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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**x****     ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Forthe quarterly period ended October 3, 2009**

 

**OR**

 

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

 

**CommissionFile Number 0-24395**

 

**bebestores, inc.**

(Exact name ofregistrant as specified in its charter)

 

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

 

**400Valley Drive**

**Brisbane,California 94005**

(Address ofprincipal executive offices)

 

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.  Yes x No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12months (or for such shorter period that the registrant was required to submitand post such files).  Yes o No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule12b-2 of the Exchange Act. (Check one):

 

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

 

Indicatebycheckmarkwhethertheregistrantisashellcompany(asdefinedinRule12b—2oftheExchangeAct).  YesoNox

 

The number of shares ofthe registrant’s common stock, par value $0.001 per share, outstanding as of October 30,2009 was 86,784,121.

 

 

 

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Tableof Contents

 

**bebestores, inc.**

 

**TABLEOF CONTENTS**

 
| ** **         | ** **                                                                                                                 | **Page No.** |
|--------------------|----------------------------------------------------------------------------------------------------------------------------|-------------------|
|               |                                                                                                                       |              |
| **PART I.**   | **FINANCIAL INFORMATION**                                                                                                  |              |
|               |                                                                                                                       |              |
| ITEM 1.            | Condensed Consolidated  Financial Statements                                                                               |              |
|               |                                                                                                                       |              |
|               | Condensed  Consolidated Balance Sheets as of October 3, 2009, July 4, 2009 and  October 4, 2008             | 3                 |
|               |                                                                                                                       |              |
|               | Condensed  Consolidated Statements of Operations for the three months ended  October 3, 2009 and October 4, 2008 | 4                 |
|               |                                                                                                                       |              |
|               | Condensed  Consolidated Statements of Cash Flows for the three months ended  October 3, 2009 and October 4, 2008 | 5                 |
|               |                                                                                                                       |              |
|               | Notes to Condensed Consolidated Financial Statements                                                                       | 6                 |
|               |                                                                                                                       |              |
| ITEM 2.            | Management’s Discussion and Analysis  of Financial Condition and Results of Operations                                | 12                |
|               |                                                                                                                       |              |
| ITEM 3.            | Quantitative  and Qualitative Disclosures about Market Risk                                                                | 17                |
|               |                                                                                                                       |              |
| ITEM 4.            | Controls and  Procedures                                                                                                   | 18                |
|               |                                                                                                                       |              |
| **PART II.**  | **OTHER INFORMATION**                                                                                                      |              |
|               |                                                                                                                       |              |
| ITEM 1.            | Legal Proceedings                                                                                                          | 19                |
|               |                                                                                                                       |              |
| ITEM 1A.           | Risk Factors                                                                                                               | 19                |
|               |                                                                                                                       |              |
| ITEM 2.            | Unregistered  Sales of Equity Securities and Use of Proceeds                                                               | 23                |
|               |                                                                                                                       |              |
| ITEM 3.            | Defaults  Upon Senior Securities                                                                                           | 23                |
|               |                                                                                                                       |              |
| ITEM 4.            | Submission  of Matters to a Vote of Security Holders                                                                       | 23                |
|               |                                                                                                                       |              |
| ITEM 5.            | Other Information                                                                                                          | 23                |
|               |                                                                                                                       |              |
| ITEM 6.            | Exhibits                                                                                                                   | 23                |
|               |                                                                                                                       |              |
| **SIGNATURE**      |                                                                                                                       | 24                |
|               |                                                                                                                       |              |
| **EXHIBIT  INDEX** |                                                                                                                       | 25                |

 

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**PART I.        FINANCIALINFORMATION**

 

ITEM 1.**        **CondensedConsolidated Financial Statements

 

**bebestores, inc.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except share data)**

**(unaudited)**

 
| ** **                                                                                                                                      | ** ** | **As of  October 3,  2009** | ** ** | **As of  July 4,  2009** | ** ** | **As of  October 4,  2008** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                                      | ** ** | ** **                            | ** ** | ** **                         | ** ** | ** **                            | ** ** |
| **Assets:**                                                                                                                                     | ** ** | ** **                            | ** ** | ** **                         | ** ** | ** **                            | ** ** |
| Current  assets:                                                                                                                                |       |                                  |       |                               |       |                                  |       |
| Cash  and equivalents                                                                                                                           |       | $                                     | 80,710     |                               | $          | 91,390                                |       | $ | 119,565 |   |
| Available  for sale securities                                                                                                                  |       | 38,477                                |       | 40,018                             |       | —                                |       |
| Trading  securities                                                                                                                             |       | 69,460                                |       | 69,504                             |       | —                                |       |
| Auction  rate securities written put option                                                                                                     |       | 12,106                                |       | 12,740                             |       | —                                |       |
| Receivables  (net of allowance of $1,277, $1,277 and $1,215)                                                                                    |       | 5,953                                 |       | 5,134                              |       | 9,976                                 |       |
| Inventories,  net                                                                                                                               |       | 36,483                                |       | 39,194                             |       | 49,312                                |       |
| Deferred  income taxes, net                                                                                                                     |       | 7,822                                 |       | 8,549                              |       | 9,283                                 |       |
| Prepaid  and other                                                                                                                              |       | 32,422                                |       | 30,947                             |       | 19,538                                |       |
| Total  current assets                                                                                                                           |       | 283,433                               |       | 297,476                            |       | 207,674                               |       |
| Available  for sale securities                                                                                                                  |       | 120,431                               |       | 118,187                            |       | 228,155                               |       |
| Property  and equipment, net                                                                                                                    |       | 120,187                               |       | 126,301                            |       | 137,022                               |       |
| Deferred  income taxes, net                                                                                                                     |       | 25,264                                |       | 24,272                             |       | 24,846                                |       |
| Other  assets                                                                                                                                   |       | 5,644                                 |       | 5,219                              |       | 4,007                                 |       |
| Total  assets                                                                                                                                   |       | $                                     | 554,959    |                               | $          | 571,455                               |       | $ | 601,704 |   |
|                                                                                                                                            |       |                                  |       |                               |       |                                  |       |
| **Liabilities and Shareholders’ Equity:**                                                                                                  | ** ** | ** **                            | ** ** | ** **                         | ** ** | ** **                            | ** ** |
| Current  liabilities:                                                                                                                           |       |                                  |       |                               |       |                                  |       |
| Accounts  payable                                                                                                                               |       | $                                     | 19,214     |                               | $          | 26,621                                |       | $ | 33,592 |   |
| Accrued  liabilities                                                                                                                            |       | 29,394                                |       | 36,671                             |       | 29,529                                |       |
| Total  current liabilities                                                                                                                      |       | 48,608                                |       | 63,292                             |       | 63,121                                |       |
| Deferred  rent and other lease incentives                                                                                                       |       | 44,781                                |       | 45,448                             |       | 47,736                                |       |
| Uncertain  tax positions                                                                                                                        |       | 3,258                                 |       | 3,220                              |       | 3,401                                 |       |
| Total  liabilities                                                                                                                              |       | 96,647                                |       | 111,960                            |       | 114,258                               |       |
|                                                                                                                                            |       |                                  |       |                               |       |                                  |       |
| 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 86,780,290, 86,758,973 and 89,004,780 shares |       | 87                                    |       | 87                                 |       | 89                                    |       |
| Additional  paid-in capital                                                                                                                     |       | 140,098                               |       | 139,437                            |       | 141,962                               |       |
| Accumulated  other comprehensive loss                                                                                                           |       | (7,753                                | )          | (12,261                            | )          | (7,739                                | )          |
| Retained  earnings                                                                                                                              |       | 325,880                               |       | 332,232                            |       | 353,134                               |       |
| Total  shareholders’ equity                                                                                                                |       | 458,312                               |       | 459,495                            |       | 487,446                               |       |
| Total  liabilities and shareholders’ equity                                                                                                |       | $                                     | 554,959    |                               | $          | 571,455                               |       | $ | 601,704 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

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**bebestores, inc.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

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

**(unaudited)**

 
| ** **                                         | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                         | ** ** | **October 3,**              | ** ** | **October 4,** | ** ** |
| ** **                                         | ** ** | **2009**                         | ** ** | **2008** | ** ** |
| ** **                                         | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Net  sales                                         |       | $                                | 125,659    |   | $ | 163,260 |   |
| Cost  of sales, including production and occupancy |       | 79,498                           |       | 89,958 |   |
|                                               |       |                             |       |   |   |
| Gross  margin                                      |       | 46,161                           |       | 73,302 |   |
| Selling,  general and administrative expenses      |       | 53,022                           |       | 59,155 |   |
|                                               |       |                             |       |   |   |
| Operating  income (loss)                           |       | (6,861                           | )          | 14,147 |   |
| Interest  and other income, net                    |       | 1,042                            |       | 3,030 |   |
|                                               |       |                             |       |   |   |
| Income  (loss) before income taxes                 |       | (5,819                           | )          | 17,177 |   |
| Income  tax provision (benefit)                    |       | (1,637                           | )          | 5,972 |   |
|                                               |       |                             |       |   |   |
| Net  income (loss)                                 |       | $                                | (4,182     | ) | $ | 11,205 |   |
|                                               |       |                             |       |   |   |
| Basic  income (loss) per share                     |       | $                                | (0.05      | ) | $ | 0.13 |   |
| Diluted  income (loss) per share                   |       | $                                | (0.05      | ) | $ | 0.12 |   |
|                                               |       |                             |       |   |   |
| Basic  weighted average shares outstanding         |       | 86,766                           |       | 88,962 |   |
| Diluted  weighted average shares outstanding       |       | 86,766                           |       | 90,038 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

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**bebestores, inc.**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(Inthousands)**

**(unaudited)**

 
| ** **                                                                    | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                    | ** ** | **October 3,********2009**  | ** ** | **October 4,********2008** | ** ** |
| ** **                                                                    | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Cash  flows from operating income:                                            |       |                             |       |   |   |
| Net  income                                                                   |       | $                                | (4,182     | ) | $ | 11,205 |   |
| Adjustments  to reconcile net income to cash provided by operating activities |       |                             |       |   |   |
| Non-cash  compensation expense                                                |       | 631                              |       | 1,739 |   |
| Depreciation  and amortization                                                |       | 7,040                            |       | 6,201 |   |
| Net  loss on disposal of property                                             |       | 2,220                            |       | 156 |   |
| Gain  on trading securities                                                   |       | (22                              | )          | — |   |
| Tax  benefit from exercise of stock options and awards                        |       | 17                               |       | 53 |   |
| Excess  tax benefit from exercise of stock options and awards                 |       | (6                               | )          | (28 | ) |
| Deferred  rent and other lease incentives                                     |       | (748                             | )          | 1,591 |   |
| Deferred  income taxes                                                        |       | (75                              | )          | — |   |
| Long  term income taxes payable                                               |       | 38                               |       | — |   |
| Changes  in operating assets and liabilities:                                 |       |                             |       |   |   |
| Receivables                                                                   |       | (1,206                           | )          | (1,791 | ) |
| Inventories                                                                   |       | 2,795                            |       | (6,660 | ) |
| Prepaid  expenses and other                                                   |       | (1,668                           | )          | (3,071 | ) |
| Accounts  payable                                                             |       | (7,409                           | )          | 10,392 |   |
| Accrued  liabilities                                                          |       | (7,306                           | )          | (5,185 | ) |
| Net  cash provided (used) by operating activities                             |       | (9,881                           | )          | 14,602 |   |
|                                                                          |       |                             |       |   |   |
| Cash  flows from investing activities:                                        |       |                             |       |   |   |
| Purchase  of property and equipment                                           |       | (3,144                           | )          | (8,830 | ) |
| Purchase  of marketable securities                                            |       | (8,477                           | )          | — |   |
| Proceeds  from sales of investment securities                                 |       | 10,718                           |       | 2,200 |   |
| Net  cash used by investing activities                                        |       | (903                             | )          | (6,630 | ) |
|                                                                          |       |                             |       |   |   |
| Cash  flows from financing activities:                                        |       |                             |       |   |   |
| Net  proceeds from issuance of common stock                                   |       | 122                              |       | 374 |   |
| Excess  tax benefit from exercise of stock options and awards                 |       | 6                                |       | 28 |   |
| Cash  dividends paid                                                          |       | (6,507                           | )          | (8,895 | ) |
| Other                                                                         |       | —                           |       | (38 | ) |
| Net  cash used by financing activities                                        |       | (6,379                           | )          | (8,531 | ) |
|                                                                          |       |                             |       |   |   |
| Net  decrease in cash and cash equivalents                                    |       | (17,163                          | )          | (559 | ) |
| Effect  of exchange rate changes on cash                                      |       | 6,483                            |       | (3,220 | ) |
| Cash  and equivalents:                                                        |       |                             |       |   |   |
| Beginning  of period                                                          |       | 91,390                           |       | 123,344 |   |
| End  of period                                                                |       | $                                | 80,710     |   | $ | 119,565 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

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**bebestores, inc.**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**INTERIMFINANCIAL STATEMENTS**

 

The accompanyingcondensed consolidated balance sheets of bebe stores, inc. (the “Company”) asof October 3, 2009, July 4, 2009 and October 4, 2008, the condensedconsolidated statements of operations for the three months ended October 3,2009 and October 4, 2008 and the condensed consolidated statements of cashflows for the three months ended October 3, 2009 and October 4, 2008 havebeen prepared in accordance with accounting principles generally accepted inthe United States of America for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X, withoutaudit. Accordingly, they do not include all of the information required byaccounting principles generally accepted in the United States of America forannual financial statements. Therefore, these condensed consolidated financialstatements should be read in conjunction with the Company’s Annual Report on Form 10-Kfor the fiscal year ended July 4, 2009.

 

In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary to present fairly the financial position at the balancesheet dates and the results of operations for the periods presented have beenincluded. The condensed consolidated balance sheet at July 4, 2009,presented herein, was derived from the audited balance sheet included in theCompany’s Annual Report on Form 10-K for the fiscal year ended July 4,2009.

 

The Company’s business isaffected by the pattern of seasonality common to most retail apparelbusinesses. The results for the periods presented are not necessarilyindicative of future financial results.

 

The Company revised cashflows from operating activities for the three months ended October 4, 2008on its statements of cash flows to separately present the tax benefit andexcess tax benefit from exercise of stock options and awards.  Net cash provided by (used in) operating andfinancing activities for the quarter changed by immaterial amounts.

 

The Company has evaluatedall subsequent events that occurred after the balance sheet date through November 12,2009, the date the condensed consolidated financial statements were issued.

 

**FISCALYEAR**

 

The Company’s fiscal yearis a 52 or 53 week period, each period ending on the first Saturday after June 30. Fiscal years 2009 and 2008 each include 52 weeks.

 

The three month periodsended October 3, 2009 and October 4, 2008 each include 13 weeks.

 

**RECENTACCOUNTING PRONOUNCEMENTS**

 

*Codification*

 

Effective July 1,2009, the Financial Accounting Standards Board’s (“FASB”) Accounting StandardsCodification (“ASC”) became the single official source of authoritative,nongovernmental generally accepted accounting principles (“GAAP”) in the UnitedStates.  The historical GAAP hierarchy was eliminated, and the ASCbecame the only level of authoritative GAAP, other than guidance issued by theSecurities and Exchange Commission.  The Company’s accountingpolicies were not affected by the conversion to ASC.  However,references to specific accounting standards in the footnotes to the Company’sconsolidated financial statements have been changed to refer to the appropriatesection of ASC.

 

*Fair Value*

 

In September 2006,the FASB issued guidance which defines fair value, establishes a framework formeasuring fair value in accordance with generally accepted accountingprinciples and expands disclosures about fair value measurements.  Thisguidance is contained in ASC 820, “Fair Value Measurements and Disclosures”.  In February 2008, the FASB deferred theeffective date for non-financial assets and liabilities, except for certainitems that are recognized or disclosed at fair value at least annually. The Company elected to partially adopt the provisions ASC 820 as of July 6,2008 for financial instruments. Although the partial adoption did notmaterially impact the Company’s financial condition, results of operations orcash flow, the Company is now required to provide additional disclosures aspart of its financial statements.  The Company’s adoption of the remainingprovisions of ASC 820, pertaining to fair value disclosures related to non-financialassets and liabilities, on July 5, 2009 has not had a material impact onthe Company’s consolidated financial position, statements of operations or cashflows.

 

In April 2009, theFASB issued additional guidance in accordance with ASC 825, “FinancialInstruments”.  The additional guidanceadds required disclosures about fair value of financial instruments in interimfinancial statements as well as in annual financial statements.  Theguidance also requires those disclosures in summarized financial information atinterim reporting periods.

 

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This guidance iseffective for interim periods ending after June 15, 2009, with earlyadoption permitted for periods ending after March 15, 2009.  The Company’s adoption of this requirement hasnot had a material impact on the Company’s consolidated financial position,statements of operations or cash flows, as it relates to disclosure only.

 

**INVENTORIES**

 

The Company’s inventoriesconsisted of:

 
| ** **                      | ** ** | **As of**                  | ** ** |
|---------------------------------|------------|---------------------------------|------------|
| ** **                      | ** ** | **October 3,********2009** | ** ** | **July 4,********2009** | ** ** | **October 4,********2008** | ** ** |
| ** **                      | ** ** | **(In thousands)**         | ** ** |
| Merchandise  available for sale |       | $                               | 34,717     |   | $ | 37,043 |   | $ | 44,329 |   |
| Raw  materials                  |       | 1,766                           |       | 2,151 |   | 4,983 |   |
| Inventories,  net               |       | $                               | 36,483     |   | $ | 39,194 |   | $ | 49,312 |   |

 

**EARNINGSPER 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:

 
| ** **                                                     | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                     | ** ** | **October 3,********2009**  | ** ** | **October 4,********2008** | ** ** |
| ** **                                                     | ** ** | **(In thousands)**          | ** ** |
| Basic  weighted average number of shares outstanding           |       | 86,766                           |       | 88,962 |   |
| Incremental  shares from the assumed issuance of stock options |       | —                           |       | 1,076 |   |
|                                                           |       |                             |       |   |   |
| Diluted  weighted average number of shares outstanding         |       | 86,766                           |       | 90,038 |   |

 

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

 

Excluded from thecomputation of the number of diluted weighted average shares outstanding wereoptions to purchase 5,056,980 and 3,372,000 shares of common stock for thethree months ended October 3, 2009 and October 4, 2008, respectively,which would have been anti-dilutive.

 

**COMMONSTOCK PURCHASES**

 

In October 2008, theboard of directors authorized a program to repurchase up to $30 million of theCompany’s common stock.  The Companyintends, from time to time, as business conditions warrant, to purchase stockin the open market or through private transactions.  Purchases may beincreased, decreased or discontinued at any time without prior notice. The plan does not obligate the Company to repurchase any specific number ofshares and may be suspended at any time at management’s discretion.  No shares were repurchased during the threemonths ended October 3, 2009 or the three months ended October 4,2008.  As of October 3, 2009, therewas $16.7 million available for repurchase under the program.

 

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**COMPREHENSIVEINCOME (LOSS)**

 

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

 
| ** **                                    | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **October 3,********2009**  | ** ** | **October 4,********2008** | ** ** |
| ** **                                    | ** ** | **(in thousands)**          | ** ** |
| Net  income (loss)                            |       | $                                | (4,182     | ) | $ | 11,205 |   |
| Gain  (loss) on available for sale securities |       | 2,243                            |       | (5,396 | ) |
| Accumulated  translation adjustments          |       | 2,265                            |       | 2,082 |   |
|                                          |       |                             |       |   |   |
| Total  comprehensive income (loss)            |       | $                                | 326        |   | $ | 7,891 |   |

 

**INVESTMENTS**

 

The Company’s investmentportfolio consists of treasury bills, guaranteed investment certificates andauction rate securities. The Company holds a variety of interest bearingauction rate securities (“ARS”) consisting of federally insured student loanbacked securities and insured municipal authority bonds. As of October 3,2009, the Company’s ARS portfolio totaled approximately $189.9 million,$69.5 million classified as trading securities (net of impairment chargesof $12.7 million) and $120.4 million (net of a temporary impairment charge of$14.6 million, of which a $2.2 million gain has been recognized in thecurrent year) classified as available for sale securities. The Company’s ARSportfolio includes approximately 98% federally insured student loan backedsecurities and 2% municipal authority bonds. The Company’s ARS portfolioconsists of approximately 46% AAA rated investments, 10% AA rated investments,33% A rated investments and 11% BBB rated investments. This is a change fromthe Company’s fiscal 2009 portfolio, which consisted of 46% AAA ratedinvestments, 14% AA rated investments, 30% A rated investments and 10% BBBrated investments. These ARS investments are intended to provide liquidity viaan auction process that resets the applicable interest rate at predeterminedcalendar intervals, allowing investors to either roll over their holdings orgain immediate liquidity by selling such interests at par. The uncertainties inthe credit markets that began in February 2008 have affected the Company’sholdings in ARS investments and auctions for the Company’s investments in thesesecurities have failed to settle on their respective settlement dates.Historically the fair value of ARS investments had approximated par value dueto the frequent resets through the auction process. While the Company continuesto earn interest on its ARS investments at the maximum contractual rate, theseinvestments are not currently trading and therefore do not currently have areadily determinable market value. Accordingly, the estimated fair value of ARSno longer approximates par value. Consequently, the investments are notcurrently liquid, and the Company will not be able to access these funds untila future auction of these investments is successful, the issuer redeems thesecurities, or at maturity. Maturity dates for these ARS investments range from2010 to 2044 with principal distributions occurring on certain securities priorto maturity.

 

In November 2008,the Company entered into a settlement agreement related to its ARS held withUBS Financial Services, Inc. (“UBS”) that grants the Company certainrights related to these ARS (the “Right”). Beginning June 30, 2010, at theCompany’s request, UBS has agreed to purchase all of the Company’s ARScurrently held with them at par value. Conversely, UBS has the right, in itsdiscretion, to purchase or sell the Company’s ARS at any time until July 2,2012, so long as the Company receives payment at par value upon any sale ordisposition. The enforceability of the Right results in a put option whichshould be recognized as a free standing asset separate from the ARS. Uponacceptance of the offer from UBS in November 2008, the Company recorded the putoption at fair value of $11.6 million, with a corresponding credit to interestand other income, net. Although it is a financial instrument, the put optiondoes not meet the FASB’s definition of a derivative instrument, therefore theCompany has elected to measure the put option at fair value. As a result,unrealized gains and losses are included in earnings.  At October 3, 2009, the fair value ofthe put option is $12.1 million, net of a reserve of $0.6 million, of which a gainof $0.02 million has been recognized in the current year. 

 

Prior to accepting theUBS offer, the Company recorded its ARS held with UBS as investments availablefor sale, with an associated unrealized loss included in other comprehensiveincome. In connection with our acceptance of the UBS offer in November 2008,the Company transferred approximately $84.4 million in ARS subject to theUBS settlement from investments available for sale to trading securities andrecorded a loss on investments of approximately $12.1 million. As aresult, subsequent changes in fair value of the ARS have been recorded as acomponent of net income. The Company intends to exercise the Right when itbecomes available, and as such the associated investments have been classifiedas short term on the balance sheet.

 

The remainder of theCompany’s ARS investment portfolio of $120.4 million, net of a temporaryimpairment charge of $14.6 million, remains available for sale on our balancesheet. The related temporary impairment charge remains as a loss in accumulatedother comprehensive income.

 

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The Company also holdsshort term available for sale securities totaling $38.5 million as of October 3,2009, that consist of treasury bills and guaranteed investment certificateswhich are classified as available for sale securities on its balance sheet atcost which approximates fair value.

 

The Company reviews itsimpairments in accordance with guidance issued by the FASB and SEC in order todetermine the classification of the impairment as “temporary” or “other-than-temporary”.A temporary impairment charge results in an unrealized loss being recorded inthe accumulated other comprehensive income component of shareholders’ equity.Such an unrealized loss does not affect net income for the applicableaccounting period. An other-than-temporary impairment charge is recorded as aloss in the condensed consolidated statements of operations for the applicableaccounting period. When evaluating the investments for other-than-temporaryimpairment, the Company estimates the expected cash flows of the underlyingcollateral by reviewing factors such as the length of time and extent to whichfair value has been below cost basis, the financial condition of the issuer andany changes thereto, and the Company’s intent to sell, or whether it is morelikely than not it will be required to sell, the investment before recovery ofthe investment’s amortized cost basis. The Company has not recorded anyimpairment loss from its available for sale investments as other-than-temporarybased on such analysis.

 

The valuation of theCompany’s investment portfolio is subject to uncertainties that are difficultto predict. Factors that may impact its valuation include changes to creditratings of the securities as well as to the underlying assets supporting thosesecurities, rates of default of the underlying assets, underlying collateralvalue, discount rates and ongoing strength and quality of market credit andliquidity.

 

The following is asummary of our available for sale securities:

 
| ** **                          | ** ** | **As of October 3, 2009** | ** ** |
|-------------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **Cost**                       | ** ** | **Unrealized  Losses  Less Than  12 Months** | ** ** | **Unrealized  Losses  12 Months  or Greater** | ** ** | **Estimated  Fair Value** | ** ** |
| ** **                          | ** ** | **(in thousands)**             | ** ** |
| Treasury  bills                     |       | $                              | 30,000     |   | $ | — |   | $ | — |   | $ | 30,000 |   |
| Guaranteed  investment certificates |       | 8,477                          |       | — |   | — |   | 8,477 |   |
| Auction  rate securities            |       | 135,025                        |       | — |   |   | (14,594 | ) | 120,431 |   |
| Total                               |       | $                              | 173,502    |   | $ | — |   | $ | (14,594 | ) | $ | 158,908 |   |

 
| ** **               | ** ** | **As of October 4, 2008** | ** ** |
|--------------------------|------------|--------------------------------|------------|
| ** **               | ** ** | **Cost**                       | ** ** | **Unrealized  Losses  Less Than  12 Months** | ** ** | **Unrealized  Losses  12 Months  or Greater** | ** ** | **Estimated  Fair Value** | ** ** |
| ** **               | ** ** | **(in thousands)**             | ** ** |
| Auction  rate securities |       | $                              | 241,350    |   | $ | (13,195 | ) | $ | — |   | $ | 228,155 |   |
|                          |            |                                |            |  |  |  |  |  |  |  |  |  |  |

 

**CREDITFACILITIES**

 

The Company has anunsecured commercial line of credit agreement which provides for borrowings andissuance of letters of credit of up to a combined total of $25.0 millionand expires on March 31, 2012. The outstanding balance bears interest ateither the bank’s reference rate (which was 3.25% as of October 3, 2009)or the LIBOR rate (which was 0.25% as of October 3, 2009) plus 1.75 percentagepoints. As of October 3, 2009, there were no outstanding cash borrowingsand there was $2.7 million of letters of credit outstanding.

 

This credit facilityrequires the Company to maintain a $2.5 million compensating balance and tocomply with certain financial covenants, including amounts for minimum tangiblenet worth, unencumbered liquid assets and profitability, and certainrestrictions on making loans and investments. As of October 3, 2009 theCompany was not in compliance with respect to one covenant of the agreementrequiring specified quarterly income levels. A waiver has been obtained for thequarter ended October 3, 2009.

 

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**STOCKBASED COMPENSATION**

 

The following tablesummarizes the stock based compensation expense recognized under the Company’sstock plan during the three months ended October 3, 2009 and October 4,2008:

 
| ** **                              | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **October 3,********2009**  | ** ** | **October 4,********2008** | ** ** |
| ** **                              | ** ** | **(in thousands)**          | ** ** |
| Stock  options                          |       | $                                | 699        |   | $ | 1,595 |   |
| Nonvested  stock awards/units           |       | (68                              | )          | 144 |   |
| Total  stock based compensation expense |       | $                                | 631        |   | $ | 1,739 |   |

 

Unrecognized compensationcost related to nonvested stock options and nonvested stock awards/unitstotaled approximately $7.7 million and $0.3 million, respectively, as of October 3,2009.  This cost is expected to be recognized over a weighted averageperiod of 2.9 years.  The weighted average fair value of stock options attheir grant date during the three months ended October 3, 2009 and October 4,2008 was $2.87 and $4.10, respectively.

 

During the first quarterof 2010, the Company filed a Tender Offer Statement on Schedule TO with the SECpursuant to which the Company extended an offer to employees and non-employeedirectors to exchange up to an aggregate of 2,058,475 options to purchaseshares of our common stock, whether vested or unvested. Options with anexercise price greater than $10.74 per share and an expiration date after September 29,2009 were eligible to be tendered pursuant to the offer. The closing marketprice on September 29, 2009 was $7.64. In accordance with the Tender Offer (the“TO”), the number of new options issued was based on exchange ratios as setforth in the table below:

 
| **Exercise Price Range** | ** ** | **Shares  Subject to Option  Surrendered** | ** ** | **Shares  Subject to  Replacement Option To  Be Granted** | ** ** |
|--------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------------|------------|
| $10.75-$14.99            |       | 1.14                                       |       | 1                                                         |       |
| $15.00-$19.99            |       | 1.84                                       |       | 1                                                         |       |
| $20.00 and above         |       | 2.06                                       |       | 1                                                         |       |

 

A total of 1,710,735 optionswere tendered and cancelled, and a total of 1,126,267 options were granted on September 29,2009 with an exercise price of $7.64 per share. Replacement options granted in exchange for fully or partially unvestedsurrendered options at the time they were surrendered for cancellation willvest as follows: (A) vested shares subject to eligible options andunvested shares subject to eligible options scheduled to vest prior to theone-year anniversary of the replacement grant date shall vest on the one-yearanniversary of the replacement grant date and (B) unvested shares subjectto eligible options scheduled to vest after the one-year anniversary of thereplacement grant date shall vest according to the original vest dates of theeligible option. The TO was subject to modification accounting pursuantto FASB ASC 718-20-35-3 whereby the total compensation cost measured atthe date of modification was the incremental cost resulting from themodification. The incremental cost resulting from the modification ismeasured as the excess of the fair value of the modified award over the fairvalue of the original award immediately before its terms are modified. Theincremental fair value of $0.3 million for the new awards was computed using anexpected life of 4.07 years, a risk-free interest rate of 1.94% and avolatility of 54%. The incremental fair value of the unvested awards isbeing amortized over the remaining service period.

 

**FAIRVALUE MEASUREMENTS**

 

The FASB has establisheda three-tier fair value hierarchy, which prioritizes the inputs used inmeasuring fair value. These tiers include: Level 1, defined as observableinputs such as quoted prices in active markets; Level 2, defined as inputsother than quoted prices in active markets that are either directly orindirectly observable; and Level 3, defined as unobservable inputs inwhich little or no market data exists, therefore requiring an entity to developits own assumptions.

 

*Assets and Liabilities Measuredat Fair Value on a Recurring Basis:*

 

As of October 3,2009, the Company held financial instruments that are measured at fair value ona recurring basis. These included cash equivalents, trading securities, awritten put option related to a UBS settlement and available for salesecurities. Cash equivalents consist of money market funds. Short termavailable for sale securities consist of government treasury bills andguaranteed investment certificates. Trading securities consist of auction ratesecurities (“ARS”) held with UBS. Long term available for sale securitiesconsist of ARS held with another broker. These securities consist of federallyinsured student loan backed securities and insured municipal authority bonds.

 

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The Company determinedthe estimated fair value of its investment in ARS as of October 3, 2009using a discounted cash flow model. The assumptions used in preparing thediscounted cash flow model include estimates for interest rates, timing, creditratings, credit wrap and amount of cash flows and expected holding periods ofthe ARS. The ARS written put right is a free-standing asset separate from theARS and represents the Company’s contractual right to require UBS to purchaseits ARS at par value during the two-year period beginning June 20, 2010.In order to value the ARS written put right, the Company considered intrinsicvalue, time value of money and its assessment of the credit worthiness of UBS.

 

The following items aremeasured at fair value on a recurring basis as of October 3, 2009:

 
| **Description**                            | ** ** | **October 3, 2009**                                          | ** ** | **Using Quoted Prices********in Active Markets for********Identical Assets** | ** ** | **Significant********Other********Observable********Inputs** | ** ** | **Significant********Unobservable Inputs** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                 | ** ** | ** **                                                             | ** ** | **(Level 1)**                                                                                         | ** ** | **(Level 2)**                                           | ** ** | **(Level 3)**                              | ** ** |
| ** **                                 | ** ** | **Fair value measurements at reporting date** | ** ** |
| ** **                                 | ** ** | **(In thousands)**                                                | ** ** |
| Cash  equivalents                          |       | $                                                                      | 51,083     |                                                                                                       | $          | 51,083                                                       |       | $                                               | —     |   | $ | — |   |
| Current  available for sale securities     |       | 38,477                                                                 |       | 38,477                                                                                                     |       | —                                                       |       | —                                          |       |
| Trading  securities                        |       | 69,460                                                                 |       | —                                                                                                     |       | —                                                       |       | 69,460                                          |       |
| ARS  written put option                    |       | 12,106                                                                 |       | —                                                                                                     |       | —                                                       |       | 12,106                                          |       |
| Non-current  available for sale securities |       | 120,431                                                                |       | —                                                                                                     |       | —                                                       |       | 120,431                                         |       |
| Total                                      |       | $                                                                      | 291,557    |                                                                                                       | $          | 89,560                                                       |       | $                                               | —     |   | $ | 201,997 |   |

 

The following tablepresents the Company’s activity for assets measured at fair value on arecurring basis using significant unobservable inputs (Level 3) for the threemonths ended October 3, 2009:

 
| ** **                                        | ** ** | **Investments  in ARS** | ** ** |
|---------------------------------------------------|------------|-------------------------|------------|
| ** **                                        | ** ** | **(In thousands)** | ** ** |
| Balance  as of July 4, 2009                  |       | $                       | 200,431    |   |
| Total  gains or (losses) (realized or unrealized) |       |                    |       |
| Included  in net loss                             |       | 22                      |       |
| Included  in accumulated other comprehensive loss |       | 2,244                   |       |
| Settlements                                       |       | (700                    | )          |
| Balance  as of October 3, 2009               |       | $                       | 201,997    |   |

 

*Assets and Liabilities Measuredat Fair Value on a Non-Recurring Basis*:

 

The Company measurescertain non-financial assets and liabilities, including long-lived assets, atfair value on a non-recurring basis. During the 13 weeks ended October 3, 2009, the Company recorded acharge of approximately $1.7 million related to the impairment of assetsrelated to under-performing stores.  Thefair market value of these assets was determined using the income approach andlevel 3 inputs, which required management to make significant estimates aboutfuture cash flows.  Management estimatesthe amount and timing of future cash flows based on its experience andknowledge of the retail market in which each store operates.  This impairment charge is included inselling, general and administrative expenses (“SG&A”) in the accompanyingcondensed consolidated statements of operations.  The Company was not required to measure anyother significant non-financial assets and liabilities at fair value.

 

**LEGALMATTERS**

 

As of the date of thisfiling, the Company was involved in ongoing legal proceedings as describedbelow.

 

A former employee suedthe Company in a complaint filed on April 28, 2005 in the United StatesDistrict Court for the Northern District of California (case No. C050177)alleging violations under the Fair Labor Standards Act, specifically that theCompany obligated her to buy and wear its brand clothing as a uniform, withoutreimbursement or credit, and the net effect of deducting the value of suchrequired purchases from her wages would often result in her not being paidminimum wages. The plaintiff purports to bring the action also on behalf of aclass of hourly, non-managerial employees who are similarly situated. Thelawsuit seeks compensatory, statutory and injunctive relief. The Companynegotiated a confidential settlement in this case which received final courtapproval on November 3, 2009. The Company accrued an amount the Companybelieves reasonably estimates the potential liability, which did not have amaterial impact on the Company’s financial position or results of operations.

 

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A former employee suedthe Company in a complaint filed July 27, 2006 in the Superior Court ofCalifornia, San Mateo County (case No. CIV 456550) alleging a failure topay all wages, failure to pay overtime wages, failure to pay minimum wages,failure to provide meal periods, violation of Labor Code §450, violation ofLabor Code §2802 and California Code of Regulations §11040(9)(A), statutorywage violations (late payment of wages), unlawful business practices underBusiness and Professions Code §16720 and §17200, conversion of wages andviolation of Civil Code §52.1. The plaintiff purports to bring the action alsoon behalf of current and former California bebe employees who are similarlysituated. The lawsuit seeks compensatory, statutory, punitive, restitution andinjunctive relief. In August 2009, the court extended its prior orderconditionally denying class certification and maintained a stay of the actionuntil a final order is issued regarding the proposed class settlement describedin the lawsuit immediately above (filed April 28, 2005).

 

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

 

The Company will defenditself vigorously against each of these claims. However, the results of anylitigation are inherently uncertain, and thus the Company cannot assure youthat it will be able to successfully defend in these lawsuits. Where required,and/or otherwise appropriate, the Company has recorded an estimate of potentialliabilities that the Company believes is reasonable. Any estimates are revisedas further information becomes available.

 

**ITEM2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The following Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontains forward-looking statements, which involve risks and uncertainties. Ouractual results may differ materially from those anticipated in theseforward-looking statements.  Statements that are predictive in nature,that depend upon or refer to future events or conditions or that include wordssuch as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “thinks,”and similar expressions are forward-looking statements.  Forward-looking statements include statements about our expectedresults of operations, capital expenditures and store openings.  Althoughwe believe that these statements are based upon reasonable assumptions, wecannot assure you that our goals will be achieved. These forward-lookingstatements are made as of the date of this Form 10-Q, and we assume noobligation to update or revise them or provide reasons why actual results maydiffer. Factors that might cause such a difference include, but are not limitedto, our ability to respond to changing fashion trends, obtain raw materials andfind manufacturing facilities, attract and retain key management personnel,develop new concepts, successfully open future stores, successfully manage ouronline business, maintain and protect information technology, respondeffectively to competitive pressures in the apparel industry and adverseeconomic conditionsand protect our intellectual property as well as declines incomparable store sales performance, changes in the level of consumer spendingor preferences in apparel and/or other factors discussed in “Risk Factors” andelsewhere in this Form 10-Q.

 

**OVERVIEW**

 

We design, develop andproduce a distinctive line of contemporary women’s apparel and accessories.While we attract a broad audience, our target customer is a 18 to 34-year-oldwoman who seeks current fashion trends to suit her lifestyle. The “bebe look”appeals to a hip, sexy, sophisticated, body-conscious woman who takes pride inher appearance. The bebe customer expects value in the form of current fashionand high quality at a competitive price.

 

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

 

We market our productsunder the bebe, BEBE SPORT, bbsp, 2b bebe and PH8 brand names through our 307retail stores, of which 212 are bebe stores, 61 are BEBE SPORT stores, 33 are2b bebe stores and 1 is a bebe accessories store as of October 3, 2009.These stores are located in 35 states, the District of Columbia, Puerto Rico,the U.S. Virgin Islands and Canada. In addition, we have an on-line store atwww.bebe.com, and our licensees operate 37 international stores as of October 3,2009. During the three months ended October 3, 2009, we opened 2 bebestores and closed a bebe store, a BEBE SPORT store and a 2b bebe store. We expect to open approximately 5 bebe stores during fiscal 2010. We also plan toexpand an existing store.  We intend toconvert our BEBE SPORT stores to PH8 stores in the second quarter of fiscal2010.

 

*bebestores.*  Wewere founded by Manny Mashouf, our Chief Executive Officer and Chairman of theBoard. We opened our first store in San Francisco, California in 1976, whichwas also the year we incorporated. We also operate one bebe accessory storethat features a limited assortment of bebe merchandise, including outerwear,shoes and accessories.

 

*BEBESPORT.* Welaunched BEBE SPORT during fiscal 2003 to address the performance and activelifestyle needs of the bebe customer.  We offer a selection of sportswearand footwear under the BEBE SPORT and bbsp brand names.  In September 2009, we began introducingproduct under our new PH8 label in our existing BEBE SPORT stores and we intendto convert the BEBE SPORT stores to PH8 stores in November 2009, and beginto offer BEBE SPORT product in bebe and 2b bebe stores starting Holiday 2009.  In our PH8 stores, we will offer a selectionof casual weekend apparel, work-out attire and accessories such as bags, shoesand various seasonal items.  In addition,we will launch a separate PH8 on-line store in June 2010 that will provide acomplete assortment of PH8 product and will also be used as a vehicle tocommunicate with our new customers.  Dueto the change in store fronts and product offering we will exclude the new PH8stores from comparable store sales as of November 2009.

 

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*2b bebestores*.  Wecurrently operate 15 2b bebe stores and 18 stores operating in the outlet storedesign under the 2b bebe name.  Thestores operating in the 2b bebe design sell bebe logo, 2b bebe merchandise anda small percentage of bebe retail markdowns. The stores operating in the outlet design with the same name change sellbebe logo, 2b bebe merchandise and a large percentage of bebe retail markdowns.

 

*On-line.* bebe.com is an extension of the bebestore experience and provides a complete assortment of bebe and BEBE SPORTmerchandise. It is also used as a vehicle to communicate with our customers.

 

**CRITICALACCOUNTING POLICIES**

 

Management’s Discussionand Analysis of Financial Condition and Results of Operations are based uponour consolidated financial statements, which have been prepared in conformitywith accounting principles generally accepted in the United States of America.

 

The preparation of thesefinancial statements requires the appropriate application of certain accountingpolicies, many of which require us to make estimates and assumptions aboutfuture events and their impact on amounts reported in our financial statementsand related notes. Since future events and their impact cannot be determinedwith certainty, the actual results will inevitably differ from our estimates.Such differences could be material to the financial statements. We believe ourapplication of accounting policies, and the estimates inherently requiredtherein, are reasonable. Our most critical accounting policies are thoserelated to revenue recognition, stock based compensation, inventories,marketable securities, impairment of long lived assets, uncertain tax positionsand liabilities for self-insurance. We continually evaluate these accountingpolicies and estimates, and we make adjustments when facts and circumstancesdictate a change. Our accounting policies are described in Note 1 to theconsolidated financial statements in our annual report on Form 10-K forthe fiscal year ended July 4, 2009. This discussion and analysis should beread in conjunction with such discussion and with our condensed consolidatedfinancials statements and related notes included in Part 1, Item 1 ofthis quarterly report.

 

**RESULTSOF OPERATIONS**

 

Our fiscal year is a 52or 53 week period, each period ending on the first Saturday after June 30. Fiscal years 2010 and 2009 each include 52 weeks.  The three months ended October 3,2009 and October 4, 2008 each include 13 weeks.

 

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

 
| ** **                                             | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                             | ** ** | **October 3,**              | ** ** | **October 4,** | ** ** |
| ** **                                             | ** ** | **2009**                         | ** ** | **2008** | ** ** |
|                                                   |       |                             |       |   |   |
| Net  sales                                             |       | 100.0                            | %          | 100.0 | % |
| Cost  of sales, including production and occupancy (1) |       | 63.3                             |       | 55.1 |   |
|                                                   |       |                             |       |   |   |
| Gross  margin                                          |       | 36.7                             |       | 44.9 |   |
| Selling,  general and administrative expenses (2)      |       | 42.2                             |       | 36.2 |   |
|                                                   |       |                             |       |   |   |
| Operating  income (loss)                               |       | (5.5                             | )          | 8.7 |   |
| Interest  and other income, net                        |       | 0.9                              |       | 1.9 |   |
|                                                   |       |                             |       |   |   |
| Income  (loss) before income taxes                     |       | (4.6                             | )          | 10.6 |   |
| Provision  (benefit) for income taxes                  |       | (1.3                             | )          | 3.7 |   |
|                                                   |       |                             |       |   |   |
| Net  income (loss)                                     |       | (3.3                             | )%         | 6.9 | % |

 

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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 expenses primarily consist of non-occupancy store costs,  corporate overhead and advertising costs. |

 

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*NetSales.* Net salesdecreased to $125.7 million during the three months ended October 3, 2009from $163.3 million for the comparable period of the prior year, a decrease of$37.6 million, or 23.0%. The decrease in sales was primarily due to a 25.7%decrease in comparable store sales resulting primarily from the overallmacroeconomic environment, in which we saw lower traffic and conversion instores, a reduced customer acceptance of the merchandise offering and a 16.6%decrease in our on-line sales.  These decreases were partially offset bystores not included in the comparable store sales, an increase in wholesalesales to international licensees and an increase in royalty revenue.

 
| ** **                                      | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|
| ** **                                      | ** ** | **October 3,**              | ** ** | **October 4,** | ** ** |
| ** **                                      | ** ** | **2009**                         | ** ** | **2008** | ** ** |
|                                            |       |                             |       |   |   |
| Net  sales (In thousands)                       |       | $                                | 125,659    |   | $ | 163,260 |   |
|                                            |       |                             |       |   |   |
| Total  net sales increase (decrease) percentage |       | (23.0                            | )%         | 1.4 | % |
|                                            |       |                             |       |   |   |
| Comparable  store sales decrease percentage     |       | (25.7                            | )%         | (10.8 | )% |
|                                            |       |                             |       |   |   |
| Net  sales per average square foot (1)          |       | $                                | 104        |   | $ | 138 |   |
|                                            |       |                             |       |   |   |
| Square  footage at end of period (In thousands) |       | 1,155                            |       | 1,143 |   |
|                                            |       |                             |       |   |   |
| Number  of store locations:                     |       |                             |       |   |   |
| Beginning  of period                            |       | 308                              |       | 303 |   |
| New  store locations                            |       | 2                                |       | 5 |   |
| Closed  store locations                         |       | 3                                |       | 1 |   |
| Number  of stores open at end of period         |       | 307                              |       | 307 |   |

 

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

 

*GrossMargin.* Grossmargin decreased to $46.2 million during the three months ended October 3,2009 from $73.3 million for the comparable period of the prior year, a decreaseof $27.1 million, or 37.0%. As a percentage of net sales, gross margindecreased to 36.7% for the three months ended October 3, 2009 from 44.9%in the comparable period of the prior year.  The decrease in gross marginas a percentage of net sales was primarily due to higher markdowns andunfavorable occupancy leverage partially offset by lower other costs.

 

*Selling,General and Administrative Expenses.* Selling, general and administrative expenses, whichprimarily consist of non-occupancy store costs, corporate overhead andadvertising costs, decreased to $53.0 million during the three months ended October 3,2009 from $59.2 million for the comparable period of the prior year, a decreaseof $6.2 million, or 10.5 %. As a percentage of net sales, selling, general andadministrative expenses increased to 42.2% during the three months ended October 3,2009 from 36.2% in the comparable period of the prior year.  The decreasein dollars over the prior year was primarily due to an increase in depreciationexpense and a $1.7 million impairment charge related to under-performing storesoffset by lower compensation and advertising expense.  The increase as a percentage of net sales isa result of lower revenues.

 

*Interestand Other Income, Net.* We generated approximately $1.0 million of interest and other income,net of other expenses during the three months ended October 3, 2009compared to approximately $3.0 million in the comparable period of the prioryear. The decrease in interest and other income resulted from investments inlower-yielding tax-exempt investments and money market funds.

 

*Provisionfor Income Taxes.*Our effective tax rate was a 28.1% benefit for the three months ended October 3,2009 compared to a 34.8% provision for the comparable period in the prior year.  The lower effective tax rate was primarilydue to discrete adjustments booked during the quarter offset by an increase intax-exempt interest income as a percent of total pre-tax loss and a change intax treatment related to our stock option exchange in which incentive stockoptions that were exchanged were converted to non-qualified stock options.

 

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**SEASONALITYOF BUSINESS AND QUARTERLY RESULTS**

 

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**

 

Our working capitalrequirements vary widely throughout the year and generally peak during thefirst and second fiscal quarters. As of October 3, 2009, we hadapproximately $309.1 million of cash and equivalents and investments on hand ofwhich approximately $40.0 million were invested in government treasury bills(of these, $10.0 million are classified as cash equivalents), approximately$8.5 million were invested in guaranteed investment certificates, andapproximately $189.9 million, net of impairment charges of $27.3 million, wereinvested in auction rate securities (“ARS”). We do not anticipate the lack ofliquidity in the ARS to impact our ability to fund our operations in theforeseeable future and believe we have sufficient cash and equivalents to fundongoing operations. In addition, we have a revolving line of credit, underwhich we may borrow or issue letters of credit up to a combined total of $25million. As of October 3, 2009, there were no cash borrowings outstandingunder the line of credit, and letters of credit outstanding totaled $2.7million.  This credit facility requires us to maintain a $2.5 millioncompensating balance and to comply with certain financial covenants, includingamounts for minimum tangible net worth, unencumbered liquid assets andprofitability, and certain restrictions on making loans and investments.  As of October 3, 2009, we were not incompliance with one covenant of the agreement requiring specified quarterlyincome levels.  We obtained a waiver as of October 3, 2009, withrespect to this covenant for the quarter ended October 3, 2009.

 

As of October 3,2009, we had cash and equivalents of $80.7 million held in accounts managed bythird-party financial institutions consisting of invested cash and cash in ouroperating accounts.  The invested cash is invested in interest bearingfunds managed by third party financial institutions.  These funds investin direct obligations of the government of the United States.  To date, wehave experienced no loss or lack of access to our invested cash or equivalents;however, we can provide no assurances that access to our invested cash andequivalents will not be impacted by adverse conditions in the financialmarkets.

 

At any point in time wealso have approximately $75 to $100 million of invested cash and cash in operatingaccounts that are with third party financial institutions.  These balancesexceed the Federal Deposit Insurance Corporation insurance limits.  Whilewe monitor daily the cash balances in our operating accounts and adjust thecash balances as appropriate, these cash balances could be impacted if theunderlying financial institutions fail or could be subject to other adverseconditions in the financial markets.  To date, we have experienced no lossor lack of access to invested cash or cash in our operating accounts.

 

Net cash used byoperating activities for the three months ended October 3, 2009 was $9.9million versus cash provided by operating activities of $14.6 million for thethree months ended October 4, 2008. The decrease of $24.5 million from thecomparable period was primarily due to a decrease in net earnings of $15.4million and decreased changes in working capital of $8.5 million primarilyrelated to lower accounts payable resulting from decreases in finished goodsinventory at stores and reduced costs related to new store openings.

 

Net cash used byinvesting activities for the three months ended October 3, 2009 was $0.9million versus $6.6 million for the three months ended October 4,2008.  The decrease of $5.7 million versus the prior year comparableperiod was primarily due to lower capital expenditures.  We expect thattotal capital expenditures will be below $20 million in fiscal 2010.

 

Net cash used byfinancing activities was $6.4 million for the three months ended October 3,2009 versus $8.5 million for the three months ended October 4, 2008. The decrease of $2.1 million from the prior year comparable period wasprimarily due to lower dividends paid related to a lower rate declared for thefirst quarter of fiscal 2010 ($0.025 per share versus $0.05 per share in theprior year).

 

We hold a variety ofinterest bearing ARS consisting of federally insured student loan backedsecurities and insured municipal authority bonds. As of October 3, 2009,our ARS portfolio totaled approximately $189.9 million, $69.5 million (net ofan impairment charge of $12.7 million) classified as trading securities and$120.4 million (net of temporary impairment charge of $14.6 million) classifiedas long-term available for sale securities. Our ARS portfolio includesapproximately 98% federally insured student loan backed securities and 2%municipal authority bonds. Our ARS portfolio consists of approximately 46% AAArated investments, 10% AA rated investments, 33% A rated investments and 11%BBB rated investments.  This is a change from our fiscal 2009 portfolio,which consisted of 46% AAA rates investments, 14% AA rated investments, 30% Arated investments and 10% BBB related investments.  These ARS investments are intended to provideliquidity via an auction process that resets the applicable interest rate atpredetermined calendar intervals, allowing investors to either roll over theirholdings or gain immediate liquidity by selling such interests at par. Theuncertainties in the credit markets that began in February 2008 haveaffected our holdings in ARS investments and auctions for our investments inthese securities have failed to settle on their respective settlement dates.Historically the fair value of ARS investments had approximated par value dueto the frequent resets through the auction process. While we continue to earninterest on our ARS investments at the maximum contractual rate, theseinvestments are not currently trading and 

 

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therefore do notcurrently have a readily determinable market value. Accordingly, the estimatedfair value of ARS no longer approximates par value.  Consequently, theinvestments are not currently liquid, and we will not be able to access thesefunds until a future auction of these investments is successful, the issuerredeems the securities, or at maturity. Maturity dates for these ARSinvestments range from 2010 to 2044 with principal distributions occurring oncertain securities prior to maturity.

 

In November 2008, weentered into a settlement agreement related to our ARS held with UBS FinancialServices, Inc. (“UBS”) that grants us certain rights related to these ARS(the “Right”).  Beginning June 30, 2010, at our request, UBS hasagreed to purchase all of our ARS currently held with them at par value. Conversely, UBS has the right, in its discretion, to purchase or sell our ARSat any time until July 2, 2012, so long as we receive payment at par valueupon any sale or disposition.  The enforceability of the Right results ina put option which should be recognized as a free standing asset separate fromthe ARS.  Upon acceptance of the offer from UBS, we recorded the putoption at fair value of $11.6 million, with a corresponding credit to interestincome.  Although it is a financial instrument, the put option does notmeet the FASB’s definition of a derivative instrument, therefore we haveelected to measure the put option at fair value.  As a result, unrealized gains and losses areincluded in earnings.  At October 3, 2009, the fair value of the putoption is $12.1 million, net of a reserve of $0.6 million, of which a gain of $0.02million has been recognized in the current year.

 

Prior to accepting theUBS offer, we recorded our ARS held with UBS as investments available for sale,with an associated unrealized loss included in other comprehensiveincome.  In connection with our acceptance of the UBS offer in November 2008,we transferred approximately $84.4 million in ARS subject to the UBS settlementfrom investments available for sale to trading securities and recorded a losson investments of approximately $12.1 million.  As a result, changes infair value of the ARS are recorded as a component of net income.  We intend to exercise the Right when itbecomes available, and as such the associated investments have been classifiedas short-term on the balance sheet.

 

In October 2008, ourboard of directors authorized a program to repurchase up to $30 million of ourcommon stock.  We may, from time to time, as business conditions warrant,purchase stock in the open market or through private transactions. Purchases may be increased, decreased or discontinued at any time without priornotice.  The plan does not obligate us to repurchase any specific numberof shares and may be suspended at any time at management’sdiscretion.   We did not repurchase any shares during the firstquarter of fiscal 2010 and $16.7 million remains available under the program.

 

We believe that our cashand cash equivalents on hand, will be sufficient to meet our capital andoperating requirements for at least the next twelve months. Our future capitalrequirements, however, will depend on numerous factors, including withoutlimitation, liquidity of our auction rate securities, the size and number ofnew and expanded stores and/or store concepts, investment costs for managementinformation systems, potential acquisitions and/or joint ventures, repurchaseof stock and future results of operations.

 

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

 

We are exposed to marketrisks, which include changes in U.S. interest rates and, to a lesser extent,foreign exchange rates. We do not engage in financial transactions for tradingor speculative purposes.

 

*InterestRate Risk*

 

We currently maintain aportfolio of variable interest rate investments consisting of cash equivalents,government treasury bills, guaranteed investment certificates and bothshort-term and long-term investments consisting of ARS.   Accordingto our investment policy, we may invest in taxable and tax-exemptinstruments.  In addition, the policy establishes limits on creditquality, maturity, issuer and type of instrument. Marketable securities areclassified as “trading” or “available for sale”.  We do not use derivativefinancial instruments in our investment portfolio.

 

All highly liquidinvestments with a maturity of three months or less at the date of purchase areconsidered to be cash equivalents.  Investments are considered short-termavailable for sale securities if the original maturity is between three monthsand twelve months, short-term trading securities if they are ARS related to theRight with UBS, or long term investments if the original maturity is greaterthan twelve months. Historically the fair value of ARS investments hadapproximated par value due to the frequent resets through the auction process.While we continue to earn interest on our ARS investments at the maximumcontractual rate, these investments are not currently trading and therefore donot currently have a readily determinable market value. Accordingly, theestimated fair value of ARS no longer approximates par value. We determined theestimated fair value of our investment in ARS as of October 3, 2009 usinga discounted cash flow model to estimate the fair value of our investments inARS. The assumptions used in preparing the discounted cash flow model includeestimates for interest rates, timing and amount of cash flows and expectedholding periods of the ARS. The ARS written put right is a free standing assetseparate from the ARS, and represents our contractual right to require UBS topurchase our ARS at par value during the two year period beginning June 20,2010.  In order to value the ARS written put right, we consideredintrinsic value, time value of money and our assessment of the creditworthiness of UBS.  We have modified our investment strategy and increasedour investments in more liquid money market investments.  An immediate anduniform increase in market interest rate of 100 basis points from levels as of October 3,2009 would cause an additional decline of approximately 3.5%, or $6.4 million,in the fair market value of our investments in ARS.

 

The following table listsour cash, cash equivalents and investments as of October 3, 2009:

 
| ** **                                 | ** ** | **Fair Value**                  | ** ** |
|--------------------------------------------|------------|--------------------------------------|------------|
| ** **                                 | ** ** | **(Dollars in thousands)** | ** ** |
| Cash                                       |       | $                                    | 29,627     |   |
| Weighted  average interest rate            |       |                                 | 0.00       | % |
| Cash  equivalents                          |       | $                                    | 51,083     |   |
| Weighted  average interest rate            |       | 0.07                                 | %          |
| Current  available for sale securities     |       | $                                    | 38,477     |   |
| Weighted  average interest rate            |       | 0.09                                 | %          |
| Trading  securities                        |       | $                                    | 69,460     |   |
| Weighted  average interest rate            |       | 0.77                                 | %          |
| Non-current  available for sale securities |       | $                                    | 120,431    |   |
| Weighted  average interest rate            |       | 0.70                                 | %          |
| Total                                      |       | $                                    | 309,078    |   |

 

The interest payable onoutstanding cash borrowings under our bank line of credit is based on variableinterest rates and is therefore affected by changes in market interestrates. If interest rates rose significantly, our results from operations andcash flows would not be materially affected since we have no outstanding borrowings.

 

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*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 FASB ASC 830, “Foreign Currency Matters”, wetranslate assets and liabilities of Canada’s operations into U.S. dollars atmonth-end rates, while we translate income and expenses at the weighted averageexchange rates for the month. We record the related translation adjustments inaccumulated other comprehensive income as a separate component of shareholders’equity. Fluctuations in exchange rates therefore impact our financial conditionand results of operations, as reported in U.S. Dollars.   We do nothedge against foreign currency risks and believe that foreign currency exchangerisk is immaterial.

 

**ITEM 4.               CONTROLSAND PROCEDURES**

 

Under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, we evaluated the effectiveness of our disclosurecontrols and procedures, as such term is defined under Rule 13a-15(e) promulgatedunder the Securities Exchange Act of 1934, as amended. Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures were effective as of the end of theperiod covered by this quarterly report at the reasonable assurance level.

 

There has been no changein our internal control over financial reporting during the quarter ended October 3,2009 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**PART II                 OTHERINFORMATION**

 

**ITEM 1.                  LEGALPROCEEDINGS**

 

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.  Except for changes to the general economic conditions risk factor,there have been no material changes in our risk factors from those disclosed inPart I, Item 1A of our Annual Report on Form 10-K for the fiscalyear ended July 4, 2009.

 

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 uponthe customer response to the creative efforts of our merchandising, design andmarketing teams and their ability to anticipate trends and fashions that willappeal to our consumer base. If we miscalculate our customers’ productpreferences or the demand for our products, we may be faced with excessinventory. Historically, this type of occurrence has resulted in excess fabricfor some products and markdowns and/or write-offs, which has impaired ourprofitability, and may do so in the future. Similarly, any failure on our partto anticipate, identify and respond effectively to changing customer demandsand fashion trends will adversely 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 not own any manufacturing facilities and therefore depend oncontractors and third parties to manufacture our products. We place all of ourorders for production of merchandise and raw materials by purchase order and donot have any long-term contracts with any manufacturer or supplier. If we failto maintain favorable relationships with our manufacturers and suppliers or areunable to obtain 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 was damagedor destroyed and we were unable to obtain replacement raw materials, ourearnings could be negatively impacted.

 

**3. Oursuccess depends on our ability to attract and retain qualified employees inorder to support our existing business and future expansion.**   From time to time we actively recruit qualified candidates tofill key executive positions from within the Company. There is substantialcompetition for experienced personnel, which we expect will continue. Wecompete for experienced personnel with companies who have greater financialresources than we do. In the past, we have experienced significant turnover ofour executive management team and retail store personnel. We are also exposedto employment practice litigation due to the large number of employees and highturnover of our sales associates. If we fail to attract, motivate, and retainqualified personnel, it could harm our business and limit our ability toexpand.

 

In addition, we depend onthe expertise and execution of our key employees, particularly Manny Mashouf,our founder, Chief Executive Officer and Chairman of the Board of Directors andKathy Lee, Chief Merchandising Officer. If we lose the services of Mr. Mashouf,Ms. Lee, or any key officers or employees, it could harm our business andresults of operations.

 

**4. If weare not able to successfully develop new concepts, including 2b bebe and PH8,our revenue base and earnings may be impaired.**  From time totime, we may pursue new concepts.  If the 2b bebe, PH8 or other newconcepts are not successful we may incur additional charges related to closedstores or store impairment and as such, our results from operations andfinancial condition may be harmed.

 

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**5.General economic conditions, including increases in energy and commodityprices, that are largely out of our control may adversely affect our financialcondition and results of operations.**   We are sensitive to changes in generaleconomic conditions, both nationally and locally. Recessionary economic cycles,higher interest rates, higher fuel and other energy costs, inflation,deflation, increases in commodity prices, higher levels of unemployment, higherconsumer debt levels, higher tax rates and other changes in tax laws or othereconomic factors that may affect consumer spending or buying habits couldadversely affect the demand for products we sell in our stores. In addition,the recent turmoil in the financial markets may have an adverse effect on theU.S. and world economy, which could negatively impact consumer spendingpatterns. We cannot assure you that government responses to the disruptions inthe financial markets will restore consumer confidence.

 

Furthermore, we couldexperience reduced traffic in our stores or limitations on the prices we cancharge for our products, either of which could reduce our sales and profitmargins and have a material adverse effect on our financial condition andresults of operations. Also, economic factors such as those listed above andincreased transportation costs, inflation, higher costs of labor, insurance andhealthcare, and changes in other laws and regulations may increase our cost ofsales and our operating, selling, general and administrative expenses, andotherwise adversely affect our financial condition and results of operations.

 

**6. Wecannot assure you that future store openings will be successful, and new storeopenings may impact existing stores.** We expect to open approximately 5 bebe stores infiscal 2010.  In the past, we have closedstores as a result of poor performance, and we cannot assure you that thestores that we plan to open in fiscal 2010, or any other stores that we mightopen in the future, will be successful or that our overall operating profitwill increase as a result of opening these stores. During the first quarter offiscal 2010 we closed 3 stores and anticipate closing 3 additional storesduring the remainder of the fiscal year. Most of our new store openings infiscal 2010 will be in existing markets. These openings may affect the existingstores’ net sales and profitability. Our failure to predict accurately thedemographic or retail environment at any future store location could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

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

 

**7. Weare subject to risks associated with our on-line sales. **We operate an on-line store at *www.bebe.com*to sell our merchandise,which we migrated to a third-party platform in February 2006. Although ouron-line sales encompass a relatively small percentage of our total sales, ouron-line operations are subject to numerous risks, including unanticipatedoperating problems, reliance on third-party computer hardware and softwareproviders, system failures and the need to invest in additional computersystems. The on-line operations also involve other risks that could have animpact on our results of operations including but not limited to diversion ofsales from our other stores, rapid technological change, liability for on-linecontent, credit card fraud and risks related to the failure of the computersystems that operate the website and its related support systems. In addition,with the migration to a third-party platform, we no longer have direct controlof certain aspects of our on-line business. We cannot assure that our on-linestore will continue to achieve sales and profitability growth or even remain atits current level.

 

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

 

**9. Werely on information technology, the disruption of which could adversely impactour business.** Werely on various information systems to manage our operations and regularly makeinvestments to upgrade, enhance or replace such systems. Any delays ordifficulties in transitioning to these or other new systems, or in integratingthese systems with our current systems, or any other disruptions affecting ourinformation systems, could have a material adverse impact on our business. Anyfailure to maintain adequate system security controls to protect our computerassets and sensitive data, including client data, from unauthorized access,disclosure or use could also damage our reputation with our clients.

 

**10. Weface significant competition in the retail and apparel industry, which couldharm our sales and profitability.** The retail and apparel industries are highlycompetitive and are characterized by low barriers to entry. We expectcompetition in our markets to increase. The primary competitive factors in ourmarkets are: brand name recognition, sourcing, product styling, quality,presentation and pricing, timeliness of product development and delivery, storeambiance, customer service and convenience. We compete with traditionaldepartment stores, specialty store retailers, business to consumer websites,off-price retailers and direct marketers for, among other things, rawmaterials, market share, retail space, finished goods, sourcing and personnel.Because many of these competitors are larger and have substantially greaterfinancial, distribution and marketing resources than we do, we may lack theresources to adequately compete with them. If we fail to remain competitive inany way, it could harm our business, financial condition and results ofoperations.

 

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**11. Ourbusiness could be adversely impacted by unfavorable international politicalconditions.** Dueto our international operations, our sales and operating results are, and willcontinue to be, affected by international social, political, legal and economicconditions. In particular, our business could be adversely impacted byinstability or changes resulting in the disruption of trade with the countriesin which our contractors, suppliers or customers are located, significantfluctuations in the value of the dollar against foreign currencies orrestrictions on the transfer of funds, or additional trade restrictions imposedby the United States and other foreign governments. Trade restrictions,including increased tariffs or quotas, embargoes and customs restrictions couldincrease the cost or reduce the supply of merchandise available to us andadversely affect our financial condition and results of operations. In addition,we purchase a substantial amount of our raw materials from China and ourbusiness 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 ourtrademarks and other proprietary rights, we cannot assure you that we will besuccessful or that others will not imitate our products or infringe upon ourintellectual property rights. In addition, we cannot assure that others willnot resist or seek to block the sale of our products as infringements of theirtrademark and proprietary rights.

 

We are seeking toregister our trademarks domestically and internationally. Obstacles may existthat may prevent us from obtaining a trademark for the bebe, BEBE SPORT, bbsp,2b bebe and PH8 names or related names. We may not be able to register certaintrademarks, purchase the right or obtain a license to use these names orrelated names on commercially reasonable terms. If we fail to obtain trademark,ownership or license the requisite rights, it would limit our ability toexpand. In some jurisdictions, despite successful registration of ourtrademarks, third parties may allege infringement and bring actions against us.In addition, if our licensees fail to use our intellectual property correctly,the reputation and value associated with our trademarks may be diluted.Furthermore, if we do not demonstrate use of our trademarks, our trademarkrights may lapse over time.

 

**13. Wemay be required to record losses in future quarters as a result of the declinein value of our investments in auction rate securities or as a result of achange in our ability to hold our investment in auction rate securities.**   We hold a variety of interestbearing ARS comprised of federally insured student loan backed securities andinsured municipal authority bonds. These ARS investments are intended toprovide liquidity via an auction process that resets the applicable interestrate at predetermined calendar intervals, allowing investors to either rollover their holdings or gain immediate liquidity by selling such interests atpar. The recent uncertainties in the credit markets that began in February 2008have affected our holdings in ARS investments and the majority of auctions forour investments in these securities have failed to settle on their respectivesettlement dates. Consequently, $189.2 million of our ARS are notcurrently liquid and we will not be able to access these funds until a futureauction of these investments is successful or securities are purchased orredeemed outside of the auction process. Maturity dates for these ARSinvestments range from 2010 to 2044, with principal distributions occurring oncertain securities prior to maturity.

 

We entered into asettlement agreement related to our ARS held with UBS Financial Services, Inc.(“UBS”) that grants us certain rights related to these ARS (the “Right”).Beginning June 30, 2010, at our request, UBS has agreed to purchase all ofour ARS currently held with them at par value. Conversely, UBS has the right,in its discretion, to purchase or sell our ARS at any time until July 2,2012, so long as we receive payment at par value upon any sale or disposition.We expect to sell our ARS under our agreement with UBS. However, if the Rightis not exercised before July 2, 2012, they will expire, and UBS will haveno further right or obligation to buy our ARS. So long as we hold our ARS, theywill continue to accrue interest as determined by the auction process or theterms of the ARS if the auction process fails. In addition, UBS’s obligationunder the Right is not secured by its assets and does not require UBS to obtainany financing to support its performance obligation under the Right. UBS hasdisclaimed any assurance that it will have sufficient financial resources tosatisfy its obligation under the Right. If UBS has insufficient funding to buyback the ARS and the auction process continues to fail, then we may incurfurther losses on the carrying value of the ARS.

 

The valuation of ourinvestment portfolio is subject to uncertainties that are difficult to predict.Factors that may impact its valuation include changes to credit ratings of thesecurities as well as to the underlying assets supporting those securities,rates of default of the underlying assets, underlying collateral value,discount rates and ongoing strength and quality of market credit and liquidity.If the current market conditions deteriorate further, or the anticipatedrecovery in market values does not occur, we may be required to recordadditional losses in other comprehensive income or losses in net income in futurequarters.

 

**14. Ifan independent manufacturer violates labor or other laws, or is accused ofviolating any such laws, or if their labor practices diverge from thosegenerally accepted as ethical, it could harm our business and brand image.** While we maintain a policy to monitor the operations of our independentmanufacturers by having an independent firm inspect these manufacturing sites,and all manufacturers are contractually required to comply with such laborpractices, we cannot control the actions or the public’s perceptions of suchmanufacturers, nor can we assure that these manufacturers will conduct theirbusinesses using ethical or legal labor practices. Apparel companies can beheld jointly liable for the wrongdoings of the manufacturers of their products.While we do not control their employees’ employment conditions or themanufacturers’ business practices, and the manufacturers act in their owninterest, they may act in a manner that result in negative public perceptionsof us and/or employee allegations or court determinations that we are jointlyliable.

 

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RISKS RELATING TO OURCOMMON STOCK:

 

**1.Because Manny Mashouf beneficially owns a substantial portion of theoutstanding shares, other shareholders may not be able to influence thedirection the company takes.**    As of October 30,2009, Manny Mashouf, our Chief Executive Officer and Chairman of the Board,beneficially owned approximately 53% of the outstanding shares of our commonstock. As a result, he can control the election of directors and the outcome ofall issues submitted to the shareholders. This may make it more difficult for athird party to acquire shares, may discourage acquisition bids, and could limitthe price that certain investors might be willing to pay for shares of commonstock. This concentration of stock ownership may have the effect of delaying,deferring or preventing a change in control of our company.

 

**2. Oursales, margins and operating results are subject to seasonal and quarterlyfluctuations.** Ourbusiness varies with general seasonal trends that are characteristic of theretail and apparel industries, such as the timing of seasonal wholesaleshipments and other events affecting retail sales. As a result, our storestypically generate a higher percentage of our annual net sales andprofitability in the second quarter of our fiscal year, which includes theholiday 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. For example, we incurred anet loss for the first quarter of fiscal 2010 and cannot assure you of futureprofitability.  A variety of factorsaffect comparable store sales, including fashion trends, competition, currenteconomic conditions, the timing of release of new merchandise and promotionalevents, changes in our merchandise mix, the success of marketing programs andweather conditions. Our ability to deliver strong comparable store salesresults and margins depends in large part on accurately forecasting demand andfashion trends, selecting effective marketing techniques, providing anappropriate mix of merchandise for our customer base, managing inventoryeffectively, and optimizing store performance by closing underperformingstores.

 

Such fluctuations mayadversely affect the market price of our common stock.

 

**3. Failureto comply with Section 404 of the Sarbanes-Oxley Act of 2002 couldnegatively impact investor confidence.** In order to meet the requirements of theSarbanes-Oxley Act of 2002 in future periods, we must continuously document,test, monitor and enhance our internal control over financial reporting. We cannot assure you that the periodic evaluation of our internal controlsrequired by Section 404 of the Sarbanes-Oxley Act will not result in theidentification of significant control deficiencies and/or material weaknessesor that our auditors will be able to attest to the effectiveness of ourinternal control over financial reporting. Failure to maintain theeffectiveness of our internal control over financial reporting or to complywith the requirements of this Act could have a material adverse effect on ourreputation, financial condition and market price of our common stock.

 

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**ITEM2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

Not applicable.

 

**ITEM3.  DEFAULTS UPON SENIOR SECURITIES**

 

Not applicable.

 

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

 

Not applicable.

 

**ITEM5.  OTHER INFORMATION**

 

Not applicable.

 

**ITEM6.  EXHIBITS**

 

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

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

 

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**SIGNATURE**

 

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

 

 
|   | Dated November 12,  2009                                      |
|--------|--------------------------------------------------------------------|
|   |                                                               |
|   | 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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