**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**ý****        QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF********THE SECURITIES EXCHANGE ACT OF1934**

 

###### **Forthe quarterly period ended October 2, 2004**

 

###### **OR**

 

**o****        TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d) OF********THE SECURITIES EXCHANGE ACT OF1934**

 

###### **CommissionFile Number 0-24395**

 

**bebe stores, inc.**

(Exactname of registrant as specified in its charter)

 

| **California**                                             | ** ** | **94-2450490**                         |
|------------------------------------------------------------|------------|----------------------------------------|
| (State  or Jurisdiction of  Incorporation or Organization) |       | (IRS  Employer  Identification Number) |

 

**400 Valley Drive**

**Brisbane, California 94005**

(Address of principal executive offices)

Telephone:**(415) 715-3900**

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

ý Yes oNo

 

Indicate by check mark whether the registrant (1) isan accelerated filer (as defined in Rule 12b-2 if the Securities Exchange Act).

ý Yes oNo

 

Indicate the number of shares outstanding of each ofthe issuers of common stock, as of the latest practicable date.

 

COMMONSTOCK, PAR VALUE OF $0.001 PER SHARE, 39,294,724SHARES OUTSTANDING AS OFNOVEMBER 1, 2004

 

 

----

 

**bebestores, inc.**

 

#### **TABLE OF CONTENTS**

 
| **PART I.**                                                                                                     | **FINANCIAL INFORMATION**                                                                   | ** ** |
|-----------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|------------|
| ITEM 1.                                                                                                         | Condensed Consolidated Financial  Statements                                                |       |
|                                                                                                            |                                                                                        |       |
| Condensed  Consolidated Balance Sheets as of October 2, 2004, June 30, 2004 and  September 30, 2003             |                                                                                        |
|                                                                                                            |                                                                                        |       |
| Condensed  Consolidated Statements of Earnings for the quarters ended October 2, 2004  and September 30, 2003   |                                                                                        |
|                                                                                                            |                                                                                        |       |
| Condensed  Consolidated Statements of Cash Flows for the quarters ended October 2, 2004  and September 30, 2003 |                                                                                        |
|                                                                                                            |                                                                                        |       |
| Notes  to Condensed Consolidated Financial Statements                                                           |                                                                                        |
|                                                                                                            |                                                                                        |       |
| ITEM 2.                                                                                                         | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |       |
|                                                                                                            |                                                                                        |       |
| ITEM 3.                                                                                                         | Quantitative and Qualitative Disclosures about  Market Risk                                 |       |
|                                                                                                            |                                                                                        |       |
| ITEM 4.                                                                                                         | Controls and Procedures                                                                     |       |
| ** **                                                                                                      | ** **                                                                                  | ** ** |
| **PART II.**                                                                                                    | **OTHER INFORMATION**                                                                       | ** ** |
| ITEM 1.                                                                                                         | Legal  Proceedings                                                                          |       |
|                                                                                                            |                                                                                        |       |
| ITEM 2.                                                                                                         | Unregistered  Sales of Equity Securities and Use of Proceeds                                |       |
|                                                                                                            |                                                                                        |       |
| ITEM  3.                                                                                                        | Defaults  Upon Senior Securities                                                            |       |
|                                                                                                            |                                                                                        |       |
| ITEM  4.                                                                                                        | Submission  of Matters to a Vote of Security Holders                                        |       |
|                                                                                                            |                                                                                        |       |
| ITEM 5.                                                                                                         | Other  Information                                                                          |       |
|                                                                                                            |                                                                                        |       |
| ITEM 6.                                                                                                         | Exhibits                                                                                    |       |
|                                                                                                            |                                                                                        |       |
| **SIGNATURE**                                                                                                   |                                                                                        |
|                                                                                                            |                                                                                        |       |
| **EXHIBIT INDEX**                                                                                               |                                                                                        |

 

2

----

 

**PART I****.****                            FINANCIAL INFORMATION**

ITEM 1.                             Condensed ConsolidatedFinancial Statements

 

**bebestores, inc.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Inthousands, except share data)**

**(unaudited)**

 

 
| ** **                                                                                                                                     | ** ** | **As of  October 2,  2004** | ** ** | **As of  June 30,  2004** | ** ** | **As of  September 30,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                                     | ** ** | ** **                  | ** ** | ** **                | ** ** | ** **                     | ** ** |
| **Assets:**                                                                                                                                    |       |                        |       |                      |       |                           |       |
| Current assets:                                                                                                                                |       |                        |       |                      |       |                           |       |
| Cash and  equivalents                                                                                                                          |       | $                           | 185,905    |                      | $          | 181,205                        |       | $ | 148,672 |   |
| Short-term  marketable securities                                                                                                              |       | 8,050                       |       | 5,050                     |       | 2,072                          |       |
| Receivables (net  of allowance of $678, $632 and $574)                                                                                         |       | 4,176                       |       | 2,911                     |       | 1,566                          |       |
| Inventories                                                                                                                                    |       | 36,886                      |       | 25,538                    |       | 30,028                         |       |
| Prepaid and  other                                                                                                                             |       | 12,640                      |       | 7,580                     |       | 5,688                          |       |
| Total current  assets                                                                                                                          |       | 247,657                     |       | 222,284                   |       | 188,026                        |       |
| Property and  equipment, net                                                                                                                   |       | 63,346                      |       | 62,355                    |       | 51,155                         |       |
| Long-term  marketable securities                                                                                                               |       | 7,875                       |       | 7,875                     |       | 7,875                          |       |
| Other assets                                                                                                                                   |       | 4,211                       |       | 4,222                     |       | 4,942                          |       |
| Total assets                                                                                                                                   |       | $                           | 323,089    |                      | $          | 296,736                        |       | $ | 251,998 |   |
|                                                                                                                                           |       |                        |       |                      |       |                           |       |
| **Liabilities  and Shareholders’ Equity:**                                                                                                |       |                        |       |                      |       |                           |       |
| Current  liabilities:                                                                                                                          |       |                        |       |                      |       |                           |       |
| Accounts payable                                                                                                                               |       | $                           | 24,909     |                      | $          | 14,467                         |       | $ | 14,485 |   |
| Accrued  liabilities                                                                                                                           |       | 23,464                      |       | 19,653                    |       | 14,003                         |       |
| Total current  liabilities                                                                                                                     |       | 48,373                      |       | 34,120                    |       | 28,488                         |       |
| Deferred rent                                                                                                                                  |       | 19,157                      |       | 18,196                    |       | 14,590                         |       |
| Total  liabilities                                                                                                                             |       | 67,530                      |       | 52,316                    |       | 43,078                         |       |
|                                                                                                                                           |       |                        |       |                      |       |                           |       |
| Commitments and  contingencies                                                                                                                 |       | —                      |       | —                    |       | —                         |       |
| Shareholders’  equity:                                                                                                                    |       |                        |       |                      |       |                           |       |
| Preferred  stock-authorized 1,000,000 shares at $0.001 par value per share; no shares  issued and outstanding                                  |       | —                      |       | —                    |       | —                         |       |
| Common  stock-authorized 60,000,000 shares at $0.001 par value per share; issued and  outstanding 39,293,820, 39,211,795 and 38,681,577 shares |       | 39                          |       | 39                        |       | 39                             |       |
| Additional  paid-in capital                                                                                                                    |       | 50,377                      |       | 49,144                    |       | 41,329                         |       |
| Deferred  compensation                                                                                                                         |       | (9                          | )          | (36                       | )          | (14                            | )          |
| Accumulated  other comprehensive income                                                                                                        |       | 719                         |       | 296                       |       | 316                            |       |
| Retained  earnings                                                                                                                             |       | 204,433                     |       | 194,977                   |       | 167,250                        |       |
| Total  shareholders’ equity                                                                                                               |       | 255,559                     |       | 244,420                   |       | 208,920                        |       |
| Total  liabilities and shareholders’ equity                                                                                               |       | $                           | 323,089    |                      | $          | 296,736                        |       | $ | 251,998 |   |
|                                                                                                                                                |            |                             |            |                           |            |                                |            |  |  |  |  |

 

See accompanyingnotes to condensed consolidated financial statements.

 

3

----

 

**bebestores, inc.**

**CONDENSED CONSOLIDATED STATEMENTS OFEARNINGS**

**(In thousands, except per share data)**

**(unaudited)**

 
| ** **                                         | ** ** | **Quarters Ended**   | ** ** |
|----------------------------------------------------|------------|----------------------|------------|
| ** **                                         | ** ** | **October 2,  2004** | ** ** | **September 30,  2003** | ** ** |
| Net sales                                          |       | $                    | 103,147    |   | $ | 83,552 |   |
| Cost of sales,  including production and occupancy |       | 53,048               |       | 45,052 |   |
| Gross profit                                       |       | 50,099               |       | 38,500 |   |
| Selling, general  and administrative expenses      |       | 32,538               |       | 29,292 |   |
| Income from  operations                            |       | 17,561               |       | 9,208 |   |
| Interest and  other income, net                    |       | 855                  |       | 461 |   |
| Earnings before  income taxes                      |       | 18,416               |       | 9,669 |   |
| Provision for  income taxes                        |       | 6,998                |       | 3,626 |   |
| Net earnings                                       |       | $                    | 11,418     |   | $ | 6,043 |   |
| Basic earnings  per share                          |       | $                    | 0.29       |   | $ | 0.16 |   |
| Diluted earnings  per share                        |       | $                    | 0.29       |   | $ | 0.15 |   |
| Basic weighted  average shares outstanding         |       | 39,237               |       | 38,596 |   |
| Diluted weighted  average shares outstanding       |       | 40,020               |       | 39,392 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

4

----

 

**bebestores, inc.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

**(unaudited)**

 
| ** **                                                                       | ** ** | **Quarters Ended**   | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                       | ** ** | **October 2,  2004** | ** ** | **September 30,  2003** | ** ** |
| Cash flows from  operating activities:                                           |       |                 |       |   |   |
| Net earnings                                                                     |       | $                    | 11,418     |   | $ | 6,043 |   |
| Adjustments to  reconcile net earnings to cash provided by operating activities: |       |                 |       |   |   |
| Non-cash  compensation expense                                                   |       | 27                   |       | 61 |   |
| Depreciation and  amortization                                                   |       | 3,151                |       | 3,182 |   |
| Tax benefit from  stock options exercised                                        |       | 239                  |       | 240 |   |
| Net loss/(gain)  on disposal of property                                         |       | 4                    |       | (5 | ) |
| Deferred rent                                                                    |       | 961                  |       | 967 |   |
| Changes in operating  assets and liabilities:                                    |       |                 |       |   |   |
| Receivables                                                                      |       | (1,242               | )          | 184 |   |
| Inventories                                                                      |       | (11,322              | )          | (4,606 | ) |
| Prepaid expenses  and other assets                                               |       | (5,089               | )          | 553 |   |
| Accounts payable                                                                 |       | 10,442               |       | (825 | ) |
| Accrued  liabilities                                                             |       | 4,036                |       | 2,317 |   |
| Net cash  provided by operating activities                                       |       | 12,625               |       | 8,111 |   |
|                                                                             |       |                 |       |   |   |
| Cash flows from  investing activities:                                           |       |                 |       |   |   |
| Purchase of  property and equipment                                              |       | (4,348               | )          | (1,978 | ) |
| Purchase of marketable securities                                                |       | (3,000               | )          | — |   |
| Proceeds from  sale of marketable securities                                     |       | —               |       | 8,428 |   |
| Net cash (used)/provided  by investing activities                                |       | (7,348               | )          | 6,450 |   |
|                                                                             |       |                 |       |   |   |
| Cash flows from  financing activities:                                           |       |                 |       |   |   |
| Net proceeds  from issuance of common stock                                      |       | 994                  |       | 1,184 |   |
| Cash dividends  paid                                                             |       | (1,962               | )          | — |   |
| Net cash  (used)/provided by financing activities                                |       | (968                 | )          | 1,184 |   |
|                                                                             |       |                 |       |   |   |
| Effect of  exchange rate changes on cash                                         |       | 391                  |       | 38 |   |
| Net increase in  cash and equivalents                                            |       | 4,700                |       | 15,783 |   |
| Cash and  equivalents:                                                           |       |                 |       |   |   |
| Beginning of  period                                                             |       | 181,205              |       | 132,889 |   |
| End of period                                                                    |       | $                    | 185,905    |   | $ | 148,672 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

5

----

 

##### **bebe stores, inc.**

 

##### **NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

##### **INTERIM FINANCIAL STATEMENTS**

 

The accompanyingcondensed consolidated balance sheets of bebe stores, inc. as of October 2,2004, June 30, 2004 and September 30, 2003, and the condensed consolidatedstatements of earnings and cash flows for the quarters ended October 2, 2004and September 30, 2003 have been prepared in accordance with accountingprinciples generally accepted in the United States of America for interimfinancial information and with the instructions to Form 10-Q and Article 10 ofRegulation S-X without audit. Accordingly, they do not include all of the informationand footnotes required by accounting principles generally accepted in theUnited States of America for complete financial statements. In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary to present fairly the financial position at the balancesheet dates and the results of earnings for the periods presented have beenincluded. The condensed consolidated balance sheet at June 30, 2004, presentedherein, was derived from the audited balance sheet included in the Form 10-Kfor the fiscal year ended June 30, 2004.

 

Our business is affected by the pattern of seasonalitycommon to most retail apparel businesses. The results for the current and priorperiods are not necessarily indicative of future financial results.

 

Certain notes and otherinformation have been condensed or omitted from the interim condensedconsolidated financial statements presented in this Quarterly Report on Form10-Q. Therefore, these condensed consolidated financial statements should beread in conjunction with our Annual Report on Form 10-K for the year ended June30, 2004.

 

##### **FISCAL YEAR**

 

##### **Beginning on July 1, 2004, theCompany changed their month end to a 4-4-5 week period end.  Each period will end on a Saturday.  The first quarter of fiscal year 2005 beganon July 1, 2004 and ended on October 2, 2004 and includes two additional days inthe reporting period than the comparative period of fiscal year 2004 which wasreported on a calendar month basis.**

 

**STOCK SPLIT**

 

In April 2004, theCompany declared a 3-for-2 stock split, which became effective in May2004.  All share and per share amountsincluded herein have been adjusted to reflect this stock split.

 

##### **EARNINGS PER SHARE**

 

Basic earnings per shareis computed as net earnings divided by the weighted average number of commonshares outstanding for the period. Diluted earnings per share reflects thepotential dilution that could occur from common shares issuable through theexercise of dilutive stock options.

 

The following is areconciliation of the number of shares used in the basic and diluted earningsper share computations:

 
| ** **                                                     | ** ** | **Quarters Ended**   | ** ** |
|----------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                     | ** ** | **October 2,  2004** | ** ** | **September 30,  2003** | ** ** |
| ** **                                                     | ** ** | **(In thousands)**   | ** ** |
| Basic weighted  average number of shares outstanding           |       | 39,237               |       | 38,596 |   |
| Incremental  shares from the assumed issuance of stock options |       | 783                  |       | 796 |   |
| Diluted weighted  average number of shares outstanding         |       | 40,020               |       | 39,392 |   |

 

6

----

 

The number of incrementalshares from the assumed issuance of stock options is calculated applying thetreasury stock method.

 

Excluded from thecomputation of the number of diluted weighted average shares outstanding wereantidilutive options of approximately 1,880,000 and 362,000, for the quartersended October 2, 2004 and September 30, 2003, respectively.

 

##### **COMPREHENSIVE INCOME**

 

Comprehensive incomeconsists of net income and other comprehensive income (income, expenses, gainsand losses that bypass the income statement and are reported directly as aseparate component of equity).  TheCompany’s comprehensive income consists of net income and foreign currencytranslation adjustments for all periods presented.

 
| ** **                  | ** ** | **Quarters Ended**   | ** ** |
|-----------------------------|------------|----------------------|------------|
| ** **                  | ** ** | **October 2,  2004** | ** ** | **September 30,  2003** | ** ** |
| Net income                  |       | $                    | 11,418     |   | $ | 6,043 |   |
| Other  comprehensive income |       | 423                  |       | 47 |   |
| Total  comprehensive income |       | $                    | 11,841     |   | $ | 6,090 |   |

 

##### **CREDIT FACILITIES**

 

**The Company has an unsecured commercial line ofcredit agreement with a bank, which provides for borrowings and issuance ofletters of credit of up to $25.0 million and expires on March 1, 2006. Theoutstanding balance bears interest at either the bank’s reference rate (whichwas 4.75% as of October 2, 2004) or the LIBOR rate plus 1.75 percentage points.As of October 2, 2004, there were no outstanding borrowings, and there was $8.8million outstanding in letters of credit.**

 

**This credit facility requires the Company to complywith certain financial covenants, including a minimum tangible net worth andcertain restrictions on making loans and investments.**

 

7

----

 

##### **STOCK BASED COMPENSATION**

 

The Company accounts forstock-based awards granted to employees using the intrinsic value methodprescribed in Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees,” and related interpretations, Statement of FinancialAccounting Standards (“SFAS”) No. 123 “Accounting for Stock-Based Compensation,”and complies with the disclosure provisions of SFAS No. 148, “Accounting forStock Based Compensation Transition and Disclosure, an Amendment of FASBStatement No. 123.”

 

Had stock based employeecompensation expense been determined based upon the fair values at the grantdates for awards under the Company’s stock plans in accordance with SFAS No.123, the Company’s pro forma net earnings, basic and diluted earnings percommon share would have been as follows:

 
| ** **                                                                                            | ** ** | **Quarters Ended**                           | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                            | ** ** | **October 2,  2004**                         | ** ** | **September 30,  2003** | ** ** |
| ** **                                                                                            | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Net income                                                                                            | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| As reported                                                                                           |       | $                                            | 11,418     |   | $ | 6,043 |   |
| Add: Stock based  employee compensation, net of income tax                                            |       | 17                                           |       | 38 |   |
| Deduct: Stock  based employee compensation determined under the fair value method, net of  income tax |       | (1,626                                       | )          | (597 | ) |
| Pro forma                                                                                             |       | $                                            | 9,809      |   | $ | 5,484 |   |
| Basic EPS                                                                                             |       |                                         |       |   |   |
| As reported                                                                                           |       | $                                            | 0.29       |   | $ | 0.16 |   |
| Pro forma                                                                                             |       | $                                            | 0.25       |   | $ | 0.14 |   |
| Diluted EPS                                                                                           |       |                                         |       |   |   |
| As reported                                                                                           |       | $                                            | 0.29       |   | $ | 0.15 |   |
| Pro forma                                                                                             |       | $                                            | 0.25       |   | $ | 0.14 |   |

 

##### **LEGAL MATTERS**

 

**As of the date of this filing, the Company isinvolved in several ongoing legal proceedings as described below.**

 

Threeformer employees sued bebe on November 20, 2003, in the Superior Court of theState of California, County of San Mateo (case No. CIV435794) alleging thatthey were misclassified as exempt employees under California law. Theplaintiffs purport to bring this action on behalf of a class of former andpresent California bebe store managers and co-managers. Plaintiffs are seekingcompensatory, statutory and injunctive relief. The parties have reached a conditional settlement agreement.  The matter was conditionally certified as aclass action for purposes of settlement only, and the court has givenpreliminary approval of the class-wide settlement.

 

Aformer employee sued bebe on January 20, 2004 in the Superior Court of theState of California, County of San Diego (case No. GIC824505) alleging unpaidwages and unfair business practices. The plaintiff purports to bring the actionon behalf of a class of California employees who hold or have held the positionof co-manager or others similarly designated. The lawsuit seeks compensatory,statutory and injunctive relief.  If theclass settlement in the San Mateo Superior Court action is given finalapproval, this individual plaintiff will have the option of participating inthe class settlement or continuing to pursue those claims not covered by theclass settlement.

 

On February 23, 2004, TheWet Seal, Inc. filed a lawsuit in the Superior Court of the State ofCalifornia, County of Orange against bebe and its current Chief ExecutiveOfficer, Greg Scott, who previously was employed as President of The Wet Seal’sArden B. division until January 7, 2004. The lawsuit asserts causes of actionagainst Scott and/or bebe for (1) specific performance of contract; (2)intentional interference with contract; (3) misappropriation of trade secrets;and (4) unfair competition.  This lawsuithas been resolved and settled.

 

8

----

 

Aformer employee sued bebe on August 2, 2004 in the Superior Court of the Stateof California, County of Sacramento (case No. 04AS03109) alleging unlawful wagepayment and unfair competition.  The plaintiff purports to bring theaction on behalf of a class of California employees who hold or at anytimewithin the past four years have held a salaried store managementposition.  The lawsuit seeks compensatory, statutory and injunctiverelief.  If the class settlement in theSan Mateo Superior Court action is given final approval, this individualplaintiff will have the option of participating in the class settlement orcontinuing to pursue those claims not covered by the class settlement.

 

Althoughthe Company intends to defend itself vigorously against these claims, theCompany has accrued liabilities for estimated settlement costs that managementbelieves are reasonable.  Although thefinal resolution of these matters may be greater than the Company’s recordedliability, management does not believe the ultimate resolution will have amaterial adverse effect on the Company’s business, financial condition orresults of operations.

 

Inaddition to the above, the Company is also involved in various other legalproceedings arising in the normal course of business.  None of these matters are expected,individually or in the aggregate, to have a material adverse effect on theCompany’s business, financial condition or results of operations.

 

9

----

 

**ITEM 2**.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS

 

The following Management’sDiscussion and Analysis of Financial Condition and Results of Operations containsforward-looking statements, which involve risks and uncertainties. Our actualresults may differ materially from those anticipated in these forward-lookingstatements.  Statements that arepredictive in nature, that depend upon or refer to future events or conditionsor that include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,”“estimates,” “thinks,” and similar expressions are forward-looking statements.   Forward looking statements include statementsabout our expected results of operations, capital expenditures and storeopenings.  Although we believe that thesestatements are based upon reasonable assumptions, we cannot assure you that ourgoals will be achieved. These forward-looking statements are made as of thedate of this Form 10-Q, and we assume no obligation to update or revise them orprovide reasons why actual results may differ. Factors that might cause such adifference include, but are not limited to, our ability to respond to changingfashion trends, miscalculation of the demand for our products, effectivemanagement of our growth, decline in comparable store sales performance,ongoing competitive pressures in the apparel industry, changes in the level ofconsumer spending or preferences in apparel, our ability to attract and retainkey management personnel and/or other factors discussed in “Risks That MayAffect Results” and elsewhere in this Form 10-Q.

 

##### **OVERVIEW**

 

We design, develop andproduce a distinctive line of contemporary women’s apparel and accessories.While we attract a broad audience, our target customers are 21 to 35-year-oldwomen who seek current fashion trends interpreted to suit their lifestyleneeds. The “bebe look,” appeals to a hip, sexy, sophisticated, body-consciouswoman who takes pride in her appearance. The bebe customer expects value in theform of quality at a competitive price.

 

Our distinctive productoffering includes a full range of fashion separates, dresses, activewear, andaccessories for all facets of the customer’s lifestyle:  career, casual, active, evening and weekendwear. We design and develop the majority of our merchandise in-house. Themerchandise is then manufactured to our specifications.  The remainder of our merchandise is selecteddirectly from third party manufacturers’ lines.

 

We market our productsunder the bebe, BEBE SPORT and bebe O brand names through our 202 retailstores, of which 158 are bebe stores, 26 are BEBE SPORT stores, and 18 are bebeoutlet stores.  These stores are locatedin 32 states, the District of Columbia and Canada. In addition, we have anon-line store at www.bebe.com and our licensees operate 12 internationalstores.  During the first quarter offiscal 2005, we opened one bebe store and two BEBE SPORT stores, relocated twobebe stores, converted two existing bebe stores into BEBE SPORT stores and didnot close any stores.  We expect to openapproximately eleven bebe stores, eight BEBE SPORT stores and one outlet storeduring the year.  Additionally, weanticipate closing three stores.

 

*bebestores.*  The Companywas founded by Manny Mashouf, our current Chairman of the Board. We opened ourfirst store in San Francisco, California in 1976, which was also the year weincorporated.

 

*BEBESPORT stores.* The Company launched BEBE SPORT in the firsthalf of fiscal 2003 to satisfy the casual lifestyle needs of the bebe customer.The BEBE SPORT product line is active inspired sportswear featuring cottonknits, fleece, casual active bottoms, sweaters, outerwear and accessories thatare easy, sexy and modern.

 

*bebeoutlet stores.*  TheCompany utilizes the outlets as a clearance vehicle for merchandise from our bebeand BEBE SPORT stores. Additionally, we round out the inventory of these storeswith a strong presentation of logo merchandise and special cuts, which bear thebebe O label, produced specifically for the outlet stores.

 

*On-linestore.* The on-line store offers the customer an extension ofthe bebe store experience and provides an assortment of bebe and BEBE SPORTmerchandise from which the customer can choose. It is also used as a vehicle to communicate with our customers throughadvertising and direct mail.

 

10

----

 

We reinforce our brandwith an extensive image advertising campaign, which addresses the lifestyleneeds and aspirations of our target customers. An outside advertising agencyworks with our internal marketing department to create edgy, high-impact ads toattract customers who are drawn to the playfully sensual and evocativeimagery.  Image ads are  produced quarterly and are featured in fashionand lifestyle magazines, transit shelters, mall kiosks, store windows andonline at bebe.com.  We believe that ouradvertising promotes brand awareness and supports numerous product lineexpansion opportunities.

 

##### **CRITICAL ACCOUNTING POLICIES**

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations arebased upon our consolidated financial statements, which have been prepared inconformity with accounting principles generally accepted in the United Statesof America.

 

Thepreparation of these financial statements requires the appropriate applicationof certain accounting policies, many of which require us to make estimates andassumptions about future events and their impact on amounts reported in ourfinancial statements and related notes. Since future events and their impactcannot be determined with certainty, the actual results will inevitably differfrom our estimates. Such differences could be material to the financialstatements. We believe our application of accounting policies, and theestimates inherently required therein, are reasonable. These accountingpolicies and estimates are constantly reevaluated, and adjustments are madewhen facts and circumstances dictate a change. Our accounting policies are morefully described in Note 1 to the consolidated financial statements in ourannual report on Form 10-K for the year ended June 30, 2004.

 

Wehave identified certain critical accounting policies, which are describedbelow:

 

*Inventories.* Our inventories are stated at the lower of weighted average cost ormarket.  Market is determined based onthe estimated net realizable value, which is generally the merchandise sellingprice.   To ensure that our raw materialis properly valued we age the fabric inventory and write down the inventory toreduce the cost in accordance with our established policy, which is based onhistorical experience. To ensure our finished goods inventory is properlyvalued we review the age and turnover of our inventory and reduce the cost ifthe selling price is marked down below cost. These assumptions can have an impact on current and future operatingresults and financial position.  We estimateshrinkage for the period between the last physical count and balance sheet datebased on historic shrinkage trends.

 

*Long-lived assets.* We review long-lived assets for impairment whenever events or changes incircumstances, such as store closures or poor performing stores, indicate thatthe carrying value of an asset may not be recoverable. If the undiscounted cashflows from a long-lived asset are less than the carrying value we record animpairment charge equal to the difference between the carrying value and theasset’s fair value.  In addition, at thetime a decision is made to close a store, we record an impairment charge, ifappropriate, or accelerate depreciation over the revised useful life of theasset. Historically, our impairment charges have been immaterial.  During the quarters ended October 2, 2004 andSeptember 30, 2003 we did not record any impairment charges.  We believe at this time that the long-livedassets’ carrying values and useful lives continue to be appropriate.

 

*SalesReturn Reserve.* We record a reserve for estimated productreturns based on historical return trends. As of October 2, 2004 and September 30, 2003, the reserve was $734,000and $507,000, respectively.  If actualreturns are greater than those projected, additional sales returns may berecorded in the future.

 

*AccruedLitigation.*  We accrue liabilities for estimates ofprobable settlements of lawsuits.  During fiscal year 2004 two lawsuits alleging misclassification ofemployment position were filed against us and in the first quarter of fiscalyear 2005 a similar lawsuit was filed against us.  The liability for the estimated payment ofclaims for these lawsuits recorded as of October 2, 2004 is an estimate andshould a greater amount of claims occur, the recorded liability may not besufficient.

 

*IncomeTaxes*. We accrueliabilities for estimates of probable settlements of domestic and foreign taxaudits.  At any one time, many tax years may be subject to audit byvarious taxing jurisdictions.  The results of these audits andnegotiations with taxing authorities may affect the ultimate settlement ofthese issues.  Our effective tax rate in a given financial statementperiod may be materially impacted by changes in the mix and level of earnings.  We also record a valuation allowance againstour deferred tax assets arising from foreign tax credit carryforwards as theutilization of these credits is not assured.

 

11

----

 

##### **RESULTS OF OPERATIONS**

 

##### **Beginning on July 1, 2004, we changed our month endto a 4-4-5 week period end.  Each periodwill end on a Saturday.  The firstquarter of fiscal year 2005 began on July 1, 2004 and ended on October 2, 2004and includes two additional days in the reporting period than the comparativeperiod of fiscal year 2004 which was reported on a calendar month basis.  For the first quarter of fiscal 2005,comparable store sales were determined using a comparable period of 94 days.**

 

The following table setsforth certain financial data as a percentage of net sales for the periodsindicated:

 
| ** **                                             | ** ** | **Quarters Ended**   | ** ** |
|--------------------------------------------------------|------------|----------------------|------------|
| ** **                                             | ** ** | **October 2,  2004** | ** ** | **September 30,  2003** | ** ** |
| **Statements of Operations Data:**                     | ** ** | ** **           | ** ** | ** ** | ** ** |
| Net sales                                              |       | 100.0                | %          | 100.0 | % |
| Cost of sales,  including production and occupancy (1) |       | 51.4                 |       | 53.9 |   |
| Gross profit                                           |       | 48.6                 |       | 46.1 |   |
| Selling, general  and administrative expenses (2)      |       | 31.5                 |       | 35.1 |   |
| Income from  operations                                |       | 17.1                 |       | 11.0 |   |
| Interest and  other income, net                        |       | 0.8                  |       | 0.6 |   |
| Earnings before  income taxes                          |       | 17.9                 |       | 11.6 |   |
| Provision for  income taxes                            |       | 6.8                  |       | 4.3 |   |
| Net earnings                                           |       | 11.1                 | %          | 7.3 | % |

 

----

(1)                                  Cost of sales includes the cost of merchandise,occupancy costs and production costs.

(2)                                  Selling, general and administrative expensesprimarily consist of non-occupancy store costs, corporate overhead andadvertising costs.

 

*NetSales.* Net sales increased to $103.1 million during thequarter ended October 2, 2004 from $83.6 million for the quarter endedSeptember 30, 2003, an increase of $19.5 million, or 23.3%. During the quarteran increase in comparable store sales of 12.5% versus the prior yearcontributed $10.0 million to the increase in sales.  The increase in comparable store salesperformance was largely due to customer acceptance of the product offering.  The remaining increase in sales of $9.5million was generated by stores not included in the comparable store salesbase, on-line sales, wholesale sales to international licensees, and royaltyrevenue from product licensees.

 

***Gross Profit.*** Gross profit increased to $50.1 million during the quarter endedOctober 2, 2004 from $38.5 million for the quarter ended September 30, 2003, anincrease of $11.6 million, or 30.1%.As a percentage of net sales, gross profit increased to 48.6% for thequarter ended October 2, 2004 from 46.1% in the quarter ended September 30,2003. The increase in gross profit as a percentage of net sales resulted from favorableoccupancy leverage of 1.5 percentage points as a result of higher comparablestore sales and improved merchandise margins of 1.0 percentage points.

** **

*Selling,General and Administrative Expenses.* Selling, general andadministrative expenses, which primarily consist of non-occupancy store costs,corporate overhead and advertising costs, increased to $32.5 million during thequarter ended October 2, 2004 from $29.3 million in the quarter ended September 30, 2003, an increase of $3.2 million, or 10.9%.As a percentage of net sales, these expenses decreased to 31.5% during thequarter from 35.1% in the comparable period of the prior year. This decrease asa percentage of net sales was largely the result of lower compensation expensesand increased leverage on fixed expense as a result of higher comparable storesales.  We expect to incur increasedexpenses as a result of compliance with Section 404 of the Sarbanes-Oxley Actof 2002.

 

12

----

 

*Interestand Other Income, Net.*We generated approximately $0.9million of interest and other income (net of other expenses) during the quarterended October 2, 2004 as compared to approximately $0.5 million in thecomparable quarter of the prior year. The increase in interest and other incomeis a result of higher average cash balances.

 

*Provisionfor Income Taxes.* The effective tax rate increased toapproximately 38.0% for the quarter ended October 2, 2004 as compared to 37.5%for the quarter ended September 30, 2003 and represents the Company’s estimateof the annual effective rate for these fiscal periods.

 

**Seasonality of Business and QuarterlyResults**

 

* *Our business varies withgeneral seasonal trends that are characteristic of the retail and apparelindustries. As a result, our typical store generates a disproportionate amountof our annual net sales and profitability in the second quarter of our fiscalyear (which includes the fall and holiday selling seasons) compared to theother quarters of our fiscal year. If for any reason our sales were belowseasonal norms during the second quarter of our fiscal year, our annualoperating results would be negatively impacted. Because of the seasonality ofour business, results for any quarter are not necessarily indicative of resultsthat may be achieved for a full fiscal year.

 

### **LIQUIDITYAND CAPITAL RESOURCES**

### ** **

Ourworking capital requirements vary widely throughout the year and generally peakin the first and second fiscal quarters. At October 2, 2004, we hadapproximately $201.8 million of cash and equivalents, short-term marketablesecurities and long-term marketable securities on hand. In addition, we had arevolving line of credit, under which we could borrow or issue letters ofcredit up to a combined total of $25.0 million. As of October 2, 2004, therewere no borrowings under the line of credit and letters of credit outstandingtotaled $8.8 million.

 

Netcash provided by operating activities for the quarter ended October 2, 2004 was$12.6 million. Cash provided by operating activities for the period wasprimarily generated by earnings adjusted for depreciation and deferred rent, aswell as an increase in accounts payable and accrued liabilities, primarily dueto the timing of payments, offset by an increase in prepaid expenses, also dueto the timing of payments, and an increase in inventory due to the ramp up forthe fall and holiday selling seasons.

 

Net cash used by investingactivities for the quarter ended October 2, 2004 was $7.3 million due to the purchaseof marketable securities and capital expenditures, primarily related to theopening of new stores.  We opened threenew stores in the first quarter of fiscal 2005 and expect to open approximately20 stores during fiscal 2005.

 

We estimate that total capitalexpenditures will be approximately $20 million in fiscal 2005.

 

Net cash used byfinancing activities was $1.0 million for the quarter ended October 2, 2004 andwas due to the payment of a cash dividend on our common stock partially offsetby proceeds from stock option exercises.

 

On August 12, 2004 ourBoard of Directors approved an annual cash dividend of $0.20 per share on ourcommon stock, which is payable quarterly. The first quarterly dividend of $0.05 per share, totaling $2.0 million,was paid on September 30, 2004 to stockholders of record on September 9, 2004.

 

Webelieve that our cash on hand, together with our cash flows from operations,will be sufficient to meet our capital and operating requirements for at leastthe next twelve months. Our future capital requirements, however, will dependon numerous factors, including without limitation, the size and number of newand expanded stores and/or store concepts, investment costs for managementinformation systems, potential acquisitions and/or joint ventures, repurchaseof stock and future results of operations.

 

### **Inflation**

 

Wedo not believe that inflation has had a material effect on the results ofoperations in the recent past. However, we cannot assure that our business willnot be affected by inflation in the future.

 

13

----

 

### **RISKSTHAT MAY AFFECT RESULTS**

 

Factorsthat might cause our actual results to differ materially from the forwardlooking statements discussed elsewhere in this report, as well as affect ourability to achieve our financial and other goals, include, but are not limitedto, the following:

 

RISKS RELATING TO OURBUSINESS:

 

**1.  The success of our business depends in largepart on our ability to identify fashion trends as well as to react to changingcustomer demand in a timely manner.** Consequently, we depend in part upon thecustomer response to the creative efforts of our merchandising, design andmarketing teams and their ability to anticipate trends and fashions that willappeal to our consumer base. If we miscalculate our customers’ productpreferences or the demand for our products, we may be faced with excessinventory. Historically, this type of occurrence has resulted in excess fabricfor some products and markdowns and/or write-offs, which has impaired ourprofitability, and may do so in the future. Similarly, any failure on our partto anticipate, identify and respond effectively to changing consumer demandsand fashion trends will adversely affect our sales.

 

**2.  If we are unable to obtain raw materials,unable to find manufacturing facilities or our manufacturers performunacceptably, our sales may be negatively affected and our financial conditionmay be harmed**. We do not own any manufacturing facilities andtherefore depend on contractors and third parties to manufacture our products.We place all of our orders for production of merchandise and raw materials bypurchase order and do not have any long-term contracts with any manufacturer orsupplier. If we fail to maintain favorable relationships with our manufacturersand suppliers or are unable to obtain sufficient quantities of quality rawmaterials on commercially reasonable terms, it could harm our business andresults of operations.  We cannot assureyou that contractors and third party manufacturers (1) will not supply similarproducts to our competitors, (2) will not stop supplying products to uscompletely or (3) will supply products in a timely manner.  Untimely receipt of products may result inmarkdowns which would have a negative impact on earnings.  Furthermore, we have received in the past,and may receive in the future, shipments of products from manufacturers thatfail to conform to our quality control standards. In such event, unless we areable to obtain replacement products in a timely manner, we may lose sales.  Certain of our third party manufacturersstore our raw materials.  In the eventour inventory was damaged or destroyed and we were unable to obtain replacementraw materials, our earnings may be negatively impacted.

 

**3.  Our success depends on our ability to attractand retain key employees in order to support our existing business and futureexpansion.** From time to time we actively recruit qualifiedcandidates to fill key executive positions from within the Company. There issubstantial competition for experienced personnel, which we expect willcontinue. We compete for experienced personnel with companies who have greaterfinancial resources than we do. In the past, we have experienced significantturnover of our executive management team and retail store personnel. We arealso exposed to employment practice litigation due to the large number ofemployees and high turnover of our sales associates. If we fail to attract,motivate and retain qualified personnel, it could harm our business and limitour ability to expand.

 

In addition, we dependupon the expertise and execution of our key employees, particularly MannyMashouf, the founder, Chairman of the Board, and majority shareholder, and GregScott, our Chief Executive Officer and member of the Board of Directors. We donot carry “key person” life insurance policies on any of our employees. If welose the services of Mr. Mashouf, Mr. Scott, or any key officers or employees,it could harm our business and results of operations.

 

**4.  If we are not able to successfully developand expand our bebe and BEBE SPORT stores our revenue base and earnings may beimpaired**. As part of our growth strategy, we may open largerbebe stores.  If these stores are notsuccessful, our financial condition may be harmed.  In addition, we launched a new store concept,BEBE SPORT, during fiscal 2003 for which we have committed significantfinancial and human resources to develop and expand. The failure of the BEBESPORT concept might result in a negative impact to earnings.

 

14

----

 

**5.  There can be no assurance that future storeopenings will be successful. **Weexpect to open approximately 20 stores in fiscal 2005, of which approximatelyeight will be BEBE SPORT stores, approximately eleven will be bebe stores, andapproximately one will be an outlet store.  In the past, we have closed stores as a result of poor performance, andthere can be no assurance that the stores that we plan to open in fiscal 2005,or any other stores that we might open in the future, will be successful orthat our overall gross profit will increase as a result of opening thesestores. In addition, most of our new store openings in fiscal 2005 will be inexisting markets. These openings may affect the existing stores’ net salesvolumes and profitability.  Our failureto predict accurately the demographic or retail environment at any future storelocation could have a material adverse effect on our business, financialcondition and results of operations.

 

**6.  Any serious disruption at our majorfacilities could have a harmful effect on our business.** Wecurrently operate our corporate office in Brisbane, California, a distributionfacility in Benicia, California, and a recently purchased design studio andproduction facility in Los Angeles, California. ** **Any serious disruptionat these facilities whether due to construction, relocation, fire, earthquake,terrorist acts or otherwise would harm our operations and could have a harmful affecton our business and results of operations. Furthermore, we have littleexperience operating essential functions away from our main corporate officesand are uncertain what effect operating such satellite facilities might have onbusiness, personnel and results of operations. We are in the process of implementing a business continuity plan thatwill address recovery in the event of a serious disruption at one of our majorfacilities.

 

**7.  We face significant competition in the retailand apparel industry, which could harm our sales and profitability.**The retail and apparel industries are highly competitive and are characterizedby low barriers to entry. Key competitors include, but are not limited to ArdenB, BCBG, Express, Guess, and the t.b.d. and Savvy Departments within Nordstrom.We expect competition in our markets to increase. The primary competitivefactors in our markets are:  brand namerecognition, sourcing strategies, product styling, quality, presentation andpricing, timeliness of product development and delivery, store ambiance,customer service and convenience.

 

We compete withtraditional department stores, specialty store retailers, business to consumerwebsites, off-price retailers and direct marketers for, among other things, rawmaterials, market share, retail space, finished goods, sourcing and personnel.Because many of these competitors are larger and have substantially greaterfinancial, distribution and marketing resources than we do, we may lack theresources to adequately compete with them. If we fail to compete in any way, itcould harm our business, financial condition and results of operations.

 

**8.   Purchases of the merchandise we sell aregenerally discretionary and are therefore particularly susceptible to economicslowdowns.**If economic conditions change, our business,financial condition and results of operations could be adversely affected.Consumers are generally more willing to make discretionary purchases, includingpurchases of fashion products, during periods in which favorable economicconditions prevail.

 

The outlook for theUnited States economy is uncertain and is directly affected by global politicalfactors that are beyond our control. Any escalation of military actioninvolving the United States could cause increased volatility in financialmarkets, further adversely affecting consumer confidence and spending habits.

 

**9.  If we are not able to successfully protectour intellectual property our ability to capitalize on the value of our brandname may be impaired.**Even though we takeactions to establish, register and protect our trademarks and other proprietaryrights, we cannot assure you that we will be successful or that others will notimitate our products or infringe upon our intellectual property rights. Inaddition, we cannot assure you that others will not resist or seek to block thesale of our products as infringements of their trademark and proprietaryrights.

** **

**Weare seeking to register our trademarks domestically and internationally.  Obstacles may exist that may prevent us fromobtaining a trademark for the bebe name or related names. We may not be able toregister certain trademarks, purchase the right or obtain a license to use thebebe name on commercially reasonable terms. If we fail to obtain trademark,ownership or license the requisite rights, it would limit our ability to expand. In some jurisdictions, despitesuccessful registration of our trademarks, third parties may allege infringementand bring actions against us. In addition, if our licensees fail to use ourintellectual property correctly, the goodwill associated with our trademarksmay be diluted.**

** **

**Furthermore,if we do not demonstrate use of our trademarks, our trademark rights may lapseover time.**

** **

**15**

----

** **

**10.    If an independent manufacturer violateslabor or other laws, or is accused of violating any such laws, or if theirlabor practices diverge from those generally accepted as ethical, it could harmour business and brand image.** While we maintain a policy tomonitor the operations of our independent manufacturers by having anindependent firm inspect these manufacturing sites, and all manufacturers arecontractually required to comply with such labor practices, we cannot controlthe actions or the public’s perceptions of such manufacturers, nor can weassure that these manufacturers will conduct their businesses using ethical orlegal labor practices. Apparel companies can be held jointly liable for thewrongdoings of the manufacturers of their products.  While we do not control their employees’employment conditions or the manufacturer’s business practices, and themanufacturers act in their own interest, they may act in a manner that resultin negative public perceptions of us and/or employee allegations or courtdeterminations that we are jointly liable.

 

RISKS RELATING TO OURCOMMON STOCK:

 

**1.  Our stock price may fluctuate because of thesmall number of shares that can be publicly traded and the low average dailytrading volumes**. The vast majority of our outstanding sharesof our common stock are not registered and are subject to trading restrictions.As of October 2, 2004, only 9,081,748 shares of our common stock were availableto be publicly traded, and as a result, our average daily trading volumes arerelatively low, and our stock price is vulnerable to market swings due to largepurchases, sales and short sales of our common stock.

 

**2.  Because a principal shareholder controls theCompany, other shareholders may not be able to influence the direction theCompany takes**. As of October 2, 2004, Manny Mashouf, theChairman of the Board, beneficially owned****approximately76% the outstanding shares of our common stock. As a result, he alone cancontrol the election of directors and the outcome of all issues submitted tothe shareholders. This may make it more difficult for a third party to acquireshares, may discourage acquisition bids, and could limit the price that certaininvestors might be willing to pay for shares of common stock. Thisconcentration of stock ownership may have the effect of delaying, deferring orpreventing a change in control of our Company.

 

##### **3.  If we account for employee stock optionsusing the fair value method, it could significantly reduce our net income. **There has been ongoing publicdebate whether stock options granted to employees should be treated as acompensation expense and, if so, how to properly value such charges. On March31, 2004, the Financial Accounting Standard Board (FASB) issued an ExposureDraft, “Share-Based Payment: an amendment of FASB statements No. 123 and 95.”  This proposed standard, as amended, wouldrequire a company to recognize, as an expense, the fair value of stock optionsand other stock-based compensation to employees beginning in fiscal year 2006and subsequent reporting periods. If we elect or are required to record anexpense for our stock-based compensation plans using the fair value method asdescribed in the Exposure Draft, we could have significant and ongoingaccounting charges, which could significantly reduce our net income.

 

**4.  Investor confidence and share value may beadversely impacted if we are unable to favorably assess, or our independentregistered public accountants are unable to provide an unqualified attestationreport on our assessment of, the effectiveness of our internal control overfinancial reporting as of the end of our 2005 fiscal year as required bySection 404 of the Sarbanes-Oxley Act of 2002.** An effective system of internal controlover financial reporting is necessary for us to provide reliable financialreports.  Rules adopted by the Securitiesand Exchange Commission pursuant to Section 404 of the Sarbanes-Oxley Actof 2002 require annual assessment of our internal control over financialreporting, and attestation of our assessment by our independent registeredpublic accountants.  This requirementwill first apply to our Annual Report on Form 10-K for the fiscal year endingJuly 2, 2005.  The rules governing thestandards that must be met for management to assess the internal control overfinancial reporting as effective are new and complex, and require significantdocumentation, testing and possible remediation to meet the detailed standardsunder the new rules.  We are diligentlyreviewing, documenting and testing our internal control over financialreporting, which has and may continue to result in increased expenses and thedevotion of significant management resources. We may encounter problems or delays in completing the implementation ofany changes necessary to make a favorable assessment of our internal controlover financial reporting under the new standards.  In addition, the evaluation and attestationprocess by our independent registered public accountants is new and we mayencounter problems or delays in completing the implementation of any requestedimprovements and receiving a favorable review and attestation by ourindependent registered public accountants. If we cannot favorably assess, or our independent registered publicaccountants are unable to provide an unqualified attestation report on ourassessment of, the effectiveness of our internal control over financialreporting, investor confidence and share value may be negatively impacted.

 

16

----

 

##### **ITEM3**.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK

 

Weare exposed to market risks, which include changes in U.S. interest rates and,to a lesser extent, foreign exchange rates. We do not engage in financialtransactions for trading or speculative purposes.

 

*Interest Rate Risk*

 

We currently maintain aportfolio of variable interest rate investments consisting of cash equivalents,short-term marketable securities and long-term marketable securities.  Marketable securities are comprised ofclosed-end variable interest rate funds that invest primarily in tax-exemptmunicipal bonds.  Due to the variablenature of these investments, their value is typically not subject to market ratechanges.  According to our investmentpolicy, we may invest in taxable and tax exempt instruments.  In addition, the policy establishes limits oncredit quality, maturity, issuer and type of instrument.  Marketable securities are classified as “availablefor sale”.    We do not use derivativefinancial instruments in our investment portfolio.

 

All highly liquidinvestments with a maturity of three months or less at the date of purchase areconsidered to be cash equivalents.  Theremaining investments are considered short-term marketable securities iforiginal maturities range between four and twelve months or long-termmarketable securities if original maturities are over twelve months.

 

Thefollowing table lists our cash equivalents, short-term marketable securitiesand long-term marketable securities at October 2, 2004:

 
| ** **                       | ** ** | **2004**                   | ** ** | **Fair Value** | ** ** |
|----------------------------------|------------|----------------------------|------------|----------------|------------|
| ** **                       | ** ** | **(Dollars in thousands)** | ** ** |
| Cash equivalents                 |       | $                          | 176,141    |           | $          | 176,141 |   |
| Weighted average interest rate   |       | 2.37                       | %          |           |       |
| Short-term marketable securities |       | 8,050                      |       | 8,050          |       |
| Weighted average interest rate   |       | 2.38                       | %          |           |       |
| Long-term marketable securities  |       | 7,875                      |       | 7,875          |       |
| Weighted average interest rate   |       | 2.82                       | %          |           |       |
| Total                            |       | $                          | 192,066    |           | $          | 192,066 |   |

 

Theinterest payable on our bank line of credit is based on variable interest ratesand therefore affected by changes in market interest rates. If interest ratesrose significantly, our results from operations and cash flows would not beaffected as we have no outstanding borrowings.

 

*ForeignCurrency Risks*

 

Weenter into a significant amount of purchase obligations outside of the United States,substantially all of which are settled in U.S. Dollars and, therefore, haveonly minimal exposure to foreign currency exchange risks. We also operate asubsidiary with a base currency other than the U.S. Dollar. Fluctuationsin exchange rates therefore impact our financial condition and results ofoperations, as reported in U.S. Dollars.   To date, we have notexperienced any significant negative impact as a result of fluctuations inforeign currency markets. We do not hedgeagainst foreign currency risks and believe that foreign currency exchange riskis immaterial.

 

##### **ITEM4**.  CONTROLS AND PROCEDURES

 

Underthe supervision and with the participation of our management, including ourChief Executive Officer and Chief Financial Officer, we evaluated theeffectiveness of our disclosure controls and procedures, as such term isdefined in Rules 13a-15(e) and 15d-15(e) promulgated under the SecuritiesExchange Act of 1934, as amended (“the Exchange Act”).  Based on this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures were effective as of October 2, 2004.

 

17

----

 

Wealso maintain a system of internal control over financial reporting, as suchterm as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act.  No changes in our internal control overfinancial reporting occurred during the quarter ending October 2, 2004 thathave materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

##### **PART II**  OTHER INFORMATION

 

**ITEM1.**  **LEGAL PROCEEDINGS**

 

From time to time, we maybe involved in litigation relating to claims arising out of our operations. Asof the date of this filing, we are currently involved in several ongoing legalproceedings; however, none of these proceedings are expected, individually orin the aggregate, to have a material adverse effect on our business, financialcondition or results of operations.

 

##### **ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OFPROCEEDS**

 

Not applicable.

 

##### **ITEM 3.  DEFAULTS UPON SENIOR SECURITIES**

 

Not applicable.

 

##### **ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

Not applicable.

 

##### **ITEM 5.  OTHER INFORMATION**

 

Not applicable.

 

##### **ITEM 6.  EXHIBITS**

 

(a) Exhibits.  The following is alist of exhibits filed as part of this Report on Form 10-Q.

 
| **Exhibit  Number** | ** ** | **Description**                                        |
|---------------------|------------|--------------------------------------------------------|
|                |       |                                                   |
| 31.1                |       | Section 302  Certification of Chief Executive Officer. |
| 31.2                |       | Section 302  Certification of Chief Financial Officer. |
| 32.1                |       | Section 906  Certification of Chief Executive Officer. |
| 32.2                |       | Section 906  Certification of Chief Financial Officer. |

 

18

----

 

**SIGNATURE**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, as amended, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 
|   | Dated November 5, 2004                 |
|--------|----------------------------------------|
|   |                                   |
|   | bebe stores, inc.                      |
|   |                                   |
|   | /s/ Walter Parks                       |   |
|   | Walter Parks, Chief  Financial Officer |

 

19

----

 

EXHIBIT INDEX

 
| **Exhibit  Number** |   | **Description**                                       |
|---------------------|--------|-------------------------------------------------------|
| 31.1                |   | Section 302  Certification of Chief Executive Officer |
| 31.2                |   | Section  302 Certification of Chief Financial Officer |
| 32.1                |   | Section 906  Certification of Chief Executive Officer |
| 32.2                |   | Section 906  Certification of Chief Financial Officer |

 

20

----