**UNITED STATESSECURITIES AND EXCHANGE COMMISSION********        Washington,D.C. 20549**

 

**FORM 10-Q**

**ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For thequarterly period ended January 1, 2005**

**OR**

**o TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**Commission File Number 0-24395**

 

 

**bebestores, inc.******(Exact name 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 ofprincipal executive offices) **Telephone: (415) 715-3900**

     Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  ýYes o No

     Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Securities Exchange Act).  ý Yes o No

     Indicate the number of shares outstanding of each of the issuers of commonstock, as of the latest practicable date.

COMMON STOCK, PAR VALUE OF $0.001 PER SHARE, 59,962,938SHARES OUTSTANDING AS OF FEBRUARY 8, 2005

 

 

 

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**bebestores, inc.**

 

#### **TABLEOF CONTENTS**

 

 

 
|              |                                                                                                                            | ** ** |
|-------------------|---------------------------------------------------------------------------------------------------------------------------------|------------|
|              |                                                                                                                            |       | ** ** |
| **PART 1.**       | **FINANCIAL  INFORMATION**                                                                                                      |       |   |
| ITEM  1.          | Condensed  Consolidated Financial Statements                                                                                    |       |   |
|              |                                                                                                                            |       |   |
|              | Condensed Consolidated  Balance Sheets as of January 1, 2005, June 30, 2004 and December 31, 2003                               |       |   |
|              |                                                                                                                            |       |   |
|              | Condensed  Consolidated Statements of Earnings for the three months and six months ended  January 1, 2005 and December 31, 2003 |       |   |
|              |                                                                                                                            |       |   |
|              | Condensed  Consolidated Statements of Cash Flows for the six months ended January 1,  2005 and December 31, 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

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

ITEM 1.       Condensed Consolidated FinancialStatements

 

**bebestores, inc.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Inthousands, except share data)**

**(unaudited)**

 
| ** **                                                                                                                                     | ** ** | **As of**           | ** ** | **As of**         | ** ** | **As of**             | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                     | ** ** | **January 1,** | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                                                                     | ** ** | **2005**            | ** ** | **2004**          | ** ** | **2003**              | ** ** |
| ** **                                                                                                                                     | ** ** | ** **          | ** ** | ** **        | ** ** | ** **            | ** ** |
| **Assets:**                                                                                                                                    |       |                |       |              |       |                  |       |
| Current assets:                                                                                                                                |       |                |       |              |       |                  |       |
| Cash and  equivalents                                                                                                                          |       | $                   | 224,519    |              | $          | 181,205               |       | $ | 185,630 |   |
| Short-term  marketable securities                                                                                                              |       | 9,000               |       | 5,050             |       | —                |       |
| Receivables (net  of allowance of $758, $632 and $558)                                                                                         |       | 4,522               |       | 2,911             |       | 1,303                 |       |
| Inventories                                                                                                                                    |       | 28,938              |       | 25,538            |       | 24,855                |       |
| Prepaid and  other                                                                                                                             |       | 14,279              |       | 7,580             |       | 5,275                 |       |
| Total current  assets                                                                                                                          |       | 281,258             |       | 222,284           |       | 217,063               |       |
| Property and  equipment, net                                                                                                                   |       | 65,072              |       | 62,355            |       | 49,756                |       |
| Long-term  marketable securities                                                                                                               |       | 7,875               |       | 7,875             |       | 7,875                 |       |
| Other assets                                                                                                                                   |       | 4,424               |       | 4,222             |       | 4,904                 |       |
| Total assets                                                                                                                                   |       | $                   | 358,629    |              | $          | 296,736               |       | $ | 279,598 |   |
|                                                                                                                                           |       |                |       |              |       |                  |       |
| **Liabilities  and Shareholders’ Equity:**                                                                                                |       |                |       |              |       |                  |       |
| Current  liabilities:                                                                                                                          |       |                |       |              |       |                  |       |
| Accounts payable                                                                                                                               |       | $                   | 23,120     |              | $          | 14,467                |       | $ | 14,780 |   |
| Accrued  liabilities                                                                                                                           |       | 23,235              |       | 19,653            |       | 25,900                |       |
| Total current  liabilities                                                                                                                     |       | 46,355              |       | 34,120            |       | 40,680                |       |
| Deferred rent                                                                                                                                  |       | 19,734              |       | 18,196            |       | 14,701                |       |
| Total  liabilities                                                                                                                             |       | 66,089              |       | 52,316            |       | 55,381                |       |
|                                                                                                                                           |       |                |       |              |       |                  |       |
| 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 90,000,000 shares at $0.001 par value per share; issued and  outstanding 59,932,041, 58,817,693 and 58,173,728 shares |       | 60                  |       | 59                |       | 58                    |       |
| Additional  paid-in capital                                                                                                                    |       | 64,754              |       | 49,124            |       | 42,586                |       |
| Deferred  compensation                                                                                                                         |       | (88                 | )          | (36               | )          | (91                   | )          |
| Accumulated  other comprehensive income                                                                                                        |       | 1,126               |       | 296               |       | 525                   |       |
| Retained  earnings                                                                                                                             |       | 226,688             |       | 194,977           |       | 181,139               |       |
| Total  shareholders’ equity                                                                                                               |       | 292,540             |       | 244,420           |       | 224,217               |       |
| Total  liabilities and shareholders’ equity                                                                                               |       | $                   | 358,629    |              | $          | 296,736               |       | $ | 279,598 |   |
|                                                                                                                                           |       |                |       |              |       |                  |       |
| See accompanying notes  to condensed consolidated financial statements.                                                                        |       |
|                                                                                                                                                |            |                     |            |                   |            |                       |            |  |  |  |  |

 

3

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**bebestores, inc.CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS(In thousands, except per share data)(unaudited)**

 

 
| ** **                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**  | ** ** |
|----------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **January 1, 2005**    | ** ** | **December 31, 2003** | ** ** | **January 1, 2005** | ** ** | **December 31, 2003** | ** ** |
|                                               |       |                   |       |                  |       |   |   |   |   |
| Net sales                                          |       | $                      | 152,581    |                  | $          | 112,014 |   | $ | 255,728 |   | $ | 195,566 |   |
| Cost of sales,  including production and occupancy |       | 74,232                 |       | 57,962                |       | 127,280 |   | 103,013 |   |
|                                               |       |                   |       |                  |       |   |   |   |   |
| Gross profit                                       |       | 78,349                 |       | 54,052                |       | 128,448 |   | 92,553 |   |
| Selling, general  and administrative expenses      |       | 40,275                 |       | 32,327                |       | 72,813 |   | 61,620 |   |
|                                               |       |                   |       |                  |       |   |   |   |   |
| Income from  operations                            |       | 38,074                 |       | 21,725                |       | 55,635 |   | 30,933 |   |
| Interest and  other income, net                    |       | 1,055                  |       | 497                   |       | 1,910 |   | 958 |   |
|                                               |       |                   |       |                  |       |   |   |   |   |
| Earnings before  income taxes                      |       | 39,129                 |       | 22,222                |       | 57,545 |   | 31,891 |   |
| Provision for  income taxes                        |       | 14,869                 |       | 8,333                 |       | 21,867 |   | 11,959 |   |
|                                               |       |                   |       |                  |       |   |   |   |   |
| Net earnings                                       |       | $                      | 24,260     |                  | $          | 13,889 |   | $ | 35,678 |   | $ | 19,932 |   |
|                                               |       |                   |       |                  |       |   |   |   |   |
| Basic earnings  per share                          |       | $                      | 0.41       |                  | $          | 0.24 |   | $ | 0.60 |   | $ | 0.34 |   |
| Diluted earnings  per share                        |       | $                      | 0.39       |                  | $          | 0.23 |   | $ | 0.58 |   | $ | 0.34 |   |
| Basic weighted  average shares outstanding         |       | 59,451                 |       | 58,080                |       | 59,149 |   | 57,987 |   |
| Diluted weighted  average shares outstanding       |       | 61,976                 |       | 59,486                |       | 61,232 |   | 59,293 |   |

 

 

 

 

See accompanying notes to condensed consolidatedfinancial statements.

 

4

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**bebe stores, inc.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Inthousands)**

**(unaudited)**

 
| ** **                                                                       | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                       | ** ** | **January 1, 2005**  | ** ** | **December 31, 2003** | ** ** |
| ** **                                                                       | ** ** | ** **           | ** ** | ** ** | ** ** |
| Cash flows from  operating activities:                                           |       |                 |       |   |   |
| Net earnings                                                                     |       | $                    | 35,678     |   | $ | 19,932 |   |
| Adjustments to  reconcile net earnings to cash provided by operating activities: |       |                 |       |   |   |
| Non-cash  compensation expense                                                   |       | 86                   |       | 84 |   |
| Depreciation and  amortization                                                   |       | 6,582                |       | 6,260 |   |
| Net loss on  disposal of property                                                |       | 240                  |       | 58 |   |
| Deferred rent                                                                    |       | 1,536                |       | 1,078 |   |
| Changes in  operating assets and liabilities:                                    |       |                 |       |   |   |
| Receivables                                                                      |       | (1,562               | )          | 398 |   |
| Inventories                                                                      |       | (3,351               | )          | 579 |   |
| Prepaid expenses  and other assets                                               |       | (5,098               | )          | 944 |   |
| Accounts payable                                                                 |       | 8,651                |       | (530 | ) |
| Accrued  liabilities                                                             |       | 8,733                |       | 14,631 |   |
| Net cash  provided by operating activities                                       |       | 51,495               |       | 43,434 |   |
|                                                                             |       |                 |       |   |   |
| Cash flows from  investing activities:                                           |       |                 |       |   |   |
| Purchase of  property and equipment                                              |       | (9,686               | )          | (3,656 | ) |
| Purchase of marketable securities                                                |       | (6,000               | )          | — |   |
| Proceeds from  sale of marketable securities                                     |       | 2,050                |       | 10,500 |   |
| Net cash  (used)/provided by investing activities                                |       | (13,636              | )          | 6,844 |   |
|                                                                             |       |                 |       |   |   |
| Cash flows from  financing activities:                                           |       |                 |       |   |   |
| Net proceeds  from issuance of common stock                                      |       | 8,637                |       | 2,182 |   |
| Cash dividends  paid                                                             |       | (3,967               | )          | — |   |
| Net cash  provided by financing activities                                       |       | 4,670                |       | 2,182 |   |
|                                                                             |       |                 |       |   |   |
| Effect of  exchange rate changes on cash                                         |       | 785                  |       | 281 |   |
| Net increase in  cash and equivalents                                            |       | 43,314               |       | 52,741 |   |
| Cash and  equivalents:                                                           |       |                 |       |   |   |
| Beginning of  period                                                             |       | 181,205              |       | 132,889 |   |
| End of period                                                                    |       | $                    | 224,519    |   | $ | 185,630 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

 

5

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##### **bebestores, inc.**

##### ** **

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

##### ** **

##### ** **

##### **INTERIM FINANCIALSTATEMENTS**

 

Theaccompanying condensed consolidated balance sheets of bebe stores, inc. as ofJanuary 1, 2005, June 30, 2004 and December 31, 2003, the condensedconsolidated statements of earnings for the three and six months ended January1, 2005 and December 31, 2003 and the condensed consolidated statements of cashflows for the six months ended January 1, 2005 and December 31, 2003 have beenprepared in accordance with accounting principles generally accepted in theUnited States of America for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X, without audit.Accordingly, they do not include all of the information and footnotes requiredby accounting principles generally accepted in the United States of America forcomplete financial statements. In the opinion of management, all adjustments(consisting of normal recurring accruals) considered necessary to presentfairly the financial position at the balance sheet dates and the results ofearnings for the three and six months then ended have been included. Thecondensed consolidated balance sheet at June 30, 2004, presented herein, wasderived from the audited balance sheet included in the Form 10-K for the fiscalyear ended June 30, 2004.

        Ourbusiness is affected by the pattern of seasonality common to most retailapparel businesses. The results for the periods presented are not necessarilyindicative of future financial results.

        Certainnotes and other information have been condensed or omitted from the interimcondensed consolidated financial statements presented in this Quarterly Reporton Form 10-Q. Therefore, these condensed consolidated financial statementsshould be read in conjunction with our Annual Report on Form 10-K for the yearended June 30, 2004.

 

##### ** **

##### **FISCAL YEAR**

##### ** **

##### **Beginningon July 1, 2004, the Company changed their month end to a 4-4-5 week periodend.  Each period will end on aSaturday.  The three months endingJanuary 1, 2005 include one less day in the reporting period than thecomparative period of fiscal year 2004 which was reported on a calendar monthbasis.  The six months ending January 1,2005 include one additional day in the reporting period than the comparativeperiod of fiscal year 2004 which was reported on a calendar month basis.**

 

 

**STOCK SPLITS**

 

                In April 2004, the Company declared a3-for-2 stock split, which became effective in May 2004.  In November 2004, the Company declared anadditional 3-for-2 stock split which became effective in December 2004.  All share and per share amounts included inthe financial statements and the related notes have been adjusted to reflectthese stock splits.

##### ** **

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

 

Basic earnings per share is computed as net earningsdivided by the weighted average number of common shares outstanding for theperiod. Diluted earnings per share reflects the potential dilution that couldoccur from common shares issuable through the exercise of dilutive stockoptions.

 

 

 

 

 

 

 

6

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The following is a reconciliation of the number ofshares used in the basic and diluted earnings per share computations:

 
| ** **                                                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**    | ** ** |
|----------------------------------------------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **                                                     | ** ** | ** **             | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                     | ** ** | **January  1,  2005**  | ** ** | **December  31,  2003** | ** ** | **January  1,  2005** |   | **December  31,  2003** |   |
| ** **                                                     | ** ** | **(In  thousands**)    |       | **(In  thousands)**     |       |
| Basic weighted  average number of shares outstanding           |       | 59,451                 |       | 58,080                  |       | 59,149 |   | 57,987 |   |
| Incremental  shares from the assumed issuance of stock options |       | 2,525                  |       | 1,406                   |       | 2,083 |   | 1,306 |   |
|                                                           |       |                   |       |                    |       |   |   |   |   |
| Diluted weighted  average number of shares outstanding         |       | 61,976                 |       | 59,486                  |       | 61,232 |   | 59,293 |   |

 

The number of incremental shares from the assumedissuance of stock options is calculated applying the treasury stock method.

 

        Excluded from thecomputation of the number of diluted weighted average shares outstanding wereantidilutive options of 114,000 and 443,000 for the three months ended January1, 2005 and December 31, 2003, respectively, and 57,000 and 554,000 for the sixmonths ended January 1, 2005 and December 31, 2003, respectively.

##### ** **

##### **COMPREHENSIVE INCOME**

 

                Comprehensiveincome consists of net income and other comprehensive income (income, expenses,gains and losses that bypass the income statement and are reported directly asa separate component of equity).  TheCompany’s comprehensive income consists of net income and foreign currencytranslation adjustments for all periods presented.

 
| ** **                  | ** ** | ** **                  | ** ** | ** **              | ** ** | ** **            | ** ** | ** **             | ** ** |
|-----------------------------|------------|-----------------------------|------------|-------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                  | ** ** | **Three Months Ended**      | ** ** | **Six Months Ended**    | ** ** |
|                        |       |                        |       |                    |       |                  |       |                   |       |
|                        |       | **January  1,  2005**       | ** ** | **December  31,  2003** | ** ** | **January  1,  2005** | ** ** | **December  31, 2003** | ** ** |
|                        | ** ** | **(Dollars  in thousands)** |       |
| Net income                  |       | $                           | 24,260     |                    | $          | 13,889                |       | $                      | 35,678     |   | $ | 19,932 |   |
| Other  comprehensive income |       | 407                         |       | 209                     |       | 830                   |       | 256                    |       |
|                        |       |                        |       |                    |       |                  |       |                   |       |
| Total  comprehensive income |       | $                           | 24,667     |                    | $          | 14,098                |       | $                      | 36,508     |   | $ | 20,188 |   |
|                        |       |                        |       |                    |       |                  |       |                   |       |
|                             |            |                             |            |                         |            |                       |            |                        |            |  |  |  |  |  |

 

##### ** **

##### **CREDIT FACILITIES**

##### ** **

**TheCompany has an unsecured commercial line of credit agreement with a bank, whichprovides for borrowings and issuance of letters of credit of up to $25.0million and expires on March 1, 2006. The outstanding balance bears interest ateither the bank’s reference rate (which was 5.25% as of January 1, 2005) or theLIBOR rate plus 1.75 percentage points. As of January 1, 2005, there were nooutstanding borrowings, and there was $4.1 million outstanding in letters ofcredit.**

** **

**Thiscredit facility requires the Company to comply with certain financialcovenants, including a minimum tangible net worth and certain restrictions onmaking loans and investments.**

##### ** **

7

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

 

The Company accounts for stock-based awards granted toemployees using the intrinsic value method prescribed in Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations, Statement of Financial Accounting Standards (“SFAS”) No. 123 “Accountingfor Stock-Based Compensation,” and complies with the disclosure provisions ofSFAS No. 148, “Accounting for Stock Based Compensation Transition andDisclosure, an Amendment of FASB Statement No. 123.”

 

Had stock based employee compensation expense beendetermined based upon the fair values at the grant dates for awards under theCompany’s stock plans in accordance with SFAS No. 123, the Company’s pro formanet earnings, basic and diluted earnings per common share would have been asfollows:

 
| ** **                                                                                                 | ** ** | **Three Months Ended**                               | ** ** | **Six Months Ended**    | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-------------------------|------------|
|                                                                                                       |       |                                                 |       |                    |       |   |   |   |   |
|                                                                                                       |       | **January  1,  2005**                                | ** ** | **December  31,  2003** | ** ** | **January  1,  2005** | ** ** | **December  31,  2003** | ** ** |
|                                                                                                       | ** ** | **(Dollars  in thousands, except per share amount)** |       |
| Net income                                                                                                 |       |                                                 |       |                    |       |   |   |   |   |
| As reported                                                                                                |       | $                                                    | 24,260     |                    | $          | 13,889 |   | $ | 35,678 |   | $ | 19,932 |   |
| Add: Stock based  employee compensation, net of income tax                                                 |       | 37                                                   |       | 15                      |       | 54 |   | 53 |   |
| Deduct: Stock  based employee compensation determined under the fair value method,  net of income tax |       | (1,614                                               | )          | (471                    | )          | (3,243 | ) | (1,052 | ) |
|                                                                                                       |       |                                                 |       |                    |       |   |   |   |   |
| Proforma                                                                                                   |       | $                                                    | 22,683     |                    | $          | 13,433 |   | $ | 32,489 |   | $ | 18,933 |   |
|                                                                                                       |       |                                                 |       |                    |       |   |   |   |   |
| Basic EPS                                                                                                  |       |                                                 |       |                    |       |   |   |   |   |
| As reported                                                                                                |       | $                                                    | 0.41       |                    | $          | 0.24 |   | $ | 0.60 |   | $ | 0.34 |   |
| Proforma                                                                                                   |       | $                                                    | 0.38       |                    | $          | 0.23 |   | $ | 0.55 |   | $ | 0.33 |   |
| Diluted EPS                                                                                                |       |                                                 |       |                    |       |   |   |   |   |
| As reported                                                                                                |       | $                                                    | 0.39       |                    | $          | 0.23 |   | $ | 0.58 |   | $ | 0.34 |   |
| Proforma                                                                                                   |       | $                                                    | 0.37       |                    | $          | 0.23 |   | $ | 0.53 |   | $ | 0.32 |   |

 

On December 16, 2004, theFASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No.123(R)”).  SFAS No. 123(R) will require companies to measure all employeestock-based compensation awards using a fair value method and record suchexpense in its consolidated financial statements.  In addition, theadoption of SFAS No. 123(R) requires additional accounting and disclosurerelated to the income tax and cash flow effects resulting from share-basedpayment arrangements.  SFAS No. 123(R) is effective for the Companybeginning in the first quarter of fiscal 2006.  The Company is in theprocess of determining the impact of the requirements of SFAS No. 123(R).

##### ** **

##### **LEGAL MATTERS**

 

**Asof the date of this filing, the Company is involved in several ongoing legalproceedings as described below.**

Three former employees sued bebe on November 20, 2003,in the Superior Court of the State of California, County of San Mateo (case No.CIV435794) alleging that they were misclassified as exempt employees underCalifornia law. The plaintiffs purport to bring this action on behalf of aclass of former and present California bebe store managers and co-managers.Plaintiffs are seeking compensatory, statutory and injunctive relief.  The parties have reached a conditionalsettlement agreement.  The matter wasconditionally certified as a class action for purposes of settlement only, andthe court has given preliminary approval of the class-wide settlement.

 

8

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A former employee sued bebe on January 20, 2004 in theSuperior Court of the State of California, County of San Diego (case No.GIC824505) alleging unpaid wages and unfair business practices. The plaintiffpurports to bring the action on behalf of a class of California employees whohold or have held the position of co-manager or others similarly designated.The lawsuit seeks compensatory, statutory and injunctive relief.  If the class settlement in the San MateoSuperior Court action is given final approval, this individual plaintiff willhave the option of participating in the class settlement or continuing topursue those claims not covered by the class settlement.

                A former employee sued bebe onAugust 2, 2004 in the Superior Court of the State of California, County ofSacramento (case No. 04AS03109) alleging unlawful wage payment and unfaircompetition.  The plaintiff purports to bring the action on behalf of aclass of California employees who hold or at anytime within the past four yearshave held a salaried store management position.  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.

A former candidate for anexecutive position sued bebe and two other named defendants in a First AmendedComplaint, filed November 9, 2004 in the Superior Court of the State ofCalifornia, County of San Francisco (case # CGC-04-435517), seeking unspecifiedmonetary damages and other equitable relief. The claims against bebe allege intentional and negligent interferencewith prospective economic advantage and contractual relations, breach of contract,breach of implied covenant of good faith and fair dealing, fraud, promissoryestoppel, negligence, intentional and negligent infliction of emotionaldistress, and violation of Labor Code Section 970.  Plaintiff and all defendants are currentlyparticipating in non-binding mediation. The company believes the claims against the company are without meritand will continue to vigorously defend this matter.

Although the Company intends to defend itselfvigorously against these claims, the Company has accrued liabilities forestimated settlement costs that management believes are reasonable.  Although the final resolution of thesematters may be greater than the Company’s recorded liability, management doesnot believe the ultimate resolution will have a material adverse effect on theCompany’s business, financial condition or results of operations.

In addition to the above, the Company is also involvedin various other legal proceedings arising in the normal course ofbusiness.  None of these matters areexpected, individually or in the aggregate, to have a material adverse effecton the Company’s business, financial condition or results of operations.

 

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** **

**ITEM2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

The following Management’s Discussion and Analysis ofFinancial Condition and Results of Operations contains forward-lookingstatements, which involve risks and uncertainties. Our actual results maydiffer materially from those anticipated in these forward-looking statements.  Statements that are predictive in nature, thatdepend upon or refer to future events or conditions or that include words suchas “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 ensure 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, our ability toobtain raw materials and manufacturing capabilities, effective management ofour growth, the success of future store openings, decline in comparable storesales performance, ongoing competitive pressures in the apparel industry,changes in the level of consumer spending or preferences in apparel, ourability to attract and retain key management personnel and/or other factorsdiscussed in “Risks That May Affect Results” and elsewhere in this Form 10-Q.

 

##### **OVERVIEW**

 

We design, develop and produce a distinctive line ofcontemporary women’s apparel and accessories. While we attract a broadaudience, our target customers are 21 to 35-year-old women who seek currentfashion trends interpreted to suit their lifestyle needs. The “bebe look,”appeals to a hip, sexy, sophisticated, body-conscious woman who takes pride inher appearance. The bebe customer expects value in the form of quality at acompetitive price.

 

Our distinctive product offering includes a full rangeof fashion separates, dresses, activewear, and accessories for all facets ofthe customer’s lifestyle:  career,casual, active, evening and weekend wear. We design and develop the majority ofour merchandise in-house. The merchandise is then manufactured to ourspecifications.  The remainder of ourmerchandise is selected directly from third party manufacturers’ lines.

 

We market our products under the bebe, BEBE SPORT andbebe O brand names through our 206 retail stores, of which 162 are bebe stores,26 are BEBE SPORT stores, and 18 are bebe outlet stores.  These stores are located in 32 states, theDistrict of Columbia, Puerto Rico and Canada. In addition, we have an on-linestore at www.bebe.com and our licensees operate 13 international stores.  During the second quarter of fiscal 2005, weopened four bebe stores and one BEBE SPORT store, relocated two bebe stores,and closed one BEBE SPORT store.  Duringthe first half of fiscal 2005, we opened five bebe stores and three BEBE SPORTstores, relocated four bebe stores, converted two bebe stores into BEBE SPORTstores and closed one BEBE SPORT store. We expect to open approximately eleven bebe stores and nine BEBE SPORTstores during the year.  Additionally, weanticipate closing four stores.

 

*bebe stores.* The Company was founded by Manny Mashouf, our current Chairman of theBoard. We opened our first store in San Francisco, California in 1976, whichwas also the year we incorporated.

 

*BEBE SPORT stores.* The Company launched BEBE SPORT in thefirst half of fiscal 2003 to satisfy the casual lifestyle needs of the bebecustomer. The BEBE SPORT product line is active inspired sportswear featuringcotton knits, fleece, casual active bottoms, sweaters, outerwear andaccessories that are easy, sexy and modern.

 

*bebe outlet stores.* The Company utilizes the outlets as a clearance vehicle for merchandisefrom our bebe and BEBE SPORT stores. Additionally, we round out the inventoryof these stores with a strong presentation of logo merchandise and specialcuts, which bear the bebe O label, produced specifically for the outlet stores.

 

*On-line store.* The on-line store offers the customer anextension of the bebe store experience and provides an assortment of bebe andBEBE SPORT merchandise from which the customer can choose.  It is also used as a vehicle to communicatewith our customers through advertising and direct mail.

 

We reinforce our brand with an extensive imageadvertising campaign, which addresses the lifestyle needs and aspirations ofour target customers. An outside advertising agency works with our internalmarketing department to create 

 

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edgy, high-impact ads to attract customers who are drawn to theplayfully sensual and evocative imagery. Image ads are produced quarterly and are featured in fashion andlifestyle magazines, transit shelters, mall kiosks, store windows and online atbebe.com.  We believe that ouradvertising promotes brand awareness and supports numerous product lineexpansion opportunities.

 

##### **CRITICAL ACCOUNTINGPOLICIES**

 

Management’s Discussion andAnalysis of Financial Condition and Results of Operations are based upon ourconsolidated financial statements, which have been prepared in conformity withaccounting principles generally accepted in the United States of America.

 

The preparation of thesefinancial statements requires the appropriate application of certain accountingpolicies, many of which require us to make estimates and assumptions aboutfuture events and their impact on amounts reported in our financial statementsand related notes. Since future events and their impact cannot be determinedwith certainty, the actual results will inevitably differ from our estimates.Such differences could be material to the financial statements. We believe ourapplication of accounting policies, and the estimates inherently requiredtherein, are reasonable. These accounting policies and estimates are constantlyreevaluated, and adjustments are made when facts and circumstances dictate achange. Our accounting policies are more fully described in Note 1 to theconsolidated financial statements in our annual report on Form 10-K for theyear ended June 30, 2004.

 

We have identified certaincritical accounting policies, which are described below:

 

*Inventories.* Our inventoriesare stated at the lower of weighted average cost or market.  Market is determined based on the estimatednet realizable value, which is generally the merchandise selling price.   To ensure that our raw material is properlyvalued we age the fabric inventory and record a reserve in accordance with ourestablished policy, which is based on historical experience. To ensure our finishedgoods inventory is properly valued we review the age and turnover of ourinventory and record a reserve if the selling price is marked down belowcost.  These assumptions can have animpact on current and future operating results and financial position.  We estimate shrinkage for the period betweenthe last physical count and balance sheet date based on historic shrinkagetrends.

*Long-lived assets.* We reviewlong-lived assets for impairment whenever events or changes in circumstances,such as store closures or poor performing stores, indicate that the carryingvalue of an asset may not be recoverable. If the undiscounted cash flows from along-lived asset are less than the carrying value we record an impairmentcharge equal to the difference between the carrying value and the asset’s fairvalue.  In addition, at the time adecision 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 six months ended January 1, 2005 andDecember 31, 2003, we recorded no impairment charges. We believe at this timethat the long-lived assets’ carrying values and useful lives continue to beappropriate.

*Sales Return Reserve.* We record a reserve for estimatedproduct returns based on historical return trends.  As of January 1, 2005 and December 31, 2003,the reserve was $1,151,000 and $1,060,000, respectively.  If actual returns are greater than thoseprojected, additional sales returns may be recorded in the future.

 

*Accrued Litigation.*  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 January 1, 2005 is an estimate andshould a greater amount of claims occur, the recorded liability may not besufficient.

 

*Income Taxes*. We accrue liabilities for estimates ofprobable settlements of domestic and foreign tax audits.  At any one time,many tax years may be subject to audit by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may affectthe ultimate settlement of these issues.  Our effective tax rate in agiven financial statement period may be materially impacted by changes in themix and level of earnings.  We alsorecord a valuation allowance against our deferred tax assets arising fromforeign tax credit carryforwards as the utilization of these credits is notassured.

 

 

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**RECENT ACCOUNTING PRONOUNCEMENT**

 

On December 16, 2004, theFASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No.123(R)”).  SFAS No. 123(R) will require companies to measure all employeestock-based compensation awards using a fair value method and record suchexpense in its consolidated financial statements.  In addition, theadoption of SFAS No. 123(R) requires additional accounting and disclosurerelated to the income tax and cash flow effects resulting from share-basedpayment arrangements.  SFAS No. 123(R) is effective for the Companybeginning in the first quarter of fiscal 2006.  The Company is in theprocess of determining the impact of the requirements of SFAS No. 123(R).

##### ** **

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

 

##### ** **Beginning on July 1, 2004, wechanged our month end to a 4-4-5 week period end.  Each period will end on a Saturday.  The three months ending January 1, 2005include one less day in the reporting period than the comparative period offiscal year 2004 which was reported on a calendar month basis.  The six months ending January 1, 2005 includeone additional day in the reporting period than the comparative period offiscal year 2004 which was reported on a calendar month basis.  For the three and six month periods endedJanuary 1, 2005, comparable store sales were determined using comparableperiods of 91 and 185 days, respectively.

 

In November 2004, the Company declared a 3-for-2 stocksplit which became effective in December 2004.

 

The following table sets forth certain financial dataas a percentage of net sales for the periods indicated:

     
| ** **                                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**    | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **                                             | ** ** | ** **             | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **January 1,  2005**   | ** ** | **December  31,  2003** | ** ** | **January  1,  2005** |   | **December  31,  2003** |   |
|                                                   |       |                   |       |                    |       |   |   |   |   |
| **Statements  of Operations Data:**                    |       |                   |       |                    |       |   |   |   |   |
| Net sales                                              |       | 100.0                  | %          | 100.0                   | %          | 100.0 | % | 100.0 | % |
| Cost of sales, including  production and occupancy (1) |       | 48.7                   |       | 51.7                    |       | 49.8 |   | 52.7 |   |
|                                                   |       |                   |       |                    |       |   |   |   |   |
| Gross profit                                           |       | 51.3                   |       | 48.3                    |       | 50.2 |   | 47.3 |   |
| Selling, general  and administrative expenses (2)      |       | 26.3                   |       | 28.9                    |       | 28.4 |   | 31.5 |   |
|                                                   |       |                   |       |                    |       |   |   |   |   |
| Income from  operations                                |       | 25.0                   |       | 19.4                    |       | 21.8 |   | 15.8 |   |
| Interest and  other income, net                        |       | 0.6                    |       | 0.4                     |       | 0.7 |   | 0.5 |   |
|                                                   |       |                   |       |                    |       |   |   |   |   |
| Earnings before  income taxes                          |       | 25.6                   |       | 19.8                    |       | 22.5 |   | 16.3 |   |
| Provision for  income taxes                            |       | 9.7                    |       | 7.4                     |       | 8.5 |   | 6.1 |   |
|                                                   |       |                   |       |                    |       |   |   |   |   |
| Net earnings                                           |       | 15.9                   | %          | 12.4                    | %          | 14.0 | % | 10.2 | % |
|                                                   |       |                   |       |                    |       |   |   |   |   |

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

(2)                                  Selling, generaland administrative expenses primarily consist of non-occupancy store costs,corporate overhead and advertising costs.

 

*NetSales.* Net salesincreased to $152.6 million during the three months ended January 1, 2005 from$112.0 million in the comparable period of the prior year, an increase of $40.6million, or 36.3%. Net sales for the quarter included $130.1 million fromstores open more than one year. During the quarter comparable store salesincreased 27.3% versus the prior year. The increase in comparable store salesperformance was largely due to customer acceptance of the product offering. Theremaining sales of $22.5 million were generated by stores not included in thecomparable store sales base, on-line sales, wholesale sales to internationallicensees, and royalty revenue from product licensees. 

 

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        For the six months endedJanuary 1, 2005, net sales increased to $255.7 million from $195.6 million inthe comparable six-month period of the prior year, an increase of $60.1million, or 30.7%. Net sales for the six-month period included $220.2 millionfrom stores open more than one year, representing a 20.8% increase incomparable store sales versus the prior year. The increase in comparable storesales performance was largely due to customer acceptance of the productoffering. The remaining sales of $35.5 million were generated by stores notincluded in the comparable store sales base, on-line sales, wholesale sales tointernational licensees, and royalty revenue from product licensees.

 

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**    | ** ** |
|---------------------------------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **                                        | ** ** | ** **             | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                        | ** ** | **January 1,  2005**   | ** ** | **December  31,  2003** | ** ** | **January  1,  2005** |   | **December  31,  2003** |   |
|                                              |       |                   |       |                    |       |   |   |   |   |
| Net sales (In  thousands)                         |       | $                      | 152,581    |                    | $          | 112,014 |   | $ | 255,728 |   | $ | 195,566 |   |
| Total net sales  increase percentage              |       | 36.3                   | %          | 11.1                    | %          | 30.7 | % | 12.0 | % |
| Comparable store  sales increase percentage       |       | 27.3                   | %          | 7.1                     | %          | 20.8 | % | 6.9 | % |
| Net sales per  average square foot (1)            |       | $                      | 209        |                    | $          | 167 |   | $ | 353 |   | $ | 294 |   |
| Square footage -  at end of period (In thousands) |       | 734                    |       | 672                     |       | 734 |   | 672 |   |
|                                              |       |                   |       |                    |       |   |   |   |   |
| Number of Store  Locations:                       |       |                   |       |                    |       |   |   |   |   |
| Beginning of  Period                              |       | 202                    |       | 184                     |       | 199 |   | 180 |   |
| New store  locations                              |       | 5                      |       | 4                       |       | 8 |   | 8 |   |
| Closed store  locations                           |       | 1                      |       | —                  |       | 1 |   | — |   |
| End of Period                                     |       | 206                    |       | 188                     |       | 206 |   | 188 |   |
|                                              |       |                   |       |                    |       |   |   |   |   |

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| (1) | Net sales per average square foot is calculated  using net store sales and a monthly average store square footage. |
|-----|--------------------------------------------------------------------------------------------------------------------|

 

* Gross Profit.*Gross profit increased to $78.3 million during thethree months ended January 1, 2005 from $54.1 million for the comparablethree-month period of the prior year, an increase of $24.2 million, or 44.7%.As a percentage of net sales, gross profit increased to 51.3% for thethree-month period January 1, 2005 from 48.3% in the comparable three-monthperiod of the prior year. The increase in gross profit as a percentage of netsales from the prior year resulted from favorable occupancy leverage of 1.8percentage points as a result of higher comparable store sales and improvedmerchandise margins of 1.2 percentage points.         Gross profit increased to$128.4 million during the six months ended January 1, 2005 from $92.6 millionfor the comparable same six-month period of the prior year, an increase of$35.8 million, or 38.7%. As a percentage of net sales, gross profit increasedto 50.2% for the six-month period ended January 1, 2005 from 47.3% in thecomparable six-month period of the prior year. The increase in gross profit asa percentage of net sales from the prior year resulted from favorable occupancyleverage of 1.8 percentage points as a result of higher comparable store salesand improved merchandise margins of 1.1 percentage points.

*        Selling,General and Administrative Expenses.*Selling, general and administrative expenses, whichprimarily consist of non-occupancy store costs, corporate overhead andadvertising costs, increased to $40.3 million during the three months endedJanuary 1, 2005 from $32.3 million in the comparable period of the prior year,an increase of $8.0 million, or 24.8%. As a percentage of net sales, theseexpenses decreased to 26.3% during the three-month period from 28.9% in thecomparable period of the prior year. This decrease as a percentage of net saleswas primarily due to reductions in compensation and increased leverage on fixedexpenses as a result of higher comparable sales.

        Forthe six months ended January 1, 2005, selling, general and administrativeexpenses increased to $72.8 million from $61.6 million in the comparablesix-month period of the prior year, an increase of $11.2 million, or 18.2%. Asa percentage 

 

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of netsales, these expenses decreased to 28.4% during the six-month period from 31.5%in the comparable period of the prior year. This decrease as a percentage of net sales was primarily due toreductions in compensation and increased leverage on fixed expenses as a resultof higher comparable sales.

*        Interest andOther Income, Net.*We generated approximately $1.1 million of interest income during the three monthsended January 1, 2005 compared to approximately $0.5 million in the comparablethree-month period of the prior year. For the six months ended January 1, 2005,we generated approximately $1.9 million of interest income compared toapproximately $1.0 million in the comparable six-month period of the prioryear. The increases are the result of higher average cash balances and higherinterest rates.

*        Provisionfor Income Taxes.*Theeffective tax rate was approximately 38.0% for the three and six month periodsended January 1, 2005 compared to approximately 37.5% for the comparableperiods in the prior year and represents the Company’s estimate of the annualeffective rate for these periods.

 

**Seasonality of Business and Quarterly Results**

 

* *Our business varies with general seasonal trends thatare characteristic of the retail and apparel industries. As a result, ourtypical store generates a higher percent of our annual net sales andprofitability in the second quarter of our fiscal year (which includes theholiday selling season) compared to the other quarters of our fiscal year. Iffor any reason our sales were below seasonal norms during the second quarter ofour fiscal year, our annual operating results would be negatively impacted.Because of the seasonality of our business, results for any quarter are notnecessarily indicative of results that may be achieved for a full fiscal year.

 

### **LIQUIDITY AND CAPITAL RESOURCES**

 

Our working capital requirements vary widelythroughout the year and generally peak in the first and second fiscal quarters.At January 1, 2005, we had approximately $241.4 million of cash and equivalents,short-term marketable securities and long-term marketable securities on hand.In addition, we had a revolving line of credit, under which we could borrow orissue letters of credit up to a combined total of $25.0 million. As of January1, 2005, there were no borrowings under the line of credit and letters ofcredit outstanding totaled $4.1 million.

Net cash provided by operating activities for the sixmonths ended January 1, 2005 was $51.5 million versus $43.4 million for the sixmonths ended December 31, 2003. Cash provided by operating activities for theseperiods was primarily generated by earnings adjusted for depreciation and amortization, deferred rent, and an increase inaccounts payable and accrued liabilities, offset by an increase in prepaidexpenses and other assets, inventories and receivables.

Net cash used by investing activities for thesix-month period ended January 1, 2005 was $13.6 million, primarily for thepurchases of marketable securities and expenditures related to the opening of 8new stores and improvements made to our new production facility and designstudio, whereas, for the six-month period ended December 31, 2003, $6.8 millionwas provided primarily due to the sale of marketable securities offset byexpenditures related to the opening of 8 new stores. We expect to openapproximately 20 stores during fiscal 2005 and estimate that total capitalexpenditures will be approximately $20.0 million in fiscal 2005.

Net cash provided by financing activities was $4.7million for the six months ended January 1, 2005 compared to $2.2 million forthe six months ended December 31, 2003, and was derived from proceeds fromstock option exercises, partially offset in fiscal 2005 by the payment of twoquarterly cash dividends of approximately $2.0 million each.

 

We believe that our cash onhand, together with our cash flows from operations, will be sufficient to meetour capital and operating requirements for at least the next twelve months. Ourfuture capital requirements, however, will depend on numerous factors,including without limitation, the size and number of new and expanded storesand/or store concepts, investment costs for management information systems,potential acquisitions and/or joint ventures, repurchase of stock and future resultsof operations.

 

### **Inflation**

 

We do not believe that inflationhas had a material effect on the results of operations in the recent past.However, we cannot assure that our business will not be affected by inflationin the future.

 

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### ** **

### ** **

 

### ** **

### **RISKS THAT MAY AFFECT RESULTS**

 

Factors that might cause ouractual results to differ materially from the forward looking statementsdiscussed elsewhere in this report, as well as affect our ability to achieveour financial and other goals, include, but are not limited to, the following:

 

 

RISKS RELATING TO OUR BUSINESS:

 

**1. The success of our business depends in large part on our ability toidentify fashion trends as well as to react to changing customer demand in atimely 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 manufacturingfacilities or our manufacturers perform unacceptably, our sales may benegatively affected and our financial condition may be harmed**. We do not own any manufacturingfacilities and therefore depend on contractors and third parties to manufactureour products. We place all of our orders for production of merchandise and rawmaterials by purchase order and do not have any long-term contracts with anymanufacturer or supplier. If we fail to maintain favorable relationships withour manufacturers and suppliers or are unable to obtain sufficient quantitiesof quality raw materials on commercially reasonable terms, it could harm ourbusiness and results of operations.  Wecannot ensure that contractors and third party manufacturers (1) will not supplysimilar products 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 attract and retain key employeesin order to support our existing business and future expansion.** From time to time we actively recruitqualified candidates to fill key executive positions from within the Company.There is substantial competition for experienced personnel, which we expectwill continue. We compete for experienced personnel with companies who havegreater financial resources than we do. In the past, we have experiencedsignificant turnover of our executive management team and retail storepersonnel. We are also exposed to employment practice litigation due to thelarge number of employees and high turnover of our sales associates. If we failto attract, motivate and retain qualified personnel, it could harm our businessand limit our ability to expand.

 

In addition, we depend upon the expertise andexecution of our key employees, particularly Manny Mashouf, the founder,Chairman of the Board, and majority shareholder, and Greg Scott, our ChiefExecutive Officer and member of the Board of Directors. We do not carry “keyperson” life insurance policies on any of our employees. If we lose theservices of Mr. Mashouf, Mr. Scott, or any key officers or employees, it couldharm our business and results of operations.

 

**4. If we are not able to successfully develop and expand our bebe and BEBESPORT stores our revenue base and earnings may be impaired**. As part of our growth strategy, we mayopen larger bebe stores.  If these storesare not successful, 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.

 

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**5. There can be no assurance that future store openings will besuccessful. **We expect to open approximately 20 storesin fiscal 2005, of which approximately nine will be BEBE SPORT stores andapproximately eleven will be bebe stores.  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 operating profit will increase as a result of opening thesestores.  During fiscal 2005, weanticipate closing four stores.  Inaddition, most of our new store openings in fiscal 2005 will be in existingmarkets. These openings may affect the existing stores’ net sales volumes andprofitability.  Our failure to predictaccurately the demographic or retail environment at any future store locationcould have a material adverse effect on our business, financial condition andresults of operations.

 

**6. Any serious disruption at our major facilities could have a harmfuleffect on our business.** We currently operate our corporate office in Brisbane, California, adistribution facility in Benicia, California, and a recently purchased design studioand production 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 arehighly competitive and are characterized by low barriers to entry. Keycompetitors include, but are not limited to Arden B, BCBG, Express, Guess, andthe t.b.d. and Savvy Departments within Nordstrom. We expect competition in ourmarkets to increase. The primary competitive factors in our markets are:  brand name recognition, sourcing strategies,product styling, quality, presentation and pricing, timeliness of productdevelopment and delivery, store ambiance, customer service and convenience.

 

We compete with traditional department stores, specialty storeretailers, business to consumer websites, off-price retailers and directmarketers for, among other things, raw materials, market share, retail space,finished goods, sourcing and personnel. Because many of these competitors arelarger and have substantially greater financial, distribution and marketingresources than we do, we may lack the resources to adequately compete with them.If we fail to compete in any way, it could harm our business, financialcondition and results of operations.

 

**8.  Purchases of the merchandise we sell are generally discretionary and aretherefore particularly susceptible to economic slowdowns.**If economic conditions change, ourbusiness, financial condition and results of operations could be adverselyaffected. Consumers are generally more willing to make discretionary purchases,including purchases of fashion products, during periods in which favorable economicconditions prevail.

 

The outlook for the United States economy is uncertain and is directlyaffected by global political factors that are beyond our control. Anyescalation of military action involving the United States could cause increasedvolatility in financial markets, further adversely affecting consumerconfidence 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.**Eventhough we take actions to establish, register and protect our trademarks andother proprietary rights, we cannot ensure that we will be successful or thatothers will not imitate our products or infringe upon our intellectual propertyrights. In addition, there is no assurance that others will not resist or seekto block the sale of our products as infringements of their trademark andproprietary rights.

** **

**We are seeking to registerour 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 allegeinfringement and bring actions against us. In addition, if our licensees failto use our intellectual property correctly, the goodwill associated with ourtrademarks may be diluted.**

** **

**Furthermore, if we do notdemonstrate use of our trademarks, our trademark rights may lapse over time.**

 

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**10.   If an independent manufacturer violates labor or other laws, or isaccused of violating any such laws, or if their labor practices diverge fromthose generally accepted as ethical, it could harm our business and brandimage.** While wemaintain a policy to monitor the operations of our independent manufacturers byhaving an independent firm inspect these manufacturing sites, and allmanufacturers are contractually required to comply with such labor practices,we cannot control the actions or the public’s perceptions of suchmanufacturers, nor can we assure that these manufacturers will conduct theirbusinesses using ethical or legal labor practices. Apparel companies can beheld jointly liable for the wrongdoings 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 OUR COMMON STOCK:

 

**   1.  Our stock price may fluctuatebecause of the small number of shares that can be publicly traded and the lowaverage daily trading volumes**. The vast majority of our outstanding shares of ourcommon stock are subject to trading restrictions. As of January 1, 2005, approximately14,400,000 shares of our common stock were available to be publicly traded, andas a result, our average daily trading volumes are relatively low, and ourstock price is vulnerable to market swings due to large purchases, sales andshort sales of our common stock.

 

**   2.  Because a principalshareholder controls the Company, other shareholders may not be able toinfluence the direction the Company takes**. As of January 1, 2005, Manny Mashouf, the Chairmanof the Board, beneficially owned****approximately76% of 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.  Investor confidence and share value may beadversely impacted if we are unable to favorably assess, or if we do notreceive an unqualified attestation report on our assessment of, theeffectiveness of our internal control over financial reporting as of the end ofour 2005 fiscal year as required by Section 404 of the Sarbanes-Oxley Actof 2002. An effective system of internal control over financialreporting is necessary for us to provide reliable financial reports.  Rules adopted by the Securities and ExchangeCommission pursuant to Section 404 of the Sarbanes-Oxley Act of 2002require annual assessment of our internal control over financial reporting, andattestation of our assessment by our independent registered publicaccountants.  This requirement will firstapply to our Annual Report on Form 10-K for the fiscal year ending July 2,2005.  The rules governing the standardsthat must be met for management to assess the internal control over financialreporting 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 if we do not receive an unqualifiedattestation report on our assessment of, the effectiveness of our internalcontrol over financial reporting, investor confidence and share value may benegatively impacted.

 

##### **ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

We are exposed to market risks,which include changes in U.S. interest rates and, to a lesser extent, foreignexchange rates. We do not engage in financial transactions for trading orspeculative purposes.

 

*InterestRate Risk*

 

We currently maintain a portfolio of variable interestrate investments consisting of cash equivalents, short-term marketablesecurities and long-term marketable securities. Marketable securities are comprised of closed-end variable interest ratefunds that invest primarily in tax-exempt municipal bonds.  Due to the variable nature of theseinvestments, their value is typically not subject to market rate changes.  According to our investment policy, we mayinvest in taxable and tax

 

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exempt instruments.  In addition,the policy establishes limits on credit quality, maturity, issuer and type ofinstrument.  Marketable securities areclassified as “available for sale”.    Wedo not use derivative financial instruments in our investment portfolio.

 

All highly liquid investments with a maturity of threemonths or less at the date of purchase are considered to be cashequivalents.  The remaining investmentsare considered short-term marketable securities if original maturities rangebetween four and twelve months or long-term marketable securities if originalmaturities are over twelve months.

 

The following table lists ourcash equivalents, short-term marketable securities and long-term marketablesecurities at January 1, 2005:

 
| ** **                        | ** ** | **Book Value**              | ** ** | **Fair Value** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|----------------|------------|
| ** **                        |       | **(Dollars  in thousands)** |       |
| Cash equivalents                  |       | $                           | 215,588    |           | $          | 215,588 |   |
| Weighted average  interest rate   |       | 1.92                        | %          |           |       |
| Short-term  marketable securities |       | 9,000                       |       | 9,000          |       |
| Weighted average  interest rate   |       | 1.82                        | %          |           |       |
| Long term  marketable securities  |       | 7,875                       |       | 7,875          |       |
| Weighted average  interest rate   |       | 2.05                        | %          |           |       |
| Total                             |       | $                           | 232,463    |           | $          | 232,463 |   |

 

 

The interest payable on our bankline of credit is based on variable interest rates and therefore affected bychanges in market interest rates. If interest rates rose significantly, ourresults from operations and cash flows would not be affected as we have nooutstanding borrowings.

 

*Foreign Currency Risks*

 

We enter into a significantamount of purchase obligations outside of the United States, substantially allof which are settled in U.S. Dollars and, therefore, have only minimal exposureto foreign currency exchange risks. We also operate a subsidiary with a basecurrency other than the U.S. Dollar. Fluctuations in exchange rates therefore impact ourfinancial condition and results of operations, as reported in U.S.Dollars.   To date, we have not experienced any significant negativeimpact as a result of fluctuations in foreign currency markets. We do not hedge against foreign currency risksand believe that foreign currency exchange risk is immaterial.

 

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

 

Under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, we evaluated the effectivenessof our disclosure controls and procedures, as such term is defined in Rules13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934,as amended (“the Exchange Act”).  Basedon this evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures were effective as of January1, 2005.

 

We also maintain asystem of internal control over financial reporting, as such term as defined inRules 13a-15(f) and 15d-15(f) of the Exchange Act.  No changes in our internal control overfinancial reporting occurred during the quarter ending January 1, 2005 thathave materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

##### ** **

##### ** **

##### ** **

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##### ** **

##### ** **

##### ** **

##### **PARTII  OTHER INFORMATION**

 

**ITEM 1.**  **LEGAL PROCEEDINGS**

 

**Asof the date of this filing, the Company is involved in several ongoing legalproceedings as described below.**

Three former employees sued bebe on November 20, 2003,in the Superior Court of the State of California, County of San Mateo (case No.CIV435794) alleging that they were misclassified as exempt employees underCalifornia law. The plaintiffs purport to bring this action on behalf of aclass of former and present California bebe store managers and co-managers.Plaintiffs are seeking compensatory, statutory and injunctive relief.  The parties have reached a conditionalsettlement agreement.  The matter wasconditionally certified as a class action for purposes of settlement only, andthe court has given preliminary approval of the class-wide settlement.

A former employee sued bebe on January 20, 2004 in theSuperior Court of the State of California, County of San Diego (case No.GIC824505) alleging unpaid wages and unfair business practices. The plaintiffpurports to bring the action on behalf of a class of California employees whohold or have held the position of co-manager or others similarly designated.The lawsuit seeks compensatory, statutory and injunctive relief.  If the class settlement in the San MateoSuperior Court action is given final approval, this individual plaintiff willhave the option of participating in the class settlement or continuing topursue those claims not covered by the class settlement.

                A former employee sued bebe onAugust 2, 2004 in the Superior Court of the State of California, County ofSacramento (case No. 04AS03109) alleging unlawful wage payment and unfaircompetition.  The plaintiff purports to bring the action on behalf of aclass of California employees who hold or at anytime within the past four yearshave held a salaried store management position.  The lawsuit seekscompensatory, statutory and injunctive relief. If the class settlement in the San Mateo Superior Court action is givenfinal approval, this individual plaintiff will have the option of participatingin the class settlement or continuing to pursue those claims not covered by theclass settlement.

A former candidate for anexecutive position sued bebe and two other named defendants in a First AmendedComplaint, filed November 9, 2004 in the Superior Court of the State ofCalifornia, County of San Francisco (case # CGC-04-435517), seeking unspecifiedmonetary damages and other equitable relief. The claims against bebe allege intentional and negligent interferencewith prospective economic advantage and contractual relations, breach ofcontract, breach of implied covenant of good faith and fair dealing, fraud,promissory estoppel, negligence, intentional and negligent infliction of emotionaldistress, and violation of Labor Code Section 970.  Plaintiff and all defendants are currentlyparticipating in non-binding mediation. The company believes the claims against the company are without meritand will continue to vigorously defend this matter.

Although the Company intends to defend itselfvigorously against these claims, the Company has accrued liabilities forestimated settlement costs that management believes are reasonable.  Although the final resolution of thesematters may be greater than the Company’s recorded liability, management doesnot believe the ultimate resolution will have a material adverse effect on theCompany’s business, financial condition or results of operations.

In addition to the above, the Company is also involvedin various other legal proceedings arising in the normal course ofbusiness.  None of these matters areexpected, individually or in the aggregate, to have a material adverse effecton the Company’s business, financial condition or results of operations.

##### ** **

##### ** **

##### **ITEM2.  UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

On December 20, 2004, theCompany issued 1,500 shares of common stock (as adjusted for the 3 for 2 stocksplit that became effective on December 29, 2004) in consideration for servicesrendered which were valued at approximately $38,000. The issuance of the shareswas exempt from the registration requirements of the Securities Act of 1933, asamended, pursuant to Section 4(2) of the Act for transactions notinvolving a public offering and based on the fact that the shares were issuedto an accredited investor. The issuance of the shares did not involve the useof an underwriter and no commissions were paid in connection with the issuanceof the shares.

##### ** **

##### **ITEM3.  DEFAULTS UPON SENIOR SECURITIES**

 

         Not applicable.

 

##### ** **

##### **ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

        bebestores, inc. held its annual meeting of shareholders at its headquarters inBrisbane, California on November 19, 2004. Of the 39,294,724 shares outstandingas of the record date, 38,336,322 shares were represented by proxy at themeeting.  The share amounts have not beenadjusted for the 3 for 2 stock split that became effective on December 29,2004. Proxies were solicited by bebe pursuant to Regulation 14A under theSecurities Exchange Act of 1934, as amended. At the meeting, bebe’sshareholders voted on the following matters:

 

 

 

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(1)          Proposal to elect seven directors to hold office for aone-year term and until their successors are elected:

 
| ** **       | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|------------------|------------|------------|------------|--------------|------------|
| Manny Mashouf    |       | 36,109,624 |       | 2,226,698    |       |
| Neda Mashouf     |       | 36,109,449 |       | 2,226,873    |       |
| Barbara Bass     |       | 37,087,795 |       | 1,248,527    |       |
| Cynthia Cohen    |       | 37,087,788 |       | 1,248,534    |       |
| Corrado Federico |       | 36,113,484 |       | 2,222,838    |       |
| Caden Wang       |       | 37,087,795 |       | 1,248,527    |       |
| Gregory Scott    |       | 36,109,869 |       | 2,226,453    |       |

 

(2)          Proposal to amend the 1997 Stock Plan to increase themaximum number of shares reserved for issuance under the Stock Plan by 500,000shares from 7,995,000 shares to 8,495,000 shares.  The share amounts have not been adjusted forthe 3 for 2 stock split that became effective on December 29, 2004.  As adjusted, the total shares reserved underthe Plan are 12,742,500.

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Not  Voted** |
|------------|------------|-------------|------------|-------------|------------|----------------|
| 32,724,149 |       | 3,632,737   |       | 1,110       |       | 1,978,326      |

 

(3)          Proposal to amend the 1997 Stock Plan to increase themaximum number of shares that may be granted to an individual in any fiscalyear under the Stock Plan by 150,000 shares from 600,000 shares to 750,000shares.  The share amounts have not beenadjusted for the 3 for 2 stock split that became effective on December 29,2004.  As adjusted, the maximum number ofshares that may be granted to an individual in any fiscal year are 1,125,000.

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Not  Voted** |
|------------|------------|-------------|------------|-------------|------------|----------------|
| 34,781,908 |       | 1,574,972   |       | 1,116       |       | 1,978,326      |

 

(4)           Proposal to ratify the appointment of Deloitte& Touche LLP as our independent auditors for the fiscal year ending July 2,2005.

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** |
|------------|------------|-------------|------------|-------------|
| 38,244,348 |       | 86,667      |       | 5,307       |

 

(5)  Proposal totransact such other business as may properly come before the meeting oradjournment therof.
| **For**    | ** ** | **Against** | ** ** | **Abstain** |
|------------|------------|-------------|------------|-------------|
| 34,118,743 |       | 3,115,578   |       | 1,102,001   |

##### ** **

 

##### **ITEM5.  OTHER INFORMATION**

 

         Not applicable.

##### ** **

##### ** **

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##### ** **

##### ** **

##### **ITEM6.  EXHIBITS**

 

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

 
| **Exhibit** | ** ** | **Description**                                                |
|-------------|------------|----------------------------------------------------------------|
| 3.1         |       | Amended and Restated Articles of Incorporation of  Registrant. |
| 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.         |

 

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**SIGNATURE**

 

         Pursuant to the requirements of theSecurities Exchange Act of 1934, as amended, the registrant has duly causedthis report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 

 
|   | Dated February 10, 2005               |
|--------|---------------------------------------|
|   |                                  |
|   | bebe stores, inc.                     |
|   |                                  |
|   | /s/  Walter Parks      |
|   | Walter Parks, Chief Financial Officer |

 

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**EXHIBIT INDEX**

 
| **Exhibit Number** | ** ** | **Description**                                               |
|--------------------|------------|---------------------------------------------------------------|
| 3.1                |       | Amended and Restated Articles of Incorporation of  Registrant |
| 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          |

 

 

 

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