The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and related Notes thereto included elsewhere in this report. The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under "Risks Factors" under Item 1A of this report.

Critical Accounting Policies

Management's Discussion and Analysis of Financial Condition and Results of Operations are based upon our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America.

The preparation of these financial statements requires the appropriate application of certain accounting policies, many of which require us to make estimates and assumptions about future events and their impact on amounts reported in our financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the financial statements. We believe our application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are constantly reevaluated, and adjustments are made when facts and circumstances dictate a change. Our accounting policies are more fully described in Note 1 to our financial statements included in this report.

We have identified certain critical accounting policies, which are described below.

Revenue recognition. We recognize revenue at the time the products are received by the customers in accordance with the provisions of Staff Accounting Bulletin (SAB") No. 101, Revenue Recognition in Financial Statements as amended by SAB No. 104, Revenue Recognition. We recognize revenue for store sales at the point at which the customer receives and pays for the merchandise at the register. For on-line sales, we recognize revenue at the time the customer receives the product. We estimate and defer revenue and the related product costs for shipments that are in transit to the customer. Customers typically receive goods within one week of shipment. We reflect amounts related to shipping billed to customers in net sales and the related costs in cost of goods sold. Sales tax collected from customers on retail sales are recorded net of retail sales at the time of the transaction.

We record a reserve for estimated product returns based on historical return trends. If actual returns are greater than those projected, we may include additional sales returns in the future.

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

We include the value of points and rewards earned by our loyalty program members as a liability and a reduction of revenue at the time the points and rewards are earned based on historical conversion and redemption rates. We recognize the associated revenue when the rewards are redeemed or expire.

We carry gift certificates sold as a liability and recognize revenue when the gift certificate is redeemed. Similarly, customers may receive a store credit in exchange for returned goods. We carry store credits as a liability until redeemed. We recognize unredeemed store credits and gift certificates as other income three and four years after issuance.

We recognize wholesale licensee revenue from sale of product to international licensee operated bebe stores at the time the licensee receives shipment. We exclude these stores from comparable store sales.

Stock Based Compensation We account for stock options and awards issued to employees in accordance with the fair value recognition provisions of Financial Accounting Standards Board ("FASB") Statement No. 123(R) ("SFAS No. 123(R)"), Share-Based Payment, using the modified prospective transition method. Under SFAS No. 123(R), stock-based awards to employees are required to be recognized as compensation expense, based on the calculated fair value on the date of grant. We determine the fair value using the Black-Scholes option pricing model. This model requires subjective assumptions, including future stock price volatility and expected term, which affect the calculated values.

Inventories. We state inventories at the lower of weighted average cost or market. We determine market based on the estimated net realizable value, which is generally the merchandise selling price. To ensure that our raw material is properly valued, we age the fabric inventory and record a reserve in accordance with our established policy, which is based on historical experience. To ensure our finished goods inventory is properly valued, we review the age and turnover of our inventory and record a reserve if the selling price is marked down below cost. These assumptions can have an impact on current and future operating results and financial position. We estimate shrinkage for the period between the last physical count and balance sheet date based on historic shrinkage trends.

Marketable securities. We hold a variety of interest bearing auction rate securities ("ARS") consisting of federally insured student loan backed securities and insured municipal authority bonds. As of July 4, 2009, our ARS portfolio totaled approximately $187.7 million, $69.5 million classified as trading securities and $118.2 million (net of a temporary impairment charge of $16.8 million, of which $12.9 million has been recognized in the current year) classified as available for sale securities. These ARS investments are intended to provide liquidity via an auction process that resets the applicable interest rate at predetermined calendar intervals, allowing investors to either roll over their holdings or gain immediate liquidity by selling such interests at par. The uncertainties in the credit markets that began in February 2008 have affected our holdings in ARS investments and auctions for our investments in these securities have failed to settle on their respective settlement dates. Historically the fair value of ARS investments had approximated par value due to the frequent resets through the auction process. While we continue to earn interest on our ARS investments at the maximum contractual rate, these investments are not currently trading and therefore do not currently have a readily determinable market value. Accordingly, the estimated fair value of ARS no longer approximates par value. Consequently, the investments are not currently liquid, and we will not be able to access these funds until a future auction of these investments is successful, the issuer redeems the securities, or at maturity. Maturity dates for these ARS investments range from 2010 to 2044 with principal distributions occurring on certain securities prior to maturity.

In November 2008, we entered into a settlement agreement related to our ARS held with UBS Financial Services, Inc. ("UBS") that grants us certain rights related to these ARS (the "Right"). Beginning June 30, 2010, at our request, UBS has agreed to purchase all of our ARS currently held with them at par value. Conversely, UBS has the right, in its discretion, to purchase or sell our ARS at any time until July 2, 2012, so long as we receive payment at par value upon any sale or disposition. The enforceability of the Right results in a put option which should be recognized as a free standing asset separate from the ARS. Upon acceptance of the offer from UBS, we recorded the put option at fair value of $11.6 million, with a corresponding credit to interest income. The put option does not meet the definition of a derivative instrument under SFAS No. 133. Therefore, we have elected to

measure the put option at fair value under SFAS No. 159, which permits an entity to elect the fair value option for recognized financial assets. As a result, unrealized gains and losses are included in earnings. The increase in the fair value of the put option of $1.1 million in the last two quarters of the current year has been recorded with a corresponding credit to interest and other income, net, in the consolidated statements of operations.

Prior to accepting the UBS offer, we recorded our ARS held with UBS as investments available for sale, with an associated unrealized loss included in other comprehensive income. In connection with our acceptance of the UBS offer in November 2008, we transferred approximately $84.4 million in ARS subject to the UBS settlement from investments available for sale to trading securities in accordance with SFAS No. 115 and recorded a loss on investments of approximately $12.1 million. As a result, changes in fair value of the ARS have been recorded as a component of net income. We intend to exercise the Right when it becomes available, and as such the associated investments have been classified as short-term on the balance sheet.

The remainder of our ARS investment portfolio of $118.2 million, net of a temporary impairment charge of $16.8 million, remains available for sale on our balance sheet. The related temporary impairment charge remains as a loss in other comprehensive income.

We also hold short-term available for sale securities totaling $40.0 million at July 4, 2009 that consist of treasury bills and are classified as available for sale securities on our balance sheet.

We review our impairments in accordance with guidance issued by the FASB and SEC in order to determine the classification of the impairment as "temporary" or "other-than-temporary". A temporary impairment charge results in an unrealized loss being recorded in the other comprehensive income component of shareholders' equity. Such an unrealized loss does not affect net income for the applicable accounting period. An other-than-temporary impairment charge is recorded as a loss in the consolidated statement of income and reduces net income for the applicable accounting period. When evaluating the investments for other-than-temporary impairment, we estimate the expected cash flows of the underlying collateral by reviewing factors such as the length of time and extent to which the fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and our intent to sell, or whether it is more likely than not it will be required to sell, the investment before recovery of the investment's unamortized cost basis.

The valuation of our investment portfolio is subject to uncertainties that are difficult to predict. Factors that may impact our valuation include changes to credit ratings of the securities as well as to the underlying assets supporting those securities, rates of default of the underlying assets, underlying collateral value, discount rates and ongoing strength and quality of market credit and liquidity. In addition, UBS's obligation under the Right is not secured by its assets and does not require UBS to obtain any financing to support its performance obligation under the Right . UBS has disclaimed any assurance that it will have sufficient financial resources to satisfy its obligations under the Right. If UBS has insufficient funding to buy back the ARS and the auction process continues to fail, then we may incur further losses on the carrying value of the ARS.

Long-lived assets. We review long-lived assets for impairment whenever events or changes in circumstances, such as store closures or poor performing stores, indicate that the carrying value of an asset may not be recoverable. Generally, if the undiscounted cash flows from the long-lived assets are less than the carrying value, we record an impairment charge equal to the difference between the carrying value and the asset's estimated fair value. However, in the case of BEBE SPORT stores we evaluated the net book value against potential replacement costs, since we are in the process of a name change and will only record an impairment to the extent net book value exceeds replacement costs. In addition, at the time a decision is made to close a store, we record an impairment charge, if appropriate, or accelerate depreciation over the revised useful life of the asset. Historically, our impairment charges have been immaterial. During fiscal 2009, we recorded an $7.3 million charge for

the impairment of store assets. We recorded an $848,000 impairment charge in fiscal 2008 and did not record an impairment charge during fiscal 2007. We believe at this time that the long-lived assets' carrying values and useful lives continue to be appropriate; however significant changes from our current future forecasts could result in additional impairment charges.

Accrued Litigation. We accrue estimates of probable liabilities associated with lawsuits and claims. The results of any litigation are inherently uncertain. As information becomes available, we assess the potential liabilities related to pending litigation and may revise our estimates as necessary. Such revisions of estimates could materially impact the results of operations and financial position.

Self-Insurance. We use a combination of insurance and self-insurance for employee related health care benefits. We record self-insurance liabilities based on claims filed and an estimate of those claims incurred but not reported. Any projection of losses concerning our liability is subject to a high degree of variability. Among the causes of this variability are unpredictable external factors affecting future inflation rates, changes in severity, benefit level changes, medical costs and claim settlement patterns. Should a different amount of claims occur compared to what was estimated or costs of the claims increase or decrease beyond what was anticipated, we may need to adjust reserves in the future.

Income Taxes. On July 8, 2007, we adopted FIN 48, Accounting for Uncertainty in Income Taxes. FIN 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues. To the extent that our estimates change or the final tax outcome of these matters is different than the amounts recorded, such differences will impact the income tax provision in the period in which such determinations are made. Our effective tax rate in a given financial statement period may be materially impacted by changes in the mix and level of earnings, changes in the expected outcome of audits or changes in the deferred tax valuation allowance.

Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157, which delayed the effective date of SFAS 157 for non-financial assets and liabilities, except for certain items that are recognized or disclosed at fair value at least annually. We elected to partially adopt the provisions of SFAS No. 157 as of July 6, 2008 for financial instruments, as permitted by FSP 157-2. Although the partial adoption of SFAS No. 157 did not materially impact our financial condition, results of operations or cash flow, we are now required to provide additional disclosures as part of its financial statements. We do not expect the adoption of the remaining provisions of SFAS 157 (delayed by FSP 157-2) to have a material impact on our consolidated financial position, statement of operations or cash flows.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115. SFAS No. 159 permits entities to choose to measure eligible items at fair value at specified election dates and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. We adopted SFAS No. 159 as of July 6, 2008. Since the adoption of SFAS No. 159, we elected the fair value option for our ARS written put right related to our ARS held with UBS. We will recognize any change in the ARS written put right as a gain or loss in the statement of income.

In April 2009, the FASB issued FSP SFAS No. 107-1 and APB No. 28-1, Interim Disclosures about Fair Value of Financial Instruments, which amends SFAS No. 107, Disclosures about Fair Values of

Financial Instruments, to require disclosures about fair value of financial instruments in interim financial statements as well as in annual financial statements. FSP No. 107-1 also amends APB No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. FSP No. 107-1 is effective for interim periods ending after June 15, 2009. We do not expect that the adoption of FSP No. 107-1 to have a material impact on our consolidated financial position, statement of operations, or cash flows as it is related to disclosure only.

In April 2009, the FASB issued FSP SFAS No. 115-2 and SFAS No. 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, which amends the other-than-temporary guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. SFAS No. 115-2 and SFAS No. 124-2 is effective for interim periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. We adopted SFAS No. 115-2 and SFAS No. 124-2 with no material impact on our consolidated financial position, statement of operations or cash flows.

In April 2009, the FASB issued FSP SFAS No. 157-4, Determining Fair Value when the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, which provides additional guidance in estimating fair value in accordance with SFAS No. 157 when the volume and level of activity for both financial and non-financial assets or liabilities have significantly decreased. SFAS No. 157-4 is effective for fiscal years and interim periods beginning after July 1, 2009 and shall be applied prospectively. Early adoption for periods ending before March 15, 2009 is not permitted. We have adopted SFAS No. 157-4 with no material impact on our consolidated financial position, statement of operations or cash flows.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events. FAS 165 defines subsequent events as events or transactions that occur after the balance sheet date, but before the financial statements are issued. It defines two types of subsequent events: recognized subsequent events, which provide additional evidence about conditions that existed at the balance sheet date, and non-recognized subsequent events, which provide evidence about conditions that did not exist at the balance sheet date, but arose before the financial statements were issued. Recognized subsequent events are required to be recognized in the financial statements, and non-recognized subsequent events are required to be disclosed. The statement requires entities to disclose the date through which subsequent events have been evaluated, and the basis for that date. FAS 165 is consistent with current practice and did not have any impact on our consolidated financial statements.

Results of Operations

Our fiscal year ends on the first Saturday after June 30. Fiscal 2009, 2008 and 2007 included 52, 52 and 53 weeks.

                                                        Fiscal Year Ended
                                          July 4, 2009    July 5, 2008    July 7, 2007
  Statement of Operating Data:
    Net sales                                     100.0 %         100.0 %         100.0 %
    Cost of sales, including production            59.7            54.1            52.0
    and occupancy(1)

    Gross margin                                   40.3            45.9            48.0
    Selling, general and administrative            38.7            34.3            32.3
    expenses(2)

    Income from operations                          1.6            11.6            15.7
    Interest and other income, net                  1.1             2.4             2.0

    Income before income taxes                      2.7            14.0            17.7
    Provision for income taxes                      0.6             4.8             6.1

    Net income                                      2.1 %           9.2 %          11.6 %

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

Fiscal Years Ended July 4, 2009 and July 5, 2008

Net Sales. Net sales decreased to $603.0 million during the year ended July 4, 2009 from $687.6 million in fiscal 2008, a decrease of $84.6 million, or 12.3%. The decrease in sales was primarily attributable to a 20.9% decrease in comparable store sales resulting primarily from the overall macroeconomic environment, in which we saw lower traffic and conversion in stores, and a 6.6% decrease in our on-line sales. These decreases were partially offset by an increase in new stores not included in comparable store sales of $29.1 million, an increase in wholesale sales of $5.7 million and an increase in royalty revenue of $1.0 million.

Gross Margin. Gross margin decreased to $243.2 million for the year ended July 4, 2009 from $315.4 million in fiscal 2008, a decrease of $72.2 million, or 22.9%. As a percentage of net sales, gross margin of 40.3% was lower than the prior year at 45.9% primarily due to higher markdowns and unfavorable occupancy leverage.

Selling, General and Administrative Expenses. Selling, general and administrative expenses, which primarily consist of non-occupancy store costs, corporate overhead and advertising costs, decreased to $233.3 million during fiscal 2009 from $236.0 million in fiscal 2008, a decrease of $2.7 million, or 1.1%. As a percentage of net sales, these expenses increased to 38.7% during fiscal 2009 from 34.3% in fiscal 2008. This increase as a percentage of net sales was primarily due to deleveraging of store depreciation expense and other fixed costs, employee acquisition and termination costs, and fixed assets write-downs and write-offs.

Interest and Other Income, Net. We generated $6.7 million of interest and other income, net of other expenses, during fiscal 2009 as compared to $16.4 million in fiscal 2008. The decrease in interest and other income resulted from investments in lower-yielding tax-exempt investments and money market funds and an approximately $0.6 million loss on the ARS written put right.

Fiscal Years Ended July 5, 2008 and July 7, 2007

Net Sales. Net sales increased to $687.6 million during the year ended July 5, 2008 from $670.9 million in fiscal 2007, an increase of $16.7 million, or 2.5%. The increase in sales is primarily attributable to an increase in sales of $54.4 million generated by stores not included in the comparable store sales base, online sales of $8.0 million and wholesale sales to international licensees of $6.7 million. The increase was partially offset by a 7.6% decrease in comparable store sales and an additional $10 million in sales in fiscal 2007 due to the extra week in fiscal 2007.

Gross Margin. Gross margin decreased to $315.4 million for the year ended July 5, 2008 from $321.8 million in fiscal 2007, a decrease of $6.4 million, or 2.0%. As a percentage of net sales, gross margin of 45.9% was lower than prior year at 48.0% primarily due to higher markdowns and unfavorable occupancy leverage, partially offset by higher initial markups.

Selling, General and Administrative Expenses. Selling, general and administrative expenses, which primarily consist of non-occupancy store costs, corporate overhead and advertising costs, increased to $236.0 million during fiscal 2008 from $216.6 million in fiscal 2007, an increase of $19.4 million, or 9.0%. As a percentage of net sales, these expenses increased to 34.3% during fiscal 2008 from 32.3% in fiscal 2007. This increase as a percentage of net sales was primarily due to increases in compensation, depreciation and advertising.

Interest and Other Income, Net. We generated $16.4 million of interest and other income, net of other expenses, during fiscal 2008 as compared to $13.1 million in fiscal 2007. The increase in interest and other income resulted from an increase in interest rates primarily on our auction rate securities and additions to our marketable securities balances due to positive operating results, partially offset by a decrease in cash and equivalents and investments due to the purchase of 5 million shares of our outstanding stock from our former Vice Chairperson, Neda Mashouf, for an aggregate purchase price of $67 million.

Provision for Income Taxes. Our effective tax rate was 34.1% for fiscal 2008 as compared to 34.7% for fiscal 2007. The lower effective tax rate for 2008 was primarily attributable to an increase in tax-exempt interest.

Seasonality of Business and Quarterly Results

Our business varies with general seasonal trends that are characteristic of the retail and apparel industries. As a result, our typical store generates a higher percentage of our annual net sales and profitability in the second quarter of our fiscal year (which includes the holiday selling season) compared to other quarters of our fiscal year. If for any reason our sales were below seasonal norms during the second quarter of our fiscal year, our annual operating results would be negatively impacted. Because of the seasonality of our business, results for any quarter are not necessarily indicative of results that may be achieved for a full fiscal year.

Offer to Exchange

In September 2009, we issued an offer to eligible option holders to exchange underwater options for a lesser number of options priced at the end of the offer period. We anticipate conversion will be accretive to existing shareholders and may result in a non-material expense.

Our working capital requirements vary widely throughout the year and generally peak during the first and second fiscal quarters. At July 4, 2009, we . . .