##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
 FORM 10-Q
  x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934For the quarterly period ended: July 29, 2006ORo
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
  PACIFIC SUNWEAR OF CALIFORNIA, INC.
  California
(State of incorporation)
    
    95-3759463
(I.R.S. Employer Identification No.)
 
 
 
    
    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 whether the 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 x Accelerated Filer o Non-Accelerated Filer o
 
    
    Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x




---



##### 



PACIFIC SUNWEAR OF CALIFORNIA, INC.
FORM 10-Q
For the Quarter Ended July 29, 2006
 Index
 Page #PART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Condensed Consolidated Financial Statements (unaudited):Condensed Consolidated Balance SheetsJuly 29, 2006 and January 28, 2006
    
    
    3Condensed Consolidated Statements of Income and Comprehensive Income
Second quarter (13 weeks) and first half (26 weeks) ended July 29, 2006
and July 30, 2005
    
    
    4Condensed Consolidated Statements of Cash Flows
First half (26 weeks) ended July 29, 2006 and July 30, 2005
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6-11Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    12-21Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    21Item 4.
    
    Controls and Procedures
    
    
    21-22PART II.
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    22Item 1A.
    
    Risk Factors
    
    
    22-26Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    26Item 3.
    
    Defaults upon Senior Securities
    
    
    26Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    26-27Item 5.
    
    Other Information
    
    
    27Item 6.
    
    Exhibits
    
    
    27SIGNATURE PAGE
    
    
    28EXHIBIT 31.1EXHIBIT 32.1
  2




---



##### Table of Contents



PACIFIC SUNWEAR OF CALIFORNIA, INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, all amounts in thousands except share amounts)
 July 29, 2006
    
    
    January 28, 2006ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    11,783
    
    
    $
    95,185Marketable securities
    
    
    
    
    
    
    74,911Merchandise inventories
    
    
    286,666
    
    
    
    215,140Other current assets
    
    
    43,870
    
    
    
    41,485Total current assets
    
    
    342,319
    
    
    
    426,721PROPERTY AND EQUIPMENT, NET:Gross property and equipment
    
    
    666,434
    
    
    
    602,962Less accumulated depreciation and amortization
    
    
    (273,665
    )
    
    
    (247,140
    )Total property and equipment, net
    
    
    392,769
    
    
    
    355,822Other Assets
    
    
    24,579
    
    
    
    25,018TOTAL ASSETS
    
    $
    759,667
    
    
    $
    807,561LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    81,633
    
    
    $
    47,550Other current liabilities
    
    
    61,412
    
    
    
    74,921Total current liabilities
    
    
    143,045
    
    
    
    122,471LONG-TERM LIABILITIES:Deferred lease incentives
    
    
    84,291
    
    
    
    81,440Deferred rent
    
    
    30,341
    
    
    
    28,748Deferred income taxes
    
    
    12,584
    
    
    
    12,584Other long-term liabilities
    
    
    9,881
    
    
    
    15,528Total long-term liabilities
    
    
    137,097
    
    
    
    138,300Commitments and contingencies (Note 5)SHAREHOLDERS EQUITY:Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued
    
    
    
    
    
    
    Common stock, $.01 par value; 170,859,375 shares authorized; 69,595,403
and 73,751,249 shares issued and outstanding, respectively
    
    
    696
    
    
    
    737Additional paid-in capital
    
    
    
    
    
    
    23,866Retained earnings
    
    
    478,829
    
    
    
    522,187Total shareholders equity
    
    
    479,525
    
    
    
    546,790TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    759,667
    
    
    $
    807,561
  3




---



##### Table of Contents



PACIFIC SUNWEAR OF CALIFORNIA, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(unaudited, all amounts in thousands except share and per share amounts)
 For the Second Quarter Ended
    
    
    For the First Half EndedJuly 29, 2006
    
    
    July 30, 2005
    
    
    July 29, 2006
    
    
    July 30, 2005Net sales
    
    $
    313,682
    
    
    $
    309,064
    
    
    $
    613,570
    
    
    $
    589,049Cost of goods sold, including buying,
distribution and occupancy costs
    
    
    216,257
    
    
    
    198,707
    
    
    
    418,862
    
    
    
    381,342Gross margin
    
    
    97,425
    
    
    
    110,357
    
    
    
    194,708
    
    
    
    207,707Selling, general and administrative expenses
    
    
    82,855
    
    
    
    77,592
    
    
    
    162,794
    
    
    
    147,714Operating income
    
    
    14,570
    
    
    
    32,765
    
    
    
    31,914
    
    
    
    59,993Interest income, net
    
    
    1,090
    
    
    
    1,180
    
    
    
    2,885
    
    
    
    2,265Income before income tax expense
    
    
    15,660
    
    
    
    33,945
    
    
    
    34,799
    
    
    
    62,258Income tax expense
    
    
    5,950
    
    
    
    12,833
    
    
    
    13,223
    
    
    
    23,539Net income
    
    $
    9,710
    
    
    $
    21,112
    
    
    $
    21,576
    
    
    $
    38,719Comprehensive income
    
    $
    9,710
    
    
    $
    21,112
    
    
    $
    21,576
    
    
    $
    38,719Net income per share, basic
    
    $
    0.14
    
    
    $
    0.28
    
    
    $
    0.30
    
    
    $
    0.51Net income per share, diluted
    
    $
    0.14
    
    
    $
    0.28
    
    
    $
    0.30
    
    
    $
    0.51Wtd. avg. shares outstanding, basic
    
    
    71,335,467
    
    
    
    75,125,782
    
    
    
    72,239,872
    
    
    
    75,209,185Wtd. avg. shares outstanding, diluted
    
    
    71,866,482
    
    
    
    76,118,501
    
    
    
    72,783,954
    
    
    
    76,338,599
  4




---



##### Table of Contents



PACIFIC SUNWEAR OF CALIFORNIA, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
 First Half EndedJuly 29, 2006
    
    
    July 30, 2005CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    21,576
    
    
    $
    38,719Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    34,385
    
    
    
    31,081Tax benefits related to exercise of stock options
    
    
    1,479
    
    
    
    5,737Stock-based compensation
    
    
    3,573
    
    
    
    Loss on disposal of property and equipment
    
    
    158
    
    
    
    Change in operating assets and liabilities:Merchandise inventories
    
    
    (71,526
    )
    
    
    (67,550
    )Other current assets
    
    
    (2,384
    )
    
    
    (2,940
    )Other assets
    
    
    439
    
    
    
    (1,325
    )Accounts payable
    
    
    34,083
    
    
    
    67,942Other current liabilities
    
    
    (21,754
    )
    
    
    (2,917
    )Deferred lease incentives
    
    
    2,851
    
    
    
    7,809Deferred rent
    
    
    1,270
    
    
    
    (658
    )Other long-term liabilities
    
    
    (5,605
    )
    
    
    1,444Net cash (used in)/provided by operating activities
    
    
    (1,455
    )
    
    
    77,342CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property and equipment
    
    
    (62,675
    )
    
    
    (48,173
    )Purchases of available-for-sale marketable securities
    
    
    (201,900
    )
    
    
    (442,350
    )Sales of available-for-sale marketable securities
    
    
    262,200
    
    
    
    457,075Purchases of held-to-maturity marketable securities
    
    
    
    
    
    
    (26,493
    )Maturities of held-to-maturity marketable securities
    
    
    14,611
    
    
    
    20,625Net cash provided by/(used in) investing activities
    
    
    12,236
    
    
    
    (39,316
    )CASH FLOWS FROM FINANCING ACTIVITIES:Repurchase and retirement of common stock
    
    
    (99,347
    )
    
    
    (19,978
    )Proceeds from exercise of stock options
    
    
    5,454
    
    
    
    10,756Principal payments under long-term debt and capital lease obligations
    
    
    (290
    )
    
    
    (885
    )Net cash used in financing activities
    
    
    (94,183
    )
    
    
    (10,107
    )NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS:
    
    
    (83,402
    )
    
    
    27,919CASH AND CASH EQUIVALENTS, beginning of period
    
    
    95,185
    
    
    
    64,308CASH AND CASH EQUIVALENTS, end of period
    
    $
    11,783
    
    
    $
    92,227SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Cash paid for interest
    
    $
    3
    
    
    $
    32Cash paid for income taxes
    
    $
    28,200
    
    
    $
    21,659SUPPLEMENTAL DISCLOSURES OF NON-CASH TRANSACTIONS:Increase to additional paid-in capital related to the issuance of stock to satisfy certain deferred compensation liabilities
    
    $
    
    
    
    $
    1,142Increase in non-cash property and equipment accruals
    
    $
    8,815
    
    
    $
    6,179
  5




---



##### Table of Contents



PACIFIC SUNWEAR OF CALIFORNIA, INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the quarterly period ended July 29, 2006
(unaudited, all amounts in thousands except share and per share amounts unless otherwise indicated)
 1. NATURE OF BUSINESS AND BASIS OF PRESENTATION
 Nature of Business
 Basis of Presentation
  2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  New Accounting Pronouncements
 6




---



##### Table of Contents



Stock-Based Compensation
 
   7




---



##### Table of Contents



First Half2006
    
    
    2005Expected Option Life
    
    5 years
    
    5 yearsStock Volatility
    
    
    44.1% - 48.7
    %
    
    
    56.7% - 62.8
    %Risk-free Interest Rates
    
    
    4.6% - 5.1
    %
    
    
    3.9% - 4.1
    %Expected Dividends
    
    None
    
    None
   Weighted-AverageRemainingWeighted-Average
    
    
    Contractual Term
    
    
    Aggregate IntrinsicStock Options
    
    Shares (000s)
    
    
    Exercise Price
    
    
    (Yrs.)
    
    
    Value ($000s)Outstanding at January 29, 2006
    
    
    4,248
    
    
    $
    19.18Granted
    
    
    169
    
    
    
    22.91Exercised
    
    
    (335
    )
    
    
    10.86Forfeited or expired
    
    
    (367
    )
    
    
    21.52Outstanding at April 29, 2006
    
    
    3,715
    
    
    $
    19.87
    
    
    
    6.34
    
    
    $
    16,825Granted
    
    
    478
    
    
    
    20.45Exercised
    
    
    (110
    )
    
    
    11.33Forfeited or expired
    
    
    (329
    )
    
    
    24.70Outstanding at July 29, 2006
    
    
    3,754
    
    
    $
    19.77
    
    
    
    6.12
    
    
    $
    7,210Exercisable at July 29, 2006
    
    
    1,825
    
    
    $
    16.39
    
    
    
    5.54
    
    
    $
    6,853
   Weighted-Average Grant-DateNon-vested Shares
    
    Shares (000)
    
    
    Fair ValueNon-vested at January 29, 2006
    
    
    0
    
    
    $
    Granted
    
    
    284
    
    
    
    20.10Vested
    
    
    0
    
    
    
    Forfeited
    
    
    (4
    )
    
    
    20.16Non-vested at July 29, 2006
    
    
    280
    
    
    $
    20.10
  8




---



##### Table of Contents



Second Quarter
    
    
    First HalfEnded
    
    
    EndedJuly 29, 2005
    
    
    July 29, 2005Net income, as reported
    
    $
    21,112
    
    
    $
    38,719Less stock-based employee
compensation expense
determined under the fair
value based method, net of
related tax effects
    
    
    (2,170
    )
    
    
    (3,991
    )Pro forma net income
    
    $
    18,942
    
    
    $
    34,728Earnings per ShareBasic, as reported
    
    $
    0.28
    
    
    $
    0.51Basic, pro forma
    
    $
    0.25
    
    
    $
    0.46Diluted, as reported
    
    $
    0.28
    
    
    $
    0.51Diluted, pro forma
    
    $
    0.25
    
    
    $
    0.46
 Segment Reporting
 PacSun
    
    
    d.e.m.o.
    
    
    One Thousand Steps
    
    
    TotalNet Sales
    
    $
    528,192
    
    
    $
    84,180
    
    
    $
    1,198
    
    
    $
    613,570Comparable Store Sales %
    
    
    (3.7
    )%
    
    
    (3.8
    )%
    
    
    n/a
    
    
    
    (3.7
    )%Contribution Margin
    
    $
    97,621
    
    
    $
    (2,511
    )
    
    $
    (1,101
    )
    
    $
    94,009Number of Stores
    
    
    928
    
    
    
    201
    
    
    
    6
    
    
    
    1,135Square Footage (in 000s)
    
    
    3,500
    
    
    
    561
    
    
    
    16
    
    
    
    4,077
  9




---



##### Table of Contents



3. OTHER CURRENT ASSETS
  July 29,
    
    
    January 28,2006
    
    
    2006Prepaid expenses
    
    $
    25,862
    
    
    $
    22,360Non-trade accounts receivable
    
    
    10,002
    
    
    
    12,679Deferred income taxes
    
    
    6,446
    
    
    
    6,446Income tax receivable
    
    
    1,560
    
    
    
    Total other current assets
    
    $
    43,870
    
    
    $
    41,485
 4. OTHER CURRENT LIABILITIES
  July 29,
    
    
    January 28,2006
    
    
    2006Accrued capital expenditures
    
    $
    17,272
    
    
    $
    8,779Accrued compensation and benefits
    
    
    7,692
    
    
    
    12,250Accrued gift cards
    
    
    7,749
    
    
    
    12,620Sales taxes payable
    
    
    6,593
    
    
    
    7,895Income taxes payable
    
    
    
    
    
    
    14,896Other
    
    
    22,106
    
    
    
    18,481Total other current liabilities
    
    $
    61,412
    
    
    $
    74,921
 5. COMMITMENTS AND CONTINGENCIES
 Litigation
 Letters of Credit
 6. COMMON STOCK REPURCHASE AND RETIREMENT
  10




---



##### Table of Contents



# of Shares
    
    
    
    
    
    
    Maximum Value ofPurchased as Part
    
    
    
    
    
    
    Shares that May Yet# of Shares
    
    
    Average Price Paid
    
    
    of Publicly
    
    
    Value of Shares
    
    
    be Purchased UnderPeriod
    
    Purchased
    
    
    Per Share
    
    
    Announced Plan
    
    
    Purchased
    
    
    the Plan2005 Authorization:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    49,856March 2006
    
    
    1,100,000
    
    
    $
    22.33
    
    
    
    1,100,000
    
    
    $
    24,563
    
    
    $
    25,293April 2006
    
    
    600,000
    
    
    $
    22.67
    
    
    
    600,000
    
    
    $
    13,600
    
    
    $
    11,693May 2006
    
    
    400,000
    
    
    $
    22.54
    
    
    
    400,000
    
    
    $
    9,016
    
    
    $
    2,677June 2006
    
    
    131,255
    
    
    $
    20.40
    
    
    
    131,255
    
    
    $
    2,677
    
    
    $
    Total
    
    
    2,231,255
    
    
    $
    22.34
    
    
    
    2,231,255
    
    
    $
    49,856
    
    
    $
    --2006 Authorization:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    100,000June 2006
    
    
    468,745
    
    
    $
    20.05
    
    
    
    468,745
    
    
    $
    9,397
    
    
    $
    90,603July 2006
    
    
    2,216,000
    
    
    $
    18.09
    
    
    
    2,216,000
    
    
    $
    40,095
    
    
    $
    50,508Total
    
    
    2,684,745
    
    
    $
    18.43
    
    
    
    2,684,745
    
    
    $
    49,492
    
    
    $
    50,508Grand Total
    
    
    4,916,000
    
    
    $
    20.21
    
    
    
    4,916,000
    
    
    $
    99,348
    
    
    $
    50,508
 7. NET INCOME PER SHARE, BASIC AND DILUTED
  Second Quarter Ended:
 July 29, 2006
    
    
    July 30, 2005Net
    
    
    
    
    
    
    
    
    
    
    NetIncome
    
    
    Shares
    
    
    
    
    
    
    Income
    
    
    SharesBasic EPS:
    
    $
    9,710
    
    
    
    71,335,467
    
    
    $
    0.14
    
    
    $
    21,112
    
    
    
    75,125,782
    
    
    $
    0.28Diluted EPS:Effect of dilutive equivalents
    
    
    
    
    
    
    531,015
    
    
    
    (0.00
    )
    
    
    
    
    
    
    992,719
    
    
    
    (0.00
    )$
    9,710
    
    
    
    71,866,482
    
    
    $
    0.14
    
    
    $
    21,112
    
    
    
    76,118,501
    
    
    $
    0.28
 First Half Ended:
 July 29, 2006
    
    
    July 30, 2005Net
    
    
    
    
    
    
    
    
    
    
    NetIncome
    
    
    Shares
    
    
    
    
    
    
    Income
    
    
    SharesBasic EPS:
    
    $
    21,576
    
    
    
    72,239,872
    
    
    $
    0.30
    
    
    $
    38,719
    
    
    
    75,209,185
    
    
    $
    0.51Diluted EPS:Effect of dilutive equivalents
    
    
    
    
    
    
    544,082
    
    
    
    (0.00
    )
    
    
    
    
    
    
    1,129,414
    
    
    
    (0.00
    )$
    21,576
    
    
    
    72,783,954
    
    
    $
    0.30
    
    
    $
    38,719
    
    
    
    76,338,599
    
    
    $
    0.51
  11




---



##### Table of Contents



ITEM 2  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF CONSOLIDATED OPERATIONS
  Cautionary Note Regarding Forward-Looking Statements
  Executive Overview
  Comparable store (or same store) net sales
 Net merchandise margins
 Operating margin
 12




---



##### Table of Contents



Store sales trends
 Cash flow and liquidity (working capital)
 Critical Accounting Policies
  Recognition of Revenue
 Valuation of Inventories
 Accounting for Store Operating Leases
 Determination of Stock-Based Compensation Expense
 13




---



##### Table of Contents



Evaluation of Long-Lived Assets
 Evaluation of Insurance Reserves
 Evaluation of Income Taxes
 Evaluation of Litigation Matters
 14




---



##### Table of Contents



Results of Operations
  Second Quarter Ended
    
    
    First Half EndedJuly 29, 2006
    
    
    July 30, 2005
    
    
    July 29, 2006
    
    
    July 30, 2005Net sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of goods sold, including buying,
distribution and occupancy costs
    
    
    68.9
    
    
    
    64.3
    
    
    
    68.3
    
    
    
    64.7Gross margin
    
    
    31.1
    
    
    
    35.7
    
    
    
    31.7
    
    
    
    35.3Selling, general and administrative expenses
    
    
    26.4
    
    
    
    25.1
    
    
    
    26.5
    
    
    
    25.1Operating income
    
    
    4.7
    
    
    
    10.6
    
    
    
    5.2
    
    
    
    10.2Interest income, net
    
    
    0.3
    
    
    
    0.4
    
    
    
    0.5
    
    
    
    0.4Income before income tax expense
    
    
    5.0
    
    
    
    11.0
    
    
    
    5.7
    
    
    
    10.6Income tax expense
    
    
    1.9
    
    
    
    4.2
    
    
    
    2.2
    
    
    
    4.0Net income
    
    
    3.1
    %
    
    
    6.8
    %
    
    
    3.5
    %
    
    
    6.6
    %
  July 29, 2006
    
    
    July 30, 2005PacSun stores
    
    
    826
    
    
    
    780Outlet stores
    
    
    102
    
    
    
    91d.e.m.o. stores
    
    
    201
    
    
    
    183One Thousand Steps stores
    
    
    6
    
    
    
    Total stores
    
    
    1,135
    
    
    
    1,054Square footage (in 000s)
    
    
    4,077
    
    
    
    3,720
 The second quarter (thirteen weeks) ended July 29, 2006 as compared to the second quarter
(thirteen weeks) ended July 30, 2005
 Net Sales
 $millions
    
    Attributable to$17
    
    Net sales from stores opened in fiscal 2005 not yet included in the comparable store base5
    
    33 new stores opened in fiscal 2006 not yet included in the comparable store base1
    
    Other non-comparable sales (net sales from expanded or relocated stores not yet included in the comparable store base and
internet net sales)(15)
    
    (5.5)% decrease in comparable store net sales in the second quarter of fiscal 2006 compared to the second quarter of fiscal 2005(3)
    
    3 closed stores in fiscal 2006 and 10 closed stores in fiscal 2005$5
    
    Total
  15




---



##### Table of Contents



Gross Margin
 Selling, General and Administrative Expenses
 %
    
    Attributable to1.0
    
    Increase in direct store expenses as a percentage of net sales to 7.7%
($24 million) for the second quarter of fiscal 2006 from 6.7% ($21
million) for the second quarter of fiscal 2005. In absolute dollars,
these expenses were up primarily due to increased depreciation
associated with the addition of 51 net new stores during the second
half of fiscal 2005 and 30 net new stores during the first half of
fiscal 2006. As a percentage of net sales, these expenses were up due
to deleveraging them against the negative same-store sales results in
the second quarter of fiscal 2006.0.8
    
    Store payroll expenses as a percentage of net sales were 13.0% ($41
million) in the second quarter of fiscal 2006 as compared to 12.2% ($38
million) in the second quarter of fiscal 2005. In absolute dollars,
these expenses were up primarily due to the new store openings. As a
percentage of net sales, these expenses were up due to deleveraging
them against the negative same-store sales results in the second
quarter of fiscal 2006.(0.5)
    
    Decrease in all other expenses as a percentage of net sales to 5.7%
($18 million) for the second quarter of fiscal 2006 from 6.2% ($19
million) for the second quarter of fiscal 2005, primarily due to
planned expense reductions as a result of deferring headcount additions
and limiting other expense growth.1.3
    
    Total
 Net Interest Income
 16




---



##### Table of Contents



Income Tax Expense
 The first half (26 weeks) ended July 29, 2006 as compared to the first half (26 weeks) ended
July 30, 2005
 Net Sales
 $millions
    
    Attributable to$42
    
    Net sales from stores opened in fiscal 2005 not yet included in the comparable store base6
    
    Net sales from 33 new stores opened in fiscal 2006 not yet included in the comparable store base1
    
    Other non-comparable sales (net sales from expanded or relocated stores not yet included in the comparable store base
and internet net sales)(20)
    
    (3.7)% decrease in comparable store net sales in the first half of fiscal 2006 compared to the first half of fiscal 2005(4)
    
    3 closed stores in fiscal 2006 and 10 closed stores in fiscal 2005$25
    
    Total
    17




---



##### Table of Contents



Gross Margin
 Selling, General and Administrative Expenses
 %
    
    Attributable to0.6
    
    Increase in store payroll expenses as a percentage of net sales to
12.9% ($79 million) in the first half of fiscal 2006 from 12.3% ($72
million) for the first half of fiscal 2005. In absolute dollars, these
expenses were up primarily due to addition of 51 net new stores during
the second half of fiscal 2005 and 30 net new stores during the first
half of fiscal 2006. As a percentage of net sales, these expenses were
up due to deleveraging them against the negative same-store sales
results in the first half of fiscal 2006.0.4
    
    Increase in general and administrative expenses as a percentage of net
sales to 6.2% ($38 million) for the first half of fiscal 2006 from 5.8%
($34 million) for the first half of fiscal 2005, primarily due to the
expensing of stock-based compensation ($3 million) during fiscal 2006
(see Note 2 to the condensed consolidated financial statements).0.4
    
    Increase in all other expenses as a percentage of net sales to 7.4%
($46 million) for the first half of fiscal 2006 from 7.0% ($42 million)
for the first half of fiscal 2005, primarily due to increased
depreciation expenses associated with new store openings and
deleveraging these expenses over the negative same-store sales results
in the first half of fiscal 2006.1.4
    
    Total
 Net Interest Income
 Income Tax Expense
 Liquidity and Capital Resources
  18




---



##### Table of Contents



Operating Cash Flows
  $millions
    
    Attributable to$(38)
    
    Decrease in cash flows from accounts payable, net of inventory, due to timing of payments and increased inventory per square foot.(17)
    
    Decrease in net income.(13)
    
    Decrease in cash flows from accrued income taxes. Cash payments for income taxes were $7 million higher and current accruals
were lower due to reduced net income.(8)
    
    Decrease in cash flows related to accrued liabilities, primarily due to lower payroll and sales-tax accruals.(5)
    
    Decrease in cash flows related to deferred compensation liabilities due to cash disbursements to former executives.(5)
    
    Decrease in cash flows related to deferred lease incentives due to receiving fewer and lower landlord allowances.7
    
    Increase in non-cash depreciation and stock compensation expenses.1
    
    Net increase in cash flows from all other operating activities$(78)
    
    Total
 Working Capital
 $millions
    
    Description$304
    
    Working capital at January 28, 2006(176)
    
    Decrease in cash and marketable securities, net of income taxes payable and accounts
payable, primarily due to stock repurchases, capital expenditures and negative same
store sales results for the first half of fiscal 2006, among other items (see cash flow
statement).72
    
    Increase in inventory, primarily due to the addition of 30 net new stores and slower
inventory turns due to the negative same-store sales results during the first half of
fiscal 2006.(1)
    
    Net decrease in working capital attributable to all other current assets and liabilities.$199
    
    Working capital at July 29, 2006
 Investing Cash Flows
  19




---



##### Table of Contents



Financing Cash Flows
   Credit Facility
 Contractual Obligations
 Payments Due by PeriodContractual Obligations(in $millions)
    
    Total
    
    
    Less than 1 year
    
    
    1-3 years
    
    
    3-5 years
    
    
    More than 5 yearsOperating lease obligations
    
    $
    629
    
    
    $
    103
    
    
    $
    195
    
    
    $
    160
    
    
    $
    171Letters of credit
    
    
    24
    
    
    
    24
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    653
    
    
    $
    127
    
    
    $
    195
    
    
    $
    160
    
    
    $
    171
  Operating Leases
 20




---



##### Table of Contents



Indemnifications
  New Accounting Pronouncements
  Inflation
  Seasonality and Quarterly Results
  
 ITEM 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4  CONTROLS AND PROCEDURES
  21




---



##### Table of Contents



PART II  OTHER INFORMATION
 
 Item 1  Legal Proceedings
  
 Item 1A  Risk Factors
  Our comparable store net sales results will fluctuate significantly, which can cause volatility
in our operating performance and stock price.
 Our failure to identify and respond appropriately to changing consumer preferences and fashion
trends in a timely manner could have a material adverse impact on our profitability.
 Our continued growth depends on our ability to develop new store concepts and open new stores
in our existing concepts. Any failure to do so may negatively impact our stock price and
operational performance.
 22




---



##### Table of Contents



We launched operations of a new retail concept, One Thousand Steps, in fiscal 2006, which could
divert attention from existing operations.
 We face significant competition from both vertically-integrated and brand-based competitors
that are growing rapidly, which could have a material adverse effect on our business.
 Our customers may not prefer our proprietary brand merchandise, which may negatively impact our
profitability.
 23




---



##### Table of Contents



Our current or prospective vendors may be unable or unwilling to supply us with adequate
quantities of their merchandise in a timely manner or at acceptable prices, which could have a
material adverse impact on our business.
 Our foreign sources of production may not always be reliable, which may result in a disruption
in the flow of new merchandise to our stores.
 We are currently evaluating store design alternatives for all of our retail concepts, which may
not result in improved operational performance.
 The loss of key personnel could have a material adverse effect on our business at any time.
 24




---



##### Table of Contents



Our information systems may not be adequate to support future growth, which could disrupt
business operations.
 Adverse outcomes of litigation matters could significantly affect our operational results.
 Our dependence on a single distribution facility exposes us to significant business disruption
risks.
 Our stock price can fluctuate significantly due to a variety of factors, which can negatively
impact our total market value.
 Selling merchandise over the internet carries particular risks that can have a negative impact
on our business.
 25




---



##### Table of Contents



Any failure by us to maintain credit facility financial covenants could have a material adverse
impact on our business.
 The effects of terrorism or war could significantly impact consumer spending and our
operational performance.
   
 Item 2  Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3  Defaults upon Senior Securities
  
 Item 4  Submission of Matters to a Vote of Security Holders
     26




---



##### Table of Contents



DIRECTOR NAME
    
    VOTES CAST FOR
    
    
    VOTES WITHHELDClass I:Michael Weiss
    
    
    68,073,096
    
    
    
    333,162Class II:Seth R. Johnson
    
    
    67,891,885
    
    
    
    514,373Sally Frame Kasaks
    
    
    68,019,571
    
    
    
    386,687Thomas M. Murnane
    
    
    68,026,121
    
    
    
    380,137Peter Starrett
    
    
    68,005,740
    
    
    
    400,518
  
 Item 5  Other Information
  
 Item 6  Exhibits
 Exhibit 10.1
    
    Form Notice of Grant of Director Stock Appreciation Rights and Terms and Conditions of Stock Appreciation Rights (1)Exhibit 10.2
    
    Form Notice of Grant of Stock Appreciation Rights and Terms and Conditions of Stock Appreciation Rights (1)Exhibit 10.3
    
    Form Notice of Grant of Restricted Stock Award and Award Agreement (1)Exhibit 10.4
    
    Amendment No. 3 to Amended and Restated Employment Agreement between the Company and Greg H. Weaver, dated March 29, 2006 (2)Exhibit 31.1
    
    Written statements of Seth R. Johnson and Gerald M. Chaney pursuant to section 302 of the Sarbanes-Oxley Act of 2002Exhibit 32.1
    
    Written statement of Seth R. Johnson and Gerald M. Chaney pursuant to section 906 of the Sarbanes-Oxley Act of 2002(1)
    
    Incorporated by reference from the Companys Current Report on From 8-K, as filed with the
Securities and Exchange Commission on May 23, 2006(2)
    
    Incorporated by reference from the Companys Current Report on From 8-K, as filed with the
Securities and Exchange Commission on April 4, 2006
 27




---



##### Table of Contents



SIGNATURES
  PACIFIC SUNWEAR OF CALIFORNIA, INC.
(Registrant)Date: August 31, 2006
    /s/   SETH R. JOHNSONSeth R. JohnsonDirector and Chief Executive Officer
(Principal Executive Officer) Date: August 31, 2006
    /s/   GERALD M. CHANEYGerald M. ChaneySenior Vice President,
Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer)




---



##### Table of Contents



EXHIBIT INDEX
 Exhibit
    
    DescriptionExhibit 10.1
    
    Form Notice of Grant of Director Stock Appreciation Rights and Terms and Conditions of Stock Appreciation Rights (1)Exhibit 10.2
    
    Form Notice of Grant of Stock Appreciation Rights and Terms and Conditions of Stock Appreciation Rights (1)Exhibit 10.3
    
    Form Notice of Grant of Restricted Stock Award and Award Agreement (1)Exhibit 10.4
    
    Amendment No. 3 to Amended and Restated Employment Agreement between the Company and Greg H. Weaver, dated March 29, 2006 (2)Exhibit 31.1
    
    Written statements of Seth R. Johnson and Gerald M. Chaney pursuant to section 302 of the Sarbanes-Oxley Act of 2002Exhibit 32.1
    
    Written statement of Seth R. Johnson and Gerald M. Chaney pursuant to section 906 of the Sarbanes-Oxley Act of 2002(1)
    
    Incorporated by reference from the Companys Current Report on From 8-K, as filed with the
Securities and Exchange Commission on May 23, 2006(2)
    
    Incorporated by reference from the Companys Current Report on From 8-K, as filed with the
Securities and Exchange Commission on April 4, 2006