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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington D.C 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 April 30, 2005 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
    
    95-3759463(State of Incorporation)
    
    (I.R.S. Employer Identification No.)3450 East Miraloma AvenueAnaheim, California
    
    92806(Address of principal executive offices)
    
    (Zip code)
 (714) 414-4000
(Registrants telephone number, including area code) 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 þ No o
 Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). Yes þ No o
 The number of shares outstanding of the registrants Common Stock, par value $.01 per share, at May
31, 2005, was 75,036,900.   1




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PACIFIC SUNWEAR OF CALIFORNIA, INC.
FORM 10-Q
For the Quarterly Period Ended April 30, 2005 Index Page(s)PART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Condensed Consolidated Financial Statements (unaudited):Condensed Consolidated Balance Sheets as of April 30, 2005 and January 29, 2005
    
    
    3Condensed Consolidated Statements of Income and Comprehensive Income for the first quarters ended April 30, 2005 and May 1, 2004 (as restated)
    
    
    4Condensed Consolidated Statements of Cash Flows for the first quarters ended April 30, 2005 and May 1, 2004 (as restated)
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6-10Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11-20Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    20-21Item 4.
    
    Controls and Procedures
    
    
    21PART II.
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    21Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    21Item 3.
    
    Defaults Upon Senior Securities
    
    
    21Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    21Item 5.
    
    Other Information
    
    
    21Item 6.
    
    Exhibits
    
    
    21SIGNATURE PAGE
    
    
    22EXHIBIT INDEX
    
    
    23EXHIBIT 31EXHIBIT 32
 2




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PACIFIC SUNWEAR OF CALIFORNIA, INC. 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands, except share amounts)
 April 30, 2005
    
    
    January 29, 2005ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    79,964
    
    
    $
    64,308Marketable securities
    
    
    81,431
    
    
    
    79,223Merchandise inventories
    
    
    172,128
    
    
    
    175,081Other current assets
    
    
    34,135
    
    
    
    34,206Total current assets
    
    
    367,658
    
    
    
    352,818PROPERTY AND EQUIPMENT, NET:Gross property and equipment
    
    
    524,198
    
    
    
    503,745Less accumulated depreciation and amortization
    
    
    (210,281
    )
    
    
    (199,523
    )Total property and equipment, net
    
    
    313,917
    
    
    
    304,222Other Assets
    
    
    22,017
    
    
    
    20,738TOTAL ASSETS
    
    $
    703,592
    
    
    $
    677,778LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    33,528
    
    
    $
    38,753Other current liabilities
    
    
    52,177
    
    
    
    56,557Total current liabilities
    
    
    85,705
    
    
    
    95,310LONG-TERM LIABILITIES:Deferred lease incentives
    
    
    72,739
    
    
    
    67,683Deferred rent
    
    
    27,115
    
    
    
    26,826Deferred income taxes
    
    
    16,132
    
    
    
    16,132Other long-term liabilities
    
    
    14,943
    
    
    
    13,793Total long-term liabilities
    
    
    130,929
    
    
    
    124,434Commitments and contingencies (Notes 5 and 7)SHAREHOLDERS EQUITY:Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued
    
    
    
    
    
    
    Common stock, $.01 par value; 170,859,375 shares authorized; 75,516,425
and 74,916,773 shares issued and outstanding, respectively
    
    
    755
    
    
    
    749Additional paid-in capital
    
    
    72,621
    
    
    
    61,310Retained earnings
    
    
    413,582
    
    
    
    395,975Total shareholders equity
    
    
    486,958
    
    
    
    458,034TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    703,592
    
    
    $
    677,778
 See accompanying notes to condensed consolidated financial statements 3




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PACIFIC SUNWEAR OF CALIFORNIA, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(unaudited)
(in thousands, except share and per share amounts)
 First Quarter EndedApril 30, 2005
    
    
    May 1, 2004(as restated, seeNote 3)Net sales
    
    $
    279,985
    
    
    $
    245,501Cost of goods sold, including buying, distribution and occupancy costs
    
    
    182,635
    
    
    
    159,296Gross margin
    
    
    97,350
    
    
    
    86,205Selling, general and administrative expenses
    
    
    70,123
    
    
    
    62,592Operating income
    
    
    27,227
    
    
    
    23,613Interest income/(expense), net
    
    
    1,086
    
    
    
    457Income before income tax expense
    
    
    28,313
    
    
    
    24,070Income tax expense
    
    
    10,706
    
    
    
    9,101Net income
    
    $
    17,607
    
    
    $
    14,969Comprehensive income
    
    $
    17,607
    
    
    $
    14,969Net income per share, basic
    
    $
    0.23
    
    
    $
    0.19Net income per share, diluted
    
    $
    0.23
    
    
    $
    0.19Weighted average shares outstanding, basic
    
    
    75,292,587
    
    
    
    78,157,771Weighted average shares outstanding, diluted
    
    
    76,579,259
    
    
    
    80,146,144
 See accompanying notes to condensed consolidated financial statements 4




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PACIFIC SUNWEAR OF CALIFORNIA, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
 First Quarter EndedMay 1, 2004(as restated,April 30, 2005
    
    
    see Note 3)CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    
    17,607
    
    
    
    14,969Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    15,001
    
    
    
    11,936Tax benefits related to exercise of stock options
    
    
    3,754
    
    
    
    2,488Loss on disposal of equipment
    
    
    
    
    
    
    1,851Change in operating assets and liabilities:Merchandise inventories
    
    
    2,953
    
    
    
    (10,161
    )Other current assets
    
    
    71
    
    
    
    (1,851
    )Other assets
    
    
    (1,279
    )
    
    
    (1,212
    )Accounts payable
    
    
    (5,225
    )
    
    
    4,161Other current liabilities
    
    
    (5,303
    )
    
    
    (19,602
    )Deferred lease incentives
    
    
    4,675
    
    
    
    2,223Deferred rent
    
    
    4
    
    
    
    (136
    )Other long-term liabilities
    
    
    1,380
    
    
    
    1,116Net cash provided by operating activities
    
    
    33,638
    
    
    
    5,782CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property and equipment
    
    
    (21,648
    )
    
    
    (17,122
    )Purchases of held-to-maturity marketable securities
    
    
    (21,383
    )
    
    
    (18,069
    )Maturities of held-to-maturity marketable securities
    
    
    13,450
    
    
    
    1,000Purchases of available-for-sale marketable securities
    
    
    (228,775
    )
    
    
    (317,200
    )Sales of available-for-sale marketable securities
    
    
    234,500
    
    
    
    321,700Net cash used in investing activities
    
    
    (23,856
    )
    
    
    (29,691
    )CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from exercise of stock options
    
    
    6,421
    
    
    
    5,334Repurchase and retirement of common stock
    
    
    
    
    
    
    (42,874
    )Principal payments under long-term debt and capital lease obligations
    
    
    (547
    )
    
    
    (463
    )Net cash provided by/(used in) financing activities
    
    
    5,874
    
    
    
    (38,003
    )NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    15,656
    
    
    
    (61,912
    )CASH AND CASH EQUIVALENTS, beginning of period
    
    
    64,308
    
    
    
    109,640CASH AND CASH EQUIVALENTS, end of period
    
    
    79,964
    
    
    
    47,728SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Cash paid for interest
    
    
    18
    
    
    
    38Cash paid for income taxes
    
    
    9,300
    
    
    
    16,314SUPPLEMENTAL DISCLOSURES OF NON-CASH TRANSACTIONS:Increase to additional paid-in capital related to the issuance of stock to
satisfy certain deferred compensation liabilities
    
    
    1,142
    
    
    
    4,853Increase in accrued capital expenditures
    
    
    2,667
    
    
    
    5,003Accrued stock repurchase transaction, not yet settled in cash
    
    
    
    
    
    
    7,121
 See accompanying notes to condensed consolidated financial statements 5




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PACIFIC SUNWEAR OF CALIFORNIA, INC. 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  For the Quarterly Period Ended April 30, 2005  (unaudited, all amounts in thousands, except share and per share amounts, unless otherwise indicated)
 1. BASIS OF PRESENTATION AND NATURE OF BUSINESS Basis of Presentation  The accompanying condensed consolidated financial statements are
unaudited and have been prepared in accordance with accounting principles generally accepted in the
United States of America (GAAP) for interim financial information and with the instructions to
Form 10-Q and Rules 5-02 and 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete financial statements. The condensed
consolidated financial statements include the accounts of Pacific Sunwear of California, Inc. and
its subsidiaries, Pacific Sunwear Stores Corp. and Miraloma Corp. (the Company). All
intercompany transactions have been eliminated in consolidation. In the opinion of management, all adjustments consisting only of normal recurring entries necessary
for a fair presentation have been included. The preparation of consolidated financial statements
in conformity with GAAP necessarily requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the consolidated financial statements as well as the reported revenues
and expenses during the reporting period. Actual results could differ from these estimates. The
results of operations for the first quarter ended April 30, 2005 are not necessarily indicative of
the results that may be expected for fiscal 2005. For further information, refer to the Companys
consolidated financial statements and notes thereto included in the Companys annual report on Form
10-K for the year ended January 29, 2005. Nature of Business  Pacific Sunwear of California, Inc. and its subsidiaries (the
Company) is a leading specialty retailer of everyday casual apparel, footwear and accessories
designed to meet the needs of active teens and young adults. The Company operates three
nationwide, primarily mall-based chains of retail stores, under the names Pacific Sunwear (as
well as PacSun), Pacific Sunwear (PacSun) Outlet and d.e.m.o. Pacific Sunwear and Pacific
Sunwear Outlet stores specialize in board-sport inspired casual apparel, footwear and related
accessories catering to teens and young adults. d.e.m.o. specializes in hip-hop inspired casual
apparel, footwear and related accessories catering to teens and young adults. In addition, the
Company operates a website (www.pacsun.com) which sells PacSun merchandise online, provides content
and community for its target customers, and provides information about the Company. The Company
will begin selling d.e.m.o. merchandise through a new website (www.demostores.com) during fiscal
2005. The Companys fiscal year is the 52- or 53-week period ending on the Saturday closest to January
31. Fiscal 2005 is the 52-week period ending January 28, 2006. Fiscal 2004 was the 52-week
period ended January 29, 2005. The first quarter of fiscal 2005 was the 13-week period ended April
30, 2005. The first quarter of fiscal 2004 was the 13-week period ended May 1, 2004. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Information regarding the Companys significant accounting policies is contained in Note 1,
Summary of Significant Accounting Policies and Nature of Business, to the consolidated financial
statements in the Companys annual report on Form 10-K for the fiscal year ended January 29, 2005.
Presented below in this and the following notes is supplemental information that should be read in
conjunction with Notes to Consolidated Financial Statements included in that report. Marketable Securities  Marketable securities consists of auction rate securities of $45.0
million, classified as available for sale, and other short-term investments of $36.4 million,
classified as held-to-maturity. Auction rate securities have long-term stated contractual maturities, but have variable interest
rates that reset at each auction period (typically 7 days, or as long as 28 or 35 days in some
cases). These securities trade in a broad, highly liquid market and the Company has never had
difficulty being able to liquidate any such investment at the end of a given auction period. The
Company typically reinvests these securities multiple times during each reporting period at each
new auction date. As a result of the resetting variable rates, the Company had no cumulative gross
unrealized or realized gains or losses from these investments. All income from these investments
was recorded as interest income for each period presented. Marketable securities, other than auction rate securities, are classified as held-to-maturity and
consist of marketable corporate and U.S. agency debt instruments with original maturities of three
months to one year and are carried at amortized cost, less other than temporary impairments in
value. At April 30, 2005, the fair value of the Companys held-to-maturity portfolio was $36.4
million, consisting of corporate debentures of $26.8 million and U.S. treasury/agency debentures of
$9.6 million. Cost is 6




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determined by specific identification, which approximates fair value at April 30, 2005 due to the relatively
short maturity period of such investments. Stock-Based Compensation  The Company accounts for stock-based compensation in accordance
with Accounting Principles Board Opinion 25 and related interpretations. Accordingly, no
compensation expense has been recognized related to employee stock options for the periods
presented. The Company follows the disclosure provisions of SFAS 123, Accounting for Stock-Based
Compensation, as amended by SFAS 148, Accounting for Stock-Based Compensation  Transition and
Disclosure. The Company will begin expensing stock options in accordance with SFAS 123(R)
beginning January 29, 2006 (see New Accounting Pronouncements). The Company has provided the
pro-forma disclosures required by SFAS 123 and SFAS 148 for the first quarter of each of fiscal
2005 and fiscal 2004 below. For the First Quarter EndedApril 30, 2005
    
    
    May 1, 2004Net IncomeAs reported
    
    $
    17,607
    
    
    $
    14,969Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all
awards, net of related tax effects
    
    
    (1,819
    )
    
    
    (1,558
    )Pro forma
    
    $
    15,788
    
    
    $
    13,411Net Income Per Share, BasicAs reported
    
    $
    0.23
    
    
    $
    0.19Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all
awards, net of related tax effects
    
    
    (0.02
    )
    
    
    (0.02
    )Pro forma
    
    $
    0.21
    
    
    $
    0.17Net Income Per Share, DilutedAs reported
    
    $
    0.23
    
    
    $
    0.19Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all
awards, net of related tax effects
    
    
    (0.02
    )
    
    
    (0.02
    )Pro forma
    
    $
    0.21
    
    
    $
    0.17
 Pro-forma net income and earnings per share related to the fair value of the Companys stock option
awards were determined using the Black-Scholes option-pricing model with the following weighted
average assumptions: First Quarter 2005
    
    First Quarter 2004Expected Option Life
    
    5 years
    
    5 yearsStock Volatility
    
    62.8%
    
    37.8%Risk-free Interest Rate
    
    3.9%
    
    3.6%Expected Dividends
    
    None
    
    None
 New Accounting Pronouncements  In March 2004, the Emerging Issues Task Force (EITF)
reached a consensus on EITF Issue No. 03-1 (EITF 03-1), The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments, for which the measurement and recognition
provisions are effective for reporting periods beginning after June 15, 2004. EITF 03-1 provides a
three-step process for determining whether investments, including debt securities, are other than
temporarily impaired and requires additional disclosures in annual financial statements. An
investment is impaired if the fair value of the investment is less than its cost. The adoption of
EITF 03-1 did not have a material impact on the Companys financial position or results of
operations because the Company has the ability and intent to hold all of its held-to-maturity
marketable securities until maturity. In December 2004, the FASB issued SFAS 123(R), Share-Based Payment. SFAS 123(R) requires that
companies recognize compensation expense equal to the fair value of stock options or other
share-based payments over the requisite service period. The standard is effective for the Company
at the beginning of its next fiscal year, which starts on January 29, 2006. The Companys net
income will be reduced as a result of the recognition of the remaining amortization of the fair
value of existing options (currently disclosed as pro-forma expense above in this Note 1) as well
as the recognition of the fair value of all newly 7




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issued stock options, which is contingent upon
the number of future options granted and other variables. The adoption of this standard will have
no impact on the Companys cash flows. Reclassifications  Certain prior year amounts have been reclassified to conform to the
current year presentation. 3. RESTATEMENT OF PRIOR YEAR FINANCIAL STATEMENTS As disclosed in the Companys Form 10-K for the fiscal year ended January 29, 2005, the Company
restated its prior year financial statements to reflect the impact of certain lease accounting
corrections and certain reclassifications related to auction rate securities and e-commerce
shipping revenues and expenses. A summary of the impact of those changes to the Companys
financial statements for the first quarter of fiscal 2004 is as follows: First Quarter Ended May 1, 2004As
    
    
    LeasePreviously
    
    
    Accounting
    
    
    E-commerce
    
    
    As(all amounts in thousands, unaudited)
    
    Reported
    
    
    Adjustments
    
    
    Restatement
    
    
    RestatedConsolidated Income StatementNet Sales
    
    $
    245,131
    
    
    $
    
    
    
    $
    370
    
    
    $
    245,501Cost of Sales
    
    
    161,559
    
    
    
    (2,737
    )
    
    
    474
    
    
    
    159,296Gross Margin
    
    
    83,572
    
    
    
    2,737
    
    
    
    (104
    )
    
    
    86,205SG&A Expenses
    
    
    59,951
    
    
    
    2,745
    
    
    
    (104
    )
    
    
    62,592Operating Income
    
    
    23,621
    
    
    
    (8
    )
    
    
    
    
    
    
    23,613Income Tax Provision
    
    
    9,104
    
    
    
    (3
    )
    
    
    
    
    
    
    9,101Net Income
    
    
    14,974
    
    
    
    (5
    )
    
    
    
    
    
    
    14,969Earnings Per Share, diluted
    
    
    0.19
    
    
    
    (0.00
    )
    
    
    (0.00
    )
    
    
    0.19
 First Quarter Ended May 1, 2004AsPreviously(all amounts in thousands, unaudited)
    
    Reported
    
    
    Restatements
    
    
    As RestatedConsolidated Cash Flow StatementNet Cash Provided by Operating Activities
    
    $
    8,926
    
    
    $
    (3,144
    )
    
    $
    5,782Net Cash Used in Investing Activities
    
    
    (30,214
    )
    
    
    523
    
    
    
    (29,691
    )Net Cash Used in Financing Activities
    
    
    (45,124
    )
    
    
    7,121
    
    
    
    (38,003
    )Net Decrease in Cash and Cash Equivalents
    
    
    (66,412
    )
    
    
    4,500
    
    
    
    (61,912
    )Cash and Cash Equivalents, Beginning
    
    
    142,840
    
    
    
    (33,200
    )
    
    
    109,640Cash and Cash Equivalents, Ending
    
    
    76,428
    
    
    
    (28,700
    )
    
    
    47,728
 4. OTHER CURRENT LIABILITIES As of the dates presented, other current liabilities consisted of the following: April 30,
    
    
    January 29,2005
    
    
    2005Accrued compensation and benefits
    
    $
    10,977
    
    
    $
    13,284Accrued capital expenditures
    
    

    8,605
    
    
    
    6,223Accrued gift cards
    
    
    7,253
    
    
    
    10,386Sales taxes payable
    
    
    5,826
    
    
    
    6,647Income taxes payable
    
    
    3,645
    
    
    
    5,993Other
    
    
    15,871
    
    
    
    14,024$
    52,177
    
    
    $
    56,557
 5. ACCRUED SUBLEASE LOSS CHARGES The Company remains liable under an operating lease covering a former store location. The Company
has subleased approximately 85% of the total square footage of these premises to third parties at
rates that are somewhat less than the Companys required lease payments. Accordingly, at April 30,
2005, the Company had $1.7 million recorded in other current liabilities to recognize its net
remaining contractual lease obligations, net of sublease income, related to these premises. The
term 8




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of the lease ends December 31, 2012. On a quarterly basis, the Company updates its sublease
income assumptions for the remaining portion of the premises not yet subleased based on its review
of current real estate market conditions and current on-going negotiations. To the extent
managements estimates relating to the Companys ability to sublease these facilities at the
assumed rates or within the assumed timeframes changes or is incorrect, additional charges or
reversals of previous charges may
be recorded in the future. At April 30, 2005, the gross remaining contractual obligation under the
Companys original lease, exclusive of any sublease income, was approximately $5.9 million. The Company also remains secondarily liable under a guarantee issued related to the assignment of
an operating lease covering another former store location. The term of the lease ends December 31,
2014. The Company had $0.4 million recorded in other current liabilities to recognize the
remaining estimated fair value of this guarantee, assuming that another assignee would be found
within one year should the original assignee default. The aggregate payments remaining on the
master lease agreement at April 30, 2005, were $5.3 million. 6. RESTRICTED STOCK During the year ended February 4, 2001, the Company granted a restricted stock award of 168,750
shares with a purchase price of $0.01 per share to its CEO. The award was scheduled to vest 25% on
each of March 15, 2002, 2003, 2004 and 2005, if, in each instance, certain cumulative annual
earnings per share growth targets had been satisfied. Under the award agreement, shares that did
not vest at a given vesting date due to the cumulative annual earnings per share growth targets not
being met remained available for future vesting if the cumulative annual earnings per share growth
targets were met as of a subsequent vesting date. During the first quarter of fiscal 2004, the CEO
became vested in and received 75% of the total share award, or 126,563 shares. During the first
quarter of fiscal 2005, the Companys Board of Directors verified that the final cumulative annual
earnings per share growth target for this award had been met. Accordingly, the CEO became vested
in and received the remaining 42,187 shares related to this award in March 2005. As a result of
the delivery of the final 42,187 shares to the CEO, the Company reclassified previously recognized
accrued compensation of $1.1 million from accrued liabilities to additional paid-in capital. 7. COMMITMENTS AND CONTINGENCIES Litigation  The Company is involved from time to time in litigation incidental to its
business. Management believes that the outcome of current litigation will not likely have a
material adverse effect upon the results of operations or financial condition of the Company and,
from time to time, may make provisions for probable litigation losses. Depending on the actual
outcome of pending litigation, charges in excess of any provisions could be recorded in the future,
which may have a material adverse affect on the Companys operating results. Indemnities, Commitments, and Guarantees  During its normal course of business, the
Company has made certain indemnities, commitments and guarantees under which it may be required to
make payments in relation to certain transactions. These indemnities include those given to
various lessors in connection with facility leases for certain claims arising from such facility or
lease and indemnities to directors and officers of the Company to the maximum extent permitted
under the laws of the State of California. The Company has issued guarantees in the form of
commercial letters of credit, of which there were $14.7 million outstanding at April 30, 2005, as
security for merchandise shipments from overseas. The duration of these indemnities, commitments
and guarantees varies, and in certain cases, is indefinite. The majority of these indemnities,
commitments and guarantees do not provide for any limitation of the maximum potential future
payments the Company could be obligated to make. The Company has not recorded any liability for
these indemnities, commitments and guarantees in the accompanying consolidated balance sheets other
than as disclosed elsewhere in this quarterly report. 8. COMMON STOCK REPURCHASES During fiscal 2004, the Companys Board of Directors authorized the Company to repurchase up to
$125.0 million of the Companys common stock in open market transactions. All repurchase activity
conducted by the Company pursuant to this plan has been previously disclosed in the Companys
annual report on Form 10-K for the year ended January 29, 2005 and no additional repurchases were
made during the first quarter of fiscal 2005. At April 30, 2005, the maximum value of shares that
may yet be purchased under this plan is approximately $15.5 million. In May 2005, the Company announced that its Board of Directors had authorized the Company to
repurchase up to an additional $100.0 million of the Companys common stock in open market
transactions. There was no expiration date specified for this plan. During May 2005, the Company
made the following repurchases of shares subject to this plan: 9




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##### Table of Contents



Maximum# of Shares
    
    
    
    
    
    
    Value ofPurchased
    
    
    
    
    
    
    Shares thatAverage
    
    
    as Part of
    

    
    
    
    
    
    May Yet bePrice
    
    
    Publicly
    
    
    Value of
    
    
    Purchased# of Shares
    
    
    Paid Per
    
    
    Announced
    
    
    Shares
    
    
    Under thePeriod
    
    Purchased
    
    
    Share
    
    
    Plan
    
    
    Purchased
    
    
    Plan$
    115,499May 2005
    
    
    490,000
    
    
    $
    21.26
    
    
    
    490,000
    
    
    $
    10,415
    
    
    $
    105,084
 9. NET INCOME PER SHARE, BASIC AND DILUTED The following table summarizes the computation of earnings per share (EPS): First Quarter EndedApril 30, 2005
    
    
    May 1, 2004Net Income
    
    
    Shares
    
    
    EPS
    
    
    Net Income
    
    
    Shares
    
    
    EPSBasic EPS:
    
    $
    17,607
    
    
    
    75,292,587
    
    
    $
    0.23
    
    
    $
    14,969
    
    
    
    78,157,771
    
    
    $
    0.19Diluted EPS:Effect of dilutive stock options
    
    
    
    
    
    
    1,286,672
    
    
    
    (0.00
    )
    
    
    
    
    
    
    1,988,373
    
    
    
    (0.00
    )$
    17,607
    
    
    
    76,579,259
    
    
    $
    0.23
    
    
    $
    14,969
    
    
    
    80,146,144
    
    
    $
    0.19
 Options to purchase 533,835 and 735,152 shares of common stock in the first quarter of fiscal 2005
and fiscal 2004, respectively, were not included in the computation of diluted earnings per share
because the option exercise price was greater than the average market price of the Companys common
stock. 10




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##### Table of Contents



ITEM 2  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
CONSOLIDATED OPERATIONS The following managements discussion and analysis of financial condition and results of operations
(MD&A) should be read in conjunction with the condensed consolidated financial statements and
notes thereto of the Company included elsewhere in this Form 10-Q. As discussed in Note 3 to the
condensed consolidated financial statements included at Item 1, the fiscal 2004 financial
statements have been restated for the effects of an error in our accounting for leases. This MD&A
gives effect to the restatement. Cautionary Note Regarding Forward-Looking Statements This report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Exchange Act, and we intend that such
forward-looking statements be subject to the safe harbors created thereby. We are hereby providing
cautionary statements identifying important factors that could cause our actual results to differ
materially from those projected in forward-looking statements of the Company herein. Any
statements that express, or involve discussions as to, expectations, beliefs, plans, objectives,
assumptions, future events or performance (often, but not always through the use of words or
phrases such as will result, expects to, will continue, anticipates, plans, intends,
estimated, projects and outlook) are not historical facts and may be forward-looking and,
accordingly, such statements involve estimates, assumptions and uncertainties which could cause
actual results to differ materially from those expressed in the forward-looking statements. All
forward-looking statements included in this report, including forecasts of fiscal 2005 planned new
store openings and capital expenditures, are based on information available to us as of the date
hereof, and we do not intend, or assume any obligation, to update or revise any such
forward-looking statements to reflect events or circumstances that occur after such statements are
made. See Risk Factors within this section. Executive Overview We consider the following items to be key performance indicators in evaluating Company performance: Comparable (or same store) sales Stores are deemed comparable stores on the first day of the
month following the one-year anniversary of their opening or expansion/relocation. We consider
same store sales to be an important indicator of current Company performance. Same store sales
results are important in achieving operating leverage of certain expenses such as store payroll,
store occupancy, depreciation, general and administrative expenses, and other costs that are
somewhat fixed. Positive same store sales results generate greater operating leverage of expenses
while negative same store sales results negatively impact operating leverage. Same store sales
results also have a direct impact on our total net sales, cash, and working capital. Net merchandise margins We analyze the components of net merchandise margins, specifically
initial markup and markdowns as a percentage of net sales. Any inability to obtain acceptable
levels of initial markups or any significant increase in our use of markdowns could have an adverse
impact on our gross margin results and results of operations. Operating margin We view operating margin as a key indicator of our success. The key drivers of
operating margins are comparable store net sales, net merchandise margins, and our ability to
control operating expenses. Operating margin as a percentage of net sales for fiscal 2004, 2003
and 2002, was 13.8%, 12.3% and 9.6%, respectively. The 13.8% operating margin result for fiscal
2004 was our highest historical annual operating margin. Operating margin as a percentage of sales
for each of the first quarters of fiscal 2005 and 2004 was 9.7% and 9.6%, respectively. For a
discussion of the changes in the components comprising operating margins, see Results of
Operations in this section. Store sales trends We evaluate store sales trends in assessing the operational performance of our
store expansion strategies. Important store sales trends include average net sales per store and
average net sales per square foot. Average net sales per store (in thousands) for fiscal 2004,
2003 and 2002 were $1,290, $1,229 and $1,102, respectively. Average net sales per square foot were
$374, $363 and $330, respectively. Cash flow and liquidity (working capital) We evaluate cash flow from operations, liquidity and
working capital to determine our short-term operational financing needs. Cash flows from
operations for fiscal 2004, 2003 and 2002 were $143,012, $161,004 and $89,488, respectively. We
expect cash flows from operations will be sufficient to finance operations without borrowing under
our credit facility during fiscal 2005. 11




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##### Table of Contents



Critical Accounting Policies The preparation of consolidated financial statements in conformity with accounting principles
generally accepted in the United States of America necessarily requires us to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements as well as the reported
revenues and expenses during the reported period. Actual results could differ from these
estimates. The accounting policies that we believe are the most critical to aid in fully
understanding and evaluating reported financial results include the following: Revenue Recognition Sales are recognized upon purchase by customers at our retail store locations
or upon delivery to and acceptance by the customer for orders placed through our website. We
accrue for estimated sales returns by customers based on historical sales return results. Actual
return rates have historically been within our expectations and the reserves established. However,
in the event that the actual rate of sales returns by customers increased significantly, our
operational results could be adversely affected. We record the sale of gift cards as a current
liability and recognize a sale when a customer redeems a gift card. The amount of the gift card
liability is determined taking into account our estimate of the portion of gift cards that will not
be redeemed or recovered. Inventory Valuation Merchandise inventories are stated at the lower of cost (first-in, first-out
method) or market. Cost is determined using the retail inventory method. At any one time,
inventories include items that have been marked down to managements best estimate of their fair
market value. We base the decision to mark down merchandise primarily upon its current rate of
sale and the age of the item, among other factors. To the extent that our estimates differ from
actual results, additional markdowns may have to be recorded, which could reduce our gross margins
and operating results. Store Operating Lease Accounting Rent expense from store operating leases represents one of the
largest expenses incurred in operating our stores. We account for store 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 our 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. We
capitalize rent expense incurred during the build-out period of our stores as a component cost of
construction and amortize this amount over the life of the related stores lease term once
construction has completed, generally upon the commencement of store operations. The Company
accounts for landlord allowances received in connection with store operating leases in accordance
with SFAS 13, Accounting for Leases, and FASB Technical Bulletin 88-1, Issues Relating to
Accounting for Leases. Accordingly, all amounts received from landlords to fund tenant
improvements are recorded as a deferred lease incentive liability, which is then amortized as a
credit to rent expense over the related stores lease term. Evaluation of Long-Lived Assets In the normal course of business, we acquire tangible and
intangible assets. We periodically evaluate the recoverability of the carrying amount of our
long-lived assets (including property, plant and equipment, and other intangible assets) whenever
events or changes in circumstances indicate that the carrying amount of an asset may not be fully
recoverable. Impairment is assessed when the undiscounted expected future cash flows derived from
an asset or asset group are less than its carrying amount. Impairments are recognized in operating
earnings. We use our best judgment based on the most current facts and circumstances surrounding
our business when applying these impairment rules to determine the timing of the impairment test,
the undiscounted cash flows used to assess impairments, and the fair value of a potentially
impaired asset. Changes in assumptions used could have a significant impact on our assessment of
recoverability. Numerous factors, including changes in our business, industry segment, and the
global economy, could significantly impact our decision to retain, dispose of, or idle certain of
our long-lived assets. Evaluation of Insurance Reserves We are responsible for workers compensation insurance claims up
to a specified aggregate stop loss amount. We maintain a reserve for estimated claims, both
reported and incurred but not reported, based on historical claims experience and other estimated
assumptions. Actual claims activity has historically been within our expectations and the reserves
established. To the extent claims experience or our estimates change, additional charges may be
recorded in the future up to the aggregate stop loss amount for each policy year. Evaluation of Sublease Loss Charges We remain liable under an operating lease covering a former
store location. At each quarterly reporting period, we update our sublease income assumptions
based on our review of current real estate market conditions and any on-going negotiations. To the
extent our previous estimates relating to our ability to sublease these facilities at the assumed
rates or within the assumed timeframes changes or is incorrect, additional charges or reversals of
previous charges may be recorded in the future (see Note 5 to the condensed consolidated financial
statements). 12




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##### Table of Contents



Evaluation of Income Taxes Current income tax expense is the amount of income taxes expected to
be payable for the current reporting period. The combined federal and state income tax expense was
calculated using estimated effective annual tax rates. A deferred income tax asset or liability is
established for the expected future consequences of temporary differences in the financial
reporting and tax bases of assets and liabilities. We consider future taxable income and ongoing
prudent and feasible tax planning in assessing the value of our deferred tax assets. Evaluating
the value of these assets is necessarily based on our judgment. If we determine that it is more
likely than not that these assets will not be realized, we would reduce the value of these assets
to their expected realizable value through a valuation allowance, thereby decreasing net income.
If we subsequently determined that the deferred tax assets, which had been written down, would be
realized in the future, the value of the deferred tax assets would be increased, thereby increasing
net income in the period when that determination was made. Evaluation of Litigation Matters We are involved from time to time in litigation incidental to
our business. We believe that the outcome of current litigation will not likely have a material
adverse effect on our results of operations or financial condition and, from time to time, may make
provisions for probable litigation losses. Depending on the actual outcome of pending litigation,
charges in excess of any provisions could be recorded in the future, which may have an adverse
effect on our operating results. Results of Operations The following table sets forth selected income statement data of the Company expressed as a
percentage of net sales for the periods indicated. The discussion that follows should be read in
conjunction with this table: First Quarter EndedApril 30, 2005
    
    
    May 1, 2004Net sales
    
    
    100.0
    %
    
    
    100.0
    %Cost of goods sold (including buying,
distribution and occupancy costs)
    
    
    65.2
    
    
    
    64.9Gross margin
    
    
    34.8
    
    
    
    35.1Selling, general and administrative expenses
    
    
    25.0
    
    
    
    25.5Operating income
    
    
    9.7
    
    
    
    9.6Interest income, net
    
    
    0.4
    
    
    
    0.2Income before income tax expense
    
    
    10.1
    
    
    
    9.8Income tax expense
    
    
    3.8
    
    
    
    3.7Net income
    
    
    6.3
    %
    
    
    6.1
    %
 The following table sets forth the Companys number of stores and total square footage as of the
dates indicated: April 30, 2005
    
    
    May 1, 2004PacSun stores
    
    
    754
    
    
    
    689Outlet stores
    
    
    86
    
    
    
    81d.e.m.o. stores
    
    
    173
    
    
    
    137Total stores
    
    
    1,013
    
    
    
    907Square footage (in 000s)
    
    
    3,548
    
    
    
    3,117
 The first quarter (thirteen weeks) ended April 30, 2005 as compared to the first quarter
(thirteen weeks) ended May 1, 2004 Net Sales Net sales increased to $280.0 million for the first quarter of fiscal 2005 from $245.5 million for
the first quarter of fiscal 2004, an increase of $34.5 million, or 14.1%. The components of this
$34.5 million increase in net sales are as follows: 13




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##### Table of Contents



Amount($million)
    
    
    Attributable to$23.4
    
    
    Net sales from stores opened in fiscal 2004 not yet included in the comparable store base6.8
    
    
    3.0% increase in comparable store net sales in the first quarter of fiscal 2005 compared to
the first quarter of fiscal 20043.2
    
    
    Other non-comparable sales (net sales from expanded or relocated stores not yet included in
the comparable store base and internet net sales)2.1
    
    
    27 new stores opened in fiscal 2005 not yet included in the comparable store base(1.0)
    
    
    4 closed stores in fiscal 2005 and 5 closed stores in fiscal 2004$34.5
    
    
    Total
 Of the 3.0% increase in comparable store net sales in the first quarter of fiscal 2005, PacSun and
PacSun Outlet comparable store net sales increased a combined 3.0% and d.e.m.o. comparable store
net sales increased 3.2%. The average sale transaction in a comparable store was up approximately
6%, driven by an approximately 8% increase in average retail prices. The increases in average
retail prices were primarily due to changes in sales mix towards higher priced merchandise,
primarily jeans, in relation to other merchandise. Total transactions per comparable store were
down approximately 3%. Within PacSun and PacSun Outlet, comparable store net sales of guys and girls merchandise
increased 4.0% and 1.8%, respectively. Guys comparable store net sales results were characterized
by strength in sneakers and denim, partially offset by weakness in accessories and shorts. Girls
comparable store net sales results were characterized by strength in denim and skirts, partially
offset by weakness in casual pants, shorts and tees. Within d.e.m.o., comparable store net sales of girls merchandise increased 19.9% while guys
merchandise decreased 9.1%. Girls comparable store net sales results were characterized by
strength in denim, wovens and knits. Guys comparable store net sales results were characterized
by weakness in tees, active hookups, and knits, partially offset by strength in wovens and denim. Gross Margin Gross margin, after buying, distribution and occupancy costs, increased to $97.4 million for the
first quarter of fiscal 2005 from $86.2 million for the first quarter of fiscal 2004, an increase
of $11.2 million, or 13.0%. As a percentage of net sales, gross margin was 34.8% for the first
quarter of fiscal 2005 compared to 35.1% for the first quarter of fiscal 2004. The 0.3% decrease
in gross margin as a percentage of net sales was primarily attributable to increases in occupancy
expenses as a percentage of net sales due to a true-up of expenses
with a service provider related to a multi-year computer maintenance
contract as well as opening 23 net new stores in the first quarter of
fiscal 2005 and the residual impact of opening 113 net new stores during fiscal 2004. Occupancy
costs as a percentage of net sales for new stores are generally higher than for mature stores. Selling, General and Administrative Expenses Selling, general and administrative expenses increased to $70.1 million for the first quarter of
fiscal 2005, up from $62.6 million for the first quarter of fiscal 2004, an increase of $7.5
million, or 12.0%. These expenses decreased to 25.0% as a percentage of net sales in the first
quarter of fiscal 2005 from 25.5% in the first quarter of fiscal 2004. The components of this 0.5%
net decrease in selling, general and administrative expenses as a percentage of net sales were as
follows: 14




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##### Table of Contents



%
    
    
    Attributable to(0.5
    )%
    
    Decrease in store payroll expenses as a percentage of net sales to 12.3% ($34.4 million) for the
first quarter of fiscal 2005 from 12.8% ($31.5 million) for the first quarter of fiscal 2004,
primarily due to more efficient management of these expenses. The increase in absolute dollars
was primarily attributable to the addition of 113 net new stores during fiscal 2004 and 23 net
new stores during the first quarter of fiscal 2005.(0.4
    )%
    
    Decrease in store closing expenses to $0.5 million for the first quarter of fiscal 2005 as compared
to $1.4 million for the first quarter of fiscal 2004, primarily due to the execution of two subleases
related to our former Manhattan store location and the execution of a lease termination
agreement during the second quarter of fiscal 2004 related to our former corporate offices.0.2

%
    
    Increase in advertising expenses as a percentage of net sales to 1.3% ($3.8 million) for the first
quarter of fiscal 2005 from 1.1% ($2.7 million) for the first quarter of fiscal 2004, primarily due
to the launch of the new d.e.m.o. advertising campaign.0.2

%
    
    Increase in general and administrative expenses as a percentage of net sales to 5.7% ($16.0
million) for the first quarter of fiscal 2005 from 5.5% ($13.6 million) for the first quarter of
fiscal 2004, primarily due to higher corporate payroll expenses as a result of increased
headcount.(0.5

)%
    
    Total
 Net Interest Income Net interest income was $1.1 million in the first quarter of fiscal 2005 compared to $0.5 million
in the first quarter of fiscal 2004, an increase of $0.6 million. This increase was primarily the
result of higher average cash and short-term investment balances as well as higher interest rates
in the first quarter of fiscal 2005 as compared to the first quarter of fiscal 2004. Income Tax Expense Income tax expense was $10.7 million for the first quarter of fiscal 2005 compared to $9.1 million
for the first quarter of fiscal 2004. The effective income tax rate was 37.8% in the first quarter
of each of fiscal 2005 and fiscal 2004. Our weighted effective state income tax rate will vary
over time depending on a number of factors, such as differing income tax rates and net incomes in
the respective states. Liquidity and Capital Resources We have historically financed our operations from internally generated cash flow, with occasional
short-term and long-term borrowings and equity financing in past years. Our primary capital
requirements have been for the construction of newly opened, remodeled, expanded or relocated
stores, the financing of working capital increases and, in the past, construction of corporate
facilities. We believe that our invested cash and cash equivalents, cash flows from operating
activities and revolving credit facility will be sufficient to meet our operating and capital
expenditure requirements for fiscal 2005. Operating Cash Flows Net cash provided by operating activities was $33.6 million for the first quarter of fiscal 2005
compared to $5.8 million for the first quarter of fiscal 2004. The $27.8 million increase in cash
provided by operations in the first quarter of fiscal 2005 as compared to the first quarter of
fiscal 2004 was attributable to the following: 15




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##### Table of Contents



Amount($million)
    
    
    Attributable to$14.3
    
    
    Increase in cash flows from other current liabilities, including $7.4 million from income
taxes, $5.9 million from accrued payroll and $1.0 million in all other current liabilities.
Cash payments for income taxes were lower primarily due to the timing of fiscal 2004
estimated income tax payments in relation to the actual income tax liability as compared
to the same items for fiscal 2003. Cash payments for payroll were lower in the first
quarter of fiscal 2005 as compared to the first quarter of fiscal 2004, primarily due to the
settlement of a litigation matter in the prior year, which resulted in a $4.0 million cash
payment during the first quarter of fiscal 2004. Annual bonus payments were also lower
in the first quarter of fiscal 2005 as compared to that for the first quarter of fiscal 2004.3.7
    
    
    Increase in cash flows from inventory, net of accounts payable, primarily due to lower
inventory per square foot in our stores.3.1
    
    
    Increase in depreciation expense, primarily due to the addition of 113 net new stores
during fiscal 2004 and 23 net new stores during the first quarter of fiscal 2005.2.6
    
    
    Increase in net income.2.5
    
    
    Increase in cash flows from deferred lease incentives, primarily due to receiving larger
landlord allowances on the 23 net new stores opened in the first quarter of fiscal 2005 as
compared to amounts received related to new stores opened during the first quarter of
fiscal 2004.1.6
    
    
    Other items netting to an increase in cash provided by operating activities.$27.8
    
    
    Total
 Working Capital Working capital at April 30, 2005 was $282.0 million compared to $257.5 million at January 29,
2005, an increase of $24.5 million. The changes in working capital were as follows: Amount($million)
    
    
    Description$257.5
    
    
    Working capital at January 29, 200517.9
    
    
    Increase in cash and marketable securities, primarily due to cash provided by operations.5.2
    
    
    Decrease in accounts payable, primarily due to timing of payments.4.4
    
    
    Decrease in other accrued liabilities.(3.0)
    
    
    Decrease in merchandise inventories.$282.0
    
    
    Working capital at April 30, 2005
 Investing Cash Flows Net cash used in investing activities in the first quarter of fiscal 2005 was $23.9 million
compared to $29.7 million for the first quarter of fiscal 2004, a decrease in cash used of $5.8
million. Of the $23.9 million in net cash used in investing activities for the first quarter of
fiscal 2005, $21.6 million was attributable to capital expenditures and $2.3 million was
attributable to net purchases of marketable securities. Capital expenditures for the first quarter
of fiscal 2005 were categorized as follows: Amount($million)
    
    
    Attributable to(17.9)
    
    
    Construction costs of new, expanded and relocated stores(2.0)
    
    
    Capital expenditure improvements on existing stores(1.7)
    
    
    Other capital expenditures, including computer hardware and software$(21.6)
    
    
    Total
 In the remainder of fiscal 2005, capital expenditures are expected to be approximately $70-75
million, of which approximately $65-70 million will be for opening new and relocated/expanded
stores, and approximately $5 million will be used for other capital expenditures, including
maintenance capital on existing stores and computer hardware and software. We plan to purchase additional land and begin construction of a new, additional corporate office
and a new, additional distribution center at any time before the end of fiscal 2007. We have
initiated planning efforts to assess these future needs. 16




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##### Table of Contents



Costs of this future construction are currently unknown. Costs to construct our current corporate
offices and distribution center were approximately $52 million and were incurred during fiscal 2000
and fiscal 2001. Financing Cash Flows Net cash provided by financing activities in the first quarter of fiscal 2005 was $5.9 million
compared to cash used of $38.0 million for the first quarter of fiscal 2004. The components of the
$5.9 million of net cash provided by financing activities in the first quarter of fiscal 2005 were
proceeds from employee exercises of stock options of $6.4 million, partially offset by $0.5 million
in repayments made pursuant to capital lease and long-term debt obligations. Prior year uses of
cash included $42.9 million in common stock repurchases. Information regarding the Companys
common stock repurchase program is contained in Note 8 to the condensed consolidated financial
statements, which note is incorporated herein by this reference. Credit Facility We have a credit facility with a bank, which expires April 1, 2007. The credit facility provides
for a $45.0 million line of credit (the Credit Line) through March 31, 2005 to be used for cash
advances, commercial letters of credit and shipside bonds. The Credit Line increases to $50.0
million from April 1, 2005 through March 31, 2006, and $60.0 million from April 1, 2006 through
expiration on April 1, 2007. Interest on the Credit Line is payable monthly at the banks prime
rate (5.75% at April 30, 2005) or at optional interest rates that are primarily dependent upon the
London Inter-bank Offered Rates for the time period chosen. We did not borrow under the credit
facility at any time during fiscal 2005 or 2004. We had $14.7 million outstanding in
letters of credit at April 30, 2005. The credit facility subjects us to various restrictive
covenants, including maintenance of certain financial ratios, and prohibits payment of cash
dividends on common stock. At April 30, 2005, we were in compliance with all of the credit
facility covenants. A significant decrease in our operating results could adversely affect our ability to maintain the
required financial ratios under our credit facility. Required financial ratios include total
liabilities to tangible net worth, limitations on capital expenditures and achievement of certain
rolling four-quarter EBITDA (earnings before interest, taxes, depreciation and amortization)
requirements. If these financial ratios are not maintained, the bank will have the option to
require immediate repayment of all amounts outstanding under the credit facility, if any. The
alternatives available to the Company if in default of its covenants are to renegotiate certain
terms of the credit agreement, obtain a waiver from the bank, or obtain a new credit agreement with
another bank, which may contain different terms. At April 30, 2005, we had no borrowings
outstanding under our credit facility. Contractual Obligations We have minimum annual rental commitments under existing store leases and capital leases for
computer equipment as of April 30, 2005. Our financial obligations under these arrangements are
approximately $95 million in fiscal 2005 and similar amounts annually thereafter. We lease all of
our retail store locations under operating leases. We lease equipment, from time to time, under
capital leases. In addition, at any time, we are contingently liable for commercial letters of
credit with foreign suppliers of merchandise. At April 30, 2005, our future financial commitments
under these arrangements were as follows: Payments Due by PeriodContractual Obligations
    
    
    
    
    
    
    
    Less than
    
    
    
    
    
    
    
    
    
    
    
    
    
    More than(in millions)
    
    
    Total
    
    
    
    1 year
    
    
    
    1-3 years
    
    
    
    3-5 years
    
    
    
    5 yearsOperating lease obligations
    
    
    $
    678.7
    
    
    
    $
    92.9
    
    
    
    $
    186.1
    
    
    
    $
    170.4
    
    
    
    $
    229.3Capital lease obligations
    
    
    
    1.4
    
    
    
    
    1.2
    
    
    
    
    0.2
    
    
    
    
    
    
    
    
    
    Letters of credit
    
    
    
    14.7
    
    
    
    
    14.7
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    $
    694.8
    
    
    
    $
    108.8
    
    
    
    $
    186.3
    
    
    
    $
    170.4
    
    
    
    $
    229.3
 The contractual obligations table above does not include common area maintenance (CAM) charges,
which are also a required contractual obligation under our store operating leases. In many of our
leases, CAM charges are not fixed and can fluctuate significantly from year to year for any
particular store. Total store rental expenses, including CAM for fiscal 2004, 2003 and 2002 were
$141.4 million, $121.6 million, and $111.3 million, respectively. We expect total CAM expenses to
continue to increase as the number of stores increases from year to year. Operating Leases  We lease our retail stores and certain equipment under operating lease
agreements expiring at various dates through December 2018. Substantially all of our retail store
leases require us to pay CAM charges, insurance, property taxes and percentage rent ranging from 5%
to 7% based on sales volumes exceeding certain minimum sales levels. The initial terms of such
leases are typically 8 to 10 years, many of which contain renewal options exercisable at our
discretion. Most leases also contain rent escalation clauses that come into effect at various
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the straight-line method over the initial term of the lease. Other rent escalation clauses can
take effect based on changes in primary mall tenants throughout the term of a given lease. Most
leases also contain cancellation or kick-out clauses in our favor that relieve us of any future
obligation under a lease if specified sales levels are not achieved by a specified date. None of
our retail store leases contain purchase options. We review the operating performance of our stores on an ongoing basis to determine which stores, if
any, to expand, relocate or close. We closed five stores in fiscal 2004 and anticipate closing
approximately ten stores in fiscal 2005. New Accounting Pronouncements Information regarding new accounting pronouncements is contained in Note 2 to the condensed
consolidated financial statements for the quarter ended April 30, 2005, which note is incorporated
herein by this reference. Inflation We do not believe that inflation has had a material effect on the results of operations in the
recent past. There can be no assurance that our business will not be affected by inflation in the
future. Seasonality and Quarterly Results Our business is seasonal by nature, with the Christmas and back-to-school periods historically
accounting for the largest percentage of annual net sales. Our first quarter historically accounts
for the smallest percentage of annual net sales with each successive quarter contributing a greater
percentage than the last. In each of fiscal 2004 and fiscal 2003, excluding sales generated by new
and relocated/expanded stores, the Christmas and back-to-school periods together accounted for
approximately 30% of our annual net sales and a higher percentage of our operating income. In
fiscal 2004, excluding net sales generated by new and relocated/expanded stores, approximately 44%
of our annual net sales occurred in the first half of the fiscal year and approximately 56% in the
second half. These results are consistent with prior years. Our quarterly results of operations
may also fluctuate significantly as a result of a variety of factors, including the timing of store
openings; the amount of revenue contributed by new stores; the timing and level of markdowns; the
timing of store closings, expansions and relocations; competitive factors; and general economic
conditions. Risk Factors The products we sell are subject to significant merchandising/fashion sensitivity.Our success is
largely dependent upon our ability to gauge the fashion tastes of our customers and to provide
merchandise at competitive prices and in adequate quantities that satisfies customer demand in a
timely manner. Our failure to anticipate, identify or react appropriately in a timely manner to
changes in fashion trends could have a material adverse effect on our same store sales results,
operating margins, financial condition and results of operations. Misjudgments or unanticipated
fashion changes could also have a material adverse effect on our image with our customers. Some of
our vendors have limited resources, production capacities and operating histories and some have
intentionally limited the distribution of their merchandise. The inability or unwillingness on the
part of key vendors to expand their operations to keep pace with the anticipated growth of PacSun,
PacSun Outlet and d.e.m.o. stores, or the loss of one or more key vendors or proprietary brand
sources for any reason, could have a material adverse effect on our business. We may not be able to manage our planned expansion effectively.Our continued growth depends to a
significant degree on our ability to open and operate stores on a profitable basis and to manage
our planned expansion. There can be no assurance that we will achieve our planned expansion, that
such expansion will be profitable, or that we will be able to manage our growth effectively. Our
planned expansion is dependent upon a number of factors, including our ability to locate and obtain
favorable store sites, negotiate acceptable lease terms, obtain adequate supplies of merchandise
and hire and train qualified management level and other employees. Factors beyond our control may
also affect our ability to expand, including general economic and business conditions affecting
consumer spending. Any failure to manage growth could have a material adverse effect on our
business, financial condition and results of operations. We plan to launch a new retail concept, which could negatively effect existing operations.We have
announced plans to launch a new retail store concept that will commence operations during fiscal
2006. We are currently in the preliminary planning stage regarding store design, merchandise
selection and site selection for this new concept. Our ability to make this new retail concept
successful is subject to numerous risks, including, but not limited to, (i) unanticipated operating
problems, (ii) lack of customer acceptance, (iii) new vendor relationships, (iv) competition from
existing and new retailers, and (v) lack of sufficient product differentiation. There can be no
assurance that this new retail concept will achieve sales and profitability levels that justify the
Companys investment in it. Additionally, the expansion of this new retail concept involves other
risks that could have 18




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a material adverse effect on the Company, including, but not limited to, (i) diversion of
managements attention from the Companys core businesses, (ii) inability to attract, train and
retain qualified personnel, including management and product designers, and (iii) difficulty in
locating and obtaining favorable store sites and negotiating acceptable lease terms. Any inability
to succeed in developing a profitable new retail concept could have a material adverse effect on
our continued growth and results of operations. Our customers may not accept our proprietary brand merchandise.Sales from proprietary brand
merchandise accounted for approximately 30%, 32% and 33% of net sales in fiscal 2004, 2003 and
2002, respectively. We may increase the percentage of net sales in proprietary brand merchandise
in the future, although there can be no assurance that we will be able to achieve increases in
proprietary brand merchandise sales as a percentage of net sales. Because our proprietary brand
merchandise generally carries higher merchandise margins than our other merchandise, our failure to
anticipate, identify and react in a timely manner to fashion trends with our proprietary brand
merchandise, particularly if the percentage of net sales derived from proprietary brand merchandise
increases, may have a material adverse effect on our same store sales results, operating margins,
financial condition and results of operations. Our comparable store net sales results can fluctuate significantly.Our comparable store net sales
results have fluctuated significantly on a monthly, quarterly, and annual basis, and are expected
to continue to fluctuate in the future. A variety of factors affect our comparable store net sales
results, including changes in fashion trends, changes in our merchandise mix, calendar shifts of
holiday periods, actions by competitors, weather conditions and general economic conditions. Our
comparable store net sales results for any particular future fiscal month, quarter or year may
decrease. As a result of these or other factors, our future comparable store net sales results are
likely to have a significant effect on the market price of our common stock. We could lose key personnel at any time.Our continued success is dependent to a significant
degree upon the services of our key personnel, particularly our executive officers. The loss of
the services of any member of our senior management team could have a material adverse effect on
our business, financial condition and results of operations. Our success in the future will also
be dependent upon our ability to attract and retain qualified personnel. Our inability to attract
and retain qualified personnel in the future could have a material adverse effect on our business,
financial condition and results of operations. Our dependence on a single distribution facility exposes us to significant operational risks.Our
distribution functions for all of our stores and for internet sales are handled from a single
facility in Anaheim, California. Any significant interruption in the operation of the distribution
facility due to natural disasters, accidents, system failures or other unforeseen causes would have
a material adverse effect on our business, financial condition and results of operations. There
can be no assurance that our current corporate office and distribution center will be adequate to
support our future growth. Selling merchandise over the internet carries particular risks that can distract attention from our
core businesses. Our internet operations are subject to numerous risks that could have a material
adverse effect on our operational results, including unanticipated operating problems, reliance on
third party computer hardware and software providers, system failures and the need to invest in
additional computer systems. Specific risks include: (i) diversion of sales from our stores; (ii)
rapid technological change; (iii) liability for online content; and (iv) risks related to the
failure of the computer systems that operate the website and its related support systems, including
computer viruses, telecommunication failures and electronic break-ins and similar disruptions. In
addition, internet operations involve risks which are beyond our control that could have a material
adverse effect on our operational results, including: (i) price competition involving the items we
intend to sell; (ii) the entry of our vendors into the internet business, in direct competition
with us; (iii) the level of merchandise returns experienced by us; (iv) governmental regulation;
(v) online security breaches involving unauthorized access to Company and/or customer information;
(vi) credit card fraud; and (vii) competition and general economic conditions specific to the
internet, online commerce and the apparel industry. Any terrorist attacks or war/threat of war could significantly affect consumer spending.The
majority of our stores are located in regional shopping malls. Any threat of terrorist attacks or
actual terrorist events, particularly in public areas, could lead to lower customer traffic in
regional shopping malls. In addition, local authorities or mall management could close regional
shopping malls in response to any immediate security concern. Mall closures, as well as lower
customer traffic due to security concerns, could result in decreased sales. Additionally, war or
the threat of war could significantly diminish consumer spending, resulting in decreased sales for
the Company. Decreased sales would have a material adverse effect on our business, financial
condition and results of operations. Our foreign sources of production may not always be reliable.We purchase merchandise directly in
foreign markets for our proprietary brands. In addition, we purchase merchandise from domestic
vendors, some of which is manufactured overseas. We do not have any long-term merchandise supply
contracts and our imports are subject to existing or potential duties, tariffs and quotas. We face
competition from other companies for production facilities and import quota capacity. We also face
a variety of other risks generally associated with doing business in foreign markets and importing
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political instability; (ii) enhanced security measures at United States ports, which could delay
delivery of imports; (iii) imposition of new legislation relating to import quotas that may limit
the quantity of goods which may be imported into the United States from countries in a region
within which we do business; (iv) imposition of duties, taxes, and other charges on imports; (v)
delayed receipt or non-delivery of goods due to the failure of foreign-source suppliers to comply
with applicable import regulations; (vi) delayed receipt or non-delivery of goods due to organized
labor strikes or unexpected or significant port congestion at United States ports; and (vii) local
business practice and political issues, including issues relating to compliance with domestic or
international labor standards which may result in adverse publicity. New initiatives may be
proposed that may have an impact on the trading status of certain countries and may include
retaliatory duties or other trade sanctions that, if enacted, would increase the cost of products
purchased from suppliers in countries that we do business with. Any inability on our part to rely
on our foreign sources of production due to any of the factors listed above could have a material
adverse effect on our business, financial condition and results of operations. Any failure by us to maintain credit facility financial covenants could have a material adverse
impact on our business.A significant decrease in our operating results could adversely affect our
ability to maintain required financial ratios under our credit facility. Required financial ratios
include a rolling four-quarter EBITDA requirement, total liabilities to tangible net worth ratio,
and limitations on capital expenditures. If these financial ratios are not maintained, the bank
will have the option to require immediate repayment of all amounts outstanding under the credit
facility, if any. The most likely result would require us to renegotiate certain terms of the
credit agreement, obtain a waiver from the bank, or obtain a new credit agreement with another
bank, which may contain different terms. The expensing of stock options will reduce our future reported earnings.The FASB has issued a new
accounting standard requiring all publicly traded companies to begin recording compensation expense
related to all unvested and newly granted stock options. This standard will go into effect for us
in fiscal 2006. Currently, we include such expenses on a pro forma basis in the notes to the
Companys quarterly and annual financial statements in accordance with accounting principles
generally accepted in the United States of America and do not include compensation expense related
to stock options in our reported earnings in the financial statements. Our reported earnings will
be lower under the new standard in fiscal 2006 and our stock price could decline as a result. Adverse outcomes of litigation matters could significantly affect our operational results.We are
involved from time to time in litigation incidental to our business. We believe that the outcome
of current litigation will not have a material adverse effect upon our results of operations or
financial condition. However, our assessment of current litigation could change in light of the
discovery of facts with respect to legal actions pending against us not presently known to us or
determinations by judges, juries or other finders of fact which do not accord with our evaluation
of the possible liability or outcome of such litigation. Our stock price can fluctuate significantly.The market price of our common stock has fluctuated
substantially in the past and there can be no assurance that the market price of the common stock
will not continue to fluctuate significantly. Future announcements or management discussions
concerning the Company or its competitors, net sales and profitability results, quarterly
variations in operating results or comparable store net sales, changes in earnings estimates by
analysts or changes in accounting policies, among other factors, could cause the market price of
the common stock to fluctuate substantially. In addition, stock markets have experienced extreme
price and volume volatility in recent years. This volatility has had a substantial effect on the
market prices of securities of many smaller public companies for reasons frequently unrelated to
the operating performance of the specific companies. ************* We caution that the risk factors described above could cause actual results or outcomes to differ
materially from those expressed in any forward-looking statements made by us or on behalf of the
Company. Further, we cannot assess the impact of each such factor on our business or the extent to
which any factor, or combination of factors, may cause actual results to differ materially from
those contained in anyforward-looking statements. 
 ITEM 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are susceptible to market value fluctuations with regard to our short-term investments.
However, due to the relatively short maturity period of those investments and our intention and
ability to hold those investments until maturity, the risk of material market value fluctuations is
not expected to be significant. To the extent we borrow under our credit facility, we are exposed to market risk related to changes
in interest rates. At April 30, 2005, there were no borrowings outstanding under our credit
facility and we did not borrow under the credit facility at any time during fiscal 2005 or 2004.
Based on the interest rate of 5.75% on our credit facility at April 30, 2005, if interest rates on
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credit facility were to increase by 10%, and to the extent borrowings were outstanding, for every
$1 million outstanding on our credit facility, net income would be reduced by approximately $3,600
per year. We are not a party with respect to derivative financial instruments. 
 ITEM 4 - CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including our principal
executive officer and principal financial officer, we conducted an evaluation of our disclosure
controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the
Securities Exchange Act of 1934, as amended (the Exchange Act). These disclosure controls and
procedures are designed to provide reasonable assurance that the information required to be
disclosed by the Company in its periodic reports filed with the Commission is recorded, processed,
summarized and reported within the time periods specified by the Commissions rules and forms.
Based on this evaluation, our principal executive officer and our principal financial officer
concluded that our disclosure controls and procedures were effective as of April 30, 2005. No change in our internal control over financial reporting occurred during the most recent fiscal
quarter that has materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting. 
 PART II-OTHER INFORMATION 
 Item 1 - Legal Proceedings For information on legal proceedings, see Litigation within Note 7 of Notes to Condensed
Consolidated Financial Statements, which is incorporated by reference in response to this Item 1. 
 Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds For information on repurchases made during fiscal 2005, see Note 8 of Notes to Condensed
Consolidated Financial Statements, which is incorporated by reference in response to this Item 2. 
 Item 3 - Defaults Upon Senior Securities- None 
 Item 4 - Submission of Matters to a Vote of Security Holders- None 
 Item 5 - Other Information- None 
 Item 6 - Exhibits Exhibit 31
    
    Written statements of Seth R. Johnson and Gerald M. Chaney pursuant to section 302 of
the Sarbanes-Oxley Act of 2002.Exhibit 32
    
    Written statement of Seth R. Johnson and Gerald M. Chaney pursuant to section 906 of
the Sarbanes-Oxley Act of 2002.
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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. Pacific Sunwear of California, Inc.(Registrant)Date:
June 1, 2005
    
    /s/ SETH R. JOHNSONSeth R. JohnsonDirector and Chief Executive Officer(Principal Executive Officer)Date:
June 1, 2005
    
    /s/ GERALD M. CHANEYGerald M. ChaneySenior Vice President, Chief Financial Officer(Principal Financial and Accounting Officer)
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EXHIBIT INDEX ExhibitNumber
    
    Description31
    
    Written statements of Seth R. Johnson and Gerald M. Chaney pursuant to section 302
of the Sarbanes-Oxley Act of 2002.32
    
    Written statement of Seth R. Johnson and Gerald M. Chaney pursuant to section 906
of the Sarbanes-Oxley Act of 2002.