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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549
 FORM 10-Q [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIESEXCHANGE ACT OF 1934
 For the quarterly period ended July 31, 2004 OR [  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIESEXCHANGE 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.)3450 East Miraloma Avenue
Anaheim, California
(Address of principal executive offices)
    
    92806
(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
[x]   No [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes
[x]   No [  ] The number of shares outstanding of the registrants Common Stock, par value
$.01 per share, at August 27, 2004, was 74,137,806.






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PACIFIC SUNWEAR OF CALIFORNIA, INC.
FORM 10-Q
For the Quarter Ended July 31, 2004 Index PagePART I. FINANCIAL INFORMATIONItem 1. Condensed Consolidated Financial Statements (unaudited):Condensed Consolidated Balance Sheets as of July 31, 2004 and January 31, 2004
    
    
    3Condensed Consolidated Statements of Income and Comprehensive Income for the second quarter and first half ended July 31, 2004 and August 2, 2003
    
    
    4Condensed Consolidated Statements of Cash Flows for the first half ended July 31, 2004 and August 2, 2003
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6-12Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13-25Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    25Item 4 Controls and Procedures
    
    
    25PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    26Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    26Item 3. Defaults Upon Senior Securities
    
    
    26Item 4. Submission of Matters to a Vote of Security Holders
    
    
    26Item 5. Other Information
    
    
    26Item 6. Exhibits and Reports on Form 8-K
    
    
    26-27SIGNATURE PAGE
    
    
    28EXHIBIT 3.1EXHIBIT 3.2EXHIBIT 10.1EXHIBIT 10.2EXHIBIT 10.3EXHIBIT 31EXHIBIT 32
  2




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PACIFIC SUNWEAR OF CALIFORNIA, INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (unaudited)
(in thousands, except share amounts)
 July 31,
    
    January 31,2004
    
    2004ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    34,544
    
    
    $
    142,840Short-term investments
    
    
    50,224
    
    
    
    33,035Accounts receivable
    
    
    7,164
    
    
    
    5,194Merchandise inventories
    
    
    213,833
    
    
    
    147,751Prepaid expenses, includes $11,179 and $10,711 of prepaid rent, respectively
    
    
    18,742
    
    
    
    16,492Deferred income taxes
    
    
    8,224
    
    
    
    8,224Total current assets
    
    
    332,731
    
    
    
    353,536PROPERTY AND EQUIPMENT:Land
    
    
    12,156
    
    
    
    12,156Buildings and building improvements
    
    
    26,691
    
    
    
    26,686Leasehold improvements
    
    
    128,605
    
    
    
    119,210Furniture, fixtures and equipment
    
    
    189,747
    
    
    
    173,222Total property and equipment
    
    
    357,199
    
    
    
    331,274Less accumulated depreciation and amortization
    
    
    (142,486
    )
    
    
    (127,630
    )Net property and equipment
    
    
    214,713
    
    
    
    203,644OTHER ASSETS:Goodwill
    
    
    6,492
    
    
    
    6,492Deferred compensation and other assets
    
    
    12,254
    
    
    
    11,589Total other assets
    
    
    18,746
    
    
    
    18,081Total assets
    
    $
    566,190
    
    
    $
    575,261LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    74,152
    
    
    $
    38,668Accrued liabilities
    
    
    41,517
    
    
    
    54,966Current portion of capital lease obligations
    
    
    1,307
    
    
    
    1,008Current portion of long-term debt
    
    
    674
    
    
    
    878Income taxes payable
    
    
    9,191
    
    
    
    15,024Total current liabilities
    
    
    126,841
    
    
    
    110,544LONG-TERM LIABILITIES:Long-term debt, net of current portion
    
    
    
    
    
    
    228Long-term capital lease obligations, net of current portion
    
    
    934
    
    
    
    1,227Deferred compensation
    
    
    12,062
    
    
    
    10,925Deferred rent
    
    
    11,960
    
    
    
    12,046Deferred income taxes
    
    
    11,529
    
    
    
    11,529Other long-term liabilities
    
    
    92
    
    
    
    Total long-term liabilities
    
    
    36,577
    
    
    
    35,955Commitments and contingencies (Note 8)SHAREHOLDERS EQUITY:Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued and
outstanding
    
    
    
    
    
    
    Common stock, $.01 par value; 170,859,375 shares authorized; 75,496,375 and
78,351,302 shares issued and outstanding, respectively
    
    
    755
    
    
    
    784Additional paid-in capital
    
    
    78,617
    
    
    
    138,877Retained earnings
    
    
    323,400
    
    
    
    289,101Total shareholders equity
    
    
    402,772
    
    
    
    428,762Total liabilities and shareholders equity
    
    $
    566,190
    
    
    $
    575,261
 See accompanying notes 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)
 For the Second Quarter Ended
    
    For the First Half EndedJuly 31, 2004
    
    August 2, 2003
    
    July 31, 2004
    
    August 2, 2003Net sales
    
    $
    274,797
    
    
    $
    234,392
    
    
    $
    519,928
    
    
    $
    432,723Cost of goods sold, including
buying, distribution and
occupancy costs
    
    
    179,977
    
    
    
    154,558
    
    
    
    341,537
    
    
    
    289,034Gross margin
    
    
    94,820
    
    
    
    79,834
    
    
    
    178,391
    
    
    
    143,689Selling, general and
administrative expenses
    
    
    64,061
    
    
    
    58,180
    
    
    
    124,011
    
    
    
    109,141Operating income
    
    
    30,759
    
    
    
    21,654
    
    
    
    54,380
    
    
    
    34,548Interest income, net
    
    
    316
    
    
    
    69
    
    
    
    773
    
    
    
    129Income before income tax expense
    
    
    31,075
    
    
    
    21,723
    
    
    
    55,153
    
    
    
    34,677Income tax expense
    
    
    11,750
    
    
    
    8,343
    
    
    
    20,854
    
    
    
    13,318Net income
    
    $
    19,325
    
    
    $
    13,380
    
    
    $
    34,299
    
    
    $
    21,359Comprehensive income
    
    $
    19,325
    
    
    $
    13,380
    
    
    $
    34,299
    
    
    $
    21,359Net income per share, basic
    
    $
    0.25
    
    
    $
    0.18
    
    
    $
    0.44
    
    
    $
    0.28Net income per share, diluted
    
    $
    0.25
    
    
    $
    0.17
    
    
    $
    0.43
    
    
    $
    0.28Weighted average shares
outstanding, basic
    
    
    76,322,161
    
    
    
    75,885,641
    
    
    
    77,239,966
    
    
    
    75,205,094Weighted average shares
outstanding, diluted
    
    
    77,911,595
    
    
    
    78,104,037
    
    
    
    79,035,717
    
    
    
    77,331,519
 See accompanying notes 4




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PACIFIC SUNWEAR OF
CALIFORNIA, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (unaudited)
(in thousands)
 For the First Half EndedJuly 31, 2004
    
    August 2, 2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    34,299
    
    
    $
    21,359Adjustments to reconcile net income to net cash provided by operating
activities:Depreciation and amortization
    
    
    19,395
    
    
    
    17,752Loss on disposal of equipment
    
    
    2,191
    
    
    
    1,085Tax benefits related to exercise of stock options
    
    
    2,906
    
    
    
    10,127Change in operating assets and liabilities:Accounts receivable
    
    
    (1,970
    )
    
    
    (1,442
    )Merchandise inventories
    
    
    (66,082
    )
    
    
    (62,600
    )Prepaid expenses
    
    
    (2,250
    )
    
    
    (1,526
    )Deferred compensation and other assets
    
    
    472
    
    
    
    2,774Accounts payable
    
    
    35,484
    
    
    
    45,688Accrued liabilities
    
    
    (11,362
    )
    
    
    (992
    )Income taxes payable and deferred income taxes
    
    
    (5,833
    )
    
    
    (10,708
    )Deferred rent
    
    
    (86
    )
    
    
    855Other long-term liabilities
    
    
    92
    
    
    
    Net cash provided by operating activities
    
    
    7,256
    
    
    
    22,372CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property and equipment
    
    
    (32,149
    )
    
    
    (18,603
    )Increase in accrued capital expenditures
    
    
    2,766
    
    
    
    2,303Purchases of short-term investments
    
    
    (19,829
    )
    
    
    Maturities of short-term investments
    
    
    2,640
    
    
    
    Net cash used in investing activities
    
    
    (46,572
    )
    
    
    (16,300
    )CASH FLOWS FROM FINANCING ACTIVITIES:Repurchases of common stock
    
    
    (74,931
    )
    
    
    Proceeds from exercise of stock options
    
    
    6,883
    
    
    
    21,503Principal payments under capital lease obligations
    
    
    (500
    )
    
    
    (771
    )Principal payments under long-term debt obligations
    
    
    (432
    )
    
    
    (406
    )Net cash (used in)/provided by financing activities
    
    
    (68,980
    )
    
    
    20,326NET DECREASE IN CASH AND CASH EQUIVALENTS:
    
    
    (108,296
    )
    
    
    26,398CASH AND CASH EQUIVALENTS, beginning of period
    
    
    142,840
    
    
    
    36,438CASH AND CASH EQUIVALENTS, end of period
    
    $
    34,544
    
    
    $
    62,836SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:Cash paid during the period for:Interest
    
    $
    81
    
    
    $
    135Income taxes
    
    $
    23,781
    
    
    $
    13,899
 Supplemental disclosures of non-cash transactions (in thousands): During the
first half ended July 31, 2004, the Company recorded an increase to additional
paid-in capital of $4,853 related to the issuance of restricted stock to
satisfy certain deferred compensation liabilities (see Note 6). See accompanying notes 5




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PACIFIC SUNWEAR OF CALIFORNIA, INC. 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  NOTE 1  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 Rule 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 ShopPacSun.com
Corp. (the Company). All intercompany transactions have been eliminated in
consolidation. The Companys fiscal year is the 52- or 53-week period ending on the Saturday
closest to January 31. Fiscal 2004 is the 52-week period ending January 29,
2005. Fiscal 2003 was the 52-week period ended January 31, 2004. The second
quarter and first half of fiscal 2004 were the 13- and 26-week periods ended
July 31, 2004, respectively. The second quarter and first half of fiscal 2003
were the 13- and 26-week periods ended August 2, 2003, respectively. 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
second quarter and first half ended July 31, 2004 are not necessarily
indicative of the results that may be expected for fiscal 2004. 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 31, 2004. NOTE 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 Form 10-K
for the fiscal year ended January 31, 2004. 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. Short-term Investments  Short-term investments 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.
Cost is determined by specific identification. At July 31, 2004, the market
value of the Companys portfolio was $49.6 million, consisting of corporate
debentures of $23.5 million, U.S. agency debentures of $17.7 million, corporate
commercial paper of $4.4 million and U.S. Treasury notes of $4.0 million. Stock Split  In August 2003, the Company effected a three-for-two stock split.
All share and per share amounts have been restated to give effect to the stock
split in prior periods. Stock-Based Compensation  The Company accounts for stock-based compensation in
accordance with Accounting Principles Board (APB) Opinion No. 25 and,
accordingly, does not currently include compensation expense related to stock
options in reported net income. The Company follows the disclosure provisions
of Statement of Financial Accounting Standards No. 148 (SFAS 148),
Accounting for Stock-Based Compensation  Transition and Disclosure. SFAS
148 requires disclosure of the effects of an entitys accounting policy with
respect to stock-based employee compensation on reported net income (loss) and
earnings (loss) per share in annual and interim financials statements. The
Company is 6




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required to follow the prescribed disclosure format and has provided
the additional disclosures required by SFAS 148 for the second quarter and
first half ended July 31, 2004 below. SFAS 123, Accounting for Stock-Based Compensation, requires the disclosure of
pro forma net income and earnings per share. Under SFAS 123, the fair value of
stock-based awards to employees is calculated through the use of option-pricing
models, even though such models were developed to estimate the fair value of
freely tradable, fully transferable options without vesting restrictions, which
significantly differ from the Companys stock option awards. These models also
require subjective assumptions, including future stock price volatility and
expected time to exercise, which greatly affect the calculated values. The
Companys calculations were made using the Black-Scholes option-pricing model
with the following ranges of weighted average assumptions: expected life, 5
years; stock volatility of 37.0% to 37.8% for fiscal 2004 and 45.3% to 53.7%
for fiscal 2003; risk-free interest rates of 3.6% to 3.7% for fiscal 2004 and
2.9% to 3.3% for fiscal 2003; and no dividends during the expected term. The
Companys calculations are based on a single-option valuation approach and
forfeitures are recognized as they occur. If the computed fair values of the
fiscal 2004 and fiscal 2003 awards had been amortized to expense over the
vesting period of the awards, net income and earnings per share for the second
quarter and first half ended July 31, 2004 and August 2, 2003, respectively,
would have been reduced to the pro forma amounts indicated below: For the Second Quarter Ended
    
    For the First Half EndedJuly 31,
    
    August 2,
    
    July 31,
    
    August 2,2004
    
    2003
    
    2004
    
    2003Net IncomeAs reported
    
    $
    19,325
    
    
    $
    13,380
    
    
    $
    34,299
    
    
    $
    21,359Deduct: Total stock-based
employee compensation
expense determined under
fair value based method for
all awards, net of related
tax effects
    
    
    (1,673
    )
    
    
    (1,570
    )
    
    
    (3,231
    )
    
    
    (3,090
    )Pro forma
    
    $
    17,652
    
    
    $
    11,810
    
    
    $
    31,068
    
    
    $
    18,269Net Income Per Share, BasicAs reported
    
    $
    0.25
    
    
    $
    0.18
    
    
    $
    0.44
    
    
    $
    0.28Deduct: Total stock-based
employee compensation
expense determined under
fair value based method for
all awards, net of related
tax effects
    
    
    (0.02
    )
    
    
    (0.02
    )
    
    
    (0.04
    )
    
    
    (0.04
    )Pro forma
    
    $
    0.23
    
    
    $
    0.16
    
    
    $
    0.40
    
    
    $
    0.24Net Income Per Share, DilutedAs reported
    
    $
    0.25
    
    
    $
    0.17
    
    
    $
    0.43
    
    
    $
    0.28Deduct: Total stock-based
employee compensation
expense determined under
fair value based method for
all awards, net of related
tax effects
    
    
    (0.02
    )
    
    
    (0.02
    )
    
    
    (0.03
    )
    
    
    (0.04
    )Pro forma
    
    $
    0.23
    
    
    $
    0.15
    
    
    $
    0.40
    
    
    $
    0.24
 New Accounting Pronouncements  In January 2003, the Financial Accounting
Standards Board (FASB) issued FIN 46, Consolidation of Variable Interest
Entities and in December 2003, issued FIN 46(R) (revised December 2003)
Consolidation of Variable Interest Entities  An Interpretation of ARB No.
51. In general, a variable interest entity is a corporation, partnership,
trust, or any other legal structure used for business purposes that either (a)
does not have equity investors with voting rights or (b) has equity investors
that do not provide sufficient financial resources for the entity to support
its activities. FIN 46 requires certain variable interest entities to be
consolidated by the primary beneficiary of the entity if the investors in the
entity do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN
46(R) clarifies the application of ARB No. 51, Consolidated Financial 7




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Statements, to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without subordinated
financial support from other parties. The consolidation requirements of FIN 46
apply immediately to variable interest entities created after January 31, 2003.
The consolidation requirements apply to older entities in the first fiscal
year or interim period beginning after June 15, 2003. Certain of the
disclosure requirements apply in all financial statements issued after January
31, 2003, regardless of when the variable interest entity was established. FIN
46(R) applies immediately to variable interest entities created after December
31, 2003, and to variable interest entities in which an enterprise obtains an
interest after that date. It applies no later than the first reporting period
ending after March 15, 2004, to variable interest entities in which an
enterprise holds a variable interest (other than special purpose) that it
acquired before January 1, 2004. FIN 46(R) applies to public enterprises as of
the beginning of the applicable interim or annual period. The Company believes
that the adoption of FIN 46 and FIN 46(R) will not have a material impact on
its financial position or results of operations because the Company has no
interest in variable interest entities. 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. EITF 03-1 outlines that an impairment would be considered
other-than-temporary unless: a) the investor has the ability and intent to
hold an investment for a reasonable period of time sufficient for the recovery
of the fair value up to (or beyond) the cost of the investment, and b) evidence
indicating that the cost of the investment is recoverable within a reasonable
period of time outweighs evidence to the contrary. Although not presumptive, a
pattern of selling investments prior to the forecasted recovery of fair value
may call into question the investors intent. In addition, the severity and
duration of the impairment should also be considered in determining whether the
impairment is other-than-temporary. The Company does not expect the adoption
of EITF 03-1 to have a material impact on its financial position or results of
operations because the Company has the ability and intent to hold any of its
held-to-maturity marketable securities with gross unrealized losses until a
recovery of fair value at maturity. Reclassifications  Certain prior year amounts have been reclassified to
conform to the current year presentation. NOTE 3 DEFERRED COMPENSATION AND OTHER ASSETS The Company maintains an Executive Deferred Compensation Plan (the Executive
Plan) covering Company officers that is funded by participant contributions
and periodic Company discretionary contributions. The deferred compensation
asset balance represents the investments held by the Company to cover the
vested participant balances in the Executive Plan of $12,062 and $10,925
included in long-term liabilities as of July 31, 2004 and January 31, 2004,
respectively. July 31,
    
    January 31,2004
    
    2004Deferred compensation
    
    $
    11,923
    
    
    $
    10,919Long-term computer maintenance contracts
    
    
    202
    
    
    
    502Other assets
    
    
    129
    
    
    
    168$
    12,254
    
    
    $
    11,589
 8




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NOTE 4  ACCRUED LIABILITIES Accrued liabilities consist of the following: July 31,
    
    January 31,2004
    
    2004Accrued compensation and benefits
    
    $
    9,082
    
    
    $
    17,578Accrued capital expenditures
    
    
    8,604
    
    
    
    5,838Accrued sales tax payable
    
    
    6,248
    
    
    
    6,189Accrued medical expenses
    
    
    2,207
    
    
    
    1,260Accrued gift cards and store merchandise credits
    
    
    2,071
    
    
    
    4,618Accrued sublease loss charges (Note 8)
    
    
    1,565
    
    
    
    5,543Accrued restricted stock compensation (Note 6)
    
    
    912
    
    
    
    5,118Other
    
    
    10,828
    
    
    
    8,822$
    41,517
    
    
    $
    54,966
 NOTE 5  COMMON STOCK REPURCHASE AND RETIREMENT The Companys Board of Directors has authorized a common stock repurchase plan
in three separate authorizations. The Companys stock repurchase activity
under this plan is as follows: (all amounts in thousands, except per share amounts) # of SharesPurchased
    
    
    
    
    
    MaximumAverage
    
    as Part of
    
    
    
    
    
    Value of SharesPrice
    
    Publicly
    
    Value of
    
    that May Yet# of Shares
    
    Paid Per
    
    Announced
    
    Shares
    
    be PurchasedPeriod
    
    Purchased
    
    Share
    
    Plan
    
    Purchased
    
    Under the PlanAuthorization #1 (1)February 2004
    
    
    75.0
    
    
    $
    23.99
    
    
    
    75.0
    
    
    $
    1,799.3
    
    
    $
    48,200.7April 2004
    
    
    2,148.7
    
    
    $
    22.43
    
    
    
    2,148.7
    
    
    $
    48,195.4
    
    
    $
    5.3Total
    
    
    2,223.7
    
    
    $
    22.48
    
    
    
    2,223.7
    
    
    $
    49,994.7Authorization #2 (2)June 2004
    
    
    482.1
    
    
    $
    19.70
    
    
    
    482.1
    
    
    $
    9,495.3
    
    
    $
    15,504.7July 2004
    
    
    812.4
    
    
    $
    19.01
    
    
    
    812.4
    
    
    $
    15,440.6
    
    
    $
    64.1Total
    
    
    1,294.5
    
    
    $
    19.26
    
    
    
    1,294.5
    
    
    $
    24,935.9Authorization #3 (3)August 2004
    
    
    1,746.0
    
    
    $
    19.80
    
    
    
    1,746.0
    
    
    $
    34,570.8
    
    
    $
    15,429.2
 (1) On January 28, 2004, the Company announced that the Board of Directors had
authorized the Company to purchase up to $50 million or 2.5 million shares of
the Companys common stock in open market transactions. There was no
expiration date specified for this authorization. During the first quarter of
fiscal 2004, the Company had substantially completed its repurchase and
retirement of shares pursuant to this authorization. (2) On May 10, 2004, the Company announced that the Board of Directors had
authorized the Company to purchase up to an additional $25 million of the
Companys common stock in open market transactions. There was no expiration
date specified for this authorization. During the second quarter of fiscal
2004, the Company had substantially completed its repurchase and retirement of
shares pursuant to this authorization. (3) On August 18, 2004, the Companys Board of Directors authorized the Company
to purchase up to an additional $50 million of the Companys common stock in
open market transactions. There was no expiration date specified for this
authorization. 9




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##### Table of Contents



NOTE 6  RESTRICTED STOCK During the year ended January 30, 2000, the Company granted a restricted stock
award of 112,500 shares with a purchase price of $0.01 per share to its Chief
Executive Officer (CEO). The award is scheduled to vest 25% on each of
September 17, 2001, 2002, 2003 and 2004, if, in each instance, certain
cumulative annual earnings per share growth targets have been satisfied. Under
the award agreement, shares that do not vest at a given vesting date due to the
cumulative annual earnings per share growth targets not being met remain
available for future vesting if the cumulative annual earnings per share growth
targets are met as of a subsequent vesting date. During the first quarter of
fiscal 2004, 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 immediately vested in and received 75% of the
total share award, or 84,375 shares. The remaining 25%, or 28,125 shares, will
become fully vested and be delivered to the CEO on September 17, 2004. As a
result of the delivery of 84,375 shares to the CEO during the first quarter of
fiscal 2004, the Company reclassified previously recognized compensation
expense of $1.9 million from accrued liabilities to additional paid-in capital.
At July 31, 2004, the Company had accrued $.5 million to recognize the
cumulative vested fair value of the remaining 28,125 shares to be delivered on
September 17, 2004. This amount is included in accrued liabilities (see Note
4) on the balance sheet. The Company will be required to account for these
final 28,125 shares under variable accounting rules, which will require
adjustments to compensation expense until the delivery date based on additional
vesting of the shares and changes in the market price of the Companys stock.
For example, based on the closing market price of the Companys stock at July
31, 2004 of $20.40, the Company would be required to record additional
compensation expense of approximately $.1 million through September 17, 2004.
Additionally, based on any change in the market price of the Companys stock
until the delivery date, the cumulative compensation expense recognized for
this portion of this award will continue to be adjusted. 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 is 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 have been satisfied. Under the award agreement, shares that do not
vest at a given vesting date due to the cumulative annual earnings per share
growth targets not being met remain available for future vesting if the
cumulative annual earnings per share growth targets are met as of a subsequent
vesting date. During the first quarter of fiscal 2004, the Companys Board of
Directors verified that the third cumulative annual earnings per share growth
target for this award had been met. Accordingly, the CEO became immediately
vested in and received 75% of the total share award, or 126,563 shares. The
remaining 25%, or 42,187 shares, will vest and be received by the CEO in March
2005 upon confirmation by the Board of Directors that the fiscal 2004
cumulative annual earnings per share growth target has been met by the Company.
As a result of the delivery of 126,563 shares to the CEO during the first
quarter of fiscal 2004, the Company reclassified previously recognized
compensation expense of $2.9 million from accrued liabilities to additional
paid-in capital. At July 31, 2004, the Company had accrued $.4 million to
recognize the cumulative vested fair value of the remaining 42,187 shares.
This amount is included in accrued liabilities (see Note 4) on the balance
sheet. The Company will be required to account for these final 42,187 shares
under variable accounting rules, which will require adjustments to compensation
expense until the delivery date based on additional vesting of the shares and
changes in the market price of the Companys stock. For example, based on the
market price of the Companys stock at July 31, 2004 of $20.40, the Company
would be required to record additional compensation expense of approximately
$.5 million through March 15, 2005. Additionally, based on any change in the
market price of the Companys stock until the delivery date, the cumulative
compensation expense recognized for this portion of this award will continue to
be adjusted. 10




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##### Table of Contents



NOTE 7  NET INCOME PER SHARE, BASIC AND DILUTED The following table summarizes the computation of EPS (all amounts in thousands
except share and per share amounts): Second Quarter Ended: July 31, 2004
    August 2, 2003Per Share
    
    
    
    
    
    
    
    
    
    Per ShareNet Income
    
    Shares
    
    Amount
    
    Net Income
    
    Shares
    
    AmountBasic EPS:
    
    $
    19,325
    
    
    
    76,322,161
    
    
    $
    0.25
    
    
    $
    13,380
    
    
    
    75,885,641
    
    
    $
    0.18Diluted EPS:Effect of dilutive stock options
    
    
    
    
    
    
    1,589,434
    
    
    
    
    
    
    
    
    
    
    
    2,218,396
    
    
    
    (0.01
    )$
    19,325
    
    
    
    77,911,595
    
    
    $
    0.25
    
    
    $
    13,380
    
    
    
    78,104,037
    
    
    $
    0.17
 First Half Ended: July 31, 2004
    
    August 2, 2003Per Share
    
    
    
    
    
    
    
    
    
    Per ShareNet Income
    
    Shares
    
    Amount
    
    Net Income
    
    Shares
    
    AmountBasic EPS:
    
    $
    34,299
    
    
    
    77,239,966
    
    
    $
    0.44
    
    
    $
    21,359
    
    
    
    75,205,094
    
    
    $
    0.28Diluted EPS:Effect of dilutive stock options
    
    
    
    
    
    
    1,795,751
    
    
    
    (0.01
    )
    
    
    
    
    
    
    2,126,425
    
    
    
    (0.00
    )$
    34,299
    
    
    
    79,035,717
    
    
    $
    0.43
    
    
    $
    21,359
    
    
    
    77,331,519
    
    
    $
    0.28
 Options to purchase 1,221,266 and 3,750 shares of common stock in the second
quarter of fiscal 2004 and fiscal 2003, respectively, and 915,644 and 138,066
shares of common stock in the first half of fiscal 2004 and fiscal 2003,
respectively, were not included in the computation of diluted earnings per
common share because the option exercise price was greater than the average
market price of the common stock. NOTE 8  COMMITMENTS AND CONTINGENCIES Litigation  During fiscal 2003, the Company reached an agreement to settle all
claims related to two lawsuits concerning overtime pay for a total of $4.0
million. The suits were Auden v. Pacific Sunwear of California, Inc., which
was filed September 17, 2001, and Adams v. Pacific Sunwear of California, Inc.,
which was filed August 2, 2002. The complaints alleged that the Company
improperly classified certain California based employees as exempt from
overtime pay. In the first quarter of fiscal 2004, the Company paid
substantially all amounts due pursuant to the terms of the settlement
agreement. The settlement did not have a material impact on the Companys
results of operations for fiscal 2004 or fiscal 2003. The Company is involved from time to time in litigation incidental to its
business. Management believes that the outcome of current litigation will not
have a material adverse effect upon the results of operations or financial
condition of the Company. 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 standby letters of credit as
security for merchandise shipments from overseas. There were $18.9 million of
these letters of credit outstanding at July 31, 2004. In the first quarter of
fiscal 2003, the Company issued a guarantee within a sublease on one of its
former store locations under which the Company remains secondarily liable on
the sublease should the sublessee default on its lease payments. The term of
the sublease ends December 31, 2014. At July 31, 2004, the Company had $.4
million recorded in accrued liabilities to recognize the estimated fair value
of this guarantee 11




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##### Table of Contents



assuming that another sublessee would be found within one
year should the original sublessee default. The
aggregate rental payments remaining on the master lease agreement at July 31,
2004, were $5.7 million. 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
noted. The Company maintains a private label credit card through a third party to
promote the PacSun brand image and lifestyle. The third party services the
customer accounts and retains all risk and financial obligation associated with
any outstanding balances on customer accounts. The Company has no financial
obligation and does not provide any guarantee related to any outstanding
balances resulting from the use of these private label credit cards by its
customers. Sublease Loss Charges  During the second quarter ended July 31, 2004, the
Company executed a lease termination agreement related to the Companys former
corporate offices and distribution center. As a result of executing this
agreement, the Company retains no future obligations regarding these premises.
The terms of this agreement resulted in the Company reversing $.9 million in
previously accrued liabilities. The Company remains liable under an operating lease covering a former store
location. The Company has subleased 3,200 of a total 5,200 square feet of
these premises. At July 31, 2004, the Company had $1.6 million recorded in
accrued liabilities to account for the Companys net remaining contractual
lease obligations for this location, which includes estimated sublease
assumptions for the remaining 2,000 square feet. The Company continues to
update its sublease assumptions on a quarterly basis based on its review of
current real estate market conditions and any 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 July 31, 2004, the gross remaining obligations
under the Companys original lease, exclusive of any sublease income, were
approximately $6.5 million. 12




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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 should be read in conjunction with the Condensed
Consolidated Financial Statements and Notes thereto of the Company included
elsewhere in this Form 10-Q. This discussion contains forward-looking
statements that involve risks and uncertainties. The Companys actual results
could differ materially from those anticipated in these forward-looking
statements as a result of certain factors, including those set forth under
Cautionary Note Regarding Forward-Looking Statements and Risk Factors in this
section. Executive Overview Management of the Company considers 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. Management of the Company considers 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 the Companys total net sales, cash, and
working capital. Net merchandise margins Management analyzes the components of net merchandise
margins, specifically initial markups and markdowns as a percentage of net
sales. Any inability to obtain acceptable levels of initial markups or any
significant increase in the Companys use of markdowns could have an adverse
impact on the Companys gross margin results and results of operations. Operating margin Management views operating margin as a key indicator of the
Companys success. The key drivers of operating margins are comparable store
net sales, net merchandise margins, and the Companys ability to control
operating expenses. Operating margin as a percentage of net sales for the
first half of fiscal 2004 was 10.5% as compared to 8.0% for the first half of
fiscal 2003. Full fiscal year operating margins for fiscal 2003, 2002 and
2001, were 12.3%, 9.6% and 6.5%, respectively. The first half of the Companys
fiscal year historically accounts for a smaller percentage of annual net sales
and operating margin as compared to the second half. The Companys highest
historical operating margin was 12.9% for fiscal 1999. Store sales trends Management evaluates store sales trends in assessing the
operational performance of the Companys 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 2003,
2002 and 2001 were $1,229, $1,102 and $1,031, respectively. Average net sales
per square foot for the same years were $363, $330 and $321, respectively. Cash flow and liquidity (working capital) Management evaluates cash flow from
operations, liquidity and working capital to determine the Companys short-term
operational financing needs. Management expects cash flows from operations
will be sufficient to finance operations without borrowing under the Companys
credit facility during the remainder of fiscal 2004. Critical Accounting Policies The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
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 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 the 13




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##### Table of Contents



Company believes 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 the
Companys retail store locations or upon shipment for orders placed through the
Companys website. The Company accrues for estimated sales returns by
customers based on historical sales return results. Actual return rates have
historically been within managements expectations and the reserves
established. However, in the event that the actual rate of sales returns by
customers increased significantly, the Companys operational results could be
adversely affected. The Company records the sale of gift cards as a current
liability and recognizes a sale when a customer redeems a gift card. The
amount of the gift card liability is determined taking into account the
Companys 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.
Management bases 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 managements estimates differ from actual results, additional
markdowns may have to be recorded, which could reduce the Companys gross
margins and operating results. Long-Lived Assets- In the normal course of business, the Company acquires
tangible and intangible assets. The Company periodically evaluates the
recoverability of the carrying amount of its 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. The
Company uses its best judgment based on the most current facts and
circumstances surrounding its 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 the Companys
assessment of recoverability. Numerous factors, including changes in the
Companys business, industry segment, and the global economy, could
significantly impact managements decision to retain, dispose of, or idle
certain of its long-lived assets. Goodwill and Other Intangible Assets- The Company evaluates the recoverability
of goodwill at least annually based on a two-step impairment test. The first
step compares the fair value of each reporting unit with its carrying amount,
including goodwill. If the carrying amount of a reporting unit exceeds fair
value, then the second step of the impairment test is performed to measure the
amount of any impairment loss. Fair value is determined based on estimated
future cash flows, discounted at a rate that approximates the Companys cost of
capital. Such estimates are subject to change and the Company may be required
to recognize impairment losses in the future. Insurance Reserves The Company is responsible for workers compensation
insurance claims up to a specified aggregate stop loss amount. The Company
maintains 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 managements
expectations and the reserves established. To the extent claims experience or
managements estimates change, additional charges may be recorded in the future
up to the aggregate stop loss amount for each policy year. Accrued Sublease Loss Charges- The Company remains liable under an operating
lease covering a former store location. The Company has subleased 3,200 of a
total 5,200 square feet of these premises. At July 31, 2004, the Company had
$1.6 million recorded in accrued liabilities to account for the Companys net
remaining contractual lease obligations for this location, which includes
estimated sublease assumptions for the remaining 2,000 square feet. The
Company continues to update its sublease assumptions on a quarterly basis based
on its review of current real estate market conditions and any on-going
negotiations. To the extent managements estimates relating to the Companys
ability to sublease these facilities at the assumed 14




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##### Table of Contents



rates or within the assumed timeframes changes or is incorrect, additional
charges or reversals of previous charges may be recorded in the future. At
July 31, 2004, the gross remaining obligations under the Companys original
lease, exclusive of any sublease income, were approximately $6.5 million. This
amount is included in the contractual obligations table within Managements
Discussion and Analysis of Financial Condition and Results of Consolidated
Operations. See Contractual Obligations within Liquidity and Capital
Resources. Income Taxes- Current income tax expense is the amount of income taxes
expected to be payable for the current year. 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. The Company considers future taxable income and
ongoing prudent and feasible tax planning in assessing the value of its
deferred tax assets. Evaluating the value of these assets is necessarily based
on the Companys judgment. If the Company determines that it is more likely
than not that these assets will not be realized, the Company would reduce the
value of these assets to their expected realizable value through a valuation
allowance, thereby decreasing net income. If the Company 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. 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 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 potential 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 the Companys operating results
(see Note 8 to the condensed consolidated financial statements). 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: Second Quarter Ended
    
    First Half EndedJuly 31,
    
    
    
    
    
    August 2,
    
    
    
    
    
    July 31,
    
    
    
    
    
    August 2,2004
    
    
    
    
    
    2003
    
    
    
    
    
    2004
    
    
    
    
    
    2003Net sales
    
    
    100.0
    %
    
    
    
    
    
    
    100.0
    %
    
    
    
    
    
    
    100.0
    %
    
    
    
    
    
    
    100.0
    %Cost of goods sold, including
buying, distribution and
occupancy costs
    
    
    65.5
    
    
    
    
    
    
    
    66.0
    
    
    
    
    
    
    
    65.7
    
    
    
    
    
    
    
    66.8Gross margin
    
    
    34.5
    
    
    
    
    
    
    
    34.0
    
    
    
    
    
    
    
    34.3
    
    
    
    
    
    
    
    33.2Selling, general and
administrative expenses
    
    
    23.3
    
    
    
    
    
    
    
    24.8
    
    
    
    
    
    
    
    23.9
    
    
    
    
    
    
    
    25.2Operating income
    
    
    11.2
    
    
    
    
    
    
    
    9.2
    
    
    
    
    
    
    
    10.4
    
    
    
    
    
    
    
    8.0Interest income, net
    
    
    0.1
    
    
    
    
    
    
    
    0.0
    
    
    
    
    
    
    
    0.2
    
    
    
    
    
    
    
    0.0Income before income tax expense
    
    
    11.3
    
    
    
    
    
    
    
    9.2
    
    
    
    
    
    
    
    10.6
    
    
    
    
    
    
    
    8.0Income tax expense
    
    
    4.3
    
    
    
    
    
    
    
    3.5
    
    
    
    
    
    
    
    4.0
    
    
    
    
    
    
    
    3.1Net income
    
    
    7.0
    %
    
    
    
    
    
    
    5.7
    %
    
    
    
    
    
    
    6.6
    %
    
    
    
    
    
    
    4.9
    %
 The following table sets forth the Companys number of stores and total square
footage as of the dates indicated: July 31,
    
    August 2,2004
    
    2003PacSun stores
    
    
    717
    
    
    
    650Outlet stores
    
    
    82
    
    
    
    75d.e.m.o. stores
    
    
    148
    
    
    
    114Total stores
    
    
    947
    
    
    
    839Total square footage (in 000s)
    
    
    3,266
    
    
    
    2,844
 15




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##### Table of Contents



The second quarter (13 weeks) ended July 31, 2004 as compared to the second
quarter (13 weeks) ended August 2, 2003 Net Sales Net sales increased to $274.8 million for the second quarter of fiscal 2004
from $234.4 million for the second quarter of fiscal 2003, an increase of $40.4
million, or 17.2%. The components of this $40.4 million increase in net sales
are as follows: Amount($ million)
    
    Attributable to$
    14.7
    
    
    6.8% increase in comparable store net sales in the second quarter of fiscal 2004 compared to the second
quarter of fiscal 200312.0
    
    
    Net sales from stores opened in fiscal 2003 not yet included in the comparable store base10.9
    
    
    Net sales from 74 new stores opened in fiscal 2004 not yet included in the comparable store base3.6
    
    
    Other non-comparable sales (net sales from expanded or relocated stores not yet included in the comparable
store base and internet net sales)(.8
    )
    
    4 closed stores in fiscal 2004 and 4 closed stores in fiscal 2003$
    40.4
    
    
    Total
 Of the 6.8% increase in comparable store net sales in the second quarter of
fiscal 2004, PacSun and PacSun Outlet comparable store net sales increased 7.2%
and d.e.m.o. comparable store net sales increased 3.0%. The increase in
comparable store net sales within PacSun and PacSun Outlet was primarily
attributable to increases in comparable store net sales of footwear,
accessories and young mens apparel. The increase in comparable store net
sales within d.e.m.o. was attributable to increases in comparable store net
sales of juniors apparel and accessories merchandise. Retail prices of the
Companys merchandise remained relatively unchanged in the second quarter of
fiscal 2004 compared to the second quarter of fiscal 2003 and had no
significant impact on the net sales increase for the second quarter of fiscal
2004. Gross Margin Gross margin, after buying, distribution and occupancy costs, increased to
$94.8 million for the second quarter of fiscal 2004 from $79.8 million for the
second quarter of fiscal 2003, an increase of $15.0 million, or 18.8%. As a
percentage of net sales, gross margin was 34.5% for the second quarter of
fiscal 2004 compared to 34.0% for the second quarter of fiscal 2003. The
components of this .5% increase in gross margin as a percentage of net sales
are as follows: %
    
    Attributable to.4
    %
    
    Increase in net merchandise margins, primarily due to a higher initial markup rate
partially offset by a higher markdown rate.2
    %
    
    Decrease in occupancy costs, primarily due to leveraging these costs over higher total sales(.1
    )%
    
    Increase in distribution costs.5
    %
    
    Total
 Selling, General and Administrative Expenses Selling, general and administrative expenses increased to $64.1 million for the
second quarter of fiscal 2004 from $58.2 million for the second quarter of
fiscal 2003, an increase of $5.9 million, or 10.1%. These expenses decreased
to 23.3% as a percentage of net sales in the second quarter of fiscal 2004 from
24.8% in the second quarter of fiscal 2003. The components of this 1.5% net
decrease in selling, general and administrative expenses as a percentage of net
sales were as follows: 16




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##### Table of Contents



%
    
    Attributable to(1.0
    )%
    
    Net decrease in general and administrative expenses, primarily due to reduced restricted
stock expense of .8%(.4
    )%
    
    Decrease in store closing, expansion and relocation expenses and other store expenses,
primarily due to the lease termination agreement related to the Companys former
corporate offices and distribution center; the lease termination resulted in the Company
reversing $.9 million in previously accrued liabilities (see Note 8 to the condensed
consolidated financial statements)(.1
    )%
    
    Decrease in store payroll, primarily due to leveraging these costs over higher total sales(1.5
    )%
    
    Total
 Net Interest Income Net interest income was $.3 million in the second quarter of fiscal 2004
compared to $.1 million in the second quarter of fiscal 2003, an increase of
$.2 million. This increase was primarily the result of higher average cash and
short-term investment balances in the second quarter of fiscal 2004 as compared
to the second quarter of fiscal 2003, primarily due to higher net income driven
by the comparable store net sales increases in the first half of fiscal 2004. Income Tax Expense Income tax expense was $11.8 million for the second quarter of fiscal 2004
compared to $8.3 million for the second quarter of fiscal 2003. The effective
income tax rate was 37.8% in the second quarter of fiscal 2004 and 38.4% in the
second quarter of fiscal 2003. The lower effective income tax rate for the
second quarter of fiscal 2004 was primarily attributable to a lower weighted
effective state income tax rate for the Company. The weighted effective state
income tax rate for the Company will vary depending on a number of factors,
such as differing income tax rates and net sales in the respective states. The first half (26 weeks) ended July 31, 2004 as compared to the first half (26
weeks) ended August 2, 2003 Net Sales Net sales increased to $519.9 million for the first half of fiscal 2004 from
$432.7 million for the first half of fiscal 2003, an increase of $87.2 million,
or 20.2%. The components of this $87.2 million increase in net sales are as
follows: Amount($ million)
    
    Attributable to$
    38.1
    
    
    9.5% increase in comparable store net sales in the first half of fiscal 2004 compared to
the first half of fiscal 200329.5
    
    
    Net sales from stores opened in fiscal 2003 not yet included in the comparable store base12.8
    
    
    Net sales from 74 new stores opened in fiscal 2004 not yet included in the comparable
store base7.8
    
    
    Other non-comparable sales (net sales from expanded or relocated stores not yet included
in the comparable store base and internet net sales)(1.0
    )
    
    4 closed stores in fiscal 2004 and 4 closed stores in fiscal 2003$
    87.2
    
    
    Total
 Of the 9.5% increase in comparable store net sales in the first half of fiscal
2004, PacSun and PacSun Outlet comparable store net sales increased 10.1% and
d.e.m.o. comparable store net sales increased 4.6%. The increase in comparable
store net sales within PacSun and PacSun Outlet was primarily attributable to
increases in comparable store net sales of footwear, accessories and young
mens apparel. The increase in comparable store net sales within d.e.m.o. was
attributable to increases in comparable store net sales of juniors apparel and
accessories merchandise. Retail prices of the Companys merchandise remained 17




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relatively unchanged in the first half of fiscal 2004 compared to the first
half of fiscal 2003 and had no significant impact on the net sales increase for
the first half of fiscal 2004. Gross Margin Gross margin, after buying, distribution and occupancy costs, increased to
$178.4 million for the first half of fiscal 2004 from $143.7 million for the
first half of fiscal 2003, an increase of $34.7 million, or 24.1%. As a
percentage of net sales, gross margin was 34.3% for the first half of fiscal
2004 compared to 33.2% for the first half of fiscal 2003. The components of
this 1.1% increase in gross margin as a percentage of net sales are as follows: %
    
    Attributable to.7
    %
    
    Decrease in occupancy costs, primarily due to leveraging these costs over higher total sales.5
    %
    
    Increase in net merchandise margins, primarily due to a higher initial markup rate
partially offset by a higher markdown rate(.1
    )%
    
    Increase in distribution costs1.1
    %
    
    Total
 Selling, General and Administrative Expenses Selling, general and administrative expenses increased to $124.0 million for
the first half of fiscal 2004 from $109.1 million for the first half of fiscal
2003, an increase of $14.9 million, or 13.7%. These expenses decreased to
23.9% as a percentage of net sales in the first half of fiscal 2004 from 25.2%
in the first half of fiscal 2003. The components of this 1.3% net decrease in
selling, general and administrative expenses as a percentage of net sales were
as follows: %
    
    Attributable to(.6
    )%
    
    Net decrease in general and administrative expenses, primarily due to reduced restricted
stock expense of .4%(.5
    )%
    
    Decrease in store closing, expansion and relocation expenses and other store expenses,
primarily due to the lease termination agreement related to the Companys former
corporate offices and distribution center; the lease termination resulted in the Company
reversing $.9 million in previously accrued liabilities (see Note 8 to the condensed
consolidated financial statements)(.2
    )%
    
    Decrease in store payroll, primarily due to leveraging these costs over higher total sales(1.3
    )%
    
    Total
 Net Interest Income Net interest income was $.8 million in the first half of fiscal 2004 compared
to $.1 million in the first half of fiscal 2003, an increase of $.7 million.
This increase was primarily the result of higher average cash and short-term
investment balances in the first half of fiscal 2004 as compared to the first
half of fiscal 2003, primarily due to higher net income driven by the
comparable store net sales increases in the first half of fiscal 2004. Income Tax Expense Income tax expense was $20.9 million for the first half of fiscal 2004 compared
to $13.3 million for the first half of fiscal 2003. The effective income tax
rate was 37.8% in the first half of fiscal 2004 and 38.4% in the first half of
fiscal 2003. The lower effective income tax rate for the first half of fiscal
2004 was primarily attributable to a lower weighted effective state income tax
rate for the Company. The weighted effective state income tax rate for the
Company will vary depending on a number of factors, such as differing income
tax rates and net sales in the respective states. 18




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##### Table of Contents



Liquidity and Capital Resources The Company has financed its operations primarily from internally generated
cash flow, with occasional short-term and long-term borrowings and equity
financing in past years. The Companys primary capital requirements have been
for the construction costs of newly opened, remodeled, expanded or relocated
stores, net of landlord allowances, as well as for the financing of
inventories. Management believes that the Companys working capital, cash
flows from operating activities and credit facility will be sufficient to meet
the Companys operating and capital expenditure requirements for the next
twelve months. Operating Cash Flows Net cash provided by operating activities was $7.3 million for the first
half of fiscal 2004 compared to $22.4 million for the first half of fiscal
2003. The $15.1 million decrease in cash provided by operations in the first
half of fiscal 2004 as compared to the first half of fiscal 2003 was
attributable to the following: Amount($ million)
    
    Attributable to$
    (10.4
    )
    
    Decrease in accrued liabilities, primarily due to the
payment of fiscal 2003 bonuses, the Auden and Adams
settlements (see Note 8 to the condensed consolidated
financial statements), and the lease termination
covering the Companys former corporate offices and
distribution center (see Note 8 to the condensed
consolidated financial statements)(10.2
    )
    
    Decrease in accounts payable leverage compared to the
first half of fiscal 2003 (Accounts payable as a
percentage of inventories decreased to 34.7% at July 31,
2004, as compared to 39.9% at August 2, 2003, primarily
due to timing of payments)(3.5
    )
    
    Increase in inventories(2.3
    )
    
    Decrease in income taxes payable, primarily due to
increased income tax payments and reduced tax benefits
from the exercise of stock options, partially offset by
higher income tax provisions12.9
    
    
    Increase in net income(1.6
    )
    
    Other items netting to a cash flow decrease$
    (15.1
    )
    
    Total
 The Companys success is largely dependent upon its ability to gauge the
fashion tastes of its customers and provide merchandise that satisfies customer
demand. Any inability to provide appropriate merchandise in sufficient
quantities in a timely manner could have a material adverse effect on the
Companys business, operating results, cash flows from operations and financial
condition. Any economic downturn that affects the retail industry as a whole
could also adversely affect the Companys business, operating results, cash
flows from operations and financial condition. Working Capital Working capital at July 31, 2004 was $205.9 million compared to $243.0 million
at January 31, 2004, a decrease of $37.1 million. The components of this $37.1
million decrease in working capital were as follows: 19




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Amount($ million)
    
    Attributable to$
    (91.1
    )
    
    Decrease in cash and short-term investments, primarily
due to $74.9 million in common stock repurchases made in
the first half of fiscal 200430.6
    
    
    Increase in inventories, net of accounts payable,
primarily due to square footage growth of 15%13.4
    
    
    Decrease in accrued liabilities, primarily due to the
payment of fiscal 2003 bonuses, the Auden and Adams
settlements (see Note 8 to the condensed consolidated
financial statements), and the lease termination
covering the Companys former corporate offices and
distribution center (see Note 8 to the condensed
consolidated financial statements), as well as the
issuance of restricted stock to satisfy certain deferred
compensation liabilities (see Note 6 to the condensed
consolidated financial statements)5.8
    
    
    Decrease in accrued income taxes due to payment of
fiscal 2003 income taxes and accrual of tax benefits
related to stock option exercises, partially offset by
fiscal 2004 income tax accruals4.2
    
    
    Other items netting to a working capital increase$
    (37.1
    )
    
    Total
 Investing Cash Flows Net cash used in investing activities in the first half of fiscal 2004 was
$46.6 million compared to $16.3 million for the first half of fiscal 2003, an
increase in cash used of $30.3 million. The components of the $46.6 million in
cash used in investing activities in the first half of fiscal 2004 are as
follows: Amount($ million)
    
    Attributable to$
    (24.0
    )
    
    Construction costs of new, expanded and relocated stores(19.8
    )
    
    Purchases of short-term investments classified as held-to-maturity(2.8
    )
    
    Other capital expenditures, including computer hardware and software(2.6
    )
    
    Maintenance capital expenditures on existing stores2.6
    
    
    Maturities of short-term investments classified as held-to-maturity$
    (46.6
    )
    
    Total
 In the remainder of fiscal 2004, capital expenditures are expected to be
approximately $23 million, of which approximately $20 million will be for
opening new and relocated/expanded stores, and approximately $3 million will be
used for other capital expenditures, including maintenance capital on existing
stores and computer hardware and software. Financing Cash Flows Net cash used in financing activities in the first half of fiscal 2004 was
$69.0 million compared to cash provided of $20.3 million for the first half of
fiscal 2003, an increase in cash used of $89.3 million. The components of the
$89.3 million increase in cash used in financing activities in the first half
of fiscal 2004 as compared to the first half of fiscal 2003 were as follows: Amount($ million)
    
    Attributable to$
    (74.9
    )
    
    Repurchases of common stock(14.6
    )
    
    Decrease in proceeds received from stock option exercises.2
    
    
    Decrease in principal payments under long-term debt and capital lease obligations$
    (89.3
    )
    
    Total
 20




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Common Stock Repurchase and Retirement  Information regarding the Companys common stock
repurchase plan is contained in Note 5 to the condensed consolidated financial statements, which note is
incorporated herein by this reference. Credit Facility The Company has 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 (4.25% at July 31, 2004) or at optional
interest rates that are primarily dependent upon the London Inter-bank Offered
Rates for the time period chosen. The Company did not borrow under the credit
facility at any time during the first half of fiscal 2004 or during fiscal
2003. The Company had $18.9 million outstanding in letters of credit at July
31, 2004. The credit facility subjects the Company to various restrictive
covenants, including maintenance of certain financial ratios, and prohibits
payment of cash dividends on common stock. At July 31, 2004, the Company was
in compliance with all of the credit facility covenants. A significant decrease in the Companys operating results could adversely
affect the Companys ability to maintain the required financial ratios under
the Companys credit facility. Required financial ratios include total
liabilities to tangible net worth, limitations on capital expenditures and
achievement of certain rolling four-quarter EBITDA 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 most likely result would be that the Company would 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. Contractual Obligations The Company has minimum annual rental commitments under existing store
operating leases, capital leases for computer equipment, and other long-term
debt obligations for multi-year computer maintenance contracts. In addition,
at any time, the Company is contingently liable for open letters of credit with
foreign suppliers of merchandise. At July 31, 2004, the Companys future
financial commitments under these arrangements were as follows: Contractual Obligations Payments Due by PeriodLess than
    
    1-3
    
    3-5
    
    More than(in millions)
    
    Total
    
    1 year
    
    years
    
    years
    
    5 yearsOperating lease obligations
    
    $
    592.6
    
    
    $
    86.2
    
    
    $
    169.9
    
    
    $
    158.2
    
    
    $
    178.3Capital lease obligations
    
    
    2.2
    
    
    
    1.3
    
    
    
    0.9
    
    
    
    
    
    
    
    Long-term debt obligations
    
    
    0.7
    
    
    
    0.7
    
    
    
    
    
    
    
    
    
    
    
    Letters of credit
    
    
    18.9
    
    
    
    18.9
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    614.4
    
    
    $
    107.1
    
    
    $
    170.8
    
    
    $
    158.2
    
    
    $
    178.3
 The Company reviews the operating performance of its stores on an ongoing basis
to determine which stores, if any, to expand, relocate or close. Most leases
contain cancellation or kick-out clauses in the Companys favor that relieve
the Company of any future obligation under a lease if certain sales levels are
not achieved by a specified date. The Company closed four stores in fiscal
2003 and anticipates closing approximately six stores in fiscal 2004. New Accounting Pronouncements Information regarding new accounting pronouncements is contained in Note 2 to
the condensed consolidated financial statements for the quarter ended July 31,
2004, which note is incorporated herein by this reference. 21




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##### Table of Contents



Inflation The Company does not believe that inflation has had a material effect on
the results of operations in the recent past. There can be no assurance that
the Companys business will not be affected by inflation in the future. Seasonality and Quarterly Results The Companys business is seasonal by nature, with the Christmas and
back-to-school periods historically accounting for the largest percentage of
annual net sales. The Companys first quarter historically accounts for the
smallest percentage of annual net sales. In fiscal 2003, excluding sales
generated by new and relocated/expanded stores, the Christmas and
back-to-school periods together accounted for approximately 36% of the
Companys annual net sales and a higher percentage of the Companys operating
income. In fiscal 2003, excluding net sales generated by new and
relocated/expanded stores, approximately 43% of the Companys annual net sales
occurred in the first half of the fiscal year and approximately 57% in the
second half. The Companys 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. Cautionary Note Regarding Forward-Looking Statements and Risk Factors 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 the Company intends that such forward-looking statements be
subject to the safe harbors created thereby. The Company is hereby providing
cautionary statements identifying important factors that could cause the
Companys 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 2004 planned new store openings and capital expenditures,
are based on information available to the Company as of the date hereof, and
the Company assumes no obligation to update or revise any such forward-looking
statements to reflect events or circumstances that occur after such statements
are made. Such uncertainties include, among others, the following factors: Merchandising/Fashion Sensitivity.The Companys success is largely dependent
upon its ability to gauge the fashion tastes of its customers and to provide
merchandise that satisfies customer demand in a timely manner. The Companys
failure to anticipate, identify or react appropriately in a timely manner to
changes in fashion trends could have a material adverse effect on the Companys
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 the Companys image with its customers. Proprietary Brand Merchandise.Sales from proprietary brand merchandise
accounted for approximately 32% of net sales in fiscal 2003. The Company may
increase the percentage of net sales in proprietary brand merchandise in the
future, although there can be no assurance that the Company will be able to
achieve increases in proprietary brand merchandise sales as a percentage of net
sales. Because the Companys proprietary brand merchandise generally carries
higher merchandise margins than its other merchandise, the Companys failure to
anticipate, identify and react in a timely manner to fashion trends with its
proprietary brand merchandise, particularly if the percentage of net sales
derived from proprietary brand merchandise increases, may have a material
adverse effect on the Companys same store sales results, operating margins,
financial condition and results of operations. 22




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##### Table of Contents



Fluctuations in Comparable Store Net Sales Results.The Companys comparable
store net sales results have fluctuated significantly in the past on a monthly,
quarterly, and annual basis, and are expected to continue to fluctuate in the
future. A variety of factors affect the Companys comparable store net sales
results, including changes in fashion trends, changes in the Companys
merchandise mix, calendar shifts of holiday periods, actions by competitors,
weather conditions and general economic conditions. The Companys comparable
store net sales results for any particular fiscal month, fiscal quarter or
fiscal year in the future may decrease. As a result of these or other factors,
the Companys future comparable store net sales results are likely to have a
significant effect on the market price of the Companys common stock. Expansion and Management of Growth.PacSuns continued growth depends to a
significant degree on its ability to open and operate stores on a profitable
basis and on managements ability to manage the Companys planned expansion.
The Company has previously announced plans to operate 1,400 stores by the end
of 2007, of which approximately 900 will be PacSun stores, approximately 100
will be PacSun Outlet stores, and approximately 400 will be d.e.m.o. stores.
At July 31, 2004, the Company operated 947 stores, of which 717 were PacSun
stores, 82 were PacSun Outlet stores, and 148 were d.e.m.o. stores. The
Companys planned expansion is dependent upon a number of factors, including
the ability of the Company 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
the Companys control may also affect the Companys ability to expand,
including general economic and business conditions affecting consumer spending.
There can be no assurance that the Company will achieve its planned expansion,
that such expansion will be profitable, or that the Company will be able to
manage its growth effectively. Any failure to manage growth could have a
material adverse effect on the Companys business, financial condition and
results of operations. Reliance on Key Personnel.The continued success of the Company is dependent
to a significant degree upon the services of its key personnel, particularly
its executive officers. The loss of the services of any member of senior
management could have a material adverse effect on the Companys business,
financial condition and results of operations. The Companys success in the
future will also be dependent upon the Companys ability to attract and retain
qualified personnel. The Companys inability to attract and retain qualified
personnel in the future could have a material adverse effect on the Companys
business, financial condition and results of operations. Dependence on Single Distribution Facility.The Companys distribution
functions for all of its 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 the Companys business, financial condition and results of operations.
There can be no assurance that the Companys corporate office and distribution
center will be adequate to support the Companys future growth. Internet Sales. The Companys internet operations are subject to numerous
risks that could have a material adverse effect on the Companys 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 PacSun 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 the Companys control that could have a material adverse effect on the
Companys operational results, including: (i) price competition involving the
items the Company intends to sell; (ii) the entry of the Companys vendors into
the internet business, in direct competition with the Company; (iii) the level
of merchandise returns experienced by the Company; (iv) governmental
regulation; (v) online security breaches; (vi) credit card fraud; and (vii)
competition and general economic conditions specific to the internet, online
commerce and the apparel industry. Economic Impact of Terrorist Attacks or War/Threat of War.The majority of the
Companys 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 23




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##### Table of Contents



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 the Companys business, financial condition
and results of operations. Reliance on Foreign Sources of Production.The Company purchases merchandise
directly in foreign markets for its proprietary brands. In addition, the
Company purchases merchandise from domestic vendors, some of which is
manufactured overseas. The Company does not have any long-term merchandise
supply contracts and its imports are subject to existing or potential duties,
tariffs and quotas. The Company faces competition from other companies for
production facilities and import quota capacity. The Company also faces a
variety of other risks generally associated with doing business in foreign
markets and importing merchandise from abroad, such as: (i) 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 that the Company does
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) organized labor
strikes or slowdowns 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 the Company does business with. The inability of the Company
to rely on its foreign sources of production due to any of the factors listed
above could have a material adverse effect on the Companys business, financial
condition and results of operations. Credit Facility Financial Covenants.A significant decrease in the Companys
operating results could adversely affect the Companys ability to maintain
required financial ratios under the Companys 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 be that the Company
would 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. Expensing of Stock Options.The FASB currently expects to issue a final
standard regarding equity-based compensation in the fourth quarter of 2004.
The FASBs existing exposure draft proposes that all publicly traded companies
begin recording compensation expense related to all unvested and newly granted
stock options prospectively for fiscal years beginning after December 15, 2004.
Currently, the Company includes 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 does not include compensation expense related to stock options in the
Companys reported earnings in the financial statements. If accounting
standards are changed to require the Company to expense stock options, the
Companys reported earnings would be lower under the new standard in the fiscal
year beginning January 30, 2005 and its stock price could decline. 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 have a material adverse effect upon the results of operations or
financial condition of the Company. However, managements assessment of the
Companys current litigation could change in light of the discovery of facts
with respect to legal actions pending against the Company not presently known
to the Company or determinations by judges, juries or other finders of fact
which do not accord with managements evaluation of the possible liability or
outcome of such litigation. Volatility of Stock Price.The market price of the Companys 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 24




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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. ************* The Company cautions that the risk factors described above could cause actual
results or outcomes to differ materially from those expressed in any
forward-looking statements of the Company made by or on behalf of the Company.
Further, management cannot assess the impact of each such factor on the
Companys business or the extent to which any factor, or combination of
factors, may cause actual results to differ materially from those contained in
any forward-looking statements. 
 ITEM 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is susceptible to market value fluctuations with regard to its
short-term investments. However, due to the relatively short maturity period
of those investments and the Companys intention to hold those investments
until maturity, the risk of material market value fluctuations is not expected
to be significant. To the extent the Company borrows under its credit facility, the Company is
exposed to market risk related to changes in interest rates. At July 31, 2004,
there were no borrowings outstanding under the Companys credit facility and
the Company did not borrow under the credit facility at any time during the
first half of fiscal 2004. Based on the interest rate of 4.25% on the
Companys credit facility, if interest rates on the credit facility were to
increase by 10%, and to the extent borrowings were outstanding, for every
$1,000,000 outstanding on the Companys credit facility, net income would be
reduced by approximately $3,000 per year. For a discussion of the Companys
accounting policies for financial instruments and further disclosures relating
to financial instruments, see Summary of Significant Accounting Policies and
Nature of Business in the Notes to Consolidated Financial Statements in the
Companys Form 10-K for the year ended January 31, 2004. The Company is not a
party with respect to derivative financial instruments. 
 ITEM 4  CONTROLS AND PROCEDURES As of the end of the period covered by this report, the Chief Executive Officer
and Chief Financial Officer of the Company (collectively, the certifying
officers) evaluated the effectiveness of the Companys disclosure controls and
procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the
Exchange Act). These disclosure controls and procedures are designed to ensure
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,
and that the information is communicated to the certifying officers on a timely
basis. The certifying officers concluded, based on their evaluation, that the
Companys disclosure controls and procedures were effective for the Company as
of the end of the period covered by this report, taking into consideration the
size and nature of the Companys business and operations. No change in the Companys internal control over financial reporting occurred
during the last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, the Companys internal control over financial
reporting. 25




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##### Table of Contents



PART II-OTHER INFORMATION 
 Item 1  Legal Proceedings For information regarding legal proceedings, see Litigation within Note 8 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 the first half of fiscal 2004, see
Note 5 of Notes to Condensed Consolidated Financial Statements, which is
incorporated by reference in response to this Item 2. 
 Item 3  Defaults Upon Senior Securities- Not Applicable 
 Item 4  Submission of Matters to a Vote of Security Holders a) The 2004 Annual Meeting of Shareholders of the Company was held on May 19,
2004. c) At the 2004 Annual Meeting, Sally Frame Kasaks, Thomas Murnane and Peter
Starrett were elected as Class I Directors of the Company for a two-year term
ending in 2006. The shareholders voted on and ratified the appointment of Deloitte & Touche LLP
as independent auditors for the Company for the year ending January 29, 2005. Voting at the 2004 Annual Meeting for the election of directors is set forth
below. Each of the nominees identified below was elected a director. NAME
    
    VOTES CAST FOR
    
    VOTES WITHHELDClass I Directors:Sally Frame Kasaks
    
    
    69,579,344
    
    
    
    2,753,862Thomas Murnane
    
    
    70,361,933
    
    
    
    1,971,273Peter Starrett
    
    
    70,508,273
    
    
    
    1,824,933
 With respect to the ratification of the appointment of Deloitte & Touche LLP as
independent auditors for the Company for the year ended January 29, 2005,
69,062,159 votes were cast for approval, 1,976,280 votes were cast against,
1,294,767 votes abstained and there were no broker non-votes. 
 Item 5  Other Information- Not Applicable 
 Item 6  Exhibits and Reports on Form 8-K Exhibit 3.1
    
    Third Amended and Restated Articles of Incorporation of the CompanyExhibit 3.2
    
    Third Amended and Restated Bylaws of the CompanyExhibit 10.1
    
    First Amendment to Business Loan Agreement dated May 7, 2004 between the Company and Bank of America, N.A.Exhibit 10.2
    
    Second Amendment to Business Loan Agreement dated August 18, 2004 between the Company and Bank of America, N.A.Exhibit 10.3
    
    Amendment No. 1 to Rights Agreement dated June 18, 2004
 26




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Exhibit 31
    
    Written statements of Greg H. Weaver and Carl W. Womack pursuant to section 302 of the
Sarbanes-Oxley Act of 2002.Exhibit 32
    
    Written statement of Greg H. Weaver and Carl W. Womack pursuant to section 906 of the
Sarbanes-Oxley Act of 2002.
 On May 10, 2004, the Company filed an 8-K furnishing a press release announcing
results of operations for the first quarter ended May 1, 2004. 27




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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: August 30, 2004
    /s/   GREG H. WEAVERGreg H. WeaverChairman of the Board
and Chief Executive Officer
(Principal Executive Officer) Date: August 30, 2004
    /s/   CARL W. WOMACKCarl W. WomackSenior Vice President, Chief
Financial Officer and Secretary
(Principal Financial and Accounting Officer) 28




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EXHIBIT INDEX Exhibit 3.1
    
    Third Amended and Restated Articles of Incorporation of the CompanyExhibit 3.2
    
    Third Amended and Restated Bylaws of the CompanyExhibit 10.1
    
    First Amendment to Business Loan Agreement dated May 7, 2004 between the Company and Bank of America, N.A.Exhibit 10.2
    
    Second Amendment to Business Loan Agreement dated August 18, 2004 between the Company and Bank of America, N.A.Exhibit 10.3
    
    Amendment No. 1 to Rights Agreement dated June 18, 2004Exhibit 31
    
    Written statements of Greg H. Weaver and Carl W. Womack pursuant to section 302 of the
Sarbanes-Oxley Act of 2002.Exhibit 32
    
    Written statement of Greg H. Weaver and Carl W. Womack pursuant to section 906 of the
Sarbanes-Oxley Act of 2002.