e10vq

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)


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

		For the quarterly period ended: July 29, 2006

		OR

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

Commission file number 0-21296

PACIFIC SUNWEAR OF CALIFORNIA, INC.

(Exact name of registrant as specified in its charter)


California (State of incorporation)		95-3759463 (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. Yes x No o

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

		Large Accelerated Filer x Accelerated Filer o Non-Accelerated Filer o

•

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

On August 31, 2006, the registrant had 69,329,893 shares of Common Stock outstanding.

PACIFIC SUNWEAR OF CALIFORNIA, INC.

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


	July 29, 2006			January 28, 2006
ASSETS

CURRENT ASSETS:
Cash and cash equivalents	$	11,783		$	95,185
Marketable securities		—			74,911
Merchandise inventories		286,666			215,140
Other current assets		43,870			41,485

Total current assets		342,319			426,721

PROPERTY AND EQUIPMENT, NET:
Gross property and equipment		666,434			602,962
Less accumulated depreciation and amortization		(273,665	)		(247,140	)

Total property and equipment, net		392,769			355,822

Other Assets		24,579			25,018

TOTAL ASSETS	$	759,667		$	807,561


LIABILITIES AND SHAREHOLDERS’ EQUITY

CURRENT LIABILITIES:
Accounts payable	$	81,633		$	47,550
Other current liabilities		61,412			74,921

Total current liabilities		143,045			122,471

LONG-TERM LIABILITIES:
Deferred lease incentives		84,291			81,440
Deferred rent		30,341			28,748
Deferred income taxes		12,584			12,584
Other long-term liabilities		9,881			15,528

Total long-term liabilities		137,097			138,300

Commitments and contingencies (Note 5)

SHAREHOLDERS’ EQUITY:
Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued		—			—
Common stock, $.01 par value; 170,859,375 shares authorized; 69,595,403 and 73,751,249 shares issued and outstanding, respectively		696			737
Additional paid-in capital		—			23,866
Retained earnings		478,829			522,187

Total shareholders’ equity		479,525			546,790

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	759,667		$	807,561

See accompanying footnotes

PACIFIC SUNWEAR OF CALIFORNIA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(unaudited, all amounts in thousands except share and per share amounts)


	For the Second Quarter Ended				For the First Half Ended
	July 29, 2006		July 30, 2005		July 29, 2006		July 30, 2005
Net sales	$	313,682	$	309,064	$	613,570	$	589,049

Cost of goods sold, including buying, distribution and occupancy costs		216,257		198,707		418,862		381,342


Gross margin		97,425		110,357		194,708		207,707

Selling, general and administrative expenses		82,855		77,592		162,794		147,714


Operating income		14,570		32,765		31,914		59,993

Interest income, net		1,090		1,180		2,885		2,265


Income before income tax expense		15,660		33,945		34,799		62,258

Income tax expense		5,950		12,833		13,223		23,539


Net income	$	9,710	$	21,112	$	21,576	$	38,719


Comprehensive income	$	9,710	$	21,112	$	21,576	$	38,719


Net income per share, basic	$	0.14	$	0.28	$	0.30	$	0.51


Net income per share, diluted	$	0.14	$	0.28	$	0.30	$	0.51


Wtd. avg. shares outstanding, basic		71,335,467		75,125,782		72,239,872		75,209,185

Wtd. avg. shares outstanding, diluted		71,866,482		76,118,501		72,783,954		76,338,599

See accompanying footnotes

PACIFIC SUNWEAR OF CALIFORNIA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)


	First Half Ended
	July 29, 2006			July 30, 2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	21,576		$	38,719
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		34,385			31,081
Tax benefits related to exercise of stock options		1,479			5,737
Stock-based compensation		3,573			—
Loss on disposal of property and equipment		158			—
Change in operating assets and liabilities:
Merchandise inventories		(71,526	)		(67,550	)
Other current assets		(2,384	)		(2,940	)
Other assets		439			(1,325	)
Accounts payable		34,083			67,942
Other current liabilities		(21,754	)		(2,917	)
Deferred lease incentives		2,851			7,809
Deferred rent		1,270			(658	)
Other long-term liabilities		(5,605	)		1,444

Net cash (used in)/provided by operating activities		(1,455	)		77,342

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(62,675	)		(48,173	)
Purchases of available-for-sale marketable securities		(201,900	)		(442,350	)
Sales of available-for-sale marketable securities		262,200			457,075
Purchases of held-to-maturity marketable securities		—			(26,493	)
Maturities of held-to-maturity marketable securities		14,611			20,625

Net cash provided by/(used in) investing activities		12,236			(39,316	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Repurchase and retirement of common stock		(99,347	)		(19,978	)
Proceeds from exercise of stock options		5,454			10,756
Principal payments under long-term debt and capital lease obligations		(290	)		(885	)

Net cash used in financing activities		(94,183	)		(10,107	)

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS:		(83,402	)		27,919
CASH AND CASH EQUIVALENTS, beginning of period		95,185			64,308

CASH AND CASH EQUIVALENTS, end of period	$	11,783		$	92,227


SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest	$	3		$	32
Cash paid for income taxes	$	28,200		$	21,659

SUPPLEMENTAL DISCLOSURES OF NON-CASH TRANSACTIONS:
Increase to additional paid-in capital related to the issuance of stock to satisfy certain deferred compensation liabilities	$	—		$	1,142
Increase in non-cash property and equipment accruals	$	8,815		$	6,179

See accompanying footnotes

PACIFIC SUNWEAR OF CALIFORNIA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the quarterly period ended July 29, 2006
(unaudited, all amounts in thousands except share and per share amounts unless otherwise indicated)

1. NATURE OF BUSINESS AND BASIS OF PRESENTATION

Nature of Business — Pacific Sunwear of California, Inc. and its subsidiaries (collectively, unless the context otherwise requires, the “Company”) is a leading specialty retailer of everyday casual apparel, footwear and accessories designed to meet the needs of active teens and young adults. The Company operates four nationwide, primarily mall-based chains of retail stores, under the names “Pacific Sunwear” (as well as “PacSun”), “Pacific Sunwear (PacSun) Outlet,” “d.e.m.o.,” and “One Thousand Steps.” Pacific Sunwear and Pacific Sunwear Outlet stores specialize in board-sport inspired casual apparel, footwear and related accessories catering to teens and young adults. d.e.m.o. specializes in fashion-focused street wear, including casual apparel, footwear and related accessories catering to teens and young adults. One Thousand Steps stores specialize in fashion-forward footwear and accessories catering to young adults. The Company launched operations for One Thousand Steps in April 2006 and, as of the date of this filing, operates nine total One Thousand Steps stores. In addition, the Company operates two e-commerce websites (www.pacsun.com and www.demostores.com) which sell PacSun and d.e.m.o. merchandise online, respectively, provide content and community for its target customers, and provide information about the Company. Also, the Company operates a One Thousand Steps website (www.onethousandsteps.com) that provides store location and product information.

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 second quarter and first half ended July 29, 2006 are not necessarily indicative of the results that may be expected for the year ending February 3, 2007 (“fiscal 2006”). For further information, refer to the Company’s consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended January 28, 2006 (“fiscal 2005”).

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Information regarding the Company’s significant accounting policies is contained in Note 1, “Nature of Business and Summary of Significant Accounting Policies,” to the consolidated financial statements in the Company’s annual report on Form 10-K for fiscal 2005. Presented below in this and the following notes is supplemental information that should be read in conjunction with “Notes to Consolidated Financial Statements” included in that report.

New Accounting Pronouncements — In June 2006, the Financial Accounting Standards Board (the “FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (FIN 48). FIN 48 requires that the financial statement effects of a tax position be recognized when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. A tax position that meets the more-likely-than-not recognition threshold shall initially and subsequently be measured as the largest amount of tax benefit that is greater than 50 percent likely of

being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. The Company must adopt FIN 48 for the fiscal year beginning February 4, 2007. The Company is currently evaluating the impact, if any, of the adoption of FIN 48 on its consolidated results of operations and financial position.

For a discussion regarding the adoption of Statement of Financial Accounting Standards (“SFAS”) 123R, “Share-Based Payment,” see “Stock-Based Compensation” below in this Note 2.

In October 2005, the FASB issued Staff Position (“FSP”) 13-1, “Accounting for Rental Costs Incurred during a Construction Period.” FSP 13-1 requires rental costs associated with ground or building operating leases that are incurred during a construction period to be recognized as rental expense. The Company adopted FSP 13-1 at the beginning of fiscal 2006. Based on current operating lease rates, the Company estimates that the adoption of FSP 13-1 will increase occupancy expenses by approximately $4 million in fiscal 2006.

In May 2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections.” SFAS 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle, and that a change in method of depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. The Company adopted SFAS 154 at the beginning of fiscal 2006. The Company does not expect SFAS 154 to have a significant impact on its financial position or results of operations.

Stock-Based Compensation — On January 29, 2006, the Company adopted the fair value recognition provisions of SFAS 123(R) under the modified prospective method. Prior to January 29, 2006, the Company had accounted for stock-based compensation under the recognition and measurement provisions of Accounting Principles Board Opinion 25 (“APB 25”) and related interpretations, as permitted by SFAS 123, “Accounting for Stock-Based Compensation.” In accordance with APB 25, no compensation expense was required to be recognized for options granted to employees that had an exercise price equal to the market value of the underlying common stock on the date of grant.

For the first half of fiscal 2006, compensation expense was recognized under the modified prospective method of SFAS 123(R) for all stock-based compensation awards granted prior to, but not yet vested as of January 29, 2006 based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and for all stock-based compensation awards granted after January 28, 2006 based
on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). The Company’s financial results for prior periods have not been restated.

Consistent with the valuation method used for the disclosure-only provisions of SFAS 123 prior to fiscal 2006, the Company is using the Black-Scholes option-pricing model to estimate the grant date fair value of its recognized stock-based compensation expense for fiscal 2006. Forfeitures are estimated at the date of grant based on historical rates and reduce the compensation expense to be recognized. The expected term of options granted is 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 the Company’s stock. The Company records stock-based compensation expense using the graded vesting method over the vesting period, which is generally three to four years. The Company’s stock-based 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 fiscal 2006, the Company’s stock-based compensation is derived from awards of stock options, non-vested shares, and stock appreciation rights, as well as from shares purchased under the Company’s employee share purchase plan.

For the first half of fiscal 2006 and 2005, the fair value of the Company’s stock-based compensation awards was determined using the following weighted average assumptions:


	First Half
	2006			2005
Expected Option Life	5 years			5 years
Stock Volatility		44.1% - 48.7	%		56.7% - 62.8	%
Risk-free Interest Rates		4.6% - 5.1	%		3.9% - 4.1	%
Expected Dividends	None			None

As a result of adopting SFAS 123(R), the Company’s net income and earnings per share for the first half of fiscal 2006 were $2.2 million and $0.03 lower, respectively, than if it had continued to account for stock-based compensation under APB 25 as it did during the first half of fiscal 2005. Stock-based compensation expense for the first half of fiscal 2006 was included in costs of goods sold for the Company’s buying and distribution employees ($1.0 million) and in selling, general and administrative expense for all other employees ($2.6 million). The adoption of SFAS 123(R) had no impact on the Company’s cash flows.

A summary of stock option activity under the Company’s 2005 Performance Incentive Plan for the first half of fiscal 2006 is presented below:


						Weighted-Average
						Remaining
				Weighted-Average		Contractual Term		Aggregate Intrinsic
Stock Options	Shares (000s)			Exercise Price		(Yrs.)		Value ($000s)
Outstanding at January 29, 2006		4,248		$	19.18
Granted		169			22.91
Exercised		(335	)		10.86
Forfeited or expired		(367	)		21.52

Outstanding at April 29, 2006		3,715		$	19.87		6.34	$	16,825
Granted		478			20.45
Exercised		(110	)		11.33
Forfeited or expired		(329	)		24.70

Outstanding at July 29, 2006		3,754		$	19.77		6.12	$	7,210

Exercisable at July 29, 2006		1,825		$	16.39		5.54	$	6,853

The weighted-average grant-date fair value of options granted during the first half of fiscal 2006 and 2005 was $9.39 and $14.79, respectively. The total intrinsic value of options exercised during the first half of fiscal 2006 and 2005 was $5.0 million and $15.6 million, respectively.

A summary of the status of the Company’s non-vested shares during the first half of fiscal 2006 is presented below. All activity regarding non-vested share awards occurred during the second quarter:


				Weighted-Average Grant-Date
Non-vested Shares	Shares (000)			Fair Value
Non-vested at January 29, 2006		0		$	—
Granted		284			20.10
Vested		0			—
Forfeited		(4	)		20.16

Non-vested at July 29, 2006		280		$	20.10

As of July 29, 2006, the Company had approximately $20.6 million of compensation cost related to non-vested stock option and non-vested share awards not yet recognized. This compensation expense is expected to be recognized over a weighted average period of approximately 2.8 years. No vesting of non-vested share awards occurred during the first half of fiscal 2006.

A reconciliation of reported net income and earnings per share for the second quarter and first half of fiscal 2005 to that which would have been reported if SFAS 123(R) had been in place for that period is presented below:


	Second Quarter			First Half
	Ended			Ended
	July 29, 2005			July 29, 2005
Net income, as reported	$	21,112		$	38,719
Less stock-based employee compensation expense determined under the fair value based method, net of related tax effects		(2,170	)		(3,991	)

Pro forma net income	$	18,942		$	34,728


Earnings per Share
Basic, as reported	$	0.28		$	0.51
Basic, pro forma	$	0.25		$	0.46

Diluted, as reported	$	0.28		$	0.51
Diluted, pro forma	$	0.25		$	0.46

Segment Reporting — The Company operates exclusively in the retail apparel industry in which the Company distributes, designs and produces clothing, accessories, footwear and related products catering to the teenage/young adult demographic through primarily mall-based retail stores. The Company has identified four operating segments (PacSun, PacSun Outlet, d.e.m.o., and One Thousand Steps) as defined by SFAS 131, “Disclosures about Segments of an Enterprise and Related Information.” The four operating segments have been aggregated into three reportable segments (PacSun, d.e.m.o. and One Thousand Steps). Information for the first half of fiscal 2006 concerning each of the three reportable segments is set forth below:


	PacSun			d.e.m.o.			One Thousand Steps			Total
Net Sales	$	528,192		$	84,180		$	1,198		$	613,570
Comparable Store Sales %		(3.7	)%		(3.8	)%		n/a			(3.7	)%
Contribution Margin	$	97,621		$	(2,511	)	$	(1,101	)	$	94,009
Number of Stores		928			201			6			1,135
Square Footage (in 000s)		3,500			561			16			4,077

The Company launched operations for One Thousand Steps in April 2006. The Company expects contribution margins for One Thousand Steps to be negative during at least the first full year of operations due to the significant start-up costs incurred in launching the initial nine stores opened to date. d.e.m.o. contribution margin was negative during the first half of fiscal 2006 primarily due to significant markdown activity taken during the second quarter due to negative comparable store net sales results.

3. OTHER CURRENT ASSETS

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


	July 29,		January 28,
	2006		2006
Prepaid expenses	$	25,862	$	22,360
Non-trade accounts receivable		10,002		12,679
Deferred income taxes		6,446		6,446
Income tax receivable		1,560		—

Total other current assets	$	43,870	$	41,485

4. OTHER CURRENT LIABILITIES

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


	July 29,		January 28,
	2006		2006
Accrued capital expenditures	$	17,272	$	8,779
Accrued compensation and benefits		7,692		12,250
Accrued gift cards		7,749		12,620
Sales taxes payable		6,593		7,895
Income taxes payable		—		14,896
Other		22,106		18,481

Total other current liabilities	$	61,412	$	74,921

5. COMMITMENTS AND CONTINGENCIES

Litigation — The Company is involved from time to time in litigation incidental to its business. Management believes that the outcome of current litigation will not likely have a material adverse effect upon the results of operations or financial condition of the Company and, from time to time, may make provisions for probable litigation losses. Depending on the actual outcome of pending litigation, charges in excess of any provisions could be recorded in the future, which may have a material adverse affect on the Company’s operating results.

Letters of Credit — The Company has issued guarantees in the form of commercial letters of credit, of which there were approximately $24 million outstanding at July 29, 2006, as security for merchandise shipments from overseas. All in-transit merchandise covered by letters of credit is accrued for in accounts payable.

6. COMMON STOCK REPURCHASE AND RETIREMENT

The Company entered fiscal 2006 with approximately $50 million remaining to be spent under its stock repurchase plan, which was originally approved by its Board of Directors and announced in January 2004. Over time, the Company’s Board of Directors has continued to authorize additional stock repurchases, including an additional $100 million authorized in May 2006. The repurchase authorizations do not expire until all authorized funds have been expended. In accordance with California law, all repurchased shares are immediately retired. During the first half of fiscal 2006 and 2005, the Company made repurchases of its own common stock of $99 million and $20 million, respectively, subject to these authorizations. Details of the Company’s fiscal 2006 share repurchase activity are presented in the table below:


					# of Shares				Maximum Value of
					Purchased as Part				Shares that May Yet
	# of Shares		Average Price Paid		of Publicly		Value of Shares		be Purchased Under
Period	Purchased		Per Share		Announced Plan		Purchased		the Plan
2005 Authorization:									$	49,856
March 2006		1,100,000	$	22.33		1,100,000	$	24,563	$	25,293
April 2006		600,000	$	22.67		600,000	$	13,600	$	11,693
May 2006		400,000	$	22.54		400,000	$	9,016	$	2,677
June 2006		131,255	$	20.40		131,255	$	2,677	$	—

Total		2,231,255	$	22.34		2,231,255	$	49,856	$	--


2006 Authorization:									$	100,000
June 2006		468,745	$	20.05		468,745	$	9,397	$	90,603
July 2006		2,216,000	$	18.09		2,216,000	$	40,095	$	50,508

Total		2,684,745	$	18.43		2,684,745	$	49,492	$	50,508


Grand Total		4,916,000	$	20.21		4,916,000	$	99,348	$	50,508

7. NET INCOME PER SHARE, BASIC AND DILUTED

The following table summarizes the computation of earnings per share (“EPS”):

Second Quarter Ended:


	July 29, 2006							July 30, 2005
	Net							Net
	Income		Shares					Income		Shares
Basic EPS:	$	9,710		71,335,467	$	0.14		$	21,112		75,125,782	$	0.28
Diluted EPS:
Effect of dilutive equivalents		—		531,015		(0.00	)		—		992,719		(0.00	)

	$	9,710		71,866,482	$	0.14		$	21,112		76,118,501	$	0.28

First Half Ended:


	July 29, 2006							July 30, 2005
	Net							Net
	Income		Shares					Income		Shares
Basic EPS:	$	21,576		72,239,872	$	0.30		$	38,719		75,209,185	$	0.51
Diluted EPS:
Effect of dilutive equivalents		—		544,082		(0.00	)		—		1,129,414		(0.00	)

	$	21,576		72,783,954	$	0.30		$	38,719		76,338,599	$	0.51

Options to purchase 2,473,036 and 2,180,576 shares of common stock in the second quarter of fiscal 2006 and 2005, respectively, and 2,064,475 and 1,676,170 shares of common stock in the first half of fiscal 2006 and 2005, respectively, were not included in the computation of diluted earnings per share because the option exercise price was greater than the average market price of the Company’s common stock.

ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF CONSOLIDATED OPERATIONS

The following management’s discussion and analysis of financial condition and results of operations (“MD&A”) should be read in conjunction with the Company’s 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 and Section 21E of the Exchange Act, and we intend that such forward-looking statements be subject to the safe harbors created thereby. We are hereby providing cautionary statements identifying important factors that could cause our actual results to differ materially from those projected in forward-looking statements of the Company herein. Any statements that express, or involve discussions as to, expectations, beliefs, plans, objectives, assumptions, future events or performance (often, but not always through the use of words or phrases such as “will result,” “expects to,” “will continue,” “anticipates,” “plans,” “intends,” “estimated,” “projects” and “outlook”) are not historical facts and may be forward-looking and, accordingly, such statements involve estimates, assumptions and uncertainties which could cause actual results to differ materially from those expressed in the forward-looking statements. All forward-looking statements included in this report, including discussions of comparable store net sales for the remainder of fiscal 2006, operating margins for fiscal 2006, and One Thousand Steps contribution margins are based on information available to us as of the date hereof, and we do not intend, or assume any obligation, to update or revise any such forward-looking statements to reflect events or circumstances that occur after such statements are made. See “Risk Factors” in Part II, Item 1A of this Form 10-Q for a discussion of some of the important risks that may affect our business, results of operations and financial condition.

Executive Overview

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

Comparable store (or “same store”) net sales — Stores are deemed comparable stores on the first day of the month following the one-year anniversary of their opening or expansion/relocation. We consider same store sales to be an important indicator of current Company performance. Same store net 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 of a more fixed nature. Positive same store net sales results generate greater operating leverage of expenses while negative same store net sales results negatively impact operating leverage. Same store net sales results also have a direct impact on our total net sales, cash, and working capital. Year-to-date same store net sales are negative for fiscal 2006, including a negative (9.4%) in August 2006 (the first month of the third quarter). Assuming this trend continues, same store net sales could continue to be negative during the remainder of fiscal 2006.

Net merchandise margins — We analyze the components of net merchandise margins, specifically initial markup and markdowns as a percentage of net sales. Any inability to obtain acceptable levels of initial markups or any significant increase in our use of markdowns could have an adverse impact on our gross margin results and results of operations. If the year-to-date same store net sales trend through August 2006 continues, markdown rates will likely be higher for the remainder of fiscal 2006 as compared to the same time period of fiscal 2005.

Operating margin — We view operating margin as a key indicator of our success. The key drivers of operating margins are comparable store net sales, net merchandise margins, and our ability to control operating expenses. Operating margins for fiscal 2006 are expected to be lower than last year due to negative same-store sales results and the expensing of stock-based compensation and pre-opening rent. See “Stock-Based Compensation” and “New Accounting Pronouncements” within Note 2 to the condensed consolidated financial statements for a discussion of stock-based compensation and pre-opening rent

expenses. For a discussion of the changes in the components comprising operating margins, see “Results of Operations” in this section.

Store sales trends — We evaluate store sales trends in assessing the operational performance of our store expansion strategies. Important store sales trends include average net sales per store and average net sales per square foot. Average net sales per store were $1.3 million for each of fiscal 2005 and 2004. Average net sales per square foot were $371 and $374, respectively. If the year-to-date same stores net sales trend through August 2006 continues, these average store sales trends will likely be lower for fiscal 2006.

Cash flow and liquidity (working capital) — We evaluate cash flow from operations, liquidity and working capital to determine our short-term operational financing needs. We expect cash flows from operations will be sufficient to finance operations without borrowing under our credit facility for the next twelve months.

Critical Accounting Policies

The preparation of consolidated financial statements in conformity with GAAP 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 increased significantly, our operational results could be adversely affected. We record the sale of gift cards as a current liability and recognize a sale when a customer redeems a gift card. The amount of the gift card liability is determined taking into account our estimate of the portion of gift cards that will not be redeemed or recovered.

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.

Accounting for Store Operating Leases — 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,” FASB Technical Bulletin (“FTB”) 85-3, “Accounting for Operating Leases with Scheduled Rent Increases” and FASB Staff Position 13-1, “Accounting for Rental Costs Incurred During a Construction Period.” Accordingly, rent expense under our store operating leases is recognized on a straight-line basis over the original term of each store’s lease, inclusive of rent holiday periods during store construction and excluding any lease renewal options. The Company accounts for landlord allowances received in connection with store operating leases in accordance with SFAS 13, “Accounting for Leases,” and FTB 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, including rent holiday periods.

Determination of Stock-Based Compensation Expense — Effective January 29, 2006, we adopted the fair value recognition provisions of SFAS 123(R) 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 vested method over the requisite service period of the award. Prior to SFAS 123(R) adoption, we accounted for stock-based payments under APB 25, “Accounting for Stock Issued to Employees,” and accordingly, we were not required to recognize compensation expense for options granted to employees that had an exercise price equal to the market value of the underlying common stock on the date of grant. Prior periods have not been restated.

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 value 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 2 to the condensed consolidated financial statements for a further discussion on stock-based compensation.

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

Evaluation of Insurance Reserves — We are responsible for workers’ compensation 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 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 deferred tax assets, which had been written down, would be realized in the future, the value of the deferred tax assets would be increased, thereby increasing net income in the period when that determination was made.

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

Results of Operations

The following table sets forth selected income statement data of the Company expressed as a percentage of net sales for the periods indicated. The discussion that follows should be read in conjunction with this table:


	Second Quarter Ended						First Half Ended
	July 29, 2006			July 30, 2005			July 29, 2006			July 30, 2005
Net sales		100.0	%		100.0	%		100.0	%		100.0	%
Cost of goods sold, including buying, distribution and occupancy costs		68.9			64.3			68.3			64.7

Gross margin		31.1			35.7			31.7			35.3
Selling, general and administrative expenses		26.4			25.1			26.5			25.1

Operating income		4.7			10.6			5.2			10.2
Interest income, net		0.3			0.4			0.5			0.4

Income before income tax expense		5.0			11.0			5.7			10.6
Income tax expense		1.9			4.2			2.2			4.0

Net income		3.1	%		6.8	%		3.5	%		6.6	%

The following table sets forth the Company’s number of stores (by store concept and in total) and total square footage as of the dates indicated:


	July 29, 2006		July 30, 2005
PacSun stores		826		780
Outlet stores		102		91
d.e.m.o. stores		201		183
One Thousand Steps stores		6		—

Total stores		1,135		1,054

Square footage (in 000’s)		4,077		3,720

The second quarter (thirteen weeks) ended July 29, 2006 as compared to the second quarter (thirteen weeks) ended July 30, 2005

Net Sales
Net sales increased to $314 million for the second quarter of fiscal 2006 from $309 million for the second quarter of fiscal 2005, an increase of $5 million, or 2%. The components of this $5 million increase in net sales are as follows:


$millions		Attributable to
$17		Net sales from stores opened in fiscal 2005 not yet included in the comparable store base
5		33 new stores opened in fiscal 2006 not yet included in the comparable store base
1		Other non-comparable sales (net sales from expanded or relocated stores not yet included in the comparable store base and internet net sales)
(15)		(5.5)% decrease in comparable store net sales in the second quarter of fiscal 2006 compared to the second quarter of fiscal 2005
(3)		3 closed stores in fiscal 2006 and 10 closed stores in fiscal 2005
$5		Total

Of the (5.5)% decrease in comparable store net sales in the second quarter of fiscal 2006, PacSun and PacSun Outlet comparable store net sales decreased a combined (5.0)% and d.e.m.o. comparable store net sales decreased (9.2)%. In percentage terms, the average sale transaction in a comparable store was down slightly while average retail prices were up slightly. Total transactions per comparable store were down

mid single digits. Comparable store net sales for August 2006, the first month of the third quarter, were down (9.4%). If the year-to-date comparable store net sales trend through August 2006 continues, comparable store net sales results could continue to be negative for the remainder of fiscal 2006.

Within PacSun and PacSun Outlet, comparable store net sales of guys’ and girls’ merchandise decreased (3.8)% and (6.5)%, respectively. Guys’ comparable store net sales results were characterized by strength in board shorts, swim and basic denim, but these strengths were more than offset by weakness in sneakers, wovens and fashion denim. Girls’ comparable store net sales results were also characterized by strength in shorts and swimwear, but these strengths were more than offset by weakness in sneakers, fashion denim and tees.

Within d.e.m.o., comparable store net sales of girls’ and guys’ merchandise decreased (4.9)% and (12.8)%, respectively. Girls’ comparable store net sales results were characterized by weakness in tops and denim, primarily due to a lack of sufficient inventory in key brands. Guys’ comparable store net sales results were primarily characterized by weakness in tees and wovens. We continue to expand our assortment of footwear and accessories in d.e.m.o. stores and believe these categories present significant growth opportunities for this concept in the future. We are also in the process of expanding and evolving our brand assortment to be more fashion-focused and not solely targeted towards the hip-hop lifestyle.

Gross Margin
Gross margin, after buying, distribution and occupancy costs, decreased to $97 million for the second quarter of fiscal 2006 from $110 million for the second quarter of fiscal 2005, a decrease of $13 million, or 12%. As a percentage of net sales, gross margin was 31.1% for the second quarter of fiscal 2006 compared to 35.7% for the second quarter of fiscal 2005. The 4.6% decrease in gross margin as a percentage of net sales was primarily attributable to a higher markdown rate and deleveraging of occupancy, distribution and buying costs due to the negative same-store sales results in the second quarter of fiscal 2006 as compared to the second quarter of fiscal 2005.

Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $83 million for the second quarter of fiscal 2006, up from $78 million for the second quarter of fiscal 2005, an increase of $5 million, or 6%. These expenses increased to 26.4% as a percentage of net sales in the second quarter of fiscal 2006 from 25.1% in the second quarter of fiscal 2005. The components of this 1.3% net increase in selling, general and administrative expenses as a percentage of net sales were as follows:


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

Net Interest Income
Net interest income was $1 million in the second quarter of each of fiscal 2006 and fiscal 2005. Interest income generated by higher interest rates was offset by the Company having lower average cash and short-

term investment balances during the second quarter of fiscal 2006 as compared to the second quarter of fiscal 2005, primarily as a result of stock repurchase activity (see Note 6 to the condensed consolidated financial statements).

Income Tax Expense
Income tax expense was $6 million for the second quarter of fiscal 2006 compared to $13 million for the second quarter of fiscal 2005. The effective income tax rate was 38.0% in the second quarter of fiscal 2006 as compared to 37.8% in the second quarter of fiscal 2005. The increase in the effective income tax rate was primarily attributable to the expected stock-based compensation expense impacts of SFAS 123R (see Note 2 to the condensed consolidated financial statements). Our weighted average effective state income tax rate will vary over time depending on a number of factors, such as differing average income tax rates and net incomes in the respective states. Our effective income tax rate may continue to change during fiscal 2006 due to the launch of One Thousand Steps, the construction of a second distribution center, and other planned business events.

The first half (26 weeks) ended July 29, 2006 as compared to the first half (26 weeks) ended July 30, 2005

Net Sales
Net sales increased to $614 million for the first half of fiscal 2006 from $589 million for the first half of fiscal 2005, an increase of $25 million, or 4%. The components of this $25 million increase in net sales are as follows:


$millions		Attributable to
$42		Net sales from stores opened in fiscal 2005 not yet included in the comparable store base
6		Net sales from 33 new stores opened in fiscal 2006 not yet included in the comparable store base
1		Other non-comparable sales (net sales from expanded or relocated stores not yet included in the comparable store base and internet net sales)
(20)		(3.7)% decrease in comparable store net sales in the first half of fiscal 2006 compared to the first half of fiscal 2005
(4)		3 closed stores in fiscal 2006 and 10 closed stores in fiscal 2005
$25		Total

Of the (3.7)% decrease in comparable store net sales in the first half of fiscal 2006, PacSun and PacSun Outlet comparable store net sales increased (3.7)% and d.e.m.o. comparable store net sales decreased (3.8)%. In percentage terms, the average sale transaction and average retail prices in a comparable store were up slightly. Total transactions per comparable store were down mid single digits. Comparable store net sales for August 2006, the first month of the third quarter, were down (9.4%). If the year-to-date comparable store net sales trend through August 2006 continues, comparable store net sales results could continue to be negative for the remainder of fiscal 2006.

Within PacSun and PacSun Outlet, comparable store net sales of guys’ and girls’ merchandise decreased (1.5)% and (6.6)%, respectively. Guys’ comparable store net sales results were characterized by strength in board shorts, swim and basic denim, but these strengths were more than offset by weakness in sneakers, wovens and fashion denim. Girls’ comparable store net sales results were also characterized by strength in shorts and swimwear, but these strengths were more than offset by weakness in sneakers, fashion denim and tees.

Within d.e.m.o., comparable store net sales of girls’ merchandise increased 1.3% while guys’ merchandise decreased (8.4)%. Girls’ comparable store net sales results were characterized by strength in footwear and accessories, partially offset by weakness in tops and denim. Guys’ comparable store net sales results were primarily characterized by weakness in tees and wovens. We continue to expand our assortment of footwear and accessories in d.e.m.o. stores and believe these categories present significant growth opportunities for this concept in the future. We are also in the process of expanding and evolving our brand assortment to be more fashion-focused and not solely targeted towards the hip-hop lifestyle.

Gross Margin
Gross margin, after buying, distribution and occupancy costs, decreased to $195 million for the first half of fiscal 2006 from $208 million for the first half of fiscal 2005, a decrease of $13 million, or 6%. As a percentage of net sales, gross margin was 31.7% for the first half of fiscal 2006 compared to 35.3% for the first half of fiscal 2005. The 3.6% decrease in gross margin as a percentage of net sales was primarily attributable to a higher markdown rate and deleveraging of occupancy, distribution and buying costs due to the negative same-store sales results in the first half of fiscal 2006 as compared to the first half of fiscal 2005.

Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $163 million for the first half of fiscal 2006 from $148 million for the first half of fiscal 2005, an increase of $15 million, or 10%. These expenses increased to 26.5% as a percentage of net sales in the first half of fiscal 2006 from 25.1% in the first half of fiscal 2005. The components of this 1.4% net increase in selling, general and administrative expenses as a percentage of net sales were as follows:


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

Net Interest Income
Net interest income was $3 million in the first half of fiscal 2006 compared to $2 million in the first half of fiscal 2005. This increase was primarily the result of higher interest rates, partially offset by lower average cash and short-term investment balances in the first half of fiscal 2006 as compared to the first half of fiscal 2005. Cash and investments were lower primarily due to stock buyback activity (see Note 6 to the condensed consolidated financial statements) and the negative same-store sales results during the first half of fiscal 2006.

Income Tax Expense
Income tax expense was $13 million for the first half of fiscal 2006 compared to $24 million for the first half of fiscal 2005. The effective income tax rate was 38.0% in the first half of fiscal 2006 as compared to 37.8% in the first half of fiscal 2005. The increase in the effective income tax rate was primarily attributable to the expected stock-based compensation expense impacts of SFAS 123R (see Note 2 to the condensed consolidated financial statements). Our weighted average effective state income tax rate will vary over time depending on a number of factors, such as differing average income tax rates and net incomes in the respective states. Our effective income tax rate may continue to change during fiscal 2006 due to the launch of One Thousand Steps, the construction of a second distribution center, and other planned business events.

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, remodeled, expanded or relocated stores, the financing of inventories and, in the past, construction of corporate facilities. We believe that our working capital and cash flows from operating activities will be sufficient to meet our operating and capital expenditure requirements without borrowing significantly under our credit facility for at least the next twelve months.

Operating Cash Flows

Net cash used by operating activities was $1 million for the first half of fiscal 2006 compared to cash provided of $77 million for the first half of fiscal 2005. The $78 million decrease in cash provided by operations in the first half of fiscal 2006 as compared to the first half of fiscal 2005 was attributable to the following:


$millions		Attributable to
$(38)		Decrease in cash flows from accounts payable, net of inventory, due to timing of payments and increased inventory per square foot.
(17)		Decrease in net income.
(13)		Decrease in cash flows from accrued income taxes. Cash payments for income taxes were $7 million higher and current accruals were lower due to reduced net income.
(8)		Decrease in cash flows related to accrued liabilities, primarily due to lower payroll and sales-tax accruals.
(5)		Decrease in cash flows related to deferred compensation liabilities due to cash disbursements to former executives.
(5)		Decrease in cash flows related to deferred lease incentives due to receiving fewer and lower landlord allowances.
7		Increase in non-cash depreciation and stock compensation expenses.
1		Net increase in cash flows from all other operating activities
$(78)		Total

Working Capital
Working capital at July 29, 2006 was $199 million compared to $304 million at January 28, 2006, a decrease of $105 million. The changes in working capital were as follows:


$millions		Description
$304		Working capital at January 28, 2006
(176)		Decrease in cash and marketable securities, net of income taxes payable and accounts payable, primarily due to stock repurchases, capital expenditures and negative same store sales results for the first half of fiscal 2006, among other items (see cash flow statement).
72		Increase in inventory, primarily due to the addition of 30 net new stores and slower inventory turns due to the negative same-store sales results during the first half of fiscal 2006.
(1)		Net decrease in working capital attributable to all other current assets and liabilities.
$199		Working capital at July 29, 2006

Investing Cash Flows

Net cash provided by investing activities in the first half of fiscal 2006 was $12 million compared to cash used of $39 million for the first half of fiscal 2005, an increase in cash flows from investing activities of $51 million. Investing cash flows for the first half of fiscal 2006 were comprised of $75 million in net maturities of marketable securities, partially offset by capital expenditures of $63 million. Capital expenditures were predominantly for the opening of new, relocated and expanded stores and improving the visual presentation of our stores. Due to the current increasing interest rate environment, the Company has been liquidating longer-term marketable securities (original maturity period of 3 months to one year) as they mature in favor of shorter term marketable securities (original maturity of less than 3 months) in order to take advantage of the increasing interest rates.

Financing Cash Flows

Net cash used in financing activities in the first half of fiscal 2006 was $94 million compared to $10 million for the first half of fiscal 2005. The Company repurchased and retired common stock in the amount of $99 million during the first half of fiscal 2006 as compared to $20 million in the first half of fiscal 2005. Proceeds from employee exercises of stock options were $5 million lower in the first half of fiscal 2006 ($5 million) than in the first half of fiscal 2005 ($10 million).

Information regarding the Company’s common stock repurchase program is contained in Note 6 to the condensed consolidated financial statements, which note is incorporated herein by this reference.

Credit Facility
We have an unsecured $200 million credit agreement with a syndicate of lenders which expires September 14, 2010. The credit facility provides for a $200 million revolving line of credit that can be increased to up to $275 million at our option under certain circumstances. The credit facility is available for direct borrowing and the issuance of letters of credit with a portion also available for swing-line loans. Direct borrowings under the credit facility bear interest at the Administrative Agent’s alternate base rate (as defined, 5.4% at July 29, 2006) or at optional interest rates that are primarily dependent upon LIBOR for the time period chosen. We had no direct borrowings outstanding under the credit facility at July 29, 2006. The credit facility requires us to maintain certain financial covenants, all of which we were in compliance with as of July 29, 2006.

Contractual Obligations
We have minimum annual rental commitments under existing store leases as well as leases for computer and other equipment as of July 29, 2006. We lease all of our retail store locations under operating leases. We lease equipment primarily under operating leases, but also occasionally under capital leases. In addition, at any time, we are contingently liable for commercial letters of credit with foreign suppliers of merchandise. At July 29, 2006, our future financial commitments under these arrangements were as follows:


	Payments Due by Period
Contractual Obligations
(in $millions)	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Operating lease obligations	$	629	$	103	$	195	$	160	$	171
Letters of credit		24		24		—		—		—
Total	$	653	$	127	$	195	$	160	$	171

The contractual obligations table above does not include common area maintenance (CAM) charges, which are also a required contractual obligation under our store operating leases. In many of our leases, CAM charges are not fixed and can fluctuate significantly from year to year for any particular store. Total store rental expenses, including CAM for fiscal 2005 and 2004 were $161 million and $138 million, respectively. We expect total CAM expenses to continue to increase as the number of stores increases from year to year.

Operating Leases — We lease our retail stores and certain equipment under operating lease agreements expiring at various dates through January 2019. 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 initial term of the lease. Other rent escalation clauses can take effect based on changes in primary mall tenants throughout the term of a given lease. Most leases also contain cancellation or kick-out clauses in our favor that relieve us of any future obligation under a lease if specified sales levels are not achieved by a specified date. None of our retail store leases contain purchase options.

We review the operating performance of our stores on an ongoing basis to determine which stores, if any, to expand, relocate or close. We anticipate closing approximately ten stores during fiscal 2006.

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 such agreements, services to be provided by us, or from 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 2 to the condensed consolidated financial statements for the quarter ended July 29, 2006, which note is incorporated herein by this reference.

Inflation

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

Seasonality and Quarterly Results

Our business is seasonal by nature. 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, 44% of our net sales have occurred in the first half of the fiscal year and 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 the timing of store openings; the amount of revenue contributed by new stores; the timing and level of markdowns; the timing of store closings, expansions and relocations; competitive factors; and general economic conditions.

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. At July 29, 2006, there were no borrowings outstanding under our credit facility and we did not borrow under the credit facility at any time during fiscal 2006 or 2005. Based on the interest rate of 5.4% on our credit facility at July 29, 2006, if interest rates on the credit facility were to increase by 10%, and to the extent borrowings were outstanding, for every $1 million outstanding on our credit facility, net income would be reduced by approximately $3 thousand per year. We are not a party to any derivative financial instruments.

ITEM 4 — CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act

of 1934, as amended (the Exchange Act). These disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by the Company in its periodic reports filed with the Commission is recorded, processed, summarized and reported within the time periods specified by the Commission’s rules and forms. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of July 29, 2006.

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 5 of Notes to Condensed Consolidated Financial Statements, which is incorporated by reference in response to this Item 1.

Item 1A — Risk Factors

We have updated and expanded our risk factors from those disclosed in Item 1A of our annual report on Form 10-K for the year ended January 28, 2006, which was filed with the Securities and Exchange Commission on March 31, 2006. We have added risk factors addressing future growth prospects for the Company, competition in the retail environment, vendor relationships, store design, and information system infrastructure. In addition, we have revised the captions of our risk factors to describe in more detail the principal concept addressed in the text of the related risk factor.

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 have varied from a low of (11%) to a high of 20%. A variety of factors affect our comparable store net sales results, including changes in fashion trends and customer preferences, changes in our merchandise mix, calendar shifts of holiday periods, actions by competitors, weather conditions and general economic conditions. Our comparable store net sales results for any particular 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 our operating performance and the market price of our common stock.

Our failure to identify and respond appropriately to changing consumer preferences and fashion trends in a timely manner could have a material adverse impact on our profitability.
Our success is largely dependent upon our ability to gauge the fashion tastes of our customers and to provide merchandise at competitive prices and in adequate quantities that satisfies customer demand in a timely manner. Our failure to anticipate, identify or react appropriately in a timely manner to changes in fashion trends could have a material adverse effect on our same store sales results, operating margins, financial condition and results of operations. Misjudgments or unanticipated fashion changes could also have a material adverse effect on our image with our customers. Some of our vendors have limited resources, production capacities and operating histories and some have intentionally limited the distribution of their merchandise. The inability or unwillingness on the part of key vendors to expand their operations to keep pace with the anticipated growth of 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 continued growth depends on our ability to develop new store concepts and open new stores in our existing concepts. Any failure to do so may negatively impact our stock price and operational performance.
Our continued growth depends to a significant degree on the success of our existing retail stores, our ability to open and operate stores on a profitable basis, and to manage our planned expansion. Our store concepts are located principally in enclosed regional shopping malls. Our PacSun concept is a relatively mature

concept with limited domestic opportunities to open new stores in such malls. The performance of our d.e.m.o. concept has been inconsistent and the size of the market for this concept is uncertain. Our newest concept, One Thousand Steps, is at a very early stage (nine stores) and is not yet proven. There can be no assurance that we will achieve what expansion is planned, that such expansion will be profitable, or that we will be able to manage our growth effectively. In addition, our ability to sustain future long-term growth is dependent, in part, on our ability to successfully develop, implement and evolve new retail concepts, including d.e.m.o. and One Thousand Steps. Our planned expansion is dependent upon a number of factors, including the performance of our existing stores, our ability to locate and obtain favorable store sites, negotiate acceptable lease terms, obtain adequate supplies of merchandise and hire and train additional qualified management level and other employees with the skills required to create or acquire new, unrelated retail concepts. Factors beyond our control may also affect our ability to expand, including general economic and business conditions affecting consumer spending. Any failure to manage growth or develop profitable new retail concepts could have a material adverse effect on our business, stock price, financial condition and results of operations.

We launched operations of a new retail concept, One Thousand Steps, in fiscal 2006, which could divert attention from existing operations.
We have launched operations for One Thousand Steps in fiscal 2006 through the opening of the first nine test stores (as of August 2006). This new concept is at a very early stage and is not yet proven. Our ability to make this new retail concept successful is subject to numerous risks, including, but not limited to, (i) lower productivity (in terms of sales per square foot) than anticipated or required to make the concept profitable and expandable, (ii) higher than anticipated construction costs, (iii) unanticipated operating problems, (iv) lack of customer acceptance, (v) new vendor relationships, (vi) competition from existing and new retailers, and (vii) lack of sufficient product differentiation. There can be no assurance that this new retail concept will achieve sales and profitability levels that justify the Company’s investment in it. Additionally, the expansion of this new retail concept involves other risks that could have a material adverse effect on the Company, including, but not limited to, (i) diversion of management’s attention from the Company’s core businesses, (ii) inability to attract, train and retain qualified personnel, including management and product designers, and (iii) difficulty in locating and obtaining favorable store sites and negotiating acceptable lease terms. Any inability to succeed in developing this new retail concept could have a material adverse effect on our continued growth 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, footwear and accessory business is highly competitive. All of our store concepts 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 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.
Sales from proprietary brand merchandise accounted for approximately 31%, 30%, and 32% of net sales in fiscal 2005, 2004 and 2003, respectively. 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 dependant 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. However, we do not 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.

We are currently evaluating store design alternatives for all of our retail concepts, which may not result in improved operational 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 visually. We have been testing or plan to test new store design alternatives for all of our retail concepts 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 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.

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. Our

inability to attract and retain qualified personnel in the future could have a material adverse effect on our business, financial condition and results of operations.

Our information systems may not be adequate to support future growth, which could disrupt business operations.
We have experienced periods of rapid growth in the past. 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 future growth or will remain adequate to support the existing needs of our business. In order to support future growth, 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 accurately capturing data and experiencing system disruptions, 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.

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

Our dependence on a single distribution facility exposes us to significant business disruption risks.
All of our current distribution functions continue to reside within a single facility in Anaheim, California. The Company has purchased land in Olathe, Kansas and plans to construct a second distribution center at that site. This new distribution center is currently expected to become operational in the second half of fiscal 2007. Any significant interruption in the operation of the existing distribution facility due to natural disasters, accidents, system failures or other unforeseen causes would have a material adverse effect on our business, financial condition and results of operations. There can be no assurance that our current distribution center will be adequate to support our future growth.

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 the Company or its 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, among other factors, could cause the market price of the common stock to fluctuate substantially. In addition, stock markets have experienced extreme price and volume volatility in the past. 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.

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.

Any failure by us to maintain credit facility financial covenants could have a material adverse impact on our business.
A significant decrease in our operating results could adversely affect our ability to maintain required financial ratios under our credit facility. Required financial ratios include a rolling four-quarter minimum fixed charge coverage ratio as well as a maximum leverage ratio. If these financial ratios are not maintained, the lenders will have the option to terminate the facility and require immediate repayment of all amounts outstanding under the credit facility, if any. The alternatives available to the Company if in default of its covenants would include renegotiating certain terms of the credit agreement, obtaining waivers from the lenders, or obtaining a new credit agreement with another bank or group of lenders, which may contain different terms.

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 for the Company. Decreased sales would have a material adverse effect on our business, financial condition and results of operations.

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

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 repurchases made during the first half of fiscal 2006, see Note 6 of Notes to Condensed Consolidated Financial Statements, which is incorporated by reference in response to this Item 2.

Item 3 — Defaults upon Senior Securities

None

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

a) The 2006 Annual Meeting of Shareholders of the Company was held on May 17, 2006.

b) At the 2006 Annual Meeting, Michael Weiss was elected as a Class I Director of the Company for a one-year term ending in 2007. Seth R. Johnson, Sally Frame Kasaks, Thomas M. Murnane and Peter Starrett were elected as Class II Directors of the Company for a two-year term ending in 2008. Additionally, Julius Jensen III, Pearson C. Cummin III and Michael Goldstein continued in office after the meeting.

c) In addition, the shareholders voted on and ratified the appointment of Deloitte & Touche LLP as the Company’s independent registered public accounting firm for the fiscal year ending February 3, 2007.

Voting at the 2006 Annual Meeting for the election of directors is set forth below. Each of the nominees identified below was elected a director.


DIRECTOR NAME	VOTES CAST FOR		VOTES WITHHELD
Class I:
Michael Weiss		68,073,096		333,162

Class II:
Seth R. Johnson		67,891,885		514,373
Sally Frame Kasaks		68,019,571		386,687
Thomas M. Murnane		68,026,121		380,137
Peter Starrett		68,005,740		400,518

With respect to the ratification of the appointment of Deloitte & Touche LLP as the Company’s independent registered public accounting firm for the year ending February 3, 2007, 66,405,587 votes were cast for approval, 1,993,398 votes were cast against approval, 7,271 votes abstained and there were no broker non-votes.

Item 5 — Other Information

None

Item 6 — Exhibits


Exhibit 10.1		Form Notice of Grant of Director Stock Appreciation Rights and Terms and Conditions of Stock Appreciation Rights (1)

Exhibit 10.2		Form Notice of Grant of Stock Appreciation Rights and Terms and Conditions of Stock Appreciation Rights (1)

Exhibit 10.3		Form Notice of Grant of Restricted Stock Award and Award Agreement (1)

Exhibit 10.4		Amendment No. 3 to Amended and Restated Employment Agreement between the Company and Greg H. Weaver, dated March 29, 2006 (2)

Exhibit 31.1		Written statements of Seth R. Johnson and Gerald M. Chaney pursuant to section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32.1		Written statement of Seth R. Johnson and Gerald M. Chaney pursuant to section 906 of the Sarbanes-Oxley Act of 2002

(1)		Incorporated by reference from the Company’s Current Report on From 8-K, as filed with the Securities and Exchange Commission on May 23, 2006

(2)		Incorporated by reference from the Company’s Current Report on From 8-K, as filed with the Securities and Exchange Commission on April 4, 2006

EXHIBIT INDEX


Exhibit		Description
Exhibit 10.1		Form Notice of Grant of Director Stock Appreciation Rights and Terms and Conditions of Stock Appreciation Rights (1)

Exhibit 10.2		Form Notice of Grant of Stock Appreciation Rights and Terms and Conditions of Stock Appreciation Rights (1)

Exhibit 10.3		Form Notice of Grant of Restricted Stock Award and Award Agreement (1)

Exhibit 10.4		Amendment No. 3 to Amended and Restated Employment Agreement between the Company and Greg H. Weaver, dated March 29, 2006 (2)

Exhibit 31.1		Written statements of Seth R. Johnson and Gerald M. Chaney pursuant to section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32.1		Written statement of Seth R. Johnson and Gerald M. Chaney pursuant to section 906 of the Sarbanes-Oxley Act of 2002

(1)		Incorporated by reference from the Company’s Current Report on From 8-K, as filed with the Securities and Exchange Commission on May 23, 2006

(2)		Incorporated by reference from the Company’s Current Report on From 8-K, as filed with the Securities and Exchange Commission on April 4, 2006


		Page #
PART I.	FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements (unaudited):

	Condensed Consolidated Balance Sheets July 29, 2006 and January 28, 2006		3

	Condensed Consolidated Statements of Income and Comprehensive Income Second quarter (13 weeks) and first half (26 weeks) ended July 29, 2006 and July 30, 2005		4

	Condensed Consolidated Statements of Cash Flows First half (26 weeks) ended July 29, 2006 and July 30, 2005		5

	Notes to Condensed Consolidated Financial Statements		6-11

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		12-21

Item 3.	Quantitative and Qualitative Disclosures about Market Risk		21

Item 4.	Controls and Procedures		21-22

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings		22

Item 1A.	Risk Factors		22-26

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		26

Item 3.	Defaults upon Senior Securities		26

Item 4.	Submission of Matters to a Vote of Security Holders		26-27

Item 5.	Other Information		27

Item 6.	Exhibits		27

	SIGNATURE PAGE		28
EXHIBIT 31.1
EXHIBIT 32.1


	PACIFIC SUNWEAR OF CALIFORNIA, INC. (Registrant)
Date: August 31, 2006	/s/ SETH R. JOHNSON
	Seth R. Johnson
	Director and Chief Executive Officer (Principal Executive Officer)



Date: August 31, 2006	/s/ GERALD M. CHANEY
	Gerald M. Chaney
	Senior Vice President, Chief Financial Officer and Secretary (Principal Financial and Accounting Officer)

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