**UNITEDSTATESSECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

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

 

**Forthe quarterly period ended April 5, 2008**

 

**OR**

 

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

 

**CommissionFile Number 0-24395**

 

**bebestores, inc.**

 (Exact name of registrant as specified in itscharter)

 

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

 

**400Valley Drive**

**Brisbane,California 94005**

(Address ofprincipal executive offices)

 

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

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 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.  x  Yeso No

 

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

 

| Large accelerated filer o                     |   | Accelerated filer x         |
|-----------------------------------------------|--------|-----------------------------|
|                                          |   |                        |
| Non-accelerated filer o                       |   | Smaller reporting company o |
| (Do not check if a smaller reporting company) |   |                        |

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b–2of the Exchange Act).

  o Yes  x No

 

The number ofshares of the registrant’s common stock, par value $0.001 per share,outstanding as of April 30, 2008 was 88,851,830.

 

 

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**bebestores, inc.**

 

**TABLEOF CONTENTS**

** **
| ** **         | ** **                | ** **                                                                                                                 | **Page No.** |
|--------------------|---------------------------|----------------------------------------------------------------------------------------------------------------------------|-------------------|
|               |                      |                                                                                                                       |              |
| **PART I.**   | **FINANCIAL INFORMATION** |                                                                                                                       |
|               |                      |                                                                                                                       |
|               | ITEM 1.                   | Condensed  Consolidated Financial Statements                                                                               |              |
|               |                      |                                                                                                                       |              |
|               |                      | Condensed  Consolidated Balance Sheets as of April 5, 2008, July 7, 2007 and  April 7, 2007                 | 3                 |
|               |                      |                                                                                                                       |              |
|               |                      | Condensed Consolidated Statements of Income for the  three and nine months ended April 5, 2008 and April 7, 2007 | 4                 |
|               |                      |                                                                                                                       |              |
|               |                      | Condensed Consolidated Statements of Cash Flows for  the nine months ended April 5, 2008 and April 7, 2007       | 5                 |
|               |                      |                                                                                                                       |              |
|               |                      | Notes to Condensed Consolidated Financial Statements                                                                       | 6                 |
|               |                      |                                                                                                                       |              |
|               | ITEM 2.                   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                | 11                |
|               |                      |                                                                                                                       |              |
|               | ITEM 3.                   | Quantitative  and Qualitative Disclosures about Market Risk                                                                | 17                |
|               |                      |                                                                                                                       |              |
|               | ITEM 4.                   | Controls and  Procedures                                                                                                   | 18                |
|               |                      |                                                                                                                       |
| **PART II.**  | **OTHER INFORMATION**     |                                                                                                                       |
|               |                      |                                                                                                                       |
|               | ITEM 1.                   | Legal Proceedings                                                                                                          | 18                |
|               |                      |                                                                                                                       |              |
|               | ITEM 1A.                  | Risk Factors                                                                                                               | 18                |
|               |                      |                                                                                                                       |              |
|               | ITEM 2.                   | Unregistered  Sales of Equity Securities and Use of Proceeds                                                               | 22                |
|               |                      |                                                                                                                       |              |
|               | ITEM 3.                   | Defaults  Upon Senior Securities                                                                                           | 22                |
|               |                      |                                                                                                                       |              |
|               | ITEM 4.                   | Submission  of Matters to a Vote of Security Holders                                                                       | 22                |
|               |                      |                                                                                                                       |              |
|               | ITEM 5.                   | Other Information                                                                                                          | 22                |
|               |                      |                                                                                                                       |              |
|               | ITEM 6.                   | Exhibits                                                                                                                   | 22                |
|               |                      |
| **SIGNATURE**      | 23                        |
|               |                      |
| **EXHIBIT  INDEX** | 24                        |

 

2

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

 

ITEM1.          Condensed ConsolidatedFinancial Statements

 

**bebestores, inc.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except share data)**

**(unaudited)**

 
| ** **                                                                                                                                      | ** ** | **As of**    | ** ** | **As of**    | ** ** | **As of**    | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                                                                                      | ** ** | **April 5,** | ** ** | **July 7,**  | ** ** | **April 7,** | ** ** |
| ** **                                                                                                                                      | ** ** | **2008**          | ** ** | **2007 (a)** | ** ** | **2007**          | ** ** |
| ** **                                                                                                                                      | ** ** | ** **        | ** ** | ** **        | ** ** | ** **        | ** ** |
| **Assets:**                                                                                                                                     |       |              |       |              |       |              |       |
| Current assets:                                                                                                                                 |       |              |       |              |       |              |       |
| Cash and  equivalents                                                                                                                           |       | $                 | 83,458     |              | $          | 65,603            |       | $ | 50,600 |   |
| Short term  marketable securities                                                                                                               |       | 13,400            |       | 327,100           |       | 313,146           |       |
| Receivables (net  of allowance of $1,168, $1,094 and $1,052)                                                                                    |       | 11,304            |       | 6,720             |       | 8,911             |       |
| Inventories                                                                                                                                     |       | 44,624            |       | 44,064            |       | 43,504            |       |
| Deferred income  taxes, net                                                                                                                     |       | 9,070             |       | 9,068             |       | —            |       |
| Prepaid and  other                                                                                                                              |       | 18,968            |       | 13,314            |       | 31,856            |       |
| Total current  assets                                                                                                                           |       | 180,824           |       | 465,869           |       | 448,017           |       |
| Long term  investments                                                                                                                          |       | 250,503           |       | —            |       | —            |       |
| Property and  equipment, net                                                                                                                    |       | 126,243           |       | 116,595           |       | 107,925           |       |
| Deferred income  taxes, net                                                                                                                     |       | 24,131            |       | 20,330            |       | —            |       |
| Other assets                                                                                                                                    |       | 4,297             |       | 4,234             |       | 19,081            |       |
| Total assets                                                                                                                                    |       | $                 | 585,998    |              | $          | 607,028           |       | $ | 575,023 |   |
|                                                                                                                                            |       |              |       |              |       |              |       |
| **Liabilities  and Shareholders’ Equity:**                                                                                                 |       |              |       |              |       |              |       |
| Current  liabilities:                                                                                                                           |       |              |       |              |       |              |       |
| Accounts payable                                                                                                                                |       | $                 | 26,448     |              | $          | 28,052            |       | $ | 27,934 |   |
| Accrued  liabilities                                                                                                                            |       | 36,373            |       | 33,982            |       | 31,634            |       |
| Current portion  of capital leases                                                                                                              |       | 94                |       | 223               |       | 221               |       |
| Total current  liabilities                                                                                                                      |       | 62,915            |       | 62,257            |       | 59,789            |       |
| Long term portion  of capital leases                                                                                                            |       | —            |       | 38                |       | 94                |       |
| Deferred rent  and other lease incentives                                                                                                       |       | 45,475            |       | 40,143            |       | 38,909            |       |
| Uncertain tax  positions                                                                                                                        |       | 2,907             |       | —            |       | —            |       |
| Total  liabilities                                                                                                                              |       | 111,297           |       | 102,438           |       | 98,792            |       |
|                                                                                                                                            |       |              |       |              |       |              |       |
| 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 135,000,000 shares at $0.001 par value per share; issued and  outstanding 88,850,749, 93,543,604 and 93,184,225 shares |       | 89                |       | 94                |       | 93                |       |
| Additional  paid-in capital                                                                                                                     |       | 137,922           |       | 126,744           |       | 120,715           |       |
| Accumulated  other comprehensive income                                                                                                         |       | 1,800             |       | 9,139             |       | 1,788             |       |
| Retained  earnings                                                                                                                              |       | 334,890           |       | 368,613           |       | 353,635           |       |
| Total shareholders’  equity                                                                                                                |       | 474,701           |       | 504,590           |       | 476,231           |       |
| Total  liabilities and shareholders’ equity                                                                                                |       | $                 | 585,998    |              | $          | 607,028           |       | $ | 575,023 |   |

 

----

 (a) Derivedfrom audited financial statements.

 

See accompanyingnotes to condensed consolidated financial statements.

 

3

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**bebestores, inc.**

**CONDENSED CONSOLIDATED STATEMENTS OFINCOME**

**(Inthousands, except per share data)**

**(unaudited)**

** **
| ** **                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                         | ** ** | **April 5,**                | ** ** | **April 7,**               | ** ** | **April 5,** | ** ** | **April 7,** | ** ** |
| ** **                                         | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                         | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                          |       | $                                | 151,729    |                            | $          | 154,354 |   | $ | 516,140 |   | $ | 508,215 |   |
| Cost of sales,  including production and occupancy |       | 85,385                           |       | 84,502                          |       | 279,282 |   | 264,731 |   |
|                                               |       |                             |       |                            |       |   |   |   |   |
| Gross margin                                       |       | 66,344                           |       | 69,852                          |       | 236,858 |   | 243,484 |   |
| Selling, general  and administrative expenses      |       | 59,002                           |       | 54,126                          |       | 177,937 |   | 163,365 |   |
|                                               |       |                             |       |                            |       |   |   |   |   |
| Operating income                                   |       | 7,342                            |       | 15,726                          |       | 58,921 |   | 80,119 |   |
| Interest and  other income, net                    |       | 5,225                            |       | 4,430                           |       | 12,979 |   | 10,099 |   |
|                                               |       |                             |       |                            |       |   |   |   |   |
| Income before  income taxes                        |       | 12,567                           |       | 20,156                          |       | 71,900 |   | 90,218 |   |
| Income tax  provision                              |       | 4,219                            |       | 7,228                           |       | 24,805 |   | 32,591 |   |
|                                               |       |                             |       |                            |       |   |   |   |   |
| Net income                                         |       | $                                | 8,348      |                            | $          | 12,928 |   | $ | 47,095 |   | $ | 57,627 |   |
|                                               |       |                             |       |                            |       |   |   |   |   |
| Basic earnings  per share                          |       | $                                | 0.09       |                            | $          | 0.14 |   | $ | 0.52 |   | $ | 0.62 |   |
| Diluted earnings  per share                        |       | $                                | 0.09       |                            | $          | 0.14 |   | $ | 0.51 |   | $ | 0.61 |   |
|                                               |       |                             |       |                            |       |   |   |   |   |
| Basic weighted  average shares outstanding         |       | 88,833                           |       | 93,069                          |       | 90,077 |   | 92,638 |   |
| Diluted weighted  average shares outstanding       |       | 90,115                           |       | 94,989                          |       | 91,473 |   | 94,914 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

4

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**bebestores, inc.**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(Inthousands)**

**(unaudited)**

 
| ** **                                                                    | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                    | ** ** | **April 5,**               | ** ** | **April 7,** | ** ** |
| ** **                                                                    | ** ** | **2008**                        | ** ** | **2007** | ** ** |
|                                                                          |       |                            |       |   |   |
| Cash flows from  operating income:                                            |       |                            |       |   |   |
| Net income                                                                    |       | $                               | 47,095     |   | $ | 57,627 |   |
| Adjustments to  reconcile net income to cash provided by operating activities |       |                            |       |   |   |
| Non-cash  compensation expense                                                |       | 8,482                           |       | 7,846 |   |
| Depreciation and  amortization                                                |       | 16,865                          |       | 14,673 |   |
| Net loss on  disposal of property                                             |       | 820                             |       | 435 |   |
| Deferred rent  and other lease incentives                                     |       | 5,285                           |       | 5,553 |   |
| Deferred income  taxes                                                        |       | (2,363                          | )          | (1,739 | ) |
| Changes in  operating assets and liabilities:                                 |       |                            |       |   |   |
| Receivables                                                                   |       | (5,114                          | )          | (3,751 | ) |
| Inventories                                                                   |       | (504                            | )          | (1,403 | ) |
| Prepaid expenses  and other                                                   |       | (5,997                          | )          | (19,021 | ) |
| Accounts payable                                                              |       | (1,866                          | )          | 4,995 |   |
| Accrued  liabilities                                                          |       | 2,046                           |       | (2,551 | ) |
| Net cash  provided by operating activities                                    |       | 64,749                          |       | 62,664 |   |
|                                                                          |       |                            |       |   |   |
| Cash flows from  investing activities:                                        |       |                            |       |   |   |
| Purchase of  property and equipment                                           |       | (27,546                         | )          | (29,627 | ) |
| Purchase of  marketable securities                                            |       | (336,950                        | )          | (292,120 | ) |
| Proceeds from  sales of marketable securities                                 |       | 392,975                         |       | 267,845 |   |
| Net cash  provided (used) by investing activities                             |       | 28,479                          |       | (53,902 | ) |
|                                                                          |       |                            |       |   |   |
| Cash flows from  financing activities:                                        |       |                            |       |   |   |
| Net proceeds  from issuance of common stock                                   |       | 2,232                           |       | 9,694 |   |
| Purchase of  common stock                                                     |       | (66,950                         | )          | — |   |
| Excess of tax  benefit from options exercised                                 |       | 632                             |       | 7,408 |   |
| Cash dividends  paid                                                          |       | (13,795                         | )          | (13,865 | ) |
| Other                                                                         |       | (167                            | )          | (195 | ) |
| Net cash  provided (used) by financing activities                             |       | (78,048                         | )          | 3,042 |   |
|                                                                          |       |                            |       |   |   |
| Net increase in  cash and cash equivalents                                    |       | 15,180                          |       | 11,804 |   |
| Effect of  exchange rate changes on cash                                      |       | 2,675                           |       | 140 |   |
| Cash and  equivalents:                                                        |       |                            |       |   |   |
| Beginning of  period                                                          |       | 65,603                          |       | 38,656 |   |
| End of period                                                                 |       | $                               | 83,458     |   | $ | 50,600 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

5

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**bebestores, inc.**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**INTERIMFINANCIAL STATEMENTS**

 

Theaccompanying condensed consolidated balance sheets of bebe stores, inc. (the “Company”)as of April 5, 2008, July 7, 2007 and April 7, 2007, thecondensed consolidated statements of income for the three and nine months endedApril 5, 2008 and April 7, 2007 and the condensed consolidatedstatements of cash flows for the nine months ended April 5, 2008 and April 7,2007 have been prepared in accordance with accounting principles generallyaccepted in the United States of America for interim financial information andwith the instructions to Form 10-Q and Article 10 of Regulation S-X,without audit. Accordingly, they do not include all of the information requiredby accounting principles generally accepted in the United States of America forannual financial statements. Therefore, these condensed consolidated financialstatements should be read in conjunction with our Annual Report on Form 10-Kfor the year ended July 7, 2007.

 

In theopinion of management, all adjustments (consisting of normal recurringaccruals) considered necessary to present fairly the financial position at thebalance sheet dates and the results of operations for the periods presentedhave been included. The condensed consolidated balance sheet at July 7,2007, presented herein, was derived from the audited balance sheet included inthe Form 10-K for the fiscal year ended July 7, 2007.

 

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.

 

**FISCALYEAR**

 

Ourfiscal year is a 52 or 53 week period, each period ending on the first Saturdayafter June 30.  Fiscal years 2008 and 2007 include 52 weeks and 53weeks, respectively.

 

Thethree month periods ended April 5, 2008 and April 7, 2007 included 13weeks and 14 weeks, respectively.  The nine month periods ended April 5,2008 and April 7, 2007 included 39 weeks and 40 weeks, respectively.

 

**INVENTORIES**

 

TheCompany’s inventories consist of:

 
| ** **                      | ** ** | **As of**          | ** ** |
|---------------------------------|------------|-------------------------|------------|
| ** **                      | ** ** | **April 5,**       | ** ** | **July 7,** | ** ** | **April 7,** | ** ** |
| ** **                      | ** ** | **2008**                | ** ** | **2007** | ** ** | **2007** | ** ** |
| ** **                      | ** ** | **(In thousands)** | ** ** |
| Raw materials                   |       | $                       | 5,903      |   | $ | 7,136 |   | $ | 8,106 |   |
| Merchandise  available for sale |       | 38,721                  |       | 36,928 |   | 35,398 |   |
| Inventories                     |       | $                       | 44,624     |   | $ | 44,064 |   | $ | 43,504 |   |

 

**EARNINGSPER SHARE**

 

Basic earnings pershare is computed as net earnings divided by the weighted average number ofcommon shares outstanding for the period. Diluted earnings per share reflectsthe potential dilution that could occur from common shares issuable through theexercise of dilutive stock options.

 

6

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

 
| ** **                                                                        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                        | ** ** | **April 5,  2008**          | ** ** | **April 7,  2007**         | ** ** | **April 5,  2008** | ** ** | **April 7,  2007** | ** ** |
| ** **                                                                        | ** ** | **(In thousands)**          | ** ** | **(In thousands)**         | ** ** |
| Basic weighted average number of shares outstanding |       | 88,833                           |       | 93,069                          |       | 90,077 |   | 92,638 |   |
| Incremental  shares from the assumed issuance of stock options                    |       | 1,282                            |       | 1,920                           |       | 1,396 |   | 2,276 |   |
| Diluted weighted  average number of shares outstanding                            |       | 90,115                           |       | 94,989                          |       | 91,473 |   | 94,914 |   |

 

The number ofincremental shares from the assumed issuance of stock options is calculatedapplying the treasury stock method.

 

Excluded from thecomputation of the number of diluted weighted average shares outstanding wereoptions of 3,143,000, and 1,903,000 for the three months ended April 5,2008 and April 7, 2007, respectively, and 2,793,000, and 1,559,000 for thenine months ended April 5, 2008 and April 7, 2007, respectively,which in each case would have been anti-dilutive.

 

**COMMONSTOCK PURCHASES**

 

On September 13,2007, the Company entered into an agreement with the Company’s former ViceChairperson Neda Mashouf to purchase 5 million shares of its outstanding commonstock beneficially owned by Ms. Mashouf at a price per share of $13.39, anaggregate purchase price of $66,950,000. The Company completed thepurchase and retired the shares during the first quarter of fiscal 2008.

 

**COMPREHENSIVEINCOME (LOSS)**

 

Comprehensiveincome (loss) consists of net income and other comprehensive income (income,expenses, gains and losses that bypass the income statement and are reporteddirectly as a separate component of equity).  The Company’s comprehensiveincome (loss) consists of net income, unrealized losses on long terminvestments and foreign currency translation adjustments for all periodspresented.

 
| ** **                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **April 5,  2008**          | ** ** | **April 7,  2007**         | ** ** | **April 5,  2008** | ** ** | **April 7,  2007** | ** ** |
| ** **                                | ** ** | **(In thousands)**          | ** ** |
| Net income                                |       | $                                | 8,348      |                            | $          | 12,928 |   | $ | 47,095 |   | $ | 57,627 |   |
| Unrealized loss  on long term investments |       | (7,173                           | )          | —                          |       | (7,173 | ) | — |   |
| Accumulated  translation adjustments      |       | (2,509                           | )          | 258                             |       | (166 | ) | (630 | ) |
| Total comprehensive  income (loss)        |       | $                                | (1,334     | )                               | $          | 13,186 |   | $ | 39,756 |   | $ | 56,997 |   |

 

**INVESTMENTS**

 

We hold a variety of interest bearing auction rate securities (“ARS”)comprised of federally insured student loan backed securities and insuredmunicipal authority bonds. As of April 5, 2008, our ARS portfolio totaled approximately $264million, of which $251 million were classified as long term investments and $13million were classified as short term marketable securities because either theARS was sold in a successful auction or was called by issuer. Our ARS portfolioincludes approximately 83% federally insured student loan backed securities and17% municipal authority bonds. Our ARS portfolio is comprised of approximately85% AAA rated investments, 4% AA rated investments and 11% A ratedinvestments.  These ARS investments areintended to provide liquidity via an auction process that resets the applicableinterest rate at predetermined calendar intervals, allowing investors to eitherroll over their holdings or gain immediate liquidity by selling such interestsat par. The recent uncertainties in the credit markets have affected ourholdings in ARS investments and auctions for the majority of our investments inthese securities have failed to settle on their respective settlement dates.Consequently, the investments are not currently liquid and we will not be ableto access these funds until a future auction of these investments issuccessful. Maturity dates for these ARS investments range from 2010 to 2045with principal distributions occurring on certain securities prior to maturity.We currently have the ability and intent to hold these ARS investments until arecovery of the auction process or until maturity.

 

Typically the fair value of ARS investments approximates par value due tothe frequent resets through the auction process. While we continue to earninterest on our ARS investments at the maximum contractual rate, theseinvestments are not currently 

 

7

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trading and therefore do notcurrently have a readily determinable market value. Accordingly, the estimatedfair value of ARS no longer approximates par value.

 

We determined the estimated fair value of our investment in ARS as of April 5,2008 using a discounted cash flow model to estimate the fair value of ourinvestments in ARS. The assumptions used in preparing the discounted cash flowmodel include estimates for interest rates, timing and amount of cash flows andexpected holding periods of the ARS. Based on this assessment of fair value, asof April 5, 2008 we determined there was a decline in the fair value ofour ARS investments of $7.2 million, with no related tax benefit, of which allwas deemed temporary and an impairment charge was recorded in the other comprehensiveincome component of shareholders’ equity.

 

We review our impairments in accordance with SFAS No. 115, *Accounting for Certain Investments in Debt and EquitySecurities*, and related guidance issued by the FASB and SEC inorder to determine the classification of the impairment as “temporary” or “other-than-temporary”.A temporary impairment charge results in an unrealized loss being recorded inthe other comprehensive income component of shareholders’ equity. Such anunrealized loss does not affect net income for the applicable accountingperiod. An other-than-temporary impairment charge is recorded as a realizedloss in the condensed consolidated statement of income and reduces net incomefor the applicable accounting period. The differentiating factors betweentemporary and other-than-temporary impairment are primarily the length of thetime and the extent to which the market value has been less than cost, thefinancial condition and near-term prospects of the issuer and our currentintent and ability to retain our investment in the issuer for a period of timesufficient to allow for any anticipated recovery in market value.

 

The valuation of our investment portfolio is subject to uncertainties thatare difficult to predict. Factors that may impact its valuation include changesto credit ratings of the securities as well as to the underlying assetssupporting those securities, rates of default of the underlying assets,underlying collateral value, discount rates and ongoing strength and quality ofmarket credit and liquidity.

 

**CREDITFACILITIES**

 

The Company has anunsecured commercial line of credit agreement with a bank, which provides forborrowings and issuance of letters of credit up to a combined total of $25million and expires on March 31, 2009. The outstanding balance bearsinterest at either the bank’s reference rate (which was 5.25% as of April 5,2008) or the LIBOR rate plus 1.75 percentage points. As of April 5, 2008,there were no outstanding borrowings, and there was $1.9 million outstanding inletters of credit.

 

This creditfacility requires the Company to comply with certain financial covenants,including amounts for minimum tangible net worth, unencumbered liquid assetsand profitability, and certain restrictions on making loans and investments.

 

**STOCKBASED COMPENSATION**

 

The 1997 StockPlan as amended (the “Stock Plan”) provides for the grant of incentive stockoptions, non-qualified stock options, stock purchase rights, stock awards andrestricted stock units. Although the Stock Plan allows for stock options andrelated awards to be granted at prices below fair market value, the Company hashistorically granted such options at the fair market value of the stock on thedate of grant.  Stock options and related awards have a maximum term of tenyears.  Options and restricted stock units granted to employees andoptions granted to Directors generally vest over four years with 20% of theaward vested in each of the first and second years, and 30% vested in each ofthe remaining two years.  Restricted stock units awarded to Directorsgenerally vest over a period of one year from the date of grant.  As of April 5,2008, the Company has reserved 7,409,061 shares of common stock for issuanceunder the Stock Plan and there were 555,051 shares available for future grant.

 

The Companyaccounts for share-based compensation under the provisions of SFAS No. 123(revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”), which requiresshare-based payment compensation related to stock options to be measured basedon the estimated fair value at the date of grant using an option pricing model.

 

The Companyrecognized share-based compensation expense of $2.2 million and $2.8 million inthe three months ended April 5, 2008 and April 7, 2007, respectively,as a component of selling, general and administrative expenses. The Companyrecognized share-based compensation expense of $8.5 million and $7.8 million inthe nine months ended April 5, 2008 and April 7, 2007,respectively.  As of April 5, 2008, there was $7.5 million (beforeany related tax benefit) of total unrecognized compensation cost related tononvested share-based compensation that is expected to be recognized over aweighted-average period of 3.1 years.

 

The fair value ofeach option grant was estimated on the date of the grant using theBlack-Scholes valuation model.  The expected life of the optionsrepresents the period of time the options are expected to be outstanding and isbased on historical trends. The expected stock price volatility is based on anaverage of the historical volatility of the Company’s stock for a periodapproximating the expected life and the implied volatility based on tradedoptions of the Company’s stock. The expected dividend yield is based onthe Company’s most recent annual dividend payout. The risk-free interest rateis based on the U.S. Treasury yield curve in effect at the time of grant andhas a term that approximates the expected life.

 

8

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The followingtable presents the weighted average assumptions used in the option pricingmodel for the stock options granted in the three and nine months ended April 5,2008 and April 7, 2007:

 
| ** **                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                     | ** ** | **April 5,**                | ** ** | **April 7,**               | ** ** | **April 5,** | ** ** | **April 7,** | ** ** |
| ** **                     | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Expected  dividend rate        |       | 1.8                              | %          | 1.1                             | %          | 1.4 | % | 0.9 | % |
| Volatility                     |       | 49.8                             | %          | 45.2                            | %          | 47.0 | % | 48.7 | % |
| Risk-free  interest rate       |       | 2.8                              | %          | 4.7                             | %          | 4.0 | % | 4.7 | % |
| Expected lives  (years)        |       | 4.3                              |       | 4.1                             |       | 4.3 |   | 4.1 |   |
| Fair value per  option granted |       | $                                | 4.56       |                            | $          | 6.98 |   | $ | 5.32 |   | $ | 8.68 |   |
|                                |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 

The following tablesummarizes stock option activity during the nine months ended April 5,2008:

 
| ** **                       | ** ** | **Options**             | ** ** | **Weighted  Average  Exercise Price  Per Share** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|----------------------------------|------------|-------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------|------------|
| ** **                       | ** ** | **(In thousands)** | ** ** | ** **                                                 | ** ** | ** **                                          | ** ** | **(In thousands)**             | ** ** |
| Outstanding,  July 7, 2007  |       | 6,098                   |       | $                                                          | 11.95      |                                                |       |                                |       |   |
| Granted                          |       | 1,253                   |       | 13.25                                                      |       |                                                |       |                                |       |
| Exercised                        |       | (291                    | )          | 7.41                                                       |       |                                                |       |                                |       |
| Cancelled                        |       | (340                    | )          | 16.51                                                      |       |                                                |       |                                |       |
|                             |       |                    |       |                                                       |       |                                                |       |                                |       |
| Outstanding,  April 5, 2008 |       | 6,720                   |       | $                                                          | 12.16      |                                                | 6.92       |                                | $          | 18,582 |   |
|                             |       |                    |       |                                                       |       |                                                |       |                                |       |
| Exercisable,  April 5, 2008 |       | 4,335                   |       | $                                                          | 9.92       |                                                | 5.91       |                                | $          | 18,175 |   |

 

Intrinsic valuefor stock options is defined as the difference between the current market valueand the grant price. For the three months and nine months ended April 5,2008, the total intrinsic value of stock options exercised was $0.2 million and$1.9 million, respectively. Cash received from stock options exercised duringthe three and nine months ended April 5, 2008 was $0.2 million and $2.2million, respectively, and the actual tax benefit realized for tax deductionsfrom stock options exercised totaled $0.1 million and $0.7 million,respectively.

 

The followingtable summarizes restricted stock unit activity during the nine months ended April 5,2008:

 
| ** **                     | ** ** | **Shares**              | ** ** | **Weighted  Average Grant  Date Fair Value  Per Share** | ** ** |
|--------------------------------|------------|-------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                     | ** ** | **(In thousands)** | ** ** | ** **                                                                  | ** ** |
| Nonvested,  July 7, 2007  |       | 67                      |       | $                                                                           | 17.23      |   |
| Granted                        |       | 33                      |       | $                                                                           | 13.16      |   |
| Vested                         |       | (10                     | )          | $                                                                           | 21.34      |   |
| Cancelled                      |       | (2                      | )          | $                                                                           | 20.60      |   |
| Nonvested,  April 5, 2008 |       | 88                      |       | $                                                                           | 16.42      |   |

 

9

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**INCOME TAXES**

 

Effective July 8,2007, the Company adopted Financial Accounting Standards Board (“FASB”)Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). The cumulative effect of adoption was a decrease to retained earnings ofapproximately $0.6 million.  As of July 8, 2007, the totalunrecognized tax benefits were approximately $5.2 million. Of this amount,approximately $2.0 million would reduce our effective tax rate if recognized.

 

The Companyaccounts for interest and penalties related to unrecognized tax benefits as acomponent of income tax expense. As of the date of adoption, the Company had$0.7 million of interest and penalties accrued associated with unrecognized taxbenefits.

 

The Company couldbe subject to Federal and state tax examinations for years 2002 and forward.The Company may also be subject to audits in Canada for years 2000 and forward.The Company is currently under state income tax audit in Arizona, Texas and NewYork and expects the commencement of certain state tax audits in the nearterm.  At this time, the Company does not believe that the outcome of anyexamination will have a material impact on the Company’s financial statements.

 

As of July 8,2007, the total amount of unrecognized tax benefits were approximately $5.2million.   At the end of the thirdquarter, the Company recognized that there were $2.5 million related to taxpositions that were no longer uncertain. This amount is comprised of a $2.2million decrease in unrecognized tax benefits due to the filing of amendedCanadian income tax returns and a $0.3 million decrease in unrecognized taxbenefits due to statute expirations.

 

**LEGALMATTERS**

 

A former employeesued bebe, purportedly on behalf of a class of all hourly, non-managerialemployees similarly situated, in a complaint filed on April 28, 2005 inthe United States District Court for the Northern District of California (caseno. C050177) alleging violations under the Fair Labor Standards Act,specifically that bebe obligated her to buy and wear its brand clothing as auniform, without reimbursement or credit, and the net effect of deducting thevalue of such required purchases from her wages would often result in her notbeing paid minimum wages. The lawsuit seeks compensatory, statutory andinjunctive relief. On January 25, 2008, the Court preliminarily approvedthe confidential settlement we previously reached in this case and we moved forwardwith class notification. The process of class notification is now complete andthe claims period is over.  A hearing hasbeen set for May 19, 2008 to determine whether the preliminarily approvedsettlement should be finally approved. We have accrued an amount that webelieve reasonably estimates the potential liability, which does not have amaterial impact on our financial position or results of operations.

 

A former employeesued bebe in a complaint filed July 27, 2006 in the Superior Court ofCalifornia, San Mateo County (case no. CIV 456550) alleging a failure to payall wages, failure to pay overtime wages, failure to pay minimum wages, failureto provide meal periods, violation of Labor Code §450, violation of Labor Code§2802 and California Code of Regulations §11040(9)(A), statutory wageviolations (late payment of wages), unlawful business practices under Businessand Professions Code §16720 and §17200, conversion of wages and violation ofCivil Code §52.1. The plaintiff purports to bring the action also on behalf ofcurrent and former California bebe employees who are similarly situated. Thelawsuit seeks compensatory, statutory, punitive, restitution and injunctiverelief.  The Court has re-set the hearingdate regarding whether class certification would be appropriate to September 2008.

 

The previouslyreported complaint filed by a former employee on July 24, 2007 in theSuperior Court of California, Orange County (case no. 07CC08220) alleging afailure to pay overtime wages, failure to provide for meal and rest breaks, andunfair business practices has been dismissed with no liability to us.

 

A former employeesued bebe in a complaint filed September 20, 2007 in the United StatesDistrict Court for the District of New Jersey (case no. 07-cv-4514 (D.N.J.))alleging various state and federal statutory breaches based on a failure to payall wages, including overtime wages and bonus, failure to provide and/or payfor meal and rest break periods, failure to credit vacation time and otherbenefits and retaliation, wrongful termination, breach of contract, breach ofcovenant of good faith and fair dealing, and unjust enrichment.  Plaintiffpurports to bring the action on behalf of current and former store managementemployees who are or were similarly situated.  The complaint seekscompensatory, statutory and punitive damages and equitable relief.  Wefiled our answer in January 2008 and the matter is in the pre-discoverystage. The matter is in the early stages of discovery and the Court isconsidering whether conditional certification of a class is appropriate.

 

A customer suedthe company in a complaint filed December 14, 2006 in the Superior Courtof Contra Costa County (case no. C06-02630) alleging that we utilized a certaintype of preprinted credit card form in a return transaction in violation ofCalifornia Civil Code §1747.08. The plaintiff purports to bring the action alsoon behalf of other customers who are similarly situated.  The lawsuitseeks compensatory, statutory, and injunctive relief.  This matter is inthe discovery stage.

 

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On February 9,2007, a customer, purportedly on behalf of other customers similarly situated,filed suit against bebe in the Central District of California (case no.CV-07-0972) alleging we violated the Fair Credit Reporting Act (the “FCRA”) byprinting on receipts more than the last five digits of the credit or debit cardnumbers and/or the expiration date. The suit seeks statutory and punitivedamages, attorney’s fees and injunctive relief. On October 11, 2007, theCourt stayed this case in its entirety pending the outcome of an interlocutoryappeal in the Ninth Circuit Court of Appeals involving class certificationissues in a similar FCRA action entitled, Soualian v. International Coffee andTea, LLC, Case No. CV-07-00502-RGK, United States District Court for theCentral District of California, Appellate Case No. 07-56377.

 

We are alsoinvolved in various other legal proceedings arising in the normal course ofbusiness. None of these matters nor the matters listed above are expected,individually or in the aggregate, to have a material adverse effect on ourbusiness, financial condition or results of operations.

 

We intend todefend ourself vigorously against each of these claims. However, the results ofany litigation are inherently uncertain. We cannot assure you that we will beable to successfully defend ourself in these lawsuits. Where required, and/orotherwise appropriate, we have recorded an estimate of potential liabilitiesthat we believe is reasonable. Any estimates are revised as further informationbecomes available.

 

**RECENTACCOUNTING PRONOUNCEMENTS**

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements*”*.  SFAS No. 157 defines fairvalue, establishes a framework for measuring fair value in accordance withgenerally accepted accounting principles, and expands disclosures about fairvalue measurements.  SFAS No. 157 applies under other accountingpronouncements that require or permit fair value measurements and accordinglydoes not require any new fair value measurements.  The provisions of SFAS No. 157are to be applied prospectively as of the beginning of the fiscal year in whichit is initially applied, with any transition adjustment recognized as acumulative-effect adjustment to the opening balance of retained earnings. The provisions of SFAS No. 157 are effective for fiscal years beginningafter November 15, 2007.  In February 2008, the FASB issued StaffPosition No. FAS 157-2 which delays the effective date of SFAS No. 157 fornonfinancial assets and liabilities except for items recognized or disclosed atfair value in the financial statements on a recurring basis to fiscal yearsbeginning after November 15, 2008. The Company does not expect the adoption ofSFAS No. 157 to have a material impact on our financial position and resultsof operations.

 

In February 2007,the FASB issued SFAS No. 159,  “The Fair Value Option for FinancialAssets and Financial Liabilities-Including an amendment of FASB Statement No. 115”. SFAS No. 159 permits entities to choose to measure eligible items at fairvalue at specified election dates and report unrealized gains and losses onitems for which the fair value option has been elected in earnings at eachsubsequent reporting date. SFAS No. 159 is effective for fiscal yearsbeginning after November 15, 2007. The Company does not expect theadoption of SFAS No. 159 to have a material impact on our financialposition and results of operations.

 

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

 

The followingManagement’s Discussion and Analysis of Financial Condition and Results ofOperations contains forward-looking statements, which involve risks anduncertainties. Our actual results may differ materially from those anticipatedin these forward-looking statements.  Statements that are predictive innature, that depend upon or refer to future events or conditions or thatinclude words such as “expects,” “anticipates,” “intends,” “plans,” “believes,”“estimates,” “thinks,” and similar expressions are forward-looking statements.  Forward-looking statements include statements about our expectedresults of operations, capital expenditures and store openings.  Althoughwe believe that these statements are based upon reasonable assumptions, we cannotassure you that our goals will be achieved. These forward-looking statementsare made as of the date of this Form 10-Q, and we assume no obligation toupdate or revise them or provide reasons why actual results may differ. Factorsthat might cause such a difference include, but are not limited to, our abilityto respond to changing fashion trends, miscalculation of the demand for ourproducts, effective management of our growth, decline in comparable store salesperformance, ongoing competitive pressures in the apparel industry, changes inthe level of consumer spending or preferences in apparel, our ability toattract and retain key management personnel and/or other factors discussed in “RisksFactors” and elsewhere in this Form 10-Q.

 

**OVERVIEW**

 

We design, developand produce a distinctive line of contemporary women’s apparel and accessories.While we attract a broad audience, our target customer is a 21 to 35-year-oldwoman who seeks current fashion trends to suit her lifestyle. 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 current fashionand high quality at a competitive price.

 

Our distinctiveproduct offering includes a full range of separates, tops, sweaters, dresses,active wear and accessories in the following lifestyle categories: career, evening, casual and active. We design and develop the majority of ourmerchandise in-house, which is manufactured to our specifications. Theremainder of our merchandise is sourced directly from third-partymanufacturers.

 

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We market ourproducts under the bebe, BEBE SPORT, bbsp and bebe O brand names through our290 retail stores, of which 207 are bebe stores, 62 are BEBE SPORT stores, 20are bebe outlet stores and 1 is a bebe accessories store as of April 5,2008. These stores are located in 35 states, the District of Columbia, PuertoRico, the U.S. Virgin Islands and Canada. In addition, we have an on-line storeat www.bebe.com and our licensees operate 20 international stores. During thethree months ended April 5, 2008, we opened 4 stores, including 3 bebestores and 1 BEBE SPORT store and closed 4 bebe stores.  During the ninemonths ended April 5, 2008, we opened 21 stores, including 13 bebe storesand 8 BEBE SPORT stores and closed 4 bebe stores.  We expect to openapproximately 35 stores, including approximately 19 bebe stores, 9 BEBE SPORTstores and 7 bebe outlet stores during our fiscal 2008. We also plan to renovate1 existing store and relocate or expand 6 existing stores, resulting in squarefootage growth of approximately 14%.

 

*bebestores.*  We were founded by Manny Mashouf, Chairman ofthe Board. We opened our first store in San Francisco, California in 1976,which was also the year we incorporated.

 

*BEBESPORT.* We launched BEBE SPORT during fiscal 2003 to addressthe performance and active lifestyle needs of the bebe customer.

 

*bebeoutlets.*  We utilize the outlets as a clearance vehiclefor merchandise from our retail stores. In addition, the inventory includes astrong presentation of bebe logo merchandise and special cuts produced underthe bebe O label exclusively for the outlet stores.  In the last quarterof 2008, we plan to open 7 new outlet stores under the new name 2b bebe andwill continue to offer a selection of bebe logo product, bebe saleconsolidations and an expanded assortment of product made exclusively for ouroutlet stores under the new name 2b bebe.

 

*On-line.*bebe.com is an extension of the bebe store experience and provides a completeassortment of bebe and BEBE SPORT merchandise. It is also used as anadvertising vehicle to communicate with our customers.  We are currentlyable to ship to customers in the United States and Canada.

 

*bebe accessories*.In September 2006, we opened our first accessory concept store featuringshoes imported from Italy, Brazil and China and a selection of fine leathergoods, bebe logo merchandise, outerwear and gift items.

 

**CRITICALACCOUNTING POLICIES**

 

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

 

The preparation ofthese financial statements requires the appropriate application of certainaccounting policies, many of which require us to make estimates and assumptionsabout future events and their impact on amounts reported in our financialstatements and related notes. Since future events and their impact cannot bedetermined with certainty, the actual results will inevitably differ from ourestimates. Such differences could be material to the financial statements. Webelieve our application of accounting policies, and the estimates inherentlyrequired therein, are reasonable. These accounting policies and estimates areconstantly reevaluated, and adjustments are made when facts and circumstancesdictate a change. Our accounting policies are more fully described in Note 1 tothe consolidated financial statements in our annual report on Form 10-Kfor the fiscal year ended July 7, 2007.

 

We have identifiedcertain critical accounting policies, which are described below:

 

*Revenuerecognition.  *We recognize revenue at the time theproducts are received by the customers in accordance with the provisions ofStaff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition inFinancial Statements” as amended by SAB No. 104, “Revenue Recognition”. We recognize revenue for store sales at the point at which the customerreceives and pays for the merchandise at the register with either cash orcredit card. For on-line sales, we recognize revenue at the time the customerreceives the product. We estimate and defer revenue and the related productcosts for shipments that are in transit to the customer. Customers typicallyreceive goods within one week of shipment. Amounts related to shipping billedto customers are reflected in net sales and the related costs are reflected incost of goods sold. Sales tax collected from customers on retail sales arerecorded net of retail sales at the time of the transaction.

 

We record areserve for estimated product returns based on historical return trends. As of April 5,2008 and April 7, 2007, the reserve was $1,283,000 and $955,000,respectively. If actual returns are greater than those projected, additionalsales returns may be recorded in the future.

 

Discounts offeredto customers consist primarily of point of sale markdowns and are recorded atthe time of the related sale as a reduction of revenue.

 

We include thevalue of points and rewards earned by our loyalty program members as aliability and a reduction of revenue at the time the points and rewards areearned based on historical conversion and redemption rates.  We recognizerevenue when the rewards are redeemed or expire.

 

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We carry giftcertificates sold as a liability and we recognize revenue when the giftcertificate is redeemed or four years after issuance if the gift certificate isunredeemed.  Similarly, customers may receive a store credit in exchangefor returned goods. We carry store credits as a liability until redeemed orthree years after issuance if the store credit is unredeemed.

 

We ship bebe goodsto various international locations and recognize revenue from these wholesalesales when the licensee receives the shipment.

 

We record royaltyrevenue from product licensees as earned, which is based on the licensee’ssales.

 

*StockBased Compensation.*We account for stock options and awardsissued to employees in accordance with the fair value recognition provisions ofFinancial Accounting Standards Board (“FASB”) Statement No. 123(R) (“SFASNo. 123(R)”), “Share-Based Payment,” using the modified prospectivetransition method. Under SFAS No. 123(R), stock-based awards to employeesare required to be recognized as compensation expense, based on the calculatedfair value on the date of grant. We determine the fair value using the BlackScholes option pricing model. This model requires subjective assumptions,including future stock price volatility and expected term, which affect thecalculated values.

 

*Inventories.*Our inventories are stated at the lower of weighted average cost or market.Market is determined based on the estimated net realizable value, which isgenerally the merchandise selling price. To ensure that our raw material isproperly valued we age the fabric inventory and record a reserve in accordancewith our established policy, which is based on historical experience. To ensureour finished goods inventory is properly valued we review the age and turnoverof our inventory and record a reserve if the selling price is marked down belowcost. These assumptions can have an impact on current and future operatingresults and financial position. We estimate shrinkage for the period betweenthe last physical count and balance sheet date based on historic shrinkagetrends.

 

*Marketablesecurities*.We hold avariety of interest bearing auction rate securities (“ARS”) comprised offederally insured student loan backed securities and insured municipalauthority bonds. Asof April 5, 2008, our ARS portfolio totaled approximately $264 million, ofwhich $251 million were classified as long term investments and $13 millionwere classified as short term marketable securities because either the ARS wassold in a successful auction or was called by issuer. Our ARS portfolioincludes approximately 83% federally insured student loan backed securities and17% municipal authority bonds. Our ARS portfolio is comprised of approximately85% AAA rated investments, 4% AA rated investments and 11% A ratedinvestments.  These ARS investments areintended to provide liquidity via an auction process that resets the applicableinterest rate at predetermined calendar intervals, allowing investors to eitherroll over their holdings or gain immediate liquidity by selling such interestsat par. The recent uncertainties in the credit markets have affected ourholdings in ARS investments and auctions for the majority of our investments inthese securities have failed to settle on their respective settlement dates.Consequently, the investments are not currently liquid and we will not be ableto access these funds until a future auction of these investments issuccessful. Maturity dates for these ARS investments range from 2010 to 2045with principal distributions occurring on certain securities prior to maturity.We currently have the ability and intent to hold these ARS investments until arecovery of the auction process or until maturity.

 

Typically the fair value of ARS investments approximates par value due tothe frequent resets through the auction process. While we continue to earninterest on our ARS investments at the maximum contractual rate, theseinvestments are not currently trading and therefore do not currently have areadily determinable market value. Accordingly, the estimated fair value of ARSno longer approximates par value.

 

We determined the estimated fair value of our investment in ARS as of April 5,2008 using a discounted cash flow model to estimate the fair value of ourinvestments in ARS. The assumptions used in preparing the discounted cash flowmodel include estimates for interest rates, timing and amount of cash flows andexpected holding periods of the ARS. Based on this assessment of fair value, asof April 5, 2008 we determined there was a decline in the fair value ofour ARS investments of $7.2 million, with no related tax benefit, of which allwas deemed temporary and an impairment charge was recorded in the othercomprehensive income component of shareholders’ equity.

 

We review our impairments in accordance with SFAS No. 115, *Accounting for Certain Investments in Debt and EquitySecurities*, and related guidance issued by the FASB and SEC inorder to determine the classification of the impairment as “temporary” or “other-than-temporary”.A temporary impairment charge results in an unrealized loss being recorded inthe other comprehensive income component of shareholders’ equity. Such anunrealized loss does not affect net income for the applicable accountingperiod. An other-than-temporary impairment charge is recorded as a realizedloss in the condensed consolidated statement of income and reduces net incomefor the applicable accounting period. The differentiating factors betweentemporary and other-than-temporary impairment are primarily the length of thetime and the extent to which the market value has been less than cost, thefinancial condition and near-term prospects of the issuer and our currentintent and ability to retain our investment in the issuer for a period of timesufficient to allow for any anticipated recovery in market value.

 

The valuation of our investment portfolio is subject to uncertainties thatare difficult to predict. Factors that may impact its valuation include changesto credit ratings of the securities as well as to the underlying assetssupporting those securities, rates of default of the underlying assets,underlying collateral value, discount rates and ongoing strength and quality ofmarket credit and liquidity.

 

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*Long-livedassets.* We review long-lived assets for impairment wheneverevents or changes in circumstances, such as store closures or poor performingstores, indicate that the carrying value of an asset may not be recoverable. Ifthe undiscounted cash flows from the long-lived assets are less than thecarrying value we record an impairment charge equal to the difference betweenthe carrying value and the asset’s fair value. 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.  Duringthe nine months ended April 5, 2008 and April 7, 2007 we recorded$773,000 and $0, respectively, of impairment charges.  We believe at thistime that the long-lived assets’ carrying values and useful lives continue tobe appropriate.

 

*AccruedLitigation.*  We accrue estimates of probable liabilitiesassociated with lawsuits and claims. The results of any litigation areinherently uncertain. As information becomes available, we assess the potentialliabilities related to pending litigation and may revise our estimates asnecessary. Such revisions of estimates could materially impact the results ofoperations and financial position.

 

*SelfInsurance*.   We use a combination of insurance andself insurance for employee related health care benefits. We record selfinsurance liabilities based on claims filed and an estimate of those claimsincurred but not reported. Any projection of losses concerning our liability issubject to a high degree of variability. Among the causes of this variabilityare unpredictable external factors such as future inflation rates, changes inseverity, benefit level changes, medical costs and claim settlement patterns.Should a different amount of claims occur compared to what was estimated orcosts of the claims increase or decrease beyond what was anticipated, reservesmay need to be adjusted in the future.

 

*IncomeTaxes*.   On July 8, 2007, we adopted FIN 48.FIN 48 prescribes a recognition threshold that a tax position is required tomeet before being recognized in the financial statements and provides guidanceon derecognition, measurement, classification, interest and penalties,accounting in interim periods, disclosure and transition issues. To the extent thatour estimates change or the final tax outcome of these matters is differentthan the amounts recorded, such differences will impact the income taxprovision in the period in which such determinations are made. Our effectivetax rate in a given financial statement period may be materially impacted bychanges in the mix and level of earnings, changes in the expected outcome ofaudits or changes in the deferred tax valuation allowance.

 

**RESULTSOF OPERATIONS**

 

Our fiscal year isa 52 or 53 week period, each period ending on the first Saturday after June 30. Fiscal years 2008 and 2007 include 52 weeks and 53 weeks, respectively. The three months ended April 5, 2008 and April 7, 2007 include 13weeks and 14 weeks, respectively.  The nine months ended April 5,2008 and April 7, 2007 include 39 weeks and 40 weeks, respectively.

 

The followingtable sets forth certain financial data as a percentage of net sales for theperiods indicated:

 
| ** **                                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **April 5,**                | ** ** | **April 7,**               | ** ** | **April 5,** | ** ** | **April 7,** | ** ** |
| ** **                                             | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Net sales                                              |       | 100.0                            | %          | 100.0                           | %          | 100.0 | % | 100.0 | % |
| Cost of sales,  including production and occupancy (1) |       | 56.2                             |       | 54.7                            |       | 54.1 |   | 52.1 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Gross margin                                           |       | 43.8                             |       | 45.3                            |       | 45.9 |   | 47.9 |   |
| Selling, general  and administrative expenses (2)      |       | 38.9                             |       | 35.1                            |       | 34.5 |   | 32.1 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Operating income                                       |       | 4.9                              |       | 10.2                            |       | 11.4 |   | 15.8 |   |
| Interest and  other income, net                        |       | 3.4                              |       | 2.9                             |       | 2.5 |   | 2.0 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Income before  income taxes                            |       | 8.3                              |       | 13.1                            |       | 13.9 |   | 17.8 |   |
| Provision for  income taxes                            |       | 2.8                              |       | 4.7                             |       | 4.8 |   | 6.5 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Net income                                             |       | 5.5                              | %          | 8.4                             | %          | 9.1 | % | 11.3 | % |

 

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(1)                                       Costof sales includes the cost of merchandise, occupancy costs, distribution centerand production costs.

 

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

 

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*NetSales.* Net sales decreased to $151.7 million during the threemonths ended April 5, 2008 from $154.4 million for the comparable periodof the prior year, a decrease of $2.7 million, or 1.7%. The decrease in salesis primarily due to an additional $10 million in sales in fiscal 2007 due tothe extra week in fiscal January 2007. Net sales excluding the additional week in fiscal 2007 increased by $7.3million or 5.1%. The increase in sales is primarily due to a $17.4 millionincrease in stores not included in the comparable store sales, an increase inon-line sales and an increase in wholesale sales to international licenseespartially offset by a 7.6% decrease in comparable store sales totaling $9.6million.  Same store sales exclude the additional week from January 2007.

 

For the ninemonths ended April 5, 2008, net sales increased to $516.1 million from $508.2million for the comparable period of the prior year, an increase of $7.9million, or 1.6%. Net sales excluding the additional week in fiscal 2007increased by $17.9 million or 3.6%. The increase in sales is primarily due to a$54.2 million increase in sales for stores not included in the comparable storesales base, an increase in on-line sales and an increase in wholesale sales tointernational licensees, partially offset by an 8.3% decrease in comparablestore sales totaling $36.8 million during the nine months ended April 5,2008 as compared to the same period in the prior.  Same store sales exclude the additional weekfrom January 2007.

 
| ** **                                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **April 5,**                | ** ** | **April 7,**               | ** ** | **April 5,** | ** ** | **April 7,** | ** ** |
| ** **                                             | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Net sales (In  thousands)                              |       | $                                | 151,729    |                            | $          | 154,354 |   | $ | 516,140 |   | $ | 508,215 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Total net sales  increase (decrease) percentage        |       | (1.7                             | )%         | 16.3                            | %          | 1.6 | % | 19.0 | % |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Comparable store  sales increase (decrease) percentage |       | (7.6                             | )%         | (0.4                            | )%         | (8.3 | )% | 5.9 | % |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Net sales per  average square foot (1)                 |       | $                                | 141        |                            | $          | 162 |   | $ | 495 |   | $ | 550 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Square footage  at end of period (In thousands)        |       | 1,060                            |       | 942                             |       | 1,060 |   | 942 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Number of store  locations:                            |       |                             |       |                            |       |   |   |   |   |
| Beginning of  period                                   |       | 290                              |       | 258                             |       | 273 |   | 242 |   |
| New store  locations                                   |       | 4                                |       | 6                               |       | 21 |   | 22 |   |
| Closed store  locations                                |       | 4                                |       | 5                               |       | 4 |   | 5 |   |
| Number of stores  open at end of period                |       | 290                              |       | 259                             |       | 290 |   | 259 |   |

 

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(1)       We calculate net sales per average squarefoot using net store sales and a monthly average store square footage.

 

*GrossMargin.*Gross margin decreased to $66.3 million during thethree months ended April 5, 2008 from $69.9 million for the comparableperiod of the prior year, a decrease of $3.6 million, or 5.2%. As a percentageof net sales, gross margin decreased to 43.8% for the three months ended April 5,2008 from 45.3% in the comparable period of the prior year.  The decreasein gross margin as a percentage of net sales resulted primarily due to unfavorableoccupancy leverage partially offset by higher merchandise margin as a result oflower markdowns.  In addition, grossmargin in the third quarter of fiscal 2007 included substantial raw materialreserves reversals.

 

For the ninemonths ended April 5, 2008, gross margin decreased to $236.9 million from$243.5 million for the comparable period of the prior year, a decrease of $6.6million, or 2.7%. As a percentage of net sales, gross margin decreased to 45.9%for the nine months ended April 5, 2008 from 47.9% in the comparableperiod of the prior year.  The decrease in gross margin as a percentage ofnet sales resulted primarily due to higher markdowns and unfavorable occupancyleverage, partially offset by a decrease in inventory reserves.

 

*Selling,General and Administrative Expenses.*Selling, general andadministrative expenses, which primarily consist of non-occupancy store costs,corporate overhead and advertising costs, increased to $59.0 million during thethree months ended April 5, 2008 from $54.1 million for the comparableperiod of the prior year, an increase of $4.9 million, or 9.1 %. As apercentage of net sales, selling, general and administrative expenses increasedto 38.9% during the three months ended April 5, 2008 from 35.1% in thecomparable period of the prior year.  The increase in selling, general andadministrative expenses as a percentage of net sales from the prior year of3.8% was primarily due to higher total compensation expense, advertisingexpense and the recording of an impairment charge for three underperformingstore locations.

 

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Selling, generaland administrative expenses increased to $177.9 million during the nine monthsended April 5, 2008 from $163.4 million for the comparable period of theprior year, an increase of $14.5 million, or 8.9 %. As a percentage of netsales, these expenses increased to 34.5% during the nine months ended April 5,2008 from 32.1% in the comparable period of the prior year.  The increaseas a percentage of net sales from the prior year of 2.4% was primarily due toan increase in total compensation expense, including stock based compensation,advertising expense and depreciation expense.

 

*Interestand Other Income, Net.* We generated approximately $5.2million of interest and other income (net of other expenses) during the threemonths ended April 5, 2008 compared to approximately $4.4 million in thecomparable period of the prior year. The increase was primarily the result ofhigher interest rates on our tax-exempt investments and $0.6 million in foreigncurrency gains related to settling intercompany inventory accounts due fromCanada.

 

For the ninemonths ended April 5, 2008, we generated approximately $13.0 million ofinterest and other income (net of other expenses), compared to $10.1 million inthe comparable period of the prior year.  The increase was primarily theresult of higher interest rates on our tax-exempt investments and $0.6 millionin foreign currency gains related to settling intercompany inventory accountsdue from Canada.

 

*Provisionfor Income Taxes.*Our effective tax rate decreased to 33.6%for the three months ended April 5, 2008 from 35.9% for the comparableperiod in the prior year primarily due to an increase in tax-exempt interestincome as a percent of total pretax income and an increase in ourallowable domestic manufacturing deduction.

 

For the ninemonths ended April 5, 2008, our effective tax rate decreased to 34.5% from36.1% for the comparable period in the prior year primarily due to an increasein tax-exempt interest income as a percentage of total pretax income and anincrease in our allowable domestic manufacturing deduction.

 

**Seasonalityof Business and Quarterly Results**

 

Our businessvaries with general seasonal trends that are characteristic of the retail andapparel industries. As a result, our typical store generates a higherpercentage of our annual net sales and profitability in the second quarter ofour fiscal year, which includes the holiday selling season, compared to theother quarters of our fiscal year. If for any reason our sales were belowseasonal norms during the second quarter of our fiscal year, our annualoperating results would be negatively impacted. Because of the seasonality ofour business, results for any quarter are not necessarily indicative of resultsthat may be achieved for a full fiscal year.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

Our workingcapital requirements vary widely throughout the year and generally peak duringthe first and second fiscal quarters. At April 5, 2008, we hadapproximately $347.4 million of cash and equivalents and investments on hand ofwhich approximately, $264 million, net of a temporary impairment charge of $7.2million, were invested in auction rate securities (“ARS”). Due to the recentfailures of these auctions we have classified $251 million of these investmentsas long term investments. We do not anticipate the lack of liquidity in the ARSto impact our liquidity and believe we have sufficient cash and equivalents tofund ongoing operations. In addition, we had a revolving line of credit, underwhich we could borrow or issue letters of credit up to a combined total of $25million. As of April 5, 2008, there were no cash borrowings outstandingunder the line of credit, and letters of credit outstanding totaled $1.9million.

 

Net cash providedby operating activities for the nine months ended April 5, 2008 was $64.7million versus $62.7 million for the nine months ended April 7, 2007. Cashprovided by operating activities for the period was primarily generated by netincome of $47.1 million adjusted for stock compensation of $8.5 million,depreciation of $16.9 million, deferred rent of $5.3 million, deferred incometaxes of $2.4 million and net loss on disposal of property of $0.8 million, aswell as changes in working capital. The changes in working capital wereprimarily due to an increase in prepaid expenses and other assets of $6.0million, an increase in receivables of $5.1 million, a decrease in accountspayable of $1.9 million and an increase in inventory of $0.5 million, partiallyoffset by an increase in accrued liabilities of $2.0 million.

 

Net cash providedby investing activities for the nine months ended April 5, 2008 was $28.5million versus net cash used by investing activities of $53.9 million for thenine months ended April 7, 2007.  Cash provided by investingactivities for the period was primarily due to the sales of marketablesecurities of $393.0 million, partially offset by purchases of marketable securitiesof $337.0 million and capital expenditures of $28.0 million related to theopening of new stores.  We opened 21 new stores in the nine months ended April 5,2008 and expect to open approximately 35 stores during fiscal 2008.  Weestimate that total capital expenditures will be approximately $45 million infiscal 2008.

 

Net cash used byfinancing activities was $78.0 million for the nine months ended April 5,2008 versus net cash provided by financing activities of $3.0 million for thenine months ended April 7, 2007.  Cash used by financing activitiesfor the period was primarily due to the purchase of 5 million shares of ouroutstanding common stock totaling $66.9 million and payments of quarterlydividends for the fourth quarter of fiscal 2007 and the first and secondquarters of fiscal 2008 totaling $13.8 million, partially offset by proceedsreceived from stock option exercises of $2.2 million and the related taxbenefit of $0.6 million.

 

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As of April 5, 2008,we had a balance of approximately $264 million in investments in ARS, of which$251 million were classified as long term investments and $13 million wereclassified as short term marketable securities because either the ARS was soldin a successful auction or was called by issuer.  Our ARS portfolio includes approximately 83%federally insured student loan backed securities and 17% municipal authoritybonds. Our ARS portfolio is comprised of approximately 85% AAA ratedinvestments, 4% AA rated investments and 11% A rated investments.  These ARS investments areintended to provide liquidity via an auction process that resets the applicableinterest rate at predetermined calendar intervals, allowing investors to eitherroll over their holdings or gain immediate liquidity by selling such interestsat par. The recent uncertainties in the credit markets have affected ourholdings in ARS investments and auctions for the majority of our investments inthese securities have failed to settle on their respective settlement dates.Consequently, the investments are not currently liquid and we will not be ableto access these funds until a future auction of these investments issuccessful. Maturity dates for these ARS investments range from 2010 to 2045with principal distributions occurring on certain securities prior to maturity.We currently have the ability and intent to hold these ARS investments until arecovery of the auction process or until maturity.

 

During our firstquarter of fiscal 2008, we entered into an agreement with our former ViceChairperson Neda Mashouf to purchase 5 million shares of our common stockbeneficially owned by Ms. Mashouf at a price per share of $13.39, anaggregate purchase price of $66,950,000.  We may purchase additional sharesfrom Ms. Mashouf or other shareholders in the future.

 

We believe thatour cash on hand, together with our cash flows from operations, will besufficient to meet our capital and operating requirements for at least the nexttwelve months. Our future capital requirements, however, will depend onnumerous factors, including without limitation, liquidity of our auction ratesecurities, the size and number of new and expanded stores and/or storeconcepts, investment costs for management information systems, potentialacquisitions and/or joint ventures, repurchase of stock and future results ofoperations.

 

**Inflation**

 

We do not believethat inflation has had a material effect on the results of operations in therecent past. However, we cannot assure you that our business will not beaffected by inflation in the future.

 

**ITEM3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

We are exposed tomarket risks, which include changes in U.S. interest rates and, to a lesserextent, foreign exchange rates. We do not engage in financial transactions fortrading or speculative purposes.

 

*InterestRate Risk*

 

We currently maintain aportfolio of variable interest rate investments consisting of cash equivalents,and short term marketable securities and long term investments comprised ofauction rate securities (“ARS”). Our ARS portfolio includes approximately 83%federally insured student loan backed securities and 17% municipal authoritybonds. Our ARS portfolio includes approximately 85% AAA rated investments, 4%AA rated investments and 11% A rated investments.  According to our investment policy, we mayinvest in taxable and tax-exempt instruments.  In addition, the policyestablishes limits on credit quality, maturity, issuer and type of instrument.Marketable securities are classified as “available for sale”.  We do notuse derivative financial instruments in our investment portfolio.

 

All highly liquidinvestments with a maturity of three months or less at the date of purchase areconsidered to be cash equivalents.  Investments are considered short termmarketable securities if the original maturity is between three months andtwelve months, or long term investments if the original maturity is greaterthan twelve months. Typicallythe fair value of ARS investments approximates par value due to the frequentresets through the auction process. While we continue to earn interest on ourARS investments at the maximum contractual rate, these investments are notcurrently trading and therefore do not currently have a readily determinablemarket value. Accordingly, the estimated fair value of ARS no longerapproximates par value. We determined the estimated fair value of ourinvestment in ARS as of April 5, 2008 using a discounted cash flow modelto estimate the fair value of our investments in ARS. The assumptions used inpreparing the discounted cash flow model include estimates for interest rates,timing and amount of cash flows and expected holding periods of the ARS. Basedon this assessment of fair value, as of April 5, 2008 we determined therewas a decline in the fair value of our ARS investments of $7.2 million, with norelated tax benefit, of which all was deemed temporary and an impairment chargewas recorded in the other comprehensive income component of shareholders’equity.  As of April 5, 2008, wereclassified $251 million of our short term marketable securities to long terminvestments on our condensed consolidated balance sheet because of ourinability to determine when our investments in ARS will settle.  We have also modified our current investmentstrategy and increased our investments in more liquid money marketinvestments.  An immediate and uniformincrease in market interest rate of 100 basis points from levels at April 5,2008 would cause an additional decline of approximately 3%, or $7.3 million, inthe fair market value of our investments in ARS.

 

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The followingtable lists our cash equivalents and investments at April 5, 2008:

 
| ** **                          | ** ** | **Book Value**                  | ** ** | **Fair Value** | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|---------------------|------------|
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| Cash equivalents                    |       | $                                    | 64,342     |                | $          | 64,342 |   |
| Weighted average  interest rate (1) |       | 2.94                                 | %          |                |       |
| Short term marketable  securities   |       | $                                    | 13,400     |                | $          | 13,400 |   |
| Weighted average  interest rate (1) |       | 6.29                                 | %          |                |       |
| Long term  investments              |       | $                                    | 250,503    |                | $          | 250,503 |   |
| Weighted average  interest rate (1) |       | 5.53                                 | %          |                |       |
| Total                               |       | $                                    | 328,245    |                | $          | 328,245 |   |

 

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(1)   Represents the weighted average interest ratefor tax-exempt municipal bonds, municipal preferreds, corporate preferreds andtaxable and tax-exempt institutional money market instruments.

 

The interestpayable on outstanding cash borrowings under our bank line of credit is basedon variable interest rates and therefore affected by changes in market interestrates. As we have no outstanding cash borrowings, if interest rates rosesignificantly, our results from operations and cash flows would not beaffected.

 

*ForeignCurrency Risks*

 

We enter into asignificant amount of purchase obligations outside of the United States,substantially all of which are negotiated and settled in U.S. Dollars and,therefore, have only minimal exposure to foreign currency exchange risks. Wealso operate a subsidiary for which the functional currency is the CanadianDollar. In accordance with SFAS No. 52, “Foreign Currency Translation”,assets and liabilities of Canada’s operations are translated into U.S. dollarsat quarter-end rates, while income and expenses are translated at the weightedaverage exchange rates for the quarter. The related translation adjustments arerecorded in accumulated other comprehensive income as a separate component ofshareholders’ equity. Fluctuations in exchange rates therefore impact ourfinancial condition and results of operations, as reported in U.S.Dollars.   We do not hedge against foreign currency risks and believethat foreign currency exchange risk is immaterial.

 

**ITEM 4.          CONTROLSAND 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 under Rule 13a-15(e) promulgatedunder the Securities Exchange Act of 1934, as amended. Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures were effective as of the end of theperiod covered by this quarterly report at the reasonable assurance level.

 

There has been nochange in our internal control over financial reporting during the quarterended April 5, 2008 that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

 

**PART II         OTHERINFORMATION**

 

**ITEM 1.          LEGALPROCEEDINGS**

 

See the Legal Matterssection of the Notes to the Condensed Consolidated Financial Statements for adiscussion of legal proceedings.

 

**ITEM 1A.       RISKFACTORS**

 

Our past performance maynot be a reliable indicator of future performance because actual future resultsand trends may differ materially depending on a variety of factors, including,but not limited to, the risks and uncertainties discussed below. In addition,historical trends should not be used to anticipate results or trends in futureperiods.

 

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Factors that might causeour actual 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, those set forthbelow.  There have been no material changes in our risk factors from thosedisclosed in Part I, Item 1A of our Annual Report on Form 10-Kfor the fiscal year ended July 7, 2007, other than with respect to ourinvestments in auction rate securities.

 

RISKS RELATING TO OURBUSINESS:

 

**1. Thesuccess of our business depends in large part on our ability to identifyfashion trends as well as to react to changing customer demand in a timelymanner.** Consequently, we depend in part upon the customerresponse to the creative efforts of our merchandising, design and marketingteams and their ability to anticipate trends and fashions that will appeal toour consumer base. If we miscalculate our customers’ product preferences or thedemand for our products, we may be faced with excess inventory. Historically,this type of occurrence has resulted in excess fabric for some products andmarkdowns and/or write-offs, which has impaired our profitability, and may doso in the future. Similarly, any failure on our part to anticipate, identifyand respond effectively to changing consumer demands and fashion trends willadversely affect our sales.

 

**2. If weare unable to obtain raw materials, or unable to find manufacturing facilitiesor if our manufacturers perform unacceptably, our sales may be negativelyaffected and our financial condition may be harmed**. We do notown any manufacturing facilities and therefore depend on contractors and thirdparties to manufacture our products. We place all of our orders for productionof merchandise and raw materials by purchase order and do not have anylong-term contracts with any manufacturer or supplier. If we fail to maintainfavorable relationships with our manufacturers and suppliers or are unable toobtain sufficient quantities of quality raw materials on commerciallyreasonable terms, it could harm our business and results of operations. Wecannot assure you that contractors and third-party manufacturers (1) willnot supply similar products to our competitors, (2) will not stopsupplying products to us completely or (3) will supply products in atimely manner. Untimely receipt of products may result in lower thananticipated sales and markdowns 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 that fail to conform to our qualitycontrol standards. In such event, unless we are able to obtain replacementproducts in a timely manner, we may lose sales. Certain of our third-party manufacturersstore our raw materials. In the event our inventory is damaged or destroyedwhile in storage and we are unable to obtain replacement raw materials, ourearnings may be negatively impacted.

 

**3. Oursuccess depends on our ability to attract and retain qualified employees inorder to support our existing business and future expansion.**From time to time we actively recruit qualified candidates to fill keyexecutive positions from within the Company. There is substantial competitionfor experienced personnel, which we expect will continue. We compete forexperienced personnel with companies who have greater financial resources thanwe do. In the past, we have experienced significant turnover of our executivemanagement team and retail store personnel. We are also exposed to employmentpractice litigation due to the large number of employees and high turnover ofour sales associates. If we fail to attract, motivate, and retain qualifiedpersonnel, it could harm our business and limit our ability to expand.

 

In addition, we depend onthe expertise and execution of our key employees, particularly Manny Mashouf,our founder and Chairman of the Board, and Gregory Scott, our Chief ExecutiveOfficer and member of the Board of Directors. If we lose the services of Mr. Mashoufor Mr. Scott, or any key officers or employees, it could harm our businessand results of operations.

 

**4. If weare not able to successfully develop new concepts, including BEBE SPORT and 2bbebe, our revenue base and earnings may be impaired**. Fromtime to time, we may pursue new concepts.  If the BEBE SPORT and 2b bebeor other new concepts are not successful, our financial condition may beharmed.

 

**5. Wecannot assure you that future store openings will be successful, and new storeopenings may impact existing stores.** We expect to openapproximately 35 stores in fiscal 2008, of which 19 will be bebe stores, 9 willbe BEBE SPORT stores and 7 will be 2b bebe stores. We cannot assure you thatthe stores that we plan to open in fiscal 2008, or any other stores that wemight open in the future, will be successful or that our overall operatingprofit will increase as a result of opening these stores. During fiscal 2008 weclosed 4 bebe stores and do not anticipate closing any additional stores for theremainder of the fiscal year. For fiscal 2008, we plan to grow our operationsprimarily through the opening of new stores. Most of our new store openings infiscal 2008 will be in existing markets. These openings may affect the existingstores’ net sales and profitability. Our failure to predict accurately thedemographic or retail environment at any future store location could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

Our ability toeffectively obtain real estate to open new stores depends upon the availabilityof real estate that meets our criteria, including traffic, square footage,co-tenancies, average sales per square foot, lease economics, demographics, andother factors, and our ability to negotiate terms that meet our financialtargets. In addition, we must be able to effectively renew our existing storeleases. Failure to secure real estate locations adequate to meet annual targetsas well as effectively managing the profitability of our existing fleet ofstores could have a material adverse effect on our results of operations.

 

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**6. Weare subject to risks associated with our on-line sales.**Weoperate an on-line store at www.bebe.com to sell our merchandise. 

Although our on-linesales encompass a relatively small percentage of our total sales, our on-lineoperations are subject to numerous risks, including unanticipated operatingproblems, reliance on third-party computer hardware and software providers. Theon-line operations also involve other risks that could have an impact on ourresults of operations including but not limited to diversion of sales from ourstores, rapid technological change, liability for on-line content, securitybreaches, consumer privacy concerns, credit card fraud, and risks related tothe failure of the computer systems that operate the website and its relatedsupport systems. In addition, given our use of a third party platform, we donot have direct control of certain aspects of our on-line business. We cannotassure you that our on-line store will continue to achieve sales andprofitability growth or even remain at its current level.

 

**7. Anyserious disruption at our major facilities could have a harmful effect on our business.**We currently operate a corporate office in Brisbane, California, a distributionfacility in Benicia, California, and a design studio and production facility inLos Angeles, California. Any serious disruption at these facilities whether dueto construction, relocation, fire, earthquake, terrorist acts or otherwisewould harm our operations and could have a harmful effect on our business andresults of operations. Furthermore, we have little experience operatingessential functions away from our main corporate offices and are uncertain whateffect operating such satellite facilities might have on business, personneland results of operations.

 

**8. Werely on information technology, the disruption of which could adversely impactour business.** We rely on various information systems tomanage our operations and regularly make investments to upgrade, enhance orreplace such systems. To support our growth we initiated a three year IS&Tstrategic plan and we are currently entering year three of this plan. Ifwe fail to successfully implement the plan, our business could be adverselyaffected.

 

**9. Weface significant competition in the retail and apparel industry, which couldharm our sales and profitability.** The retail and apparelindustries are highly competitive and are characterized by low barriers toentry. We expect competition in our markets to increase. The primarycompetitive factors in our markets are: brand name recognition, sourcing,product styling, quality, presentation and pricing, timeliness of productdevelopment and delivery, store ambiance, customer service andconvenience.  We compete with traditional department stores, specialtystore retailers, 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 withthem. If we fail to remain competitive in any way, it could harm our business,financial condition and results of operations.

 

**10.Purchases of the merchandise we sell are generally discretionary and aretherefore particularly susceptible to economic conditions.**The outlook for the United States economy is uncertain and is directly affectedby global factors that are beyond our control. Such factors include disposableconsumer income, oil prices, recession and fears of recession, war and fears ofwar, terrorist attacks, inclement weather, consumer debt, interest rates, salestax rates, consumer confidence in future economic conditions and politicalconditions, and consumer perceptions of personal well-being and security.Consumers are generally more willing to make discretionary purchases, includingpurchases of fashion products, during periods in which favorable economicconditions prevail. If economic conditions change, our business, financialcondition and results of operations could be adversely affected. We cannotpredict the indirect effects such as rising oil and freight prices, consumerspending or other economic factors that natural disasters will have on ourresults of operations.

 

**11. Ourbusiness could be adversely impacted by unfavorable international politicalconditions.** Due to our international operations, our salesand operating results are, and will continue to be, affected by internationalsocial, political, legal and economic conditions. In particular, our businesscould be adversely impacted by instability or changes resulting in thedisruption of trade with the countries in which our contractors, suppliers orcustomers are located, significant fluctuations in the value of the dollaragainst foreign currencies or restrictions on the transfer of funds, oradditional trade restrictions imposed by the United States and other foreigngovernments. Trade restrictions, including increased tariffs or quotas,embargoes, and customs restrictions could increase the cost or reduce the supplyof merchandise available to the company and adversely affect its financialcondition and results of operations. In addition, we purchase a substantialamount of our raw materials from China and our business and operating resultsmay be affected by changes in the political, social or economic environment inChina.

 

**12. Ifwe are not able to successfully protect our intellectual property our abilityto capitalize on the value of our brand name may be impaired**.Even though we take actions to establish, register and protect our trademarksand other proprietary rights, we cannot assure you that we will be successfulor that others will not imitate our products or infringe upon our intellectualproperty rights. In addition, we cannot assure that others will not resist orseek to block the sale of our products as infringements of their trademark andproprietary rights.

 

We are seeking toregister our trademarks domestically and internationally. Obstacles may existthat may prevent us from obtaining a trademark for the bebe name or relatednames. We may not be able to register certain trademarks, purchase the right orobtain a license to use the bebe name or related names on commerciallyreasonable terms. If we fail to obtain trademark, ownership or license the requisiterights, 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 reputation and value associatedwith our trademarks may be diluted.  Furthermore, if we do not demonstrateuse of our trademarks, our trademark rights may lapse over time.

 

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**13. We may be required to record impairment charges infuture quarters as a result of the decline in value of our investments inauction rate securities.**We hold a variety of interestbearing auction rate securities (“ARS”) comprised of federally insured studentloan backed securities and insured municipal authority bonds. These ARSinvestments are intended to provide liquidity via an auction process thatresets the applicable interest rate at predetermined calendar intervals,allowing investors to either roll over their holdings or gain immediateliquidity by selling such interests at par. The recent uncertainties in thecredit markets have affected our holdings in ARS investments and the majorityof auctions for our investments in these securities have failed to settle ontheir respective settlement dates. Consequently, $251 million of our ARS arenot currently liquid and we will not be able to access these funds until afuture auction of these investments is successful or a buyer is found outsideof the auction process. Maturity dates for these ARS investments range from2010 to 2045 with principal distributions occurring on certain securities priorto maturity.

 

The valuation of our investment portfolio is subject to uncertainties thatare difficult to predict. Factors that may impact its valuation include changesto credit ratings of the securities as well as to the underlying assetssupporting those securities, rates of default of the underlying assets,underlying collateral value, discount rates and ongoing strength and quality ofmarket credit and liquidity.

 

Although we currently have the ability and intent to hold these ARSinvestments until a recovery of the auction process or until maturity, if thecurrent market conditions deteriorate further, or the anticipated recovery inmarket values does not occur, we may be required to record additionalunrealized losses in other comprehensive income or impairment charges in futurequarters.

 

**14. Ifan independent manufacturer violates labor or other laws, or is accused ofviolating any such laws, or if their labor practices diverge from thosegenerally accepted as ethical, it could harm our business and brand image**.While we maintain a policy to monitor the operations of our independentmanufacturers by having an independent firm inspect these manufacturing sites,and all manufacturers are contractually required to comply with such laborpractices, 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 manufacturers’business practices, and the manufacturers act in their own interest, they mayact in a manner that result in negative public perceptions of us and/oremployee allegations or court determinations that we are jointly liable.

 

 RISKS RELATING TOOUR COMMON STOCK:

 

**1. Ourstock price may fluctuate because of the relatively low number of shares thatcan be publicly traded.** The vast majority of our outstandingshares of our common stock are subject to trading restrictions. As of April 5,2008, of the approximately 89,000,000 shares of our common stock thenoutstanding, approximately 27,000,000 shares were available to be publiclytraded, and as a result, our stock price is vulnerable to market swings due tolarge purchases, sales and short sales of our common stock.

 

**2.Because Manny Mashouf beneficially owns a substantial portion of theoutstanding shares, other shareholders may not be able to influence thedirection the company takes.** As of April 30, 2008, MannyMashouf, the Chairman of the Board, beneficially owned approximately 56% of theoutstanding shares of our common stock. As a result, he can control theelection of directors and the outcome of all issues submitted to theshareholders. 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. Oursignificant shareholders hold a substantial portion of our stock which mayresult in the trading volatility or may adversely affect our common stock.**As of April 30, 2008, Ms. Neda Mashouf currently owned approximately13% of the outstanding shares of our common stock. As a result, any change inownership of a significant portion of these shares, including sales by Ms. Mashouf,may result in trading volatility in our common stock or may adversely affectour stock price.

 

**4. Our sales,margins and operating results are subject to seasonal and quarterlyfluctuations.** Our business varies with general seasonaltrends that are characteristic of the retail and apparel industries, such asthe timing of seasonal wholesale shipments and other events affecting retailsales. As a result, our stores typically generate a higher percentage of ourannual net sales and profitability in the second quarter of our fiscal year,which includes the holiday selling season, compared to other quarters.

 

In addition, ourcomparable store sales have fluctuated significantly in the past, and we expectthat they will continue to fluctuate in the future. A variety of factors affectcomparable store sales, including fashion trends, competition, current economicconditions, the timing of release of new merchandise and promotional events,changes in our merchandise mix, the success of marketing programs and weatherconditions. Our ability to deliver strong comparable store sales results andmargins depends in large part on accurately forecasting demand and fashiontrends, selecting effective marketing techniques, providing an appropriate mixof merchandise for our customer base, managing inventory effectively, andoptimizing store performance by closing underperforming stores. Suchfluctuations may adversely affect the market price of our common stock.

 

**5.Failure to comply with Section 404 of the Sarbanes-Oxley Act of 2002 couldnegatively impact investor confidence.**In order to meet therequirements of the Sarbanes-Oxley Act of 2002 in future periods, we mustcontinuously document, test, monitor and enhance our internal control overfinancial reporting.  We cannot assure you that the periodic evaluation ofour internal controls required by Section 404 of the Sarbanes-Oxley Actwill not result in the identification of significant control deficienciesand/or material weaknesses or that our auditors will be able to attest to theeffectiveness of our internal control over financial reporting. 

 

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Failure to maintain theeffectiveness of our internal control over financial reporting or to complywith the requirements of this Act could have a material adverse effect on ourreputation, financial condition and market price of our common stock.

 

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

 

Not applicable.

 

**ITEM3.  DEFAULTS UPON SENIOR SECURITIES**

 

Not applicable.

 

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

 

Not applicable.

 

**ITEM5.  OTHER INFORMATION**

 

                Not applicable.

 

**ITEM6.  EXHIBITS**

 

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

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

 

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**SIGNATURE**

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|   | Dated May 15, 2008                                             |
|--------|---------------------------------------------------------------------|
|   |                                                                |
|   | bebe stores, inc.                                                   |
|   |                                                                |
|   | /s/ Walter Parks                                                    |
|   | Walter Parks, Chief  Operating Officer and Chief Financial  Officer |

 

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EXHIBIT INDEX

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

 

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