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

 

**FORM 10-Q**

 

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

 

**For thequarterly period ended October 6, 2007**

 

**OR**

** **

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

 

**Commission File Number 0-24395**

 

**bebestores, inc.******(Exact name ofregistrant as specified in its charter)

 

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

** **

**400 Valley Drive**

**Brisbane, California 94005**

(Address of principal executive offices)

 

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

 

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

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of theSecurities Exchange Act).  o Large accelerated filer x Accelerated filer oNon- accelerated filer

 

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

 

The number of shares of the registrant’s common stock,par value $0.001 per share, outstanding as of October 31, 2007 was 88,609,936.

 

**bebe stores, inc.**

 

 

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#### **TABLE OF CONTENTS**

#### ** **

| **PART  I.     FINANCIAL INFORMATION** |                                                                                                            |
|-----------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------|
|                                                            |                                                                                                            |   |
| ITEM 1.                                                         | Condensed Consolidated  Financial Statements                                                                    |   |
|                                                            |                                                                                                            |   |
|                                                            | Condensed  Consolidated Balance Sheets as of October 6, 2007, July 7, 2007 and September  30, 2006              | 3 |
|                                                            |                                                                                                            |   |
|                                                            | Condensed  Consolidated Statements of Income for the quarters ended October 6, 2007 and  September 30, 2006     | 4 |
|                                                            |                                                                                                            |   |
|                                                            | Condensed  Consolidated Statements of Cash Flows for the quarters ended October 6, 2007  and September 30, 2006 | 5 |
|                                                            |                                                                                                            |   |
|                                                            | Notes to Condensed Consolidated Financial Statements                                                            | 6 |
|                                                            |                                                                                                            |   |
| ITEM 2.                                                         | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                     | 13 |
|                                                            |                                                                                                            |   |
| ITEM 3.                                                         | Quantitative  and Qualitative Disclosures about Market Risk                                                     | 20 |
|                                                            |                                                                                                            |   |
| ITEM 4.                                                         |  Controls and Procedures                                                                                   | 21 |
|                                                            |                                                                                                            |   |
| **PART  II.     OTHER INFORMATION**    |                                                                                                            |
|                                                            |                                                                                                            |   |
| ITEM 1.                                                         | Legal Proceedings                                                                                               | 22 |
|                                                            |                                                                                                            |   |
| ITEM 1A.                                                        | Risk Factors                                                                                                    | 22 |
|                                                            |                                                                                                            |   |
| ITEM 2.                                                         | Unregistered  Sales of Equity Securities and Use of Proceeds                                                    | 26 |
|                                                            |                                                                                                            |   |
| ITEM 3.                                                         | Defaults Upon  Senior Securities                                                                                | 26 |
|                                                            |                                                                                                            |   |
| ITEM 4.                                                         | Submission of  Matters to a Vote of Security Holders                                                            | 26 |
|                                                            |                                                                                                            |   |
| ITEM 5.                                                         | Other Information                                                                                               | 27 |
|                                                            |                                                                                                            |   |
| ITEM 6.                                                         | Exhibits                                                                                                        | 27 |
|                                                            |                                                                                                            |   |
| **SIGNATURE**                                                   | 28                                                                                                              |
|                                                            |                                                                                                            |   |
| **EXHIBIT  INDEX**                                              | 29                                                                                                              |
|                                                                 |                                                                                                                 |  |  |

 

2

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| **PART  I.** | **FINANCIAL  INFORMATION**                   |
|--------------|----------------------------------------------|
| ITEM 1.      | Condensed  Consolidated Financial Statements |

 

**bebestores, inc.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except share data)**

**(unaudited)**

 
| ** **                                                                                                                                      | ** ** | **As of**      | ** ** | **As of**    | ** ** | **As of**         | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                                                                                      | ** ** | **October 6,** | ** ** | **July 7,**  | ** ** | **September 30,** | ** ** |
| ** **                                                                                                                                      | ** ** | **2007**            | ** ** | **2007 (a)** | ** ** | **2006**               | ** ** |
| ** **                                                                                                                                      | ** ** | ** **          | ** ** | ** **        | ** ** | ** **             | ** ** |
| **Assets:**                                                                                                                                     |       |                |       |              |       |                   |       |
| Current assets:                                                                                                                                 |       |                |       |              |       |                   |       |
| Cash and  equivalents                                                                                                                           |       | $                   | 40,590     |              | $          | 65,603                 |       | $ | 50,391 |   |
| Short term  marketable securities                                                                                                               |       | 283,925             |       | 327,100           |       | 292,414                |       |
| Receivables (net  of allowance of $1,139, $1,094 and $935)                                                                                      |       | 10,247              |       | 6,720             |       | 8,704                  |       |
| Inventories                                                                                                                                     |       | 52,064              |       | 44,064            |       | 53,427                 |       |
| Deferred income  taxes, net                                                                                                                     |       | 9,071               |       | 9,068             |       | 6,780                  |       |
| Prepaid and  other                                                                                                                              |       | 19,900              |       | 13,314            |       | 4,431                  |       |
| Total current  assets                                                                                                                           |       | 415,797             |       | 465,869           |       | 416,147                |       |
| Property and  equipment, net                                                                                                                    |       | 121,193             |       | 116,595           |       | 96,643                 |       |
| Deferred income  taxes, net                                                                                                                     |       | 24,402              |       | 20,330            |       | 13,859                 |       |
| Other assets                                                                                                                                    |       | 4,218               |       | 4,234             |       | 3,351                  |       |
| Total assets                                                                                                                                    |       | $                   | 565,610    |              | $          | 607,028                |       | $ | 530,000 |   |
|                                                                                                                                            |       |                |       |              |       |                   |       |
| **Liabilities  and Shareholders’ Equity:**                                                                                                 |       |                |       |              |       |                   |       |
| Current  liabilities:                                                                                                                           |       |                |       |              |       |                   |       |
| Accounts payable                                                                                                                                |       | $                   | 33,948     |              | $          | 28,052                 |       | $ | 28,821 |   |
| Accrued  liabilities                                                                                                                            |       | 28,493              |       | 33,982            |       | 26,672                 |       |
| Current portion  of capital leases                                                                                                              |       | 206                 |       | 223               |       | 237                    |       |
| Total current  liabilities                                                                                                                      |       | 62,647              |       | 62,257            |       | 55,370                 |       |
| Long term  portion of capital leases                                                                                                            |       | —              |       | 38                |       | 205                    |       |
| Deferred rent  and other lease incentives                                                                                                       |       | 43,584              |       | 40,143            |       | 37,293                 |       |
| Uncertain tax  positions                                                                                                                        |       | 5,278               |       | —            |       | —                 |       |
| Total  liabilities                                                                                                                              |       | 111,509             |       | 102,438           |       | 93,228                 |       |
|                                                                                                                                            |       |                |       |              |       |                   |       |
| 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 88,607,755, 93,543,604 and 92,621,101 shares |       | 89                  |       | 94                |       | 93                     |       |
| Additional  paid-in capital                                                                                                                     |       | 130,155             |       | 126,744           |       | 108,523                |       |
| Accumulated  other comprehensive income                                                                                                         |       | 12,180              |       | 9,139             |       | 2,411                  |       |
| Retained  earnings                                                                                                                              |       | 311,677             |       | 368,613           |       | 325,745                |       |
| Total  shareholders’ equity                                                                                                                |       | 454,101             |       | 504,590           |       | 436,772                |       |
| Total  liabilities and shareholders’ equity                                                                                                |       | $                   | 565,610    |              | $          | 607,028                |       | $ | 530,000 |   |

 

----

(a) Derived fromaudited financial statements.

 

See accompanyingnotes to condensed consolidated financial statements.

 

3

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**bebe stores, inc.**

**CONDENSED CONSOLIDATED STATEMENTS OFINCOME**

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

**(unaudited)**

 
| ** **                                         | ** ** | **Quarters Ended** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|
| ** **                                         | ** ** | **October 6,**     | ** ** | **September 30,** | ** ** |
| ** **                                         | ** ** | **2007**                | ** ** | **2006** | ** ** |
|                                               |       |                    |       |   |   |
| Net sales                                          |       | $                       | 161,082    |   | $ | 157,059 |   |
| Cost of sales,  including production and occupancy |       | 84,567                  |       | 77,773 |   |
|                                               |       |                    |       |   |   |
|   Gross  margin                          |       | 76,515                  |       | 79,286 |   |
| Selling, general  and administrative expenses      |       | 56,180                  |       | 50,290 |   |
|                                               |       |                    |       |   |   |
| Operating income                                   |       | 20,335                  |       | 28,996 |   |
| Interest and  other income, net                    |       | 3,695                   |       | 3,173 |   |
|                                               |       |                    |       |   |   |
| Income before  income taxes                        |       | 24,030                  |       | 32,169 |   |
| Income tax  provision                              |       | 8,651                   |       | 11,742 |   |
|                                               |       |                    |       |   |   |
| Net income                                         |       | $                       | 15,379     |   | $ | 20,427 |   |
|                                               |       |                    |       |   |   |
| Basic earnings  per share                          |       | $                       | 0.17       |   | $ | 0.22 |   |
| Diluted earnings  per share                        |       | $                       | 0.16       |   | $ | 0.22 |   |
|                                               |       |                    |       |   |   |
| Basic weighted  average shares outstanding         |       | 92,683                  |       | 91,980 |   |
| Diluted weighted  average shares outstanding       |       | 94,177                  |       | 94,398 |   |

 

See accompanying notes to condensed consolidatedfinancial statements.

 

4

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**bebe stores, inc.**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(In thousands)**

**(unaudited)**
| ** **                                                                         | ** ** | **Quarters Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                         | ** ** | **October 6,**     | ** ** | **September 30,** | ** ** |
| ** **                                                                         | ** ** | **2007**                | ** ** | **2006** | ** ** |
|                                                                               |       |                    |       |   |   |
| Cash flows from  operating income:                                                 |       |                    |       |   |   |
| Net income                                                                         |       | $                       | 15,379     |   | $ | 20,427 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                    |       |   |   |
| Non-cash  compensation expense                                                     |       | 2,973                   |       | 2,364 |   |
| Depreciation and  amortization                                                     |       | 5,392                   |       | 4,271 |   |
| Deferred rent  and other lease incentives                                          |       | 3,352                   |       | 3,910 |   |
| Deferred income  taxes                                                             |       | (873                    | )          | (621 | ) |
| Changes in  operating assets and liabilities:                                      |       |                    |       |   |   |
| Receivables                                                                        |       | (1,861                  | )          | (1,675 | ) |
| Inventories                                                                        |       | (7,867                  | )          | (11,273 | ) |
| Prepaid expenses  and other                                                        |       | (3,572                  | )          | 2,516 |   |
| Accounts payable                                                                   |       | 5,878                   |       | 5,874 |   |
| Accrued  liabilities                                                               |       | (1,266                  | )          | (2,754 | ) |
| Net cash  provided by operating activities                                         |       | 17,535                  |       | 23,039 |   |
|                                                                               |       |                    |       |   |   |
| Cash flows from  investing activities:                                             |       |                    |       |   |   |
| Purchase of  property and equipment                                                |       | (9,828                  | )          | (7,664 | ) |
| Purchase of  marketable securities                                                 |       | (141,300                | )          | (69,375 | ) |
| Proceeds from  sales of marketable securities                                      |       | 184,475                 |       | 65,975 |   |
| Net cash  provided (used) by investing activities                                  |       | 33,347                  |       | (11,064 | ) |
|                                                                               |       |                    |       |   |   |
| Cash flows from  financing activities:                                             |       |                    |       |   |   |
| Net proceeds  from issuance of common stock                                        |       | 388                     |       | 5,853 |   |
| Purchase of  common stock                                                          |       | (66,950                 | )          | — |   |
| Excess of tax  benefit from options exercised                                      |       | 212                     |       | 4,538 |   |
| Cash dividends  paid                                                               |       | (9,354                  | )          | (9,216 | ) |
| Other                                                                              |       | (55                     | )          | (67 | ) |
| Net cash  provided (used) by financing activities                                  |       | (75,759                 | )          | 1,108 |   |
|                                                                               |       |                    |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                              |       | (24,877                 | )          | 13,083 |   |
| Effect of  exchange rate changes on cash                                           |       | (136                    | )          | (1,348 | ) |
| Cash and  equivalents:                                                             |       |                    |       |   |   |
| Beginning of  period                                                               |       | 65,603                  |       | 38,656 |   |
| End of period                                                                      |       | $                       | 40,590     |   | $ | 50,391 |   |

 

See accompanying notes to condensed consolidatedfinancial statements.

 

5

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##### ** **

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

##### ** **

##### **NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

##### ** **

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

##### ** **

Theaccompanying condensed consolidated balance sheets of bebe stores, inc. (the “Company”)as of October 6, 2007, July 7, 2007 and September 30, 2006, the condensedconsolidated statements of income for the quarters ended October 6, 2007 andSeptember 30, 2006 and the condensed consolidated statements of cash flows forthe quarters ended October 6, 2007 and September 30, 2006 have been prepared inaccordance with accounting principles generally accepted in the United Statesof America for interim financial information and with the instructions to Form10-Q and Article 10 of Regulation S-X, without audit. Accordingly, they do notinclude all of the information required by accounting principles generallyaccepted in the United States of America for annual financial statements.Therefore, these condensed consolidated financial statements should be read inconjunction with our Annual Report on Form 10-K for 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 in theForm 10-K for the fiscal year ended July 7, 2007.

 

                Our business is affected by the pattern of seasonalitycommon to most retail apparel businesses. The results for the periods presentedare not necessarily indicative of future financial results.

 

##### **FISCAL YEAR**

##### ** **

Our fiscal year is a 52or 53 week period, each period ending on the first Saturday after June 30. Fiscalyears 2008 and 2007 include 52 weeks and 53 weeks, respectively.

 

##### **The quarters ended October 6,2007 and September 30, 2006 both included 13 weeks.**

 

6

----

 

**INVENTORIES**

 

The Company’sinventories consist of: 

 
| ** **                      | ** ** | **As of**          | ** ** |
|---------------------------------|------------|-------------------------|------------|
| ** **                      | ** ** | **October 6,**     | ** ** | **July 7,** | ** ** | **September 30,** | ** ** |
| ** **                      | ** ** | **2007**                | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                      | ** ** | **(In thousands)** | ** ** |
| Raw materials                   |       | $                       | 6,845      |   | $ | 7,136 |   | $ | 11,442 |   |
| Merchandise  available for sale |       | 45,219                  |       | 36,928 |   | 41,985 |   |
| Inventories                     |       | $                       | 52,064     |   | $ | 44,064 |   | $ | 53,427 |   |

 

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

##### ** **

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

 

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

 
| ** **                                                     | ** ** | **Quarters Ended**   | ** ** |
|----------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                     | ** ** | **October 6,  2007** | ** ** | **September 30,  2006** | ** ** |
|                                                           |       | **(In  thousands)**       |       |
| Basic weighted  average number of shares outstanding           |       | 92,683                    |       | 91,980 |   |
| Incremental  shares from the assumed issuance of stock options |       | 1,494                     |       | 2,418 |   |
|                                                           |       |                      |       |   |   |
| Diluted weighted  average number of shares outstanding         |       | 94,177                    |       | 94,398 |   |

 

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

 

Excluded from thecomputation of the number of diluted weighted average shares outstanding wereoptions of 2,342,000, and 1,445,000 for the quarters ended October 6, 2007 andSeptember 30, 2006, respectively, which in each case would have beenanti-dilutive.

 

##### **COMMON STOCK 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.  As of October 6, 2007, theCompany completed the purchase and retired the shares.

 

7

----

 

##### **COMPREHENSIVE INCOME**

##### ** **

Comprehensive incomeconsists of net income and other comprehensive income (income, expenses, gainsand losses that bypass the income statement and are reported directly as aseparate component of equity). The Company’s comprehensive income consists ofnet income and foreign currency translation adjustments for all periodspresented.

 
| ** **                  | ** ** | **Quarters Ended**   | ** ** |
|-----------------------------|------------|---------------------------|------------|
| ** **                  | ** ** | **October 6,  2007** | ** ** | **September 30,  2006** | ** ** |
| ** **                  | ** ** | **(In thousands)**        |
| Net income                  |       | $                         | 15,379     |   | $ | 20,427 |   |
| Other  comprehensive income |       | 3,041                     |       | (7 | ) |
|                        |       |                      |       |   |   |
| Total  comprehensive income |       | $                         | 18,420     |   | $ | 20,420 |   |

 

##### **CREDIT FACILITIES**

##### ** **

**The Company has an unsecured commercial line ofcredit agreement with a bank, which provides for borrowings and issuance of lettersof credit up to a combined total of $25.0 million and expires on March 31,2009. The outstanding balance bears interest at either the bank’s referencerate (which was 7.75% as of October 6, 2007) or the LIBOR rate plus 1.75percentage points. As of October 6, 2007, there were no outstanding borrowings,and there was $2.1 million outstanding in letters of credit.**

** **

**This credit facility requires the Company to complywith certain financial covenants, including amounts for minimum tangible networth, unencumbered liquid assets and profitability, and certain restrictionson making loans and investments.**

** **

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

##### ** **

The 1997 Stock Plan as amended (the “Stock Plan”)provides for the grant of incentive stock options, non-qualified stock options,stock purchase rights, stock awards and restricted stock units. Although theStock Plan allows for stock options and related awards to be granted at pricesbelow fair market value, the Company has historically granted such options atthe fair market value of the stock on the date of grant.  Stock optionsand related awards have a maximum term of ten years.  Options andrestricted stock units granted to employees and options granted to Directorsgenerally vest over four years with 20% of the award vested in each of thefirst and second years, and 30% vested in each of the remaining twoyears.  Restricted stock units awarded to Directors generally vest over aperiod of one year from the date of grant.  As of October 6, 2007, theCompany has reserved 7,645,485 shares of common stock for issuance under theStock Plan and there were 803,990 shares available for future grant.

 

The Company accounts for share-based compensationunder the provisions of SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFASNo. 123(R)”), which requires share-based payment compensation related to stockoptions to be measured based on the estimated fair value at the date of grantusing an option pricing model.

 

8

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The Company recognized share-based compensationexpense of $3.0 million and $2.4 million in the quarters ended October 6, 2007and September 30, 2006, respectively, as a component of selling, general andadministrative expenses. As of October 6, 2007, there was $11.9 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 2.77 years.

 

The fair value of each option grant was estimated onthe date of the grant using the Black-Scholes valuation model.  Theexpected life of the options represents the period of time the options areexpected to be outstanding and is based on historical trends. The expectedstock price volatility is based on an average of the historical volatility ofthe Company’s stock for a period approximating the expected life and theimplied volatility based on traded options of the Company’s stock. Theexpected dividend yield is based on the Company’s most recent annual dividend payout.The risk-free interest rate is based on the U.S. Treasury yield curve in effectat the time of grant and has a term that approximates the expected life.

 

The following table presents the weighted averageassumptions used in the option pricing model for the stock options granted inthe quarters ended October 6, 2007 and September 30, 2006:

 
| ** **                     | ** ** | **Quarters Ended** | ** ** |
|--------------------------------|------------|-------------------------|------------|
| ** **                     | ** ** | **October 6,**     | ** ** | **September 30,** | ** ** |
| ** **                     | ** ** | **2007**                | ** ** | **2006** | ** ** |
| Expected  dividend rate        |       | 1.3                     | %          | 0.8 | % |
| Volatility                     |       | 46.6                    | %          | 49.5 | % |
| Risk-free  interest rate       |       | 4.1                     | %          | 4.7 | % |
| Expected lives  (years)        |       | 4.3                     |       | 4.1 |   |
| Fair value per  option granted |       | $                       | 5.31       |   | $ | 8.85 |   |
|                                |            |                         |            |  |  |  |  |

 

9

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##### **The following table summarizesstock option activity during the quarter ended October 6, 2007:**

##### ** **

| ** **                    | ** ** | **Options  (In thousands)** | ** ** | **Weighted   Average  Exercise Price  Per Share** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic Value  (In thousands)** | ** ** |
|-------------------------------|------------|----------------------------------|------------|-------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------------|------------|
| Outstanding,  July 7, 2007    |       | 6,098                            |       | $                                                           | 11.95      |                                                |       |                                                     |       |   |
| Granted                       |       | 925                              |       | 13.23                                                       |       |                                                |       |                                                     |       |
| Exercised                     |       | (59                              | )          | 5.94                                                        |       |                                                |       |                                                     |       |
| Cancelled                     |       | (200                             | )          | 16.92                                                       |       |                                                |       |                                                     |       |
|                          |       |                             |       |                                                        |       |                                                |       |                                                     |       |   |   |
| Outstanding,  October 6, 2007 |       | 6,764                            |       | $                                                           | 12.03      |                                                | 7.28       |                                                     | $          | 29,360 |   |
|                          |       |                             |       |                                                        |       |                                                |       |                                                     |       |
| Exercisable,  October 6, 2007 |       | 3,859                            |       | $                                                           | 9.63       |                                                | 6.32       |                                                     | $          | 23,708 |   |

##### ** **

**Intrinsic value for stock options is defined as thedifference between the current market value and the grant price. For thequarter ended October 6, 2007, the total intrinsic value of stock optionsexercised was $0.5 million. Cash received from stock options exercised duringthe quarter ended October 6, 2007 was $0.3 million and the actual tax benefitrealized for tax deductions from stock options exercised totaled $0.2 million.**

** **

##### **The following table summarizesrestricted stock unit activity during the quarter ended October 6, 2007:**

 
| ** **                  | ** ** | **Shares  (In thousands)** | ** ** | **Weighted  Average Grant  Date Fair Value  Per Share** | ** ** |
|-----------------------------|------------|---------------------------------|------------|-----------------------------------------------------------------------------|------------|
| Nonvested, July  7, 2007    |       | 67                              |       | $                                                                           | 20.68      |   |
| Granted                     |       | 25                              |       | $                                                                           | 13.44      |   |
| Vested                      |       | (6                              | )          | $                                                                           | 19.92      |   |
| Cancelled                   |       | (1                              | )          | $                                                                           | 18.74      |   |
|                        |       |                            |       |                                                                        |       |   |
| Nonvested,  October 6, 2007 |       | 85                              |       | $                                                                           | 15.36      |   |

##### ** **

**INCOME TAXES**

 

Effective July 8, 2007, theCompany adopted Financial Accounting Standards Board (“FASB”) InterpretationNo. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). The cumulativeeffect of adoption was a decrease to retained earnings of approximately $0.6million. As of July 8, 2007, the total unrecognized tax benefits wereapproximately $5.2 million. Of this amount, approximately $2.0 million wouldreduce our effective tax rate if recognized.

 

The Company accounts forinterest and penalties related to unrecognized tax benefits as a component ofincome tax expense. As of the date of adoption, the Company had $0.7 million ofinterest and penalties accrued associated with unrecognized tax benefits.

 

The Company could besubject to Federal and state tax examinations for years 2002 and forward. TheCompany may also be subject to audits in Canada for years 2000 and forward. TheCompany is currently under state income tax audit in New Jersey 

 

10

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and expects thecommencement of certain state tax audits in the near term. At this time, theCompany does not believe that the outcome of any examination will have amaterial impact on the Company’s financial statements.

 

As of July 8, 2007, thetotal amount of unrecognized tax benefits was approximately $5.2 million, andthere has been no material change to the amount of unrecognized tax benefits asof that date. The Company currently does not expect significant changes relatedto unrecognized tax benefits through July 5, 2008.

 

##### **LEGAL MATTERS**

##### ** **

A former employee suedbebe in a complaint filed on April 28, 2005 in the United States District Courtfor the Northern District of California (case no. C050177) alleging violationsunder the Fair Labor Standards Act, specifically that bebe obligated her to buyand wear its brand clothing as a uniform, without reimbursement or credit, andthe net effect of deducting the value of such required purchases from her wageswould often result in her not being paid minimum wages. The plaintiff purportsto bring the action also on behalf of a class of hourly, non-managerialemployees who are similarly situated. The lawsuit seeks compensatory, statutoryand injunctive relief. We have negotiated a confidential settlement in thiscase which remains subject to court approval. One objection to the settlementhas been filed by the plaintiff in the lawsuit described in the next paragraphof this section. We have accrued an amount that we believe reasonably estimatesthe potential liability, which does not have a material impact on our financialposition or results of operations.

 

A former employee suedbebe in a complaint filed July 27, 2006 in the Superior Court of California,San Mateo County (case no. CIV 456550) alleging a failure to pay all wages,failure to pay overtime wages, failure to pay minimum wages, failure to providemeal periods, violation of Labor Code §450, violation of Labor Code §2802 andCalifornia Code of Regulations §11040(9)(A), statutory wage violations (latepayment of wages), unlawful business practices under Business and ProfessionsCode §16720 and §17200, conversion of wages and violation of Civil Code §52.1.The plaintiff purports to bring the action also on behalf of current and formerCalifornia bebe employees who are similarly situated. The lawsuit seeks compensatory,statutory, punitive, restitution and injunctive relief. Due to certainsimilarities in claims between this action and the one previously mentioned(Case No. C050177), the parties and the Court havepostponed active litigation and discovery until such time as thepreviously mentioned case resolves the claims incommon. Notwithstanding, the Court in this case has set a hearingin June, 2008 regarding whether class certification would beappropriate if, and to the extent, any claim(s) in this caseremain(s) active at that time.

 

A former employee suedbebe in a complaint filed July 24, 2007 in the Superior Court of California,Orange County (case no. 07CC08220) alleging a failure to pay overtime wages,failure to provide for meal and rest breaks, and unfair business practices (toinclude the above allegations and misclassifying store managers as “exempt”). Theplaintiff purports to bring the action also on behalf of current and formerCalifornia bebe employees who are similarly situated. The lawsuit seekscompensatory, statutory, and punitive damages and injunctive relief. Thismatter is in the early stages of discovery.

 

A former employee suedbebe in a complaint filed September 20, 2007 in the United States DistrictCourt for the District of New Jersey (case no. 07-cv-4514 (D.N.J.)) allegingvarious state and federal statutory breaches based on a failure to pay allwages, including overtime wages and bonus, failure to provide and/or pay formeal and rest break periods, failure to credit vacation time and other benefitsand retaliation, wrongful termination, breach of contract, breach of covenantof good 

 

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faith and fair dealing,and unjust enrichment. Plaintiff purports to bring the action on behalf ofcurrent and former store management employees who are or were similarlysituated. The complaint seeks compensatory, statutory and punitive damages andequitable relief. We are currently reviewing the allegations.

 

A customer sued thecompany in a complaint filed December 14, 2006 in the Superior Court of ContraCosta County (case no. C06-02630) alleging that we utilized a certain type ofpreprinted credit card form in a return transaction in violation of CaliforniaCivil Code §1747.08. The plaintiff purports to bring the action also on behalfof other customers who are similarly situated. The lawsuit seeks compensatory,statutory, and injunctive relief. We are currently reviewing the allegations atthis early stage. This matter is in the early stages of discovery.

 

Three customers filedseparate complaints alleging the Company violated The Fair Credit Reporting Act(the “FCRA”). Two of such cases were filed January 10 and January 16, 2007 inthe United States District Court for the Northern District of California (casenos. C07-0203 & C07-0255, respectively). In late April 2007, each of thesetwo lawsuits were voluntarily dismissed, without prejudice, by their respectiveplaintiff. The third lawsuit, filed on February 9, 2007 in the Central Districtof California (case no. CV-07-0972) remains active. This latter lawsuitalleges that we violated the FCRA by printing on receipts more than the lastfive digits of the credit or debit card numbers and/or the expiration date. Theplaintiff purports to bring the action also on behalf of other customers whoare similarly situated and seeks statutory and punitive damages, attorney’sfees and injunctive relief. We are currently reviewing the allegations at thisearly stage. This matter is in the early stages of discovery.

 

We are also involved invarious other legal proceedings arising in the normal course of business. Noneof these matters nor the matters listed above are expected, individually or inthe aggregate, to have a material adverse effect on our business, financialcondition or results of operations.

 

We intend to defendourself vigorously against each of these claims. However, the results of anylitigation are inherently uncertain. We cannot assure you that we will be ableto 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.

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

In September 2006, theFASB issued SFAS No. 157, “Fair Value Measurements*”*.SFAS No. 157 defines fair value, establishes a framework for measuring fairvalue in accordance with generally accepted accounting principles, and expandsdisclosures about fair value measurements. SFAS No. 157 applies under otheraccounting pronouncements that require or permit fair value measurements andaccordingly does not require any new fair value measurements. The provisions ofSFAS No. 157 are to be applied prospectively as of the beginning of the fiscalyear in which it is initially applied, with any transition adjustmentrecognized as a cumulative-effect adjustment to the opening balance of retainedearnings. The provisions of SFAS No. 157 are effective for fiscal yearsbeginning after November 15, 2007. The Company is in the process of determiningthe impact that the adoption of SFAS No. 157 will have on its financialposition and results of operations.

 

In February 2007, theFASB issued SFAS No. 159,  “The FairValue Option for Financial Assets and Financial Liabilities-Including anamendment of FASB Statement No. 115”. SFAS No. 159 permits entities to chooseto measure eligible 

 

12

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items at fair value at specified election dates and report unrealizedgains and losses on items for which the fair value option has been elected inearnings at each subsequent reporting date. SFAS No. 159 is effective forfiscal years beginning after November 15, 2007. We are currently in the processof assessing the impact the adoption of SFAS No. 159 will have on our financialposition and results of operations.

 

**ITEM 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

** **

The following Management’s Discussion and Analysis ofFinancial Condition and Results of Operations contains forward-lookingstatements, which involve risks and uncertainties. Our actual results maydiffer materially from those anticipated in these forward-looking statements. Statements that are predictive in nature, that depend upon or refer tofuture events or conditions or that include words such as “expects,” “anticipates,”“intends,” “plans,” “believes,” “estimates,” “thinks,” and similar expressionsare forward-looking statements.   Forward-looking statements includestatements about our expected results of operations, capital expenditures andstore openings.  Although we believe that these statements are based uponreasonable assumptions, we cannot assure you that our goals will be achieved.These forward-looking statements are made as of the date of thisForm 10-Q, and we assume no obligation to update or revise them or providereasons why actual results may differ. Factors that might cause such adifference include, but are not limited to, our ability to respond to changingfashion trends, miscalculation of the demand for our products, effectivemanagement of our growth, decline in comparable store sales performance,ongoing competitive pressures in the apparel industry, changes in the level ofconsumer spending or preferences in apparel, our ability to attract and retainkey management personnel and/or other factors discussed in “Risks Factors” andelsewhere in this Form 10-Q.

 

##### **OVERVIEW**

##### ** **

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

 

Our distinctive product offering includes a full rangeof separates, tops, sweaters, dresses, active wear and accessories in thefollowing lifestyle categories:  career, evening, casual and active. Wedesign and develop the majority of our merchandise in-house, which ismanufactured to our specifications. The remainder of our merchandise is sourceddirectly from third-party manufacturers.

 

We market our products under the bebe, COLLECTIONbebe, BEBE SPORT, bbsp and bebe O brand names. As of October 6, 2007, we had 279retail stores, of which 202 were bebe stores, 56 were BEBE SPORT stores, 20 werebebe outlet stores and 1 was a bebe accessories store. These stores are locatedin 35 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islandsand Canada. In addition, we have an on-line store at www.bebe.com and ourlicensees operate 18 international stores, including shop in shops. During thequarter ended October 6, 2007, we opened 6 stores, including 4 bebe stores and2 BEBE SPORT stores. We expect to open approximately 40 stores during fiscal2008, including approximately 25 to 27 bebe stores, 6 to 8 BEBE SPORT storesand 3 to 5 bebe outlet stores. During fiscal 2008, we anticipate closing up to4 stores. We also plan to renovate 2 existing 

 

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stores andrelocate or expand 6 existing stores, resulting in square footage growth ofapproximately 15%.

 

*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 quarter of2008, we plan to open 3 to 5 new or expanded outlet stores under the new name2b bebe and will 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.

 

*bebeaccessories*. In September 2006, we opened our firstaccessory concept store featuring shoes imported from Italy, Brazil and Chinaand a selection of fine leather goods, bebe logo merchandise, outerwear andgift items.

 

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

##### ** **

Management’s Discussion and Analysis of FinancialCondition and Results of Operations are based upon our consolidated financialstatements, which have been prepared in conformity with accounting principlesgenerally accepted in the United States of America.

 

The preparation of these financial statements requiresthe appropriate application of certain accounting policies, many of whichrequire us to make estimates and assumptions about future events and theirimpact on amounts reported in our financial statements and related notes. Sincefuture events and their impact cannot be determined with certainty, the actualresults will inevitably differ from our estimates. Such differences could bematerial to the financial statements. We believe our application of accountingpolicies, and the estimates inherently required therein, are reasonable. Theseaccounting policies and estimates are constantly reevaluated, and adjustmentsare made when facts and circumstances dictate a change. Our accounting policiesare more fully described in Note 1 to the consolidated financial statements inour annual report on Form 10-K for the fiscal year ended July 7, 2007.

 

We have identified certain critical accountingpolicies, 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”. Werecognize revenue for store sales at the point at which the customer receivesand pays for the merchandise at the register with either cash or credit card.For on-line sales, we recognize revenue at the time the customer receives theproduct. We estimate and defer revenue and the related product costs forshipments that are in transit to the customer. Customers typically receivegoods within one week of shipment. Amounts related to shipping billed tocustomers are reflected in net sales and the related costs are reflected incost of goods 

 

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sold. Sales taxcollected from customers on retail sales are recorded net of retail sales atthe time of the transaction.

 

We record a reserve for estimated product returns based on historicalreturn trends. As of October 6, 2007 and September 30, 2006, the reserve was$1,161,000 and $1,148,000, respectively. If actual returns are greater thanthose projected, additional sales returns may be recorded in the future.

 

Discounts offered to customers consist primarily of point of salemarkdowns and are recorded at the time of the related sale as a reduction ofrevenue.

 

We include the value of points and rewards earned by our loyaltyprogram members as a liability and a reduction of revenue at the time thepoints and rewards are earned based on historical conversion and redemptionrates. We recognize revenue when the rewards are redeemed or expire.

 

We carry gift certificates sold as a liability and we recognize revenuewhen the gift certificate is redeemed or four years after issuance if the giftcertificate is unredeemed. Similarly, customers may receive a store credit inexchange for returned goods. We carry store credits as a liability untilredeemed or three years after issuance if the store credit is unredeemed.

 

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

 

We record royalty revenue from product licensees as earned, which isbased on the licensee’s sales.

 

*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.

 

*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 quarters ended October 6, 2007 and September 30, 2006 we did not need to 

 

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record animpairment charge.  We believe at this time that the long-lived assets’carrying values and useful lives continue to be appropriate.

 

*AccruedLitigation.* We accrue estimates of probable liabilities associated with lawsuits andclaims. The results of any litigation are inherently uncertain. As informationbecomes available, we assess the potential liabilities related to pendinglitigation and may revise our estimates as necessary. Such revisions ofestimates could materially impact the results of operations and financialposition.

 

*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 variability areunpredictable 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 prescribesa recognition threshold that a tax position is required to meet before beingrecognized in the financial statements and provides guidance on derecognition,measurement, classification, interest and penalties, accounting in interimperiods, disclosure and transition issues. To the extent that our estimateschange or the final tax outcome of these matters is different than the amountsrecorded, such differences will impact the income tax provision in the periodin which such determinations are made. Our effective tax rate in a givenfinancial statement period may be materially impacted by changes in the mix andlevel of earnings, changes in the expected outcome of audits or changes in thedeferred tax valuation allowance.

 

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

##### ** **

##### **Our fiscal year is a 52 or 53week period, each period ending on the first Saturday after June 30. Fiscal year 2008 is a 52 week fiscal year ending on July 5, 2008. The quartersended October 6, 2007 and September 30, 2006 both include 13 weeks.**

 

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

 

 
| ** **                                             | ** ** | **Quarters Ended** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|
| ** **                                             | ** ** | **October 6,**     | ** ** | **September 30,** | ** ** |
| ** **                                             | ** ** | **2007**                | ** ** | **2006** | ** ** |
|                                                   |       |                    |       |   |   |
| Net sales                                              |       | 100.0                   | %          | 100.0 | % |
| Cost of sales,  including production and occupancy (1) |       | 52.5                    |       | 49.5 |   |
|                                                   |       |                    |       |   |   |
| Gross margin                                           |       | 47.5                    |       | 50.5 |   |
| Selling, general  and administrative expenses (2)      |       | 34.9                    |       | 32.0 |   |
|                                                   |       |                    |       |   |   |
| Operating income                                       |       | 12.6                    |       | 18.5 |   |
| Interest and  other income, net                        |       | 2.3                     |       | 2.0 |   |
|                                                   |       |                    |       |   |   |
| Income before  income taxes                            |       | 14.9                    |       | 20.5 |   |
| Provision for  income taxes                            |       | 5.4                     |       | 7.5 |   |
|                                                   |       |                    |       |   |   |
| Net income                                             |       | 9.5                     | %          | 13.0 | % |

 

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

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

 

*Net Sales.* Net sales increased to $161.1 million during thequarter ended October 6, 2007 from $157.1 million for the comparable period ofthe prior year, an increase of $4.0 million, or 2.5%.The increase in sales was primarily dueto a $13.8 million increase in sales for stores not included in the comparablestore sales base, a $1.5 million increase in on-line sales, a $1.4 millionincrease in wholesale sales to international licensees and a $0.3 millionincrease in loyalty revenue. The increase was partially offset by a  9.3% decrease in comparable store salestotaling $13.1 million during the quarter ended October 6, 2007 as compared tothe same quarter in the prior year.

 

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| ** **                                             | ** ** | **Quarters Ended** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|
| ** **                                             | ** ** | **October 6,**     | ** ** | **September 30,** | ** ** |
| ** **                                             | ** ** | **2007**                | ** ** | **2006** | ** ** |
|                                                   |       |                    |       |   |   |
| Net sales (In  thousands)                              |       | $                       | 161,082    |   | $ | 157,059 |   |
|                                                   |       |                    |       |   |   |
| Total net sales  increase percentage                   |       | 2.5                     | %          | 24.5 | % |
|                                                   |       |                    |       |   |   |
| Comparable store  sales increase (decrease) percentage |       | (9.3                    | )%         | 12.8 | % |
|                                                   |       |                    |       |   |   |
| Net sales per  average square foot (1)                 |       | $                       | 158        |   | $ | 176 |   |
|                                                   |       |                    |       |   |   |
| Square footage  at end of period (In thousands)        |       | 1,013                   |       | 898 |   |
|                                                   |       |                    |       |   |   |
| Number of store  locations:                            |       |                    |       |   |   |
| Beginning of  period                                   |       | 273                     |       | 242 |   |
| New store  locations                                   |       | 6                       |       | 6 |   |
| Closed store  locations                                |       | 0                       |       | 0 |   |
| Number of stores  open at end of period                |       | 279                     |       | 248 |   |

 

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

 

*Gross Margin.*Gross margin decreased to $76.5 million during thequarter ended October 6, 2007 from $79.3 million for the comparable quarter ofthe prior year, a decrease of $2.8 million, or 3.5%. As a percentage of netsales, gross margin decreased to 47.5% for the quarter ended October 6, 2007from 50.5% in the comparable quarter of the prior year. The decrease in grossmargin as a percentage of net sales resulted primarily due to higher markdownspartially offset by higher initial markup and unfavorable occupancy leverage. Thedecrease was further offset by a reduction in raw material reserves.

 

*Selling, General and Administrative Expenses.*Selling, general and administrativeexpenses, which primarily consist of non-occupancy store costs, corporateoverhead and advertising costs, increased to $56.2 million during the quarterended October 6, 2007 from $50.3 million for the comparable period of the prioryear, an increase of $5.9 million, or 11.7 %. As a percentage of net sales,these expenses increased to 34.9% during the quarter from 32.0% in thecomparable period of the prior year. The increase in selling, general andadministrative expenses as a percentage of net sales from the prior year of2.9% was primarily due to a $2.7 million increase in total compensationexpense, which includes a stock based compensation expense increase of $0.6million, a $1.1 million increase in advertising expense and a $1.1 millionincrease in depreciation expense.

 

* Interest and Other Income, Net.* We generated approximately $3.7 millionof interest and other income (net of other expenses) during the quarter endedOctober 6, 2007 compared to approximately $3.2 million in the comparablequarter of the prior year. The increase was the result of higher average cashbalances and higher interest rates.

 

*Provisionfor Income Taxes.*Our effective tax rate decreased to 36% forthe quarter ended October 6, 2007 from 36.5% for the comparable period in theprior year primarily due to an increase in our allowable domestic manufacturingdeduction.

 

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**Seasonality of Business and QuarterlyResults**

 

Our business varies withgeneral seasonal trends that are characteristic of the retail and apparelindustries. As a result, our typical store generates a higher percentage of ourannual net sales and profitability in the second quarter of our fiscal year,which includes the holiday selling season, compared to the other quarters ofour fiscal year. If for any reason our sales were below seasonal norms duringthe second quarter of our fiscal year, our annual operating results would benegatively impacted. Because of the seasonality of our business, results forany quarter are not necessarily indicative of results that may be achieved fora full fiscal year.

 

### **LIQUIDITYAND CAPITAL RESOURCES**

### ** **

Ourworking capital requirements vary widely throughout the year and generally peakduring the first and second fiscal quarters. At October 6, 2007, we hadapproximately $324.5 million of cash and equivalents and short-term marketablesecurities on hand. In addition, we had a revolving line of credit, under whichwe could borrow or issue letters of credit up to a combined total of $25.0million. As of October 6, 2007, there were no cash borrowings outstanding underthe line of credit, and letters of credit outstanding totaled $2.1 million.

 

Netcash provided by operating activities for the quarter ended October 6, 2007 was$17.5 million versus $23.0 million for the quarter ended September 30, 2006.Cash provided by operating activities for the period was primarily generated byincome of $15.4 million adjusted for stock compensation of $3.0 million,depreciation of $5.4 million and deferred rent of $3.4 million, as well aschanges in working capital. The changes in working capital were primarily dueto an increase in accounts payable of $5.9 million, partially offset by anincrease in inventory of $7.9 million due to the preparation for the fall andholiday selling season and an increase in prepaid expenses of $3.6 million as aresult of the timing of tax payments.

 

Netcash provided by investing activities for the quarter ended October 6, 2007 was$33.3 million versus net cash used by investing activities of $11.1 million forthe quarter ended September 30, 2006. Cash provided by investing activities forthe period was primarily due to the sales of marketable securities of $184.5million, partially offset by purchases of marketable securities of $141.3million and capital expenditures of $9.8 million related to the opening of newstores. We opened 6 new stores in the quarter ended October 6, 2007 and expectto open approximately 40 stores during fiscal 2008. We estimate that totalcapital expenditures will be approximately $45 million in fiscal 2008.

 

Net cash used byfinancing activities was $75.8 million for the quarter ended October 6, 2007versus net cash provided by financing activities of $1.1 million for thequarter ended September 30, 2006. Cash used by financing activities for thequarter 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 quarter of fiscal2008 totaling $9.4 million, partially offset by proceeds received from stockoption exercises of $0.4 million and the related tax benefit of $0.2 million.

 

During the quarter weentered into an agreement with our former Vice Chairperson Neda Mashouf topurchase 5 million shares of our common stock beneficially owned by Ms. Mashoufat a price per share of $13.39, an aggregate purchase price of$66,950,000.  We may purchase additional shares from Ms. Mashouf or othershareholders in the future.

 

Webelieve that our cash on hand, together with our cash flows from operations,will be sufficient to meet our capital and operating requirements for at leastthe next twelve months. Our future capital requirements, however, will dependon numerous factors, including without limitation, the size and number of newand 

 

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expanded stores and/or store concepts, investmentcosts for management information systems, potential acquisitions and/or jointventures, repurchase of stock and future results of operations.

 

### **Inflation**

### ** **

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

 

##### **ITEM 3. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

##### ** **

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

 

*Interest Rate Risk*

* *

We currently maintain aportfolio of variable interest rate investments consisting of cash equivalentsand short-term marketable securities. Marketable securities consist ofclosed-end variable interest rate funds that invest primarily in tax-exemptmunicipal bonds. Due to the variable nature of these investments, their valueis typically not subject to market rate changes. According to our investmentpolicy, we may invest in taxable and tax exempt instruments. In addition, thepolicy establishes limits on credit quality, maturity, issuer and type ofinstrument. Marketable securities are classified as “available for sale”. We donot use 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 marketable securities if the original maturity isgreater than twelve months. Auction rate securities have stated maturitiesbeyond one year but are priced and traded as short-term instruments due to theliquidity provided through the interest rate reset mechanism and are classifiedas short-term when they represent investments of cash that are intended for usein current operations.

 

Thefollowing table lists our cash equivalents and short-term marketable securitiesat October 6, 2007:

 
| ** **                          | ** ** | **Book Value**                  | ** ** | **Fair Value** | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|---------------------|------------|
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| Cash equivalents                    |       | $                                    | 27,771     |                | $          | 27,771 |   |
| Weighted average  interest rate (1) |       | 3.51                                 | %          |                |       |
| Short-term  marketable securities   |       | 283,925                              |       | 283,925             |       |
| Weighted average  interest rate (1) |       | 4.55                                 | %          |                |       |
| Total                               |       | $                                    | 311,696    |                | $          | 311,696 |   |

 

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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 interest payable on outstanding cash borrowingsunder our bank line of credit is based on variable interest rates and thereforeaffected by changes in market 

 

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interest rates. As we have no outstanding cashborrowings, if interest rates rose significantly, our results from operationsand cash flows would not be affected.

 

*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”, assetsand liabilities of Canada’s operations are translated into U.S. dollars at quarter-endrates, while income and expenses are translated at the weighted averageexchange 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. CONTROLS ANDPROCEDURES**

##### ** **

(a)           Under the supervision and withthe participation of our management, including our Chief Executive Officer andChief Financial Officer, we evaluated the effectiveness of our disclosurecontrols and procedures, as such term is defined underRule 13a-15(e) promulgated under the Securities Exchange Act of 1934,as amended. Based upon that evaluation, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective as of the end of the period covered by this quarterly report at thereasonable assurance level.

 

(b)           There has been no change inour internal control over financial reporting during the quarter ended October6, 2007 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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

##### ** **

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

 

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

 

**ITEM1A. RISK FACTORS**

 

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.

 

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-K forthe fiscal year ended July 7, 2007.

 

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-partymanufacturers store our raw materials. In the event our inventory is damaged ordestroyed while in storage and we are unable to obtain replacement raw materials,our earnings may be negatively impacted.

 

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**3. Oursuccess depends on our ability to attract and retain qualified employees inorder to support our existing business and future expansion.**Fromtime to time we actively recruit qualified candidates to fill key executivepositions from within the Company. There is substantial competition forexperienced 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 ofMr. Mashouf or Mr. Scott, or any key officers or employees, it couldharm our business and results of operations.

 

**4. If weare not able to successfully develop new concepts, including BEBE SPORT, ourrevenue base and earnings may be impaired**. From time to time,we may pursue new concepts. If the BEBE SPORT or other new concepts are notsuccessful, our financial condition may be harmed.

 

**5. Wecannot assure you that future store openings will be successful, and new storeopenings may impact existing stores.**We expect to openapproximately 40 stores in fiscal 2008, of which 25 to 27 will be bebe stores,8 to 10 will be BEBE SPORT stores and 3 to 5 will be 2b bebe stores. We cannotassure you that the stores that we plan to open in fiscal 2008, or any otherstores that we might open in the future, will be successful or that our overalloperating profit will increase as a result of opening these stores. Duringfiscal 2008 we anticipate closing up to 4 stores. For fiscal 2008, we plan togrow our operations primarily through the opening of new stores. Most of ournew store openings in fiscal 2008 will be in existing markets. These openingsmay affect the existing stores’ net sales and profitability. Our failure topredict accurately the demographic or retail environment at any future storelocation could have a material adverse effect on our business, financial conditionand results of operations.

 

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.

 

**6. Weare subject to risks associated with our online sales.**Weoperate an on-line store at www.bebe.com to sell our merchandise.Although our online sales encompass a relatively small percentage of our totalsales, our on-line operations are subject to numerous risks, includingunanticipated operating problems, reliance on third-party computer hardware andsoftware providers, system failures and the need to invest in additionalcomputer systems. The on-line operations also involve other risks that couldhave an impact on our results of operations including but not limited todiversion of sales from our other stores, rapid technological change, liabilityfor online content, security breaches, consumer privacy concerns, credit cardfraud, and risks related to the failure of the computer systems that operatethe website and its related support systems. In addition, given our use of athird party platform, we do not have direct control of certain aspects of ouron-line business. We cannot assure 

 

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you that our on-linestore will continue to achieve sales and profitability growth or even remain atits current level.

 

**7. Anyserious disruption at our major facilities could have a harmful effect on ourbusiness.**We currently operate a corporate office inBrisbane, California, a distribution facility in Benicia, California, and adesign studio and production facility in Los Angeles, California. Any seriousdisruption at these facilities whether due to construction, relocation, fire,earthquake, terrorist acts or otherwise would harm our operations and couldhave a harmful effect on our business and results of operations. Furthermore,we have little experience operating essential functions away from our maincorporate offices and are uncertain what effect operating such satellitefacilities might have on business, personnel and 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 or replacesuch 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 and convenience. Wecompete with traditional department stores, specialty store retailers, businessto consumer websites, off-price retailers and direct marketers for, among otherthings, raw materials, market share, retail space, finished goods, sourcing andpersonnel. Because many of these competitors are larger and have substantiallygreater financial, distribution and marketing resources than we do, we may lackthe resources to adequately compete with them. If we fail to remain competitivein any way, it could harm our business, financial condition and results ofoperations.

 

**10.Purchases of the merchandise we sell are generally discretionary and aretherefore particularly susceptible to economic conditions.**Theoutlook for the United States economy is uncertain and is directly affected byglobal 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 thesupply of merchandise 

 

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available to the companyand adversely affect its financial condition and results of operations. Inaddition, we purchase a substantial amount of our raw materials from China andour business and operating results may be affected by changes in the political,social or economic environment in China.

 

**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 therequisite rights, it would limit our ability to expand. In some jurisdictions,despite successful 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 demonstrate useof our trademarks, our trademark rights may lapse over time.

 

**13. 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 themanufacturers’ business practices, and the manufacturers act in their owninterest, they may act in a manner that results in negative public perceptionsof us and/or employee allegations or court determinations that we are jointlyliable.

 

RISKS RELATING TO OURCOMMON 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 October6, 2007, of the approximately  89,000,000shares of our common stock then outstanding, approximately 27,000,000 shareswere available to be publicly traded, and as a result, our stock price isvulnerable to market swings due to large purchases, sales and short sales ofour common stock.

 

**2.Because Manny Mashouf beneficially owns a substantial portion  of the outstanding shares, other shareholdersmay not be able to influence the direction the company takes.**Asof October 31, 2007, Manny Mashouf, the Chairman of the Board, beneficiallyowned approximately 57% of the outstanding shares of our common stock. As aresult, he can control the election of directors and the outcome of all issuessubmitted to the shareholders. This may make it more difficult for a thirdparty to acquire shares, may discourage acquisition bids, and could limit theprice that certain investors might be willing to pay for shares of 

 

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common stock. Thisconcentration of stock ownership may have the effect of delaying, deferring orpreventing a change in control of our company.

 

**3. Our significant shareholdershold a substantial portion of our stock which may result in the tradingvolatility or may adversely affect our common stock.**Asof  October 31, 2007, Ms. Neda Mashouf beneficiallyowned approximately 13% of the outstanding shares of our common stock. As aresult, any change in ownership of a significant portion of these shares,including sales by Ms. Mashouf, may result in trading volatility in our commonstock or may adversely affect our stock price.

 

**4. Oursales, 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 under performing 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 of ourinternal controls required by Section 404 of the Sarbanes-Oxley Act willnot result in the identification of significant control deficiencies and/ormaterial weaknesses or that our auditors will be able to attest to theeffectiveness of our internal control over financial reporting. Failure to maintainthe effectiveness 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.

 

##### **ITEM 2.  UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

##### ** **

*IssuersPurchases of Equity Securities*

 

On September 13, 2007, weentered into an agreement with our former Vice Chairperson Neda Mashouf topurchase 5 million shares of our outstanding common stock beneficially owned byMs. Mashouf at a price per share of $13.39, an aggregate purchase price of$66,950,000.  As of October 6, 2007, we completed the purchase and retiredthe shares.

 

##### **ITEM 3.  DEFAULTSUPON SENIOR SECURITIES**

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Not applicable.

 

##### **ITEM 4.  SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

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Not applicable.

 

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##### **ITEM 5.  OTHERINFORMATION**

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Not applicable.

 

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

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(a)Exhibits. The following is a list of exhibits filed as part of this Report onForm 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 November 15, 2007                                             |
|--------|---------------------------------------------------------------------|
|   |                                                                |
|   | 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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