• forecasts of future comparable store net sales, gross margins, inventory levels 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 2009

• expectations regarding future borrowings and repayments under our credit facility

• 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 Annual Report on Form 10-K for the year ended January 31, 2009 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 Company performance:
Comparable (or "same store") sales - Stores are deemed comparable stores on the first day of the month following the one-year anniversary of their opening or expansion/relocation. We consider same store sales to be an important indicator of current Company performance. Same store sales results are important in achieving operating leverage of certain expenses such as store payroll, store occupancy, depreciation, general and administrative expenses, and other costs that are somewhat fixed. Positive same store sales results generate greater operating leverage of expenses while negative same store sales results negatively impact operating leverage. Same store sales results also have a direct impact on our total net sales, cash, and working capital.
Net merchandise margins - We analyze the components of net merchandise margins, specifically initial 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 2009 and 2008, 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. For fiscal 2008, average net sales per store were $1.3 million while average net sales per square foot were $339.
Cash flow and liquidity (working capital) - We evaluate cash flow from operations, liquidity and working capital to determine our short-term operational financing needs. Cash flows from operations for fiscal 2008 were $34 million. Cash flows from operations for fiscal 2008 were significantly lower than in prior years, primarily due to negative same-store sales results, higher markdown activity associated with those sales results, and lease termination charges associated with the closure of our former demo concept. We believe that our working capital, cash flows from operating activities and potential intermittent credit facility borrowings will be sufficient to meet our operating and capital expenditure requirements for at least the next twelve months. Critical Accounting Policies
There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," included in our Form 10-K for the fiscal year ended January 31, 2009. Results of Operations
The following table sets forth selected income statement data from our continuing operations expressed as a percentage of net sales for the fiscal quarters indicated. The table and discussion that follows excludes the operations of the discontinued demo concept (see Note 4 to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q). The discussion that follows should be read in conjunction with the following table:

                                                                     First Quarters Ended
                                                                    May 2,            May 3,
                                                                     2009              2008
Net sales                                                               100.0 %         100.0 %
Cost of goods sold, including buying, distribution and
occupancy costs                                                          72.6            71.7

Gross margin                                                             27.4            28.3
Selling, general and administrative expenses                             34.4            35.9

Operating loss from continuing operations                                (7.0 )          (7.6 )
Other expense/(income), net                                               0.1            (0.3 )

Loss from continuing operations before income taxes                      (7.1 )          (7.3 )
Income tax benefit                                                       (3.1 )          (2.8 )

Net loss from continuing operations                                     (4.0) %         (4.5) %


Numbers of stores open at end of period                                   927             942
Total square footage (in 000s)                                          3,578           3,596

The first quarter (thirteen weeks) ended May 2, 2009 as compared to the first quarter (thirteen weeks) ended May 3, 2008 Net Sales
Net sales decreased to $223 million for the first quarter of fiscal 2009 from $267 million for the first quarter of fiscal 2008. The components of this $44 million decrease in net sales are as follows:

 $ millions                                    Attributable to
$        (45 )      18% decline in comparable store net sales in the first quarter of
                    fiscal 2009 compared to the first quarter of fiscal 2008 driven by a
                    19% decrease in average unit retail.

          (2 )      Store closures.

           3        Non-comparable sales from new, expanded or relocated stores not yet
                    included in the comparable store base and e-commerce net sales.

$        (44 )      Total

Comparable store net sales of Juniors and Young Mens apparel were down 6% and 8%, respectively. Juniors comparable store net sales results were characterized by strength in Bullhead denim, offset by weakness in swim and shorts. Young Mens comparable store net sales results were characterized by strength in Bullhead denim, offset by weakness in boardshorts. Comparable store net sales of non-apparel were down 57% from last year primarily due to our shift in strategy to become more apparel focused and the exit from our sneaker business. We expect apparel to represent approximately 85% of total sales for fiscal 2009 with non-apparel (consisting of accessories and limited footwear assortments) representing the remaining 15%. We currently expect total comparable store net sales to continue to be negative throughout fiscal 2009. Gross Margin
Gross margin, after buying, distribution and occupancy costs, was $61 million for the first quarter of fiscal 2009 versus $75 million for the first quarter of fiscal 2008. As a percentage of net sales, gross margin was 27.4% for the first quarter of fiscal 2009 compared to 28.3% for the first quarter of fiscal 2008. The components of this 0.9% decrease in gross margin as a percentage of net sales were as follows:

  %                                      Attributable to
  (3.2 )      Deleverage of occupancy costs as a result of the negative 18%
              same-store sales results for the first quarter of fiscal 2009.

   1.3        Increase in merchandise margin due to increased initial markups.

   1.0        Decrease in freight and distribution costs of $4 million primarily due
              to the consolidation of our distribution function in the first quarter
              of fiscal 2008.

  (0.9 )      Total

We expect consumer spending to continue to be negatively impacted throughout fiscal 2009 and we plan to manage our inventories to respond to this environment. At the end of the first quarter of fiscal 2009, inventories per square foot were down 31% in dollars and 25% in total units versus the end of the first quarter of fiscal 2008. We intend to maintain significantly reduced inventory levels versus the prior year (at least 20%) throughout fiscal 2009 until sales trends improve appreciably and consistently. Selling, General and Administrative Expenses Selling, general and administrative expenses decreased to $77 million for the first quarter of fiscal 2009 from $96 million for the first quarter of fiscal 2008, a decrease of $19 million, or 20%. These expenses decreased to 34.4% as a percentage of net sales in the first quarter of fiscal 2009 from 35.9% in the first quarter of fiscal 2008. The components of this 1.5% decrease in selling, general and administrative expenses as a percentage of net sales were as follows:

  %                                      Attributable to
  (2.4 )      Decrease in non-cash asset impairment charges of $7 million.

   1.2        Increase in payroll and payroll-related expenses as a percentage of
              sales due to deleveraging these expenses against the negative 18%
              same-store sales result. In dollars, payroll and payroll-related
              expenses were down $6 million.

  (0.3 )      Decrease in other SG&A expenses of $6 million primarily due to lower
              legal, depreciation and consulting expenses, among other items.

  (1.5 )      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 within selling, general and administrative expenses for underperforming stores in future quarters.
Other expense (income), net
Other expense was $0.2 million for the first quarter of fiscal 2009 compared to other income of $0.8 million for the first quarter of fiscal 2008, a decrease of $1 million. The decrease in fiscal 2009 was primarily the result of decreased interest income on lower average cash balances due to operating losses and a $0.3 million cash surrender charge upon the liquidation of deferred compensation assets in fiscal 2009.
Income Taxes
We recognized income tax benefits of $7 million and $8 million for the first quarters of fiscal 2009 and 2008, respectively. The effective income tax rate was 44.4% in the first quarter of fiscal 2009 versus 38.9% in the first quarter of fiscal 2008. The increase in the effective income tax rate was primarily attributable to lower projected annual income for fiscal 2009. Our weighted-average effective state 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 borrowings. Our primary capital requirements have been for the financing of inventories and the construction of newly opened, remodeled, expanded or relocated stores. We believe that our working capital, cash flows from operating activities, and potential intermittent credit facility borrowings will be sufficient to meet our operating and capital expenditure requirements for at least the next twelve months. Operating Cash Flows
Net cash provided by operating activities was $13 million for the first quarter of fiscal 2009 compared to net cash used of $25 million for the first quarter of fiscal 2008. The $38 million increase in cash from operating activities in the first quarter of fiscal 2009 as compared to the first quarter of fiscal 2008 was largely attributable to the impact of the discontinued demo concept (see Note 4 to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q). Additional details regarding the increase in cash from operating activities were as follows:

 $ millions                                    Attributable to
$         44        Change in income tax receivable from prior year as a result of
                    operating losses and the closing of the discontinued demo concept in
                    the first quarter of fiscal 2008.

          28        Lower operating losses in the current year as a result of the closing
                    of the discontinued demo concept last year.

         (13 )      Increase in merchandise inventories versus the end of fiscal 2008, net
                    of accounts payable.

         (11 )      Change in deferred tax assets associated with the discontinued demo
                    concept.

          (7 )      Decrease in non-cash asset impairments.

          (5 )      Decrease in non-cash depreciation and amortization as a result of the
                    closing of the Anaheim distribution center, write-off of remaining
                    goodwill and impairment of store assets in fiscal 2008.

           2        Other changes in working capital items.

$         38        Total

Working Capital
Working capital at May 2, 2009 was $104 million compared to $98 million at January 31, 2009, an increase of $6 million. The changes in working capital were as follows:

 $ millions                                      Description
$         98        Working capital at January 31, 2009

          (9 )      Increase in accounts payable due to timing of payments

          (9 )      Decrease in other current assets, primarily from a decrease in prepaid
                    rent due to timing of rent payments.

           9        Decrease in other current liabilities, primarily from a decrease in
                    accrued salaries and benefits based on timing of payments.

           8        Increase in merchandise inventories from fiscal year end due to
                    planned receipt flows

           7        Increase in cash and cash equivalents (see condensed consolidated cash
                    flow statement).

$        104        Working capital at May 2, 2009

Investing Cash Flows
Net cash used in investing activities in the first quarter of fiscal 2009 was $5 million compared to $21 million for the first quarter of fiscal 2008, a decrease in cash used of $16 million. Investing cash flows for the first quarter of fiscal 2009 were comprised of capital expenditures of $9 million offset by proceeds from the sale of land of approximately $4 million. Investing cash flows for the first quarter of fiscal 2008 were comprised entirely of capital expenditures of $21 million. We expect total capital expenditures for fiscal 2009 to be approximately $30 million.
Financing Cash Flows
Net cash used in financing activities in the first quarter of fiscal 2009 was nominal compared to cash used in financing activities of $9 million in the first quarter of fiscal 2008. In the first quarter of fiscal 2008, we repurchased and retired common stock in the amount of approximately $10 million, partially offset by approximately $1 million in proceeds received from employee exercises of stock options.
Credit Facility
Information regarding our credit facility is contained in Note 10 to the condensed consolidated financial statements for the quarter ended May 2, 2009, which note is incorporated herein by this reference. Contractual Obligations
We have minimum annual rental commitments under existing store leases as well as minor commitments under 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 May 2, 2009, our future financial commitments under all existing contractual obligations 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          $     439         $      91        $  147        $   106        $     95
Capital lease obligations                 <0.1              <0.1          <0.1              -               -
FIN 48 obligations including
interest and penalties                       1                 -             1              -               -
Letters of credit                           17                17             -              -               -

Total                                $     457         $     108        $  148        $   106        $     95

We expect approximately 100 store operating leases per year to reach the end of their original lease term in each of the next three fiscal years. These leases will need to be renewed or extended, potentially at different rates, or allowed to expire. As a result, depending on market conditions, actual future rental commitments and the time frame of such commitments may differ significantly from those shown in the table above.

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, were $165 million in fiscal 2008. We currently expect total CAM expenses to continue to increase from year to year 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 February 2021. Substantially all of our retail store leases require us to pay minimum rent, CAM charges, insurance, property taxes and additional percentage rent ranging from 3% to 14% 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 expand, relocate or close. We closed five PacSun stores in the first quarter of 2009. We currently anticipate closing approximately 15 stores in the second quarter of 2009 and 35-50 stores for fiscal 2009.
The FIN 48 obligations shown in the table above represent uncertain tax positions related to temporary differences. The years for which the temporary differences related to the uncertain tax positions will reverse have been estimated in scheduling the obligations within the table. 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 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.
Off-Balance Sheet Arrangements
The Company has not entered into any transactions with unconsolidated entities whereby the Company has financial guarantees, subordinated retained interests, derivative instruments, or other contingent arrangements that expose the Company to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to the Company. Recent Accounting Pronouncements
Information regarding recent accounting pronouncements is contained in Note 3 to the condensed consolidated financial statements for the quarter ended May 2, 2009, 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, approximately 45% of our net sales have occurred in the first half of the fiscal year and 55% have occurred in the second half, with the back-to-school and Christmas selling periods accounting for approximately 30-34% of our annual net sales and a higher percentage of our operating income on a combined basis. 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.