regional malls in
      prosperous urban areas where the Company believes demographics are favorable.
      In
      making site selections, we also consider a variety of other factors, including
      proximity to large population centers, area income, the prestige and potential
      customer-draw of the other tenants in the center or area, rent and operating
      costs, store location and visibility within the center, and the accessibility
      and visibility of the center from nearby thoroughfares.





9





The
      table
      below sets forth the number of TWC stores located in each state as of December
      31, 2006.





**State**
            
            **No.
                of Stores**
            
            **State**
            
            **No.
                of Stores**Arkansas
            
            2
            
            Minnesota
            
            3Arizona
            
            7
            
            Missouri
            
            5California
            
            20
            
            Nevada
            
            7Colorado
            
            6
            
            New
                Hampshire
            
            1Connecticut
            
            4
            
            New
                Jersey
            
            6Delaware
            
            1
            
            New
                York
            
            3District
                of Columbia
            
            1
            
            North
                Carolina
            
            3Florida
            
            11
            
            Ohio
            
            4Georgia
            
            3
            
            Oklahoma
            
            1Hawaii
            
            2
            
            Oregon
            
            6Idaho
            
            1
            
            Pennsylvania
            
            5Illinois
            
            7
            
            South
                Carolina
            
            1Indiana
            
            5
            
            Tennessee
            
            2Kansas
            
            1
            
            Texas
            
            4Kentucky
            
            2
            
            Utah
            
            1Louisiana
            
            1
            
            Virginia
            
            4Maryland
            
            3
            
            Washington
            
            7Massachusetts
            
            5
            
            Wisconsin
            
            1Michigan
            
            5





Our
      TWC
      stores average approximately 1,700 square feet. We opened 24 new stores and
      closed two under-performing stores during 2006. Our cost to open a store in
      2006, including leasehold improvements and furniture and fixtures, was
      approximately $240,000. The average per store initial inventory (largely
      financed by trade payables) for the new 2006 stores was approxi-mately $208,000
      and pre-opening expenses averaged approximately $11,000 per store.





Our
      TWC
      store operations are managed by a Senior Vice President - Retail, Vice President
      - Retail, Director of Retail Operations, Director of Store Development, two
      Regional Managers, 14 district managers, and eight district training
      coordinators. Each of the stores is managed and operated by a store manager,
      an
      assistant manager and full-time and part-time sales associates. We seek to
      further enhance the TWC customer’s shopping experience by developing a
      knowledgeable and enthusiastic sales staff to distinguish TWC from its
      competition. In this regard, we (and the companies whose shoe brands we feature)
      provide instructive seminars and training to our staff to educate them on the
      technical quality of our shoes and to allow them to guide our customers to
      the
      products that best meet their comfort needs. We believe our commitment to
      knowledgeable customer service enhances our ability to generate repeat business
      and to attract new customers.





SOURCING





Domestic
      and International Sourcing. TWC
      sources its product from a number of selected and approved brands located in
      the
      United States and abroad. TWC does not own or operate any manufacturing
      facilities. Occasionally, the Company goes directly to the manufacturer and
      has
      a shoe made to TWC specifications.





BIG
      DOGS
      AND TWC OPERATIONS





SEGMENTS





The
      Company has two reportable segments, Big Dogs and TWC. See Note 10 of the
      Consolidated Financial Statements.





10





MANAGEMENT
      INFORMATION SYSTEMS





The
      Company is committed to utilizing technology to enhance its competitive
      position. We have put in place computer hardware, systems applications and
      networks that are the same as those used by a number of large retailers. These
      systems support the sales and distribution of products to our stores and
      customers and improve the integration and efficiency of our domestic and foreign
      sourcing operations. The Company’s management information system (“MIS”)
      provides integration of store, merchandising, distribution and financial
      systems. These systems include stock keeping unit ("SKU") and classification
      inventory tracking, purchase order management, open-to-buy, merchandise
      distribution, automated ticket making, general ledger, sales audit, accounts
      payable, fixed asset management, payroll and integrated financials. These
      systems operate on an IBM AS 400 platform and a Microsoft NT server network
      and
      utilize Island Pacific software. Our point-of-sale ("POS") system consists
      of
      registers providing price look-up, e-mail and credit card and check
      authorization. Through automated two-way communication with each store, sales
      information, e-mail and timekeeping information are uploaded to the host system,
      and receiving, price changes and systems maintenance are down-loaded through
      the
      POS devices. Sales are updated daily in the merchandising report systems by
      polling sales from each store's POS terminals. We evaluate information obtained
      through daily polling, including a daily tracking of gross margin, to implement
      merchandising decisions regarding reorders, markdowns and allocation of
      merchandise. Catalog operations are also supported by MIS applications from
      an
      established vendor, designed specifically to meet the unique requirements of
      this business. These applications include customer service phone center, order
      processing and mailing list maintenance.





ALLOCATION
      AND DISTRIBUTION OF MERCHANDISE





Allocation
      and distribution of our inventory is performed centrally at the SKU, merchandise
      classification and store levels using integrated third-party software. Utilizing
      our MIS capabilities, our planning and allocation group works closely with
      the
      merchandising and retail departments to monitor and respond to customer
      purchasing trends and meet the seasonal and locale-specific merchandising
      requirements of our retail stores.





Our
      main
      warehouse facility and our mail order warehouse and fulfillment facility are
      located in a 230,000 square-foot distribution facility in Charlotte, North
      Carolina. All merchandise is delivered by vendors to this facility, where it
      is
      inspected, entered into our merchandising software system, picked and boxed
      for
      shipment to the stores or customers. We ship merchandise to our stores at least
      weekly, to provide a steady flow of merchandise.





TRADEMARKS





The
      Company utilizes a variety of trademarks which it owns; including the U.S.
      registered trademarks BIG DOGS®, BIG DOG SPORTSWEAR®, dog logo, BIG DOG®, LITTLE
      BIG DOGS®, BIG BIG DOGS®, THE WALKING COMPANY®, and FOOTWORKS®. In addition, we
      have registered certain of our trademarks or have registration applications
      pending in over 22 other countries. We regard our trademarks and other
      proprietary rights as valuable assets and believe they have significant value
      in
      the marketing of our products. Like most popular brands, from time to time
      in
      the course of business we discover products or businesses in the marketplace
      that we believe infringe upon our trademark rights. In addition, in regard
      to
      Big Dogs, companies occasionally claim that a certain product or graphic of
      ours
      infringes on their intellectual property rights (sometimes in regard to our
      parodies of other’s trademarks that we do as part of the Big Dogs sense of fun).
      We vigorously protect our trademarks and defend ourselves against claims of
      others. Actions against infringers include the use of cease and desist letters,
      administrative proceedings and lawsuits.





COMPETITION





The
      level
      and nature of competition differ somewhat for Big Dogs versus TWC and among
      the
      product categories each of them feature. Both companies compete primarily on
      the
      basis of the brand image we develop and maintain for them, as well as product
      quality assortment and price, store location and layout, and customer service.
      Big Dogs also competes by offering a unique combination of quality, value and
      fun (in both its products and its store experience). TWC also competes by
      offering a unique assortment of quality, hard-to-find brands. The markets for
      each of our products are highly competitive. We believe that our long-term
      competitive position will depend upon our ability to anticipate and respond
      effectively to changing consumer demands and to offer customers a wide variety
      of high-quality, unique products at competitive prices.





Although
      we believe Big Dogs does not compete directly with any single company with
      respect to its entire range of merchandise, within each merchandise category
      it
      competes with well-known apparel and specialty retail companies such as The
      GAP
      and Eddie Bauer and The Disney Stores, as well as a large number of national
      and
      regional department stores, specialty retailers and apparel designers and
      manufacturers. In addition, in recent years, the amount of casual sportswear
      and
      activewear manufactured specifically for department stores and sold under their
      own labels has significantly increased.





11





TWC
      competes primarily with small independent specialty shoe retailers (“mom &
pop” operators), small shoes chains and also department store operators such as
      Nordstrom and Federated. We believe that due to the relatively high price points
      for the shoes TWC offers and the high-level of customer service required to
      effectively sell the technical comfort benefits of such shoes, the big-box,
      mass-market retailers do not present a significant potential competitive threat
      to TWC.





Some
      of
      the Company’s competitors are significantly larger and more diversified and have
      substantially greater financial, distribution, marketing and other resources
      and
      have achieved greater recognition for their brand names than the
      Company.





SEASONALITY





For
      a
      discussion of the extent to which the business of the Company is seasonal,
      see
“Seasonality and Quarterly Results” in “Part I. Item
      7.
      Management’s Discussion and Analysis of Financial Condition and Results of
      Operations .”





WORKING
      CAPITAL ITEMS





The
      Company, as well as the retail industry, experiences significant fluctuations
      in
      working capital related to their seasonality. The Company maintains a line
      of
      credit, which provides them with the flexibility to increase inventory, as
      needed, in advance of those periods of higher sales demand.





EMPLOYEES





At
      March
      1, 2007, we had approximately 1,100 full-time and 1,200 part-time employees.
      Our
      need for part-time retail employees fluctuates significantly based on seasonal
      needs. No employees are covered by collective bargaining agreements.





AVAILABLE
      INFORMATION





Big
      Dogs’
website is www.bigdogs.com and
      TWC’s website is at www.thewalkingcompany.com .
      We make
      available free of charge through our www.bigdogs.com website
      the Company’s annual, quarterly and current reports, and any amendments to those
      reports, as soon as reasonably practical after electronically filing such
      reports with the Securities and Exchange Commission. This website is intended
      to
      be an inactive textual reference only and none of the information contained
      in
      our website is part of this report or is incorporated in this report by
      reference.





ITEM
                1A.
            RISK
                FACTORS





See
      discussion of Risk Factors in “Part I. Item 7. Management’s Discussion and
      Analysis of Financial Condition and Results of Operations.”





ITEM
                1B.
            UNRESOLVED
                STAFF COMMENTS





Not
      applicable.





ITEM
                2.
            PROPERTIES





Our
      corporate headquarters are in leased offices comprising approximately 24,000
      square feet in Santa Barbara, California. This lease expires July 2011, with
      two
      options to extend for five years each. Our distribution facility is located
      in
      Charlotte, North Carolina in a building comprising approximately 230,000 square
      feet under a lease that expires in 2016. The Company has two options to extend
      this lease for ten years each. Prior to 2006, the distribution center was
      located in Santa Fe Springs, California. In January, 2007, the Company paid
      a
      termination fee to terminate the lease on the Santa Fe Springs facility.
      Additionally, the TWC merchandising department is in an office comprising
      approximately 15,000 square feet in Westlake Village, California. This lease
      expires in December 2013, with two options to extend for five years
      each.





12





We
      lease
      all of our store locations. Big Dogs store leases are typically for an initial
      term of five years with a five-year option and provide for base rent plus
      contingent rent based upon a percentage of sales in excess of agreed-upon sales
      levels. In recent years, we have negotiated shorter-term renewals for Big Dogs’
stores in malls where we perceive a risk of declining sales. See “Item 1.
      BUSINESS - RETAIL STORES” for both Big Dogs and TWC. The leases for TWC store
      locations typically have longer terms, as required by leading mall developers.





ITEM
                3.
            LEGAL
                PROCEEDINGS





In
      July
      2004, a lawsuit was filed against the Company by Big Dog Motorcycles LLC (“BDM”)
      in the U.S. District Court for the Central District of California. The complaint
      alleged breach and wrongful termination of a trademark license
      agreement.  BDM sought $1.5 million in liquidated damages and attorneys
      fees.  In July 2006 the parties agreed to dismiss all claims against each
      other, with no compensation being paid by either party.




On
      March
      14, 2006, the Company received a notice of proposed adjustments from the
      Internal Revenue Service ("IRS”) related to its audit of the Company’s 2002 Tax
      Year. The IRS has proposed adjustments to increase the Company’s income tax
      payable for the 2002 year under examination. The adjustments are related to
      the
      tax accounting for two short bond transactions recorded in 2002.





In
      2002,
      the Company entered into two transactions relating to the short-sale and
      repurchase of Treasury Securities. The transactions were intended to address
      interest rate exposure and generate capital gains that could be used to offset
      previously incurred capital losses. The IRS contended that the transactions
      were
      incorrectly characterized for IRS purposes. The notice of proposed changes
      to
      our 2002 federal income tax return would have resulted in additional tax due
      of
      approximately $1.6 million plus penalties. The Company obtained expert legal
      tax
      counsel and appealed the proposed adjustment. The Company believes that it
      has
      meritorious defenses and intends to vigorously contest the proposed adjustments.
      The Company does not believe the IRS will prevail in this matter and has not
      recorded a reserve for this proposed tax adjustment in the accompanying
      consolidated financial statements.





In
      addition, from time to time the Company is involved in pending or threatened
      litigation incidental to its business.  The Company believes that the
      outcome of such litigation will not have a  material
      adverse impact on its operations or financial condition.





ITEM
                4.
            SUBMISSION
                OF MATTERS TO A VOTE OF THE SECURITY
                HOLDERS





Not
      applicable.


PART
      II





ITEM
                5.
            MARKET
                FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
                PURCHASES OF EQUITY SECURITIES





The
      common stock of our Company is traded on the NASDAQ Global Market under the
      symbol BDOG. The following table sets forth, for the period from the first
      quarter 2005 through the fourth quarter 2006, the high and low “sales” prices of
      the shares of our common stock, as reported on the NASDAQ Global
      Market.





2006
            
            2005High
            
            Low
            
            High
            
            LowFirst
                Quarter
            
            $
            14.80
            
            $
            7.41
            
            $
            7.55
            
            $
            5.82Second
                Quarter
            
            
            14.49
            
            
            11.20
            
            
            7.80
            
            
            5.00Third
                Quarter
            
            
            12.58
            
            
            10.26
            
            
            7.40
            
            
            5.57Fourth
                Quarter
            
            
            16.45
            
            
            12.30
            
            
            7.50
            
            
            6.07





On
      March
      1, 2007, the last sales price of the common stock as reported on the NASDAQ
      Global Market was $15.50 per share. As of March 1, 2007, we had approximately
      148 shareholders of record of our common stock.





Our
      current credit agreement prohibits the payment of dividends (see Liquidity
      and
      Capital Resources). We did not pay a dividend in 2006 and 2005, and do not
      expect to pay dividends in the foreseeable future.





13





**Performance
      Graph**





The
      performance graph below compares the cumulative shareholder return on the Big
      Dog Holdings’ Common Stock with the cumulative total return on the NASDAQ RETAIL
      INDEX and the NADAQ COMPOSITE INDEX. The graph assumes an investment of $100.00
      on January 1, 2001. The performance graph represents past performance and should
      not be considered an indication of future performance.










14




ITEM
                6.
            SELECTED
                FINANCIAL DATA





The
      selected consolidated financial data set forth below should be read in
      conjunction with the Consolidated Financial Statements and the Notes thereto
      and
      with "Management's Discussion and Analysis of Financial Condition and Results
      of
      Operations" appearing elsewhere in this Form 10-K.





YEARS
                ENDED DECEMBER 31,2006
            
            2005
            
            2004
            
            2003
            
            2002(in
                thousands, except per share and operating data)STATEMENT
                OF OPERATIONS DATA:Net
                sales
            
            $
            218,604
            
            $
            179,115
            
            $
            161,358
            
            $
            103,757
            
            $
            108,756Cost
                of goods sold
            
            
            101,723
            
            
            80,311
            
            
            72,733
            
            
            45,025
            
            
            46,970Gross
                profit
            
            
            116,881
            
            
            98,804
            
            
            88,625
            
            
            58,732
            
            
            61,786Selling,
                marketing and distribution expenses
            
            
            103,428
            
            
            80,624
            
            
            73,956
            
            
            49,089
            
            
            51,528General
                and administrative expenses
            
            
            9,823
            
            
            9,631
            
            
            8,060
            
            
            5,199
            
            
            5,252Total
                operating expenses
            
            
            113,251
            
            
            90,255
            
            
            82,016
            
            
            54,288
            
            
            56,780Income
                from operations
            
            
            3,630
            
            
            8,549
            
            
            6,609
            
            
            4,444
            
            
            5,006Other
                income
            
            
            ---
            
            
            ---
            
            
            (82
            )
            
            ---
            
            
            ---Interest
                income(1)
            
            
            (8
            )
            
            (44
            )
            
            (26
            )
            
            (2
            )
            
            (3,175
            )Interest
                expense(1)
            
            
            2,084
            
            
            976
            
            
            857
            
            
            320
            
            
            3,761Income
                before provision for income taxes
            
            
            1,554
            
            
            7,617
            
            
            5,860
            
            
            4,126
            
            
            4,420Provision
                for income taxes
            
            
            583
            
            
            2,894
            
            
            2,172
            
            
            1,489
            
            
            603Net
                income
            
            $
            971
            
            $
            4,723
            
            $
            3,688
            
            $
            2,637
            
            $
            3,817Net
                income per shareBasic
            
            $
            0.11
            
            $
            0.52
            
            $
            0.42
            
            $
            0.32
            
            $
            0.45Diluted
            
            $
            0.10
            
            $
            0.49
            
            $
            0.40
            
            $
            0.32
            
            $
            0.45Weighted
                average common sharesBasic
            
            
            9,180
            
            
            9,145
            
            
            8,722
            
            
            8,307
            
            
            8,409Diluted
            
            
            9,531
            
            
            9,726
            
            
            9,174
            
            
            8,307
            
            
            8,409OPERATING
                DATA:Number
                of stores(2)Stores
                open at beginning of period
            
            
            268
            
            
            262
            
            
            203
            
            
            209
            
            
            208Stores
                added due to acquisitions
            
            
            37
            
            
            7
            
            
            72
            
            
            ---
            
            
            ---Stores
                opened during period
            
            
            27
            
            
            14
            
            
            5
            
            
            7
            
            
            7Stores
                closed during period
            
            
            (26
            )
            
            (15
            )
            
            (18
            )
            
            (13
            )
            
            (6
            )Stores
                open at end of period
            
            
            306
            
            
            268
            
            
            262
            
            
            203
            
            
            209Comparable
                stores sales increase(decrease)(3)
                (4)
            
            
            3.0
            %
            
            3.3
            %
            
            3.5
            %
            
            (3.6
            )%
            
            (6.3
            )%BALANCE
                SHEET DATA:Working
                capital
            
            $
            22,590
            
            $
            31,639
            
            $
            32,727
            
            $
            29,574
            
            $
            26,122Total
                assets
            
            
            102,661
            
            
            72,753
            
            
            58,831
            
            
            42,582
            
            
            39,679Total
                indebtedness(5)
            
            
            30,346
            
            
            9,183
            
            
            1,092
            
            
            ---
            
            
            ---Stockholders’
                equity
            
            
            49,128
            
            
            46,448
            
            
            42,541
            
            
            34,214
            
            
            31,983





(1)
      In
      2002, we earned $3,172,000 of interest income and incurred $3,288,000 of
      interest expense relating to the short-sale and repurchase of $95,384,000 of
      U.S. Treasury Securities.





(2)
      Includes three temporary stores which were open as of December 31,
      2003.





15





(3)
      Comparable store sales represent net sales of stores open at least one full
      year. Big Dog stores are considered comparable beginning on the first day of
      the
      third month following the one-year anniversary of their opening. TWC stores
      are
      considered comparable beginning on the first day of the first month following
      the one-year anniversary of their opening. Stores that are relocated but remain
      in the same shopping area remain in the comparable store base. The Company
      believes this method best reflects the effect of one-time promotional events
      and
      is most consistent with industry methods.





(4)
      In
      2006, comparable store sales increase consists of a 10.6% increase in TWC
      comparable store sales, which is offset by a 4.8% decrease in Big Dogs
      comparable store sales. In 2005, comparable store sales increase consists of
      a
      12.8% increase in TWC comparable store sales, which is offset by a 4.1% decrease
      in Big Dogs comparable store sales. In 2004, comparable store sales increase
      consists of a 12.7% increase in TWC comparable store sales, which is offset
      by a
      1.9% decrease in Big Dogs comparable store sales.





(5)
      Includes notes payable, obligations under the bank line of credit and
      obligations under capital leases.




ITEM
                7.
            MANAGEMENT’S
                DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
                OPERATIONS





The
      following discussion and analysis should be read in conjunction with the
      Consolidated Financial Statements and Notes thereto of the Company contained
      elsewhere in this Form 10-K.





GENERAL





Big
      Dog
      Holdings, Inc. is the parent company of two retail chains, Big Dog USA, Inc.,
      which does business as “Big Dog Sportswear” (“Big Dogs” or “Big Dog Sportswear”)
      and The Walking Company (“TWC”). Big Dogs develops, markets and retails a
      branded, lifestyle collection of unique, high-quality, popular-priced consumer
      products, including active wear, casual sportswear, accessories and gifts.
      TWC,
      acquired March 3, 2004, is a specialty retailer of authentic
      comfort footwear and accessories.





RESULTS
      OF OPERATIONS





The
      following table sets forth, for the periods indicated, certain selected
      statement of operations data expressed as a percentage of net sales:





YEARS
                ENDED DECEMBER 31,2006
            
            2005
            
            2004Net
                sales
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %Cost
                of goods sold
            
            
            46.5
            
            
            44.8
            
            
            45.1Gross
                profit
            
            
            53.5
            
            
            55.2
            
            
            54.9Selling,
                marketing and distribution expenses
            
            
            47.3
            
            
            45.0
            
            
            45.8General
                and administrative expenses
            
            
            4.5
            
            
            5.4
            
            
            5.0Total
                operating expenses
            
            
            51.8
            
            
            50.4
            
            
            50.8Income
                from operations
            
            
            1.7
            %
            
            4.8
            %
            
            4.1
            %





YEARS
      ENDED DECEMBER 31, 2006 AND 2005





NET
      SALES. Net sales consist of sales from the Company’s stores, catalog, internet
      website, and corporate sales accounts, all net of returns and allowances. Net
      sales increased to $218.6 million in 2006 from $179.1 million in 2005, an
      increase of $39.5 million, or 22.1%. The increase is primarily driven by our
      TWC
      segment and relates to the impact of the TWC acquisitions as well as sales
      growth. The increase is offset in part by decreased sales from the Big Dogs’
segment.





16





TWC
      Operations .
      Net
      sales from TWC operations increased to $135.7 million in 2006 from $87.0 million
      in 2005, an increase of $48.7 million, or 56.0%. The increase was primarily
      attributable to the acquisitions of Footworks in August, 2005 and Steve’s Shoes
      in January, 2006, which increased sales by $7.5 million and $21.2 million in
      2006, respectively. In addition, an increase of $8.5 million was attributable
      to
      a 10.6% increase in comparable store sales, $10.7 million attributable to an
      increase in TWC sales for stores not yet qualifying as comparable stores, which
      includes the closure of stores netted against new stores opened in the period,
      and a $0.8 million increase in the Company’s TWC catalog/Internet business. The
      increase in TWC comparable store sales is primarily related to improved
      inventory levels and merchandise selection at the TWC stores since the Company
      purchased TWC out of bankruptcy in March 2004.





Big
      Dogs’ Operations .
      Net
      sales from Big Dogs’ operations decreased to $82.9 million in 2006 from $92.1
      million in 2005, a decrease of $9.2 million, or 10.0%. The decrease was related
      to $3.7 million attributable to a 4.8% decrease in Big Dog Sportswear comparable
      store sales for the period, $5.7 million attributable to a decrease in Big
      Dog
      Sportswear sales for stores not qualifying as comparable stores, which includes
      the closure of unprofitable stores netted against new stores opened in the
      period, and $0.1 million attributable to a decrease in the Company’s Big Dog
      Sportswear corporate sales business. The decreases were offset by a $0.3 million
      increase in the Company’s Big Dog Sportswear catalog/Internet business. The
      decrease in Big Dog Sportswear comparable store sales is primarily related
      to an
      overall decrease in consumer traffic in our stores and outlet locations. The
      decrease in Big Dog Sportswear sales for stores not qualifying as comparable
      stores is primarily attributable to an additional nine net Big Dog store
      closures during 2006 as compared to 2005, with 21 net Big Dog stores closed
      in
      2006 and 12 net Big Dog stores closed in 2005.




GROSS
      PROFIT. Gross profit increased to $116.9 million in 2006 from $98.8 million
      in
      2005, an increase of $18.1 million, or 18.3%. As a percentage of net sales,
      gross profit decreased to 53.5% in 2006 from 55.2% in 2005. TWC’s gross profit
      remained relatively constant in 2006 and 2005 at 51.7% and 51.8%, respectively.
      Big Dogs’ gross profit decreased to 56.3% in 2006 compared to 58.4% in 2005. The
      2.1% decrease was primarily due to a shift to promotional sales from
      higher-margined sales. Gross profit may not be comparable to those of other
      retailers, since some retailers include distribution costs and store occupancy
      costs in costs of goods sold, while we exclude them from gross margin, including
      them instead in selling, marketing and distribution expenses.




SELLING,
      MARKETING AND DISTRIBUTION EXPENSES. Selling, marketing and distribution
      expenses consist of expenses associated with creating, distributing, and selling
      products through all channels of distribution, including occupancy, payroll
      and
      catalog costs. Selling, marketing and distribution expenses increased to **$** 103.4
      million in 2006 from $80.6 million in 2005, an increase of **$** 22.8
      million, or 28.3%. The $22.8 million increase is primarily due to the
      acquisition of Footworks on August 31, 2005 and Steve’s Shoes on January 26,
      2006. As a percentage of net sales these expenses increased to 47.3% in 2006
      from 45.0% in 2005, an increase of 2.3%. The increase is primarily related
      to
      spreading the fixed component of Big Dog expenses over a smaller sales base,
      increased expenses related to operating the Steve’s Shoes stores acquired out of
      bankruptcy, an additional $0.7 million incurred to relocate the Company’s
      distribution center to a larger facility, and an increase in corporate
      infrastructure to facilitate future growth in the Company’s TWC
      segment.





GENERAL
      AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist of
      administrative salaries, corporate occupancy costs and other corporate expenses.
      General and administrative expenses increased to **$** 9.8
      million in 2006 from $9.6 million in 2005. As a percentage of net sales these
      expenses decreased to 4.5% in 2006 from 5.4% in 2005, a decrease of 0.9%. The
      increase is attributable to a small increase in administration to support the
      Company’s continued growth.





INTEREST
      INCOME. Interest income for 2006 and 2005 was less than $0.1 million. Interest
      income is primarily earned on excess cash balances invested on an overnight
      basis. As the Company generally uses excess cash to reduce the outstanding
      balances on their line of credit, interest income in future periods is not
      expected to be significant.





INTEREST
      EXPENSE. Interest expense increased to $2.1 million in 2006, from $1.0 million
      in 2005 related to an increase in borrowing as a result of new store
      construction and the Footworks and Steve’s Shoes acquisitions and additional
      working capital requirement.





INCOME
      TAXES. In 2006, the provision for income taxes reflects a 37.5% effective tax
      rate, compared to a 38.0% effective tax rate in 2005.





17





YEARS
      ENDED DECEMBER 31, 2005 AND 2004





NET
      SALES. Net sales consist of sales from the Company’s stores, catalog, internet
      website, and corporate sales accounts, all net of returns and allowances. Net
      sales increased to $179.1 million in 2005 from $161.4 million in 2004, an
      increase of $17.7 million, or 11.0%. The increase is primarily driven by our
      TWC
      segment and relates to the impact of the TWC acquisitions as well as sales
      growth. Increased hurricane activity in 2005, including Hurricane Katrina,
      impacted a number of Company stores on a short-term basis. Losses as a result
      of
      these store closures are covered under the Company’s insurance policy and did
      not have a significant effect on the Company’s results of operations.





TWC
      Operations .
      Net
      sales from TWC operations increased to $87.0 million in 2005 from $62.6 million
      in 2004, an increase of $24.4 million, or 39.0%. The increase was primarily
      related to the acquisition of TWC on March 3, 2004 and Footworks on August
      31,
      2005, which accounted for an increase in net sales of $13.7 million. In
      addition, an increase of $7.4 million was attributable to a 12.3% increase
      in
      comparable store sales for TWC subsequent to the acquisition, $3.0 million
      attributable to an increase in TWC sales for stores not yet qualifying as
      comparable stores, which includes the closure of stores netted against new
      stores opened in the period and a $0.3 million increase in the Company’s TWC
      catalog/Internet business. The increase in TWC comparable store sales is
      primarily related to improved inventory levels and merchandise selection at
      the
      TWC stores since the Company purchased TWC out of bankruptcy in March 2004.





Big
      Dogs’ Operations .
      Net
      sales from Big Dogs’ operations decreased to $92.1 million in 2005 from $98.8
      million in 2004, a decrease of $6.7 million, or 6.8%. The decrease was related
      to $3.7 million attributable to a 4.1% decrease in Big Dog Sportswear comparable
      store sales for the period, $2.9 million attributable to a decrease in Big
      Dog
      Sportswear sales for stores not yet qualifying as comparable stores, which
      includes the closure of unprofitable stores netted against new stores opened
      in
      the period, and $0.8 million attributable to a decrease in the Company’s Big Dog
      Sportswear wholesale business. The decreases were offset by a $0.7 million
      increase in the Company’s Big Dog Sportswear catalog/Internet business. The
      decrease in Big Dog Sportswear comparable store sales is primarily related
      to an
      overall decrease in consumer traffic in our stores and outlet locations. The
      Company closed its Big Dog wholesale division in the second quarter of 2004.




GROSS
      PROFIT. Gross profit increased to $98.8 million in 2005 from $88.6 million
      in
      2004, an increase of $10.2 million, or 11.5%. As a percentage of net sales,
      gross profit increased to 55.2% in 2005 from 54.9% in 2004. TWC’s gross profit
      remained relatively constant in 2005 and 2004 at 51.8% and 51.9%, respectively.
      Big Dogs’ gross profit increased to 58.4% in 2005 compared to 56.8% in 2004. The
      1.6% increase was primarily due to less promotional sales. Gross profit may
      not
      be comparable to those of other retailers, since some retailers include
      distribution costs and store occupancy costs in costs of goods sold, while
      we
      exclude them from gross margin, including them instead in selling, marketing
      and
      distribution expenses.




SELLING,
      MARKETING AND DISTRIBUTION EXPENSES. Selling, marketing and distribution
      expenses consist of expenses associated with creating, distributing, and selling
      products through all channels of distribution, including occupancy, payroll
      and
      catalog costs. Selling, marketing and distribution expenses increased to $80.6
      million in 2005 from $74.0 million in 2004, an increase of $6.6 million, or
      8.9%. The $6.6 million increase is primarily due to the acquisition of TWC
      on
      March 3, 2004 and Footworks on September 1, 2005. However, as a percentage
      of
      net sales these expenses decreased to 45.0% in 2005 from 45.8% in 2004, a
      decrease of 0.8%. The decrease is primarily related to spreading the expenses
      over a larger sales base and the net closure of 12 Big Dogs stores in
      2005.





GENERAL
      AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist of
      administrative salaries, corporate occupancy costs and other corporate expenses.
      General and administrative expenses increased to $9.6 million in 2005 from
      $8.1
      million in 2004. As a percentage of net sales these expenses increased to 5.4%
      in 2005 from 5.0% in 2004, an increase of 0.4%. The increase is attributable
      to
      TWC and Footworks acquisitions, as well as an increase in legal expenses related
      to litigation.





OTHER
      INCOME. Other income of $0.1 million in 2004 is the gain from early debt
      extinguishment at a discount of the redeemable convertible notes related to
      The
      Walking Company acquisition.





INTEREST
      INCOME. Interest income for 2005 and 2004 was less than $0.1 million. Interest
      income is primarily earned on excess cash balances invested on an overnight
      basis. As the Company generally uses excess cash to reduce the outstanding
      balances on their lines of credit, interest income in future periods is not
      expected to be significant.





18





INTEREST
      EXPENSE. Interest expense remained relatively constant in 2005 and 2004 at
      $1.0
      million and $0.9 million, respectively.





INCOME
      TAXES. In 2005, the provision for income taxes reflects a 38.0% effective tax
      rate, compared to a 37.1% effective tax rate in 2004.





SEASONALITY
      AND QUARTERLY RESULTS





We
      believe our seasonality is somewhat different than many apparel retailers since
      a significant number of our Big Dog Sportswear stores are located in tourist
      areas and outdoor malls that have different visitation patterns than urban
      and
      suburban retail centers. We believe that the seasonality of TWC stores will
      more
      closely resemble traditional retailers. The third and fourth quarters
      (consisting of the summer vacation, back-to-school and Christmas seasons) have
      historically accounted for the largest percentage of our annual sales and
      profits. We have historically incurred operating losses in the first half of
      the
      year and may be expected to do so in the foreseeable future.





Our
      quarterly results of operations may also fluctuate as a result of a variety
      of
      factors, including the timing of store openings, the amount of revenue
      contributed by new stores, changes in comparable store sales, changes in the
      mix
      of products sold, customer acceptance of new products, the timing and level
      of
      markdowns, competitive factors and general economic conditions.





OFF
      BALANCE SHEET ARRANGEMENTS





The
      Company has no off-balance sheet arrangements that have or are reasonably likely
      to have a current or future effect on our consolidated financial condition,
      changes in our consolidated financial condition, revenues or expenses,
      consolidated results of operations, liquidity, capital expenditures or capital
      resources.





LIQUIDITY
      AND CAPITAL RESOURCES





During
      2006, our primary uses of cash were for merchandise inventories, the acquisition
      of Steve’s Shoes, capital expenditures, and general operating activity. We
      satisfied our cash requirements from existing cash balances, short-term
      borrowings under our line of credit agreements and other borrowings.





Cash
      (used in) provided by operating activities was ($2.1) million and $7.2 million
      for 2006 and 2005, respectively. The $9.3 million decrease in cash provided
      by
      operating activities primarily relates to an $8.6 million increase in inventory
      purchases and a $3.8 million decrease in our net income, which was offset in
      part by various fluctuations in operating assets and liabilities. Inventory
      increased as a result of new store openings. We opened 27 new stores (24 TWC
      and
      3 Big Dogs) in 2006 with total initial inventory of $5.6 million. The balance
      of
      the increase in inventory purchases primarily relates to re-merchandising the
      37
      acquired Steve's Shoes stores.





Cash
      used
      in investing activities was $20.5 million and $9.6 million for 2006 and 2005,
      respectively. Of the cash used in investing activities in 2006, $15.9 million
      was used for capital expenditures, including 24 new TWC store openings, three
      new Big Dog Sportswear store openings, retrofitting existing stores and
      corporate additions. In addition, $4.6 million was used to acquire Steve’s
      Shoes, Inc. Of the cash used in investing activities in 2005, $4.1 million
      relates to the acquisition of Footworks and $5.4 million relates to capital
      expenditures including 11 new TWC store openings, three new Big Dog Sportswear
      store openings, retrofitting existing stores and corporate additions.





Cash
      provided by financing activities in 2006 was $22.6 million compared to $1.2
      million of cash used in financing activities in 2005. The increase in cash
      provided by financing is primarily due to increased cash borrowings under the
      line of credit. As of December 31, 2006, we had short term borrowings of $25.7
      million compared to $2.8 million on December 31, 2005.





19





In
      October 2001, the Company entered into a credit facility with Wells Fargo Retail
      Finance, which was most recently amended in November 2006 (the “Amended Credit
      Agreement”). Subsequent to the November 2006 amendment, the Amended Credit
      Agreement provides for a total commitment of $60,000,000 with the ability for
      the Company to issue documentary and standby letters of credit of up to
      $3,000,000. Prior to the amendment, the agreement provided for a total
      commitment of $47,000,000. The Company’s ability to borrow under the facility
      was determined using an availability formula based on eligible assets. The
      facility was collateralized by substantially all of the Company’s assets and
      requires daily, weekly and monthly financial reporting as well as compliance
      with financial, affirmative and negative covenants. The most significant of
      the
      amended financial covenants, amended in October, 2006, include compliance with
      a
      pre-defined annual maximum capital expenditure amount and a restriction on
      the
      payment of dividends. For all periods presented, the Company was in compliance
      with all covenants, as amended. This credit agreement provides for a
      performance-pricing structured interest charge which was based on excess
      availability levels. The interest rate ranged from the bank’s base rate (8.25%
      as of December 31, 2006) or a LIBOR loan rate plus a margin ranging up to 1.75%
      (6.85% as of December 31, 2006). The Company had $3,222,000 in borrowings based
      on the bank’s base rate and $22,500,000 in LIBOR loans outstanding at December
      31, 2006. The Amended Credit Agreement expires in October 2011. At December
      31,
      2006, the Company had approximately $2,755,000 of outstanding letters of credit
      expiring through October 2008, which includes a $2,000,000 stand-by letter
      of
      credit related to a promissory note entered in conjunction with the acquisition
      of Footworks.





As
      part
      of the acquisition of The Walking Company, TWC assumed priority tax claims
      totaling approximately $627,000. The Bankruptcy Code requires that each holder
      of a priority tax claim will be paid in full with interest at the rate of six
      percent per year with annual payments for a period of six years. At December
      31,
      2006 and 2005, $60,000 and $59,000, respectively, of the priority tax claim
      note
      is classified as current and is included in current portion of long-term debt
      in
      the accompanying consolidated balance sheet. As of December 31, 2006 and 2005,
      the remaining notes had a balance of $52,000 and $121,000,
      respectively.





In
      conjunction with the Company’s acquisition of Footworks, Wells Fargo Retail
      Finance issued a $3,000,000 four-year term loan facility. Monthly payments
      of
      $55,555 were due beginning in March of 2006 with the balance due at the maturity
      date of the loan, October 2009. The term loan interest charge is Prime plus
      .5%
      or LIBOR plus 2.75% (8.75% at December 31, 2006). At December 31, 2006, $667,000
      of the term loan facility is classified as current and is included in current
      portion of long-term debt in the accompanying consolidated balance
      sheet.





Additionally,
      in conjunction with the acquisition of Footworks, the Company also entered
      into
      a $3,000,000 three-year promissory note with the seller, Bianca of Nevada,
      Inc.
      The principal on this note is payable in three annual installments beginning
      August 31, 2006. The note bears an interest rate of 5.0% and accrued interest
      is
      payable quarterly beginning December 2005. The note is partially secured by
      a
      $2,000,000 stand-by letter of credit. Upon payment of the second principal
      installment, the stand-by letter of credit shall be reduced to $1,000,000.
      At
      December 31, 2006, $1,000,000 of the promissory note is classified as current
      and is included in current portion of long-term debt in the accompanying
      consolidated balance sheet.





Management
      believes that available cash, the credit facilities in place at December 31,
      2006, and cash generated from operations will be adequate to fund the Company’s
      working capital requirements for the foreseeable future.





20





COMMITMENTS
      AND OBLIGATIONS





As
      of
      December 31, 2006, we had the following obligations, which include both
      principal and interest payments:




Amounts
                  of Commitment Expiration per PeriodTotal
                  Amounts Committed
              
              Less
                  than 1 year
              
              1
                  to 3 years
              
              4
                  to 5 years
              
              Over
                  5 yearsDebt:Revolving
                  line of credit
              
              $
              34,087,000
              
              $
              27,453,000
              
              $
              3,461,000
              
              $
              3,173,000
              
              $
              ---Notes
                  payable
              
              
              4,904,000
              
              
              1,927,000
              
              
              2,977,000
              
              
              ---
              
              
              ---Priority
                  tax claims
              
              
              119,000
              
              
              65,000
              
              
              52,000
              
              
              2,000
              
              
              ---Contractual
                  Obligations:Operating
                  leases
              
              
              185,838,000
              
              
              32,916,000
              
              
              56,162,000
              
              
              43,949,000
              
              
              52,811,000Capital
                  leases
              
              
              72,000
              
              
              44,000
              
              
              14,000
              
              
              14,000
              
              
              ---Other
                  Commercial Commitments:Letters
                  of credit
              
              
              2,755,000
              
              
              1,755,000
              
              
              1,000,000
              
              
              ---
              
              
              ---Total
                  Commitments
              
              $
              227,775,000
              
              $
              64,160,000
              
              $
              63,666,000
              
              $
              47,138,000
              
              $
              52,811,000


Revolving
      Lines of Credit - We have a revolving credit facility with Wells Fargo Retail
      Finance that we use to finance our operations. Commitments related to interest
      on the credit facility are estimated based on the prior year’s average balance
      and the current weighted average interest rate (7.03% at December 31, 2006).
      See
“Part I. Item 7. - Liquidity and Capital Resources” for additional information
      regarding our credit facility.





Notes
      Payable - In conjunction with the acquisition of Footworks, we entered into
      two
      loans used to finance the purchase. Commitments related to interest expense
      on
      these loans are estimated based on expected balance and the current interest
      rates (ranging from 5% to 8.75% at December 31, 2006). See “Part I. Item 7. -
      Liquidity and Capital Resources” for additional information regarding our notes
      payable.





Priority
      Tax Claims - In conjunction with the acquisition of The Walking Company, we
      assumed priority tax claims. Commitments related to interest expense on these
      claims are estimated based on the expected balance and the current interest
      rate
      of 6%. See “Part I. Item 7. - Liquidity and Capital Resources” for additional
      information regarding our priority tax claim debt.





Operating
      Leases - We lease retail and office space under various operating leases.
      Certain leases are cancelable with substantial penalties. See “Part I. Item 2. —
Properties” for additional information regarding our leases.





Capital
      Leases - We lease certain computer and copier equipment under various capital
      leases. Certain leases are cancelable with substantial penalties.





Letters
      of Credit - We open letters of credit to facilitate inventory purchases as
      required by certain vendors.  The letters of credit list certain
      documentation requirements that each vendor must present to our bank before
      payment is made.  We are obligated to make these payments upon presentation
      of these documents.





See
      additional discussion above under Liquidity and Capital Resources.





RECENT
      ACCOUNTING PRONOUNCEMENTS





In
      July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB
      Interpretation No. 48 (“FIN 48”), *Accounting
      for Uncertainty in Income Taxes - an Interpretation of FASB Statement No.
      109* .
      FIN 48
      clarifies the accounting for income taxes by prescribing the minimum recognition
      threshold a tax position is required to meet before being recognized in the
      financial statements. FIN 48 also provides guidance on derecognition,
      measurement, classification, interest and penalties, accounting in interim
      periods, disclosure and transition. In addition, FIN 48 excludes income taxes
      from SFAS No. 5, *Accounting
      for Contingencies* .
      FIN 48
      is effective for fiscal years beginning after December 15, 2006 and
      provides transitional guidance for treating differences between the amounts
      recognized in the statements of financial position prior to the adoption of
      FIN
      48 and the amounts reported after adoption. We have not yet completed our
      evaluation of uncertain tax positions, and we are currently unable to quantify
      the amounts of additional deferred income tax assets and income tax liabilities
      we expect to record upon adoption of FIN 48.





21





In
      July 2006, the Emerging Issues Task Force promulgated Issue No. 06-3
      (“Issue”), *How
      Taxes Collected from Customers and Remitted to Governmental Authorities Should
      be Presented in the Income Statement (i.e., Gross Versus Net
      Presentation)* .
      The
      Task Force concluded that entities should present these taxes in the income
      statement on either a gross or a net basis based upon their accounting policy.
      However, this Issue states that if such taxes are significant, and are presented
      on a gross basis, the amounts of those taxes should be disclosed. This Issue
      should be applied to financial reports for interim and annual reporting periods
      beginning after December 15, 2006. Since the Company currently records
      taxes on a net basis (i.e., sales tax is not included in sales, but is instead
      recorded as a liability under accrued expenses), the adoption of this Issue
      will
      not have a material impact on the Company’s consolidated financial statements.





In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements* .
      This
      statement provides guidance for using fair value to measure assets and
      liabilities. The statement also responds to investors’ requests for expanded
      information about the extent to which companies measure assets and liabilities
      at fair value, the information used to measure fair value, and the effect of
      fair value measurements on earnings. The statement applies whenever other
      statements require (or permit) assets or liabilities to be measured at fair
      value, but does not expand the use of fair value in any new circumstances.
      SFAS
      No. 157 is effective for financial statements issued for fiscal years
      beginning after November 15, 2007, and interim periods within those fiscal
      years. There are numerous previously issued statements dealing with fair values
      that are amended by SFAS No. 157. The Company is in the process of
      evaluating the impact, if any, that the adoption of SFAS No. 157 will have
      on the Company’s consolidated financial statements.





In
      September 2006, the SEC issued Staff Accounting Bulletin (“SAB”)
      No. 108, *Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements* .
      SAB
      No. 108 (a.k.a. SAB Topic 1.N) addresses quantifying the financial
      statement effects of misstatements or, more specifically, how the effects of
      prior year uncorrected errors must be considered in quantifying misstatements
      in
      the current year financial statements. SAB No. 108 does not change the SEC
      staff’s previous positions in SAB No. 99, *Materiality* (a.k.a.
      SAB Topic 1.M) regarding qualitative considerations in assessing the materiality
      of misstatements. SAB No. 108 is effective for fiscal years ending after
      November 15, 2006. The adoption of SAB No. 108 did not have a material
      impact on the Company’s consolidated financial statements.





In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for Financial Assets and Financial Liabilities.* SFAS
      No. 159 provides companies with an option to report many financial
      instruments and certain other items at fair value that are not currently
      required to be measured at fair value. The objective of SFAS No. 159 is to
      reduce both complexity in accounting for financial instruments and the
      volatility in earnings caused by measuring related assets and liabilities
      differently. The FASB believes that SFAS No. 159 helps to mitigate
      accounting-induced volatility by enabling companies to report related assets
      and
      liabilities at fair value, which would likely reduce the need for companies
      to
      comply with detailed rules for hedge accounting. SFAS No. 159 also
      establishes presentation and disclosure requirements designed to facilitate
      comparisons between companies that choose different measurement attributes
      for
      similar types of assets and liabilities, and would require entities to display
      the fair value of those assets and liabilities for which the company has chosen
      to use fair value on the face of the balance sheet. The new statement does
      not
      eliminate disclosure requirements included in other accounting standards,
      including requirements for disclosures about fair value measurements included
      in
      SFAS No. 157, *Fair
      Value Measurements* .
      This
      statement is effective as of the beginning of an entity’s first fiscal year
      beginning after November 15, 2007. The Company is in the process of
      evaluating the impact, if any, that the adoption of SFAS No. 159 will have
      on the Company’s consolidated financial statements.





There
      are
      no other accounting standards issued as of March 12, 2007 that are expected
      to have a material impact on the Company’s consolidated financial statements.





CRITICAL
      ACCOUNTING POLICIES





We
      prepare our consolidated financial statements in accordance with accounting
      principles generally accepted in the United States of America. Our significant
      accounting policies are discussed in Note 1 to the consolidated financial
      statements. Certain of these accounting policies as discussed below require
      management to make estimates and assumptions about future events that could
      materially affect the reported amounts of assets, liabilities, revenues and
      expenses and disclosure of contingent assets and liabilities. Our most critical
      estimate relates to projecting future cash flows used in assessing future store
      operating performance and testing long-lived assets, including goodwill, for
      impairment.





22





We
      evaluate the carrying value of long-lived assets, including goodwill, for
      impairment whenever events or changes in circumstances indicate that the
      carrying value of such assets may not be recoverable. This evaluation is
      performed based on the estimated undiscounted future cash flows from operating
      activities compared with the carrying value of the related asset. If the
      undiscounted future cash flows are less than the carrying value, an impairment
      loss is recognized, measured by the difference between the carrying value and
      the estimated fair value of the assets, with such estimated fair values
      determined using the best information available generally based on prices for
      similar assets for stores recently opened. There were no impairment losses
      included in the consolidated results of operations for the years ended December
      31, 2006, 2005 and 2004.





The
      Company is self insured for medical insurance coverage. The self insurance
      liability is based on the historical claims rate and is anticipated to cover
      reported claims as well as incurred but not reported claims. The Company also
      maintains stop loss insurance coverage which reimburses the Company for an
      individual claim in excess of $120,000 and for company-wide claims in excess
      of
      an aggregate amount. The annual aggregate amount is determined based on a per
      month, per participant amount which ranges from $250 to $749.





Inventories,
      consisting substantially of finished goods, are valued at the lower of cost
      (first-in, first-out and weighted average methods) or market. We continually
      evaluate our inventories by assessing slow moving current product as well as
      prior seasons' inventory. Market value of non-current inventory is estimated
      based on historical sales trends for this category of inventory, the impact
      of
      market trends, and an evaluation of economic conditions. The Company closely
      monitors its off-price sales to ensure the actual results closely match initial
      estimates. Estimates are regularly updated based upon this continuing review.
      Inventory adjustments incurred during the years ended December 31, 2006, 2005
      and 2004 were $0.2, $0.0 and $0.1 million, respectively.





We
      account for income taxes using an asset and liability approach for measuring
      deferred income taxes based on temporary differences between the financial
      statement and income tax bases of assets and liabilities existing at each
      balance sheet date. A valuation allowance is established, when necessary, to
      reduce deferred income tax assets to the amount expected to be realized. The
      Company considers a number of factors to determine if a valuation allowance
      is
      necessary, including historical earnings and past experience with similar timing
      differences. For the three years ended December 31, 2006, the Company determined
      that a valuation allowance was not required.





RISK
      FACTORS





Investors
      in the Company should consider the following risk factors as well as the other
      information contained herein.





CONTROL
      BY MAJORITY SHAREHOLDER, SMALL PUBLIC FLOAT, AND LOW TRADING VOLUME OF
      SHARES .
      Our
      Chairman of the Board, Fred Kayne, owns approximately 57% of Big Dogs’
outstanding common stock. In addition, approximately 66% of our shares are
      held
      by Mr. Kayne and other directors, officers or beneficial owners of more than
      10%, none of whom have historically traded in the shares on any regular basis.
      As a result, Mr. Kayne, acting either individually or with the Company’s current
      directors and executive officers, will be able to control the election of
      directors, and to determine the outcome of any other matter submitted to a
      vote
      of our stockholders, including a change in control. While our shares are
      currently listed on the NASDAQ Global Market System, the average daily trading
      volume, particularly in recent years, has been very low. Due to all the
      foregoing, and other factors, there has been and can expect to be significant
      illiquidity in our shares.





CONTINUED
      STORE CLOSURES. The Company continues to evaluate its current Big Dogs and
      TWC
      store portfolio for potential store closures. In 2006, the Company closed
      24 **** underperforming
      Big Dogs’ stores and in 2007 to date has closed 13 Big Dogs and 2 TWC stores. We
      will continue to take a careful position in regard to long-term real estate
      commitments and may close additional stores if considered appropriate. Store
      closures will reduce sales and may result in the Company incurring additional
      costs related to the closure.





23





CHANGES
      IN CONSUMER PREFERENCES. The consumer products industry in general and the
      apparel industry in particular, are subject to changing consumer demands and
      preferences. Although we believe our Big Dogs and TWC products historically
      have
      not been significantly affected by fashion trends, its products are subject
      to
      changing consumer preferences. Big Dogs’ success will depend significantly on
      our ability to continue to produce popular graphics and products that
      anticipate, gauge and respond in a timely manner to changing consumer demands
      and preferences. We also continue to evaluate our introduction of more risqué
graphics in the Big Dogs line in recent years, and balance their sales against
      the risk of offending some customers. In addition, over the years general
      consumer preferences rise and decline in regard to the type of graphic and
      logo-oriented merchandise provided by Big Dogs, which can have an effect on
      our
      business.





FACTORS
      AFFECTING STORE TRAFFIC. Nearly all of our stores for both Big Dogs and TWC
      are
      located in malls. Accordingly our sales in such stores are, and will in the
      future continue to be, affected by the ability of such malls to continue to
      generate customer traffic. Big Dogs stores are located largely in outlet malls,
      with a majority of such malls we have selected being in tourist areas or
      tourist-serving areas where we think the customers will be attracted to Big
      Dogs
      merchandise. Outlet mall traffic appears to have declined overall in recent
      years. In addition, tourism may from time to time adversely be affected by
      such
      factors as economic downturns, adverse weather, war or international conflict,
      acts of terrorism or terrorism alerts, and increases in the cost of travel.
      In
      addition, customer traffic in both outlet malls and the regional malls in which
      TWC has stores is also affected by such factors as changing consumer
      preferences, opening of new malls in the area, the closing of high-profile
      stores in the mall and declines in the desirability of the shopping environment
      in a particular mall.





DEPENDENCE
      ON KEY PERSONNEL. Our success is significantly dependent on the performance
      of
      our key management, particularly Chief Executive Officer, Andrew Feshbach,
      Executive Vice President—Merchandising, Doug Nilsen, Executive Vice President -
      Business Affairs, General Counsel, Anthony Wall, Chief Financial Officer,
      Roberta Morris, Senior Vice President - Retail Operations, Lee Cox and Senior
      Vice President - Merchandising, Michael Grenley. We cannot assure you that
      we
      will be able to attract and retain key personnel. The loss of our key personnel
      could have an adverse effect on the Company’s results of operations and
      financial position. We do, however, maintain key-person life insurance policies
      on all of our senior executive officers.





DEPENDENCE
      ON THIRD-PARTY AND FOREIGN MANUFACTURERS AND SUPPLIERS. We do not own or operate
      any manufacturing facilities and are therefore dependent on third parties for
      the manufacture and supply of our Big Dogs and TWC products. The loss of major
      suppliers or the failure of such suppliers to timely deliver our products or
      to
      meet our quality standards, could adversely affect our ability to deliver
      products to our customers in a timely manner. The majority of our Big Dogs
      products are purchased from trading companies with relationships with
      manufacturing facilities located outside the United States. Our operations
      could
      be adversely affected by events that result in disruption of trade from foreign
      countries in which our suppliers are located. Our staff or agents periodically
      visit and observe the operations of such foreign and domestic manufacturers,
      but
      we do not control such manufacturers or their labor practices. Therefore we
      cannot necessarily prevent legal or ethical violations by independent
      manufacturers of Big Dogs goods, and it is uncertain what impact such violations
      would have on us.





SUBSTANTIAL
      COMPETITION. The markets for each of our products are highly competitive. In
      regard to our Big Dogs apparel products, the increased consumer shift toward
      large mass-market and discount retailers has put substantial pricing and
      competitive pressure on apparel retailers in general. We believe Big Dogs’
long-term competitive position will depend upon our ability to anticipate and
      respond effectively to changing consumer demands and to offer customers a wide
      variety of high-quality, fun products at competitive prices.





RELIANCE
      ON INFORMATION SYSTEMS. We rely on various information systems to manage our
      operations and regularly make investments to upgrade, enhance or replace such
      systems. Substantial disruptions affecting our information systems could have
      an
      adverse effect on our business.





DEPENDENCE
      ON TRADEMARKS. We use a number of trademarks, the primary ones of which are
      registered with the United States Patent and Trademark Office and in a number
      of
      foreign countries. While we believe our trademark rights are strong, in our
      pursuit and defense of particular infringement claims it cannot be assured
      that
      we will always prevail. See “Business - Trademarks.”





24





FORWARD-LOOKING
      STATEMENTS





This
      Annual Report on Form 10-K contains forward-looking statements that involve
      risks and uncertainties. The statements contained in this Form 10-K that are
      not
      purely historical are forward-looking statements, including without limitation
      statements regarding our expectations, beliefs, intentions or strategies
      regarding the future. Such forward-looking statements include the discussions
      in
      this Management’s Discussion and Analysis of Financial Condition and Results of
      Operations regarding the seasonality of business, expected new store openings,
      integration of acquisition and costs and inflation risks. All forward-looking
      statements in this document are based upon information available to us on the
      date hereof, and we assume no obligation to update any such forward-looking
      statements.





ITEM
                7A.
            QUANTITATIVE
                AND QUALITATIVE DISCLOSURES ABOUT MARKET
                RISK





We
      do not
      believe we have material exposure to losses from market-rate sensitive
      instruments. We have not invested in derivative financial instruments. Our
      overseas sourcing contracts are denominated in US dollars.





Our
      consolidated financial position and consolidated results of operations are
      subject to market risk associated with interest rate movements on borrowings.
      Currently, our credit facilities contain a performance-pricing
      structured-interest charge based on excess availability levels and index based
      on Prime or LIBOR. Additionally, we have a term loan with an interest charge
      index based on Prime or LIBOR. We had $25,722,000 outstanding borrowings under
      these arrangements as of December 31, 2006. Based on these outstanding
      borrowings at December 31, 2006 and the current market condition, a one percent
      increase in the applicable interest rates would decrease our annual cash flow
      and pretax earnings by approximately $257,000. Conversely, a one percent
      decrease in the applicable interest rates would increase annual cash flow and
      pretax earnings by $257,000. Our market risk on interest rate movements will
      increase based on higher borrowing levels. See “Item 7. Management’s Discussion
      and Analysis of Financial Condition and Results of Operations—Liquidity and
      Capital Resources.”





ITEM
                8.
            FINANCIAL
                STATEMENTS AND SUPPLEMENTARY DATA





See
      “Index to Consolidated Financial Statements” at Item 15(a) for a listing of the
      consolidated financial statements filed as part of this report.





ITEM
                9.
            CHANGES
                IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
                DISCLOSURE





None.





ITEM
                9A.
            CONTROLS
                AND PROCEDURES





EVALUATION
      OF DISCLOSURE CONTROLS AND PROCEDURES .  Based
      on the evaluation of our management, including the Chief Executive Officer
      and
      Chief Financial Officer, we have concluded that our disclosure controls and
      procedures were effective as of December 31, 2006 to provide reasonable
      assurance that information we are required to disclose in reports that we file
      or submit under the Securities Exchange Act ("Act") is recorded, processed,
      summarized and reported within the time periods as defined under the Act. 
There has been no change in our internal controls over financial reporting
      that
      occurred during the quarter ended December 31, 2006 that has materially
      affected, or is reasonably likely to materially affect, the Company's internal
      controls over financial reporting.





ITEM
                9B.
            OTHER
                INFORMATION.





None.





ITEM
                10.
            DIRECTORS,
                EXECUTIVE OFFICERS AND CORPORATE
                GOVERNANCE





Other
      information with respect to this item is incorporated by reference from the
      registrant’s definitive proxy
      statement to be filed with the Commission not later than 120 days after the
      end
      of the registrant’s fiscal year.





25





EXECUTIVE
      OFFICERS OF THE REGISTRANT





Set
      forth
      below are the names, ages, titles and present and recent past positions of
      persons serving as our executive officers as of March 1, 2007:





NAME
            
            AGE
            
            POSITIONAndrew
                D. Feshbach
            
            46
            
            President,
                Chief Executive Officer and DirectorDouglas
                N. Nilsen
            
            58
            
            Executive
                Vice President - Merchandising (Big Dog USA)Anthony
                J. Wall
            
            51
            
            Executive
                Vice President - Business Affairs, General Counsel and SecretaryRoberta
                J. Morris
            
            47
            
            Chief
                Financial Officer, Treasurer and Assistant SecretaryLee
                M. Cox
            
            38
            
            Senior
                Vice President - Retail OperationsMichael
                Grenley
            
            49
            
            Senior
                Vice President-Merchandising (TWC)





ANDREW
      D.
      FESHBACH co-founded the Company in May 1992 and has served as President, Chief
      Executive Officer and as a director since that time. From 1990 until the
      present, he has served as a Vice President of Fortune Financial, a private
      merchant banking firm owned by the Company’s Chairman and majority stockholder,
      Fred Kayne. Mr. Feshbach has an M.B.A. from Harvard University.





DOUGLAS
      N. NILSEN has served as Executive Vice President—Merchandising for Big Dog USA
      for more than five years. From 1990 to September 1995, he served as Director
      of
      Merchandise at Walt Disney Attractions, Inc. for its U.S. theme parks and
      resorts, and in such capacity was responsible for merchandising all apparel
      and
      accessories. Mr. Nilsen has an M.B.A. from New York University.





ANTHONY
      J. WALL has served as Executive Vice President, General Counsel and Secretary
      of
      the Company for more than five years. Mr. Wall also provides legal services
      to
      Fortune Fashions Industries LLC, a custom manufacturer of embellished apparel,
      Paige Premium Denim, a designer and manufacturer of denim jeans and casuals
      apparel, and Fortune Swimwear, a manufacturer of swimwear for the mass market,
      all of which are controlled by Fred Kayne.





ROBERTA
      J. MORRIS has served as Chief Financial Officer since March 1998, having
      previously served as Senior Vice President—Finance since January 1995. Prior to
      joining the Company in 1993, Ms. Morris was employed as a Senior Audit Manager
      with Deloitte & Touche LLP. Ms. Morris is a certified public accountant.





LEE
      M.
      COX joined the Company in September 2000 and has served as Senior Vice President
      - Retail since February 2001. From 1994 until September 2000, Mr. Cox was
      employed by Adidas Retail, Inc. in various capacities, most recently as Director
      of Retail Stores.





MICHAEL
      GRENLEY joined the Company in March 2004 and serves as Senior Vice President
      -
      Merchandising for TWC. From 1994 until the Company’s acquisition of The Walking
      Company, Mr. Grenley served as Executive Vice President - Merchandise and
      Chief Operations Officer for the previous The Walking Company. Prior
      to The Walking Company, Mr. Grenley was a Vice President of Merchandise at
      Macy's California.





The
      members of the Audit Committee of the Board of Directors are Steven Good
      (Chairman), David Walsh and Skip Coomber. Our Board, in its judgment, has
      determined that Mr. Good meets the Securities and Exchange Commission’s
      definition of audit committee financial expert and has designated him as such.
      Our Board has further determined that Messrs. Good, Walsh and Coomber are
      independent as such term is used under Schedule 14A of the Securities Exchange
      Act of 1934.





We
      have
      adopted a code of ethics for our principal executive officer and senior
      financial officers. Copies of the code of ethics are available by writing to
      Big
      Dog Holdings, Inc., Attention General Counsel, 121 Gray Ave., Santa Barbara,
      CA
      93101. Should any changes to or waivers of this code of ethics be made, such
      changes to or waivers will be timely disclosed on the Company’s website, unless
      the same is disclosed in a current report on Form 8-K filed with the Securities
      Exchange Commission.





26





ITEM
                11.
            EXECUTIVE
                COMPENSATION





Information
      with respect to this item is incorporated by reference from the registrant’s
      definitive proxy statement to be filed with the Commission not later than 120
      days after the end of the registrant’s fiscal year.





ITEM
                12.
            SECURITY
                OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
                STOCKHOLDER MATTERS





Information
      with respect to this item is incorporated by reference from the registrant’s
      definitive proxy statement to be filed with the Commission not later than 120
      days after the end of the registrant’s fiscal year.





ITEM
                13.
            CERTAIN
                RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR
                INDEPENDENCE





Information
      with respect to this item is incorporated by reference from the registrant’s
      definitive proxy statement to be filed with the Commission not later than 120
      days after the end of the registrant’s fiscal year.





ITEM
                14.
            PRINCIPAL
                ACCOUNTING FEES AND SERVICES





The
      information required by Item 14 of Part III is incorporated by reference from
      the Proxy Statement of Big Dog Holdings, Inc., relating to the 2006 Annual
      Meeting of Stockholders, to be filed with the SEC within 120 days of the fiscal
      2006 year end.





PART
      IV





ITEM
                15.
            EXHIBITS,
                FINANCIAL STATEMENT SCHEDULES.





(a)
            1.
            The
                financial statements listed in the “Index to Consolidated Financial
                Statements” at page F-1 are filed as a part of this
                report.





2.
            Schedule
                II - Valuation and Qualifying
                Accounts





Schedules
      other than that referred to above have been omitted because they are not
      applicable or are not required under the instructions contained in Regulation
      S-X or because the information is included elsewhere in the Consolidated
      Financial Statements or the Notes thereto.





3.
            Exhibits
                included or incorporated herein:


See
      “Index to Exhibits.”





(b)
                Reports
                    on Form 8-K.


On
      November 3, 2006 the Company filed a Form 8-K to disclose third quarter
      financial results.


On
      December 20, 2006 the Company filed a Form 8-K to disclose an amendment to
      a
      loan agreement that increased the maximum amount of credit available to the
      Company.





27





SIGNATURES





Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, the Registrant has duly caused this report to be signed on March 30,
      2007
      on its behalf by the undersigned, thereunto duly authorized.




BIG
                DOG HOLDINGS, INC.By
            /s/ANDREW
                D. FESHBACHAndrew
                D. FeshbachChief
                Executive Officer and President





Each
      person whose signature appears below hereby authorizes Andrew D. Feshbach and
      Anthony J. Wall or either of them, as attorneys-in-fact to sign on his behalf,
      individually, and in each capacity stated below and to file all amendments
      and/or supplements to the Annual Report on Form 10-K.





Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the Registrant and in the
      capacities and on the dates indicated.





**SIGNATURE**
            
            **TITLE**
            
            **DATE**/s/ANDREW
                D. FESHBACH
            
            
            Chief
                Executive Officer, President and Director
            
            March
                30, 2007Andrew
                D. Feshbach
            
            
            (Principal
                Executive Officer)/s/ROBERTA
                J. MORRIS
            
            
            Chief
                Financial Officer, Treasurer and Assistant
            
            March
                30, 2007Roberta
                J. Morris
            
            
            Secretary
                (Principal Financial and Accounting Officer)/s/FRED
                KAYNE
            
            
            Chairman
                of the Board
            
            March
                30, 2007Fred
                Kayne/s/SKIP
                R. COOMBER, III
            
            
            Director
            
            March
                30, 2007Skip
                R. Coomber, III/s/STEVEN
                C. GOOD
            
            
            Director
            
            March
                30, 2007Steven
                C. Good/s/DAVID
                J. WALSH
            
            
            Director
            
            March
                30, 2007David
                J. Walsh


28




**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**




INDEX
      TO
      CONSOLIDATED FINANCIAL STATEMENTS





YEARS
      ENDED DECEMBER 31, 2006, 2005, and 2004





PAGEReport
                of Independent Registered Public Accounting Firm
            
            F-2Consolidated
                Balance Sheets as of December 31, 2006 and 2005
            
            F-3Consolidated
                Statements of Income for the years ended December 31, 2006, 2005, and
                2004
            
            F-4Consolidated
                Statements of Stockholders’ Equity for the years ended December 31,
                2006, 2005, and 2004
            
            F-5Consolidated
                Statements of Cash Flows for the years ended December 31, 2006, 2005,
                and 2004
            
            F-6Notes
                to the Consolidated Financial Statements
            
            F-8





F-1





REPORT
      OF
      INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








To
      the
      Board of Directors


Big
      Dog
      Holdings, Inc. and subsidiaries


Santa
      Barbara, California





We
      have
      audited the consolidated balance sheets of Big Dog Holdings, Inc. and
      subsidiaries (collectively, the “Company”) as of December 31, 2006 and 2005, and
      the related consolidated statements of income, stockholders’ equity and cash
      flows for each of the three years in the period ended December 31, 2006. 
Our audits also included the financial statement schedule of the Company listed
      in Item 15(a).  These financial statements and financial statement schedule
      are the responsibility of the Company's management.  Our responsibility is
      to express an opinion on these financial statements based on our
      audits.





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





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the financial position of the Company as of December
      31, 2006 and 2005, and the results of their operations and their cash flows
      for
      each of the three years in the period ended December 31, 2006, in conformity
      with U.S. generally accepted accounting principles.  Also, in our opinion,
      the related financial statement schedule, when considered in relation to the
      basic consolidated financial statements taken as a whole, presents fairly in
      all
      material respects the information set forth therein.





SINGER
      LEWAK GREENBAUM & GOLDSTEIN LLP








Los
      Angeles, California


March
      30,
      2007





F-2





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





CONSOLIDATED
      BALANCE SHEETS





DECEMBER
                31,2006
            
            2005ASSETSCURRENT
                ASSETS:Cash
                and cash equivalents
            
            $
            3,587,000
            
            $
            3,530,000Receivables,
                net
            
            
            2,511,000
            
            
            894,000Inventories
            
            
            58,608,000
            
            
            44,518,000Prepaid
                expenses and other current assets
            
            
            1,170,000
            
            
            1,046,000Deferred
                income taxes (Note 7)
            
            
            2,741,000
            
            
            1,681,000Total
                current assets
            
            
            68,617,000
            
            
            51,669,000PROPERTY
                AND EQUIPMENT, net (Note 2)
            
            
            24,174,000
            
            
            11,931,000INTANGIBLE
                ASSETS, net (Notes 1 and 4)
            
            
            4,125,000
            
            
            4,473,000GOODWILL
                (Note 4)
            
            
            3,131,000
            
            
            3,131,000DEFERRED
                INCOME TAXES (Note 7)
            
            
            2,221,000
            
            
            1,187,000OTHER
                ASSETS
            
            
            393,000
            
            
            362,000TOTAL
            
            $
            102,661,000
            
            $
            72,753,000LIABILITIES
                AND STOCKHOLDERS' EQUITYCURRENT
                LIABILITIES:Short-term
                borrowings (Note 5)
            
            $
            25,722,000
            
            $
            2,796,000Current
                portion of long-term debt (Note 6)
            
            
            1,769,000
            
            
            1,775,000Accounts
                payable
            
            
            8,690,000
            
            
            7,478,000Income
                taxes payable (Note 7)
            
            
            1,511,000
            
            
            1,367,000Accrued
                expenses and other current liabilities (Note 3)
            
            
            8,335,000
            
            
            6,614,000Total
                current liabilities
            
            
            46,027,000
            
            
            20,030,000NOTE
                PAYABLE (Note 6)
            
            
            2,829,000
            
            
            4,565,000CAPITAL
                LEASE OBLIGATIONS (Note 8)
            
            
            26,000
            
            
            47,000DEFERRED
                RENT AND LEASE INCENTIVES (Note 8)
            
            
            4,508,000
            
            
            1,468,000DEFERRED
                GAIN ON SALE-LEASEBACK (Note 2)
            
            
            143,000
            
            
            195,000Total
                liabilities
            
            
            53,533,000
            
            
            26,305,000COMMITMENTS
                AND CONTINGENCIES (Notes 5 and 8)STOCKHOLDERS'
                EQUITY (Note 9):Preferred
                stock, $.01 par value, 3,000,000 shares authorized, none issued and
                outstanding
            
            $
            ---
            
            $
            ---Common
                stock $.01 par value, 30,000,000 shares authorized, 10,973,264 and
                10,784,280 shares issued at December 31, 2006 and 2005,
                respectively
            
            
            109,000
            
            
            108,000Additional
                paid-in capital
            
            
            27,622,000
            
            
            25,914,000Retained
                earnings
            
            
            30,843,000
            
            
            29,872,000Treasury
                stock, 1,710,598 and 1,710,598 shares at December 31, 2006 and 2005,
                respectively
            
            
            (9,446,000
            )
            
            (9,446,000
            )Total
                stockholders' equity
            
            
            49,128,000
            
            
            46,448,000TOTAL
            
            $
            102,661,000
            
            $
            72,753,000





See
      notes
      to consolidated financial statements.





F-3





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





CONSOLIDATED
      STATEMENTS OF INCOME




YEARS
                ENDED DECEMBER 31,2006
            
            2005
            
            2004NET
                SALES
            
            $
            218,604,000
            
            $
            179,115,000
            
            $
            161,358,000COST
                OF GOODS SOLD
            
            
            101,723,000
            
            
            80,311,000
            
            
            72,733,000GROSS
                PROFIT
            
            
            116,881,000
            
            
            98,804,000
            
            
            88,625,000OPERATING
                EXPENSES:Selling,
                marketing and distribution
            
            
            103,428,000
            
            
            80,624,000
            
            
            73,956,000General
                and administrative
            
            
            9,823,000
            
            
            9,631,000
            
            
            8,060,000Total
                operating expenses
            
            
            113,251,000
            
            
            90,255,000
            
            
            82,016,000INCOME
                FROM OPERATIONS
            
            
            3,630,000
            
            
            8,549,000
            
            
            6,609,000OTHER
                INCOME
            
            
            ---
            
            
            ---
            
            
            (82,000
            )INTEREST
                INCOME
            
            
            (8,000
            )
            
            (44,000
            )
            
            (26,000
            )INTEREST
                EXPENSE (Note 5 and 6)
            
            
            2,084,000
            
            
            976,000
            
            
            857,000INCOME
                BEFORE PROVISION FOR INCOME TAXES
            
            
            1,554,000
            
            
            7,617,000
            
            
            5,860,000PROVISION
                FOR INCOME TAXES (Note 7)
            
            
            583,000
            
            
            2,894,000
            
            
            2,172,000NET
                INCOME
            
            $
            971,000
            
            $
            4,723,000
            
            $
            3,688,000NET
                INCOME PER SHAREBASIC
            
            $
            0.11
            
            $
            0.52
            
            $
            0.42DILUTED
            
            $
            0.10
            
            $
            0.49
            
            $
            0.40





See
      notes
      to consolidated financial statements.





F-4





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





CONSOLIDATED
      STATEMENTS OF STOCKHOLDERS' EQUITY





ADDITIONALCOMMON
                STOCK
            
            PAID-IN
            
            RETAINED
            
            TREASURY
                STOCKSHARES
            
            AMOUNT
            
            CAPITAL
            
            EARNINGS
            
            SHARES
            
            AMOUNT
            
            TOTALBALANCE,JANUARY 1,
                2004
            
            
            9,698,284
            
            $
            97,000
            
            $
            20,510,000
            
            $
            21,461,000
            
            
            1,455,152
            
            $
            (7,854,000
            )
            $
            34,214,000Repurchased
                common stock (Note 9)
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            74,846
            
            
            (374,000
            )
            
            (374,000
            )Warrants
                exercised (Note 9)
            
            
            993,146
            
            
            10,000
            
            
            4,922,000
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            4,932,000Options
                exercised
            
            
            17,600
            
            
            ---
            
            
            63,000
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            63,000Tax
                benefits related to exercise of stock options (Notes 7 and
                9)
            
            
            ---
            
            
            ---
            
            
            18,000
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            18,000Net
                income
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            3,688,000
            
            
            ---
            
            
            ---
            
            
            3,688,000BALANCE,DECEMBER 31,
                2004
            
            
            10,709,030
            
            
            107,000
            
            
            25,513,000
            
            
            25,149,000
            
            
            1,529,998
            
            
            (8,228,000
            )
            
            42,541,000Repurchased
                common stock (Note 9)
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            180,600
            
            
            (1,218,000
            )
            
            (1,218,000
            )Options
                exercised
            
            
            75,250
            
            
            1,000
            
            
            322,000
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            323,000Tax
                benefits related to exercise of stock options (Notes 7 and
                9)
            
            
            ---
            
            
            ---
            
            
            79,000
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            79,000Net
                income
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            4,723,000
            
            
            ---
            
            
            ---
            
            
            4,723,000BALANCE,DECEMBER 31,
                2005
            
            
            10,784,280
            
            
            108,000
            
            
            25,914,000
            
            
            29,872,000
            
            
            1,710,598
            
            
            (9,446,000
            )
            
            46,448,000Options
                exercised
            
            
            188,984
            
            
            1,000
            
            
            957,000
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            958,000Tax
                benefits related to exercise of stock options (Notes 7 and
                9)
            
            
            ---
            
            
            ---
            
            
            540,000
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            540,000Non-cash
                compensation recognized on share based payments (Note 9)
            
            
            ---
            
            
            ---
            
            
            211,000
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            211,000Net
                income
            
            
            ---
            
            
            ---
            
            
            ---
            
            
            971,000
            
            
            ---
            
            
            ---
            
            
            971,000BALANCE,DECEMBER 31,
                2006
            
            
            10,973,264
            
            $
            109,000
            
            $
            27,622,000
            
            $
            30,843,000
            
            
            1,710,598
            
            $
            (9,446,000
            )
            $
            49,128,000





See
      notes
      to consolidated financial statements.





F-5





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





CONSOLIDATED
      STATEMENTS OF CASH FLOWS





YEARS
                ENDED DECEMBER 31,2006
            
            2005
            
            2004CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                income
            
            $
            971,000
            
            $
            4,723,000
            
            $
            3,688,000Adjustments
                to reconcile net income to net cash provided by operating
                activities:Depreciation
                and amortization
            
            
            6,524,000
            
            
            4,173,000
            
            
            3,666,000Stock-based
                compensation expense
            
            
            211,000
            
            
            ---
            
            
            328,000Excess
                tax benefits from share-based payment arrangements
            
            
            (540,000
            )
            
            (79,000
            )
            
            (18,000
            )Gain
                on early extinguishment of notes payable
            
            
            ---
            
            
            ---
            
            
            (82,000
            )Amortization
                of deferred financing fees
            
            
            16,000
            
            
            168,000
            
            
            273,000Provision
                for losses on receivables
            
            
            2,000
            
            
            2,000
            
            
            87,000Loss
                on disposition of property and equipment
            
            
            14,000
            
            
            39,000
            
            
            51,000Deferred
                income taxes
            
            
            (1,554,000
            )
            
            (56,000
            )
            
            (894,000
            )Changes
                in operating assets and liabilities:Receivables
            
            
            (1,619,000
            )
            
            (485,000
            )
            
            (381,000
            )Inventories
            
            
            (11,422,000
            )
            
            (2,843,000
            )
            
            (2,075,000
            )Prepaid
                expenses and other current assets
            
            
            (111,000
            )
            
            (176,000
            )
            
            1,635,000Accounts
                payable
            
            
            1,212,000
            
            
            2,301,000
            
            
            1,308,000Income
                taxes payable
            
            
            144,000
            
            
            (1,275,000
            )
            
            1,130,000Accrued
                expenses and other current liabilities
            
            
            1,588,000
            
            
            284,000
            
            
            (2,700,000
            )Deferred
                rent and lease incentives
            
            
            2,559,000
            
            
            526,000
            
            
            337,000Deferred
                gain on sale-leaseback
            
            
            (53,000
            )
            
            (53,000
            )
            
            (53,000
            )Net
                cash (used in) provided by operating activities
            
            
            (2,058,000
            )
            
            7,249,000
            
            
            6,300,000CASH
                FLOWS FROM INVESTING ACTIVITIES:Capital
                expenditures
            
            
            (15,870,000
            )
            
            (5,446,000
            )
            
            (1,886,000
            )Acquisitions,
                net of cash acquired
            
            
            (4,587,000
            )
            
            (4,122,000
            )
            
            (1,577,000
            )Proceeds
                from sale of property and equipment
            
            
            3,000
            
            
            1,000
            
            
            ---Other
            
            
            (60,000
            )
            
            (26,000
            )
            
            ---Net
                cash used in investing activities
            
            
            (20,514,000
            )
            
            (9,593,000
            )
            
            (3,463,000
            )CASH
                FLOWS FROM FINANCING ACTIVITIES:Net
                borrowings under line of credit agreement
            
            
            22,926,000
            
            
            2,491,000
            
            
            (7,634,000
            )Repayment
                of redeemable convertible notes and rights
            
            
            ---
            
            
            ---
            
            
            (363,000
            )Repurchase
                of common stock
            
            
            ---
            
            
            (1,218,000
            )
            
            (374,000
            )Payment
                of deferred financing fees
            
            
            ---
            
            
            (70,000
            )
            
            (175,000
            )Exercise
                of stock options
            
            
            959,000
            
            
            322,000
            
            
            63,000Excess
                tax benefits from share-based payment arrangements
            
            
            540,000
            
            
            79,000
            
            
            18,000Repayment
                of capital lease obligations
            
            
            (171,000
            )
            
            (220,000
            )
            
            (166,000
            )Repayment
                of notes payable
            
            
            (1,625,000
            )
            
            (180,000
            )
            
            (39,000
            )Net
                cash provided by (used in) financing activities
            
            
            22,629,000
            
            
            1,204,000
            
            
            (8,670,000
            )NET
                (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
            
            
            57,000
            
            
            (1,140,000
            )
            
            (5,833,000
            )CASH
                AND CASH EQUIVALENTS, BEGINNING OF YEAR
            
            
            3,530,000
            
            
            4,670,000
            
            
            10,503,000CASH
                AND CASH EQUIVALENTS, END OF YEAR
            
            $
            3,587,000
            
            $
            3,530,000
            
            $
            4,670,000SUPPLEMENTAL
                DISCLOSURES OF CASH FLOW INFORMATION:Cash
                paid for:Interest
            
            $
            2,069,000
            
            $
            841,000
            
            $
            545,000Income
                taxes
            
            $
            2,532,000
            
            $
            4,305,000
            
            $
            1,954,000





See
      notes
      to consolidated financial statements.





F-6





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





CONSOLIDATED
      STATEMENTS OF CASH FLOWS





SUPPLEMENTAL
                INFORMATION ON NON-CASH INVESTING AND FINANCING
                ACTIVITIES:2006
            
            2005
            
            2004ACQUISITIONS:Inventories
            
            $
            2,669,000
            
            $
            1,951,000
            
            $
            12,754,000Properties
            
            
            2,052,000
            
            
            508,000
            
            
            7,320,000Other
                current assets
            
            
            ---
            
            
            ---
            
            
            1,944,000Intangibles
            
            
            ---
            
            
            4,532,000
            
            
            ---Goodwill
            
            
            ---
            
            
            3,131,000
            
            
            ---Accrued
                expenses and other liabilities
            
            
            (134,000
            )
            
            ---
            
            
            (14,762,000
            )Redeemable
                convertible notes and rights assumed
            
            
            ---
            
            
            ---
            
            
            (4,998,000
            )Notes
                payable
            
            
            ---
            
            
            (6,000,000
            )
            
            (681,000
            )Net
                cash effect due to acquisitions
            
            $
            4,587,000
            
            $
            4,122,000
            
            $
            1,577,000REDEMPTION
                OF NOTES AND RIGHTS:Redeemable
                convertible notes and rights assumed
            
            
            
            
            
            
            
            $
            4,998,000Expiration
                of warrants
            
            
            
            
            
            
            
            
            328,000Accrued
                interest
            
            
            
            
            
            
            
            
            75,000Amortization
                of premium on convertible notes
            
            
            
            
            
            
            
            
            (24,000
            )Gain
                on early extinguishment of debt
            
            
            
            
            
            
            
            
            (82,000
            )Issuance
                of 993,146 shares of common stock
            
            
            
            
            
            
            
            
            (4,932,000
            )Net
                cash effect due to redemption of notes and rights
            
            
            
            
            
            
            
            $
            363,000OTHER:Tenant
                improvements paid by landlord
            
            $
            480,000
            
            $
            ---
            
            $
            ---Capital
                leases
            
            $
            33,000
            
            $
            ---
            
            $
            383,000





See
      notes
      to consolidated financial statements.





F-7





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS





1.
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





*ORGANIZATION
      AND BUSINESS*





The
      consolidated financial statements include the accounts of Big Dog Holdings,
      Inc.
      and its subsidiaries Big Dog Sportswear (“Big Dogs”) and The Walking Company
      (“TWC”), collectively the "Company". All significant intercompany accounts and
      transactions have been eliminated.





Big
      Dogs
      principally develops and markets apparel and other consumer products through
      Company-operated retail stores located throughout the United States, corporate
      sales accounts, catalogs and the Internet website.





TWC
      principally markets and sells authentic comfort footwear and accessories through
      Company-operated retail stores located throughout the United States, catalogs
      and the Internet website.





*CASH
      AND CASH EQUIVALENTS*





The
      Company considers all highly liquid investments with a maturity of less than
      three months when purchased to be cash equivalents.




*RECEIVABLES,
      NET*





Receivables,
      net consist primarily of tenant allowances, corporate sales and credit card
      transactions that remain outstanding at the end of the period. These amounts
      are
      reflected net of any allowance for doubtful accounts. The Company does not
      extend credit to its customers, except through third-party credit
      cards.





*INVENTORIES*




Inventories,
      consisting substantially of finished goods, are valued at the lower of cost
      (first-in, first-out and weighted average methods) or market. The Company
      continually evaluates its inventories by assessing slow moving current product
      as well as prior seasons' inventory. Market value of non-current inventory
      is
      estimated based on historical sales trends for this category of inventory,
      the
      impact of market trends, and an evaluation of economic conditions. The Company
      closely monitors its off-price sales to ensure the actual results closely match
      initial estimates. Estimates are regularly updated based upon this continuing
      review. Inventory adjustments incurred during the years ended December 31,
      2006,
      2005 and 2004 were $0.2, $0.0 and $0.1 million, respectively.




*PROPERTY
      AND EQUIPMENT*





Property
      and equipment are stated at cost, less accumulated depreciation. Depreciation
      and amortization of property and equipment are provided using the straight-line
      method over the following useful lives:





Store
                fixtures
            5
                yearsMachinery
                and equipment
            5
                yearsComputer
                equipment
            3
                yearsSoftware
            5
                years





Leasehold
      improvements are depreciated over the lesser of the estimated useful life of
      the
      asset or the term of the lease, whichever is shorter.





F-8





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





1.  SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES (continued)





*IMPAIRMENT
      OF LONG-LIVED ASSETS*





The
      Company evaluates the carrying value of long-lived assets for impairment
      whenever events or changes in circumstances indicate that the carrying value
      of
      such assets may not be recoverable. This evaluation is performed based on the
      estimated undiscounted future cash flows from operating activities compared
      with
      the carrying value of the related asset. If the undiscounted future cash flows
      are less than the carrying value, an impairment loss is recognized, measured
      by
      the difference between the carrying value and the estimated fair value of the
      assets, with such estimated fair values determined using the best information
      available generally based on prices for similar assets for stores recently
      opened. The Company’s evaluation for the years ended 2006, 2005 and 2004, which
      included all retail locations, indicated that no asset impairment existed and
      therefore no write-down of assets was recorded.





*GOODWILL
      AND OTHER INTANGIBLE ASSETS*





*Indefinite
      Lived Intangibles*





The
      Company accounts for indefinite lived intangible assets in accordance with
      Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other
      Intangible Assets. The Company tests trademarks for impairment on an annual
      basis, in the fourth quarter, and more often as circumstances require. The
      Company’s evaluation for the year ended 2004 indicated that the trademark for
      its Lifeforms brand was impaired. As such, the Company recorded a $45,000
      write-down of this asset in 2004. Such costs are included in general and
      administrative expenses in the consolidated statements of income. As of December
      31, 2006 and 2005, net trademarks totaled $299,000 and $298,000, respectively.
      Based on the evaluation performed in the last two years, management does not
      believe any impairment of its trademark related intangible assets existed at
      December 31, 2006 and 2005, respectively.





*Leasehold
      Intangible Assets*





In
      conjunction with the Footworks acquisition in 2005 (see Note 4), the Company
      acquired lease related intangible assets valued at $4,408,000, which are being
      amortized over the life of the related leases. Accumulated amortization was
      $583,000 and $233,000 at December 31, 2006 and 2005, respectively.





The
      estimate of aggregate amortization expense for the subsequent years is as
      follows:





FOR
                THE YEARS ENDED DECEMBER 31,2007
            
            $
            437,0002008
            
            
            437,0002009
            
            
            439,0002010
            
            
            435,0002011
            
            
            353,000Thereafter
            
            
            1,724,000$
            3,825,000





*Goodwill*





The
      Company accounts for goodwill in accordance with Statement of Financial
      Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets. In
      2005, the Company recorded $3,131,000 of goodwill in conjunction with the
      Footworks acquisition (see Note 4). All of the Company’s goodwill is allocated
      to the TWC segment. The Company tests goodwill for impairment in the fourth
      quarter of each year and more often as circumstances
      require. Based on its most recent analysis, management does not believe any
      impairment of its goodwill existed at December 31, 2006 and 2005, respectively.





F-9





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





1.
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)




*REVENUE
      RECOGNITION*





Substantially
      all of the Company's revenues are generated by its retail operations, which
      are
      recognized at the time of sale.  The Company also generates revenues
      through its corporate sales, Internet and mail order catalog operations, which
      are recognized at the time of shipment. Outbound shipping charges billed to
      customers are included in net sales when the products are shipped for corporate
      sales, Internet and mail order catalog sales. The Company records an allowance
      for estimated returns in the period of sale based on prior experience. Gift
      certificates and gift card sales are recorded as a liability, until the
      certificate or card is redeemed. As the gift certificates and gift cards do
      not
      expire, the Company does not record income for unused gift certificates or
      gift
      cards. The Company accrues for estimated sales returns by customers based on
      historical sales return results.





*INCOME
      STATEMENT COMPONENTS*





Cost
      of
      goods sold consists of the cost of the product and related overhead costs
      related to the product, including purchasing, inbound freight charges, warehouse
      receiving costs, quality control inspection costs, internal product development
      costs and shipping and other handling costs to our stores or customers.
      Depreciation is not included in the calculation of cost of goods
      sold.





Selling,
      marketing and distribution expenses consist of expenses associated with
      creating, distributing, and selling products through all channels of
      distribution, including occupancy, payroll and catalog costs. The distribution
      costs included in selling, marketing and distribution expense were $5,329,000,
      $3,314,000 and $3,147,000 for the years ended December 31, 2006, 2005 and 2004,
      respectively.





General
      and administrative expenses consist of administrative salaries, corporate
      occupancy costs and other corporate expenses.





*VENDOR
      ALLOWANCES*





Vendor
      allowances include allowances, rebates and cooperative advertising funds
      received from vendors. The amount of these funds is determined for each fiscal
      year and the majority is based on various quantitative contract terms.
      Amounts received from vendors relating to the purchase of merchandise
      inventories are recognized as a reduction of cost of the
      inventory .
      Amounts
      that represent a reimbursement of costs incurred, such as advertising, are
      recorded as a reduction to the related expense in the period that the related
      expense is incurred.





*STORE
      PREOPENING EXPENSES*





The
      Company expenses store pre-opening costs as incurred, which totaled $311,000,
      $236,000 and $87,000 in 2006, 2005 and 2004, respectively.





*ADVERTISING
      COSTS*





Costs
      associated with the production of our mail order catalogs are capitalized and
      expensed over the expected revenue stream following the mailing of the
      respective catalog, generally three months. All other advertising costs are
      expensed as incurred. Advertising expense charged to operations for the years
      ended December 31, 2006, 2005 and 2004 was $3,211,000, $1,389,000 and
      $1,254,000, respectively. Capitalized advertising
      costs related to our mail order catalogs were $295,000 and $227,000 as of
      December 31, 2006 and 2005, respectively, and are included in prepaid expenses
      and other current assets on the consolidated balance sheets.





F-10





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





1.
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)




*DEFERRED
      LEASE INCENTIVES*





The
      Company accounts for landlord allowances in accordance with SFAS 13, “Accounting
      for Leases” and FASB Technical Bulletin 88-1, “Issues Relating to Accounting for
      Leases”. Accordingly, all incentives received from landlords to fund tenant
      improvements are recorded as deferred liabilities and then amortized over the
      related store’s lease term.





*STRAIGHT-LINE
      RENT*





The
      Company accounts for rent expense in accordance with SFAS 13, “Accounting
      for Leases,” and FASB Technical Bulletin 85-3, “Accounting for Operating
      Leases with Scheduled Rent Increases.” Accordingly, rent expense under the
      Company’s store operating leases is recognized on a straight-line basis over the
      original term of each store’s lease, inclusive of rent holiday periods during
      store construction and excluding any lease renewal options.





*MEDICAL
      SELF-INSURANCE RESERVE*





The
      Company is self-insured for medical insurance coverage. The self-insurance
      liability is based on the historical claims rate and is anticipated to cover
      reported claims as well as incurred but not reported claims. The Company also
      maintains stop loss insurance coverage which reimburses the Company for an
      individual claim in excess of $120,000 and for company-wide claims in excess
      of
      an aggregate amount. The annual aggregate amount is determined based on a per
      month, per participant amount which ranges from $250 to $749.





*INCOME
      TAXES*





The
      Company accounts for income taxes using an asset and liability approach for
      measuring deferred income taxes based on temporary differences between the
      financial statement and income tax bases of assets and liabilities existing
      at
      each balance sheet date. A valuation allowance is established, when necessary,
      to reduce deferred income tax assets to the amount expected to be realized.
      The
      Company considers a number of factors to determine if a valuation allowance
      is
      necessary, including historical earnings and past experience with similar timing
      differences. For the three years ended December 31, 2006, the Company determined
      that a valuation allowance was not required.





*EARNINGS
      PER SHARE*





Basic
      earnings per share is calculated based on the weighted average number of shares
      outstanding. Diluted earnings per share is calculated based on the same number
      of shares plus additional shares representing stock distributable under
      stock-based plans computed using the treasury stock method.





F-11





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





1.  SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES (continued)





The
      following reconciles the numerator and denominator of the basic and diluted
      per-share computations for net income:





YEARS
                ENDED DECEMBER 31,2006
            
            2005
            
            2004Net
                income
            
            $
            971,000
            
            $
            4,723,000
            
            $
            3,688,000Basic
                Weighted Average Shares:Weighted
                average number of shares outstanding
            
            
            9,180,000
            
            
            9,145,000
            
            
            8,722,000Effect
                of Dilutive Securities:Options
                and warrants
            
            
            351,000
            
            
            581,000
            
            
            452,000Diluted
                Weighted Average Shares:Weighted
                average number of shares outstanding and Common share
                equivalents
            
            
            9,531,000
            
            
            9,726,000
            
            
            9,174,000Antidilutive
                options and warrants
            
            
            **--**
            
            
            230,000
            
            
            566,000





Antidilutive
      options and warrants consist of the weighted average of stock options and
      warrants for the respective years that had an exercise price greater than the
      average market price during the year. Such options and warrants are therefore
      excluded from the computation of diluted earnings per share.





*ACCOUNTING
      FOR STOCK-BASED COMPENSATION*





On
      January 1, 2006, the Company adopted the provisions of Financial Accounting
      Standards Board Statement No. 123R, *Share-Based
      Payment* (“SFAS
      123R”). The statement provides for, and the Company has elected to adopt the
      standard using the modified prospective application under which compensation
      cost is recognized on or after the required effective date for the fair value
      of
      all future share based award grants and the portion of outstanding awards at
      the
      date of adoption of this statement for which the requisite service has not
      been
      rendered, based on the grant-date fair value of those awards calculated under
      Statement 123 for pro forma disclosures.





Prior
      to
      January 1, 2006, the Company accounted for its stock-based compensation
      using the intrinsic value method prescribed in Accounting Principles Board
      Opinion No. 25, *Accounting
      for Stock Issued to Employees* ,
      and
      related interpretations. No stock-based employee compensation cost was reflected
      in net income, as all options granted under those plans had an exercise price
      equal to the market value of the underlying common stock on the date of grant.
      The Company recorded a $493,000 tax benefit for the year ended December 31,
      2006
      related to the exercise of stock options for which no compensation expense
      was
      recorded.





F-12





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





1.  SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Stock-based
      compensation for the years ended December 31, 2005 and 2004 was determined
      using the intrinsic value method. The following table provides supplemental
      information for those periods as if stock-based compensation had been recognized
      under SFAS 123R:




YEARS
                ENDED DECEMBER 31,2005
            
            2004Net
                income:As
                reported
            
            $
            4,723,000
            
            $
            3,688,000Add:
                Stock-based employee compensation expense included in reported net
                income,
                net of related tax effects
            
            
            ---
            
            
            114,000Deduct:
                Total stock-based employee compensation expense determined under
                fair
                value method, net of related tax effects
            
            
            (454,000
            )
            
            (380,000
            )Pro
                forma
            
            $
            4,269,000
            
            $
            3,422,000Net
                income per share:As
                reported:Basic
            
            $
            0.52
            
            $
            0.42Diluted
            
            $
            0.49
            
            $
            0.40Pro
                forma:Basic
            
            $
            0.47
            
            $
            0.39Diluted
            
            $
            0.44
            
            $
            0.37





*USE
      OF ESTIMATES*





The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      the financial statements and the reported amounts of revenues and expenses
      during the reporting period. Actual results could differ from those
      estimates.





*CONCENTRATION
      OF CREDIT RISK*





The
      Company had $135,000, $845,000 and $4,127,000 of cash on deposit with a high
      credit quality financial institution in excess of the Federal Deposit Insurance
      Corporation limits as of December 31, 2006, 2005 and 2004,
      respectively.





*FAIR
      VALUE OF FINANCIAL INSTRUMENTS*





The
      estimated fair values of receivables, accounts payable and short-term borrowings
      approximate their carrying values because of the short-term maturity of these
      instruments.





The
      fair
      value of the Company’s debt instruments are based on the amount of future cash
      flows associated with each instrument discounted using the Company’s borrowing
      rate. At December 31, 2006 and 2005, the carrying value of all financial
      instruments was not materially different from fair value, as both the fixed
      and
      variable rate debt approximated rates currently available to the
      Company.





*RECENTLY
      ISSUED ACCOUNTING STANDARDS*





In
      July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB
      Interpretation No. 48 (“FIN 48”), *Accounting
      for Uncertainty in Income Taxes - an Interpretation of FASB Statement No.
      109* .
      FIN 48
clarifies
      the accounting for income taxes by prescribing the minimum recognition threshold
      a tax position is required to meet before being recognized in the financial
      statements. FIN 48 also provides guidance on derecognition, measurement,
      classification, interest and penalties, accounting in interim periods,
      disclosure and transition. In addition, FIN 48 excludes income taxes from SFAS
      No. 5,*Accounting
      for Contingencies*.
      FIN 48
      is effective for fiscal years beginning after December 15, 2006 and
      provides transitional guidance for treating differences between the amounts
      recognized in the statements of financial position prior to the adoption of
      FIN
      48 and the amounts reported after adoption. We have not yet completed our
      evaluation of uncertain tax positions, and we are currently unable to quantify
      the amounts of additional deferred income tax assets and income tax liabilities
      we expect to record upon adoption of FIN 48.





F-13





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





1.  SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES (continued)




In
      July 2006, the Emerging Issues Task Force promulgated Issue No. 06-3
      (“Issue”), *How
      Taxes Collected from Customers and Remitted to Governmental Authorities Should
      be Presented in the Income Statement (i.e., Gross Versus Net
      Presentation)* .
      The
      Task Force concluded that entities should present these taxes in the income
      statement on either a gross or a net basis based upon their accounting policy.
      However, this Issue states that if such taxes are significant, and are presented
      on a gross basis, the amounts of those taxes should be disclosed. This Issue
      should be applied to financial reports for interim and annual reporting periods
      beginning after December 15, 2006. Since the Company currently records
      taxes on a net basis (i.e., sales tax is not included in sales, but is instead
      recorded as a liability under accrued expenses), the adoption of this Issue
      will
      not have a material impact on the Company’s consolidated financial statements.





In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements* .
      This
      statement provides guidance for using fair value to measure assets and
      liabilities. The statement also responds to investors’ requests for expanded
      information about the extent to which companies measure assets and liabilities
      at fair value, the information used to measure fair value, and the effect of
      fair value measurements on earnings. The statement applies whenever other
      statements require (or permit) assets or liabilities to be measured at fair
      value, but does not expand the use of fair value in any new circumstances.
      SFAS
      No. 157 is effective for financial statements issued for fiscal years
      beginning after November 15, 2007, and interim periods within those fiscal
      years. There are numerous previously issued statements dealing with fair values
      that are amended by SFAS No. 157. The Company is in the process of
      evaluating the impact, if any, that the adoption of SFAS No. 157 will have
      on the Company’s consolidated financial statements.





In
      September 2006, the SEC issued Staff Accounting Bulletin (“SAB”)
      No. 108, *Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements* .
      SAB
      No. 108 (a.k.a. SAB Topic 1.N) addresses quantifying the financial
      statement effects of misstatements or, more specifically, how the effects of
      prior year uncorrected errors must be considered in quantifying misstatements
      in
      the current year financial statements. SAB No. 108 does not change the SEC
      staff’s previous positions in SAB No. 99, *Materiality* (a.k.a.
      SAB Topic 1.M) regarding qualitative considerations in assessing the materiality
      of misstatements. SAB No. 108 is effective for fiscal years ending after
      November 15, 2006. The adoption of SAB No. 108 did not have a material
      impact on the Company’s consolidated financial statements.





In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for Financial Assets and Financial Liabilities.* SFAS
      No. 159 provides companies with an option to report many financial
      instruments and certain other items at fair value that are not currently
      required to be measured at fair value. The objective of SFAS No. 159 is to
      reduce both complexity in accounting for financial instruments and the
      volatility in earnings caused by measuring related assets and liabilities
      differently. The FASB believes that SFAS No. 159 helps to mitigate
      accounting-induced volatility by enabling companies to report related assets
      and
      liabilities at fair value, which would likely reduce the need for companies
      to
      comply with detailed rules for hedge accounting. SFAS No. 159 also
      establishes presentation and disclosure requirements designed to facilitate
      comparisons between companies that choose different measurement attributes
      for
      similar types of assets and liabilities, and would require entities to display
      the fair value of those assets and liabilities for which the company has chosen
      to use fair value on the face of the balance sheet. The new statement does
      not
      eliminate disclosure requirements included in other accounting standards,
      including requirements for disclosures about fair value measurements included
      in
      SFAS No. 157, *Fair
      Value Measurements* .
      This
      statement is effective as of the beginning of an entity’s first fiscal year
      beginning after November 15, 2007. The Company is in the process of
      evaluating the impact, if any, that the adoption of SFAS No. 159 will have
      on the Company’s consolidated financial statements.





F-14




**BIG
        DOG HOLDINGS, INC. AND SUBSIDIARIES**
 
 NOTES
        TO
        CONSOLIDATED FINANCIAL STATEMENTS (continued)





*RECLASSIFICATIONS*





Certain
      amounts in the prior year’s consolidated financial statements have been
      reclassified to conform to the current year’s presentation.





2.
      PROPERTY AND EQUIPMENT





Property
      and equipment consist of the following:





DECEMBER
                31,2006
            
            2005Leasehold
                improvements
            
            $
            22,411,000
            
            $
            14,456,000Store
                fixtures
            
            
            19,585,000
            
            
            14,660,000Machinery
                and equipment
            
            
            7,181,000
            
            
            3,943,000Computer
                equipment and software
            
            
            9,006,000
            
            
            7,932,000Land
            
            
            63,000
            
            
            ---58,246,000
            
            
            40,991,000Less
                accumulated depreciation and amortization
            
            
            34,072,000
            
            
            29,060,000Property
                and equipment, net
            
            $
            24,174,000
            
            $
            11,931,000





Depreciation
      and amortization expense of property and equipment totaled $6,174,000,
      $3,940,000 and $3,666,000 in 2006, 2005 and 2004, respectively.





In
      May
      1999, the Company purchased the building which houses its downtown Santa Barbara
      retail store for $1,600,000. In August 1999, the Company sold this building
      for
      $2,119,000 and simultaneously entered into a 10-year lease. The $527,000 gain
      related to the sale of this building is being deferred over the life of the
      lease.





3.
      ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES





Accrued
      expenses and other current liabilities consist of the following:





DECEMBER
                31,2006
            
            2005Accrued
                compensation and benefits
            
            $
            4,092,000
            
            $
            3,015,000Sales
                tax payable
            
            
            1,880,000
            
            
            1,596,000Store
                credits
            
            
            576,000
            
            
            446,000Sales
                return reserve
            
            
            499,000
            
            
            335,000Gift
                certificates
            
            
            514,000
            
            
            375,000Other
                current liabilities
            
            
            774,000
            
            
            847,000Total
                accrued expenses and other current liabilities
            
            $
            8,335,000
            
            $
            6,614,000





4.
      ACQUISITIONS





THE
      WALKING COMPANY ACQUISITION





On
      March
      3, 2004 (the “TWC acquisition date”), the Company acquired substantially all of
      the assets and assumed certain liabilities of The Walking Company (the “TWC
      acquisition”), pursuant to an asset purchase agreement
      for a purchase price of approximately $22 million. The Walking Company is a
      leading independent specialty retailer of high quality, technically designed
      comfort footwear and accessories. The Walking Company had total annual sales
      of
      approximately $74 million in 2003 and had been operating under the protection
      of
      the U.S. Bankruptcy Court since July 2003. The Company was selected as the
      highest and best bidder for The Walking Company assets at a U.S. Bankruptcy
      Court ordered auction, which was confirmed on March 2, 2004. Under the terms
      of
      the asset purchase agreement, a subsidiary of the Company acquired substantially
      all of the assets of The Walking Company including, but not limited to, the
      inventory and fixed assets of 72 stores located in 28 states and trademarks,
      all
      of which will be used by the subsidiary to continue the business under the
      name
“The Walking Company” (“TWC”). The transaction was accounted for under the
      purchase method of accounting, and accordingly the results of operations of
      TWC
      have been consolidated in the Company financial statements since the TWC
      acquisition date.





F-15





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





4.
      ACQUISITIONS (continued)





THE
      WALKING COMPANY ACQUISITION (continued)




The
      purchase price consisted of approximately $1.7 million in cash, $5.0 million
      in
      issuance of notes and rights (see Note 6), $15.4 million of assumption of
      accounts payable, accrued expenses and other liabilities (including acquisition
      related costs of $1.3 million.) The Company funded the cash portion of the
      purchase price by drawing upon existing and new lines of credit, and from
      available cash.





During
      2005, the Company received additional invoices related to the acquisition and
      adjusted the purchase price allocation accordingly. The total purchase
      consideration is now finalized and allocated to the assets and liabilities
      acquired based on their respective estimated fair values as summarized below.





Cash
                and cash equivalents
            
            $
            123,000Inventories
            
            
            12,754,000Other
                current assets
            
            
            1,944,000Property,
                plant and equipment
            
            
            7,320,000Total
                assets acquired
            
            $
            22,141,000Current
                and other liabilities
            
            
            15,489,000Notes
                payable and rights issued
            
            
            4,952,000Total
                liabilities assumed
            
            $
            20,441,000Net
                assets acquired over liabilities
            
            $
            1,700,000





The
      following table presents unaudited pro forma results of the combined operations
      for the year ended December 31, 2004 , as if the TWC acquisition had occurred
      as
      of the beginning of such a period rather than as of the TWC acquisition date.


Year
                  EndedDecember
                  31,2004Net
                  sales
              
              $
              169,677,000Net
                  income
              
              $
              3,137,000Net
                  income per common share:Basic
              
              $
              0.36Diluted
              
              $
              0.34




F-16





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





4.
      ACQUISITIONS (continued)





THE
      WALKING COMPANY ACQUISITION (continued)





The
      pro
      forma results have been prepared based on available information, using
      assumptions that the Company’s management believes are reasonable and include no
      significant non-recurring items. The results do not purport to represent the
      actual financial position or results of operations that would have occurred
      if
      the TWC acquisition had occurred on the dates specified. The results above
      are
      not necessarily indicative of the results that may be achieved in the future.
      These results also do not reflect any adjustments for the effect of certain
      operating synergies or expected cost reductions that the Company may realize
      as
      a result of the TWC acquisition. No assurances can be given that the amount
      of
      financial benefits, if any, may actually be realized as the result of the TWC
      acquisition.





FOOTWORKS
      ACQUISITION





On
      August
      31, 2005, the Company acquired substantially all of the assets of Footworks,
      a
      division of a privately held shoe retailer. The total purchase price was
      approximately $10.1 million which included the payment and issuance of cash
      and
      notes by the Company pursuant to the definitive agreement. The acquisition
      included a chain of 7 retail stores selling comfort shoes and accessories.
      Footworks’ operations have historically focused on high- visibility
      stores in Las Vegas, Nevada. The Company has converted the majority of the
      acquired stores into “The Walking Company” stores. Through an independent
      valuation, intangibles related to below market leases acquired were valued
      at
      approximately $4.4 million and acquired trademark intangibles were valued at
      approximately $0.1 million. Intangibles related to below market leases are
      amortized over the remaining lease term. Goodwill recorded in connection with
      the acquisition is approximately $3.1 million. The results of the Company’s
      operations for the Footworks stores have been included in the Company’s
      consolidated financial statements since the acquisition date. Pro forma results
      of operations are not presented as the acquisition is not considered material
      to
      the Company’s consolidated financial statements.





STEVE’S
      SHOES ACQUISITION





On
      January 31, 2006, the Company acquired, through bankruptcy court, substantially
      all of the assets and assumed certain liabilities of Steve’s Shoes, Inc.,
      pursuant to an asset purchase agreement for a purchase price of approximately
      $4.2 million. The Company also incurred acquisition related costs of $0.4
      million. Of this amount $2.1 million was allocated to fixed assets, $2.6 million
      was allocated to inventory and $0.1 million was allocated to liabilities. The
      Company assumed liabilities for $65,000 in accrued vacation, $39,000 in
      outstanding sales returns and $30,000 in gift certificates. The purchase price
      allocation is subject to adjustment related to additional acquisition related
      costs and assumed liabilities and is expected to be finalized in the first
      quarter 2007.





Under
      the
      terms of the asset purchase agreement, TWC acquired substantially all of the
      assets of Steve’s Shoes, Inc. including, but not limited to, the inventory and
      fixed assets of 37 stores. The primary reason for the acquisition was to
      continue the growth of TWC by acquiring stores in strategic locations. During
      2006 and 2007, the Company has or will be converting the majority of the
      acquired stores into “The Walking Company” stores. The transaction was accounted
      for under the purchase method of accounting, and accordingly the results of
      operations have been consolidated in the Company’s financial statements since
      acquisition on January 31, 2006.





The
      Company funded the purchase price by drawing upon existing lines of credit,
      and
      from available cash. No goodwill was recorded in connection with the
      acquisition. Pro forma results of operations will not be presented as the
      acquisition is not considered material (either individually or combined with
      Footworks) to the Company’s consolidated financial statements.





F-17





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





5.
      SHORT-TERM BORROWINGS





In
      October 2001, the Company entered into a credit facility with Wells Fargo Retail
      Finance, which was most recently amended in November 2006 (the “Amended Credit
      Agreement”). Subsequent to the November 2006 amendment, the Amended Credit
      Agreement provides for a total commitment of $60,000,000 with the ability for
      the Company to issue documentary and standby letters of credit of up to
      $3,000,000. Prior to the amendment, the Amended Credit Agreement provided for
      a
      total commitment of $47,000,000. The Company’s ability to borrow under the
      facility was determined using an availability formula based on eligible assets.
      The facility was collateralized by substantially all of the Company’s assets and
      requires daily, weekly and monthly financial reporting as well as compliance
      with financial, affirmative and negative covenants. The most significant of
      these financial covenants, amended in October 2006, include compliance with
      a
      pre-defined annual maximum capital expenditure amount and a restriction on
      the
      payment of dividends. For all periods presented, the Company was in compliance
      with all covenants, as amended. This credit agreement provides for a
      performance-pricing structured interest charge which is based on excess
      availability levels. The interest rate ranges from the bank’s base rate (8.25%
      on December 31, 2006) or a LIBOR loan rate plus a margin ranging up to 1.75%
      (6.85% as of December 31, 2006). The Company had $3,222,000 in borrowings based
      on the bank’s base rate and $22,500,000 in LIBOR loans outstanding at
      December 31, 2006. The weighted-average interest rate on short-term borrowing
      as
      of December 31, 2006 and 2005 was 7.03% and 7.25%, respectively. The Amended
      Credit Agreement expires in October 2011. At December 31, 2006, the Company
      had
      approximately $2,755,000 of outstanding letters of credit expiring through
      October 2008, which includes a $2,000,000 stand-by letter of credit related
      to a
      promissory note entered in conjunction with the acquisition of Footworks, as
      further disclosed in Note 6.





6.
      NOTES
      PAYABLE





DECEMBER
                31,2006
            
            2005Wells
                Fargo Retail Finance 4-year term facility
            
            $
            2,444,000
            
            $
            3,000,000Bianca
                of Nevada, Inc. 3-year promissory note
            
            
            2,000,000
            
            
            3,000,000Priority
                tax claim notes
            
            
            112,000
            
            
            180,0004,556,000
            
            
            6,180,000Less
                current installments
            
            
            1,727,000
            
            
            1,615,000Notes
                payable, excluding current installments
            
            $
            2,829,000
            
            $
            4,565,000





As
      part
      of the acquisition of The Walking Company, TWC assumed priority tax claims
      totaling approximately $627,000. The Bankruptcy Code requires that each holder
      of a priority tax claim will be paid in full with interest at the rate of six
      percent per year with annual payments for a period of six years. At December
      31,
      2006 and 2005, $60,000 and $59,000, respectively, of the priority tax claim
      note
      is classified as current and is included in current portion of long-term debt
      in
      the accompanying consolidated balance sheets. As of December 31, 2006 and 2005,
      the remaining notes had a balance of $52,000 and $121,000,
      respectively.





In
      conjunction with the acquisition of Footworks, Wells Fargo Retail Finance issued
      a $3,000,000 four-year term loan facility. Monthly payments of $55,555 were
      due
      beginning in March of 2006 with the balance due at the maturity date of the
      loan, October 2009. The term loan interest charge is Prime plus .5% or LIBOR
      plus 2.75% (8.75% at December 31, 2006). At December 31, 2006, $667,000 of
      the
      term loan facility is classified as current and is included in current portion
      of long-term debt in the accompanying consolidated balance sheets.





Additionally,
      in conjunction with the acquisition of Footworks, the Company also entered
      into
      a $3,000,000 three-year promissory note with the seller, Bianca of Nevada,
      Inc.
      The principal on this note is payable in three annual installments beginning
      August 31, 2006. The note bears an interest rate of 5.0% and accrued interest
      is
      payable quarterly beginning December 2005. The note is partially secured by
      a
      $2,000,000 stand-by letter of credit. Upon payment of the second principal
      installment, the stand-by letter of credit shall be reduced to $1,000,000.
      At
      December 31, 2006, $1,000,000 of the promissory note is classified as current
      and is included in current portion of notes payable in the accompanying
      consolidated balance sheets.





F-18





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





6.
      NOTES
      PAYABLE (continued)




Maturities
      of notes payable are as follows:





Years
                Ending December 31,2007
            
            $
            1,727,0002008
            
            
            1,714,0002009
            
            
            1,113,0002010
            
            
            2,0002011
            
            
            ---$
            4,556,000





7.
      INCOME
      TAXES





The
      provision for (benefit from) income taxes consists of the
      following:





YEARS
                ENDED DECEMBER 31,2006
            
            2005
            
            2004Current:Federal
            
            $
            2,271,000
            
            $
            2,520,000
            
            $
            2,615,000State
            
            
            406,000
            
            
            509,000
            
            
            469,000Total
            
            
            2,677,000
            
            
            3,029,000
            
            
            3,084,000Deferred:Federal
            
            
            (1,806,000
            )
            
            (114,000
            )
            
            (767,000
            )State
            
            
            (288,000
            )
            
            (21,000
            )
            
            (145,000
            )Total
            
            
            (2,094,000
            )
            
            (135,000
            )
            
            (912
                ,000
            )Total
                income tax provision
            
            $
            583,000
            
            $
            2,894,000
            
            $
            2,172,000








The
      Company's effective income tax rate differs from the federal statutory rate
      due
      to the following:





YEARS
                ENDED DECEMBER 31,2006
            
            2005
            
            2004Federal
                statutory income tax rate
            
            
            34.0
            %
            
            34.0
            %
            
            34.0
            %State
                taxes, net of federal benefit
            
            
            3.6
            
            
            3.9
            
            
            3.9Other,
                net
            
            
            (0.1
            )
            
            0.1
            
            
            (0.8
            )Total
            
            
            37.5
            %
            
            38.0
            %
            
            37.1
            %




F-19





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





7.
      INCOME
      TAXES (continued)





Significant
      components of the Company's net deferred income tax assets are as
      follows:




DECEMBER
                31,2006
            
            2005Deferred
                income tax assets:Allowance
                for doubtful receivables and sales returns
            
            $
            199,000
            
            $
            135,000Accrued
                vacation
            
            
            171,000
            
            
            150,000Inventory
                uniform capitalization
            
            
            1,760,000
            
            
            1,051,000Depreciation
            
            
            455,000
            
            
            570,000Intangible
                assets
            
            
            ---
            
            
            67,000Deferred
                rent
            
            
            1,781,000
            
            
            472,000Deferred
                gain on sale of building
            
            
            56,000
            
            
            78,000Stock-based
                compensation
            
            
            69,000
            
            
            ---State
                income taxes
            
            
            ---
            
            
            11,000Reserve
                liabilities
            
            
            801,000
            
            
            458,000Total
                deferred income tax assets
            
            
            5,292,000
            
            
            2,992,000Deferred
                income tax liabilities:Intangible
                assets
            
            
            (71,000
            )
            
            ---State
                income taxes
            
            
            (134,000
            )
            
            ---Prepaid
                expenses
            
            
            (125,000
            )
            
            (124,000
            )Total
                deferred income tax liabilities
            
            
            (330,000
            )
            
            (124,000
            )Deferred
                income tax asset, net
            
            $
            4,962,000
            
            $
            2,868,000








8.
      COMMITMENTS AND CONTINGENCIES





*LEASES*





The
      Company leases retail stores, office buildings and warehouse space under lease
      agreements that expire through 2018. Future minimum lease payments under
      noncancelable operating and capital leases are as follows:




Operating
              
              CapitalYEARS
                  ENDING DECEMBER 31,
              
              Leases
              
              Leases2007
              
              $
              32,916,000
              
              $
              44,0002008
              
              
              30,220,000
              
              
              7,0002009
              
              
              25,942,000
              
              
              7,0002010
              
              
              20,920,000
              
              
              7,0002011
              
              
              23,029,000
              
              
              7,000Thereafter
              
              
              52,811,000
              
              
              ---Total
                  minimum obligations
              
              $
              185,838,000
              
              
              72,000Less
                  amount representing interest
              
              
              
              
              
              4,000Present
                  value of minimum lease payments
              
              
              
              
              
              68,000Less
                  current portion
              
              
              
              
              
              42,000Long-term
                  portion
              
              
              
              
              $
              26,000




F-20





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





8.
      COMMITMENTS AND CONTINGENCIES (continued)





The
      above
      amounts do not include contingent rentals based on sales in excess of the
      stipulated minimum that may be paid under certain leases on retail stores.
      Additionally, certain leases contain future adjustments in rental payments
      based
      on changes in a specified inflation index. The effective annual rent expense
      for
      the Company is the total rent paid over the term of the lease, amortized on
      a
      straight-line basis. The difference between the actual rent paid and the
      effective rent recognized for financial statement purposes is reported as
      deferred rent.





Rent
      expense for 2006, 2005 and 2004, totaled $33,659,000, $26,478,000 and
      $24,332,000, respectively, and includes contingent rentals of $681,000, $586,000
      and $572,000 for 2006, 2005, and 2004, respectively, which are included in
      operating expenses in the consolidated statements of income. The cost of
      equipment under capital leases at December 31, 2006 and 2005 was $432,000 and
      $535,000, respectively, and accumulated depreciation for such equipment at
      December 31, 2006 and 2005 was $210,000 and $179,000, respectively. As described
      in Note 13, in January 2007 the Company paid $491,000 to terminate a lease
      early
      and also entered into a $2,953,000 capital lease.





*LITIGATION*





In
      July
      2004, a lawsuit was filed against the Company by Big Dog Motorcycles LLC (“BDM”)
      in the Central District of California. The complaint alleged breach and
      wrongful termination of a trademark license agreement.  BDM sought $1.5
      million in liquidation damages and attorneys fees.  The Company
      countersued. In July 2006 the parties agreed to dismiss all claims against
      each other, with no compensation being paid by either party.





In
      addition, from time to time the Company is involved in pending or threatened
      litigation incidental to its business.  The Company believes that the
      outcome of such litigation will not have a material adverse impact on its
      consolidated operations or financial condition.





*TAX
      RELATED CONTINGENCY*





On
      March
      14, 2006, the Company received a notice of proposed adjustments from the
      Internal Revenue Service ("IRS”) related to its audit of the Company’s 2002 Tax
      Year. The IRS has proposed adjustments to increase the Company’s income tax
      payable for the 2002 year under examination. The adjustments are related to
      the
      tax accounting for two short bond transactions recorded in 2002.





In
      2002,
      the Company entered into two transactions relating to the short-sale and
      repurchase of Treasury Securities. The transactions were intended to address
      interest rate exposure and generate capital gains that could be used to offset
      previously incurred capital losses. The IRS contended that the transactions
      were
      incorrectly characterized for IRS purposes. The notice of proposed changes
      to
      our 2002 federal income tax return would have resulted in additional tax due
      of
      approximately $1.6 million plus penalties. The Company obtained expert legal
      tax
      counsel and appealed the proposed adjustment. The Company believes that it
      has
      meritorious defenses and intends to vigorously contest the proposed adjustments.
      The Company does not believe the IRS will prevail in this matter and has not
      recorded a reserve for this proposed tax adjustment in the accompanying
      consolidated financial statements.





9.
      STOCKHOLDERS' EQUITY





*COMMON
      STOCK*





The
      Company is authorized to issue 30,000,000 shares of common stock. As of December
      31, 2006 and 2005, the Company had 10,973,264 and 10,784,280 of common stock
      issued, respectively.





F-21





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





9.
      STOCKHOLDERS' EQUITY (continued)





In
      March
      1998, the Board of Directors authorized the repurchase of up to $10,000,000
      of
      its common stock. The Company has repurchased 1,710,598 shares totaling
      $9,446,000 as of December 31, 2005 and 2006.





The
      Company’s credit agreement prohibits the payment of dividends. The Company did
      not pay a dividend in 2006 and 2005, and does not expect to pay dividends in
      the
      future.





*PREFERRED
      STOCK*





The
      Company is authorized to issue 3,000,000 shares of preferred stock. As of
      December 31, 2006 and 2005, the Company did not have any preferred stock issued
      or outstanding. Under the Company’s Certificate of Incorporation, the Board of
      Directors is authorized to fix the terms of the preferred stock provided for
      in
      such Certificate.





*STOCK
      OPTIONS*





In
      August
      1997, the Company adopted the 1997 Performance Award Plan to attract, reward
      and
      retain officers and employees. The maximum number of shares reserved for
      issuance under this plan was 1,000,000. In February 1998, the Company amended
      the 1997 Performance Award Plan (the “Plan”) to increase the maximum number of
      shares reserved for issuance under the Plan to 2,000,000. The Company amended
      the Plan again in April 2002 to increase the maximum number of shares reserved
      for issuance under the Plan to 3,000,000. Awards under this Plan may be in
      the
      form of nonqualified stock options, incentive stock options, stock appreciation
      rights, restricted stock, performance shares, stock bonuses, or cash bonuses
      based upon performance.





On
      January 1, 2006, the Company adopted the provisions of Financial Accounting
      Standards Board Statement No. 123R, *Share-Based
      Payment* (“SFAS
      123R”). This statement establishes standards surrounding the accounting for
      transactions in which an entity exchanges its equity instruments for goods
      or
      services. The statement focuses primarily on accounting for transactions in
      which an entity obtains employee services in share-based payment transactions,
      such as the options issued under the Company’s Stock Option Plans. The statement
      provides for, and the Company has elected to adopt the standard using the
      modified prospective application under which compensation cost is recognized
      on
      or after the required effective date for the fair value of all future share
      based award grants and the portion of outstanding awards at the date of adoption
      of this statement for which the requisite service has not been rendered, based
      on the grant-date fair value of those awards calculated under Statement 123
      for
      pro forma disclosures. The Company’s stock option compensation expense was
      $211,000 for year ended December 31, 2006, and is included in Operating
      Expenses in the accompanying consolidated statement of income. The Company
      also
      recorded a related $79,000 tax benefit, of which $69,000 is recorded as a
      deferred tax asset for year ended December 31, 2006.





The
      fair
      value of each option is estimated on the date of grant using the Black-Scholes
      option-pricing model. This model incorporates certain assumptions for inputs
      including a risk-free market interest rate, expected dividend yield of the
      underlying common stock, expected option life and expected volatility in the
      market value of the underlying common stock. The Company used the following
      assumptions for options granted in the years ended December 31, 2005 and 2004.
      There were no options granted in the year ended December 31, 2006.





F-22





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





9.
      STOCKHOLDERS’ EQUITY (continued)





Expected
                volatility
            
            
            35
            %Expected
                lives
            
            
            7
                yrs.Risk-free
                interest rate - high
            
            
            4.80
            %Risk-free
                interest rate - low
            
            
            3.75
            %Expected
                dividend yield
            
            
            none





Expected
      volatilities are based on the historical volatility of the Company’s common
      stock. The risk free interest rate is based upon quoted market yields for United
      States Treasury debt securities. The expected dividend yield is zero as the
      Company is subject to a debt covenant prohibiting the payment of dividends.
      Expected term isderived from the historical option exercise
      behavior.





F-23





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





9.
      STOCKHOLDERS’ EQUITY (continued)





The
      following table summarizes stock option activity during the years ended
      December 31, 2004, 2005 and 2006:




Options
            
            Shares
            
            Weighted-
              Average
              Exercise
              Price
            
            Weighted-
              Average
              Remaining
              Contractual
              Term
            
            Aggregate
              Intrinsic
              ValueBalance
                at January 1, 2004
            
            
            1,744,500
            
            
            5.10Granted
            
            
            400,000
            
            
            4.50Exercised
            
            
            (17,600
            )
            
            3.57Forfeited
            
            
            (45,250
            )
            
            5.78Outstanding
                at December 31, 2004
            
            
            2,081,650
            
            $
            4.98Granted
            
            
            112,250
            
            
            6.93Exercised
            
            
            (75,250
            )
            
            4.30Forfeited
            
            
            (33,150
            )
            
            5.35Outstanding
                at December 31, 2005
            
            
            2,085,500
            
            $
            5.10Granted
            
            
            -
            
            
            -Exercised
            
            
            (188,984
            )
            
            5.07Forfeited
            
            
            (4,650
            )
            
            4.48Outstanding
                at December 31, 2006
            
            
            1,891,866
            
            $
            5.39
            
            
            4.46
            
            $
            20,821,000Vested
                and expected to vest at December 31, 2006
            
            
            1,853,247
            
            $
            5.40
            
            
            4.40
            
            $
            20,357,000Exercisable
                at December 31, 2006
            
            
            1,616,016
            
            $
            5.57
            
            
            3.98
            
            $
            17,507,000




F-24





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





9.
      STOCKHOLDERS’ EQUITY (continued)





In
      addition, during the year ended December 31, 2004, 1,067,817 stock rights were
      granted at an exercise price of $4.35, of which 993,146 were exercised and
      74,671 were forfeited. There were no further stock rights granted, exercised
      or
      forfeited in the years ended December 31, 2005 and 2006.





The
      weighted-average grant-date fair value of options granted during the years
      ended
      December 31, 2005 and 2004 was $2.73 and $2.04, respectively. No options
      were granted in the year ended December 31, 2006. The total intrinsic value
      of
      options exercised during the year ended December 31, 2006, 2005 and 2004
      was $1,487,000, $200,000, $45,000, respectively, determined as of the date
      of
      each option exercised. The intrinsic value is the amount by which the current
      market value exceeds the exercise price of the stock option.




As
      of
      December 31, 2006, there was $366,000 of total unrecognized compensation
      cost, net of a 14% expected forfeiture rate, related to unvested options granted
      under the Company’s option plans. That cost is expected to be recognized over a
      weighted average period of 2 years. The total fair value of shares vested during
      the year ended December 31, 2006 was $196,000.




Cash
      received from option exercise under share-based payment arrangements for the
      years ended December 31, 2006, 2005 and 2004 was $959,000, $322,000 and $63,000,
      respectively.





The
      following table summarizes information about stock options outstanding at
      December 31, 2006:


OPTIONS
                  OUTSTANDING
              
              OPTIONSEXERCISABLERANGE
                  OF EXERCISEPRICES
              
              OPTIONS
                  OUTSTANDING
              
              WEIGHTED-AVERAGE
                  REMAINING CONTRACTUALLIFE
              
              WEIGHTED-AVERAGE
                  EXERCISEPRICE
              
              OPTIONS
                  EXERCISABLE
              
              WEIGHTED-AVERAGE
                  EXERCISEPRICE$2.90
                  - 3.60
              
              
              472,466
              
              
              5.5
                  years
              
              $
              3.47
              
              
              320,866
              
              $
              3.454.00
                  - 4.85
              
              
              644,950
              
              
              4.5
                  years
              
              
              4.28
              
              
              631,350
              
              
              4.285.00
                  - 6.50
              
              
              566,150
              
              
              5.0
                  years
              
              
              6.25
              
              
              455,500
              
              
              6.418.00
              
              
              12,500
              
              
              4.1
                  years
              
              
              8.00
              
              
              12,500
              
              
              8.0010.00
                  - 12.00
              
              
              195,800
              
              
              0.3
                  years
              
              
              11.07
              
              
              195,800
              
              
              11.072.90
                  - 12.00
              
              
              1,891,866
              
              
              4.5
                  years
              
              
              5.39
              
              
              1,616,016
              
              
              5.57




10.
      SEGMENT INFORMATION





Since
      The
      Walking Company acquisition on March 3, 2004, the Company has operated its
      business under two reportable segments: (i) Big Dog Sportswear business, and
      (ii) TWC business. The Big Dog Sportswear business includes the Company’s 155
      Big Dog retail stores (primarily located in outlet malls), corporate sales,
      and
      its catalog and internet business selling quality sportswear. The TWC business
      includes the Company’s 151 Walking Company stores located primarily in leading
      retail malls selling comfort footwear. These two retail chains are managed
      separately.





The
      accounting policies of the reportable segments are consistent with the
      consolidated financial statements of the Company. The Company evaluates
      individual store profitability in terms of a store’s contribution which is
      defined as gross margin less direct selling, occupancy, and certain indirect
      selling costs. Below are the results of operations on a segment basis for the
      years ended December 31, 2006, 2005 and 2004 (with TWC’s 2004 results being
      reported only for the period from the March 3, 2004 acquisition
      date):





F-25





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





10.
      SEGMENT INFORMATION (continued)





Big
                Dog Sportswear
            
            The
                Walking Company
            
            TotalYear
                Ended December 31, 2006Statements
                of Income:Sales
            
            $
            82,923,000
            
            $
            135,681,000
            
            $
            218,604,000Gross
                margin
            
            
            46,696,000
            
            
            70,185,000
            
            
            116,881,000Depreciation
                and amortization
            
            
            1,518,000
            
            
            5,007,000
            
            
            6,525,000Interest
                income
            
            
            (3,000
            )
            
            (5,000
            )
            
            (8,000
            )Interest
                expense
            
            
            765,000
            
            
            1,319,000
            
            
            2,084,000Provision
                for (benefit from) income taxes
            
            
            (770,000
            )
            
            1,353,000
            
            
            583,000Net
                (loss) income
            
            
            (1,284,000
            )
            
            2,255,000
            
            
            971,000Balance
                Sheet:Total
                assets
            
            $
            35,336,000
            
            $
            67,325,000
            
            $
            102,661,000Increases
                in long-term assets
            
            
            3,770,000
            
            
            9,190,000
            
            
            12,960,000Year
                Ended December 31, 2005Statements
                of Income:Sales
            
            $
            92,104,000
            
            $
            87,011,000
            
            $
            179,115,000Gross
                margin
            
            
            53,755,000
            
            
            45,049,000
            
            
            98,804,000Depreciation
                and amortization
            
            
            1,363,000
            
            
            2,810,000
            
            
            4,173,000Interest
                income
            
            
            (40,000
            )
            
            (4,000
            )
            
            (44,000
            )Interest
                expense
            
            
            463,000
            
            
            513,000
            
            
            976,000Provision
                for income taxes
            
            
            1,225,000
            
            
            1,669,000
            
            
            2,894,000Net
                income
            
            
            2,000,000
            
            
            2,723,000
            
            
            4,723,000Balance
                Sheet:Total
                assets
            
            $
            31,692,000
            
            $
            41,061,000
            
            $
            72,753,000Increases
                (decreases) in long-term assets
            
            
            (714,000
            )
            
            10,248,000
            
            
            9,534,000Year
                Ended December 31, 2004Statements
                of Income:Sales
            
            $
            98,771,000
            
            $
            62,587,000
            
            $
            161,358,000Gross
                margin
            
            
            56,150,000
            
            
            32,475,000
            
            
            88,625,000Depreciation
                and amortization
            
            
            1,675,000
            
            
            1,991,000
            
            
            3,666,000Interest
                income
            
            
            (2,000
            )
            
            (24,000
            )
            
            (26,000
            )Interest
                expense
            
            
            428,000
            
            
            429,000
            
            
            857,000Provision
                for income taxes
            
            
            973,000
            
            
            1,199,000
            
            
            2,172,000Net
                Income
            
            
            1,654,000
            
            
            2,034,000
            
            
            3,688,000Balance
                Sheet:Total
                assets
            
            $
            35,378,000
            
            $
            23,453,000
            
            $
            58,831,000Increases
                (decreases) in long-term assets
            
            
            (524,000
            )
            
            6,527,000
            
            
            6,003,000




F-26





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





11.
      EMPLOYEE BENEFIT PLAN





The
      Company has a Retirement Savings Plan (the “Plan”), a defined contribution plan
      adopted pursuant to Section 401(k) of the Internal Revenue Code. The Plan is
      available to substantially all of the Company’s employees. The Company amended
      the Plan in November 2000 to match each dollar deferred up to 3% of
      compensation, which is limited to $1,000 annually, per participant. Participants
      vest in the Company’s contribution at varying rates of 0% to 20% per year over
      six years. The Company contributed approximately $188,000, $187,000 and $156,000
      in 2006, 2005 and 2004, respectively.





12.
      RELATED PARTY TRANSACTIONS





Two
      of
      the Company's stockholders and directors have ownership interests in two former
      merchandise vendors to the Company. Merchandise inventory purchased from these
      related vendors totaled $3,000, $135,000 and $324,000 in 2006, 2005 and 2004,
      respectively.





The
      Company engaged a related party to perform retail construction services.
      Construction services provided to the Company totaled $203,000 in 2005. No
      construction services were provided in 2006 or 2004.





In
      the
      normal course of business, one of the Company's officers pays for certain
      operating expenses which are reimbursed by the Company.  At December 31,
      2006 and 2005, the related outstanding payable was $70,000 and $654,000,
      respectively.





In
      January 2005, the Company made a temporary loan of $4 million to a company
      where
      a majority stockholder and director is the majority owner of the company. The
      loan was used to facilitate the purchase of an airplane from a third party
      until
      suitable replacement financing could be obtained. Interest on such loan was
      payable at the prime rate plus .05%. The note was fully repaid to the Company
      in
      March 2005 including $34,000 of interest. From time to time, the Company may
      rent the plane for its own corporate travel use. The Company has no obligation
      to use such plane for any minimum amount, and to the extent it does use it,
      the
      Company will pay for such use on terms at least as favorable to the Company
      as
      could be obtained from an independent third party. Costs associated with the
      use
      of such plane totaled $215,000 and $189,000 for the year ended December 31,
      2006
      and 2005, respectively.





13.
      SUBSEQUENT EVENTS





In
      January 2007, the Company terminated their lease of a 143,000 square foot
      facility in Santa Fe Springs, California and as a result paid a $491,000
      termination fee. The Company’s distribution center was housed in this facility
      prior to its relocation to a larger facility in Charlotte, North Carolina.
      The
      termination of the lease was recorded in accordance with SFAS No. 146,
“Accounting for Costs Associated with Exit or Disposal Activities”. Under SFAS
      146, liabilities arising from exit or disposal activities are recognized only
      when incurred, and measured at their fair value.





Additionally,
      in January, 2007, the Company entered into a $2,953,000 four-year capital lease
      to finance equipment purchases for the new distribution center. The new facility
      is 230,000 square feet and features state-of-the-art technologies and equipment
      including advanced conveyor systems, automated shipping and receiving systems
      and an enhanced inventory management infrastructure.





F-27





**BIG
      DOG HOLDINGS, INC. AND SUBSIDIARIES**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS (continued)





14.
      QUARTERLY FINANCIAL DATA (unaudited)





FIRSTQUARTER
            
            SECONDQUARTER
            
            THIRDQUARTER
            
            FOURTHQUARTER(in
                thousands, except per share)Year
                ended December 31, 2006:Net
                sales
            
            $
            38,671
            
            $
            53,178
            
            $
            54,127
            
            $
            72,628Gross
                profit
            
            
            20,097
            
            
            29,383
            
            
            28,982
            
            
            38,419Selling,
                marketing and distribution expenses
            
            
            22,639
            
            
            25,497
            
            
            25,355
            
            
            29,937General
                and administrative expenses
            
            
            2,247
            
            
            2,346
            
            
            2,301
            
            
            2,930Total
                operating expenses
            
            
            24,886
            
            
            27,843
            
            
            27,656
            
            
            32,866(Loss)
                income from operations
            
            
            (4,789
            )
            
            1,540
            
            
            1,326
            
            
            5,553Net
                (loss) income
            
            
            (3,160
            )
            
            641
            
            
            471
            
            
            3,019Net
                (loss) income per shareBasic
            
            $
            (0.35
            )
            $
            0.07
            
            $
            0.05
            
            $
            0.33Diluted
            
            $
            (0.35
            )
            $
            0.06
            
            $
            0.05
            
            $
            0.31Weighted
                average shares outstandingBasic
            
            
            9,092
            
            
            9,177
            
            
            9,211
            
            
            9,236Diluted
            
            
            9,092
            
            
            9,509
            
            
            9,476
            
            
            9,885Year
                ended December 31, 2005:Net
                sales
            
            $
            31,345
            
            $
            43,441
            
            $
            44,909
            
            $
            59,420Gross
                profit
            
            
            16,227
            
            
            24,680
            
            
            25,286
            
            
            32,611Selling,
                marketing and distribution expenses
            
            
            18,267
            
            
            19,327
            
            
            20,055
            
            
            22,975General
                and administrative expenses
            
            
            1,743
            
            
            2,286
            
            
            2,207
            
            
            3,395Total
                operating expenses
            
            
            20,010
            
            
            21,613
            
            
            22,262
            
            
            26,370(Loss)
                income from operations
            
            
            (3,783
            )
            
            3,067
            
            
            3,024
            
            
            6,241Net
                (loss) income
            
            
            (2,414
            )
            
            1,718
            
            
            1,770
            
            
            3,649Net
                (loss) income per shareBasic
            
            $
            (0.26
            )
            $
            0.19
            
            $
            0.19
            
            $
            0.40Diluted
            
            $
            (0.26
            )
            $
            0.18
            
            $
            0.18
            
            $
            0.38Weighted
                average shares outstandingBasic
            
            
            9,180
            
            
            9,187
            
            
            9,141
            
            
            9,075Diluted
            
            
            9,180
            
            
            9,760
            
            
            9,680
            
            
            9,664




F-28




**SCHEDULE
      II**


**VALUATION
      AND QUALIFYING ACCOUNTS**


**FOR
      THE YEARS ENDED DECEMBER 31, 2004, 2005 AND 2006**





Balance
                at Beginning of Year
            
            Additions
                Charged to Costs and Expenses
            
            Write-offs,
                Net of Recoveries
            
            Balance
                at End of YearYear
                ended December 31, 2004Reserves
                and allowances deducted from asset accounts:Allowance
                for uncollectible accounts receivable
            
            $
            96,000
            
            $
            87,000
            
            $
            (180,000
            )
            $
            3,000Self-insurance
                reserves
            
            $
            375,000
            
            $
            2,815,000
            
            $
            (2,748,000
            )
            $
            442,000Sales
                returns
            
            $
            50,000
            
            $
            235,000
            
            $
            ---
            
            $
            285,000Obsolete
                inventory reserves
            
            $
            ---
            
            $
            385,000
            
            $
            ---
            
            $
            385,000Year
                ended December 31, 2005Reserves
                and allowances deducted from asset accounts:Allowance
                for uncollectible accounts receivable
            
            $
            3,000
            
            $
            1,000
            
            $
            (2,000
            )
            $
            2,000Self-insurance
                reserves
            
            $
            442,000
            
            $
            2,731,000
            
            $
            (2,695,000
            )
            $
            478,000Sales
                returns
            
            $
            285,000
            
            $
            50,000
            
            $
            ---
            
            $
            335,000Obsolete
                inventory reserves
            
            $
            385,000
            
            $
            22,000
            
            $
            (150,000
            )
            $
            257,000Year
                ended December 31, 2006Reserves
                and allowances deducted from asset accounts:Allowance
                for uncollectible accounts receivable
            
            $
            2,000
            
            $
            2,000
            
            $
            ---
            
            $
            4,000Self-insurance
                reserves
            
            $
            478,000
            
            $
            4,202,000
            
            $
            (4,006,000
            )
            $
            674,000Sales
                returns
            
            $
            335,000
            
            $
            164,000
            
            $
            ---
            
            $
            499,000Obsolete
                inventory reserves
            
            $
            257,000
            
            $
            267,000
            
            $
            (54,000
            )
            $
            470,000




F-29




INDEX
        TO
        EXHIBITS
 Exhibit
                    Number
                Description2.1
                Second
                    Amended Plan of Reorganization of Shoes Liquidation Co. (formerly
                    The
                    Walking Company) and Alan’s Shoes, Inc., confirmed on March 2, 2004.
                    (1)2.2
                Order
                    of the United States Bankruptcy Court for the Central District
                    of
                    California confirming the Second Amended Plan of Reorganization
                    of Shoes
                    Liquidation Co. (formerly The Walking Company) and Alan’s Shoes, Inc.,
                    entered on March 2, 2004.(1)2.3
                Asset
                    Purchase Agreement, dated May 20, 2005, by and among The Walking
                    Company, as buyer, Bianca of Nevada, Inc., a Nevada corporation,
                    as
                    seller, and Sal Palermo, as shareholder. (7)2.4
                Asset
                    Purchase Agreement, dated January 31, 2006, by and among The
                    Walking
                    Company, as buyer, and Steve’s Shoes, Inc., Debtor in Possession, as
                    seller. (9)3.1
                Amended
                    and Restated Certificate of Incorporation (2)3.1A
                Certificate
                    of Correction (3)3.2
                Amended
                    and Reinstated Bylaws (3)4.1
                Reference
                    is hereby made to Exhibits 3.1, 3.1A, and 3.24.2
                Specimen
                    Stock Certificate (2)10.1
                Term
                    Loan Note, dated August 31, 2005, among the lenders signatory
                    thereto,
                    Wells Fargo Retail Finance II, LLC, as agent, and Big Dog USA,
                    Inc. and
                    The Walking Company, as borrowers. (8)10.2
                Promissory
                    Note Secured by Letter of Credit, dated August 31, 2005, among
                    the lenders
                    signatory thereto, Bianca of Nevada, Inc., as payee, and The
                    Walking
                    Company, as maker. (8)10.10
                Amended
                    and Restated 1997 Performance Award Plan (5)10.10A
                Form
                    of Employee Nonqualified 1997 Performance Award Plan
                    (2)10.10B
                Terms
                    and Conditions for Non-Qualified Options Granted under the Amended
                    and
                    Restated 1997 Performance Award Plan (4)10.10C
                Form
                    of Eligible Director Non-Qualified Stock Option Agreement
                    (4)10.11
                Lease
                    between Big Dog USA, Inc. and The Prudential Insurance Company
                    of America
                    dated November 4, 1997 (3)10.12
                Form
                    of Indemnification Agreement (1)10.13
                Lease
                    between Big Dog Holdings, Inc. and TKC XCIX, LLC dated March
                    13, 2006
                    (10)21.1
                List
                    of Subsidiaries of Big Dog Holdings, Inc. (6)23.1
                Consent
                    of Independent Registered Public Accounting Firm24.1
                Power
                    of Attorney (included in signature
                    page)
  
  31.1
                Certification
                    of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
                    Act of 200231.2
                Certification
                    of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley
                    Act of 200232.1
                Certification
                    of Chief Executive Officer and Chief Financial Officer Pursuant
                    to 18
                    U.S.C. Section 1350,as Adopted Pursuant to Section 906 of the
                    Sarbanes-Oxley Act of 200299.1
                Loan
                    and Security Agreement, dated March 3, 2004, among the lenders
                    signatory
                    thereto, Wells Fargo Retail Finance II, LLC, as agent, and The
                    Walking
                    Company (formerly TWC Acquisition Corp.), as
                    borrower.(1)99.2
                Third
                    Amendment to Loan and Security Agreement, dated March 3, 2004,
                    among the
                    lenders signatory thereto, Wells Fargo Retail Finance II, LLC,
                    as agent,
                    and Big Dog Holdings, Inc., Big Dog USA, Inc. and CSI Acquisition
                    Corporation, as borrowers.(1)99.3
                First
                    Amended, Restated and Consolidated Loan and Security Agreement,
                    dated July
                    7, 2005, among the lenders signatory thereto, Wells Fargo Retail
                    Finance
                    II, LLC, as agent, and Big Dog Holdings, Inc., Big Dog USA, Inc.,
                    and The
                    Walking Company, as borrowers. (7)99.4
                Third
                    Amendment to First Amended, Restated, and Consolidated Loan and
                    Security
                    Agreement, dated November 28, 2006, among the lenders signatory
                    thereto,
                    Wells Fargo Retail Finance II, LLC, as agent, and Big Dog Holdings,
                    Inc.,
                    Big Dog USA, Inc., and The Walking Company, as borrowers.
                    (11)
  
 (1)
              Incorporated
                  by reference from the Company’s Current Report on Form 8-K filed as of
                  March 3, 2004. The exhibits and schedules to the Plan have been
                  omitted
                  from this filing pursuant to Item 601(b)(2) of Regulation S-K.
                  Big Dog
                  Holdings, Inc. will furnish copies of any of such exhibits and
                  schedules
                  to the Securities and Exchange Commission upon request.
 (2)
              Incorporated
                  by reference from the Company’s S-1 Registration Statement (No. 333-33027)
                  as amended , which became effective September 25,
                  1997.
 (3)
              Incorporated
                  by reference from the Company’s Annual Report on Form 10-K for the year
                  ended December 31, 1997.
 (4)
              Incorporated
                  by reference from the Company’s Schedule TO filed July 31,
                  2000.
 (5)
              Incorporated
                  by reference from the Company’s Annual Report on Form 10-K for the year
                  ended December 31, 1998.
 (6)
              Incorporated
                  by reference from the Company’s Annual Report on Form 10-K for the year
                  ended December 31, 2003.
 (7)
              Incorporated
                  by reference from the Company’s Quarterly Report on Form 10-Q for the
                  period ended June 30, 2005.
 (8)
              Incorporated
                  by reference from the Company’s Quarterly Report on Form 10-Q for the
                  period ended September 30, 2005.
 (9)
              Incorporated
                  by reference from the Company’s Annual Report on Form 10-K for the year
                  ended December 31, 2005.
 (10)
              Incorporated
                  by reference from the Company’s Current Report on Form 8-K filed as of May
                  4, 2006.
 (11)
              Incorporated
                  by reference from the Company’s Current Report on Form 8-K filed as of
                  December 20, 2006.