##### Table of Contents



UNITED
STATES
 SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended: October 28, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 Commission file number 0-21296
 PACIFIC SUNWEAR OF CALIFORNIA, INC.
  California
(State of incorporation)
    
    95-3759463
(I.R.S. Employer Identification No.)
 
 
 þ  o
  þ o o
 o þ




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##### 



PACIFIC SUNWEAR OF CALIFORNIA, INC.
FORM 10-Q
For the Quarter Ended October 28, 2006
 Index
 Page #PART I.
    
    FINANCIAL INFORMATIONItem 1.
    

Condensed
Consolidated Financial Statements (unaudited):Condensed
Consolidated Balance Sheets
October 28, 2006 and January 28, 2006
    
    
    3Condensed
Consolidated Statements of Income and Comprehensive Income
Third quarter (13 weeks) and nine months (39 weeks) ended October 28, 2006
and October 29, 2005
    
    
    4Condensed
Consolidated Statements of Cash Flows
Nine months (39 weeks) ended October 28, 2006 and October 29, 2005
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6-12Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    13-23Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    23Item 4.
    
    Controls and Procedures
    
    
    24PART II.
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    24Item 1A.
    
    Risk Factors
    
    
    24-28Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    28Item 3.
    
    Defaults upon Senior Securities
    
    
    28Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    28Item 5.
    
    Other Information
    
    
    28Item 6.
    
    Exhibits
    
    
    29SIGNATURE PAGE
    
    
    30EXHIBIT 3.1EXHIBIT 10.5EXHIBIT 31.1EXHIBIT 32.1
  2




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PACIFIC SUNWEAR OF CALIFORNIA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, all amounts in thousands except share amounts)
 October 28, 2006
    
    
    January 28, 2006ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    55,453
    
    
    $
    95,185Marketable securities
    
    
    
    
    
    
    74,911Merchandise inventories
    
    
    252,680
    
    
    
    215,140Other current assets
    
    
    32,120
    
    
    
    41,485Total current assets
    
    
    340,253
    
    
    
    426,721PROPERTY AND EQUIPMENT, NET:Gross property and equipment
    
    
    707,555
    
    
    
    602,962Less accumulated depreciation and amortization
    
    
    (288,159
    )
    
    
    (247,140
    )Total property and equipment, net
    
    
    419,396
    
    
    
    355,822Other Assets
    
    
    16,350
    
    
    
    25,018TOTAL ASSETS
    
    $
    775,999
    
    
    $
    807,561LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    77,911
    
    
    $
    47,550Other current liabilities
    
    
    67,807
    
    
    
    74,921Total current liabilities
    
    
    145,718
    
    
    
    122,471LONG-TERM LIABILITIES:Deferred lease incentives
    
    
    86,377
    
    
    
    81,440Deferred rent
    
    
    31,039
    
    
    
    28,748Deferred income taxes
    
    
    12,584
    
    
    
    12,584Other long-term liabilities
    
    
    8,799
    
    
    
    15,528Total long-term liabilities
    
    
    138,799
    
    
    
    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; 69,397,391
and 73,751,249 shares issued and outstanding, respectively
    
    
    694
    
    
    
    737Additional paid-in capital
    
    
    2,976
    
    
    
    23,866Retained earnings
    
    
    487,812
    
    
    
    522,187Total shareholders equity
    
    
    491,482
    
    
    
    546,790TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    775,999
    
    
    $
    807,561
  3




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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 Third Quarter Ended
    
    
    For the Nine Months EndedOctober 28, 2006
    
    
    October 29, 2005
    
    
    October 28, 2006
    
    
    October 29, 2005Net sales
    
    $
    375,427
    
    
    $
    377,491
    
    
    $
    988,996
    
    
    $
    966,540Cost of goods sold, including
buying, distribution and occupancy
costs
    
    
    269,085
    
    
    
    233,052
    
    
    
    687,947
    
    
    
    614,395Gross margin
    
    
    106,342
    
    
    
    144,439
    
    
    
    301,049
    
    
    
    352,145Selling, general and administrative
expenses
    
    
    92,562
    
    
    
    80,905
    
    
    
    255,355
    
    
    
    228,618Operating income
    
    
    13,780
    
    
    
    63,534
    
    
    
    45,694
    
    
    
    123,527Interest income, net
    
    
    709
    
    
    
    1,566
    
    
    
    3,594
    
    
    
    3,831Income before income tax expense
    
    
    14,489
    
    
    
    65,100
    
    
    
    49,288
    
    
    
    127,358Income tax expense
    
    
    5,506
    
    
    
    24,616
    
    
    
    18,729
    
    
    
    48,155Net income
    
    $
    8,983
    
    
    $
    40,484
    
    
    $
    30,559
    
    
    $
    79,203Comprehensive income
    
    $
    8,983
    
    
    $
    40,484
    
    
    $
    30,559
    
    
    $
    79,203Net income per share, basic
    
    $
    0.13
    
    
    $
    0.54
    
    
    $
    0.43
    
    
    $
    1.06Net income per share, diluted
    
    $
    0.13
    
    
    $
    0.54
    
    
    $
    0.43
    
    
    $
    1.04Wtd. avg. shares outstanding, basic
    
    
    69,344,402
    
    
    
    74,531,489
    
    
    
    71,274,716
    
    
    
    74,983,286Wtd. avg. shares outstanding, diluted
    
    
    69,561,420
    
    
    
    75,337,910
    
    
    
    71,657,385
    
    
    
    76,003,452
  4




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PACIFIC SUNWEAR OF CALIFORNIA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
 Nine Months EndedOctober 28, 2006
    
    
    October 29, 2005CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    30,559
    
    
    $
    79,203Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    52,632
    
    
    
    46,782Stock-based compensation
    
    
    5,392
    
    
    
    Tax benefits related to stock-based compensation
    
    
    1,556
    
    
    
    6,895Excess tax benefits related to stock-based compensation
    
    
    (963
    )
    
    
    Loss on disposal of property and equipment
    
    
    373
    
    
    
    126Change in operating assets and liabilities:Merchandise inventories
    
    
    (37,540
    )
    
    
    (68,734
    )Other current assets
    
    
    12,237
    
    
    
    (5,899
    )Other assets
    
    
    8,668
    
    
    
    (3,098
    )Accounts payable
    
    
    30,361
    
    
    
    7,970Other current liabilities
    
    
    (18,879
    )
    
    
    10,163Deferred lease incentives
    
    
    4,937
    
    
    
    12,786Deferred rent
    
    
    1,969
    
    
    
    (1,356
    )Other long-term liabilities
    
    
    (6,687
    )
    
    
    2,456Net cash provided by operating activities
    
    
    84,615
    
    
    
    87,294CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property and equipment
    
    
    (107,087
    )
    
    
    (77,815
    )Purchases of available-for-sale marketable securities
    
    
    (226,503
    )
    
    
    (602,925
    )Sales of available-for-sale marketable securities
    
    
    286,803
    
    
    
    599,875Purchases of held-to-maturity marketable securities
    
    
    
    
    
    
    (21,038
    )Maturities of held-to-maturity marketable securities
    
    
    14,611
    
    
    
    29,000Net cash used in investing activities
    
    
    (32,176
    )
    
    
    (72,903
    )CASH FLOWS FROM FINANCING ACTIVITIES:Repurchase and retirement of common stock
    
    
    (99,347
    )
    
    
    (43,739
    )Proceeds from exercise of stock options
    
    
    6,532
    
    
    
    12,957Excess tax benefits from stock-based compensation
    
    
    963
    
    
    
    Principal payments under long-term debt and capital lease obligations
    
    
    (319
    )
    
    
    (1,216
    )Net cash used in financing activities
    
    
    (92,171
    )
    
    
    (31,998
    )NET DECREASE IN CASH AND CASH EQUIVALENTS:
    
    
    (39,732
    )
    
    
    (17,607
    )CASH AND CASH EQUIVALENTS, beginning of period
    
    
    95,185
    
    
    
    64,308CASH AND CASH EQUIVALENTS, end of period
    
    $
    55,453
    
    
    $
    46,701SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Cash paid for interest
    
    $
    4
    
    
    $
    41Cash paid for income taxes
    
    $
    34,941
    
    
    $
    35,638SUPPLEMENTAL 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
    
    $
    9,492
    
    
    $
    8,821
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PACIFIC SUNWEAR OF CALIFORNIA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the quarterly period ended October 28, 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 www.pacsun.com www.demostores.com
 Basis of Presentation
  2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  New Accounting Pronouncements
 6




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Stock-Based Compensation
   7




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Fiscal Year2006
    
    
    2005Expected Option Life
    
    5 years
    
    5 yearsStock Volatility
    
    
    41.3%  48.7 %
    
    
    
    53.4%  62.8%Risk-free Interest Rates
    
    
    4.6%  5.1%
    
    
    
    3.9%  4.5%Expected Dividends
    
    None
    
    None
   Weighted-Weighted-
    
    
    Average
    
    
    AggregateAverage
    
    
    Remaining
    
    
    IntrinsicShares
    
    
    Exercise
    
    
    Contractual
    
    
    ValueStock Options
    
    (000s)
    
    
    Price
    
    
    Term (Yrs.)
    
    
    ($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
    
    
    $
    7,210Granted
    
    
    11
    
    
    
    17.17Exercised
    
    
    (82
    )
    
    
    13.17Forfeited or expired
    
    
    (395
    )
    
    
    22.92Outstanding at October 28, 2006
    
    
    3,288
    
    
    $
    19.55
    
    
    
    5.80
    
    
    $
    7,130Exercisable at October 28, 2006
    
    
    1,879
    
    
    $
    16.90
    
    
    
    5.37
    
    
    $
    6,926
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Weighted-Shares
    
    
    Average Grant-Non-vested Shares
    
    (000)
    
    
    Date Fair ValueNon-vested at January 29, 2006
    
    
    
    
    
    $
    Granted
    
    
    284
    
    
    
    20.10Vested
    
    
    
    
    
    
    Forfeited
    
    
    (4
    )
    
    
    20.16Non-vested at July 29, 2006
    
    
    280
    
    
    $
    20.10Granted
    
    
    12
    
    
    
    15.04Vested
    
    
    
    
    
    
    Forfeited
    
    
    (15
    )
    
    
    20.16Non-vested at October 28, 2006
    
    
    277
    
    
    $
    19.87
   Third Quarter
    
    Nine MonthsEnded
    
    EndedOctober 29,
    
    October 29,2005
    
    2005Net income, as reported
    
    $
    40,484
    
    
    $
    79,203Less stock-based employee
compensation expense determined
under the fair value based
method, net of related tax
effects
    
    
    (1,540
    )
    
    
    (5,530
    )Pro forma net income
    
    $
    38,944
    
    
    $
    73,673Earnings per ShareBasic, as reported
    
    $
    0.54
    
    
    $
    1.06Basic, pro forma
    
    $
    0.52
    
    
    $
    0.98Diluted, as reported
    
    $
    0.54
    
    
    $
    1.04Diluted, pro forma
    
    $
    0.52
    
    
    $
    0.98
 Segment Reporting
 9




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OneThousandPacSun
    
    demo
    
    Steps
    
    TotalNet Sales
    
    $
    855,402
    
    
    $
    130,790
    
    
    $
    2,804
    
    
    $
    988,996Comparable Store Sales %
    
    
    (4.6
    )%
    
    
    (6.9
    )%
    
    
    n/a
    
    
    
    (4.9
    )%Contribution Margin
    
    $
    148,341
    
    
    $
    (1,547
    )
    
    $
    (2,007
    )
    
    $
    144,787Number of Stores
    
    
    945
    
    
    
    215
    
    
    
    9
    
    
    
    1,169Square Footage (in 000s)
    
    
    3,582
    
    
    
    603
    
    
    
    24
    
    
    
    4,209
  3. OTHER CURRENT ASSETS
  October 28,
    
    
    January 28,2006
    
    
    2006Prepaid expenses
    
    $
    12,800
    
    
    $
    22,360Non-trade accounts receivable
    
    
    10,003
    
    
    
    12,679Deferred income taxes
    
    
    6,446
    
    
    
    6,446Income taxes receivable
    
    
    2,871
    
    
    
    Total other current assets
    
    $
    32,120
    
    
    $
    41,485
 4. OTHER CURRENT LIABILITIES
  October 28,
    
    
    January 28,2006
    
    
    2006Accrued capital expenditures
    
    $
    17,950
    
    
    $
    8,779Accrued compensation and benefits
    
    
    13,870
    
    
    
    12,250Accrued gift cards
    
    
    7,282
    
    
    
    12,620Sales taxes payable
    
    
    6,185
    
    
    
    7,895Income taxes payable
    
    
    
    
    
    
    14,896Other
    
    
    22,520
    
    
    
    18,481Total other current liabilities
    
    $
    67,807
    
    
    $
    74,921
 5. COMMITMENTS AND CONTINGENCIES
 Litigation
 Letters of Credit
 10




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6. COMMON STOCK REPURCHASE AND RETIREMENT
  # 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
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7. NET INCOME PER SHARE, BASIC AND DILUTED
  Third Quarter Ended:
    
    October 28, 2006
    
    October 29, 2005Net
    
    
    
    
    
    
    
    
    
    NetIncome
    
    Shares
    
    EPS
    
    Income
    
    Shares
    
    EPSBasic EPS:
    
    $
    8,983
    
    
    
    69,344,402
    
    
    $
    0.13
    
    
    $
    40,484
    
    
    
    74,531,489
    
    
    $
    0.54Diluted EPS:Effect of dilutive equivalents
    
    
    
    
    
    
    217,018
    
    
    
    (0.00
    )
    
    
    
    
    
    
    806,421
    
    
    
    (0.00
    )$
    8,983
    
    
    
    69,561,420
    
    
    $
    0.13
    
    
    $
    40,484
    
    
    
    75,337,910
    
    
    $
    0.54
 Nine Months Ended:
    
    October 28, 2006
    
    October 29, 2005Net
    
    
    
    
    
    
    
    
    
    NetIncome
    
    Shares
    
    EPS
    
    Income
    
    Shares
    
    EPSBasic EPS:
    
    $
    30,559
    
    
    
    71,274,716
    
    
    $
    0.43
    
    
    $
    79,203
    
    
    
    74,983,286
    
    
    $
    1.06Diluted EPS:Effect of dilutive equivalents
    
    
    
    
    
    
    382,669
    
    
    
    (0.00
    )
    
    
    
    
    
    
    1,020,166
    
    
    
    (0.02
    )$
    30,559
    
    
    
    71,657,385
    
    
    $
    0.43
    
    
    $
    79,203
    
    
    
    76,003,452
    
    
    $
    1.04
  12




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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
 13




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##### Table of Contents



Store sales trends
 Cash flow and liquidity (working capital)
 Critical Accounting Policies
  Recognition of Revenue
 Valuation of Inventories
 Determination of Stock-Based Compensation Expense
  14




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Evaluation of Long-Lived Assets
 Evaluation of Insurance Reserves
 Evaluation of Income Taxes
 Evaluation of Litigation Matters
 15




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##### Table of Contents



Results of Operations
  Third Quarter Ended
    
    Nine Months EndedOct. 28, 2006
    
    Oct. 29, 2005
    
    Oct. 28, 2006
    
    Oct. 29, 2005Net sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of goods sold, including
buying, distribution and
occupancy costs
    
    
    71.7
    
    
    
    61.7
    
    
    
    69.6
    
    
    
    63.6Gross margin
    
    
    28.3
    
    
    
    38.3
    
    
    
    30.4
    
    
    
    36.4Selling, general and
administrative expenses
    
    
    24.6
    
    
    
    21.5
    
    
    
    25.8
    
    
    
    23.6Operating income
    
    
    3.7
    
    
    
    16.8
    
    
    
    4.6
    
    
    
    12.8Interest income, net
    
    
    0.2
    
    
    
    0.4
    
    
    
    0.4
    
    
    
    0.4Income before income tax expense
    
    
    3.9
    
    
    
    17.2
    
    
    
    5.0
    
    
    
    13.2Income tax expense
    
    
    1.5
    
    
    
    6.5
    
    
    
    1.9
    
    
    
    5.0Net income
    
    
    2.4
    %
    
    
    10.7
    %
    
    
    3.1
    %
    
    
    8.2
    %
  October 28, 2006
    
    October 29, 2005PacSun stores
    
    
    835
    
    
    
    798Outlet stores
    
    
    110
    
    
    
    93demo stores
    
    
    215
    
    
    
    193One Thousand Steps stores
    
    
    9
    
    
    
    Total stores
    
    
    1,169
    
    
    
    1,084Square footage (in 000s)
    
    
    4,209
    
    
    
    3,828
 The third quarter (thirteen weeks) ended October 28, 2006 as compared to the third quarter
(thirteen weeks) ended October 29, 2005
 Net Sales
  $millions
    
    Attributable to$
    (24
    )
    
    7% decrease in comparable store net sales in the third quarter of fiscal 2006 compared
to the third quarter of fiscal 2005(1
    )
    
    3 closed stores in fiscal 2006 and 10 closed stores in fiscal 200511
    
    
    Net sales from stores opened in fiscal 2005 not yet included in the comparable store base10
    
    
    67 new stores opened in fiscal 2006 not yet included in the comparable store base2
    
    
    Other non-comparable sales (net sales from expanded or relocated stores not yet included
in the comparable store base and internet net sales)$
    (2
    )
    
    Total
  16




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##### Table of Contents



Gross Margin
  Selling, General and Administrative Expenses
  17




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##### Table of Contents



%
    
    Attributable to1.3
    
    Store payroll expenses as a percentage of net sales were 11.8% ($44
million) in the third quarter of fiscal 2006 as compared to 10.5%
($40 million) in the third quarter of fiscal 2005. In absolute
dollars, these expenses were up primarily due to 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 third quarter of fiscal 2006.1.3
    
    Increase in direct store expenses as a percentage of net sales to
7.1% ($27 million) for the third quarter of fiscal 2006 from 5.8%
($22 million) for the third quarter of fiscal 2005. In absolute
dollars, these expenses were up primarily due to increased
depreciation associated with the addition of 24 net new stores
during the fourth quarter of fiscal 2005 and 64 net new stores
during the first nine months 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 third quarter of
fiscal 2006.0.5
    
    Expenses incurred during the third quarter of fiscal 2006 that are
non-comparable to the third quarter of fiscal 2005 include stock
compensation expenses of $1.3 million (see Note 2, Stock-Based
Compensation, in the notes to the condensed consolidated financial
statements), and a charge of $1.1 million related to the
resignation of our former CEO.0.0
    
    Other general and administrative expenses remained flat as a
percentage of net sales at 5.2% in the third quarter of each of
fiscal 2006 and 2005.3.1
    
    Total
 Net Interest Income
  Income Tax Expense
  18




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##### Table of Contents



The nine months (39 weeks) ended October 28, 2006 as compared to the nine months (39 weeks)
ended October 29, 2005
 Net Sales
  $millions
    
    Attributable to$
    52
    
    
    Net sales from stores opened in fiscal 2005 not yet included in the comparable store base16
    
    
    Net sales from 67 new stores opened in fiscal 2006 not yet included in the comparable
store base3
    
    
    Other non-comparable sales (net sales from expanded or relocated stores not yet included
in the comparable store base and internet net sales)(44
    )
    
    5% decrease in comparable store net sales in the first nine months of fiscal 2006
compared to the first nine months of fiscal 2005(5
    )
    
    3 closed stores in fiscal 2006 and 10 closed stores in fiscal 2005$
    22
    
    
    Total
    Gross Margin
  19




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##### Table of Contents



Selling, General and Administrative Expenses
  %
    
    Attributable to1.0
    
    Increase in direct store expenses as a percentage of net sales to
7.4% ($73 million) for the first nine months of fiscal 2006 from
6.4% ($62 million) for the first nine months 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 nine months of fiscal 2006.0.9
    
    Increase in store payroll expenses as a percentage of net sales to
12.5% ($123 million) in the first nine months of fiscal 2006 from
11.6% ($112 million) for the first nine months of fiscal 2005. In
absolute dollars, these expenses were up primarily due to addition
of 24 net new stores during the fourth quarter of fiscal 2005 and 64
net new stores during the first nine months of fiscal 2006. As a
percentage of net sales, these expenses were up primarily due to
deleveraging them against the negative same-store sales results in
the first nine months of fiscal 2006.0.5
    
    Expenses incurred during the first nine months of fiscal 2006 that
are non-comparable to the first nine months of fiscal 2005 include
stock compensation expenses of $4 million (see Note 2, Stock-Based
Compensation, in the notes to the condensed consolidated financial
statements), and a charge of $1 million related to the resignation
of our former CEO.(0.2)
    
    Decrease in all other general and administrative expenses as a
percentage of net sales to 5.5% ($54 million) for the first nine
months of fiscal 2006 from 5.7% ($55 million) for the first nine
months of fiscal 2005.2.2
    
    Total
 Net Interest Income
  Income Tax Expense
  Liquidity and Capital Resources
  20




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##### Table of Contents



Operating Cash Flows
  $millions
    
    Attributable to$
    (49
    )
    
    Decrease in net income.(23
    )
    
    Decrease in cash flows from accrued income taxes. Cash payments for
income taxes were $1 million lower than prior year, but current year
accruals have been lower due to reduced net income.54
    
    
    Increase in cash flows from accounts payable, net of inventory, due to
timing of payments and decreased inventory per square foot.14
    
    
    Increase in cash flows from prepaid expenses due to timing of payments.2
    
    
    Increase in net cash flows from all other assets and liabilities.$
    (2
    )

    
    Total
 Working Capital
  $millions
    
    Description$
    304
    
    
    Working capital at January 28, 2006(145
    )
    
    Decrease in cash and marketable securities, net of accounts payable, primarily due to
stock repurchases, capital expenditures and negative same store sales results for the
first nine months of fiscal 2006, among other items (see cash flow statement).38
    
    
    Increase in inventory, primarily due to the addition of 64 net new stores and slower
inventory turns due to the negative same-store sales results during the first nine
months of fiscal 2006.(2
    )
    
    Net decrease in working capital attributable to all other current assets and liabilities.$
    195
    
    
    Working capital at October 28, 2006
 Investing Cash Flows
  Fiscal 2007 Store Opening Plans
  Financing Cash Flows
  21




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##### Table of Contents



Credit Facility
  Contractual Obligations
  Contractual Obligations
    
    Payments Due by Period(in $millions)
    
    Total
    
    Less than 1 year
    
    1-3 years
    
    3-5 years
    
    More than 5 yearsOperating lease obligations
    
    $
    681
    
    
    $
    108
    
    
    $
    206
    
    
    $
    171
    
    
    $
    196Letters of credit
    
    
    21
    
    
    
    21
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    702
    
    
    $
    129
    
    
    $
    206
    
    
    $
    171
    
    
    $
    196
  Operating Leases
  22




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##### Table of Contents



Indemnifications
   New Accounting Pronouncements
  Inflation
  Seasonality and Quarterly Results
  
 ITEM 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  23




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##### Table of Contents



ITEM 4  CONTROLS AND PROCEDURES
   
 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.
  24




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##### Table of Contents



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.
  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.
  25




---



##### 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.
  26




---



##### 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.
  27




---



##### 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
  
 Item 5
 Other Information
  28




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##### Table of Contents



Item 6  Exhibits
 Exhibit 3.1
    
    Third Amended and Restated Bylaws of the Company, as amended to dateExhibit 10.1
    
    Amendment No. 1 to Credit Agreement, dated as of October 12, 2006, with JPMorgan Chase Bank, N.A., as
Administrative Agent, and a syndicate of other lenders (1)Exhibit 10.2
    
    Amendment to Employment Agreement and Resignation, dated September 29, 2006, between the Company and Seth R.
Johnson (2)Exhibit 10.3
    
    Summary of Board of Directors Compensation dated August 16, 2006 (3)Exhibit 10.4
    
    Notice of Election to Extend Employment Agreement of Seth R. Johnson (4)Exhibit 10.5
    
    Summary of Compensation Arrangements with Sally Frame Kasaks, Interim Chief Executive OfficerExhibit 31.1
    
    Written statements of Sally Frame Kasaks and Gerald M. Chaney pursuant to section 302 of the Sarbanes-Oxley Act of
2002Exhibit 32.1
    
    Written statement of Sally Frame Kasaks 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 October 18, 2006(2)
    
    Incorporated by reference from the Companys Current Report on From 8-K, as filed with the
Securities and Exchange Commission on October 2, 2006(3)
    
    Incorporated by reference from the Companys Current Report on From 8-K, as filed with the
Securities and Exchange Commission on August 21, 2006(4)
    
    Incorporated by reference from the Companys Current Report on From 8-K, as filed with the
Securities and Exchange Commission on August 2, 2006
 29




---



##### Table of Contents



SIGNATURES
  PACIFIC SUNWEAR OF CALIFORNIA, INC.
(Registrant)Date: December 4, 2006
    /s/ SALLY FRAME KASAKSSally Frame KasaksDirector and Interim Chief Executive Officer
(Principal Executive Officer) Date: December 4, 2006
    /s/ GERALD M. CHANEYGerald M. ChaneySenior Vice President,
Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer) 30




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##### Table of Contents



Exhibit Index
 Exhibit 3.1
    
    Third Amended and Restated Bylaws of the Company, as amended to dateExhibit 10.1
    
    Amendment No. 1 to Credit Agreement, dated as of October 12, 2006, with JPMorgan Chase Bank, N.A., as
Administrative Agent, and a syndicate of other lenders (1)Exhibit 10.2
    
    Amendment to Employment Agreement and Resignation, dated September 29, 2006, between the Company and Seth R.
Johnson (2)Exhibit 10.3
    
    Summary of Board of Directors Compensation dated August 16, 2006 (3)Exhibit 10.4
    
    Notice of Election to Extend Employment Agreement of Seth R. Johnson (4)Exhibit 10.5
    
    Summary of Compensation Arrangements with Sally Frame Kasaks, Interim Chief Executive OfficerExhibit 31.1
    
    Written statements of Sally Frame Kasaks and Gerald M. Chaney pursuant to section 302 of the Sarbanes-Oxley Act of
2002Exhibit 32.1
    
    Written statement of Sally Frame Kasaks 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 October 18, 2006(2)
    
    Incorporated by reference from the Companys Current Report on From 8-K, as filed with the
Securities and Exchange Commission on October 2, 2006(3)
    
    Incorporated by reference from the Companys Current Report on From 8-K, as filed with the
Securities and Exchange Commission on August 21, 2006(4)
    
    Incorporated by reference from the Companys Current Report on From 8-K, as filed with the
Securities and Exchange Commission on August 2, 2006
 31