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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended July 31, 2004



OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



For the transition period from  to



Commission file number 0-21406



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Brookstone, Inc.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 06-1182895                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



One Innovation Way,
Merrimack, NH 03054

(address of principal executive offices, zip code)



603-880-9500

(Registrants telephone number, including area code)



17 Riverside Street, Nashua, NH 03062

(Former name, former address and former fiscal year, if changed since last report)



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



APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS



Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the
Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes ̈No ̈



APPLICABLE ONLY TO CORPORATE ISSUERS:



Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date:
20,327,638 shares of common stock as of August 27, 2004.



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##### Table of Contents

BROOKSTONE, INC.



Index to Form 10-Q



|         |                                                                                     |                                                                                                                 |   |   
|-------- | ----------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------- | - | --
|         |                                                                                     | Page No.                                                                                                       
|Part I:  |                                                                                     | Financial Information                                                                                           |   |   
|         |                                                                                     |                                                                                                                
|Item 1:  |                                                                                     |                                                                                                                 |   |   
|         | Consolidated Balance Sheet as of July 31, 2004, January 31, 2004 and August 2, 2003 |                                                                                                                 | 4
|         |                                                                                     |                                                                                                                
|         |                                                                                     | Consolidated Statement of Operations for the thirteen & twenty-six weeks ended July 31, 2004 and August 2, 2003 |   | 5 
|         |                                                                                     |                                                                                                                
|         |                                                                                     | Consolidated Statement of Cash Flows for the twenty-six weeks ended July 31, 2004 and August 2, 2003            |   | 6 
|         |                                                                                     |                                                                                                                
|         |                                                                                     | Notes to Consolidated Financial Statements                                                                      |   | 7 
|         |                                                                                     |                                                                                                                
|Item 2:  |                                                                                     | Managements Discussion and Analysis of Financial Condition and Results of Operations                           |   | 13
|         |                                                                                     |                                                                                                                
|Item 3:  |                                                                                     | Quantitative and Qualitative Disclosures about Market Risk                                                      |   | 16
|         |                                                                                     |                                                                                                                
|Item 4:  |                                                                                     | Controls and Procedures                                                                                         |   | 16
|         |                                                                                     |                                                                                                                
|Part II: |                                                                                     | Other Information                                                                                               |   |   
|         |                                                                                     |                                                                                                                
|Item 1:  |                                                                                     | Legal Proceedings                                                                                               |   | 17
|         |                                                                                     |                                                                                                                
|Item 2:  |                                                                                     | Change in Securities                                                                                            |   | 17
|         |                                                                                     |                                                                                                                
|Item 3:  |                                                                                     | Defaults by the Company upon its Senior Securities                                                              |   | 17
|         |                                                                                     |                                                                                                                
|Item 4:  |                                                                                     | Submission of Matters to a Vote of Security Holders                                                             |   | 17
|         |                                                                                     |                                                                                                                
|Item 5:  |                                                                                     | Other Information                                                                                               |   | 18
|         |                                                                                     |                                                                                                                
|Item 6:  |                                                                                     | Exhibits and Reports on Form 8-K                                                                                |   | 18



Exhibits



|      |  |                                                                                                                                                    
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|10.40 |  | Real Estate Loan Agreement between Banknorth, N.A. and Brookstone Company, Inc. (filed herewith)                                                   
|      | 
|10.41 |  | Real Estate Promissory Note between Banknorth, N.A. and Brookstone Company, Inc. (filed herewith)                                                  
|      | 
|10.42 |  | Mortgage and Security Agreements between Banknorth, N.A. and Brookstone Company, Inc. (filed herewith)                                             
|      | 
|10.43 |  | International Swap Dealers Association, Inc. Master Agreement between Banknorth, N.A. and Brookstone Company, Inc. (filed herewith)                
|      | 
|10.44 |  | Schedule to the International Swap Dealers Association, Inc. Master Agreement between Banknorth, N.A. and Brookstone Company, Inc. (filed herewith)
|      | 
|10.45 |  | Brookstone, Inc. Defined Contribution Supplemental Executive Retirement Plan (filed herewith)                                                      



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##### Table of Contents

|     |  |                                                                                                                                                                                                                            
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1 |  | Certification of Principal Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of The Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 (filed herewith)    
|     | 
|31.2 |  | Certification of Principal Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of The The Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 (filed herewith)
|     | 
|32.1 |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)                                                         
|     | 
|32.2 |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)                                                         



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##### Table of Contents

PART I



Item 1:



BROOKSTONE, INC.

CONSOLIDATED BALANCE SHEET

(In thousands, except share data)



|                                                                                                                                                                         |  |                          |         |   |                  |   |         |                           |  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------------ | ------- | - | ---------------- | - | ------- | ------------------------- |  | - | ------- | -
|                                                                                                                                                                         |  | (Unaudited)July 31, 2004 |         |   | January 31, 2004 |   |         | (Unaudited)August 2, 2003 | 
|Assets                                                                                                                                                                   |  |                          |         |   |                  |   |         |                           |  |   |         |  
|Current assets:                                                                                                                                                          |  |                          |         |   |                  |   |         |                           |  |   |         |  
|Cash and cash equivalents                                                                                                                                                |  | $                        | 30,942  |   |                  | $ | 69,738  |                           |  | $ | 29,008  |  
|Receivables, net                                                                                                                                                         |  |                          | 9,520   |   |                  |   | 7,476   |                           |  |   | 6,478   |  
|Merchandise inventories                                                                                                                                                  |  |                          | 68,886  |   |                  |   | 66,876  |                           |  |   | 55,489  |  
|Deferred income taxes                                                                                                                                                    |  |                          | 9,502   |   |                  |   | 4,799   |                           |  |   | 9,849   |  
|Other current assets                                                                                                                                                     |  |                          | 6,998   |   |                  |   | 6,217   |                           |  |   | 6,024   |  
|                                                                                                                                                                         |  |                          |         |   |                  |   |         |                           |  |   |         |  
|Total current assets                                                                                                                                                     |  |                          | 125,848 |   |                  |   | 155,106 |                           |  |   | 106,848 |  
|                                                                                                                                                                         |  |                          |        
|Deferred income taxes, net                                                                                                                                               |  |                          | 4,738   |   |                  |   | 4,738   |                           |  |   | 5,854   |  
|Property and equipment, net                                                                                                                                              |  |                          | 64,829  |   |                  |   | 53,970  |                           |  |   | 45,184  |  
|Intangible assets, net                                                                                                                                                   |  |                          | 3,988   |   |                  |   | 4,123   |                           |  |   | 4,258   |  
|Other assets                                                                                                                                                             |  |                          | 5,377   |   |                  |   | 2,390   |                           |  |   | 1,937   |  
|                                                                                                                                                                         |  |                          |         |   |                  |   |         |                           |  |   |         |  
|                                                                                                                                                                         |  | $                        | 204,780 |   |                  | $ | 220,327 |                           |  | $ | 164,081 |  
|                                                                                                                                                                         |  |                          |         |   |                  |   |         |                           |  |   |         |  
|Liabilities and Shareholders Equity                                                                                                                                     |  |                          |         |   |                  |   |         |                           |  |   |         |  
|                                                                                                                                                                         |  |                          |        
|Current liabilities:                                                                                                                                                     |  |                          |         |   |                  |   |         |                           |  |   |         |  
|Accounts payable                                                                                                                                                         |  | $                        | 15,356  |   |                  | $ | 15,759  |                           |  | $ | 10,780  |  
|Other current liabilities                                                                                                                                                |  |                          | 26,603  |   |                  |   | 41,827  |                           |  |   | 23,647  |  
|                                                                                                                                                                         |  |                          |         |   |                  |   |         |                           |  |   |         |  
|Total current liabilities                                                                                                                                                |  |                          | 41,959  |   |                  |   | 57,586  |                           |  |   | 34,427  |  
|                                                                                                                                                                         |  |                          |        
|Other long-term liabilities                                                                                                                                              |  |                          | 17,453  |   |                  |   | 15,676  |                           |  |   | 14,567  |  
|Long-term obligation under capital lease                                                                                                                                 |  |                          | 1,946   |   |                  |   | 1,941   |                           |  |   | 2,027   |  
|                                                                                                                                                                         |  |                          |        
|Commitments and contingencies                                                                                                                                            |  |                          |         |   |                  |   |         |                           |  |   |         |  
|                                                                                                                                                                         |  |                          |        
|Shareholders equity:                                                                                                                                                    |  |                          |         |   |                  |   |         |                           |  |   |         |  
|Preferred stock, $0.001 par value:                                                                                                                                       |  |                          |         |   |                  |   |         |                           |  |   |         |  
|Authorized - 2,000,000 shares; issued and outstanding - 0 shares at July 31, 2004, January 31, 2004 and August 2, 2003                                                   |  |                          |         |   |                  |   |         |                           |  |   |         |  
|Common stock, $0.001 par value:                                                                                                                                          |  |                          |         |   |                  |   |         |                           |  |   |         |  
|Authorized 50,000,000 shares; issued and outstanding  20,327,188 shares at July 31, 2004, 20,024,288 shares at January 31, 2004 and
19,343,466 shares at August 2, 2003 |  |                          | 20      |   |                  |   | 20      |                           |  |   | 19      |  
|Additional paid-in capital                                                                                                                                               |  |                          | 64,741  |   |                  |   | 59,169  |                           |  |   | 53,240  |  
|Unearned stock compensation                                                                                                                                              |  |                          | (2,349  | ) |                  |   | (184    | )                         |  |   |        |  
|Accumulated other comprehensive loss                                                                                                                                     |  |                          | (991    | ) |                  |   | (991    | )                         |  |   | (1,031  | )
|Retained earnings                                                                                                                                                        |  |                          | 82,048  |   |                  |   | 87,157  |                           |  |   | 60,879  |  
|Treasury stock, at cost-8,136 shares at July 31, 2004, January 31, 2004 and August 2, 2003                                                                               |  |                          | (47     | ) |                  |   | (47     | )                         |  |   | (47     | )
|                                                                                                                                                                         |  |                          |         |   |                  |   |         |                           |  |   |         |  
|Total shareholders equity                                                                                                                                               |  |                          | 143,422 |   |                  |   | 145,124 |                           |  |   | 113,060 |  
|                                                                                                                                                                         |  |                          |         |   |                  |   |         |                           |  |   |         |  
|                                                                                                                                                                         |  | $                        | 204,780 |   |                  | $ | 220,327 |                           |  | $ | 164,081 |  
|                                                                                                                                                                         |  |                          |         |   |                  |   |         |                           |  |   |         |  



Note: The accompanying notes are an
integral part of these financial statements.



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BROOKSTONE, INC.

CONSOLIDATED STATEMENT OF OPERATIONS

(In thousands, except per share data)

(Unaudited)



|                                                                     |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |         |  
|-------------------------------------------------------------------- |  | -------------------- | ------ | - | ---------------------- | - | ------ | ------------- |  | - | -------------- | - |  | - | ------- | -
|                                                                     |  | Thirteen Weeks Ended |        |   | Twenty-Six Weeks Ended |  
|                                                                     |  | July 31, 2004        |        |   | August 2, 2003         |   |        | July 31, 2004 |  |   | August 2, 2003 |  
|Net sales                                                            |  | $                    | 98,316 |   |                        | $ | 80,474 |               |  | $ | 175,767        |   |  | $ | 141,431 |  
|Cost of sales                                                        |  |                      | 63,664 |   |                        |   | 53,850 |               |  |   | 118,028        |   |  |   | 100,017 |  
|                                                                     |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |         |  
|Gross profit                                                         |  |                      | 34,652 |   |                        |   | 26,624 |               |  |   | 57,739         |   |  |   | 41,414  |  
|Selling, general and administrative expenses                         |  |                      | 35,036 |   |                        |   | 30,207 |               |  |   | 65,276         |   |  |   | 55,291  |  
|                                                                     |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |         |  
|Loss from operations                                                 |  |                      | (384   | ) |                        |   | (3,583 | )             |  |   | (7,537         | ) |  |   | (13,877 | )
|Interest expense, net                                                |  |                      | 209    |   |                        |   | 181    |               |  |   | 445            |   |  |   | 311     |  
|                                                                     |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |         |  
|Loss before taxes and other party interests in consolidated entities |  |                      | (593   | ) |                        |   | (3,764 | )             |  |   | (7,982         | ) |  |   | (14,188 | )
|Income tax benefit                                                   |  |                      | (228   | ) |                        |   | (1,449 | )             |  |   | (3,073         | ) |  |   | (5,462  | )
|                                                                     |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |         |  
|Loss before other party interests inconsolidated entities            |  |                      | (365   | ) |                        |   | (2,315 | )             |  |   | (4,909         | ) |  |   | (8,726  | )
|Other party interests in consolidated entities,net of tax            |  |                      | 100    |   |                        |   |       |               |  |   | 200            |   |  |   |        |  
|                                                                     |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |         |  
|Net Loss                                                             |  | $                    | (465   | ) |                        | $ | (2,315 | )             |  | $ | (5,109         | ) |  | $ | (8,726  | )
|                                                                     |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |         |  
|Basic and diluted loss per share:                                    |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |         |  
|Net Loss                                                             |  | $                    | (0.02  | ) |                        | $ | (0.12  | )             |  | $ | (0.25          | ) |  | $ | (0.45   | )
|                                                                     |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |         |  
|Weighted average shares outstanding  basic and diluted              |  |                      | 20,203 |   |                        |   | 19,323 |               |  |   | 20,118         |   |  |   | 19,267  |  
|                                                                     |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |         |  



Note: The accompanying notes are an
integral part of these financial statements.



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BROOKSTONE, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                             |  |                        |         |   |                |   |         |  
|---------------------------------------------------------------------------- |  | ---------------------- | ------- | - | -------------- | - | ------- | -
|                                                                             |  | Twenty-Six Weeks Ended |        
|                                                                             |  | July 31, 2004          |         |   | August 2, 2003 |  
|Cash flows from operating activities:                                        |  |                        |         |   |                |   |         |  
|Net loss                                                                     |  | $                      | (5,109  | ) |                | $ | (8,726  | )
|                                                                             |  |                       
|Adjustments to reconcile net loss to net cash used for operating activities: |  |                        |         |   |                |   |         |  
|Depreciation and amortization                                                |  |                        | 6,581   |   |                |   | 5,929   |  
|Amortization of debt issuance costs                                          |  |                        | 92      |   |                |   | 120     |  
|Stock Based Compensation expense                                             |  |                        | 225     |   |                |   |        |  
|Deferred income taxes                                                        |  |                        | (4,703  | ) |                |   | (5,688  | )
|Related tax benefits on exercise of stock options                            |  |                        | 1,504   |   |                |   | 167     |  
|Increase in other assets                                                     |  |                        | (3,079  | ) |                |   | (23     | )
|Increase in other long-term liabilities                                      |  |                        | 1,777   |   |                |   | 758     |  
|                                                                             |  |                       
|Changes in working capital:                                                  |  |                        |         |   |                |   |         |  
|Accounts receivable, net                                                     |  |                        | (2,044  | ) |                |   | (399    | )
|Merchandise inventories                                                      |  |                        | (2,010  | ) |                |   | 3,498   |  
|Other current assets                                                         |  |                        | (781    | ) |                |   | (744    | )
|Accounts payable                                                             |  |                        | (403    | ) |                |   | 60      |  
|Other current liabilities                                                    |  |                        | (15,162 | ) |                |   | (9,550  | )
|                                                                             |  |                        |         |   |                |   |         |  
|Net cash used for operating activities                                       |  |                        | (23,112 | ) |                |   | (14,598 | )
|                                                                             |  |                        |         |   |                |   |         |  
|Cash flows from investing activities:                                        |  |                        |         |   |                |   |         |  
|Expenditures for property and equipment                                      |  |                        | (17,305 | ) |                |   | (11,238 | )
|                                                                             |  |                        |         |   |                |   |         |  
|Net cash used for investing activities                                       |  |                        | (17,305 | ) |                |   | (11,238 | )
|                                                                             |  |                        |         |   |                |   |         |  
|Cash flows from financing activities:                                        |  |                        |         |   |                |   |         |  
|Payments on capital lease                                                    |  |                        | (57     | ) |                |   | (83     | )
|Payment for debt issuance costs                                              |  |                        |        |   |                |   | (80     | )
|Proceeds from exercise of stock options                                      |  |                        | 1,678   |   |                |   | 863     |  
|                                                                             |  |                        |         |   |                |   |         |  
|Net cash provided by financing activities                                    |  |                        | 1,621   |   |                |   | 700     |  
|                                                                             |  |                        |         |   |                |   |         |  
|Net decrease in cash and cash equivalents                                    |  |                        | (38,796 | ) |                |   | (25,136 | )
|Cash and cash equivalents at beginning of period                             |  |                        | 69,738  |   |                |   | 54,144  |  
|                                                                             |  |                        |         |   |                |   |         |  
|Cash and cash equivalents at end of period                                   |  | $                      | 30,942  |   |                | $ | 29,008  |  
|                                                                             |  |                        |         |   |                |   |         |  



Note: The accompanying notes are an
integral part of these financial statements.



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BROOKSTONE, INC.

Notes to Consolidated Financial Statements

(Unaudited)



|1. | The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. In the
opinion of the Company, these financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position, the results of operations, and the cash flows for the periods reported.
Certain information and footnote disclosures normally included in financial statements presented in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. It is suggested that the
accompanying unaudited consolidated financial statements be read in conjunction with the annual financial statements and notes thereto which may be found in the Companys Fiscal 2003 annual report on Form 10-K.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|2. | The results of the thirteen-week and twenty-six week periods ended July 31, 2004 are not necessarily indicative of the results for the full fiscal year. The Companys business,
like the business of retailers in general, is subject to seasonal influences. Historically, the Companys fourth fiscal quarter, which includes the winter holiday selling season, has produced a disproportionate amount of the Companys net
sales and substantially all of its income from operations. The Company expects that its business will continue to be subject to such seasonal influences.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. | Accumulated other comprehensive loss consists of the Companys minimum pension liability which is disclosed in the accompanying consolidated balance sheets. Total comprehensive
loss was equal to the net loss disclosed for the thirteen and twenty-six week periods presented.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. | Stock-Based Compensation
|-- | ------------------------



The Company has stock option plans in effect that provide for the issuance of non-qualified and incentive stock options. Statement of Financial Accounting
Standards No. 123 (SFAS No. 123), Accounting for Stock-Based Compensation,as amended by Statement of Accounting Standards No. 148 (SFAS 148), permits the Company to follow the measurement provisions of APB
Opinion No. 25 (APB No. 25), Accounting for Stock Issued to Employees. Stock Options have historically been granted at or above the market price on the date of the grant. The Company has also issued restricted and
deferred stock awards under its stock option plans. Restricted and deferred stock awards are issued at no cost to the recipient of the award. The market value in excess of cost is charged to income ratably over the period during which these awards
vest. The restricted shares vest ratably over a four-year period as the restrictions lapse commencing May 1, 2005. The deferred shares are subject to the satisfaction of certain performance criteria and vest following the first fiscal quarter of
2007. During the second quarter of Fiscal 2004,18,000 options were issued under the provisions of the 1996 Directors Stock Option Plan, the Board of Directors approved the award of 65,000 options issued under the 1999 Equity Incentive
Plan, 1,000 shares of restricted stock under the 1999 Equity Incentive Plan, and 136,274 shares of deferred stock under the 2004 Equity Incentive Plan. Had compensation cost for the Companys stock-based incentive compensation plans been
determined based on the fair value at the grant dates of awards under those plans, consistent with the methodology prescribed by SFAS No. 123, as amended by SFAS No. 148, the Companys net loss and related loss per share for the thirteen-week
and twenty-six week periods ended July 31, 2004 and August 2, 2003 would have been increased to the pro forma amounts indicated below:



|                                                                                                                       |  |                |       |   |                  |   |        |               |  |   |                |   |  |   |        |  
|---------------------------------------------------------------------------------------------------------------------- |  | -------------- | ----- | - | ---------------- | - | ------ | ------------- |  | - | -------------- | - |  | - | ------ | -
|                                                                                                                       |  | Thirteen-weeks |       |   | Twenty-six weeks |  
|                                                                                                                       |  | July 31, 2004  |       |   | August 2, 2003   |   |        | July 31, 2004 |  |   | August 2, 2003 |  
|Net loss - as reported                                                                                                 |  | $              | (465  | ) |                  | $ | (2,315 | )             |  | $ | (5,109         | ) |  | $ | (8,726 | )
|                                                                                                                       |  |                |       |  
|Deduct: Stock-based employee compensation expense determined under fair value based method, net of related tax effects |  |                | (216  | ) |                  |   | (189   | )             |  |   | (341           | ) |  |   | (374   | )
|Add: Stock-based employee compensation expense included in reported net loss, net of related tax effects               |  |                | 125   |   |                  |   |       |               |  |   | 138            |   |  |   |       |  
|                                                                                                                       |  |                |       |   |                  |   |        |               |  |   |                |   |  |   |        |  
|Net loss - pro forma                                                                                                   |  | $              | (556  | ) |                  | $ | (2,504 | )             |  | $ | (5,312         | ) |  | $ | (9,100 | )
|                                                                                                                       |  |                |       |   |                  |   |        |               |  |   |                |   |  |   |        |  
|Net loss per share  basic and diluted                                                                                 |  |                |       |   |                  |   |        |               |  |   |                |   |  |   |        |  
|As reported                                                                                                            |  | $              | (0.02 | ) |                  | $ | (0.12  | )             |  | $ | (0.25          | ) |  | $ | (0.45  | )
|Pro forma                                                                                                              |  | $              | (0.03 | ) |                  | $ | (0.13  | )             |  | $ | (0.26          | ) |  | $ | (0.47  | )



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##### Table of Contents

On April 30, 2004 the six-month option period for the Employee Stock Purchase Plan (ESPP),
which began on November 1, 2003, closed. On May 3, 2004 the Company issued 28,874 shares under its 2000 ESPP related to this option period.



|5. | The exercise of stock options granted under the Companys stock option plans gives rise to compensation, which is includable in the taxable income of the optionees and
deductible by the Company for tax purposes upon exercise. Such compensation reflects an increase in the fair value of the Companys common stock subsequent to the date of grant. For financial reporting purposes, the tax effect of this deduction
is accounted for as a credit to additional paid-in capital. Such exercises resulted in a tax benefit of approximately $1.5 million and $0.2 million for the twenty-six week periods ended July 31, 2004 and August 2, 2003, respectively, which is
reflected in the Companys operating cash flow.
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|6. | In March of 2002, the Company was served with a lawsuit brought in California superior court in Los Angeles as a class action on behalf of current and former managers and assistant
managers of the Companys California stores, alleging that they were improperly classified as exempt employees. The lawsuit sought damages including overtime pay, restitution and attorneys fees. On August 15, 2003, a settlement agreement was
finalized with a maximum amount of $1.5 million for this matter. As a result of this settlement and settlement of other ongoing routine legal matters, a charge of $1.1 million was recorded during the second quarter of 2003. On April 16, 2004 and
April 29, 2004, the Los Angeles Superior Court (Court) held hearings to determine whether the Class Action Settlement and Release Agreement (Agreement) negotiated between Brookstone and various named Plaintiffs should be
granted final approval. On April 29, 2004, the Court ruled that the Agreement was fair, reasonable, and adequate to the class members, certified a class for settlement purposes only, and overruled the one objection to the Agreement filed by one
class member. On May 5, 2004, the Court: (1) entered an order granting final approval to the Agreement; and (2) entered judgment dismissing the wage and hour class actions filed in Los Angeles County (Berry, et al. v. Brookstone) and Santa Barbara
(Charbonnea v. Brookstone) against Brookstone with prejudice as to all class members, with the exception of the four class members who opted out of the Agreement. On July 6, 2004, one class member appealed the final order of the Court. Settlement
funds will be distributed, if at all, on terms ordered by the Court only after the appeal is resolved.
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|7. | Business conducted by the Company is segmented into two distinct areas determined by the method of distribution channel. The retail segment is comprised of all full-year stores in
addition to all temporary stores and kiosks. Retail product distribution is conducted directly through the store location. The direct marketing segment is comprised of three catalog titles (Hard-to-Find Tools,Brookstone Catalog and
Gardeners Eden), the Internet sites www.Brookstone.com and www.Gardenerseden.com and sales to corporate customers. Direct marketing product distribution is conducted through the Companys direct marketing customer sales and
contact center, through its distribution facility located in Mexico, Missouri and by the Companys vendors. Both segments of the Company sell similar products, although not all Company products are fully available within both segments.
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



All costs directly attributable to the direct
marketing segment are so charged while all remaining operating costs are charged to the retail segment. The Companys management does not review assets by segment.



The tables below disclose segment net sales and pre-tax loss for the thirteen-week and twenty-six week periods ended July
31, 2004 and August 2, 2003 (in thousands).



|                    |  |               |         |                                                                                     |   |               |  |   |                |   |  |   |         |  
|------------------- |  | ------------- | ------- | ----------------------------------------------------------------------------------- | - | ------------- |  | - | -------------- | - |  | - | ------- | -
|Thirteen-weeks:     |  | Net Sales     |         | Pre-tax Income (Loss)before taxes and other party interests inconsolidated entities |  
|                    |  | July 31, 2004 |         | August 2, 2003                                                                      |   | July 31, 2004 |  |   | August 2, 2003 |  
|Reportable segment: |  |               |         |                                                                                     |   |               |  |   |                |   |  |   |         |  
|Retail              |  | $             | 81,986  |                                                                                     | $ | 66,470        |  | $ | (557           | ) |  | $ | (4,005  | )
|Direct Marketing    |  |               | 16,330  |                                                                                     |   | 14,004        |  |   | 173            |   |  |   | 422     |  
|Reconciling items:  |  |               |         |                                                                                     |   |               |  |   |                |   |  |   |         |  
|Interest expense    |  |               |        |                                                                                     |   |              |  |   | (324           | ) |  |   | (310    | )
|Interest income     |  |               |        |                                                                                     |   |              |  |   | 115            |   |  |   | 129     |  
|                    |  |               |         |                                                                                     |   |               |  |   |                |   |  |   |         |  
|Consolidated:       |  | $             | 98,316  |                                                                                     | $ | 80,474        |  | $ | (593           | ) |  | $ | (3,764  | )
|                    |  |               |         |                                                                                     |   |               |  |   |                |   |  |   |         |  
|                    |  |              
|Twenty-six weeks:   |  | Net Sales     |         | Pre-tax Income (Loss)before taxes and other party interests inconsolidated entities |  
|                    |  | July 31, 2004 |         | August 2, 2003                                                                      |   | July 31, 2004 |  |   | August 2, 2003 |  
|Reportable segment: |  |               |         |                                                                                     |   |               |  |   |                |   |  |   |         |  
|Retail              |  | $             | 147,651 |                                                                                     | $ | 117,304       |  | $ | (7,315         | ) |  | $ | (13,595 | )
|Direct Marketing    |  |               | 28,116  |                                                                                     |   | 24,127        |  |   | (222           | ) |  |   | (282    | )
|Reconciling items:  |  |               |         |                                                                                     |   |               |  |   |                |   |  |   |         |  
|Interest expense    |  |               |        |                                                                                     |   |              |  |   | (718           | ) |  |   | (706    | )
|Interest income     |  |               |        |                                                                                     |   |              |  |   | 273            |   |  |   | 395     |  
|                    |  |               |         |                                                                                     |   |               |  |   |                |   |  |   |         |  
|Consolidated:       |  | $             | 175,767 |                                                                                     | $ | 141,431       |  | $ | (7,982         | ) |  | $ | (14,188 | )
|                    |  |               |         |                                                                                     |   |               |  |   |                |   |  |   |         |  



9



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|8. | Basic and diluted earnings per share (EPS) were calculated for the thirteen-week and twenty-six week periods ended July 31, 2004 and August 2, 2003 as follows:
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                                     |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |        |  
|---------------------------------------------------- |  | -------------------- | ------ | - | ---------------------- | - | ------ | ------------- |  | - | -------------- | - |  | - | ------ | -
|                                                     |  | Thirteen Weeks Ended |        |   | Twenty-Six Weeks Ended |  
|                                                     |  | July 31, 2004        |        |   | August 2, 2003         |   |        | July 31, 2004 |  |   | August 2, 2003 |  
|Net loss                                             |  | $                    | (465   | ) |                        | $ | (2,315 | )             |  | $ | (5,109         | ) |  | $ | (8,726 | )
|                                                     |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |        |  
|Weighted average number of commonshares outstanding  |  |                      | 20,203 |   |                        |   | 19,323 |               |  |   | 20,118         |   |  |   | 19,267 |  
|Effect of dilutive securities:                       |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |        |  
|Stock options                                        |  |                      |       |   |                        |   |       |               |  |   |               |   |  |   |       |  
|                                                     |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |        |  
|Weighted average number of common shares as adjusted |  |                      | 20,203 |   |                        |   | 19,323 |               |  |   | 20,118         |   |  |   | 19,267 |  
|                                                     |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |        |  
|Net loss per share  basic and diluted               |  | $                    | (0.02  | ) |                        | $ | (0.12  | )             |  | $ | (0.25          | ) |  | $ | (0.45  | )
|                                                     |  |                      |        |   |                        |   |        |               |  |   |                |   |  |   |        |  



For the thirteen-week
and twenty-six week periods ended July 31, 2004, antidilutive shares of 736,602 and 759,443 were excluded from the computations of diluted earnings per share. For the thirteen-week and twenty-six week periods ended August 2, 2003, antidilutive
shares of 552,341 and 459,412 respectively were excluded from the computations of diluted earnings per share.



|9. | Recent Accounting Pronouncements
|-- | --------------------------------



In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities. In December 2003, the FASB revised
this interpretation (FIN46R). Interpretation No. 46R requires variable interest entities to be consolidated if the total equity investment at risk is not sufficient to permit the entity to finance its activities without financial support
or the equity investors lack certain specified characteristics of a controlling financial interest. Interpretation No. 46R was adopted by the Company during the first quarter of Fiscal 2004. See also Note 10.



In May 2004, the FASB released Staff Position No. 106-2, Accounting
and Disclosure Requirements related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (FSP 106-2), which supercedes Staff Position No. 106-1. FSP 106-2 addresses the accounting and disclosure
implications that are expected to arise as a result of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 enacted on December 8, 2003. The Company is currently reviewing the provisions of FSP 106-2 and will adopt FSP 106-2 for
the quarterly reporting period ended October 30, 2004.



|10. | Joint Ventures
|--- | --------------



The Company operates two of its airport stores in Chicago, four airport stores in Atlanta and one airport store in Las Vegas under three separate Joint
Venture arrangements. The Company has a 70% ownership interest in the Chicago venture, a 49% ownership interest in the Atlanta venture and an 80% ownership in the Las Vegas venture. The Chicago and Las Vegas ventures have been consolidated since
inception (Fiscal 2001 for the Chicago venture and Fiscal 2003 for the Las Vegas venture) based on the Companys ownership of the majority voting interests in accordance with Accounting Research Bulletin No. 51.



10



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##### Table of Contents

Under the requirements of FIN46R, variable interest entities are required to be consolidated if the total
equity investment at risk is not sufficient to permit the entity to finance its activities without financial support or the equity investors lack certain specified characteristics of a controlling financial interest. The Company has reviewed the
requirements of FIN 46R and has determined that the Atlanta Joint Venture qualifies as a Variable Interest Entity (VIE) as of its inception date in Fiscal 2001 and that the Company is the primary beneficiary of the VIE. As primary
beneficiary, the Company consolidated this entity effective for the first fiscal quarter of 2004 which is the Companys first interim or annual reporting period ending after March 15, 2004 as required by this interpretation. As a result of the
consolidation, $525 thousand of the Atlanta joint venture assets, $660 thousand in minority interests and no liabilities are reflected in the Companys July 31, 2004 balance sheet. Additionally, as a result of the Atlanta joint venture
consolidation, the Companys revenues increased by $1,348 thousand and $2,374 thousand, cost of sales increased $674 thousand and $1,193 thousand, selling and general administrative expenses increased $369 thousand and $674 thousand, and other
party interests in consolidated entities, net of tax increased $57 thousand and $121 thousand respectively for the thirteen and twenty-six week periods ended July 31, 2004. Additionally, interest expense increased by $2 thousand for the thirteen and
twenty-six week periods ended July 31, 2004. The consolidation had no impact on the Companys consolidated net loss for the thirteen and twenty-six week periods ended July 31, 2004.



|11. | Post-Retirement Pension and Medical Benefit Plans
|--- | -------------------------------------------------



The Company contributed more than the minimum required amount for the past year to the pension plan. As a result, there is no required contribution during
Fiscal 2004 but it is the intent of the Company to contribute approximately $340 thousand to maintain a funded status that is more than the minimal required level under ERISA. The Company made no payments during the first half of Fiscal 2004.



The components of net periodic pension cost were as
follows:



|                                   |  |                      |         |   |                        |   |         |               |  |   |                |   |  |   |          |  
|---------------------------------- |  | -------------------- | ------- | - | ---------------------- | - | ------- | ------------- |  | - | -------------- | - |  | - | -------- | -
|                                   |  | Thirteen Weeks Ended |         |   | Twenty-Six Weeks Ended |  
|                                   |  | July 31, 2004        |         |   | August 2, 2003         |   |         | July 31, 2004 |  |   | August 2, 2003 |  
|Service cost                       |  | $                    | 31,000  |   |                        | $ | 32,000  |               |  | $ | 62,000         |   |  | $ | 63,000   |  
|Interest cost                      |  |                      | 78,000  |   |                        |   | 76,000  |               |  |   | 156,000        |   |  |   | 152,000  |  
|Expected return on plan assets     |  |                      | (74,000 | ) |                        |   | (60,000 | )             |  |   | (145,000       | ) |  |   | (119,000 | )
|Amortization of prior service cost |  |                      |        |   |                        |   |        |               |  |   |               |   |  |   |         |  
|Recognized net actuarial loss      |  |                      | 25,000  |   |                        |   | 25,000  |               |  |   | 50,000         |   |  |   | 49,000   |  
|                                   |  |                      |         |   |                        |   |         |               |  |   |                |   |  |   |          |  
|Net periodic benefit cost          |  | $                    | 60,000  |   |                        | $ | 73,000  |               |  | $ | 123,000        |   |  | $ | 145,000  |  
|                                   |  |                      |         |   |                        |   |         |               |  |   |                |   |  |   |          |  



The components
of the net periodic post-retirement medical benefits cost were:



|                                   |  |                      |         |   |                        |   |         |               |  |   |                |   |  |   |         |  
|---------------------------------- |  | -------------------- | ------- | - | ---------------------- | - | ------- | ------------- |  | - | -------------- | - |  | - | ------- | -
|                                   |  | Thirteen Weeks Ended |         |   | Twenty-Six Weeks Ended |  
|                                   |  | July 31, 2004        |         |   | August 2, 2003         |   |         | July 31, 2004 |  |   | August 2, 2003 |  
|Service cost                       |  | $                    | 4,000   |   |                        | $ | 3,000   |               |  | $ | 8,000          |   |  | $ | 6,000   |  
|Interest cost                      |  |                      | 16,000  |   |                        |   | 17,000  |               |  |   | 32,000         |   |  |   | 34,000  |  
|Amortization of prior service cost |  |                      | (15,000 | ) |                        |   | (15,000 | )             |  |   | (30,000        | ) |  |   | (30,000 | )
|Recognized net actuarial gain      |  |                      | (4,000  | ) |                        |   | (5,000  | )             |  |   | (8,000         | ) |  |   | (10,000 | )
|                                   |  |                      |         |   |                        |   |         |               |  |   |                |   |  |   |         |  
|Net periodic benefit cost          |  | $                    | 1,000   |   |                        | $ |        |               |  | $ | 2,000          |   |  | $ |        |  
|                                   |  |                      |         |   |                        |   |         |               |  |   |                |   |  |   |         |  



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##### Table of Contents

|12. | Revolving Credit Agreement
|--- | --------------------------



The Company maintains a revolving credit agreement to finance inventory purchases. Amounts due under the facility were collateralized by the personal
property of the Company, tangible or intangible including all stock of Brookstone, Inc.s subsidiaries, but excluding real property, machinery and equipment encumbered on February 21, 2002, and general intangibles. The collateral interest in
the facility was subject to collateral release conditions dependent upon four consecutive quarters fixed charge coverage ratio of 1.40 to 1.00 and consolidated EBITDA for the four quarters then ended of at least $34.5 million. During the second
fiscal quarter of 2004, the Company agreed with its lenders to forego its collateral release conditions in exchange for reduced interest rates within its revolving credit agreement (Amendment No. 2). The new fixed charge coverage ratios
that determine which of three different levels of fees and applicable margin rates are to be charged on applicable borrowings are as follows: the Company may borrow at either the agent banks base lending rate plus the applicable percentage
(0.250%, 0.000% or 0.000%), or the Eurodollar rate for the applicable period plus the applicable percentage (1.750%, 1.500%, or 1.250%). In addition, the Company is obligated to pay a fee of 0.500%, 0.375% or 0.300% on the unused portion of the
commitment, 0.875%, 0.750%, or 0.625% on the documentary letters of credit and 1.875%, 1.625% or 1.375% on the standby letters of credit. Amendment No. 2 also adjusted certain capital expenditure restrictions, including an increase in aggregate
spending allowed for the new headquarters facility from $10.0 million to $11.0 million in either Fiscal 2003 or Fiscal 2004.



|13. | Interest Rate Commitment
|--- | ------------------------



On July 8, 2004, the Company entered into a commitment with a bank to provide for an interest rate swap agreement which would be effective concurrent with
the closing of a mortgage loan agreement. At the end of the second fiscal quarter, the value of that commitment was a liability of approximately $72 thousand.



|14. | Subsequent Events
|--- | -----------------



In August of Fiscal 2004, the Company entered into an $8.0 million mortgage loan agreement with a ten year term to finance its new headquarters facility.
Concurrent with the mortgage loan agreement, the Company entered into an interest rate swap agreement with a notional amount of $4.0 million to hedge future fluctuations in the mortgage loans interest rates. The mortgage loan requires monthly
principal payments of $66,666.67 and the interest rate is tied to the LIBOR rate index plus 1%. The interest rate swap agreement carries a fixed interest rate of 5.67%. The mortgage loan is collateralized by the facility. (see Attached Exhibits
10.40 through 10.44) Additionally, the Company relocated its headquarters operations to the new facility during August 2004.



On September 7, 2004, the Compensation Committee of the Board of Directors of Brookstone, Inc. approved a Defined Contribution Supplemental Executive
Retirement Plan and named Michael F. Anthony, the Companys Chairman, President and Chief Executive Officer, and Director as a participant in such plan (see Attached Exhibit 10.45).



12



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##### Table of Contents

BROOKSTONE, INC.



Item 2



Managements
Discussion and Analysis of

Financial Condition and Results of Operations for

the Thirteen-Week and Twenty-Six Week Periods Ended July 31, 2004



Results of Operations



For the thirteen-week and twenty-six week periods ended July 31, 2004, net sales increased 22.2% and 24.3% respectively over
the comparable periods last year. For the quarter, retail sales increased $15.5 million or 23.3% over the comparable period last year. Year to date retail sales increased $30.3 million or 25.9% over the comparable period last year. Same store sales
increased 13.3% for the quarter and 16.2% for the year to date period ended July 31, 2004 generating $8.7 million and $18.9 million in increased retail sales, respectively. The remaining retail sales increase of $6.8 million for the quarter and
$11.4 million year to date primarily resulted from the opening of 19 new stores less two store closings subsequent to the second quarter of Fiscal 2003. The total number of stores open at the end of the twenty-six week period ended July 31, 2004 was
280 versus 263 at the end of the comparable period in Fiscal 2003. Driving the retail same store increases were new product introductions and strong sales performances in Personal Care, Massage, Travel, Personal Accessories, Home Comfort, Games and
Stationary.



Direct marketing sales for the thirteen-week
period ended July 31, 2004 increased to $16.3 million versus the comparable period last year of $14.0 million. Year-to-date, direct marketing sales increased to $28.1 million as compared to $24.1 million last year. The $2.3 million increase for the
quarter is comprised of a $2.9 million or 28.6% increase in the Brookstone Brand (Hard-to-Find Tools, Brookstone Catalog,Internet and Corporate Sales) driven primarily by the increase of approximately 65% in catalog circulation. For the
quarter Gardeners Eden direct marketing sales decreased $0.6 million or 17.2% primarily as a result of decreased productivity from the Gardeners EdenCatalog. (Gardeners Eden catalog circulation decreased approximately 2% for the
quarter.) The year to date increase in direct marketing of $4.0 million is comprised of a $4.5 million or 24.4% increase in the Brookstone Brand (Hard-to-Find Tools, Brookstone Catalog,Internet and Corporate Sales) driven primarily by an
increase of approximately 43% in catalog circulation. Year to date Gardeners Eden direct marketing sales decreased $0.5 million or 7.9% primarily as a result of decreased productivity from the Gardeners EdenCatalog. (Gardeners Eden
catalog circulation decreased approximately 3% year to date.)



For the thirteen-week period ended July 31, 2004, gross profit as a percentage of net sales increased 2.1% to 35.2% versus 33.1% for the comparable period last year due to a decrease of 2.1% in occupancy costs and a decrease of 0.2% in
order postage expense (costs associated with the delivery of products to customers) primarily as a result of leveraging sales. Offsetting the decreases from occupancy costs and order postage expense was a decrease in product purchase margins of 0.2%
primarily driven by product mix during the quarter. For the twenty-six week period ended July 31, 2004 gross profit as a percentage of net sales increased 3.5% to 32.8% versus 29.3% for the comparable period last year primarily due to a decrease of
2.7% in occupancy costs as a result of leveraging sales. Also contributing to the year to date increase in gross profit as a percent of net sales were a year to date improvement in product purchase margins of 0.7% primarily driven by reduced
markdowns and a decrease of 0.1% in order postage expense.



For
the thirteen week period ended July 31, 2004, selling, general and administrative expenses as a percentage of net sales decreased 1.9% to 35.6% versus 37.5% for the comparable period last year. For the twenty-six week period ended July 31, 2004,
selling, general and administrative expenses as a percentage of net sales decreased 2.0% to 37.1% versus 39.1% for the comparable period last year. Decreases in payroll costs (100 basis points in the quarter and 160 basis points year to date)
resulted from leveraging sales. In addition decreased legal costs in Fiscal 2004 (see also Note 6) as compared to Fiscal 2003, contributed approximately 140 basis points for the quarter and 80 basis points year to date. The quarterly decreases were
offset by net increases in catalog costs of 30 basis points and 20 basis points in other selling, general and administrative expenses. The year to date decreases were offset by a net increase of 40 basis points in other selling, general and
administrative expenses.



Net interest expense for the
thirteen-week and twenty-six week periods ended July 31, 2004 was $209 thousand and $445 thousand respectively compared to $181 thousand and $311 thousand during the comparable periods last year. The increases in net interest expense in Fiscal 2004
resulted primarily from a decrease in interest income as a result of lower interest rates earned on investments.



The Company has recorded a tax benefit at the anticipated full year rate of 38.5% which is consistent with Fiscal 2003. However, the tax rate may be
adjusted for discrete items as they occur, particularly in the third or fourth fiscal quarters of 2004.



13



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##### Table of Contents

The Company operates two of its airport locations in Chicago, four airport locations in Atlanta and one
airport location in Las Vegas under three separate Joint Venture arrangements. The Company has a 70% ownership interest in the Chicago venture, a 49% ownership interest in the Atlanta venture and an 80% ownership in the Las Vegas venture. In Fiscal
2004, all of these joint venture entities are consolidated in the Companys financial statements. The ownership interest in the revenues and expenses for these joint ventures for the second fiscal quarter of 2004 and year to date 2004 belonging
to the Companys Joint Venture partners (the 30% ownership interest in the Chicago venture, the 51% ownership interest in the Atlanta venture and the 20% ownership interest in the Las Vegas venture) comprises the balance of $100 thousand, net
of tax, and $200 thousand, net of tax, respectively, in other party interests in consolidated entities on the Statement of Operations. Prior to Fiscal 2004, the Atlanta joint venture was accounted for as an equity investment and as such the Joint
Venture partners interests were not consolidated.



As a
result of the foregoing, the Company reported a net loss of $465 thousand, or $0.02 per basic and diluted share for the thirteen-week period ended July 31, 2004, as compared to a net loss of $2.3 million (after reflecting one-time legal settlements
of $1.1 million or $0.04 per basic and diluted share), or $0.12 per basic and diluted share, for the comparable period last year. For the twenty-six week period ended July 31, 2004 the Company reported a net loss of $5.1 million, or $0.25 per basic
and diluted share as compared to an $8.7 million net loss, or $0.45 per basic and diluted share, for the comparable period last year.



Financial Condition



For the twenty-six week period ended July 31, 2004, net cash used by operating activities totaled $23.1 million, primarily as a result of the net loss and
a decrease in other current liabilities resulting primarily from the payment of income taxes ($9.1 million) and the payment of accrued incentive compensation ($6.3 million). Cash used for investment activities during the first twenty-six weeks of
Fiscal 2004, representing the purchase of property and equipment, amounted to $17.3 million. Cash from financing activities during the twenty-six week period of Fiscal 2004 amounted to $1.6 million, resulting primarily from the exercise of stock
options, partially offset by capital lease payments.



For the
twenty-six week period ended August 2, 2003, net cash used by operating activities totaled $14.6 million, primarily as a result of the net loss and a decrease in other current liabilities resulting primarily from the payment of income taxes and
accrued incentive compensation. Cash used for investment activities during the first twenty-six weeks of Fiscal 2003, representing the purchase of property and equipment, amounted to $11.2 million. Cash from financing activities during the
twenty-six week period of Fiscal 2003 amounted to $700 thousand, primarily as a result of proceeds from the exercise of stock options.



Merchandise inventories increased approximately 3% to $68.9 million at July 31, 2004 compared to $66.9 at January 31, 2004 and increased approximately
24.1% compared to the balance of $55.5 million at August 2, 2003. The Company anticipates that inventory levels will grow at a rate faster than the sales rate increase in the third quarter of Fiscal 2004 as the Company builds its inventory for the
Holiday season.



Receivables increased 27.3% to $9.5 million at
July 31, 2004 as compared to $7.5 million at January 31, 2004 primarily as a result of an increase in product returns to vendors. Other current assets increased 12.6% to $7.0 million from $6.2 million at January 31, 2004 primarily as a result of
increased prepayments of state income taxes and increased insurance premiums.



The Companys $17.3 million in capital expenditures for the twenty-week period ended July 31, 2004 were primarily related to construction of the new headquarters building, the continued expansion of the
distribution center (Phase III - the replacement of the current material handling system), the opening of seven Brookstone stores, the remodel of three Brookstone stores and construction related to stores anticipated to open in the upcoming fiscal
quarters. The Company anticipates opening up to 20 new stores, including up to three airport locations, and to remodel approximately 12 stores in Fiscal 2004, all in the new store format developed in Fiscal 2002. The Company anticipates spending
approximately $7.0 million on Phase III of the Distribution Center expansion in Fiscal 2004, of which $4.6 million was spent in the first two fiscal quarters. While a substantial portion of the project was completed in the second fiscal quarter of
2004, the Company expects the remainder of the project to be completed in the third fiscal quarter. In late Fiscal 2003, the Company began construction of its new headquarters facility and anticipates the $11.0 million facility to be completed in
the third fiscal quarter of 2004. The Company anticipates spending $9.0 million in Fiscal 2004 on the new headquarters, of which $6.0 million was spent in the first two fiscal quarters.



14



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##### Table of Contents

The Company maintains a revolving credit agreement to finance inventory purchases, which historically
peak in the third quarter in anticipation of the winter holiday selling season. At July 31, 2004 and at August 2, 2003 the Company had no borrowings outstanding under its revolving credit agreement. Amounts due under the facility were collateralized
by the personal property of the Company, tangible or intangible including all stock of Brookstone, Inc.s subsidiaries, but excluding real property, machinery and equipment encumbered on February 21, 2002, and general intangibles. The
collateral interest in the facility was subject to collateral release conditions dependent upon four consecutive quarters fixed charge coverage ratio of 1.40 to 1.00 and consolidated EBITDA for the four quarters then ended of at least $34.5 million.
During the second fiscal quarter of 2004, the Company agreed with its lenders to forego its collateral release conditions in exchange for reduced interest rates within its revolving credit agreement (Amendment No. 2). The new fixed
charge coverage ratios that determine which of three different levels of fees and applicable margin rates are to be charged on applicable borrowings are as follows: the Company may borrow at either the agent banks base lending rate plus the
applicable percentage (0.250%, 0.000% or 0.000%), or the Eurodollar rate for the applicable period plus the applicable percentage (1.750%, 1.500%, or 1.250%). In addition, the Company is obligated to pay a fee of 0.500%, 0.375% or 0.300% on the
unused portion of the commitment, 0.875%, 0.750%, or 0.625% on the documentary letters of credit and 1.875%, 1.625% or 1.375% on the standby letters of credit. Amendment No. 2 also adjusted certain capital expenditure restrictions, including an
increase in aggregate spending allowed for the new headquarters facility from $10.0 million to $11.0 million in either Fiscal 2003 or Fiscal 2004.



The Company believes that cash on hand, anticipated cash generated from operations and available borrowings will be sufficient to finance its capital
requirements, including Phase III of the distribution center expansion and the construction of the new headquarters, throughout Fiscal 2004. In conjunction with the expansion of the distribution center, the Company amended the distribution center
capital lease, extending the expiration date from October 2013 to March 2024 and reducing the interest rate to prime from prime plus 1% per annum. In August of Fiscal 2004, the Company finalized a mortgage loan agreement and an interest rate swap
agreement to finance its new headquarters facility (see note 13). In Fiscal 2004, the Company anticipates funding approximately $340 thousand for its obligation under its defined pension plan.



Critical Accounting Estimates



The preparation of the Companys consolidated financial statements in
accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and
liabilities as of the date of the financial statements and the reported amounts of revenue and expense during the reporting periods. Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 1 of the Notes
to Consolidated Financial Statements in the Companys Annual Report on Form 10-K for the year ended January 31, 2004 describe the significant accounting policies and critical accounting estimates used in the preparation of the consolidated
financial statements. The Companys management is required to make judgments and estimates about the effect of matters that are inherently uncertain. Actual results could differ from managements estimates. There have been no significant
changes in the Companys critical accounting estimates during the quarter or six months ended July 31, 2004.



Outlook: Important Factors and Uncertainties



Statements in this quarterly report which are not historical facts, including statements about the Companys confidence
or expectations, plans for opening new stores, capital needs and liquidity and other statements about the Companys operational outlook, are forward-looking statements subject to risks and uncertainties that could cause actual results to differ
materially from those set forth in such forward-looking statements. Such risks and uncertainties include, without limitation, risks of changing market conditions in the overall economy and the retail industry, consumer demand, the availability of
appropriate real estate locations and the ability to negotiate favorable lease terms in respect thereof, customer response to the Companys direct marketing initiatives, availability of products, availability of adequate transportation of such
products and other factors detailed from time to time in the Companys annual and other reports filed with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date thereof. The Company undertakes no obligations to publicly release any revisions to these forward-looking statements or reflect events or circumstances after the date hereof.



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##### Table of Contents

Item 3: Quantitative and Qualitative Disclosures about Market Risk



The Companys exposure to interest rate fluctuations is minimal due to the Companys use of short term borrowings and cash flows to fund
operations and capital improvements rather than long term borrowings. Through the second fiscal quarter of 2004, the Company has not used derivative financial instruments. (See note 13)



Item 4: Controls and Procedures



Within the 90 days prior to the date of filing this Quarterly Report on Form 10Q, the Company carried out an evaluation, under the supervision and with the participation of the Companys Disclosure Committee and the Companys
management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that
evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Companys disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Companys periodic SEC filings. Subsequent to the date of that evaluation, there have been no significant changes in the Companys internal controls or in other factors that could
significantly affect internal controls, nor were any corrective actions required with regard to significant deficiencies and material weaknesses.



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##### Table of Contents

PART II



Other Information



|Item 1: | LEGAL PROCEEDINGS
|------- | -----------------



| | In March of 2002, the Company was served with a lawsuit brought in California superior court in Los Angeles as a class action on behalf of current and former managers and assistant
managers of the Companys California stores, alleging that they were improperly classified as exempt employees. The lawsuit sought damages including overtime pay, restitution and attorneys fees. On August 15, 2003, a settlement agreement was
finalized with a maximum amount of $1.5 million for this matter. As a result of this settlement and settlement of other ongoing routine legal matters, a charge of $1.1 million was recorded during the second quarter of 2003. On April 16, 2004 and
April 29, 2004, the Los Angeles Superior Court (Court) held hearings to determine whether the Class Action Settlement and Release Agreement (Agreement) negotiated between Brookstone and various named Plaintiffs should be
granted final approval. On April 29, 2004, the Court ruled that the Agreement was fair, reasonable, and adequate to the class members, certified a class for settlement purposes only, and overruled the one objection to the Agreement filed by one
class member. On May 5, 2004, the Court: (1) entered an order granting final approval to the Agreement; and (2) entered judgment dismissing the wage and hour class actions filed in Los Angeles County (Berry, et al. v. Brookstone) and Santa Barbara
(Charbonnea v. Brookstone) against Brookstone with prejudice as to all class members, with the exception of the four class members who opted out of the Agreement. On July 6, 2004, one class member appealed the final order of the Court. Settlement
funds will be distributed, if at all, on terms ordered by the Court only after the appeal is resolved.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Brookstone is also involved in various other legal proceedings related to the conduct of its business. The Company does not believe that any of these legal proceedings individually
or in the aggregate will have a material adverse effect on Brookstones financial condition, results of operations or cash flows.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Item 2: | CHANGES IN SECURITIES
|------- | ---------------------



| | None
| | ----



|Item 3: | DEFAULT UPON SENIOR SECURITIES
|------- | ------------------------------



| | None
| | ----



|Item 4: | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ---------------------------------------------------



| | A) | The 2004 Annual Meeting of Stockholders of the Company was held on June 8, 2004.
| | -- | --------------------------------------------------------------------------------



| | B) | The following persons were elected Directors at the 2004 Annual Meeting for a one-year term expiring at the 2005 Annual Meeting of Stockholders.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------



|                   |  |            |  |         
|------------------ |  | ---------- |  | --------
|                   |  | For        |  | Withheld
|Michael F. Anthony |  | 14,017,989 |  | 366,376 
|Mone Anathan, III  |  | 13,967,107 |  | 417,258 
|Michael L. Glazer  |  | 14,185,402 |  | 198,963 
|Kenneth E. Nisch   |  | 13,836,226 |  | 548,139 
|Andrea M. Weiss    |  | 14,131,949 |  | 252,416 



| | C) | The appointment of PricewaterhouseCoopers LLP as the independent accountants to examine the financial statements of the Company and its subsidiaries for the fiscal year ending
January 29, 2005 was ratified.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|           |  |         |  |        
|---------- |  | ------- |  | -------
|For        |  | Against |  | Abstain
|13,975,233 |  | 407,832 |  | 1,300  



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##### Table of Contents

| | D) | The 2004 Equity Incentive Plan was approved and adopted.
| | -- | --------------------------------------------------------



|           |  |           |  |         |  |          
|---------- |  | --------- |  | ------- |  | ---------
|For        |  | Against   |  | Abstain |  | No Vote  
|10,637,766 |  | 1,300,268 |  | 196,359 |  | 2,249,972



|Item 5: | OTHER INFORMATION
|------- | -----------------



| | None
| | ----



|Item 6: | EXHIBITS AND REPORTS ON FORM 8-K
|------- | --------------------------------



| | A) | 10.40 Real Estate Loan Agreement between Banknorth, N.A. and Brookstone Company, Inc.
| | -- | -------------------------------------------------------------------------------------



10.41 Real Estate Promissory Note between Banknorth, N.A. and Brookstone Company, Inc.



10.42 Mortgage and Security Agreements between Banknorth, N.A. and
Brookstone Company, Inc.



10.43 International Swap Dealers
Association, Inc. Master Agreement between Banknorth, N.A. and Brookstone Company, Inc. (filed herewith)



10.44 Schedule to the International Swap Dealers Association, Inc. Master Agreement between Banknorth, N.A. and Brookstone Company, Inc. (filed herewith)



10.45 Brookstone, Inc. Defined Contribution Supplemental
Executive Retirement Plan (filed herewith)



| | B) | Reports on Form 8-K
| | -- | -------------------



Current Report on Form 8-K dated August 3, 2004  On August 3, 2004, the company furnished a press release reporting sales results for the second
fiscal quarter ended July 31, 2004.



Current Report on Form
8-K dated August 18, 2004  On August 18, 2004, the company furnished a press release reporting financial results for the second fiscal quarter ended July 31, 2004.



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##### Table of Contents

Signatures



Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.



|                  |  |                                                      
|----------------- |  | -----------------------------------------------------
|                  |  | Brookstone, Inc.                                     
|                  |  | (Registrant)                                         
|                  |  | /S/    PHILIP W. ROIZIN                              
|September 9, 2004 |  | (Signature)                                          
|                  | 
|                  |  | Philip W. Roizin                                     
|                  |  | Executive Vice President, Finance and Administration,
|                  |  | Treasurer and Secretary                              
|                  |  | (Principal Financial Officer                         
|                  |  | and duly authorized to sign on behalf of registrant  



19