Pacific Sunwear Of California 10Q 2009 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended: November 1, 2008


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

Commission file number 0-21296

PACIFIC SUNWEAR OF CALIFORNIA, INC.

(Exact name of registrant as specified in its charter)


California		95-3759463
(State of incorporation)		(I.R.S. Employer Identification No.)

3450 East Miraloma Avenue, Anaheim, CA 92806
(Address of principal executive offices and zip code)

(714) 414-4000
(Registrant’s telephone number)

•

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. Yesþ Noo

•

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


Large Accelerated Filerþ	Accelerated Filero	Non-Accelerated Filero	Smaller Reporting Companyo
		(Do not check if a smaller reporting company)

•

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

On December 1, 2008, the registrant had 65,687,089 shares of Common Stock outstanding.

PACIFIC SUNWEAR OF CALIFORNIA, INC.
FORM 10-Q
For the Quarter Ended November 1, 2008

Index


		Page #
PART I.	FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements (unaudited):
	Condensed Consolidated Balance Sheets—November 1, 2008 and February 2, 2008		3
	Condensed Consolidated Statements of Operations and Comprehensive Operations—Third quarter (13 weeks) and three quarters (39 weeks) ended November 1, 2008 and November 3, 2007		4
	Condensed Consolidated Statements of Cash Flows—Three quarters (39 weeks) ended November 1, 2008 and November 3, 2007		5
	Notes to Condensed Consolidated Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		14
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		25
Item 4.	Controls and Procedures		25

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings		26
Item 1A.	Risk Factors		26
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		30
Item 3.	Defaults upon Senior Securities		30
Item 4.	Submission of Matters to a Vote of Security Holders		30
Item 5.	Other Information		30
Item 6.	Exhibits		30

	SIGNATURE PAGE		31
EX-31.1
EX-31.2
EX-32.1

PACIFIC SUNWEAR OF CALIFORNIA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, all amounts in thousands except share amounts)


	November 1, 2008			February 2, 2008
ASSETS

CURRENT ASSETS:
Cash and cash equivalents	$	4,817		$	97,587
Merchandise inventories		233,814			170,182
Other current assets		73,635			52,818

Total current assets		312,266			320,587

PROPERTY AND EQUIPMENT, NET:
Gross property and equipment		678,305			688,241
Less accumulated depreciation and amortization		(324,371	)		(311,998	)

Total property and equipment, net		353,934			376,243

Assets held for sale		15,637			—
Other assets		31,423			55,313

TOTAL ASSETS	$	713,260		$	752,143


LIABILITIES AND SHAREHOLDERS’ EQUITY

CURRENT LIABILITIES:
Accounts payable	$	113,799		$	62,349
Short-term borrowings		43,100			—
Other current liabilities		47,365			71,107

Total current liabilities		204,264			133,456

Deferred lease incentives		55,054			74,012
Deferred rent		23,471			27,669
Other long-term liabilities		32,213			33,661

Total liabilities		315,002			268,798

Commitments and contingencies (Note 11)

SHAREHOLDERS’ EQUITY:
Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued		—			—
Common stock, $.01 par value; 170,859,375 shares authorized; 64,993,641 and 70,026,510 shares issued and outstanding, respectively		650			700
Additional paid-in capital		1,538			16,761
Retained earnings		396,070			465,884

Total shareholders’ equity		398,258			483,345


TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	713,260		$	752,143

See accompanying footnotes

PACIFIC SUNWEAR OF CALIFORNIA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE OPERATIONS

(unaudited, in thousands except share and per share amounts)


	For the Third Quarter Ended						For the Three Quarters Ended
	November 1, 2008			November 3, 2007			November 1, 2008			November 3, 2007
Net sales	$	323,612		$	341,874		$	903,204		$	921,755

Cost of goods sold, including buying, distribution and occupancy costs		230,836			227,148			639,705			629,986

Gross margin		92,776			114,726			263,499			291,769

Selling, general and administrative expenses		95,308			88,325			281,163			251,962

Operating (loss) income from continuing operations		(2,532	)		26,401			(17,664	)		39,807

Other expense (income), net		1,100			(652	)		461			(2,162	)

(Loss) income from continuing operations before income taxes		(3,632	)		27,053			(18,125	)		41,969

Income tax (benefit) expense		(112	)		9,910			(6,344	)		15,906

(Loss) income from continuing operations		(3,520	)		17,143			(11,781	)		26,063

Income (loss) from discontinued operations, net of tax		1,046			(37,180	)		(24,999	)		(61,660	)


Net loss	$	(2,474	)	$	(20,037	)	$	(36,780	)	$	(35,597	)


Comprehensive loss	$	(2,474	)	$	(20,037	)	$	(36,780	)	$	(35,597	)


(Loss) income from continuing operations per share:
Basic	$	(0.05	)	$	0.25		$	(0.18	)	$	0.37

Diluted	$	(0.05	)	$	0.25		$	(0.18	)	$	0.37


Net loss per share:
Basic	$	(0.04	)	$	(0.29	)	$	(0.55	)	$	(0.51	)

Diluted	$	(0.04	)	$	(0.29	)	$	(0.55	)	$	(0.51	)


Weighted average shares outstanding:
Basic		64,968,707			69,765,113			67,182,918			69,678,733
Diluted		64,968,707			69,949,070			67,182,918			69,975,662

See accompanying footnotes

PACIFIC SUNWEAR OF CALIFORNIA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)


	Three Quarters Ended
	Nov. 1, 2008			Nov. 3, 2007
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(36,780	)	$	(35,597	)
Adjustments to reconcile net loss to net cash from operating activities:
Depreciation and amortization		58,743			58,295
Asset impairment		14,821			59,756
Goodwill impairment		6,492			—
Loss on disposal of property and equipment		2,368			3,245
Non-cash stock based compensation		4,442			5,119
Tax (deficiencies) benefits related to stock-based compensation		(1,408	)		320
Excess tax benefits related to stock-based compensation		(5	)		(292	)
Change in operating assets and liabilities:
Merchandise inventories		(63,632	)		(36,997	)
Other current assets		(20,817	)		(25,349	)
Other assets		17,398			(3,093	)
Accounts payable		51,450			39,770
Other current liabilities		(21,776	)		(8,047	)
Deferred lease incentives		(18,958	)		(11,170	)
Deferred rent		(4,199	)		(2,211	)
Other long-term liabilities		(1,454	)		2,115

Net cash (used in)/provided by operating activities		(13,315	)		45,864


CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(71,528	)		(94,939	)
Proceeds from sale of property and equipment		275			—
Purchases of available-for-sale marketable securities		—			(171,400	)
Sales of available-for-sale marketable securities		—			202,900
Purchases of held-to-maturity marketable securities		—			(23,300	)

Net cash used in investing activities		(71,253	)		(86,739	)


CASH FLOWS FROM FINANCING ACTIVITIES:
Repurchases of common stock		(52,911	)		—
Borrowings under credit facility		168,739			—
Principal payments under credit facility		(125,639	)		—
Proceeds from exercise of stock options		1,613			2,237
Principal payments under capital lease obligations		(9	)		(42	)
Borrowing under long-term financing obligation		—			23,300
Excess tax benefits related to stock-based compensation		5			292

Net cash (used in)/provided by financing activities		(8,202	)		25,787


NET DECREASE IN CASH AND CASH EQUIVALENTS:		(92,770	)		(15,088	)
CASH AND CASH EQUIVALENTS, beginning of period		97,587			52,267

CASH AND CASH EQUIVALENTS, end of period	$	4,817		$	37,179


SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest	$	174		$	5
Cash paid for income taxes	$	539		$	10,635
SUPPLEMENTAL DISCLOSURES OF NON-CASH TRANSACTIONS:
(Decrease)/Increase in non-cash property and equipment accruals	$	(2,013	)	$	247
Capital lease transaction for property and equipment	$	20		$	9

See accompanying footnotes

PACIFIC SUNWEAR OF CALIFORNIA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the quarterly period ended November 1, 2008

(unaudited, all amounts in thousands except share and per share

amounts unless otherwise indicated)

1. NATURE OF BUSINESS

Pacific Sunwear of California, Inc. and its subsidiaries (collectively, the “Company,” “we,” “us,” or “our”) is a leading lifestyle specialty retailer rooted in the youth culture and fashion vibe of Southern California. We sell casual apparel with a limited selection of accessories and footwear designed to meet the needs of teens and young adults. We operate a nationwide, primarily mall-based chain of retail stores under the names “Pacific Sunwear” and “Pacific Sunwear Outlet” (as well as “PacSun” and “PacSun Outlet”). In addition, we operate an e-commerce website atwww.pacsun.com which sells PacSun merchandise online, provides content and community for our target customers, and provides information about the Company.

2. BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rules 5-02 and 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The condensed consolidated financial statements include the accounts of Pacific Sunwear of California, Inc. and its subsidiaries (Pacific Sunwear Stores Corp. and Miraloma Corp.). All intercompany transactions have been eliminated in consolidation.

In the opinion of management, all adjustments consisting only of normal, recurring entries necessary for a fair presentation have been included. The preparation of consolidated financial statements in conformity with GAAP 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 three quarters ended November 1, 2008 are not necessarily indicative of the results that may be expected for the fiscal year ending January 31, 2009 (“fiscal 2008”). For further information, refer to the consolidated financial statements and notes thereto included in our annual report on Form 10-K for the fiscal year ended February 2, 2008 (“fiscal 2007”).

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Information regarding our significant accounting policies is contained in Note 1, “Nature of Business and Summary of Significant Accounting Policies,” to the consolidated financial statements in our annual report on Form 10-K for fiscal 2007. 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.

New Accounting Pronouncements — In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”). This new standard provides guidance for using fair value to measure assets and liabilities and information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. This framework is intended to provide increased consistency in how fair value determinations are made under various existing accounting standards which permit, or in some cases require, estimates of fair market value. SFAS 157 also expands financial statement disclosure requirements about a company’s use of fair value measurements, including the effect of such measures on earnings. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. However, the FASB staff has approved a one year deferral for the implementation of SFAS 157 for non-financial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. Non-financial assets and liabilities for which we have not applied the provisions of SFAS 157 include those

measured at fair value in goodwill impairment testing and asset impairments under SFAS 144. We adopted this statement for financial assets and liabilities effective February 3, 2008. There was no impact from adoption of this standard on our consolidated financial statements. We do not expect adoption of this standard as it pertains to non-financial assets and liabilities to have a material impact on our consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Liabilities” (“SFAS 159”), which permits companies to choose to measure certain financial instruments and other items at fair value that are not currently required to be measured at fair value. We adopted SFAS 159 effective February 3, 2008. The adoption of this standard did not have a material impact on our consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”), which requires us to record fair value estimates of contingent consideration and certain other potential liabilities during the original purchase price allocation, expense acquisition costs as incurred and does not permit certain restructuring activities previously allowed under EITF 95-3 to be recorded as a component of purchase accounting. We will adopt this standard at the beginning of our fiscal year in 2010 for all prospective business acquisitions, if any.

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements — an amendment of ARB No. 51” (“SFAS 160”), which causes non-controlling interests in subsidiaries to be included in the equity section of the balance sheet. We will adopt this standard at the beginning of our fiscal year in 2010. We do not expect the adoption of this standard to have a material impact on our consolidated financial statements.

4. DISCONTINUED OPERATIONS

During the first quarter of fiscal 2008 ended May 3, 2008, we completed inventory liquidation sales and closed our remaining demo stores. During the fourth quarter of fiscal 2007 ended February 2, 2008, we closed our nine-store footwear concept, One Thousand Steps (“OTS”). Accordingly, the operations of the demo and OTS businesses have been removed from continuing operations and are presented as discontinued operations within our condensed consolidated statements of operations and comprehensive operations for all periods presented. The operating results of the discontinued operations are summarized as follows:


	For the Third Quarter						For the Three Quarters
	Ended						Ended
	Nov. 1,			Nov. 3,			Nov. 1,			Nov. 3,
	2008			2007			2008			2007
Net sales	$	—		$	31,274		$	27,051		$	116,196
Loss before income tax benefit		(683	)		(64,151	)		(40,818	)		(105,310	)
Income tax benefit		(1,729	)		(26,971	)		(15,819	)		(43,650	)
Net income (loss)		1,046			(37,180	)		(24,999	)		(61,660	)
Net income (loss) per diluted share	$	0.02		$	(0.53	)	$	(0.37	)	$	(0.89	)

At November 1, 2008, $0.4 million remained in accrued liabilities associated with one demo store for which lease termination negotiations had been finalized but not yet paid. At the date of this filing, there are no remaining financial obligations associated with the discontinued demo concept.

5. SEGMENT REPORTING

We operate exclusively in the retail apparel industry in which we distribute, design and produce clothing and related products catering to the teen/young adult demographic through primarily mall-based retail stores. In recent years, our operating and reportable segments included the operations of the demo and OTS store concepts. As discussed in Note 4, we are now a “one brand” business (PacSun) after having discontinued the demo and OTS businesses. Accordingly, for fiscal 2008, we have identified three operating segments (PacSun, PacSun Outlet, and pacsun.com) as defined by SFAS 131, “Disclosures about Segments of an Enterprise and Related Information.” The three operating segments have been aggregated into one reportable segment based on the similar nature of products sold, production, merchandising and distribution processes involved, target customers, and economic characteristics among the three operating segments.

6. STOCK-BASED COMPENSATION

We account for stock-based compensation in accordance with the provisions of SFAS 123(R), “Share-Based Payment.” Forfeitures are estimated at the date of grant based on historical rates and reduce the compensation expense to be recognized. The expected terms of options granted are derived from historical data on employee exercises. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the date of grant. Expected volatility is based primarily on the historical volatility of our stock. We record stock-based compensation expense using the graded vesting method over the vesting period, which is generally three to four years. Our stock-based compensation awards generally begin vesting one year after the grant date and, for stock options, expire in seven to ten years or three months after termination of employment with the Company. For the three quarters of each of fiscal 2008 and 2007, the fair value of our stock-based compensation awards, which includes stock options, non-vested shares, share appreciation rights and shares purchased under our employee stock purchase plan (“ESPP”), was determined using the following weighted average assumptions:


	Fiscal Three Quarters
	2008						2007
	Stock Awards			ESPP			Stock Awards			ESPP
Expected Life	4 years			0.5 years			4 years			0.5 years
Stock Volatility		40.3% - 42.8	%		45.4% - 57.0	%		34.7% - 36.6	%		31.9	%
Risk-free Interest Rates		2.3% - 3.0	%		2.1% - 3.2	%		4.3% - 4.9	%		5.0	%
Expected Dividends	None			None			None			None

Stock-based compensation expense for each of the first three quarters of fiscal 2008 and 2007 was included in costs of goods sold for our buying and distribution employees ($1.8 million and $1.5 million, respectively) and in selling, general and administrative expense for all other employees ($2.8 million and $3.0 million, respectively).

A summary of stock option activity, including share appreciation rights, under our 2005 Performance Incentive Plan for the first three quarters of fiscal 2008 is presented below:


						Weighted-
				Weighted-		Average		Aggregate
				Average		Remaining		Intrinsic
				Exercise		Contractual		Value
Stock Options/SARs	Shares			Price		Term (Yrs.)		($000s)
Outstanding at February 2, 2008		2,821,794		$	19.96
Granted		484,080			13.19
Exercised		(98,764	)		9.55
Forfeited or expired		(391,652	)		20.98
Outstanding at May 3, 2008		2,815,458		$	19.02		4.92	$	958
Granted		75,000			9.49
Exercised		(27,734	)		9.29
Forfeited or expired		(281,168	)		20.52

Outstanding at August 2, 2008		2,581,556		$	18.69		4.93	$	57
Granted		18,000			7.97
Exercised		—			—
Forfeited or expired		(123,230	)		20.15

Outstanding at November 1, 2008		2,476,326		$	18.54		4.88	$	—


Vested and expected to vest at November 1, 2008		1,970,353		$	19.32		4.59	$	—


Exercisable at November 1, 2008		1,411,928		$	20.13		4.18	$	—

The weighted-average grant-date fair value of options granted during the three quarters of each of fiscal 2008 and 2007 was $4.34 and $6.70 per share, respectively. The total intrinsic value of options exercised during the first three quarters of fiscal 2008 and 2007 was $0.4 million and $1.8 million, respectively.

A summary of the status of our non-vested share awards during the first three quarters of fiscal 2008 is presented below:


				Weighted-
				Average Grant-
Non-vested Shares	Shares			Date Fair Value
Outstanding at February 2, 2008		769,075		$	19.01
Granted		276,120			13.19
Vested		(58,690	)		21.00
Forfeited		(169,018	)		19.16

Outstanding at May 3, 2008		817,487		$	16.86
Granted		21,907			9.49
Vested		(40,225	)		20.05
Forfeited		(54,240	)		16.66

Outstanding at August 2, 2008		744,929		$	16.55
Granted		24,203			7.97
Vested		(39,631	)		16.35
Forfeited		(31,253	)		16.13

Outstanding at November 1, 2008		698,248		$	16.28

As of November 1, 2008, we had approximately $13 million of compensation cost related to non-vested stock option and non-vested share awards, net of estimated forfeitures, not yet recognized. This compensation expense is expected to be recognized over a weighted average period of approximately 2.7 years.

7. EARNINGS PER SHARE

We report earnings per share in accordance with the provisions of SFAS No. 128, “Earnings Per Share.” Basic earnings per common share is computed using the weighted average number of shares outstanding. Diluted earnings per common share is computed using the weighted average number of shares outstanding adjusted for the incremental shares attributed to outstanding options to purchase common stock or restricted awards. For purposes of calculating diluted earnings per share, incremental shares were excluded for all periods where there is a net loss or loss from continuing operations presented as their effect would have been anti-dilutive. The following table summarizes the computation of earnings per share (“EPS”):

Third Quarter Ended:


	November 1, 2008								November 3, 2007
	Loss from								Income from
	continuing					Per Share			continuing				Per Share
	operations			Shares		Amount			operations		Shares		Amount
Basic EPS:	$	(3,520	)		64,968,707	$	(0.05	)	$	17,143		69,765,113	$	0.25
Effect of dilutive equivalents		—			—		(0.00	)		—		183,957		(0.00	)

Diluted EPS:	$	(3,520	)		64,968,707	$	(0.05	)	$	17,143		69,949,070	$	0.25


						Per Share								Per Share
	Net loss			Shares		Amount			Net loss			Shares		Amount
Basic EPS:	$	(2,474	)		64,968,707	$	(0.04	)	$	(20,037	)		69,765,113	$	(0.29	)
Effect of dilutive equivalents		—			—		(0.00	)		—			—		(0.00	)

Diluted EPS:	$	(2,474	)		64,968,707	$	(0.04	)	$	(20,037	)		69,765,113	$	(0.29	)

Three Quarters Ended:


	November 1, 2008								November 3, 2007
	Loss from								Income from
	continuing					Per Share			continuing				Per Share
	operations			Shares		Amount			operations		Shares		Amount
Basic EPS:	$	(11,781	)		67,182,918	$	(0.18	)	$	26,063		69,678,733	$	0.37
Effect of dilutive equivalents		—			—		(0.00	)		—		296,929		(0.00	)

Diluted EPS:	$	(11,781	)		67,182,918	$	(0.18	)	$	26,063		69,975,662	$	0.37


						Per Share								Per Share
	Net loss			Shares		Amount			Net loss			Shares		Amount
Basic EPS:	$	(36,780	)		67,182,918	$	(0.55	)	$	(35,597	)		69,678,733	$	(0.51	)
Effect of dilutive equivalents		—			—		(0.00	)		—			—		(0.00	)

Diluted EPS:	$	(36,780	)		67,182,918	$	(0.55	)	$	(35,597	)		69,678,733	$	(0.51	)

Options to purchase 2,546,602 and 2,405,831 shares of common stock in the third quarter of fiscal 2008 and 2007, respectively, and 2,621,356 and 2,293,894 shares of common stock in the first three quarters of fiscal 2008 and 2007, respectively, were not included in the computation of diluted earnings per share because either the option exercise price or the grant date fair value of the non-vested share was greater than the market price of our common stock at the end of the respective period.

8. OTHER CURRENT ASSETS

As of the dates presented, other current assets consisted of the following:


	Nov. 1,		Feb. 2,
	2008		2008
Income taxes receivable	$	46,638	$	5,200
Prepaid expenses		13,514		25,228
Deferred income taxes		9,547		12,179
Non-trade accounts receivable		3,936		10,211

Total other current assets	$	73,635	$	52,818

9. OTHER CURRENT LIABILITIES

As of the dates presented, other current liabilities consisted of the following:


	Nov. 1,		Feb. 2,
	2008		2008
Accrued gift cards	$	8,915	$	15,493
Accrued compensation and benefits		8,250		21,619
Accrued capital expenditures		5,431		7,444
Sales taxes payable		2,872		3,024
Accrued lease terminations		369		3,958
Other		21,528		19,569

Total other current liabilities	$	47,365	$	71,107

10. CREDIT FACILITY

Direct borrowings under the New Credit Facility bear interest at the Administrative Agent’s alternate base rate (as defined, 3.6% at November 1, 2008) or at optional interest rates that are primarily dependent upon LIBOR or the Federal Funds Effective Rate for the time period chosen. We had $43 million in direct borrowings and $39 million in letters of credit outstanding under the New Credit Facility at November 1, 2008. Our remaining availability at November 1, 2008 was $68 million and our weighted average interest rate on our outstanding borrowings during the third quarter of fiscal 2008 was 4.8%.

The New Credit Facility replaces a $200 million unsecured credit agreement, dated as of September 14, 2005, by and between us and a syndicate of lenders (the “Prior Credit Facility”). The Prior Credit Facility, which was scheduled to mature on September 14, 2010, was terminated concurrently with the execution of the New Credit Facility.

11. COMMITMENTS AND CONTINGENCIES

Litigation — We are involved from time to time in litigation incidental to our business. We believe that the outcome of current litigation will not likely have a material adverse effect on our results of operations or financial condition and, from time to time, we may make provisions for probable litigation losses. Depending on the actual outcome of pending litigation, charges in excess of any provisions could be recorded in the future, which may have an adverse effect on our operating results.

Letters of Credit — We have issued guarantees in the form of commercial letters of credit, of which there were approximately $39 million outstanding at November 1, 2008, as security for merchandise shipments from overseas. All in-transit merchandise covered by letters of credit is accrued for in accounts payable.

12. COMMON STOCK REPURCHASE AND RETIREMENT

There were no share repurchases during the third quarter of fiscal 2008. During fiscal 2008, we repurchased shares as follows:


									Maximum
									Value of
					# of Shares				Shares that
					Purchased				May Yet be
			Average		as Part of		Value of		Purchased
			Price		Publicly		Shares		Under the
	# of Shares		Paid Per		Announced		Purchased		Plan
Period	Purchased		Share		Plan		($000s)		($000s)
									$	50,508
April 2008		799,010	$	12.83		799,010	$	10,248	$	40,260
May 2008		1,280,000		9.26		1,280,000		11,853	$	28,407
June 2008(1)		2,944,900		9.64		2,944,900		28,384	$	23
July 2008 (2)		323,634		7.50		323,634		2,426	$	47,597

Total		5,347,544	$	9.89		5,347,544	$	52,911


(1)		In June 2008, we completed the remainder of our $100 million stock repurchase program announced in May 2006. This repurchase authorization expired when the funds were fully expended.

(2)		As announced in July 2008, the Board of Directors has authorized us to repurchase up to $50 million of our common stock. This repurchase authorization does not expire until all authorized funds have been expended.

13. FAIR VALUE MEASUREMENTS

Effective February 3, 2008, we adopted SFAS 157 for financial assets and liabilities. This standard defines fair value, provides guidance for measuring fair value and requires certain disclosures. This standard does not require any new fair value measurements, but rather applies under other accounting pronouncements that require or permit fair value measurements.

SFAS 157 discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow) and the cost approach (cost to replace the service capacity of an asset or replacement cost). The statement establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

	•		Level 1: Observable inputs such as quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

	•		Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

	•		Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

As of November 1, 2008, we held deferred compensation assets associated with our Executive Deferred Compensation Plan (the “Executive Plan”) that are required to be measured at fair value on a recurring basis. Our Executive Plan covers Company officers and is funded by participant contributions and periodic Company contributions. The investments held by us are included in other assets and are intended to cover the vested participant balances in the Executive Plan. These deferred compensation asset investments are classified as trading securities and are stated at fair market value in accordance with SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities.” Fair value is determined by the most recent publicly quoted market price of the securities at the balance sheet date.

The following table represents our fair value hierarchy for financial assets measured at fair value on a recurring basis as of November 1, 2008:

Fair Value Measurements at November 1, 2008

Quoted Prices

Significant

in Active

Other

Significant

Markets for

Observable

Unobservable

Identical Assets

Inputs

Total

(Level 1)

(Level 2)

(Level 3)

Deferred compensation assets

6,391

—

6,391

—

14. GOODWILL IMPAIRMENT

We evaluate the recoverability of the carrying amount of goodwill annually in conjunction with the preparation of our annual financial statements or whenever events or changes in circumstances indicate that the carrying amount of goodwill may not be fully recoverable. Impairment is assessed when the fair value of the reporting unit, including goodwill, is less than its carrying amount. The amount of impairment loss recognized is equal to the difference between the reporting unit goodwill carrying value and the implied fair value of the goodwill, with the implied fair value determined using the best information available, generally the discounted future cash flows of the assets. With the significant deterioration in the retail business climate as well as a large decline in the market value of the Company’s common stock during the third quarter of fiscal 2008, we determined an interim evaluation of goodwill recoverability was warranted. As a result of our assessment, we determined that the goodwill created in connection with our 1986 four-store acquisition in California and our 1997 fifteen-store acquisition in Florida was fully impaired and we recorded a pre-tax, non-cash goodwill impairment charge of approximately $6 million (approximately $4 million after tax or $0.06 per diluted share) during the third quarter of fiscal 2008. After recording the impairment charge, we have no goodwill remaining on our consolidated balance sheet as of November 1, 2008.

15. ASSETS HELD FOR SALE

In the first quarter of fiscal 2008, the Company announced the closing of its Anaheim, California distribution center and its intent to sell the facility as part of a plan to consolidate its logistics operations in Olathe, Kansas. In connection with the planned sale, the Company recorded an impairment charge of $8 million in the first quarter of fiscal 2008, which represented the excess of the carrying value over the estimated fair value of materials handling equipment and furniture and fixtures, less estimated costs to sell, and was included in selling, general and administrative expenses in the condensed consolidated statement of operations. The Company has classified remaining assets of $16 million, consisting of building and land, as held for sale on the condensed consolidated balance sheet. The sale of the Anaheim distribution center closed in November 2008 and the Company received approximately $25 million in net cash proceeds. The Company expects to record an after-tax gain on the sale of approximately $6 million or $0.10 per diluted share in the fourth quarter of fiscal 2008 as a result of the sale.

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 consolidated operations (“MD&A”) should be read in conjunction with our condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q.

Cautionary Note Regarding Forward-Looking Statements

This report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and we intend that such forward-looking statements be subject to the safe harbors created thereby. In Item 1A, Risk Factors, in this report, we provide cautionary statements identifying important factors that could cause our actual results to differ materially from those projected in the forward-looking statements contained herein. Any statements that express, or involve discussions as to, expectations, beliefs, plans, objectives, assumptions, future events or performance (often, but not always identifiable by 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. Examples of forward-looking statements in this report include, but are not limited to, the following categories of expectations about:

	•		forecasts of future store closures, including planned fiscal 2008 closures

	•		forecasts of future comparable store net sales, gross margins, and selling, general and administrative expenses

	•		the sufficiency of working capital, operating cash flows and available credit to meet our operating and capital expenditure requirements

	•		expectations regarding our capital expenditure plans for fiscal 2008 and 2009

	•		expectations regarding future borrowings and repayments under our credit facility and cash balances at fiscal year-end

	•		expectations regarding future increases in common area maintenance (CAM) expenses

All forward-looking statements included in this report are based on information available to us as of the date hereof, and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. See Item 1A, Risk Factors, in this report for a discussion of these risks and uncertainties. We assume no obligation to update or revise any such forward-looking statements to reflect events or circumstances that occur after such statements are made.

Executive Overview

We consider the following items to be key performance indicators in evaluating our performance:

Comparable (or “same store”) sales- Stores are deemed comparable stores on the first day of the month following the one-year anniversary of their opening or expansion/relocation. We consider same store sales to be an important indicator of our current performance. Same store sales results are important in achieving operating leverage of certain expenses such as store payroll, store occupancy, depreciation, general and administrative expenses, and other costs that are somewhat fixed. Positive same store sales results generate greater operating leverage of expenses while negative same store sales results negatively impact operating leverage. Same store sales results also have a direct impact on our total net sales, cash, and working capital.

Net merchandise margins- We analyze the components of net merchandise margins, specifically initial markups and markdowns as a percentage of net sales. Any inability to obtain acceptable levels of initial markups or any significant increase in our use of markdowns could have an adverse impact on our gross margin results and results of operations.

Operating margin- We view operating margin as a key indicator of our success. The key drivers of operating margins are comparable store net sales, net merchandise margins, and our ability to control operating expenses. For a discussion of the changes in the components comprising operating margins during fiscal 2008 and 2007, see “Results of Operations” in this section.

Store sales trends- We evaluate store sales trends in assessing the operational performance of our stores. Important store sales trends include average net sales per store and average net sales per square foot. Average net sales per store for fiscal 2007 were $1.3 million. Average net sales per square foot for fiscal 2007 were approximately $350.

Cash flow and liquidity (working capital)- We evaluate cash flow from operations, liquidity and working capital to determine our short-term operational financing needs. As a result of lease termination payments associated with the discontinued demo concept, share repurchases and losses from continuing operations during the first three quarters of fiscal 2008, we ended the third quarter with $43 million in direct borrowings outstanding under our credit facility. We expect to repay these borrowings during the fourth quarter with cash flows from operations and the proceeds from the sale of our Anaheim distribution center and end fiscal 2008 with approximately $20 million in cash and no short-term borrowings under our credit facility.

Critical Accounting Policies

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America necessarily requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported revenues and expenses during the reported period. Actual results could differ from these estimates. The accounting policies that we believe are the most critical to aid in fully understanding and evaluating reported financial results include the following:

Recognition of Revenue- Sales are recognized upon purchase by customers at our retail store locations or upon delivery to and acceptance by the customer for orders placed through our website. We accrue for estimated sales returns by customers based on historical sales return results. Actual return rates have historically been within our expectations and the reserves established. However, in the event that the actual rate of sales returns by customers increases significantly, our operational results could be adversely affected. We record the sale of gift cards as a current liability and recognize a sale when a customer redeems a gift card. The amount of the gift card liability is determined taking into account our estimate of the portion of gift cards that will not be redeemed or recovered (“gift card breakage”). Gift card breakage is recognized as revenue after 24 months, at which time the likelihood of redemption is considered remote based on our historical redemption data.

Valuation of Inventories- Merchandise inventories are stated at the lower of average cost or market utilizing the retail method. At any given time, inventories include items that have been marked down to management’s best estimate of their fair market value. We base the decision to mark down merchandise primarily upon its current rate of sale and the age of the item, among other factors. To the extent that our estimates differ from actual results, additional markdowns may have to be recorded, which could reduce our gross margins and operating results.

Determination of Stock-Based Compensation Expense- Stock-based compensation expense is determined according to the fair value recognition provisions of SFAS 123(R), “Share Based Payment,” using the modified prospective transition method. Under this method, we recognize compensation expense for all stock-based compensation awards granted after January 28, 2006 and prior to, but not yet vested as of, January 28, 2006, in accordance with SFAS 123(R). Under the fair value recognition provisions of SFAS 123(R), we recognize stock-based compensation net of an estimated forfeiture rate and only recognize compensation cost for those shares expected to vest using the graded vesting method over the requisite service period of the award.

Determining the appropriate fair value model and calculating the fair value of stock-based compensation awards require the input of highly subjective assumptions, including the expected life of the stock-based compensation awards and stock price volatility. We use the Black-Scholes option-pricing model to determine compensation expense. The assumptions used in calculating the fair value of stock-based compensation awards represent management’s best estimates, but the estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. See “Stock-Based Compensation” within Note 6 to the condensed consolidated financial statements for a further discussion on stock-based compensation.

Store Operating Lease Accounting- Rent expense from store operating leases represents one of the largest expenses incurred in operating our stores. We account for store rent expense in accordance with SFAS 13, “Accounting for Leases,” and FASB Technical Bulletin 85-3, “Accounting for Operating Leases with Scheduled Rent Increases.” Accordingly, rent expense under our store operating leases is recognized on a straight-line basis over the original term of each store’s lease, inclusive of rent holiday periods during store construction and exclusive of any lease renewal options. Pre-opening rent is expensed in accordance with FASB Staff Position 13-1, “Accounting for Rental Costs Incurred during a Construction Period.” We account for landlord allowances received in connection with store operating leases in accordance with SFAS 13, “Accounting for Leases,” and FASB Technical Bulletin 88-1, “Issues Relating to Accounting for Leases.” Accordingly, all amounts received from landlords to fund tenant improvements are recorded as a deferred lease incentive liability, which is then amortized as a credit to rent expense over the related store’s lease term.

Evaluation of Long-Lived Assets- In the normal course of business, we acquire tangible and intangible assets. We periodically evaluate the recoverability of the carrying amount of our long-lived assets (including property, plant and equipment, and other intangible assets) whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. Impairment is assessed when the undiscounted expected future cash flows derived from an asset or asset group are less than its carrying amount. The amount of impairment loss recognized is equal to the difference between the carrying value and the estimated fair value of the asset, with such estimated fair values determined using the best information available, generally the discounted future cash flows of the assets using a rate that approximates our weighted average cost of capital. Impairments are recognized in operating earnings. We use our best judgment based on the most current facts and circumstances surrounding our business when applying these impairment rules to determine the timing of the impairment test, the undiscounted cash flows used to assess impairments, and the fair value of a potentially impaired asset. Changes in assumptions used could have a significant impact on our assessment of recoverability. Numerous factors, including changes in our business, industry segment, and the global economy, could significantly impact our decision to retain, dispose of, or idle certain of our long-lived assets.

The estimation of future cash flows from operating activities requires significant estimates of factors that include future sales growth and gross margin performance. If our sales growth, gross margin performance or other estimated operating results are not achieved at or above our forecasted level, the carrying value of certain of our retail stores may prove unrecoverable and we may incur additional impairment charges in the future.

Evaluation of Insurance Reserves- We are responsible for workers’ compensation and medical insurance claims up to a specified aggregate stop loss amount. We maintain reserves for estimated claims, both reported and incurred but not reported, based on historical claims experience and other estimated assumptions. Actual claims activity has historically been within our expectations and the reserves established. To the extent claims experience or our estimates change, additional charges may be recorded in the future up to the aggregate stop loss amount for each policy year.

Evaluation of Income Taxes- Current income tax expense is the amount of income taxes expected to be payable for the current reporting period. The combined federal and state income tax expense was calculated using estimated effective annual tax rates. A deferred income tax asset or liability is established for the expected future consequences of temporary differences in the financial reporting and tax bases of assets and liabilities. We consider future taxable income and ongoing prudent and feasible tax planning in assessing the value of our deferred tax assets. Evaluating the value of these assets is necessarily based on our judgment. If we determined that it was more likely than not that the carrying value of these assets would not be realized, we would reduce the value of these assets to their expected realizable value through a valuation allowance, thereby decreasing net income. If we

subsequently determined that the carrying value of these assets, which had been written down, would be realized in the future, the value of the deferred tax assets would be increased, thereby increasing net income in the period when that determination was made.

Evaluation of Litigation Matters- We are involved from time to time in litigation incidental to our business. We believe that the outcome of current litigation will not likely have a material adverse effect on our results of operations or financial condition and, from time to time, we may make provisions for probable litigation losses. Depending on the actual outcome of pending litigation, charges in excess of any provisions could be recorded in the future, which may have an adverse effect on our operating results.

Results of Operations

The following table sets forth selected income statement data from continuing operations expressed as a percentage of net sales for the periods indicated. The table and discussion that follows excludes the operations of our demo concept which was discontinued during the first quarter of fiscal 2008 and our One Thousand Steps concept which was discontinued during fiscal 2007. The discussion that follows should be read in conjunction with the following table:


	Third Quarter Ended						Three Quarters Ended
	Nov. 1,			Nov. 3,			Nov. 1,			Nov. 3,
	2008			2007			2008			2007
Net sales		100.0	%		100.0	%		100.0	%		100.0	%
Cost of goods sold, including buying, distribution and occupancy costs		71.3			66.4			70.8			68.3

Gross margin		28.7			33.6			29.2			31.7
Selling, general and administrative expenses		29.5			25.8			31.1			27.3

Operating (loss) income from continuing operations		(0.8	)		7.7			(2.0	)		4.3
Other expense (income), net		0.3			(0.2	)		0.1			(0.2	)

(Loss) income from continuing operations before income taxes		(1.1	)		7.9			(2.0	)		4.6
Income tax expense (benefit)		0.0			2.9			(0.7	)		1.7

(Loss) income from continuing operations		(1.1	)%		5.0	%		(1.3	)%		2.8	%

The following table sets forth the number of stores and total square footage as of the dates indicated for PacSun and PacSun Outlet only:


	Nov. 1,		Nov. 3,
	2008		2007
PacSun stores		815		838
PacSun Outlet stores		125		119

Total stores		940		957

Square footage (in 000s)		3,608		3,667

During the first quarter of fiscal 2008, we closed our remaining 153 demo stores which comprised a total of approximately 438,000 square feet. During fiscal 2007, we closed 74 demo stores and all nine of our One Thousand Steps stores.

The third quarter (thirteen weeks) ended November 1, 2008 as compared to the third quarter (thirteen weeks) ended November 3, 2007

Net Sales

Net sales decreased to $324 million for the third quarter of fiscal 2008 from $342 million for the third quarter of fiscal 2007. The components of this $18 million decrease in net sales are as follows:


$ millions			Attributable to
$	(22	)	Decrease due to a (7.0)% decline in comparable store net sales in the third quarter of fiscal 2008 compared to the third quarter of fiscal 2007. In percentage terms, the average sale transaction in a comparable store was down 10% partially offset by a 3% increase in total transactions
	(6	)	Net decrease in sales due to store closures
	10		Increase due to non-comparable sales from new, expanded or relocated stores not yet included in the comparable store base and internet net sales

$	(18	)	Total

Within PacSun and PacSun Outlet, comparable store net sales of Juniors and Young Mens apparel were up 16% and down 1%, respectively. Juniors comparable store net sales results were characterized by strength in Bullhead denim, tees and knits, partially offset by weakness in shorts, swim and dresses. Young Mens comparable store net sales results were characterized by strength in Bullhead denim and knits offset by weakness in shorts, tees, fleece and wovens. Comparable store net sales of non-apparel were down 25% from last year primarily due to our shift in strategy to become more apparel focused. We currently expect total comparable store net sales to continue to be negative in the fourth quarter of fiscal 2008.

Gross Margin

Gross margin, after buying, distribution and occupancy costs, was $93 million for the third quarter of fiscal 2008 versus $115 million for the third quarter of fiscal 2007. As a percentage of net sales, gross margin was 28.7% for the third quarter of fiscal 2008 compared to 33.6% for the third quarter of fiscal 2007. The components of this 4.9% decrease in gross margin as a percentage of net sales were as follows:


%			Attributable to
	(3.6	)	Decline in merchandise margin due to increased markdowns
	(1.4	)	Deleverage of occupancy costs as a result of the negative seven percent same-store sales results for the third quarter of fiscal 2008
	(0.2	)	Deleverage of buying costs as a result of the negative seven percent same-store sales results for the third quarter of fiscal 2008
	0.3		Decrease in freight and distribution costs of $1 million due primarily to the consolidation of our distribution function in the first quarter of fiscal 2008

	(4.9	)	Total

We currently expect gross margin to continue to be negatively impacted in the fourth quarter of fiscal 2008 as a result of increased promotional activity and deleveraging of occupancy and buying costs.

Selling, General and Administrative Expenses

Selling, general and administrative (“SG&A”) expenses increased to $95 million for the third quarter of fiscal 2008, up from $88 million for the third quarter of fiscal 2007, an increase of $7 million, or 8%. These expenses increased to 29.5% as a percentage of net sales in the third quarter of fiscal 2008 from 25.8% in the third quarter of fiscal 2007. The components of this 3.7% increase in SG&A expenses as a percentage of net sales were as follows:


%		Attributable to
	2.6	Increase in asset impairment charges of $8 million primarily attributable to a $6 million goodwill impairment charge and a $2 million increase in store fixed asset impairments
	0.5	Increase in payroll and payroll-related expenses due to deleveraging these expenses against the negative seven percent same-store sales result. In dollars, payroll and payroll-related expenses were down $1 million.
	0.5	Increase in depreciation expense, primarily due to the impact of accelerated depreciation associated with store closures and relocations, and new depreciation on existing stores from our refresh program
	0.1	Increase in other SG&A expenses

	3.7	Total

We evaluate the recoverability of the carrying amount of long-lived assets for all stores (primarily property, plant and equipment) whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. Should comparable store net sales and gross margin continue to decline, we may record additional non-cash impairment charges for underperforming stores in the fourth quarter of fiscal 2008.

Other expense (income), net

For the third quarter of fiscal 2008, we recorded other expenses of $0.8 million related to costs incurred in connection with the sale of our Anaheim distribution center. The sale of the distribution center closed in November 2008. Net interest expense was $0.3 million for the third quarter of fiscal 2008 compared to approximately $0.7 million net interest income for the third quarter of fiscal 2007. Interest income was lower in the third quarter of fiscal 2008 due to the Company having increased direct borrowings under our credit facility and lower average cash balances compared to the prior year due to share repurchases, the payment of demo lease terminations and losses from continuing operations.

Income Taxes

We recognized an income tax benefit of $0.1 million for the third quarter of fiscal 2008 compared to a $10 million income tax benefit for the third quarter of fiscal 2007. The effective income tax rate was 3.1% in the third quarter of fiscal 2008 versus 36.6% in the third quarter of fiscal 2007. The effective income tax rate in the third quarter of fiscal 2008 reflects the tax impact of a decrease in the overall estimated effective tax rate for fiscal 2008 from 43.0% to 35.0% based on revised operating loss projections for fiscal 2008. Our weighted average effective income tax rate will vary over time depending on a number of factors, such as differing average state income tax rates and changes in forecasted annual earnings.

The three quarters (39 weeks) ended November 1, 2008 as compared to the three quarters (39 weeks) ended November 3, 2007

Net Sales

Net sales decreased to $903 million for the first three quarters of fiscal 2008 from $922 million for the first three quarters of fiscal 2007, a decrease of $19 million, or 2.1%. The components of this $19 million decrease in net sales are as follows:


$ millions			Attributable to
$	(27	)	Decrease due to a (3.0)% decline in comparable store net sales in the first three quarters of fiscal 2008 compared to the first three quarters of fiscal 2007. In percentage terms, the average sale transaction in a comparable store was down 5% partially offset by a 2% increase in total transactions
	(17	)	Decrease in sales due to store closures
	25		Increase due to non-comparable sales from new, expanded or relocated stores not yet included in the comparable store base and internet net sales

$	(19	)	Total

Within PacSun and PacSun Outlet, comparable store net sales of Juniors and Young Mens apparel were up 22% and 1%, respectively. Juniors comparable store net sales results were characterized by strength in Bullhead denim, tees, and dresses partially offset by weakness in shorts and swim. Young Mens comparable store net sales results were characterized by strength in Bullhead denim, knits and fleece offset by weakness in swim and wovens. Comparable store net sales of non-apparel was down 20% from last year primarily due to our shift in strategy to become more apparel focused. We currently expect total comparable store net sales to continue to be negative in the fourth quarter of fiscal 2008.

Gross Margin

Gross margin, after buying, distribution and occupancy costs, decreased to $263 million for the first three quarters of fiscal 2008 from $292 million for the first three quarters of fiscal 2007, a decrease of $29 million, or 9.9%. As a percentage of net sales, gross margin was 29.2% for the first three quarters of fiscal 2008 compared to 31.7% for the first three quarters of fiscal 2007. The 2.5% decrease in gross margin as a percentage of net sales was primarily attributable to the following:


%			Attributable to
	(1.2	)	Deleverage of occupancy costs as a result of the negative three percent same-store sales result for the first three quarters of fiscal 2008
	(1.1	)	Decrease in merchandise margins primarily due to higher markdowns
	(0.2	)	Deleverage of buying costs as a result of the negative three percent same-store sales result for the first three quarters of fiscal 2008

	(2.5	)	Total

We currently expect gross margin to continue to negatively impacted in the fourth quarter of fiscal 2008 as a result of increased promotional activity and deleveraging of occupancy and buying costs.

Selling, General and Administrative Expenses

Selling, general and administrative expenses (“SG&A”) increased to $281 million for the first three quarters of fiscal 2008 from $252 million for the first three quarters of fiscal 2007, an increase of $29 million, or 11.5%. These expenses increased to 31.1% as a percentage of net sales in the first three quarters of fiscal 2008 from 27.3% in the first three quarters of fiscal 2007. The components of this 3.8% increase in SG&A as a percentage of net sales were as follows:


%		Attributable to
	2.1	Increase in asset impairment and disposal charges of $19 million, including $8 million from the materials handling equipment and furniture and fixtures in our closed Anaheim distribution center, $6 million from the impairment of goodwill, and an increase of $5 million in store fixed asset impairments and losses on disposals
	0.8	Increase in depreciation expense of $6 million, primarily due to the impact of accelerated depreciation associated with store closures and relocations and new depreciation on existing stores from our refresh program
	0.6	Increase in other SG&A expenses of $4 million primarily due to an increase of $2 million in e-commerce related expenses based on the growth of our e-commerce business, $1 million in legal settlement costs and $1 million for all other SG&A expenses
	0.3	Deleverage of payroll and payroll-related costs due to the negative three percent same-store sales result for the first three quarters of fiscal 2008. In dollars, payroll and payroll-related expenses were flat.

	3.8	Total

Other expense (income), net

For the first three quarters of fiscal 2008, we recorded other expenses of $1 million related to costs incurred in connection with the sale of our Anaheim distribution center. The sale of the distribution center closed in November 2008. Net interest income was $0.5 million in the first three quarters of fiscal 2008 compared to $2.2 million in the first three quarters of fiscal 2007. Interest income was lower in the first three quarters of fiscal 2008 due to the Company having increased direct borrowings under our credit facility and lower average cash balances compared to the prior year due to share repurchases, the payment of demo lease terminations and losses from continuing operations.

Income Taxes

The Company recognized an income tax benefit of approximately $6 million for the first three quarters of fiscal 2008 compared to tax expense of $16 million for the first three quarters of fiscal 2007. The change is primarily due to the net loss sustained by the Company during the first three quarters of fiscal 2008. The effective income tax rate was 35.0% in the first three quarters of fiscal 2008 as compared to 37.9% in the first three quarters of fiscal 2007. The decrease in the effective income tax rate is primarily attributable to revised operating loss projections for fiscal 2008. Our weighted average effective income tax rate will vary over time depending on a number of factors, such as differing average state income tax rates and changes in forecasted annual earnings.

Liquidity and Capital Resources

We have historically financed our operations primarily from internally generated cash flow, with occasional short-term and long-term borrowings and equity financing in past years. Our primary capital requirements have been for the construction of newly opened, refreshed, expanded or relocated stores, the financing of inventories and, in the past, construction of corporate facilities. As a result of lease termination payments associated with the discontinued demo concept, share repurchases and losses from continuing operations in the first three quarters of fiscal 2008, we ended the third quarter of fiscal 2008 with $43 million in direct borrowings outstanding under our credit facility. We currently expect to repay these borrowings during the fourth fiscal quarter of 2008 with cash flows from operations and the proceeds from the sale of our Anaheim distribution center and end fiscal 2008 with approximately $20 million in cash and no direct borrowings under our credit facility. We believe that our working capital, cash flows from operations and available credit will be sufficient to meet our operating and capital expenditure requirements for at least the next twelve months.

Operating Cash Flows

Net cash used in operating activities was $13 million for the first three quarters of fiscal 2008 compared to cash provided by operating activities of $46 million for the first three quarters of fiscal 2007. The $59 million decrease in operating cash flows in the first three quarters of fiscal 2008 as compared to the first three quarters of fiscal 2007 was largely attributable to the impact of the discontinued demo concept (see Note 4 to the condensed consolidated financial statements). Additional details regarding the decrease in cash from operating activities are as follows:


$ millions			Attributable to
$	(39	)	Decrease in non-cash asset impairments and loss on disposals primarily due to the discontinued demo concept
	(15	)	Decrease in cash flows from an increase in merchandise inventories, net of accounts payable, due primarily to in-transit holiday shipments and related timing of payments
	(14	)	Decrease in cash flows from other current liabilities due to reduced compensation and lease termination accruals primarily associated with the discontinued demo concept
	(8	)	Decrease in cash flows primarily due to payback of unamortized portions of deferred lease incentives in conjunction with demo lease terminations
	(8	)	Decrease in cash flows from other changes in working capital items
	25		Increase in cash flows related to other current assets and other assets primarily due to the timing of rent payments and increased income tax receivables due to the discontinued demo concept and current year operating losses

$	(59	)	Total

Working Capital

Working capital at November 1, 2008 was $108 million compared to $187 million at February 2, 2008, a decrease of $79 million. The changes in working capital were as follows:


$ millions			Description
$	187		Working capital at February 2, 2008
	(93	)	Decrease in cash and cash equivalents, primarily due to the payment of demo lease terminations, share repurchases and current year operating losses, among other items (see cash flows statement)
	(43	)	Increase in short-term borrowings under our secured credit facility
	24		Net decrease in other current liabilities from reduced compensation accruals primarily due to lower store counts as a result of the discontinued demo concept and a decrease in our accrued gift card liability as a result of current year redemptions net of new gift card issuances
	21		Net increase in other current assets primarily due to an increase in income tax receivables resulting from the discontinued demo concept and current year operating losses
	12		Increase in inventories, net of accounts payable, due to timing of payments and increased inventory levels in advance of the peak holiday selling season

$	108		Working capital at November 1, 2008

Investing Cash Flows

Net cash used in investing activities in the first three quarters of fiscal 2008 was $71 million compared to $87 million for the first three quarters of fiscal 2007, a decrease in cash used of $16 million. Investing cash flows for the first three quarters of fiscal 2008 were comprised entirely of capital expenditures of $71 million. In the first three quarters of fiscal 2007, capital expenditures were $95 million offset by net maturities of marketable securities of $8 million. Capital expenditures were predominantly for the opening of refreshed, relocated and expanded stores. We expect total capital expenditures for fiscal 2008 to be approximately $80 million. We currently expect total capital expenditures for fiscal 2009 to be approximately $30 million primarily for store refreshes and other infrastructure improvements.

Financing Cash Flows

Net cash used in financing activities in the first three quarters of fiscal 2008 was $8 million compared to cash provided of $26 million in the first three quarters of fiscal 2007. In the first three quarters of fiscal 2008, we repurchased and retired $53 million of common stock, offset by net direct borrowings under our credit facility of $43 million and $2 million of proceeds from employee exercises of stock options. In the three quarters of 2007, we completed an industrial revenue bond transaction associated with our Olathe, Kansas distribution center which resulted in a cash inflow of $23 million and we received $2 million in proceeds from employee exercises of stock options.

Credit Facility

On April 29, 2008, we entered into a new, asset-backed credit agreement with a syndicate of lenders (the “New Credit Facility”) which expires April 29, 2013. The New Credit Facility provides for a secured revolving line of credit of up to $150 million, which can be increased to up to $225 million subject to lender approval. Extensions of credit under the New Credit Facility are limited to a borrowing base consisting of specified percentages of eligible categories of assets, primarily cash and inventory. The New Credit Facility is available for direct borrowing and, subject to borrowing base availability ($150 million at November 1, 2008), up to $75 million is available for the issuance of letters of credit and up to $15 million is available for swing-line loans. The New Credit Facility is secured by our cash, cash equivalents, deposit accounts, securities accounts, credit card receivables, and inventory. Direct borrowings under the New Credit Facility bear interest at the Administrative Agent’s alternate base rate (as defined, 3.6% at November 1, 2008) or at optional interest rates that are primarily dependent upon LIBOR or the Federal Funds Effective Rate for the time period chosen. We had $43 million in direct borrowings and $39 million in letters of credit outstanding under the New Credit Facility at November 1, 2008. Our remaining availability at November 1, 2008 was $68 million and our weighted average interest rate on our outstanding borrowings during the third quarter of fiscal 2008 was 4.8%.

The New Credit Facility replaces a $200 million unsecured credit agreement, dated as of September 14, 2005, by and between the Company and a syndicate of lenders (the “Prior Credit Facility”). The Prior Credit Facility, which was scheduled to mature on September 14, 2010, was terminated concurrently with the execution of the New Credit Facility.

Contractual Obligations

We have minimum annual rental commitments under existing store leases as well as a minor amount of capital leases for computer equipment. We lease all of our retail store locations under operating leases. We lease equipment, from time to time, under both capital and operating leases. In addition, at any time, we are contingently liable for commercial letters of credit with foreign suppliers of merchandise. At November 1, 2008, our future financial commitments under all existing contractual obligations related to our PacSun and PacSun Outlet businesses were as follows:


	Payments Due by Period (in $ millions)
			Less						More
			than 1		1-3		3-5		than 5
Contractual Obligations	Total		year		years		years		years
Operating lease obligations	$	592	$	95	$	182	$	139	$	176
Capital lease obligations		<0.1		<0.1		—		—		—
FIN 48 obligations including interest and penalties		2		—		2		—		—
Letters of credit		39		39		—		—		—
Total	$	633	$	134	$	184	$	139	$	176

We expect a significant number of store operating leases (90-150 per year) to reach the end of their original lease term in each of the next 5 years. These leases will need to be renewed, extended or allowed to expire. As a result, actual future rental commitments may be significantly higher than that shown in the table above due to newly adjusted lease rates for renewals or extensions that are more expensive than current lease rates on expiring leases.

The contractual obligations table above does not include common area maintenance (CAM) charges, which are also a required contractual obligation under our store operating leases. In many of our leases, CAM charges are not fixed and can fluctuate significantly from year to year for any particular store based on a variety of factors, including fluctuations in the occupancy level at the particular mall or retail center. Total PacSun and PacSun Outlet store rental expenses, including CAM, were $158 million for fiscal 2007 and $124 million through the first three quarters of fiscal 2008. We expect total CAM expenses to continue to increase due to annual inflationary adjustments and as long-term leases come up for renewal at current market rates in excess of original lease terms.

Operating Leases — We lease our retail stores and certain equipment under operating lease agreements expiring at various dates through January 2020. Substantially all of our retail store leases require us to pay CAM charges, insurance, property taxes and percentage rent ranging from 5% to 7% based on sales volumes exceeding certain minimum sales levels. The initial terms of such leases are typically 8 to 10 years, many of which contain renewal options exercisable at our discretion. Most leases also contain rent escalation clauses that come into effect at various times throughout the lease term. Rent expense is recorded under the straight-line method over the life of the lease. Other rent escalation clauses can take effect based on changes in primary mall tenants throughout the term of a given lease. Most leases also contain cancellation or kick-out clauses in our favor that relieve us of any future obligation under a lease if specified sales levels are not achieved by a specified date. None of our retail store leases contain purchase options.

We review the operating performance of our stores on an ongoing basis to determine which stores, if any, to refresh, expand, relocate or close. We closed 25 PacSun stores in fiscal 2007. Through November 1, 2008, we closed 27 PacSun and PacSun Outlet stores and currently anticipate closing an additional 11 stores in the fourth quarter of fiscal 2008.

Indemnifications

In the ordinary course of business, we may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of our breach of agreements, our occupancy of retail stores, services to be provided by us, or intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and certain of our officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. We maintain director and officer insurance, which may cover certain liabilities arising from our obligation to indemnify our directors and officers in certain circumstances.

It is not possible to determine our maximum potential liability under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Such indemnification agreements may not be subject to maximum loss clauses. Historically, we have not incurred material costs as a result of obligations under these agreements.

New Accounting Pronouncements

Information regarding new accounting pronouncements is contained in Note 3 to the condensed consolidated financial statements for the quarter ended November 1, 2008, which note is incorporated herein by this reference.

Inflation

We do not believe that inflation has had a material effect on our results of operations in the recent past. There can be no assurance that our business will not be affected by inflation in the future.

Seasonality and Quarterly Results

Our business is seasonal by nature. Our first quarter historically accounts for the smallest percentage of annual net sales with each successive quarter contributing a greater percentage than the last. In recent years, excluding sales generated by new and relocated/expanded stores, approximately 44% of our net sales have occurred in the first half of the fiscal year and approximately 56% have occurred in the second half, with the Christmas and back-to-school selling periods together accounting for approximately 30% of our annual net sales and a higher percentage of our operating income. Our quarterly results of operations may also fluctuate significantly as a result of a variety of factors, including unfavorable economic conditions and decreases in consumer spending; the timing of store openings; the amount of revenue contributed by new stores; the timing and level of markdowns; the timing of store closings, refreshes, expansions and relocations; competitive factors; calendar shifts that impact holiday and back to school selling periods; and weather conditions.

ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

To the extent we borrow under our credit facility, we are exposed to market risk related to changes in interest rates. Direct borrowings under the credit facility bear interest at the Administrative Agent’s alternate base rate or at optional interest rates that are primarily dependent upon LIBOR or the Federal Funds Effective Rate for the time period chosen. At November 1, 2008, there were $43 million in direct borrowings outstanding under our credit facility. We did not borrow under the credit facility at any time during fiscal 2007. Based on the interest rate of 3.6% on our credit facility at November 1, 2008, if interest rates on the credit facility were to increase by 10%, for every $1 million outstanding on our credit facility, net income would be reduced by approximately $2,000 per year. We are not a party with respect to derivative financial instruments.

ITEM 4 — CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). These disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Security and Exchange Commission’s rules and forms. Our disclosure controls and procedures are also designed to provide reasonable assurance that information required to be disclosed in the periodic reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, in order to allow timely decisions regarding required disclosures. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of November 1, 2008.

No change in our internal control over financial reporting occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1 — Legal Proceedings

For information on legal proceedings, see “Litigation” within Note 11 to the condensed consolidated financial statements for the quarter ended November 1, 2008, which is incorporated by reference in response to this Item 1.

Item 1A — Risk Factors

We have updated the risk factors discussed in Item 1A of our Annual Report on Form 10-K for the year ended February 2, 2008. Our risk factors, as amended, are included below in this Item 1A.

The current volatility in the U.S. economy has adversely affected consumer spending, which could negatively impact our business, operating results and stock price.Our business operations and financial performance depend significantly on general economic conditions and their impact on levels of consumer spending. Consumer spending is impacted by a number of factors, including consumer confidence in the strength of the general economy, fears of economic recession or depression, the availability and cost of consumer credit, the cost of basic necessities such as food, fuel and housing, inflation and unemployment levels. Current unfavorable economic conditions in the U.S. have resulted in an overall slowing in the retail sector because of decreased consumer spending, which may continue to decline for the foreseeable future. The cost of purchased merchandise may increase as economies of scale are eroded by decreased global demand, and as other costs increase. These and other economic factors could have a material adverse effect on demand for our merchandise and on our financial condition and results of operations.

We are also dependent upon the continued popularity of malls as a shopping destination and the ability of shopping mall anchor tenants and other attractions to generate customer traffic. A continued slowdown in the U.S. economy or an uncertain economic outlook could continue to lower consumer spending levels and cause a decrease in shopping mall traffic, each of which would adversely affect our sales results and financial performance.

Our comparable store net sales results will fluctuate significantly, which can cause volatility in our operating performance and stock price.Our comparable store net sales results have fluctuated significantly on a monthly, quarterly, and annual basis, and are expected to continue to fluctuate in the future. For example, over the past five years, monthly comparable store net sales results for our PacSun and PacSun Outlet stores have varied from a low of minus 16% to a high of plus 16%. A variety of factors affect our comparable store net sales results, including unfavorable economic conditions and decreases in consumer spending, changes in fashion trends and customer preferences, changes in our merchandise mix, calendar shifts of holiday periods, actions by competitors, and weather conditions. Our comparable store net sales results for any particular fiscal month, quarter or year may decrease. As a result of these or other factors, our comparable store net sales results, both past and future, are likely to have a significant effect on the market price of our common stock and our operating performance, including our use of markdowns and our ability to leverage operating and other expenses that are somewhat fixed.

Our failure to identify and respond appropriately to changing consumer preferences and fashion trends in a timely manner could have a material adverse impact on our business and profitability. Our success is largely dependent upon our ability to gauge the fashion tastes of our customers and to provide merchandise at competitive prices and in adequate quantities that satisfies customer demand in a timely manner. Our failure to anticipate, identify or react appropriately in a timely manner to changes in fashion trends could have a material adverse effect on our same store sales results, gross margins, operating margins, financial condition and results of operations. Misjudgments or unanticipated fashion changes could also have a material adverse effect on our image with our customers. Some of our vendors have limited resources, production capacities and operating histories and some have intentionally limited the distribution of their merchandise. The inability or unwillingness on the part of key vendors to expand their operations to keep pace with the anticipated growth of our store concepts, or the loss of one or more key vendors or proprietary brand sources for any reason, could have a material adverse effect on our business.

Our net sales, operating income and inventory levels fluctuate on a seasonal basis.We experience major seasonal fluctuations in our net sales and operating income, with a significant portion of our operating income typically realized during the third quarter back to school and fourth quarter holiday season. Any decrease in sales or margins during these periods could have a disproportionately adverse effect on our financial condition and results of operations. Seasonal fluctuations also affect our inventory levels, since we usually order merchandise in advance of

peak selling periods and sometimes before new fashion trends are confirmed by customer purchases. We generally carry a significant amount of inventory, especially before the holiday season selling period. If we are not successful in selling inventory during this period, we may have to sell the inventory at significantly reduced prices, which may adversely affect profitability.

We have stated our intention to place a greater emphasis on apparel, juniors merchandise, and the proprietary brand penetration within the juniors category in our merchandising assortments than we have in the past, which may not be successful in improving our store productivity or profitability. Our goal is to improve the productivity of our stores in terms of sales per square foot and the profitability of our business as a whole by placing a greater emphasis on apparel, juniors merchandise, and the proprietary brand penetration within the juniors category in our merchandising assortments than we have in the past. It is uncertain that this shift in merchandising strategy will result in higher sales per square foot in our stores or improved operating margins for our business as a whole. The failure of these strategies to improve sales per square foot and profitability could have a material adverse impact on our business, financial condition, results of operations and stock price.

We continue to reinvest in our existing store base, which may not result in improved operating performance.We believe that store design is an important element in the customer shopping experience. Many of our stores have been in operation for many years and have not been updated or renovated since opening. Some of our competitors are in the process of updating, or have updated, their store designs, which may make our stores appear less attractive in comparison. We have been reinvesting in our stores in an attempt to update the look of our stores and improve their productivity. This process carries additional risks such as higher than anticipated construction costs, lack of customer acceptance, and lower store productivity than planned or anticipated, among others. There can be no assurance that this process will prove successful in improving operational results or that we can achieve meaningful results within our existing or planned capital budgets or in an adequate timeframe. Any inability on our part to successfully implement new store designs in a timely manner could have a material adverse effect on our business, financial condition and results of operations.

Our future growth depends, in part, on our ability to open and operate new/existing stores that achieve acceptable levels of profitability. Any failure to do so may negatively impact our stock price and operational performance.Our stores are located principally in enclosed regional shopping malls. PacSun is a relatively mature concept with limited domestic opportunities to open new stores in such malls. There can be no assurance that we will be able to successfully operate existing stores or open and operate new stores that will enable us to continue to grow profitably. Any inability to sustain future long-term growth opportunities could have a material adverse impact on our business, stock price, financial condition and results of operations.

We face significant competition from both vertically-integrated and brand-based competitors that are growing rapidly, which could have a material adverse effect on our business.The retail apparel business is highly competitive. All of our stores compete on a national level with a diverse group of retailers, including vertically-integrated and brand-based national, regional and local specialty retail stores, and certain leading department stores and off-price retailers that offer the same or similar brands and styles of merchandise as we do. Many of our competitors are larger and have significantly greater resources than we do. We believe the principal competitive factors in our industry are fashion, merchandise assortment, quality, price, store location, environment and customer service.

Our customers may not prefer our proprietary brand merchandise, which may negatively impact our profitability.For our PacSun and PacSun Outlet stores, sales from proprietary brand merchandise accounted for approximately 30% of net sales in fiscal 2007 and approximately 37% of net sales for the first three quarters of fiscal 2008. There can be no assurance that we will be able to achieve increases in proprietary brand merchandise sales as a percentage of net sales. Because our proprietary brand merchandise generally carries higher merchandise margins than our other merchandise, our failure to anticipate, identify and react in a timely manner to fashion trends with our proprietary brand merchandise, particularly if the percentage of net sales derived from proprietary brand merchandise changes significantly (up or down), may have a material adverse effect on our same store sales results, operating margins, financial condition and results of operations.

Our current or prospective vendors may be unable or unwilling to supply us with adequate quantities of their merchandise in a timely manner or at acceptable prices, which could have a material adverse impact on our business.The success of our business is dependent upon developing and maintaining good relationships with our vendors. We work very closely with our vendors to develop and acquire appropriate merchandise at acceptable prices for our stores. We do not, however, have any contractual relationships with our vendors. In addition, some of our vendors are relatively unsophisticated or underdeveloped and may have difficulty in providing adequate quantities or quality of merchandise to us in a timely manner. Also, certain of our vendors sell their merchandise directly to retail customers in direct competition with us. Our vendors could discontinue their relationship with us or raise prices on their merchandise at any time. There can be no assurance that we will be able to acquire sufficient quantities of quality merchandise at acceptable prices in a timely manner in the future. Any inability to do so, or the loss of one or more of our key vendors, could have a material adverse impact on our business, results of operations and financial condition.

Our foreign sources of production may not always be reliable, which may result in a disruption in the flow of new merchandise to our stores.We purchase merchandise directly in foreign markets for our proprietary brands. In addition, we purchase merchandise from domestic vendors, some of which is manufactured overseas. We do not have any long-term merchandise supply contracts and our imports are subject to existing or potential duties, tariffs and quotas. We face competition from other companies for production facilities and import quota capacity. We also face a variety of other risks generally associated with doing business in foreign markets and importing 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 within which we do business; (iv) imposition of duties, taxes, and other charges on imports; (v) delayed receipt or non-delivery of goods due to the failure of foreign-source suppliers to comply with applicable import regulations; (vi) delayed receipt or non-delivery of goods due to organized labor strikes or unexpected or significant port congestion at United States ports; and (vii) local business practice and political issues, including issues relating to compliance with domestic or international labor standards which may result in adverse publicity. New initiatives may be proposed that may have an impact on the trading status of certain countries and may include retaliatory duties or other trade sanctions that, if enacted, would increase the cost of products purchased from suppliers in countries that we do business with. Any inability on our part to rely on our foreign sources of production due to any of the factors listed above could have a material adverse effect on our business, financial condition and results of operations.

The loss of key personnel could have a material adverse effect on our business at any time.Our continued success is dependent to a significant degree upon the services of our key personnel, particularly our executive officers. The loss of the services of any member of our senior management team could have a material adverse effect on our business, financial condition and results of operations. Our success in the future will also be dependent upon our ability to attract and retain qualified personnel. In this regard, we have historically used stock awards as a component of our total employee compensation program in order to align employees’ interests with the interests of our shareholders, encourage employee retention and provide competitive compensation and benefit packages. As a result of the decline in our stock price in recent periods, most of our employee stock options have exercise prices in excess of our current stock price, which reduces their value and could affect our ability to retain present, or attract prospective employees. Our inability to attract and retain qualified personnel in the future could have a material adverse effect on our business, financial condition and results of operations.

Adverse outcomes of litigation matters could significantly affect our operating results.We are involved from time to time in litigation incidental to our business. We believe that the outcome of current litigation will not have a material adverse effect upon our results of operations or financial condition. However, our assessment of current litigation could change in light of the discovery of facts with respect to legal actions pending against us not presently known to us or determinations by judges, juries or other finders of fact which do not accord with our evaluation of the possible liability or outcome of such litigation.

Our dependence on a single distribution facility exposes us to significant operational risks.All of our current distribution functions reside within a single facility in Olathe, Kansas. Any significant interruption in the operation of our distribution facility due to natural disasters, accidents, system failures or other unforeseen causes would have a material adverse effect on our business, financial condition and results of operations. There can be no assurance that our distribution center will be adequate to support our future growth.

Selling merchandise over the internet carries particular risks that can have a negative impact on our business.Our internet operations are subject to numerous risks that could have a material adverse effect on our operational results, including unanticipated operating problems, reliance on third party computer hardware and software providers, system failures and the need to invest in additional computer systems. Specific risks include: (i) diversion of sales from our stores; (ii) rapid technological change; (iii) liability for online content; and (iv) risks related to the failure of the computer systems that operate the website and its related support systems, including computer viruses, telecommunication failures and electronic break-ins and similar disruptions. In addition, internet operations involve risks which are beyond our control that could have a material adverse effect on our operational results, including: (i) price competition involving the items we intend to sell; (ii) the entry of our vendors into the internet business, in direct competition with us; (iii) the level of merchandise returns experienced by us; (iv) governmental regulation; (v) online security breaches involving unauthorized access to Company and/or customer information; (vi) credit card fraud; and (vii) competition and general economic conditions specific to the internet, online commerce and the apparel industry.

The effects of terrorism or war could significantly impact consumer spending and our operational performance.The majority of our stores are located in regional shopping malls. Any threat or actual act of terrorism, particularly in public areas, could lead to lower customer traffic in regional shopping malls. In addition, local authorities or mall management could close regional shopping malls in response to any immediate security concern. Mall closures, as well as lower customer traffic due to security concerns, could result in decreased sales. Additionally, war or the threat of war could significantly diminish consumer spending, resulting in decreased sales. Decreased sales would have a material adverse effect on our business, financial condition and results of operations.

Our stock price can fluctuate significantly due to a variety of factors, which can negatively impact our total market value.The market price of our common stock has fluctuated substantially and there can be no assurance that the market price of the common stock will not continue to fluctuate significantly. Future announcements or management discussions concerning us or our competitors, net sales and profitability results, quarterly variations in operating results or comparable store net sales, changes in earnings estimates made by management or analysts, or changes in accounting policies, unfavorable economic conditions, among other factors, could cause the market price of our common stock to fluctuate substantially. In addition, the recent distress in the financial markets has resulted in extreme price and volume volatility. This volatility has had a substantial effect on the market prices of securities of many public companies for reasons frequently unrelated to the operating performance of the specific companies.

Any material failure, interruption or security breach of our computer systems or information technology may adversely affect the operation of our business and our financial results.We are dependent on our computer systems and information technology to properly conduct business. A failure or interruption of our computer systems or information technology could result in the loss of data, business interruptions or delays in our operations. Also, despite our considerable efforts and technological resources to secure our computer systems and information technology, security breaches, such as unauthorized access and computer viruses, may occur resulting in system disruptions, shutdowns or unauthorized disclosure of confidential information. Any security breach of our computer systems or information technology may result in adverse publicity, loss of sales and profits, damages, fines or other loss resulting from misappropriation of information.

In addition, while we regularly evaluate our information systems capabilities and requirements, there can be no assurance that our existing information systems will be adequate to support the existing or future needs of our business. We may have to undertake significant information system implementations, modifications and/or upgrades in the future at significant cost to us. Such projects involve inherent risks associated with replacing and/or changing existing systems, such as system disruptions and the failure to accurately capture data, among others. Information system disruptions, if not anticipated and appropriately mitigated, could have a material adverse effect on our business, results of operations and financial condition.

*************

We caution that the risk factors described above could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on behalf of the Company. Further, we cannot assess the impact of each such factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds

For information on common share repurchases, see Note 12 to the condensed consolidated financial statements for the quarter ended November 1, 2008, which is incorporated by reference in this Item 2.

Item 3 — Defaults upon Senior Securities

None.

Item 4 — Submission of Matters to a Vote of Security Holders

None.

Item 5 — Other Information

None.

Item 6 — Exhibits


Exhibit 3.1		Third Amended and Restated Articles of Incorporation of the Company (1)

Exhibit 3.2		Certificate of Determination of Preferences of Series A Junior Participating Preferred Stock of the Company (2)

Exhibit 3.3		Fourth Amended and Restated Bylaws of the Company (3)

Exhibit 31.1		Written statement of Sally Frame Kasaks pursuant to section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.2		Written statement of Michael L. Henry pursuant to section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32.1		Written statements of Sally Frame Kasaks and Michael L. Henry pursuant to section 906 of the Sarbanes-Oxley Act of 2002


Note Reference:

(1)		Incorporated by reference from the Company’s Quarterly Report on Form 10-Q, as filed with the Securities and Exchange Commission on August 31, 2004

(2)		Incorporated by reference from the Company’s Current Report on Form 8-K, as filed with the Securities and Exchange Commission on December 24, 1998

(3)		Incorporated by reference from the Company’s Current Report on Form 8-K, as filed with the Securities and Exchange Commission on November 26, 2008

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: December 9, 2008	/s/ SALLY FRAME KASAKS
	Sally Frame Kasaks
	Chairman and Chief Executive Officer (Principal Executive Officer)


Date: December 9, 2008	/s/ MICHAEL L. HENRY
	Michael L. Henry
	Senior Vice President, Chief Financial Officer and Secretary (Principal Financial and Accounting Officer)

Exhibit Index


Exhibit 3.1		Third Amended and Restated Articles of Incorporation of the Company (1)

Exhibit 3.2		Certificate of Determination of Preferences of Series A Junior Participating Preferred Stock of the Company (2)

Exhibit 3.3		Fourth Amended and Restated Bylaws of the Company (3)

Exhibit 31.1		Written statement of Sally Frame Kasaks pursuant to section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.2		Written statement of Michael L. Henry pursuant to section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32.1		Written statements of Sally Frame Kasaks and Michael L. Henry pursuant to section 906 of the Sarbanes-Oxley Act of 2002


Note Reference:

(1)		Incorporated by reference from the Company’s Quarterly Report on Form 10-Q, as filed with the Securities and Exchange Commission on August 31, 2004

(2)		Incorporated by reference from the Company’s Current Report on Form 8-K, as filed with the Securities and Exchange Commission on December 24, 1998

(3)		Incorporated by reference from the Company’s Current Report on Form 8-K, as filed with the Securities and Exchange Commission on November 26, 2008

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. sophomore Good

Pacific Sunwear Of California (PSUNQ) Inactive 10-Q2009 Q3 Quarterly report

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